Hannover Re holds back ILS fund capital, cites cat bond pricing

German reinsurer Hannover Re, the anchor investor in the Leine Investment SICAV-SIF Insurance-Linked Securities Sub-Fund 1, told us that currently only about 25% of its seed capital has been deployed by the fund.

The first Leine Investment ILS fund launched in late 2012 with Hannover Re seeding the fund, as an anchor investor, with up to $150m of capital as well as providing assistance with the funds operation. The fund then opened to external investors, but to date has not accepted any third-party capital.

We spoke with Henning Ludolphs, Director of Hannover Re’s insurance-linked securities unit, who told us that market conditions in 2013 had made deployment of capital, while still meeting the ILS funds return targets, difficult.

The main reason that only 25% of the capital seeded into the fund has been deployed is the decline in ILS and catastrophe bond pricing over the course of this year. Mr. Ludolphs told us; “As an investor we are not very happy with cat bond pricing currently. The situation differs strongly from a few years ago where Hannover Re had invested around USD 150 m. in cat bonds through a previously operated ILS fund.”

The Leine ILS fund targets a benchmark return of LIBOR +5% after fees, following what Ludolphs termed a lower risk, adequate return strategy. The strategy is to invest across the more remote risks in the cat bond market.

Ludolphs continued; “Of course we see every cat bond transaction as it comes to market and we put in our bids as normal, but with many recent cat bond offerings we see the pricing drop too far for our targets.”

The Leine ILS fund has a mandate that means it cannot underwrite a lot of collateralized reinsurance. It is cat bond focused, so the fund cannot do what other ILS investment managers are now doing and increase the amount of collateralized reinsurance while reducing cat bond allocations.

Ludolphs explained that some cat bonds that sit in its target return range have too high an expected loss, while other bonds they would invest in if the price was a little higher.

The current market conditions have made deploying capital difficult for the Leine ILS fund, but Ludolphs said it would continue to assess new cat bonds on a case by case basis. “The fund is fortunate with Hannover Re as anchor investor not to be under pressure to invest,” Ludolphs commented.

“The technical pricing on cat bonds is in most cases still okay,” Ludolphs continued, “However the margins are increasingly being squeezed and additional management costs will have to be figured in as well. We’re happy to be hesitant in investing right now.”

The Leine Investment ILS fund is managed by its board of management. The fund maintains a similar investment philosophy to the one Hannover Re operated. With Hannover Re as anchor investor and members of the investment committee having been involved in the previous ILS fund it gives the fund a ready-made track record.

While the fund hasn’t taken on any third-party capital as yet, the ILS fund has been building relationships with potential investors and will be ready to call on them once market conditions are more conducive.

Ludolphs said; “If we (Hannover Re) do not feel it’s a good time to invest in cat bonds right now we certainly don’t want to take on external money at this time.”