Allianz Capital Markets Day: risk management · PDF fileAllianz Capital Markets Day: risk management Munich July 15, 2004. ... Stress tests and diversification ... “No Surprises”

Allianz Capital Markets Day:risk management

MunichJuly 15, 2004

Agenda

A. Risk management: No Surprises

B. Risk capital methodology

C. RoRAC calculation

Raj Singh

Jürgen Guhe

Rainer Schwarz

A 1

B 1

C 1

D. Appendix Related published charts D 1Investor Relations contacts D 2Financial calendar 2004/2005 D 3Disclaimer D 4

A. Risk management: No Surprises!

Allianz Capital Markets DayJuly 15, 2004

Raj Singh - Head of Group Risk Controlling

Agenda

I. Vision

II. Governance

III. Identification

IV. Quantification

V. Diversification

VI. Solvency II

A 01

The challenge: protect capital base andenhance value creation

Key elements

� Sufficient economic risk capital� Compliance with regulatory requirements� Stress tests and diversification

� Capital requirements� Cost of capital� Risk reports

No Surprises!

� Optimized risk-reward profile� Sustainable profitability� Transparency and accountability

Protect financial strength

Support decision-making process

Enhance value creation

Protect reputationand brand

� Customers� Shareholders� Employees

Assureefficiency and

integrity of riskmanagement

I. Vision

A 02

Agenda

I. Vision

II. Governance

III. Identification

IV. Quantification

V. Diversification

VI. Solvency II

A 03

Incorporate common sense and defy destiny

� General framework of risk managementfor Allianz currently being developed

� “No Surprises” project defines minimumstandards for OEs1

� Operational risk management tooptimise processes

II. Governance

Risk management processes haveto be embedded in the institution

Proactive management of riskon the books can reduce losses

� Active portfolio review processnecessary

� Early warning systems provideinformation to management

� Contingency plans help to reduce riskstimely

1) OE = Operating entity

A 04

Ins./BankingSubcommittees

� Decision making on transactions/products withGroup relevance

Enhanced management of Group risk profilethrough Group Risk Committee (RiCo)

Local risk management is complemented by independent Group risk oversight

Function

Group RiskCommittee

� Monitor Group/OE risk profile and solvency� Approve/recommend actions to mitigate� Set overall risk limits for OEs� Set risk policies and ensure risk controls/culture

Operatingentities

� Manage risks proactively within Group policies,guidelines and limits

� Report exposures to Group risk controlling

Group RiskControlling

� Enhance risk dialogue between Group and OEs� Extend internal risk capital model� Group risk reporting and communication

II. Governance

OE OE OE OE

Group Risk Controlling(GRC)

Insurance/Bankingsubcommittees

AllianzGroup Board

Group Risk Committee

AllianzGroup Board

� Set Group strategic risk framework� Decide risk appetite at segment and risk factor level

A 05

Consistent portfolio oversight by Allianz

Function

II. Governance

AllianzCredit Commission

Risk Executive Committee(RExCo)

� Definition of risk policies/guidelines, frameworks andrisk related methods and instruments

� Definition of risk control/management processes� Portfolio monitoring

Dresdner BankGroup Board � Set Group strategic risk framework

Group CreditCommittee(GCC)

� Credit decisions/recommendations for the Board� Decision about building and dissolving SLLP2 or

recommendations to the Board respectively decisionon country risk

Capital &TreasuryCommittee(CTC)

� Setting of capital sub-limits for divisions and/or risktypes

� Review/approval of risk capital methodology� Initiation of capital management measures

Market RiskCommittee(MaRCo)

� Review of market risk strategy and positions� Preparation of board decision of top level VaR limit� Review of market risk management/control

Dresdner BankBoard

RExCo GCC GTC MaR

CoAZ

GRC1

BU3 BU3 BU3 BU3

Risk Controlling(RCO)

Portfolio review

Dresdner Bank fully integrated into Allianz Grouprisk governance

1) Allianz Group Risk Controlling 3) Business units2) Specific loan-loss provisions

A 06

Group risk policy and minimum standardsare mandatory for all OEs

� Group risk policies and standards ensure consistently high standards of risk management

� OE risk guidelines are tailored to accommodate local context (e.g. regulation, governance)

Hierarchy of standards

� Group risk policy

� OE minimum standards

� Segment-specific guidelines(Insurance, Banking, Asset Management)

� OE-specific risk guidelines

AZ Group

Segments

Insurance

AssetManagement

Banking

Operating entities

II. Governance

A 07

� Risk-based strategy

� Risk limits &policies

� Risk organization

� Risk processes

� Risk reporting

� Risk methodologyand tools

Minimum standards provide the basis for localrisk policies

Minimum standards capture all elements of the Allianz risk governance andmanagement framework

� Clear risk strategy to be defined in line with overall Group strategy

� A limit framework must formalize the risk strategy� OEs must have in place documented policies for all risk-related

processes

� Senior risk committee oversees all OE risk activities� Independent risk oversight without direct p&l responsibility

� Tasks and decision authorities must be clearly defined anddocumented for all steps in the risk process (Risk identification, analysis& evaluation, management decision & execution, monitoring & reporting)

� Holistic risk reporting(to cover all risk categories and exposures in all business areas)

� Local risk methodology to be defined within Group standards� Allianz risk capital tool as central steering parameter� Allianz stress test tool for regulatory and S&P solvency mandatory for

selected OEs

Key elements Details

A 08

II. Governance

Risk diagnostic to be performed annually to assessOE risk management capabilities

Key elements

Analysis of OE risk management

capabilities

Dialogue on results

GRC follow-up & support

in development

Group RiCo status update

� Identification of main development priorities for OE riskmanagement

� Discussion & agreement between Group and OE ondevelopment plan

� Regular reporting on status� Escalation of critical issues

� GRC as internal advisor leverages existing knowledge� Ongoing controlling of implementation process in OE

