Hannover Rueck SE
XETRA:HNR1
Earnings Call Analysis
Q3-2023 Analysis
Hannover Rueck SE
Throughout the earnings call, the company emphasized its robust performance marked by improved profitability across its business groups. Revenue in reinsurance has remained stable, and the company has managed to grow its financial solutions business despite the deliberate and conservative actions taken in the U.S. mortality and morbidity segments. The reinsurance service result was particularly strong, benefitting from positive one-off events, and the overall earnings before interest and taxes (EBIT) included positive extraordinary items. Despite this strength, executives maintained a cautiously optimistic tone, preferring not to adjust full-year guidance due to the inherently long-term and volatile nature of the Life & Health business which could potentially introduce variability in quarterly results.
The company's investment strategy proved to be effective this period. There was an increase in ordinary investment income due to the higher interest rate environment, although the company noted that they expect some impairment on the valuations of direct real estate assets in the fourth quarter. Nonetheless, they are confident that any impact would be within the buffer included in their guidance. The return on investments (ROI) for the nine months was strong at 3%, and the company expressed comfort in the likelihood of exceeding their full-year ROI guidance.
Despite a conservative approach to annual assumptions and some expected quarter-to-quarter volatility, executives indicated that they are in a comfortable position to exceed their full-year guidance. The call highlighted that assumption checkups, which are conducted regularly each year in the third and fourth quarter, have been positive in total for the year, thus improving their confidence in meeting or surpassing targets.
The call touched upon the future of dividend payouts, outlining that the ordinary dividend should at least be in line with the previous year, with room for growth correlating to earnings. The executives voiced confidence regarding their capitalization, suggesting the potential for an attractive dividend, including a special dividend, based on capitalization and capital deployment post-January renewals. The company's performance so far supports the anticipation of increased dividends, in accordance with their growth-oriented dividend strategy and one of the main objectives for the ensuing years.
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Ladies and gentlemen, thank you for standing by. I welcome you to today's Hannover Rück conference call on the Q3 2023 results. For your information, this conference is being recorded. [Operator Instructions]. At this time, I would like to hand the call over to your host today, Karl Steinle, please go ahead, sir.
Well, good morning, everyone, and welcome to our earnings call and webcast to our financial results for the first 9 months 2023. Today's speakers will be Jean-Jacques Henchoz, our CEO; and Clemens Jungsthofel, Hannover SE's CFO. And after the Q&A session or during the Q&A session, we will be joined by Klaus Miller and [indiscernible].And with that, I hand over to you, Jean-Jacques.
Well, thank you very much, Carl, and good morning, everyone. I'm pleased today to present very favorable results for the first 9 months of 2023. The business development of Hannover Rück overall and within our business groups has been well in line with our expectations. Hence, the group net income of EUR 1.4 billion and the return on equity of 20% reflects a healthy level of profitability and bring us in a very comfortable position to achieve or even exceed our full year guidance. Compared to previous years, our top line growth in P&C is a bit more moderate. This reflects our active cycle management with a clear focus on improving the quality of our portfolio. The success of our approach in the 2023 renewals is well reflected in the 55% combined increase in new business CSM and loss component. The impact from large losses remained below the budget for the first 9 months of the year, even though the frequency of large losses has picked up notably in the third quarter. As always, we have nevertheless booked the full budget year-to-date. The EBIT of EUR 1.1 billion and the combined ratio of around 91.9% are based on a healthy underlying profitability, but include a material increase in reserve resiliency in line with our planning for the full year. The operating performance in Life & Health continued to be strong. The underwriting performance was favorable compared to expectations with particularly strong contributions from financial solutions and our mortality business. Additionally, the EBIT of EUR 730 million is better than initially expected and was supported by some one-offs, including a positive derivative valuation of around EUR 60 million. Reinsurance revenue was stable, mainly reflecting volume effects connected to in-force management actions in our U.S. mortality business and limited appetite for morbidity business. The return on investment of 3% is very satisfactory, strong ordinary income is mainly driven by the combination of higher interest rates and the strong operating cash flow. The contribution from inflation-linked bonds was another positive factor even though this contribution declined as expected compared to the previous year. Finally, our capitalization remains very strong with the solvency ratio standing at 270% at the end of the third quarter. Overall, the shareholders' equity increased by 5.7%, mainly driven by the group net income for the period. The impact from increasing interest rates is moderate due to the more economic view of IFRS 17 and our strict asset liability management. Looking at the details, the overall impact from market movements on the valuation of our investments is somewhat higher than on reinsurance liabilities. The CSM increased by 26%, driven by the new business value generated in both Life & Health and P&C. Additionally, updated assumptions had a positive impact in Life & Health. The risk adjustment decreased by 4.6%, mainly driven by changes in estimates in Life & Health reinsurance. So considering all 3 balancesheet items together, it becomes clear that we have been successful in creating significant value for our shareholders up to the end of the third quarter. On that note, I'd like to hand over to Clemens for a more detailed review of the financials.
