Reinsurance sidecars, conventionally referred to as "sidecars", are financial structures that are created to allow

investor An investor is a person who allocates financial capital with the expectation of a future Return on capital, return (profit) or to gain an advantage (interest). Through this allocated capital the investor usually purchases some species of pr ...

s to take on the risk and return of a group of

insurance policies In insurance, the insurance policy is a contract (generally a standard form contract) between the insurer and the policyholder, which determines the claims which the insurer is legally required to pay. In exchange for an initial payment, known as ...

(a "book of business") written by an insurer or reinsurer (henceforth re/insurer) and earn the risk and return that arises from that business. A re/insurer will only pay ("cede") the premiums associated with a book of business to such an entity if the investors place sufficient funds in the vehicle to ensure that it can meet claims if they arise. Typically, the liability of investors is limited to these funds. These structures have become quite prominent in the aftermath of

Hurricane Katrina Hurricane Katrina was a powerful, devastating and historic tropical cyclone that caused 1,392 fatalities and damages estimated at $125 billion in late August 2005, particularly in the city of New Orleans and its surrounding area. ...

as a vehicle for re/insurers to add risk-bearing capacity, and for investors to participate in the potential profits resulting from sharp price increases in re/insurance over the four quarters following Katrina. An earlier and smaller generation of sidecars were created after

9/11 The September 11 attacks, also known as 9/11, were four coordinated Islamist terrorist suicide attacks by al-Qaeda against the United States in 2001. Nineteen terrorists hijacked four commercial airliners, crashing the first two into ...

for the same purpose.

Precedents

Sidecars have precedents in the

reinsurance Reinsurance is insurance that an insurance company purchases from another insurance company to insulate itself (at least in part) from the risk of a major claims event. With reinsurance, the company passes on ("cedes") some part of its own insu ...

market under the name "quota-share reinsurance" — a common arrangement both historically and currently. In such an agreement, a re/insurer agrees to cede to the quota-share reinsurer a percentage of all premiums arising from a book of business in exchange for the reinsurer bearing the same percentage liability for losses. The quota-share reinsurer pays a "ceding commission" to compensate the ceding company for its expenses. The ceding commission typically also includes a profit allowance, which increases in proportion to the expected profitability of the business. Such reinsurance treaties enable ceding companies to write more business than they could bear based on their own capital and to earn a certain amount of fee-based income (through the ceding commission). Quota-share reinsurers act as insurance wholesalers, allowing them to earn a return on capital without creating primary insurance distribution. Among other specialist reinsurers,

Lloyd's of London Lloyd's of London, generally known simply as Lloyd's, is a insurance and reinsurance market located in London, England. Unlike most of its competitors in the industry, it is not an insurance company; rather, Lloyd's is a corporate body gover ...

"names" accept such business, placing the resources of individual and firms at risk for books of business written by professional underwriters and agents.

Early sidecars: reinsurance joint ventures

Re/insurers have occasionally created joint ventures through which multiple parties place capital at the disposal of one or more expert underwriters for the same reasons. The earliest sidecars were created in Bermuda in the 1990s in such a fashion, and included Top Layer Re and OpCat, both of which placed capacity under the control of Renaissance Re on the part of other re/insurers (Overseas Partners, State Farm).

Market growth following 9-11 and Hurricane Katrina

In the years following 9-11, the idea of raising funds from capital markets investors in addition to re/insurers to support quota-shares arose and a handful of such ventures were consummated (Olympus, DaVinci, Rockridge). These were the first true sidecars, and were a natural outgrowth of the development of re/insurance as an asset class in the form of

catastrophe bond Catastrophe bonds (also known as cat bonds) are a subset of insurance-linked securities (ILS) that transfer a specified set of risks from a sponsor to investors. They were created and first used in the mid-1990s in the aftermath of Hurricane And ...

s. Following

, the sidecar idea became very prominent among investors because it was seen as a way to participate in the risk/return of the higher-priced ("hard") reinsurance market without investing in either existing reinsurers (who might have liabilities from the past that would undermine returns) or new reinsurers ("newcos" that would have a lengthy and expensive "ramp up" period). Three such entities were up and running by year-end 2005: These entities have been created since 2006: Together with supplementary capital raises at Olympus, DaVinci, Blue Ocean and Kaith, this brought the total capital raised to over $4bn by September 2006 and established sidecars as a major capital raising vehicle for catastrophe risk. By year-end 2006, it began to appear as though supply and demand in the reinsurance and catastrophe bond markets had achieved balance at the prevailing price level. The market began to "soften" (fall in price), particularly following the decision by the State of Florida to expand the size of the reinsurance protection offered by the Florida Hurricane Catastrophe Fund by at least $12 billion in January 2007. Creation of new sidecars slowed markedly in the first half of 2007 in consequence,SIDECARS HAVE A SPECIFIC ROLE TO PLAY, October 19, 2008
/ref> with only one transaction being closed that included an equity offering (Starbound II, itself in some respects as much a rollover of Starbound I as a new transaction). The sidecar market continued to be active, however, with three different issuers accessing the bank loan market for debt to leverage their own equity: Hannover Re (Kepler), the Citadel reinsurance companies (Emerson) and State Farm (Merna, primarily a 4(2) bond issuance but in part a bank loan offering).

Sidecar investments

Investors are typically offered debt (generally in the form of bank loans), preferred stock and equity investments in the sidecar. Debt may be rated by the rating agencies, which include

Standard & Poor's S&P Global Ratings (previously Standard & Poor's and informally known as S&P) is an American credit rating agency (CRA) and a division of S&P Global that publishes financial research and analysis on stocks, bonds, and commodities. S&P is co ...

Moody's Moody's Ratings, previously and still legally known as Moody's Investors Service and often referred to as Moody's, is the bond credit rating business of Moody's Corporation, representing the company's traditional line of business and its histo ...

and A. M. Best. Most sidecar debt has been rated in the "BB" category (below investment grade), but some investment grade debt has been issued. In 2007, the rating agencies offered detailed criteria discussions for this type of issuance.

Notes

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External links