Hannover Re’s CEO bets on traditional reinsurance business despite soft market

But not all. While many of its rival reinsurers are seeking alternative growth opportunities through fee income relating to advisory services, technology or the use of alternative risk-transfer structures, Hannover Re’s chief executive officer Ulrich Wallin believes sufficiently profitable traditional risk transfer business will remain available for the foreseeable future.

“We are currently growing in the US, both in property/casualty as well as in personal liability/casualty reinsurance,” says Wallin. “We grow via clients’ demand for new products or through participation in their growth opportunities. This trend continues in 2017.”

In the US, Hannover Re offers reinsurance cover to around 600 primary insurers. North America contributed 35 percent to Hannover Re’s €9.21 billion ($10 billion) property/casualty reinsurance gross written premium in 2016, according to a March 9 annual results presentation. Similarly, the US business made up 30 percent of the company’s €7.15 billion ($7.8 billion) non-life reinsurance gross written premium in 2016.

In China, where margins in some property/casualty segments are relatively low, Hannover Re is scaling back, but the situation is better in South-East Asia, including Thailand, Malaysia, Indonesia, and the Philippines, Wallin notes. “Here we are growing in double digits with good margins,” he says.

Pulling back

The current soft market, driven by overcapacity particularly in property/casualty as low interest rates attract investors, is not leaving Hannover Re unscathed, however.

As part of the firm’s efforts to avoid writing business which may end up being unprofitable, for the first time in many years Hannover Re recorded a decrease in premium in 2016. Gross premium written dropped 4.2 percent year on year to €16.35 billion ($17.88 billion) in 2016.

But this approach had a positive effect on underwriting profitability. The reinsurer’s combined ratio improved to 93.7 percent in 2016 compared to 94.4 percent a year earlier, helping to boost the group net income by 1.8 percent to €1.17 billion ($1.28 billion). “In the life/health reinsurance business profits are rising,” Wallin says.

However, in 2016, net income after tax in life & health reinsurance dropped 12.7 percent year on year to €252.9 million ($276.5 million). Gross premiums fell 4.3 percent year on year adjusted for exchange rate effects. However, this performance may not be indicative for the nature of the segment, as the comparison year of 2015 was particularly strong, according to the company’s annual report.

“The determining factor here was the exceptional premium growth booked in 2015,” the firm commented.

In 2015, the value of new business recorded in life & health totalled €893 million ($976.5 million), by far beating the targeted level of €220 million ($240.5 million).

Looking at the broader picture, the business segment is growing. Between 2011 and 2016, the life & health reinsurance segment of Hannover Re grew gross premium by an average of 6.3 percent per year.

“The life & health business is less affected by the current market cycle,” Wallin says.

The situation in property/casualty reinsurance may be more complicated. Rates in some lines are so low that many reinsurers prefer not to write it. Sustained strong competition in property/casualty reinsurance requires a profit-oriented, selective underwriting policy, Hannover Re explained in the report.

The difficult market environment is exacerbated by the fact that primary insurers remain able to maintain high retentions thanks to their healthy capital resources. At the same time, capital is increasingly flowing into the reinsurance market from the steadily expanding insurance-linked securities (ILS) sector (including catastrophe bonds and collateralised reinsurance) owing to the lack of higher-yield investment alternatives, Hannover Re explained in the report. As a result, the available capacity in the reinsurance market continues to clearly outstrip demand.

Strategy shows results

Ultimately, Hannover Re believes that in the prevailing market climate the pursuit of profit targets clearly takes precedence over growth targets.

Hannover Re appears to have succeeded in this respect in the property/casualty segment.

Despite the challenging market conditions, the combined ratio in property/casualty improved to 93.7 percent in 2016 from 94.4 percent a year before.

At constant exchange rates, gross premium in property/casualty remained stable year on year in 2016 at €9.2 billion ($10 billion).

Group net income from the segment even climbed by 3.8 percent year on year to €949.9 million ($1 billion).

“In non-life reinsurance we believe that we can maintain underwriting profitability at current levels; we have a wide and diversified portfolio,” Wallin says.

He also remains optimistic about improvements in the operating environment.

“The soft market in non-life reinsurance won’t continue forever. Market participants are mostly listed companies or investment funds in case of the ILS market, which can’t afford recording losses over longer periods,” he notes.

Pressure from all sides

Pressure on insurance rates from alternative capital is likely to remain high, at least in the short term.

The ILS market is “firing on all cylinders” and is set for rapid growth stemming from a robust pipeline, despite issuance in the first quarter of 2017 lagging levels in the same quarter a year earlier, according to an April report by Willis Towers Watson Securities.

Sponsors are responding to the attractive spread environment by seeking new protection backed by liquid ILS (cat bonds) as well as continuing to ramp up protection in other forms, according to the report. As a result, a record year for ILS issuance seems possible in 2017, the authors stated.

Significant losses in the cat bond market may change the picture and investors’ strategies, Wallin suggests.

