Bloomberg News

Wall Street Bets on Reinsurance After Record Japan Earthquake

June 07, 2011

June 8 (Bloomberg) -- Wall Street investors who started reinsurers after Hurricane Katrina in 2005 are again increasing bets on the industry to profit from higher rates, this time with a focus on limiting their time commitments.

Money managers are cooperating with reinsurers after Japan’s earthquake this year by supplying funds to back new coverage instead of setting up their own carriers to compete. That strategy may prove profitable to both investors and companies whose returns were crimped since 2007 by price declines, said Peter Hearn, chairman of Willis Group Holdings Plc’s reinsurance brokerage.

“I think the cautionary tale from 2005 is: The easiest thing is to get into the reinsurance business, the hardest is to get out,” Hearn said yesterday at the Bloomberg Link Japan conference in New York. “Permanent capital rushed in, the market spiked and it came right back down in 2007, a fairly short window to benefit from the increased pricing.”

Stone Point Capital LLC, the private-equity firm overseen by Goldman Sachs Group Inc. Director Stephen Friedman, contributed $100 million in April to a pool of funds that reinsurer Alterra Capital Holdings Ltd. is using to write new policies. Validus Holdings Ltd. and RenaissanceRe Holdings Ltd. each announced deals this month to raise capital from investors.

The funding agreements, known as sidecars, have a limited life span and give investors the opportunity to bet on reinsurance risks in periods of rising prices, Kenneth Pierce, global coordinating leader of insurance at law firm Mayer Brown LLP, said in an April report. First-quarter natural disasters, including the March 11 earthquake in Japan and floods in Australia, may increase their use, he said.

Insured Losses

Total insured losses from catastrophes in the first three months of 2011 may exceed $50 billion, insurance broker Aon Corp. estimated. Matthias Weber, head of property and specialty at Swiss Re, the world’s second-biggest reinsurer, said prices for earthquake coverage rose as much as 60 percent in Japan on April 1 when contracts were renewed. Katrina, which devastated New Orleans, cost the industry $62.2 billion, according to estimates by Munich Re, the largest reinsurer.

Reinsurers created in the Class of 2005 by banks, private equity and hedge funds have turned to mergers in the past two years to gain scale and return capital to investors. Stone Point became the biggest shareholder of newly created Alterra last year when its privately held Harbor Point Ltd. combined with Max Capital Group Ltd. In 2009, Validus bought IPC Holdings Ltd.

Investors seeking to bet on reinsurers may choose to buy catastrophe bonds. The securities pay higher-than-benchmark yields to investors who risk losing their principal in the event of disasters that meet predefined conditions.

Munich Re

At least one cat bond, a $300 million security sponsored by Munich Re, was wiped out as a result of the Japan disaster, according to an April report from Willis. The bond responded as people would have expected, which was “ultimately a good thing for the cat-bond industry,” said Jeremy Goodman, executive managing director at Aon Benfield, a unit of Aon, the world’s largest insurance broker.

“If there had been a loss of this magnitude and that bond hadn’t responded, I think people might have started to question the validity of cat bonds,” he said at the Bloomberg Link Japan conference.

Issuance of the securities in the first three months of the year set a first-quarter record as Munich Re, Swiss Re, Hartford Financial Services Group Inc. and Chubb Corp. sold $1.02 billion in four transactions, according to Willis. That compares with $650 million new issues in the first quarter of 2010. More of the securities may be sold as reinsurance rates rise.

“Historically, we have seen a positive correlation between cat-bonds issuance and reinsurance prices,” Weber of Swiss Re said at the conference. “When prices go up, typically soon after the number of cat bonds increase a little bit.”

The Swiss Re Cat Bond Price Return Index has declined about 5 percent since the March 11 earthquake, as yields have climbed.

--Editors: Dan Reichl, Peter Eichenbaum

To contact the reporters on this story: Andrew Frye in New York at afrye@bloomberg.net; Noah Buhayar in New York at nbuhayar@bloomberg.net.

To contact the editor responsible for this story: Dan Kraut at dkraut2@bloomberg.net


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