This section describes external factors that could have a particularly significant impact on risk management in 2019 and subsequent years.
Brexit: The terms of the United Kingdom’s withdrawal from the European Union have still not been determined. The possibility of the UK leaving the EU without an agreement continues to exist. The Hannover Re Group is prepared for this scenario and a Group-wide working group has been set up to address readiness measures.
The Hannover Re Life UK Branch will be materially affected. In order to be able to continue its activities even after a “hard” Brexit, an application to operate under the so-called temporary permissions regime (TPR) has been filed and already approved by the financial regulator. Increased administrative expenses and higher capital costs cannot be ruled out over the medium term. Argenta Holdings Limited is a wholly owned subsidiary of Hannover Re that operates on a standalone basis in the United Kingdom and is already authorised as a member of Lloyd’s. We also write reinsurance 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.
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: The possibility that the increased storm activity in recent years 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.
Reserve risks: The 2018 financial year was heavily impacted by natural catastrophe events that caused market losses in excess of USD 100 billion. In common with other market players, Hannover Re was among those affected – principally by typhoon Jebi and several wildfires in California. Given that these events occurred in the second half of 2018 the loss estimates are inevitably subject to uncertainty, with the amounts due to be paid out over the next few years. With this in mind, some additional uncertainty has been allowed for in the remaining anticipated loss payments as part of the estimated technical reserves.
Ogden rate: In 2017 a change (i.e. reduction) was made in the so-called Ogden rate – primarily affecting UK motor insurance – which is used to calculate personal injury compensation payments. A massive cut in the rate led to a rise in the expected loss costs. These increased amounts have since been reflected in the technical reserves for the relevant lines. Shortly after the end of the reporting period the UK government changed the rate from -0.75% to -0.25% effective 5 August 2019. This decision on the rate reduces the anticipated run-off result, although it is still expected to be positive thanks to the company’s prudent reserving policy. The future payment patterns for these claims remain subject to uncertainty.
US mortality business: As part of our in-force management actions we initiated rate adjustments for a portfolio acquired in 2009. Insofar as the cedants affected by rate adjustments exercise their right of recapture, this can lead to one-time charges to the IFRS result in a few remaining isolated cases. We continue to monitor the further development of the underlying mortality on an ongoing basis.
Capital market environment: The protracted low level of interest rates is a major external factor influencing the return that can be generated on our investments. Interest rate declines – which in some instances were very marked – affected both euro-denominated bonds as well as the US dollar and sterling markets. Negative yields are now being seen on euro area government bonds extending beyond the 10-year maturity point. The cautious actions taken by central banks, continued uncertainty surrounding the process for the United Kingdom’s exit from the European Union and numerous geopolitical flashpoints as well as simmering trade and tariff wars made the search for a clear direction on capital markets difficult in the period under review. The nervousness that was evident towards the close of the previous year subsequently levelled off, as reflected for example in sharp decreases in risk premiums on corporate bonds. From the middle of the reporting period onwards, however, corporate bond spreads began to widen again, although they did not reach the levels seen at the end of the previous year.
We continue to have exposure to the private equity market. Fair value changes here tend to be less influenced by general market conditions and more by company-specific evaluations. The risks are therefore primarily associated with the business model and profitability and to a lesser extent with the interest rate component in a consideration of cash flow forecasts. In the period under review, for example, we see the need to take somewhat higher write-downs not as a reflection of an elevated risk in the market, but rather in the context of the risk profile specific to this asset class. The significance of real estate risks has continued to grow owing to our consistent participation in this sector. We spread these risks through broadly diversified investments in high-quality markets around the world, with each investment decision being preceded by extensive analyses of the relevant property, manager and market.
As far as our investments are concerned, we anticipate continuing elevated volatility on global capital markets in the immediate future, although we also see this as an opportunity and believe that we are appropriately prepared with the current rather defensive posture of our asset portfolio. For further information please see the “Investments” section of the management report on page 10 et seq.