Major external factors influencing risk management in the financial year just ended

Regulatory developments: A review of selected aspects of Solvency II was conducted in the year under review at the instigation of the European Commission. In this regard the European Insurance and Occupational Pensions Authority (EIOPA) made technical recommendations to the European Commission. Implementation of the new rules is still pending, but will most likely do not have any material implications for the Hannover Re Group.

In the year under review the reinsurance entities belonging to the Hannover Re Group in the European Union received approval from the Federal Financial Supervisory Authority (BaFin) to calculate their operational risks using the internal model with retroactive effect from the year-end reporting 2017. The Hannover Re Group has already had such approval since 2017. This means that both the Hannover Re Group and the specified individual companies are now calculating their capital requirements under Solvency II on the basis of a full internal model. In addition, Hannover Re was granted approval by the BaFin in 2018 to use volatility adjustments pursuant to § 82 VAG. This is intended to mitigate the effect of value fluctuations on the bond market.

Parallel to the regulatory developments in Europe, we are seeing adjustments worldwide to the regulation of (re)insurance undertakings.

Capital market environment: A major external influencing factor is the protracted low level of interest rates, especially with an eye to the return that can be generated on our investments. While significant rate increases are now being seen on the USD and GBP side, negative yields persist on euro area government bonds well into the medium maturity segment. The ending of the ECB’s programme of monthly corporate sector purchases (CSPP) at year-end, protracted uncertainty surrounding the process for the United Kingdom’s exit from the European Union and numerous geopolitical flashpoints as well as simmering trade and tariff wars impacted the capital market climate in the period under review. As a result, many areas of the capital market were rather unsettled. Thus, for example, risk premiums on corporate bonds increased – sometimes markedly – in the course of the year, while the losses seen on stock markets towards the end of the year were in some instances appreciable. Owing to the liquidation of our equity portfolio in the previous year, however, we remained unaffected. As far as our investments are concerned, we anticipate elevated volatility on global equity and credit markets in the immediate future, although we also see this as an opportunity and believe that we are appropriately prepared with the currently more defensive posture of our asset portfolio. For further information please see the “Investments” section of the management report.

Brexit: The terms of the United Kingdom’s withdrawal from the European Union have still not been determined. The possibility of the UK leaving the EU without an agreement continues to exist. The Hannover Re Group is prepared for this and all other scenarios and a Group-wide working group has been set up to address readiness measures.

The Hannover Re Life UK Branch will be materially affected. In order to be able to continue its activities even after a “hard” Brexit, an application to operate under the so-called temporary permissions regime (TPR) has been filed and already approved by the financial regulator. Increased administrative expenses and higher capital costs cannot be ruled out over the medium term. Argenta Holdings Limited is a wholly owned subsidiary of Hannover Re that operates on a standalone basis in the United Kingdom and is already authorised as a member of Lloyd’s. We also write reinsurance business in the United Kingdom through Group companies in Hannover, Ireland and Bermuda. In this regard we do not anticipate any significant changes as a result of Brexit.

All in all, our current analyses indicate that the implications of Brexit are manageable for the Hannover Re Group.

US tax reform: The changes in tax legislation adopted by the US administration at the end of 2017 entered into force on 1 January 2018. They provide for new tax regulations that have far-reaching financial implications for subsidiaries operating in the United States. On the one hand, the reform cuts the corporate tax rate from 35% to 21%. On the other hand, the legislative package includes the introduction of the so-called “Base Erosion and Anti-Abuse Tax” (BEAT). In this connection, premiums for ceded insurance risks within the corporate group are also included in the taxable base and will in future be taxed at a rate of 5% to 12.5% (rising over the next nine years). We have undertaken some restructuring activities within the Group in order to avert this increased burden of taxation. Most notably, US life reinsurance business previously written through Hannover Re Ireland was transferred to a Bermuda-based subsidiary. The latter is subject to US taxation, thereby avoiding a substantial tax loss; the solvency ratio decreased, however, due to a higher risk margin for the Hannover Re Group.

Risks from electronic data retention: Recent years have seen the increasing emergence of risks relating to electronic systems and their data. Hannover Re, in common with other companies, is at risk of attacks on its IT systems and has put in place extensive safeguards. Furthermore, Hannover Re offers reinsurance coverage for risks connected with electronic systems and the associated data. The dynamic pace of developments in the context of digitalisation presents a particular challenge to the assessment of such risks.

Natural catastrophe risks and climate change: 2017 was notable for an above-average number of natural disasters. Large losses caused by typhoons and hurricanes left their mark on 2018 as well. The scale of the natural disasters recorded in the financial year was reflected in the assumptions underlying the natural perils models which are used for pricing and managing catastrophe risks. The possibility that the increased storm activity of recent years is due in part to progressive global warming cannot be ruled out. Hannover Re works together with partners to closely monitor the implications of global warming for extreme weather events so as to be able to incorporate the insights gained into the models and the management of risks.

Risks from US mortality business: The actual mortality experience of the portfolio acquired by Hannover Re at the beginning of 2009 proved to be better than expected in 2018. As part of our inforce management measures we initiated rate adjustments for the portfolio concerned. In a few remaining isolated instances one-time charges to the IFRS result may arise if cedants affected by rate adjustments exercise their right of recapture. We are monitoring the further development of the underlying mortality on an ongoing basis.

Joint venture with HDI Global Specialty: In the year under review Hannover Rück SE and HDI Global SE already began making preparations, under the umbrella of Talanx AG, to launch a joint initiative in worldwide specialty business. To this end, the two companies are transferring their specialty activities to a new joint venture. The new company, HDI Global Specialty SE, will write agency and specialty business in lines including professional indemnity, directors’ & officers’ liability, legal expenses, sports and entertainment, aviation, offshore energy and pet and farm pack. Subject to regulatory approval, the joint venture will commence operational business on 1 January 2019.