Solvency Management in Life Insurance The company s perspective

Group Risk IAA Seminar 19 April 2007, Mexico City Uncertainty Exposure Solvency Management in Life Insurance The company s perspective

Agenda 1. Key elements of Allianz Risk Management framework 2. Drawbacks of current regulatory framework / financial reporting framework 3. Industry needs and business implications of Solvency II 4. Outlook 2

Risk Management is a continuous process for Allianz Ongoing enhancements of integrated risk management Pilot of internal risk capital model Enhanced risk governance structure introduced Performance measurement linked to risk capital results Introduction of complementary risk and scenario assessment Process enhancements to ensure robustness and auditability the calculation 2000 2002 2005 ongoing 2004 The evolving Solvency II standards are a unique opportunity to leverage existing risk management framework 3

Our objective: protect the capital base and enhance value creation Key elements Risk Governance Protection of capital base Risk adequate organization Risk policy and minimum standards Risk Strategy Risk Reporting Capital at Risk for different solvency regimes internal modeling (economic view) stress tests (regulator, rating agency view) limit setting On site Risk diagnostics to ensure local implementation Support for value creation and decision making Integration of risk/capital into management processes EVA /RoRAC (key performance metric) risk based resource allocation Earnings at risk (volatility management) Key is balancing risk/return trade off, No Surprises as a critical objective 4

Group wide risk governance is clearly defined Tasks Allianz SE Board Group Risk Committee Ins./Banking/AM Committees Group Risk Approve Group Risk Policy Define risk strategy of Allianz Group Set limit system and Group limits Monitor solvency and risk profile Set risk policies and OE limits Recommend/approve actions to mitigate risk Make decisions on new products and transactions with Group relevance Enhance risk dialogue between Group and OEs Implement internal risk capital model Reporting and communication of Group risks Allianz SE Board Group Risk Committee Ins./Banking/ Asset Mgt. Committees Group Risk Operating Entities (OE) Manage risks proactively within Group policies and limits Report risk exposures to Group Risk Local Risk Committee OE Local Risk Committee OE The risk organization reflects structures at Group level 5

Market Consistent Embedded Value (MCEV) is the right concept to value and analyze risks of our life businesses Economic Balance Sheet How much value do we have? 1 2 Who gets this value? Best estimate policyholder liability: Assets at market value Guaranteed payments Expected bonuses Policy holder Run Off projection of current portfolio using best estimate assumptions Appropriate evaluation of risk through Risk neutral valuation, i.e. risk premiums only valued when earned Explicit valuation of O &G Explicit charge for non financial risk O&G Taxes Economic Value Tax authority Share holder Shareholder value can be split in Future profit margin Net asset value component Potential deviation of MCEV represents risk we have to capitalize for 6

Internal Risk Capital analysis is implemented in stateof the art Asset Liability Interaction Model (ALIM) Market engine Thousands of scenarios Company specific business parameters Discounting Leveraging Economic value Management decision rules + Interdependencies between market returns, accounting rules and regulation explicitly modeled Balance sheet Y 1 Y N P&L Y 1 Y N Cash flow Y 1 Y N Reserves Y 1 Y N + Management decision rules/degrees of freedom in future years accounted for + Options & guarantees explicitly modeled consistent with market prices 7

Stand alone risk capital assessment requires identification of single risk drivers AAA 0,01% Solvency standard AA 0,03% A 0,07% Probability Density Credit Mortality Lapse Markets Operational Worst Case MCEV at valuation date Required risk capital Risk Capital quantifies the adverse change of MCEV over the course of one year within a 99.97% confidence interval (Worst Case) 8

Aggregation of stand alone capital requirements allows for diversification benefits Group Risk capital Risk capital Market / ALM risk Risk capital Credit risk Risk capital Actuarial risk Risk capital Business risk Risk type & segment diversification OE 1 OE 1 OE 1 OE 1 OE2 OE 2 OE 2 OE 2 Geographical diversification The economic view allows to identify risk diversification effects both across regions and across risk types and business segments 9

Allianz applies an integrated measurement suite for our Life business Past Today NAV / IAS Capital Embedded Value / EEV Risk Capital ALM analysis Economic Value/ MCEV Option & Guarantees Risk Capital ALM /Pricing Enhance transparency of value drivers and their dynamics Ensure consistent reporting across all applications Avoid double development and raise synergies by using available best practise approaches Integrated valuation and risk capital approach leverages value creation 10

Agenda 1. Key elements of Allianz Risk Management framework 2. Drawbacks of current regulatory / financial reporting framework 3. Industry needs and business implications of Solvency II 4. Outlook 11

Currently Allianz faces multiple regulatory requirements on different levels based on multiple accounting standards Insurance AZ Group Segments Asset Management Banking Current regulatory framework European Union only (selection) Financial conglomerates directive Regulation of parent company AZ SE Partly based on consolidated IFRS, partly local Gaap Segment specific regulation like Insurance Group directive Regulation of Sub groups by local regulators Sub group treatment in 10 Countries Operating Entities Solo regulation based on local standards 30 different national supervisors in 19 countries Going forward global players depend on an efficient and effective regulation calling for more standardized approaches and defined responsibilities 12

