Sidecar development peaked at midyear last year, with seven of the 20 sidecars tallied formed late in the second quarter.
At about the same time, A.M. Best announced it would publish issuer credit and debt ratings on those sidecars that had debt as a component of their capital structures.
Four have ratings currently: Triomphe Re, Panther Re, Concord Re and Stoneheath (which is not a true sidecar but more of a contingent capital facility).
Robert DeRose, assistant vice president for the Oldwick, N.J.-based rating agency, noted that while earlier sidecars also had debt, when those sidecars revved up, Best didn't realize there would be such momentum going forward.
"We didn't feel it was necessary…to put methodologies out [for] what we thought were really going to be one-off deals."
But once they became prevalent, Best also decided to communicate its approach to evaluating the impact of sidecars on sponsors' financial strength ratings, releasing a formal report in October titled, "Assessing the 'Tail Risk' of Sidecars."
Mr. DeRose said analysts go through a due-diligence process to determine the amount of credit, if any, they'll give to the sponsor's probable maximum loss–a number used in Best's capital model to stress the company for cat-related exposures.
A sidecar that isn't sufficiently capitalized to meet its reinsurance obligations to the sponsor is said to have "tail risk." This means that loss obligations exceeding the sidecar's level of capital may ultimately be borne by the sponsor, and full credit can't be given to the sponsor's PML for sidecar reinsurance.
This is essentially what had occurred in June 2006, when White Mountains announced it would bail out Olympus–the sidecar for its subsidiary, Folksamerica, which would have otherwise seen its capital base wiped out by adverse development from the 2005 storms. Best downgraded Folksamerica's rating to "A-minus."
In general, however, Best has found the sidecar structures to be "very sound," Mr. DeRose said. "There have been a few exceptions where there was tail risk that was factored into the analysis of a sponsor," but the sponsor rating wasn't downgraded because its overall capitalization–even with that tail risk coming back in–was sufficient to support its rating, he explained.
"If it wasn't, chances are they would go in and increase the capital of the sidecar. So the public would still never know," he said.
head:
Could a sidecar ever prompt the upgrade of sponsor's rating?
"We haven't had to vet that particular question at a committee, but intuitively I would say no because it's not permanent capital."
Robert DeRose, Assistant V.P.
A.M. Best
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