Senior management commitment for key development needs

II. Governance

A 09

Risk View

Risk/Capital analysis Risk/Capital reporting Capital-management process

Capital View

� Group capital & solvency

� OE capital & solvency

� Recommendations for RiCo decisions

� Internal risk-capital model

� Stress tests

� Quarterly updates

� Senior management report

� Results from quarterly risk-capital analysis and stresstesting as key input

0

1

2

3

4

5

6

OE 1 OE 2 OE 3

1Q 2003

1Q 2004

� Impact of corporate strategyon capital availability

� Capital allocation

� Mandatory contingency plans

Risk/Capital analysis is integrated in existingbusiness-planning process

Pre-strategic dialogue

Strategic dialogue

Planning dialogue

Embedding risk management into existing business processes is a key to success

II. Governance

A 10

Capital overview is supplemented by OE level drill-downs

Example: Allianz Capital View - executive summary

II. Governance

� Comment

Risk capital S&P capital Regulatory capital

� Comment � Comment

A 11

Group

OEs

Segments� Comment � Comment � Comment

� Comment � Comment � Comment

Illustrative

GroupOE1OE2............................................

No immediate threat Yellow light Red light

Heat map of threats - regulatory Comments

Example: Allianz Capital View - heat map of stress resultson supervisory capital requirements across OEs

II. Governance

Current Base Case

Equity Fall IR Rise IR Fall Credit

Def.New

BusinessMini CAT Reserve � Comment on critical developments

and operating entities

A 12

Illustrative

Agenda

I. Vision

II. Governance

III. Identification

IV. Quantification

V. Diversification

VI. Solvency II

A 13

Know where you stand

� Comprehensive definition of risk categories for all business segments

� Standardized risk quantification to allow risk aggregation

� Different models tailored to different applications- Risk capital- Stress tests- Scenario analysis

Risk identification and quantification is the basis for all risk management decisions

III. Identification

A 14

Risk categories

Integrated risk framework throughout Allianz Group

1) Fiduciary

III. Identification

Insurance Banking Asset Management

Market/ALM

Credit/Counterparty� Investment� Reinsurance� Wholesale Banking� Retail Banking

Actuarial� Premium Non-Cat� Premium Cat� Reserve� Life biometric risk

Operating� Business� Operational

✔✔✔✔

✔✔✔✔

✔✔✔✔

✔✔✔✔

✔✔✔✔

✔✔✔✔

✔✔✔✔

✔✔✔✔

✔✔✔✔

✔✔✔✔

✔✔✔✔

✔✔✔✔

✔✔✔✔

✔✔✔✔

(✔✔✔✔)1

(✔✔✔✔)1

✔✔✔✔

✔✔✔✔

A 15

…split by risk categories …split by business segments

(in EUR bn)

Property/Casualty

Total

Operating risk12%

Actuarial25%

Credit/counter-party risk17%

17.8

35.5

1) Allianz internal risk capital, as of 12/2003

Banking7.7

Life/Health4.8

Holding1.6 Asset Management3.5

The risk-capital analysis sheds light on the truerisk drivers for Allianz

III. Identification

Risk capital for Allianz Group 20031

A 16

Market/ALM risk46%

Independent risk oversight will improve risk-rewardbalance of complex products

Responsibilities

Business

Local risk function

Group risk insurance

subcommittee

Group riskfunction

� Underwriting within limits of risk guidelines� Proactive risk management

� Setting of local product-related risk guidelines� Independent risk oversight over OE transactions/products� Escalation of complex/large transactions

� Setting of global product related risk minimum standards� Independent risk review over OE transactions with Group relevance� Escalation of complex/large transactions in case of dissent

� Decision-making on products/transactions with Group relevance

Basic principle is local responsibility combined with independent riskoversight and management of risk concentrations

III. Identification

A 17

Agenda

I. Vision

II. Governance

III. Identification

IV. Quantification

V. Diversification

VI. Solvency II

A 18

Put money away for a rainy day

� Adequate capitalization of risks mandatory

� Risk buffer to protect against rating downgrade

� Risk-adjusted pricing includes charging for cost of capital

Risk requires capital and capital has a price

IV. Quantification

A 19

Planningquality

Losses are random

Best-estimateNAV

Risk

Expected losses have to be considered in efficient budgeting and planning

Risk capital is required to cover volatility due tounexpected losses

NAVvolatility

Expected Unexpected

IV. Quantification

A 20

Economic risk capital1

Available risk-bearing funds

Allocated economicrisk capital

1) Before minorities

IV. Quantification

Surplus:11.8

Adequate capitalization is key ...(as of 12/2003, in EUR bn)

47.3

35.5

A 21

Economic Value Added

Risk adjustedperformancemeasurement

EVA

MarketexpectationRisk drivers

(Risk Capital CoC)x= NOPAT1 –

� Integration of risk into regular budgeting/planning process

� Management compensation linked to economic value creation

IV. Quantification

... but risk has a price

Cost of capital has to be earned on risk capital

1) Normalized profit after tax A 22

+ Gross premiums earned

– Premiums ceded

+ Investment income

– Operating cost/commissions

– Best estimate reserves

– Capital charge

= EVA

Cost of capital has to be included in pricing

+ Interest income

– Interest expense

+ Fee income

– Operating cost

– Expected loss

– Capital charge

= EVA

EVA for insurance EVA for credit

Calculate break-even combined ratio Calculate break-even margin

IV. Quantification

A 23

� Capital necessary toprotect liabilities even ina worst case shock- One-year time horizon

� Measures economic risk

� In line with regulatorydevelopments

� Standardized riskmeasurement approachwithin Allianz Group

Customized models cover specific aspects of riskand capital

� Testing effect ofpossible scenarios onthe balance sheet- Multi-year time horizon

� Simulates economicbalance sheet

� Internal planning tools(e.g. ALM)

� Model to be developed

Complementary view on risk and capital

� Quantifies effect of astress scenario onbalance sheet- One-year time horizon

� Balance sheet impact(Local GAAP and IFRS)

� Also required byregulators

� Standardized riskmeasurement approachwithin Allianz Group

IV. Quantification

A. Risk capital B. Stress test C. Scenario analysis

A 24

Stress tests on regulatory and rating capital complementthe economic perspective of risk capital

