NEW YORK (Reuters) - Citadel Investment Group, one of the world's biggest hedge funds, is shuttering a Bermuda reinsurer it formed in 2004, according to a source familiar with the matter.

Citadel, which manages roughly $18 billion, thought it had a winning business plan with CIG Re because it was fully collateralised, giving the insured certainty their claims would be paid if catastrophe struck.

It is unwinding the reinsurer, according to this person, because the company's cost of capital is too high. The reinsurer, which does not have a financial strength rating, has also had a hard time competing with rivals who do.

The Chicago-based firm formed the property-catastrophe reinsurer, CIG Reinsurance Ltd, four years ago because it saw reinsurance as uncorrelated with its other investment strategies.

The $1.9 trillion hedge fund industry has been having a rough time of late. On average, funds have lost roughly 19 percent this year, and analysts expect there will be collapses.

Recently, questions over Citadel's fate have dogged it, prompting chief executive Ken Griffin to hold a call with investors last month, when he firmly brushed aside talk that the firm he founded 18 years ago might fail. A second, non-collateralised Bermuda-incorporated reinsurer formed by Citadel, New Castle Reinsurance Co Ltd., in 2005 will remain open, the source said. It is rated "A-" by AM Best, best known for rating insurers.

New Castle Re was formed after Hurricane Katrina, which cost insurers more than $40 billion, constraining capacity and pushing up pricing for property coverage.

It is wholly-owned by a trio of Citadel funds, two of which — Kensington and Wellington — have performed poorly so far this year. The funds are down about 35 percent.

Property-catastrophe reinsurers provide back-up coverage to other insurers spreading the risk of large losses among several carriers.