Risk management in a challenging environment

Zanders Risico management seminar

Theo Berg ,, 27 maart 2014

Agenda

I. Over 200 years of reliability and trust

II. Delta Lloyd’s view on risk management

III. Changing regulatory environment

IV. Questions & answers

Building on 200 years of history

1807

1967

1969

1999

2002

2003

Hollandsche Societeit Nedlloyd

Delta

Nuts / OHRA

Delta Lloyd

Delta Lloyd Nuts OHRA

Amstleven

Delta Lloyd NV

ABN AMRO Insurance

IPO 2009

1973 delisting

• A strong Group: Dutch market leader in

new Life business (NAPI € 431m)

• An €4.7bn GWP/76 bln. AuM company:

• Life & Pension

• General Insurance

• Asset Management

• Banking

• Brands: Delta Lloyd, OHRA and ABN AMRO

• Approx. 5,200 permanent staff, focus on

the Netherlands and Belgium

• Listed in Amsterdam and Brussels

Delta Lloyd Group: reliable partner since 1807

FY 2013 FY 2012

IGD Group solvency ratio

184% 177%

Net operational result (€m)

430404

FY 2013 FY 2012

Financial services – A challenging environment....

Economic environment challenging

Uncertainty

on pensions

Real estate

crisis

Unemployment

rising

20 %

97 63 41 28

164140

11476

71

5043

40

251

224

210

183

75

76

77

72

181

149

127

69

0

100

200

300

400

500

600

700

800

900

2009 2010 2011 2012

Mortgages

Term

Annuities

Funeral

Pension

Saving

• Unit-linked misseling, total compensation exceeds € 2 billion, 95% drop in sales • Market CAGR -/- 18% a year!, New production halved in 4 years • Bank savings increased with 39% in 2011 and exceeds individual life market • Only in 2009 positive technical result

New Business (APE) in €m

Individual life market fastly contracting, Group life market moving from DB to DC

839

702

612

468

Challenging Non-life market

• Sales volume follow GDP

• Limited profit on insurance coverage

• Gradual decrease in CoR

• Crisis effects claims culture

• “In de brand, uit de brand”

• WGA-ER (disability) coverage misperceived by insurers, effecting capital ratio’s

Results of Non-life insurers, Combined operating Ratio

95

96

97

98

99

100

101

102

2006 2007 2008 2009 2010 2011 2012 2013

Investment result important part of surplus generation insurance

Agenda

I. Over 200 years of reliability and trust

II. Delta Lloyd’s view on risk management

III. Changing regulatory environment

IV. Questions & answers

History of Value reporting

• Dutch GAAP, using amortisation method • Liabilities value @ historical cost price : 4% interest • Embedded Value concept started in early ’90s

19/20th Century

2002/2005 • Introduction IFRS and regulatory reporting on market values • Delta Lloyd decided to use market interest for valuing liabilities • Assets at marked value

2010+

• New mortgages valued @ amortised cost • Minimum replicating cost introduced for market interest • Valuation difference with regulatory reporting

2008/2009

• Alignment with Solvency II • Back to EEV/Cash flow reporting • Introduction of UFR, IFRS and regulatory

