In reporting its results this morning, global reinsurance firm Hannover Re has revealed significant growth in its insurance-linked securities (ILS) related activities, particularly in risk transformation and fronting for collateralised reinsurance.
Hannover Re has become increasingly involved in the ILS market, acting as a conduit for its ceding clients to access the capital markets as a source of reinsurance, facilitating deals for ILS investors and ILS funds, as well as using collateralised retrocession for its own protection needs.
The reinsurance firm has previously noted that this ILS related business has been growing steadily, while meeting its cost-of-capital and providing a valuable source of fee income.
While the reinsurer doesn’t clearly break out its fees earned from ILS related activities, it does reveal the amount of reinsurance limits transformed and fronted for, numbers which grew again in 2018.
In the collateralised fronting area of Hannover Re’s ILS related business, the volume of these transactions is measured by the ceded exposure limit of the underlying retrocessional reinsurance agreements, which reached EUR 6.1313 billion by the end of 2018.
That’s a significant jump of 17% from the EUR 5.2352 billion of collateralised reinsurance limit fronted by Hannover Re a year earlier.
Hannover Re takes on some uncollateralised reinsurance risk from these transactions, something we discussed in a recent article on fronting trends here.
The reinsurer explains that its maximum risk of loss from these collateralised fronting transactions, based on the uncollateralised exposure limit and any credit risk from the collateral, reached EUR 3.0631 billion at the end of 2018, up 10% from EUR 2.7754 billion.
However, this is very remote risk and Hannover Re explains that this tail risk has an expected loss on a modelled basis in a worst-case scenario of 10,000 years that at maximum reaches EUR 50 million.
That demonstrates the remote level of risk involved in the tail Hannover Re takes on from ILS funds, so despite the fact some question whether fronters are paid for this risk, it can be so remote as to be very cheap to hold for a diversified reinsurer like Hannover Re.
In terms of gross premiums involved, Hannover Re does not break out is ILS business, but it does report EUR 2.9261 billion of premiums in 2018 for its structured reinsurance and ILS business combined.
That figure grew by 12.2% from the prior year, as these large structured reinsurance and ILS transactions become an increasingly attractive source of income for Hannover Re. This business also came in below target for its combined ratio, at 97.7%, suggesting more than acceptable profitability.
In fact, operating profit (EBIT) increased to EUR 129.3 million for this structured and ILS business, up from EUR 94.8 million in 2017.
In 2018, Hannover Re worked on US $1.5 billion of catastrophe bond transactions as well, where it acts as a ceding reinsurance company to help clients access the capital markets.
During the year, Hannover Re also expanded its work in collateralised reinsurance.
“In collateralised reinsurance business we continued to step up our cooperation with selected fund managers and in so doing generated attractive margins. It was also pleasing to note that we were able to further expand the transfer of life reinsurance risks to the capital market,” the reinsurer explained.
With reinsurance markets still pressured by weight of capacity, thanks to ongoing investor demand for access to insurance risks, Hannover Re is ensuring it can earn income from these trends, even when some areas of risk may no longer sit as profitably on its own balance-sheet.
For 2019 the reinsurer expects to sustain its volumes of structured reinsurance and ILS business.
The company said, “In the area of insurance-linked securities (ILS) we essentially expect to see continued growth in demand. Investors are seeking a negative or minimal correlation with other financial investments and hence greater diversification. We are responding to this market situation with a strong emphasis on service, offering individually tailored solutions – from collateralised reinsurance to the transformation of catastrophe bonds – for property and life reinsurance risks. Over the coming years we expect our ILS activities to deliver a positive and consistently rising profit contribution.”
Hannover Re also used the capital markets for a little more retrocession capacity at the January renewals, with growth seen in its K-Cessions sidecar vehicle to around $650 million.
Hannover Re continues to position itself as a route for capital markets investors to access reinsurance risks, becoming an increasingly important player in the collateralised reinsurance fronting market.
With a gap left in that market due to the removal of Tokio Millennium Re, but others looking to step in including Arch, Hannover Re may also find it is in more demand for standing in between investors and insurers in the year to come.
However, the trend towards investors seeking to establish their own reinsurance platforms, to become less reliant on fronting, is another one that is developing and could see the pendulum swing the other way if enough of the major ILS funds choose this route in the years ahead.