Hannover Re will sponsor its first cyber cat bond: Sehm & Ludolphs
Speaking with Artemis, Hannover Re senior executives Silke Sehm and Henning Ludolphs explained that tapping into the insurance-linked securities (ILS) market for cyber retrocessional reinsurance capacity is a priority and with a quota share already arranged, the next step is sponsoring the reinsurer’s first cyber catastrophe bond, details of the form were not revealed.
Hannover Re is confident that the capital markets can become a meaningful provider of capital to support cyber risks and intends to work to develop an array of risk transfer structures that will allow it to source retro capacity to support its cyber reinsurance book.
Member of the Executive Board Silke Sehm, who has responsibility for catastrophe XL, structured reinsurance, insurance-linked securities (ILS) and retrocession at Hannover Re, and Henning Ludolphs, Managing Director for Retrocession & Capital Markets at the reinsurer, explained in a recent interview that this is a journey the reinsurer has been working towards for a number of years now.
Sehm told us, “Roughly three years ago, we started to look at bringing cyber reinsurance business to the capital markets, with the same intention as we have for our nat cat business.
“Cyber is a high growth market, so over that three years we’re probably seeing two or more times that business, with strong demand, and it will continue to develop in that direction.
“So, we started, three years ago to place certain limits of cyber risk to retrocession. Then the idea was to go into two other directions at the same time.”
These directions were to replicate the successful quota share approach that Hannover Re has through its K-Cession capital market backed sidecar-like structure, while also looking at ways to transfer cyber risks to the capital markets on an excess-of-loss basis as well.
Sehm continued, “One possibility was a quota share, like we have with K-Cession for our nat cat business but for cyber risks. So, the same structure, the same concept but adapted to specifics of cyber business. The idea would be that we would share what we write as underwriters at Hannover Re, with our underwriting philosophy and profitability, on a one-to-one basis with our partners on the retrocession side.
“Another idea was looking at what we can do with the cat bond marketplace, either through a traditional cat bond or via a parametric cover using a parametric trigger or index on certain risks, to place it that way to the capital market.
“So we went down these two routes and now the cyber quota share, the $100 million transaction you are aware of, has been finalised.
“On the second route, the cyber cat bond, we are still going and we are very confident we will also come up with another solution in the not too distant future.”
Ludolphs added, “We knew that Hannover Re was very strong in cyber business and the idea was to have others sharing in it, so that we can offer more capacity to our clients where we don’t want to keep it all ourselves. This idea slowly but surely also involved ILS investors.”
Ludolphs explained that the key was working closely with investors and having K-Cession as a blueprint helped, but he added that, “it still could not just be a copy and paste because there are other features.”
“Cyber is new ground and losses may take longer to develop, but investors need finality at a certain stage,” Ludolphs continued to explain. “So there needed to be a bridge, between them both, and this was probably the most difficult part.
“But at the end, the solution was to listen to the requirements of your counterpart, you try to understand the requirements and then you try to bridge it, if you have two different opinions.”
Ludolphs said that while this has been a roughly three year journey for Hannover Re, it all came down to around 8 months of very detailed discussions to finalise on a quota share structure that worked for the reinsurer and for the investors.
“It was not simply taking K-Cession and copying it, there was a lot of fine-tuning to do,” Ludolphs said. “I’m sure over the next couple of years, we will further evolve it with the experience we gain, and working with our investors we will develop it further.”
Moving on to discuss the potential for a cyber catastrophe bond, Ludolphs said that this is a natural progression for the reinsurer, with some excess-of-loss retro arrangements already in place for its cyber book.
“We are confident that we will also get cyber risk out in other forms,” Ludolphs stated. “We already have a cyber contract which is placed with traditional markets. The new quota share was really the first big step into the ILS market, but I’m very confident that we will also get other non-proportional forms in the ILS market soon.”
Sehm added, “This will develop further and it is interesting from an investor’s point of view as a diversified risk, but of course investors always like to have it modelled.”
“The industry will develop on modelling these risks and assessing cyber. The better we can assess and model it, compared to nat cat business, the easier it will be to place it into the capital market.”
Ludolphs went into more detail, by saying, “It’s important to start, even if investors only take a few million at the beginning. It’s also important to grow together.”
He added that, “I’m not sure whether at the beginning we will have a 144a cat bond, or a private transaction, it depends on appetite and discussions with investors, so focusing on developing what they need.”
“We are not the only one, but we are happily among those who have started broadening the range. But I’m optimistic that cyber will become bigger for the capital markets.”
Ludolphs is bullish that cyber risk will become a significant component of the ILS market in time, with the capital sorely needed by traditional underwriters as they grow their cyber books.
“There will be a huge demand on the cyber side. This won’t just be a limited niche business,” he said. “The capacity cannot be provided by just insurance and reinsurance companies, so we need to win support from capital market investors for additional capacity.”
“Now, a few transactions are done, we may have other investors say it’s not a bad idea to start.”
“I appreciate some investors are simply not allowed, they have clear guidelines, but it may open-up overtime and broaden the capabilities of investors as well,” Ludolphs concluded.
Also read: Long investor relationships helped drive K-Cession growth: Hannover Re’s Sehm & Ludolphs.
