Reinsurance Sidecar
Encyclopedia
Reinsurance sidecars, conventionally referred to as "Sidecars," are financial structures that are created to allow investor
s to take on the risk and return of a group of insurance policies (a "book of business") written by an insurer or reinsurer (henceforth re/insurer) and earn the risk and return that arises from that business. A re/insurer will only pay ("cede") the premiums associated with a book of business to such an entity if the investors place sufficient funds in the vehicle to ensure that it can meet claims if they arise. Typically, the liability of investors is limited to these funds. These structures have become quite prominent in the aftermath of Hurricane Katrina
as a vehicle for re/insurers to add risk-bearing capacity, and for investors to participate in the potential profits resulting from sharp price increases in re/insurance over the four quarters following Katrina. An earlier and smaller generation of sidecars were created after 9-11 for the same purpose.
market under the name "quota-share reinsurance." In such an agreement, a re/insurer agrees to cede to the quota-share reinsurer a percentage of all premiums arising from a book of business in exchange for the reinsurer bearing the same percentage liability for losses. The quota-share reinsurer pays an amount called the "ceding commission" to compensate the ceding company for its expenses. The ceding commission typically also includes a profit allowance, which increases in proportion to the expected profitability of the business. These reinsurance treaties currently and traditionally provide ceding companies with the ability to write more business than they could bear based on their own capital and to earn a certain amount of fee-based income (through the ceding commission). Quota-share reinsurers act as insurance wholesalers, allowing them to earn a return on capital without creating primary insurance distribution. Lloyd's of London
"names" act as such reinsurers, placing the resources of individual and firms at risk to books of business written by professional underwriters and agents.
s.
Following Hurricane Katrina
, the sidecar idea became very prominent among investors because it was seen as a way to participate in the risk/return of the higher-priced ("hard") reinsurance market without investing in either existing reinsurers (who might have liabilities from the past that would undermine returns) or new reinsurers ("newcos" that would have a lengthy and expensive "ramp up" period). Three such entities were up and running by year end 2005 (sidecar, capital raised, ceding re/insurer):
These entities have been created since 2006 (sidecar, capital raised, ceding re/insurer, book of business):
Together with supplementary capital raises at Olympus, DaVinci, Blue Ocean and Kaith, this brought the total capital raised to over $4bn by September 2006 and established sidecars as a major capital raising vehicle for catastrophe risk.
By year end 2006, it began to appear as though supply and demand in the reinsurance and catastrophe bond markets had achieved balance at the prevailing price level. The market began to "soften" (fall in price), particularly following the decision by the State of Florida to expand the size of the reinsurance protection offered by the Florida Hurricane Catastrophe Fund by at least $12 billion in January 2007. Creation of new sidecars slowed markedly in the first half of 2007 in consequence, with only one transaction being closed that included an equity offering (Starbound II, itself in some respects as much a rollover of Starbound I as a new transaction). The sidecar market continued to be active, however, with three different issuers accessing the bank loan market for debt to leverage their own equity: Hannover Re (Kepler), the Citadel reinsurance companies (Emerson) and State Farm (Merna, primarily a 4(2) bond issuance but in part a bank loan offering).
and A. M. Best. Most sidecar debt has been rated in the "BB" category (below investment grade), but some investment grade debt has been issued. In 2007, the rating agencies offered detailed criteria discussions for this type of issuance.
, Merrill Lynch
, Morgan Stanley
, Swiss Re Capital Markets and Deutsche Bank
have advised on the creation of sidecars, typically alongside specialist consultancies such as Risk Management Solutions.
Lead equity investors that have been publicly disclosed include J.C. Flowers, First Reserves, Goldentree, Highfields, Goldman Sachs
and Farallon.
Numerous law firms have been active in this field, notably Mayer Brown LLP, Cadwalader, Wickersham & Taft, Conyers Dill & Pearman
in Bermuda and Fried Frank, Willkie Farr & Gallagher
, Dewey & LeBoeuf
, Debevoise & Plimpton
, and others in the US and UK.
