Management of risks associated with investments

The structure of assets under own management (excluding funds withheld by ceding companies) is regularly examined in order to monitor strategic asset allocation.

N44 WEIGHTING OF MAJOR ASSET CLASSES
  IN %
    Parameter as
per investment
guidelines
Position
as at
31.12.2013
Position
as at
31.12.2012
  Bonds (direct holdings and investment funds) At least 50 91 91
  Listed equities (direct holdings and investment funds) At most 25 1 1
  Real estate (direct holdings and investment funds) At most 5 3 2
   

Our comprehensive asset/liability management systems endeavour to balance the investment goals of security, profitability, liquidity, mix and spread and are subject to compliance with the company’s risk-carrying capacity and regulatory requirements. The main challenges to achieving these investment goals are market risk, counterparty default risk and liquidity risk. Limits are set using the Talanx limit and threshold system for the weighting of investment classes. These did not change over the previous year, whereby there are still small differences between property/casualty insurers, life primary insurance and the reinsurance segments. The ratios presented for bonds, equities and real estate as of 31 December 2013 are within the defined Group limits.

Market risk

Market risk consists primarily of the risk that the market prices of fixed-income assets and equities may change and of the risk that exchange rates may fluctuate where there is no matching cover. This may lead to a need to take impairments or to losses being realised when financial assets are sold. A decline in interest rates related to the reinvestment may also reduce investment income.

One important means of monitoring and controlling market price risk is continuous analysis of value at risk (VaR), where alongside investments, consideration is also given to projected cashflows from underwriting commitments and their sensitivity to market risk factors (ALM-VaR). The ALM-VaR is based on historical market data and represents a model-based forecast for the maximum loss potential within a given holding period (e.g. ten days), which cannot be exceeded with the given probability. The ALM-VaR is calculated based on a confidence level of 99.5% and a holding period of ten days. This means that there is a 0.5% probability of this estimated loss potential being exceeded within ten days. The input data for the calculation are portfolio investment values, which are updated daily. Alongside the portfolio data for investments, replicating portfolios for the projected cashflows from underwriting commitments are also taken into account in the form of payment obligations (so-called short positions) to reflect and monitor dependencies between investments and underwriting benefits as well as any existing duration gap in the investment. A duration gap is the mismatch in fixed interest rate durations between investments and commitments.

The market data used for this risk model cover the past 521 weeks. On this basis, 520 weekly changes are calculated for each relevant market parameter, such as equity prices, exchange rates, commodities prices and interest rates, and then used to ascertain the ALM-VaR. The time series used as the basis for calculating the risk parameters are updated monthly, with the market parameters of the oldest four weeks being removed and replaced by those of the last four weeks. The risk model is thus recalibrated monthly on the basis of the updated market data.

The risk model used is a multi-factor model based on a multitude of representative time series, e.g. interest rates, exchange rates and stock indexes, from which all risk-relevant factors can be ascertained by using on principal component analysis. Correlations between the time series are taken into account in the weighting of risk factors. In this way the risk assessment makes allowance for cumulative and diversification effects. The individual elements of the portfolio are analysed through regression towards these factors. The factor weightings ascertained in this process establish a correlation between movements in the factors, which in turn were extrapolated from movements in the representative time series, and movements in the securities. Risks associated with securities are extrapolated by simulating trends in the factors. The risk associated with derivatives, such as options, is extrapolated through comprehensive remeasurement during risk simulation, which also takes into account non-linear correlations between option prices and price movements in the underlying instruments.

The ALM-VaR is ascertained using normal market scenarios extrapolated from the past.

As at 31 December 2013 the ALM-VaR (confidence level 99.5%, holding period of ten days) totalled EUR 1.3 billion, corresponding to 1.5% of the investments observed.

Besides the rather long-term monitoring of risk-carrying capacity of the market risks associated with the investments, a model version is used to identify risks early where only the last 180 weekly yields are considered and where market observations from the most recent past have a stronger influence on risk figures through the use of exponential weighting. This version exhibits a much higher sensitivity of the ALM-VaR model to current volatility changes on the capital markets and can also provide early indications of higher risk.

