Annual Report 2010 > Management report > Opportunity and risk report > Risk report > Quantitative risk management methods

Quantitative risk management methods

Hannover Re has developed an internal capital model for risk quantification as a central risk management tool. The purpose of risk quantification inter alia is to assess the capital resources of the Hannover Re Group and its individual companies. In addition, the model is used to establish the risk contribution made by individual business groups and business segments to the total company risk as well as the risk-appropriate allocation of the cost of capital.

The internal capital model of Hannover Re is a stochastic enterprise model. It establishes probability distributions for key performance indicators and balance sheet ratios, such as company profit and shareholders’ equity, in light of all material internal and external influencing factors. These include the structure of the insurance and investment portfolio, taxation and capital market developments.

The model draws on statistical, stochastic and actuarial methods and practices in order to ensure the most realistic possible representation of the company and its environment. The risk capital is calculated on the basis of a Value at Risk (VaR) with a confidence level of 99.97% and an observation period of one year. This level of confidence also ensures that future regulatory capital requirements, e.g. the confidence level of 99.5% required under Solvency II, are satisfied or exceeded.

The required risk capital of the Hannover Re Group in connection with business-related risks increased in the year under review by EUR 792.1 million to EUR 5,410.6 million. This increase was attributable principally to the regrouping of investments into a higher-risk portfolio and the growth in the volume of assets due to a positive cash flow. We successively raised our equity allocation in 2010 and moved investments out of government bonds into corporate bonds. The slight increase in the underwriting risks reflects the enlarged business volume in the non-life and life/health reinsurance business groups. The increased credit risk can also be attributed to the larger business volume, above all in life and health reinsurance, since the value of accounts receivable from ceding companies has risen.

The available economic capital is composed of the components of IFRS shareholders’ equity (including minority interests), valuation reserves and hybrid capital. The valuation reserves for non-life reinsurance business primarily relate to the difference between the nominal (undiscounted) loss reserves according to IFRS and their discounted value, increased by the cost of capital needed to cover the fluctuation potential of the liabilities. In life and health reinsurance we show the difference between IFRS measurement and market-consistent measurement, which largely follows the principles of Market Consistent Embedded Value. The measurement adjustments for investments derive from the difference between fair value and book value.

The available economic capital grew by EUR 1,055.5 million from EUR 7,326.2 million to EUR 8,381.7 million in the course of the year under review. This was principally due to the rise in the IFRS shareholders’ equity. Our hybrid bond issued in the year under review also increased the available capital.

Of special significance to our company is the overarching diversification between our business segments and lines. As a result, we are able to significantly reduce the total capital actually required. We define the cost of capital to be generated per business unit according to the capital required by our business segments and lines as well as their contribution to diversification.

Diversification effect within the non-life reinsurance business group

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The indicators described above are further tools used to monitor and manage the risks associated with our business activities.