Mismatch liability valuation and assets

1. What is the value of the liability?

2. Can we invest in the same curve? Do we want to?

SWAP ECB – AAA Collateralised –

AAA

Swap + liquidity premium

3. What is our actual investment strategy?

Mix of debt, credit, equity and real estate

Difficult Possible Difficult Possible, but

no exact match

Mismatch volatility; required capital

Corporates vs Swap

0

50

100

150

200

250

300

350

400

450

dec-0

7

mrt

-08

jun-0

8

sep-0

8

dec-0

8

mrt

-09

jun-0

9

sep-0

9

dec-0

9

mrt

-10

jun-1

0

sep-1

0

dec-1

0

mrt

-11

jun-1

1

sep-1

1

dec-1

1

mrt

-12

jun-1

2

sep-1

2

dec-1

2

mrt

-13

jun-1

3

sep-1

3

dec-1

3

Corp AA Corp A Corp BBB

Bond markets developments

Credit crisis

Euro crisis

QE

Volatile valuation curve developments

0,00%

1,00%

2,00%

3,00%

4,00%

5,00%

6,00%

2007

2008

2008

2008

2009

2009

2010

2010

2010

2011

2011

2011

2012

2012

2012

2013

COLL-AAA ECB AAA Swap

Credit crisis

Spanish downgrades QE

Euro crisis

Effect of curve development

0

1.000

2.000

3.000

4.000

5.000

6.000

2007 2008 2009 2010 2011 2012 2013

IFRS equity IGD equity

Positive effect A/L mismatch

Negative effect A/L mismatch

IFRS profit 745 -153 -81 671 -153 -1.465 168

Align all balance sheet elements Duration analysis impacted by valuation concept

Balance sheet of Delta Lloyd Group (Q3 2012 in bn)

Life Liabilities

Bank, GI, Germany, AM, and Other

Shareholders’ Funds

UL Liabilities

Life Equity

Life UL

Life FI €29

€13

€3

€34

€23

€13

€3

€34

Life mortgages, property

€6

ASSETS LIABILITIES

• Duration

13 • Duration

15

• Duration

0

Bank, GI, Germany, AM, and Other)

Exit price vs. discounted cash flows

Exit price assets:

Transaction value assets:

• Representative similar market instruments

• Sales value house, based on similar transactions

• Sales value mortgages, based on funding spreads

Exit value liabilities:

Value of liabilities for a willing buyer:

• Expected value

• Option price

• Margin for uncertainty

Discounted cash flows, or matching adjustment:

• Matching cash flows of assets and liabilities per duration

• In case cash flows emerge in same time frame similar valuation

• Buffer needed for defaults and fluctuations in cash flows

Latest Solvency II proposals allow this mechanic, but not for rental income

Interest rate risk: limited downside risk

Interest rates ‘Normal’ times:

•Interest rate risk is non-rewarding

•Hedging is cheap

In extremely low interest rate environment: higher probability of significant increases than decreases

Current models already reflect non-negativity of interest rates

Equity hedging: downside protected, upside left open

• Derivatives on equity indices ― better liquidity and lower premium than

on individual stocks ― hedge against market risk, confident

about portfolio

• Preference for listed derivatives and long puts, other instruments if needed in case of high volatility

• Sensible spread ― different exercise dates (roof tile

construction) ― different exercise prices

• Hedge reduced after underlying equity portfolio decreased

Equity derivatives - value scenarios

Matching spread risk is vitally important

•Exposure to credit spreads is vital for

supporting long-term guarantee business

•Investments by insurers are also important

for the Dutch and European economy,

especially with banks lending less

•As long as defaults are negligible, spread

risk should not ‘hurt’

•We strongly support the Volatility and

Matching Adjustment concepts

Agenda

I. Over 200 years of reliability and trust

II. Delta Lloyd’s view on risk management

III. Changing regulatory environment

IV. Questions & answers

Changing capital regimes

• Since beginning ’70’s Solvency I regime: — legal framework, volume based required capital — Liability Adequacy Test (“LAT”) in The Netherlands — Europe: cost-price +

Solvency I

(current regime)

Solvency II

(regime as from

1-1-2016)

• End ’90’s decision to move to new European framework — market value based, risk weighted capitals — governance, risk management and information are

other key elements of this system

• 2013: DNB interim measures (Solvency 1.5) — Theoretical Solvency Criterion (“TSC”) for dividend

payments of Dutch life insurance entities — Dutch ORSA (“ERB”) included in regulatory returns

Solvency 1.5

(requirement for 2014-2015)

