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 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 6.0
Direct Equity exposure 9,123   10,431  
IFU and alternative investments 6,528   6,666  
Fixed income instruments 280,542 87.7 242,984 85.4
Government bonds 138,760   115,371  
Corporate bonds 110,108   97,346  
Loans (oth. fixed income investments) 22,506   22,253  
IFU bonds 9,167   8,013  
Land and buildings 23,850 7.5 24,372 8.6
RE Investment properties 18,209   18,590  
Self-used real estates 3,477   3,542  
IFU real estates 2,165   2,240  
Total 320,043 100.0 284,455 100.0

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.

Group’s exposures to investments in equities - detailed by sector and country of risk of investees - as well as to direct real estate investments - detailed by country of location - are reported at fair values in the following tables:

Breakdown of equity investments by sector of location
  31.12.2012  
(€ million)Total fair value Impact (%)
Equity instruments 15,652  
Financial 3,269 20.9
Consumer 1,433 9.2
Utilities 850 5.4
Industrial 1,003 6.4
Other 2,569 16.4
Alternative funds 2,408 15.4
Asset allocation funds 4,120 26.3

The total exposure to equity instruments at the end of the period amounted to € 15,652 million. With reference to the composition of direct equity investments the main sectors the Group is exposed are financial (35.9%), consumer (15.8%), industrial (11.1%) and utilities (9.4%). The category “other” mainly includes  telecommunications, materials and energy sectors equities.

Breakdown of direct equity investments by country of risk
  31.12.2012 
(€ million) Total fair value Impact (%)
Direct equity investments 9,123  
Italy 2,956 32.4
France 1,966 21.6
Germany 992 10.9
Central and Eastern Europe 201 2.2
Rest of Europe 2,477 27.2
Spain 457 5.0
Austria 168 1.8
Switzerland 367 4.0
The Netherlands 310 3.4
United Kingdom 342 3.8
Others 833 9.1
Rest of world 531 5.8

The direct equity exposure totalled € 9.123 million, principally invested in Italy (32.4%), France (21.6%) and Germany (10.9%)

Breakdown of direct real estate investments by country of location
  31.12.2012   31.12.2012  
  Investment properties 
Self-used real estates 
(€ million) Total fair value Impact (%) Total fair value Impact (%)
Direct Real-estate investments 18,209   3.477  
Italy 6,912 38.0 1,377 39.6
France 4,921 27.0 423 12.2
German 2,555 14.0 720 20.7
Central and Eastern Europe 170 0.9 89 2.5
Rest of Europe 3,449 18.9 767 22.1
Spain 722 4.0 135 3.9
Austria 1,198 6.6 135 3.9
Switzerland 904 5.0 464 13.3
Others626 3.4 34 1.0
Rest of world
201 1.1 101 2.9

The direct exposure to Real estate investments was of € 21,686 of which € 18,209 million of investment properties and € 3,477 of properties with self-used destination. Real estate investments were mainly focussed in western European countries, mainly in Italy (38.2%), France (24.6%) and Germany (15.1%).

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.

Life embedded value sensitivities: Market Risks
(%) 31.12.2012 31.12.2011
Interest rate +1% 8.4
12.1
Interest rate -1% -15.3 -17.2
Equity price -10% -4.0 -4.8
Property price -10% -2.8 -2.8

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 2012 showed that the Company suffered 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(3),
  • 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.

Sensitivity on non-life and financial Shareholders’equity
(%) 31.12.2012 31.12.2011
Interest rate +1% -546 -443
Interest rate -1% 527 462
Equity price +10% 209 265
Equity price -10% -210 -266
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(3)In the sensitivity analysis is assumed not to reach the defined impairment triggers.

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

(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.