Summary of major accounting policies

Summary of major accounting policies

Recognition of insurance contracts

In March 2004 the IASB published IFRS 4 “Insurance Contracts”. The first standard governing the accounting of insurance contracts, it divides the “Insurance Contracts” project into two phases. IFRS 4 represents the outcome of Phase 1 and serves as a transitional arrangement until the IASB redefines the measurement of insurance contracts after completion of Phase 2. The exposure draft (ED/2010/8) “Insurance Contracts” has now been published; the final standard is expected in the second quarter of 2011.

IFRS 4 (Phase 1) – which also applies to reinsurance contracts – requires that all contracts written by insurance companies be classified either as insurance contracts or investment contracts. An insurance contract exists if one party (the insurer) assumes a significant insurance risk from another party (the policyholder) by agreeing to pay the policyholder compensation if a defined uncertain future event detrimentally impacts the policyholder. For the purposes of recognizing insurance contracts within the meaning of IFRS 4, insurance companies are permitted to retain their previously used accounting practice for insurance contracts for the duration of the currently applicable project stage (Phase 1). Underwriting items in the consolidated financial statement are therefore recognized in accordance with US GAAP. All contracts without a significant underwriting risk are treated as investment contracts pursuant to IFRS 4. Investment contracts that carry a discretionary surplus participation are also recognized in accordance with US GAAP. Investment contracts that do not have a discretionary surplus participation are treated as financial instruments pursuant to IAS 39.

Assets

Intangible assets
Intangible assets – with the exception of goodwill and insurance-related intangible assets – are recognized at amortized costs less scheduled straight-line depreciation and, as appropriate, impairment losses. The following useful lives were taken as a basis for all intangible assets with the exception of goodwill.

   

Software (self-developed or purchased)

3–10 years

Insurance-related intangible assets (subject to the underlying insurance contracts)

Until approx. 2056

Goodwill
The goodwill arising out of corporate acquisitions is the positive difference between the cost of acquisition and the pro-rata fair value of identified assets, liabilities and contingent liabilities (fair value of the revalued net assets). Negative differences from initial consolidation are to be recognized immediately in income after fresh testing pursuant to IFRS 3 “Business Combinations”. Goodwill is an asset with an indefinite useful life and hence scheduled depreciation is not taken; instead, in accordance with IFRS 3 “Business Combinations” in conjunction with IAS 36 “Impairment of Assets”, goodwill is tested for impairment at least annually according to the “impairment-only approach” and written down as necessary depending on the outcome of the test. An impairment loss established in this way is recognized in income.

For the purposes of the impairment test pursuant to IAS 36.80 et seqq. “Impairment of Assets”, goodwill is allocated to “cash generating units” (CGUs) (see item 1 of these Notes “Goodwill”). In order to determine a possible impairment the recoverable amount – defined as the higher of the value in use or the fair value less costs to sell – of a CGU is established and compared with the carrying values of this CGU in the Group including goodwill. If the carrying values including goodwill exceed the recoverable amount, a goodwill impairment is recognized. The impairment loss on goodwill is recognized as a separate item in the statement of income.

Insurance-related intangible assets
The present value of future profits (PVFP) on acquired insurance portfolios refers to the present value of the expected future net cash flows from life insurance contracts existing at the time of acquisition. It consists of a shareholders’ and tax portion, on which deferred taxes are established, and a policyholders’ portion. Amortization is taken on the insurance portfolios according to the realization of the surpluses on which the calculation is based. Impairment and the measurement parameters used are tested at least once a year; as necessary, the amortization patterns are adjusted or an impairment loss is taken. Only the amortization of the shareholders’ portion is taken as a charge against future earnings. The portion of the PVFP in favor of policyholders is recognized as a liability by life insurance companies which are required to enable their policyholders to participate in all profits through the establishment of a provision for deferred premium refunds.

Software
The other intangible assets also consist of acquired and self-developed software. Intangible assets acquired for a consideration are recognized at amortized costs; self-developed software is carried at production cost less straight-line depreciation. The other intangible assets are tested for impairment as at the balance sheet date and written down if necessary. These depreciation and impairment expenses are allocated to the functional units; insofar as allocation to functional units is not possible, they are recognized under other expenses. Write-ups on these assets are recognized in other income.

