Risk Categories

Our main risk categories are insurance risk, market risk, credit risk, liquidity risk and operational risk.

Insurance risk

Eureko is engaged in selling a full range of life, non-life, disability and health insurance products. The risks are primarily managed through standard underwriting policies, reserve adequacy testing and our reinsurance policy. Underwriting includes product design review processes and risk limitations related to insurance policy terms and conditions with the customer.

In the life insurance business the main risks are longevity, mortality and morbidity, policy lapses and expense risk. These risks are monitored regularly based on historic and current data. We regularly make sensitivity analyses to calculate the impact on our Embedded Value.

In the non-life and health sectors the main risks are fire, hail, storm, motor accident, pandemic risk, disability risk and health risk. Mitigation of these risks is managed primarily through risk diversification within and between business lines and, for larger risks, through reinsurance. Although measured in gross written premiums, Health is our largest business, health risk is very limited due to the equalisation funds in the Dutch health system.

Reinsurance

In general, large risks are covered by excess of loss treaties. Risks that exceed the treaty limit are reinsured on a facultative basis. Catastrophe risks, such as wind storm, hail or earthquake are covered by catastrophe excess of loss treaties. The main danger in the Netherlands is wind-storm risk. The upper limits are based on 1 in 200-year events. The upper limit for the Dutch 2009 property catastrophe programme is €1,275 million and for the greenhouses catastrophe programme €235 million. In 2008, Eureko participated for 40% in the top layer to optimise the risk-return profile. For 2009, Eureko has placed 100% of the top layer in the market to reduce the risk profile. In the current financial climate, the market has hardened rapidly, primarily due to cost of capital. This is reflected in the pricing for 2009.

Market risk

Our main source of market risk is the investment portfolio and our strategic investments. Eureko manages market risk positions on its investment portfolio within an Asset and Liability Management (ALM) framework. It is a key tool in determining the investment mix, management of interestrate exposure and regulatory solvency. We have been hit hard by the rapid decline of equity prices and the equally fast increase in credit spreads – these are two of the primary risks within the market category. Others are regular interest-rate, property and foreign-exchange rate risk. Eureko has an investment policy in place to manage market risk. The decision to maintain only a limited exposure to asset backed securities proved a wise one. Given our exposure to listed equity (7% of our investments), at the beginning of 2008, Eureko decided to hedge a significant part of the downside risk. However, this could not prevent considerable losses. We have decided to continue reducing exposure to equity risk in 2009.

Equity risk
Our equity risk management and mitigation was tested to the hilt in 2008. Eureko is obliged to report serious losses on the equity component in its investment portfolio. Impairments are €1,054 million. The derivative contract we put in place in May 2008 to hedge the risk of decreasing equity prices for our Dutch insurance entities proved foresighted. The option contract can be broken down into two separate call-put combinations (equity collar) with different maturities. In both cases the put option had, at the time of purchase, a strike price of 70% of the underlying equity basket and the call option had a strike price of 130% of the underlying equity basket. The notional amount of both combinations is €3.2 billion. The fair value movements on the equity hedge included in Profit before tax amounted to €251 million. At year-end 2008, our exposure to listed equity was €2 billion.

Interest-rate risk
Eureko bears interest-rate risk with many of its insurance and investment products. Investing in assets that closely match the expected cash flow of the insurance liabilities of each major legal entity can and generally does mitigate this risk. Our duration matching is managed on an economic, rather than accounting basis. Derivative instruments, such as swaps and swaptions, are used to mitigate the risk that changes in interest rates can affect the market value of liabilities in a different way than the related assets.

Some life products contain minimum guarantees. If the return on the underlying assets is insufficient to cover the guarantee, then Eureko is obliged to supplement the shortfall. Eureko has a hedging programme in place for these interest-rate risks.

Property risk
As part of our diversification strategy we also invest in direct and indirect property. At year-end 2008, total investments in direct investment property amounted to €1.5 billion (4%) of total investment portfolio. The greater part is invested in direct real estate in the Netherlands, with a sound spread over all major categories, including residential, office, retail and industrial premises. Indirect unquoted investments in Europe and the US have the same diversifying effects. We have no exposure to the US sub-prime market.

