Life Underwriting Risk
Life underwriting risks derive from the Group’s core insurance business in the life segment. Life technical provisions refer mostly to traditional business, related to insurance with profit participation business. Unit-linked products represent a minor component of the Group portfolio in respect to the traditional business, although their incidence is increasing. For the Group’s life underwriting business key figures, please see the Section Details on insurance and investment contracts in the Notes.
The Group’s life portfolio has a prevailing component of traditional savings business. The life portfolio also includes pure risk covers, with related mortality risk, and some annuity portfolios, with the presence of longevity risk.
Life and health underwriting risks include biometric and operating risks embedded in the life and health insurance policies. Biometric risks derive from the uncertainty in the assumptions regarding mortality, longevity, health, morbidity and disability rates. Operating risks derive from the uncertainty regarding the amount of expenses and the adverse exercise of contractual options by policyholders. Along with the premium payment, the lapse of the policy is the most significant contractual option held by the policyholders.
The life and health underwriting risks are:
- Mortality risk, defined as the risk of loss, or of adverse change in the value of insurance liabilities, resulting from changes in mortality rates, where an increase in mortality rates leads to an increase in the value of insurance liabilities. Mortality risk also includes mortality catastrophe risk, resulting from the significant uncertainty of pricing and provisioning assumptions related to extreme or irregular events;
- Longevity risk that, similarly to mortality, is defined as the risk resulting from changes in mortality rates, where a decrease leads to an increase in the value of insurance liabilities;
- Disability and morbidity risks derive from changes in the disability, sickness, morbidity and recovery rates;
- Lapse risk is linked to the loss or adverse change in liabilities due to a change in the expected exercise rates of policyholder options. The relevant options are all legal or contractual policyholder rights to fully or partly terminate, surrender, decrease, restrict or suspend insurance cover or permit the insurance policy to lapse. This also includes the catastrophic event on lapse;
- Expense risk results from changes in the expenses incurred in servicing insurance or reinsurance contracts;
- Health risk results from changes in health claims and also includes health catastrophe risk.
The approach underlying the life underwriting risk measurement is based on the calculation of the loss resulting from unexpected changes in biometric and/or operating assumptions. Capital requirements for life underwriting risks are calculated on the basis of the difference between the Solvency II technical provisions before and after the application of the stress.
Life underwriting risks are measured by means of the Group PIM.
The Economic SCR for life underwriting risk before diversification amounts to € 2,204.6 million. The total is mainly given by expense risk, followed by longevity and mortality risks. In terms of contribution to the risk profile, it is to be noted that life underwriting risks are well diversified with other categories.
Life underwriting risk management is based on two main processes:
- Ex-ante selection of risks through underwriting; and
- Accurate pricing.
Product pricing consists of setting product features and assumptions regarding expenses, biometric and policyholders’ behaviour assumptions so as to allow the Group to withstand any adverse development in the realization of these assumptions.
For savings business, this is mainly achieved through profit testing, while for protection business with a biometric component, this is achieved by setting prudent assumptions.
Lapse risk, related to voluntary withdrawal from the contract, and expense risk, related to the uncertainty around the expenses that the Group expects to incur in the future, are evaluated in a prudential manner in the pricing of new products. This evaluation is taken into account in the construction and profit testing of a new tariff, considering the underlying assumptions derived from the Group’s experience.
For insurance portfolios with a biometric risk component, comprehensive reviews of the mortality experience are compared with expected mortality of the portfolio, determined according to the most up-to-date mortality tables available in each market. To this end, mortality by sex, age, policy year, sum assured and other underwriting criteria are taken into consideration to ensure mortality assumptions remain adequate and avoid the risk of misestimating for the next underwriting years.
The same annual assessment of the adequacy of the mortality tables used in the pricing is performed for longevity risk. In this case, not only are biometric risks considered but also the financial risks related to the minimum interest rate guarantee and any potential mismatch between the liabilities and the corresponding assets.
As part of the underwriting process, the Group Parent Company issues underwriting guidelines and determines operating limits to be followed by Group companies. This aims to ensure a consistent use of capital and risk exposure and their maintenance between the pre-set limits.
