The Intelligent Quarterly from the publishers of The Insurance Insider

Spring 2013

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From Ace and XL in the 1980s to the class of 2005, waves of (re)insurer start-ups came after market dislocations, whether actual or perceived.

But for underwriters and potential investors hoping that a 2011 of near record cat losses, model changes and dire investment returns would fracture demand and supply, the reality is there have been only localised and limited opportunities to deploy new capital.

And yet a wave of new start-ups has begun to roll across the Bermuda shores; only these companies - led by Third Point Re and PaCRe, with Sac Re next in line - come in a very different form.

Whereas previous clusters of new companies were drawn by an explosion of underwriting opportunities in volatile market conditions, the latest entrants are intent on loading risk on the asset side of the balance sheet.

Following the model successfully employed by David Einhorn's Greenlight Re since 2004, Third Point Re was the first to enter the fray, with former Harbor Point CEO and Alterra reinsurance chief John Berger at the helm, $780mn of capital and an A- AM Best rating.

The start-up's assets are managed by Dan Loeb's event-driven $7.9bn hedge fund Third Point LLC, and invested pari passu with his strategy - contrasting with the risk-averse approach usually taken by conventional reinsurers.

To counter that risk, Third Point Re plans to "build a reinsurance portfolio that seeks to generate stable underwriting profits over time" in "lower volatility business" (see box-out).

And, as Berger tells IQ, from an underwriting perspective the timing for the launch of a traditional start-up would not have made sense.

"It's not a great time to be a reinsurance underwriter - it's pretty competitive out there," he acknowledges.

Bad market, good timing
Not that a bad market has ever acted as a barrier to entry for the executive before. "This is the third time I've been involved with a start-up," Berger says.

The first was F&G Re in 1983 with a high calibre of executives including RenaissanceRe founder Jim Stanard.

"That was a very tough time to start a company, but very quickly it became a very good time to be in the business and the mid-80s were wonderful."

Then in 1998 - another "terrible" underwriting period - he launched Chubb Re. "We found some stuff to do that made sense - not on a large scale but Chubb was fine with that," he explains.

After that, 9/11 occurred in a confluence of events that triggered the last true industry-wide hard market, and the rest is history.

"We went from a couple of hundred million dollars to $1.4bn almost overnight - you can do that in reinsurance," Berger observes.

Chubb Re was spun-off as part of the class of 2005 as the quasi start-up Harbor Point - which was itself the subject of a merger with Max Capital to create Alterra in 2010.

And this time last year, Berger says he was set for retirement before a call from then Aon Benfield executive Rob Bredahl set the veteran on an entirely different course.

Fundraising for Third Point Re closed with investment including $250mn and $125mn respectively from private equity firms Kelso and Pine Brook, $75mn of Loeb's own cash, $5mn from Berger and $15mn from broker-dealer Dowling & Partners.

Berger lured Bredahl and his former Aon Benfield colleague Dan Malloy over from the reinsurance broker to join his launch team, along with Tony Urban, who headed US working layer reinsurer JRG Re.

Other high-profile additions include general counsel Tonia Marshall from Butterfield Bank and former Goldman Sachs executive Manoj Gupta - who launched and led the bank's $500mn Steamboat Re sidecar.

In a positive start the reinsurer has begun to build its underwriting deal book (see box-out), while Third Point is targeting a 15 percent investment return that would be a stark contrast to the anaemic performance of traditional portfolios in the sector.

Third Point Re - and PaCRe - follow the template set by the Cayman Islands' Greenlight Re, whose performance in recent years has been lauded and rewarded with a ratings upgrade from AM Best and a relatively respectable trading multiple.

But the new start-ups also follow a number of failed examples of employing a hedge fund strategy, including Stockton Re and Greenwich Re.

Right time, right model?
So if there isn't a wrong time to be entering as a start-up, could there be a wrong model?

The question was addressed at The Insurance Insider's recent InsiderScope 2012 event in New York, where the inherent volatility in such vehicles was challenged.

Ron Bobman, who runs insurance-focused hedge fund Capital Returns, said he was sceptical about the model and highlighted a road "littered with failures".

And he added: "I also have great questions as to the capacity of AM Best to, in effect, rate a hedge fund, which is part and parcel of the ratings that these entities are receiving."

But while acknowledging that "there aren't too many examples of this model working", Berger tells IQ that the key to success for Third Point Re is balancing the levels of risk assumed via its investment strategy with those on its book of underwriting.

He also emphasises the stress-testing conducted by AM Best before awarding a rating. The agency took Third Point LLC's worst year on record - when it lost 30 percent in 2008 as hedge funds were mired in the financial crisis - and flexed Third Point Re's model for that level of degradation.

"It follows that you cannot fully deploy your capital on an underwriting basis because you have that risk as a result of being fully deployed on the asset side," explains the executive.

Berger is also adamant that, despite the prospect of high investment returns, Third Point Re will not look to subsidise underwriting performance.

"You might look at Dan Loeb and say historically over 16 years he has a 21 percent average return and conclude that you could write long-tail casualty with a duration of seven years running a 180 percent combined ratio and still make money. We would never do that.

"Hedge fund results are choppy, so you cannot embed that investment return into your underwriting decisions. If we write that kind of business it's to make an underwriting profit, and then if Dan overachieves on the investment side we make a lot of money," he says.

IPO timing
Another way that investors stand to make "a lot of money" is, of course, through an exit strategy; and here the timing is key.

The start-up has built a preferred window of 2013-14 into its business plan, but Berger acknowledges that the timing of an IPO is out of his hands.

"Valuations in the sector have to rise - why would you go public when the average valuation is 0.8x book?" he says.

In the meantime Third Point Re is putting in place the compliance and regulatory work to ensure that it is ready when the time is right.

But if an IPO has not occurred within five years, each of the founding partners has the right to close down the company. The clock is ticking...