Cars are not particularly welcome on the streets of Bermuda, butat least three reinsurance sidecars were allowed to park there latelast year.

Tanked up with fuel of existing reinsurers, the sidecars–likemopeds used by some Bermuda travelers–are smaller than full-sizedrelatives with Class 4 licenses. According to the Bermuda MonetaryAuthority, Blue Ocean Reinsurance Ltd. and Cyrus Reinsurance Ltd.received Class 3 licenses in October, while Flatiron got itslicense in December 2005.

Christopher Klein, head of counterparty risk for Benfield Groupin London, noted that Rockridge Re–set up before last year'shurricanes in second-quarter 2005 by Montpelier Re–is also asidecar. But Cayman Islands-based Rockridge, established with just$90 million, was smaller than those that came later.

o Cyrus, co-founded by XL and Highlands Capital, had openingcapital of $500 million.

o Flatiron Re, sponsored by Arch Capital Group, had more than$200 million.

o Blue Ocean Re–which, like Rockridge, was co-founded byMontpelier and West End Capital–had $300 million.

Among them, that represents $1 billion, Mr. Klein noted.

Giving a broad definition that applies to all four, he said asidecar is basically a special purpose vehicle in which third-partyinvestors, such as hedge funds or private equity funds, collaboratewith an underwriter to provide additional capacity to existingreinsurers for property-catastrophe retrocession or short-taillines of business.

For all but Blue Ocean, the added capacity is provided to thesponsor reinsurer. Blue Ocean accepts retrocessional business forreinsurers other than Montpelier.

While the four vehicles are all retrocessional, primary insurersare considering reinsurance sidecars also, according to Tom Upton,a managing director for Standard & Poor's in New York.

In general, a sidecar is a “pot of money” assembled by outsideinvestors that is managed by the ceding company. The money raisedis put into short-term, high-quality securities, which serve ascollateral in the event of any losses. “In effect, it's aself-managed reinsurance company with somebody else's money,” hesaid.

While no reinsurance sidecars with primary insurer sponsors havebeen publicly announced, for carriers considering them, “theimpetus is the expectation that reinsurance for certain lines ofbusiness, particularly property lines, would become veryexpensive,” according to Mr. Upton. “This was a way of gaining thesame kind of protection and hedging some of [their] risks.”

Reinsurers that have set up sidecars are also reacting to risingrates–or more specifically, to the lure of being able to writeattractively priced property-cat reinsurance, said S&P DirectorSteven Ader. But the most favorably priced regions are likely to bethose most exposed to disasters, the analyst said, adding that theability to cede business to a sidecar allows reinsurers toparticipate in an improving market while mitigating losses fromvolatile business.

Using the example of retro business, Benfield's Mr. Klein notedthat while such business is attractive from a price standpoint, itincurs heavy capital charges from internal risk-based capitalmodels, and also from rating agencies. Setting up a sidecar “gets acapital-intensive portfolio off your main balance sheet,” hesaid.

A sidecar is “a separate company altogether. It's detached fromthe balance sheet of the sponsor [original] reinsurer.”

The capital of a sidecar is typically provided by a third party,while underwriting expertise is provided by the sponsor. So thesponsor can still participate in the upside of writing volatileclasses–essentially by getting a fee for managing other people'smoney, the experts said.

However, approaches to sharing in that upside vary, Mr. Kleinsaid. Montpelier, in addition to managing retrocessions ofthird-party reinsurers to Blue Ocean (and earning a managementfee), is also a Blue Ocean shareholder. XL and Arch cede quotashares of their own business to their sidecars. “So they're usingthis to get some risk off their balance sheet, but also retainingsome”–and the corresponding profits, he said.

“These things can be set up and closed down quite quickly,” hesaid. So for companies such as Arch and XL, it is a way to takeadvantage of a short-term opportunity that is present for only ayear or two while prices are high. “It's much easier than closingdown a whole company,” he said.

Since investor commitments in sidecars are short term, they arewilling to fully collateralize all potential obligations, Mr. Adersaid, noting collateralization can be letters of credit orsecurities held in trust.

That means sidecars don't need financial strength ratings.“Reinsurers have ratings because [the ratings] are supposed tomeasure the risk of the reinsurers defaulting,” Mr. Klein said. Ifreinsurance has been fully collateralized, “the cash is there,ready and waiting to draw down.”

That doesn't mean, however, that rating agencies have afavorable view of companies that cede business to sidecars,according to Mr. Upton. If sidecars “are used to too great anextent,” regardless of whether it's a primary insurer or reinsurerceding to them, “we'd probably look negatively on that in ouranalysis,” he said.

Explaining the negative view, he said a sidecar is funded by“short-term money that is coming into the market. It is theretoday, certainly, but may not be there tomorrow.” He added,however, that sidecars “used in moderation” would be viewed on parwith traditional reinsurance by S&P analysts.

For the sponsoring company, another drawback of a sidecar may bethe inability to reinstate a limit, Mr. Ader said. Typically, withtraditional reinsurance, “you can get coverage twice for acatastrophic event for payment of a reinstatement premium,” butcollateralized sidecar vehicles might only provide coverage for oneevent, he said.

Experts agree that with total capital at only $1 billion, thesidecars won't have any impact on market conditions. Should theirdevelopment become more popular, though, they could bringdiscipline to the market.

Recalling the past sins of the industry, Mr. Upton said: “Therewas always the choice to be made about whether to deploy capital orreturn it to investors, and because there was a resistance toreturn capital, managers tended to compromise quality in theirunderwriting just to deploy it. The fact that these representshort-term capital that can go in and out of the market fairlyeasily suggests they would tend to dampen tendencies likethat.”

Mr. Klein said he expected to see more. “That only three havebeen consummated was something of a surprise, with most of thecapital going into existing companies or start-ups based on atraditional model.”

Robert Cooney, CEO of Max Re, said his company looked at theidea but dismissed it. “I'd never say never, but we don't haveenough exposure,” he said, arguing that sidecars made more sensefor companies that lost big chunks of equity as a result of 2005storms. “We're not prepared to lose more than 20 percent of ourequity,” he said, noting that others lost more than 60 percent.

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