Allianz Capital Markets Day: risk management. Munich July 15, 2004

Transcription

1 Allianz Capital Markets Day: risk management Munich July 15, 2004

2 Agenda A. Risk management: No Surprises Raj Singh A 1 B. Risk capital methodology Jürgen Guhe B 1 C. RoRAC calculation Rainer Schwarz C 1 D. Appendix Related published charts D 1 Investor Relations contacts D 2 Financial calendar 2004/2005 D 3 Disclaimer D 4

3 Raj Singh - Head of Group Risk Controlling A. Risk management: No Surprises! Allianz Capital Markets Day July 15, 2004

4 Agenda I. Vision II. III. IV. Governance Identification Quantification V. Diversification VI. Solvency II A 01

5 I. Vision The challenge: protect capital base and enhance value creation Key elements Protect financial strength Sufficient economic risk capital Compliance with regulatory requirements Stress tests and diversification Protect reputation and brand Enhance value creation Customers Shareholders Employees Optimized risk-reward profile Sustainable profitability Transparency and accountability Assure efficiency and integrity of risk management Support decisionmaking process Capital requirements Cost of capital Risk reports No Surprises! A 02

6 Agenda I. Vision II. III. IV. Governance Identification Quantification V. Diversification VI. Solvency II A 03

7 II. Governance Incorporate common sense and defy destiny Risk management processes have to be embedded in the institution Proactive management of risk on the books can reduce losses General framework of risk management for Allianz currently being developed Active portfolio review process necessary No Surprises project defines minimum standards for OEs 1 Early warning systems provide information to management Operational risk management to optimise processes Contingency plans help to reduce risks timely 1) OE = Operating entity A 04

8 II. Governance Enhanced management of Group risk profile through Group Risk Committee (RiCo) Allianz Group Board Group Risk Committee Insurance/Banking subcommittees Group Risk Controlling (GRC) Allianz Group Board Group Risk Committee Ins./Banking Subcommittees Group Risk Controlling Function Set Group strategic risk framework Decide risk appetite at segment and risk factor level 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 Decision making on transactions/products with Group relevance Enhance risk dialogue between Group and OEs Extend internal risk capital model Group risk reporting and communication OE OE OE OE Operating entities Manage risks proactively within Group policies, guidelines and limits Report exposures to Group risk controlling Local risk management is complemented by independent Group risk oversight A 05

9 II. Governance Dresdner Bank fully integrated into Allianz Group risk governance Allianz Credit Commission Dresdner Bank Group Board Function Set Group strategic risk framework Dresdner Bank Board Risk Executive Committee (RExCo) Definition of risk policies/guidelines, frameworks and risk related methods and instruments Definition of risk control/management processes Portfolio monitoring AZ GRC 1 REx Co Portfolio review GCC GTC MaR Co Group Credit Committee (GCC) Credit decisions/recommendations for the Board Decision about building and dissolving SLLP 2 or recommendations to the Board respectively decision on country risk Risk Controlling (RCO) BU 3 BU 3 BU 3 BU 3 Capital & Treasury Committee (CTC) Market Risk Committee (MaRCo) Setting of capital sub-limits for divisions and/or risk types Review/approval of risk capital methodology Initiation of capital management measures Review of market risk strategy and positions Preparation of board decision of top level VaR limit Review of market risk management/control Consistent portfolio oversight by Allianz 1) Allianz Group Risk Controlling 3) Business units 2) Specific loan-loss provisions A 06

10 II. Governance Group risk policy and minimum standards are mandatory for all OEs Hierarchy of standards Group risk policy AZ Group OE minimum standards Segments Insurance Asset Management Banking Segment-specific guidelines (Insurance, Banking, Asset Management) Operating entities OE-specific risk guidelines 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) A 07

11 II. Governance Minimum standards provide the basis for local risk policies Key elements Risk-based strategy Details Clear risk strategy to be defined in line with overall Group strategy Risk limits & policies Risk organization Risk processes Risk reporting Risk methodology and tools 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 and documented 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 Minimum standards capture all elements of the Allianz risk governance and management framework A 08

12 II. Governance Risk diagnostic to be performed annually to assess OE risk management capabilities Key elements Analysis of OE risk management capabilities Identification of main development priorities for OE risk management Dialogue on results Discussion & agreement between Group and OE on development plan Group RiCo status update Regular reporting on status Escalation of critical issues GRC follow-up & support in development GRC as internal advisor leverages existing knowledge Ongoing controlling of implementation process in OE Senior management commitment for key development needs A 09

13 II. Governance Risk/Capital analysis is integrated in existing business-planning process Risk/Capital analysis Risk/Capital reporting Capital-management process 6 Risk View Pre-strategic dialogue Q Q 2004 Capital View Group capital & solvency Strategic dialogue 2 OE capital & solvency 1 0 OE 1 OE 2 OE 3 Recommendations for RiCo decisions Planning dialogue Internal risk-capital model Stress tests Quarterly updates Senior management report Results from quarterly riskcapital analysis and stress testing as key input Impact of corporate strategy on capital availability Capital allocation Mandatory contingency plans Embedding risk management into existing business processes is a key to success A 10

