Total return reinsurers continue to struggle in 2018

Last year marked a new low for total return reinsurers Third Point Re and Greenlight Re, as their respective investment portfolios caused the companies to post record losses.

These results add further questions around the long-term viability of the total return reinsurer model, a business already facing scrutiny due to challenges on the underwriting side that have been compounded by underperformance on investments in recent years.

While the total return reinsurer model comes with expected volatility due to more aggressive investment strategies, over the past six years the two firms have failed to deliver the superior investment returns the business model is predicated on.

“Let’s first acknowledge that our overall performance in 2018 was very poor,” said Greenlight Re CEO Simon Burton on the firm’s Q4 conference call.

And at Third Point Re, while CEO Rob Bredahl reaffirmed his belief in portfolio manager Daniel Loeb, he admitted that “the returns have not been what either of us have come to expect” while speaking to analysts after the disclosure of fourth-quarter results.

The underperforming investment strategies have led the two companies to become more focused on improving profits from underwriting. The model was originally more heavily dependent on generating float and turbo-charging returns from investments.

This cloud of uncertainty over the first generation of total return reinsurers comes at an interesting juncture for the market, as Watford Re – the Arch sidecar that represents a new generation of the model – is preparing to IPO.

Valuations at six-year lows

The market’s disappointment with and creeping scepticism of the businesses model is clearly noticeable when looking at valuations over time, as Third Point Re and Greenlight Re are currently trading at their lowest multiples since 2013.

Both companies were trading at 66-75 percent of book value at the end of 2018 after trading at a premium just a few years ago.

Notably, both companies were seen in their early days as a vehicle for retail or other investors to gain exposure to “superstar hedge fund managers”. With hedge funds falling somewhat out of fashion, and the lustre of the superstar fund managers similarly fading, both stocks appear to have struggled to maintain investor interest.

Valuations at six-year lows

The market’s disappointment with and creeping scepticism of the businesses model is clearly noticeable when looking at valuations over time, as Third Point Re and Greenlight Re are currently trading at their lowest multiples since 2013.

Both companies were trading at 66-75 percent of book value at the end of 2018 after trading at a premium just a few years ago.

Notably, both companies were seen in their early days as a vehicle for retail or other investors to gain exposure to “superstar hedge fund managers”. With hedge funds falling somewhat out of fashion, and the lustre of the superstar fund managers similarly fading, both stocks appear to have struggled to maintain investor interest.

Third Point Re was down nearly 8 percent to $10.69 per share the day after it disclosed Q4 results – pushing down its price-to-book multiple from 0.72x to 0.66x on 28 February. Greenlight Re was trading at 0.73x on the same day.

Risks and returns

While the two firms enjoyed strong returns in their early years, ultimately the persistently poor underwriting results and irregular investment yields have not proved to be a winning combination.

As shown below, returns on average common equity fluctuated for the two companies due to the volatile nature of their investments – with Greenlight Re posting a devastating 70.4 percent loss last year.

At Third Point Re, the Loeb-led investment portfolio has generated double-digit investment returns in two of the carrier’s six years of existence. The aggregate net investment income generated over that time period was $201.7mn – Third Point Re’s average cash and investments over 2018 stood at around $3bn.

At Greenlight Re, David Einhorn’s investment portfolio has not got close to repeating the 8.3 percent yearly return on investments recorded in 2013.

And last year, the investment portfolios of the two first-generation hedge fund reinsurers recorded their biggest losses since inception: Third Point Re’s net investment yield was negative 8.3 percent, while Greenlight Re lost 16.4 percent of total invested assets last year.

Third Point Re’s investments have performed better than Greenlight Re’s historically over the comparable period. However, the firms have struggled to outperform the results that a simple indexed exposure to US equities would have generated.

For example, in 2013, the S&P 500 had a total return of 32.4 percent and in 2017 it returned 21.8 percent. Though it is understandable that long/short funds would underperform in significant bull markets, over time the performance should outperform benchmark indices.

Fix the underwriting

The underwriting segments of the two companies have not generated profits over the past five years, pressuring management to redesign their portfolios and target underwriting profitability.

Speaking to analysts after the firm’s 2018 results, Third Point Re’s Bredahl said: “As we talked about for several quarters, we continue to build out our underwriting platform and gradually shift our underwriting portfolio to higher-margin business to help drive down our combined ratio below 100.”

Bredahl noted Third Point was looking to improve its underwriting results by adding higher margin but higher volatility business in catastrophe.

“Consistent with our previously announced plans, we began writing a modest amount of property catastrophe business in the first quarter of 2019,” he said.

“We are pleased with the portfolio that we have constructed at the important January 1 renewal date, which benefited from some modest improvements in pricing, and we continue to expect our combined ratio to trend to below 100 percent as we earn in the catastrophe premium and continue to expand our underwriting platform into other higher margin types of reinsurance and lines of business.”

The challenge for the firm will be to improve results without adding too much additional volatility on the liability side of the balance sheet, given the company has a higher than average volatility on the asset side of the business.

At Greenlight Re, the underwriting portfolio has been repositioned over the past few years to get it closer to profitability. The company’s 2018 combined ratio was 105.1 percent, 3.5 points better than a year earlier.

“While an improvement on the prior year, there is still some way to go before I consider our underwriting business to be a significant value contributor. All of that work has been completed, but not yet done to our financials and more is to come,” said CEO Burton.