Need for simultaneous risk & capital management for all segmentsunder various perspectives increases management complexity

Regulatory capital

Perspective

Approach

Comment

� Local solvencyperspective

� Rating agencyperspective

� Economicperspective

� Internally definedstress tests

� Internally definedstress tests

� Internal riskcapital model

� Legal solvency onoperating entity (OE) /Group level

� Contingency plan� Integrated into capital

planning process

� OE and Group rating� Contingency plan� Integrated into capital

planning process

� EVA� Capital allocation� Risk management

Rating agency capital Risk capital

IV. Quantification

A 25

Current

Equity

Int. rate up

Int. rate down

Credit

New business

Mini CAT

Reserves

Combined

Current

Equity

Int. rate up

Int. rate down

Credit

New business

Mini CAT

Reserves

Combined

250%

95%

151%

210%

150%

160%

190%

190%

130%

0% 50% 100% 150% 200% 250% 300%

AAABBBStress test results: rating

IllustrativeExample: Capital View shows results for regulatoryand rating stress tests

IV. Quantification

A 26

Stress test results: regulatory solvency

260%

160%

170%

250%

220%

200%

230%

210%

180%

0% 50% 100% 150% 200% 250% 300%

Contingency plans approved by SD (for relevant OEs only)

Full risk analysisFull stress test

Risk viewCapital view

Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec

Risk analysis updateStress test update

Management reporting

Analysis

Management process � Action plan

approval by RiCo(in case ofdisagreement withOE plan escalationto board)

� Action planapproval by RiCoand integration inSD

� Action planapproval by RiCo(in case ofdisagreement withOE plan escalationto board)

� Action planapproval by RiCo

� Support for OEidentification forpre-strategicdialogue






IV. Quantification

Risk capital analysis and stress testing is integratedinto management processes and quarterly reporting

A 27

Action plan

No actionrequired

Contingencyplan

Action plan

No actionrequired

Contingencyplan

Action plan

No actionrequired

Contingencyplan

Action plan

No actionrequired

Contingencyplan

Example: OE-specific action plan

Proposed actions GRC recommendationsAction Description Timing Cost / benefit

1

2

3

Impact on CARImpact on regulatory solvency

80%90%

100%110%120%130%140%

No Acti

onActi

on 1

Action 2

Action 3

Action

4

80%90%

100%110%120%130%140%

No Acti

onActio

n 1Acti

on 2

Action

3Actio

n 4Worst case Base case

IV. Quantification

A 28

Illustrative

Scenario analysis uses available inputs to generate“what if” outputs that link to planning

Business figures Profit & loss

Balance sheet

Risk capital

EVA

Cash flows

All of these are readilyavailable

Scenario analysis

From business plan:� Business growth� Claims ratio� Expense ratio� Investment mix

From Dresdner economics unit� Equity markets� Interest rates� Exchange rates Data from risk analysis

� Liability structure� Durations� Profit sharing rules

Market environment

Scenario analysis extends one year decision horizon

OutputsInputs

IV. Quantification

A 29

Agenda

I. Vision

II. Governance

III. Identification

IV. Quantification

V. Diversification

VI. Solvency II

A 30

� Limits are necessary to avoid high concentrations

� Capital requirements can be reduced through diversification

� Reinsurance and securitization provide means to optimize diversification

Diversification is key principle for risk management

Don’t put all your eggs in one basket

V. Diversification

A 31

� Controlling of concentration risksat Group and portfolio level

– Counterparty (credit)

– Insurance accumulation

– Combinations of risks

� Triggering specific risk reductionor capital actions according tocapital/risk action plans

� Avoidance of non-strategic risks

A comprehensive limit system is necessary to manageconcentration risks

� Optimization of risk/return structure

� Budgeting, i.e. allocation of scarceresources (e.g. Risk-adjusted capital)

� Definition and delegation of risktaking competencies consistentwith pre-agreed business unitstrategy and mandate

V. Diversification

Management steering Risk control

Focus on value management Focus on risk monitoring

Limitframework

A 32

The overall Group limit framework coversdifferent types of limits

Implementation of a comprehensive limit system

Develop internal risk limits rather than receive prescriptive limits from supervisors

Solvency limits

Capital budgets

Concentration limits

Investment limits

Nat Cat limits1

Types of limits Group limits OE limits set by Group

Solvency target & corridor

Counterparty/obligor exposure limits

OE risk capital limit

Group-wide counter-party credit risk limit

Group-wideNat Cat limit

V. Diversification

1) Implementation under development A 33

Loan products

Derivatives

Bonds

Creditinsurance

Cededreinsurance

Equity

IntegratedGroup limits

set byAllianz GRC

Aggregatelimit usage

acrossall OEs

Volume-basedmeasure of

“Maximum LossPotential”

Net commitment

MtM1 + Internaladd-on

Max of (MtM1;face value)

Named limits

Market value

Best estimate ontotal exposures

� Maximum of client limit and usage to account for instances ofoverdrafts/limit breaches (both banking and insurance)

� Current MtM-value of derivative position (both banking andinsurance) plus the internal add-on approximating the 95%-ile of thefuture exposure profile after internal economic netting (“worst case”)

� Maximum of current MtM1-value or face value of the bond, i.e. face valueis taken in case bonds trade at a discount to the nominal (par) value.For Pfandbriefe a 5% and for MBS a 10% risk factor is applied

� Aggregation across all insurers regarding net probable maximumloss

� Aggregated ceded reserves plus IBNR/IBNER plus unearnedpremiums plus accounts receivables plus prospective exposures

� Current MtM1-value of equity position including strategicshareholdings (both banking and insurance)

Available limit

V. Diversification

Maximum loss potential as a harmonized measureof usage within integrated group limits

1) Marked-to-market A 34

Example: limit system to manage and controlcounterparty credit exposure

Approach helps to identify growing risk concentrations at an early stage

Group level

OE level

Credit limit- Purely based on counterparty financials

Capital limit - Considers concentrations within Allianz Group portfolio

Early warning limit - Market data (share price) considered to achieve a real-time adjustment of the limit in line with actual development of credit quality

