Risk Management

At Eureko, the aim of risk management is to optimise the balance between risk and return, taking only those risks on board which yield an adequate return, creating long-term value for stakeholders and securing the continuity and solvency of the Group. The 2008 financial environment had a significant impact on our business. Through the year we increased our risk monitoring among others by the creation of a taskforce that brings together experts from across the full range of disciplines. Further, we decided that we need to strengthen our risk management organisation. Actions have been taken and include a reinforced risk management organisation.

Managing risk

As an insurer, risk management is an integral part of our business. We have a long-term horizon, specifically in terms of our commitments to customers. Our risk management is organised and driven by that long-term view. We continued implementing market-based principles into the Group’s business planning and control processes and the embedding of those principles into the measurement and management of the Group’s risk profile. We closely follow the developments on Solvency II, the new risk-based regulatory regime for European insurance companies, and IFRS Phase II, which, among others, will require insurance companies to report insurance liabilities at market value in the balance sheet. However, like the majority of organisations that work in financial markets, the reporting year, 2008, threw up realities that resulted in ‘tail’ outcomes on risk assessments. We suffered considerable losses due to impairments on our investment portfolio following rapid falls in equity markets. Widening credit spreads also impacted performance negatively. Therefore, although the basic framework and governance we use to manage our risk are comprehensive, viable and solid, we also identified some areas where our risk management function needs to be strengthened, especially on our Group steering. Actions have been taken to address them.

Framework

Eureko’s risk management framework enables us to identify, assess, measure, manage and monitor the risks to which we are exposed. The framework has been implemented throughout the whole organisation at all levels. At the same time, great effort is put into risk awareness. Risk governance is based on a three-line defence that ensures risk management processes are embedded at every relevant level of the organisation.

A complex of policies and procedures is in place for the management of our risk position. These include risk limits, procedures and contingency plans. Policies and procedures are designed and structured to ensure our risk profile is in line with our strategic risk budget and takes into account relevant regulatory requirements. Policies and procedures are reviewed on a regular basis and updated via the relevant risk committees.

Our risk position is reviewed and evaluated through regular reporting. Risk reporting assesses whether our risk profile is within predefined risk limits and action is taken when necessary. A Eureko Risk Dashboard has been developed and implemented to provide an overview of all key risk indicators. The Group Financial Risk Committee, the Executive Board and the Audit Committee discuss this overview on a quarterly basis. Due to the financial crisis, monitoring frequency was increased substantially and several risks were monitored on a daily basis. Eureko applies several methods and models to measure our risk profile including regulatory and rating models. Furthermore, an economic capital model has been developed to provide an overall view of our Group risk profile.

Economic capital

Economic Capital allows us to quantify our risks per risk category, product group, division, legal entity, and for the Group as a whole using comparable measures of risk, in a consistent and transparent way using market-consistent principles. The results are used more and more as input for day-to-day business, for our investment and reinsurance strategies, but also as input for value management related activities like Embedded Value. The model was further improved during 2008, taking into account recent developments in the insurance industry as a whole, such as the QIS4. Both IFRS and Solvency II have endorsed the ‘Cost of Capital’ approach as a market consistent way to value the unhedgeable risks in insurance liabilities.

Economic Capital by business area

Economic Capital after the impact of diversification as of 31 December 2008 amounted to €3.7 billion. This outcome is based on a maximum loss over a one-year period using a confidence level of 99.95% and after allowance for taxes (i.e. it represents the maximum after-tax loss Eureko is expected to incur following one or a series of extreme events which, in the aggregate, occur with a probability of 1/2000). Economic Capital is categorised by each major business activity. All risks (insurance, market, credit and operational risk) within each major business activity are aggregated.

The investment in PZU is allocated to Life and Non-Life, based on the estimated contribution of PZU’s Life and Non-Life businesses to the combined market value. Eureko’s investments in MillenniumBCP, F&C Asset Management and Friends Provident are included in ‘Other’. Diversification benefits accrue from operating in different business areas, resulting from the notion that not all potential losses will materialise across all businesses at the same time.

The decrease of our Economic Capital is mainly due to decreased market risk as a result of lower exposure to equity risk.

Economic Capital by risk type

Market risk and the insurance risk associated with the Non-Life business dominate Economic Capital. Market risk reflects the net exposure to the capital markets, including equity, property and fixed income. The risks resulting from our non-consolidated strategic investments are also included in market risk. The market risk decreased significantly mainly a result of a hedge of the largest part of the equity portfolio.

Non-Life insurance risk concerns mostly the exposure to European storm risk, which at the confidence level of 99.95% is quite substantial as we have chosen to accept this risk and not to obtain reinsurance protection above the confidence level of 99.5%. Life risk has increased as we have taken more severe scenarios for longevity risk and also included a pandemic scenario in mortality risk. Business risk has also increased as the lapse risk on some life products grew because the potential impact of lapses is more servere due to decreased interest rates.