Newly formed hedge fund reinsurers are unlikely to achieve an insurer financial strength rating in the ‘A’ category under Fitch Ratings’ methodology, the rating agency said last week.

Fitch pointed to general constraints applied to startup companies, as well as potential unique asset and pricing risks tied to the hedge fund reinsurer business model, in explaining the reasons, going on to suggest that over the longer term, there is some possibility that a hedge fund reinsurer with a successful track record of balancing risks, and demonstrating an established business could be rated in the ‘A’ category in years to come. Initially, Fitch cites the challenges of attracting new business as well as the potential operational and corporate governance issues as a company builds its track record.

“We often see major strategic changes as new reinsurance companies work to build a franchise or as they move from private to public ownership,” Fitch said in a statement released during the Rendez-Vous de Septembre in Monte Carlo last week.

Even with a sufficient track record, hedge fund reinsurers would be less likely to achieve an ‘A’ category rating than traditional reinsurers, Fitch said, noting that most reinsurers take on very little asset risk. In contrast, hedge fund reinsurers aim to use stable premium flows to support high risk-adjusted returns on their investments and are therefore exposed to both asset and underwriting risk.

“This creates further risk from the potential for a hedge fund to strategically use its above-average expected investment results to price lower than competitors, resulting in the dangers of cash flow underwriting,” the Fitch announcement said.

Fitch also noted that a big fall in asset values could deplete a hedge fund reinsurers’ capital, putting potential strain on the company if it coincided with unusually high claims payouts.

Source: Fitch Ratings