ulrich wallin, ceo · 2008 start of solvency ii pre-application ... target capital driven by rating...

Integrated corporate steeringby using Economic Capital Model (ECM) and IVC

Ulrich Wallin, CEO

15th International Investors' DayLondon, 18 October 2012

1. Strategic Goals 2. Economic Capital Model 3. Pricing Metrics 4. Performance Measurement

Integrated corporate steering to accomplish strategic goals

1 Integrated corporate steering

4 steps

2. Economic Capital Model1. Strategic Goals

4. Performance Measurement (IVC)

3. Transformation into Pricing Metrics

1. Strategic Goals


Integrated corporate steering brings our strategy to life

2

With a strategic review cycle of three years

Integrated corporate steering

1. Strategic Goals


Risks and chances are to be managed consistently

3

We have ambitious profit and growth targets

� Our Economic Capital Model is the foundation of our management strategy and, based on this

model, we aim to achieve a profit in excess of the cost of capital. This profit, which we refer to

as Intrinsic Value Creation (IVC), is the key ratio used to manage our business activities.

� We offer our shareholders the prospect of a sustained above-average return on their capital.

As such, we aim to generate an IFRS RoE of at least 750 bps above the risk-free interest rate.

We manage risks actively

� The foundation of our risk management strategy is our Economic Capital Model (ECM).

Based on this model we manage our risk exposure to achieve a positive IFRS net income with

a probability of 90%. We also ensure that the probability of a complete loss of our economic

as well as IFRS shareholders' equity does not exceed 0.03%.

� Our shareholders' equity is allocated to the individual areas of our business activity based on

our ECM and in consideration of the rating agencies’ capital requirement with the aim of

maximising the risk-adjusted profits.


1. Strategic Goals


Careful capital and asset management support our profit targets

4

We maintain an adequate level of capitalisation

� Our required equity resources are determined by the requirements of our ECM, solvency

regulations, the expectations of the rating agencies in relation to our target ratings and the

expectations of our clients.

� For the sake of optimisation we use capital substitutes such as hybrid capital and we transfer

risks to the capital or retrocession markets.

� In order to maintain attractive RoEs, we carefully manage our capital downwards when we

have significant excess capital. This will be achieved by paying out dividends above our target

of 35% - 40% of the IFRS Group net income, in addition share buyback may also be

considered.

We strive for a stable investment income

� On the basis of our ECM we allocate part of our shareholders' equity to the risks associated

with our asset holdings generating more than the "risk free" interest. Regular crosschecking

of the composition of our assets against our defined risk budget forms part of our careful

approach. As a return on our investments we strive for the "risk-free" interest rate plus the

cost of capital.


1. Strategic Goals


Long-standing history of quantitative methods for steering

5

The history of our economic capital model (ECM)

When? What?

Mid 90's Risk-based capital allocation

Late 90's Early model analysis with a focus on ALM

1999 Decision to implement a proprietary economic capital tool (incl. ESG)

2004 First full external audit

Since 2005 Semi-annual reporting of capital requirements

2006/2007 Decision to extend the modelling framework towards external tools

2007 Redesign and full integration of the nat cat exposure management system

2007 Growing life business volume initiates life modelling project

2008 Start of Solvency II pre-application

2009 Redesign of capital allocation process towards full internal model integration

2009/ 2010 Implementation of risk budgeting and optimisation process for investment mgmt.

Since 2009/2010 Regular capital impact assessments for large transactions

2011 Standard & Poor's review of Hannover Re's economic capital model


2. Economic Capital Model


Benefits from collaboration of actuaries and business experts

6

� The internal capital model is a stochastic enterprise model establishing probability

distributions for key performance indicators and balance sheet variables

• Simulation approach

• Focus on economic perspective

� Unified framework to determine overall required capital and capital required for

individual segments and risk categories (e.g. underwriting risk, market risk)

� Quantifies risk over a one-year time horizon for in-force business and one year of

expected new business

� Reflection of diversification is a key building block

� Full integration of Hannover Re's business expertise via expert settings and

management involvement

� We are, since 2008, in the pre-application phase in order to get our capital model

approved by our regulators with the Solvency II framework

The key features of the model




ECM covers all risks of our business operations

7

� Risk factor and dependency model calibration is based on

• Hannover Re's internal loss data base

• Hannover Re's internal expert assessments

• Publically available market data

• Additional external data sources (e.g. private market data)

� The capital model covers the business operations of the Hannover Re group, i.e.

