Risk Management: One CRO’s thoughtsCASS-CAPCO Fourth Annual Risk Management ConferenceLondon, 14 April, 2011

Thomas C. Wilson, Chief Risk Officer

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How does Risk Management add value?Asking the right questions…

Risk communication

• Is Allianz’s risk profile and strategy understood by the market and reflected in our valuation multiple and required capital?

Risk strategy • Does Allianz have a clear risk and solvency strategy and optimize its risk / reward profile accordingly?

• Are delegated authorities set consistent with this strategy?

Risk controlling • Is the risk profile of Allianz transparent to management?

• Is it within delegated authorities?Risk underwriting

• Are the risks which we want to take appropriately structured, underwritten and priced?

• Are all other risks (e.g. operational / reputational risk) appropriately identified and managed?

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How does Risk Management add value?

Questions…

Risk communication

Risk strategy

Risk controlling

Risk underwriting

Processes

Information& Systems

Goverance

… answering them correctly, acting on the decisions

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Standard Committee Structure

Page 4* For details of standard local RiCo agenda see Appendix

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Target Operating Model for OE Risk Organization

Standard operating model to ensure that responsibilities and authorities of Risk function are adequate

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Blueprint for risk management and recommendation for department organization

Source: OTP Finance

§ Scope of activities mandatory under the governance of the CFO§ Split by

department into sub-departments recommended, but not mandatory

§ In-depth understanding of risk profile§ Control of large risk acceptance, critical positions§ Commentary to risk reports

Risk controlling

§ SOX and ORM– Design

central processes

– Setup annual control plan

§ Management and develop-ment of credit risk models and mea-surement

§ Management and develop-ment of in-surance risk models and measurement§ Risk capital

calculation and allocation§ Risk

aggregation Life/Health and P&C§ Solvability

monitoring

§ Management and develop-ment of Fin-ancial risk models and measure-ment§ Limit setting

Risk policies and guide-lines

§ Exposure and limit controlling§ Satisfaction

of Reporting requirements– Group

interfaces– Local re-

quirements§ Reconcilia-

tion of input and output

§ Risk policy and guidelines development§ Risk

committee facilitation

Risk Management

ORM/SOX Credit risk Insurance risk

Financial risk

3Risk

Management3

Page 5

* For details please see separate TOM and relevant OTP documentation

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Group Risk Appetite and Limit Framework

Allianz Group’s Risk Appetite consists of three pillars outlined below:§ Allocating capital and defining minimum (target) capital ratios§ Defining risk tolerance and quantitative limits§ Managing liquidity to ensure flexibility

Examples OE limits set by GroupGroup limits

Solvency limits

Capital limits

Concentration limits

Investment limits

Nat Cat limits

Solvency Capital: Economic,Rating agency, Regulatory OE Risk Capital

Strategic Asset Allocation

Group-wideNat Cat limit

OE specific Nat Cat limits

Strategic Asset Allocation

Solvency target & corridor

Counterparty/Obligor exposure and VaR (Market and Credit Risk)

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Risk Identification and Assessment processes

Risk ControlledSelf-Assessment

Top Risk Assessment

Emerging Risk Initiative

COSO framework

1. Risk identification

2. Prioritization

3. Assessment (frequency, severity)

4. Mitigating controls

5. Testing

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Example: L/H product approval process

PASS

Gate 1: Acceptability

Checks on certain products (VA, EIA) and features (AL mismatches, riders, …)*

Gate 2: Profitability

NBM* check against

thresholds and approval of

limits if appropriate

All new products

Existing products with a low

or negative NBM*

PASS

FAIL FAIL

Escalation option

Escalation option

Launch new products / retain

or modify existing products

Local OE product approval and monitoring processesStart

* VA = Variable Annuities, FIA = Fixed Index Annuities, AL = Asset / liability, NBM = New Business Margin

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Financial & Risk ControllingPDSD

Embedding risk management in medium term planning

TDI

§ Capital requirements projected on a statutory, economic and rating agency basis

§ Guidance for cumul risk limits: NatCat, Country Risk, SAA risks, etc.

