Hedge funds’ involvement in the reinsurance industry is an area of growth.

The PwC Bermuda Reinsurance 2014 conference saw John Berger, chairman and chief executive officer (CEO) and chief underwriting officer (CUO) at Third Point Reinsurance Limited, John Rathgeber, CEO of Watford Re Ltd and Aurora Swithenbank, managing director and co-head of insurance structured finance at Goldman Sachs, discuss the strategy, which is emerging amid an environment of depressed pricing and low interest rates.

Moderated by Scott Watson-Brown, asset management leader for PwC Bermuda, the panel painted a picture of an industry in a state of flux as it faces multiple internal and external challenges. He noted that reinsurers have turned to hedge funds, along with structured equity products and collateralised loan obligations (CLOs).

Mr Rathgeber said: “It’s a difficult market environment right now. The outlook is pretty bleak. It’s difficult for anyone to make a decent return ... you are seeing a migration towards riskier assets — that gets down to management philosophy and appetite for risk.”

He noted there are a number of “Watford Re-style” vehicles that are in the pipeline. Watford Re’s strategy is to combine a diversified reinsurance business with a “disciplined investment strategy” comprised primarily of non-investment grade credit assets, according to its website.

Ms Swithenbank said: “There’s been a dozen of these deals, but in the near term we’ve only had Watford, and we will see one or two before year end, and five or seven next year. There is space for a number of these vehicles, but it’s tough to get done and tough to put together a solid team.”

Ms Swithenbank said hedge funds want to get into the reinsurance market. “The misconception is that hedge funds are hard, and reinsurance is easy,” she said.

Other issues the industry must face include public perception of the models, both established and new.

Mr Rathgeber said: “Hedge funds, reinsurance — on the one hand people think there is no underlying risk, it’s an asset play, a tax dodge. On the other hand, people believe there is significant asset risk, as well as underwriting risk — burning at both ends of the candle.”

He said the perception is that “the hedge fund owns the vehicle, manages the vehicle, that it’s short term money. All I can say is, all these beliefs are just not correct.

“Hedge funds have no seats on the board, they are not in control of underlying policies. In our case [at Watford Re] we take significant underwriting risk, and much less cat risk than you get in a typical underwriter. It’s a rebalance, a recalibration.”

Among other issues raised by the panel are:

— Risk is increasingly being managed internally as cost effective solutions are sought. Cited as an example is the Berkshire Hathaway fully owned railway interest which is self-insured, in a vehicle which was described by one panellist as one of the largest insurers in the world. Additionally, the structure of the industry is complex and expensive with multiple layers in play between the insured and the eventual reinsurer, each getting their piece of the pie. Insureds now actively seek ways to cut out those additional, expensive layers.

— As auto safety improves, the revenue stream from auto insurance, one of the mainstays of the industry, will reduce.

— The US Treasury Department is suspicious of the relationship between reinsurers and hedge funds, and sometimes see reinsurance as a front for hedge funds to operate.

— AM Best was cited as the ratings agency which had taken time and energy on getting to grips with its complexities of the model. Mr Berger said they had done a “Terrific job” in understanding their vehicle.

— There are opportunities in the IT space which the industry is excited about, and are actively developing.

On tax, Mr Rathgeber said the US Treasury Department would like a test to differentiate between “legitimate” reinsurers, and those that are not.

He added: “It is not easy to come up with a ‘bright line” (to determine this) — a lot of respectable onshore companies would not pass this test.”

He noted that after the recent US midterm elections with a Republican-dominated House and Senate there will be a change in the chairmanship of the Finance Committee, which may impact enthusiasm for determining a line.

And he added the issue is a ‘tiny’ one compared to companies such as General Electric Co which, he said, made $11 billion in profits and paid no federal income tax. “The agenda there is it is quite likely fuelled by traditional companies.”

Reuters has reported that the company had paid no federal income tax for the years between 2008-2012, the years measured by the group Citizens for Tax Justice.