Investments including income and expenses
With respect to real estate, a distinction is made between investment property and own-use real estate based on the following criteria: investment and own-use real estate for mixed-use properties is classified separately if the portions used by third parties and for own use could be sold separately. If this is not the case, properties are only classified as investment property if less than 10% is used by Group companies.

Investment property is measured at acquisition or manufactoring costs less scheduled depreciation and impairment. Scheduled depreciation is taken on a straight-line basis over the expected useful life, at most 50 years. An impairment expense is taken if the market value (recoverable amount) determined using recognized valuation methods is less than the carrying amount. In the case of the directly held portfolio, a qualified external opinion is drawn up for each object every five years on the basis of the discounted cash flow method (calculation of the discounted cash flows from rents etc. that can be generated from an object). Expert opinions are obtained at shorter intervals if special facts or circumstances exist that may affect the value. In addition, internal assessments are drawn up per object on each balance sheet date, also based on the discounted cash flow method, in order to review the value. An external fair value opinion is obtained for real estate special funds every 12 months – the key date is the date of first appraisal. For properties that are not rented out, the fair value is established using the discounted cash flow method in light of the forecast vacancy rate.

Maintenance costs and repairs are expensed in investment income; value-enhancing expenditures are capitalized using the equity method and can extend the useful life in individual cases.

Investments in associated companies encompass solely the associated companies valued using the equity method on the basis of the proportionate shareholders’ equity attributable to the Group. The portion of an associated company’s year-end result relating to the Group is included in the net investment income. The shareholders’ equity and year-end result are taken from the associated company’s latest available annual financial statement. In this context, allowance is made for specific extraordinary circumstances in the appropriate reporting period, if they are material to the associated company’s assets, financial position or net income.

Financial assets/liabilities including derivative financial instruments in the directly held portfolio are recognized/derecognized upon acquisition or sale as at the settlement date in accordance with IAS 39 “Financial Instruments: Recognition and Measurement”. Upon addition to the portfolio, financial assets are allocated to the four categories “loans and receivables”, “financial instruments held to maturity”, “financial instruments available for sale” and “financial instruments at fair value through profit or loss”. Financial liabilities are classified either as “financial instruments at fair value through profit or loss” or “at amortized cost”. Depending on their categorization, the transaction costs directly connected with the acquisition may be recognized. Subsequent measurement of financial instruments depends on the above categorization and is carried out either at amortized cost or at fair value. The amortized costs are determined from the historical costs after allowance for amounts repayable, premiums or discounts amortized within the statement of income using the effective interest rate method and any unscheduled impairment. Fair value is the amount for which an asset could be exchanged between knowledgeable, willing parties in an arm’s length transaction or for which a liability could be settled.

Financial instruments due on demand are recognized at face value. Such instruments include inter alia cash in hand and funds held by ceding companies.

The item Investments in affiliated companies and participating interests consists inter alia of investments in companies that are not consolidated because of their subordinate importance for the presentation of the assets, financial position and net income of the Group. Associated companies not measured at equity on account of their subordinate importance are also carried in this item of the balance sheet. Recognition of investments in listed companies is at fair value on the balance sheet date; other investments are recognized at cost, less impairments where applicable.

Loans and receivables are non-derivative financial instruments with fixed or determinable payments that are not listed on an active market and are not intended to be sold at short notice. They consist primarily of fixed-income securities in the form of borrower’s note loans, registered debentures and mortgage loans. They are carried at amortized cost using the effective interest rate method. The individual receivables are tested for impairment as at the balance sheet date. Unscheduled depreciation is taken if full repayment of the loan or receivable is no longer expected. Reversals are recognized in earnings via the statement of income. The upper limit of the write-up is the amortized cost that would have arisen at the measurement date without impairment.

Financial assets held to maturity are comprised of financial assets that entail fixed or determinable payments and have a defined due date, but which are not loans or receivables. The Group has the intention and ability to hold the securities recognized here until maturity. The procedure for measuring and testing impairment is the same as for the “loans and receivables”.

