Investments (incl. funds held by ceding companies) 27 526.4 +9,4% 25 167.5 22 031.1 20 305.8 19 278.0 45/64
Book value per share in EUR 21.57 +3.0% 20.93 19.94 17.90 17.21 12/62
Dividend per share in EUR – 1.00 0.95 0.85 – 132
As you may perhaps recall, in last year’s annual report I wrote that 2004 had gone down as the most expensive year of natural disasters ever recorded in insurance history. At that time we could scarcely have imagined that this negative record would last for just one year.
The news is doubtless more than familiar from the media: in late August 2005 hurricane "Katrina" laid waste to the city of New Orleans and the southern United States on a hitherto unprecedented scale. With an estimated market loss of USD 50 billion "Katrina" took over as the most expensive insured event of all time. It was accompanied by the three hurricanes "Dennis", "Rita" and "Wilma", all of which ranked high in the list of the most costly natural disasters. We were thus impacted by a devastating hurricane season – both in terms of frequency and intensity. What is more, the global insurance industry also had to cope with numerous other major claims.
So what were the repercussions of these events on your company? We had to carry a load in excess of EUR 1 billion from catastrophe losses in our retention in the year under review; the hurricanes alone cost us around EUR 800 million. This historically unparalleled burden quite literally swept away our profit. This is of course painful, but compared to most of the companies in our industry – which lost not only their profits but also, to a greater or lesser extent, capital resources – we continue to be a reinsurer of exceptional financial strength despite these extraordinary events. Just how profitable your company is these days can be measured by the fact that as recently as 2001 – the year of the terrorist attacks on New York and Washington D.C. – half the current major loss expenditure would have been sufficient to erode the entire operating profit (EBIT).
I would now like to briefly outline the development of our portfolio broken down into our four strategic business groups. For further details please see pages 16 to 44 of this report.
Our financial reinsurance business group gathered momentum again after the reduced premium income of the past two years. Particularly in the fourth quarter – i.e. following the devastating hurricanes – demand picked up for surplus relief contracts. Yet we still closed the year under review with a lower premium volume and hence reduced profitability. Bearing in mind the future growth prospects, however, I am not dissatisfied with the performance of our financial reinsurance business group.
We continued to optimise the business processes in our specialty insurance business group in the year under review. Having already repositioned the Clarendon Insurance Group in July with a stronger focus on niche business, we systematically raised the profile of our specialty business in the course of the year. Although the result in the year under review cannot be considered satisfactory, the trend towards a more profitable future is already clearly discernible.
Although our share failed to keep step with the international equity markets in the year under review, we did stay ahead – albeit only marginally – of our internal benchmark, the weighted "ABN Amro Rothschild Global Reinsurance Index", which includes all listed reinsurers worldwide.
What will the current year bring for your company? I am speaking not merely out of unshakeable optimism when I state that everything points to an excellent business development. Having felt the negative effects of an enormous catastrophe loss burden in the year under review, we can now profit – as is not unusual in the aftermath of such loss events – from further improvements in rates and conditions. As anticipated, your company again enjoyed highly successful treaty renewals in property and casualty reinsurance as at 1 January 2006; the "hard" market has been sustained. As a reinsurer with strong capital resources, we are optimally placed to share in the profitable market opportunities to the fullest extent. What is more, I am convinced that the advantageous conditions in property and casualty reinsurance will harden still further with subsequent renewal phases in the course of the year – once the market has accepted that the simulation models and hence also rates will have to be revised upwards not only for US hurricane risks but also for other peak risks such as earthquake covers.
During our treaty renewal negotiations we not only stressed pricing commensurate with the risk, however. We also scaled back peak risks as part of our proactive approach to risk management. In the context of our risk management activities we also completed
another transfer of insurance risks to the capital market. This transaction enables us to protect a substantial portion of our catastrophe reinsurance portfolio while conserving our capital resources. In this way we are able not only to secure the underwriting capacity that is vital if we are to continue to profit from the attractive market opportunities; we can also keep our cost of capital low, reduce the volatility of our results and enable our shareholders to enjoy a higher return on equity.
My colleagues on the Executive Board and I have done everything in our power to keep your company on track in what was a difficult year. On my own behalf and that of the entire Executive Board, I thank you most sincerely for your trust – which we shall strive unceasingly to live up to. Let us all hope that this year your company's highly promising potential is at last fully realised.
2005 heralded a positive turnaround on international capital markets. European indices, in particular, responded to the broadly upbeat mood on the world's capital markets with strong performances. Many market bellwethers of the "Old World" thus booked double-digit price gains in percentage terms. The German stock index (Dax) closed at 5,408 points on 31 December 2005, a rise of 27.1%, and charted a new high for the year of 5,459 in the fourth quarter.
year-end, however, the German CDax for insurance stocks had come back strongly to close at +31.2%. In part this undoubtedly echoes the positive stock market sentiment, although it also speaks to the optimistic outlook for the insurance sector.
In the year under review almost all international (re-)insurance companies suffered massive inroads into their profits and in some cases also their capital resources – initially reflected in the third quarter in a negative impact on share price performances throughout the industry; by
Our share was unable to keep step with the outstanding performance of the European stock markets in the year under review. Although the Hannover Re share closed the year higher at EUR 29.93 – a positive overall tendency of +4.1% – it fell back from its high for the year of just over EUR 33.
The price of our share was hit hard late in the summer by the revision of our profit fore-
The Hannover Re share: a safe haven even in turbulent times …
3 Ja nuary 11 Ja nuary 23 Ja nuary 4 Fe bru ary 16 Fe bru ary 28 Fe bru ary
arch 24 M arch 5 A pril 17 A pril 29 A pril 11 M ay 2005 23 M ay 2005 16 Ju ne 2 4 Ju ne 2 28 Ju ne 2 10 Ju ly 2005 22 Ju ly 2005 3 A ugust 15 A ugust 27 A ugust 8 Sep te mber 20 Sep te mber 14 O cto ber 2 O cto ber 26 O cto ber 7 N ove mber 19 N ove mber 13 D ec em ber 1 D ec em ber 30 D ec em ber
The positive outlook for the 2006 financial year has reinforced investor confidence in Hannover Re stock. Analysts currently put the price target for the Hannover Re share at around EUR 32 on average. Given a price of roughly EUR 30, the price/earnings (P/E) ratio based on the consensus profit estimate for 2006 is around 8. As at 31 December, 14 of the 31 analysts listed in Bloomberg (i.e. roughly 45%) recommended the Hannover Re share as a "buy". The extremely vigorous performance of the Hannover Re share in the early part of 2006 clearly bears out the price potential inherent in the industry and in our share.
In the Handelsblatt ranking of Investor Relations websites operated by all listed German enterprises, our online IR activities have taken top honours in both the MDax and the German insurance industry for two years in succession –
brief overview of Hannover Re from a capital market perspective is also available as a brochure.
Above-average profitability: For us this means that we strive to be one of the three most profitable reinsurers worldwide in terms of
Economic independence: For us this means: • financing growth with self-generated profits and • avoiding difficulties that would necessitate contributions by shareholders.
1) Based on German Commercial Code (HGB) 2) Based on US GAAP
1. Profit target • Minimum return on equity of 750 basis points above the risk-free interest rate • Annual double-digit growth in the - operating profit (EBIT) - earnings per share - book value per share (triple 10 target)
Reinsurance Index • Target to be achieved through - consistent rise in profitability - above-average Investor Relations (IR)
• Accounting - satisfies internal and external reporting requirements - supports our business processes through provision of transparent and timely information 8. Human resources policy • We offer attractive jobs for - performance-minded employees - who identify with our corporate objectives. • Constant enhancement of skills and motivation • Fostering of entrepreneurial thinking on all levels • Delegation of tasks, authorities and responsibility wherever possible • Management by objectives (MbO) • Performance-related compensation 9. Enterprise and risk management • Intrinsic Value Creation (IVC) is our central management tool • Comprehensive risk management safeguards continued business survival
Following a year heavily weighed down by natural disasters in 2004, we experienced another exceptionally active and costly hurricane season in the year under review. Hurricane "Katrina " alone went down in insurance history as the most expensive insured loss of all time, and hurricanes "Rita" and "Wilma" also took a significant toll on the insurance industry – and hence also on Hannover Re. These and other losses produced a net burden of catastrophe losses in excess of EUR 1 billion for our company.
By contrast, the rest of our property and casualty portfolio as well as our life and health reinsurance business developed very successfully. The record losses did indeed leave their mark on net income: in November 2005, once the overall scale of the damage from "Katrina" had become clear and after "Rita" and "Wilma" had also grown into devastating catastrophe losses, we were compelled to revise our profit forecast downwards to a merely break-even result. Nevertheless, the fact that we did not suffer any capital depletion in the face of these massive losses is a testament to the healthy diversification and quality of our portfolio. This underlines Hannover Re's significant earnings power.
The upturn in the global economy was sustained in the year under review. The cyclical trend was robust, despite a sharp surge in energy prices.
Growth in the key US economy continued to be driven by private consumption and capital spending. Even multiple interest rate hikes by the Federal Reserve Board and the severe hurricanes failed to halt this trend.
Having achieved an operating profit of EUR 538.8 million in the previous year, EBIT came in at just EUR 122.2 million in the year under review. Group net income shrank from EUR 279.9 million to EUR 49.3 million, producing earnings of EUR 0.41 (EUR 2.32) a share.
On the capital markets 2005 was a broadly satisfactory year. Our results were better than planned despite maintaining the defensive posture of our bond portfolio: thanks to a strong cash flow from the technical account, our portfolio of assets under own management grew to EUR 19.1 billion (EUR 16.0 billion). This enlarged volume offset the lower average yield, with the result that ordinary investment income came in higher than in the previous year at EUR 671.8 million (EUR 604.5 million). Gains of altogether EUR 272.2 million were generated on disposals in the year under review, contrasting with losses of EUR 110.0 million. The balance of profits and losses on disposals was therefore slightly lower than in the previous year at EUR 162.2 million (EUR 167.4 million). Write-downs were, however, reduced even more sharply, and extraordinary income was therefore modestly higher overall. Net investment income consequently improved on the previous year by 4.1% to EUR 1,123.7 million (EUR 1,079.9 million).
In view of the heavy losses recorded in the year under review we are proud to report that our equity base remained untouched. This achievement, combined with the fact that Standard & Poor's and A.M. Best – the key rating agencies for our industry – stood by their assessment of our financial strength with very good, above-average ratings (AA- "very strong" and A "excellent" respectively ), gives us an excellent foundation for the profitable operation of our business.
Retrocession, i.e. the passing on of portions of our covered risks to other (re-)insurers, continues to be a core risk management tool for our company. In this context, the reinsurance recoverables on unpaid claims reached a level of EUR 4.7 billion (EUR 4.2 billion) in the year under review. This increase was in large measure due to retrocessions of hurricane losses in the 2005 financial year. Since settlement of the receivables is for the most part of a short-term nature, we are already anticipating a reduction in 2006. As has always been the case, we attach exceptional importance to the quality of our retrocessionaires: more than 93% of the companies with which we maintain business relations have an investment grade rating of "BBB" or better from Standard & Poor's.
Accounting for 48% of our total portfolio, property and casualty reinsurance is our largest and most significant business group. Never before has a year witnessed two such contradictory developments: on the one hand, property and casualty reinsurance suffered a historically unprecedented burden of natural catastrophe losses; on the other hand, very good opportunities opened up to write profitable business. Rates and conditions remained on a high level and even improved in some areas. This was especially true of the property and catastrophe reinsurance lines as well as the marine (including offshore) business that had been impacted by the severe hurricanes of 2004. Consequently, we were again able to profit from advantageous market conditions in the year under review.
Gross written premium in property and casualty reinsurance grew by 12.0% to EUR 4.7 billion in the year under review. Exchange-rate effects were merely a marginal factor at 0.3%. In view of the good quality of the business written we further increased our retention to 84.4% (83.0%). Net premium earned climbed 13.4% to EUR 3.9 billion (EUR 3.5 billion).
Property and casualty reinsurance ness development, the segmental report provided in the annual financial statement shows the key balance sheet items and profit components broken down into each business group.
Major loss burden * 1996–2004 = 5% and 2005 = 6% of net earned premium in property and casualty reinsurance
A limitation of liability to EUR 100 million under the original policies has now become established in motor third party liability insurance in Germany. It is therefore gratifying to note that our portfolio of policies providing unlimited coverage continues to shrink. General third party liability business developed very favourably, with prices remaining stable.
