Management of technical risks in property/casualty insurance

With regard to non-life insurance (primary insurance and reinsurance), the principal risks are those involving premium/loss, reserving, and concentration.

The insurance business is based on assuming individual risks from policyholders (in primary insurance) and cedants (in reinsurance) and spreading these risks over the community of (re)insureds and over time. For the insurer, the fundamental risk (premium/loss risk) lies in providing insurance benefits, the amount and timing of which are unknown, from premiums that are calculated in advance and cannot be changed. Reserving risk means that loss reserves created on the balance sheet may prove to be insufficient, which can have a negative impact on the technical result. Concentration risk results from significant geographical concentration of the insured risks as well as from concentration on certain business areas or insurance lines.

Premium/loss risk

We counter the assumed premium/loss risk, inter alia, by obtaining appropriate reinsurance. The volume of reinsurance cover relative to gross written premium is determined by the retention ratio, which shows the proportion of underwritten risks retained for our risk.

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N29 RETENTION RATIO BY SEGMENT IN PROPERTY/CASUALTY INSURANCE
  IN %
    2013 2012 2011 2010 2009 2008 2007 2) 2006 2005 2) 2004 2)
  Industrial Lines 44.5 45.6 44.1 46.1 43.7 n. a. n. a. n. a. n. a. n. a.
  Retail Germany 94.9 94.6 92.9 91.6 85.6 n. a. n. a. n. a. n. a. n. a.
  Retail International 88.5 88.5 88.7 92.4 86.9 n. a. n. a. n. a. n. a. n. a.
  Non-Life Primary Insurance 1) n. a. n. a. n. a. n. a. n. a. 66.7 61.2 61.6 62.0 42.3
  Non-Life Reinsurance 89.9 90.2 91.3 88.9 94.1 89.0 82.2 82.0 76.1 83.9
  Total property/casualty insurance 79.3 79.8 79.8 78.9 78.7 76.9 71.4 73.0 71.5 64.3
  1) In 2010 the Group brought its segment reporting into line with IFRS 8 “Operating Segments” after having implemented a corporate reorganisation by customer group in its primary insurance business. Because of cost/benefit considerations, however, reporting for periods prior to 2009 was not retroactively adjusted
2) Due to changes in segment allocation, the years 2007, 2005 and 2004 are comparable to only a limited extent
   

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N30 LOSS RATIO BY SEGMENT FOR OWN ACCOUNT
  IN %
    2013 2012 2011 2010 2009 2008 2007 2) 2006 2005 2) 2004 2)
  Industrial Lines 80.8 75.2 66.8 82.0 68.6 n. a. n. a. n. a. n. a. n. a.
  Retail Germany 67.0 65.2 67.5 69.4 62.5 n. a. n. a. n. a. n. a. n. a.
  Retail International 66.3 68.9 70.4 75.6 71.6 n. a. n. a. n. a. n. a. n. a.
  Non-Life Primary Insurance 1) n. a. n. a. n. a. n. a. n. a. 69.1 73.5 73.7 69.4 77.2
  Non-Life Reinsurance 70.3 70.7 78.8 72.0 72.8 70.5 73.6 71.3 82.4 76.3
  Total property/casualty insurance 70.7 70.3 74.4 73.6 70.5 69.9 73.6 72.2 78.8 76.6
  1) In 2010 the Group brought its segment reporting into line with IFRS 8 “Operating Segments” after having implemented a corporate reorganisation by customer group in its primary insurance business. Because of cost/benefit considerations, however, reporting for periods prior to 2009 was not retroactively adjusted
2) Due to changes in segment allocation, the years 2007, 2005 and 2004 are comparable to only a limited extent
   

The increase in the loss ratio in the Industrial Lines segment is attributable to large claims. Following the natural disasters that occurred in the reporting year, especially the flooding in southern and eastern Germany, hailstorm “Andreas” and storm “Xaver”, as well as the burdens caused by other major claims (particularly damage to property), the loss ratio increased by 5.6 percentage points. In the Retail Germany segment this ratio increased by 1.8 percentage points. Alongside the higher large claims and natural disaster claims that arose in the third quarter, this was also influenced significantly by the participation of policyholders in our life insurers’ investment income. Higher premiums and lower claim settlement costs in individual markets resulted in a decline in the loss ratio for the Retail International segment by 2.6 percentage points. The loss ratios in the Non-Life Reinsurance segment fell by 0.4 percentage points, despite the increased net burden in major losses of EUR 578 (478) million.