Thank you, Jean-Jacques, and good morning, everyone. So let me start on Slide 6 with P&C reinsurance. With an FX adjusted growth of 5.5%, P&C reinsurance revenue is in line with our full year expectation. As Jean-Jacques mentioned, our portfolio management with a shift towards nonproportional business and some portfolio pruning for larger proportional treaties in the 2023 renewals did have an impact on the top line development. This is getting more visible now in Q3 as the weight of business earned from the underwriting year 2023 is increasing in the reinsurance revenue. On top of that, currency effects had a particularly strong negative impact in the third quarter on the revenue. So the material increase in expected profitability in 2023, renewals is reflected well in the new business CSM, increasing significantly to EUR 2.2 billion. At the same time, the new business loss component has decreased sharply given the current pricing environment and higher interest rates in addition to that. Large losses totaled to EUR 1.2 billion. That's EUR 124 million below our budget. As usual, we have reserved the full budget and COVID-related claims from our Accident & Health business in Northeast Asia amounted to around EUR 85 million, so decreasing significantly compared to last year as expected. On discounting, so the positive impact of discounting on the combined ratio is 5.6 percentage points. So this is around EUR 140 million higher than the impact on the reinsurance finance result, in line with what we've done in the first half year. We have kept this temporary tailwind in the reserves for now. Furthermore, the overall favorable profitability enabled us to take a further step in increasing the resiliency of our reserves. Nevertheless, we have seen a very positive runoff result of EUR 487 million in the first 9 months. Adding up all effects, the combined ratio stands at 91.9%, well within our target range. The difference to an underlying target of around 88 to 89 is connected to really additional reserve resiliency. And on top of this, just as a reminder, we are carrying now more than EUR 800 million of risk adjustment in P&C, which can really be seen as an additional level of prudency in our reserving. This number has actually increased by more than EUR 100 million year-to-date. On investments, P&C, the strong investment result primarily stems from the increased ordinary income from fixed income. The increase is mainly driven by higher interest rates supported by a very strong operating cash flow. Last but not least, the amortization of our inflation-linked bonds added EUR 109 million, in line with our expectations. Other results contains the currency results as well as other income and expenses. The latter amounted to around EUR 240 million. This number mainly includes nondirectly attributable expenses and is, I would say, at the normal level. Currency result was slightly negative compared to a positive contribution in the previous year. Altogether, the EBIT of EUR 1.1 billion is in line with our expectation as well as our target for an increase in reserve resiliency. Moving on to Slide 7. So you can see here the main contributors to the reinsurance result, which is, of course, the regular CSM release of EUR 989 million. Compared to the first 2 quarters, the release has been rather low in the third quarter. This is mainly connected to an exposure-based high release of ceded CSM in the third quarter. Our rerecession also had an impact on the experience variance. As you know, we have bought material retro protection in 2023. And looking at the actual losses, we have seen a rather high level of nat cat losses in nonpeak areas, which have resulted in a below-average relief from our retro protection. Combining both effects, the ceded result was significantly higher than expected. Furthermore, reserving the difference between actual and budgeted large losses does not assume any benefit from retrocession either. And altogether, the experience variance is therefore a negative EUR 553 million. The runoff result of EUR 487 million reflects a very positive experience variance and includes EUR 134 million release of risk adjustment within the LIC, so the liability for incurred claims. Finally, the new business loss component was rather small at EUR 39 million. So looking at the CSM development over the year, the new business significantly increases the CSM, as you can see, due to the high share of business being renewed in the first half of the year, the new business, CSM, follows seasonality. I already mentioned why the CSM release was relatively low in the third quarter. With regards to change in estimates, so we have a compensating positive effect from updated assumptions to a more stable retro protection in Q3. So retrocession has led to some volatility in individual IFRS 17 items on a quarterly basis. However, the year-to-date view is well in line with our expectations. Slide 8. So even though the Atlantic hurricane season has been benign so far, we have seen a significant impact of large losses in Q3, particularly driven by high frequency of Nat Cat events in many regions, but with most significant impact on Europe. Still, the net impact from Nat Cat is within our budget on a 9-month basis, largely driven by a high number of property losses. The 9 months budget for man-made losses has been exceeded. Overall, the fact that we have not yet released reserves in response to the underutilization of the budget means that we have EUR 521 million budget available to cover large losses in the fourth quarter. So let's move on to Life & Health on the next slide, Slide 10. Reinsurance revenue is rather stable at 1.3% adjusted for FX. Growth is mainly impacted, as Jean-Jacques already mentioned by in-force management actions in U.S. mortality and morbidity. On the other hand, we have successfully grown our financial solutions business. The reinsurance service result of EUR 730 million is very strong and includes a positive one-off of EUR 30 million from the recapture of a retrocession treaty. Otherwise, the increase is mainly driven by mortality and the contribution from financial solutions and longevity remained at very favorable levels. The reinsurance finance result is minus EUR 130 million, slightly higher than initially expected, mainly due to higher interest rates. The ordinary investment income increased driven by higher interest rates in addition, the fair value of financial instruments in Life & Health was a positive EUR 60 million due to valuation effects on derivatives. Nevertheless, the overall investment result is lower than in the previous year, where we -- you might recall that had recorded a significant positive impact from our pandemic retro cap. Other income and expenses amounted to minus EUR 137 million, and currency effects were slightly positive at EUR 5 million. Altogether, the EBIT includes some positive extraordinary items, but is based on very healthy underlying profitability. In relation to our expectation for the full year, the 9 months performance looks very strong, but the long-term nature of Life & Health business and a relatively high share of business, which will run through a review of assumptions in Q4 can create some quarterly volatility just as a reminder. So