“They will have to change their strategy in case of losses which will lead to hardening rates as seen in 2009 and 2012 after in the previous years the average return on equity of reinsurers fell under 5 percent. The hardening of rates seen then offered good growth opportunities without leading to market dislocation,” he explains.

Meanwhile, Hannover Re will have to try to make the best out of what the market offers, selecting the best opportunities and shedding others.

“Profits in the soft market and low interest rate environment won’t grow exorbitantly, but also not fall massively, and instead remain stable on similar large losses occurrence,” Wallin says.

Hannover Re may show stamina in the soft market as it is likely to be able to bump up its profitability through prior year reserve releases.

“In the comparatively good years of 2012 to 2016 we have significantly improved the quality of our claims reserves. We have accumulated significant buffers. We will partially need them to keep the underwriting profitability stable during the soft market.”

Meanwhile, Hannover Re’s competitors are testing alternative income sources to improve their financial performances while shrinking the traditional insurance business.

Munich Re, for example, is investing in IT and data analytics to boost revenues from services, potentially through fee income.

The technology is to be applied by Munich Re in its reinsurance operations to support medium-sized primary insurers which could not shoulder such an investment on their own.

“Fee income can be generated by making use of our expertise or by allowing the use of our balance sheet through a fee such as in the market for ILS or sidecars,” Wallin notes.

Reinsurers can also offer services in advisory for the structuring of the reinsurance portfolio, or Solvency II advisory, for the most efficient configuration of internal models. Or they can help primary insurers in the digitisation process and in boosting sales, he adds.

No game-changer

Such fee-based income is, however, unlikely to turn into a game changer. “The profit pool is much smaller than the one generated by the reinsurance risk transfer model,” Wallin says.

He is sceptical whether advisory services can be a solution to offset the effects of the soft market, not least because reinsurers are likely to face competition from brokers, auditing and consultancy firms, further reducing the business potential.

“Boosting fee income is not an easy task for reinsurers because they face new competitors and they face a conflict because they also want to do traditional reinsurance business with these primary insurers and it becomes unclear where to charge them for the additional services,” Wallin says.

Munich Re is also investing in insurtech startups via its subsidiary Digital Partners as it seeks to develop new insurance products and ways to sell insurance to consumers or small businesses.

Munich Re has, for example, in November 2016  partnered with app-based insurance provider Wrisk, an insurtech venture, to become its exclusive carrier for business underwritten in the UK, Europe and US.

It is also  funding California-based insurtech start-up Trov which offers on-demand insurance, enabling users to buy insurance for specific products, for specific amounts of time, through their smartphones. Users can turn insurance on and off with a swipe and also file claims through the app.

The German reinsurer has also provided funding to insurtech startup Bought By Many which uses social media and search data to offer “insight-driven insurance”.

At the same time, Bought By Many signed a long-term insurance  agreement with Munich Re and with its Digital Partners business unit that encompasses underwriting, technology, carrier licences, regulatory permissions, and venture capital.

Hannover Re is also participating in the insurtech developments by reinsuring Ladder Life, which promises “a smart, secure, straightforward way to take care of your people, while saving you time, money, and lots of hassle,” according to the website.

“They use our platform ReFlex as underwriting engine,” says Wallin, but his excitement remains somewhat subdued. “It’s not easy for insurtechs to be successful because the market is highly regulated. The personal lines business, which is the target of most of the insurtech startups, is an area where the big insurers are operating in a pretty efficient way.”

Meanwhile Swiss Re has high hopes for its tailored transactions operations within property/casualty. Tailored transactions are generally seen as more profitable than the traditional reinsurance business.

But for this business segment, Wallin is also cautious. “Demand does fluctuate and also the type of transactions changes over time,” he notes, pointing to the end of the 1990s, when deals that discounted loss reserves were popular.

Now, reinsurance transactions related to Solvency II are on the rise in Europe. In addition, new rules introduced by ratings agency AM Best are fuelling demand in the US, Wallin notes, but at the same time, demand in China’s motor sector has fallen on the back of the introduction of the so-called C-Ross regulation, he adds. “Looking at the business over a five-year period it is relatively stable,” he says.

Despite his scepticism regarding alternative income sources in the current soft market, Wallin is confident that the reinsurance business will be able to seize growth. First, on the back of new changes to insurance regulatory regimes worldwide, reinsurers will be able to offer significant balance sheet and income optimisation to primary insurers.

“In addition, there are new risks such as cyber, and new risk exposures from the Internet of Things which are set to offer growth opportunities reinsurers can take advantage of,” he says.

Hannover Re sees itself in a good position to capture such growth.

“It seems that the bigger reinsurers face better growth prospects than the smaller and more specialised ones due to a more holistic approach of reinsurance buyers,” Wallin says.

Larger reinsurers may be in an advantageous position because they can offer more capacity and are able to cover all sectors and geographies.

“I see the bulk of our income in the future being generated through risk transfer from primary insurers,” Wallin says.