6.5 Risk profile

UNIQA’s risk profile is very heavily influenced by life insurance and health insurance portfolios in UNIQA Österreich Versicherungen AG. This situation means that market risk plays a central role in UNIQA’s risk profile. The composition of market risk is described in the section “Market risk”.

The subsidiaries in Central Europe (CE: Hungary, Czech Republic, Slovakia and Poland) operate insurance business in the property and casualty segment and in the life and health insurance segment.

In the regions of Southeastern (SEE) and Eastern Europe (EE), insurance business is currently conducted primarily in the property and casualty segment, in particular in the motor vehicle insurance segment.

This structure is important to UNIQA, because it creates a high level of diversification from the life and health insurance lines dominated by the Austrian companies.

The distinctive risk features of the regions are also reflected in the risk profiles determined by using the internal measurement approach.

After every calculation for the life, non-life and composite insurers at UNIQA, benchmark profiles are created and compared with the risk profile for each company. The benchmark profiles show that, for composite insurers, there is a balance between market and actuarial risk. Composite insurers are also in a position to achieve the highest diversification effect.

Market and credit risks

Market and credit risks have different weightings and various degrees of seriousness, depending on the investment structure. The table below shows investments classified by asset category.

The effects of the market and credit risks on the value of investments also influence the level of actuarial liabilities. Thus, there is – particularly in life insurance – a dependence between the growth of assets and liabilities from insurance contracts. UNIQA monitors the income expectations and risks of assets and liabilities arising from insurance contracts as part of the asset liability management (ALM) process. The objective is to achieve a return on capital that is sustainably higher than the technical liabilities carried forward while retaining the greatest possible security. To do this, assets and liabilities are allocated to different accounting groups.

The following two tables show the main accounting groups generated by the various product categories.

These values refer to the following statement of financial position items:

• Property, plant and equipment
• Investment property
• Equity investments accounted for using the equity method
• Investments
• Unit-linked and index-linked life insurance investments
• Current bank balances and cash-in-hand

These values refer to the following statement of financial position items:

• Technical provisions
• Technical provisions for unit-linked and index-linked life insurance
• Reinsurance liabilities (only securities account liabilities from reinsurance ceded)
• Reinsurers’ share of technical provisions
• Reinsurers’ share of technical provisions for unit-linked and index-linked life insurance

Interest rate risk

Interest rate risk arises on all statement of financial position asset and liability items the value of which fluctuates as a result of changes in risk-free yield curves or associated volatility. Given the investment structure and the high proportion of interest-bearing securities in the asset allocation, interest rate risk forms an important part of market risk. However, a structural reduction to the interest rate risk has been achieved in recent years as a result of the ALM-based investment strategy implemented in 2012.

The following table shows the maturity structure of interest-bearing securities and bonds reclassified as loans. The actual interest rate is calculated using the weighted average returns and in terms of the purchase price is an average of 2.13 per cent with fixed-income securities.

In comparison with this, the next table shows the insurance provision before reinsurance in health and life insurance and the gross provision for unsettled insurance claims in non-life insurance, broken down into annual brackets. In health and life insurance the breakdown takes place using expected cash flows from the ALM process.

Due to the particular importance of the ALM process in life insurance, the focus will be placed on this segment. For practical reasons, it is not possible to fully achieve the objective of matching cash flows for assets and liabilities. The duration of the assets in life insurance is 8.1 years, while for liabilities it is longer. This is referred to as a duration gap. It gives rise to an interest rate risk which in the Solvency II risk capital calculation must be backed by capital. The discount rate that may be used in the costing when new business is written is based in most UNIQA companies on a maximum discount rate imposed by the relevant local supervisory authority. In all those countries in which the maximum permissible discount rate is not imposed in this way, appropriate prudent, market-based assumptions are made by the actuaries responsible for the calculation. In our core market of Austria, the maximum interest rate from 1 January 2017 is 0.5 per cent per year. However, the portfolio also includes older contracts with different discount rates. In the relevant markets of the UNIQA Group, these rates amount to as much as 4.0 per cent per year.

The following table provides an indication of the average discount rates for each region.

