Flagstone Re, a new Bermuda reinsurer formed by hedge fund company West End Capital, will profit from the group?s in-house capital markets expertise, say management, as convergence between financial and insurance markets accelerates.

?The capital markets and the reinsurance markets have been coming together at a very rapid pace over the last couple of years,? said chairman Mark Byrne, in an interview last week.

Capital markets investors are drawn to investing in the sector because the risk of losses are uncorrelated with bond and equity markets. And the sector is also under improved profit forecasts based on a surge in demand after increased hurricane activity over the last two years.

Flagstone, one of a string of reinsurers formed late last year after record hurricane losses, is mostly focused on selling property-catastrophe policies. ?This is where we think there has been the biggest dislocation in the market,? said chief executive David Brown. And the new reinsurer also looks poised to capitalise on surging interest in insurance-linked investments: It is currently pursuing a structured financial transaction that will spread risk to capital market investors.

Details of the transaction won?t be unveiled for a few weeks, Mr. Byrne said, citing regulatory restrictions that bar him from divulging specifics until the deal is closed.

During the first two months of the year, investors poured $2 billion into catastrophe bonds, one of the most popular insurance-linked investments. That is more than double the amount invested during the same period a year earlier, and is equal to the entire issuance in the sector from 1988 through 1996.

Hedge funds have been front and centre with investments since the markets began to converge.

Reinsurers? primary business is to sell policies to other insurers, spreading the risk of losses. And a certain degree of investing savvy has always been required because insurers count on additional income, often a significant portion of earnings, to be made off investing premiums.

As investor interest in the sector has grown, particularly from hedge funds, so has the range of products being created to tap the increasing investments. And the advent of insurance-linked investments stepped up the need for investment acumen as the opportunities to profit from convergence between the two markets expanded.

Flagstone isn?t the first reinsurer to be formed by a hedge fund company ? a number of other Bermuda-based reinsurers count hedge fund firms as parent companies. And generally the hedge fund puts up the money and leaves the underwriting of policies to hired industry experts.

West End was Flagstone?s sponsor, and Mr. Byrne?s father, insurance icon John (Jack) Byrne, made a personal investment. Lehman Brothers Merchant Banking, and Lightyear Capital, a New York-based private equity firm, rounded out institutional investments, bringing Flagstone?s capital up to $715 million.

But unlike some its hedge fund peers, West End didn?t have to look outside to find Flagstone?s management. It tapped its own principals to do double duty, naming Mr. Byrne Flagstone chairman and Mr. Brown chief executive. Both previously worked in the insurance sector, and say they had been toying with the idea of forming a reinsurer for some time.

Mr. Byrne was previously chairman and chief executive of Gen Re securities, a former division of Berkshire Hathaway Inc., one of the most profitable insurance groups. And Mr. Brown was formerly chief executive of Bermuda reinsurer Centre Re.

Beyond the benefits of marrying the capital markets expertise residing in West End with the investment opportunities created by forming a reinsurer, Flagstone is also set to capitalise on cost benefits from its relationship with the hedge fund firm, management said.

West End is handling some of Flagstone?s investing activity, and is also overseeing the investment activity for a portion being outsourced to another investment firm.

Flagstone, which shares West End?s Church Street premises, has also been able to quickly form satellite offices in Halifax, Nova Scotia and in India, by moving into existing West End premises.

?We think it reflects the realities of Bermuda in 2006,? said Mr. Byrne, citing the decision to spread Flagstone?s operations over the the three geographically diverse offices. ?This plan doesn?t require parachuting 30 people from overseas into Bermuda.? Flagstone has also hired an international business development officer, based in London.

In Bermuda, Flagstone?s personnel are ?highly composed of Bermudians, permanent residents and spouses of Bermudians,? Mr. Byrne said. The reinsurer?s key decisions, including underwriting, are made in Bermuda, he added. More labour-intensive services such as accounting and claims are handled out of Halifax, while research and development specialists are based in India.

?One of the advantages, with working out of different time zones, is that if we get a submission that we are interested in we can turn it around, model it and come back with an answer in a very short period of time,? said marketing manager Brent Slade.

?This isn?t some kind of theory that Mark and I dreamed up,? said Mr. Brown. ?It has worked so well for West End that it was a logical extension that it would work well for Flagstone.?

Mr. Byrne said the model also makes Flagstone one of the most cost efficient reinsurers to run.

West End has developed its business model since forming its main fund, Value Capital LP, in 1998.

Flagstone isn?t divulging the value of the business it has won nsince it started selling policies on January 1. The privately-held company doesn?t set premium targets, Mr. Byrne said. And he characterised business so far as ?well above expectations?.

He added that Flagstone?s $715 million capitalisation has already grown to include retained earnings. And he said the company?s capital is seen as adequate to take advantage of current market opportunities.

Flagstone expects business prospects to continue to be strong. More insurance companies are now buying reinsurance, Mr. Brown said. ?Their models are telling them that they are probably more exposed (to losses) than they thought they were and the rating agencies are forcing discipline.?