German global reinsurance firm Hannover Re has embraced insurance-linked securities (ILS) and collateralized reinsurance in 2014, expanding its cooperation with a select group of ILS fund managers during the year.
The large globally diverse reinsurers have differing approaches to ILS and the continued entry of third-party capital into the reinsurance market. Hannover Re is one that has learned to enjoy the benefits of the capital markets, leveraging it for its own retrocession needs as well as earning fees and commission from working on behalf of, or alongside, ILS fund managers and capital.
Reinsurers like Hannover Re stand to benefit from ILS and alternative capital in a number of ways. Firstly by using it as a lower-cost source of retrocessional capacity, to help them to offload risks to the capital markets. Secondly, by establishing sidecars and facilities that allow them to underwrite more business with the backing of third-party capital. And thirdly, by providing services to ILS managers and capital to enable them to more efficiently access insurance and reinsurance risks.
Hannover Re has been active in all three ways in the capital markets in the last year and has clearly shown its appreciation for the multiple ways that third-party capital can help it to reduce its own cost-of-capital, something that all three of the examples above assist with.
In its annual results, which the reinsurer reported yesterday, Hannover Re expressed pleasure at the growing cooperation between it and the ILS space as it increasingly works to facilitate, front and transform collateralized reinsurance and insurance-linked securities deals for partners.
“In the year under review we continued to expand our cooperation with selected managers of investor funds in the area of collateralised reinsurance business and thereby generated attractive margins,” the reinsurer explained.
As Artemis explained just last month, Hannover Re placed over EUR 3.135 billion worth of collateralized reinsurance contracts on behalf of ILS investors in 2014, which is estimated to be approximately 10% of total collateralized reinsurance activity.
The reinsurer explained; “As part of its extended Insurance-Linked Securities (ILS) activities, Hannover Re has concluded so-called collateralised fronting arrangements under which risks assumed from ceding companies are passed on to institutional investors outside the Group using structured entities (special purpose entities). The purpose of such transactions is to directly transfer clients’ business. The volume of the transactions is derived from the ceded exposure limit of the underlying retrocession agreements and amounted to EUR 3,135.3 million as at the balance sheet date.”
The result of this work, with ILS managers and investors, is income in the low double-digit million Euros region, providing another valuable revenue stream for the reinsurer in the currently pressured market environment.
Hannover Re notes the continued strong growth in the ILS and alternative reinsurance capital markets, with; “Demand on the capital market for ILS products shows no signs of easing.”
As a result of this demand Hannover Re has itself been able to consistently bring a portfolio of its own risks to investors through its ‘K’ series of quota-share deals, with K-Cessions being the newest incarnation of these deals at $400m in 2015.
Hannover Re noted that 2014 saw “another strong inflow of cash into the ILS market. In the first place, investors value the low correlation with other financial assets and the associated diversification, while at the same time they also find the market for insurance risks relatively appealing in comparison with other investments.”
The decline in catastrophe bond pricing has helped to drive interest in accessing reinsurance in other ways and the collateralized reinsurance market was a significant beneficiary of this investor demand in 2014.
This growth has benefitted the fronting and transformation work that Hannover Re performs, helping it to expand its work with the selected group of ILS fund managers that find a rated reinsurers assistance in accessing risks invaluable.
The other side of the ILS market where Hannover Re has an interest is as an investor, where it invests in catastrophe bonds itself alongside ILS investment manager Leine Investments. However the decline in catastrophe bond pricing has resulted in a pull-back on these activities at Hannover.
The reinsurer explained; “When it comes to investing in catastrophe bonds, on the other hand, we showed restraint on account of the sharp decline in prices.”
Hannover Re’s cooperation with ILS fund managers is likely to continue to grow, as the reinsurer finds its rating and access to reinsurance business a draw for investors in ILS.
The reinsurer said; “Along with protecting our own peak exposures, we make use of the broad range of opportunities available here, particularly in collateralised reinsurance business. Over the coming years we expect to see a positive and steadily rising profit contribution.”
In 2015 so far Hannover Re has already seen continued growth in this collateralized reinsurance fronting and ILS, with CEO Ulrich Wallin expressing an expectation that growth will continue through 2015 during the reinsurers analyst call yesterday.
The reinsurer could even use these relationships to help it to grow in the challenging market environment, using ILS capital from managers alongside its own to the benefit of cedents, the ILS managers who can gain access to more risks and to itself from the increasing ILS related revenue stream.
In this way, the ILS fund managers that Hannover Re works with could almost be considered a flow of capital that can be leveraged as required and as opportunities allow, almost like a sidecar but with the ability to turn the flow on and off again.
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