E.4. Market risk
Unexpected movements in prices of equities, real estate, currencies and interest rates might negatively impact the market value of the investments.
These assets are invested to meet the obligation towards both life and non-life policyholders and to earn a return on capital expected by the shareholder. The same changes might affect both assets and the present value of the insurance liabilities.
The market risk of the Group’s financial asset and liability trading positions is monitored and measured on a continuing basis, using Standard Formula pre-defined by EIOPA and other methods (cash-flow matching, duration analysis, etc.). Due to Solvency II requirements the previously used Value at Risk analysis is not used any more.
Risks are monitored on a fair value basis so that some accounting categories with insignificant risks are omitted from further chapters. Investment portfolios therefore include all Investments except for Investments in subsidiaries, Unit-linked policies, Receivables and some specific immaterial investments. It also includes Cash and cash equivalents and Financial liabilities.
Trade receivables face mainly risk of credit default. Due to the short-term pattern of trade receivables the Group considers a market risk of trade receivables as insignificant.
At year-end 2015, those investments whose market risk affects the Group were of CZK 159.6 billion at market value1.
1 Investments whose market risk affects the Group are total investments, excluding investments backing unit-linked policies since the risk is borne by policyholders, mortgage loans, receivables from banks or customers and other financial investments other than equities and bonds.
Market risk exposure
| 31.12.2015 | 31.12.2014 | |||
|---|---|---|---|---|
| (CZK million) | Total fair value | Weight (%) | Total fair value | Weight (%) |
| Equities | 12,075 | 8 | 12,226 | 8 |
| Bonds | 149,145 | 93 | 150,361 | 94 |
| Derivatives | (1,632) | (1) | (2,954) | (2) |
| Total | 159,588 | 100 | 159,633 | 100 |
Of which the Transformed fund
| 31.12.2015 | 31.12.2014 | |||
|---|---|---|---|---|
| (CZK million) | Total fair value | Weight (%) | Total fair value | Weight (%) |
| Equities | 2,673 | 3 | 2,676 | 3 |
| Bonds | 89,226 | 98 | 83,799 | 98 |
| Derivatives | (730) | (1) | (979) | (1) |
| Total | 91,169 | 100 | 85,496 | 100 |
E.4.1. Interest rate risk
The Group’s operations are subject to the risk of interest rate fluctuations to the extent that interest-earning assets (including investments) and interest-bearing liabilities mature or reprice at different times or in differing amounts. In the case of floating rate assets and liabilities the Group is also exposed to an interest rate cash flow risk, which varies depending on the different repricing characteristics of the various floating rate instruments.
Interest rate derivatives are primarily used to bridge the mismatch in the repricing of assets and liabilities. In some cases derivatives are used to convert certain interest-earning assets to floating or fixed rates to reduce the risk of losses in fair value due to interest rate changes or to lock-in spreads.
The Group monitors the sensitivity of financial assets and liabilities to various standard and non-standard interest rate scenarios. Standard scenarios that are considered on a monthly basis include a 100 basis point (bp) parallel fall or rise in all yield curves worldwide.
Unit-linked instruments are excluded from sensitivities due to the fact that investment risk is borne by the policyholders. Therefore the assets whose value is subject to interest rate risk are represented mainly by bonds and interest rate derivatives.
The table below summarises the breakdown of their carrying amount by company.
Interest rate risk exposure
| 31.12.2015 | 31.12.2014 | |||
|---|---|---|---|---|
| (CZK million) | Total carrying amount | Weight (%) | Total carrying amount | Weight (%) |
| Česká pojišťovna | 57,527 | 39 | 64,268 | 43 |
| Penzijní společnost ČP | 1,506 | 1 | 1,352 | 1 |
| The Transformed fund | 89,226 | 60 | 83,799 | 56 |
| Other companies | 690 | 0 | 731 | 0 |
| Total | 148,949 | 100 | 150,150 | 100 |
Sensitivity analysis of interest rate movements is presented for the three biggest companies (Česká pojišťovna, Penzijní společnost ČP and the Transformed fund), since the Group exposure to interest rate movements is highly concentrated in these companies.
Sensitivity to interest risk movements has been calculated by apllying a stress test (+/- 100 basis points parallel fall or rise in all yield curves) to portfolios as at 31 December 2015 and 31 December 2014.
