Management indicators

As part of our performance management we measure economic value creation from strategic planning to operational management using our central management indicator, namely Intrinsic Value Creation (IVC).

The IVC enables us to record and consistently allocate the value contributions of the Group on different hierarchical levels – Group, segment/division and company. The IVC and its methodological determination form the basis on which the value contributions of the segments/divisions and of the individual operational units can be measured in a comparable manner – making allowance for their specific characteristics – in order to reliably identify value-creating areas. The core management ratios, the operational management ratios and their respective degrees of goal accomplishment create the transparency needed to optimize the allocation of capital and resources, pinpoint risks and opportunities and initiate further measures.

Our value-based management tools were continuously refined and anchored in the Group-wide management process in 2010. A key point of emphasis – one that should also be viewed in conjunction with the relevant initiatives to regulate remuneration systems in the insurance sector – was conceptualizing the operationalization of value-based management on the levels of areas of Board responsibility, companies and lines of business. The methodological determination of the IVC – and hence of the economic value creation – is carried out unchanged according to the basic scheme for the life and non-life companies. Under this approach, the intrinsic value creation constitutes the economic net income for the period less the cost of capital.

The IVC is calculated differently for “life” and “non-life” on the basis of distinct specific ratios:

Image: IVC for “life” and “non-life”

In non-life business (i.e. property/casualty insurance and non-life reinsurance) the IVC measures the difference between the NOPAT (net operating profit after adjustments and tax) and the cost of capital for risk-based capital and excess capital.

The NOPAT is an economically informative performance and management ratio for the reporting period in question. It is comprised of the Group net income recognized under IFRS after tax and fair value adjustments that arise out of the change in differences between present values and carrying amounts in the balance sheet (loss reserve discount, excess loss reserves, fair value changes not recognized in income).

The cost of capital consists of the costs for the allocated risk-based capital and the costs of excess capital. While the risk-based capital is divided between the profit centers in a manner commensurate with the risk using the Talanx risk model on the basis of a 99.97 percent Value at Risk, the excess capital is arrived at as the difference between the risk-based capital and the company’s capital. The costs for the risk-based capital are determined from the following components: a risk-free basic interest rate*, frictional costs** and a risk margin to reflect the market in question. For the excess capital, on the other hand, only the risk-free interest rate and the frictional costs are used, since the capital involved here is not at risk. On the basis of our currently applicable determination of the cost of capital, the investor incurs opportunity costs for the risk-based capital that are 600 basis points above the risk-free interest rate. Value is created above this rate of return. The targeted return-on-equity for the Group of at least 750 basis points above “risk-free” defined in our umbrella strategy thus already includes a not inconsiderable aspiration to intrinsic value creation.

Image: IVC ratios

Value creation in life business (i.e. life insurance and life/health reinsurance) is measured on the basis of the change in the Market Consistent Embedded Value (MCEV), which is expressed in the MCEV earnings. The MCEV earnings are thus equivalent to the NOPAT. The MCEV is defined as the value of the undertaking, which is measured as the discounted present value of future earnings until final run-off of the in-force portfolio plus the fair value of equity, making allowance for capital commitment costs. We chose the MCEV as the basis for value-based management of the life insurance business because it constitutes the value of the undertaking inherent in the already transacted insurance portfolio from the standpoint of the shareholder. The IVC Life is determined as the difference between the MCEV earnings and the roll forward; the latter corresponds to the expected cost of capital after allowance for the risk exposure in relation to capital market risks.

In order to measure the comparable return delivered by business units or divisions of varying size, the IVC is considered in relation to the corresponding available capital. In this way we arrive at the ratio known as the xRoCC (Excess Return on Company’s Capital), which indicates the return for the shareholder in excess of the cost of capital.

* In the context of the risk-based capital: calculated as the three-year average of ten-year swap rates
** Opportunity costs incurred by shareholders as a consequence of the fact that they invest their capital not directly in the capital market but rather by a “roundabout route” through a company and the capital is tied to the company rather than being freely fungible