Standard and Poor’s (S&P) said yesterday that the hedge fund reinsurers philosophy of running a higher risk portfolio in order to underwrite at lower rates could be flawed.

The idea that hedge-fund reinsurers will earn higher investment returns than a typical reinsurer running a low-risk asset portfolio, with the result that they can compete by underwriting at lower rates, is flawed because hedge fund reinsurers need to allocate more capital as a buffer against the greater investment risk, thus offsetting the benefit of the extra return, the rating agency argued.

S&P has not rated the recent hedge fund-backed start ups as yet, such as Bermuda-based Third Point Re, Hamilton Re or Watford Re, which have all received ratings from rival AM Best.

S&P has warned pursuing a more aggressive investment strategy than traditional carriers consumes much more capital, and argued the tax advantages of an offshore reinsurer did not tip the balance.

The rating agency said the ability of asset managers and reinsurers to bridge their cultural divide was important to the success of the model.

Traditional reinsurers typically have much more comprehensive risk controls in place to manage volatility than hedge fund asset managers, S&P pointed out.

Risk frameworks on the asset side would make it easier to assess their future risk profile and allow for higher ratings, the agency added.

But it believes asset managers will resist giving up their autonomy.

“We believe that the trade-off between flexibility and adhering to a prudent risk tolerance is a tension that (hedge fund reinsurers) will struggle to reconcile,” S&P stated.

The rating agency’s views came out in the wake of Third Point Re’s second-quarter earnings statement, which showed investment income of $40.5 million, driving net earnings of $31.3 million, as the company made an underwriting loss that narrowed from the same period in 2013.