Sidecars - Overview
While not a new concept, so-called “Sidecars” have been more popular in the post-Hurricane Katrina era as a mechanism for allowing capital market investors to participate in the underwriting results of a specific class of business of an insurer or reinsurer. The structure allows reinsurers to increase capacity and for investors to participate in underwriting profits.
A sidecar is typically set up with a limited lifespan of one or two years, possibly with options to extend the reinsurance arrangement based on the cumulative results of the ceded business.
A more extensive presentation on Sidecars is included in our Information Center.
There are several motivations for forming a sidecar from both the investors’ and the cedant’s points of view:Investor’s Motivations
Swift access to current reinsurance market conditions
Sidecars provide an opportunity to respond to and benefit from improving market conditions. Partnering with an established re/insurer allows immediate access to the market. Bermuda legislation and practice allows for incorporation and licensing of a suitable corporate vehicle in a matter of weeks.
Bank on expected high returns prospectively
Investors will expect to benefit in the cedants demonstrated track record of profitability.
Access to underwriting expertise
Sidecars make use of the proven underwriting ability of the cedant, removing the need to hire an underwriting team in-house (an expensive, time-consuming and potentially risky process).
Relative ease of entry and exit
The sidecar’s capital can be immediately deployed reinsuring a mature book of business, without the need to develop re/insurance relationships with multiple insureds. The short-tail nature of the covered risk lends itself to relatively easy and painless exit once the reinsurance agreement has run its course (although it is important to consider the exit process in detail before entering the deal, to ensure that investor and cedant interests are aligned).
Structured to last one or two years; sidecar deals usually run for one or two years, with options to extend based on results of the initial year(s). Investors may therefore have the opportunity to redeploy funds in other projects after the sidecar has run its course.
No need to set up infrastructure
A sidecar does not need underwriting, marketing, and administration departments. No office space is required. Typically, such back-office activities are sub-contracted to a suitably experienced Insurance Manager.
Asset class diversification and/or Arbitrage
Sidecars provide a ready opportunity for investors to diversify into an industry with little correlation to their current investments.
No legacy issue vs. Equity transaction
Establishing a new corporate entity for the transaction eliminates the risk of any legacy issues associated with buying into an existing entity. There are no prior transactions that could unexpectedly taint the current transaction.
Capitalize on franchise value via override and profit commission
The cedant is able to leverage additional value for its bottom line by the negotiation of override commissions and profit commission.
Provide additional underwriting capacity
The sidecar effectively provides surplus relief for the cedant. The additional underwriting capacity allows the cedant to take advantage of other profitable opportunities that it might previously been constrained from undertaking.
Possibly allow for more influence to dictate market terms
Following on from the previous point, the cedant may be in a position to take a bigger share of reinsurance opportunities, putting it in stronger negotiating position.
Easier than raising capital
Structuring a quota share reinsurance agreement, including collateral provisions, is a relatively straight forward process that provides the cedant with immediate access to additional capacity. This contrasts with often onerous public offering procedures required for capital raising. Additionally, the cedant has built-in flexibility in that the ‘capital’ provided is for a short and finite period, and may be restructured in a subsequent deal on maturity of the sidecar.
Avoids dilution of shareholders’ equity
The equity position of existing shareholders is not diluted at all by the additional capacity provided by the sidecar.
Possible replacement of retro program
The ability to cede a portion of its business to the sidecar may favorably impact the cedant’s needs for other retro protection.