Although rates for catastrophe business initially came under pressure in the year under review, further erosion was prevented. Here too the severe hurricanes in the United States had favourable pricing implications.
These products feature a range of assistance benefits that our clients make available to their policyholders who are in need of help after an accident, including for example the provision of
All in all, the development of business in our domestic market was highly satisfactory. Industrial fire insurance suffered an appreciable increase in major claims, however, and the results booked by primary insurers were therefore only scarcely adequate. Original premiums in motor insurance fell by 2.5%, although this trend was again offset by a further decrease in the claims frequency and stable average loss costs. There were no significant developments to report in the casualty lines or in catastrophe business.
On the reinsurance side satisfactory rates and conditions were obtained in the year under review; no softening was observed on the market, and we were therefore able to achieve our forecast profit target.
Highly satisfactory developments in the credit/surety, marine and aviation lines in Germany a household emergency call system, a "meals on wheels" service or accompaniment on trips to the doctor or official agencies.
Marine and aviation business continued to develop highly satisfactorily in the year under review. Marine business in the primary market came under pressure, and softening tendencies can be detected here. For reinsurers, however, the market environment was very largely stable. Rates and conditions remained relatively constant. Only in aviation reinsurance did prices continue to retreat. Our market share in aviation business, which we had again considerably enlarged in 2004, remained stable in the year under review.
United Kingdom and Ireland Rates in the primary insurance sector came under moderate pressure in the United Kingdom and Ireland. Although this could be felt across all lines of business, it was particularly appreciable in difficult liability lines such as directors' and officers' (D&O) and professional indemnity covers.
Drilling platforms in the Gulf of Mexico heavily damaged by hurricanes
The London Market is also a prominent centre for the underwriting of marine and aviation risks. Given the surplus capacity prevailing in this sector, rates in aviation insurance – as previously mentioned – softened further by up to 15% compared to the previous year. Surplus capacities on the reinsurance side are limited, however, by the fact that ceding companies still attach considerable importance to their reinsurer 's financial standing. Following an initial decline in rates, price increases of as much as 10% were obtained in the aftermath of the severe hurricanes.
In marine reinsurance our primary emphasis continued to be on consolidating our portfolio. The rate level improved considerably in the wake of hurricane "Ivan" in 2004, which was by far the largest ever loss incurred in marine business. We again concentrated on writing more profitable non-proportional business. Our proportional acceptances are limited to just a few lines, such as offshore business and war risks. Facultative business is written on a purely opportunistic basis.
Business results in Europe highly satisfactory likely, it must be anticipated that original rates will at least see a symbolic reduction.
In the Benelux countries we successfully defended our market share and even enlarged it in certain lines. Our business in Belgium developed according to plan, both in the motor and workers' compensation lines. We acquired new clients in facultative and treaty reinsurance alike. In the Netherlands we were able to cultivate and expand business with our target clients, the mutual insurance societies. We also stepped up our involvement with large insurance groups. Low-margin proportional treaties were further scaled back in favour of more profitable non-proportional business, especially in the motor third party liability sector. All in all, rates on the Dutch market remained stable and the loss situation was highly favourable. As in the previous year, for example, the frequency of fire claims in 2005 was again relatively low.
The Italian non-life market recorded its weakest premium growth of the past decade at around just 2.5% in the year under review. This was attributable to the sluggish state of the Italian economy. With the aid of clear customer and market segmentation, however, we were still able to generate modest volume increases in our preferred lines without jeopardising the profitability of our portfolio. In this context, Hannover Re continued to restructure its portfolio in the year under review by replacing proportional business with non-proportional arrangements. As in other markets, the financial standing of reinsurers is becoming an increasingly important factor in Italy. With our above-average rating we were therefore a highly sought-after partner.
All in all, we were again able to profitably expand our market position in Italy, where we rank fourth in the non-life reinsurance market. No significant major losses were incurred in any of our lines of business.
Northern European market. As before, we rank among the most prominent reinsurers and are a desirable partner thanks to our expertise and very good ratings. Once again, we were able to profitably enlarge our premium volume in the Northern European market.
On the claims side the situation was less favourable: both Denmark and Sweden were hard hit by winter storm "Erwin". In total, we incurred a strain running into the lower double-digit million euros in connection with this event. As a further factor, property business in Sweden was impacted by a number of fire losses.
Eastern Europe The Eastern European markets continued to grow at an above-average pace in the year under review. Although original rates in property insurance declined in all Eastern European countries, the hard market on the reinsurance side was sustained. Overall, the rate level held stable in the property lines and in motor third party liability insurance.
Until the end of the second quarter of 2005 the state of the American primary insurance market was exceptionally healthy. It was only the severe hurricanes of the third and fourth quarters that took a heavy toll on insurers' capital resources – especially among those companies that had concentrated primarily on private customer business. Premium trends had been flat as a consequence of the continuing fierce level of competition, but in property insurance they began to climb thanks to rising rates after the hurricane season. Original rates in casualty business, on the other hand, declined somewhat.
The investigations launched by the New York Attorney General continued to make waves on the US insurance market in the year under review. As a consequence of these probes and the Sarbanes-Oxley Act to promote enhanced transparency of financial reporting, the insurance industry witnessed a number of balance sheet revisions and resignations by prominent corporate managers.
For reinsurers the year under review posed a special challenge: on the one hand, the exacting capital adequacy standards – including those imposed by the rating agencies – required the combined ratios for catastrophe-exposed parts of the portfolio to remain well below 95%. On the other hand, the industry found itself facing historically unparalleled hurricane losses that put the desired combined ratios beyond reach. A not insignificant number of reinsurers were compelled to report a net loss and had to turn to the capital market to replenish their equity base.
In accordance with our anticyclical underwriting policy, our strategy is to reduce our premium volume as the market softens. In the year under review we therefore identified those busi-
In property insurance the extraordinarily intense hurricanes have prompted a particularly marked rate trend that will continue well into 2006. While many cedants have responded with substantial premium increases in their property insurance business, some have withdrawn entirely from hurricane-exposed regions. Hannover Re continues to stand by its clients for the coverage of catastrophe risks; nevertheless, we have optimised our own accumulation situation and have somewhat restricted our catastrophe exposure in coastal regions.
our very good ratings and our clients' positive assessment of our financial strength, we are one of the few reinsurers that ceding companies also approach for the placement of long-tail casualty risks. We were therefore again able to write such treaties highly selectively in the year under review and generate attractive business.
Thanks to our conservative reserving policy and our reduced participation in soft market years, we again had no need on balance to establish additional reserves for past underwriting years.
Credit and surety reinsurance remained an exceptionally hard market, and we thus enjoyed some highly inviting business opportunities. Hannover Re ranks among the market leaders in this line. As in the past, the US market is dominated by surety business, and both growth and profitability were highly satisfactory. These lines were in large measure spared any loss events associated with the hurricanes, and from an overall perspective too credit and surety reinsurance did not witness any spectacular major losses in the year under review.
Our primary focus in marine reinsurance was the consolidation of our portfolio. While we write a relatively broadly spread portfolio in the non-proportional sector, we concentrate our proportional treaty acceptances on just a few lines (e.g. offshore) and work together with providers of niche products. Facultative business is written on a purely opportunistic basis. In North America too marine business posted heavy losses in the year under review. Most notably, hurricanes "Katrina " and "Rita" inflicted serious damage on oil facilities in the Gulf of Mexico. Particularly in this region, therefore, we shall respond by reducing our natural catastrophe aggregate.
Hannover through brokers and thus enjoys far less direct contact with ceding companies. Taking the brokerage market in isolation, Hannover Re is ranked as the undisputed number one reinsurer in North America.
Argentina continue to be Hannover Re's most important markets in Latin America. These countries anticipate growth in gross domestic product of between 4% and 10% in 2005.
In property business the market was in a tense state throughout the region until hurricane season, with rates tending downwards. This situation brightened in the wake of the hurricanes, especially in Mexico but also in other areas, and reinsurance conditions improved. Our results were nevertheless heavily overshadowed by the effects of hurricane "Wilma".
In some motor insurance markets insurers achieved double-digit growth rates; this tendency was fostered by more stable exchange rates and lower consumer credit interest rates.
Overall, in accordance with our strategic objectives, we further expanded our profitable nonproportional portfolio.
All in all, our premium volume contracted slightly – for the most part in casualty business. This was attributable to the fact that the largest provider of general liability and professional indemnity covers raised its retention in the year under review, hence leading to a reduction in our share.
Exceptionally gratifying result in Asia in the year under review. Treaties that had suffered little or no impact from the typhoons saw minimal increases or unchanged rates. Nevertheless, reinsurance terms and conditions for windstorm events and commissions for proportional treaties both showed improvements. More beneficial for reinsurers than the price increases was the fact that – in the aftermath of the heavy losses in 2004 – demand for additional windstorm covers increased among Japanese insurers as they sought to better protect their peak exposures.
China remains a target market for the international insurance and reinsurance industry, and competition is correspondingly fierce. We are keeping a very close eye on this market. Although Hannover Re does not have a local license to transact business in China, we maintain good business relations with Chinese insurers. We intend to step up our involvement in this market as soon as rates reach an adequate level.
All in all, we are exceptionally satisfied with our results in Asia.
New Zealand again developed highly satisfactorily in the year under review. Although original rates came under pressure, the repercussions for the reinsurance market were only slight. Rates in non-proportional casualty business held steady, while in catastrophe insurance rate reductions could be observed up until the treaty renewals as at 1 July. Here too, though, the natural catastrophe events in the USA made themselves felt: even on loss-free programmes price increases were pushed through in the treaty renewals as at 1 October 2005. The market did not suffer any significant loss events.
considerable importance to long-term customer relationships, although not at the expense of profitability. Our aim in the year under review was once again to enlarge our share of non-proportional business and scale back proportional acceptances – a goal which we succeeded in achieving. Hannover Re was very satisfied with the performance of its portfolio in the year under review.
In the interests of a consistent market presence we operate – in addition to our Home Office in Hannover – an international network of altogether 18 subsidiaries, branches and service offices on all five continents under the proprietary brand name of Hannover Life Re.
In the international arena the signs continue to point to long-term growth that should extend to all areas of life and health reinsurance (life, annuity, health and personal accident). Annuity and health insurance products are likely to profit most from the secular demographic trends and should constitute the primary driver of growth for many life insurers in the years to come.
Our Home Office in Hannover – in its role as Hannover Life Re International – fulfils a dual function: it transacts our business in foreign markets such as France, Scandinavia and Asia and serves as a central risk manager for the Hannover Life Re network and retrocessionaire for the foreign life subsidiaries.
The level of premium retained by Hannover Life Re continued to rise in the year under review, reaching an all-time high of 92.8%. Net premium earned consequently climbed 15.4% to EUR 2.3 billion (EUR 2.0 billion).
Hannover Life Re's performance is primarily determined by four factors: • development of the biometric risks of mortality, morbidity and longevity,
• development of the risk associated with the persistency of the business in force and of the credit risk associated with the ceding company,
The biometric risk of mortality developed satisfactorily overall, albeit with regional differences as in the previous years: the results in Europe and Asia ranged from good to very good, while the experience in the USA fell somewhat short of expectations. In the major South African and Australian markets we recorded a number of mid-sized claims with sums insured of up to EUR 3 million. Our actuarial analyses indicated that these were of a random nature, however, and did not indicate a trend shift.
Gross premium incl. premium deposits 2 733.2 +9.9% 2 487.9 2 534.2 2 728.3 2 660.0
Net premium incl. premium deposits 2 532.1 +13.9% 2 223.5 2 149.7 2 257.5 1 869.0
The operating profit (EBIT) generated in life and health reinsurance of EUR 93.1 million surpassed the previous year's figure (EUR 76.7 million) by 21.5%. The EBIT margin, calculated as a quotient of the operating profit (EBIT) and net premium earned, stood at 4.1%. Group net income climbed by a substantial 56.7% to EUR
Following the tax-induced boom of the previous year, the German life insurance market experienced a marked decline in new business and a shift towards traditional and unit-linked annuity products in the year under review. As a further factor, sales structures had to be modified in line with the new EU Mediation Directive.
This new requirement has had particularly far-reaching implications for the marketing channel served by brokers and multiple agents, where new standards concerning not only liability but also transparency and the sales process must be satisfied.