Investor
An investor is a party that makes an investment into one or more categories of assets --- equity, debt securities, real estate, currency, commodity, derivatives such as put and call options, etc...
s to take on the risk and return of a group of insurance policies (a "book of business") written by an insurer or reinsurer (henceforth re/insurer) and earn the risk and return that arises from that business. A re/insurer will only pay ("cede") the premiums associated with a book of business to such an entity if the investors place sufficient funds in the vehicle to ensure that it can meet claims if they arise. Typically, the liability of investors is limited to these funds. These structures have become quite prominent in the aftermath of Hurricane Katrina
Hurricane Katrina
Hurricane Katrina of the 2005 Atlantic hurricane season was a powerful Atlantic hurricane. It is the costliest natural disaster, as well as one of the five deadliest hurricanes, in the history of the United States. Among recorded Atlantic hurricanes, it was the sixth strongest overall...
as a vehicle for re/insurers to add risk-bearing capacity, and for investors to participate in the potential profits resulting from sharp price increases in re/insurance over the four quarters following Katrina. An earlier and smaller generation of sidecars were created after 9-11 for the same purpose.
Precedents
Sidecars have precedents in the reinsuranceReinsurance
Reinsurance is insurance that is purchased by an insurance company from another insurance company as a means of risk management...
market under the name "quota-share reinsurance." In such an agreement, a re/insurer agrees to cede to the quota-share reinsurer a percentage of all premiums arising from a book of business in exchange for the reinsurer bearing the same percentage liability for losses. The quota-share reinsurer pays an amount called the "ceding commission" to compensate the ceding company for its expenses. The ceding commission typically also includes a profit allowance, which increases in proportion to the expected profitability of the business. These reinsurance treaties currently and traditionally provide ceding companies with the ability to write more business than they could bear based on their own capital and to earn a certain amount of fee-based income (through the ceding commission). Quota-share reinsurers act as insurance wholesalers, allowing them to earn a return on capital without creating primary insurance distribution. Lloyd's of London
Lloyd's of London
Lloyd's, also known as Lloyd's of London, is a British insurance and reinsurance market. It serves as a partially mutualised marketplace where multiple financial backers, underwriters, or members, whether individuals or corporations, come together to pool and spread risk...
"names" act as such reinsurers, placing the resources of individual and firms at risk to books of business written by professional underwriters and agents.
Early sidecars: reinsurance joint ventures
Re/insurers have occasionally created joint ventures through which multiple parties place capital at the disposal of one or more expert underwriters for the same reasons. The earliest sidecars were created in Bermuda in the 1990s in such a fashion, and included Top Layer Re and OpCat, both of which placed capacity under the control of Renaissance Re on the part of other re/insurers (Overseas Partners, State Farm).Market growth following 9-11 and Hurricane Katrina
In the years following 9-11, the idea of raising funds from capital markets investors in addition to re/insurers to support quota-shares arose and a handful of such ventures were consummated (Olympus, DaVinci, Rockridge). These were the first true sidecars, and were a natural outgrowth of the development of re/insurance as an asset class in the form of catastrophe bondCatastrophe bond
Catastrophe bonds are risk-linked securities that transfer a specified set of risks from a sponsor to investors...
s.
Following Hurricane Katrina
Hurricane Katrina
Hurricane Katrina of the 2005 Atlantic hurricane season was a powerful Atlantic hurricane. It is the costliest natural disaster, as well as one of the five deadliest hurricanes, in the history of the United States. Among recorded Atlantic hurricanes, it was the sixth strongest overall...
, the sidecar idea became very prominent among investors because it was seen as a way to participate in the risk/return of the higher-priced ("hard") reinsurance market without investing in either existing reinsurers (who might have liabilities from the past that would undermine returns) or new reinsurers ("newcos" that would have a lengthy and expensive "ramp up" period). Three such entities were up and running by year end 2005 (sidecar, capital raised, ceding re/insurer):
- Flatiron, $840m, Arch Capital
- Blue Ocean, $355m, Montpelier Re
- Cyrus, $550m, XL Capital
These entities have been created since 2006 (sidecar, capital raised, ceding re/insurer, book of business):
- Petrel, $200m, Validus, marine and energy reinsurance
- Kaith/K5, $370m, Hannover ReHannover ReHannover Re , with a gross premium of around €11 billion, is one of the leading reinsurance groups in the world...