Moreover, a particular emphasis is placed on the underwriting of new contracts with reference to medical, financial and moral hazard risks. The Group has defined clear underwriting standards through manuals, forms and medical and financial underwriting requirements. For insurance riders, which are most exposed to moral hazard, maximum insurability levels are also set, lower than those applied for death covers. In order to mitigate these risks, policy exclusions are also defined.
Regular risk exposure monitoring and adherence to the operative limits, reporting and escalation processes are also in place, allowing for potential remediation actions to be swiftly undertaken.
The product approval process foresees a review by the Risk Management Function to ensure that new products are in line with the risk appetite and that risk absorption is considered part of risk-adjusted performance management.
Reinsurance represents the main risk mitigating technique. The Parent Company acts as core reinsurer for the Group companies and cedes part of the business to external reinsurers. The Group reinsurance program also grants the coverage of geographical concentration in relation to catastrophe risk.
Non-Life Underwriting Risk
Non-life underwriting risks derive from the Group’s insurance business in the P&C segment. The Group operates in the retail, middle market and corporate & commercial segments and has a client centric philosophy based on a multichannel distribution model. Generali coordinates a variety of distribution channels (e.g. tied agents, professional intermediaries, direct channels), with the objective of improving the service provided to its customers and also to diversify the risks. The Group favors longstanding relationships with clients to reduce the risk of moral hazard and adverse selection.
For the volumes of premiums and related geographic breakdown please refer to property&casualty segment indicators by country in the Management Report, for technical provisions please refer to the Section Details on insurance and investment contracts in the Notes.
Non-life underwriting risks arise in relation to the perils covered and the processes used in the conduct of the business model described above. They include the risk of underestimating the frequency and/or severity of the claims in defining pricing and reserves (respectively pricing risk and reserving risk), the risk of losses arising from extreme or exceptional events (catastrophe risk) and the risk of policyholder lapses from P&C insurance contracts:
- The pricing and the catastrophe risks derive from the possibility that premiums are not sufficient to cover future claims, contract expenses and extremely volatile events;
- The reserving risk relates to the uncertainty of the claims reserves’ run-off around its expected value, in a one-year time horizon;
- The lapse risk arises from the uncertainty of the underwriting profits recognised in the premium provisions.
Non-life underwriting risks are assessed by means of the Group PIM. For the majority of risks assessed through the PIM, the assessments are based on in-house developed models and external models that are primarily used to assess the catastrophic events, for which broad market experience is considered beneficial.
The Economic SCR for non-life underwriting risk before diversification amounts to € 3,763.5 million. The total is mainly given by reserve and pricing risks, followed by CAT risk. Non-life lapse risk contributes only for a marginal amount to the risk profile.
In terms of CAT risk, the Group’s largest catastrophe exposures are earthquakes in Italy, European windstorms and European floods. Less material catastrophe risks are also taken into account and assessed by means of additional scenario analysis.
Based on the Group RAF, P&C risk selection starts with an overall proposal in terms of underwriting strategy and corresponding business selection criteria. During the strategic planning process, targets are established and translated into underwriting limits to ensure business is underwritten according to the plan. Underwriting limits define the maximum size of risks and classes of business that Group companies shall be allowed to write without seeking any additional or prior approval. The limits may be set based on value, risk type, product exposure or class of occupancy. The purpose of these limits is to attain a coherent and profitable book of business founded on the expertise of each company.
Additional indicators such as relevant exposures, risk concentration and risk capital figures are used for the purpose of P&C underwriting risk monitoring. The indicators are calculated on a quarterly basis to ensure alignment with the RAF.
Reinsurance is the key mitigating factor for balancing the P&C portfolio. It aims to optimize the use of risk capital by ceding part of the underwriting risk to selected counterparties, whilst simultaneously minimizing the credit risk associated with such operations.
The P&C Group Reinsurance Strategy is developed consistently with the risk appetite and the risk preferences defined in the RAF. The reinsurance market cycle is also taken into account.
