Hannover, 30 April 1998:
Reinsurance treaties are renegotiated ("renewed") once a year, in most cases as at January 1st. The terms and conditions as well as the prices for both existing and new treaties are set during this renewal phase, thereby laying the cornerstone for the economic situation in the current financial year. Each year in March an internal "renewal conference" takes place at Hannover Re, at which the underwriting managers present the results of their negotiations with our clients (the primary insurers, known as "cedants"). This provides management with a condensed and up-to-date summary of the state of the markets throughout the world.
As in the previous year, we would like to use this Newsletter to pass on to you the most important insights gained at this year's renewal conference. More detailed comments on the property/casualty reinsurance markets to which we have attached strategic priority are to be found in the Appendix.
Substantial competitive pressure in property/casualty reinsurance
Particularly in the highly developed markets of North America and western Europe, the volume of business in the property/casualty insurance markets has grown little, and indeed in some cases it has declined. Furthermore, the increasing trend towards concentration among companies is leading to higher retentions and a subsequent drop in reinsurance cessions. Due to the high profits recorded by insurers and reinsurers alike in the previous years, there is a surplus of both available equity and capacity in the markets. In other words, the decline in demand has been accompanied by an increase in supply. Price levels have therefore decreased, and reinsurance terms and conditions have been eased.
In property/casualty reinsurance we do not have any growth targets per se, but assume business purely on a profit-oriented basis. As a control instrument, we assign individual capital requirements to our various business segments on the basis of a highly sophisticated "risk-based capital" model. This model leads to a "minimum return on revenue requirements", which serve to ensure the attainment of our corporate profit target. Profit-oriented underwriting means for our underwriting managers that they strictly have to adhere to the minimum returns when accepting business. Whilst it is therefore true that the deterioration in conditions in property/casualty reinsurance will lead to a decline in volume, the attainment of our profit targets is safeguarded.
The strict adherence to profit margin requirements has particularly resulted in a decrease in proportional property business. This segment is directly influenced by the largely negative trend in the primary insurance sector and - on account of the considerable premium volumes involved - it is also exposed to excessive competition among reinsurers. In non-proportional reinsurance, by contrast, the reinsurer does not "simply" assume a proportional share of the risk; rather, it takes on shares in specially defined losses in excess of a certain size. The price for this type of reinsurance is determined largely independently of the primary insurance markets. The undue decline in the price level for primary insurance can thus be counteracted to some degree, as a consequence of which we have expanded this segment. This is also partially true of the liability classes of business, which are still offering fresh potential and continue to provide sufficiently profitable niche segments.
Financial reinsurance continues to develop favourably
We have concentrated our activities in financial reinsurance at our Irish subsidiaries in the International Financial Services Centre (IFSC) in Dublin, which bear worldwide responsibility for this business. Vigorous competition prevails in this segment too, but it has not as yet resulted in the ill-judged developments of the property/casualty market. We have consequently stepped up our marketing efforts in this area. Specifically, we also offer financial reinsurance treaties - generally customised to meet our clients' requirements - in those countries where this type of reinsurance has so far tended to play a rather minor role.
In addition to the transfer of insurance risks, such treaties include a financial component which may, for example, cushion an insurer's balance sheet or cash flow burdens in a highly systematic manner or it may spread them over a number of years. Owing to the fact that financial reinsurance business typically consists of a relatively small number of very high-volume treaties, the premium income can fluctuate sharply from year to year. However, following the successful expansion of this segment in 1997, we anticipate further substantial double-digit growth in 1998.
Major successes in life and health reinsurance
The life and health insurance lines show the highest growth rates throughout the world and continue to offer promising scope for development. In the light of the highly favourable and stable earnings potential, we have set ourselves ambitious goals for the expansion of our business in life and health reinsurance lines. The more traditional, risk-oriented sector of the life reinsurance market is also intensely competitive, and we have therefore cultivated an area of specialist expertise, namely in the field of financing reinsurance.
