Hedge Fund Managers Benefit from Fee-Paying Reinsurer Units

Stock pops or stock drops, there’s always been at least one winner when it comes to Daniel Loeb’s reinsurance company: Daniel Loeb’s hedge fund.

Loeb’s Bermuda-based Third Point Reinsurance Ltd. paid $98.8 million since 2013 to the entities that manage its money — Loeb’s Third Point hedge fund and its affiliates.

David Einhorn has a similar arrangement with Greenlight Capital Re Ltd. Since 2007, the Cayman Islands-based reinsurer has paid more than $280 million in management and performance fees to Einhorn’s DME Advisors, which oversees investments for the reinsurer that mirror his hedge funds.

Having a reinsurer is a “good deal” for money managers because “they essentially view it as permanent capital,” while the risks for investors can outweigh the benefits of favorable tax treatment, said Dean Rubino, president of Terrapin Asset Management, an investment adviser and manager.

Third Point Re has pitched its stock as a way for the public to benefit from Loeb’s acumen. But that hasn’t happened. While investors in his hedge fund would have made about 11 percent from the end of August 2013, the month that Third Point Re went public, through March 31, the reinsurer fell 14 percent in that span.

Greenlight Re trades for just 14 percent more than its May 2007 initial public offering price. Compare that to an investment in Einhorn’s hedge fund, Greenlight Capital Inc., which rose more than 50 percent from the end of that month.

Elissa Doyle, a spokeswoman for Loeb’s hedge fund, declined to comment, as did Third Point Re’s Manoj Gupta. Jonathan Gasthalter, an external spokesman for Einhorn’s fund and Brian Ruby, a spokesman for Greenlight Re at ICR, also declined to comment.

Reinsurers provide coverage for primary insurers and can invest the premiums that they hold to back policyholder obligations. Third Point Re has written contracts on crops while Greenlight Re has insured Florida homeowners.

Money managers have helped start similar vehicles for more than a decade. Louis Moore Bacon’s Moore Capital Management helped form Max Re Capital, which went public in 2001. That reinsurer later merged with a rival.

Tax advantages, along with capital that can serve as a buffer against redemptions, make reinsurers such a winning play that other firms are planning their own.

Goldman Sachs Group Inc. last year raised $1.5 billion to help create an insurer with a plan to take it public, according to a marketing document obtained by Bloomberg News. Highbridge Capital Management, majority-owned by JPMorgan Chase & Co., is tied to a venture, Watford Re, that may file for an IPO as early as this year, according to a person familiar with the plan. And Howard Marks’ Oaktree Capital Group LLC recently raised about $600 million to start a venture.

Other asset managers that have sought funding for such ventures in the past year include Blackstone Group LP and UBS O’Connor, the hedge-fund manager in Switzerland’s largest bank. Representatives of the banks and money managers declined to comment.

However, investor interest may be waning. Goldman Sachs fell $500 million short of its maximum target, while BlackRock Inc., raised $800 million from clients for a venture after seeking as much as $1.3 billion. A BlackRock spokeswoman declined to comment.

Policy pricing has declined in recent years as more money managers enter the reinsurance business. Third Point Re Chief Operating Officer Robert Bredahl told investors in September that he’s not hopeful for an immediate industry rebound.

“With most of these companies having hiccups, Third Point and Greenlight, you’re probably not going to see vast amounts of new investor interest in the model,” said Meyer Shields, an analyst with Keefe, Bruyette & Woods.

Reinsurance shareholders gain a tax advantage. A U.S. investor in a hedge fund would have to pay the 39.6 percent rate for ordinary income on gains the hedge fund makes in short-term holdings. By holding shares of the reinsurer, they’d be subject to a lower long-term capital-gains rate.

This has drawn the attention of politicians such as U.S. presidential hopeful Hillary Clinton and Oregon Senator Ron Wyden, who called the disparity a tax loophole. Hedge fund manager John Paulson recently shuttered a reinsurance venture amid the scrutiny and after years of poor performance.

The tax treatment only works for shareholders if reinsurers’ stock rises along with hedge fund gains. Lately, poor insurance underwriting has deepened the share slumps as Greenlight Re and Third Point Re paid out more in claims than they collected in premiums last year.

But in years of poor performance, fees and taxes aren’t the only perks for hedge fund managers. Reinsurance assets tend to be sticky, which can soften the impact of client redemptions and mute pressure to sell securities in a panic.

Third Point Re’s $2.3 billion investment portfolio accounted for about 13 percent of the assets Loeb’s hedge fund firm managed as of Dec. 31. Greenlight Re’s $1.1 billion portfolio comprised a similar ratio of the assets invested in its main stock-focused hedge fund at the start of 2016, according to documents seen by Bloomberg. The hedge funds charge the reinsurers fees that are the same as what most investors pay: That includes a management fee and as much as 20 percent of profits.

Both companies have said in filings or conference calls that performance could be more volatile than that of traditional insurers, which invest mostly in bonds. Ken Billingsley, an analyst at Compass Point Research & Trading, said patient stockholders may eventually be rewarded along with money managers.

“In one or two years of good earnings on the investing side, they could make up for three or four years of underperformance,” he said.