Paulson Reinsurer Lags Peers in Sales in First Year

Billionaire John Paulson’s Bermuda venture, which positions its owners to avoid taxes on hedge fund earnings by routing money through a reinsurer, sold about 3 percent as much coverage as competitors in its first year.

Pacre Ltd., set up by top executives at Paulson’s New York hedge fund firm, collected about $11 million of premiums in the year ended March 31, or 2.3 percent of shareholders’ equity, according to results released last week. The average ratio for 13 publicly traded Bermuda reinsurers is about 68 percent.

Hedge fund insurers are gaining in popularity, with three Bermuda ventures last year investing a combined sum of about $1.7 billion with the U.S. managers who set them up, Bloomberg News reported this year. The U.S. Internal Revenue Service said a decade ago that some insurance companies based in tax havens may be hedge funds in disguise, and shouldn’t qualify for the tax benefits the insurance industry enjoys.

While insurers may earn investment income, they need to be “primarily” in the business of underwriting risk in order to qualify for the tax advantages, the IRS said in its 2003 notice. The notice didn’t quantify how much insurance is enough. Reinsurers sell coverage to other insurers.

Paulson executives set up Pacre last April with $450 million of their own money, and an established Bermuda reinsurer, Validus Holdings Ltd., contributed $50 million. The initial capital was invested in Paulson & Co. hedge funds.

Disaster Coverage

Armel Leslie, a spokesman for Paulson, declined to comment. Validus Chief Executive Officer Ed Noonan, in an April 26 interview, labeled as “nonsense” the idea that Pacre is a tax dodge.

Pacre specializes in selling protection against the most unlikely natural disasters. Because of the remote chance of triggering its policies, the venture collects only a small amount of premiums compared with the amount of protection it’s selling, Noonan said on a conference call last year.

Pacre planned on selling policies in its first year that would provide $170 million in protection for clients, or about a third of the reinsurer’s capital, Noonan said on the call. That amount would only be needed if Pacre had to pay out on every policy in full, according to Noonan.

The capital that Pacre holds is necessary to meet regulatory requirements and maintain a “strong” credit rating, Validus said in a written statement. Pacre has a financial-strength rating of A- from A.M. Best Co.

Investment Risk

“Pacre takes on a lot of risk underwriting the business,” Noonan said in the interview. “We also take on a lot of risk in the investment portfolio, much more so than other insurers or reinsurers. You can’t take on that much risk on both sides of the balance sheet and write the type of premiums that you would write in a traditional reinsurer.”

In its first year, Pacre experienced zero insurance losses, according to last week’s disclosures.

Pacre’s sales are dwarfed by other Bermuda reinsurance startups. Validus collected net written premiums of 48 percent of shareholders’ equity in 2006, its first full year of operations. For Allied World Assurance Co. in 2002, the ratio was 56 percent.

Other hedge fund-backed reinsurers’ plans called for selling more coverage than Paulson. Steven A. Cohen’s SAC Re, and Daniel Loeb’s Third Point Reinsurance Ltd., both of which started underwriting in Bermuda last year, targeted premiums of 30 percent and about 19 percent of equity in their first year, according to brokerage reports reviewed by Bloomberg. Neither is publicly traded.

Tax Rates

Cayman Islands-based Greenlight Capital Re Ltd., which counts New York hedge fund manager David Einhorn as chairman, sold about 53 percent last year.

Ordinarily, hedge fund investors pay either the 39.6 percent tax rate for ordinary income or the 20 percent long-term capital gains rate, depending on how frequently securities are traded, plus an extra 3.8 percent health-law surcharge. By routing money through a Bermuda reinsurer, which in turn puts assets into a hedge fund, investors can defer taxes until selling the stake. They then pay the lower capital gains rate.

So far, the Paulson Bermuda venture probably hasn’t generated any tax savings compared with direct bets in hedge funds, because the investments have lost money. The hedge fund stakes, bought for $500 million last April and June, were valued at about $475 million as of March 31, according to Validus disclosures.

Paulson’s taxes have been in the news for other reasons this year. In March, Bloomberg News reported Paulson was considering moving to Puerto Rico to lower his tax bill. He said four days later he wouldn’t set up permanent residence on the island.

Last week, he was scheduled to present a new fund to investors that would enable them to defer or avoid taxes on gains, according to an invitation obtained by Bloomberg News.

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