ING Insurance Economic Capital Framework

ING Insurance Economic Capital Framework Thomas C. Wilson Chief Insurance Risk Officer Kent University, September 5, 2007 www.ing.com

Objectives of this session ING has been using economic capital internally over many years to support management decisions within an Enterprise Risk Management framework The framework which ING has developed is unique in many respects, being based on An economic or market value balance sheet Using replicating portfolios in order to model the financial component of liabilities In this session, we would like to accomplish two important objectives: First, demonstrate how economic capital integrally supports risk and value management within ING Second, describe our economic capital framework and provide some insights Insurance - Banking - Asset Management 2

Contents Role of economic capital at ING Insurance ING s economic capital framework ING s risk profile Insurance - Banking - Asset Management 3

How concretely does Insurance Risk Management support ING strategy? IRM Mission Statement: Together with the business, build a sustainable competitive advantage by fully integrating risk management in our daily business activities and strategy and ensure that: Risk Disclosure Risk Strategy Risk Controlling Risk Underwriting Our risks and strategy are transparent to internal and external stakeholders to support an appropriate evaluation Delegated authorities are consistent with the overall Group strategy for profitable growth and the Group s risk appetite Our risk profile is transparent, e.g. no surprises, and consistent with delegated authorities Our products and portfolios are structured, underwritten, priced, approved and managed appropriately Insurance - Banking - Asset Management 4

How does Economic Capital support Insurance Risk Management s mandate? Risk Disclosure Examples Risk disclosures Embedded value reporting Role of Economic Capital Investor disclosures IFRS 7 Risk Paragraph Basis for Solvency II Risk Strategy Risk Controlling Risk appetite / hotspots Strategic planning & targets Economic capital & limits Value metrics, e.g. vroec Capital management & planning Risk Dashboard Limits Defines economic solvency Calibrates capital for traditional value metrics Basis for market value metrics Core element of risk measurement and limit framework Risk Underwriting Standards of Practice/Guidelines Value metrics / targets IRR, market consistent Product Approval Process (PARP) Incorporated in PARP Calibrates traditional value metrics Basis for market value metrics Insurance - Banking - Asset Management 5

What is Insurance Risk Management? Group CRO Koos Timmermans Audit & Risk Committee Group CIRO Thomas C. Wilson Finance & Risk Committee CIRO Canada CIRO US CIRO Latin America CIRO Rest of Europe CIRO Division Intermediaries CIRO Asia Pacific Asset/Liability Committees Group Regional Local Model Parameter Committee Global network of 725+ combined risk / actuarial professionals in 30+ countries Internationally recognized: One of only three insurers globally with S&P Excellent ERM rating 2006 Insurer of the Year, Risk Magazine 2007 Insurance CRO of the Year, Life & Pensions Magazine Insurance - Banking - Asset Management 6

Contents Role of economic capital at ING Insurance ING s economic capital framework ING s risk profile Insurance - Banking - Asset Management 7

Overview of ING Economic Capital Framework Definition: ING Insurance economic capital defined as maximum loss to ING Insurance s Market Value Surplus (MVS) within a 99.95% confidence interval based on shocks which could occur over a one year horizon Market Value Assets Market Value Liabilities Expected value One year MVS Scenarios MVS Based on total Market Value Surplus Current balance sheet value, no future business Market Value of Liabilities, including options and guarantees, not best estimate liabilities Includes free surplus; no assumption about duration of equity or surplus EC 99.95% worst case 99.95% confidence interval Consistent with AA rating More conservative than minimum Solvency II Consistency with Solvency II Maximum loss / VaR not tail risk One year horizon, not run-off Insurance - Banking - Asset Management 8

