Business development
The effects of the financial market crisis on Hannover Re
The international financial market crisis also influenced the development of Hannover Re's business to a not inconsiderable extent in the year under review. After our investment portfolio had been affected only marginally by subprime losses, write-downs on insolvent financial institutions also remained within tight limits. Our investments were not, however, able to escape the turmoil on international equity markets entirely unscathed.
In the area of fixed-income securities the price rally - prompted by interest rate cuts on the part of central banks and the flight towards more secure assets - had positive implications for our shareholders' equity. Yet this was significantly tempered by the rise in risk premiums for corporate bonds. Ultimately, though, the positive effect prevailed. On equity markets the downward trend that had set in during the first six months of the year gained additional massive momentum in September/October. As a result, we were compelled to take considerable write-downs and realise sizeable losses on our equity portfolio, which were partially limited by the countereffect of hedge instruments.
In view of the high volume of write-downs taken, we published an ad hoc disclosure on 21 October 2008 in which we reported on a substantial profit decline for the third quarter.
+++ No solvency problems despite the financial market crisis +++
Irrespective of the appreciable value adjustments on our equity portfolio, however, Hannover Re does not - unlike the various banks that got into difficulties - have any liquidity or solvency problems whatsoever. Our long-term financial strength remains robust. This was also reaffirmed by the rating agency Standard & Poor's, which confirmed our very good rating of "AA-" with a stable outlook in October after the issue of our profit warning.
With a clearly positive cash flow and no need for refinancing, the liquidity and solvency of the Hannover Re Group are in no way impaired.
The repercussions of the financial market crisis on our reinsurance business were as follows:
In life and health reinsurance the income statement took a charge from derivatives embedded in US modified coinsurance contracts. The total charges here amounted to EUR 72.1 million.
In non-life reinsurance the effects of the financial market crisis were particularly notable in the directors' and officers' (D&O) and professional indemnity lines. The number of our directly exposed D&O contracts in the United States - at nine - was minimal in 2008; this was also true of the maximum amount of liability. The premium volume was in the order of EUR 35 million. Our exposure was even more modest in professional indemnity business. Other contracts that could be affected in the widest sense by the financial market crisis cover attorneys, auditors, architects, small banks and real estate brokers. The exposures under these contracts are appropriately reflected in our IBNR reserves.
Our credit and surety business was not affected by the real estate crisis since we do not write any mortgage guarantee contracts. An overall deterioration in the loss ratios cannot, however, be ruled out. In this case, too, appropriate allowance has been made in our IBNR reserves.
All in all, though, the implications of the financial market crisis for the reinsurance industry are positive: the heavy loss of capital at primary insurers is prompting growing demand for reinsurance and hence rising rates. Early indications were already apparent in the year under review. The round of treaty renewals completed on 1 January 2009 impressively lived up to expectations. Detailed information in this regard is provided in the forecast.
Development of operating business
Reinsurance business developed satisfactorily in the year under review: the market environment for non-life reinsurance was softer overall, as expected, and rates declined in most lines. Nevertheless, for the most part we were able to obtain prices that were commensurate with the risks.
+++ Softer market environment in non-life reinsurance +++
The balance of major claims and catastrophe losses was burdened by a number of severe natural disasters - especially hurricane "Ike" - in the year under review and came in slightly higher than the multi-year expected level.
In Brazil, the largest insurance market on the South American continent, Hannover Re opened a representative office following the lifting of the reinsurance monopoly; since July of the year under review it has been licensed as an "admitted reinsurer". This gives us more direct access to clients and puts in place an optimal platform for participating in the up-and-coming Brazilian market.
+++ Restrained growth in life and health reinsurance +++
Our second business group - life and health reinsurance - fell short of our expectations, principally due to the restraining effects of movements in exchange rates in the first six months. In the medium term, however, we are standing by our ambitious goal of generating double-digit growth in the original currencies. Both the demographic trend in industrialised nations and the growing urban middle class in threshold markets offer a solid basis for dynamic growth and justify such ambitious plans. We continue to participate in product development activities aimed at senior citizens, a customer group that is still neglected in Germany. What is more, we are optimally positioned in our largest market, the United Kingdom, thanks to our long-standing focus on enhanced annuities and the reinsurance of existing pension funds. In the United States, too, business with health insurance products for seniors shows great promise.
Last but not least, we remain keenly interested in the Asian growth markets. Hannover Re commenced business operations in China and South Korea in the year under review through its newly established branches in Shanghai and Seoul. In India, too, we have put in place a platform that will enable us to respond rapidly to market opportunities as they present themselves: in June Hannover Re concluded a cooperation agreement with the leading Indian reinsurer GIC Re regarding the joint development of a profitable portfolio with the promise of further growth. These plans are supported by the service company that we established in Mumbai.