The Group has historically preferred traditional reinsurance as a tool for mitigating catastrophe risk resulting from its P&C portfolio, adopting a centralized approach where the placement of reinsurance towards the market is managed through a central Group Reinsurance Function.
The Property Catastrophe Reinsurance Program is designed as follows:
- The protection aims to cover single occurrence losses up to a return period of at least 250 years;
- The protection has proved capable in all recent major catastrophe losses;
- The program has proved to be effective in a multi-territory event by reducing the volatility of the Group;
- Substantial risk capital has been saved by means of the protection;
- An additional aggregate XL programme is protecting the Group balance sheet in case of multiple events in a year.
The same level of return period protection and risk capital savings are guaranteed for other non-catastrophe protections, i.e. related to single extreme risks in property, transportation and liability lines of business.
Due to the increasing weight of European windstorm exposures in the protected portfolio in the past years, part of these exposures have been carved out from the main reinsurance protection and placed in the Insurance Linked Securities (ILS) market, offering more competitive terms, whilst keeping the dominant Italian exposure in the traditional reinsurance market with a consequent optimization of the overall pricing.
Alternative risk transfer solutions are continuously analyzed and options for the implementation of such tools are present in Group protections in order to keep the door open to more competitive reinsurance solutions. As an example, in addition to traditional reinsurance, a protection has been recently placed on the capital market to reduce the impact of a high Loss Ratio for what concerns the Group motor liability portfolio.
Financial Risk and Credit Risk
The Group invests collected premiums in a wide variety of financial assets, with the purpose of honoring future promises to policyholders and generating value for its shareholders.
As a result, the Group is exposed to the financial risks that:
- Invested assets do not perform as expected because of falling or volatile market prices;
- Cash from maturing bonds is reinvested at unfavourable market conditions, typically lower interest rates.
Generali’s traditional life savings business is a long term business, therefore the Group holds mostly long term investments which have the capability to absorb short-term decreases and fluctuations in the market value of assets.
Nonetheless, the Group manages its investments in a prudent way according to the so-called “Prudent Person Principle”1, and strives to optimize the return of its assets while minimizing the negative impact of short term market fluctuations on its solvency.
Under Solvency II, the Group is also required to hold a capital buffer, with the purpose of maintaining a sound Solvency Position even in the circumstances of adverse market movements.
To ensure a comprehensive management of the impact of financial and credit risks on assets and liabilities, the Group Strategic Asset Allocation (SAA) process needs to be liability-driven and strongly interdependent with insurance-specific targets and constraints. For this reason the Group has integrated the Strategic Asset Allocation (SAA) and the Asset Liability Management (ALM) within the same process.
The aim of the SAA&ALM process is to define the most efficient combination of asset classes which, according to the “Prudent Person Principle” set out in the Solvency II Directive and related relevant implementation measures, maximizes the investment contribution to value creation, taking into account solvency, actuarial and accounting indicators. The aim is not just to mitigate risks but also to define an optimal risk-return profile that satisfies both the return target and the risk appetite of the Group over the Business Planning period.
The asset portfolio is invested and rebalanced according to the asset class and duration weights. One of the main risk mitigation techniques used by the Group is liability-driven management of the assets. This technique aims at granting the comprehensive management of assets whilst taking into account the liabilities structure (for example, interest rate and currency risk are mitigated when a movement observed on the asset side would correspond to an offsetting movement on the liability side of the balance sheet).
ALM&SAA activities aim at ensuring the Group holds sufficient and adequate assets in order to reach defined targets and meet liability obligations. For this purpose, analyses of the asset-liability relationship under a range of market scenarios and expected/stressed investment conditions are undertaken.
Close interaction between the Investment, Finance, Actuarial, Treasury and Risk Management Functions is pursued in order to ensure that the ALM&SAA process remains consistent with the RAF, the strategic planning and the capital allocation processes.
The annual SAA proposal:
- Defines target exposure and limits for each relevant asset class, in terms of the minimum and maximum exposure allowed;
- Embeds the deliberate ALM mismatches permitted and potential mitigation actions that can be enabled on the investment side.
