Investment risk

Financial Risks

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 2012 the investments whose market risk affects the Group were of € 320 billion at market value(1).

  31.12.2012  31.12.2011 
(€ million) Total fair value Impact (%) Total fair value Impact (%)
Equity instruments 15,652 4.9 17,098.0 6.0
Direct Equity exposure 9,123   10,431.5  
IFU and alternative investments 6,528   6,666.5  
Fixed income instruments 280,542 87.7 242,984.6 85.4
Government bonds 138,76   115,371.8  
Corporate bonds 110,108   97,346.0  
Loans (oth. fixed income investments) 22,506   22,253.5  
IFU bonds 9,167   8,013.2  
Land and buildings 23,85 7.5 24,372.6 8.6
RE Investment properties 18,209   18,590.1  
Self-used real estates 3,477   3,542.4  
IFU real estates 2,165   2,240.1  
Total 320,043 100.0 284,455.2 100.0

The exposure to fixed income instruments, expressed as percentage of investments bearing market risks, as defined above,  increased to 87.7% (85.4% as at 31 December 2011) while the exposure to equity instruments decreased to 4.9% (6.0% as at 31 December 2011). In decrease also real estate investments that moved from 8.6% to 7.5%.

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.

Credit Risk

Financial Instruments Credit Risk

Credit risk refers to possible losses arising from a counterparty failing to meet its obligations (default) or from a deterioration in its creditworthiness (downgrade or migration), respectively, in relation to debt instruments the Group invests in or to a counterparty of a derivative contract. Furthermore, the risk resulting from a generalized increase in the level of spreads in the market is considered, due to events such as a credit crunch or a liquidity crisis, having an impact on the economic solvency of the Group.

Within the Group Risk Guidelines, investment in high credit quality securities (investment grade) is preferred and the diversification (or dispersion) of risk is encouraged.

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.

For the internal rating assessment of an issue or issuer, rating of the main agency ratings are used. In the case of different rating judgements, the second best value available is used. Securities without a rating are given an internal one based on exhaustive economic and financial analysis.

The manager of the central financial risk control department reports periodically to the Group Risk Committee on the Groups’ exposure to the components of the credit risk.

The portfolio of fixed income investments of the Group is prudently built.

The distribution by rating class shows that the absolute majority of the fixed income investments is of high rating standing.

In order to mitigate the counterparty risk, related to market risk hedging strategies, the following measures have been put in place: the counterparty selection, the use of exchange traded instruments and the integration of ISDA Master Agreements with the Credit Support Annex (CSA). CSA requires the counterparty to post collateral when the derivative position is beyond an agreed threshold.

Note that the same considerations on market risk regard also the financial instruments backing  life insurance policies, so default, downgrades or changes in spread could affect the financial liabilities values with a consequent mitigation effect.

Amongst the financial assets not impaired, there are no significant positions of debt past due, whereas the main part of the receivables arising from insurance operations are included in the Group assets since three months.

Group’s exposures to investments in government bonds - detailed by country of risk and rating - are reported at fair value in the following tables:

Breakdown of investments in government bonds by country of risk
  31.12.2012      
(€ million) Total fair value Impact (%) of which home-country Impact (%)
Government bonds 138,760      
Italy 59,715 43.0 55,331 92.7
France 26,439 19.1 20,718 78.4
Germany  10,958 7.9 8,270 75.5
Central and Eastern Europe 8,317 6.0 6,022 72.4
Rest of Europe 20,928 15.1 10,236 48.9
Spain 5,442 3.9 4,018 73.8
Austria 3,825 2.8 2,090 54.6
Belgium 7,002 5.0 1,949 27.8
Others 4,659 3.4 2,179 46.8
Rest of world 5,925 4.3 4,238 71.5
Supranational 6,478 4.7 na na
Breakdown of investments in government bonds by rating
  31.12.2012   31.12.2011  
(€ million) Total fair value Impact (%) Total fair value Impact (%)
Government bonds 138,760   115.372  
AAA 18,863 13.6 38,118 33.0
AA 43,505 31.4 21,516 18.6
A 3,760 2.7 47,891 41.5
BBB 69,592 50.2 4,496 3.9
Non investment grade 2,884 2.1 3,194 2.8
Not Rated 156 0.1 158 0.1

The government bonds portfolio amounted to € 138,760 million at the end of the period, with the 62% of the portfolio represented by Italian and French debt instruments. The exposure to individual sovereign bonds is mainly allocated to their respective countries of operation.

With reference to ratings, the AA class included the French debt instruments following their downgrade by both S&P’s (AA+, 13 January 2012) and Moody’s (Aa1, 19 November 2012). The BBB rating class included mainly the Italian debt instruments following their downgrade by both S&P’s (13 January 2012) and Moody’s (Baa2, 13 July 2012).

Group’s exposures to investments in corporate bonds - detailed by sector and rating- are reported at fair value in the following tables:

Breakdown of direct investments in corporate bonds by sector
  31.12.2012  
(€ million) Total fair value Impact (%)
Corporate bonds 110,108  
Financial  36,909 33.5
Covered Bonds 34,259 31.1
Asset-backed 2,331 2.1
Utilities 9,301 8.4
Industrial 9,413 8.5
Consumer 5,533 5.0
Telecommunication services 5,674 5.2
Energy 3,033 2.8
Other 3,656 3.3
Breakdown of direct investments in corporate bonds by rating
  31.12.2012   31.12.2011  
(€ million) Total fair value Impact (%) Total fair value Impact (%)
Corporate bonds 110,108   97,346  
AAA 32,179 29.2 32,387 33.3
AA 8,672 7.9 10,636 10.9
A 33,933 30.8 33,685 34.6
BBB 28,474 25.9 16,659 17.1
Non investment grade 4,878 4.4 1,975 2.0
Not Rated 1,972 1.8 2,005 2.1

The investments in corporate bonds totalled € 110,108 million at the end of the period. The portfolio was composed for 33% by non-financial corporate bonds, for 34% by financial corporate bonds and for 31% by covered bonds.

(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.