Property and Casualty Treaty Reinsurance Germany, Austria, Switzerland and Italy; Credit, Surety & Political Risk worldwide; Group Legal Services; Run Off Solutions
Hannover Re's stock market year in 2005 was again supported by a broad range of Investor Relations activities. Our goal is to further enhance the profile of our share in the international arena and to provide capital market players with comprehensive, regular and timely information on the development of Hannover Re's business. Along with numerous roadshows in all the world's major financial marketplaces (19), various investor conferences and share forums for private investors (27), international telephone
%-figures = participation You may find the addresses of our branch offices and subsidiaries on pages 157 to 159
Persistent sluggish domestic demand was again the hallmark of the weak cyclical trend in the Eurozone in the first half of the year. The summer of 2005, however, heralded an economic revival. Exports and domestic demand were the major drivers here, although private consumption showed only modest growth. The European Central Bank (ECB) began to tighten the reins of monetary policy with an increase of 25 basis points in key lending rates on 1 December, thereby helping to curb the smouldering inflationary risks.
Although there were signs of a rate decline in industrial fire and fire loss of profits insurance, we were able to write profitable business in what are important lines for our company. This was also true of our largest line, namely motor
Credit and surety insurance was notable for a continued high level of insolvencies due to the depressed state of the economy. Yet the insurance industry was again able to divorce itself from the protracted adverse credit cycle. Insurers achieved low loss ratios on the basis of their restrictive underwriting policies and thanks to a limited loss burden. These favourable conditions were similarly reflected on the reinsurance side. The established reinsurers wrote higher shares. As had been seen in the previous year, second- and third-tier reinsurers as well as the Bermuda-based players increasingly forced their way into the market, albeit without any appreciable pressure on conditions. In view of the satisfactory results posted by reinsurers in the previous year, ceding companies tried to obtain improvements – sometimes substantially so – in reinsurance terms and conditions. For the most part, however, we were able to withstand this pressure in the 2005 treaty renewals.
There was no change in the gratifying development of the morbidity risk, which has a bearing on the disability, critical illness and health lines; this was especially true of the US health market, where we concentrate on special covers for senior citizens and sectoral (e.g. dental) covers in group business.
The longevity risk has for many years been of greatest relevance to the business that we write in the UK market: acceptances of enhanced annuities (for persons with a reduced life expectancy ) were in life with our projections in this market.
The risk associated with the persistency of the in-force reinsured portfolios as well as the credit risk associated with the cedant are of primary importance for the financing transactions that we write in numerous European markets, the USA, South Africa and Asia. With one exception (death benefit insurances in the USA), the actual results in this area were in line with our projected calculations. This gratifying experience can be attributed in part to our prudent selection and analysis of ceding companies.
Asia We continue to serve the Asian markets through our life branches in Kuala Lumpur – responsible for the ASEAN markets – and Hong Kong, which bears responsibility for the Chinesespeaking market region as well as Japan and Korea. They write predominantly risk-oriented business in the life and critical illness lines.
Taken together, the companies transacting specialty insurance saw their gross premium contract by 16.4% to EUR 1.8 billion (EUR 2.1 billion) in the year under review.
• random fluctuation of the actual claims experience from the forecast development (risk of random fluctuations),
• Aggregate control is a fundamental risk management tool. It is used to determine the strain on the Hannover Re portfolio associated with particular natural catastrophe scenarios and return periods. The aggregate amount of the exposures expected from one or more treaties for a specific combination of countries and hazard zones and a specific probability (e.g. 1% probability = 100-year return period) are calculated.
Financial reinsurance The ongoing discussions surrounding business practices in international financial reinsurance – triggered by the probes launched by the New York Attorney General and US stock exchange regulators (SEC) – also affected Hannover Re's financial reinsurance business.
In view of the advantageous market conditions we again made use of the capital market to enlarge our underwriting capacity for catastrophe risks. We have been a pioneer in this field since 1994, when we concluded the first transaction of this type in the reinsurance industry. Designated "K5", our latest transaction – which has a volume of around USD 370 million and is initially limited to a term of three years – was placed with institutional investors, primarily in North America. This risk securitisation adds a further pillar to our risk management capabilities in light of possible capacity shortages and rising prices on the retrocession markets. In the renewals as at 1 January 2006 we were consequently able to offer the underwriting capacity needed to share in the profitable market opportunities that will present themselves over the coming years. The portfolio underlying the "K5" securitisation consists of property catastrophe, aviation and marine reinsurance risks. As part of our capital management approach we have used the securitisation of insurance risks as an equity substitute for a number of years now. In this way we are able to keep our cost of capital low and return on equity high.
