A growing trend by cash rich hedge funds to invest in reinsurance may be broadening to include joint venture partnerships with established reinsurers.

Hedge funds have been making investments in catastrophe reinsurance, or ?cat?, bonds for several years.

The trend broadened a year ago to include hedge funds taking the bigger step of actually setting up traditional catastrophe reinsurance companies. In the latter case, hedge funds are backing the ventures and hiring veterans of the property catastrophe industry to run them.

Now, at least one established reinsurer ? Bermuda?s Montpelier Re Holdings Ltd. ? has jumped into a partnership with hedge fund manager West End Capital Management (Bermuda) Ltd., to form a new reinsurer, Rockridge Reinsurance Ltd., based in the Cayman Islands.

The number of hedge funds ? privately owned, cash rich investment vehicles that generally can boast solid, higher than average returns ? has doubled in recent years as wealthy individuals and institutional investors, including insurers, have increased their investments.

Hedge funds have attracted more investors, according to a July report from global accounting giant KPMG and UK think tank CREATE, partly because ?of the prolonged bear market? with investors pessimistic about the returns they can get in the stock market, seeking alternative ways to grow their assets.

The situation has led hedge fund managers to seek more places to invest the growing pools of private money they oversee, as well as new ways to make returns ? hence, the increasing investments in catastrophe reinsurance.

Reinsurers sell insurance policies to insurers, and in the case of catastrophe reinsurance, insurers buy the reinsurance as a way to spread the risk from policies sold to protect against the cost of damage from catastrophic events, like hurricanes and earthquakes.

Bermuda-based Nephila Capital, set up in 1999, was an early example of a hedge fund investing in catastrophe bonds.

Catastrophe bonds allow insurance risk to be sold to institutional investors in the form of bonds, thus spreading the risk through the capital markets instead of by traditional reinsurance coverage.

Another Bermuda company ? CIG Re ? was set up last year as a proper catastrophe reinsurer. The company is backed by Citadel Investment Group, a Chicago-based hedge fund firm led by Kenneth Griffin, one of the hedge fund industry?s top traders, who got his start trading stock options from his Harvard University dormitory room.

The variations of ways hedge funds are investing in reinsurance comes as fund managers face pressures to outwit each other for new ways to maintain the high returns the industry is known for.

Montpelier?s foray into hedge fund-backed reinsurance may be a classic case of ?if you can?t beat them, join them?.

In its first quarter earnings report in April, Montpelier lamented that it was seeing more competition in the marketplace, largely as a result of softening market conditions, where reinsurance capacity exceeds demand, generally pushing down prices.

As prices fall, reinsurers may actually reduce the number, or value, of the policies they sell because the going rate may be too low to turn a profit.

Montpelier said softening market conditions were being compounded by hedge fund investments in reinsurance, a trend it referred to as ?the growth of a new class of competition in our markets?.

By June 1, Montpelier had put $10 million of its own money into Rockridge Reinsurance Ltd., a $90.9 million capitalised Cayman Island reinsurer backed by West End Capital Management (Bermuda) Ltd. and other investors, rather than stand by and watch hedge funds erode already fragile reinsurance capacity levels.

Under the Rockridge arrangement, Montpelier is set to increase its fee income, and boost its access to retrocessional reinsurance ? reinsurance for reinsuers. West End will manage Rockridge?s investment portfolio with a fixed income arbitrage approach.

Montpelier, in its second quarter earnings statement, said Rockridge was established to sell reinsurance for high-layer, short-tail risks to its reinsurance unit, Montpelier Reinsurance Ltd.

In effect, Rockridge?s reinsurance policies will only cover events that carry a high price tag, with high layer policies generally only kicking in if claims reach a specified multi-million dollar threshold. The likelihood of claims reaching those high levels with any regularity are slim. And the short-tail nature of the policies Rockridge plans to sell won?t bar West End from being able to make timely reports to investors.

Most hedge funds, driven by investor expectations, issue comprehensive annual updates on how the fund?s investments have performed. Most of the hedge fund investments in reinsurance seen to date have been in short-tail types of insurance where claims are generally settled quickly.