including all its subsidiaries

� Main applications cover the whole insurance group

Dependency assumptions determine the diversification benefits

Non-life underwriting risks

Life and health underwriting risks

Market risk Credit risk Operational risks

Premium Longevity & Mortality Equity Cedant default People Catastrophe

Catastrophe Morbidity & Disability Interest rate Retrocession default Systems

Reserve Lapse Real estate Default of other counterparties Processes

Catastrophe Foreign exchange External events

Spread




Business steering based on capital model results

8

� New business valuation, in particular in the context of large transactions /

acquisitions

• Underwriting and investment guidelines require capital impact assessments for large

transactions

� Capital cost allocation for pricing and performance measurement

• Including Cost of Residual Non-Hedgeable Risks (CoRNHR) in MCEV framework for our

life and health business

• Included within our remuneration system via IVC system




Reconciliation (economic capital/shareholders' equity) in m. EUR 2011 2010

Shareholders' equity (incl. non-controlling interests) 5,607 5,118

Value adjustments fon non-life reinsurance 1,263 1,490

Value adjustments for life and health reinsurance 752 676

Value adjustments for assets under own management 369 233

Tax effect and other (963) (1,004)

Economic equity 7,027 6,513

Hybrid capital 1,732 1,869

Available economic capital 8,759 8,382

Continued growth of our economic capital

9

� Change non-life: lower interest rate � lower discounting effects

� Change life and health:PVFP growth due to new business

� Change assets: lower interest rates and higher spreads � increased valuation reserve

� Other changes: incl. higher tax effects for economic valuation

Effects of interest rate changes moderated on an economic basis


3. Pricing Metrics


The different views on our capital have to be managed

10

Target capital driven by rating agency requirements

Internal perspective External constraints


(rating agencies)

3. Pricing Metrics


How do we calculate our return targets?

11

Our pricing is based on ~900 bps above risk free on IFRS equity

Factor

Equity 5,000 X (750 + 270) = 510 / (1 - 0.3) = 729

Risk capital X (1 - tax) EBIT

bps risk free

/

Minorities 600 X (750 + 270) = 61 / (1 - 0.3) = 87

Hybrid 1,700 X 550 = 94 / (1 - 0.0) = 94

Valuation adj. 1,400 X 600 = 84 / (1 - 0.3) = 120

Total 8,700 749 1,030

=

MRC (EBIT / risk capital) 11.8%

Risk free - 2.7%

Minimum Return on Capital (MRC) spread 9.1%

Net income=


3. Pricing Metrics


Capital allocation process: a multi-level approach

12

Integrating return requirements for pricing and performance measurement

Group

Asset Management Underwriting

Life and health R/I Non-life R/I

Line 1 Line n Line 1 Line m... ...


3. Pricing Metrics


How do we calculate the capital margin. . .

13

. . .for our underwriters and our investment decisions

MRC

Non-lifereinsurance 4,785 X 9.1 / 6,800 = 6.40% + 2.9% = 9.30%

Riskcapital

X NPECapital marginabove risk-free

(pre-tax)

/

Life and healthreinsurance

Assetmanagement

= + Admin. expenses

=Capital marginabove risk-free

(pre-tax)

2,393 X 9.1 / 5,000 = 4.35% + 2.9% = 7.25%

1,523 X 9.1 / 30,000 = 0.46%

AUM

55.0%

27.5%

17.5%


3. Pricing Metrics


NPE + Economic revaluation - MRC = MtCR

100% + 4.4% - 6.4% = 98.0%

MtCR translates our economic targets into IFRS

Net premium earned

Discount effect onnon-life net loss reserves(% of NPE)

Minimum Return on Capital spread(% of NPE)

Maximum tolerableCombined Ratio

At an MtCR of ~98% we earn 900 bps above risk free


3. Pricing Metrics


North America*

Germany*

Marine (incl. energy)

Aviation

Credit, surety & political risks

Global facultative

Global cat. XL

Global treaty*

Total non-life

MRCNet premium earned (100%) MtCR

97.5%

99.9%

94.8%

99.2%

97.7%

99.2%

79.5%

97.7%

98.0%

7.1%

5.2%

3.7%

4.6%

3.0%

4.4%

Economic revaluation

9.6%

5.3%

8.9%

5.4%

5.3%

6.4%

Structured R/I & ILS 100.1%1.6% 1.5%

4.1%

1.4%

5.2%

21.9%

6.0%

6.4%

UK, London market & direct 3.6% 5.3% 98.3%

MtCR varies substantially by line of business

As at March 2012

* All lines of non-life reinsurance except those stated separately

+ - =


3. Pricing Metrics


Targets are split further down

16

� Pricing includes higher return requirements than our strategic target (minimum

return on capital) which is even higher than our cost of capital

� Minimum return on capital is further allocated to

• the business segments life and non-life

• lines of business, e.g. property, marine, annuity

• volatility classes, e.g. rate-on-line

� Special business features (e.g. risk mitigation) are taken into account

� Return requirements are not explicitly allocated to legal entities but mirror the

group's perspective with full group diversification, i.e. each client benefits from

Hannover Re's group-wide diversification including

• the diversification between life and non-life operations

• the diversification between countries and regions

• the diversification between lines of business and product types

� Pricing metrics as part of our global underwriting guidelines ensure risk adequate

and consistent pricing within the whole HR Group


3. Pricing Metrics


Intrinsic Value Creation (IVC) has a proven track record

17

When? What?