, several lines of insurance and reinsurance - Helicon, $330m, White Mountains Re, property catastrophe reinsurance
- BayPoint, $150m, Harbor PointHarbor PointBuilt in 1972, Harbor Point Condominiums is a residential and commercial building in Chicago, Illinois, United States, on Lake Michigan. Standing nearly 168 meters with 54 floors, it is among the tallest buildings in Chicago....
, selected short-tailed lines of business - Timicuan/RPP, $70m, Renaissance Re, reinstatement premium protection
- Starbound, $315m, Renaissance Re, Florida treaty business
- Sector Re, $220m, Swiss ReSwiss ReSwiss Reinsurance Company Ltd , generally known as Swiss Re, is a Swiss reinsurance company. It is the world’s second-largest reinsurer, after having acquired GE Insurance Solutions. The company has its headquarters in Zurich...
, property catastrophe and aviation reinsurance - Castlepoint Re, $265m, Tower Group, program and specialty insurance
- Monte Fort Re, $60m, Flagstone Re, peak zone and ILW (industry loss warranty) coverage
- Sirocco, $95m, Lancashire Re, Gulf of Mexico offshore energy
- Concord, $730m, AIGAmerican International GroupAmerican International Group, Inc. or AIG is an American multinational insurance corporation. Its corporate headquarters is located in the American International Building in New York City. The British headquarters office is on Fenchurch Street in London, continental Europe operations are based in...
, US commercial property business - MaRI, $400m, MarshMarsh & McLennan CompaniesMarsh & McLennan Companies, Inc. is a US-based global professional services and insurance brokerage firm. In 2007, it had over 57,000 employees and annual revenues of $10.49 billion. Marsh & McLennan Companies was ranked the 221st largest corporation in the United States by the 2009 Fortune 500...
/ ACE, US commercial property
Together with supplementary capital raises at Olympus, DaVinci, Blue Ocean and Kaith, this brought the total capital raised to over $4bn by September 2006 and established sidecars as a major capital raising vehicle for catastrophe risk.
By year end 2006, it began to appear as though supply and demand in the reinsurance and catastrophe bond markets had achieved balance at the prevailing price level. The market began to "soften" (fall in price), particularly following the decision by the State of Florida to expand the size of the reinsurance protection offered by the Florida Hurricane Catastrophe Fund by at least $12 billion in January 2007. Creation of new sidecars slowed markedly in the first half of 2007 in consequence, with only one transaction being closed that included an equity offering (Starbound II, itself in some respects as much a rollover of Starbound I as a new transaction). The sidecar market continued to be active, however, with three different issuers accessing the bank loan market for debt to leverage their own equity: Hannover Re (Kepler), the Citadel reinsurance companies (Emerson) and State Farm (Merna, primarily a 4(2) bond issuance but in part a bank loan offering).
Sidecar investments
Investors are typically offered debt (generally in the form of bank loans), preferred stock and equity investments in the sidecar. Debt may be rated by the rating agencies, which include Standard & Poors, Moody'sMoody's
Moody's Corporation is the holding company for Moody's Analytics and Moody's Investors Service, a credit rating agency which performs international financial research and analysis on commercial and government entities. The company also ranks the credit-worthiness of borrowers using a standardized...
and A. M. Best. Most sidecar debt has been rated in the "BB" category (below investment grade), but some investment grade debt has been issued. In 2007, the rating agencies offered detailed criteria discussions for this type of issuance.
Market participants
Investment banks including GC Securities, Aon Capital Markets, Goldman SachsGoldman Sachs
The Goldman Sachs Group, Inc. is an American multinational bulge bracket investment banking and securities firm that engages in global investment banking, securities, investment management, and other financial services primarily with institutional clients...