Financial assets classified as available for sale include fixed-income or variable-yield financial assets that the Group does not immediately intend to sell and that cannot be allocated to any other category. These securities are carried at fair value. Premiums and discounts are spread over the maturity period so as to achieve a constant effective interest rate. Unrealized gains and losses arising out of changes in fair value are recognized via the other income/expenses in equity (other reserves) after allowance for accrued interest, deferred taxes and premiums at life insurers due to policyholders upon realization (provision for deferred premium refunds).

Financial assets at fair value through profit or loss consist of the trading portfolio and those financial assets categorized upon acquisition as measured at fair value through profit or loss. The trading portfolios (financial instruments held for trading) contain all fixed-income and variable-yield securities that the Group acquired for trading purposes and with the aim of generating short-term gains. In addition, all derivative financial instruments with positive fair values including embedded derivatives in hybrid financial instruments that must be separated as well as derivatives connected with insurance contracts that do not satisfy the requirements for recognition as a hedging relationship (hedge accounting as per IAS 39) are carried here. Derivatives with negative fair values are shown under other liabilities. We use derivative financial instruments to a carefully judged extent in order to hedge parts of our portfolio against interest rate and market price risks, optimize returns or realize intentions to buy/sell. Financial assets held for trading are carried at their fair value on the balance sheet date. Financial assets at fair value through profit or loss consist principally of unsecured debt instruments issued by corporate issuers. Structured products are also recognized in this category subject to application of the fair value option provided in IAS 39. Structured financial instruments requiring separation from the host contract – the fair value of which can be reliably established – that would have had to have been broken down into their constituent components (host contract and one or more embedded derivatives) had they been allocated to the loans and receivables, held to maturity or available for sale categories are also recognized here. The Group utilizes the fair value option solely for selected parts of the investment portfolio.

All securities measured at fair value through profit or loss are carried at fair value on the balance sheet date. If market prices are not available as fair values, the carrying values are established using recognized measurement methods. All unrealized gains or losses from this valuation are – in common with the realized gains and losses – recognized in net investment income.

Derivative financial instruments designated as hedging instruments pursuant to IAS 39 (Hedge Accounting) are to be carried at fair value upon initial measurement. The method used to recognize gains and losses upon subsequent valuation is dependent upon the type of hedged risk. The Group designates some derivatives as hedges on the fair value of particular assets (fair value hedges) and others as hedges against specific risks of fluctuating cash flows associated with a liability recognized in the balance sheet or a transaction that is expected and highly likely to materialize in the future (cash flow hedges); further information is provided in item 12 of the Notes “Derivative financial instruments and hedge accounting”. These hedging instruments are carried under other assets or other liabilities.

Establishment of fair values: The fair value of a financial instrument corresponds to the amount that the Group would receive or pay if it were to sell or settle the said financial instrument on the balance sheet date. The fair value of securities is thus determined on the basis of current, publically available, unadjusted market prices. Insofar as market prices are listed on markets for financial instruments, their bid price is used; financial liabilities are measured at the asked price. In the case of securities for which no current market price is available, a valuation price is normally determined using models of financial mathematics on the basis of current and observable market data. Such models are used principally for the measurement of unlisted securities.

The Group uses various valuation models for this purpose, the details of which are provided in the following table:

Financial instrument

Pricing method

Parameter

Pricing model

Fixed-income securities

     

Unlisted plain vanilla bonds

Theoretical price

Interest rate curve

Present-value method

Unlisted structured bonds

Theoretical price

Interest rate curve, volatility surfaces, correlations

Hull-White, Black-Karasinski, LIBOR market model etc.

Unlisted bond funds

Theoretical price

Audited Net Asset Values (NAV)

Net Asset Value method

ABS/MBS for which no market prices are available

Theoretical price

Prepayment speed, incurred losses, default probabilities, recovery rates

Future cash flow method, liquidation method

CDOs/CLOs, profit participation certificates

Theoretical price

Risk premiums, default rates,
recovery rates, redemptions

Present-value method

Equities

     

Unlisted equities

Theoretical price

Acquisition cost, cash flows, EBIT multiples, as applicable book value

Net Asset Value method

Other invested assets

     

Private equity

Theoretical price

Acquisition cost, cash flows, EBIT multiples, market prices

Net Asset Value method

Derivative financial instruments

     