Since 1995Working with the DB5 concept in non-life for business steeringDB5 covers the full minimum return on capital target

2001/2002 Board decision and conceptual work on IVC

2002 First IVC calculation for non-life business on Group level

2003 IVC calculation extended to non-life, life & Group

2004 Introduction of BCs/bottom up IVC calculation

2005 Life methodology changed to EEV

2006 Full integration of IVC into planning and forecasting process

2007 Publication of IVC in annual report

2008 Life methodology changed to MCEV

2009Integration of internal model, capital allocation, pricing and IVC;Pricing targets always include positive value creation as IVC accounts only for the cost of capital and not the minimum return on capital

2011 Decision to include IVC in incentive scheme for management from 2012 onwards


4. Performance Measurement


What's the use of IVC?

18

IVC should

1. be an appropriate measure of value creation

2. measure the change in economic capital within a period

3. allow the analysis of value drivers

4. increase transparency between different business activities

5. allow planning and forecasting

6. support the communication with the financial community

7. be tied to the managers' incentives (MbO)

8. support the use test under Solvency II

IVC sets incentives to write profitable business




IVC our central management tool

19

Determines parts of the variable bonus of the management

Do we generate enough profit to compensate our cost of capital?

CA

NOPAT Shareholders equity (average)

Group net income + Minorities (average)

+ Minority interest in profit or loss + Economic valuation adjustments (average)

+ Economic adjustments (Loss reserve discount, EVNR) + Hybrid capital (average)

+/- Reclassification Net investemnet income AuM Capital allocated

+ Technical interest (riskfree on neutral portfolio) − = IVC

+ Interest on hybrid capital CoC

+ Tax effect on adjustments Cost of debt

Net operating profit after adjustments + taxes (NOPAT) + Cost of equity

+ Cost of economic valuation adjustments

Weighted average cost of capital

×

=

=

=




Who created how much?

20

2011 in m. EURNon-life

reinsurance

Life and health

reinsurance

Asset

managementGroup

Group net income 456 182 16 606

Non-controlling interests in profit or loss 66 5 0 71

Net income 522 187 16 677

Total adjustments (104) (22) 208 129

Economic adjustements 296 27 (284) 30

Reclassification NII AuM (808) (236) 443 (601)

Technical interest (risk free on neutral portfolio) 393 180 28 601

Interest on hybrid capital 0 0 0 99

Tax effect on adjustments 15 7 21 0

Net Operating Profit after Adjustments and Taxes (NOPAT) 417 165 224 806

Cost of Capital (CoC) 291 145 145 582

Intrinsic value creation (IVC) 126 20 78 224




External reporting in the Annual Report

21

pp 80-83




NEW: Target Matrix

22

1) Excl. inflation swap and ModCo 2) 750 bps above 5-year rolling average of 10-year German government-bond rate ("risk free"), after tax

3) Growth of book value + paid dividends 4) In average throughout the cycle5) Incl. expected net major losses of EUR 560 m. 6) EBIT / net premium earned7) Excess return on the allocated economic capital 8) Organic growth only9) EBIT / net premium earned: ≥2% for financing and longevity business; ≥6% for other business

Business group Key figures Strategic targets

Group Return on investment1)≥3.5%

Minimum return on equity ≥10.2%2)

Earnings per share growth (year-on-year) ≥10%

Value creation per share3)≥10%

Non-life R/I Gross premium growth4) 3% - 5%

Combined ratio5)≤98%

EBIT margin6)≥10%

xRoCA7)≥2%

Life and health R/I Gross premium growth8) 5% - 7%

Value of New Business (VNB) growth ≥10%

EBIT margin9)≥2% and ≥6%

xRoCA7)≥5%




Disclaimer

This presentation does not address the investment objectives or financial situation of any particular person or

legal entity. Investors should seek independent professional advice and perform their own analysis regarding

the appropriateness of investing in any of our securities.

While Hannover Re has endeavoured to include in this presentation information it believes to be reliable,

complete and up-to-date, the company does not make any representation or warranty, express or implied,

as to the accuracy, completeness or updated status of such information.

Some of the statements in this presentation may be forward-looking statements or statements of future

expectations based on currently available information. Such statements naturally are subject to risks and

uncertainties. Factors such as the development of general economic conditions, future market conditions,

unusual catastrophic loss events, changes in the capital markets and other circumstances may cause the

actual events or results to be materially different from those anticipated by such statements.

This presentation serves information purposes only and does not constitute or form part of an offer

or solicitation to acquire, subscribe to or dispose of, any of the securities of Hannover Re.

© Hannover Rückversicherung AG. All rights reserved.

Hannover Re is the registered service mark of Hannover Rückversicherung AG.

ulrich wallin, ceo · 2008 start of solvency ii pre-application ... target capital driven by rating...

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