Gross premium by region (in %)
Detailed information on both business groups is provided in the following sections.
Following the withdrawal from specialty business at the beginning of 2007 and in the face of weak exchange rates - especially the US dollar and pound sterling in the first half-year - gross written premium in total business contracted by 1.7% to EUR 8.1 billion (EUR 8.3 billion). At constant exchange rates the premium volume would have grown by 3.9%. The level of retained premium increased to 89.1% (87.4%) as a consequence of appreciable savings on the costs of our own protection covers and reduced proportional cessions; net premium earned fell by 3.2% to EUR 7.1 billion (EUR 7.3 billion).
Investment performance
The performance of our investments was overshadowed by the worldwide financial market crisis in the year under review. After international equity markets had already retreated in the first half of the year, the downward slide continued - especially in September and October. This was attributable to the loss of confidence on financial markets triggered by the meltdown on the US real estate market as well as the liquidity and capital crunch affecting the banks. While interest rate markets soared, especially towards the end of the year, risk premiums on corporate bonds widened enormously. It is gratifying to note that our portfolio of assets under own management nevertheless grew to EUR 20.1 billion thanks to a positive cash flow from the technical account and the rise of the US dollar towards year-end. This corresponds to an increase of 1.6% compared to the level as at 31 December 2007 (EUR 19.8 billion). Ordinary investment income excluding deposit interest fell short of the previous year at EUR 829.8 million (EUR 859.0 million) owing to portfolio regrouping into low-interest government bonds.
A large portion of the realised gains totalling EUR 379.2 million (EUR 244.0 million) can be explained by the tactical modification of durations in the US dollar portfolio undertaken in the first quarter as well as the liquidation of the hedge on around one-fifth of the equity portfolio in the fourth quarter. This contrasted with realised losses of -EUR 492.8 (-EUR 69.7 million) attributable largely to the sharp reduction of the equity allocation in the fourth quarter. The necessary write-downs of altogether EUR 479.9 million (EUR 71.4 million) were due in very large measure to the downslide on equity markets during the first three quarters, while write-downs on fixed-income securities accounted for an amount of EUR 96.9 million. The unrealised gains reported in the statement of income derived primarily from US quota share reinsurance treaties with a retained deposit, under which the partial assumption of default risks is envisaged and appropriately recognised. Total net investment income contracted by 75.2% to EUR 278.5 million (EUR 1.1 billion).
+++ Financial market crisis leaves a clear mark on investment income +++
Result of total business
We are not satisfied with the results trend in the year under review. The operating profit (EBIT) fell by 84.0% to EUR 148.1 million (EUR 928.0 million) owing to the effects of the financial market crisis. Group net income contracted by 117.6% to -EUR 127.0 million (EUR 721.7 million), although the previous year had been assisted by a positive special effect associated with the reform of corporate taxation in an amount of EUR 191.5 million (before minority interests). The result in the year under review was additionally hampered by the fact that losses on equities are not tax-deductible in Germany and hence a tax load of EUR 205.6 million was incurred despite posting a pre-tax result of 70.6 million. Earnings per share stood at -EUR 1.05 (EUR 5.98).
Policyholders' surplus
Compared to the position as at 31 December 2007, shareholders' equity decreased by EUR 519.0 million in the year under review to EUR 2.8 billion. The book value per share consequently fell by 15.5% to EUR 23.47. The total policyholders' surplus - consisting of shareholders' equity, minority interests and hybrid capital - amounted to EUR 4.7 billion (EUR 5.3 billion).
We use retrocession, i.e. the passing on of portions of our covered risks to other reinsurers, as a means of risk reduction. In the course of the year the reinsurance recoverables on unpaid claims - i.e. receivables due to us from our retrocessionaires - decreased to EUR 2.1 billion (EUR 2.5 billion). We continue to attach considerable importance to the quality of our retrocessionaires: more than 95% of the companies with which we maintain such business relations have an investment grade rating of "BBB" or better from Standard & Poor's.
Alongside traditional retrocessions we also conserve our capital by transferring insurance risks to the capital market. In the year under review Hannover Re was the recipient of several distinctions: the highly respected international trade magazine "The Review" crowned us Reinsurance Company of the Year, and our Chief Executive Officer Wilhelm Zeller was honoured with the Lifetime Achievement Award. We were proud to accept further awards in Russia, where we were named as best foreign reinsurer on two occasions.