The impact is detailed in the tables below:
Česká pojišťovna portfolio
| 31.12.2015 | 31.12.2014 | ||||
|---|---|---|---|---|---|
| (CZK million) | Income Statement | Shareholders' Equity | Income Statement | Shareholders' Equity | |
| 100 bp parallel increase | Gross impact on interest income | – | – | – | – |
Gross impact on fair value | 21 | (3,400) | (599) | (3,150) | |
Income tax charge / (credit) | (4) | 646 | 114 | 599 | |
Total net impact | 17 | (2,754) | (475) | (2,486) | |
| 100 bp parallel decrease | Gross impact on interest income | – | – | – | – |
Gross impact on fair value | (24) | 4,332 | 566 | 3,406 | |
Income tax charge / (credit) | 5 | (823) | (108) | (647) | |
Total net impact | (19) | 3,509 | 449 | 2,694 | |
Penzijní společnost ČP
| 31.12.2015 | 31.12.2014 | ||||
|---|---|---|---|---|---|
| (CZK million) | Income Statement | Shareholders' Equity | Income Statement | Shareholders' Equity | |
| 100 bp parallel increase | Gross impact on interest income | – | – | – | – |
Gross impact on fair value | – | (38) | – | (47) | |
Income tax charge / (credit) | – | 7 | – | — | |
Total net impact | – | (31) | – | (47) | |
| 100 bp parallel decrease | Gross impact on interest income | – | – | – | — |
Gross impact on fair value | – | 41 | – | 51 | |
Income tax charge / (credit) | – | (8) | – | — | |
Total net impact | – | 33 | – | 51 | |
The Transformed fund
| 31.12.2015 | 31.12.2014 | ||||
|---|---|---|---|---|---|
| (CZK million) | Income Statement | Shareholders' Equity | Income Statement | Shareholders' Equity | |
| 100 bp parallel increase | Gross impact on interest income | – | – | – | – |
Gross impact on fair value | 504 | (3,776) | (142) | (3,792) | |
Income tax charge / (credit) | – | – | – | – | |
Total net impact | 504 | (3,776) | (142) | (3,792) | |
| 100 bp parallel decrease | Gross impact on interest income | – | – | – | – |
Gross impact on fair value | (573) | 4,273 | 142 | 4,275 | |
Income tax charge / (credit) | – | – | – | – | |
Total net impact | (573) | 4,273 | 142 | 4,275 | |
E.4.2. Asset liability matching
A substantial part of insurance liabilities carries an interest rate risk. Asset-liability management is significantly involved in interest rate risk management. The management of interest rate risk implied from the net position of assets and liabilities is a key task of asset-liability management (ALM).
GCEE Group has an Asset and Liability Committee which is an advisory body of the Board of Directors and is in charge of the most strategic investments and ALM-related decisions. The committee is responsible for setting and monitoring the GCEE Group’s strategic asset allocation in the main asset classes, i.e. government and corporate bonds, equities, real estate, etc. and also the resulting asset and liability strategic position. The objective is to establish appropriate return potential together with ensuring that the GCEE Group can always meet its obligations without undue cost and in accordance with the GCEE Group’s internal and regulatory capital requirements. In order to guarantee the necessary expertise and mandate, the Committee consists of representatives of top management, asset management, risk management and ALM experts from business units.
The ALM manages the net asset-liability positions in both, life and non-life insurance, with the main focus on traditional life with long-term nature and often with embedded options and guarantees. The insurance liabilities are analysed, including the embedded options and guarantees and models of future cash-flows are prepared in cooperation with actuaries. The models allow for all guarantees under the insurance contracts and for expected development of the key parameters, primarily mortality, morbidity, lapses, administration expenses.
At first, government bonds are used to manage the net position of assets and liabilities and in particular its sensitivity to parallel and non-parallel shifts in the yield curve. Next, corporate bonds and derivatives, primarily interest rate swaps, can be used. However, in line with the credit risk management policy, investments in long-term and thus also high-duration instruments focus on government bonds. The use of interest rate swaps is limited due to their accounting treatment – as their revaluation which is reported in the income statement does not match with the reporting of the insurance liabilities.