even though we are very confident to exceed our target in Life and Health, we prefer to remain somewhat cautious in our guidance. On the next slide, the IFRS 70 components in Life & Health, the CSM release of EUR 654 million includes a positive one-off, as mentioned in the amount of EUR 30 million. Moreover, the revised assumptions regarding U.K. longevity, which have included the total CSM on the right-hand side of this slide, have also contributed to the CSM release in the current period, or I buy to, of course, a modest degree. Overall, the annualized release is within the 12% to 14% range we have indicated for the year. The risk adjustment release of EUR 194 million was above our expectation. It does include extraordinary releases from our U.S. business. The loss component is mainly driven by changes in estimates for morbidity and not by new business. So the CSM, as you can see, has increased by almost 10% over the course of 2023. The contribution from new business and extensions of existing business, add up to favorable EUR 572 million, the change in estimates is another positive EUR 517 million, mainly driven by updated assumptions in longevity and to a smaller extent in Financial Solutions. Again, please bear in mind that this item can be volatile on a quarterly basis due to the long-term nature of Life & Health business. So more over the accounting impact from assumption changes can be azemetric under IFRS 17. Some changes are only affecting the CSM, whereas others can result in a loss component and therefore, directly -- are directly being recorded in the P&L, which is not the case, as you know, for the CSM. So from an economic perspective, one should not put these changes in different buckets, economically. So assumption changes in this year were clearly positive in total. Hence, the CSM increased favorably reflecting the value we have created in our Life & Health business. On the next slide, performance of our investments. I think it's fair to say it was very satisfactory. The ordinary investment income increased, thanks to higher interest rate environment and positive operating cash flow. As expected, the contribution from inflation-linked bonds within the ordinary income decreased compared to the previous year, but still supported the result was EUR 109 million. Otherwise, the investment income is presently unremarkable in particularly in terms of expected credit loss, so impairments as well as real estate and private equity funds at fair value through P&L.As you know, we have included some allowance for negative effects in our guidance in this regard, and we do expect to see some impact from decreasing valuations of direct real estate assets in the fourth quarter. But the impact should be well in the buffer included in our guidance. Altogether, the 9 months ROI is a strong 3%, and we are in a comfortable position to exceed our full year guidance. To conclude my remarks, the business performance for the 9 months supports us in reaching or exceeding our group net income target of EUR 1.7 billion, depending on the development in the fourth quarter and might even provide some flexibility to further strengthen the balance sheet at year-end. On that note, I'll hand back to you, Jean-Jacques, for the comments on the outlook.
Thank you, Clemens. And as reiterated by Clemens, we feel very comfortable to confirm our full year targets based on this business performance for the first 9 months of the year. As explained earlier, reinsurance revenue growth will not be at the level of previous years, but this does not worry us at all because it reflects our deliberate underwriting decisions in 2023. The significant expansion of margins will also provide us with a strong earnings base for the next year and a very positive outlook as we go into the renewals for January 2024. After 9 months, we're well above our initial guidance for the ROI as stated by Clemens. But as mentioned, the 2.4% target includes some assumptions for decreasing valuations, particularly for private equity and commercial real estate. As Clemens already explained, we have not yet seen any material movements in our portfolio, but do expect some impact, mainly again on real estate in the fourth quarter. Still, we hope to have some upside to our investment performance compared to our initial target and altogether, the 9 months result leaves us with more upside than downside risk to our guidance, which might provide some flexibility to further strengthen the balance sheet at the end of the year while meeting or exceeding our guidance. As always, at this stage of the year, it is premature to be specific on the dividend decision to be made in the new year. But according to our dividend strategy, the ordinary dividend should not only be at least at the level of the previous year, but also grow with the earnings over time and the 9 months results points to a favorable growth of earnings in 2023. With regards to the special dividend, we will make our proposals based on capitalization and capital deployment after the January renewals. But as of today, I do not see any reason why our capitalization should not provide room for an attractive dividend, including a special dividend. On the next slide, moving on to the underlying assumptions of our 2 business groups. We have only made minor changes compared to our initial planning. Interest rates are higher. This will have some impact on both the discounting effect in P&C reinsurance and also the interest accretion within the finance results, which we now expect to be around EUR 650 million in P&C and EUR 170 million in Life and Health. As Clemens explained already, there is a temporary benefit due to the timing of the 2 effects, just like in the first half year, it is our intention to not just let this tailwind flow into the P&L in the current year, hence, the combined ratio target remains unchanged. The expectation for the service result in Life & Health remains between EUR 750 million and EUR 800 million, bearing in mind that the 9-month figure is already EUR 677 million. The outlook might look very cautious. However, we have a material share of our business, which will run through a review of assumptions in Q4 as planned generally. So negative effects are possible, and we therefore prefer to be positioned on the cautious side with our outlook. The same is true for the EBIT in Life & Health, even though we are very confident to exceed the full year target. In P&C, the EBIT target is within reach as well for 2023. In summary, we're very pleased with the company's performance to date, which reflects the improved profitability in both our business groups. We see continued profitable earnings growth opportunities and have the capital strength to support our future growth trajectory. We're very confident about our ability to deliver on our guidance for the full year as well as to strengthen our P&C reserve resiliency by the end of this year. Last but not least, we expect to propose an attractive dividend for 2023, reflecting our strong capitalization and the very satisfying performance this year. With that, I conclude my remarks, and we would be happy to answer your questions.
[Operator Instructions] The first question comes from the line of Andrew Ritchie with Autonomous.
