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TheStreet Open House

SAC Capital's Next Hurricane

Stocks in this article: BRK.B BRK.A GLRE

NEW YORK ( TheStreet) -- Wall Street may believe SAC Capital Advisors faced a tsunami of bad news Thursday when the Department of Justice levied five criminal charges against the hedge fund, however, the firm and its billionaire head Steven A. Cohen remain exposed to other catastrophic events, including earthquakes, tornadoes, floods and hurricanes.

SAC Capital, as an investment manager for S.A.C. Re, is responsible for an unknown amount of reinsurance that could come back to bite the hedge fund, given its current state of distress.

A giant natural disaster and any prospective reinsurance claims against S.A.C Re could put the hedge fund at risk of having to cover losses. Meanwhile, SAC Capital may be challenged to make investments that cover the reinsurance S.A.C. Re has already underwritten, given criminal charges against the hedge fund, outflows of investor money and the prospect Wall Street trading counterparts cut ties with Cohen & Co.

The plight of SAC Capital could also bring to light long-held concerns about a rush of hedge funds into Bermuda's reinsurance market.

In addition to S.A.C. Re, David Einhorn's Greenlight Capital has controlled a reinsurance subsidiary called Greenlight Re (GLRE - Get Report) since 2004. Daniel Loeb's Third Point Capital filed a prospectus earlier in July for a $250 million initial public offering of its reinsurance subsidiary, Third Point Reinsurance. John Paulson-run Paulson & Co. controls PaCRe alongside minority investor Validus Holdings (VR), a reinsurer.

Are hedge funds plowing billions of dollars of hot money into the reinsurance market that is susceptible to large trading losses, investor redemptions or the criminal probes that often ensnare Wall Street hedge funds? The DoJ's charges against SAC Capital could be a major test.

In 2012, SAC Capital and private equity firm Capital Z Partners opened S.A.C. Re with $500 million of capital. The goal was to have S.A.C Re underwrite low-risk property and casualty reinsurance and have SAC Capital's hedge fund wizards profitably invest the reinsurance float.

So far, $500 million of S.A.C Re assets have been invested back in SAC Capital and it is unclear how much reinsurance the venture has underwritten.

A.M. Best currently gives S.A.C Re a solid financial strength rating of (A-), however, it highlights a convergence of underwriting risk and investment risk in the hedge fund industry as the firm's most significant challenge. The rating firm is assessing whether S.A.C. Re will be impacted by the DoJ's charges against SAC Capital.

Bloomberg reported earlier in 2013 that Paulson's PaCRe had only underwritten a minimal amount of reinsurance, while investing about $500 million into Paulson & Co. funds. It characterized hedge funds' reinsurance operations as a tax dodge and calculated that a combined $1.7 billion has been reinvested in Third Point, SAC Capital and Paulson & Co funds.

Greenlight Re does appear to have underwritten a significant amount of reinsurance. It reported net premium and investment income of $171 million and $60 million in operating income in the first quarter of 2013.

Warren Buffett of insurance and investment conglomerate Berkshire Hathaway sees hedge funds' entrance into the reinsurance industry as a perfectly legal way to defer taxes on their investment gains. However, Buffett said at Berkshire's May 4 shareholder meeting hedge funds have increased competition for premiums and made reinsurance pricing too low.

"Hedge funds have entered the reinsurance business quite aggressively in the last few years," Buffett said. He said Berkshire Hathaway wasn't going to push heavily into certain reinsurance markets given prevailing prices.

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