Hannover Re focuses on ‘careful growth’ and sensible reserving as soft market continues

Commercial Risk Europe’s Adrian Ladbury interviews Ulrich Wallin, CEO of Hannover Re, to discuss the broad range of issues currently affecting the international reinsurance market and broader risk transfer sector. He finds Mr Wallin in cautiously optimistic mood, despite the pressure being applied to the whole sector by the stubborn soft market and dwindling reserves. Mr Wallin is, however, concerned about rising protectionism in markets such as Asia and the US. Last year was the first time since 2008 that Hannover Re had not seen any growth in premium income, with the soft P&C market to blame, Ulrich Wallin, CEO of Hannover Re explains to Commercial Risk Europe. There are bright spots in areas such as cyber and the US market, but overall the outlook remains tough. However, Mr Wallin does not expect a bloody, industry-wide reserving crisis on the scale that occurred back in 2002 to 2006. The reinsurer is absolutely clear that his company and others need to play a very conservative game in such a tight operating environment and focus on “careful” growth. Hannover Re’s life and health (L&H) business is performing better than P&C currently, but is also a mixed bag. “We were affected by less large single premium contracts. In L&H we benefited from some very good progress in financial solutions business. But there were still some issues on older underwriting years in mortality business. There was a higher than expected mortality level and so-called conversions whereby term policies are converted into permanent policies,” explains Mr Wallin. The continued softening P&C market dominates the picture and demands a naturally conservative forecast. “Strategy needs to be focused on careful growth, because this is the only strategy in a soft market. We are making progress in some specialist areas such as tailor-made capital relief transactions that deliver good top line and profitability. These treaties have rather secure but lower margins. We expect continued increased production in life and health, particularly in financial solutions business,” says Mr Wallin. “But generally speaking, we are looking at another soft year. Interest rates remain a concern, but it does seem to be bottoming out with an increase in the US. This is good for us because about 50% of our investments are in US dollars, so we can expect improving investment income without having to make high risk investments,” he adds. Expense control Given this tight market and relative lack of growth, it seems focus must turn to the expense ratio to help support the combined ratio and profitability. Mr Wallin agrees and says that, in this respect, Hannover Re is in a relatively good position compared to the wider market. “We are in an advantageous position on the expenses side compared with peers because we have a lower expense ratio than others as a percentage of net premium, or if you look at it as a percentage of EBIT or average EBIT per employee. In all categories of business we are in a good position in this sense compared with our peers,” explains Mr Wallin. The other key element in this tricky part of the cycle – if such a thing still exists – is reserves. Clearly those reinsurers and insurers that have adopted a more conservative underwriting and reserving strategy will be able to maintain profits for longer in this market. Mr Wallin says that Hannover Re is again in a strong position relative to the market. “Also, at the same time we work with a very conservative loss reserving policy and this should help us show acceptable results even in a soft market. At the end of the day it all depends on how the reinsurance market performs overall. We will not see a fundamental change in the market, so expenses and reserving will become more important,” he says. The role of reserving strategy is becoming an increasingly important factor for the international insurance and reinsurance market as the soft market drags on alongside continued tough investment conditions. Inflection point It is a simple fact that the reinsurance market has been able to maintain profits, and the soft market at the same time, by releasing reserves on previous underwriting years. But this cannot continue forever. Mr Wallin agrees that the market is possibly at an inflection point from a reserving perspective. “One could see the effects of the continued softening market and this was reflected in the loss ratio. Since 1 June 2013, prices have been going down slightly. But everyone continues to show quite strong results despite this and thus, so far so good. The underwriting result for us was better than expected in 2015 so we could add reserve buffers. But in 2016 this was more or less flat, according to the external actuaries,” he says. To an outside observer it seems obvious, however, that something must give as combined ratios near 100%, reserves releases from older years – notably 2012 and 2013 – dry up and inflation picks up. Mr Wallin agrees with this logic. “The industry average combined ratio for 2016 is about 95% and this is still being helped by older years. This is because we are coming off a period of pretty good results in 2012 and 2013 when there was pretty good pricing and low inflation. So it was pretty favourable,” he says. “If you look at the rate decreases coming through, I would pretty much say that 2016 is really the last year that any benefit from 2012 and 2013 will be felt. The years 2013 and 2014 were more challenging, so it is gradually getting tougher. I think you can expect to see combined ratios closer to 100% in 2017,” continues Mr Wallin. Capital exodus? So if combined ratios hit 100% and results suffer just as interest rates begin to rise, will that result in an exodus of capital as the capital markets finally decide to seek returns elsewhere? Mr Wallin does not believe it is that black and white. “I do not necessarily see an exit of capital from the traditional reinsurance market. Maybe from the ILS market to an extent, but this will really only mean a slowdown in the overall capital increase. The market will continue to be competitive as long as we continue to see acceptable results. If there are no major losses this year, it will remain soft with a high level of capacity,” he says. Reserving crisis? Given that reserves are running perilously thin in a rising number of cases and we have recently seen some big reserve additions at insurers such as AIG and Zurich, are we about to enter an industry-wide reserving crisis that could force a sudden and dramatic market hardening? Mr Wallin does not believe the market is quite at that point and is better reserved generally than in the past. But he clearly does not rule out a potentially significant shift at some point soon if the soft market drags on. “We are not yet there but I do see inflation pushing up a little and this will therefore be recognised on reserves. In the UK we had the revision to the Ogden tables, which means that reserves look certainly less conservative than before and this will have a particularly heavy impact on reinsurance. This will come especially in motor reinsurance because of the disproportionate impact on the excess of loss market because of larger claims. If we have more things like that then reserves will look tight. In general though, I have to say that the industry is better reserved than it was at the end of the 1990s. But each year that the market remains like this the quality of results will deteriorate,” says Mr Wallin.

Hannover Re focuses on ‘careful growth’ and sensible reserving as soft market continues

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