The first question, you made reference to, you may look for opportunity to further strengthen the balance sheet at year-end. I guess I'm just asking why? I mean it sounds like you're on track for the buffer build in P&C. I mean if I include the unused large loss budget, you're probably at that point. Maybe just clarify that. So why seek to strengthen the balance sheet further? And is there reason got to do that from an auditor point of view? Second question is on P&C, this is probably a stupid question, apologies in IFRS 17 land. I'm just contrasting the revenue momentum with the CSM new business momentum, especially the CSM net of loss component, which is clearly very strong. Is it the right way to think to focus on that new business CSR because that's the real indication of profitability, and therefore, that will better capture the positive effect of the mix shift between lower-margin proportional and higher margin nonproportional. But again, I'm still confused why the revenue momentum wouldn't be stronger or maybe just clarify which would you focus on the revenue or the new business net of loss component momentum?
Yes, Andrew. Thanks for your question. This is Clemens. So on the resiliency of the balance sheet, it's really just that we want to make clear that we will make an assessment later in the year. We are running our reserve study, as you all know, in the fourth quarter. So in case there is room for resiliency rebuild, and you're perfectly right, we are well on track to rebuild that buffer of at least EUR 300 million that we said. We have made a quite a substantial step in the Q3 results in the third quarter as you can see.Strengthening the balance sheet was meant in various ways. It was not only meant when it comes to really P&C reserves. We will see where we land. It also was meant the fact of -- on the investment side, for example. So if our results allow for looking at our fixed income portfolio, looking at unrealized losses, we might consider also to reinvest some of that in higher yields. So it's really just as a general statement on how we look at Q4. On the profitability, Andrew, I think you're perfectly right. Particularly in our case, I mean, if we look at the target combined ratio, I would say our underlying run rate should be in this discount environment, roughly around 88, 89. The difference to the reported combined ratio is, I think, mainly a reflection of the prudency, the resiliency rebuild that we've done in the first 9 months. It's also a reflection of the fact that we, let's call it, the tailwind of the discounting verse interest accretion, which I would in the dynamic interest rate environment call rather an unintended consequence, which is I think, still sort of manageable in the GMM approach because we are discounting the new business. And it's -- the combined was also impacted. And as you know, we've kept that in the loss picks and the combined ratio is also impacted, of course, by the retro. So therefore, I think it is absolutely useful in the GMM approach to have this new KPI, the CSM of new business. And this is really how we look at it. Even though the CSM of new business is still impacted, of course, by the current market environment. It's also impacted by our rather prudent reserving approach. But directionally, as we have not changed our reserving approach, directionally, you can really see, so the increase of 55% year-on-year in the new business CSM is really the reflection of the increase of the quality of our portfolio.
So can I ask in relation to the P&C CSM, the implication is also there was an unusually low release of that CSM in Q3. Is that the case? Is there something all about the pattern of recognition of the release of P&C CSM?
Yes, that's the case, Andrew, particularly when you look at the net number, at the net CSM release, so the driver of the comparesd low release in the third quarter is mainly that we have released quite a significant retro CSM whilst we have not seen a lot of relief on the coverage on the retro side. So that's mainly the effect. It's not a gross impact, although I would say, I mean, we are still learning on IFRS 17. However, I would consider this on the gross basis being a rather stable number. So this is mainly due to retro in Q3.
The next question comes from the line of Kamran Hossain JP Morgan.
I've got 2 questions. The first one is on, I guess, the underlying combined ratio that you've alluded to, not just this quarter but in the previous quarter as well. Is there any reason why the 86% to 89% shouldn't be the kind of starting point for next year for 2024? The second question is on retrocession use of it. I think at the beginning of this year, you tactically made the decision to use a bit more retro in some ways to reward the market standing behind you and to position ourselves for future years. When you think about retro going into 2024, would you expect as a proportion of kind of, I guess, revenues at this stage, would you expect it to be more or less or any change on that front? Just I'm interested in any thoughts on that.
Kamran, it's Clemens. So I'll take the first question, and then [indiscernible] will take the second one on Vitro. So on the underlying combined ratio, a short answer, no. I think it is a good starting point. Given current sort of discount rates, et cetera, if we just normalize that, I think it's a good starting point for us when we look into 2024. We will provide some details on our assumptions, of course, in a month from now on our Investor Day. But that's the way we would think about it. Just as a reminder, that still implies, of course, quite some buffer building, so some resiliency. We are still very consistent when it comes to our reserving approach. So that approach would be also included in the combined ratio of 88% to 89%. And again, not to forget the risk adjustment to substantial risk adjustment that we've been building. On retrocession, [indiscernible]?
Yes, on the retrocessional side, you're absolutely right. We have a long-term partnership approach with our retrocessional partners. And some of them were in a deficit position after the last number of years. So with the improvement in the original reinsurance market, we have decided to see it more, particularly on our facility. The flip side of the low recoveries we were reporting about during the first 9 months, of course, is a positive effect that the payback to our retrocession partners is coming in quicker than originally anticipated which is giving us the necessary flexibility to look at our amount of retro we are purchasing. We have the flexibility due to our risk appetite and with budgets to place less going into '20 for we have not made any conclusion on that side yet. We are in discussion with our partners. But directionally, I would say that on the expo side, our coverage should be very similar to what we are purchasing today. And on the proportional side, we will most likely see it a little less compared to what we have seeded in '23.