14 II. Governance Example: Allianz Capital View - executive summary Illustrative Risk capital S&P capital Regulatory capital Comment Comment Comment Group Comment Comment Comment Segments Comment Comment Comment OEs Capital overview is supplemented by OE level drill-downs A 11

15 II. Governance Example: Allianz Capital View - heat map of stress results on supervisory capital requirements across OEs Heat map of threats - regulatory Comments Illustrative Group Current Base Case Equity Fall IR Rise IR Fall Credit Def. New Business Mini CAT Reserve Comment on critical developments and operating entities OE1 OE No immediate threat Yellow light Red light A 12

16 Agenda I. Vision II. III. IV. Governance Identification Quantification V. Diversification VI. Solvency II A 13

17 III. Identification Know where you stand Risk identification and quantification is the basis for all risk management decisions 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 A 14

18 III. Identification Risk categories Insurance Banking Asset Management Market/ALM ( ) 1 Credit/Counterparty Investment Reinsurance Wholesale Banking Retail Banking ( ) 1 Actuarial Premium Non-Cat Premium Cat Reserve Life biometric risk Operating Business Operational Integrated risk framework throughout Allianz Group 1) Fiduciary A 15

19 III. Identification The risk-capital analysis sheds light on the true risk drivers for Allianz Risk capital for Allianz Group split by risk categories split by business segments Operating risk 12% Market/ALM risk 46% (in EUR bn) 3.5 Holding 1.6 Asset Management Credit/counterparty risk 17% Life/Health Banking 17.8 Property/Casualty Actuarial 25% 35.5 Total 1) Allianz internal risk capital, as of 12/2003 A 16

20 III. Identification Independent risk oversight will improve risk-reward balance of complex products Responsibilities Business Underwriting within limits of risk guidelines Proactive risk management Local risk function Setting of local product-related risk guidelines Independent risk oversight over OE transactions/products Escalation of complex/large transactions Group risk function 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 Group risk insurance subcommittee Decision-making on products/transactions with Group relevance Basic principle is local responsibility combined with independent risk oversight and management of risk concentrations A 17

21 Agenda I. Vision II. III. IV. Governance Identification Quantification V. Diversification VI. Solvency II A 18

22 IV. Quantification Put money away for a rainy day Risk requires capital and capital has a price Adequate capitalization of risks mandatory Risk buffer to protect against rating downgrade Risk-adjusted pricing includes charging for cost of capital A 19

23 IV. Quantification Risk capital is required to cover volatility due to unexpected losses Losses are random Expected Unexpected Planning quality Best-estimate NAV NAV volatility Risk Expected losses have to be considered in efficient budgeting and planning A 20

24 IV. Quantification Adequate capitalization is key... (as of 12/2003, in EUR bn) Economic risk capital 1 Surplus: Available riskbearing funds Allocated economic risk capital 1) Before minorities A 21

25 IV. Quantification... but risk has a price Economic Value Added EVA = NOPAT 1 (Risk Capital x CoC) Risk adjusted performance measurement Risk drivers Market expectation Integration of risk into regular budgeting/planning process Management compensation linked to economic value creation Cost of capital has to be earned on risk capital 1) Normalized profit after tax A 22

26 IV. Quantification Cost of capital has to be included in pricing EVA for insurance + Gross premiums earned EVA for credit + Interest income Premiums ceded Interest expense + Investment income + Fee income Operating cost/commissions Operating cost Best estimate reserves Expected loss Capital charge Capital charge = EVA = EVA Calculate break-even combined ratio Calculate break-even margin A 23

27 IV. Quantification Customized models cover specific aspects of risk and capital A. Risk capital B. Stress test C. Scenario analysis Capital necessary to protect liabilities even in a worst case shock - One-year time horizon Quantifies effect of a stress scenario on balance sheet - One-year time horizon Testing effect of possible scenarios on the balance sheet - Multi-year time horizon Measures economic risk In line with regulatory developments Standardized risk measurement approach within Allianz Group Balance sheet impact (Local GAAP and IFRS) Also required by regulators Standardized risk measurement approach within Allianz Group Simulates economic balance sheet Internal planning tools (e.g. ALM) Model to be developed Complementary view on risk and capital A 24

28 IV. Quantification Stress tests on regulatory and rating capital complement the economic perspective of risk capital Regulatory capital Rating agency capital Risk capital Perspective Local solvency perspective Rating agency perspective Economic perspective Approach Internally defined stress tests Internally defined stress tests Internal risk capital model Comment Legal solvency on operating 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 Need for simultaneous risk & capital management for all segments under various perspectives increases management complexity A 25

