Major external factors influencing risk management in the financial year just ended

Regulatory developments: The implementation of the new European supervisory regime Solvency II effective 1 January 2016 continued to make itself felt in 2017. Among other things, a Solvency and Financial Condition Report had to be compiled for the first time. Hannover Re published the report on 10 May 2017 on its website. Additional reporting requirements to the insurance regulator were fulfilled in 2017.

Hannover Re received approval from the regulatory authorities to calculate its solvency requirements using a partial internal capital model with effect from the entry into force of Solvency II on 1 January 2016. In 2017 the Hannover Re Group additionally received permission from the Federal Financial Supervisory Authority (BaFin) to calculate the operational risk on the Group level using the internal model and now has a full internal model. The aim is to obtain approvals for the solo entities belonging to the Group.

Parallel to the regulatory developments in Europe, we are seeing adjustments worldwide to the regulation of (re)insurance undertakings. It is often the case that various local supervisory authorities take their lead from the principles of Solvency II or the requirements set out by the International Association of Insurance Supervisors (IAIS).

Capital market environment: A major external influencing factor is the protracted low level of interest rates, especially with an eye to the return that can be generated on our investments. The announcement by the ECB of its decision to reduce its monthly corporate sector purchases but at the same time extend the programme until September 2018, the sluggish progress of negotiations over the United Kingdom’s exit from the European Union and numerous geopolitical flashpoints impacted the capital market climate in the period under review. With this in mind, the risk management team has deployed a working group on Brexit. Despite all these influencing factors the capital market proved to be relatively stable, although it was still shaped by a low level of interest rates overall and a continuing decline in risk premiums on corporate bonds. For further information please see the “Investments” section of the management report.

Brexit: In view of the slow progress of negotiations in 2017, it is increasingly likely that the status of legal relations between the European Union and United Kingdom will not be entirely resolved by the withdrawal date of 30 March 2019. Consequently, the Hannover Re Group must also be prepared for a “hard” Brexit and the associated workload and expenses. With this in mind, Hannover Re has set up a Group-wide working group to address readiness measures. The major impacts will be felt by our entities in the United Kingdom. The “Hannover Re Life UK Branch” and “Inter Hannover UK Branch” write significant premium volumes in life reinsurance as well as property and casualty insurance respectively. The legal status of a locally authorised entity in the United Kingdom in the form of a “third-country branch” will be sought in order to continue operations after a hard Brexit. This would be necessary in the event of the United Kingdom not recognising EU supervision and / or the Solvency II regulatory regime in the future. This will, however, entail an increased regulatory workload and capital expenditure. “Argenta Holdings plc” is a stand-alone subsidiary in the United Kingdom and already authorised as a member of Lloyd’s. Furthermore, the business volume transacted with the EU is minimal with a premium share of less than 5%. Argenta will therefore be affected only marginally. We also write business in the United Kingdom through Group companies in Hannover and Ireland. In this regard we do not anticipate any significant changes as a result of Brexit.

All in all, our current analyses indicate that the implications of Brexit are manageable for the Hannover Re Group.

US tax reform: The changes in tax legislation adopted by the US administration at the end of 2017 entered into force on 1 January 2018. They provide for new tax regulations that have far-reaching implications for subsidiaries operating in the United States. On the one hand, the reform cuts the corporate tax rate from 35% to 21%. On the other hand, the legislative package includes the introduction of the so-called “Base Erosion and Anti-Abuse Tax” (BEAT). In this connection, premiums for ceded insurance risks within the corporate group are also included in the taxable base and will in future be taxed at a rate of 5% - 12.5% (rising over the next nine years). We have already undertaken some restructuring activities within the Group and initiated further steps in order to avert this increased burden of taxation.

Risks from electronic data retention: Recent years have seen the increasing emergence of risks relating to electronic systems and their data. Hannover Re, in common with other companies, is at risk of attacks on its IT systems and has put in place extensive safeguards. Furthermore, Hannover Re offers reinsurance coverage for risks connected with electronic systems and the associated data. The dynamic pace of developments in the context of digitalisation presents a particular challenge to the assessment of such risks.

Natural catastrophe risks and climate change: 2017 was notable for an above-average number of natural disasters. The largest insured losses resulted from the three hurricanes in the Atlantic, the cyclone in Australia and the two earthquakes in Mexico. For Hannover Re, too, these events constituted major losses. All these events were optimally reflected in the assumptions underlying the natural perils models which are used for pricing and managing natural catastrophe risks. The possibility that the increased storm activity is due to progressive global warming cannot be ruled out. Hannover Re works together with partners to closely monitor the implications of global warming for extreme weather events so as to be able to incorporate the insights obtained into the models.

Increase in risks from US mortality business: In view of a renewed deterioration in the performance, most notably, of the large block of business acquired by Hannover Re at the beginning of 2009, the technical provisions calculated in accordance with IFRS and in the economic balance sheet according to Solvency II were reassessed by a project set up specifically for this purpose. This resulted in a substantial increase in the technical provisions under Solvency II. Under IFRS the provisions continued to be calculated according to the lock-in principle because the value in force (VIF) of the book of US mortality business remained positive overall.