The next question comes from the line of Tryfonas Spyrou from Joh. Berenberg.
So one of them is on the potential write-downs you mentioned, I think, real estate in Q4. I think there was a slight change of tone. I think you previously mentioned private equity will be something that could potentially be coming through. So I don't know if you can share any comments as to what do you expect between the 2? And then if you don't see any sort of updates coming through this year, would you look to book them this year, given that it's within your guidance, so we look to roll them over for next year's guidance. And the second one is just on the buffer again. So you mentioned the risk adjustment is EUR 800 million thing. How should we think about that in conjunction with the buffers? I guess, do you view this as settings? And/or is any risk just mean something that could be released later on I just to understand how should we think about them and how you think about them internally.
Yes, happy to take those questions. So on investments, real estate, private equity. So to be clear, in the first 9 months, we didn't really see any really material markdowns on the private equity portfolio that we are carrying. We have seen some markdowns in the low double-digit million area. But given our EUR 2 billion portfolio in private equity, that's not really material. And actually, that amount has been overcompensated by distributions from those funds. And I think it's -- I think it really demonstrates how resilient that portfolio is. Still, I do believe those valuations are at a very high level. historically. And therefore, we are still expecting some of those in Q4 in Q1. Again, we will see how much of that will be overcompensated by distributions. But we would still allow for some of that coming through in 2024. I mean we cannot book those valuations within IFRS 9, they flow through the P&L as we receive the valuations, and those are funds we received notifications and only up on those notifications, we can book those. On the real estate side, we have a substantial portfolio of direct real estate investments, roughly EUR 3 billion, which is added by roughly EUR 700 million of indirect real estate investments, which are also sitting in funds. On the direct real estate side, we haven't seen any material revaluations yet. However, naturally, those valuations are done rather at year end. So we are expecting the valuations coming through of this portfolio rather sort of in late November, early December, and we are expecting some impairments on the real estate side, particularly in the U.S. So a couple of -- we have identified a couple of items where we would take the opportunity to take some of the valuations down. That would be rather, I would say, a high double-digit million number in terms of values. So we'll see where we end in December. Again, it's not easy to just write off any of these items. But again, we would then still be looking into our overall investment performance, including fixed income securities and see how we can manage to strengthen our results there in the future. On the buffer or on the resiliency of our P&C reserves in general, I mean, as mentioned, we haven't really changed our reserving approach being at the upper range of possible best estimates. So we are reserving at best estimate. However, consistently rather at the upper range, and that is meant in connection, particularly with our liabilities for incurred claims, so the link. And the risk adjustment is actually coming on top of that. So we absolutely see the risk adjustment as being future profits. And I think the -- most of the capital model providers, rating agencies have also acknowledged that, that the risk adjustment is a source of future profits. Having said that, in terms of release, yes, the risk adjustment will form a regular part of our runoff result. And we have also seen that in the first 9 months, so roughly EUR 100 million to EUR 150 million of our runoff gains for the first 9 months are stemming from the risk adjustment. However, the mechanics of calculating the risk adjustments are a bit more stable, so they wouldn't allow for any extraordinary release. But again, ultimately, this risk adjustment will find its way into our P&C earnings.
Next question comes from the line of Vinit Malhotra, Mediobanca.
Sir, 2 questions, please. One is on the large loss. One is on retro. On the large loss, really, there are 2 parts to this, please. One is when your large losses do appear higher than peers, unicast, for example. I'm just guessing -- I'm just checking, do you think this is because you are more conservative? Or did you see any particular surprises, say, Marco, EUR 70 million. I mean could you point out anything that was more surprising? And then just monthly of the large lawn Jean-Jacques you mentioned frequency of growth is picking up. And I'm just curious that I thought that this was a trend that should not have been a surprise in the sense the industry and yourselves are moving away from proportional moving away from some of the secondary perils. So just curious, does this comment means more needs to happen or you need to view a little bit retro strategy here? And just the second question linked to retro is back to the Slide 7, where I apologize, I missed some of the very interesting comments. When I look at the experience variance, for example, in discrete 3Q is not even a minus EUR 50 million or maybe EUR 47 million minus. I mean, does this very low negative experience variance imply that retro worked better or retro did not yet give recoveries, as I can imagine, as I can see. Could you just clarify how to meet this line item? And again, please guide by how retro has not had or what you're changing.
I'll probably start with the last question, and then you can probably clarify if I really understood the question correctly. But if we look at Slide 7, what we're trying to do here is really looking at the profit driver of the reinsurance service results or the underwriting result, and that is, of course, mainly the earning of the margin, so the CSM release. And then, as you know, given our reserving approach and what I've just mentioned on the risk adjustment, quite a chunk of that would also be -- come on top of that when it comes to runoff results. The experience variance is really reflecting any sort of a AOEs when it comes to premiums or AOE when it comes to claims. I can say that on the gross side, the experience variance so on the inward side is rather low. So that would rather be a low number. So what you see here, the EUR 553 million is really a reflection on the fact that by the end of the third quarter, we haven't seen the relief on the retro side, given our large losses on the inward side. So that's really where we adjusted our expectations on the retro side. There's also a small piece in there or a piece in there that is linked to experience variance on the retro premium side, but the bulk is really claims. So in general, I would say that's given the retro movement, I would -- I'm inclined to say that's rather a large number and should be seen usually going forward as a bit lower number here when it comes to AOE. Does that answer your question, Vinit, on that end?