§ CapCo approval of Group cumulrisk limits

§ SD decisions reconfirmed

§ Lower level segment SAA approved by FiCo and CapCo

§ On-going monitoring of capital positions and limit adherence as part of controlling

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RAI - System Architecture Framework

Central Risk Platform Algorithmics

Market dataMinD

Valuation, Risk Capital, Scenarios, Sensitivities

Local Systems

ReplicatingScenarios

Feeder Systemsò Partially locally developed

and parameterized modelsò Centrally developed,

parameterized and controlled models

ò Centrally developed, locallyparameterized models

ALIM CFModels

Life/P&CAsset Input

MKMV

InvestmentData System

BusinessRisk

Web-based User Interface§ Market Value § Balance Sheet§ Available Capital§ Limits§ Hierarchies§ Tax calculation § Minorities

Market Risk Insur. Risk Credit Risk Oper. Risk Cost Risk

Replicatingportfolio tool/

Greeks

Marginaldist. /

Parameters

Marginaldist. /

Parameters

Marginaldist. /

Parameters

Marginaldist. /

Parameters

Risk Engine: MC-Simulation - Inter / Intra Risk-Aggregation Model

PRISM

PRISM R/I

OR System

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Qualitative Reporting

§ Standardized quarterly reporting on:

- Governance & Compliance with Group Standards

- General Risk Issues

- Regulatory & Legal Issues

- Market Environment & Competitive Risks

- New Product & Underwriting Approvals

- Financial Risk Exposure & Limit Adhere

- Solvency II Implementation

- L&H appendix: new product approvals, negative margin products, guarantee levels & new money rates

§ Progress on resolution of issues is tracked

§ Reports are circulated to OE and Group management ensuring transparency

Y Life Cancellation Option (New Issue):

n Deficiencies in the information provided to individual life policyholders in the past and a new insurance law enacted at the end of 2005 will require AGF to contact existing unit-linked policyholders and give them an option to cancel their policies. Policyholders will have 30 days to request a refund of their original premium.

n The worst case exposure, assuming 100% cancellation was estimated at EUR 315 mn at the end of Q1. AGF has booked a reserve of EUR 9.6 mn as of Q1, assuming a 3.6% cancellation rate would apply to a worst case exposure of EUR 260 mn (this value is lower than total unrealized losses on unit linked because policyholders have been identified to whom a letter had been sent). An action plan to send suitable information to policyholders by registered mail is being prepared. The plan may trigger higher cancellations in current market conditions ; therefore it will need to be monitored carefully.

n Group Risk is concerned that the actual lapse rate after the mailing campaign may be far higher than the expected 3.6%, although no action would potentially leave the worst case loss at much higher levels if markets deteriorate.

G

Regulatory Fines (New Issue):

n SOCA (an Oddo subsidiary) received a EUR 50k penalty for failing to comply with insurance law while acting as a broker. There is no immediate consequence for AGF entities.

4. Market Environment & Competitive Risks

R Financial Crisis Impact Update (Red in Q4)

n Equity risk remains high for L&H business, and real estate risk for P&C and L&H businesses. Liquidity is also under pressure due to money market fund support and surrenders for UL business where illiquid assets are backing some UL products. Structured credit exposures in the Allianz Banque trading portfolio are still on the balance sheet (with the risk mostly realized). The independent asset valuation review performed by Moody’s will be maintained in 2009 at the request of AGF and ABRM.

Y Hospitaliers Pension Scheme Update (Green in Q4)

n Initial decisions have been taken on 2009 annuity revaluation under planned targets and according to agreement governance. Projection updates to be produced in June. At present, equity losses and low interest rate levels have seriously damaged the capacity of the pension scheme to reach full life annuity coverage by 2028 as planned, though this is not an XXX liability (annuity rights generated before 2008 are currently limited to 8 years).

n AGF Vie exposure to market risks has also increased due to the low interest rate and equity environment, and transfer of buffers generated by new pension rights toward in-force ones.

