Derivative financial instruments and hedge accounting

Hedge accounting

In the context of hedge accounting the Group seeks to compensate for the changes in value/changes in cash flows of an underlying caused by changes in market price by taking out a hedging instrument (derivative), the changes in value or changes in cash flows of which develop along approximately opposite lines. Hedging is carried out on the level of individual transactions (micro hedge). On closing of the transaction we document the hedge relationship between the underlying and the hedging instrument, the purpose of risk management and the underlying hedging strategy. In addition, at the outset of the hedge relationship we document our assessment of the extent to which the hedging instruments are effective in offsetting the corresponding changes of the underlying. Proof of the effectiveness of the hedge relationships has been furnished.

Fair value hedges

In order to hedge changes in the fair value of equities (underlyings), the Group designated equity swaps as hedging derivatives in 2010. Under these fair value hedges, the changes in the fair value of the derivative are recognized with the changes in the fair value of the underlying allocable to the hedged risk in the investment income. In the year under review losses of –EUR 1 million from the underlying transactions and gains of EUR 1 million from the hedging derivatives were recognized in income for the fair value hedges. There was no ineffectiveness in the case of these hedges.

Cash flow hedges

The Group uses interest rate swaps in the context of cash flow hedges in order to hedge cash flows relating to certain floating-rate commitments (underlyings) against the associated interest rate risk. The plain vanilla interest rate swaps serve to protect against adverse effects in the net profit or loss for the period in the event of rising interest rates. The interest payments received from the swaps (floating rates) are opposed by interest payments in the same amount in connection with the liabilities; in addition, the Group undertakes to make fixed interest payments to the swap partners. The selection of highly rated counterparties ensures that we avoid entering into a significant credit risk. The floating rate varies according to the 3-month EURIBOR. In addition, in 2010 the Group hedged future transactions that are very likely to occur against the interest rate risk. In this connection valuation units are established consisting of forward transactions in securities (forward purchases) and planned securities purchases. The forward purchases are used to hedge the risk associated with already firm future reinvestments that it may only be possible in future to generate low returns on reinvestments due to falling interest rates. The underlying in relation to the hedging instruments is the future investment at the then applicable returns/rates. IAS 39 only permits the hedging of planned transactions to be captured as cash flow hedges.

The effective part of the hedging instruments measured at fair value is recognized directly in equity in the cash flow hedge reserve after allowance for deferred taxes. The ineffective part of such changes in value, on the other hand, is booked directly in the statement of income in the investment income – in the case of effective hedging of floating-rate liabilities in other income/expenses. The underlying continues to be measured at amortized cost in accordance with allocation to the category pursuant to IAS 39. If the hedged transactions result in the recognition of financial assets, the amounts carried in shareholders’ equity are amortized over the maturity period of the acquired asset.

The following table presents a reconciliation of the cash flow hedge reserve (before taxes):

Changes in the cash flow hedge reserve

2010

2009

Figures in EUR million

   

Balance at 31.12. of the previous year

–33

–26

Allocations (hedging of cash flows from floating interest rates)

7

–7

Reductions (hedging of planned transactions)

–110

Balance at 31.12. of the year under review (before taxes)

–136

–33

The negative balance of the cash flow hedge reserve increased in the year under review by –EUR 103 (–7) million (before taxes) and –EUR 100 (–5) million (after taxes).

An amount of EUR 1.2 (0.2) million was recognized in income in the year under review owing to the ineffectiveness of cash flow hedges.

The expected cash flows from the cash flow hedges and their respective contribution to profit or loss are as follows:

Cash flows of the hedged transaction

< 1 year

> 1 year and
< 5 years

Expected total amount

31.12.2010 1)

31.12.2009 1)

Figures in EUR million

         

Cash flow of the underlyings

–10

–903

–913

–5

–10

Cash flow of the hedging instruments

–16

–9

–25

–21

–16

Profit/loss

–26

–15

–41

–26

–26


1) Cash flow of the period in question

Fair values of the hedging instruments

The fair values of the derivative financial instruments designated in the context of hedge accounting were as follows as at the balance sheet date:

Hedging instruments

2010

2009

Figures in EUR million

   

Fair value hedges

   

Equity swaps

–6

Cash flow hedges

   

Interest rate swaps

–33

–42

Forward securities transactions

–110

Total

–149

–42

The net gains or losses on derivatives used for hedging carried in the statement of income amounted to –EUR 22 (–16) million in the year under review and relate chiefly to current interest payments (–EUR 21 (–16) million), changes in value recognized in income on grounds of ineffectiveness (EUR 1.2 (0.2) million), EUR 1 million from hedging derivatives in connection with fair value hedges and –EUR 3 million from other payments.