Credit Suisse creates "side pocket" in insurance fund

Credit Suisse will create a separate portfolio in its dedicated insurance-linked securities (ILS) fund to house any investments potentially exposed to losses from superstorm Sandy.

Credit Suisse will "side-pocket" all of its north-east U.S. hurricane investments exposed to possible events causing an insured industry loss of up to $35 billion, corresponding to 4.9 percent of the net asset value of the fund, the firm said in a note to shareholders on Thursday.

The so-called "side pocket" will protect new investors in its CS Iris Low Volatility Plus Fund from exposure to losses from Sandy.

"This will ensure that future value developments on the illiquid investments due to hurricane Sandy only accrue to shareholders that were invested at the time of the event," Credit Suisse said.

ILS are capital market vehicles that allow a company to shed a risk. The most common form of ILS is the catastrophe bond - in which insurers manage their exposure to natural disasters by passing on potential losses to investors.

A loss estimate from U.S. data aggregator Property Claims Service (PCS) - which is used to define whether an insurance event qualifies for a payout under the terms of the deal - put insured losses from Sandy at $11 billion, but this figure is expected to dramatically increase.

PCS raised its estimates for 2011's Hurricane Irene by nearly 18 percent to $4.3 billion from its previous report.

The uncertainty around Sandy's loss has made a large portion of Credit Suisse's fund illiquid.

"Until there is more certainty around the loss range and whether (and to what degree) these positions will be impacted, the guarantees and associated collateral cannot be released," the firm said.

Side pocketing is a common practice for hedge funds, which developed it during the credit crisis, when buyers for many assets disappeared and investors started demanding their money back.

Hedge funds created side pockets that could be wound down separately to stop clients who redeemed later from being left with the hard-to-sell assets.

- For more details on cat bond transactions, see the Thomson Reuters Insurance Linked Securities Community, click on http://financial.thomsonreuters.com/ils.