Overall, the loss ratio at Group level rose slightly by 0.4 percentage points. The moderate loss ratios in recent years reflect our cautious underwriting policy and our success in active claims management.

Major losses are losses that exceed a stipulated amount or which fulfil other criteria, and as such they have particular significance for property/casualty insurance. The following table shows the major losses (net) during the financial year in millions of euro, divided into natural catastrophes and other major losses, as well as their share of the Group’s combined ratio:

N31 MAJOR LOSSES (NET) DURING THE FINANCIAL YEAR
   
    2013 1) 2012 1) 2011 2)
  Figures in EUR million      
  Major losses (net) 838 600 1,173
  thereof natural catastrophes 563 454 900
  thereof other 275 146 273
  In %      
  Combined loss/cost ratio for non-life primary and reinsurance 96.9 96.4 101.0
  thereof major losses (net) 6.8 5.1 11.5
  1) Natural catastrophes and other major losses over EUR 10 million, gross, for the share of the Group
2) Natural catastrophes and other major losses over EUR 5 million, gross (reinsurance, industrial liability insurance, industrial fire insurance), over EUR 2.5 million, gross (industrial marine insurance, industrial engineering insurance), and over EUR 1 million, gross (all other lines), for the share of the Group
   

Reserving risk

To ensure that we will be able to meet our benefit commitments at all times, we establish provisions and continuously analyse their adequacy using actuarial methods. These also provide insights into the quality of the underwritten risks, their distribution across individual lines with differing risk exposures and anticipated claims and claims expenses. In addition, our portfolios are subject to active claims management. Analyses of the distribution of claim amounts and claim frequency facilitate targeted management of risks.

Loss reserves, which are calculated using actuarial methods, are supplemented where necessary by additional reserves based on our own actuarial claims estimates and by IBNR (losses incurred but not reported) reserves. In view of the long run-off of such claims, especially liability claims, IBNR reserves are calculated differently depending on risk class and region.

Adequately calculating reserves for asbestos-related claims and pollution damage is a highly complex matter, since in many cases several years or even decades may lapse between the harm being caused and a claim being reported. The Group’s exposure to asbestos-related claims and pollution damage is, however, relatively limited. The adequacy of these reserves is normally estimated on the basis of the survival ratio. This ratio expresses how long the reserves would last if the average amount of claims and claims expenses paid over the past three years were to continue. At the end of the year under review, our survival ratio in the Non-Life Reinsurance segment stood at 32.1 (29.1) years, and reserves for asbestos-related claims and pollution damage amounted to EUR 200 (210) million.

Licensed scientific simulation models, supplemented by the expertise of the relevant specialist departments, are used to estimate the major catastrophe risks associated with natural hazards (earthquakes, storms, flooding) for the Group on a consistent basis. Furthermore, we quantify the risk to our portfolio under various scenarios in the form of probability distributions. Monitoring of the portfolio’s exposure to natural hazards (accumulation control) is rounded out by realistic extreme loss scenarios. The adequacy of the estimates and the simulation models employed as a whole are subject to a comprehensive and independent validation process. This means the independent risk control function performs a validation regardless of the units assuming risks.

In the following section „concentration risks“ on the basis of selected relevant accumulation scenarios for natural hazards we report estimates for net loss burdens from these scenarios.

Run-off triangles are another tool used to test our assumptions within the Group. These triangles show how reserves change over time as claims are paid and as reserves to be established as at each balance sheet date are recalculated. Adequacy is monitored using actuarial methods (cf. item 21 in the Notes, “Loss and loss adjustment expense reserve”). In addition, the quality of our own actuarial calculations of the adequacy of reserves is verified annually by external actuaries and auditors.

To hedge against inflation risk at least in part, our subsidiary Hannover Rück SE has obtained inflation swaps (USD and EUR zero-coupon swaps). These derivatives serve to hedge parts of the claims reserves against inflation risks. Inflation risk means the possibility of inflation causing our obligations (e.g. claims reserves) to develop differently than was assumed at the time when the reserves were established. We purchased inflation cover for the first time in the second quarter of 2010, with terms of four and five years. This cover was increased in the first quarter of 2011 (eight-year term). Moreover, to be able to more precisely the impact of an unexpected change in inflation on the Group’s loss reserves, stress scenarios on the Talanx primary insurance group, and the resulting effects are regularly analysed by external actuaries.

