Financial risks

In its underwriting and investment operations, Sampo Group is consciously taking certain risks in order to generate earnings. Successful management of underwriting risks and investment portfolio market risks is the main source of earnings for Sampo Group companies. These earnings risks are carefully selected and actively managed.

Day-to-day management of earnings risks, i.e. maintaining them within given limits and authorizations is the responsibility of the business areas and the investment units. Underwriting risks are priced to reflect their inherent risk levels and the expected return of investments is compared to the related risks. Furthermore, earnings related risk exposures are adjusted continuously and their impact on the capital need is assessed regularly.

Some risks such as interest rate, currency and liquidity risks are by their nature simultaneously linked to various activities. In order to manage these risks efficiently, Sampo Group companies have to have a detailed understanding of expected cash flows and their variance within each of the company’s activities. In addition, a thorough understanding of how the market values of assets and liabilities may fluctuate at the total balance sheet level under different scenarios is needed. These balance sheet level risks are commonly defined as Asset and Liability Management (“ALM”) risks. In addition to interest rate, currency and liquidity risk, inflation risk and risks relating to GDP growth rates are central ALM risks in Sampo Group. The ALM risks are one of the focus areas of senior management because of their relevance to risks and earnings in the long run.

Reserve risks

If Group (“If”) conducts property and casualty (“P&C”) insurance operations in the Nordic and Baltic countries, offering a full range of insurance solutions and services to private individuals and corporations over a geographically diverse area. Nordic corporate customers with global operations are also served by branch offices in France, Germany, the Netherlands and the United Kingdom as well as via international partners. Thus, the underwriting business of If is well diversified across countries, lines of business and customer segments.

The main reserve risks for If are stemming from uncertainty in the claim amounts caused by higher than expected claims inflation, change in discount rates or an increased retirement age with the consequences that both annuities and lump sum payments would increase. The actuaries continuously monitor the level of provisions to ensure that they comply with the established guidelines. The actuaries also develop methods and systems to support these processes.

Despite the diversified portfolio, risk concentrations and consequently severe claims may arise through, for example, exposures to natural catastrophes such as storms and floods. The geographical areas most exposed to such events are Denmark, Norway and Sweden. In addition to natural catastrophes, single large claims could have an impact on the result of insurance operations. The negative economic impact of natural catastrophes and single large claims is effectively mitigated by having a well-diversified portfolio and a group-wide reinsurance program in place.

Topdanmark provides insurance and pension services in Denmark through the non-life insurance company Topdanmark Forsikring A/S and the life insurance company Topdanmark Livsforsikring A/S.

The main underwriting risk that influences the performance is the risk of catastrophe events. However, Topdanmark Forsikring has a comprehensive reinsurance programme in place contributing to the low level of underwriting risk. The reserve risks in non-life insurance represent mostly the ordinary uncertainty of calculation and claims inflation, i.e. an increase in the level of compensation due to the annual increase in compensation per policy being higher than the general development in prices or due to a change in judicial practice or legislation.

The actuarial team has a continuous dialogue with the claims departments on any changes in the practices regarding new legislation, case-law or compensation practices as well as on the impact of such changes on the routines used to calculate individual provisions.

The risk inherent in the life business is firstly related to the with profit technical provisions. As the majority of new contracts are written as unit-linked contracts, the risk will not increase as much as the volume of premiums and total provisions. The loss-absorbing buffers are a crucial part of the with profit concept in leveling of yields and claims over time. Therefore, Topdanmark Livsforsikring has continuous focus on the solvency position, the changes in the individual risks and the development of the loss-absorbing buffers. The latter is important because over time it can level out the market and insurance risks within the individual risk groups.

