6.7 Technical provisions

In order to show the net technical provisions remaining in the retention the following table compares the gross provisions with the corresponding retrocessionaires’ shares, which are shown as assets in the balance sheet.

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The loss and loss adjustment expense reserves are in principle calculated on the basis of the information supplied by ceding companies. Additional IBNR reserves are established for losses that have been incurred but not as yet reported.

In the previous year technical provisions were discounted at interest rates of between 6.5% and 8.5% with respect to a certain group of contracts relating to the Hannover Re Advanced Solutions division. The interest rates were determined by the contractual agreements. The period from inception to expiry of these contracts was at least four years. No further discounting was taken for the year under review because the contracts will be terminated in less than four years.

The development of the loss and loss adjustment expense reserve is shown in the following table. Commencing with the gross reserve, the change in the reserve after deduction of the reinsurers’ portions is shown in the year under review and the previous year.

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In the year under review specific value adjustments on retrocessions, i.e. on the reinsurance recoverables on unpaid claims, were reversed in an amount of EUR 22.2 million (previous year: established in an amount of EUR 20.2 million). Consequently, cumulative specific value adjustments of EUR 24.5 million (EUR 46.7 million) were recognised in these reinsurance recoverables as at the balance sheet date.

The total amount of the net reserve before specific value adjustments, to which the following remarks apply, was EUR 15,652.8 million (EUR 14,806.2 million) as at the balance sheet date.

The table below shows the net loss reserve (loss and loss adjustment expense reserve) for nonlife reinsurance in the years 1999 to 2009 as well as the run-off of the reserve (so-called run-off triangle).

To some extent the loss and loss adjustment expense reserves are inevitably based upon estimations that entail an element of uncertainty. The difference between the previous year’s and current estimates is reflected in the net run-off result. In addition, owing to the fact that the period of some reinsurance treaties is not the calendar year or because they are concluded on an underwriting-year basis, it is frequently impossible in reinsurance business to make an exact allocation of claims expenditures to the current financial year and the previous year. The run-off triangles are therefore shown after adjustment for effects associated with the additional premium.

The development of the euro relative to the most relevant foreign currencies is also a significant influencing factor in the analysis of run-off triangles. In particular, despite the opposing effects of other major foreign currencies, the appreciation of 2.6% in the US dollar against the euro compared to the previous year led to a slight increase in the loss and loss adjustment expense reserve on a euro basis.

The run-off triangles show the run-off of the reserve established as at each balance sheet date, this reserve comprising the provisions constituted in each case for the current and preceding occurrence years.

The run-off results shown reflect the changes in the ultimate loss arising in the 2009 financial year for the individual run-off years.

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The result for the run-off years was EUR 84.9 million in the 2009 financial year. This is equivalent to 0.6% of the original reserve.

Maturities of the technical reserves

IFRS 4.38 in conjunction with 4.39(d) requires information which helps to clarify the amount and timing of cash flows expected from reinsurance contracts. In the following tables we have shown the future maturities of the technical reserves broken down by the expected remaining times to maturity. As part of our maturity analysis we have directly deducted the deposits put up as security for these reserves, since the cash inflows and outflows from these deposits are to be allocated directly to the ceding companies. For further explanation of the recognition and measurement of the reserves please see Section 3.2 “Summary of major accounting policies”.

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The average maturity of the loss and loss adjustment expense reserves was 5.7 years (5.5 years), or 5.8 years (5.7 years) after allowance for the corresponding retrocession shares. The benefit reserve had an average maturity of 13.0 years (14.2 years) – or 13.3 years (14.4 years) on a net basis.

The average maturity of the reserves is determined using actuarial projections of the expected future payments. A payment pattern is calculated for each homogenous category of our portfolio – making allowance for the business sector, geographical considerations, treaty type and the type of reinsurance – and applied to the outstanding liabilities for each underwriting year and run-off status.

The payment patterns are determined with the aid of actuarial estimation methods and adjusted to reflect changes in payment behaviour and outside influences. The calculations can also be distorted by major losses, and these are therefore considered separately using reference samples or similar losses. The payment patterns used can be compared year for year by contrasting the projected payments with the actual amounts realised.

Liabilities in liability and motor reinsurance traditionally have long durations, sometimes in excess of 20 years, while liabilities in property business are settled within the first ten years.

The benefit reserve is established for life, annuity, personal accident and health reinsurance contracts. Based on the duration of these contracts, long-term reserves are constituted for life and annuity policies and predominantly short-term reserves are set aside for health and personal accident business.

The benefit reserve is calculated on the basis of the following parameters:

1. interest income;
2. lapse rates;
3. mortality and morbidity rates.

The values for the first two components differ according to the country concerned, product type, investment year etc. The mortality and morbidity rates used are chosen on the basis of national tables and the insurance industry standard. Empirical values for the reinsured portfolio, where available, are also taken into consideration. In this context insights into the gender, age and smoker structure are incorporated into the calculations, and allowance is also made for factors such as product type, sales channel and the frequency of premium payment by policyholders.

At the inception of every reinsurance contract, assumptions about the three parameters are made and locked in for the purpose of calculating the benefit reserve. At the same time, safety/fluctuation loadings are built into each of these components. In order to ensure at all times that the originally chosen assumptions continue to be adequate throughout the contract, checks are made on a regular – normally annual – basis in order to determine whether these assumptions need to be adjusted (’unlocked‘).

The benefit reserve is established in accordance with the principles set out in FASB ASC 944–40–30 and –35 (previously contained in SFAS 60 ”Accounting and Reporting by Insurance Enterprises“). The provisions are based on the Group companies‘ information regarding mortality, interest and lapse rates.

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The unearned premium reserve derives from the deferral of ceded reinsurance premium. The unearned premium is determined by the period during which the risk is carried and established in accordance with the information supplied by ceding companies. In cases where no information was received, the unearned premium was estimated using suitable methods. Premium paid for periods subsequent to the date of the balance sheet was deferred from recognition within the statement of income.

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The adequacy of the technical liabilities arising out of our reinsurance treaties is reviewed as at each balance sheet date. As part of the adequacy test for technical liabilities the anticipated future contractual payment obligations are compared with the anticipated future income. Hannover Re adopts the “loss recognition” method set out under US GAAP. Should the result of the test indicate that the anticipated future income will not be sufficient to fund future payments, the entire shortfall is recognised in income by first writing off capitalised acquisition costs corresponding to the shortfall. Any remaining difference is constituted as an additional provision.