Steering limit- Actual limit for the operating entities- Set to control difference between capital limit and actual exposure

MaxNet limit- Relation of gross to net exposure- Defines potential for additional collateralized exposure

V. Diversification

Hierarchical order of different limit perspectives

A 35

Reducing risk concentrations reducescapital requirements

Diversification effects

Portfolio optimization can create value

Original portfolioOptimized portfolio

0

20

40

60

80

100

120

140

160

Unit A Unit B Unit C Unit D Unit E Unit F

Business units

Risk

Total

� Reduction of high risks(concentrations) causes over-proportional reduction of total risk

� Smaller risks can be increasedwithout significant increase of totalrisk

� Potential instruments- Volume growth/shrink- Limit systems- Secondary markets

(e.g. reinsurance)

V. Diversification

Portfolio optimization

A 36

Illustrative

Agenda

I. Vision

II. Governance

III. Identification

IV. Quantification

V. Diversification

VI. Solvency II

A 37

Solvency II project will significantly change theEuropean insurance solvency system

While the new framework is familiar to banks, it is a radical change for insurers

� Provide supervisors with quantitative and qualitative tools to assessthe overall solvency of an insurance company

� Risk-sensitive approach– Higher risk business will require more capital– Businesses will be given an incentive to enhance risk management

� Ensure consistency across financial sectors– Interaction of directives to be considered– Inconsistencies and multiple supervision to be avoided– Products containing similar risk should be subject to the same capital requirements

� Main focus on individual operating entities within a group– Need to adequately account for risk aggregation across individual regulated entities

VI. Solvency II

A 38

Basel II type three-pillar structure proposed fornew solvency system

Allianz Group is proactively shaping risk management and risk governanceframework to comply with developing regulatory requirements

Quantitative requirements Supervisory review process Disclosure requirements

� Harmonization ofprovisions for outstandingclaims

� Risk capital requirements

� Investment rules

� Risk governanceprinciples: internal controland risk management

� ALM principles

� Long-term viability of thebusiness

� Intervention powers andresponsibilities ofsupervisors

� Enhanced transparency

� Disclosure requirementswill depend on methodsand measures adoptedfor pillars 1 and 2

� Reporting requirementsto be coordinated withIASB, InternationalAssociation of InsuranceSupervisors (IAIS) andBasel II

VI. Solvency II

A 39

Allianz risk management approach should lead tofull compliance with regulatory requirements

Need to co-operate with regulators in order to develop adequate standards

Building blocks Solvency II

Identification; quantification;diversification

Risk and capital reporting

Governance

Pillar I(Quantitative requirements)

Pillar II(Supervisory review process)

Pillar III(Transparency)

VI. Solvency II

A 40

B. Risk capital methodology


Jürgen Guhe - Head of Risk Aggregation & Control

Agenda

I. Valuation

II. Risk capital framework

III. P/C

IV. L/H

V. Bank

VI. Asset Management

VII. Diversification

VIII. Stress tests

B 01

Available capital acts as a buffer against unfavorabledevelopments

=Required capital

+Excess capital

Market crisis

Large claims

How much capital does a company need to withstand extreme events?

Liabilities

Availablecapital

Assets

I. Valuation

B 02

Available capital� Shareholders’ equity (IAS)� Total adjusted capital (S&P)� Risk bearing funds (Risk capital)

Liabilities

Required capital

Excess capital

Capital definitions are driven by the valuation concept

There is no unique definition of required capitalnor of available capital

Assets Regulatory capital

Rating agency capital

Internal risk capital

I. Valuation

B 03

IAS equity artificially volatile due to inconsistent valuation ofassets and liabilities

Equitysecurities

Real estate

AFS fixedmaturities(marketvalue)

IAS equity

Insuranceliabilities

Application example: interest rate increase in L/H business; IAS balance sheet

IAS equity volatility due to accounting mismatch is not true economic risk

Equitysecurities

Real estate

AFS fixedmaturities(marketvalue)

IAS equity

Insuranceliabilities

Equity decreases

IAS b/s IAS b/s after IR-increase

Interest rateincrease

I. Valuation

B 04

Risk capital quantifies capital due to volatility ofeconomic value of business

1) PV of expected premiums - claims - expenses

Allianz takes a market consistent approach for the valuation of liabilities, i.evaluation approach is calibrated to the market environment

Assets LiabilitiesStatutory balance sheet

Economicvalue

Regulatoryavailablecapital

Statutory valueof assets

Statutoryvalue ofliabilities

Solvencymargin

Excess capital

Market valueof current

assets

Fair valueof future

cash flows1

Fair valueof liabilities

Economicrisk capital

Excess capital

Assets LiabilitiesEconomic balance sheet

I. Valuation

B 05

Agenda

I. Valuation


III. P/C

IV. L/H

V. Bank



VIII. Stress tests

B 06

Risk is uncertainty about the future development ofthe economic value of the business

Market value of assets

Fair value of liabilities

Available capital after one year

Probability

0

Availablecapital

Economicvalue

Asset volatility

Liability volatility

Need to quantify the minimum required amount of capital

Economic insolvency


B 07

AAA AA A

Probability

Common risk framework allows for consistenttranslation of risk taking into capital requirement

Solvencystandard

0Worstcase

Change ineconomic value

Expectation= Best estimateRequired risk capital

Risk capital is the minimum amount of capital required to ensure solvency over thecourse of one year with a certain probability which is linked to our rating ambition

One year value at risk (VaR) approach


B 08

To calculate risk capital, all risk drivers have to beidentified and classified into broader risk categories

� Currentaccidentyear– Cat– Non-Cat

� Previousaccidentyears– Under-reserving

�Equities

� Interestrates(Asset-liabilitymismatch)

�Real Estate

�Mortality

�Calamity

� Longevity

� Lapses/ renewals

�Costinflation

Premiumrisks

Reserverisks

� Investments

� Loans

�Reinsurance

Establish a common risk language across the group while ensuring that all risk typesare adequately captured