United Kingdom In the United Kingdom, Europe's largest life reinsurance market, Hannover Life Re writes its business through three business centers in accordance with a local marketing approach.
Total gross written premium in the United Kingdom increased by 45.6% year-on-year to EUR 535.4 million (EUR 367.8 million); of this amount, EUR 183.4 million was attributable to Hannover Life Re UK and EUR 352.0 million to Hannover Life Re Ireland as well as Hannover Life Re International. The United Kingdom thus ranks ahead of Germany, France and Italy as our most important life market in Europe.
The risk experience for mortality and critical illness was gratifying in the year under review. We continue to monitor closely the run-off of a former major client's terminated portfolio of enhanced annuities; our analyses indicate that runoff of the portfolio – containing over 20,000 policies – is progressing on a solvent basis and according to plan.
Hannover Life Re UK achieved an operating profit (EBIT) of EUR 13.5 million (EUR 10.2 million), corresponding to an EBIT margin of 19.1% on the company's net premium earned. Net income after tax totalled EUR 9.2 million (EUR 7.0 million).
Ireland Our Irish subsidiary Hannover Life Re Ireland writes treaty business on a worldwide basis, although predominantly in the USA, UK, Canada and South Africa. Under transactions that involve a full risk transfer the company is able to make the most of the tax and other advantages associated with its Dublin location so as to design attractive, bespoke reinsurance solutions for our clients.
The results posted by Hannover Life Re Ireland were better than anticipated in the year under review. Gross premium income grew by 43.7% to EUR 498.6 million (EUR 346.9 million), while net premium earned amounted to EUR 455.7 million (EUR 291.0 million).
Hannover Re boosted the paid-up shareholders ' equity of Hannover Life Re Ireland by EUR 65.0 million in December 2005 in order to reinforce the company's capital base for the long term.
France, Italy, Spain and Arab countries In the Romance-speaking countries we operate through our life branch in Paris and service offices in Milan and Madrid, principally in the areas of bancassurance and pension funds. We also concentrate on distribution through brokers and financial advisors.
In addition, our Paris branch bears responsibility for Near Eastern and Arab markets as well as French-speaking Canada.
Results in the year under review were again gratifying, and the financing transactions written showed the projected positive development.
We continue to operate only on a highly selective basis in individual term insurance, which for most of our competitors constitutes the main sphere of activity in the US market.
Gross premium income in the year under review amounted to EUR 495.0 million – a modest decline of 3.6% compared to the previous
Results varied: while the performance of block assumption transactions in life business and of Latin American risks was very good, Medicare Supplement covers suffered under increasing competition on the US market. The profit margin for these treaties declined somewhat, although the level is still satisfactory.
For Hannover Life Re America too results in the year under review proved to be better than expected. The operating profit (EBIT) stood at EUR 17.4 million (EUR 17.8 million), and net income after tax was boosted to EUR 10.5 million (EUR 10.2 million).
Gross premium fell by 7.8% to EUR 93.9 million (EUR 100.7 million). Against the backdrop of a favourable claims experience, the operating profit (EBIT) surged sharply to EUR 4.0 million (EUR 1.5 million).
We were able to expand our position, particularly in the Chinese-speaking market region and in Korea. China contributed a premium volume in excess of EUR 10 million for the first time, and in Korea we succeeded in writing our first substantial participations with leading market players.
Subsidiary Hannover Life Re Australasia market leader in Australia, New Zealand and Oceania
When it comes to underwriting the risks, however, financial reinsurance uses the same actuarial models and treaty constructions as those found in traditional property and casualty reinsurance; for organisational purposes many reinsurers therefore include it within this business group. Hannover Re, however, transacts financial reinsurance as a separate business group established under the Hannover Re Advanced Solutions brand. By taking this approach we would like to create optimal transparency for our clients and shareholders.
Outside the USA too demand was again strong in the year under review. The ongoing preparations among European insurers for the transition to International Financial Reporting Standards (IFRS) continued to be a major issue which also generated new business for our company. In the first year of adoption – for many enterprises, including Hannover Re, this will be the 2005 financial year – these new standards give rise to greater volatility in the results recognised in ceding companies' balance sheets. The establishment of equalisation reserves – mandatory under German accounting rules, for example, in order to offset fluctuations in the annual results – is not permitted under IFRS. The resulting increased capital requirement is already reinvigorating the debate surrounding and the demand for cost-effective financial reinsurance solutions.
Key figures for financial reinsurance 1) On a US GAAP basis 2) Operating profit/net premium earned
Stronger demand for covers with a greater level of risk transfer
In concrete terms, we were once again able to profitably enlarge our business outside the USA, most notably in Europe but also in Asia and Latin America.
We are one of the world's three largest providers of traditional financial reinsurance solutions. The brand name Hannover Re Advanced Solutions embodies our expertise in developing individually tailored customer solutions. Based on our considerable experience, technical expertise and not least our proven financial business success, we enjoy numerous long-term client relationships in the United States, by far our largest market. We work together with large and specialist brokerage houses, with whom we maintain similarly close business relations.
Most of our business contacts in the United Kingdom are with Lloyd's syndicates and Londonbased brokerage firms. The German market is served by our subsidiary E+S Rück. In the rest of Europe we have been able to significantly enhance our profile through targeted marketing activities, especially in the countries of Eastern Europe. On the Australian market, however, we still detected a certain caution that can be attributed to the insolvency of a major Australian insurer whose financial reinsurance transactions had come in for some criticism. In Asia we made unqualified progress, as is also borne out by new contracts in China, Korea and Kazakhstan. In Latin America too we made advances, especially in the markets of Venezuela, Ecuador and Mexico.
Stronger demand was observed in the market for covers that facilitate a greater level of risk transfer. This was one of the consequences of the ongoing open debate surrounding the minimum risk transfer under reinsurance contracts. We see this situation as an opportunity for Hannover Re. By way of internal cooperation across our organisation's business groups, we are able to precisely calculate the commensurate risk premium according to the risk content of the business. The Hannover Re Group's rating tools are applied consistently by all underwriters in the financial reinsurance and property/casualty reinsurance business groups. This gives us a competitive edge that opens up further market potentials for our company.
We use the term "specialty insurance" to designate a form of primary insurance which concentrates on closely defined, homogeneous portfolios of niche or other non-routine business that is not normally offered or adequately covered by traditional insurers. Major functions of the business (from acquisition through the issuing of policies and premium collection to claims settlement) are normally outsourced and handled by specialised managing general agents (MGAs) or thirdparty administrators (TPAs).
Rates on the American primary insurance market softened somewhat on average in the year under review, whereas in other markets they held stable. Contract conditions for insurers were maintained on their present highly attractive level. In California reforms implemented in workers' compensation insurance have substantially reduced insurers' costs since the middle of 2004, without eroding the premium base to the same degree. The profitability of this line consequently improved in the year under review. The state of New York announced similar plans to reform the workers' compensation market in November 2005. On the other hand, the proposals of the US Congress seeking to reinterpret the law of damages, inter alia with the aim of limiting punitive damages and moving class action lawsuits from local courts to the federal level, were rejected by the Senate in July.
All in all, the year under review was a satisfactory one for financial reinsurance. Due to the uncertainties in US demand, however – especially in the first half of the year –, our gross written premium contracted by a sizeable 21.9% to EUR 924.1 million (EUR 1,183.3 million); a further factor here was the cancellation of a large contract by a long-standing customer. Exchangerate effects had only a minimal positive impact of 0.1%. Net premium earned fell by an even more appreciable 30.9% to EUR 833.8 million
Following the disastrous claims experience of the previous year, the year under review also suffered catastrophe losses that – while few in number – produced very heavy losses. Taken together, the three hurricanes "Katrina", "Rita" and "Wilma" took a toll of EUR 40.3 million on the result for net account. Still, the proportional reinsurance protection taken out in the wake of the previous year's hurricanes afforded considerable relief in this respect: at the time the net loss from the 2004 hurricanes had been as much as EUR 90.0 million. Our risk management thus proved its worth in the year under review.
The business written by Inter Hannover in the year under review in its main markets of the United Kingdom, Ireland, Scandinavia, France and Germany was notable for deteriorating rates in the UK motor and liability market. Premium in specialty insurance nevertheless grew substantially as the company was able to expand its market presence through cooperation with several newly established managing general agents. New cooperations were entered into with MGAs in Norway and Germany. Inter Hannover generated gross premium income of EUR 279.5 million (EUR 258.4 million) and net income of EUR 4.1 million (EUR 5.0 million).
Compass, our South African subsidiary, successfully cultivated new business relationships in the year under review: it attracted three new managing general agents and boosted its premium volume accordingly. Gross premium income climbed to EUR 45.0 million (EUR 40.0 million), while the after-tax profit stood at EUR 1.1 million (EUR 1.4 million).
In January 2006 A.M. Best, the major rating agency for US business, confirmed its rating of "excellent" ("A-"); this is a good platform for the future pursuit of a successful business policy.
The European bond market temporarily uncoupled itself from US parameters and outperformed US treasury bonds well into the third quarter. European 10-year bonds fell to a yield low of 3.0% in the course of the year, only to recover to 3.3% by year-end. The yield gap between US and European ten-year government bonds thus stood at 105 basis points at the end of the year.
As 2005 progressed players on the foreign exchange markets profited increasingly from the interest rate advantage enjoyed by the USA over the Eurozone and Japan, causing the US dollar to appreciate significantly. Both the yen and the euro shed around 13% of their value against the greenback. The euro closed 2005 at
Hannover Re used the positive movements on equity markets to realise profits and adjust its tactical positioning, as a consequence of which our equity allocation was reduced to a slightly lower level than in the previous year at 6.4%.
Despite the slightly defensive posture of our bond portfolio the investment performance was in line with our planning. Thanks to the strong cash inflow from the technical account, our portfolio of self-managed assets grew to EUR 19.1 billion (EUR 16.0 billion). It was thus possible to offset the decline in average yields, and the ordinary income of EUR 671.8 million (EUR 604.5 million) came in slightly higher than in the previous year.
Deposit interest and expenses contributed EUR 343.1 million (EUR 382.1 million) on balance to net investment income. Gains of altogether EUR 272.2 million were realised on disposals in the reporting period, as against losses of EUR 110.0 million. The positive balance of EUR 162.2 million was thus slightly lower than in the previous year. Net investment income improved by 4.1% year-on-year to EUR 1,123.7 million (EUR 1,079.9 million).
As in previous years, we actively managed the duration of our fixed-income portfolio, thereby not only optimising our returns but also conserving our shareholders' equity. By the end of the first quarter we had increased the modified duration of our bond portfolio to 3.6, a figure that climbed to 3.9 by September and 4.1 (3.2) as at year-end 2005.
dex – gained only a disappointing 2.9%. Indeed, the more narrow Dow Jones Industrial Index of US blue chips actually retreated by 0.7%.
Once again, expectations among players on the bond markets were dominated by the theme of interest rate rises. The US prime rate was hiked 25 basis points on each of altogether eight occasions to close the year at 4.25%. Tenyear US yields for the most part moved in a range of 4.0% to 4.5% throughout the year, closing
Our portfolio of fixed-income securities had grown by 20.6% as at 31 December 2005 to EUR 15.7 billion (EUR 13.0 billion). We used the decline in yields in Euroland to realise price gains of EUR 44.2 million (EUR 83.0 million) on balance in the bond portfolio. In view of the low interest rate level and the minimal yield advantages of corporate bonds over government bonds we attached special importance to high quality. Our holdings of corporate bonds were consequently not significantly expanded. Our preferred asset classes in Europe were instead government bonds and jumbo mortgage bonds. New investments were made primarily in short- or medium-duration instruments. Unrealised gains in our portfolio of fixed-income securities totalled EUR 56.2 million, compared to EUR 156.8 million in the previous year.
As at 31 December 2005 we held a total amount of EUR 769.8 million in short-term assets, including overnight money and time deposits, and EUR 465.2 million in current assets. Funds held by ceding companies, on the other hand, decreased to EUR 8.4 billion (EUR 9.2 billion).
In light of the favourable trend on equity markets we realised increased gains. Owing to the strong growth in the overall asset portfolio the equity allocation therefore fell, despite the fact that in absolute terms the equity portfolio grew to EUR 1,213.3 million (EUR 1,100.6 million ). New equity investments were made predominantly in index-tracking investment instruments from the Eurozone. By using targeted option strategies we exploited market volatilities in order to optimise our portfolio.
