NEW YORK, July 11 (Reuters) - Hedge fund and private equity investors are putting money into unusual insurance investment vehicles called sidecars, but some players have already lost big money and losses could mount if this year's hurricane season is anything like last year's, experts said.

These investors have poured $3 billion into sidecars since late last year, in expectation that recent price increases in reinsurance, or cover for insurers, will generate returns as high as 30 percent.

The vehicles are attractive to investors looking to get into the reinsurance business without having any underwriting experience.

Here's how sidecars work: A reinsurance company sets up a sidecar, using funds from outside investors, who agree to tie up their funds for two or three years.

The sidecar has almost no staff of its own, and the reinsurer that sets it up does all of the underwriting. The reinsurer shares some of the risk, and takes some of the premiums earned by the vehicle, in a contract known as a quota share.

Recent investors in sidecars include Boston-based hedge fund management firm Highfields Capital and Seattle-based private equity firm Farallon Capital Management LLC.

If the hurricane season turns out to be relatively benign, sidecar returns could be 20 percent to 30 percent. But if the hurricane season is as bad as 2005 -- when total insured losses reached nearly $60 billion -- investors could get burned.

In 2005, Olympus Reinsurance Co. Ltd., a Bermuda-based sidecar, saw its $650 million in capital wiped out when the insurer it was linked to, White Mountains Insurance Group Ltd. <WTM.N>, experienced heavy storm losses.

"It's a lesson for investors," warned White Mountains Chairman John "Jack" Byrne, who had personally invested in Olympus. "Sidecars are not without risk," he said in an interview.

"There will be other examples," Byrne added. "It is the nature of the business: Every four to five years we get shocked."

A DUMPING GROUND?

Leucadia National Corp.<LUK.N>, a New York-based conglomerate lost $48 million in Olympus. Other investors to get burned included investment management firms Fairholme Capital and Third Avenue, and hedge fund firm Och-Ziff Capital Management.

Leucadia blamed bad underwriting for its losses, and that may be where investors need to be most careful: making sure they've invested with a good underwriting team, said Andre Perez, a consultant to sidecar sponsors and investors.

"Underwriters are not all created equal," Perez said.

Donald Light, an analyst with Celent LLC, said investors need to make sure insurers don't use sidecars as a dumping ground for their worst risks.

"Insurers that use sidecars for reinsurance have to exercise the same level of diligence as with any other partner," he said.

White Mountains last month saved a second group of sidecar investors from being wiped out when it reimbursed Olympus for additional storm losses, Byrne said. But investors cannot expect such relief in most cases.

Lois Herzeca, a lawyer who has advised on three of the 10 most recent sidecar deals, said investors need to be comfortable with all the details before signing on. "Once you invest you are stuck there."

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By Lilla Zuill

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