Clemens, I think -- I mean, if you look at discrete Q3, then there is hardly any experience variance almost negligible in this slide, so minus EUR 50 million, as I said. And that's what was driving the question that does that mean that retro behaved as you expected? Is that simplest way to think of it in Q3?
Yes. Well, I think you should probably see Q2 and Q3 together. I think we've done some work on the retro AOE, particularly in Q2 and Q3. And I would watch these 2 quarters together. I think we took already some of the expected charge here on the experience variance already in Q2. So therefore, probably it was not much to do when it came to the claims side on the Q3. But again, there's also a bit of an element of premium in there. So it's a mixed bag of Q2 and Q3.
So that's more clear. On your first question, Vinit, I have not analyzed the Nat Cat experience of our peers. But I guess, what you are referring to is simply the fact that we are less U.S. heavy in our cat writings compared to our average peer. We have a stronger focus on global diversification. And given the fact that we had significant frequency also outside of the U.S. this year. You see a normal cat experience on our side, but you are not seeing the big loss in the U.S. And so from that point of view, you may have the perception that our net cat experience is different compared to our peers. So I think that's the main driver. You know that particularly on the U.S. wind side, over the last 4 to 5 years, we have managed the growth on that side very carefully in order to improve the diversification. And we will continue with that trend. Overall, after 9 months, our stand-alone cat budget within our major loss budget was utilized by 85%, which is telling us that our risk assumptions, our pricing assumptions are sound. So from that point of view, we are happy with the experience year-to-date.
Next question comes from the line of Ashik Musaddi, Morgan Stanley.
Just a couple of questions. So first of all, the Slide #7, going back to Andrew's question on this new business, CSM, how should we think about the release of this? I mean is there a proportion that gets released this year and next year? Is it possible to get that proportion? Or is it like 70% this year, 30% next year in case there is any, say, a simple way of thinking about that. So that's the first thing. And second thing is just around the other line item where you mentioned that there was a significant currency effect in third quarter in P&C. Any color on that would be very helpful.
Ashik, it's Clemens. So on the CSM of new business, so in general, I would say that we've seen, of course, when you look at the number here, the EUR 2.2 billion that we've seen the bulk of the new business being created in the first 9 months, of course, given our renewal dates. However, that number will slightly increase by year-end. When it comes to the stock of CSM that you see the EUR 2.3 billion, I would expect that number to be slightly decreasing. It might stay sort of above given -- we see what we see in Q4, but it might stay above the EUR 2 billion mark, but I don't have a concrete number. In terms of how is the margin being earned. I mean it very much follows what we have looked at when we looked at our earning patterns pre-IFRS 17 so really a rough -- very rough estimate would be, let's say, new business CSM that we are creating would be earned roughly 55% in the first year. So the underwriting value that we are creating will be flowing through the P&L under IFRS 17, roughly 55% in the first year, roughly 30% probably in the second year and another 10% to 15%, I would say, in the following years. That's roughly the earnings pattern you can think of it. On the second question, Ashik, so on currency, what I was particularly referring to when it comes to revenue. You will see already in the 9 months that the FX-adjusted revenue on P&C was 5.5% is largely in line with our expectation. However, the currency impact is very, very high. And that's particularly true with Q3. So of course, you might have wondered why the revenue on the P&C side is a bit more subdued in the third quarter. So a huge impact is really coming from currency. And then I just wanted to clarify that on top of the fact that, again, that the earnings of the recent renewals are coming a bit more pronounced now in Q3, and that would also be the Q4. But again, just to be clear on that, our overall expectation for business growth in P&C is fully in line with expectation. When it comes to the other income, I think there is an effect of currency in there, but I would call it a regular volatility within the currency results. So nothing -- not a big or a huge item in there.
The next question comes from the line of Ivan Bokhmat from Barclays.
I've got 2 questions related to P&C. The first one, I was just wondering if -- as we think about your combined ratio over 9 months and especially maybe in Q3, could you try to help us understand what's the impact of the mix shift that you've highlighted that was more pronounced on the top line basis and then more towards excessive loss and away from proportional business? And then secondly, related to that, as you look into 2024, do you think there is any need to make changes of the same nature as a move more towards excessive loss any particular portfolios or classes of business you'd like to deemphasize and what impact that might also have on your profitability?
So Ivan Jean-Jacques can complement. I think I tried to recall the numbers that we reported in our renewal calls. But I think the -- on the underlying combined ratio, if we think of our, let's say, 96% on a nominal basis, IFRS 4 combined ratio, we clearly would think that the shift, well, both the portfolio pruning that we've done on the proportional side, but particularly the shift from proportional to nonproportional will have had a significant impact already on, let's say, in IFRS 4 nominal combined ratio. I'm looking at Swehm, but I would say that's probably 2 percentage points on a, let's say, financial year earned basis, and we will benefit from that going forward as well. So that's, I would say, underlying profitability increase from that shift, I would guess that being 2 percentage point. So we do see that in -- also, of course, in IFRS 17 terms. And I would like to understand the second question a bit better, Ivan. Was it about sort of are we looking into shifting the portfolio even more? That's a question for Sehm, I believe shifting the portfolio even more to nonproportional or have we sort of reached a level when it comes to the shift from prop to not NP where we think we have landed at a point now and we won't see a significant impact in 1/1.