Continuity is also the hallmark of the esteem in which Hannover Re is held as an employer. Following our successful participation in the 2004 survey "Germany's best employer" conducted on the basis of a standardised questionnaire, we carried out a company-specific survey in the year under review to explore in even greater detail just how our staff rate us as an employer. On the basis of a questionnaire tailored specifically to our company, Hannover Re's staff once again expressed their considerable satisfaction overall: nine out of ten employees – more precisely 92% – consider Hannover Re to be a very good employer. The overall level of satisfaction was thus even higher than in the previous standardised survey. Irrespective of the highly positive overall findings, we identified room for improvement and advancement in some areas. Working together with the Employee Council we analysed these weakness and initiated appropriate countermeasures. Some areas of the company, for example, expressed a desire for more support in handling in-house conflicts. Since the adverse repercussions of unresolved conflicts are plain to see, we offered a cycle of training activities in the year under review designed to convey conflict management skills to our managerial staff.
We reviewed our range of personnel development tools such as appraisal interviews, personnel development workshops and other internal seminar offerings. In their feedback on behaviouroriented coaching our staff praised the existing range of seminars, but they also expressed additional needs.
We combined our two personnel tools Management Feedback (assessment of a manager's performance from the standpoint of his/her supervised staff) and 270° Feedback (assessment of a manager from the standpoint of his/her supervisor and colleagues) in the year under review with a view to constantly enhancing our customer orientation and streamlining internal processes. With the new, intelligent linking of these tools we have striven to improve managerial performance, on the one hand, while at the same time creating more time for customers.
The use of the intranet as an important medium for information and communication has long been established practice at Hannover Re. This is equally true of the intranet presence maintained by Human Resources Management, which employees use inter alia to obtain information or register for seminars. The technical innovations of recent years now facilitate highly varied use of the intranet for personnel purposes.
The Hannover Re Group employed 1,989 (1,954) staff from 18 countries as at 31 December 2005. The staff turnover of 3.2% (2.3%) – measured in relation to the average workforce of 857 employed at Home Office in Hannover – remains considerably better than the industry average. Along with the current state of the labour market, there can be no doubting the role played here by our continuous and systematic personnel development and leadership.
We would like to thank our employees for their initiative, dedication and performance. In the year under review our staff once again pursued the company's strategic objectives with enthusiasm and energy. We would also like to express our appreciation to the representatives of staff and senior management for their critical yet always constructive cooperation.
In accordance with its strategy Hannover Re strives to be one of the three most profitable reinsurers in the world – both in terms of the return on equity and the annual growth in earnings per share. In our pursuit of this goal we never lose sight of our social responsibility. We are committed to the City of Hannover and our sense of responsibility is reflected in a foundation that benefits the Sprengel Museum Hannover. Launched in 1991 on the occasion of Hannover Re's twentyfifth anniversary, the foundation has a clear mission: the advancement of contemporary art in Hannover through the acquisition of paintings and sculptures for the Sprengel Museum Hannover and the funding of accompanying publications and events. In the year under review the foundation was able to hand over a fourth work on permanent loan to the museum following its purchase of "Bilddreiundzwanzig" by Georg Baselitz.
Hannover Re is held in high international esteem. In the year under review clients and other market players once again assessed our company highly positively: in the first place, our Chief Executive Officer was crowned "Chief Executive of the Year" by the UK reinsurance magazine "Reactions"; secondly, Hannover Re achieved excellent results in the customer survey conducted by the American Flaspöhler Research Group, having already been voted the best reinsurer on the US market in the previous year's corresponding broker survey.
Global risks • Global risks are beyond our direct sphere of influence and there are therefore limits to the extent to which they can be reduced or avoided. Early detection is the top priority here. Global risks derive, inter alia, from: • changes in the legal framework, including changes in the general regulatory and tax environment,
• social and demographic changes as well as developments in the insurance industry,
As an internationally operating reinsurer, our business inevitably involves commercial risks – which take different forms in the various strategic business groups and geographical regions. The acceptance of risks and the professional management of this risk portfolio constitute the core business of a reinsurance enterprise. Our risk management is based on a business strategy geared to sustained enhancement of the company 's value. This means that we systematically enter into entrepreneurial risks provided the associated opportunities promise a commensurate increase in the value of the company.
– Local risk controlling aggregates and manages individual risks on the level of specific business groups and, where necessary, initiates appropriate risk-minimisation measures.
– Centralised risk controlling steers the entire process and is responsible for mapping the risk situation of the company across all business groups.
• Documentation of the principal elements of risk management in guidelines that are valid throughout the Group.
• Regular internal and external review of the efficiency of the risk management system and adjustment to the prevailing business environment.
• regular adjustment of our underwriting policy (e.g. through appropriate contractual exclusions or by way of material and geographical diversification of the portfolio),
• analysis of the frequency of and extent of losses associated with natural disasters attributable to climate factors using detailed simulation models (e.g. frequency and intensity of windstorm events due to climate change),
Strategic risks Our overriding strategic objective is to grow as an optimally diversified and economically independent reinsurance group of above-average profitability. All other goals are derived from and subordinate to this overriding objective. Every three years we review the assumptions underlying our strategy. In order to translate our strategic objectives into operating practice, we have defined company-wide ratios and controlling processes that are used to measure and steer the contribution made by each business segment to the overall corporate performance. Performance Excellence is the method used to put our strategy into practice. At annual Excellence workshops we systematically deploy a number of tools – inter alia the SWOT1 analysis – to examine the implications of strategic decisions. The resulting diverse initiatives lead to consistent refinement of value-enhancing processes.
Technical operating risks Risks in underwriting business can essentially be subdivided into risks of random fluctuation, risks of error and risks of change.
For further information we would refer the reader to the explanatory remarks contained in Section 7.2 of the Notes, "Technical risks".
Breakdown of technical operating risks into risks of random fluctuation, error and change
Property and casualty reinsurance In property and casualty reinsurance the main methods used to reduce risks are as follows: • The loss reserves are determined on an actuarial basis. The point of departure for our calculations is the information provided by cedants. In addition to the claims reported by our clients, we establish additional reserves that may seem appropriate on the basis of our loss estimations. Furthermore, we constitute an IBNR (incurred but not reported) reserve for losses that have probably already occurred but have not yet been reported to us. This applies primarily to claims in the liability lines. Furthermore, the calculations made by our own actuaries are regularly reviewed by external actuaries and auditors. For more information on the risk of losses exceeding premiums please refer to the Notes in Section 7.2 of this report, "Technical risks".
• The complexity involved in correctly measuring the loss reserves is illustrated by asbestosand pollution-related claims, since in this area years and sometimes even decades may elapse between causation and reporting of a loss. The relative level of the reserves for asbestos claims is determined using the so-called "survival ratio". This expresses how many years the reserves would cover if the average level of paid claims over the past three years were to continue. As at the end of the year under review our survival ratio stood at 26.0 years, a very good figure.
• Hannover Re analyses the findings of all available scientific research into possible changes in the risk situation associated with natural disasters (e.g. frequency and intensity of windstorm events) with an eye to the implications for potential losses. To this end we use recognised licensed simulation models and also employ our own scientists, who control the quality of the models and develop our own risk management tools. The extreme natural catastrophe events of 2005 revealed structural flaws in the risk models. As an immediate step intended to restore our calculations to a riskadequate basis, we are adding safety loadings to the output of the simulation models.
Careful consideration of our retrocession partners in light of credit considerations
Investment income should be maximised subject to a limited and clearly defined risk
In our understanding, the category of operational risks encompasses the risk of losses occurring directly or indirectly because of
Listed equities (direct holdings and investment funds) At most 17.5% 6.4%
We bring together the management of our assets and liabilities under the umbrella of our asset/liability management (ALM) approach. This enables us to optimise Hannover Re's overall position according to a single financial risk/ return target.
The management of investment risks makes allowance for certain risk preferences specified by the Executive Board. Risks in the investment sector consist most notably of market, credit and liquidity risks. Currency exposures are also of considerable relevance to an internationally operating reinsurance enterprise that writes a major portion of its business in foreign currencies. These risks are, however, largely neutralised because we adhere rigorously to the principle of matching currency cover.
As an internationally exposed reinsurance group we face many potential risks that could have a not inconsiderable impact on our assets, finances and earnings. Based on the information currently available, however, we cannot discern any risks that could jeopardise the continued existence of our company in the short or medium term or have a significant, lasting effect on our assets, financial position or net income.
The state of the US economy will depend not least on how quickly it is able to stem the headline-grabbing disruptions in oil production that followed the severe hurricane damage. To a far greater extent than this effect, however, the tightening of monetary policy is likely to bring about a modest cooldown in the US economy.
The upturn in the world economy has also been supported by economic expansion in Japan and Western Europe. The emerging markets of East Asia – with their consistently vigorous manufacturing growth – will also contribute to the upswing, even though a slight slowdown is likely to take hold in China during the current year.
In Germany a modest economic recovery can be anticipated. Given the favourable worldwide environment, exports are likely to reinvigorate the economy. Much will depend, however, on whether domestic demand increases. As a further factor, the consolidation of corporate finance will also support the resurgence of the German economy. Yet the stubbornly depressed level of consumption among private households – influenced by rising energy costs, the uncertain state of the labour market and slow growth in employment income – has still not been alleviated. On the other hand, the latter factor promotes the competitive position of the German economy in the international arena. All in all, the economic picture in Germany too should improve significantly in 2006.
The treaty renewals as at 1 January 2006 – the date when roughly two-thirds of our portfolio was renegotiated – were satisfactory for our company. Although not all our expectations were fulfilled, we were still able to surpass the already very high rate level in some areas.
In addition to adjusting our models we reduced our peak exposures as part of our risk management measures. With a roughly unchanged premium volume, our property and casualty reinsurance portfolio is thus ready to face the challenges of the current year.
It was once again evident from this year's renewal season that ceding companies are attaching ever-greater importance to a reinsurer's rating. This is especially true of the underwriting of long-tail liability business, where a very good rating is absolutely indispensable. Hannover Re is one of the few reinsurers that continues to satisfy this condition without reservation on the basis of its very good ratings ("AA-" from Standard & Poor's and "A" from A.M. Best).
In light of our good financial strength rating we profited disproportionately strongly from the sustained hard market; indeed, in lines that had been hard hit by last year's hurricane events we were able to obtain sometimes appreciable rate increases. Even in lines that had been spared major losses we recorded for the most part at least stable – and hence highly attractive – rates.
Management report forecast that considerably greater importance is being attached to the financial standing of reinsurers. In some instances this enabled us to write larger shares and acquire new business, thereby in large measure offsetting the decline in premium associated with the sometimes substantially higher retentions carried by primary insurers.
In North America, our largest and most important market, our primary focus in the current financial year will be on the continued optimisation of our portfolio. With this in mind we are pressing ahead with the restructuring of our proportional acceptances in favour of considerably more profitable non-proportional business. In the liability sector we shall consolidate our portfolio. Our clients here continue to attach particular importance to better-then-average financial strength. Thanks to our very good rating we have thus become a preferred partner in this line. Yet we are not satisfied with the development of all liability lines. In directors' & officers' (D&O) insurance, for example, we found the rates to be inadequate and consequently wrote our business on an extremely selective basis. Should rates here continue their downward slide, it is likely that we will significantly scale back our premium volume.
In the aftermath of the heavy hurricane losses, the affected property lines saw substantial price increases combined with reduced coverage limits. In catastrophe reinsurance we achieved rate increases averaging around 100% in programmes that had suffered a total loss, compared to around 50% in those with only partial losses; even under loss-free programmes we were able to obtain improvements of 5–10%. Rates in other lines of property and casualty reinsurance generally at least held stable. We expect our North American business – provided it is spared exceptionally high natural catastrophe losses – to show strong profitability.
Business in Australia is progressing very well. In this market some treaties are renewed as at 1 January, others on 1 July. Thus far, rates have held very stable on a high level, and we expect further highly attractive business from the Australian market.
Striking growth in new business is expected in numerous European markets for the current financial year.
We consistently pursue a conservative underwriting and pricing policy that is enshrined in our global underwriting guidelines. Since we are able to offer our clients a high level of financial strength we are a sought-after reinsurance partner.
In the area of unit-linked products – primarily annuities – in German-speaking markets we shall continue to finance our clients' new business acquisition costs. Our business is also expected to expand in the United Kingdom.