Plain vanilla interest rate swaps

Theoretical price

Interest rate curve

Present-value method

Currency forwards

Theoretical price

Interest-rate curves, spot and
forward rates

Interest parity model

OTC stock options,
OTC stock index options

Theoretical price

Listing of the underlying share, implicit volatilities, money-market interest rate, dividend yield

Black-Scholes

Interest rate futures

Theoretical price

Interest rate curve

Present-value method

Inflation swaps

Theoretical price

Inflation swap rates (Consumer Price Index), historical index fixings, interest rate curve

Present-value method with seasonality adjustment

Insurance derivatives

Theoretical price

Market values of the cat. bonds,
interest rate curve

Present-value method

We have allocated all financial instruments measured at fair value to a level of the fair value hierarchy in accordance with IFRS 7. For further explanation please see our remarks in item 11 of the Notes “Fair value hierarchy”.

The value determined on the basis of valuation models at time of acquisition can, however, diverge from the actual cost of acquisition. The resulting measurement difference constitutes a theoretical “day-one profit/loss”. As at the balance sheet date this produced only an insignificant loss.

Impairment: At each balance sheet date we review our financial assets – with the exception of financial assets at fair value through profit or loss (since impairments are implicitly included in the fair value) – with an eye to objective, substantial indications of impairment. Permanent impairments on all these financial assets are charged to the statement of income. IAS 39.59 contains a list of objective indications for impairment of a financial asset. IAS 39.61 sets out additional requirements with regard to indications of objective evidence for the impairment of equity instruments, according to which impairment exists if there is a significant or prolonged decrease in the fair value below acquisition cost. For the Group, this means that a decrease in the fair value of equity instruments is deemed to be significant if it falls by more than 20% below acquisition cost; a prolonged decrease exists if the fair value falls consistently below cost for a period of at least nine months. In the case of securities denominated in foreign currencies, assessment is made in the functional currency of the entity holding the equity instrument. In principle, we take as a basis for fixed-income securities the same indicators as for equity instruments. Qualitative case-by-case analysis is also carried out. Reference is made, first and foremost, to the rating of the instrument, the rating of the issuer/borrower as well as the individual market assessment in order to establish whether impairment exists. What is more, when instruments measured at amortized cost are tested for impairment, we examine whether material items – looked at on their own – are impaired.

Impairments are taken on the fair value as at the balance sheet date in the event of a prolonged decrease in value – if available, on the publically listed market price. In this context, impairments on investments are recognized directly on the assets side – without using an adjustment account – separately from the relevant items. Reversals on debt instruments are recognized in income up to the level of the amortized costs. In the case of financial assets available for sale, any further amount is recognized directly in equity with no effect on income. Reversals on equity instruments are recognized in equity via the other income/expenses outside the statement of income.

Securities loaned in the context of securities lending continue to be carried in the balance sheet since the material opportunities and risks resulting from such securities remain within the Group.

Other invested assets are recognized for the most part at fair value. Insofar as these financial assets are not listed on public markets (e.g. participating interests in private equity firms), they are carried at the latest available “net asset value” as an approximation of fair value. Loans included in this item are recognized at amortized cost.

Funds held and contracts without sufficient technical risk
Funds held by ceding companies are receivables due under reinsurance provided to our clients in the amount of the cash deposits contractually withheld by such clients; funds held under reinsurance treaties (shown under liabilities) represent the cash deposits furnished to us by our retrocessionaires. Neither of these types of deposit triggers any cash flows and the funds cannot be used without the consent of the other party. Funds held by ceding companies/funds held under reinsurance treaties are recognized at acquisition cost (nominal amount). Appropriate allowance is made for credit risks.

Insurance contracts that satisfy the test of a significant risk transfer to the reinsurer as required by IFRS 4 but fail to meet the risk transfer required by US GAAP are recognized using the “deposit accounting” method and eliminated from the technical account. The compensation elements for risk assumption booked to income under these contracts are shown under other income/expenses. The balances are shown as contract deposits on the assets and liabilities sides of the balance sheet, the fair values of which correspond approximately to their book values.

Investments for the account and risk of holders of life insurance policies
This item consists of policyholders’ investments under unit-linked life insurance policies. The insurance benefits under these insurance contracts are linked to the unit prices of investment funds or a portfolio of separate financial assets. The assets are kept and invested separately from other invested assets. They are recognized at fair value. The unrealized gains or losses are opposed by changes in the technical provisions. Policyholders are entitled to the profits generated; they are likewise liable for the incurred losses.

