Total return reinsurers head down different paths

News that Harrington Re is fielding interest from potential buyers that are understood to include legacy players is the latest example of a potential change of direction among the class of total return reinsurers that emerged between 2012 and 2016.

As revealed this week by The Insurer, the Axis and Blackstone-sponsored Bermudian is not subject to an official sales process or strategic review, but is understood to have an internal deadline in its agreement with founding investors to look at a potential IPO or other liquidity event early next year.

It is one of six Bermudian vehicles launched over a five year period with various iterations representing an evolution of the so-called hedge fund reinsurer model most recently deployed by Greenlight Re – itself now in the throes of transformation.

And the group of total return reinsurers has seen contrasting fortunes since.

At the outset, they had broadly similar approaches, where the strategy was built on taking a more balanced approach between risk on the liabilities and assets side of the balance sheet, albeit with investment strategies between them ranging from hedge funds to junk bonds.

The idea was that the underwriting side of the business would create float that would then be invested more aggressively than the traditionally conservative approach taken by carriers to generate a superior total return for reinsurers.

Some – Third Point Re, Hamilton and Fidelis (which we were hesitant in bracketing with the peer group) – followed the Greenlight Re model of in-house underwriting but outsourcing investment management.

The others were vehicles launched by carriers that also took an equity stake, with the reinsurers outsourcing both their underwriting and investments to their sponsors.

Harrington Re, for example, has Axis as an investor with the (re)insurer also managing its underwriting, while Blackstone – also an investor – manages its investments. The company has not made an annual underwriting profit since inception and has had to contend with the financial markets turmoil in a challenging 2020.

Eight years on from the launch of Third Point Re with a seasoned and well-regarded management team led by John Berger and investments managed by Dan Loeb’s Third Point LLC hedge fund, the total return reinsurer model has largely either pivoted, been watered down, or effectively abandoned.

AM Best pressure

Under pressure from ratings agency AM Best and investors – the three publicly traded total return reinsurers all trade at a significant discount to book – several of the companies have been repositioning their underwriting and have sought to significantly de-risk their investment strategies.

For most, the reality is that underwhelming performance on underwriting as they expanded in a soft market has come at a time of volatility in the investment markets that has exposed the model.

Once the poster child of the model that the new wave companies were initially compared to, Greenlight Re was hit by heavy investment losses in 2015 and 2018 that undid a stellar track record of returns for its investors.

With its underwriting portfolio also underperforming, the carrier overhauled management. It then set about repositioning its underwriting in pursuit of profitability and taking actions to address volatility in its investments.

Last year it undertook a strategic review led by Credit Suisse, with live and legacy players linked with a potential transaction. But eventually its board said it would create more value as a standalone company than it could through an M&A transaction with a third party.

The Cayman Islands-based reinsurer remains at A- with AM Best on a negative outlook.

Third Point Re also has a negative outlook from AM Best on its A- rating and has also overhauled its management, repositioned its underwriting and de-risked its investments towards a fixed income portfolio.

The M&A path

In contrast to Greenlight Re, Third Point Re has pressed ahead in its pursuit of M&A and in a widely anticipated move it was confirmed earlier this month that it had agreed a $788mn deal to combine with Sirius to create SiriusPoint.

The deal – effectively an acquisition by Third Point Re – will see a “reconstituted strategic partnership” with Third Point LLC.

The hedge fund will be a “strategic partner to SiriusPoint on portfolio allocation, manage assets directly under the direction of SiriusPoint where they have a competitive advantage, and will likely utilize sub-advisors to manage the majority of the portfolio”.

The Third Point Re assets portfolio has already undergone a dramatic transition in the last 18 months, with 73 percent invested with the hedge fund in Q1 last year and 27 percent in fixed income and collateral, compared to 70 percent in fixed income and collateral and just 30 percent with Third Point LLC in Q1 2020 .

Post-merger, the expected SiriusPoint balance will be around three-quarters in fixed income and high credit collateral holdings and the balance in Third Point LLC and alternatives.

The parties will be hopeful that the de-risking will be favoured by AM Best, which currently has a negative outlook on both companies’ A- ratings.

Hamilton changes

Another of the total return reinsurers to go down the M&A path is Hamilton Insurance Group, which has its origins in SAC Re, the vehicle launched by hedge fund manager Steven Cohen in 2012, that was rebooted as Hamilton in 2013 with a buyout led by Brian Duperreault and investors including Two Sigma.

The company has also seen significant management changes – most recently with the departure of Kathleen Reardon.

Under management led by former Munich Re executive Pina Albo, the Bermudian completed a transformative deal with its acquisition of Lloyd’s platform Pembroke and Ironshore Europe from Liberty Mutual last year as it looks to execute a strategy to build out a global specialty (re)insurance business.

The company’s performance has been supported by generally strong investment returns managed by Two Sigma funds.

And last year founding investor Capital Z sold out its remaining $200mn stake in the company as it cashed in on a significant return.

Hamilton’s A- rating from AM Best currently has a stable outlook.

There have been mixed fortunes among the other total return reinsurers.

Watford pressure

Of the public companies, Watford Re trades at the biggest discount to book (0.43x, compared to 0.59x for Greenlight Re and 0.61x for Third Point Re).

This year the Arch-sponsored vehicle, which has its underwriting managed by the (re)insurer and its investments managed by JP Morgan spin-off HPS, came under investor led by Capital Returns’ call for a strategic review.

The carrier’s rating is also precariously positioned, remaining under review with negative implications after AM Best acted in response to first quarter investment losses.

New CEO Jon Levy has stated his confidence in resolving the status as risk-adjusted capitalization is restored to its former level.

Despite reports that the vehicle has also been targeted by the PE-backed start-up project being worked on by former Arch CEO Dinos Iordanou, The Insurer understands Watford has not been the subject of an approach and its sponsors are not believed to be looking for a sale.

Instead sources have suggested that Watford management and sponsors may view the vehicle as being well-positioned to capitalize on hard market opportunities, with an established (re)insurance platform and the ability to grow its underwriting portfolio profitably.

The investor scrutiny and steep discount to book Watford, Greenlight Re and Third Point Re all trade at does highlight the challenges faced by those total return reinsurers that decided to operate as public companies.

The inherent volatility in the model – at least pre-respositioning – has not been welcomed by investors in the public equity markets.

Fidelis prospers

For at least one of the group that eschewed the public spotlight there has been a very different story.

Richard Brindle’s Fidelis was initially billed as a total return vehicle because of its hybrid model aimed at balancing underwriting profit and an investment strategy to leverage a panel of fund managers to generate an outperforming total return.

But the focus on underwriting profit from the outset has seen it strongly outperform its peers, with sector-beating combined ratios.

The strong track record in a relatively short period since its 2015 launch with $1.5bn of capital has meant that in contrast to its peers it has been rewarded with an AM Best upgrade to A.

The pedigree of its underwriting has also attracted fresh capital with ease as it was able to raise a total of $1.1bn in equity and debt this year to target hard market opportunities across its book.

In common with the other vehicles that started out as total return reinsurers, Fidelis has also transitioned to a lower risk investment strategy, however, as it takes volatility out of the asset side of the balance sheet.

The model for all the 2012-2016 entrants was born out of a soft market where the difficulty in generating strong underwriting results and a low interest environment motivated a reach for better returns by pursuing a more aggressive investment strategy.

With most of the companies pivoting in the last couple of years, the opportunity in significantly improved underwriting conditions is there for those that can execute and continue to reinvent themselves.