As these discount rates are guaranteed by the insurance company, the financial risk lies in not being able to generate these returns. Because classic life insurance business predominantly invests in interest-bearing securities (bonds, loans, etc.), the unpredictability of long-term interest rate trends is the most significant financial risk for a life insurance company. Investment and reinvestment risk arises from the fact that premiums received in the future must be invested to achieve the rate of return guaranteed when a policy is written. However, it is entirely possible that no appropriate securities will be available at the time the premium is received. In the same way, future income must be reinvested to achieve a return equivalent to at least the original discount rate. For this reason, UNIQA has already decided to offer products to its key markets that are only based on a low or zero discount rate.

Spread risk

Since the interest rate risk has been reduced significantly through the ALM process, the spread risk, also stemming predominantly from interest-bearing securities, represents the biggest market risk in terms of the standard approach under Solvency II. Spread risk refers to the risk of changes in the price of asset or liability items in the financial statement, as a consequence of changes in credit risk premiums or associated volatility, and under Solvency II is ascertained for individual securities in accordance with their rating and duration. When investing in securities, UNIQA chooses securities with a wide variety of ratings, taking into consideration the potential risks and returns.

The following table shows the credit quality of those interest rate-sensitive securities that are neither overdue nor written down, based on their ratings.

Equity risk

Equity risk arises from movements in the value of equities and similar investments as a result of fluctuations in international stock markets and therefore stems in particular from the asset categories of shares and investments. The effective equity weighting is controlled by hedging with the selective use of derivative financial instruments.

UNIQA’s equity risk from investments in shares and equity as at the reporting date has been reduced as part of the process in recent years to implement an ALM-based investment strategy, and now only plays a subordinate role in the composition of the ECR market risk.

Currency risk

Currency risk is caused by fluctuations in exchange rates and associated volatility. Given the international nature of the insurance business, UNIQA invests in securities denominated in different currencies, thus following the principle of ensuring matching liabilities with assets in the same currency to cover liabilities at the coverage fund or company level. Despite the selective use of derivative financial instruments for hedging purposes, it is not always possible on cost grounds or from an investment point of view to achieve complete and targeted currency matching between the assets and liabilities. As in the previous year, the greatest component of this risk arises from investments in US dollars. The following table shows a breakdown of assets and liabilities by currency.

Liquidity risk

Ongoing liquidity planning takes place in order to ensure that UNIQA is able to meet its payment obligations over the next twelve months. A minimum amount of cash reserves which must be available daily is also defined at Group Management Board level for the individual companies according to their business model.

Investments are aimed at maximum possible (even if not complete) matching of maturities as part of the ALM process, to ensure coverage for liabilities with maturities exceeding twelve months. Aside from this, a majority of the securities portfolio is listed in liquid markets and can be sold quickly and without significant markdowns if cash is required.

Regarding private equity investments, there are still remaining payment obligations in the amount of € 1.2 million.

Specific events in 2016

The ongoing political uncertainty in Ukraine as a result of the armed conflict since 2014 in the east of the country, between separatists aligned with Russia and Ukraine’s central government, continues to constrain the country’s economic performance. According to the International Monetary Fund, which is providing 17.5 billion dollars in support to the country as part of a programme agreed in 2014, additional measures, to combat rampant corruption and implement economic structural reforms, are needed for the country’s continued economic development. Timely servicing of government debt is not necessarily guaranteed, despite international support, given that implementation of these required measures is being met with resistance in some cases. In 2015 the debt owed to international creditors holding Ukrainian government bonds was reduced by 20 per cent haircut.

As at 31 December 2016, the UNIQA Group’s portfolio of Ukrainian government bonds came to a nominal value of € 34.2 million and a fair value of € 30.1 million. Of these, a nominal value of € 31.2 million are invested in the Ukrainian subsidiary.

The Ukrainian currency, the hryvnia (UAH), weakened by approximately 7.8 per cent against the euro during the course of 2016 (exchange rate as at 31 December 2016: 0.0353). The total value of all the UAH securities in the UNIQA Group amounts to a fair value of € 11.7 million.

