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24 FINANCE DUBLIN | OCTOBER 2013

Asset managers turn to the industry for uncorrelated investment returns

An increasing number of asset managers are setting up reinsurance companies as a way of increasing while giving investors exposure to a new asset class writes EY's FERGUS MCNALLY. Ireland is well positioned to benefit from this trend due to its strong position as a re/ centre and industry specific professional services expertise he writes.

cross the Atlantic a trend has established, this model also benefits the What are the benefits from the asset started to emerge in the traditional asset manager through establishing managers perspective? Ahedge fund industry which could ‘permanent capital’. drive new business to Ireland. Asset The business model Raising Assets Under Management managers have been establishing works in that the (AUM) reinsurance vehicles as they seek to attract reinsurance entity This structure provides an offering for new investors and generate non-correlated will focus on its the asset manager and given the benefits and diversified returns. chosen lines of from an investor's perspective, there is an The idea of asset managers creating business from an increased ability to raise additional AUM. insurance/reinsurance companies isn’t underwriting This in turn, will allow the asset manager new. Warren Buffett was a pioneer in this perspective with to generate increased performance and space and one of Berkshire Hathaway’s investible assets management fees. Additionally, as first acquisitions after Buffett took being managed by the Fergus McNally exchange traded entities, they open the control, was to purchase a number of sponsoring asset possibility that investors who might insurance companies, wherein they used manager, who will earn management and the ‘float’ provided by these entities performance fees on these. “The reinsurance industry has (investible premiums) to finance been recognised as creating an Berkshire’s investment activities. So what are the benefits from an additional option and vehicle It’s no secret that for any asset manager, investors’ perspective? there are two key tenets for business for asset managers.” success: i) an ability to increase and Returns maintain assets under management; and Fund vehicles are the traditional otherwise have been precluded from (ii) an ability to generate market beating mechanism through which investors gain investing with the asset manager might returns. access to a particular asset manager’s now invest through this avenue. expertise. By investing directly in a reinsurer instead of into a fund, the Permanent Capital “The business model works in investor will generate the same return The capital raised in the reinsurance that the reinsurance entity will together with the potential of additional entity is permanent capital, removing the focus on its chosen lines of uncorrelated risk in the form of a return on ever present threat for asset managers of business from an underwriting reinsurance underwriting activities. unforeseen redemptions. Every investor perspective with investible who converts their direct investment from assets being managed by the a into an investment in the “The capital raised in the reinsurer, converts a redeemable sponsoring asset manager, who reinsurance entity is investment into permanent capital from will earn management and permanent capital, removing the asset managers perspective. Once the performance fees on these.” the ever present threat for reinsurer is public, the investors can sell asset managers of unforeseen their investment in the reinsurer on a real In 2012, we began to see the emergence time basis without any reduction in the of start-up reinsurers backed by traditional redemptions.” capital of the reinsurer, and thus AUM for hedge fund managers including Third the asset manager remains unchanged. Point, Greenlight Capital, SAC Capital, Liquidity AQR and Paulson & Co. The reinsurance Typically the intent is for the Free Money to Invest industry has been recognised as creating reinsurance entity to be taken public The reinsurance entity will also have an additional option and vehicle for asset within a reasonably period of time, the benefit of using 'free money' (i.e. its managers. which means that the investor will get reinsurance premiums) - through the sale The key business rationale is to raise daily liquidity (i.e. they can sell their of reinsurance contracts, the reinsurance capital via private placement with a view shares in the reinsurance entity any day premiums collected by the reinsurer will to achieving a public exchange listing the exchange is open) versus the typical be available to be invested by the asset within a short period of time. The initial redemption restrictions associated with manager. Thus, in addition to the initial capital typically comes from the investing in a hedge fund. Third Point capital that is managed, the reinsurance sponsoring asset manager, its’ founders listed their Reinsurance vehicle on the company will generate additional assets to and outside investors. Since this is not a New York Stock Exchange in August of be managed, generating additional fees for traditional fund vehicle where investors this year. the asset manager. Typically, reinsurance can subscribe and redeem at will, once entities have investable assets of 1.5 times FD October 2013(Combined_5)_Layout 1 04/10/2013 12:15 Page 33

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their capital base. Therefore, there are compelling reasons for both an investor and an asset manager to want to avail of the business rationale of a reinsurance company.

And the risks... You are probably asking yourself, 'If it’s so attractive why isn’t everybody doing it?' Well, a reinsurance company does carry with it the possibility of unexpected payouts as a consequence of the premiums it writes. Therefore, in establishing such an entity, the people you have on the ground running the day to day operations will need to be experts in their field. The types of risk written will drive the risk profile of any investment. As noted earlier, from an investor’s point of view, there is a promise of liquidity, however depending on the entities performance and market “The idea of asset managers creating insurance/reinsurance companies isn’t new. Warren Buffett was a pioneer in this space and one of Berkshire Hathaway’s first acquisitions after Buffett took control, was to purchase a number of insurance companies, wherein they used “Every investor who converts the ‘float’ provided by these entities (investible premiums) to finance Berkshire’s investment their direct investment from a activities.” hedge fund into an investment in the reinsurer, converts a the world’s leading reinsurers with It would also revitalise the reinsurance redeemable investment into operations established here. This growth industry here and attract additional asset over 25 years, albeit we have seen a slight management expertise permanent capital from the While there are obvious challenges in asset managers perspective.” competing with other jurisdictions, “As exchange traded entities, Ireland has a very strong offering and is sentiment; this may not always manifest they open the possibility that strategically well placed to attract new itself. Additionally, investors expecting to investors who might otherwise investment. In order to do so, it is compare returns of this entity against have been precluded from important that we remain flexible by those of the fund they may otherwise have investing with the asset facilitating new business opportunities invested in need to remember that because of the underwriting exposures the manager might now invest through this avenue.” re-insurance entity takes, the correlation “Despite strong competition between the two will differ. from other jurisdictions, Ireland decline in the last few, has resulted in is a well-established, highly Why is this of interest to Ireland? Ireland building up significant industry Asset managers and their investors expertise in terms of workforce and regulated reinsurance location, looking to establish reinsurance entities industry specific professional services which puts it in a strong will need to determine an appropriate support. The needs of the market have position to attract these types domicile to establish the reinsurance resulted in the development of specialised of vehicles. “ vehicle, which will be impacted by the service providers for outsourced services, regulatory framework, tax regime and which can assist in the set up and day to and responding to international ability for the entity to find appropriate day running of entities. Running developments. A highly regulated, expertise on the ground. alongside all of this, Ireland is an onshore business friendly environment is key to Despite strong competition from other location with a transparent tax regime and asset managers and their investors. This jurisdictions, Ireland is a well-established, extensive network of double taxation flexibility together with the solid highly regulated reinsurance location, agreements. foundations that have been built over the which puts it in a strong position to attract As has been demonstrated in the asset last 25 years should mean that Ireland is these types of vehicles. management industry, increased well placed to continue to win in this new The international insurance industry in employment in the wider financial business opportunity against other Ireland is approaching its 25th birthday services sector is the key opportunity. European locations such as Luxembourg and over those 25 years, Ireland has This not only includes adding to the and Switzerland and take advantage of established itself as a global centre for insurance expertise already here but also international developments and the insurance and reinsurance, with the result encompassing the traditional resulting opportunities that come our way. that today Ireland is globally recognised, administration and custody providers who as a well regulated, reputable (re) could partner with the reinsurance entities Fergus McNally is a partner at EY. insurance location with more than half of and the traditional insurance providers.