Maybe just recalling, Ivan, the it's Jean-Jacques speaking, the renewal call, which was, of course, focusing on the 1/1 renewals, we showed the mix of proportional, nonproportional. This was 1/1. So roughly speaking, 2/3, 1/3 non-prop. We had premium changes of 11.4%. And in -- this is proportional and nonproportional, we had premium changes of plus 11.7%. This is in the slide deck we presented in February after the 1/1 renewals. So that gives you a bit of a proxy for order shift and the rest of the year was relatively comparable, I believe.
Sorry, just to clarify what I was asking, yes, that's exactly for the 2024 business, do you think that there will be any further change within the mix?
Not on a portfolio level basis. So you can see with a relatively small figure on the loss component that we have done most of the pruning job we wanted to do in 2023. Just as a reminder, I mean there were 2 areas of us shifting from proportional to nonproportional, the one was more nat cat driven, where both in Europe and in North America, we wanted to make room to write more natural catastrophe exposure and an excess of loss basis by writing less on a proportional basis. And the second area was more profitability-related mostly in APAC, where we discontinued certain business. But those developments will go more at the portfolio level and considerations. Going forward, we would say that we have done that job. And wherever we will still shift, that would be more on a client-specific basis. So I'm not saying that we will not do any shift at all. But the pace would not be at the level we have seen in '23.
The next question comes from the line of Jochen Schmitt Metzler.
I have one question on your segmental EBIT target for P&C for '23. Also bearing in mind the potential markdowns on investments, which you indicated for Q4. To me, it seems like the EUR 1.6 billion could be somewhat difficult to reach. The other way to look at the segmental targets might be that you could possibly offset the potential EBIT shortfall in P&C by Life&Health. Could you just clarify? That's my question.
Jochen happy to clarify. I think the reason why that looks difficult to reach for you probably in after the 9 months that we've really taken a significant step in reserve rebuilding in the third quarter. Again, I mean, we have reserved our budget to the full extent. So overall, I think the resiliency rebuild in the third quarter has, I think, drawn that picture that you see here. I'm still very optimistic and confident that we will reach our EBIT target also for the P&C side in the fourth quarter.
The next question comes from the line of Roland Pfänder from ODDO BHF.
Yes, two questions from my side, please. First of all, on the Life & Health side, contractual service margin, you had a very significant positive number and change in estimates. It's actually positive for the third quarter in a row. So my question is, is this a structurally positive number to be expected there because maybe of conservative assumption settings? Or how should we read this? Second question, could you maybe provide an overview of your collateralized reinsurance business and how the market is behaving in this context?
Yes, I can start with the question on the Life & Health side. What we do regularly is regularly means annually, we look at all our assumptions for mortality and longevity and morbidity business. And this was a significant change now after COVID, we have seen that we have been extremely conservative on the longevity side. And the bullet of this is from longevity assumption changes. This is not the total portfolio. There is probably more to come, whether it's on the same level remains to be seen. We have started with the largest portfolios we have. But as Clemens pointed out earlier, we do these assumption checkups regularly each year in the third and fourth quarter. Reason for that is that we do it basically on the year-end numbers from the last year, and it takes some time to get all the data from the clients. So after the first half year, we start this work, and this is regular work each and every year.
Just to be clear, Roland, this is Clemens and glad to that. Structurally, as Klaus said, we are usually prudent in our assumptions. So I would expect an AOE being a positive number, but not to that extent. So what you see here is really us not doing all the work that Klaus mentioned in one quarter. There will be volatility on the updates in sort of -- within the year, but at year-end, we should have a more stable view. And therefore, again, this is really longevity that you're seeing here to work on mortality is something that we'd rather do at year-end in Q4, and I would expect some impacts from our updates on the mortality side. Some of that will impact the CSM, some of that, if there is no CSM available might impact the loss component, that's different mechanics under IFRS 17. But I would consider this number to be ordinary high as for now.
And as to your question on the collateralized fronting business, we are doing in our ILS practice. This is an area where we have been active for a long time by now. It's a nicely growing portfolio over time. It's also behaved from a volume point of view, relatively stable despite the capacity situation, the ILS market is in. So from that point of view, there are no developments to report, which would imply that this portfolio will not continue to grow and the way we are thinking about it as far as value creation is concerned, there's definitely less in terms of premium or revenue before sales in and out in a fronting model. It's more about fee generation. And here, we can say it's a nice contributor with middle middle double-digit million figure every year.
Maybe just one follow-up. Do you see this market still growing? Or did it slow down lately?
Well, I mean, for the 23 year, there was little growth in that market. But structurally, this is a growing asset class. But of course, it's competing with other asset classes. So there is a certain cycle to the availability of funds for that asset class. But structurally, we are working under the expectation that the absolute amount of investments going into alternative capital on the reinsurance side is going to grow.
The next question comes from the line of James Shuck from Citi.
