Counterparty default risk
Counterparty default risk describes the risk that a borrower is not willing or, in the case of insolvency, is not capable of meeting its obligations with respect to its creditors.
At the Talanx Group, counterparty default risk for investments comprises the following risks:
- Issuer risk (default risk, migration risk)
- Counterparty risk (replacement risk and settlement risk)
- Concentration risk
Counterparty default risk is primarily limited by the Talanx limit and threshold system and by our investment guidelines and is constantly monitored. To this end, limits are determined at portfolio, issuer/counterparty and sometimes asset class level, ensuring a broad mix and spread in the portfolio. The credit rating of the issuer is the main requirement for the investment decision. Credit rating assessments are based on the Group’s own credit risk analyses, which are supplemented by ratings from external agencies such as Standard & Poor’s or Moody’s. New investments are largely restricted to investment-grade securities. An early-warning system has been implemented on the basis of market information (especially credit spreads and equity prices) to recognise initial signs of a critical situation at companies and to identify potential migration risks. To reduce counterparty risk, OTC transactions are only carried out with a select group of counterparties, and cross-product framework agreements are agreed on that comprise both netting and collateral services (cf. item 13 in the Notes on “Derivative financial instruments and hedge accounting"). We also use credit default swaps to hedge credit risks.
In the Group, counterparty default risk is characterised at the level of the individual counterparty using the following principal risk components:
- Probability of default (PD) is based on an internal rating and describes the probability that a debtor will default within a defined period
- Loss given default (LGD) shows the anticipated loss in the event of default on the investment. It relates to the specific issue and is influenced by the nature and degree of the security and the seniority of receivables
- Exposure at default (EAD) shows the anticipated amount of the receivable at the time of default
- Change in credit spreads with constant, objective credit condition
An expected loss is calculated for the investment that takes into account the rating, the probability of default assigned to that investment and the expected loss rate. In addition, at the portfolio level, an unexpected loss (i.e. possible deviation from expected loss) and a credit VaR are calculated. The credit VaR takes into account specific features for individual credit risk assessment as well as portfolio concentrations (sectors, countries, debtor groups) and correlations between individual levels. The credit VaR shows the impairment to the observed portfolio of investments occasioned by credit risk, and this may not be exceeded at a stipulated probability for a period of one year.
The procedure for risk calculation defined in this way ensures that, taking into account clustering effects, higher-risk investments are assigned significantly higher risk than lower-risk investments. The risk parameters ascertained in this way are grouped together at various control levels and aid in the monitoring and control of credit risk.
As at 31 December 2013, the credit VaR for the entire Group amounted to EUR 2,982 (2,918) million, or 3.5 (3.4)% of assets under own management. In comparison with the previous year, the credit VaR ratio of 3.4% thus rose by 0.1 percentage point. In internal risk quantification, all investments exposed to credit risk, with the exception of country exposure, have a rating better than AA– and are therefore modelled significantly more conservatively than in the current version of the Solvency II standard model.
The table shows the sensitivity of the credit portfolio to certain credit scenarios, measured as credit VaR. It depicts both the impact of a downgrade in issuer ratings by one or two levels and the reduction of the expected recovery rates in the event of payment default. Sensitivities are ascertained by keeping all other parameters constant.
The maximum default risk exposure (of our investments, excluding funds withheld by ceding companies) as at the balance sheet date, irrespective of collateral or other agreements that serve to minimise default risk, corresponds to the balance sheet item.
Investments are serviced regularly by the debtors. Collateral is in place particularly for covered bonds/asset-backed securities and for mortgage loans secured by a charge on property.
In the Group, a total of EUR 527 (372) million in financial assets serves to secure liabilities and contingent liabilities. Of this amount, carrying amounts of EUR 92 (84) million secure existing derivative transactions for which separate assets are maintained in blocked custody accounts. We have received collateral with a fair value of EUR 60 (9) million for existing derivative transactions. In addition, Hannover Re Real Estate Holdings granted customary collateral to various credit institutions for liabilities in connection with real estate investments and transactions. As at the balance sheet date, this collateral amounted to EUR 460 (288) million.
For further information about collateral granted by the Group or received in connection with business, cf. “Contingent liabilities and other financial commitments” in the section “Other information”.
With the exception of mortgage loans, the portfolio did not contain any overdue, unadjusted assets as at the balance sheet date, because overdue securities are written down immediately. Mortgage loans show arrearages totalling EUR 19 (17) million. This figure includes accounts receivable of EUR 7 (4) million in arrears by more than 12 months. Since these receivables are adequately secured by charges on property, no impairment was taken. Pursuant to contractual provisions, realisation is possible only in the event of failure to perform. With regard to impairments taken on investments during the year under review, cf. item 30 in the Notes.
Credit rating structure of investment portfolio: As at the end of the reporting period, 95 (95)% of our investments in fixed-income securities were issued by debtors with an investment-grade rating (AAA to BBB), with 81 (83)% rated A or better. Upon acquisition debenture bonds and registered debt securities are assigned an internal rating that is derived, where possible, from the issuer’s rating. Approximately 61 (61)% of short-term investments, mainly in overnight money, time deposits and money-market securities with a maturity of up to one year (balance sheet item: “Other investments”) are rated A or better.
The rating structures of our fixed-income securities, differentiated by balance sheet item, as well as investment contracts and short-term investments are presented in the relevant items in the “Notes on the consolidated balance sheet – assets”.