, Merrill Lynch
Merrill Lynch
Merrill Lynch is the wealth management division of Bank of America. With over 15,000 financial advisors and $2.2 trillion in client assets it is the world's largest brokerage. Formerly known as Merrill Lynch & Co., Inc., prior to 2009 the firm was publicly owned and traded on the New York...
, Morgan Stanley
Morgan Stanley
Morgan Stanley is a global financial services firm headquartered in New York City serving a diversified group of corporations, governments, financial institutions, and individuals. Morgan Stanley also operates in 36 countries around the world, with over 600 offices and a workforce of over 60,000....
, Swiss Re Capital Markets and Deutsche Bank
Deutsche Bank
Deutsche Bank AG is a global financial service company with its headquarters in Frankfurt, Germany. It employs more than 100,000 people in over 70 countries, and has a large presence in Europe, the Americas, Asia Pacific and the emerging markets...
have advised on the creation of sidecars, typically alongside specialist consultancies such as Risk Management Solutions.
Lead equity investors that have been publicly disclosed include J.C. Flowers, First Reserves, Goldentree, Highfields, Goldman Sachs
Goldman Sachs
The Goldman Sachs Group, Inc. is an American multinational bulge bracket investment banking and securities firm that engages in global investment banking, securities, investment management, and other financial services primarily with institutional clients...
and Farallon.
Numerous law firms have been active in this field, notably Mayer Brown LLP, Cadwalader, Wickersham & Taft, Conyers Dill & Pearman
Conyers Dill & Pearman
Conyers Dill & Pearman is an offshore law firm. Founded in Bermuda in 1928 , the firm has subsequently opened legal practices in a number of other offshore financial centres, including the British Virgin Islands, the Cayman Islands and Mauritius...
in Bermuda and Fried Frank, Willkie Farr & Gallagher
Willkie Farr & Gallagher
Founded in 1888, Willkie Farr & Gallagher LLP is an international law firm with eight offices in six countries . The firm has cultivated a strong corporate practice focused on investment funds, bankruptcy and intellectual property...
, Dewey & LeBoeuf
Dewey & LeBoeuf
Dewey & LeBoeuf LLP is a prominent global white shoe law firm, headquartered in New York City. Originally founded in 1909, the firm currently has over 2400 lawyers spread throughout 26 offices in 15 countries on 4 continents, and is known primarily for its corporate, insurance, litigation, tax and...
, Debevoise & Plimpton
Debevoise & Plimpton
Debevoise & Plimpton LLP is a prominent international law firm based in New York City. Founded in 1931 by Eli Whitney Debevoise and William Stevenson, Debevoise has been a long established leader in corporate litigation and large financial transactions. In recent years, its practice has taken on an...
, and others in the US and UK.
See also
- Catastrophe bondCatastrophe bondCatastrophe bonds are risk-linked securities that transfer a specified set of risks from a sponsor to investors...
s - ReinsuranceReinsuranceReinsurance is insurance that is purchased by an insurance company from another insurance company as a means of risk management...
- Alternative Risk TransferAlternative Risk TransferAlternative Risk Transfer is the use of techniques other than traditional insurance and reinsurance to provide risk bearing entities with coverage or protection...
- Captive insuranceCaptive insuranceCaptive insurance companies are insurance companies established with the specific objective of financing risks emanating from their parent group or groups, but they sometimes also insure risks of the group's customers as well...
- International Society of Catastrophe ManagersInternational Society of Catastrophe ManagersThe International Society of Catastrophe Managers is a professional association that promotes catastrophe management professionalism within the insurance industry.-Goal and objectives:...
External links
- Conference on Insurance- and Risk-Linked Securities (the Bond Markets Association)
- Mad scramble for capital fuels cat bond market
- Presentation by Diego Rangel
- Different Angle (article by Kenneth Rijock)
- International Society of Catastrophe Managers
- Reinsurance Guru - reinsurance news and analysis Web-site