Reinsurance recoverables on technical provisions
The reinsurers’ portions of the technical provisions are calculated according to the contractual conditions of the underlying reinsurance treaties using a simplified method; the reader is referred to the explanatory notes on the corresponding liabilities-side items. Appropriate allowance is made for credit risks.

Deferred acquisition costs
Acquisition costs which are closely connected with the closing of insurance contracts and variable in relation to the acquired new business are capitalized in accordance with US GAAP as deferred acquisition costs (FASB ASC 944). Deferred acquisition costs are regularly tested for impairment using an adequacy test. The actuarial bases are also subject to ongoing review and adjustment as necessary.

In the case of property/casualty insurance companies and non-life reinsurance, acquisition costs are normally deferred pro rata for the unearned portion of the premiums. They are amortized at a constant rate over the average contract period. In the case of life insurers and in life/health reinsurance, the deferred acquisition costs are determined in light of the period of the contracts, the expected surrenders, the lapse expectancies and the anticipated interest income. The amount of amortization depends on the gross margins of the contracts calculated for the corresponding year of the contract period. Depending on the type of contract, amortization is taken either in proportion to the premium income or in proportion to the expected profit margins.

In the case of life reinsurance treaties classified as “universal life-type contracts”, the deferred acquisition costs are amortized on the basis of the expected profit margins from the reinsurance treaties, making allowance for the period of the insurance contracts. A discount rate based on the interest rate for medium-term government bonds was applied to such contracts. In the case of annuity policies with a single premium payment, these values refer to the expected policy period or period of annuity payment.

Deferred tax assets
IAS 12 “Income Taxes” requires that assets-side deferred taxes be established if asset items are to be recognized in a lower amount or debit items in a higher amount in the consolidated balance sheet than in the tax balance sheet of the relevant Group company and if these differences will lead to reduced tax burdens in the future. In principle, such valuation differences may arise between the tax balance sheets drawn up in accordance with national standards and the IFRS balance sheets of the companies included in the consolidated financial statement drawn up in accordance with uniform group standards. Deferred tax assets are also recognized for tax credits and on tax loss carry-forwards. The assessment as to whether deferred tax claims from tax loss carry-forwards can be used, i.e. are not impaired, is guided by the results planning of the company and concretely realizable tax strategies. Value adjustments are taken on impaired deferred tax assets.

Insofar as deferred taxes refer to items carried directly in shareholders’ equity via the other income/expenses, the resulting deferred taxes are also recognized outside the statement of income.

Deferred taxes are based on the current country-specific tax rates. In the event of a change in the tax rates on which the calculation of the deferred taxes is based, appropriate allowance is made in the year in which the change in the tax rate is adopted in law. Deferred taxes at the Group level are booked using the Group tax rate of 31.6%, unless they can be allocated to specific companies.

Other assets
Other assets are carried at amortized cost. Derivatives recognized as hedging instruments in the context of hedge accounting which show a positive fair value are carried at fair value. Property, plant and equipment are recognized at acquisition or manufacturing costs less straight-line depreciation. The useful life for own-use real estate is at most 50 years; the useful life for fixtures and fittings is normally between 2 and 10 years. Impairment expenses are spread across the technical functional areas or recognized under other income/expenses.

Disposal groups pursuant to IFRS 5
Long-lived assets held for sale (or groups of assets and liabilities held for sale) are classified as held for sale pursuant to IFRS 5 if their carrying amount is realized largely through sale rather than through continued operational use. Sale must be highly probable. The assets or disposal group held for sale are measured at the lower of carrying amount and fair value less costs to sell and recognized separately in the balance sheet as assets or liabilities. Scheduled depreciation is recognized until the date of classification as held for sale. Impairment losses on fair value less costs to sell are recognized in profit or loss; any subsequent increase in fair value less costs to sell leads to the realization of gains up to the amount of the cumulative impairment loss. If the impairment loss to be taken on a disposal group exceeds the carrying amount of the corresponding non-current assets, the need to establish a provision within the meaning of IAS 37 “Provisions, Contingent Liabilities and Contingent Assets” is examined. More detailed information on the non-current assets held for sale and disposal groups is contained in the subsection of the same name.

