Faced with a challenging capital market climate, particularly high importance attaches to preserving the value of assets under own management and the stability of the return. Hannover Re’s portfolio is therefore guided by the principles of a balanced risk / return profile and broad diversification. Based on a risk-averse asset mix, the investments reflect both the currencies and durations of our liabilities. Market price risks include equity risks, interest rate risks, currency risks, real estate risks, spread risks and credit risks. Our portfolio currently consists in large part of fixed-income securities, and hence credit and spread risks account for the bulk of the market risk. We minimise interest rate and currency risks through the greatest possible matching of payments from fixed-income securities with the projected future payment obligations from our insurance contracts. Market risks derive from the investments managed by Hannover Re itself and from investment risks of ceding companies that we assume in connection with insurance contracts. The following table shows the risk capital with a confidence level of 99.5 % for the market risks from investments under own and third-party management.
|Required risk capital 1 for market risks|
|in EUR million||2014||2013|
|Credit and spread risk||2,639.0||1,408.1|
|Interest rate risk||851.9||812.9|
|Real estate risk||404.4||287.7|
|1 Required risk capital with a confidence level of 99.5%|
2 Including private equity
The sharp rise in the credit and spread risk is attributable to the strengthening of various model parameters, the increased investment volume and an interaction between the two effects.
With a view to preserving the value of our assets under own management, we constantly monitor adherence to a trigger mechanism based on a clearly defined traffic light system that is applied across all portfolios. This system defines clear thresholds and escalation channels for the cumulative fluctuations in fair value and realised gains / losses on investments since the beginning of the year. These are unambiguously defined in conformity with our risk appetite and trigger specified information and escalation channels if a corresponding fair value development is overstepped. Despite the conservative orientation of our investment portfolio, it profited substantially from movements in interest rates and spreads over the course of the year and consistently boosted its fair value reserves. The escalation levels of the trigger mechanism were not activated at any point in time.
The short-term loss probability measured as the “Value at Risk” (VaR) is another vital tool used for monitoring and managing market price risks. It is calculated on the basis of historical data, e. g. the volatility of the securities positions under own management and the correlation between these risks. As part of these calculations the decline in the fair value of our portfolio is simulated with a certain probability and within a certain period. The VaR of the Hannover Re Group determined in accordance with these principles specifies the decrease in the fair value of our securities portfolio under own management that with a probability of 95 % will not be exceeded within ten trading days. A multi-factor model is used to calculate the VaR indicators for the Hannover Re Group. It is based on time series of selected representative market parameters (equity prices, yield curves, spread curves, exchange rates, commodity prices and macro-economic variables). All asset positions are mapped on the level of individual positions within the multi-factor model; residual risks (e. g. market price risks that are not directly explained by the multi-factor model) can be determined through back-calculation and are incorporated into the overall calculation. The model takes into account interest rate risks, credit and spread risks, systematic and specific equity risks, commodity risks and option-specific risks. Against the backdrop of what was still a difficult capital market environment, the volatilities of fixed-income assets, in particular, and hence the market price risks increased in the year under review relative to the previous year. Based on continued broad risk diversification and the orientation of our investment portfolio, our Value at Risk was nevertheless clearly below the Value at Risk upper limit defined in our investment guidelines. It amounted to 0.8 % (1.1 %) as at the end of the reporting period.
Stress tests are conducted in order to be able to map extreme scenarios as well as normal market scenarios for the purpose of calculating the Value at Risk. In this context, the loss potentials for fair values and shareholders’ equity (before tax) are simulated on the basis of already occurred or notional extreme events.
|Scenarios for changes in the fair value of material asset classes|
|in EUR million||Scenario||Portfolio change on a fair value basis||Change in equity before tax|
|Equity securities and private equity||Share prices -10%||-71.9||-71.9|
|Share prices -20%||-143.9||-143.9|
|Share prices +10%||+71.9||+71.9|
|Share prices +20%||+143.9||+143.9|
|Fixed-income securities||Yield increase +50 basis points||-762.5||-648.2|
|Yield increase +100 basis points||-1,489.1||-1,265.6|
|Yield decrease -50 basis points||+787.0||+667.6|
|Yield decrease -100 basis points||+1,608.0||+1,364.0|
|Real estate||Real estate market values -10%||-135.8||-91.5|
|Real estate market values +10%||+130.0||+34.1|
Further significant risk management tools – along with the various stress tests used to estimate the loss potential under extreme market conditions – include sensitivity and duration analyses and our asset / liability management (ALM). The internal capital model provides us with quantitative support for the investment strategy as well as a broad diversity of VaR calculations. In addition, tactical duration ranges are in place, within which the portfolio can be positioned opportunistically according to market expectations. The parameters for these ranges are directly linked to our calculated risk-bearing capacity. Further information on the risk concentrations of our investments can be obtained from the tables on the rating structure of fixed-income securities as well as on the currencies in which investments are held. Please see our comments in the section of the notes entitled “Investments under own management”.