Returning to Slide 7, please. I just wanted to clarify my understanding. The experience variance in Ava in the reinsurance service result. I mean you've been clear that, that is an unusually large number. But I think you mentioned that you would expect it to be more modest going forward. Can you just help me understand why that would be negative at all? Because I would thought that the CSM itself is already net of retro. And therefore, I would have expected the experience for us to be broadly neutral or maybe even positive given how conservative you are. Just keen to understand what that would be negative. Then on the runoff results of the EUR 487 million, EUR 150 million or so is from the risk adjustment and the LIC, what's the rest of that runoff result coming from? Because you're adding to the overall reserve resiliency, but I'm seeing a big release here. I'm just trying to square that. And then final question, Jean-Jacques, I think you mentioned a few times in the presentation about the dividend policy and the dividend policy being at least in line with prior year. I know you've got your Capital Markets Day coming up. I'm just keen to understand the flexibility you have around the entire capital management approach particularly in the light of the S&P model changes, which potentially give you a little bit more renter maneuver, let's say.
James, I'll start with the first 2 questions on Slide 7, CSM and the run-off results. So I -- so the experience variance really, I think there are 2 or 3 elements in there. I think, first of all, again, admittedly, we are still learning a bit on how we -- how the mechanics in terms of initial recognition under IFRS 17 work, how do we estimate premium, how do we estimate claims, et cetera. And we have of course, adjusted here and there within the quarter. So quarter-on-quarter, it can be a bit of a volatile number here. Again, as for 2023, and I fully agree that number should be rather stable. And it is stable on a gross basis. On the retro side, again, I would say it's not a usual picture that we've seen for the first 9 months when it comes to our retrocession protection. When we look at our large loss list. And that's really, really the driver here because it is a very unusual picture when you look at our large loss list in the gross and the net of that. So that's really the main driver. But I would consider this number to be a bit more stable. On the runoff results, the EUR 487 million, again, I don't have the numbers fully at hand, but I would say EUR 100 million to EUR 150 million as risk adjustment rest is regular runoff result, and you are perfectly right. I think the positive news here is although we have significantly strengthened our reserve, we have seen quite a nice runoff result across our lines of business. So nothing that really stands out. Where we have seen a bit of a negative development is, of course, on our APAC area when it comes to the COVID claims in APAC because those claims naturally go into prior years, underwriting years and they have produced some runoff losses. But generally, the runoff result has been fueled by a very nice development of all our lines of business, which is also a reflection on -- and again, I don't want to preempt our discussions on reserves at year-end, but what also shows that, as of now, we haven't seen any major development when it comes to reserve strengthening or inflation or something like that. So overall, quite positive.
And James, on the dividend outlook, you read carefully what we said. We will, of course, be more clear when we have our Investor Day. What we look at is clearly the quality of the book, the earnings outlook and the capitalization will have much more clarity in December on the S&P methodology. This will really be the piece which we'd like to have. But based on what we know so far, I think we see good room for a more optimistic outlook when it comes to dividend policy. And this is for this year, but also for the next strategy cycle, which you know, is 24% to 26%.
We have a follow-up question from Will Hardcastle, UBS.
First one is, any potential prudence in the limited retro protection that you've assumed in Q3 losses, just looking at Slide 20, '21? What is it just a function the losses that we've had in the locations they've been? I think sometimes you've mentioned you booked some loss of gross and net the same as they've been quite recent events. I was wondering if that's the case here. The second one is just a high level, how is your view on this EUR 1.7 billion P&C reserve after being the desired landing point now changed? Or is it still the same? I guess, those comments about potential more balance sheet strength filled in the year-end. I'm wondering if that's in other balance sheet areas.
Will, let me start with your first question. I mean when we look at the losses of accident year '23, none of them was large enough to attach to our nonproportional retro structures. So therefore, a lot of the line items you would see on a gross or net basis. Our proportional case transaction is only protecting certain peak territories. And given the geographical distribution of the major losses this year, quite a few of them were not covered by our proportional K protection. So from that point of view, I mean, there is nothing unexpected when it comes to the possibility of us recovering from retro. But this year, the geographical split is such that our K transaction is less busy than it was in previous years.
When it comes to prudency, really, your question on metro prudency, I think it's fair to say that particularly in the first quarters of the year, we are a bit more prudent on when we think about gross claims versus net claims when it comes to retro relief and particularly when you look at the third quarter. So the underutilization of EUR 124 million does not include any retro protection. So therefore, you could argue there is an element of prudency in there. And when it comes to retro costs, et cetera, that could also be a slight element of put. But just to add on that note, that's the only topic I can think of. In addition, when it comes to the reserve buffer, the EUR 1.7 billion is still our desired level. We said we ideally want to do that in one go to EUR 300 million, 200 million, EUR 400 million. So we're still trying to land there. But again, we're doing the study at year-end, and then we see where we land and make an assessment there. But again, we will, as always, be very transparent about what we're doing there. But again, the EUR 1.7 billion is our target at year-end, and then we gradually grow our resiliency with our book.
There are no more questions at this time.
Well, in that case, I'd like to thank you all for joining our call. We had several objectives for this year. The first, we discussed what was our guidance, where we feel much more comfortable. The second was building up a buffer of resiliency. Here again, the results to date show that we're very well on track. We also wanted to make sure that our retro partner a part of that upside in the current market in P&C. Here, the payback is going to be clear, which gives us a sound basis for 2024. We want to have the capital strength to embark on a successful streams of renewals in P&C and support the Life&Health growth. Here again, we tick the box. And we want to make sure the dividend keeps increasing with our growth and is one of the main goals for the next few years. So we believe we've reached all these goals and hope to be able to confirm all of this when we present the year-end result. In between, we'll have Investor Day, where we'll talk about the strategy and we look forward to meeting many of you to our Investor Day early December. With that, I close the call, and thank you very much again for your participation.
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