E.4. Market risk
Unexpected movements in prices of equities, real estate, currencies and interest rates might negatively impact the market value of the investments.
These assets are invested to meet the obligation towards both life and non-life policyholders and to earn a return on capital expected by the shareholders. The same changes might affect both assets and the present value of the insurance liabilities.
The market risk of the Company’s investment portfolios’ financial assets and liabilities is monitored and measured on a regular basis, using Generali Group’s Internal Model (compared to Standard Formula pre-defined by EIOPA, it allows the Company to better reflect company-specific risks) and other methods (cash-flow matching, duration analysis, etc.). Risks are monitored on a fair value basis.
E.4.1. Interest rate risk
The Company’s operations are subject to the risk of interest rate fluctuations to the extent that interest-earning assets (including investments) and interest-bearing liabilities mature or reprice at different times or in differing amounts. In the case of floating rate assets and liabilities, the Company is also exposed to an interest rate cash flow risk, which varies depending on the different repricing characteristics of the various floating rate instruments.
Interest rate derivatives are primarily used to bridge the mismatch in the repricing of assets and liabilities. In some cases derivatives are used to convert certain interest-earning assets to floating or fixed rates to reduce the risk of losses in value due to interest rate changes or to lock in spreads.
The Company monitors the sensitivity of financial assets and liabilities to various standard and non-standard interest rate scenarios. Standard scenarios that are considered on a monthly basis include a 100 basis point (bp) parallel fall or rise in all yield curves worldwide. Unit-linked instruments are excluded from sensitivities due to the fact that investment risk is borne by the policyholders. The following table shows this sensitivity analysis at year end, before and after the related taxes. The overall impact on the Company’s position is the result of sensitivity analysis on both the asset and liability side that creates a mitigating effect.
| In CZK million, as at 31 December 2016 | Current value | 100bp parallel increase | 100bp parallel decrease | ||
|---|---|---|---|---|---|
| Income statement | Shareholders' equity | Income statement | Shareholders' equity |
||
| Loans and receivables | 8,540 | – | – | – | – |
| Bonds | |||||
| Bonds AFS | 55,259 | – | – | – | – |
– gross impact on fair value | – | (441) | (3,480) | 466 | 4,440 |
– income tax charge /(credit) | – | 84 | 661 | (89) | (844) |
| Bonds FVTPL | 2,386 | – | – | – | – |
– gross impact on fair value | – | (64) | – | 67 | – |
– income tax charge /(credit) | – | 12 | – | (13) | – |
| Derivatives | |||||
| Derivatives FVTPL | (754) | – | – | – | – |
– gross impact on fair value | – | 626 | – | (668) | – |
- income tax charge /(credit) | – | (119) | – | 127 | – |
| In CZK million, as at 31 December 2015 | Current value | 100bp parallel increase | 100bp parallel decrease | ||
|---|---|---|---|---|---|
| Income statement | Shareholders’ equity | Income statement | Shareholders’ equity |
||
| Loans and receivables | 1,780 | – | – | – | – |
| Bonds | |||||
| Bonds AFS | 54,806 | – | – | – | – |
– gross impact on fair value | – | (478) | (3,400) | 507 | 4,332 |
– income tax charge /(credit) | – | 91 | 646 | (96) | (823) |
| Bonds FVTPL | 3,194 | – | – | – | – |
– gross impact on fair value | – | (91) | – | 96 | – |
– income tax charge /(credit) | 17 | – | (18) | – | |
| Derivatives | |||||
| Derivatives FVTPL | (1,004) | – | – | – | – |
– gross impact on fair value | – | 594 | – | (631) | – |
– income tax charge /(credit) | – | (113) | – | 120 | – |
E.4.2. Asset liability matching
A substantial part of insurance liabilities carries an interest rate risk. Asset-liability management is significantly involved in interest rate risk management. The management of interest rate risk, implied from the net position of assets and liabilities, is a key task of asset-liability management.
GCEE has Local Investment Committee which is an advisory body of the Board of Directors of the Company and is in charge of the most strategic investment and ALM-related decisions. The Committee is responsible for setting and monitoring the GCEE Group’s strategic asset allocation in the main asset classes, i.e. government and corporate bonds, equities, real estate, etc. and also the resulting asset and liability strategic position. The objective is to establish appropriate return potential together with ensuring that the GCEE Group can always meet its obligations without undue cost and in accordance with the GCEE Group’s internal and regulatory capital requirements. In order to guarantee the necessary expertise and mandate, the Committee consists of representatives of top management, asset management, risk management and ALM experts from business units.
The ALM manages the net asset-liability positions in both, life and non-life insurance, with the main focus on traditional life with the long-term nature and often with embedded options and guarantees. The insurance liabilities are analysed, including the embedded options and guarantees and models of future cash flows are prepared in cooperation with actuaries. The models allow for all guarantees under the insurance contracts and for expected development of the key parameters, primarily mortality, morbidity, lapses and administration costs.
