Sampo Group

Annual Report 2011
Market Risks
Investment Portfolio Risks

ALM Risks

The company is exposed to ALM risk when changes in different market risk variables (e.g. interest rates, inflation, foreign exchange rates and equity prices) cause a change in the value of investment assets that is of different size than the respective change in the economic value of insurance liabilities. ALM risk also includes the uncertainty stemming from the fact that the future cash flows of insurance policies are modeled estimates and therefore uncertain in relation to both their timing and amount.

In Sampo Group, ALM risks are managed as a part of managing the investment portfolios. ALM risks are analyzed regularly and these analyses together with actual capitalization, regulatory requirements and rating targets are taken into account when defining the Group companies’ investment policies.

The asset and liability management process applied in Sampo Group companies is illustrated in the figure 'Asset and liability management principles in Sampo Group'.

 

If P&C and Mandatum Life may apply slightly different approaches in their asset and liability management which are based on the specific characteristics of their businesses.

Asset and Liability Management in If P&C

If P&C's approach in asset and liability management is defined in accordance with the above described group wide principles. In addition, the composition of If P&C’s investment assets must at all times comply with supervisory authorities’ regulations and ensure an adequate solvency ratio.

The Board of Directors annually approves If P&C’s Investment Policy. The structure of the companies’ technical provisions, risk-bearing capacities, regulatory requirements, rating targets and risk tolerance are taken into account when defining asset allocations and limits and when setting return and liquidity targets. The Investment Policy also defines mandates and authorizations and sets guidelines on the use of derivatives.

Most of the technical provisions in If P&C are stated in the balance sheet in nominal terms. The provisions for annuities are discounted, and potential changes in the discount rates will affect the level of technical provisions in the company’s balance sheet. The discount rates vary between countries mainly due to differences in legislation but they are at least indirectly impacted by the prevailing market interest rate environment. Hence, from an accounting perspective, the company is mainly exposed to changes in expected future claims inflation and in the regulatory discount rate. However, from an economic perspective the value of all technical provisions are exposed to changes in market interest rates.

The basis for risk taking within If P&C is the overall risk appetite. For Investment Policy purposes the risk appetite is expressed in terms of 1 year 99.5% Value at Risk (VaR). Allocation and risk limits shall be derived such that the overall risk appetite is fulfilled both from an accounting and economic perspective and also when taking insurance risk and other risks into consideration. The chosen approach shall enable follow-up on both total market risk as well as for the separate risk types.

The asset and liability management is taken into account through the risk appetite framework and in order to comply with the overall risk appetite the liability cash flows may be matched through investments in fixed income instruments denominated in the same currency as the corresponding liability. FX swaps or other currency risk mitigating derivatives are used to eliminate currency risk if investments are made in instruments not denominated in the same currency as the liability.

Within the limits set in the Investment Policy, investments are managed actively by utilizing market views and in order to enhance returns the portfolio may also contain equities in addition to fixed income investments.

Asset and Liability Management in Mandatum Life

In Mandatum Life, the approach to ALM risk management is also based on an analysis of technical provisions and current solvency position. A common feature for all with-profit technical provisions is the guaranteed rate and bonuses based on principle of fairness. The cash flows of Mandatum Life's technical provisions are relatively well-predictable because in most of the company’s with-profit products, surrenders or extra investments are restricted. The company’s estimates for claims costs do not contain any significant element of inflation risk and thus the inflation risk in Mandatum Life is mainly related to administrative expenses.

In the long run the most significant risk is that fixed income investments will not generate a return at least equal to the guaranteed interest rate of technical provisions.

Mandatum Life is prepared for low interest rates on the liability side by e.g. reducing the minimum guaranteed interest rate in new contracts and by supplementing the technical provisions by applying a lower discount rate. In addition, existing contracts have been changed to accommodate improved management of reinvestment risk.

The long-term target for investments is to provide sufficient return to cover the guaranteed interest rate plus bonuses based on principle of fairness as well as the shareholder’s return requirement with acceptable level of risk. The company manages its investment portfolio actively and also interest rate derivatives are used.

The Board of Mandatum Life approves the Investment Policy annually, which sets principles and limits for investment activities. The Investment Policy also includes measures and limits for maximum acceptable market risk. These measures and limits are based on both Solvency I and Solvency II type of approaches. When it comes to the Solvency I type of approach, limits are set above Solvency I requirement using a VaR analysis of the investment assets. In the Solvency II type of approach, limits are set based on different confidence levels in addition to the 99.5 per cent level used in Sampo Group. ALCO reports limit breaches to the Board which makes the decisions related to the capitalization and the market risks in the balance sheet. The general objective is to maintain the required solvency and to ensure that investments are sufficient and eligible for covering technical provisions.

Sampo plc’s investment organization makes the day-to-day investment decisions based on principles set in Mandatum Life’s Investment Policy. However, the most significant investment decisions are made by the Board. The ALCO regularly controls that limits and principles defined in the Investment Policy are followed.

Market Risks
Investment Portfolio Risks