Market Value of Liabilities Definition: The market value of each of ING s insurance liabilities is defined as the current cash value which would be required by an independent, professional, well diversified and financially secure insurance company or investor in order for them to assume the liability in an orderly manner. Comments Exit or transfer value Each individual liability (and asset) is valued on a stand alone basis Liabilities divided into two components: Financial Component of Liabilities (FCL) and Market Value Margin (MVM) Liabilities Which Do Not Depend on Financial Markets, eg Term Life, Non-Life Liabilities Which - Do Depend on Financial Markets, eg SPVA, etc Value of options/guarantees/ profit sharing Liability cashflow = + Fixed payouts Liability cashflow = + Guaran - teed liabilities Financial component Non - financial component Financial Non - financial component (MVM) Insurance - Banking - Asset Management 9

Risks which impact Market Value Surplus Financial risk Credit & transfer risk Insurance risk Operational risk Business risk Changes in financial markets which would impact the market value of assets and liabilities (including options in assets and liabilities) from: Interest rates Equity prices Real estate Credit spreads Implied vols Currency rates Changes in the credit quality of assets, reinsurance receivables and counterparties, including default. The recovery risk in case of default or loss of value due to migration. The inability to repatriate or transfer shareholder value due to transfer restrictions. Deviations from best estimate claims development, including size, frequency and timing of both level and long term trend, covering: Mortality Morbidity Longevity risk Property Casualty NATCAT Unexpected events such as processing errors, fraud, systems failures, litigation, regulatory or compliance breaches, etc. Deviations from best estimates on business expenses, lapses / persistency and future premium re-rating Insurance - Banking - Asset Management 10

Best Practice Models Within and Across Risks Across risk classes Best-in-class aggregation model Conservative correlation assumptions Risk Aggregation ( Gaussian Copula based on conservative correlations) Financial risk Credit & transfer risk Insurance risk Operational risk Business risk Monte Carlo simulation MKMV portfolio manager, meeting BIS II advanced Actuarial models for each risk, inhouse and external Internal/ external data / model, meeting BIS II advanced Internal models For each risk Best-in-class models Best estimate correlations Historical vol & correlations, 5 yr weekly data MKMV correlations Management correlation assumptions Management correlation assumptions Management correlation assumptions Insurance - Banking - Asset Management 11

Summary of Challenges of current EC process Source Data Cash flow Systems Actuarial Analysis System Spreadsheets Regional Office Consolidated Reporting Spreadsheets Spreadsheets BU 1 BU 2 Current Data Interface = EC / Shocks CIRM Efficiency: Complex processes & system environment implying need to automate interfaces, optimize hardware / software, balance precision & effort, leverage development Control & Audit: Confidence in numbers & consistency, implying need for clear standards, improved systems, documentation, controls & procedures Functionality: Improved methods and greater analysis needs, implying need for changing data interface and new techniques In 40+ different units + 8 Regional Offices + CIRM globally! Insurance - Banking - Asset Management 12

Overview of ECAPS Project Approach Source Data Cash flow Systems Actuarial Analysis System Spreadsheets Consolidated Reporting Spreadsheets Web-Based Access to Input And Results at BU BU 1 Improved interface, pushing boundary Improved analysis at BU, Region, and CIRM ECAPS Tool Available on the desktop of BU CIROs and risk professionals Significantly reducing the number of downstream spreadsheets Improved Analytics: based on industry market risk platform well known within ING (e.g. Algorithmics) Facilitating timely reporting Improved methods Insurance - Banking - Asset Management 13

Replicating portfolio approach insurance contract as bundle of financial products Insurance contract financial component Best estimate claims, expenses, etc. Minimum accumulation guarantees, ratchets, etc. Option to annuitize at predetermined rate Crediting rate influenced by current long term investment conditions Increased lapses driven by increasing rates, persistency driven by decreasing rates Standard capital market equivalents Zero coupon cash flows Put option on underlying asset returns, ratchet options, etc. Interest rate swaption Constant maturity swap pay-out American style put option on underlying insurance contract ING Replicating Portfolio Approach What portfolio of standardized capital market instruments best represents the cash flow uncertainty of the insurance contract under a wide range of economic scenarios? Assessment criteria: R-Squared (goodness of fit measure), sensitivities ( Greeks, duration, convexity, tail behavior, etc.) Accurate representation of value and risk profile Supports optimal hedge decisions Reinforce financial engineering during product design and pricing Insurance - Banking - Asset Management 14