In this regard, in addition to accepting insurance risks, we finance the high initial new-business strain incurred by life insurers as they build up a portfolio or - especially in the USA - we take over entire portfolios (predominantly those closed for new business) under what are known as block assumption transactions. The prefinancing which we provide in this way will accrue to our account in subsequent years as earnings. It is these transactions, in particular, which will enable us to continue our systematic and successful expansion in 1998. We shall thus take another significant step towards attaining our long-term objective of generating at minimum one-third of our premium from life and health reinsurance.
Although new investments in these lines of business remain at a substantial level, the now considerable returns on our investments from previous years are bringing us closer to the break-even point. If suitable opportunities arise we are, however, prepared to continue to invest disproportionately heavily in this sector (cf. also our Newsletter of April 15, 1998 regarding the first life reinsurance transaction concluded with the capital market).
Summary
Despite differences across classes of business and countries, market conditions in property/casualty insurance are very soft. Price levels and terms and conditions in both the primary and reinsurance sectors have deteriorated - in some cases drastically -, as a result of which the premium income from individual treaties is declining and the potential for loss is growing. In the light of profit considerations, we reduced our shares in certain treaties or in some cases withdrew completely during the recent renewals. The systematic expansion of strategic markets failed to offset this development, as a consequence of which premium income in the property/casualty reinsurance classes will decline.
In the financial reinsurance segment, and to an even greater extent in life and health reinsurance, we were able to continue our strategically prioritised and highly successful expansion. We therefore anticipate that the Hannover Re Group will record further appreciable and profitable overall growth across all classes of business in 1998.
Appendix to the Newsletter
The purpose of this Appendix to the Newsletter is to provide more detailed information on the development of property/casualty reinsurance in the various regions and classes to which our company attaches strategic priority.
In Germany, the property/casualty insurance classes have been marked by a general deterioration in market conditions. Intense competition in motor business - which already has shown a decrease in premium income of approx. 4,5% in 1997 - has led to further cuts in premiums. While the physical damage segment closed with favourable results in 1997, motor third party liability business resulted in a substantial loss. Of late, however, there have been the first hints of a recovery in premium levels.
Whereas the private property insurance classes are posting slight growth, premiums for industrial fire insurance are virtually in a state of "free fall". In this sector, concessions in prices and conditions have been made on a scale which opens up a considerable loss potential for the near future. Partly due to the various favourable claims experience of the previous years, this competitive climate has also spread to the reinsurance sector. In this situation, the fact that the bulk of our German business derives from our own shareholders makes itself felt to our benefit. Both in terms of the original terms and conditions and the reinsurance conditions, the quality of this business is considerably higher than the market average. To this extent, our company is affected to a lower-than-average extent by the market development and it therefore appears that our profit objectives for 1998 will scarcely be affected.
The USA is our most important foreign market. Here, too, the very favourable claims experience of the recent past has made it possible to achieve substantial profits. Such profits serve to explain the fierce competition which currently prevails there as well as the surplus equity available in the insurance and reinsurance markets.
Particularly in the USA, therefore, we have sought to cushion the negative effects on the direct markets by stepping up our involvement in non-proportional treaties. This approach has met with considerable success, especially in the property sector. Non-proportional - otherwise known as "per risk" - reinsurance still offers generally adequate premium rates. In natural catastrophe reinsurance, rate levels for the very large US reinsurance programmes remain favourable. We have substantial participations in these so-called "mega cat" programmes, and expect them to generate positive results. Owing to the reduction in our share of proportional property business - which accounts for a sizeable premium volume -, we are expecting a slight reduction in premium income for our North American business.
The United Kingdom and the London insurance market (incl. Lloyd's) rank among the most innovative insurance and reinsurance markets in the world. The past 18 months have witnessed a number of spectacular take-overs and mergers. In the UK, too, the increased capacities on offer and the search by market players for new areas of activity have resulted in appreciable price cuts and a deterioration in terms and conditions. Unlike many other markets, however, conditions for proportional treaties have remained largely unchanged compared to 1997, although the rates for non-proportional reinsurance treaties have decreased - in some cases by up to 30%.
