NEW YORK (CNN/Money) -
For some hedge funds, getting involved in the reinsurance business looked like a good idea last year, when some high-profile shops set up reinsurance operations. Then came the $16 billion hurricane.
Cash-rich and hungry for untapped investment opportunities, a handful of hedge funds set up or invested in firms that specialize in reinsurance, which is coverage that insurance companies buy to pass on some of their risk to a third party – essentially, an insurance policy for an insurance policy. When insurance companies get hit up by their policyholders, the insurance companies in turn hit up the reinsurers.
While the full amount of monetary damages from Hurricane Katrina won't be felt for weeks, it could end up costing between $9 billion and $16 billion in insured losses, according to estimates from risk modeling firm Eqecat.
"There are some hedge funds that have made pretty sizable investments in specialty reinsurers," said Bob Cooney, chairman, president and CEO of Max Re Capital, a Bermuda-based reinsurer. "They tend to be private reinsurance companies, and they probably have a meaningful exposure -- anyone who is in the space will be affected by the loss (from Katrina) because it's going to be a big one."
Cooney said hedge funds generally have exposure to reinsurance companies in one of two ways. Either they have made equity investments in publicly-traded reinsurance companies, which they view as an asset class that is not correlated to the traditional equity and bond markets, or they set up their own reinsurance operations.
"I think what attracted hedge funds (to the reinsurance business) was that these are random events that don't correlate to bond markets and stocks, and you get certainty pretty quickly," said Cooney. "You either have the loss or you don't."
Most hedge fund managers underwriting this kind of business do not allocate more than 5 percent of their total capital to it, according to Risk & Insurance, a trade publication tracking the insurance industry.
"Any reinsurance company that is involved in property reinsurance will probably feel some effects," said Cooney. "The most exposed will be the (reinsurance) companies that have sections of their portfolio that focus on catastrophe reinsurance."
Last year, Citadel Investments, a Chicago-based hedge fund firm with an estimated $12 billion in assets, invested a reported $450 million in Cig Re, a Bermuda-based reinsurer that specializes in catastrophe insurance for events like hurricanes and earthquakes.
Last December, startup Glacier Re, which specializes in property reinsurance, got funding in part from some hedge funds, including legendary hedge fund manager George Soros' eponymous firm, and Dallas-based HBK Investments.
There were also some early adopters. Max Re formed in 1999 with funding in part from Moore Holdings LLC, a division of New York-based hedge fund Moore Capital. (Max Re in turn invests some of its assets in investment funds Moore manages.) Bermuda-based Nephila Capital, a hedge fund that invests in insurance-linked securities, catastrophe bonds, insurance swaps and weather derivatives, also formed in 1999.
Cooney said it will take months for companies to realize the true magnitude of the loss.
Others may have profited
But some hedge funds may have actually gained from the havoc wreaked by Katrina. Funds with long positions in energy at the start of the hurricane benefited as prices shot higher after Katrina tore through the Gulf of Mexico, where many oil and gas refineries are located.
"My best guess is that people really didn't get hurt that much because the markets were pointed up," said Rajpal Arulpragasam, president and CEO of Archetype Risk Advisors, a New Haven, Conn.-based quantitative investment firm. "This wasn't a situation where people were short and got their faces ripped off because you had a spike."
Oil hits record near $71: Click here.
How much will Katrina cost? Click here.