Liabilities

Shareholders’ equity
The common shares, reserves (additional paid-in capital, retained earnings) and cumulative other comprehensive income are recognized in equity. The common shares and additional paid-in capital are comprised of the amounts paid in by the shareholder of Talanx AG on its shares. The retained earnings consist of profits generated and reinvested by Group companies and special investment funds since they have belonged to the Group as well as income and expenses from changes in the consolidated group. In addition, in the event of a retrospective change of accounting policies, the adjustment for previous periods not included in the financial statement is recognized in the opening balance sheet value of the retained earnings and comparable items of the earliest reported period. Unrealized gains and losses from changes in the fair value of financial assets held as available for sale are carried in cumulative other comprehensive income; translation differences resulting from the currency translation of foreign subsidiaries as well as unrealized gains/losses from the valuation of associated companies at equity are also recognized under the other reserves. In addition, write-ups on available-for-sale variable-yield securities are recognized under this item of shareholders’ equity. In the year under review various derivatives were used as hedging instruments in the context of cash flow hedges. The fluctuations in value are recognized in a separate reserve item in equity.

Minority interests are shown in the consolidated statement of income following the net income. Minority interests in shareholders’ equity are consequently recognized as a component of shareholders’ equity. They refer to the shares held by companies outside the Group in the shareholders’ equity of subsidiaries.

Technical provisions (gross)
The technical provisions are shown for gross account in the balance sheet, i.e. before deduction of the portion attributable to reinsurers; the reader is referred here to the explanatory notes on the corresponding asset items. The reinsurers’ portions of the technical provisions are calculated and recognized on the basis of the individual reinsurance treaties.

Unearned premiums correspond to already collected premiums that are apportionable to future risk periods. These premiums are normally deferred by specific dates for insurance contracts (predominantly in primary insurance); in reinsurance business global methods are sometimes used if the accounting data required from prior insurers for a calculation pro rata temporis is unavailable.

Benefit reserves are calculated and recognized in life insurance business using actuarial methods for commitments arising out of guaranteed claims of policyholders in life insurance and of ceding companies in life/health reinsurance. They are calculated as the difference between the present value of future expected payments to policyholders/cedants and the present value of future expected net premium still to be collected from policyholders/cedants. The calculation includes assumptions relating to mortality, morbidity, lapse rates and the future interest rate development. The actuarial bases used in this context allow an adequate safety margin for the risks of change, error and random fluctuation.

In the case of life insurance contracts without a surplus participation, the method draws on assumptions as to the best estimate of investment income, life expectancy and morbidity risk, allowing for a risk margin. These assumptions are based on customer and industry data. In the case of life insurance contracts with a surplus participation, reference is made to assumptions that are contractually guaranteed or used to establish the surplus participation.

Life insurance products must be divided into the following categories pursuant to FASB Accounting Standards Codification (ASC) 944–40 for the measurement of the benefit reserve:

In the case of life insurance contracts with a “natural” surplus distribution (previously included in FAS 120 in conjunction with SOP 95-1 (Statement of Principles)), the benefit reserve is composed of the net level premium reserve and a reserve for maturity bonuses. The net level premium reserve is arrived at from the present value of future insurance benefits (including earned bonuses, but excluding loss adjustment expenses) less the present value of the future premium reserve. The net level premium reserve is calculated as the net premium less the portion of premium earmarked to cover loss adjustment expenses. The reserve for maturity bonuses is generally constituted from a fixed portion of the gross profit generated in the financial year from the insurance portfolio.

For contracts in life insurance with no surplus distribution (previously included in FAS 60), the benefit reserve is calculated as the difference between the present value of future benefits and the present value of the future net level premium reserve. The net level premium reserve corresponds to the portion of the gross premium used to fund future insurance benefits.

In the case of primary life insurance contracts classified according to the “universal life” model, unit-linked life insurances or similar life/health reinsurance treaties (previously included in FAS 97), a separate account is kept to which the premium payments less costs and plus interest are credited. We recognize the benefit reserve in the area of life insurance insofar as the investment risk is borne by policyholders separately in liabilities item D.

