Tuesday, I had lunch with Gene Mueller, who is an attorney at Mueller Carey and an expert on insurance. We talked about last week's IPO of Greenlight Capital Re (NASDAQ:GLRE). "The company's young hedge fund superstar David Einhorn is making large bets with shareholder dollars," Mueller said. "Einhorn took 18th place in the World Series of Poker in Vegas last year, with both his baseball cap and chair turned backwards in true contrarian fashion." The IPO was not contrarian, though. On its first day of trading, the stock rose 26%.
Greenlight provides reinsurance coverage for post-Katrina catastrophic risks. A big chunk of the business is in Florida, and the company charges fat premiums. It's a large market, and there are major competitors like XL Capital (NYSE:XL) and PartnerRe (NYSE:PRE).
While traditional reinsurance companies tend to invest in safe fixed-income vehicles, Greenlight instead relies on the performance of Einhorn's hedge fund operation -- DME Advisors. Over the past 10 years, he has had a phenomenal track record, and he follows the investment principles of Berkshire Hathaway's (NYSE:BRK-A) (NYSE:BRK-B) Warren Buffett. Some even think he could be the next Buffett.
The problem is that Einhorn has made some blunders lately. One of his big bets was on subprime lender New Century. The company is now mired in bankruptcy. In Q1, DME Advisors posted a 4.2% drop in its portfolios, so Greenlight had a net investment loss of $14.3 million.
"Based on the two-year and one-quarter results, it looks like Greenlight will need to make sound underwriting bets to ensure they have the capital for payouts," said Joseph Pellis II, an attorney at Reed Smith who specializes in insurance. "I personally would not want to have a model where the investment return is less than a positive number. Underwriting performance is tough enough without making it pick up losses on the reserve dollars." (You can read the full interview on my Motley Fool CAPS blog.)
And what happens if there are major hurricanes this year and the losses pile up? It could be a big problem for shareholders. Foolish investors could lose a lot of green on Greenlight, an insurance stock that could have above-average risk.
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Fool contributor Tom Taulli, author of The Complete M&A Handbook, does not own shares mentioned in this article. He is ranked 2,817 out of 29,306 rated investors in Motley Fool CAPS.