Due to the intensification of our marketing efforts and our membership of LIRMA (London and International Insurance and Reinsurance Market Association), we are increasingly often regarded as part of the London market - despite our Hanover-based underwriting. One consequence of this is that we are frequently offered business which is not normally placed outside London. This has enabled us to establish a number of new business links which, in spite of the general market climate, hold the promise of sufficient profits. For this reason, even though the underlying situation has deteriorated, we will probably achieve slight growth in the United Kingdom in 1998.
As far as the ASEAN countries are concerned, our involvement in Asia - which has been highly successful to date - has of course been affected by the economic and financial crisis which this region is experiencing. Taking a more differentiated perspective, it may be observed that Malaysia and Singapore have reconsolidated, whereas the Philippines, Thailand and above all Indonesia have been hit by substantial losses. As a reinsurer, we are primarily affected by the negative macro-economic developments only inasmuch as our premium income declines due to exchange-rate movements. Since we strictly observe the principle of matching currencies, not only the investments held in the original currency but also a corresponding level of loss reserves will be devalued, as a consequence of which these factors will have little impact on our results.
We had based our assumptions on the prospects of double-digit annual growth rates and despite the unfavourable developments in this region, we still expect single-figure growth.
The Asian crisis has made little impression on the Chinese market. However, the rapid progress achieved with the opening up of the Chinese insurance market has ground to a halt for the time being. Due to a number of palpably incorrect developments, such as interest promises in life insurance which can no longer be fulfilled, the Chinese supervisory authorities have strictly reduced awarding new licences to insurance companies. In the short term, therefore, growth expectations for this region will have to be adjusted.
In Japan, treaties are renewed as at April 1st each year. Our staff with market responsibility are currently reporting a delay in the completion of this year's renewals, owing to the fact that cedants commenced negotiations at a very late stage and sought wherever possible to wait and see what the latest developments would bring. On the one hand, this is attributable to a market-wide atmosphere of uncertainty concerning the effects of the recently begun deregulation of the insurance market. On the other hand, it is of course the case that Japanese cedants monitored the renewals in the other world markets and sought for their part to obtain more favourable prices. Consequently, rate levels in Japan have also declined, which will a mean slight drop in our premium income. However, at least in the mid term, the deregulation of the markets will also open up new opportunities.
Due to their special international features, aviation/marine and credit/bond business are organised on a class basis at our company. The volume of our aviation business was very significantly influenced in 1997 by the retroactive assumption of the portfolio of Skandia International, Stockholm. This acquisition enabled us to boost our premium income by approximately 35% in 1997. However, the aviation market is under strong competitive pressure, especially the high-premium segment accounted for by the major airlines. Owing to the resulting decline in the premium level, coupled with the fact that some treaties were not renewed, the premium income will contract slightly in the current year. Even though the market climate has become more difficult, we anticipate that in 1998 we will again attain our profit objectives.
The insurance and reinsurance premium volume available in credit business still derives principally from the countries of western Europe. Following further company take-overs and mergers, direct insurance business is now concentrated on just five major groups. With the exception of Germany and - at the moment - Asia, the insolvency pressure on companies is currently low. This has led to low loss ratios and corresponding profits in recent years. The commission level therefore came under pressure during the 1998 renewals, although it remained satisfactory overall. In Germany, efforts to restore business to profitability, i.e. to finally secure a return to satisfactory premium levels, have not as yet proved as successful as anticipated. Nevertheless we expect to be able to show profits in 1998 in Germany, despite the continuing rise in insolvency figures.
Over the last eight years we have succeeded in increasing our premium income five-fold in this strategic priority class five-fold, and in 1998 we expect a slight overall growth and favourable results.
Facultative is a term used to denote the reinsurance of individual (generally very large) risks. There are strong parallels between this type of reinsurance and direct insurance, and it is therefore important to be present in the individual markets. The retroactive acquisition of Skandia International's facultative portfolio combined with our own organic growth enabled us to increase our business by around 150% in 1997. In accordance with our strategic objectives, we thus already have an appreciable premium volume in this business segment, which we intend to expand further. In the light of the need to be present in the regional markets, the facultative branches and staff which we also acquired in Stockholm, Paris, Madrid and Mexico City offer considerable potential for development. Following this significant boost in 1997 and due to the increased competition also affecting this segment (primarily in the area of property reinsurance), we will achieve only slight growth in the current year.