Insurance-linked securities (ILS) and alternative capital providers are not the enemy of the traditional reinsurance market, according to Hannover Re’s Head of ILS, Henning Ludolphs who was speaking in a recent press briefing.
A recent article by Bloomberg that covers comments made during German reinsurance giant Hannover Re’s recent renewals press conference on Tuesday 3rd February in Hanover, Germany, cites Ludolphs as describing the ever-expanding use of third-party investor backed capital markets capacity within the reinsurance market as “more friend than foe.”
Artemis wrote a piece titled, Alternative reinsurance capital; friend or foe? Perhaps compatriot?, back in November 2013, discussing the need for reinsurers to get on-side with the alternative capital trend or risk being left behind.
It’s encouraging to see that another of the big reinsurers is being more positive on ILS and alternative capital, as there has tended to be some negativity displayed in the past. But increasingly the large global reinsurance firms are realising that they need to embrace the alternative capital trend and adapt to the changing market, another case in point is Munich Re which said it would use alternative capital to stimulate growth.
The Bloomberg piece focuses on the fact that 2014 was the second year running, and ever recorded, during which investors preferred collateralized reinsurance to catastrophe bonds as a way to access the returns of the reinsurance sector.
It’s no surprise though, as collateralized reinsurance has not been in use for as long as catastrophe bonds and was always destined to overtake the use of securities for packaging and transferring risks to investors. It is worth noting, however, that many of the largest institutional investors would like to see more risk in cat bond form, as collateralized reinsurance does not meet every investors mandates, particularly due to the lack of liquidity.
Speaking at the firm’s conference call on property & casualty treaty renewals on the morning of Wednesday 4th February, Hannover Re executives noted that competition is still intense in reinsurance and that the market witnessed another particularly low natural catastrophe loss year.
This, combined with further inflows of alternative capital via collateralized reinsurance, ILS and sidecars will ensure much predicted continued softening, the firm said.
According to Hannover Re, and noted by Bloomberg, collateralized reinsurance is now the biggest market for alternative or third-party capital, growing from just $2 billion of coverage in 2009 to $30 billion (or more) in size last year.
In contrast, the once favoured cat bonds ended 2014 with roughly $25 billion of issued deals outstanding, according to the Artemis Deal Directory.
Although it’s worth noting that 2014 was still a record year of issuance for the catastrophe bond asset class, highlighting the ongoing growth and continued investor appetite for these types of securities.
The growth of reinsurance as an asset class and investors appetite for accessing insurance risks is benefiting firms that are choosing to capitalise on it, like Hannover Re. The company noted that during 2014 it placed around $3 billion of collateralized reinsurance deals on behalf of investors, so roughly 10% of the global total.
Ludolphs continued to explain that Hannover Re benefits from “low, two-digit million-euro range” profits from fees earned for arranging reinsurance coverage for companies seeking to tap into the sector.
While adding some diversification to the firm’s portfolios, it’s a good way to build client relationships and earn extra fees, and despite this side of Hannover Re’s operations being relatively minimal to its traditional reinsurance coverage earnings, “it’s better to stay involved than let others make the business”, added Ludolphs.
He advised that; “While cat bonds on average returned 6 per cent to 7 per cent to investors last year in a market that hasn’t seen losses, collateralized reinsurance should on average have offered slightly better returns at slightly higher risks. Still, the market for both hasn’t been really tested by a major widespread loss.”
“The world is changing,” Ludolphs stressed, a point emphasised during the reinsurer’s renewals conference call on Wednesday morning, as the influx of alternative capital, benign catastrophe season and increased merger & acquisition (M&A) activity was discussed.
In response to a question on how Hannover Re felt about how the latter, M&A deals would impact its operations, the company said; “We feel that as long as we have mergers in the market then we see this as positive on the reinsurance side, as it reduces the amount of players.”
“Of the deals so far the size is not big enough to marginalise us, so we see it as a positive.”
Hannover Re has positioned itself to take advantage of the alternative capital and ILS trend in a number of ways.
Firstly, fronting for collateralized reinsurance players. Secondly, by offering its facilities to enable private cat bonds and cat bond lites to be sponsors, something that the firm has increased in recent months. Then through its share in the ILS investment operations at Leine Investments. And finally by leveraging the capital markets directly for its own retrocession needs, through the K-Cessions series of deals and transactions such as its recent capital markets mortality swap.
All of these activities show that the reinsurer is taking the ILS and alternative capital trend very seriously and is keen to ensure it maximises the profits it can make from this growing portion of the reinsurance market.