The expected positive underwriting cash flow will likely lead to further growth in the total asset volume. If interest rates rise slightly investment income should also increase again. In the area of fixed-income securities we continue to stress the high quality of our portfolio. Combined with our continuing investments not only in equities but also in alternative asset categories, we should be able to generate a stable profit contribution over the long term.
Against the backdrop of the current advantageous market conditions prevailing in the various business groups, it is our expectation that the positive trend forecast for 2006 will be sustained. In 2007 we therefore anticipate another good result – assuming that the major loss expenditure comes in around the multi-year average of 8% of net premium in property and casualty reinsurance and as long as there are no exceptionally adverse developments on the capital markets.
Other assets in the segment 2 234 829 1 937 405 167 942 213 950
IAS 39 is to be applied retrospectively. Consequently, accumulated depreciation of EUR 17.4 million from financial years prior to the date of transition was to be reclassified in the IFRS opening balance sheet from retained earnings to other comprehensive income.
The aforementioned changes were reflected altogether in an additional EUR 16.3 million of unrealised gains on investments. Taken together with the reclassification from other changes in cumulative other comprehensive income, the amount shown under this item in the IFRS opening balance sheet was EUR 5.6 million lower. As at 31 December 2004 the unrealised gains increased by altogether EUR 19.9 million compared to the amounts that were reported for the same date under US GAAP.
IAS 21 "The Effects of Changes in Foreign Exchange Rates" requires that translation adjustments arising on the translation of the financial statements of foreign consolidated entities be recognised as a separate component of shareholders' equity in the consolidated financial statement. Under the
Within the scope of a contract-by-contract analysis, circumstances were identified in the life and health reinsurance segment that necessitate such separation. For the purposes of the IFRS opening balance sheet the values of the derivative components of these contracts were determined using appropriate mathematical models. This entails a change in our previous accounting policies due to the firsttime adoption of IFRS 4, the effects of which result from transactions effected prior to the date of transition to IFRS. Pursuant to IFRS 1.11 we have booked the resulting adjustments of EUR 9.4 million before tax directly to retained earnings in the IFRS opening balance sheet, an item which therefore reflects a charge of EUR 5.6 million after tax.
Assets and liabilities from defined benefit plans are to be measured in conformity with IAS 19 at the transitional date. For this purpose, it is necessary to retrospectively calculate and project the actuarial gains and losses for each pension plan since the commitment date or the date when IAS 19 entered into force. We have availed ourselves of the option provided under IFRS 1.20 – in a departure from IAS 19 – not to apply the corridor method for actuarial gains and losses. Upon first-time adoption of IFRS we therefore realised all actuarial gains or losses from defined benefit commitments in the IFRS opening balance sheet ("fresh start" method). In this context a corresponding increase of EUR 1.5 million was recognised in retained earnings. The corridor method will be used in subsequent consolidated financial statements.
At fair value through profit or loss – 109 562 109 562
Effects of the transition to IFRS on the consolidated cash flow statement as at 31 December 2004
Real estate used by third parties (investment property) is valued at cost less scheduled depreciation and impairment. Straight-line depreciation is taken over the expected useful life – at most 50 years. Under the impairment test the market value of real estate for third-party use is determined using acknowledged valuation methods and compared with the carrying value. Maintenance costs and repairs are expensed. Value-enhancing expenditures are capitalised if they extend the useful life.
Since November 2000 Hannover Re has held voting equity interests in a special purpose entity for the securitisation of reinsurance risks in France and Monaco. The securitisation ended as per the contractual agreement on 18 November 2005. The bonds issued as security were repaid in full to investors. The special purpose entity is expected to be wound up in the 2006 financial year.
Hannover Re uses detailed simulation models to analyse the frequency of natural disasters due to climate changes and the extent of the resulting losses (e.g. storm frequencies and intensities). To this end we use recognised simulation models and also employ our own scientists, who control the quality of licensed models and develop in-house tools. The most significant events for Hannover Re in the year under review were the hurricanes "Katrina", "Rita" and "Wilma". Our burden of losses from these events amounted to EUR 2,071.8 million for gross account and EUR 838.2 million net. The major natural disasters in 2005 revealed structural shortcomings in the risk models. As an immediate step – in order to adjust the basis of our calculations to ensure that they are commensurate with the risks – we are adding extra safety loadings to the results of our simulation models.
The use of stress tests and sensitivity analyses constitutes a global risk management tool. Starting from the expected scenario for a one-year time horizon, the possible future implications of changes in crucial capital market and underwriting variables for shareholders' equity and net income are examined. The anticipated scenario includes estimates of future developments according to our budgetary planning and is based on our internal risk model. In the following illustrative simulation we assume the occurrence of the modelled events in the course of 2006.
