Perspectives - PDF document

Perspectives ÐInsurance Sidecars January 2007 Sidecars are financial entities created to allow investors to take the risk and return of a smalland limited category of insurance policies Ð generally short-tailed property catastropherereÕs entire book of business or legacy loss reserves.A.M.Best defines sidecarsas Òlimited-life special purpose entities that generally provide property catastrophe quota-share reinsurance exclusively to its sponsor.팀Others refer to them as Òdisposable reinsurers.팀A.M.Best has provided the following diagram of a simplified sidecar structure. periodic publication Reinsurance Sidecar Entity Reinsurer Sponsor BayPoint Harbor Point CastlePoint Validus Re Timicuan Renaissance Re Panther Hiscox Why Sidecars? ReReer Perspective While sidecars emerged after 9/11,it was the capital-depleting2005 hurricane season that prompted A.M.Best and other creditagencies to raise the bar substantially in terms of minimallyacceptable capital levels for reinsurers and insurers.In essence,Catastrophe insurance they could write or increase capitalseason.ReReaced sidecars because they improvemaintaining acceptable financial credit ratings.It is worthmentioning that sidecars are generally fully collateralized and alsoprovide their sponsors with ceding and profit commissions. hy Sidecar On the other side of the equation,investors primarily made up ofprivate equity and hedge funds have viewed sidecars as worthwhileinvestments for a number of reasons.On a macro level,anabundance of private equity and hedge fund capital has beenreturns on investment not easily obtained in the traditional financialmarkets.Reinsurance sidecars allow these investor groups to deploys reinsurance capacity-constrained hard market andgenersaid to be as high as 20 percentsaid to be as high as 20 percentiiWithout taking on any legacy risks associated with the 2005(ii)Without taking on the long-tailed liabilities that reinsurers useiiiiiiWithout being tied to financial market risks associated withivivWithout having to hire their own underwriting staffPut simply,sidecar investors are seeking high-yield andWe stress the point that sidecars are designed to beopportunistic investments that can be terminated very quickly.Given that most sidecar arrangements have a term of one-to-three years,investors will shift their focus toward opportunitieswith greater rates of return once pricing softens or lossespersuade sidecar investors to exit.In some cases,sidecarinvestors have mid-term exit mechanisms in place if rates soften.Therefore,stability of this capital isensured only to the extent that hard market pricing prevails,andinvestors are not in significant loss positions.Interestinglyterm capacity shortfalls,thereby creating opportunity for othersto take advantage of hardening rates Ð a kind of Catch-22 forthose who want to stay one step ahead of the market. The Impact of Sidecars their deployable limits for US Property Catastrophe business.Policyholders should benefit from a greater amount ofavailable capacity in the currently constrained environment. North