The EU sanctions imposed on Russia on account of the Ukrainian conflict, along with the low price of crude oil, had a severely negative impact on economic development for 2015 and 2016. Expectations of a return to economic growth in 2017 (as estimated by the International Monetary Fund) did, however, result in a recovery in the exchange rate for the rouble against the euro from 0.0124 (31 December 2015) to 0.0156 (31 December 2016). The fall in the interest rate level, which accompanied the rise in the exchange rate, increased the value of securities quoted in roubles, with the market value for these amounting to € 116.1 million as at the reporting date, of which € 101.4 million is invested in the Russian subsidiary’s investment portfolio. The nominal value of Russian government bonds in the UNIQA Group’s portfolio (not only those quoted in roubles) amounts to € 131.2 million (of which € 112.0 million is held by the Russian subsidiary), with a fair value of € 128.8 million.

UNIQA strives to keep investment concentrations in securities from individual issuers or groups of issuers as low as possible depending on their credit rating.

The United Kingdom’s exit from the EU as decided in the referendum on 23 June 2016 (Brexit) provoked strong immediate reactions on the financial markets, influenced by risk aversion, and these also have a negative impact on the UNIQA Group’s economic balance sheet (under Solvency II). Due to the relatively prompt correction in the financial markets however, the consequences of this decision for the UNIQA Group are limited to the impact – estimated to be minor – on the long-term economic development of UNIQA’s core markets of Austria, Central, Eastern and Southeastern Europe, and on investments held in the British pound, which has suffered a sustained loss in value as a result of Brexit. The market value of investments quoted in British pounds as at 31 December 2016 was € 1.7 million (nominal value of € 1.7 million).

Sensitivities

Market and credit risk

Stress tests and sensitivity analyses are used in particular to measure and manage the market and credit risk, in addition to figures from the established market and credit risk models (MCEV, SCR, ECR, etc.).

The following tables show the most important market risks in the form of key sensitivity figures, along with their impact on the net profit and equity. These key figures represent a snapshot on the reporting date and are only intended as an indication of future changes in fair value. Depending on the measurement principle to be applied, any future losses from the valuation at fair value may result in different fluctuations in the net profit for the year or in other comprehensive income. The key figures are calculated theoretically on the basis of actuarial principles and do not take into consideration any diversification effects between the individual market risks or countermeasures taken in the various market scenarios.

The sensitivities are determined by simulating each scenario for each individual item, with all other parameters remaining constant in each case.

Life insurance

In life insurance the interest rate assumptions are the crucial influencing factor on the liability adequacy test and the deferred acquisition costs. The impact of the implied new funds assumption (including reinvestment) is therefore stated below.

If new funds are assumed with a +100 bp increase, then the resulting net effect (after accounting for the deferred profit participation) amounts to €+9 million. A –100 bp reduction in this assumption results in net effect of €–10 million. The effects described relate to the changes in the deferred acquisition costs along with the impact on the liability adequacy test. The results were determined using the traditional business in Austria which makes up the majority of the insurance provision in the Group.

Non-life insurance

The provision for unsettled insurance claims is formed based on reported claims and applying accepted statistical methods. One crucial assumption here is that the pattern of claims observed from the past can be sensibly extrapolated for the future. Additional adjustments need to be made in cases where this assumption is not possible.

The calculation of the claim provisions is associated with uncertainty based on the time required to process claims. In addition to the normal chance risk, there are also other factors that may influence the future processing of the claims that have already occurred. The reserving process for court damages in property/casualty insurance should be mentioned here in particular. A reserve estimate is prepared here for these damages based on expert assessment, although this estimate can be exposed to high levels of volatility specifically with major damage at the start of the process for collecting court costs.

The partial model in property and casualty insurance is a suitable instrument for quantifying the volatility involved in processing. Following analysis of these model results and after consulting experts it was determined that a deviation of 5 per cent from the basic provision determined may represent a realistic scenario. On basis of the current provision for unsettled claims of € 2,202 million (excluding additional provisions such as provisions for claims settlement) in the Group on gross basis, this would mean an increase in claims incurred by € 110.1 million.