Combined and catastrophe loss ratio over the past ten years 1) Based on figures reported in accordance with US GAAP 2) Based on figures reported in accordance with the German Commercial Code (HGB) 3) Natural catastrophes and other man-made major losses > EUR 5 million gross for the share of the Hannover Re Group as a percentage of net premium earned
Amortised cost, unrealised gains and losses and accrued interest on loans and receivables as well as their fair value
Fixed-income securities – loans and receivables – – 591 301 – 14 444 26 963 – 22 238 654 946
Balance at 1 January of the year under review 182 367 163 013
For further explanatory remarks please see Section 4 "Summary of major accounting policies".
Net book value at 31 December of the year under review 20 210 041 4 739 026 15 471 015 18 247 706 4 163 138 14 084 568
Net book value at 31 December of the year under review 1 977 570 463 528 1 514 042 1 825 914 489 085 1 336 829
8.4 Goodwill; present value of future profits on acquired life reinsurance portfolios
Deferred tax assets and liabilities are booked in accordance with IAS 12 for tax reductions and additional tax charges expected in subsequent financial years, insofar as they result from different valuations of individual balance sheet items. In principle, such valuation differences may arise between the national tax balance sheet and the national commercial balance sheet, the uniform consolidated balance sheet and the national commercial balance sheet as well as from tax loss carry-forwards and tax credits. Deferred taxes are based on the current tax rates. In the event of a change in the tax rates on which the calculation of the deferred taxes is based, appropriate allowance is made in the year in which the change in the tax rate is stipulated in law with sufficient certainty. Deferred taxes at the Group level are booked using the Group tax rate of 40%.
Staff The average number of staff at the companies included in the consolidated financial statement of the Hannover Re Group was 1,972 (1,945). Of this number, 857 were employed in Germany in the year under review. The majority of staff were employed at the consolidated Group companies abroad.
In order to safeguard the sustained financial strength of the Hannover Re Group, Hannover Re issued additional subordinated debt. In February 2004 subordinated debt in the amount of EUR 750 million was placed through Hannover Finance (Luxembourg) S.A., a wholly owned subsidiary of Hannover Re, on the European capital markets. The bond was placed predominantly with institutional investors. The bond was priced at a spread of 163 basis points over the 10-year mid-swap rate and has a final maturity of 20 years. It may be redeemed by Hannover Re after 10 years at the earliest and at each coupon date thereafter. If the bond is not called at the end of the tenth year, the coupon will step up to a floating-rate yield of quarterly EURIBOR +263 basis points.
As a consequence of unscheduled depreciation of EUR 1.4 million taken in the 2005 financial year, the book values and fair values of the own-use real estate are the same.
Effective 1 July 2003 Hannover Re took out insurance for pension commitments. The commitments involve deferred annuities with regular premium payment under a group insurance policy. In accordance with IAS 19 they were carried as a separate asset at fair value as at the balance sheet date in an amount of EUR 36.2 million (EUR 28.9 million).
Interest pursuant to 233a Fiscal Code (AO) 13 187 – 13 187 1 934 – – – 15 121
Most of the contracts underwritten by our Group are classified as short-duration contracts.
The average fair value of each stock appreciation right was EUR 4.43 for the 2000 allocation year, EUR 4.94 for the 2002 allocation year, EUR 4.31 for the 2003 allocation year and EUR 2.33 for the 2004 allocation year.
We have audited the consolidated financial statements prepared by the Hannover Rückversicherung AG, Hannover, comprising the balance sheet, the income statement, statement of changes in equity, cash flow statement and the notes to the consolidated financial statements, together with the group management report for the business year from 1 January to 31 December 2005. The preparation of the consolidated financial statements and the group management report in accordance with IFRS, as adopted by the EU, and the additional requirements of German commercial law pursuant to § 315a Para 1 HGB and supplementary provisions of the articles of incorporation are the responsibility of the parent company's management. Our responsibility is to express an opinion on the consolidated financial statements and on the group management report based on our audit.
• Up-to-date information was also provided on the Web and through press releases and newsletters. Special mention should be made here of the expanded information on Corporate Governance provided as part of the redesign of our Internet presence as well as of our IR Online Magazine. Published monthly, this can be accessed at the click of a mouse on our website's homepage and is also available to interested readers by e-mail subscription.
Hannover Re Services USA, Inc. 500 Park Blvd. Suite 1350 Itasca, Illinois 60143