As far as enhanced annuities are concerned, our focus is on the European market – especially Germany, the United Kingdom and Switzerland. Bancassurance business will develop notable momentum, particularly in the German, Italian and Greek markets.
In the USA we are making the most of new opportunities that have opened up for the coming years in the field of health insurance for senior citizens with the launch of drug covers for seniors on 1 January 2006. We are also working intensively on the roll-out of system-supported solutions for the sale of life policies by major US financial services providers.
The South African market, in which we now rank as one of the leading reinsurers, offers additional growth potential in already existing customer relationships. In Asia we shall step up our marketing and services for Thailand and Vietnam, although China and South Korea will also figure prominently; we intend to significantly intensify our cultivation of these markets from our Hong Kong office.
The licensing procedure for a life branch in China continues to move forward, and we still hope to receive a licence in the first half of 2006.
All in all, we are again looking to doubledigit increases in premium volume and net income for the current year.
It is our expectation that the strong surge in demand from the USA in the fourth quarter of the year under review will be sustained in 2006, with a special focus on solvency-stabilising surplus relief contracts. The majority of our clients are mutual insurance societies or other privately owned companies that do not have access to the capital market. We are confident of our ability to
Management report forecast continue generating adequate profitable growth worldwide, and especially in Eastern European and Asian markets.
In the course of the current year we shall move forward with the strategic realignment of Clarendon initiated in July 2005: the newly established Praetorian will be positioned as a specialty provider for niche business, while Clarendon will handle the professional run-off of terminated programs. Both companies are led by seasoned specialists.
In view of the expected development of our business groups and the economic climate, Hannover Re is poised to enjoy a very good performance. We are striving for a return on equity of at least 15%. As always, this projection is conditional upon major loss expenditure remaining within the bounds of the multi-year average and there being no unexpected downturns on capital markets.
On the Group level our return-on-equity target is at least 750 basis points above the risk-free interest rate.
Both the earnings per share and the book value per share also constitute central management ratios and performance indicators for our company: our strategic objective is to increase these key figures – together with the operating profit (EBIT) – by at least 10% every year (triple 10 target).
Fixed-income securities – available for sale 8.1 14 383 176 11 771 045
Fixed-income securities – at fair value through profit or loss 8.1 88 111 97 078
Total investments and cash under own management 19 079 059 15 984 323
Reinsurance recoverables on other technical reserves 8.2 19 436 9 903
Loss and loss adjustment expense reserve 8.1 20 210 041 18 247 706
Unrealised gains and losses on investments 8.1 14 471 10 699
Total depreciation, impairments and appreciation of investments 8.1 21 463 41 054
Changes without effect on income – – (33 588) 35 098 (1913) (323) 7 405 6 679
Changes in other assets and liabilities (net) (62 696) 36 800
Cash flow from operating activities 1 554 346 1 638 385
Change in cash and cash equivalents (I.+II.+III.+IV.) (15 890) 90 539
Hannover Re's segmental report is based on IAS 14 "Segment Reporting" and on the principles set out in German Accounting Standard No. 3 "Segment Reporting" (DRS 3) of the German Standards Council, supplemented by the requirements of DRS 3-20 "Segment Reporting of Insurance Enterprises".
Total investments and cash under own management 12 430 328 9 906 281 2 081 187 1 677 339
Reinsurance recoverables on unpaid claims 2 178 090 1 482 750 107 100 90 562
Reinsurance recoverables on benefit reserves – – 94 089 101 634
Other liabilities in the segment 1 492 279 1 214 938 1 150 229 1 320 088
From insurance business with external third parties 4 564 882 4 087 032 2 406 764 2 176 545
Commission and brokerage, change in deferred acquisition costs and other technical income/expenses 823 864 639 326 684 142 589 555
The parent company Hannover Rückversicherung AG ("Hannover Re") and its subsidiaries (collectively referred to as the "Hannover Re Group") transact all lines of property/casualty, life/health and financial/finite-risk reinsurance as well as specialty insurance. The Group maintains business relations with more than 5,000 insurance companies in about 150 countries. With gross premium of approximately EUR 10 billion, Hannover Re is one of the largest reinsurance groups in the world. The company's global network consists of more than 100 subsidiaries, affiliates, branches and representative offices in 18 countries. The Group's German business is conducted exclusively by the subsidiary E+S Rück. We employ over 800 staff in Hannover and roughly 2,000 worldwide. The parent company is a joint-stock corporation, the registered office of which is located at Karl-Wiechert-Allee 50, 30625 Hannover, Germany.
Since 2002 the standards adopted by the International Accounting Standards Board (IASB) have been referred to as "International Financial Reporting Standards (IFRS)"; the standards dating from
In addition to the individual requirements of specific standards, the basic procedure for the transition to IFRS is set out in IFRS 1 "First-time Adoption of International Financial Reporting Standards". IFRS 1 contains optional and mandatory exceptions from the basic principle defined in IFRS 1.7 that all IFRS effective on the first closing date of 31 December 2005 are to be applied retrospectively, i. e. as if the financial statements had always been prepared in accordance with current IFRS.
In principle, IFRS 1 requires that all business combinations be recognised as at 31 December 2005 subject to retrospective application of IFRS 3 "Business Combinations". This would mean that all business combinations in the past would have to be reconsolidated. Under the exemptions of IFRS 1.15 it is not necessary to apply IFRS 3 to business combinations recognised in accordance with other accounting principles prior to the date of transition; instead, the previous methods of consolidation and measurements may be retained. Hannover Re has applied the exemptions. Due to retention of the previous recognition in compliance with SFAS 141 "Business Combinations", the transition to IFRS as at 1 January 2004 did not have any effects.
IFRS 1.36A offers the option of not applying the provisions of IAS 32 "Financial Instruments: Presentation and Disclosure" and IAS 39 "Financial Instruments: Recognition and Measurement" as well as the requirements of IFRS 4 "Insurance Contracts" to the comparative figures for the corresponding period of the previous year. Hannover Re did not avail itself of this exemption.
Estimates made as part of the IFRS opening balance sheet are based upon the same assumptions as those used to prepare the consolidated financial statements under the previous accounting principles, unless such assumptions were objectively incorrect.
Unrealised gains/losses on investments 160 862 (5 571) – – 155 291
Gains and losses from currency translation (340 938) – 333 117 – (7 821)
Other changes in cumulative other comprehensive income (22 685) 21 861 – 1 140 316
Shareholders' equity excl. minority interests 2 404 650 (25 818) – (18 284) 2 360 548
Gains and losses from currency translation (413 259) – 371 850 – (41 409)
Other changes in cumulative other comprehensive income (2 890) – – 1 293 (1 597)
Shareholders' equity excl. minority interests 2 556 684 (14 733) – (16 798) 2 525 153
Transition of the consolidated statement of income for the 2004 financial year
A further effect derived from the measurement of our participating interests in private equity firms in accordance with IAS 39 at fair value, or by way of approximation at "net asset value". Under US GAAP these participations were reported at cost of acquisition. The change caused an increase in other comprehensive income of EUR 0.8 million after tax.
We reclassified effects from the fair value measurement of interest rate swaps in an amount of EUR 21.9 million from the other changes in cumulative other comprehensive income to unrealised losses
on investments. These interest rate swaps were taken up in connection with the issue of floating-rate debt in the amount of USD 400.0 million. The reader is referred to Section 8.8 "Loans and long-term liabilities" for further information.
Further effects, which led to an overall decrease of EUR 1.3 million after tax in unrealised gains on investments, were largely due to the change in the basis for the quoted fair value measurement from the average price to the market bid price.
In total, shareholders' equity was reduced by EUR 25.8 million in the IFRS opening balance sheet and by EUR 14.7 million as at 31 December 2004 due to the first-time adoption of IAS 39.
The change caused a reduction of EUR 250.3 million in the retained earnings recognised in the IFRS opening balance sheet by way of a reclassification in the same amount from the changes in other comprehensive income to retained earnings.
Foreign currency transactions in the separate financial statements of consolidated entities are translated into the reporting currency at the rate of exchange on the date of the transaction. The recognition of the resulting translation gains and losses is determined pursuant to IAS 21 by the nature of the underlying balance sheet item. While translation differences on monetary items are directly reported in profit or loss in the period of their occurrence, translation differences on non-monetary items are first recognised outside the statement of income in a separate component of shareholders' equity and are only realised in profit or loss upon settlement of the underlying transaction. Application of these provisions led to recognition of a reduction of EUR 82.8 million after tax in the retained earnings reported in the IFRS opening balance sheet with no effect on income.
As a consequence of these changes, a total burden of EUR 333.1 million was removed from the changes in other comprehensive income recognised in the IFRS opening balance sheet by reclassification into retained earnings outside the statement of income. The corresponding reclassification as at yearend 2004 amounted to EUR 371.9 million.
In March 2004 the IASB published IFRS 4 "Insurance Contracts". The first standard governing the accounting of insurance contracts, it divides the "Insurance Contracts" project into two phases. IFRS 4 represents the outcome of Phase I and serves as a transitional arrangement until the IASB defines the measurement of insurance contracts after completion of Phase II. Underwriting business is to be subdivided into insurance or so-called investment contracts. Contracts with a significant insurance risk are considered to be insurance contracts, while contracts without significant insurance risk are to be classified as so called "investment contracts". The standard is also applicable to reinsurance contracts.
• Adjustment of estimates from financial years prior to the date of the IFRS consolidated opening balance sheet
Making allowance for tax of EUR 15.3 million and minority interests in shareholders' equity of EUR 1.9 million, the changes in the technical account set out above resulted in a charge of EUR 20.9 million to retained earnings in the IFRS opening balance sheet.
Largely as a consequence of application of the aforementioned standards, the retained earnings recognised in the IFRS opening balance sheet were reduced by an amount of EUR 19.4 million after tax. In total the decrease in shareholders' equity from other effects amounted to EUR 18.3 million. As at 31 December 2004 the effects of the transition led to a reduction of EUR 18.1 million after tax compared to the retained earnings shown under US GAAP as at the same date, while shareholders' equity was EUR 16.8 million lower overall.
New asset categories were introduced as a consequence of the first-time adoption of IAS 32. The available-for-sale portfolio of EUR 12,045.2 million recognised under US GAAP alone accounted for EUR 149.7 million of the total accrued interest, an amount now recognised directly with the investments. Of this cumulative portfolio, an amount of EUR 256.1 million was reclassified as loans and receivables after allowance for the necessary revaluation effects. With regard to the modified valuation we would refer the reader to our explanatory comments concerning the effects of the transition resulting from investments which were reflected in shareholders' equity. In addition, by exercising the fair value option provided under IAS 39, further securities recognised in the available-for-sale portfolio under US GAAP plus accrued interest were reclassified as financial assets at fair value through profit or loss – which were thus shown at EUR 109.6 million in the IFRS opening balance sheet. They primarily consisted of structured securities such as convertible bonds and catastrophe bonds. The effected reclassifications, the change in the presentation of accrued interest and the changeover in the basis of fair value measurement from the average price to the quoted bid price led to an overall decrease of EUR 210.7 million in the available-for-sale portfolio to EUR 11,834.4 million.
Investments in associated companies are to be recognised separately under IAS 28. This led to a reclassification of EUR 138.4 million from the other invested assets, in which they were included under US GAAP. In addition IAS 28.23 requires the application of the equity method based on the investor's share of the results of operations of the investee. Consequently, the goodwill of EUR 24.2 million apportionable to the associated companies must be recognised together with the investments in associated companies. Under US GAAP this goodwill was shown under the other assets. Making allowance for these changes, investments in associated companies in an amount of EUR 162.6 million were recognised in the IFRS opening balance sheet.
The other portfolio changes were principally attributable to accrued interest as well as to circumstances described above with respect to the effects of the transition resulting from investments which were reflected in shareholders' equity.
Financial assets classified as available for sale are carried at fair value; accrued interest is recognised in this context. Unrealised gains and losses arising out of changes in the fair value of securities held as available for sale are recognised – with the exception of currency valuation differences on monetary items – in shareholder's equity after deduction of deferred taxes.
The fair value of fixed-income and variable-yield securities is determined primarily by means of prices fixed on publicly quoting markets or exchanges on the basis of "bid" prices. If such financial assets are not quoted on public markets, the fair value is calculated on the basis of the acknowledged effective interest rate method or estimated using other financial assets with similar credit rating, duration and return characteristics. Under the effective interest rate method the current market interest rate levels in the relevant fixed-interest-rate periods are always taken as a basis. The fair value of equities and equity-like financial assets is also calculated primarily on the basis of prices fixed on publicly quoting markets and exchanges.