29 IV. Quantification Example: Capital View shows results for regulatory and rating stress tests Stress test results: regulatory solvency Stress test results: rating BBB A AA Illustrative Current 250% Current 210% Equity 170% Equity 151% Int. rate up 160% Int. rate up 95% Int. rate down 260% Int. rate down 250% Credit 210% Credit 190% New business 230% New business 190% Mini CAT 200% Mini CAT 160% Reserves 220% Reserves 150% Combined 180% Combined 130% 0% 50% 100% 150% 200% 250% 300% 0% 50% 100% 150% 200% 250% 300% A 26

30 IV. Quantification Risk capital analysis and stress testing is integrated into management processes and quarterly reporting Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec Analysis Full risk analysis Full stress test Risk analysis update Stress test update Risk analysis update Stress test update Risk analysis update Stress test update Management reporting Risk view Capital view Risk view Capital view Risk view Capital view Risk view Capital view Management process Action plan Contingency plan No action required Action plan approval by RiCo (in case of disagreement with OE plan escalation to board) Action plan Contingency plan No action required Action plan approval by RiCo and integration in SD Contingency plans approved by SD (for relevant OEs only) Action plan Contingency plan No action required Action plan approval by RiCo (in case of disagreement with OE plan escalation to board) Action plan Contingency plan No action required Action plan approval by RiCo Support for OE identification for pre-strategic dialogue A 27

31 IV. Quantification Example: OE-specific action plan Proposed actions Illustrative GRC recommendations Action Description Timing Cost / benefit Impact on regulatory solvency Impact on CAR 140% 130% 120% 110% 100% 90% 80% 140% 130% 120% 110% 100% 90% 80% No Action Action 1 Action 2 Action 3 Action 4 No Action Action 1 Action 2 Action 3 Action 4 Worst case Base case A 28

32 IV. Quantification Scenario analysis uses available inputs to generate what if outputs that link to planning Inputs Business figures Outputs Profit & loss From business plan: Business growth Claims ratio Expense ratio Investment mix Market environment From Dresdner economics unit Equity markets Interest rates Exchange rates All of these are readily available Scenario analysis Data from risk analysis Liability structure Durations Profit sharing rules Balance sheet Risk capital EVA Cash flows Scenario analysis extends one year decision horizon A 29

33 Agenda I. Vision II. III. IV. Governance Identification Quantification V. Diversification VI. Solvency II A 30

34 V. Diversification Don t put all your eggs in one basket Diversification is key principle for risk management Limits are necessary to avoid high concentrations Capital requirements can be reduced through diversification Reinsurance and securitization provide means to optimize diversification A 31

35 V. Diversification A comprehensive limit system is necessary to manage concentration risks Management steering Risk control Optimization of risk/return structure Budgeting, i.e. allocation of scarce resources (e.g. Risk-adjusted capital) Definition and delegation of risk taking competencies consistent with pre-agreed business unit strategy and mandate Limit framework Controlling of concentration risks at Group and portfolio level Counterparty (credit) Insurance accumulation Combinations of risks Triggering specific risk reduction or capital actions according to capital/risk action plans Avoidance of non-strategic risks Focus on value management Focus on risk monitoring A 32

36 V. Diversification The overall Group limit framework covers different types of limits Implementation of a comprehensive limit system Types of limits Group limits OE limits set by Group Solvency limits Solvency target & corridor Capital budgets OE risk capital limit Concentration limits Counterparty/obligor exposure limits Investment limits Group-wide counterparty credit risk limit Nat Cat limits 1 Group-wide Nat Cat limit Develop internal risk limits rather than receive prescriptive limits from supervisors 1) Implementation under development A 33

37 V. Diversification Maximum loss potential as a harmonized measure of usage within integrated group limits Integrated Group limits set by Allianz GRC Aggregate limit usage across all OEs Volume-based measure of Maximum Loss Potential Available limit Loan products Derivatives Bonds Credit insurance Ceded reinsurance Equity Net commitment MtM 1 + Internal add-on Max of (MtM 1 ; face value) Named limits Best estimate on total exposures Market value Maximum of client limit and usage to account for instances of overdrafts/limit breaches (both banking and insurance) Current MtM-value of derivative position (both banking and insurance) plus the internal add-on approximating the 95%-ile of the future exposure profile after internal economic netting ( worst case ) Maximum of current MtM 1 -value or face value of the bond, i.e. face value is 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 maximum loss Aggregated ceded reserves plus IBNR/IBNER plus unearned premiums plus accounts receivables plus prospective exposures Current MtM 1 -value of equity position including strategic shareholdings (both banking and insurance) 1) Marked-to-market A 34

38 V. Diversification Example: limit system to manage and control counterparty credit exposure Hierarchical order of different limit perspectives Credit limit - Purely based on counterparty financials Group level 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 OE level 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 Approach helps to identify growing risk concentrations at an early stage A 35