5. New Products & Group Insurance Committee Approvals

R New Product Process Failure (New Issue)

n The new “Fipavie Diversifié” product (Generation Vie / Life Partnerships) was launched before risk review / approval with insufficient prior evidence that an appropriate process had been established to manage this completely new product. – Action 7: Product review to be completed post-launch with a local RiCo opinion. Proper

controls to be put in place before the next version of the product is launched.

– Q1 Status: Review is now 90% complete. The main risks identified to date are: (1) the

XXX Risk report – Q1 2009

2. General Risk Issues

R Internal Transactions Update (Red in Q4)

n Several XXX insurance entities have purchased shares of AZ money market funds at the official NAV price to support fund liquidity.

n In a second stage, AGF Vie purchased EUR 600mn of corporate bonds (floaters) from these funds at the mark-to-model price in December 2008, with a significant delta versus contributed market prices (the difference between the official NAV price and the model price being subsidized by AGI).

n Further support from AGF Vie was provided again in March 2009 due to growing redemptions, leading to an additional purchase of EUR 492mn of corporate bonds from these funds.

n Full liquidation of the AGI France Money Market funds could lead to an ultimate estimated need for EUR 733mn of additional liquidity support.

Y Crediting Strategy (New Issue)

n XXX has indicated to Group Risk that the current internal working assumption is for an average bonus of 3.50% in 2009. This assumption would mean paying out c. EUR 1,450mn to policyholders relative to a minimum guarantee cost of c. EUR 950mn.

n Group Risk recognizes that the French life insurance market is competitive and AGF is under pressure to maintain bonuses to attract new business and minimize surrenders.

n However, Group Risk is concerned that AGF may have reached a tipping point on bonus sustainability given the current market environment. In order to make the planned 3.50% payment, XXX would need to reduce current UAR reserves by EUR 500 mn (42% based on year-end 2008 UAR figures). This will have a material adverse impact on O&G costs, MCEV, NBM figures, Risk Capital, Statutory Solvency and the general sustainability of the traditional business.

– Action 4: Group Risk and Group Actuarial to work with AGF to quantify the impact on the above items of different crediting strategies.

Owners: Philippe Léglise CRO, GR, GA Due Date: End of Q2 2009

G Madoff Exposure Update (Red in Q4)

n Exposure in various AZ French entities has remained almost unchanged, estimated at EUR 47mn (30 November 2008), mainly through the AAAM alternative funds “Phenix Alternative Holding” and “Licorne”, and also through Oddo AM “GAP” funds. About half of this exposure is for UL assets (mostly Generation Vie and AVIP), and half for various Life and P&C portfolios.

n Decisions have been made during Q1 to notify UL clients of their entitlement to any recoverable assets from Madoff defeasance (side-pockets) extracted from some of their UL funds, and of the disappearance of several closed Madoff funds (Luxalpha, Thema). No subsidization of losses should be supported by Allianz Life Operating Entities in principle.

n Reputational risk is seen as moderate, but could increase due to some complaints already registered, as surrenders cannot be paid for a few suspended funds. Subsidization of Madoff losses even in one case might be an argument used for payment in all cases, which would result in a worst case loss of EUR 24mn for AGF France.

XXX Risk report – Q1 2009

XXX Risk report – Q1 2009

OE Contact: XXX

Group Risk Contacts: Stuart Robinson, Ioannis Kotsianos

1. Governance & Group Standards Compliance

Y Reserve Governance Update (Yellow in Q4)

n Group Actuarial has raised concerns that reserving decisions are effectively made at BU level and the Reserve Committee role and authority to challenge decisions needs to be strengthened. – Action 1: Completion of the Finance Unit organization project in order to better enhance

efficiency, including non-life actuarial reserving processes. – Q1 Status: Presentation on the Finance Unit organization project to union

representatives completed, enforcement decision still subject to union representative answer. Update on implementation to be included in Q2.