The loss and loss adjustment expense reserves are constituted for payment obligations from insurance claims that have occurred but have not yet been settled. They relate to payment obligations under insurance and reinsurance contracts in respect of which the amount of the insurance benefit or the due date of payment is still uncertain. Insofar they are based on estimates that may vary from the actual payment. The loss and loss adjustment expense reserves are subdivided into reserves for claims reported by the balance sheet date and reserves for claims that have already been incurred but not yet reported (IBNR) by the balance sheet date.

Reserves for claims reported by the balance sheet date are based on recognized actuarial methods used to estimate future claims expenditure including expenses associated with loss adjustment. They are recognized according to best estimate principles in the amount that will probably be utilized. In order to measure the “ultimate liability” the expected ultimate loss ratios are calculated for all lines of non-life reinsurance with the aid of actuarial methods such as the chain ladder method. The development of a claim until completion of the run-off is projected on the basis of statistical triangles. In this context it is assumed that the future rate of inflation of the loss run-off will be analogous to the average rate of the past inflation contained in the data. The more recent underwriting years in actuarial projections are subject to greater uncertainty, although this is reduced with the aid of a variety of additional information. Particularly in reinsurance business, a considerable period of time may elapse between the occurrence of an insured loss, notification by the insurer and pro-rata payment of the loss by the reinsurer. The realistically estimated future settlement amount (“best estimate”), calculated in principle on the basis of the information provided by ceding companies, is therefore brought to account. This estimate draws on past experience and assumptions as to the future development, taking account of market information. The amount of the reserves and their allocation to occurrence years are determined using established forecasting methods of non-life actuarial science.

Reserves for claims that have occurred but not yet been notified by the balance sheet date are constituted in the same way as reserves for claims that have already occurred. The Group draws here on empirical values adjusted according to current trends and other relevant factors. These reserves are constituted using actuarial and statistical models of the expected costs for final settlement and handling of claims. The analyses are based upon currently known facts and circumstances, projections of future events, estimates of the future inflationary trend as well as other social and economic factors. The latest trends observed in claim notifications, the extent of losses and increases in risk are also considered.

Sufficient statistical data is not available for major losses. In these instances appropriate reserves are established after analysis of the portfolio exposed to such risks and, as appropriate, after individual scrutiny. These reserves represent the best estimates of the Group.

With the exception of a few reserves, the loss and loss adjustment expense reserves are not discounted.

The provision for premium refunds is constituted in life insurance for obligations regarding the surplus participation of policyholders that have not yet been definitively allocated to individual insurance contracts on the balance sheet date. It consists of amounts allocated to policyholders in accordance with national regulations or contractual provisions and amounts resulting from temporary differences between the IFRS consolidated financial statement and the local annual financial statements (provision for deferred premium refunds, shadow provision for premium refunds) that will have a bearing on future calculations of the surplus distribution.

We regularly subject all technical provisions to an adequacy test in accordance with IFRS 4. If current experience indicates that future income will not cover the expected expenses, the technical provisions are adjusted in income or an additional provision for anticipated losses is established after writing off the deferred acquisition costs. We review the adequacy of the benefit reserve on the basis of current assumptions as to the actuarial bases.

Shadow Accounting
IFRS 4.30 allows unrealized, but recognized profits and losses (these derive predominantly from changes in the fair value of assets classified as “available for sale”) reported in equity (Other Comprehensive Income, OCI) to be included in the measurement of technical items. This may affect the following items: deferred acquisition costs, present values of future profits (PVFPs), provisions for maturity bonuses of policyholders, provisions for deferred costs and the provision for premium refunds. The aforementioned assets and liabilities items and their corresponding amortization schemes are determined on the basis of the estimated gross margins (EGMs). The latter are modified accordingly following subsequent recognition of unrealized gains and losses. The resulting adjustments are carried as so-called “shadow adjustments” to the affected items. The contra item in equity (OCI) is reported analogously to the underlying changes in value.

Technical provisions in the area of life insurance insofar as the investment risk is borne by policyholders
In the case of life insurance products under which policyholders carry the investment risk themselves (e.g. in unit-linked life insurance), the benefit reserves and other technical provisions reflect the fair value of the corresponding investments; these provisions are recognized separately. We would refer the reader to the explanatory notes on the assets-side item “Investments for the account and risk of holders of life insurance policies”.