39 V. Diversification Reducing risk concentrations reduces capital requirements Illustrative Diversification effects Risk Original portfolio Optimized portfolio Portfolio optimization Reduction of high risks (concentrations) causes overproportional reduction of total risk Smaller risks can be increased without significant increase of total risk Potential instruments - Volume growth/shrink - Limit systems - Secondary markets (e.g. reinsurance) 0 Unit A Unit B Unit C Unit D Unit E Unit F Business units Total Portfolio optimization can create value A 36

40 Agenda I. Vision II. III. IV. Governance Identification Quantification V. Diversification VI. Solvency II A 37

41 VI. Solvency II Solvency II project will significantly change the European insurance solvency system Provide supervisors with quantitative and qualitative tools to assess the 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 While the new framework is familiar to banks, it is a radical change for insurers A 38

42 VI. Solvency II Basel II type three-pillar structure proposed for new solvency system Quantitative requirements Supervisory review process Disclosure requirements Harmonization of provisions for outstanding claims Risk capital requirements Investment rules Risk governance principles: internal control and risk management ALM principles Long-term viability of the business Intervention powers and responsibilities of supervisors Enhanced transparency Disclosure requirements will depend on methods and measures adopted for pillars 1 and 2 Reporting requirements to be coordinated with IASB, International Association of Insurance Supervisors (IAIS) and Basel II Allianz Group is proactively shaping risk management and risk governance framework to comply with developing regulatory requirements A 39

43 VI. Solvency II Allianz risk management approach should lead to full compliance with regulatory requirements Building blocks Solvency II Identification; quantification; diversification Pillar I (Quantitative requirements) Governance Pillar II (Supervisory review process) Risk and capital reporting Pillar III (Transparency) Need to co-operate with regulators in order to develop adequate standards A 40

44 Jürgen Guhe - Head of Risk Aggregation & Control B. Risk capital methodology Allianz Capital Markets Day July 15, 2004

45 Agenda I. Valuation II. III. IV. Risk capital framework P/C L/H V. Bank VI. VII. VIII. Asset Management Diversification Stress tests B 01

46 I. Valuation Available capital acts as a buffer against unfavorable developments Assets Liabilities Large claims Available capital = Required capital + Excess capital Market crisis How much capital does a company need to withstand extreme events? B 02

47 I. Valuation There is no unique definition of required capital nor of available capital Assets Liabilities Regulatory capital Rating agency capital Internal risk capital Required capital Excess capital Available capital Shareholders equity (IAS) Total adjusted capital (S&P) Risk bearing funds (Risk capital) Capital definitions are driven by the valuation concept B 03

48 I. Valuation IAS equity artificially volatile due to inconsistent valuation of assets and liabilities Application example: interest rate increase in L/H business; IAS balance sheet IAS b/s IAS b/s after IR-increase Equity securities Equity securities Real estate Insurance liabilities Interest rate increase Real estate Insurance liabilities AFS fixed maturities (market value) IAS equity AFS fixed maturities (market value) IAS equity Equity decreases IAS equity volatility due to accounting mismatch is not true economic risk B 04

49 I. Valuation Risk capital quantifies capital due to volatility of economic value of business Statutory balance sheet Assets Liabilities Economic balance sheet Assets Liabilities Statutory value of assets Statutory value of liabilities Solvency margin Excess capital Regulatory available capital Market value of current assets Fair value of future cash flows 1 Fair value of liabilities Economic risk capital Excess capital Economic value Allianz takes a market consistent approach for the valuation of liabilities, i.e valuation approach is calibrated to the market environment 1) PV of expected premiums - claims - expenses B 05

50 Agenda I. Valuation II. III. IV. Risk capital framework P/C L/H V. Bank VI. VII. VIII. Asset Management Diversification Stress tests B 06

51 II. Risk capital framework Risk is uncertainty about the future development of the economic value of the business Available capital after one year Market value of assets Fair value of liabilities Liability volatility Economic value Available capital 0 Economic insolvency Probability Asset volatility Need to quantify the minimum required amount of capital B 07

52 II. Risk capital framework Common risk framework allows for consistent translation of risk taking into capital requirement One year value at risk (VaR) approach Solvency standard Probability AAA AA A Worst case 0 Required risk capital Expectation = Best estimate Change in economic value Risk capital is the minimum amount of capital required to ensure solvency over the course of one year with a certain probability which is linked to our rating ambition B 08

53 II. Risk capital framework To calculate risk capital, all risk drivers have to be identified and classified into broader risk categories Market/ ALM risks Credit/ Counterparty risks Actuarial risk Operating risks Equities Investments P/C risks L/H risks Operational risks Business risks Interest rates (Assetliability mismatch) Real Estate Loans Reinsurance Premium risks Current accident year Cat Non-Cat Reserve risks Previous accident years Underreserving Mortality Calamity Longevity IT failure Litigation External events Lapses/ renewals Cost inflation Establish a common risk language across the group while ensuring that all risk types are adequately captured B 09

