Capital market risks
The net income or loss generated by the Hannover Re Group is fundamentally determined by two components, namely the "underwriting result" and the "investment income". The asset portfolios derive in substantial measure from insurance premiums that must be set aside for future loss payments. The risks in the investment sector encompass primarily market risks (share price, interest rate, real estate and currency risks as well as the spread risk). Credit risks are also relevant.
The share price risk results from volatilities on equity markets. Fixed-income securities are exposed to the interest rate risk when market interest rates change. Declining market yields lead to increases and rising market yields to decreases in the fair value of fixed-income securities portfolios. Real estate risks derive from unfavourable changes in the value of our own real estate. This may be caused by a general downslide in market values (as seen with the present US real estate crash) or a deterioration in the particular qualities of the property. Real estate risks are of subordinate importance for our company owing to our minimal real estate portfolio. Currency risks result from fluctuations in exchange rates – especially if there is a currency imbalance between the technical liabilities and the investments. By systematically adhering to matching currency coverage, i.e. extensive matching of currency distributions on the assets and liabilities side, we are able to minimise this risk. The spread risk refers to the risk that the interest rate differential between a risk-entailing bond and risk-free bond may change while the quality remains unchanged.
We reduce these potential risks using a broad range of risk-controlling measures, the most significant of which are monitoring of the Value at Risk (VaR), various stress tests that estimate the loss potential under extreme market conditions as well as sensitivity and duration analyses and our asset/liability management (ALM). Despite our conservative investment strategy, restrictive limits and thresholds as well as the controlling tools described above, we cannot divorce ourselves entirely from general market developments. We took a number of riskminimising measures in the year under review in response to the financial market crisis:
- Limitation of the investment spectrum to government or supranational bonds in September 2008. Although this step reduced the average yield for 2008, it also limited any new risk-taking on the credit markets in view of the uncertain state of the market.
- Elimination of all counterparty risks with respect to existing options for equity hedging.
- Despite the already high diversification of the portfolio, further tightening of issuer limits for all investments of the Hannover Re Group in September 2008 in order to minimise potential accumulation risks.
- Near complete reduction of unhedged holdings of listed equities in October 2008.
- Thorough review of the existing investment guidelines in December 2008. Scarcely any adjustments were necessary even in the present circumstances; the limits, especially in respect of covered bonds, ABS and MBS, were nevertheless further refined.
- Making available of a minimum level of liquidity or assets that can be realised at any time in an amount of at least EUR 4 billion or around 20% of the investments under own management as the prevailing illiquidity of secondary markets that had begun in September 2008 continued and in view of the risks arising in connection with the acceptance of LOCs by ceding companies.