Risk modelling shows that a 5% increase in the net loss ratio for the property/casualty primary and reinsurance segment would reduce after-tax net income by EUR 424 (406) million.

Concentration risks

In non-life insurance, concentration risk results, in particular, from geographical concentration and from insured natural-catastrophe risks.

We analyse extreme scenarios and accumulations that could lead to large losses. A uniform Global Event Set has been developed as part of Solvency II to analyse natural hazard accumulation risks.

Based on the most recently calculated figures, the estimates for the Group’s net loss burdens under the following accumulation scenarios for natural hazards are as follows:

N32 ACCUMULATION SCENARIOS, INCLUDING NON-CONTROLLING INTERESTS, BEFORE TAX 1), 2)
  FIGURES IN EUR MILLION
    2013 2012
  250-year loss event Atlantic hurricane 3) 1,429 1,209
  250-year loss event US earthquake 4) 1,032 978
  250-year loss event Europe storm (winter storm) 954 670
  250-year loss event Japan earthquake 5) 615 694
  250-year loss event Pacific typhoon 6) 532 593
  250-year loss event Australia earthquake 7) 545 575
  1) Actual trends in natural hazards may diverge from the model assumptions
2) The geographical nature of the scenarios presented and the basis for the calculations were adjusted compared to the previous year. This resulted in changes to the figures compared with the 2012 annual financial statements. Alongside general improvements to the model, the change was prompted by an effort to raise the consistency vis-à-vis the limit system and the Group risk model further
3) Previous year’s scenario limited to USA
4) Previous year’s scenario limited to California
5) Previous year’s scenario limited to Tokyo
6) Previous year’s scenario limited to Japan
7) Previous year’s scenario limited to Sydney
   

In addition, other accumulation scenarios are regularly tested. We protect ourselves against peak exposures from accumulation risks by using carefully and individually selected reinsurance coverage. This enables us to effectively limit large individual losses and the impact of accumulation events and thereby to make them plannable.

The following table depicts the distribution of loss provisions by region on both a gross and a net basis (after allowing for the reinsurers’ share of these provisions):

N33 LOSS AND LOSS ADJUSTMENT EXPENSE RESERVE 1)
  FIGURES IN EUR MILLION
    Gross Re Net 2)
         
  31.12.2013      
  Germany 8,366 1,368 6,998
  United Kingdom 3,790 553 3,237
  Central and Eastern Europe including Turkey (CEE) 1,381 68 1,313
  Rest of Europe 7,160 1,254 5,906
  USA 5,368 569 4,799
  Rest of North America 964 627 337
  Latin America 1,025 55 970
  Asia and Australia 1,915 120 1,795
  Africa 189 5 184
  Total 30,158 4,619 25,539
         
  31.12.2012      
  Germany 7,675 1,336 6,339
  United Kingdom 3,590 527 3,063
  Central and Eastern Europe including Turkey (CEE) 1,298 67 1,231
  Rest of Europe 7,169 1,362 5,807
  USA 5,485 726 4,759
  Rest of North America 882 493 389
  Latin America 890 269 621
  Asia and Australia 2,265 178 2,087
  Africa 225 10 215
  Total 29,479 4,968 24,511
  1) After elimination of internal transactions within the Group across segments
2) After allowing for the reinsurers’ share of these provisions
   

The following table shows the focus of the insurance business that we conduct in property/casualty primary insurance, broken down by key insurance types and segments:

N34 PREMIUM BY INSURANCE TYPE AND SEGMENT
  FIGURES IN EUR MILLION
    Gross written
premium
Net written
premium
       
  31.12.2013    
  Property/casualty primary insurance    
  Motor insurance 3,088 2,921
  Property insurance 2,359 992
  Liability insurance 1,579 882
  Accident insurance 280 230
  Other property/casualty insurance 902 645
  Non-Life reinsurance 7,818 7,031
  Total 16,026 12,701
       
  31.12.2012    
  Property/casualty primary insurance    
  Motor insurance 2,815 2,680
  Property insurance 2,111 870
  Liability insurance 1,501 828
  Accident insurance 309 255
  Other property/casualty insurance 674 485
  Non-Life reinsurance 7,717 6,959
  Total 15,127 12,077
   

Interest rate risk

In the case of the reserve for pension benefits, which forms part of the loss and loss adjustment expense reserve, we also monitor interest rate trends, which can embody interest rate risk. A fall in actuarial interest rates, at least in local accounting, would result in a charge to income owing to the need to establish a reserve.

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