German reinsurance firm Hannover Re continued to grow its use of the capital markets as retrocessionaire and also source of fee income, by expanding its insurance-linked securities (ILS) activities during 2017, an area of the business it sees as growing while meeting cost-of-capital.
Hannover Re has been growing its ILS activities steadily in recent years, working in the risk transformer space, as a fronting partner for ILS funds and collateralized markets, and also ceding risk to third-party investors through its well-established retrocession program.
The reinsurer has found that it can access new sources of revenue and fee income, particularly in areas of property catastrophe reinsurance underwriting where risks no longer sit as well on its own balance-sheet, but the capital markets cost-of-capital is still attracted to sourcing such risks.
Hannover Re works with certain cedants to help them access the capital markets, acting as a fronting reinsurer and transformer to bring collateralized reinsurance capacity to them through the issuance of catastrophe bonds.
Additionally, it also helps investors and ILS funds to access reinsurance programs, by acting as a fronting reinsurer and transformer for their risk appetite as well.
In this way, Hannover Re can earn fee income from the appetite of ceding companies to access lower-cost capital from third-party investors, as well as from the appetite of those investors to access risks that it perhaps no longer wants to underwrite on its own balance-sheet capacity.
The reinsurer bundles the ILS business alongside its structured risk underwriting and sees both as areas of opportunity and growth.
Premiums grew in this segment of the reinsurers business in 2017, while at the same time the company reported a combined ratio across structured risks and ILS of 97.7%, coming in just below its maximum tolerable level for the year, showing that this business remained profitable despite the major loss experience from hurricanes and other catastrophes during 2017.
Hannover Re reported an EBIT margin of 4.7% for the structured risk and ILS business in 2017, down from 7.8% in 2016.
But the overall activity in that area of Hannover Re’s book increased dramatically in 2017, as structured risks and ILS only made up 14% of Hannover Re’s gross written premiums in property and casualty reinsurance a year ago, but for full-year 2017 the reinsurer reported structured and ILS GWP contributing a much larger 24% of the overall book.
That equates to gross premium volume for the structured reinsurance and ILS activities at Hannover Re in 2017 of EUR 2.61 billion, representing an increase of 99.2% over 2016.
How much of this growth was in structured risk underwriting versus in the ILS underwriting and facilitation business is not broken out, but Hannover Re clearly likes this area of the business, as it is one that has continued to earn its cost-of-capital while adding incremental income to the reinsurers bottom line.
Hannover Re highlights the “intensely competitive” state of the property and casualty reinsurance market when announcing its results this morning, also adding that “the market for catastrophe bonds continued to make capacity available” which no doubt heightened competition for the reinsurer.
But despite the competition it experiences, thanks to the growing influence of the capital markets in reinsurance, Hannover Re also benefits through its position as a market facilitator.
In its annual report the company noted that, “The strong demand on the capital market for (re)insurance risks remains undiminished, particularly given the diversifying nature of such investments.”
Hannover Re also said that the loss experience of 2017 underscores the important role that ILS investors now play in global reinsurance markets and the reinsurer itself will have benefited from this due to ceding some of its losses through to ILS investors that back its retrocession program and also its K-Cession sidecar structure.
“The ILS market shouldered a substantial portion of the catastrophe losses incurred in 2017,” the reinsurer explained, adding “Thereby underscoring the importance of ILS investors for disaster scenarios.”
The reinsurer said that it continues to make use of “the entire spectrum of opportunities offered by the insurance-linked securities market,” ranging from taking out retrocessional reinsurance direct from ILS investors, to activities that see Hannover Re “transfer risks for our customers to the capital market as a service.”
Hannover Re said that, in this business of collateralized reinsurance and catastrophe bond facilitation, “our business partners on the investment side are principally specialised ILS funds.”
While Hannover Re assisted on more than US $1 billion of catastrophe bond issues during 2017, specifically the $210 million Integrity Re Ltd. (Series 2017-1) cat bond for American Integrity, the $400 million Alamo Re Ltd. (Series 2017-1) transaction for the Texas Windstorm Insurance Association (TWIA), and the $350 million Cranberry Re Ltd. (Series 2017-1) for the Massachusetts Property Insurance Underwriting Association (MPIUA), it is the collateralized reinsurance fronting and transformation business that has experienced the most growth.
On collateralised reinsurance the company explained, “Hannover Re stepped up its cooperation with selected fund managers in the year under review and generated attractive margins.”
This collateralised reinsurance fronting and transformation business is not just growing in property catastrophe risks either, Hannover Re explained that, “It is also pleasing to note that we were able to further expand the transfer of life reinsurance risks to the capital market.”
Hannover Re is a major life reinsurance player and to be able to leverage the appetite of the ILS market for life risks, alongside its own capacity, will also provide a valuable way to grow that book overall while earning fee income for the risks it passes on to capital market investors.
Hannover Re has previously said that this ILS business generates it a source of “low risk and attractive margins” which alongside its use of ILS capacity for its own retrocession is all helping it to manage the results of its business at a time when rates can be challenging and competition high.
In fact, as we covered at the start of the year, Hannover Re increased the size of its regular K-Cession capital markets retrocession placement to $600 million for 2018, as the reinsurer continued to leverage ILS funding as a source of protection and to augment its own capacity.
So Hannover Re’s use of the capital markets is growing in all areas. As a source of retrocessional protection and as a source of fee income, meaning that an increasing share of the ILS markets underwriting flows through this traditional reinsurer.
However, it’s worth noting that where reinsurers like Hannover Re are providing a service to ILS funds as a front or transformer, the income received through this avenue may not always be around, as in time we’d expect that ILS fund managers will look to find ways to access risks more directly and cut intermediaries out of the transaction chain.
Of course, the reinsurer has enormous reach that ILS fund managers can leverage and capitalise on, so as a facilitator Hannover Re is an attractive partner and would be difficult to replace.
But paying fees to access risk is not ingrained in the ILS strategy. Hence we’d expect managers to look for more efficient ways to access underwriting in time to come, which suggests that the low risk, attractive margin fee business that Hannover Re is benefiting from at the moment may not last forever.