There is a strategic target asset-liability interest rate position set within the strategic asset allocation process (SAA). With the goals being a) to deliver rates of return that are in line with both, commercial needs and strategic planning targets, and b) that the overall SAA, including equity, credit, real estate allocation and also including the strategic asset & liability duration position, is in line with the risk and capital management policy. Despite that for number of reasons it is e.g. not possible to perfectly match future cash flows of assets and liabilities, the position has been substantially reduced within the last years, primarily via purchases of long-term government bonds. In addition to the management of the strategic position, there are certain limits allowed for tactical asset manager positions, so that asset interest rate sensitivity can deviate from the benchmark in a managed manner.
E.4.3. Equity price risk
Equity price risk is the risk that equity prices will fluctuate affecting the fair value of equity investments and other instruments that derive their value from a particular equity investment or index of equity prices.
The Group manages its use of equity investments in response to changing market conditions using the following risk management tools:
a) the portfolio is diversified,
b) the limits for investments are set and carefully monitored.
The equity price risk is measured using Standard Formula (full description of methodology can be found in the legislation defined by EIOPA). The model is based on factor approach with pre-defined stresses for each equity category and diversification between them.
The table below summarises the breakdown of the carrying amount of equities and investment fund unit portfolios by company.
| 31.12.2015 | 31.12.2014 | |||
|---|---|---|---|---|
| (CZK million) | Total carrying amount | Weight (%) | Total carrying amount | Weight (%) |
| Česká pojišťovna | 8,556 | 71 | 8,072 | 66 |
| The Transformed fund | 2,673 | 22 | 2,675 | 22 |
| Other companies | 847 | 7 | 1,479 | 12 |
| Total | 12,076 | 100 | 12,226 | 100 |
Sensitivity analysis of equity prices is only presented for the two biggest companies (Česká pojišťovna and the Transformed fund), since they represent the vast majority of the Group overall equity portfolio.
For both companies equity risk evaluation has been performed by applying a stress test (+/- 10% change in equity prices) to all equities and investment fund unit portfolios at 31 December 2015 and 31 December 2014.
The sensitivity analysis is in compliance with IFRS as at the year end, before and after the related deferred taxes.
Česká pojišťovna portfolio
| 31.12.2015 | 31.12.2014 | ||||
|---|---|---|---|---|---|
| (CZK million) | Income Statement | Shareholders' Equity | Income Statement | Shareholders' Equity | |
| Equity price +10% | Gross impact on interest income | – | – | – | – |
Gross impact on fair value | – | 723 | – | 747 | |
Income tax charge / (credit) | – | (137) | – | (142) | |
Total net impact | – | 586 | – | 605 | |
| Equity price -10% | Gross impact on interest income | – | – | – | – |
Gross impact on fair value | – | (723) | – | (747) | |
Income tax charge / (credit) | – | 137 | – | 142 | |
Total net impact | – | (586) | – | (605) | |
The Transformed fund portfolio
| 31. 12. 2015 | 31.12.2014 | ||||
|---|---|---|---|---|---|
| (CZK million) | Income Statement | Shareholders' Equity | Income Statement | Shareholders' Equity | |
| Equity price +10% | Gross impact on interest income | – | – | – | – |
Gross impact on fair value | 34 | 233 | 78 | 189 | |
Income tax charge / (credit) | – | – | – | – | |
Total net impact | 34 | 233 | 78 | 189 | |
| Equity price -10% | Gross impact on interest income | – | – | – | – |
Gross impact on fair value | (34) | (233) | (78) | (189) | |
Income tax charge / (credit) | – | – | – | – | |
Total net impact | (34) | (233) | (78) | (189) | |
E.4.4. Currency risk
The Group is exposed to currency risk through transactions in foreign currencies and through its assets and liabilities denominated in foreign currencies. The business units of the Group have different functional currencies.
The currency risk is almost entirely concentrated in Česká pojišťovna.
The only exception is represented by the bond portfolio held by the Transformed fund for an overall amount of CZK 15,080 million at 31 December 2015 (out of which CZK 9,004 million is denominated in EUR and CZK 5,167 million is denominated in USD) and of CZK 12,974 million at 31 December 2014 (out of which CZK 7,982 million is denominated in EUR and CZK 4,530 million is denominated in USD).
This exposure is however matched by the use of FX hedging derivatives, and therefore the net exposure of the Transformed fund is not material.