Permanent impairments on all fixed-income and variable-yield securities are recognised directly in the statement of income. In addition, IAS 39.61 (rev. 2003) states that in the case of securities with the character of equity a significant or prolonged decrease in fair value below acquisiton cost constitutes objective evidence of impairment. In the event of permanent impairment, depreciation is taken on the fair value as at the closing date – if available, on the publicly quoted stock exchange price.
Other invested assets are for the most part recognised at nominal value. Insofar as such financial assets are not listed on public markets (e.g. private equities), they are carried at the latest available "net asset value".
Investments in associated companies are valued at equity on the basis of the proportionate shareholders ' equity attributable to the Group. The year-end result of an associated company relating to the Group's share is included in the net investment income and shown separately. As a general rule, the shareholders' equity and year-end result are taken from the associated company's latest available annual financial statement.
Deferred acquisition costs principally consist of commissions and other variable costs directly connected with the acquisition or renewal of existing reinsurance contracts. These acquisition costs are capitalised and amortised over the expected period of the underlying reinsurance contracts. Deferred acquisition costs are regularly tested for impairment.
Other assets are accounted for at amortised cost. Own-use real estate is measured in the same way as investment property.
Long-term liabilities principally consist of subordinated debts that can only be satisfied after the claims of other creditors in the event of liquidation or bankruptcy. They are measured at amortised cost.
Shareholders' equity: the items "common shares" and "additional paid-in capital" are comprised of the amounts paid in by the parent company's shareholders on its shares. The retained earnings consist of reinvested profits generated by the Hannover Re Group companies in previous periods. In addition, in the event of a retrospective change of accounting policies, the adjustment for previous periods is recognised in the opening balance sheet value of the retained earnings and comparable items of the earliest reported period. Unrealised gains and losses from the fair value measurement of financial instruments held as available for sale are carried in cumulative other comprehensive income under unrealised price gains/losses from investments. Translation differences resulting from the currency translation of separate financial statements of foreign subsidiaries are recognised under gains and losses from currency translation.
In the consolidated financial statement it is to some extent necessary to make estimates and assumptions which affect the assets and liabilities shown in the balance sheet, the information on con-
In life business too the calculation of reserves and assets is crucially dependent on actuarial projections of the covered business. So-called model points are defined according to the type of business covered. The main distinguishing criteria are the age, sex and (non-)smoker status of the insured, tariff, policy period, period of premium payment and amount of insurance. The portfolio development is simulated for each model point, in which regard the key input parameters are either predefined by the tariff (e.g. allowance for costs, amount of premium, actuarial interest rate) or need to be estimated (e.g. mortality or disability rates, lapse rates). These assumptions are heavily dependent on country-specific parameters and on the sales channel, quality of the cedant's underwriting and claims handling, type of reinsurance and other framework conditions of the reinsurance treaty. The superimposition of numerous model points gives rise to a projection, which incorporates inter alia assumptions concerning the portfolio composition and the commencement of covered policies within the year. Such assumptions are estimated at the inception of a reinsurance treaty and subsequently adjusted to the actual production.
Zweite Hannover Rück Beteiligung Verwaltungs-GmbH, Hannover/Germany 100.0 EUR 379 996 (4)
Hannover Euro Private Equity Partners III GmbH & Co. KG, Hannover/Germany1) 63.8 EUR 23 337 (36)
Hannover Euro Private Equity Partners II GmbH & Co. KG, Hannover/Germany1) 54.9 EUR 36 988 942
In determining the carrying values for certain financial assets it is sometimes necessary to make assumptions in order to calculate fair values. In this regard we would refer the reader to our remarks in Section 4 "Summary of major accounting policies" concerning financial assets at fair value through profit or loss and securities held as available for sale. Assumptions concerning the appropriate applicability criteria are necessary when determining the need for impairments on non-monetary financial assets held as available for sale. In this regard we would refer to our explanatory remarks in Section 3 "Transition from US GAAP to IFRS".
Hannover Rückversicherung AG is the parent company of the Group. The consolidated financial statement includes ten German and sixteen foreign companies, as well as three foreign subgroups. Four German and three foreign associated companies were consolidated using the equity method.
In conformity with Item 7.1.4 of the recommendations of the German Corporate Governance Code as amended on 2 June 2005, the following table also lists major participations in unconsolidated third companies.
Hannover Finance (UK) Limited, Virginia Water/United Kingdom 100.0 GBP 111 084 (9)
Hannover Life Reassurance (Ireland) Ltd., Dublin/Ireland 100.0 EUR 183 104 13 263
Hannover Life Reassurance (UK) Ltd., Virginia Water/United Kingdom 100.0 GBP 32 052 3 121
Hannover Re (Bermuda) Ltd., Hamilton/Bermuda 100.0 EUR 888 312 61 278
Hannover Services (UK) Ltd., Virginia Water/United Kingdom 100.0 GBP 736 50
Notes consolidated companies and consolidation principles 1) Financial year as at 30 September 2005 2) Provisional (unaudited) figures 3) Inactive company 4) IFRS figures 5) US GAAP figures 6) Financial year as at 31 December 2004 7) Company is in liquidation 8) Formerly: WPG Corporate Development Associates IV (Overseas) L.L.C. 9) Financial year as at 31 July 2005 10) Consolidated figures 11) Financial year as at 31 October 2005
Summit at Southpoint Corporation, Jacksonville/USA 5) 100.0 USD 7 400 48 5115 Sedge Corporation, Chicago/USA 5) 100.0 USD 2 010 167
Hannover Life Re of Australasia Ltd., Sydney, Australia 77.9 AUD 166 537 22 834
WPG CDA IV Liquidation Trust, Grand Cayman/Cayman Islands 6) 7) 8) 26.8 USD 1 974 (20)
Inter Ocean Holdings Ltd., Hamilton/Bermuda10) 11) 9.1 USD 71 501 (1 410)
The capital consolidation complies with the prescriptions of IAS 27 "Consolidated and Separate Financial Statements". Subsidiaries are consolidated as soon as Hannover Re acquires a majority voting interest or de facto controlling influence. The capital consolidation is based on the revaluation method.
In the context of the "purchase accounting" method the acquisition costs of the parent company are netted with the proportionate shareholders' equity of the subsidiary at the time when it is first included in the consolidated financial statement after the revaluation of all assets and liabilities. After recognition of all acquired intangible assets that in accordance with IFRS 3 "Business Combinations" are to be accounted for separately from goodwill, the difference between the revalued shareholders' equity of the subsidiary and the purchase price is recognised as goodwill. Under IFRS 3, in conformity with the existing procedure under US GAAP, scheduled amortisation is not taken on goodwill. Instead, unscheduled amortisation is taken where necessary on the basis of annual impairment tests. Immaterial and negative goodwill are recognised in the statement of income in the year of their occurrence. Where minority interests in shareholders' equity exist, such interests are reported within Group shareholders' equity.
The minority interest in profit or loss amounted to EUR 32.1 million (EUR 53.4 million) as at 31 December 2005.
Companies over which Hannover Re is able to exercise a controlling influence ("associated companies ") are normally consolidated "at equity" with the proportion of the shareholders' equity attributable to the Group. A controlling influence is presumed to exist if a company belonging to the Hannover Re Group directly or indirectly holds at least 20% – but no more than 50% – of the voting rights. Income from investments in associated companies is recognised separately in the consolidated statement of income.
Securitisation of reinsurance risks The securitisation of reinsurance risks is largely structured through the use of special purpose entities. The existence of a consolidation requirement in respect of such entities is to be examined in accordance with SIC-12 "Consolidation – Special Purpose Entities". In cases where IFRS do not currently contain any specific standards, Hannover Re's analysis – in application of IAS 8.12 – again falls back on the relevant standards of US GAAP.
Since 20 September 2002 Hannover Re has held the equity of a special purpose entity for the purchase and handling of so-called "life settlements" through its Irish subsidiary Hannover Life Reassurance (Ireland) Ltd. The entity's total financing volume amounted to EUR 333.8 million as at the balance sheet date. The entire technical risk of the special purpose entity is borne by an insurance company. This cedant retrocedes part of the risk to Hannover Re. The contract was terminated with effect from 30 June 2003. The special purpose entity is closed for the acceptance of new business and is currently in the process of winding up. Hannover Re does not exercise a controlling influence in any of its business relations with the company.
Hannover Re Sweden Insurance Company Ltd., which had been inactive since the 2002 financial year, was wound up in April 2005.
The following share transfers were effected and intermediate holding companies established in the 2005 financial year with an eye to the segment-oriented restructuring of the Hannover Re Group. Overall, they did not have any implications for the Group's earnings situation: Within the scope of two capital increases in the form of contributions in kind Hannover Re transferred its shares in Hannover Re (Bermuda) Ltd. and Hannover Reinsurance (Ireland) Ltd. to Hannover Rück Beteiligung Verwaltungs-GmbH in August 2005.
Notes management of risks 7. Management of technical and financial risks 7.1 General risk management
Claims trends around the world are constantly monitored as part of the management of global risks. In the year under review particularly close attention was paid to claims associated with asbestos, silica, pollution damage, electromagnetic fields and pharmaceutical risks.
Developments affecting the relevant legal fields and applicable accounting standards (IFRS/US GAAP) are also subject to continuous monitoring. Particularly significant at the present time are developments in supervisory law, compliance requirements (especially as regards insider trading laws and anti-trust legislation) and tax law. Monitoring is carried out by specialised units within Hannover Re.
The diversification of our portfolio also serves as a risk-reducing measure. Diversification reduces by altogether roughly 50% the equity resources otherwise required in property and casualty reinsurance and at the same time promotes risk spreading across business groups.
In July 2005, as part of the restructuring of the Clarendon Group, the Praetorian Financial Group, Inc., Delaware, was established as a wholly owned subsidiary of Hannover Finance, Inc. In this connection the shares in the Insurance Corporation of Hannover and Redland Insurance Company were transferred from Clarendon National Insurance Company to Hannover Finance, Inc., which then transferred them as a contribution in kind to the Praetorian Financial Group, Inc.
Figures in EUR million Effect on forecast shareholders' equity as at 31 December 2006
Rise in the overall interest rate curve: from 200 basis points for the three-month interest rate to 100 basis points for the 10-year interest rate (with a linear interpolation between the two) (465)
Parallel downward shift in the interest rate curve by 100 basis points 396
Figures in EUR million Effect on forecast net income for 2006 100-year loss California earthquake (270)
In addition to considering individual scenarios, more extensive investigations are conducted using the internal risk model. Mathematical models are used for all relevant variables in order to generate a large number of conceivable future scenarios. This opens up a broad variety of avenues of exploration for better understanding the company's overall risk situation. It is thus possible, for example, to make certain probability statements regarding the development of shareholders' equity or dividend payments for various time horizons.
The correct measurement of loss reserves for asbestos- and pollution-related claims is a highly complex matter. Decades may elapse between causation of the loss and reporting of the claim. Hannover Re's exposure to asbestos-related claims and pollution damage is comparatively slight. The relative level of these reserves is measured using the so-called "survival ratio". This ratio expresses how many years the reserves would cover if the average level of paid claims over the past three years were to continue. As at the end of the year under review our survival ratio stood at 26.0 years.
Risks of change describe possible divergences in the collective actual amount of claims from the estimated empirical value as a consequence of the fact that the probability distribution of the total loss unexpectedly experiences a significant change – for example due to economic or legal deviations from the estimation parameters – after the estimation is made.
32.6% of our recoverables from reinsurance business are secured by deposits or letters of credit. What is more, for the majority of our retrocessionaires we also function as reinsurer, meaning that in principle recoverables can potentially be set off against our own liabilities. Since 2001 we have – as an additional step – consistently reduced the level of recoverables by altogether 29.6%.
Our large proportion of broker business gives rise to potential default risks (e.g. loss of the premium paid by the cedant to the broker or double payment of claims). This risk potential is therefore actively tracked and minimised with the aid of a number of measures. All broker relationships are reviewed once a year on a rotating basis with an eye to criteria such as the existence of professional indemnity insurance, payment performance and proper contract implementation.