Owners: XXX Due Date: End of Q4 2009

Y

Product Approval Update (Yellow in Q4)

n A risk review of new products is always carried out, but process governance needs to be further reinforced in 2009 (risk review before launch, formalized sign-off process, independent actuarial review). – Action 2: Global process for new product design to be reengineered by Technical Area,

including Risk and Actuarial reviews before launch. – Q1 Status: Presentation on the new Product Process to Executive Committee

successfully completed. Practical set-up to be rolled-out. Update on implementation to be included in Q2.

Owners: XXX Due Date: End of Q2 2009

Y Partnerships Update (Red in Q4)

n Control of life JVs needs to be strengthened so that XXX can effectively monitor compliance and ensure governance is robust. Regulatory and reputational risks are the main concern. – Q1 Status: Local internal control position planned with 1 FTE. Agreement reached that

the general XXX product approval process will apply for JVs. Update on implementation to be included in Q2.

Owners: XXX Due Date: End of Q2 2009

G General Governance (Green in Q4)

n No major deviations from the Group Risk Policy

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Addressing the issues

Examples

Risk communication

• Regulatory filings• Rating agency disclosures• Public disclosures: Annual Report, Investor Day

Risk strategy • Risk appetite: EaR, CaR, Risk Capital• Strategic Planning, not Budgeting: TDI, SD, PD

Risk controlling • Capital solvency, EaR and CaR reporting• Individual risk reporting• Associated limit systems • Separation of duties

Risk underwriting

• Product approval processes• A/L or Strategic Asset Allocation processes• Pricing guidelines, u/w minimum standards• Risk Controlled Self-Assessment, Top Risk

Assessment

- Examples -

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Asking the right questions, answering them and acting on the decisionsExamples

Risk communication

Risk strategy

Risk controlling

Risk underwriting

Processes

Information& Systems

Goverance

Focusing on the foundations of good ERM is an important first step…but is it

sufficient?

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Outward signs of ERM: Necessary. . .but not sufficient!Warren Specter, co-COO Bear Stearns, to the Senate Financial Crisis Inquiry Committee

You have also asked me to address risk management practices. Risk at Bear Stearns was managed through a system of checks and balances. Each business unit was responsible for managing its risk, and the head of each division was then responsible for managing the aggregate risk within its units. The Executive Committee approved explicit limits for all areas of the firm - at the trading book level, and also by unit and by department - which were monitored by departmentheads. These limits were reviewed and monitored by the Risk Management Group, which was an independent unit that reported to the Executive Committee and met regularly with the Board's Risk Committee. This group, headed by Bear Stearns' Chief Risk Officer, served as an independent check on the business units' own risk management function. It distributed daily P&L statements that highlightedany significant gains and losses. It also provided daily written reports to senior managementcommenting on changes in exposure, any unusual trades, and any concentrated positions. The Risk Committee held weekly meetings, and the Risk Management Group made monthly presentations to the Executive Committee. At the weekly meetings, trading managers reported on their positions and theirrisk, and the risk management teams were present to verify the accuracy of these reports and to express their views. In this way, the Risk Committee and the business units served as constant checks on each other. There was an active dialogue among senior management about the firm's overall risk appetite, which we reviewed during both weekly and monthly meetings.In my opinion, Bear Stearns' risk management practices were robust and effective. During my tenure on the Executive Committee I found the Risk Management team to be highly trained and very experienced. Overall, I thoughtBear Stearns was well-managed, and I was saddened and disappointed whenthe firm collapsed.

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Signs of a dysfunctional risk culture:Golden Rule

Symptom: Make the gold, make the rules (and should not be challenged!)

Case study: AIG FP• PwC, AIG's auditor, concluded that the ability to access AIG FP by the risk

management and other control functions "may require strengthening". • Federal Office of Thrift Supervision (OTS), AIG FP’s regulator, sent a letter

which said that the unit "was allowed to limit access of key risk control groups while material questions relating to the valuation of the [swap portfolio] were mounting".

