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Value-based management

Profitable growth has been at the heart of our business activities for many years and hence remains a crucial objective of our Group strategy. We are striving to cement and further extend our position as one of the leading globally operating reinsurance groups of above-average profitability.

With a view to allocating our demanding profit and growth targets for the Group to the individual business activities and profit centres on a basis that adequately reflects the risks and in order to be able to measure goal attainment, we have used a set of value-based management tools for many years now.

System of value-based management: Performance Excellence (PE) combines the strategic and operational levels

System of value-based management:
Performance Excellence (PE) combines the strategic and operational levels (bar chart) enlarge zoom

In Performance Excellence (PE) we have at our disposal a consistent method Group-wide that enables us to steer the development of the company and measure the extent to which we have achieved our strategic objectives. The decentralised approach used by PE is of special importance in this context: every single organisational unit defines and continuously examines its contributions to execution of the Hannover Re Group strategy and develops improvement initiatives.

Planning process

The planning process spans the three levels of Results, Risks and Resources, which are closely interrelated. These three levelsare planned by the responsible officers with central support and are reviewed and approved by the Executive Board. On the basis of the corporate strategy and the corresponding strategy contributions of all treaty/regional departments and service units, the planning is adopted by the Executive Board and subsequently communicated within the Group.

Management by Objectives

The targets that emerge out of the planning process are integrated into the individual agreements on objectives with managers. When it comes to the definition of objectives, the participants take into account not only profit-oriented but also non-financial variables derived from the strategic parameters.

Management Reporting

The annual Management Reporting presents in detail the degree of goal attainment for each individual operational unit and for the Group as a whole. On this basis appropriate performance controlling is carried out, potential scope for improvement and refinement is identified and performance-oriented remuneration components defined in the context of Management by Objectives are established.

Capital allocation

The main component of value-based management is the risk-appropriate allocation of capital to the individual business activities. This enables us to evaluate the assumption of underwriting risks and investment risks both in light of individual risk/return aspects and against the backdrop of our overall risk appetite. Our economic capital model supplies the key parameters for this purpose. In addition, along with considerations of business policy, outside influencing factors such as the requirements of regulatory authorities and rating agencies also play a major role in the allocation of capital. Allowance is therefore made for them in the form of collateral conditions on the various allocation levels. Starting out from the Group’s overall risk situation, capital is first allocated to the functional areas of underwriting and investments. We then further divide the capital within the underwriting sector, first between the business segments of non-life reinsurance and life/health reinsurance and then between the various reinsurance products according to risk categories/treaty types and lines. In this way, we ensure that when evaluating and pricing our various reinsurance products our profit targets are taken into consideration consistently and in light of risk/return aspects.

IVC – the decisive management ratio

In order to fine-tune the portfolios and individual treaties we apply underwriting-year-oriented measurement principles based on expected cash flows that appropriately accommodate the specific characteristics of non-life and life/health reinsurance. The accomplishment of targets in a particular financial year is also of interest – especially from the standpoint of shareholders. Based on our economic capital model, the foundation of our enterprise management, we strive to generate a profit in excess of the cost of capital. This return, which is the decisive ratio for the management of our business activities, is referred to as Intrinsic Value Creation (IVC).

With the aid of the IVC ratio it is possible to compare the value contributions of the Group as a whole, its two business groups and the individual operational units. This enables us to reliably identify value creators and value destroyers. In this way, we can

  • optimise the allocation of capital and resources,
  • identify opportunities and risks and
  • measure strategy contributions with an eye to our demanding profit and growth targets.

The IVC (Intrinsic Value Creation) is calculated according to the following formula:
Adjusted operating profit (EBIT) − (capital allocated x weighted cost of capital) = IVC

The adjusted operating profit (EBIT) is comprised of two factors: the IFRS Group net income recognised after tax and the change in the balancing items for differences between economic valuations and amounts stated in the IFRS balance sheet. By way of the latter we make allowance for changes in the fair values of assets not recognised in income under IFRS, discount effects of the loss reserves and the Embedded Value Not Recognised (EVNR) in life/health reinsurance. In addition, interest on hybrid capital already recognised in the IFRS Group net income and the non-controlling interest in profit and loss are included back in the calculation.

Intrinsic Value Creation and excess return on capital allocated
in EUR million 2012 2011
  IVC xRoCA Reported IVC Adjustment1 Final IVC xRoCA
1 Adjustment based on amended allocation of economic effects (non-life reinsurance/investments) and final MCEV calculation (life and health reinsurance)
2 Income above risk-free after deduction of risk-appropriate cost of capital
Non-life reinsurance 251.8 +5.2% 91.2 35.0 126.2 +3.0%
Life and health reinsurance 58.6 +2.4% 221.4 -201.6 19.8 +0.9%
Investments2 790.7 +50.9% 114.5 -36.2 78.3 +3.7%
Group 1,088.8 +11.6% 427.1 202.8 224.3 +2.7%

The allocated capital consists of three components: the IFRS shareholders’ equity including non-controlling interests, the balancing items for differences between economic valuations and amounts stated in the IFRS balance sheet and the hybrid capital. In this context, capital that is not at risk (excess capital) is disregarded, i. e. it is not allocated. Capital is allocated to the profit centres as described above according to the risk content of the business in question. A systematic distinction is made here between the assumption of underwriting risks, on the one hand, and investment risks, on the other. Under the IVC calculation, therefore, only risk-free interest income on the generated cash flows is allocated to the business segments of non-life and life/health reinsurance. The investment income above and beyond risk-free is allocated in its entirety to the functional area of investments and included in the IVC after deduction of the risk-appropriate cost of capital and the administrative expenses.

