(Reuters) – U.S. private equity firms are looking at starting up reinsurance companies, after an active U.S. hurricane season created demand for coverage and stormy financial markets have weakened many potential competitors.
The conversations are still in early stages, but consultants to the insurance industry say their phones are often ringing.
“Before we used to get calls from hedge funds, but now we’re mainly hearing from private equity firms,” said Andrew Barile, an insurance consultant in Rancho Santa Fe, California.
Hedge funds including Citadel Investments set up reinsurers in 2005, as newly flush funds looked for investment opportunities and harsh hurricanes like Katrina increased reinsurance demand.
But hedge funds are broadly facing massive investor redemptions, and are hardly in a position to pour hundreds of millions of dollars into new companies. George Soros, one of the world’s first hedge fund managers, estimates the industry will shrink by a half to two-thirds.
Even reinsurers with no connection to hedge funds still have problems: they suffered significant losses from hurricanes this year. And with the U.S. stock market down by about 40 percent and the U.S. corporate bond market down more than 7 percent this year, reinsurers’ investment portfolios have been hit hard.
Anyone starting a reinsurer from scratch, without payouts to make and investment losses to bear, has a real advantage, Barile said.
Demand for reinsurance — which is basically insurance for insurance companies — is increasing now after a tough hurricane year that cost insurers billions. Swiss Re said on Thursday that insured losses soared to $50 billion in 2008, making it among the costliest years ever, second only to 2005.
Hurricane Ike alone cost the industry $20 billion this year, the reinsurer said.
After a year like that, said Chris O’Kane, chief executive of Aspen Insurance, “There is a near infinite demand for Florida hurricane capacity.” Aspen sells both insurance and reinsurance, and was founded in part by Blackstone Group in 2001, during a big wave of private equity investment in reinsurers.
NOT A SURE THING
To be sure, any new reinsurer would face obstacles. Borrowing to help capitalize the firms could be difficult. And reinsurance is a tough business, so there is no guarantee that private equity firms, or any other startups, will make money where others have stumbled.
“New entrants often come into the market, and learn three to five years down the road how hard it is to underwrite,” said Bill Bergman, senior analyst covering reinsurers at Morningstar in Chicago.
But it does make sense for private equity firms to consider pouring capital into the sector. By some estimates, they have more than $600 billion of capital to put to work now. Their standard way of making money, namely buying up companies using a good deal of debt, does not work very well during a credit crunch.
A startup reinsurer that is properly capitalized could generate returns of more than 20 percent a year, said Barile, the consultant.
That kind of performance is in line with what private equity investors look for, and could make any investor salivate in a year of plunging asset values.
“There are a lot of reasons to look at something like this now,” said one private equity fund manager. (Additional reporting by Megan Davies and Lilla Zuill, editing by Matthew Lewis)