� IT failure

� Litigation

�External events

Market/ALM risks

Credit/Counterparty

risksL/H

risksBusiness

risksOperational

risks

Operatingrisks

P/Crisks

Actuarialrisk


B 09

Risk categories

Integrated risk framework throughout Allianz Group

1) Fiduciary

Insurance Banking Asset management

Market/ALM

Credit/Counterparty� Investment� Reinsurance� Wholesale Banking� Retail Banking

Actuarial� Premium Non-Cat� Premium Cat� Reserve� L/H biometric risk

Operating� Business� Operational

✔✔✔✔

✔✔✔✔

✔✔✔✔

✔✔✔✔

✔✔✔✔

✔✔✔✔

✔✔✔✔

✔✔✔✔

✔✔✔✔

✔✔✔✔

✔✔✔✔

✔✔✔✔

✔✔✔✔

✔✔✔✔

(✔✔✔✔)1

(✔✔✔✔)1

✔✔✔✔

✔✔✔✔


B 10

All standalone risk capital numbers are aggregated

Premiumrisks

Reserverisks

Market/ALM

Credit /counterparty OperatingActuarial

P/C

Aggregationto OE-widerisk capital

Aggregationto risk types

L/Hrisks


Operating entity risk capital

B 11

Economic capital is a customized refinement ofrating agency capital adequacy methodologies

Internal model - the stochastic approach

� Customized approach to account for localbusiness specifics

� Systematic evaluation of internal loss data

� Explicitly accounting for diversificationeffects

� Explicit modeling of all relevant risk drivers

� Hedging activities (derivatives) can beexplicitly modeled

� Direct links to specific risk tools (e.g.NatCat, Embedded Value)

S&P model - the deterministic approach

� Standard approach heavily influenced byUS experience

� Risk factors based on average marketloss data

� No diversification effects

� Risk drivers not always explicitly modeled(e.g. NatCat)

� No explicit modeling of hedging strategies

� No interfaces to other risk tools

Internal risk capital model provides management with more accurate view onunderlying risks than standard approaches


B 12

Agenda

I. Valuation


III. P/C

IV. L/H

V. Bank



VIII. Stress tests

B 13

P/C risk capital requirements aremainly driven by actuarial risks

Premium riskTwo components

� Non-CAT– Losses– Pricing margin

� CAT– Losses– Pricing margin

Reserve risk� Volatility of best estimate ultimate

loss reserves

Actuarial models applied for premiumand reserve risk

Market/ALM

Businessrisks

ActuarialrisksCredit

Currentaccident year

� Non-Cat

� Cat

Previousaccident years

� Loss reserves

Premiumrisk

Reserverisk

P/C

III. P/C

B 14

Measuring NatCat exposure relies on probabilisticmodeling techniques

� Financial model– Exposure– Reinsurance coverage

� Vulnerability model

� Hazard model– Location geocoding– Local conditions– Regional impacts– Hazard

Key elements

Risk concentrations need to be managed by limit system

III. P/C

B 15

Reinsurance has a dual effect on risk capital

Reduction of actuarial risk� Extreme events passed on to reinsurer

Increase of credit risks� Possibility of reinsurer default

Market/ALM

BusinessrisksCredit

P/C

Internal risk capital model properly accounts for reinsurance effects

III. P/C

Actuarialrisks

B 16

Other risk categories in P/C

� Equity

� Interestrate

� Realestate

Market risk� Equity and real estate modeled by

standard approach

� Liability cash flows (claims run-off) for ALM risk determined with actuarial models

Credit� Monte Carlo simulation of correlated

losses

Business risk� Risk that fixed costs are not covered by

new or renewal business (assumption ofnormally distributed renewal rates)

� Invest-ments

� Rein-surance

� Newbusinessrisk

� Renew-al risk

Market/ALM

Businessrisks


P/C

III. P/C

B 17

Group risk capital by line of business1

Actuarial (49%)

Credit (8%)

Market/ALM (39%)

Operating (5%)

P/C risk capital split(as per 12/2003)

1) Group diversified

Total risk capital EUR 17.8bn

III. P/C

B 18

Agenda

I. Valuation


III. P/C

IV. L/H

V. Bank



VIII. Stress tests

B 19

L/H business is mainly driven by Market/ALM risk –insurance risks diversify away in large portfolios

Profit sharing creates a tie between assetreturns and liability value� Liability cash flows (usually) depend on

future asset returns

Policyholders own valuable options(guarantees)� Embedded value improper to assess

value of embedded options as just onedeterministic scenario is used

Complex modeling required to getliability cash flow projections undervarious scenarios

� Equity

� Interestrate

� Realestate

Market/ALM

Businessrisks


L/H

IV. L/H

B 20

LiabilitiesAssets

L/H

Fair value of liabilities determined by

- Future cash flows to P/H ➨ simulation required- Discount rate (risk adjusted) ➨ risk neutral technique

Economic value

PV of futurenet outflows

(Benefits+ Expenses- Premiums )

Investments at

market value

Guaranteedrate

Discounted future cash flows

Return

Time

Credited returns

Investment return

Options and guarantees are implicitly valued on a market consistent basis within arisk neutral framework

Fair value balance sheet Simulation of future cash flows

Value of liabilities has to be determined in astochastic asset/liability model

IV. L/H

B 21

Overview of valuation steps

1

2

3

4

5

Generate market scenario (risk neutral) Determine cash flows

Generate asset returnsDiscount @ Risk-free rate

Average simulation values

Liability value = USD 1.7bn

Liability value = USD 1.3bn

0%4%8%

12%16%

0 10 20 30 40 50 60Year

Rate (%)

-30%

-10%

10%

30%

0 10 20 30 40 50 60

Return (%)

Year

Asset allocation strategy

Determining cash flowsfrom asset returns

requires assumptions-200

-150

-100

-50

0

50Year

CF's

Crediting strategy

Risk neutral valuation allows: expected asset return = risk-freediscount rate = risk-free