In light of the above-mentioned concentration, the information provided in the remaining part of this section concerns only the Česká pojišťovna portfolio.
Česká pojišťovna portfolio
As the currency in which the Company presents its financial statements is CZK, movements in the exchange rates between selected foreign currencies and CZK affect the Company’s financial statements.The general strategy of the Company is to fully hedge currency risk exposure. The Company ensures that its net exposure is kept to an acceptable level by buying and selling foreign currencies at spot rates when considered appropriate, or using short-term FX operations. The FX position is regularly monitored and the hedging instruments are reviewed on a monthly basis and adjusted accordingly. Derivative financial instruments are used to manage the potential earnings impact of foreign currency movements, including currency swaps, spot and forward contracts. When suitable other instruments are also considered and used.
The Company’s main foreign exposures are to European countries and the United States of America. Its exposures are measured mainly in Euros (“EUR”) and U.S. Dollars (“USD”) and Polish Zloty (“PLN”).
The following table shows sensitivities of the portfolio to changes in foreign exchange rates. The portfolio does not contain instruments covering unit-linked policies, as the investment risk is transferred from the Company to the policyholder. Currency shocks are considered to be a rise or a fall in the value of a foreign currency position by a specified percentage. This approach is in line with the Solvency II definition of a currency risk.
Due to hedge accounting, the impact of potential increase or decrease of foreign exchange rates is limited and recognized through the income statement.
The following tables show sensitivities of the investment portfolio (including derivatives classified as financial liabilities) to change in currency risk:
| 31.12.2015 | EUR | USD | Other | ||||
|---|---|---|---|---|---|---|---|
(CZK million) | Income Statement | Shareholders' Equity | Income Statement | Shareholders' Equity | Income Statement | Shareholders' Equity |
|
| FX rate +10% | Gross impact on interest income | – | – | – | – | – | – |
Gross impact on fair value | 217 | – | 21 | – | 11 | – | |
Income tax charge / (credit) | (41) | – | (4) | – | (2) | – | |
Total net impact | 176 | – | 17 | – | 9 | – | |
| FX rate -10% | Gross impact on interest income | – | – | — | – | – | – |
Gross impact on fair value | (217) | – | (21) | – | (11) | – | |
Income tax charge / (credit) | 41 | – | 4 | – | 2 | – | |
Total net impact | (176) | – | (17) | – | (9) | – | |
| 31.12.2014 | EUR | USD | Other | ||||
|---|---|---|---|---|---|---|---|
(CZK million) | Income Statement | Shareholders' Equity | Income Statement | Shareholders' Equity | Income Statement | Shareholders' Equity |
|
| FX rate +10% | Gross impact on interest income | – | – | – | – | – | – |
Gross impact on fair value | 8 | – | (12) | – | 22 | – | |
Income tax charge / (credit) | (2) | – | 2 | – | (4) | – | |
Total net impact | 6 | – | (10) | – | 18 | – | |
| FX rate -10% | Gross impact on interest income | – | – | – | – | — | – |
Gross impact on fair value | (8) | – | 12 | – | (22) | – | |
Income tax charge / (credit) | 2 | – | (2) | – | 4 | – | |
Total net impact | (6) | – | 10 | – | (18) | – | |
The following tables show sensitivities of the insurance liabilities to change in currency risk:
| 31.12.2015 | EUR | USD | Other | ||||
|---|---|---|---|---|---|---|---|
(CZK million) | Income Statement | Shareholders' Equity | Income Statement | Shareholders' Equity | Income Statement | Shareholders' Equity | |
| FX rate +10% | Gross impact on interest income | – | – | – | – | – | – |
Gross impact on fair value | (126) | – | (3) | – | (23) | – | |