54 II. Risk capital framework Risk categories Insurance Banking Asset management Market/ALM ( ) 1 Credit/Counterparty Investment Reinsurance Wholesale Banking Retail Banking ( ) 1 Actuarial Premium Non-Cat Premium Cat Reserve L/H biometric risk Operating Business Operational Integrated risk framework throughout Allianz Group 1) Fiduciary B 10

55 II. Risk capital framework All standalone risk capital numbers are aggregated Operating entity risk capital Aggregation to OE-wide risk capital Market/ ALM Credit / counterparty Actuarial Operating Aggregation to risk types P/C L/H risks Premium risks Reserve risks B 11

56 II. Risk capital framework Economic capital is a customized refinement of rating agency capital adequacy methodologies Internal model - the stochastic approach S&P model - the deterministic approach Customized approach to account for local business specifics Systematic evaluation of internal loss data Explicitly accounting for diversification effects Explicit modeling of all relevant risk drivers Hedging activities (derivatives) can be explicitly modeled Direct links to specific risk tools (e.g. NatCat, Embedded Value) Standard approach heavily influenced by US experience Risk factors based on average market loss 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 on underlying risks than standard approaches B 12

57 Agenda I. Valuation II. III. IV. Risk capital framework P/C L/H V. Bank VI. VII. VIII. Asset Management Diversification Stress tests B 13

58 III. P/C P/C risk capital requirements are mainly driven by actuarial risks Market/ ALM Credit P/C Premium risk Current accident year Actuarial risks Business risks Reserve risk Previous accident years Premium risk Two components Non-CAT Losses Pricing margin CAT Losses Pricing margin Reserve risk Volatility of best estimate ultimate loss reserves Non-Cat Cat Loss reserves Actuarial models applied for premium and reserve risk B 14

59 III. P/C Measuring NatCat exposure relies on probabilistic modeling techniques Key elements Financial model Exposure Reinsurance coverage Vulnerability model Hazard model Location geocoding Local conditions Regional impacts Hazard Risk concentrations need to be managed by limit system B 15

60 III. P/C Reinsurance has a dual effect on risk capital P/C Reduction of actuarial risk Extreme events passed on to reinsurer Market/ ALM Credit Actuarial risks Business risks Increase of credit risks Possibility of reinsurer default Internal risk capital model properly accounts for reinsurance effects B 16

61 III. P/C Other risk categories in P/C P/C Market risk Equity and real estate modeled by standard approach Market/ ALM Credit Actuarial risks Business risks Liability cash flows (claims run-off) for ALM risk determined with actuarial models Equity Interest rate Real estate Investments Reinsurance New business risk Renewal risk Credit Monte Carlo simulation of correlated losses Business risk Risk that fixed costs are not covered by new or renewal business (assumption of normally distributed renewal rates) B 17

62 III. P/C P/C risk capital split (as per 12/2003) Group risk capital by line of business 1 Operating (5%) Credit (8%) Actuarial (49%) Market/ALM (39%) Total risk capital EUR 17.8bn 1) Group diversified B 18

63 Agenda I. Valuation II. III. IV. Risk capital framework P/C L/H V. Bank VI. VII. VIII. Asset Management Diversification Stress tests B 19

64 IV. L/H L/H business is mainly driven by Market/ALM risk insurance risks diversify away in large portfolios L/H Profit sharing creates a tie between asset returns and liability value Liability cash flows (usually) depend on future asset returns Market/ ALM Credit Actuarial risks Business risks Policyholders own valuable options (guarantees) Equity Interest rate Embedded value improper to assess value of embedded options as just one deterministic scenario is used Real estate Complex modeling required to get liability cash flow projections under various scenarios B 20

65 IV. L/H Value of liabilities has to be determined in a stochastic asset/liability model Fair value balance sheet Assets Liabilities Simulation of future cash flows Return Investment return Investments at market value PV of future net outflows (Benefits + Expenses - Premiums ) L/H Credited returns Guaranteed rate Time Discounted future cash flows Economic value Fair value of liabilities determined by - Future cash flows to P/H simulation required - Discount rate (risk adjusted) risk neutral technique Options and guarantees are implicitly valued on a market consistent basis within a risk neutral framework B 21

66 IV. L/H Overview of valuation steps 1 Generate market scenario (risk neutral) Rate (%) 16% 12% 8% 4% 0% Year 3 Determine cash flows CF's Illustrative Year Determining cash flows from asset returns requires assumptions 2 Asset allocation strategy Generate asset returns 4 Risk-free rate Return (%) Liability value = USD 1.7bn 30% 10% -10% -30% Year Average simulation values Liability value = USD 1.3bn Crediting strategy Risk neutral valuation allows: expected asset return = risk-free discount rate = risk-free B 22