These stress tests and scenario analyses complement the range of our management tools. In the case of interest-rate-sensitive products and equities, we calculate a possible change in fair value on a daily basis using a historical worst-case scenario, estimating the potential loss under extreme market conditions. In connection with the scenarios, we simulate changes in equity prices, exchange rates, general interest rates and yields for bonds of issuers prone to credit risk (spreads). Interest rate risk means that the value of financial assets held in the portfolio may change unfavourably due to changes in market interest rates. The fair value of the fixed-income securities portfolio increases with declining market yields and decreases with rising market yields. (Unsecured) equity price risk means that the value of equities and equity- or index-linked derivatives may change unfavourably due to e.g. downward movements on particular stock indexes. Currency risk is of considerable importance to an internationally operating insurance group that writes a significant amount of its business in foreign currencies.

The following table shows scenarios depicting trends in investments held by the Group as at the balance sheet date. The amounts shown are gross amounts. In particular, the depicted effects make no allowance for taxes or the provision for premium refunds. Effects in connection with surplus participations to policyholders in life/health primary insurance are thus not part of the analysis. If allowance were made for these effects, the depicted impact on earnings and shareholders’ equity would be much milder.

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N45 SCENARIOS DEPICTING CHANGES IN THE FAIR VALUE OF ASSETS HELD BY THE GROUP AS AT THE BALANCE SHEET DATE
  FIGURES IN EUR MILLION
  Portfolio Scenario   Recognised in
the statement of
income 1)
Recognised in
other comprehen-
sive income 1)
31.12.2013
Portfolio
change based on
market value 2)
31.12.2012
Portfolio
change based on
market value 2)
  Equities 3)            
    Share prices +20% 31 154 185 +175
    Share prices +10% 16 77 93 +88
    Share prices –10% –20 –93 –113 –109
    Share prices –20% –41 –186 –227 –219
  Fixed-income securities            
    Yield increase +200 bps –325 –4,618 –9,764 –9,283
    Yield increase +100 bps –182 –2,465 –5,262 –4,972
    Yield decrease –100 bps 215 2,675 5,534 +5,372
    Yield decrease –200 bps 452 5,628 11,596 +11,489
  Exchange-rate-sensitive investments            
    Change in exchange rate 4) +10% –1,847 –137 –1,984 –2,374
    thereof USD   –1,185 –108 –1,293 –1,263
    thereof GBP   –277 –2 –279 –277
    thereof AUD   –151 –151 –183
    thereof other   –234 –27 –261 –651
    Change in exchange rate 4) –10% 1,847 137 1,984 +2,374
    thereof USD   1,185 108 1,293 +1,263
    thereof GBP   277 2 279 +277
    thereof AUD   151 151 +183
    thereof other   234 27 261 +651
  1) Gross (before taxes and surplus participation)
2) Including financial assets in the categories “Loans and receivables” and “Financial assets held to maturity”
3) Including derivatives
4) Exchange rate fluctuations of +/–10% versus the euro, on the basis of the balance sheet values
   

The breakdown by currency of our investments under own management, including investment contracts, was as follows:

N46 INVESTMENTS
  IN %
    31.12.2013 31.12.2012
  EUR 76 70
  USD 15 15
  GBP 3 3
  AUD 2 2
  Other 4 10
  Total 100 100
   

We use derivative financial instruments to partially hedge portfolios, especially against price, currency and interest rate risks and to optimise our portfolio in light of risk/return considerations. Contracts are concluded solely with first-class counterparties and in compliance with the standards defined in the investment guidelines in order to avoid risks – especially credit risks – associated with the use of such transactions (for counterparty default risk cf. also the following section). By systematically adhering to the principle of matching currency coverage, we are also able to significantly reduce foreign currency risk within the Group. More information on the use of derivative financial instruments can be found in item 13 “Derivative financial instruments and hedge accounting” in the Notes – assets.