Are hedge funds credible reinsurers?
A.M. Best's review of hedge fund-backed reinsurance moves the relationship between the insurance and investment worlds back into the spotlight - especially given the large catastrophe losses suffered by the industry in 2011.
While this unlikely relationship was first forged in the aftermath of Katrina and rising rates in 2005, it is a business model that is based on a premise that cat reinsurers, like their investment counterparts, rely heavily on complex modelling to assess risk and that there is little, if any, correlation with the traditional equity and bond markets.
Given that reinsurer cat models have proven to be wholly inadequate in a world of rapid climatic change, it begs the question as to whether this relationship is more about hedge funds tapping into a rich vein of global funds to fuel their alternative investment strategies - many of which have contributed to the global financial crisis - than it is about creating innovative capacity in the insurance marketplace.
The attention of the like of AM Best in such special purpose vehicles (SPV) can only be a good thing as it will ensure that there is a balanced approach to risk-taking and equality of insurance and investment management input within these SPVs.
To take this "watchdog" concept a step further... perhaps there should also be a parallel focus by EIOPC, as part of the ongoing Solvency 2 debate, on the use of these vehicles and the weighting of such reinsurance assets in any new risk-based solvency calculations.
Given the surplus capacity currently available in the reinsurance market - even after the large losses of 2011 - does anyone really care?