• Rep. Gary Peters (D., Mich.) asked AIG CEO Edward Liddy during a congressional hearing, "Where was the risk management of your company? Where was the failure of your own internal risk-management procedures?" Mr. Liddy’s response, "We had risk-management practices in place. They generally were not allowed to go up into the financial-products business.”

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Signs of a dysfunctional risk culture:„Dancing while the music is playing“

Symptom: Following the market, even when standards are deteriorating

Case study: US mortgage market• Chuck (Charles) Prince, ex-CEO of Citigroup: “When the music stops,

in terms of liquidity, things will be complicated. But as long as the music is playing, you've got to get up and dance. We're still dancing.”

• When compared to the behaviour of a lemming at an FCIC hearing, Mr. Prince’s reply was, "It would have been impossible to say to bankers, we’re not going to participate … and expect to have any people left."

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Signs of a dysfunctional risk culture:Arbitraging the system

Symptom: Building a business based on the flaws in our models

Case study: Lehman Brothers• ‘Repo 105’ transactions were considered a sale of the assets under English

law. • Court appointed examiner’s report said these deals created "a materially

misleading picture of the firm’s financial condition in late 2007 and 2008” and were “actionable balance sheet manipulation” and “nonculpable errors of business judgment”,

• Condoned by senior management of the firm, as the email excerpt illustrates: - “It’s basically window-dressing.”- “I see … so it’s legally do-able but doesn’t look good when we actually do it? Does

the rest of the street do it? Also is that why we have so much BS [balance sheet] to Rates Europe?”

- “Yes, No and yes. :)”

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How much can we rely on compensation to steerculture?

• „Dick Fuld (CEO) is also, in some sense, a victim. He’d held on to 10 million shares of Lehman stock until the end and lost almost $1 billion“

• „Mr Prince, whose exit was sealed late last week, already owns 1.61 million shares in Citi“ which decreased in value from USD 50 to USD 5 between 2007-2009.

• On March 14, 2008, CNBC reported that „the value of Jimmy Cayne's(CEO) holdings in Bear Stearns had declined from $993 million to …less than $15 million as a result, effectively removing him from the list of the wealthiest individuals in the country.“

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Three lines of defense

First line of defense:

Business isresponsible for both profit and loss, risk and

returns

OEs

Second line of defense:

Functions whichdefine framework

within whichbusiness is

allowed to work

Risk, Legal, Compliance

Third line of defense:

Ensure that the framework isadhered to

Audit

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Second line of defense:

Functions whichdefine framework

within whichbusiness is

allowed to work

Risk, Legal, Compliance

Three lines of defense

First line of defense:

Business isresponsible for both profit and loss, risk and

returns

OEs

e.g. pricing & underwriting guidelines, risk measures & limits, capital allocation

Third line of defense:

Ensure that the framework isadhered to

Audit

Management has to takeresponsibility, our frameworks have to be in place, butIn the next crisis, our models will be wrong with probability 1All frameworks can (and will) bearbitragedNo framework can anticipate all new businesses

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Management lever Risk controlling Risk management Risk communication

Risk strategy

Risk controlling

Risk underwriting

What does „risk management“ really meanin the context of the second line of defense?

Risk controlling§ Define frameworks within which business can

be done§ Control risk and limits and provide transparency§ Provide technical analysis to support business

decisionsRisk management§ Have a deep, professional understanding of the

business (not just the models!)§ Be close to the business, discussing key

decisions before they are taken§ Exercise professional judgement, occasionally

saying „no“ if our frameworks are inadequate, ifthey are being arbitraged

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Culture…the missing piece

Examples

Risk communication

Risk strategy

Risk controlling

Risk underwriting

Processes

Information& Systems

Culture

Goverance

US Supreme Court Justice Potter Stewart (on risk culture??), 1964 Jacobellis vs. Ohio“I shall not today attempt further to define the kinds of material I understand to be embraced within that shorthand description; and perhaps I could never succeed in intelligibly doing so. But I know it when I see it…”