67 IV. L/H The asset/liability model allows calculation of risk capital through a revaluation of business under economic stresses Economic scenario generator provides stress scenarios Value Best estimate asset value Worst case Asset value impact Asset value impact Liability value impact Risk capital Worst case Best estimate Liability value impact B 23

68 IV. L/H Current IAS does not adequately reflect interest rate changes on L/H business Illustrative Non-linear interest rate sensitivity in L/H 30% Fair value Change of economic value 15% 0% -15% Current IAS -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 The fair value sensitivity to interest rate movements is inverse to IAS and less pronounced B 24

69 IV. L/H Actual liability interest rate sensitivity much lower than respective duration Illustrative Duration: 6.09 IR sensitivity 1 : 4.65 Assets Liabilities Duration: IR sensitivity 1 : 5.41 Economic value 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 Interest rate sensitivity is much lower than suggested by duration due to adjustment of liability cash flows in response to change in interest rates 1) Quantifiable change in value caused by interest rate shifts B 25

70 IV. L/H L/H risk capital split (as per 12/2003) Group risk capital by line of business 1 Actuarial (2%) Operating (20%) Market/ALM (55%) Credit (23%) Total risk capital EUR 4.8bn 1) Group diversified B 26

71 Agenda I. Valuation II. III. IV. Risk capital framework P/C L/H V. Bank VI. VII. VIII. Asset Management Diversification Stress tests B 27

72 V. Bank Credit risk is the main risk driver for the bank Bank Potential loss in value due to changes in credit quality Downgrade Default Market ALM Credit Loan risk Issuer risk Counterparty risk Operating risk Need for credit portfolio measurement and management Credit risk depends on portfolio composition (correlation and concentration effects) B 28

73 V. Bank Credit risk is characterized by high loss potential due to default correlation and obligor concentration Credit losses Credit losses Risk capital Expected Loss Time (years) Frequency B 29

74 V. Bank The expected portfolio credit loss is the sum of expected losses of individual exposures Probability at default (PD) Calibration based on historical data Exposure at default (EaD) Max loss in case of default Expected loss of obligor i = EL i = PD i x EaD i x LGD i EL EL i i Loss given default (LGD) Fraction of exposure lost in case of default Allows calculation of transaction and customer specific loss figure For the determination of risk capital the complete portfolio loss distribution needs to be estimated B 30

75 V. Bank Monte Carlo simulation is required to derive the portfolio credit loss distribution Probability 7 bp chance of annual losses exceeding this point 1 Expected loss Risk capital Market value of portfolio Losses Default correlation Defines probability that different obligor default at the same time High default correlation implies high risk capital requirement Obligor concentration Exists if significant share of overall exposure is attributable to single obligor High concentration will increase risk capital requirement 1) According to the chosen solvency standard of A B 31

76 V. Bank Market/ALM and operational risk tools comply with Basle II advanced approach Bank Market risk Trading book Scaling of (99%, 10 days) VaR to (99.93%, 1 year) VaR (99%, 10 days) VaR model approved by BaFin Market/ ALM Interest rate Credit Operating risk Banking book (99.93%, 1 year) VaR approach for equity positions FX Equity Commodities Operational risk Failures in processes, controls, projects Business risk Profit margins Volumes Operating risk Operational risk Structured self assessment process and loss database provide basis for loss distribution parameters Business risk Difference between expected/budget NOP 1 and stress NOP 1 1) Normalized Profit B 32

77 V. Bank Bank risk capital split (as per 12/2003) Group risk capital by line of business 1 Operating (8%) Credit (50%) Market/ALM (42%) Total risk capital EUR 7.7bn 1) Group diversified B 33

78 Agenda I. Valuation II. III. IV. Risk capital framework P/C L/H V. Bank VI. VII. VIII. Asset Management Diversification Stress tests B 34

79 VI. Asset Management Rating agency approach in place internal model for operational risk under development Asset Management Operational event risk Current capital charge: based on assets under management Market ALM Credit Operational risk Operating risk Business Roll-out of advanced measurement approach (AMA) underway based on structured self assessment and internal data Combined operational risk management/sox compliance procedure Failures in processes, controls, projects B 35

80 Agenda I. Valuation II. III. IV. Risk capital framework P/C L/H V. Bank VI. VII. VIII. Asset Management Diversification Stress tests B 36

81 VII. Diversification Since most risks are not fully correlated, diversification benefits have to be considered Equity risks Probability Aggregation Probability Worst case Probability Expected case Equity value Worst case Expected case Real estate value Worst case Expected case Asset value Real estate risks B 37

82 VII. Diversification All standalone risk capital numbers are aggregated using appropriate diversification Market/ALM OE risk capital Diversification between risk types Credit Actuarial Group risk capital Geographical diversification OE risk capital Operating OE risk capital Diversified risk capital can be disaggregated to individual risk types B 38