Illustrative

IV. L/H

B 22

Value

Best estimate

asset value Asset

value impact

Bestestimate

Liabilityvalue

impact

Assetvalue

impactLiabilityvalue

impact

Risk capital

Worstcase

Economic scenario generator provides stress scenarios

The asset/liability model allows calculation of risk capitalthrough a revaluation of business under economic stresses

Worstcase

IV. L/H

B 23

Current IAS does not adequately reflect interestrate changes on L/H business

Non-linear interest rate sensitivity in L/H

-30%

-15%

0%

15%

30%

-2.0% -1.5% -1.0% -0.5% 0.0% 0.5% 1.0% 1.5% 2.0% 2.5% 3.0%

Shift of yield curve

Cha

nge

of e

cono

mic

val

ue

The fair value sensitivity to interest rate movements isinverse to IAS and less pronounced

Fair value

Current IAS

Illustrative

IV. L/H

B 24

� Traditional Macaulay duration- Reasonable proxy for the interest rate sensitivity of assets- Misleading for the liability side as liability cash flows depend on asset returns

Actual liability interest rate sensitivity much lowerthan respective duration

AssetsLiabilities

Economicvalue

Duration: 6.09IR sensitivity1: 4.65

Duration: 14.31IR sensitivity1: 5.41

Interest rate sensitivity is much lower than suggested by duration due toadjustment of liability cash flows in response to change in interest rates

Illustrative

IV. L/H

1) Quantifiable change in value caused by interest rate shifts B 25


Market/ALM (55%)

Credit (23%)

L/H risk capital split(as per 12/2003)



Actuarial (2%)

Operating (20%)

IV. L/H

B 26

Agenda

I. Valuation


III. P/C

IV. L/H

V. Bank



VIII. Stress tests

B 27

Credit risk is the main risk driver for the bank

Potential loss in value due to changesin credit quality� Downgrade� Default

Need for credit portfolio measurementand management� Credit risk depends on portfolio

composition (correlation andconcentration effects)

� Loan risk

� Issuer risk

� Counter-party risk

MarketALM

OperatingriskCredit

Bank

V. Bank

B 28

Credit risk is characterized by high loss potentialdue to default correlation and obligor concentration

Credit losses

Time (years)

Credit losses

Frequency

Expected Loss

Risk capital

V. Bank

B 29

The expected portfolio credit loss is the sum ofexpected losses of individual exposures

Exposure atdefault(EaD)

Loss givendefault(LGD)

Expected loss of obligor iELi = PDi x EaDi x LGDi

EL ELii

=�

For the determination of risk capital the completeportfolio loss distribution needs to be estimated

Max loss incase ofdefault

Fraction ofexposure lost

in case ofdefault

Probabilityat default

(PD)

Calibrationbased on

historical data

Allows calculationof transaction and customer

specific loss figure

V. Bank

B 30

Monte Carlo simulation is required to derive theportfolio credit loss distribution

� Defines probability that different obligordefault at the same time

� High default correlation implies high riskcapital requirement

1) According to the chosen solvency standard of A

7 bp chance of annuallosses exceeding

this point 1

Probability

LossesExpected loss Market value of portfolio

Risk capital

Default correlation� Exists if significant share of overall exposure

is attributable to single obligor

� High concentration will increase risk capitalrequirement

Obligor concentration

V. Bank

B 31

Market/ALM and operational risk tools complywith Basle II advanced approach

Market risk� Trading book

– Scaling of (99%, 10 days) VaR to (99.93%,1 year) VaR

– (99%, 10 days) VaR model approved byBaFin

� Banking book– (99.93%, 1 year) VaR approach for equity

positions

Operating risk� Operational risk

– Structured self assessment process andloss database provide basis for lossdistribution parameters

� Business risk– Difference between expected/budget NOP1

and stress NOP1

OperatingriskCredit

Bank

� Interest rate

� FX

� Equity

� Commo-dities

� Failures inprocesses,controls,projects

� Profitmargins

� Volumes

1) Normalized Profit

V. Bank

Market/ALM

Operational risk

Businessrisk

B 32


Credit (50%)

Market/ALM (42%)

Operating (8%)

Bank risk capital split(as per 12/2003)



V. Bank

B 33

Agenda

I. Valuation


III. P/C

IV. L/H

V. Bank



VIII. Stress tests

B 34

Rating agency approach in place – internal modelfor operational risk under development

Operational event risk� Current capital charge: based on assets

under management� Roll-out of advanced measurement

approach (AMA) underway based onstructured self assessment and internaldata

� Combined operational riskmanagement/SOX compliance procedure

MarketALM

OperatingriskCredit

AssetManagement

Business

� Failures inprocesses,controls,projects


Operationalrisk

B 35

Agenda

I. Valuation


III. P/C

IV. L/H

V. Bank



VIII. Stress tests

B 36

Since most risks are not fully correlated, diversificationbenefits have to be considered

Probability

Equity valueExpectedcase

Worstcase

Probability

Real estate valueExpectedcase

Worstcase

Equity risks

Real estate risks

Aggregation

Probability

Asset valueExpectedcase

Worstcase


B 37

All standalone risk capital numbers are aggregatedusing appropriate diversification

OE riskcapital

Market/ALM

Credit

Actuarial

Operating

OE riskcapital

Group riskcapital

OE riskcapital

Diversified risk capital can be disaggregated to individual risk types

Geo-graphicaldiversi-fication

Diversi-fication

between risk types


B 38

1Q 2004 risk capital diversification effects (EUR bn)

� Correlation partly based on assumptions - benchmarking with peers requiredto improve reliability

� Conservative approach: no negative correlation

� Consistency of correlation between OE and Group level

0

20

40

60

80

100

47.437.0 32.0 35.0

-21%-14% +9%

Group diversified(business mix and IR risk netting) [A]

Group divers. incl. geogr. divers. [A]

Total Group [AA]

Market/ALMCreditActuarialOperating

OE diversified [A]