Health insurance

Health insurance operated on the similar to life technique is now also affected by the period of low interest rates, as the tariffs that are currently covered primarily result in actuarial discount rates of 3 per cent, but also in some cases of 2.5 per cent and even of 1.75 per cent. Since the average discount rate is still relatively high, the capital earnings may not be enough for the required addition to the coverage capital. A reduction in the capital earnings by 100 bp (based on investment results 2016) would reduce the profit from ordinary activities by € 30 million.

Actuarial risks

Non-life

The actuarial risk in the non-life segment is broken down into the three risk categories of premium, reserve and catastrophe risk.

Premium risk is defined as the risk that future benefits and expenses in connection with insurance operations will exceed the premiums collected for the insurance concerned. Such a loss may also be caused in insurance operations by exceptionally significant, but rare loss events, known as major claims or shock losses. Appropriate distribution assumptions are made to ensure that these events are also adequately incorporated into risk modelling.

Natural disasters represent a further threat from events that are infrequent but that nevertheless cause substantial losses. This risk includes financial losses caused by natural hazards, such as floods, storms, hail or earthquakes. In contrast to major individual claims, insurance companies in this case refer to cumulative losses.

Reserve risk refers to the risk that technical provisions recognised for claims that have already occurred will turn out to be inadequate. The loss in this case is referred to as run-off loss. The claims reserve is calculated using actuarial methods. External factors, such as changes in the amount or frequency of claims, legal decisions, repair and/or handling costs, can lead to differences compared with estimates.

To counter and actively manage these risks, UNIQA runs a number of processes integrated into its insurance operations. For example, Group guidelines specify that new products may only be launched if they satisfy certain profitability criteria. Major claims and losses from natural disasters are appropriately managed by means of special risk management in the underwriting process (primarily in corporate activities) and by the provision of suitable reinsurance capacity.

In connection with claim reserves, guidelines also specify the procedures to be followed by local units when recognising such reserves in accordance with IFRS. A quarterly monitoring system and an internal validation process safeguard the quality of the reserves recognised in the whole of the Group.

An essential element in risk assessment and further risk management is the use of the non-life partial model. This risk model uses stochastic simulations to quantify the risk capital requirement for each risk class at both Company and Group levels. The model also produces further key figures that are then used as part of the risk- and value-based management of the insurance business.

Life

The risk of an individual insurance contract lies in the occurrence of the insured event. The occurrence is considered random and therefore unpredictable. Various risks exist in life insurance, particularly in classic life insurance. The insurance company takes on this risk for a corresponding premium. When calculating the premium, the actuary refers to the following carefully selected calculation principles:

• Interest: the discount rate is set so low that it can be produced as expected in each year.
• Mortality: the probabilities of dying are deliberately and carefully calculated for each type of insurance.
• Costs: these are calculated in such a way that the costs incurred by the policy can be permanently covered by the premium.

Carefully selecting the calculation principles gives rise to well-planned profits, an appropriate amount of which is credited to the policyholders as part of profit participation.

The calculation of the premium is also based on the acceptance of a large, homogenous inventory of independent risks, so that the randomness inherent in an individual insurance policy is balanced out by the law of large numbers.

The following risks exist for a life insurance company:

• The calculation bases prove to be insufficient despite careful selection.
• Random fluctuations prove disadvantageous for the insurer.
• Policyholders exercise certain implicit options to their advantage.

The risks of the insurer can be roughly divided into actuarial and financial risks.

UNIQA’s portfolio consists primarily of long-term insurance contracts. Short-term assurances payable at death play a minor role.

The table below shows the distribution of the premium portfolio by type and region.

Mortality

With respect to assurance involving death risk, premiums are calculated based on an accounting table, implicitly allowing for the safety loading of risk premiums.

Using risk selection (health examinations) means that the mortality probabilities of the portfolio are consistently smaller than those of the overall population. In addition, the gradual improvement of mortality rates means that the real mortality probabilities are consistently smaller than the values shown in the accounting table. Analyses of mortality data carried out at Group level show that, historically, the level of premiums has been sufficient to cover the death benefits.

Due to the large number of lives insured by UNIQA in the Austrian market, the mortality trends are of particular importance here. According to the 2010/2012 mortality table published by Statistics Austria, life expectancy has increased and is over 80 years for new-borns for the first time.