The reserves in life business are calculated in accordance with actuarial principles using secure biometric actuarial bases and with the aid of portfolio information provided by our clients. Local supervisory authorities ensure that the reserves established by ceding companies satisfy all requirements with respect to the calculation methods used and assumptions made (e.g. use of mortality and disability tables, assumptions regarding the lapse rate etc.). Due to the prefinancing of our clients' new business acquisition costs the lapse risk and the credit risk are also of major importance. In many instances the interest rate guarantee risk is only of minimal risk relevance owing to contractual exclusions and the use of conservative assumptions. Our asset/liability management is subject to constant enhancement with a view to minimising the interest rate risk. A key tool of our value-oriented management in the area of life and health reinsurance is systematic tracking of the development of the value in force of the net portfolio as well as sensitivity analyses performed on this basis, a major element of off-balancesheet embedded value reporting. These analyses are used to simulate the influence of key parameters (e.g. persistency of the in-force business, discount rate, mortality and morbidity) on the value in force. In this context it is evident that thanks to the diversification of the business the risk of unfavourable underwriting experiences due to unforeseen movements in these parameters is minimal.
Interest rate risks refer to an unfavourable change in the value of financial assets held in the portfolio due to changes in the general interest rate level. Declining interest rates lead to increases and rising interest rates to decreases in the fair value of fixed-income securities portfolios.
The investments also encompass investments in associated companies, investment property, other invested assets, short-term investments, cash and funds held/contract deposits.
due after five through ten years 316 565 342 977 307 118 327 836
Loans and receivables due after one through two years 19 015 19 709 76 389 76 769 due after two through three years 24 609 26 934 155 288 158 385 due after three through four years 63 631 62 955 25 139 27 890 due after four through five years 127 626 126 003 56 569 56 902 due after five through ten years 436 778 435 410 60 351 63 800 due after ten years 36 906 36 766 – –
Variable-rate bonds (so-called "floaters") are shown under the maturities due in one year and constitute our interest-related, within-the-year reinvestment risk.
Debt securities issued by semi-governmental entities 226 610 749 2 124 6 206 231 441
Debt securities issued by semi-governmental entities 271 747 3 360 238 1 619 276 488
Government debt securities of EU member states 1 147 438 9 131 4 086 19 358 1 171 841
Government debt securities of EU member states 1 571 588 10 689 2 025 28 083 1 608 335
Fair value of financial assets at fair value through profit or loss before and after accrued interest as well as accrued interest on such financial assets
As at 31 December 2005 Hannover Re's trading portfolio was for the first time comprised exclusively of technical derivatives in an amount of EUR 22.8 million that were separated from the underlying transaction and measured at fair value. In the previous year these derivatives had been recognised under other invested assets in an amount of EUR 17.3 million. Option holdings with a fair value of EUR 1.2 million were credited to the liabilities as at the balance sheet date. We would refer the reader to our comments on derivative financial instruments in this section.
Profit or loss on shares in associated companies 3 863 2 239
Interest expense on funds withheld and contract deposits 28 152 42 751
Impairments on participating interests and other financial assets 7 361 8 185
Financial assets – at fair value through profit or loss 4 311 3 713
Transfer of gains/losses from the fair-value measurement of the available-for-sale portfolio to the result for the period (72 814)
Fixed-income securities – loans and receivables 224 208 270 657 185 906 38 604 168 26 439 – – 745 982
Fixed-income securities – at fair value through profit or loss 906 47 689 8 145 19 328 3 555 6 753 – 1 735 88 111
Total fixed-income securities incl. derivatives 8 684 403 2 911 778 2 771 826 819 513 49 850 307 983 8 403 94 876 15 648 632
Fixed-income securities – held-to-maturity 33 776 188 082 205 623 53 022 – – – – 480 503
Fixed-income securities – loans and receivables 146 580 310 507 172 327 19 786 268 5 478 – – 654 946
Fixed-income securities – loans and receivables – – 634 588 7 447 – 76 368 – 27 579 745 982
Fixed-income securities – at fair value through profit or loss – – 13 141 – – 74 970 – – 88 111
Equity securities – available-for-sale – 2 768 1 068 347 7 080 – 121 102 13 994 – 1 213 291
Equity securities – available-for-sale – 1 936 900 996 5 225 – 180 312 11 442 657 1 100 568
A small number of treaties in life and health reinsurance meet criteria which require the application of the prescriptions in IFRS 4.7 to 4.9 governing embedded derivatives. The derivatives embedded in such host contracts are to be reported separately from the underlying reinsurance arrangements at fair value.
Hannover Re calculates the fair value of the embedded derivatives using the market information available on the valuation date on the basis of a "credit spread" method. Under this method the derivative is valued at zero on the date when the contract is concluded and its value then fluctuates over time according to changes in the credit spread of the securities. The pre-tax strain on the investment income amounted to altogether EUR 2.3 million as at the balance sheet date.
The application of the standards had no significant impact on the consolidated financial statement in the financial year. The fair values of the embedded derivatives were recognised in the investments as at the balance sheet date and to this extent increased the investment income by altogether EUR
As at 31 December 2005 the portfolio contained 530 short-call option contracts on the S&P 500 index. The underlying volume of these contracts amounted to EUR 58.2 million and accounted for 50% of our holding of USD equities. The fair value of this position totalled -EUR 1.2 million as at 31 December 2005 and was recognised under the other liabilities. The change in the fair value of these contracts in 2005 amounted to EUR 0.6 million and was recognised under unrealised gains and losses in the net investment income. In total, gains of EUR 5.8 million were realised from option contracts taken out in 2005 on the S&P 500 and Dax indices.
Net book value at 31 December of the year under review 170 414 182 082
The fair value of investments in associated companies included in the consolidated financial statement using the equity method amounted to EUR 170.4 million (EUR 182.1 million) as at the balance sheet date. The fair value was based primarily on stock exchange listings and internal valuations arrived at using recognised methods, e.g. discounted cash flow models.
The investments in associated companies include goodwill in the amount of EUR 21.6 million (EUR 24.2 million).
For further details of our major participating interests please see section 5 "Consolidated companies and consolidation principles".
Cumulative depreciation at 31 December of the previous year 84 150 65 531
Cumulative depreciation at 31 December of the year under review 92 385 84 150
Net book value at 31 December of the previous year 205 755 230 591
Technical assets The retrocessionaires' portions of the technical provisions are based on the contractual agreements of the underlying reinsurance treaties. For further details please refer to our remarks on the technical provisions.
Net book value at 31 December of the previous year 1 994 273 1 660 285
Balance at 1 January of the year under review 2 080 825 1 622 874
In one subsegment of financial reinsurance technical provisions were discounted at interest rates of between 2.0% and 8.2%. The interest rates are determined by the contractual agreements. The period from inception to expiry of such contracts is at least four years. The discounted amount totals EUR 44.2 million (EUR 356.1 million). As at year-end 2005 the discounted provisions amounted to EUR 283.3 million (EUR 2,197.8 million).
Reserve at 1 January of the year under review 20 006 726 4 613 284 15 393 442 17 755 553 4 132 126 13 623 427
The following table shows the net loss reserve (loss and loss adjustment expense reserve) for property and casualty reinsurance in the years 1995 to 2005 as well as the run-off of the reserve. The figures for the years 1995 to 1997 have been drawn up in accordance with German accounting standards. The data from 1998 onwards is based upon United States Generally Accepted Accounting Principles (US GAAP).
Loss and loss adjustment expense reserve (from balance sheet) 3 957.6 4 304.7 4 849.4 5 002.1 5 696.3 6 162.3 6 867.8 5 846.1 6 584.9 7 337.5 9 908.1
Net run-off result of the loss reserve 676.8 1 231.6 1 390.2 884.5 1 097.1 675.7 802.4 167.9 (75.4) (446.2)
Of which currency exchange rate differences 17.1 97.8 (189.4) 14.2 (451.3) (655.9) (869.4) (378.0) 310.1 666.3
Net run-off result excluding currency exchange rate differences 693.9 1 329.4 1 200.8 898.7 645.8 19.8 (67.0) (210.1) 234.7 220.1
Reserve at 1 January of the year under review 5 529 801 105 446 5 424 355 3 774 763 194 456 3 580 307
Unearned premium derives from the deferral of ceded reinsurance premium. It is determined by the period during which the risk is carried and established in accordance with the information supplied by ceding companies. In cases where no information was received, the unearned premium was estimated using suitable methods. Premium paid for periods subsequent to the date of the balance sheet was deferred from recognition within the statement of income.
Reserve at 1 January of the year under review 2 030 726 549 456 1 481 270 2 019 163 530 440 1 488 723
We have identified insurance contracts which do not satisfy the requirements of SFAS 113 "Accounting and Reporting for Reinsurance of Short-Duration and Long-Duration Contracts". These involve reinsurance treaties under which the risk transfer between the ceding company and the reinsurer is of merely subordinate importance. These contracts were recognised using the so-called "deposit accounting" method and hence eliminated from the technical account. The profit components were netted under other income/expenses. The payment flows resulting from these contracts were reported in the cash flow statement under financing activities. The balances were shown as contract deposits, the fair values of which corresponded approximately to their book values.
Net book value at 31 December of the previous year 173 315 179 422
Balance at 1 January of the year under review 9 925 12 193
Development of the present value of future profits (PVFP) on acquired life reinsurance portfolios
Actual tax for the year under review 48 316 111 805
Please refer to section 4 "Summary of major accounting policies" regarding the recognition and measurement of deferred tax assets and liabilities.
Availability of limited and unlimited loss carry-forwards in subsequent years 8.6 Staff and expenditures on personnel
Expenditures on personnel The expenditures on insurance business, claims expenses (claims settlement) and expenditures on the administration of investments include the following personnel expenditures: 8.7 Provisions for pensions and other post-employment benefit obligations
Net book value at 31 December of the previous year 55 265 52 640
Net book value at 31 December of the year under review 57 626 55 265
The pension costs are recognised in the consolidated statement of income, principally under the other expenses as well as the administrative expenses and other investment expenses.
The actual return on the assets of US plans amounted to EUR 0.9 million (EUR 0.8 million) in the year under review.
In May 2005 Hannover Re issued further subordinated debt in the amount of EUR 500.0 million through its subsidiary Hannover Finance (Luxembourg) S.A. As part of the transaction, holders of Hannover Re's EUR 350.0 million subordinated debt placed in 2001 were offered an opportunity to exchange their existing issue for holdings in the new bond, which has a term of 30 years and may be called in prior to maturity by the issuer after 10 years. Participation in the exchange was nominally EUR 211.9 million, corresponding to EUR 240.5 million of the new bond issue. The cash component of the new bond in the amount of nominally EUR 259.5 million was placed predominantly with institutional investors in Europe. The remaining volume of the bond issued in 2001 after the exchange amounted to EUR 138.1 million.
Shareholders’ equity is shown as a separate component of the financial statement in accordance with IAS 1 "Presentation of Financial Statements" and subject to IAS 32 "Financial Instruments: Disclosure and Presentation" in conjunction with IAS 39 "Financial Instruments: Recognition and Measurement". The change in shareholders’ equity comprises not only the net income deriving from the statement of income but also the changes in the value of asset and liability items not recognised in the statement of income.
In addition, conditional capital of up to EUR 48,500 thousand is available. It can be used to grant shares to holders of convertible bonds and bonds with warrants and has a time limit of 13 November 2007.
Weighted average of issued shares – 120 597 134 120 597 134
Neither in the year under review nor in the previous reporting period were there any extraordinary components of income which should have been included in the calculation.
Dividends of EUR 120.6 million, or EUR 1.00 per share, were paid in the 2005 financial year for
The fair values were calculated using the discounted cash flow method.
Gross book value at 31 December of the year under review 85 606 71 374
Cumulative depreciation at 31 December of the previous year 44 777 38 592
Cumulative depreciation at 31 December of the year under review 55 389 44 777
Net book value at 31 December of the previous year 26 597 18 809
Net book value at 31 December of the year under review 30 217 26 597
With regard to the measurement of fixtures, fittings and equipment, the reader is referred to our explanatory notes on the other assets in section 4 "Summary of major accounting policies".
Gross book value at 31 December of the year under review 129 566 115 234
Cumulative depreciation at 31 December of the previous year 90 558 88 354
Cumulative depreciation at 31 December of the year under review 93 730 90 558
As at the balance sheet date the item included EUR 0.2 million (EUR 0.3 million) for self-provided software and EUR 15.0 million (EUR 11.7 million) for purchased software. Scheduled depreciation is taken over useful lives of 3 to 10 years.