Risk capital before and after diversification

B 39

Agenda

I. Valuation


III. P/C

IV. L/H

V. Bank



VIII. Stress tests

B 40

Modelapproach

Analysis

Stress test models were built to identify threats toexternal capital requirements (early warning system)

Contingency plans required for each OE

Regulatory stress test on OE level

� Stresses applied to year endprojection of solvency ratio

� Once per year full review ofassumptions, quarterly updates ofbalance sheets and planing data

� Stresses applied to current solvencyratio as instant shock

� Once per year full review ofassumptions, simplified quarterlyupdates

All other stress tests1

1) S&P Group & OE solvency, regulatory Group solvency

Seven standalone stresses:� Equity -30%� Interest rate +200 bps / -150 bps� Credit default (EL + Standard deviation)� New business +50%� Mini-CAT (for P/C)� Reserve strengthening (for P/C)

Calibrated to“1-in-10-year”

event

VIII. Stress tests

B 41

C. RoRACN calculation


Rainer Schwarz - Head of Group Planning and Controlling

Allianz capital efficiency metrics – accounting view

Simple measure, direct determination fromP&L and balance sheet

IFRS net income does not reflect full operatingperformance

Based on shareholders’ equity, which does notrepresent economically required capital

Determination from published annual report possible

Adjustments eliminate inconsistenciesand many distortions

Ratio still follows accounting conventions


Simple measure, direct determination fromP&L and balance sheet

Corrected for goodwill amortization; however,some distortions and inconsistencies remain


Net incomeØ SH equity

Net income + GW amort.Ø SH equity

“Total” gain to SH1

Ø SH equity

-4.66.4

1) IFRS net income adjusted for change in revaluation reserves (EUR 2.5bn), goodwill amortization (EUR 1.4bn),currency translation differences (EUR -1.7bn), and other impacts (EUR -0.8bn)

-0.3

12.1

-32.4

11.8

2002 2003

2002 2003

2002 2003

IFRS RoE b/goodwillamortization (%)

IFRS RoE (%)

Comprehensive IFRS RoE b/goodwill amort.(%)

+

+

+

+

-

-

-

-

--

C 01


First publication in 2003 analysts’ presentation;will replace RoACN going forward

Good approximation of economic reality, accountsfor Allianz’s specific economic risk situation

Corresponds to Allianz keyinternal performance metrics

Based on internal profit metrics

Better approximation of economic reality

S&P model rather mechanistic

Diversification effects on Group level not considered

Allianz capital efficiency metrics – economic view

NOPAT1

Ø Capital necessary for AA rating

NOPAT2

Ø Risk-adjusted capital3

3.211.8

3.1

12.6

1) Normalized profit after taxes (old model)

2) Normalized profit after taxes (new model); definition see on page C 09

3) Probability of economic insolvency ≤ 7bp

2002 2003

2002 2003

RoACN/old model (%)

RoRACN/new model (%)

+

+

--

+

+

+

C 02


Why RoRACN?

� Reflects economic reality better thanalternative metrics

� Corresponds to Allianz Group’s keyperformance metric (EVA)

� Adjusted IFRS data– Includes all relevant sources of economic

gains and losses from operating activities– Includes normalized investment income

� Avoids mechanistic accounting conventions,but also introduces several assumptions

� Normalization cannot be reproduced frompublished financial reports

� Superior metric of capital adequacy(as compared to alternatives likeshareholders’ equity/rating requirements)

� Represents funds required to maintainAA rating over 1-year horizon

� Derived through internal, stochastic model

� Financial diversification fully considered

NOPAT

Risk-adjusted capital (RAC)

C 03


Economic ValueAdded (EVA) Risk Capital (RoRACN - CoC)

Performancemeasurement Risk drivers Market

expectation Capital efficiency

RoRACN and EVA are closely linked

NOPATRAC

� Portfoliomanagement

� Target setting

� Capital allocation

� Managementcompensation

� Risk analysis

� Limit setting

� Early warning

� Risk-adjustedbenchmark

� Effective use of allocated capital

RoRACN === x with:

C 04


Overview: the numerator – NOPAT

IFRS net

incomeNOPAT

Adjustment and normalization process on OE level

1

2

3

4 Other impacts, mainlya) Non-Life reserve discountingb) Normalized investment incomec) Excess capital charge

Elimination of goodwill and acquisition-related expenses

Banking: Restructuring expenses

C 05


Banking: IAS 39 impact

Economic rationaleAdjustment

The numerator – adjustments

Item

Claims reserves4a

2

3

Banking:Restructuringexpenses

Discounting

Add-back

Elimination

Elimination

Because claims payments relating to balance sheet reservesare not due immediately, reserves are discounted in thenormalization process. The discount rate equals the actual,average bond yield on investments.

Restructuring expenses in Banking segment are exceptionaland not part of operating performance.

Under IFRS, timing differences of P&L impacts arise betweenclasses of securities because of their different classification(e.g. hedges and their underlying), even though economically,those impacts should occur simultaneously.

Operating management performance is not impacted bygoodwill-like expenses which arise as part of companyacquisitions.

Banking:IAS 39 impact

Goodwillamortization andacquisition-related expenses

C 06


1

Economic rationale

The numerator – normalized investment income

Normalization

Adjustment

4b

Cash (4%)2

Real estate(4%)

Equity(16%)

Fixed income(76%)

Current IFRS investment income of period

Risk-free interest rate times 120%

Average, long-term yield for equity investmentsconsistent with cost of capital, assuming β = 1(in Euro and US zones: 8.5%), plus: average deviationof actual investment results from benchmark3

Current IFRS investment income plus:average3 IFRS realized gains/ losses

∅∅∅∅ normalizedinvestment

income rate forOE

1) % of total investments of Group of EUR 338bn (without trading assets)2) Including “other” investments3) Average over 3 years; benchmark defined by OE and “Group Investments”; by default respective MSCI country index4) NII = normalized investment income

� Neutralize the volatility of equity markets� Eliminate discretionary effects from realization of capital gains/losses� Determine an adequate economic normalized return from the investment portfolio

OE asset allocation1 Normalization OE NII rate4

Valuation base: market value of portfolio at beginning of period plus 50% of net new investments in period

C 07


OEs earn normalized investment income on all their investments.Thus they earn income also on the portion of capital held on top of risk-adjustedcapital requirements. This extra income is reversed for RoRACN calculations tocreate a numerator consistent with the denominator.

