Financial risks

Life Segment | Non life and financial segment 

The analysis of market risks indicated within the IFRS 7 framework, in relation to price changes of financial instruments, is included in the broader context of financial risks defined in the Group Risk Map.
Financial risks include equity risk, interest rate risk, foreign exchange risk, real estate and concentration risk. Equity risk arises from unexpected movements in stock prices and also includes changes in equity volatility. Interest rate risk derives from unexpected changes in interest rates and also takes in account interest rate volatility. In addition, risks related to changes in property values, exchange rates and finally, concentration risk are considered.
Unexpected movements of interest rates, equities, real estate and exchange rates can negatively impact the economic, financial and capital position of the Group, both in terms of value and solvency.

Assets subject to market movements are invested to profitably employ the capital subscribed by shareholders and to meet contractual obligations to policyholders; consequently, financial market movements imply a change both in the value of investment and insurance liabilities. Therefore, oversight through analysis of the impact of adverse market movements implies an adequate consideration of volatility, correlations among risks and the effects on the economic value of the related insurance liabilities.

Within the processes of investment management, Group companies are required to apply the Group Risk Guidelines.

 At year-end 2011 the investments whose market risk affects the Group were of 284.4 billion euro at market value (1).

(1) Investments whose market risk affects the Group are total investments excluded investments back to policies where the investment risk is borne by the policyholders, investments in subsidiaries, associated companies and joint ventures, derivatives, mortgage loans, receivables from banks or customers and other residual financial investments different than equities and or loans as well as land and buildings used by third parties and cash and cash equivalents. Instead, self used properties are included.

  31.12.2011 31.12.2010
  Total
fair value
Impact
(%)
Total
fair value
Impact
%
(€ million)     
Equity instruments (*) 17,098.0 6.0 23,345.4 7.8
Fixed income instruments (**) 242,984.6 85.4 252,282.5 84.2
Bonds 212,717.8   225,053.8  
Other fixed income instruments (**) 30,266.8   27,228.7  
Land and buildings (***) 24,372.6 9.0 24,122.9 8.0
Total investments 284,455.2 100.0 299,750.8 100

(*) Investment fund units amount to 3,638.1 million ( 4,213.9 million at 31 December 2010).

(**) Investment fund units amount to 8,013.2 million ( 8,110.9 million at 31 December 2010). 

(***) Investment fund units amount to 2,240.1 million ( 2,412.3 million at 31 December 2010) and it includes also self used properties fair value.

As mentioned above, the economic impact of changes in interest rate, equity values and the related volatilities for the shareholders will depend not only on the sensitivity of the assets to these shifts but also on how the same movements affect the present values of its insurance liabilities, which may absorb a portion of risk.

In life business this absorption is generally based on the level and structure of minimum return guarantees and profit sharing arrangements. The impact of the minimum guaranteed rates of return on solvency, both on the short and long terms, is assessed through deterministic and stochastic analysis. These analyses are performed at company and, if necessary, at single portfolio level and take into account the interaction between assets and liabilities helping to develop product strategies and strategic asset allocations aiming at optimising the risk/return profile.

In order to control the Group exposure towards the financial markets, while maintaining a perspective of risk/return, the management adopts procedures and actions are adopted on the single portfolios including:

  • credit and tactical asset allocation guidelines are being updated to the changing market conditions and to the changing ability of the Group to assume financial risks;
  • matching strategies, at net cash flow lever or duration matching strategies, for the management of the interest rate risk;
  • hedging strategies with approaches of dynamic hedging or through the use of derivatives instruments as option, swap, swap options, interest rate forwards, interest and currency swaps, futures, caps and floors;
  • portfolio and pricing management rules, coherent with sustainable guarantee level§

The Group uses a data warehouse to collect and consolidate the financial investments, which guarantees a homogeneous, time effective and high quality analysis of the financial risks§

The currency risk arising from the recent issuance of subordinated debts in British pound sterling has been mitigated with a specific hedging strategy. up.png

Life Segment

Taking into consideration the specific characteristics of the Life business, the impact of negative changes in the financial market conditions has to be assessed both on assets and liabilities. As allowed by IFRS 4, this impact is here represented as percentage change of Group’s Embedded Value (2).

Embedded Value is an actuarially determined estimate of the Group value, net of any value attributable to future new business.