The reduction in the probability of dying at any given age is causing a huge amount of uncertainty in the annuity business. Improvements in mortality rates as a result of medical progress and changed lifestyles are virtually impossible to extrapolate.

Attempts to predict this effect were made when producing the generation tables. However, such tables only exist for the Austrian population and this data cannot be applied to other countries. In the UNIQA Group, longevity risk relates mainly to the Austrian life insurance companies because very few pension products are sold in the regions covered by the international business.

Homogeneity and independence of insurance risks

An insurance company takes great pains to compose a portfolio of the most homogenous, independent risks possible, in accordance with the classic, deterministic approach to calculating premiums. Because this is virtually impossible in practice, a considerable risk arises for the insurer due to random fluctuations, in particular from the outbreak of epidemic illnesses, as not only could the calculated mortality probabilities prove to be too low, the independence of the risks can also no longer be assumed.

Antiselection

UNIQA’s portfolios contain large quantities of risk insurance policies with a premium adjustment clause, particularly in Austria. This allows the insurer to raise the premiums in case of an (unlikely) worsening of the mortality behaviour. However, this presents the danger of possible antiselection behaviour, meaning that policies for good risks tend to be terminated while worse ones remain in the portfolio.

The right to choose pensions for deferred retirement annuities also results in antiselection. Only those policyholders who feel very healthy choose the annuity payment; all others choose partial or full capital payment. In this way, the pension portfolio tends to consist of mostly healthier people, i.e. from the insurer’s point of view worse risks than the population average.

This phenomenon is countered by corresponding modifications to the retirement mortality tables. A further possibility exists in the requirement that the intention to exercise the right to choose annuity payments must be announced no later than one year in advance of the expiration.

Costs

Besides the risks discussed above, the cost risk must also be mentioned: the insurer guarantees that it will deduct only the calculated costs for the entire term of the policy. The business risk here is that the cost premiums are insufficient (e.g. due to cost increases resulting from inflation).

Health

The health insurance business is operated primarily in Austria (92.4 per cent is domestic and 7.6 per cent is international). As a result, the focus lies on risk management in Austria.

Health insurance is a loss insurance which is calculated under consideration of biometric risks and is operated in Austria according to the “similar to life technique”.

Terminations by the insurer are not possible except in the case of obligation violations by the insured. Premiums must therefore be calculated in such a way that the premiums are sufficient to cover the insurance benefits that generally increase with age, assuming probabilities that remain constant. The probabilities and cost structures can change frequently over time. For this reason, the health insurer has the possibility to adjust the premiums as necessary to reflect the changed calculation bases.

When taking on risks, the existing risk of the individual is also evaluated. If it is established that an illness already exists for which the cost risk is expected to be higher than for the calculated portfolio, then either this illness is excluded from the policy, an adequate risk surcharge is demanded or the risk is not underwritten.

In health insurance, assurance coverage (“aging provision”) is built up through calculation according to “similar to life techniques” and reduced again in later years because this is used to finance an ever larger part of the benefits that increase with age.

The discount rate for this actuarial reserve is 3.0, 2.5 or 1.75 per cent. If the discount rate is not achieved by the investment, there are safety margins in the premiums that can be used to cover insufficient investment results. A circular was published by the Financial Market Authority Austria (FMA) in October 2013 regarding the discount rate in health insurance, meaning that between 1 January 2014 and 30 April 2016, new business was calculated with a discount rate of 2.5 per cent. A further circular was sent by the FMA in October 2015 which determined that the tariffs for new sales from 1 May 2016 at the latest should include a discount rate of 1.75 per cent. This results in a further improvement of the risk in cases where the investment results are insufficient. The average discount rate as at 31 December 2016 was approximately 2.93 per cent.

The legal risks arise primarily from the effects that changes to legislation have on the existing private health insurance business model. This includes, in particular, changes to the legal framework that make it harder or impossible to adapt to changed circumstances or that sharply reduce the income opportunities. Developments in this area will be observed by the insurance association, and an attempt will be made where necessary to react to negative developments from the perspective of the private health insurer.

