Look both ways for reinsurance side-cars (May 17, 2006)

Reinsurance “side-cars” special-purpose reinsurers are likely to become increasingly important to the business strategy of insurers and reinsurers, according to a recent Moody’s report.
In its report, Reinsurance Side-Cars: Going Along for the Ride, Moody’s notes reinsurance side-cars are “a recent innovation in the catastrophe-battered insurance and reinsurance industries, whose managements are seeking solutions to stabilize capital and to reduce earnings volatility.”
Moody’s believes side-cars offer a “conceptually simple but versatile alternative, or at least complement, to the traditional reinsurance marketplace — and one that looks directly to the capital markets for insurance risk transfer capacity.”
Ultimately, Moody’s says, the prospects for side-cars will be linked to the cyclical dynamics of the insurance industry.
“In their simplest format,” Alan Murray, a senior credit officer in Moody’s insurance group, says, “these new instruments are established to assume underwriting risk from ceding insurers or reinsurers.”
Murray says reinsurance side-cars typically assume underwriting risk “via a quota-share reinsurance contract. This contract is one in which the side-car assumes a percentage of the ceding company’s underwriting risk (underwriting losses and related expenses) in exchange for a similar percentage of the associated premiums.”
The Moody’s report notes that “for private equity investors, the side-car structure is an attractive alternative to start-up and traditional corporate-reinsurance entities; these investors are keen to capitalize on short-term opportunities offered by disruptions in the insurance and reinsurance marketplaces.”
Moody’s expects that reinsurance side-car structures will likely be aided by improved computer-based tools that should help to evaluate more easily underwriting and credit risks.
Another driver behind the side-car structures’ expansion is a heightened sensitivity on the part of insurers and reinsurers to the financial and business consequences of assuming an excessive underwriting risk burden, the report says.
Murray said he expects “this structure will eventually find utility in parts of the insurance and reinsurance/retrocessional marketplace other than property/catastrophe risk, such as casualty, life, health, and financial-guaranty risks.”