Sidecars – Is now the right time to be taken for a ride?

Feb 2015

Casting one’s mind back to the heady premium days of post Katrina / Wilma, life for the reinsurance market, including the nascent ILS market, was good. It was what in the industry is called a ‘hard market’, a market where terms are hard i.e. high premiums combined with narrow coverage scope. Premiums had sky-rocketed and capacity remained fairly scarce. Once they had put to work their own capital, enterprising reinsurers pondered how to continue to capitalise on this boom time. Coming from the reinsurance industry they knew what they really needed was further quota share capacity on which they could charge a healthy commission to put someone else’s capital to work in the space. Only all reinsurance capacity was being used. They needed a new source of capital and therefore turned to the capital markets. They would create a separate special purpose reinsurance company that would be financed by investors and would in turn provide quota share capacity to the reinsurer – everywhere the reinsurer’s portfolio would go, the quota share would assume a corresponding share – a little like a sidecar going everywhere the motorcycle went. Hence the ‘reinsurance sidecar’ was born.

It made perfect sense for those investors who did not have any other way to access the market. For various reasons it made much less sense for ILS funds such as Solidum to invest this way.. The market had never paid so much for risk transfer and, through a temporary vehicle linked to a reinsurer, the investors could easily access the risk and have it vetted. Alignment of interest with the reinsurer was structural and all that remained was to reasonably remunerate the reinsurer. Finally, as the market cycle changed and capacity became more plentiful resulting in falling premiums, it would be easy to ‘detach’ the sidecar, refund the investors and allow the reinsurer to ‘go it alone’ shrinking the book of business to be supported by the own capital. This was flexible capital management that made total sense.

As the market softened, i.e. premiums fell and capacity became more available, these early sidecars were shelved, as had been the design, and all but disappeared....