SIDECARS

Rough Notes, Mar 2007 by Moody, Michael J

Post-Katrina

XL was one of the first to take advantage of the sidecar concept following Katrina. In November 2005, they established Cyrus Re by capitalizing it with $500 million from several capital sources, but no direct investment from XL. Cyrus Re sits alongside the XL reinsurer and participates in high-level property coverage and a retrocessional book of property business under a quota share arrangement.

After the storms, Montpelier Re quickly realized that it was going to suffer significant losses, to the tune of net losses for the third quarter of 2005 of an estimated $875 million. Those losses left the reinsurer in bad financial condition, and the subsequent ratings downgrades did not help at all. However, the management developed specific strategies that included entering into two CAT bond transactions, as well as launching an additional sidecar, Blue Ocean Re.

Arch Insurance Company also started a sidecar, Flatiron Re, on December 29, 2005. The company was formed to take a 45% quota share of certain property and marine business that was written by Arch. Arch does not have any direct investment in the reinsurer but rather depends on investors developed by Goldman Sachs to secure the funds for Flatiron Re. White Mountains also launched another sidecar in the latter part of 2005. The sidecar, Helicon, will write up to 35% of White Mountains' U.S. reinsurance for property business.

Movement in the sidecar business has been hot and heavy since the hurricane activity of 2005. In addition to the above noted transactions, Validus Re has formed Petrel Re, and Renaissance Re formed yet another sidecar known as Starbound Re. Several additional sidecars were also rolled out during 2006. In addition, a number of other sidecars were in various stages of development as the 2006 underwriting year ended.

But it is the introduction of a new sidecar in early 2007 that is attracting the most attention. This was a joint venture between Marsh, Inc., and ACE USA that was announced on January 11, 2007. The program was the first sidecar facility, named Marsh Risk Innovations (MaRI), specifically designed to provide additional catastrophic property capacity directly to corporate insurance purchasers. Another unique feature of this venture is that it combines the capacity of the capital markets and an A rated insurer that can offer admitted paper directly to Marsh's corporate clients. MaRI's purpose is to give corporate insurance buyers exclusive access to CAT property capacity that can be used to fill gaps in their corporate property programs. Heretofore, sidecars had been reserved for retail insurers and reinsurers; however, now corporations can gain direct access to the capital markets, in much the same manner that captives allow corporate buyers direct access to reinsurance markets.

Conclusion

Obviously sidecars, just like CAT bonds, will never account for a high percentage of the reinsurance market. For example, Lehman Brothers estimated that sidecars accounted for only about $4 billion to 4.5 billion in 2006, while CAT bonds are expected to have about $4 billion in issuances during 2006. What is clear is that both of these capital market products should have a permanent place in the catastrophic property insurance coverage arena.