Hannover Re: Capital Markets Are ‘More Friend Than Foe’ to Reinsurers

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Pension and hedge funds flush with cash and hungry for yield are creating a market for reinsurers willing to look past the price cuts these investors have inflicted on traditional catastrophe coverage.

The growth of insurance-linked products that allow investors to participate in the reinsurance market is “more friend than foe,” Henning Ludolphs, who oversees this burgeoning area of business at Hannover Re, said at a press conference in Hanover. “The world is changing.”

Capital markets offer “extra protection and risk transfer as well as an opportunity to earn fees,” Ludolphs said. The reinsurer is earning fees in the “low, two-digit million-euro range” for arranging reinsurance coverage for industry outsiders, he said, without giving a precise figure.

While that’s a small fraction of what Hannover Re earns from traditional coverage, “it’s better to stay involved than let others make the business,” Ludolphs said.

Record-low interest rates ushered in by the global financial crisis have lured new participants seeking higher investment returns to put up capital to back reinsurance risks. The market for investments tied to insurance or reinsurance risks swelled to $54 billion last year from $43 billion in 2013, propelled by sales of collateralized reinsurance, according to Hannover Re.

Last year was the second in a row in which investors on the whole preferred collateralized reinsurance to catastrophe bonds, the vehicle first used by hedge funds and pension funds for forays into the market.

Market Force

Collateralized reinsurance became a force in 2009 with $2 billion of coverage, according to Hannover Re. Back then, cat bonds dominated with $16 billion in capital outstanding.

Now collateralized reinsurance, a private contract backed by money held in trust, is the biggest market for alternative capital, growing to $30 billion last year from $22 billion in 2013, according to Hannover Re. Cat bonds trailed with about $24 billion of these debt products outstanding at the end of 2014.

Hannover Re stands out in an industry that has seen prices fall for seven of the past 10 years. Its bigger rivals, Munich Re and Swiss Re AG, have yet to embrace collateralized reinsurance, with Hannover Re and units of Allianz SE and Mitsui Sumitomo Insurance Co. the top three arrangers for the contracts.

Hannover Re last year placed about $3 billion of collateralized reinsurance transactions on behalf of investors, or about 10 percent of the worldwide total, Ludolphs said.

Above-Market Yields

Catastrophe bonds offer protection to carriers against disasters capable of causing wide-scale devastation, such as hurricanes and earthquakes. Investors get above-market yields for taking the risk that their principal could be wiped out. Issuing a cat bond normally starts to make sense at around $100 million. Costs associated with rating these securities, necessary because they are publicly traded, and with ensuring they are legally sound make lower amounts financially prohibitive.

Collateralized reinsurance, on the other hand, is tailored to disasters where the damage is more contained, such as airplane crashes and shipwrecks. Typically the amount is under $10 million.

“While cat bonds on average returned 6 percent to 7 percent 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,” Ludolphs said. “Still, the market for both hasn’t been really tested by a major widespread loss.”