Economic rationale

The numerator – excess capital charge

Deduct

Adjustment

4c

Illustrative example1 (EUR m)

Net asset value

RAC

Excess capital

Normalized return rate

Excess capital charge

1000

800

200

6%

12

Capital held on top of risk requirements

Weighted normalized investment yield of OE

Eliminated from normalized profits to reflectinvestment income on RAC basis only

1) All numbers here for demonstration purposes only

C 08


The numerator – from IFRS net income to NOPAT(2003)

C 09


IFRS netincome

Banking: IAS39 impact1

Banking:restructuringexpenses1 Other 3

Goodwillamortization,acquisition-

related expenses2 NOPAT

1,616 142

588

1,880

-126

Allianz Group (EUR m)

4,100

1) After tax; before tax: IAS 39 impact EUR 202m; restructuring expenses EUR 840m2) Of which goodwill amortization: EUR 1,413m; acquisition-related expenses: EUR 467m3) Includes normalized investment income adjustment, reserve discounting and minorities

Before minorities

The denominator – RAC factors in diversificationbenefits

Allianz Group (Average 2003, after minorities, EUR bn)

P/C L/H BankingAsset

Management CorporateGroupbefore

diversifi-cation

Diversificationimpact

RACdiversified

OEs consolidated in segment

21.2

7.6

10.82.7

2.4 44.7

-12.1

32.6

C 10


Allianz Group: RoRACN calculation(2003, after minorities)

= 12.6%RoRACN =Average RAC EUR 32.6bn

C 11


Normalized profit EUR 4.1bn

D. Appendix


Allianz Group risk capital: required vs. available funds(in EUR bn)

Required vs. available

1) Without reserves on real estate own use, before minorities2) Excluding asset valuation differences

Available funds

Shareholders’ equityMinoritiesHybrid CapitalSupp. Cap. at DresdnerOff b/s rev. Reserves1

Loss reserve discountPVFP not acc. in IFRS equ.2

OtherGoodwillTotal

28.68.45.67.31.54.12.22.0

-12.447.3

35.5

47.3

SurplusEUR 11.8bn

Availablefunds

RequiredFunds

(internalmodel)

Business linesProperty/CasualtyLife/HealthBankingAsset ManagementHoldingTotal

17.84.87.71.63.5

35.5

Required risk-adjusted capital

Risk categoriesMarket/ALMCredit/counterpartyPremiumReserveLife actuarialBusinessTotal

16.26.27.11.80.14.1

35.5

D. Appendix

from: Analysts‘ Conference 2004, Page B 54

D 01

Investor Relations contacts

D. Appendix

Oliver Schmidt Tel. +49 (0) 89 3800-3963

Head ofInvestor Relations

e-mail:[email protected]

Susanne Arheit Tel. +49 (0) 89 3800-3324


Peter Hardy Tel. +49 (0) 89 3800-18180


Andrea Förterer Tel. +49 (0) 89 3800-6677


Stefan Engelke Tel. +49 (0) 89 3800-18124


DanielaMeintzschel

Tel. +49 (0) 89 3800-17975

e-mail:[email protected] events

Fax: +49 (0) 89 3800-3899

e-mail: [email protected]

Internet (English): www.allianzgroup.com/investor-relations

Internet (German): www.allianzgroup.com/ir

ChristianLamprecht

Tel. +49 (0) 89 3800-3892


D 02

Financial calendar 2004/2005

15 July 2004 Capital Markets Day

16 August 2004 Financial report first half 2004

12 November 2004 Financial report first three quarters 2004

17 March 2005 Financial press conference for the 2004 fiscal year

18 March 2005 Analysts’ conference on fiscal year 2004 in Munich

21 March 2005 Analysts’ conference on fiscal year 2004 in Frankfurt

22 March 2005 Analysts’ conference on fiscal year 2004 in London

04 May 2005 Annual General Meeting 2005

13 May 2005 Financial report first quarter of 2005

12 August 2005 Financial report first half 2005

11 November 2005 Financial report first three quarters of 2005

D. Appendix

D 03

Disclaimer

These assessments are, as always, subject to the disclaimer provided below.

Cautionary Note Regarding Forward-Looking StatementsCertain of the statements contained herein may be statements of future expectations and other forward-looking statements that are basedon management's current views and assumptions and involve known and unknown risks and uncertainties that could cause actualresults, performance or events to differ materially from those expressed or implied in such statements. In addition to statements which areforward-looking by reason of context, the words ‘may, will, should, expects, plans, intends, anticipates, believes, estimates, predicts,potential, or continue’ and similar expressions identify forward-looking statements. Actual results, performance or events may differmaterially from those in such statements due to, without limitation, (i) general economic conditions, including in particular economicconditions in the Allianz Group's core business and 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) the extent ofcredit defaults, (vii) interest rate levels, (viii) currency exchange rates including the Euro-U.S. dollar exchange rate, (ix) changing levels ofcompetition, (x) changes in laws and regulations, including monetary convergence and the European Monetary Union, (xi) changes in thepolicies of central banks and/or foreign governments, (xii) the impact of acquisitions, including related integration issues, (xiii)reorganization measures and (xiv) general competitive factors, in each case on a local, regional, national and/or global basis. Many ofthese factors may be more likely to occur, or more pronounced, as a result of terrorist activities and their consequences. The mattersdiscussed herein may also involve risks and uncertainties described from time to time in Allianz AG’s filings with the U.S. Securities andExchange Commission. The company assumes no obligation to update any forward-looking statement.

No duty to updateThe company assumes no obligation to update any information contained herein.

D. Appendix

D 04

Documents

Allianz Capital Markets Day: risk management · PDF fileAllianz Capital Markets Day: risk management Munich July 15, 2004. ... Stress tests and diversification ... “No Surprises”