At first, government bonds are used to manage the net position of assets and liabilities and in particular its sensitivity to parallel and non-parallel shifts in the yield curve. Next corporate bonds and derivatives, primarily interest rate swaps, can be used. However, in line with the credit risk management policy, investments in long-term and thus also in high-duration instruments focus on government bonds. The use of interest rate swaps is limited due to their accounting treatment – as their revaluation which is reported in the income statement does not match with the reporting of the insurance liabilities.
There is a strategic target asset-liability interest rate position set within the strategic asset allocation process (SAA). With the goals being a) to deliver rates of return that are in line with both, commercial needs and strategic planning targets, and b) that the overall SAA, including equity, credit, real estate allocation and also including the strategic asset & liability duration position, is in line with the risk and capital management policy. In addition to the management of the strategic position, there are certain limits allowed for tactical asset managers’ positions, so that asset interest rate sensitivity can deviate from the benchmark in a managed manner.
E.4.3. Equity price risk
Equity price risk is the risk that equity prices will fluctuate affecting the fair value of equity investments and other instruments that derive their value from a particular equity investment or index of equity prices.
The Company manages its use of equity investments in response to changing market conditions using the following risk management tools:
a) the portfolio is diversified,
b) the limits for investments are set and carefully monitored.
Following table shows the sensitivity analysis in compliance with IFRS as at the year end, before and after the related deferred taxes.
| In CZK million, as at 31 December 2016 | Current value | Equity price +10% | Equity price -10% | ||
|---|---|---|---|---|---|
| Income statement | Shareholders’ equity | Income statement | Shareholders’ equity |
||
| Equities | |||||
| Equities AFS | 5,353 | – | – | – | – |
- gross impact on fair value | – | – | 535 | – | (535) |
- income tax charge /(credit) | – | – | (102) | – | 102 |
| Total net impact | – | – | 433 | – | (433) |
| In CZK million, as at 31 December 2015 | Equity price +10% | Equity price -10% | |||
|---|---|---|---|---|---|
| Current value | Income statement | Shareholders’ equity | Income statement | Shareholders’ equity | |
| Equities | |||||
| Equities AFS | 7,226 | – | – | – | – |
- gross impact on fair value | – | – | 723 | – | (723) |
- income tax charge /(credit) | – | – | (137) | – | 137 |
| Total net impact | – | – | 586 | – | (586) |
| Derivatives* | |||||
| Derivatives FVTPL | 2 | – | – | – | – |
* Derivatives included in the table above are only those sensitive to equity price risk.
E.4.4. Currency risk
The Company is exposed to currency risk through transactions in foreign currencies and through its assets and liabilities denominated in foreign currencies. As the currency in which the Company presents its financial statements is CZK, movements in the exchange rates between selected foreign currencies and CZK affect the Company’s financial statements.
The general strategy of the Company is to fully hedge currency risk exposure. The Company ensures that its net exposure is kept on an acceptable level by buying and selling foreign currencies at spot rates when considered appropriate, or using short-term FX operations. The FX position is regularly monitored and the hedging instruments are reviewed on a monthly basis and adjusted accordingly. Derivative financial instruments are used to manage the potential earnings impact of foreign currency movements, including currency swaps, spot and forward contracts. When suitable other instruments are also considered and used.
The Company’s main foreign exposures are to European countries and the United States of America. Its exposures are measured mainly in Euros (“EUR”) and U.S. Dollars (“USD”).
The currency exposure is shown in the following tables.
The following table shows sensitivities of the portfolio to changes in currency risk. The portfolio does not contain instruments covering unit-linked policies, as the investment risk is transferred from the Company to the policyholder. Currency shocks are considered to be a rise or a fall in the value of foreign currency position by a specified percentage. This approach is in line with the Solvency II definition of the currency risk.
Due to hedge accounting, the impact of potential increase or decrease of foreign exchange rates is limited and recognized through the income statement.
The following table shows sensitivities of the investment portfolio (including derivatives classified as financial liabilities) to change in currency risk.
| In CZK million, as at 31 December 2016 | EUR | USD | CZK | Other | |||||
|---|---|---|---|---|---|---|---|---|---|
| Current value | 10 % | -10 % | 10 % | -10 % | 10 % | -10 % | 10 % | -10 % | |
| FX investment portfolio exposure | 70,705 | – | – | – | – | – | – | – | – |
| Income statement | |||||||||
– Impact on income statement | – | 564 | (564) | 137 | (137) | – | – | 57 | (57) |
– Income tax charge /(credit) | – | (107) | 107 | (26) | 26 | – | – | (11) | 11 |
| In CZK million, as at 31 December 2015 | EUR | USD | CZK | Other | |||||
|---|---|---|---|---|---|---|---|---|---|
| Current value | 10 % | -10 % | 10 % | -10 % | 10 % | -10 % | 10 % | -10 % | |
| FX investment portfolio exposure | 68,498 | – | – | – | – | – | – | – | – |
| Income statement | |||||||||
– Impact on income statement | – | 217 | (217) | 21 | (21) | – | – | 11 | (11) |
– Income tax charge /(credit) | – | (41) | 41 | (4) | 4 | – | – | (2) | 2 |
The following table shows sensitivities of the insurance liabilities to change in currency risk.
