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Investments

Stock markets around the world were plunged into an unparalleled downward slide in the year under review. The German stock index (Dax) had fallen by around 40% by the end of the year. The EuroStoxx 50 and S&P 500 experienced slumps of similar dimensions. Although equity markets rallied somewhat from their lows of October and November, the Dax stood at just 4,810 points at the end of December - compared to a level in excess of 8,000 at the start of the year.

While the US Federal Reserve Board slashed its key lending rates dramatically to 0% to 0.25%, the adjustments made by the European Central Bank were more moderate. It too cut the base rate, albeit initially only to 2.5%. In view of the recessionary tendencies in virtually all major currency areas, a cycle of interest rate reductions was set in motion worldwide.

The return on ten-year US treasury bonds declined appreciably to less than 2.8% in view of the economic outlook. In Europe, too, ten-year bonds paid a return of less than 3.0%, while highs markedly in excess of 4.0% were recorded by the middle of the year. As the fourth quarter progressed corporate bonds were listed with considerable risk premiums - against a backdrop of extensive illiquidity. The euro slipped slightly against the US dollar in the course of the year, but held its ground - in some cases forcefully - against other currencies.

Hannover Re's investment policy continues to be guided by the following core principles:

• generation of stable, plannable and tax-optimised returns while at the same time maintaining the high quality standard of the portfolio;
• ensuring the company's liquidity and solvency at all times;
• high diversification of risks;
• limitation of currency exposures in accordance with the principle of matching currencies.

With these goals in mind we engage in active risk management on the basis of balanced risk/return analyses. In this context we observe centrally implemented investment guidelines and are guided by the insights of dynamic financial analysis. These measures - in combination with a positive technical cash flow - ensure that at all times we are able to meet our payment obligations.

Within the scope of our asset/liability management activities, the allocation of investments by currency is determined by the development of underwriting items on the liabilities side of the balance sheet. We are thus able to achieve extensive currency matching of assets and liabilities, thereby ensuring that our result is not significantly affected by fluctuations in exchange rates. As at year-end 43.8% of our asset portfolio was held in euros, 40.3% in US dollars and 6.1% in pounds sterling.

Thanks to a positive cash flow from the technical account and investments, and assisted by a slight recovery in the US dollar, our portfolio of assets under own management grew to EUR 20.1 billion (EUR 19.8 billion) despite the fall in fair value.

Breakdown of investments (in %)

Ordinary investment income, on the other hand, was flat and came in below the previous year at EUR 829.8 million (EUR 859.0 million). This was due to a lower average yield than a year earlier, attributable principally to tactical regrouping into low-risk securities.

The balance of our deposit interest and expenses was largely unchanged at EUR 199.6 million (EUR 220.1 million). Write-downs of EUR 479.9 million (EUR 71.4 million) were taken on securities. Gains of EUR 379.2 million realised on disposals were attributable to the tactical modification of durations in the US dollar portfolio undertaken in the first quarter as well as the liquidation of a hedge on around one-fifth of the equity holdings in the fourth quarter. This contrasted with realised losses of EUR 492.8 million (EUR 69.7 million) that resulted principally from the significant reduction of the equity allocation in the fourth quarter. In light of the developments described above, net investment income contracted appreciably to EUR 278.5 million (EUR 1,121.7 million).

For years we have actively managed the average duration of our fixed-income portfolio, thereby conserving our shareholders' equity. In the course of the year under review we initially reduced the modified duration of our bond portfolio. As at 31 December 2008 it was roughly back on a par with the previous year at 3.8.

The portfolio of fixed-income securities climbed sharply to EUR 17.9 billion (EUR 15.7 billion), primarily as a consequence of the reduced equity allocation but also due to inflows of cash from the technical account. The funds were invested predominantly in government bonds. Hidden reserves for fixed-income securities recognised in shareholders' equity totalled EUR 101.7 million, compared to hidden losses of EUR 103.4 million in the previous year. The quality of the bonds – measured in terms of rating categories – was maintained on a consistently high level. The proportion of securities rated "A" or better – at 92.9% – was slightly higher than in the previous year (92.3%).

Investments

The crash on the US real estate sector snowballed into a crisis on global credit and financial markets as the year progressed. After our investments had been only marginally impacted by subprime losses, the value adjustments prompted by loan defaults and write-downs on financial securities also remained within bounds. It was thanks to our broad diversification and tight issuer limits that losses on other individual instruments were within the singledigit million euro range. What is more, not only is the counterparty risk limited, the portfolio is also diversified by sectors and product types. This was another reason why write-downs on fixed-income securities were restricted to altogether EUR 96.9 million (EUR 26.6 million).

We held a total amount of EUR 1.2 billion (EUR 1.3 billion) in short-term assets and current assets as at the end of the year under review. Funds held by ceding companies amounted to EUR 10.1 billion (EUR 9.2 billion).

The downward trend on equity markets that had started in the first half of the year gathered pace on a massive scale in the fourth quarter. As a result, we were compelled to take write-downs of EUR 356.1 million (EUR 34.2 million). In addition, the equity allocation was reduced to a minimum in the fourth quarter, and it now stands at less than 1% (10.1%).

Rating of fixed-income securities (in %)

Holdings of alternative investments continued to grow. As at 31 December 2008 an amount of EUR 751.8 million (including uncalled capital) was invested in private equity funds, a further EUR 294.5 million in high-return bond funds and loans as well as CDOs and altogether EUR 139.1 million in structured real estate investments.

During the reporting period we also began to implement our real estate investment programme. An initial property has already been acquired, and further buildings are under review; the real estate allocation will therefore rise progressively as planned, although it is currently still below 1%.

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Net investment income