Available Capital

Build up of Solvency I capital

Assets Liabilities

Exit price

Best Estimate Liability

Best Estimate Liability

Risk Margin2

Surrender Floor1

Market Value

Buffer

Solvency I

• Required capital ― volume based ― 4% of life reserves; 18% of general

insurance premiums

• Available capital: Market value of assets (based on exit price) -/- Best Estimate Liability -/- Risk Margin -/- Surrender Floor

• Available capital ≠ embedded value

• Solvency ratio =

1. Safety margin against policyholders liquidating their assets 2. Margin for uncertainty around Best Estimate Liability

Available capital

Required capital

Required Capital (100%)

Build up of Solvency II capital

Assets Liabilities

Best Estimate Liability

Solvency II • Required capital

― risk based ― based on 99.5% confidence interval ― based on BBB level (100%) ― buffer provides insight in credit standing

above BBB level

• Available capital: Market value of assets (based on exit price) -/- Best Estimate Liability -/- Risk Margin

• Surrender Floor included as available capital

• Available capital ≠ embedded value

• Solvency ratio = Available capital

Required capital

Available Capital

Marktwaarde

Exit price

Best Estimate Liability

Best Estimate Liability

Market Value

Buffer

Risk margin

Required Capital (100%)

Solvency I to Solvency II: from volume to risk based

Capital elements

Solvency I (current regime)

Solvency 1.5

(requirement for 2014-2015;

dutch life entities only)

Solvency II (regime as from 1-1-2016)

Available Capital Excludes future value of UL

business (Surrender Floor)

Excludes future value of UL

business

Includes future value of UL

business

Liability

valuation

ECB AAA/Swap Curve ECB AAA/Swap Curve Swap + Volatility Adjustment,

or Matching Adjustment

Assets Market value Market value Market value

÷ ÷ ÷ ÷ Required Capital

(SCR)

Volume based, 4% of life

reserves, 18% of non-life

premiums

Risk based, using Solvency II,

with risk changes to

mortgages and loans

Risk based, but possibility to

use internal model to better

reflect risks

=

Solvency Ratio (%) Available / Required capital Available / Required capital

* scaling factor (0.90)

Available / Required capital

Dealing with multiple capital regimes

Insurance NL Insurance Foreign Other Bank

Local GAAP WFT: market value Basel II/III IFRS: market value

Insurance NL Insurance Foreign Other Bank

Delta Lloyd Group

Local GAAP WFT: market value Basel II/III IFRS: market value

Insurance NL Insurance Foreign Other Bank

Delta Lloyd Group

Local GAAP WFT: market value Basel II/III IFRS: market value

IGD Group solvency

Regulatory solvency insurance entities

Regulatory solvency

Delta Lloyd Levens-

verzekering

Delta Lloyd Group

And increasing number of prudential supervisors

Same risk, same rules principles should be applied

UWV

Banks

Pension funds

Effects of differences in prudential supervision

• OFS Q1 2013 : “Insurers provide high guarantees”

• Banking annuities based on funding (mainly mortgages)

• Insurance annuity based on risk free curve (exit value)

• Revenues move from insurance to banking sector

Capital regimes determines consumer price

t=0 t=10 premium

payment

S-II

S-I

S-II*

ECB AAA

Swap

Swap + VB of MA

110

104

100

2,0% 1,8%

1,6%

Bank Mortgages 90

2,8%

Need to stay in control ourselves

• More rule leads the wrong mindset, and draws attention away from the real risks

• In the end, it is not about models and systems, but about people taking the right decisions at the right time

• In practice, it’s a small group of people taking the ‘real’ decisions, requiring:

Risk-intelligent’ people (Dylan Evans): experience and knowlegde to balance risk and return

• Transparency (market valuation) • Act swiftly between Board, investment and risk specialists

Risk / Return tradeoff very important:

‘It is not so much about what you know, but about your sense of reality what you don’t know’

Agenda

I. Over 200 years of reliability and trust

II. Delta Lloyd’s view on risk management

III. Changing regulatory environment

IV. Questions & answers