Consolidation of special purpose entities
Below we make a distinction between investment funds, investments, securitisation of reinsurance risks and the assumed life and health reinsurance business as well as between retrocessions and insurance-linked securities (ILS). Relations with such special purpose entities are to be examined, inter alia, in accordance with SIC 12 with a view to their consolidation requirement. In cases where IFRSs do not currently contain any specific standards, our analysis also falls back – in application of IAS 8 – on the relevant standards of US GAAP.
The scope of SIC 12 includes, inter alia, special investment funds that are chiefly created to serve a narrowly defined purpose. As such the Group must assess whether economic control according to IAS 27.13 in conjunction with SIC 12 exists for its investment funds. Economic control exists, for example, when the majority of the economic benefits or risks arising out of the activities of a special fund is attributable to a Group company. As at the balance sheet date, 36 special funds were included in the consolidated financial statements due to the existence of a controlling relationship or economic control with respect to the special investment fund. Of these, 25 were domestic funds.
In the year under review, 17 investment funds were launched and consolidated for the first time. Public fund terrAssisi Aktien I AMI (Retail Germany segment) was deconsolidated in the third quarter of 2013 due to a reduction of the holding in the special investment fund to 31.09% and carried as a financial instrument. The Group liquidated or deconsolidated a further nine funds, mainly for reasons of materiality regarding assets, financial position and net income.
As part of its asset management activities, the Group participates in numerous special purpose entities – predominantly funds – which for their part transact certain types of equity and debt-capital investments. On the basis of our analysis of the relations with these entities, we concluded that the Group does not exercise a controlling influence in any of these transactions and that a consolidation requirement therefore does not exist.
Hannover Re participates in a number of special purpose entities through Leine Investment SICAF-SIF which was founded in September 2012 and is based in Luxembourg for the securitisation of catastrophe risks by investing in catastrophe (CAT) bonds. Leine Investment General Partner S. à. r. l. is the managing partner of the asset management company Leine Investment SICAV-SIF, whose purpose consists of the development, holding and management of a portfolio of insurance-linked securities (CAT bonds), including for investors outside the Group. Since Hannover Rück SE does not exercise a controlling influence in any of these transactions either, there is no consolidation requirement for the special purpose vehicles in question. The portfolio of CAT bonds held by Hannover Insurance-Linked Securities GmbH & Co. KG (HILS), which was used for these transactions until the previous year, was completely wound down in the year under review through sales and repayments.
Securitisation of reinsurance risks
The securitisation of reinsurance risks is largely structured through the use of special purpose entities.
In the previous year, Hannover Rück SE issued a CAT bond with the aim of transferring to the capital market peak natural catastrophe exposures deriving from European storm events. The term of the CAT bond, which has a nominal volume of EUR 100 million, runs until 31 March 2016 and was placed with institutional investors from Europe, North America and Asia by Eurus III Ltd., a special purpose entity domiciled in Hamilton, Bermuda that was registered in August 2012 as a special purpose insurer under the Bermuda Insurance Act of 1978. The retrocessions concluded in connection with the transaction with Eurus III Ltd. afford Hannover Rück SE, E+S Rückversicherung AG and Hannover Re (Bermuda) Ltd. protection against the aforementioned catastrophe risks. Since Hannover Rück SE does not exercise any controlling influence over Eurus III Ltd., there is no consolidation requirement for the special purpose entity.
Within the scope of its “K” transactions, Hannover Rück SE raised underwriting capacity for catastrophe risks on the capital market. “K-cession”, which was placed with institutional investors from Europe, North America and Asia involves a quota share cession on worldwide natural catastrophe business as well as aviation and marine risks. The volume of “K-cession” was equivalent to EUR 239 (268) million as at the balance sheet date. The transaction has an indefinite term and can be cancelled annually by the investors. Kaith Re Ltd., a special purpose entity domiciled in Bermuda, is being used for transformer purposes in relation to part of this transaction.
Hannover Rück SE also uses Kaith Re Ltd. for various retrocessions of its traditional covers to institutional investors. In accordance with SIC 12, it is included in the consolidated financial statements.
Assumed life/health reinsurance business
Some transactions in the Life/Health Reinsurance segment require the involvement of cedant special purpose entities as contractual partners established by parties outside the Group and from whom companies of the Hannover Re Group assume certain technical and/or financial risks. For example, the transactions serve to transfer extreme mortality risks above a contractually defined retention ratio or to transfer longevity risks. Since Hannover Rück SE does not bear the majority of the economic risks or benefits arising out of its business relations with these special purpose entities and is not capable of exercising a controlling influence over them, there is no consolidation requirement for Hannover Rück SE. Depending on the classification of the contracts in accordance with International Financial Reporting Standards – IFRS 4 or IAS 39, the transactions are recognised either under reinsurance or as derivative financial instruments or financial guarantees.
With reinsurance contracts that serve to finance statutory reserves (so-called Triple-X or AXXX reserves), under which special purpose entities carry extreme mortality risks securitised by cedants above a contractually defined retention ratio, these risks are transferred by way of a fixed/floating swap to a Group company of Hannover Re Group. The total of the contractually agreed upon capacities of the transactions is equivalent to EUR 1,372 (1,138) million, of which the equivalent of EUR 892 (848) million has been underwritten as at the balance sheet date. The variable payments to the special purpose entities guaranteed by companies of the Hannover Re Group cover their payment obligations. For some of the transactions, payments resulting from swaps in the event of a claim are reimbursed by the cedants’ parent companies by way of compensation agreements. In this case reimbursement claims under the compensation agreements are to be capitalised separately from and up to the amount of the provision. Under IAS 39 these transactions are to be recognised at fair value as a financial guarantee. To this end Hannover Rück SE uses the net method, according to which the present value of the agreed upon fixed swap premiums is netted with the present value of the guarantee commitment. The fair value on initial recognition therefore amounted to zero. The higher of the fair value and the amount carried as a provision on the liabilities side pursuant to IAS 37 is recognised at the point in time at which utilisation is considered probable. This was not the case as at the balance sheet date.
Retrocessions and insurance-linked securities (ILS)
As part of its extended insurance-linked securities (ILS) activities, Hannover Rück SE has underwritten so-called collateralised fronting arrangements, under which risks assumed from ceding companies are passed on to institutional investors outside the Group using special purpose entities. The purpose of such transactions is to directly transfer clients’’ business. Due to the lack of a controlling influence over the special purpose entities involved, there is no consolidation requirement for Hannover Rück SE with respect to these structures.
In the course of selling the operational companies of the subgroup Clarendon Insurance Group, Inc. (CIGI), Wilmington, to Enstar Group Ltd., Hamilton, Bermuda, a partial portfolio of CIGI was retroceded to a special purpose entity with effect from 12 July 2011. The term of the retrocession runs until final settlement of the underlying obligations. Since Hannover Rück SE is not the major beneficiary of the special purpose entity and exercises neither indirect nor direct control over it, there is no consolidation requirement for this special purpose entity.