Income tax charge / (credit) | 24 | – | 1 | – | 4 | – | |
Total net impact | (102) | – | (2) | – | (19) | – | |
| FX rate -10% | Gross impact on interest income | – | – | – | – | – | – |
Gross impact on fair value | 126 | – | 3 | – | 23 | – | |
Income tax charge / (credit) | (24) | – | (1) | – | (4) | – | |
Total net impact | 102 | – | 2 | – | 19 | – | |
| 31.12.2014 | EUR | USD | Other | ||||
|---|---|---|---|---|---|---|---|
(CZK million) | Income Statement | Shareholders' Equity | Income Statement | Shareholders' Equity | Income Statement | Shareholders' Equity | |
| FX rate +10% | Gross impact on interest income | – | – | – | – | – | – |
Gross impact on fair value | (137) | – | (4) | – | (26) | – | |
Income tax charge / (credit) | 26 | – | 1 | – | 5 | – | |
Total net impact | (111) | – | (3) | – | (21) | – | |
| FX rate -10% | Gross impact on interest income | – | – | – | – | – | – |
Gross impact on fair value | 137 | – | 4 | – | 26 | – | |
Income tax charge / (credit) | (26) | – | (1) | – | (5) | – | |
Total net impact | 111 | – | 3 | – | 21 | – | |
The following table shows the composition of financial assets and liabilities with respect to the main currencies of Česká pojišťovna a.s.:
| 31.12.2015 (CZK million) | EUR | USD | CZK | PLN | Other | Total |
|---|---|---|---|---|---|---|
| Loans | 363 | – | 3,752 | – | – | 4,115 |
| Financial assets available-for-sale | 17,723 | 9,177 | 33,164 | 270 | 1,698 | 62,032 |
| Financial assets at fair value through profit or loss | (4,374) | (5,112) | 22,370 | – | (1,535) | 11,349 |
| Reinsurance assets | 2 | – | 9,780 | 8 | – | 9,790 |
| Receivables | 1,418 | 85 | 3,924 | 557 | 102 | 6,086 |
| Cash and cash equivalents | 134 | 97 | 1,649 | – | 66 | 1,946 |
| Total assets | 15,266 | 4,247 | 74,639 | 835 | 331 | 95,318 |
| Insurance liabilities | 1,264 | 29 | 66,169 | 60 | 170 | 67,692 |
| Financial liabilities | 710 | 61 | 993 | – | – | 1,764 |
| Deposits received from reinsurers | – | – | 1,402 | – | – | 1,402 |
| Payables | 381 | 157 | 7,194 | 12 | 7 | 7,751 |
| Other liabilities | – | – | 1,882 | – | – | 1,882 |
| Total liabilities | 2,355 | 247 | 77,640 | 72 | 177 | 80,491 |
| Net foreign currency position | 12,911 | 4,000 | (3,001) | 763 | 154 | 14,827 |
| 31.12.2014 (CZK million) | EUR | USD | CZK | PLN | Other | Total |
|---|---|---|---|---|---|---|
| Loans | 372 | – | 5,880 | – | – | 6,252 |
| Financial assets available-for-sale | 16,395 | 8,129 | 36,991 | 1,599 | 1,855 | 64,969 |
| Financial assets at fair value through profit or loss | 221 | 308 | 14,036 | 11 | 36 | 14,612 |
| Other investments | – | – | 2 | – | – | 2 |
| Reinsurance assets | 6 | 6 | 9,244 | 697 | 1 | 9,954 |
| Receivables | 1,248 | 102 | 4,427 | 212 | 47 | 6,036 |
| Cash and cash equivalents | 84 | 81 | 2,113 | 215 | 11 | 2,504 |
| Total assets | 18,326 | 8,626 | 72,693 | 2,734 | 1,950 | 104,329 |
| Insurance liabilities | 1,374 | 36 | 72,193 | 3,142 | 205 | 76,950 |
| Financial liabilities | 462 | 292 | 1,851 | 19 | 29 | 2,653 |
| Deposits received from reinsurers | – | – | 1,403 | – | – | 1,403 |
| Payables | 354 | 121 | 7,161 | 331 | 8 | 7,975 |
| Other liabilities | – | – | 1,763 | 42 | – | 1,805 |
| Total liabilities | 2,190 | 449 | 84,371 | 3,534 | 242 | 90,786 |
| Net foreign currency position | 16,136 | 8,177 | (11,678) | (800) | 1,708 | 13,543 |
E.4.5. Risk limits
The principal tools used to measure and control market risk exposure within the investment portfolios of the Company Česká pojišťovna are a system of risk limits.
The system includes single and total limits on foreign currency (FX), interest rate (IR) and equity (EQ) risks. The primarily aim of the system of limits is to control exposure to single type of risks. Limits are monitored on daily basis and allow Risk Management to take immediate action and actively manage the level of the undertaken risks.