Audits and costs of publishing the annual financial statements 2 814 153 2 967 2 696 2 691 87 (6) 2 879
Notes notes on the individual items 8.14 Technical statement of income
HDI Haftpflichtverband der Deutschen Industrie V.a.G. (HDI) indirectly holds a majority interest in Hannover Re through the subsidiaries Talanx AG and HDI Verwaltungs-Service AG and through Zweite HDI Beteiligungsgesellschaft mbH, all based in Hannover.
In February 2005 Hannover Re acquired participation certificates of HDI Haftpflichtverband der Deutschen Industrie V.a.G. in an amount of EUR 18.8 million for a limited term until the end of the 2007 financial year. The participation certificates have a coupon of 7.25%. Repayment is scheduled for 1 October 2008. The participation certificates may be cancelled with at least two years' notice to the end of a financial year.
Within the contractually agreed framework Ampega Asset Management GmbH performs investment and asset management services for Hannover Re and some of its subsidiaries. The assets of US subsidiaries are managed by Ampega Investment AG. Ampega Immobilien Management GmbH performs services for Hannover Re within the framework of a management contract.
Companies belonging to the Talanx Group granted the Hannover Re Group insurance protection inter alia in the areas of public liability, fire, group accident and business travel collision insurance. Divisions of Talanx AG also performed services for us in the area of general administration.
9.2 Remuneration and stockholdings of the management boards of the parent company and further information with respect to the German Corporate Governance Code
The total remuneration received by the members of the Executive Board included variable components of EUR 1.9 million (EUR 1.5 million). The variable remuneration of the Executive Board is determined on the basis of the year-end result and the value creation. The value creation is measured using an appropriate benchmark (the performance of the Hannover Re share relative to the weighted ABN Amro Rothschild Global Reinsurance Index). The benchmarks cannot be retroactively changed.
Transactions in excess of EUR 5,000 involving shares, options or derivative financial instruments of Hannover Re effected by Executive Board and Supervisory Board members of Hannover Re or by other persons with management responsibilities who regularly have access to insider information regarding the company and are authorised to take major business decisions as well as by persons in a close relationship with the aforementioned officers are reported in the table below in accordance with § 15a Securities Trading Act (WpHG).
Members of the Supervisory Board and Executive Board of Hannover Re as well as their spouses or registered partners and first-degree relatives hold less than 1% of the issued shares. As at 31 December 2005 the total holding amounted to 0.024% of the issued shares, i.e. 28,381 shares. The total volume of stock appreciation rights held by members of the Executive Board on the basis of the virtual stock option plan amounted to 1.49% of the share capital as at the balance sheet date. The value of these stock appreciation rights was EUR 1.8 million.
Mortgage loans granted to members of the management boards 9.3 Share-based payment
The internal performance criterion is accomplishment of the target performance defined by the Supervisory Board, expressed in terms of the "diluted earnings per share" (EPS) under IAS 33 "Earnings per Share". If the target performance is surpassed or undershot, the provisional basic number of stock appreciation rights initially granted is increased or reduced accordingly to produce the EPS basic number. The external performance criterion is the development of the share price in the allocation year. The benchmark used in this regard is the (weighted) ABN Amro Rothschild Global Reinsurance Index. This index encompasses the performance of all listed reinsurers worldwide. Depending upon the outperformance or underperformance of this index, the EPS basic number is increased – albeit by at most 400% of the EPS basic number – or reduced – although by no more than 50% of the EPS basic number.
The amount paid out is limited to a maximum calculated as a quotient of the total volume of remuneration to be granted in the allocation year and the total number of stock appreciation rights awarded in the year in question.
The allocations for the years 2000 and 2002 to 2004 gave rise to the following commitments in the 2005 financial year:
Number of rights existing at 31.12.2005 204 774 784 439 409 835 176 127
Amounts paid out in the 2005 financial year (in EUR million) – – 1.42 3.55
Expense in the 2005 financial year (in EUR million) 0.48 1.73 0.77 0.85
Number of options at 31.12.2002 – – – 1 097 235
The calculations were based on the year-end closing price of the Hannover Re share of EUR 29.93 as at 30 December 2005, volatility of 21.92%, a dividend yield of 0.00% and risk-free interest rates of 3.08% for the 2000 allocation year, 3.20% for the 2002 allocation year, 3.25% for the 2003 allocation year and 3.30% for the 2004 allocation year.
As security for our technical liabilities, various financial institutions have furnished sureties for our company in the form of letters of credit. The total amount of the letters of credit as at the balance sheet date was EUR 3,154.2 million (EUR 2,663.7 million).
Rental income totalled EUR 14.3 million (EUR 14.3 million) in the 2005 financial year.
Most rental contracts end in 2010 as per the contractual agreement. Renegotiation of the tenancies is not expected to commence prior to 2008.
Rented property Hannover Re Real Estate Holdings rents out real estate in Florida; the period of the rental contracts ranges from three to ten years. Non-cancellable contracts will produce the income shown below in subsequent years: 10.5 Currency translation
Currency translation differences from the translation of non-monetary assets measured at fair value via the statement of income are recognised with the latter as profit or loss from fair value measurement changes.
Exchange differences from non-monetary items – such as equity securities – classified as available for sale are recognised in the other comprehensive income.
Of this total amount, EUR 1.4 million was attributable to the fee paid to the appointed auditor of the consolidated financial statement as defined by § 318 German Commercial Code (HGB). The amount includes a fee of EUR 1.0 million for the auditing of the financial statement, EUR 0.2 million for tax consultancy services and EUR 0.2 million for consultancy and other services performed for the parent or subsidiary companies.
The Supervisory Board also paid close attention to the development of the Group's other major subsidiaries and participations. With a view to unifying the Group's market presence and sales activities, the Supervisory Board gave the green light to the reorganisation of financial reinsurance operations in Ireland. The ultimate goal here is to bring together all the Group's activities in a single company. The Supervisory Board also approved the inclusion of two life reinsurance subsidiaries in a special "Beteiligungs -GmbH". Capital measures at various subsidiaries were discussed, including for example capital increases of EUR 65 million at Hannover Life Reassurance (Ireland) Ltd. and USD 25 million at Hannover Life Reassurance Company of America. Both these capital measures will safeguard the companies' growth and satisfy more exacting market requirements with respect to ratings and solvency. In this context we also examined and assessed the issue of capital tie-up at the subsidiaries and the flexibility of capital repatriation.
With the aid of specialist analyses the Supervisory Board took an in-depth look at financial reinsurance, which has come in for heavy criticism especially in the USA. On the basis of extensive information provided by the Executive Board, the Supervisory Board satisfied itself that in this business group too the worldwide activities conducted by the Hannover Re Group are in conformity with legal standards.
The report on the company's relations with affiliated companies drawn up by the Executive Board has likewise been examined by KPMG DTG and given the following unqualified audit certificate: "Having audited the report in accordance with our professional duties, we confirm that 1. its factual details are correct; 2. in the case of the transactions detailed in the report, the expenditure of the company was not unreasonably high."
Hannover Re has long practised good enterprise management and supervision in the spirit of state-of-the-art Corporate Governance. This is already evident from the fact that in 2004 and 2005 the company fulfilled all the recommendations of the Code with just two exceptions and thus clearly surpassed the average compliance level achieved by the companies represented in the MDax – put at 90% in 2004 by the German Corporate Governance Code (DCGK) Government Commission.
Corporate Governance describes for the Executive Board and Supervisory Board of Hannover Re the legal and actual institutional framework for the management and supervision of the company in all key areas of enterprise constitution, including for example in company and capital market law, accounting and risk management. Corporate Governance is not an end in itself; rather, it continues to serve the goal of bringing about sustained growth in the value of the company as well as strengthening and consolidating on a lasting basis the trust placed in the enterprise by our shareholders, business partners, clients, employees and the general public. On this basis Hannover Re supports the principles of value-oriented and transparent enterprise management and supervision as defined in the German Corporate Governance Code (DCGK) and recognises their importance in guiding its activities.
In the year just-ended we again consistently devoted special attention to our communication with the financial markets and developed an impressive range of Investor Relations activities, including: • We organised four international teleconferences for analysts and institutional investors for the purpose of explaining our quarterly financial statements, discussing the underlying financial data and our business policy and answering questions. The accompanying presentations were broadcast live over the Internet.
• Around 50 roadshows and investor conferences were held at various international financial marketplaces.
• Representatives of the company also met with almost 40 international analysts and investors in Hannover for one-to-one discussions.
• Key financial data was discussed on a regular basis with the rating agencies. By way of interactive management meetings we enhanced the sharing of information with Standard & Poor's and A.M. Best, the major rating agencies for the reinsurance industry.
Securities transactions pursuant to Item 6.6 of the German Corporate Governance Code (DCGK)
Dealings in shares, options and derivatives of Hannover Rückversicherung AG effected by members of the Executive Board or Supervisory Board of Hannover Re or by other persons with managerial functions who regularly have access to insider information concerning the company and who are authorised to take major business decisions – as well as such dealings conducted by certain persons closely related to the aforementioned individuals – in excess of EUR 5,000 are listed under Item 9.2 of the Notes to this Annual Report.
Shareholdings pursuant to Item 6.6 of the German Corporate Governance Code (DCGK)
Information in this respect is also provided under Item 9.2 of the Notes to this Annual Report.
Information regarding this topic is provided under Item 9.3 of the Notes.
Once again, the company failed to comply with the recommendations of the Code only with respect to individualised specification of the compensation received by the Executive Board and Supervisory Board (Code Items 4.2.4 and 5.4.7 Para. 3). The required disclosure regarding the recommendations of the German Corporate Governance Code not currently implemented by Hannover Re is provided in the following declaration of conformity.
The compensation received by the members of the Executive Board and the Supervisory Board is supposed to be reported in the Notes to the consolidated financial statements and/or in the Corporate Governance Report on an individualised basis broken down into its constituent elements. Hannover Re is of the opinion that the legal protection of rights of personality should take precedence over the disclosure and transparency interests of investors. For this reason, as has been the case to date, a summary presentation of the compensation and its constituent elements is provided in the Notes to the consolidated financial statements. This disclosure enables our shareholders to fully assess the appropriateness of the total amount of compensation.
Hannover Rückversicherung AG Australian Branch – Chief Agency The Re Centre Level 21 Australia Square 264 George Street G. P. O. Box 3973 Sydney NSW 2001
Canada Hannover Rückversicherung AG Canadian Branch - Chief Agency 3650 Victoria Park Avenue, Suite 201 Toronto, Ontario M2H 3P7
Japan Hannover Re Services Japan KK 7th Floor, Hakuyo Building 3-10 Nibancho Chiyoda-ku Tokio 102-0084
Malaysia Hannover Rückversicherung AG Malaysian Branch Suite 31-1, 31st Floor Wisma UOA II No. 21 Jalan Pinang 50450 Kuala Lumpur
USA Clarendon Insurance Group, Inc. 7 Times Square, 36th and 37th Floor New York, NY 10036
Earnings retention: non-distribution of a company's profits leading to a different treatment for tax purposes than if profits were distributed.
IBNR (Incurred but not reported) reserve: provision for claims which have already occurred but which have not yet been reported.
Life and health (re-)insurance: collective term for the lines of business concerned with the insurance of persons, i.e. life, pension, health and personal accident insurance.
Loss, insured: the insured loss reflects the total amount of losses covered by the insurance industry (insurers and reinsurers).
Loss ratio: proportion of loss expenditure in the ➞ retention relative to the (gross or net) premiums earned.
Matching currency cover: coverage of technical liabilities in foreign currencies by means of corresponding investments in the same currency in order to avoid exchangerate risks.
Other securities, held-to-maturity: investments in debt securities intended to be held to maturity. They are measured at amortised cost.
Protection cover: protection of segments of an insurer's portfolio against major losses (per risk/per event), primarily on a non-proportional basis.
Quota share reinsurance: form of proportional reinsurance under which the reinsurer assumes a contractually set percentage share of the written risk. Since the insurer is responsible for acquisition, pricing, policy administration and claims handling, the administrative expenditure for the reinsurer is very low. The latter therefore participates
Risk, insured: defines the specific danger which can lead to the occurrence of a loss. The insured risk is the subject of the insurance contract.
Segmental reporting: presentation of items from the annual financial statements separated according to functional criteria such as segments and regions.
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