| In CZK million, as at 31 December 2016 | EUR | USD | CZK | Other | |||||
|---|---|---|---|---|---|---|---|---|---|
| Current value | 10 % | -10 % | 10 % | -10 % | 10 % | -10 % | 10 % | -10 % | |
| FX insurance liabilities exposure | 56,982 | – | – | – | – | – | – | – | – |
| Income statement | |||||||||
– Impact on income statement | – | (131) | 131 | (5) | 5 | – | – | – | – |
– Income tax charge /(credit) | – | 25 | (25) | 1 | (1) | – | – | – | – |
| In CZK million, as at 31 December 2015 | EUR | USD | CZK | Other | |||||
|---|---|---|---|---|---|---|---|---|---|
| Current value | 10 % | -10 % | 10 % | -10 % | 10 % | -10 % | 10 % | -10 % | |
| FX insurance liabilities exposure | 60,099 | – | – | – | – | – | – | – | – |
| Income statement | |||||||||
– Impact on income statement | – | (126) | 126 | (3) | 3 | – | – | (23) | 23 |
– Income tax charge /(credit) | – | 24 | (24) | 1 | (1) | – | – | 4 | (4) |
The following table shows the composition of financial assets and liabilities with respect to the main currencies:
| In CZK million, as at 31 December 2016 | EUR | USD | CZK | Other | Total |
|---|---|---|---|---|---|
| Loans | 493 | – | 8,047 | – | 8,540 |
| Financial assets available-for-sale | 18,982 | 8,862 | 31,063 | 1,705 | 60,612 |
| Financial assets at fair value through profit or loss | (4,734) | 331 | 15,786 | (868) | 10,515 |
| Reinsurance assets | 1 | 11 | 9,678 | 7 | 9,697 |
| Receivables | 2,022 | 140 | 3,949 | 149 | 6,260 |
| Cash and cash equivalents | 251 | 138 | 2,340 | 40 | 2,769 |
| Total assets | 17,015 | 9,482 | 70,863 | 1,033 | 98,393 |
| Insurance liabilities | 1,306 | 52 | 63,223 | 191 | 64,772 |
| Financial liabilities | 294 | 697 | 7,604 | 29 | 8,624 |
| Payables | 416 | 201 | 7,122 | 10 | 7,749 |
| Other liabilities | – | – | 2,054 | – | 2,054 |
| Total liabilities | 2,016 | 950 | 80,003 | 230 | 83,199 |
| Net foreign currency position | 14,999 | 8,532 | (9,140) | 803 | 15,194 |
| In CZK million, as at 31 December 2015 | EUR | USD | CZK | Other | Total |
|---|---|---|---|---|---|
| Loans | 363 | – | 3,752 | – | 4,115 |
| Financial assets available-for-sale | 17,723 | 9,177 | 33,164 | 1,968 | 62,032 |
| Financial assets at fair value through profit or loss | (4,374) | (5112) | 22,370 | (1535) | 11,349 |
| Reinsurance assets | 2 | – | 9,780 | 8 | 9,790 |
| Receivables | 1,418 | 85 | 3,924 | 659 | 6,086 |
| Cash and cash equivalents | 134 | 97 | 1,649 | 66 | 1,946 |
| Total assets | 15,266 | 4,247 | 74,639 | 1,166 | 95,318 |
| Insurance liabilities | 1,264 | 29 | 66,169 | 230 | 67,692 |
| Financial liabilities | 710 | 61 | 2,395 | – | 3,166 |
| Payables | 381 | 157 | 7,262 | 19 | 7,819 |
| Other liabilities | – | – | 1,882 | – | 1,882 |
| Total liabilities | 2,355 | 247 | 77,708 | 249 | 80,559 |
| Net foreign currency position | 12,911 | 4,000 | (3,069) | 917 | 14,759 |
E.4.5. Risk limits
The principal tools used to measure and control market risk exposure within the Company’s investments portfolios are a System of Investment Risk Limits.
This covers single and total limits on credit concentration, foreign currency, interest rate and equity risks. The primary aim of the system of limits is to control exposure to single types of risk. Limits are monitored on daily basis and allow Risk Management to take immediate action and actively manage the level of the undertaken risks.