Risk Management

Flood of Hedge-Fund Money Could Keep Insurance Cheap

Investor financing boosts coverage supply — which could lower premiums for corporations.
Caroline McDonaldJune 1, 2012

In a move that could keep corporate property-casualty insurance prices manageable even when catastrophe strikes, hedge-fund investors are taking a cue from Warren Buffett. They are forming their own reinsurance companies or investing in reinsurers as special-purpose insurers, mostly in Bermuda, according to a reinsurance-investment expert.

The new reinsurers will fortify the traditional property-casualty reinsurance market, thus buttressing the capacity of insurers to assume risk. “They won’t replace reinsurers, because reinsurers do what they do very well,” explains Chi Hum, global head of ILS Distribution, GC Securities, the capital markets and insurance-linked securities arm of reinsurance broker Guy Carpenter.

“The objective is to create a block of business with a regular premium flow, without a lot of surprise losses. In fact, this is basically what Buffett does with his reinsurance and insurance businesses,” says Hum. “He calls it the ‘float’ in his business — the premiums the companies collect, he gets to invest. It becomes a low-cost source of investment cash for him.”

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Established reinsurers get high returns for taking on risks that may have a high frequency of occurrence over long periods of time, says Hum, adding: “Their cost of capital, capital structure, and their shareholders need that kind of return profile.”

In contrast, the new reinsurers want to take on more catastrophic risks that may occur less frequently, but for shorter periods of time. While the new money coming into the industry is looking for less risk and lower loss frequency, “they can absorb a total loss. So it’s actually complementary to a lot of the existing capacity,” he says.

And from the perspective of the buyer — the insurance company — “it’s actually a healthier situation,” observes Hum. For example, a large U.S. insurer that needs to buy $2 billion of reinsurance every year “can be in a tough spot,” he notes.

During good years, there is plenty of capacity and pricing is good. But in a bad year, such as the one following Hurricane Katrina, capacity may be low and coverage hard to find. What’s more, “Those reinsurers that do have capacity multiply the price. When capacity is scarce, pricing increases.”

Thus, by providing a greater buffer for insurance companies, the new reinsurers can keep the supply of insurance steady when corporations are demanding more of it. And that’s a great formula for CFOs interested in keeping their premium payments low.

Caroline McDonald is a freelance journalist who has written about risk management and the insurance industry for more than 15 years. She may be reached at [email protected].


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