Reinsurance Sidecar

What Is a Reinsurance Sidecar?

A reinsurance sidecar is a financial entity that requests private investment in a quota share treaty with an insurance company. In the quota treaty the ceding company and reinsurer share premiums and losses as per a fixed percentage. Investors who partake in reinsurance sidecars share in premiums and losses from the guaranteed policies. Profits and losses will be in proportion to the amount invested.

How a Reinsurance Sidecar Works

Insurance companies normally set up reinsurance sidecar structures to endorse some portion of their book of business. Commonly, existing reinsurers will make sidecars as they try to spread the risk among third-party investors, for example, hedge funds and equity firms.

Reinsurance is insurance for insurers or stop-loss insurance for these suppliers. Through this cycle, a company might spread the risk of underwriting policies by relegating them to other insurance companies. The primary company, who initially composed the policy, is the ceding company. The subsequent company, which expects the risk, is the reinsurer. The reinsurer gets a customized share of the premiums. They will either take on a percentage of the claim losses or take on losses over a specific amount.

Reinsurers will make sidecars as they work to spread the underwriting risk they have assumed. As they can sell the sidecar to third-party investors, they might reduce the dollar amount of risk displayed on their accounts. This reduction in claim risk will permit the reinsurer to expect the extra risk from a ceding company. The 2005 tropical storms of Katrina, Rita, and Wilma caused insurance rating agencies, as A.M. Best, to set new reinsurer capital requirements. These companies made more sidecars to free up this capital, and the reinsurance sidecar market developed.

While sidecars can technically have quite a few cedents, their relatively clear nature makes them appealing for individual companies as a method for raising capital and increase underwriting capacity. For third-party investors, sidecars offer the potential for high-yield investments with relatively limited risk due to their limited duration and flexible structure.

Special Considerations

Reinsurance sidecars have risks and rewards like other quota share treaty agreements. Investor returns rely on claim rates on the underlying policies covered by the sidecar. The lower the claim rates during the sidecar's presence, the higher returns investors will see. This arrangement permits insurers to increase their underwriting capacity by selling a percentage of their risk portfolio of business to private or third-party investors.

Reinsurance sidecars appeal to investors as a result of the smaller scope of the book of business, or risk portfolio, guaranteed. The more modest book limits an investor's risk exposure relative to the more extensive set of risks, insurance types, or geologies generally present in an insurance company's full book of business.

In practice, this permits investors with almost no experience with insurance underwriting to participate in the insurance market with an experienced partner. Investors can likewise search out or arrange the types of policies they endorse, permitting them some flexibility in limiting their expected exposure. Since sidecars exist for a settled upon period, investors can exploit the reduced risk from the investment's more limited tail.

Reinsurance sidecars generally limit investors' exposure to their invested capital, since most require adequate investment to cover claims which emerge in the guaranteed policies. This means the risk of loss commonly equals something like the amount invested.

Highlights

• These sidecars are utilized by insurance companies to endorse a portion of their book of business.
• A reinsurance sidecar requests investment in a quota share treaty with an insurance company.
• Under the quota share treaty the ceding company and reinsurer share premiums and losses on a fixed percentage.