The recent trend for establishing sidecar reinsurers provides a convenient way for companies to maintain their presence in a market while reducing their exposures. But some insurance leaders say that using sidecars is a defensive move that can lead to problems.
Three sidecars have been set up in recent months, backed by the reinsurers and other investors. XL set up Cyrus Re, which has $500 million of capital, to take on some of its property-catastrophe business. Arch set up Flatiron Re with $256 million to take property-catastrophe quota-share exclusively from Arch. And Montpelier Re set up Blue Ocean Re to take its retrocession business. Blue Ocean is different from the others because it will also accept business from reinsurers other than Montpelier.
Greg Hendrick, president and chief underwriting officer of XL Re in Bermuda, says setting up Cyrus Re was a flexible way to meet rating agencies’ demands. “There are a number of driving factors,” he says. “Rating agencies are requiring more capital to service the same level of cat risk. We had the desire to retain the same market presence but reduce our net exposure.”
But there may not be many new sidecars appearing. Other Bermudian companies are not so keen on sidecar arrangements. And Jeff Radke, chief executive of PXRe, says it will be hard to get investors to back sidecars.
“Sidecars are going to be hard to do,” he says. One of the reasons, he argues, is the difficulty of deciding which risks stay at the parent reinsurer and which get transferred to the sidecar. Investors may feel that the parent reinsurer is keeping the best risks for itself and transferring the undesirable business to the sidecar.
“Whenever you try to split the baby, there are concerns about adverse selection and cherry picking,” says Radke. “Three have been done, and two of them were substantially smaller than expected.”
Hendrick says that in XL’s case, it was dealing with a partner it was familiar with and that there is an alignment of interests. Highfields Capital provides the bulk of the backing for Cyrus Re. The vehicle has been set up for two years.
“In our particular instance, we are dealing with partners we have worked with before so the speed and efficiency of setting up this deal was quicker than alternatives like cat bonds,” he says. “Cyrus Re’s interests are aligned with ours – we both retain a significant part of the risk. So both sides get comfort that they are driving in the same direction,” he says.
Others point out that sidecar arrangements are a defensive move that can take profitable business away from reinsurers.
“We decided not to do a sidecar,” says Keith Hynes, CFO of Max Re. “It is clearly more profitable to write on our balance sheet. The people doing them can’t afford to write this business on their balance sheets. If you have business and you can’t keep it because of balance sheet issues, a sidecar is a good way rather than shrinking the business.”
Ken LeStrange, CEO of Endurance, says sidecars are one of many options Endurance is considering. But he says an arrangement such as a sidecar could weaken a company’s risk management.
“We have a plan for that on the shelf. But when you think about the efficacy of such an arrangement, some organisations are clearly using these vehicles to lever up the amount of business they can write on their platform,” he says. “We’re not fond of leverage that way. The more leveraged one becomes, the more indifferent one becomes about the gross exposure that is being taken on.”