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Reinsurance sidecars find going tougher than expected with hedge funds

Despite the perception that hedge funds currently possess an unalloyed enthusiasm for all things reinsurance, the sponsors of the new sidecar arrangements are not being overwhelmed with interest from the cash-rich funds.

These so-called sidecars are new, quota-share partnership vehicles which reinsurers are hoping to establish with hedge funds to provide renewable pots of capital that sit-alongside existing (rated) carriers following this year’s severe storm losses.

XL Capital is the most prominent (re)insurer when last month it revealed the formation of Cyrus Re with an “alternative asset manager”, widely thought to be Boston-based Highfields Capital. Under the arrangement, XL will agree to cede specific proportions of its property cat and retro book under a quota share arrangement.

The Bermudian-based insurer – which stunned investors with plans for a $2.8bn fund raising and a cut in its quarterly dividend earlier this month – said it expected Cyrus Re to be capitalised with between $500mn and $1bn.

It confirmed later, however, that Highfields had settled at the lower end of its target with $500mn. “Our quota share counter-party, Cyrus Re, has recently obtained a Bermuda Monetary License to act as a reinsurer of XL property catastrophe and retrocessional business and has initially funded a collateral trust with $500mn to support such reinsurance activities,” explained XL’s president and chief executive Brian O’Hara.

But at least Cyrus Re has attracted sufficient capital, albeit at the low end of its expectations. In contrast, Glacier Re is now thought to have postponed its plans to establish a sidecar of up to $500mn. Montpelier Re, which is looking to set up a sidecar called Blue Ocean Re, has not confirmed fundraising. Blue Ocean Re was, however, licenced as a “Class 3” reinsurer on Bermuda in October. Sources also suggest White Mountains is working on a sidecar venture with its associated Bermudian catastrophe reinsurer, Olympus Re.

Montpelier Re – which lost over 70 percent of its equity base from this year’s storm losses – pioneered sidecars when it helped form the $91mn Cayman Island reinsurer Rockridge Reinsurance Ltd earlier this year. The “Class of 2001” reinsurer invested $10mn of its own money in Rockridge – which was also backed by Bermudian hedge fund manager West End Capital Management (Bermuda) Ltd. Under the arrangement, Rockridge will act as a reinsurer to Montpelier with the Tony Taylor headed company earning a fee income from the business.

The sluggish progress of sidecars post-storms should not, however, be read as a sign that hedge funds are turning their back on the sector. Glacier Re, for instance, is a product of their interest. Formed in December 2004 with $300mn of capital, the Swiss-based reinsurer is backed by the hedge funds HBK Investments LP and Soros Fund Management LLC. Benfield’s corporate finance arm, Benfield Advisory – which advised on the initial formation of Glacier Re – is again attempting to raise the funds for the sidecar.

Ken Griffin’s giant Citadel hedge fund has increased its support for its Bermudian reinsurer, CIG Re, and also formed the start-up New Castle Re following the storms.

Headed by the catastrophe reinsurance specialist Chris McKeown, this gives Citadel the unique platform of having a rated reinsurer (New Castle Re) sitting alongside the unrated CIG Re, but offers cedants the opportunity of collateralised reinsurance.

Hedge Funds are also taking private equity stakes in some of the other “Class of 2005” reinsurance start-ups, such as Flagstone Re and Lancashire Re.

Sources say some potential investors were not won over by the structure or the investment prospects of these sidecar ventures.

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