83 VII. Diversification Risk capital before and after diversification 1Q 2004 risk capital diversification effects (EUR bn) Operating Actuarial Credit Market/ALM % % +9% OE diversified [A] Group diversified (business mix and IR risk netting) [A] Group divers. incl. geogr. divers. [A] Total Group [AA] Correlation partly based on assumptions - benchmarking with peers required to improve reliability Conservative approach: no negative correlation Consistency of correlation between OE and Group level B 39

84 Agenda I. Valuation II. III. IV. Risk capital framework P/C L/H V. Bank VI. VII. VIII. Asset Management Diversification Stress tests B 40

85 VIII. Stress tests Stress test models were built to identify threats to external capital requirements (early warning system) Analysis 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 Model approach Regulatory stress test on OE level Stresses applied to year end projection of solvency ratio Once per year full review of assumptions, quarterly updates of balance sheets and planing data All other stress tests 1 Stresses applied to current solvency ratio as instant shock Once per year full review of assumptions, simplified quarterly updates Contingency plans required for each OE 1) S&P Group & OE solvency, regulatory Group solvency B 41

86 Rainer Schwarz - Head of Group Planning and Controlling C. RoRAC N calculation Allianz Capital Markets Day July 15, 2004

87 C. RoRAC N calculation Allianz capital efficiency metrics accounting view IFRS RoE (%) IFRS RoE b/goodwill amortization (%) Comprehensive IFRS RoE b/goodwill amort.(%) Net income Ø SH equity Net income + GW amort. Ø SH equity Total gain to SH 1 Ø SH equity Simple measure, direct determination from P&L and balance sheet IFRS net income does not reflect full operating performance Based on shareholders equity, which does not represent economically required capital Simple measure, direct determination from P&L and balance sheet Corrected for goodwill amortization; however, some distortions and inconsistencies remain Based on shareholders equity, which does not represent economically required capital Determination from published annual report possible Adjustments eliminate inconsistencies and many distortions Ratio still follows accounting conventions 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) Based on shareholders equity, which does not represent economically required capital C 01

88 C. RoRAC N calculation Allianz capital efficiency metrics economic view RoAC N /old model (%) + Based on internal profit metrics NOPAT 1 Ø Capital necessary for AA rating + - Better approximation of economic reality S&P model rather mechanistic Diversification effects on Group level not considered RoRAC N /new model (%) + First publication in 2003 analysts presentation; will replace RoAC N going forward 12.6 NOPAT 2 Ø Risk-adjusted capital 3 + Good approximation of economic reality, accounts for Allianz s specific economic risk situation Corresponds to Allianz key internal performance metrics 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 C 02

89 C. RoRAC N calculation Why RoRAC N? NOPAT Risk-adjusted capital (RAC) Reflects economic reality better than alternative metrics Corresponds to Allianz Group s key performance metric (EVA) Adjusted IFRS data Includes all relevant sources of economic gains and losses from operating activities Includes normalized investment income Superior metric of capital adequacy (as compared to alternatives like shareholders equity/rating requirements) Represents funds required to maintain AA rating over 1-year horizon Derived through internal, stochastic model Financial diversification fully considered Avoids mechanistic accounting conventions, but also introduces several assumptions Normalization cannot be reproduced from published financial reports C 03

90 C. RoRAC N calculation RoRAC N and EVA are closely linked Economic Value Added (EVA) = Risk Capital x (RoRAC N - CoC) with: RoRAC N = NOPAT RAC Performance measurement Risk drivers Market expectation Capital efficiency Portfolio management Target setting Capital allocation Risk analysis Limit setting Early warning Risk-adjusted benchmark Effective use of allocated capital Management compensation C 04

91 C. RoRAC N calculation Overview: the numerator NOPAT Adjustment and normalization process on OE level 1 Banking: IAS 39 impact IFRS net income 2 3 Banking: Restructuring expenses Elimination of goodwill and acquisition-related expenses NOPAT 4 Other impacts, mainly a) Non-Life reserve discounting b) Normalized investment income c) Excess capital charge C 05

92 C. RoRAC N calculation The numerator adjustments Item Adjustment Economic rationale 1 Banking: IAS 39 impact Elimination Under IFRS, timing differences of P&L impacts arise between classes of securities because of their different classification (e.g. hedges and their underlying), even though economically, those impacts should occur simultaneously. 2 Banking: Restructuring expenses Add-back Restructuring expenses in Banking segment are exceptional and not part of operating performance. 3 Goodwill amortization and acquisitionrelated expenses Elimination Operating management performance is not impacted by goodwill-like expenses which arise as part of company acquisitions. 4a Claims reserves Discounting Because claims payments relating to balance sheet reserves are not due immediately, reserves are discounted in the normalization process. The discount rate equals the actual, average bond yield on investments. C 06