With reference to the covered business at the date of valuation, and to the relevant consolidation perimeter (i.e. the operating life, health and pension companies of the group), the EV is equal to the sum of the Adjusted Net Asset Value (ANAV), and the Value In-Force (VIF):

  • the Adjusted Net Asset Value corresponds to the market value of the consolidated shareholders’ funds, net of goodwill and DAC, and before the payment of dividends from profits in the year;
  • the Value In-Force corresponds to the present value of the projected stream of after-tax industrial profits generated by the business in force at the valuation date. This value takes into account the cost of financial guarantees related to the options, embedded in insurance contracts, and less the frictional costs of holding the capital and the cost of non-financial risks.

Regarding the market risk the Group performs the following sensitivities on its Embedded Value, according to the parameters indicated by the CFO Forum:

  • Yield curve +1%: sensitivity to an upward parallel shift of 100 basis points in the underlying market risk free rates, accompanied by an upward shift of 100 basis points in all economic assumptions;
  • Yield curve -1%: sensitivity to a downward parallel shift of 100 basis points in the underlying market risk free rates, accompanied by a downward shift of 100 basis points in all economic assumptions;
  • Equity value -10%: sensitivity to a 10% market value simultaneous reduction at valuation date for equity investments;
  • Property value -10%: sensitivity to a 10% market value simultaneous reduction at valuation date for property investments.

The changes in embedded value (%) at 31 December 2011 and 31 December 2010 are reported in the table below.

(2) Generali Group publishes annually also a separate Embedded Value report for life segment.

Life embedded value sensitivities: Market Risks
(%)
31.12.2011 31.12.2010
Interest rate +1% 12.2 4.2
Interest rate -1% -17.2 -8.0
Equity price -10% -4.8 -4.3
Property price -10% -2.8 -1.9

When analyzing the data from a general point of view, if it is straightforward to observe that the decrease in equity and real estate prices has a negative impact on the shareholders’ value, must be noted that a shift in risk free rates might have both positive and negative effects, driven by the insurance portfolio structure and by the assets and liabilities mismatch in terms of cash flow. Similarly to the previous year, data at 31 December 2011 show that the Company suffers the interest rate downward movement. The impact is also higher than the increase corresponding to the opposite risk free variation, due to the presence of financial guarantees and options granted to policyholders, whose costs, taking into consideration the current level of interest rates, increase significantly in respect of a further reduction.up.png

Non life and financial segment

According to the requirements of IFRS 7, the impact on the non-life and financial segment of possible changes in interest rates and values of the equity instruments is represented by the impact on the result of the period and on the shareholder’s equity of the Group, net of the corresponding tax effects.

Market risk evaluation has been performed, for both non-life and financial segments, following a bottom up approach and using a full evaluation model which calculates the change in value of each financial instrument caused by applied stress tests (+/- 100bp yield curve change, +/- 10% change for equity).
The market risk evaluation was done on all the financial instruments in the portfolios at the end of the year, both from direct and indirect investments held by funds, and derivatives instruments.

Valuation of impact on Group’s financial statements deriving from possible changes in interest rate was assessed both considering instrument with fixed interest rate (exposing Group to “fair value” risk with impact on equity or result depending on their accounting classification) and with floating interest rate (exposing Group to “cash flow” risk with impact on profit or loss). This impact was assessed considering the 12 month period ending at the reporting date.
The stress test of +/- 100bp on the yield curve and of +/-10% of equity value changes shows:

  • a potential impact on the Group shareholders' equity attributable to the consequent change in the fair value of bonds and equities classified as available for sale(5),
  • a potential impact on the Group's result of the period attributable to the consequent change in the fair value of debt securities and equities classified as financial assets at fair value through profit or loss,
  • a potential impact on the Group's result of the period related to the re-computation on coupon and accrued interest of floating rate securities.

Changes in interest rates and equity prices, net of the related deferred taxes, may have a potential impact on shareholders’ equity. The impact is detailed in the table here below. With regard to the sensitivity on the result of the period, it is not material and therefore considered within the impact on shareholders’ equity.

5 In the sensivity analysis is assumed not to reach the defined impairment triggers.

Sensitivity on non-life and financial Shareholders’equity
(%)
31.12.2011 31.12.2010
Interest rate +1% -443.6 -467.1
Interest rate -1% 462.1 485.8
Equity price +10% 265.4 272.7
Equity price -10% -266.0 -276.5

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