On Group level we have to monitor three capital regimes for different stakeholders providing mixed signals for steering Financial conglomerates Inconsistent coverage of segments Based on B/S, P&L & market data as well as partly on internal data Not risk based Portfolio effects not considered Limited coverage of risk categories and risk types Internal model Consistent coverage of all segments Systematic evaluation of internal data (economic balance sheet) Explicitly accounting for diversification effects Covers all risk categories (Market/ALM, credit, actuarial, business) incl. OpRisk S&P model Only insurance segment Based on B/S, P&L & market data Portfolio effects not considered Limited coverage of risk categories and risk types (ALM, OpRisk, not covered) The Internal model is the relevant metrics for steering the business 4/17/2007 13

Agenda 1. Key elements of Allianz Risk Management framework 2. Drawbacks of current regulatory / financial reporting framework 3. Industry needs and business implications of Solvency II 4. Outlook 14

CRO Forum stipulated five core principles with regard to a general framework for Solvency II 1. Solvency capital and liabilities for solvency purposes should be based on the economics of the business and accurately reflect risk mitigation 2. Solvency capital and liabilities for solvency purposes should not include excessive prudence 3. Solvency capital should accurately reflect diversification 4. Internal models, in addition to standard approaches, should be allowed 5. Solvency reporting can be different from financial reporting because of differences in the scope and objectives, although the differences must be reconcilable Position papers of other bodies (CFO Forum, IAIS) are in line with these principles 15

A coherent framework for Solvency II and IFRS phase II is envisaged ASSETS TOTAL LIABILITIES Accounting TOTAL LIABILITIES Solvency Equity Profit Margin Available capital for solvency purposes Market value of assets Assets Backing accounting Liabilities Risk Margin Best Estimate Liability to Policyholders Market value margin Best Estimate Liability to Policyholders Insolvency Accounting Liabilities MVL (market consistent) = Current Value Customer Intangible Asset Corresponding liability adjustment to CIA Policyholder is protected as long as eligible solvency capital absorbs risks 16

which could also form the basis for a future regulatory and financial reporting framework Regulatory reporting Solvency II Regulators Solvency I and current financial reporting (CRO Forum / CEA) Financial reporting Commonality IFRS, including IFRS Insurance Contracts Phase II Commonality Improved transparency and relevance of information for stakeholders to facilitate their decision making Consumers (CFO Forum / CEA) Supplemental reporting (EEV) Investors Different perspectives underpinned by a common goal 17

The company specific risk profile will be better reflected Market view Capital requirements risk sensitive Investment strategy based on liability structure Allianz perspective Risk capital based on internal model already embedded into performance measurement Investment strategy (including hedging) based on risk bearing capacity taking risk sharing with P/H into and risk mitigating funds into account Clearly defined management rules on future crediting strategies in place Allianz will benefit from the alignment of internal steering and regulatory rules 18

leading to higher transparency concerning economic capitalization Market view Book value replaced by economic valuation will force weaker undertakings to act Diversification effects will have a positive impact on capital requirements for well diversified undertakings Consolidation accelerated Allianz perspective Due to strong financial position and diversified portfolio high risk bearing capacity of Allianz to fund growth Effect of risk mitigation activities (e.g. hedging) valued in line with financial markets As Integrated Financial Service Provider peak risks can be diversified across segments Level playing field across business segments required 19

and fostering the efficient usage of economic capital Market view Allocation in line with economic requirements Economic excess capital might increase but significant part will be locked (e.g. rating) Allianz perspective Risk capital is single currency between entities and segments RoRAC calculations per LoB to make performance transparent Consistent approach across segments and countries important 20

Product design, pricing and underwriting will be more focused on balance between risk transfer and reward Market view Peak risks will not be taken by weaker players anymore thus accelerating consolidation Pricing impact of financial guarantees and low frequency/high severity risks Incentives of sales force will reflect risk/return profile of product Increased competition if market price exceeds significantly risk adequate price Allianz perspective Valuation (MCEV) and risk assessment fully integrated MCEV will form main pricing target Portfolio effects are analyzed during underwriting process Capital charge used for pricing reflects already diversification benefits Need for risk adequate pricing is getting more obvious 21

Agenda 1. Key elements of Allianz Risk Management framework 2. Drawbacks of current regulatory / financial reporting framework 3. Industry needs and business implications of Solvency II 4. Outlook 22

The success of Solvency II will depend on some crucial factors Modernized regulatory framework Ensure that groups are supervised in line with their risk profile Level playing field independent of group location Foster risk management best practices Avoid regulatory arbitrage Ensure efficient reporting Success factors Clearly defined lead supervisor concept with separation of roles & responsibilities; allowance for diversification Harmonisation of supervisory standards & practise across member states Incentives to implement full internal models (more accurate than standard model) Supervision of sectors not covered by SII has to be upgraded (e.g. pension funds) Starting point for public disclosure has to be future IFRS standard Harmonized group supervision will ensure customer and provider access to a common EU insurance market 23

Presented by: Marco Hauck Head of Team Life Insurance Group Risk Tel.: +49 89 3800 19783 mail: marco.hauck@allianz.com 24