While its 11 percent stake hardly makes it Rockridge?s leading investor, Montpelier chief financial officer Kip Oberting explained Montpelier should profit handsomely from the arrangement because Montpelier frees up its capacity to sell more high layer reinsurance policies itself, as well an agreement that Rockridge will pay Montpelier service fees.

Mr. Oberting did not rule out Rockridge, one day, selling reinsurance to third parties but said the business plan, for now, was only to sell policies to Montpelier.

It is common for insurers to only buy policies from reinsurers that have a strong financial strength rating from industry ratings agencies like A.M. Best, Standard&Poor?s or Fitch Ratings.

Rockridge does not plan to seek a rating anytime soon, if ever, said Mr. Oberting.

To date only one hedge fund backed reinsurer, Swiss reinsurance company Glacier Re, has been rated.

Glacier was set up by HBK Investments Ltd. and Soros Fund Management, a fund of George Soros, a leading light in the hedge fund industry for his success as a hedge fund manager. The company has an A- (Excellent) rating from A.M. Best.

Most insurers shy away from doing business with a reinsurer that isn?t rated, but because hedge funds are flush with cash the necessity of having a third party attest to one?s financial strength may be reduced. This is because policies bought from hedge fund-backed reinsurers can be secured by letters of credit.

For flush hedge funds ?it?s probably not a big deal to post the collateral to support the obligations of this unrated company to a counterparty,? said Robert Cooney, chief executive of Max Re, a Bermuda reinsurer that is on the opposite side of this trend with it being an investor in hedge funds. About 30 percent of Max Re?s investment portfolio is in fund of funds, investment funds set up to invest in a variety of hedge funds.

Mr. Cooney sees hedge funds as a good place to invest (the company has had up to 50 percent of its investment funds invested in funds) because of a track record of high returns and low volatility.

It isn?t known if Rockridge will post some form of security behind the policies it sells to Montpelier. Montpelier?s partner in Rockridge, West End, is run by Mark Byrne, son of former White Mountains and Montpelier Re chairman John (Jack) Byrne.

White Mountains, a founding investor in Montpelier, is partly owned by Warren Buffett?s Berkshire Hathaway. Mr. Buffett, who is America?s second wealthiest man (after Microsoft?s Bill Gates), with a personal fortune of $44 billion, according to Forbes? annual survey, put $600 million of his own money into West End when it opened in 1998. The fund opened to outside investors in 2003.

Mark Byrne, who formerly ran a Berkshire Hathaway unit, is Mr. Buffett?s godson.

Outside investors put $300 million into West End?s main fund ?Value Capital LP ? bringing its total up to $950 million under management, according to a Bloomberg report last November. Mr. Buffett is committed to keeping his $600 million in the West End fund until at least 2007.

How long the trend for hedge funds to invest in catastrophe reinsurance will continue is a question on many minds, with some saying the staying power of hedge fund investments will be tested when claims from a serious storm, or other event come in.

Although 2004 was the worst year for natural catastrophe insured losses, after a wave of deadly hurricane and typhoon activity, most of the hedge fund backed ventures were still trying to get on their feet when these events hit, limiting exposure to those claims.

Chris McKeown, hired to run CIG Re after a career with ACE Limited?s catastrophe reinsurance unit, ACE Tempest Re, told The Wall Street Journal his company was ?committed to being a meaningful, long-term, differentiated provider of catastophe reinsurance?. Mr. McKeown did not return a call from The Royal Gazette for further information on CIG Re.

The reason some doubt the longevity of hedge fund investments in reinsurance is because hedge funds tend to only stick around if money can be made.

Although catastrophe reinsurance rates have been buoyed, especially in the Florida market, by last year?s storm activity, insurance and reinsurance markets in general, are showing signing of softening, or price declines.

?Hedge funds are known for their nimbleness to get in and out,? said Mr. Cooney, who said investors may be willing to do business with the new ventures, even if the long-term outlook for the companies is as yet untested.

?In this day, clients are realistic enough, and accepting, that if markets are very soft and underwriters are likely to lose money, there is going to be a pulling back.?