In calculating the cost of capital, our assumption – based on a Capital Asset Pricing Model (CAPM) approach – is that the investor’s opportunity costs are 450 basis points above the risk-free interest rate, meaning that value is created above this threshold. Our strategic return on equity target of 750 basis points above risk-free thus already contains a not insignificant target value creation. We allocate equity sparingly and use equity substitutes to optimise our average cost of capital. At 6.8%, we can point to a lower average cost of capital than our competitors.

Since comparison of absolute amounts is not always meaningful, we have introduced the xRoCA (excess return on capital allocated) in addition to the IVC. This describes the IVC in relation to the allocated capital and shows us the relative excess return generated above and beyond the weighted cost of capital. Complementary to this, the IVC margin corresponds to the ratio of the IVC to the net premium earned, i. e. the intrinsic value creation as a percentage of our net premium income.

In addition to the intrinsic value creation, we also take into consideration traditional performance indicators (balance sheet ratios) as summarised in our target matrix for the Group and the business groups.

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Target attainment
Business group Key data Targets 2012 2012 2011 2010 2009 2008
1 Excluding inflation swaps and ModCo derivatives
2 750 basis points above the 5-year average return on 10-year German government bonds after tax
3 Growth in book value per share including dividends paid
4 Average over the reinsurance cycle
5 Including major loss budget of EUR 625 million
6 EBIT/net premium earned
7 Excess return on allocated economic capital
8 Organic growth only
9 EBIT margin for total life and health reinsurance
Group Investment return1 ≥ 3.5% 4.1% 4.1% 4.0% 3.4% 0.8%
  Return on equity ≥ 10.0%2 15.6% 12.8% 18.2% 22.4% -4.1%
  Growth in earnings per share (year-on-year comparison) ≥ 10% 41.6% -19.1% 2.1% > 100% -117.6%
  Value creation per share3 ≥ 10% 19.4% 12.0% 20.6% 21.0% -5.4%
Non-life reinsurance Gross premium growth4 3% – 5% 13.1% 7.7% 10.3% 15.2% -3.8%
  Combined ratio5 ≤ 98% 95.8% 104.3% 98.2% 96.6% 95.4%
  EBIT margin6 ≥ 10% 15.9% 10.1% 16.3% 14.0% 0.1%
  xRoCA7 ≥ 2% 5.2% 3.0% 7.5% 1.6% -8.0%
Life and health reinsurance Gross premium growth8 5% – 7% 14.9% 3.5% 12.4% 44.5% 1.7%
  Value of New Business (VNB) growth ≥ 10% n.a. 61.2% 89.2% -44.2% 41.4%
  EBIT margin 6 Financial Solutions/Longevity ≥ 2% 2.7% 4.4% 6.1%9 9.2%9 4.3%9
  EBIT margin6 Mortality/Morbidity ≥ 6% 7.1% 4.6%      
  xRoCA7 ≥ 5% 2.4% 0.9% 15.5% 17.9% 11.2%
Target attainment
Business group Key data Targets 2012 2012 2011 2010 2009 2008
1 Excluding inflation swaps and ModCo derivatives
2 750 basis points above the 5-year average return on 10-year German government bonds after tax
3 Growth in book value per share including dividends paid
4 Average over the reinsurance cycle
5 Including major loss budget of EUR 625 million
6 EBIT/net premium earned
7 Excess return on allocated economic capital
8 Organic growth only
9 EBIT margin for total life and health reinsurance
Group Investment return1 ≥ 3.5% 4.1% 4.1% 4.0% 3.4% 0.8%
  Return on equity ≥ 10.0%2 15.6% 12.8% 18.2% 22.4% -4.1%
  Growth in earnings per share (year-on-year comparison) ≥ 10% 41.6% -19.1% 2.1% > 100% -117.6%
  Value creation per share3 ≥ 10% 19.4% 12.0% 20.6% 21.0% -5.4%
Non-life reinsurance Gross premium growth4 3% – 5% 13.1% 7.7% 10.3% 15.2% -3.8%
  Combined ratio5 ≤ 98% 95.8% 104.3% 98.2% 96.6% 95.4%
  EBIT margin6 ≥ 10% 15.9% 10.1% 16.3% 14.0% 0.1%
  xRoCA7 ≥ 2% 5.2% 3.0% 7.5% 1.6% -8.0%
Life and health reinsurance Gross premium growth8 5% – 7% 14.9% 3.5% 12.4% 44.5% 1.7%
  Value of New Business (VNB) growth ≥ 10% n.a. 61.2% 89.2% -44.2% 41.4%
  EBIT margin 6 Financial Solutions/Longevity ≥ 2% 2.7% 4.4% 6.1%9 9.2%9 4.3%9
  EBIT margin6 Mortality/Morbidity ≥ 6% 7.1% 4.6%      
  xRoCA7 ≥ 5% 2.4% 0.9% 15.5% 17.9% 11.2%

History

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