Share price risks derive from the possibility of unfavourable changes in the value of equities, equity derivatives or equity index derivatives in our portfolio. We hold such assets only on a very modest scale as part of strategic participations. The scenarios for changes in equity prices consequently have only extremely slight implications for our portfolio. Please see our comments in the section of the notes entitled “Investments under own management”.
The portfolio of fixed-income securities is exposed to the interest rate risk. Declining market yields lead to increases and rising market yields to decreases in the fair value of the fixed-income securities portfolio. The credit spread risk should also be mentioned. The credit spread refers to the interest rate differential between a risk-entailing bond and risk-free bond with the same maturity. Changes in these risk premiums, which are observable on the market, result – analogously to changes in pure market yields – in changes in the fair values of the corresponding securities.
Currency risks are especially relevant if there is a currency imbalance between the technical liabilities and the assets. Through extensive matching of currency distributions on the assets and liabilities side, we reduce this risk on the basis of the individual balance sheets within the Group. The short-term Value at Risk therefore does not include quantification of the currency risk. We regularly compare the liabilities per currency with the covering assets and optimise the currency coverage in light of various collateral conditions such as different accounting requirements by regrouping assets. Remaining currency surpluses are systematically quantified and monitored within the scope of economic modelling. A detailed presentation of the currency spread of our investments is provided in the section entitled “Investments under own management”.
Real estate risks result from the possibility of unfavourable changes in the value of real estate held either directly or through fund units. They may be caused by a deterioration in particular qualities of a property or by a general downslide in market values. Real estate risks continued to grow in importance for our portfolio owing to our ongoing involvement in this sector. We spread these risks through broadly diversified investments in high-quality markets of Germany, Europe as a whole and the United States; each investment is preceded by detailed analyses of the property, manager and market concerned.
We use derivative financial instruments only to the extent needed to hedge risks. The primary purpose of such financial instruments is to hedge against potentially adverse developments on capital markets. In the year under review we took out inflation swaps to hedge part of the inflation risks associated with the loss reserves in our technical account. Some of these inflation swaps reached their maturity date during the year and were not renewed. In addition, as in the previous year, a modest portion of our cash flows from the insurance business as well as currency risks were hedged using forward exchange transactions because currency matching could not be efficiently achieved. Hannover Re holds further derivative financial instruments to hedge interest rate risks from loans taken out to finance real estate. In addition, Hannover Re has taken out hedges in the form of equity swaps to hedge price risks in connection with the stock appreciation rights granted in the first quarter of 2014 under the Share Award Plan. These are intended to neutralise changes in the fair values of the awarded stock appreciation rights. Contracts are concluded with reliable counterparties and for the most part collateralised on a daily basis so as to avoid credit risks associated with the use of such transactions. The remaining exposures are controlled according to the restrictive parameters set out in the investment guidelines. Our investments entail credit risks that arise out of the risk of a failure to pay (interest and / or capital repayment) or a change in the credit status (rating downgrade) of issuers of securities. We attach equally vital importance to exceptionally broad diversification as we do to credit assessment conducted on the basis of the quality criteria set out in the investment guidelines. We measure credit risks in the first place using the standard market credit risk components, especially the probability of default and the potential amount of loss – making allowance for any collateral and the ranking of the individual instruments depending on their effect in each case.
IWe then assess the credit risk first on the level of individual securities (issues) and in subsequent steps on a combined basis on the issuer level. In order to limit the risk of counterparty default we set various limits on the issuer and issue level as well as in the form of dedicated rating quotas. A comprehensive system of risk reporting ensures timely reporting to the functions entrusted with risk management.
|Rating structure of our fixed-income securities1|
|Rating classes||Government bonds||Securities issued by|
semi-governmental entities 2
|in%||in EUR million||in%||in EUR million||in%||in EUR million||in%||in EUR million|
|1 Securities held through investment funds are recognised pro rata with their corresponding individual ratings.|
2 Including government-guaranteed corporate bonds
The measurement and monitoring mechanisms that have been put in place safeguard a prudent, broadly diversified investment strategy. This is reflected inter alia in the fact that within our portfolio of assets under own management the exposures to government bonds or instruments backed by sovereign guarantees issued by the so-called GIIPS states (Greece, Ireland, Italy, Portugal, Spain) amount to altogether just EUR 245.9 million on a fair value basis. This corresponds to a proportion of 0.7%. The individual countries account for the following shares: Spain EUR 118.0 million, Italy EUR 72.1 million, Ireland EUR 30.2 million and Portugal EUR 25.6 million. No impairmentshad to be taken on these holdings. Our portfolio does not contain any bonds of Greek issuers.
On a fair value basis EUR 4,266.9 million of the corporate bonds held by our company were issued by entities in the financial sector. Of this amount, EUR 3,574.0 million was attributable to banks. The vast majority of these bank bonds (76.5 %) are rated “A” or better. Our investment portfolio under own management does not contain any written or issued credit default swaps.