Hastings is a digital and technology enabled insurance provider focusing on motor and home insurance in the UK. Most of its customers join Hastings through a Price Comparison Website. Hastings operates as an insurance provider with two separate businesses. The Retail business, Hastings Insurance Services Limited (trading as “Hastings Direct”, “HISL”), a UK regulated intermediary, is responsible for end customer pricing, fraud management, product design, distribution and management of the underlying customer relationships. The Underwriting business, Advantage Insurance Company Limited (“AICL”), based in Gibraltar, engages in risk selection, technical risk pricing, reserving and claims handling. Almost all policies are directly underwritten by Advantage, with the remaining underwritten by a panel of insurance partners who provide additional underwriting capacity.

Hastings uses excess of loss and quota share reinsurance arrangements to limit its underwriting risks. These arrangements reduce the volatility that could otherwise be caused by individual large claims.

The main reserve risks are stemming from uncertainty in the claim amounts caused by higher than expected claims inflation. Advantage holds an internal risk margin versus internal best estimate. Since reserving is subject to expert judgment the Chief Actuary calculates the best estimate, the Senior Actuary verifies the data, appropriateness of techniques utilized and assumptions used to create the best estimate and an additional best estimate is created by an independent third party.

Mandatum Life operates in Finland and offers savings and pension policies as well as policies covering mortality, morbidity and disability risks.

The existing with profit liabilities and assets backing these liabilities are the most critical areas from a risk management point of view, since the business in question forms a major part of Mandatum Life’s Solvency Capital Requirement. The unit-linked business has been Mandatum Life’s main focus area since 2001. Since then the trend of unit-linked technical provisions has been upward. In contrast to the unit-linked trend, the trend of with profit technical provisions has been downward since 2005 (except for year 2014 when the group pension portfolio from Suomi Mutual was transferred to Mandatum Life).

The long duration of policies and Mandatum Life’s restricted right to change policy terms and conditions and tariffs increase biometric risks. If the premiums turn out to be inadequate and cannot be increased, technical provisions have to be supplemented by an amount corresponding to the increase in expected losses.

Longevity risk is the most critical biometric risk in Mandatum Life.

In the longer term, disability and morbidity risks are mitigated by the company’s right to raise insurance premiums for existing policies in case there is an unfavorable change in the claims development.

The underwriting portfolio of Mandatum Life is relatively well diversified and does not include any major concentration of biometric risks. To further mitigate the effects of possible risk concentrations, Mandatum Life has catastrophe reinsurance in place.

In general, biometric risks are managed by careful risk selection, by setting prices to reflect the risks and costs, by setting upper limits for the protection granted and by use of reinsurance.

Market risks

Fixed income investments and listed equity instruments form the major part of the investment portfolio. The role of real estate, private equity, and other alternative investments is immaterial.

Most of the fixed income exposures are in investment grade issues and currently the role of Nordic covered bonds and Nordic banks as issuers is central. In the equity portfolio, most of the equity investments are selectively chosen direct investments in the Nordic markets. When investing in non-Nordic equities, funds or other assets, third party managed investments are mainly used.

The Asset and Liability Management (ALM) risk is considered through the risk appetite framework and its management and governance are based on If’s Investment Policies. In general, to maintain the ALM risk within the overall risk appetite, the cash flows of insurance liabilities are matched by investing in fixed income instruments denominated in the same currencies as the liabilities. Derivatives can be used to manage the ALM risk.

In general, If is negatively affected when interest rates are decreasing or remaining at low levels, as the duration of liabilities in If is longer than the duration of assets. The overall interest rate risk is managed by sensitivity limits for instruments sensitive to interest rate changes.

If writes insurance policies that are mostly denominated in the Scandinavian currencies and in the euro. The currency risk is to a large extent reduced by matching technical provisions with investment assets denominated in the corresponding currencies or by using currency derivatives.

In If, liquidity risk is limited, since premiums are collected in advance and large claims payments are usually known a long time before they fall due. Liquidity risks are managed by cash management functions which are responsible for liquidity planning. Liquidity risk is reduced by having investments that are readily tradable in liquid markets.

In addition to fixed income instruments Topdanmark has invested, among other things, in equities, properties and CLOs (collateralized loan obligations) in order to improve the average investment return.

