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Internal risk assessment
In this section we compare the available economic capital with the required risk capital in greater detail. Hannover Re calculates the economic equity as the difference between the market-consistent value of the assets and the market-consistent value of the liabilities. While fair values are available for most investments, the market-consistent valuation of reinsurance treaties necessitates a specific valuation model. We establish the market-consistent value of technical items as the present value of projected payments using actuarial methods. This is adjusted by a risk loading that factors in the fluctuation in future payments. Such fluctuations result from risks that cannot be hedged by means of capital market products, such as underwriting risks. For the discounting of future cash flows we use the risk-free basic yield curves without volatility adjustment or matching adjustment calculated in accordance with Solvency II rules. Market prices for options and guarantees embedded in insurance contracts are determined or approximated using option valuation models from the field of financial mathematics. The volume of these options and guarantees in our portfolio is, however, comparatively slight. The adjustments for assets under own management shown in the following table indicate the difference between fair value and book value of those investments recognised under IFRS at book values. Other adjustments encompass above all the deferred taxes. The available economic capital, which is available as liable capital for policyholders, is composed of the economic equity and the hybrid capital and includes the deduction of foreseeable dividends as required by Solvency II. Hybrid capital is recognised at market-consistent value as required by Solvency II, with changes in the own credit risk not being included in the valuation.
| Reconciliation (economic capital / shareholders’ equity) | ||
| in EUR million | 31.12.2016 | 30.9.2015 |
|---|---|---|
| Shareholders' equity including minorities | 9,740.6 | 8,428.1 |
| Adjustments for assets under own management | 513.4 | 510.6 |
| Adjustments for technical provisions1 | 3,870.6 | 3,791.0 |
| Adjustments due to tax effects and other2 | (1,648.8) | (1,318.6) |
| Economic equity | 12,475.8 | 11,411.1 |
| Hybrid capital | 1,656.1 | 1,583.6 |
| Foreseeable dividends | (647.0) | (380.0) |
| Available economic capital3 | 13,484.9 | 12,614.7 |
| 1 Adjustments for technical provisions including risk margin 2 In contrast to the Annual Report 2015 the deduction of foreseeable dividends is not included in this position, but shown separately. 3 The figures are based on the Solvency II reporting as of 31 December 2016. The related audits are at present (not fully) completed. |
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The available economic capital increased to EUR 13,484.9 million as at 31 December 2016 compared to EUR 12,614.7 million as at 30 September 2015. This was due principally to the successful business performance in the last five quarters as well as positive effects from the weakening of the euro against our major foreign currencies, in particular the US dollar. The economic valuation of the technical provisions is largely stable relative to the position as at 30 September 2015. The change in the other items derives primarily from an increased valuation of the subordinated liabilities attributable principally to the decline in Eurozone interest rates. Conversely, the value of the available capital from hybrid capital also rose. The changes relating to taxes resulted from the aforementioned valuation differences as well as from refinements in accounting policies. The deduction for foreseeable dividends is higher because allowance was not made for special dividends as at 30 September 2015.
The required risk capital of the Hannover Re Group at the target confidence level of 99.5% rose slightly to EUR 5,149.5 million as at 31 December 2016, compared to EUR 5,126.3 million as at 30 September 2015. The bulk of the increase was due to the weaker euro against our major foreign currencies and the associated higher foreign-currency volumes underlying the risks, including for example the volume of investments. These increases in volume driven by exchange rate movements caused the risk capital to climb in all risk categories.
The elevated risk in relation to market risks was not only volume- driven but also reflected the higher allocation of equity in the investment portfolio. As a further factor, the exchange rate risk increased owing to a larger proportion of own funds held in US dollars.
The underwriting risks in property and casualty reinsurance increased primarily on account of higher catastrophe risks, which can be attributed above all to the stronger US dollar. The underwriting risks in life and health reinsurance remained largely stable. Counterparty default risks increased principally as a result of a larger volume with respect to ceding companies and retrocessionaires.
The model for operational risks was revised. The stand alone operational risk rose as a consequence of the model change, although the new model also makes explicit allowance for diversification effects with other risk categories. All in all, the model change for operational risks therefore led to a decrease in the total required risk capital.
The increase in the tax effects reflects model refinements relating to the calculation of the loss-absorbing effect of taxes.
The internal capital model is based on current methods from actuarial science and financial mathematics. In the case of underwriting risks, we are able to draw on a rich internal data history to estimate the probability distributions, e. g. for the reserve risk. For risks from natural perils we use external models, which are adjusted in the context of a detailed internal review process such that they reflect our risk profile as closely as possible. In the area of life and health reinsurance long-term payment flows are modelled under various scenarios. With respect to all the aforementioned risks we use internal data to define scenarios and probability distributions. The internal data is enhanced by way of parameters set by our internal experts. These parameters are especially significant in relation to extreme events that have not previously been observed.
When it comes to aggregating the individual risks, we make allowance for dependencies between risk factors. Dependencies arise, for example, as a consequence of market shocks, such as the financial crisis, which simultaneously impact multiple market segments. What is more, several observation periods may be interrelated on account of market phenomena such as price cycles. In dealing with these dependencies, however, it is our assumption that not all extreme events occur at the same time. The absence of complete dependency is referred to as diversification. Hannover Re’s business model is based inter alia on building up the most balanced possible portfolio so as to achieve the greatest possible diversification effects and in order to deploy capital efficiently. Diversification exists between individual reinsurance treaties, lines, business segments and risks. We define the cost of capital to be generated per business unit according to the capital required by our business segments and lines and based on their contribution to diversification.
| Required risk capital | ||||
| 31.12.2016 | 30.9.2015 | |||
|---|---|---|---|---|
| in EUR million | Confidence level 99.5% | Confidence level 99.5% | ||
| Underwriting risk property and casualty reinsurance | 3,552.9 | 3,408.9 | ||
| Underwriting risk life and health reinsurance | 2,117.9 | 2,109.6 | ||
| Market risk | 4,225.4 | 3,903.1 | ||
| Counterparty default risk | 296.5 | 279.9 | ||
| Operational risk | 503.9 | 431.1 | ||
| Diversification | (3,773.8) | (3,329.5) | ||
| Tax effects | (1,773.3) | (1,676.8) | ||
| Required risk capital of the Hannover Re Group | 5,149.5 | 5,126.3 | ||