It's easy, and perhaps even commonplace, to label anything in the reinsurance industry with the words "hedge fund" attached to it as "alternative capital" and categorize it in the same bucket as every other new-capital approach. But just as traditional reinsurers employ a number of different strategies when they do business, so too do players backed by capital from non-traditional sources.
Alternative capital has become a hot topic in recent years among reinsurers as hedge funds and pension funds have flooded the market with capacity and innovative approaches to writing business at a lower cost of capital, increasing competition and pressuring rates particularly in lines like property catastrophe. However, just because a player in the reinsurance market is backed by capital from a non-traditional source does not mean that in most respects it can't walk, talk and act like a more traditional reinsurer, albeit with its own approach to building its book of business.
The many faces of 'alternative capital'
Speaking to PC360, Bart Hedges, CEO of hedge-fund reinsurer Greenlight Capital Re, established by hedge-fund manager David Einhorn, seeks to distinguish his company and its approach from others in the market—both traditional and non-traditional players. Noting that hedge-fund reinsurers are often considered "alternative capital," he says, "We get lumped in with a lot of other sources of alternative capital. You have sidecars that have been set up. You have insurance-linked-security managers who take other people's money and do investments in either sidecars or write securitized cat-type placements; you have what now has become more commonplace: industry-loss warranties.
"So all these kinds of things have been bucketed together."
As for hedge-fund reinsurers, and more specifically Greenlight Capital Re, Hedges says the model itself is not much different from any other reinsurance company. Greenlight Capital Re has underwriters, actuaries and uses reinsurance brokers like Aon, Guy Carpenter, Willis, Tiger Risk, JLT and Towers.
"It's a multiline reinsurance-company structure," he says, noting that it sources business in private-passenger auto, homeowners, health insurance and other lines. Greenlight Capital Re is also regulated, in Cayman and Ireland, and has an 'A' A.M. Best rating.
"In a lot of ways, there are really not that many differences to the business," he says. "Where the difference really stands out is in our investment strategy."
Greenlight Capital Re is aligned with and has an investment-advisory agreement with a hedge fund: Greenlight Capital, which invests the reinsurer's assets, including its capital, "in a fashion that is very similar to what they do for their limited partners in the hedge fund," Hedges says. "But our account is a separately managed account that sits outside of the hedge fund and the assets in it are not co-mingled with the hedge fund.
"But the assets are invested…in the same investments and same basic proportions, subject to a small number of investment guidelines we give them that may create discrepancies between the Greenlight Re portfolio and the Greenlight Capital LP portfolio."
An older hedge-fund reinsurer sees a different market today
Greenlight Capital Re is further differentiated from other forms of alternative capital and even other hedge-fund reinsurers because it is not a recent entrant into the marketplace. It was funded in 2004 and began as an underwriting company in 2006, when Hedges joined as president and chief underwriting officer.
"It was a different market," Hedges says of the time when Greenlight Capital Re entered. The catastrophe retrocession market, where sidecars and ILS managers are involved today, did not have competition from such sources then. "They didn't really exist much back then, so we didn't see them as competition in 2006, and we wrote a fair bit of cat retro back then because we thought it was a really good risk-adjusted price," Hedges says. Since then, he notes, it's become much more competitive and the company has written less in that space.
In general, Hedges says 2006 was a better time to underwrite. "If you started in 2012," he says, "that's a more competitive environment."
Still, even with the heavier competition, and while acknowledging that the extra capital entering the market today is "not great for the industry," Hedges says the behavior he has seen from recent alternative-capital players has been normal. "No one seems to be doing anything silly," he says.
Market players enter with their own strategies, he says: Hamilton Re is doing more insurance and less reinsurance, Watford Re, established by Arch Capital, has elected to outsource underwriting, Third Point Re seems more open to write retrospective transactions and is incentivized to produce more float, and so on.
For Greenlight Capital Re, Hedges says the reinsurer is staking its claim on being a services-oriented company. In the reinsurance business, he says, there are a number of different strategies to pursue: one can have a product-oriented strategy, or rely on size and scale to offer coverage cheaper. "We haven't really selected either of those," he says, "although at times you need to be good at both of those."
Instead, he says, "We want to partner with companies that look at reinsurance as truly another form of capital that they can use. And they would look at the reinsurance transaction as a long-term commitment the way they would other capital sources, and then we're going to partner and come up with ways to work with them so that whatever insights we might have for the business, we share with them in hopes that they do their business better. And if they do the business better, we're more likely to be successful."
Reinsurance 5 years from now
It's a strategy Greenlight Capital Re is comfortable with and will carry forward into the future, even as the reinsurance landscape changes. Asked where the reinsurance business might be five years from now, Hedges says, "I think what is called alternative capital today could very well be mainstream tomorrow."
The current landscape may not be a new normal, but if it is, it will be a world where the most efficient capital wins, he says. And each player will bring its own strategy. There are benefits to Greenlight Capital Re's service-oriented strategy, Hedges says, and benefits to being an ILS manager that can write big lines efficiently.
In the ILS market, Hedges says, "Number one, there are a lot of guys out there doing it very well. They've been creative and smart about bringing capital more efficiently to segments of the market," particularly property cat and other short-tail lines. As they bring capital more efficiently, he says, they're able to price risks at lower rates.
"A small number of people can put a lot of capital to work on a relatively low cost basis," he says. "I think that's what we've been observing."
Is it possible this approach will eventually come to longer-tail lines? Hedges says he would not rule it out. "There are some extremely intelligent people who are creative and spending a lot of time looking at the insurance business and figuring out how to model it." If it can be modeled, he says, they try to find a way to make it a commodity, and once it's commoditized, they try to bring capital to bear.
"I wouldn't say they won't be able to do it," he says. "In fact, I would say if you are managing a long-tail business and you weren't thinking really hard about how this might impact your business five years from now, then you're not asking yourself the right questions. Because I think there's a very good opportunity for them to figure something out."
For traditional reinsurers, then, Hedges says there are many challenges to face going forward. But like others in the business, he notes there are smart people who are always thinking of ways to adapt.
Opportunities and challenges
In the case of Greenlight Capital Re, Hedges says in areas of business where there is some turmoil, there may be opportunities. He says the company has been looking at workers' compensation, particularly in California. "We haven't pulled the trigger yet, but there are problems manifesting themselves, and usually when that happens there are rate actions or reforms." In California, "There's been some of both of those. We haven't been convinced it's the time to jump in, but others have and maybe we'll prove to be a little late. But there will still be an opportunity."
Health care is another area the company is looking at. "Certainly full implementation of ACA is causing dislocation, and there's some opportunity there for us," Hedges says.
Conversely, he says Greenlight Capital Re has let go part of its cat book. "It's become increasingly difficult to find deals that pay decent risk adjusted prices" in that line, he says.
Other short-tail lines that are easily modeled are likewise difficult, he says. "Those risks have become commoditized, and once they're commoditized, it gets outside the places where we can be effective."
Ultimately, he says Greenlight Capital Re must remain nimble, and its smaller size (altogether 30 people, Hedges says) allows it to do so. Brokers and partners, he notes, get direct access to the CEO or chief underwriting officer, which allows for better relationship and communication between decision-makers.
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