Consolidation of special purpose entities

With regard to the consolidation of special purpose entities, the Group makes a distinction below between the areas of investments (excluding special and public funds), securitization of reinsurance risks and Insurance-Linked Securities (ILS). Such special purpose entities are to be examined in accordance with SIC-12 “Consolidation – Special Purpose Entities” with an eye to their consolidation requirement. In cases where IFRS do not currently contain any specific standards, our analysis also falls back – in application of IAS 8 – on the relevant standards of US GAAP.

Investments

Within the scope of its asset management activities our subsidiary Hannover Re, Hannover, has participated since 1988 in numerous special purpose entities – predominantly funds –, which for their part transact certain types of equity and debt capital investments. On the basis of our analysis of the relations with these entities we concluded that the Group does not exercise a controlling influence in any of these transactions and a consolidation requirement therefore does not exist.

Hannover Re participates – primarily through the companies Secquaero ILS Fund Ltd., Grand Cayman/Cayman Islands, and Hannover Insurance-Linked Securities GmbH & Co. KG, Hannover, – in a number of special purpose entities for the securitization of catastrophe risks by investing in disaster bonds (or “cat bonds”). Since Hannover Re does not exercise a controlling influence in any of these transactions either there is no consolidation requirement

Securitization of reinsurance risks

The securitization of reinsurance risks is largely structured through the use of special purpose entities.

In July 2009 Hannover Re issued a catastrophe (“cat”) bond with the aim of transferring to the capital market peak natural catastrophe exposures deriving from European windstorm events. The term of the cat bond, which has a volume of nominally EUR 150 million, runs until 31 March 2012; it was placed with institutional investors from Europe and North America by Eurus II Ltd., a special purpose entity domiciled in the Cayman Islands. Hannover Re does not exercise a controlling influence over the special purpose entity. Under IFRS this transaction is to be recognized as a financial instrument.

Effective 1 January 2009 Hannover Re raised further underwriting capacity for catastrophe risks on the capital market by way of the “K6” transaction. This securitization, which was placed with institutional investors in North America, Europe and Asia, involves a quota share cession on worldwide natural catastrophe business as well as aviation and marine risks. The volume of “K6”, which was increased in the year under review, was equivalent to EUR 249 (123) million as at the balance sheet date. The planned term of the transaction runs until 31 December 2011 or in the case of the new shares placed in the year under review until 31 December 2012. Kaith Re Ltd., a special purpose entity domiciled in Bermuda, is being used for the securitization.

Hannover Re also uses the special purpose entity Kaith Re Ltd. for various retrocessions of its traditional covers to institutional investors. In accordance with SIC-12 Kaith Re Ltd. is included in the consolidated financial statement.

Effective 26 April 2010 Hannover Re made use of its right of early cancellation and terminated the credit default swap underlying the “Merlin” transaction. Since 2007 Hannover Re had used this transaction to transfer risks from reinsurance recoverables to the capital market. The securities serving as collateral were issued through the special purpose entity Merlin CDO I B.V., over which Hannover Re did not exercise a controlling influence.

Insurance-Linked Securities (ILS)

In the course of 2010, as part of its extended Insurance-Linked Securities (ILS) activities, Hannover Re wrote a number of so-called collateralized fronting arrangements under which risks assumed from ceding companies were passed on to institutional investors outside the Group using special purpose entities. The purpose of such transactions is to directly transfer clients’ business. Due to the lack of a controlling influence over the special purpose entities involved, there is no consolidation requirement for Hannover Re with respect to these structures.

The largest single transaction in this connection is “FacPool Re”, under which Hannover Re has transferred a portfolio of facultative reinsurance risks to the capital market since September 2009. The contracts, which cover worldwide individual risks, are mediated by an external reinsurance intermediary, written by Hannover Re and placed on the capital market in conjunction with a service provider. The “FacPool Re” transaction consists of a quota share reinsurance arrangement and two non-proportional cessions. The total amount of capital provided is equivalent to EUR 45 (42) million, with Hannover Re keeping a share of approximately EUR 4 (4) million and additionally assuming losses that exceed the capacity of “FacPool Re”. The term of the transaction is roughly two and a half years. A number of special purpose entities participate in the reinsurance cessions within “FacPool Re”; Hannover Re does not hold any shares in these special purpose entities and does not bear the majority of the economic benefits or risks arising out of their activities through any of its business relations.