Global reinsurance firm Hannover Re continued to expand its activities in the fronting space, with the volume of limit fronted for insurance-linked securities (ILS) investors and funds increasing by 7% during the year.
Hannover Re has positioned itself as one of the key facilitators for the ILS market, with its activities spanning a number of different segments of the space.
The reinsurer acts as a conduit for its ceding clients to access the capital markets as a source of reinsurance, in catastrophe bond and collateralised reinsurance form.
Hannover Re also works with the capital markets by facilitating deals directly for ILS investors and ILS funds, who use the reinsurer as a fronted balance-sheet. The company also uses collateralised sources of retrocession for its own protection needs.
On the latter, Hannover Re has been steadily growing the size of its capital markets backed K-Cessions quota share retro reinsurance sidecar facility, which increased in size to $680 million for 2020.
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.
Hannover Re doesn’t break out how much in fee income it earns from its growing ILS related activities, but it does reveal the amount of reinsurance limits transformed and fronted for, numbers which grew again in 2019.
In the collateralised fronting area of Hannover Re’s ILS business, the volume of those fronted transactions is measured by the ceded exposure limit of the underlying retrocessional reinsurance agreements.
This figure increased by 7% during 2019 to reach EUR 6.5594 billion, up from EUR 6.1313 billion for the prior year.
Hannover Re does take on some uncollateralised reinsurance risk from these fronted ILS transactions, something we discussed in a previous article on fronting trends, but these tail-risks are particularly remote and either absorbed and held by the reinsurer, or perhaps hedged away elsewhere in its retro program.
The reinsurer explained 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 3.1259 billion as of the end of 2019, up 2% from EUR 3.0631 billion at the end of 2018.
Interestingly though, Hannover Re said that its tail-risk exposure may actually be lower, at a more reasonable actuarial level, saying that its collateralised reinsurance related tail-risk has an expected loss on a modelled basis in a worst-case scenario of 10,000 years that at maximum reached EUR 31 million at the end of 2019, which is actually down from a level of EUR 50 million a year ago.
That suggests either Hannover Re has hedged itself further, or the profile of risks fronted for ILS has become more remote at that modelled level.
The relatively small expected loss figure at the 1-in-10,000 year level is because the rest of this exposure can be considered so remote that it is very cheap for a reinsurance company of the scale and diversification of Hannover Re to hold.
Hannover Re doesn’t report the total premiums featured in these fronted collateralised ILS deals, but it does for the entire structured reinsurance and ILS segment of its business, where premiums grew over 23% in 2019 to reach EUR 3.6037 billion, up from 2018’s EUR 2.9261 billion.
However, the combined ratio for this business segment rose to 98.3% in 2019, up from 2018’s 97.7%, which contributed to a decline in operating profit (EBIT) to EUR 104 million, down from the prior years EUR 129.3 million.
Also of note, Hannover Re acted as a fronting and intermediary reinsurance carrier on some US $1.1 billion of catastrophe bonds during 2019, further underlining the reinsurers key role in the global ILS market.