Other provisions
This item includes inter alia the provisions for pensions and other post-employment benefit obligations. The Group companies normally grant their employees pension commitments based on defined contributions or defined benefits. The type and amount of the commitments depends on the pension plans in force at the time when the commitment was given. They are based principally on an employee’s length of service and salary level.

In addition, since the mid-1990s various German companies have offered the opportunity to obtain pension commitments through deferred compensation. The employee-funded commitments included in the provisions for accrued pension rights are protected by insurance contracts with HDI-Gerling Lebensversicherung AG, Cologne, and Neue Leben Lebensversicherung AG, Hamburg. Furthermore, Group employees have the opportunity to accumulate additional old-age provision by way of deferred compensation through contributions to special insurance companies known as “Pensionskassen”. The benefits are guaranteed for their members and surviving dependants and comprise traditional pension plans with bonus increases as well as unit-linked hybrid annuities. In addition to these pension plans, executive staff and Board members, in particular, enjoy individual commitments as well as commitments given under the benefits plan of the Bochumer Verband. Additional similar obligations based upon length of service exist at some Group companies.

In the case of pensions commitments based on defined contributions the companies pay a fixed amount to an insurer or pension fund. The commitment given by the company is finally discharged upon payment of the contribution. Under pension commitments based on defined benefits the employee receives a specific pension commitment from the company or a pension fund. The contributions payable by the company to fund the commitment are not fixed in advance.

If the pension commitments are balanced against assets of a legally independent entity (e.g. a fund) that may be used solely to cover the pension assurances given and cannot be seized by any creditors, the pension commitments are to be recognized less the assets.

Pension commitments under defined benefit plans are measured in accordance with IAS 19 “Employee Benefits” using the projected unit credit method. Not only are the benefit entitlements and current annuities existing as at the balance sheet date measured, but allowance is also made for their future development. The interest rate used for discounting the pension commitments is based upon the rates applicable to first-rate fixed-income corporate bonds in accordance with the currency and duration of the pension commitments.

The amounts payable under defined contribution plans are expensed when they become due.

Actuarial gains or losses from pension commitments and plan assets derive from divergences between the estimated risk experience and the actual risk experience (irregularities in the risk experience, effects of changes in the calculation parameters and unexpected gains or losses on plan assets). The Group uses the “corridor method” defined in IAS 19 to recognize its actuarial gains and losses. Under the corridor method, a portion of the actuarial gains and losses is recognized in profit or loss to the extent that the hitherto unrecognized actuarial gains or losses at the beginning of the financial year exceed the higher of the following amounts: 10% of the present value of the earned pension entitlements or 10% of the fair value of any plan assets. The amount outside the corridor – divided by the expected average remaining working lives of the beneficiaries – is included as income or expense in the statement of income.

Sundry provisions are established on the basis of best estimates in the amount that is likely to be used. The provisions are discounted if the interest rate effect is of material significance. The carrying amount of the provisions is reviewed as at each balance sheet date. Provisions in foreign currencies are translated at the exchange rate on the balance sheet date.

Liabilities and subordinated liabilities
Financial liabilities including subordinated liabilities, insofar as they do not involve funds held under reinsurance treaties or liabilities from derivatives, are reported at amortized costs. Subordinated liabilities are financial obligations that can only be satisfied after the claims of other creditors in the event of liquidation or bankruptcy. Funds held under reinsurance treaties are measured at nominal value and liabilities from derivatives are recognized at fair value (on the valuation models used within the Group to establish fair values see the subsection “Investments including income and expenses”). In addition, derivatives used as hedging instruments in the context of hedge accounting are shown under the “Other liabilities”; further explanatory information in this regard is provided in item 12 of the Notes “Derivative financial instruments and hedge accounting”.

Deferred tax liabilities
Deferred tax liabilities must be recognized in accordance with IAS 12 “Income Taxes” if assets are to be recognized in a higher amount or liabilities in a lower amount in the consolidated balance sheet than in the tax balance sheet of the group company in question and if this – as a temporary difference – will lead to additional tax loads in the future; cf. the explanatory notes on deferred tax assets.