Value-based management
Management system
Value-based management
Our integrated system of enterprise management is central to the accomplishment of our strategic objectives. Located at its core are, first and foremost, our profit and growth targets, which are summarised for the Group and its business groups in the so-called target matrix. In addition to traditional performance indicators geared to the IFRS balance sheet, our system of targets also includes economic targets derived from our economic capital model. The targets are analysed and where necessary adjusted as part of a regular process. Our focus is on long-term strategic target attainment.
| Target attainment | ||||||||
|---|---|---|---|---|---|---|---|---|
| Business group | Key data | Targets for 2013 |
Target attainment | |||||
| 2013 | 20121 | 2011 | Ø 2011-20132 | |||||
| Group | Investment return3 | ≥ 3.4% | 3.4% | 4.1% | 4.1% | 3.9% | ||
| Return on equity | ≥ 9.8%4 | 15.0% | 15.4% | 12.8% | 13.9% | |||
| Growth in earnings per share (year-on-year comparison) |
≥ 10% | 5.4% | 41.6% | -19.1% | 6.2% | |||
| Value creation per share5 | ≥ 10% | 3.6% | 19.4% | 12.0% | 11.1% | |||
| Non-life reinsurance | Gross premium growth6 | 3–5% | 3.5% | 9.3% | 9.4% | 7.3% | ||
| Combined ratio | ≤ 96%7 | 94.9% | 95.8% | 104.3% | 98.1% | |||
| EBIT margin8 | ≥ 10% | 15.5% | 15.9% | 10.1% | 14.0% | |||
| xRoCA9 | ≥ 2% | 5.4% | 6.0% | 3.0% | 4.9% | |||
| Life and health reinsurance | Gross premium growth10 | 5–7% | 5.1% | 9.8% | 5.2% | 6.7% | ||
| Value of New Business (VNB) growth | ≥ 10% | -1.6% | 30.3% | 61.2% | 27.4% | |||
| EBIT margin8, 11 Financial Solutions/Longevity |
≥ 2% | 5.2% | 5.0% | 5.5% | 5.2% | |||
| EBIT margin8, 11 Mortality/Morbidity |
≥ 6% | 1.2% | 5.2% | 3.9% | 3.4% | |||
| xRoCA9 | ≥ 3% | 8.3% | -1.3% | 0.9% | 2.9% | |||
| 1 Adjusted pursuant to IAS 8 (cf. Section 3.1 of the notes) 2 Average annual growth, otherwise weighted averages 3 Excluding inflation swaps and ModCo derivatives 4 750 basis points above the 5-year average return on 10-year German government bonds after tax 5 Growth in book value per share including dividends paid 6 Average over the reinsurance cycle at constant exchange rates 7 Including major loss budget of EUR 625 million 8 EBIT/net premium earned 9 Excess return on allocated economic capital 10 Organic growth only; annual average growth (5 years); at constant exchange rates 11 Reclassification of treaties |
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With a view to allocating our profit and growth targets for the Group and its business groups to the individual business activities and profit centres on a basis that adequately reflects the risks and in order to be able to measure target attainment, we have for many years now used various value-based management tools that are integrated into our corporate processes.
System of value-based management: Performance Excellence (PE) combines the strategic and operational levels (chart)
enlarge
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 levels are 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 standardised financial indicators but also non-financial variables derived from the strategic parameters.
Management Reporting
The annual Management Reporting presents in detail the degree of target 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 basis 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 capitalwithin the underwriting sector, first between the business segments of non-life reinsurance and life and 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 and 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 and 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 | 2013 | 2012 | ||||
| IVC | xRoCA | Reported IVC | Adjust- ment1 | Final IVC | xRoCA | |
| Non-life reinsurance | 295.5 | +5.4% | 251.8 | 40.5 | 292.2 | +6.0% |
| Life and health reinsurance | 226.6 | +8.3% | 58.6 | (89.4) | (30.8) | -1.3% |
| Investments2 | 108.6 | +6.2% | 790.7 | (29.3) | 761.4 | +49.4% |
| Group | 617.1 | +5.9% | 1,088.8 | (78.0) | 1,010.8 | +10.8% |
| 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 | ||||||
The allocated capital consists of three components: the 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 and 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 6.4%, our average cost of capital is comparatively low.
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.