Foreign-exchange rate risk
As an international group, Eureko is exposed to foreign exchange risk. Eureko has not hedged the net investment in, or the income streams from, its non-euro operations, the main exposures being the Polish zloty, through the investment in PZU, the pound sterling, through the investments in F&C Asset Management, and the Turkish lira, through the investments in Eureko Sigorta and Garanti Emeklilik, and the Russian rouble through our recently-acquired Oranta. In addition, Eureko invests part of its regular investment portfolio, both equities and fixed income, in non-euro denominated assets, particularly in US dollars. At the end of 2008, the investment portfolio was fully hedged.

Credit risk

Credit risk associated with Eureko’s investment activities and banking activities is managed within diversified investment portfolios and generic and specific risk limits. Eureko deals with counterparties of good credit standing and, when appropriate, obtains collateral. The financial crisis showed us that even counterparties with good credit standing were not immune and we have increased our counterparty monitoring procedures and frequency considerably. In a limited number of special cases, we bought protection with credit default swaps. Master netting agreements provide for the net settlement of contracts with the same counterparty in the event of default. Credit risk in the fixed income portfolio is managed based on limits for each rating category. However, impairments in 2008 still amounted to €71 million (2007: no impairments). The following table provides information regarding the aggregated credit risk exposure for financial assets with external credit ratings:

The counterparty exposures on reinsurers are managed by a set of limits per reinsurer and thresholds per rating category, based on a weighted exposure of claim reserves, reinsurance premiums and catastrophe capacity. The minimum rating is A- (S&P or AM Best) for short tail contracts and A+ (S&P) for long tail contracts.

Liquidity risk

We distinguish between funding and market liquidity risk. The former is the risk that counterparties will withdraw or not roll over on short-term funding. An overview of how we manage our funding and related risk is included in Capital and Liquidity management. Eureko’s banking subsidiaries have access to a diversified funding base. Funds are raised through a range of instruments. In the current financial crisis, we expect some funding sources are more appropriate, others unavailable. In 2009, we expect liquidity will be tight but manageable. The aim is to maintain a balance between continuity of funding and flexibility through the use of liabilities with a range of maturities.

Market liquidity risk
This is the risk that general disruption in asset markets will make normally liquid assets illiquid. Contingency planning enables Eureko holding companies to operate for a minimum of 90 days without any access to financial markets. The insurance entities must hold sufficient liquid/ marketable assets of their own.

Operational risk

We define operational risk as the risk of loss resulting from inadequate or failed internal processes, people and systems or from external events. Operational risks, as specified in the risk control framework used throughout Eureko, encompass a wide variety of risk arising from amongst others: processes, information and communication technology, project management, information security, fraud, compliance, safety and business continuity. Eureko has in place a comprehensive internal control procedure for operational risk. An Internal Control Statement (ICS) is compiled annually to provide a fair view of risk exposure and level of control over the internal organisation and its processes. All divisions and operating companies are required to complete an Internal Control Statement, demonstrating that the outcome is a true representation of both exposure and control levels. All Internal Control Statements are subject to assessment by the Group Audit and Risk Services department. The Executive Board is also involved in the process as the Board performs its own self-assessment of risk exposures and control levels and discusses the results. The outcome of the ICS process shows that the business entities were able to address the most important risk issues and to improve their control level where necessary.

Compliance risk
This is the risk of legal or regulatory sanctions, material financial loss, or loss of reputation that a financial institution may suffer as a result of its failure to comply with laws, regulations, rules, related self-regulatory organisation standards, and codes of conduct applicable to its activities. Eureko has in place a risk framework to manage and mitigate this risk – the Eureko Compliance Programme.

Within this framework, compliance with rules and regulations and their integration into procedures is secured through three integrated lines of defence. The ambitious Compliance Programme is characterised by an entrepreneurial and risk-based approach. The emphasis lies on embedding compliance into daily business practice and Eureko’s risk management framework. In addition to activities related to the implementation of the Eureko Compliance Programme, in 2008 the focus was on implementing rules and regulations, including those related to a new incidents policy and a whistle-blower’s charter. A further focus point was developing instruments to enhance compliance awareness within the organisation. Based on the compliance awareness plans of the Dutch divisions, these instruments have been used from the beginning of 2008.