XL’s McGavick: Hedge Funds Grow in Sophistication in Insurance Arena

Investors such as hedge funds and pensions are becoming more sophisticated as they partner with insurers, XL Group Plc Chief Executive Officer Mike McGavick said.

In the past, capital-markets partners would “pat you on the head and they’d say, ‘You just go kinda do some break-even underwriting for us,'” McGavick said today on a conference call with analysts. “As the year went on, it was very clear that the smart players in those alternative capital spaces started saying, ‘You know, actually underwriting matters too.”

Wall Street is seeking weather-related bets and other insurance risks in pursuit of assets that are uncorrelated with stock and bond markets. In some cases, insurance contracts can give investors a tax advantage or funds they can use to buy securities before paying claims.

McGavick said today’s $4.2 billion deal for Dublin-based XL to buy Catlin Group Ltd. will make his company a better partner for hedge funds and pensions. The relationships can help insurers boost income and diversify risks.

Traditionally, outside investors had mainly invested in catastrophe coverage. Now, as that market becomes more crowded, they are considering bets on some forms of specialty coverage as well, McGavick said.

“You had all this so-called smart capital out there that was all looking to apply their investment strategy, match it to some reliable pool of risk,” he said in a phone interview. “What really changed was that reliable pools of risk got harder to come by.”

It’s not clear whether investors will keep putting money into reinsurance, according to a report last month from the U.S. Federal Insurance Office. Some less sophisticated investors may not understand the risks, and the catastrophe bond market hasn’t yet seen big losses, according to the report.

Greenberg’s Vision

Ace Ltd., the Zurich-based insurer with operations in more than 50 nations, has said that the industry can play a bigger role in partnerships with hedge funds and other investors.

“I can envision a day when we aren’t simply accessing traditional reinsurers but originating risk globally that we package and distribute directly through the capital markets,” Ace CEO Evan Greenberg said in his annual letter to shareholders last year.

–With assistance from Oliver Suess in Munich and Jing Cao in New York.