The EU Directive on the equal treatment of men and women in insurance, which is implemented in Austria by the Insurance Amendment Act 2006, was also taken into account in the calculation of premiums at the end of the second quarter of 2007. This stipulated that the costs of birth and pregnancy be distributed across both sexes. No significant risk to profit has been identified here.

In the meantime, a European Court of Justice decision regarding insurance policies results in a new situation as at 21 December 2012: as at that date only completely identical premiums are allowed for men and women, excluding considerations such as age and individual pre-existing conditions. Experience from 2013 to 2016 has shown that this has not resulted in any negative changes to the portfolio structure of new business.

The risk of the health insurance business outside Austria (approx. € 47.7 million) is currently dominated primarily by Switzerland (approx. € 11.3 million), where there is sufficient risk capital.

The remaining premiums are divided among multiple companies and are of only minor importance there. Life-long health insurance policies without termination options by the insurer rarely exist outside of Austria, meaning that the risk can be considered low for this reason as well.

Other risks

Operational risks

Operational risk includes losses that are caused by insufficient or failed internal processes, as well as losses caused by systems, human resources or external events.

Operational risk includes legal risk, but not reputation or strategic risk. Legal risk is the risk of uncertainty due to lawsuits or uncertainty in the applicability or interpretation of contracts, laws or other legal requirements.

At UNIQA, legal risks are monitored on an on-going basis and reports made the Management Board. UNIQA’s risk management process also defined the risk process for operational risks in terms of methodology, workflow and responsibilities. The risk manager is responsible for compliance in all subsidiaries.

A distinctive feature of operational risk is that it can surface in all processes and departments. This is why operational risk is identified and evaluated in every operational company at a very broad level within UNIQA. Risks are identified with the help of a standardised risk catalogue that is regularly checked for completeness. Scenarios are defined for evaluating these risks; these scenarios are meant to convey the likelihood of occurrence and the possible amount of the claim. The results are then presented by the risk manager in the form of a summarised risk report.

This process is usually conducted twice a year.

Business Continuity Management

According to international standards, the UNIQA Group – as a financial service provider – forms part of the critical infrastructure of key importance to the national community. If this infrastructure were to fail or become impaired, it would cause considerable disruption to public safety and security or lead to other drastic consequences.

As a rule, emergencies, crises and disasters are unexpected events for which it is impossible to plan, although systems and processes can be put in place to deal with such events. The systems and processes must then be treated as a special responsibility of management and must be dealt with professionally, efficiently and as quickly as possible.

UNIQA has implemented a Business Continuity Management system (BCM) covering the issues of crisis prevention, crisis management and business recovery (including business continuity plans). The main objectives are as follows:

• to prevent personal injury to, or death of, employees or third parties
• to minimise the impact from failure of key business processes
• to be appropriately prepared with continuously updated emergency and recovery plans

The UNIQA BCM model is based on international rules and standards and was further implemented in 2016. The implementation of a BCM system forms part of UNIQA’s response to the requirements imposed by relevant authorities (solvency, critical infrastructure) and the market (calls for tender). This holistic approach to a risk management system not only reduces potential losses following an event but also enhances the quality of day-to-day operations.

Reputational and strategic risks

Reputational risk describes the risk of loss that arises due to possible damage to the Company’s reputation, a deterioration in prestige, or a negative overall impression due to negative perception by customers, business partners, shareholders or supervisory agencies.

Reputational risks that occur in the course of core processes such as claims processing or advising and service quality are identified, evaluated and managed as operational risks in our subsidiaries.

The most important reputational risks are presented, like the operational risks, in an aggregated form in the risk report.

Group risk management then analyses whether the risk observed in the Group or in another unit may occur, and whether the danger of “contagion” within the Group is possible.

Strategic risk describes the risk that results from management decisions or insufficient implementation of management decisions that may influence current/future income or solvency. This includes the risk that arises from management decisions that are inadequate because they ignore a changed business environment.

Like operational and reputational risks, strategic risks are evaluated twice a year. Furthermore, important decisions in various committees, such as the Risk Committee, are discussed with the Management Board. As outlined in the explanation of the risk management process, the management receives a monthly update regarding the most significant risks in the form of a heat map.