ECAPS Overview Via Intranet ECAPS Tool Scenario Generator Replicating Portfolio (X/Y) Economic Capital (EC) Calculation Reporting Business Unit (BU) Focus on providing asset/ liability data and non-market risk EC Insurance - Banking - Asset Management 15

Where do these scenarios come from? Automated process via ING s Global Market Database Scenarios generated quarterly for EC calculations Market data from real data as much as possible Incomplete Market data and Non-market data linked to known market data as much as possible Few remaining items based on expert judgment Get Market Data Develop Correlations/ Volatilities ALGO Scenario Generator Bloomberg Reuters Lehman Bros CIRM ING s GMDB ECAPS Insurance - Banking - Asset Management 16

ING replicating portfolio approach Comparing target with replicating portfolio Insurance - Banking - Asset Management 17

ING replicating portfolio approach Understanding portfolio characteristics Insurance - Banking - Asset Management 18

Additional information useful for interpreting the numbers Corporate line is defined by a set of internal transactions representing Group funding transactions and associated hedges Virtual transfer of free surplus from US, NN, and Taiwan This is not fully consistent with the corporate line presented for P/L Recognition of risk diversification ING EC model assumes full ability to move capital if necessary to cover a loss in a specific legal entity Diversification benefits across businesses are fully allocated to business units on a proportional basis relative to undiversified EC Economic capital is based on instantaneous quarterly shocks, scaled to annual value impact with recognition given for explicitly recognized dynamic hedging programs Insurance - Banking - Asset Management 19

Contents Role of economic capital at ING Insurance ING s economic capital framework ING s risk profile Insurance - Banking - Asset Management 20

ING Insurance Economic Capital Profile 12.06 Geographic Breakdown 4% Risk breakdown 4% 15% 25% 14% 14% 62% 32% 24% 6% Americas Europe Asia Pacific Corp Line Not Modelled Financial Credit Insurance Non-financial Not Modelled ING Economic Capital Balanced across regions Dominated by financial risks Insurance - Banking - Asset Management 21

ING Insurance solvency position As of 12.06 Economic Solvency Statutory Solvency Euro billion Euro billion 0 0 Book Equity EU Solvency (100%, 150%) Shareholders equity Tier 1 Sub Debt Market Value Adjustments Deferred Tax Liability Available Financial Resources Economic Capital Insurance - Banking - Asset Management 22

ING Insurance benefits from geographic and risk diversification Euro billions, 12.31.06 Risk Geographic 31% 36% 0 Undiversified EC Diversified EC 0 Undiversified EC Diversified EC Financial risk Insurance risk Diversified EC Credit risk Non-financial risk Americas Asia Pacific Diversified EC Europe Corporate Line ING enjoys strong benefits from diversification with total diversification = XX% Diversification across risk categories = 31% Diversification across regions = 36% Insurance - Banking - Asset Management 23

Certain of the statements contained herein are statements of future expectations and other forward-looking statements. These expectations are based on management's current views and assumptions and involve known and unknown risks and uncertainties. Actual results, performance or events may differ materially from those in such statements due to, among other things, (i) general economic conditions, in particular economic conditions in ING s core markets, (ii) performance of financial markets, including emerging markets, (iii) the frequency and severity of insured loss events, (iv) mortality and morbidity levels and trends, (v) persistency levels, (vi) interest rate levels, (vii) currency exchange rates (viii) general competitive factors, (ix) changes in laws and regulations, (x) changes in the policies of governments and/or regulatory authorities. ING assumes no obligation to update any forward-looking information contained in this document. www.ing.com Insurance - Banking - Asset Management 24