93 C. RoRAC N calculation 4b The numerator normalized investment income Adjustment Normalization Economic rationale 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 allocation 1 Normalization OE NII rate 4 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 investments consistent with cost of capital, assuming β = 1 (in Euro and US zones: 8.5%), plus: average deviation of actual investment results from benchmark 3 Current IFRS investment income plus: average 3 IFRS realized gains/ losses normalized investment income rate for OE Valuation base: market value of portfolio at beginning of period plus 50% of net new investments in period 1) % of total investments of Group of EUR 338bn (without trading assets) 2) Including other investments 3) Average over 3 years; benchmark defined by OE and Group Investments ; by default respective MSCI country index 4) NII = normalized investment income C 07

94 C. RoRAC N calculation 4c The numerator excess capital charge Adjustment Deduct Economic rationale OEs earn normalized investment income on all their investments. Thus they earn income also on the portion of capital held on top of risk-adjusted capital requirements. This extra income is reversed for RoRAC N calculations to create a numerator consistent with the denominator. Illustrative example 1 (EUR m) Net asset value RAC Excess capital Capital held on top of risk requirements Normalized return rate Excess capital charge 6% 12 Weighted normalized investment yield of OE Eliminated from normalized profits to reflect investment income on RAC basis only 1) All numbers here for demonstration purposes only C 08

95 C. RoRAC N calculation The numerator from IFRS net income to NOPAT (2003) Allianz Group (EUR m) 1, , , IFRS net income Banking: IAS 39 impact 1 Goodwill Banking: restructuring expenses 1 amortization, acquisitionrelated expenses 2 Other 3 NOPAT Before minorities 1) After tax; before tax: IAS 39 impact EUR 202m; restructuring expenses EUR 840m 2) Of which goodwill amortization: EUR 1,413m; acquisition-related expenses: EUR 467m 3) Includes normalized investment income adjustment, reserve discounting and minorities C 09

96 C. RoRAC N calculation The denominator RAC factors in diversification benefits Allianz Group (Average 2003, after minorities, EUR bn) P/C L/H Banking OEs consolidated in segment Asset Management Corporate Group before diversification Diversification impact RAC diversified C 10

97 C. RoRAC N calculation Allianz Group: RoRAC N calculation (2003, after minorities) Normalized profit EUR 4.1bn RoRAC N = Average RAC EUR 32.6bn = 12.6% C 11

98 D. Appendix Allianz Capital Markets Day July 15, 2004

99 D. Appendix Allianz Group risk capital: required vs. available funds (in EUR bn) from: Analysts Conference 2004, Page B 54 Required risk-adjusted capital Required vs. available Available funds Risk categories Market/ALM Credit/counterparty Premium Reserve Life actuarial Business Total Business lines Property/Casualty Life/Health Banking Asset Management Holding Total ) Without reserves on real estate own use, before minorities 2) Excluding asset valuation differences Surplus EUR 11.8bn 35.5 Required Funds (internal model) 47.3 Available funds Shareholders equity 28.6 Minorities 8.4 Hybrid Capital 5.6 Supp. Cap. at Dresdner 7.3 Off b/s rev. Reserves Loss reserve discount 4.1 PVFP not acc. in IFRS equ Other 2.0 Goodwill Total 47.3 D 01

100 D. Appendix Investor Relations contacts Oliver Schmidt Tel. +49 (0) Peter Hardy Tel. +49 (0) Head of Investor Relations Susanne Arheit Tel. +49 (0) Christian Lamprecht Tel. +49 (0) Stefan Engelke Tel. +49 (0) Daniela Meintzschel IR events Tel. +49 (0) Andrea Förterer Tel. +49 (0) Fax: +49 (0) Internet (English): Internet (German): D 02

101 D. Appendix Financial calendar 2004/ July 2004 Capital Markets Day 16 August 2004 Financial report first half November 2004 Financial report first three quarters 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 May 2005 Financial report first quarter of August 2005 Financial report first half November 2005 Financial report first three quarters of 2005 D 03

102 D. Appendix Disclaimer These assessments are, as always, subject to the disclaimer provided below. Cautionary Note Regarding Forward-Looking Statements Certain of the statements contained herein may be statements of future expectations and other forward-looking statements that are based on management's current views and assumptions and involve known and unknown risks and uncertainties that could cause actual results, performance or events to differ materially from those expressed or implied in such statements. In addition to statements which are forward-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 differ materially from those in such statements due to, without limitation, (i) general economic conditions, including in particular economic conditions 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 of credit defaults, (vii) interest rate levels, (viii) currency exchange rates including the Euro-U.S. dollar exchange rate, (ix) changing levels of competition, (x) changes in laws and regulations, including monetary convergence and the European Monetary Union, (xi) changes in the policies 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 of these factors may be more likely to occur, or more pronounced, as a result of terrorist activities and their consequences. The matters discussed herein may also involve risks and uncertainties described from time to time in Allianz AG s filings with the U.S. Securities and Exchange Commission. The company assumes no obligation to update any forward-looking statement. No duty to update The company assumes no obligation to update any information contained herein. D 04