Market risks are limited to the extent that is considered appropriate, so that it is highly probable that the company gains a profit even in very unfavorable financial market scenarios.

The main investment assets are government and mortgage bonds, which comprise primarily Danish mortgage bonds. The assets in this asset class are interest rate sensitive and to a significant extent equivalent to the total interest rate sensitivity of the non-life insurance provisions.

Interest rate risk is calculated for assets, liabilities and derivative instruments, for which the carrying amount is dependent on the interest rate level. Regarding insurance liabilities Topdanmark is exposed to interest rate risk due to provisions for outstanding claims in non-life insurance and guaranteed benefits in life insurance. Generally, the interest rate risk is limited and controlled by investing in interest-bearing assets in order to reduce the overall interest rate exposure of the assets and liabilities to the desired level. Therefore, the Danish mortgage bonds and government bonds have a central role in the asset portfolios. To further reduce the interest rate sensitivity of the balance sheet, interest rate swaps have been used for hedging purposes.

Most of Topdanmark's interest-bearing assets comprise of AAA rated Danish mortgage bonds and debt issued or guaranteed by top-rated European states. The main source of spread risk are the mortgage bonds. Due to high allocation of these investments in the portfolios, spread risk is the most material source of market risk.

In practice, the investment assets are the only source of currency risk while the insurance liabilities are in Danish kroner. The currency risk is mitigated by derivatives and net exposures in different currencies are minor except in the euro.

Topdanmark Group has a strong liquidity position. Firstly, as premiums are paid in the beginning of the coverage period the liquidity risk related to customers’ payments is very limited. Secondly, the combination of insurance businesses is of a character in which it is highly unlikely that a liquidity shock could occur, because insurance liabilities are by their nature stable liabilities and in asset portfolios money market investments are complemented by a large portfolio of liquid listed Danish government and mortgage bonds.

Hastings’ investment portfolio has been designed to generate a targeted return whilst operating within the conservative risk appetite parameters.

The core investment portfolio of debt securities, supplemented by a diversified portfolio of holdings in collective investment schemes, is held by Advantage. The criteria for the portfolio structure, classes of holdings and individual limits are consistent with a very low risk appetite. These investment rules are monitored on a quarterly basis internally and using an external consultancy.

Cash and cash equivalent balances are held in current accounts or short-term money market instruments.

Foreign currency risk is insignificant in Hastings.

In Mandatum Life, the approach to market risk management is based on an analysis of technical provisions’ expected cash flows, interest rate level and current solvency position, i.e. active Asset and Liability Management.

Mandatum Life’s market risks arise mainly from equity investments and interest rate risk related to fixed income assets and insurance liabilities with a guaranteed interest rate. The most significant interest rate risk in the life insurance business is that fixed income investments will not, over a long period of time, generate a return at least equal to the guaranteed interest rate of technical provisions. The probability of this risk increases when market interest rates fall and stay at a low level. The duration gap between the balance sheet’s technical provisions and fixed income investments is constantly monitored and managed. Control levels based on an internal risk capacity model are used to manage and ensure adequate capital in different market situations. A growing part of Mandatum Life’s business, i.e. unit-linked and life and health business, is not interest rate sensitive, which mitigates the whole company’s interest rate risk.

The role of non-investment grade bonds and of alternative investments – real estate, private equity, biometric and other alternative assets – is also significant.

In Mandatum Life, currency risk arises mainly from investments in other currencies than the euro as the company’s technical provisions are denominated in the euro. Open FX exposures are managed within given limits.

Liquidity risk is relatively immaterial for Mandatum Life because liability cash flows in most lines of business are fairly stable and predictable and an adequate share of the investment assets is in cash or short-term money market instruments.

In life insurance companies in general, a large change in surrender rates could influence the liquidity position. However, in Mandatum Life, only a relatively small part of the insurance policies can be surrendered, and it is therefore possible to forecast short-term cash flows related to claims payments with a very high accuracy.