Regarding specific asset classes such as (i) private equity, (ii) alternative fixed income, (iii) hedge funds, (iv) derivatives and structured products, the Group has centralized their management and monitoring. In particular:
- These kind of investments are subject to accurate due diligence in order to assess their quality, the level of risk related to the investment and its consistency with the approved liability-driven SAA;
- The extent and thoroughness of the analysis may vary according to criteria such as the investment structure under evaluation, the volume of investments and the regulatory framework.
The Group also uses derivatives with the aim of mitigating the risk present in the asset or/and liability portfolios.
The derivatives help the Group to improve the quality, liquidity and profitability of the portfolio, according to the Business Planning targets.
In addition to the risk tolerance limits set on the Group Solvency Position within the RAF, the current Group risk monitoring process is also integrated by the application of the Generali Group Risk Guidelines (GRG). The GRG include general principles, quantitative risk limits (with a strong focus on credit and market concentration), authorization processes and prohibitions that Group entities need to adhere with.
Within the life business, the Group assumes a considerable financial risk when it guarantees policyholders with a minimum return on the accumulated capital over a long period. If during the contractual period the return generated by the financial investment is below the guaranteed return for a prolonged period, the Group shall compensate itself the contractual guarantees. In addition, independently on their realization, the Group has to ensure that the value of the financial investments backing the insurance contracts do not fall below the value of its obligations.
Unit-Linked business typically does not represent a source of financial risk for insurers (except in case of guarantees issued), although market fluctuations typically have profitability implications.
Regarding P&C business, the Group has to ensure that the benefits can be paid on a timely basis when claims occur.
In more detail, the Group is exposed to:
- Equity risk deriving from the risk of adverse changes in the market value of the assets or in the value of liabilities due to changes in the level of equity market prices which can lead to financial losses;
- Equity volatility risk deriving from changes in the volatility of equity markets. Exposure to equity volatility is typically related to equity option contracts;
- Interest rate risk, defined as the risk of adverse changes in the market value of the assets or in the value of liabilities due to changes in the level of interest rates in the market. The Group is mostly exposed to downward changes in interest rates as lower interest rates increase the present value of the promises made to policyholders more than the value of the assets backing those promises. As a result, it may become increasingly expensive for the Group to maintain its promises, thereby leading to financial losses. Linked to that, interest rate volatility risk derives from changes in the level of interest rate implied volatilities. This comes, for example, from insurance products sold with embedded minimum interest rate guarantees whose market consistent value is sensitive to the level of interest rates volatility;
- Property risk deriving from changes in the level of property market prices. Exposure to property risk arises from property asset positions;
- Currency risk deriving from adverse changes in exchange rates;
- Concentration risk deriving from asset portfolio concentration to a small number of counterparties. This increases the possibility that a negative event hitting only a small number or even a single counterparty can produce large losses.
For further details on the Group’s key figures and details on financial assets please refer to the Section Investments in the Notes.
Financial risks are measured by means of the Group PIM. In particular, losses are modelled as follows:
- Equity risk is modelled by associating each equity exposure to a market index representative of its industrial sector and/or geography. The potential changes in market value of the equities are then estimated based on past shocks observed for the selected indices;
- Equity volatility risk models the impact that changes in the equity implied volatility can have on the market values of derivatives;
- Interest rate risk models the changes in the term structure of the interest rates for various currencies and the impact of these changes on bonds values (and of other interest rate sensitive assets) and also on the value of future liability cash-flows;
- Interest rate volatility risk models the impact that the variability in interest rate curves can have on both the market value of derivatives and on the value of liabilities sensitive to interest rate volatility assumptions (such as minimum pension guarantees);
- Property risk models returns on a selection of published property investment indices and the associated impact on the value of the Group’s property assets. These are mapped to various indices based on property location and type of use;
- For currency risk the plausible movements in exchange rate of the reporting currency of the Group in respect to foreign currencies are modelled, as well as the consequent impact on the value of asset holdings not denominated in the domestic currency;
- For concentration risk the extent of additional risk borne by the Group due to insufficient diversification in its equity, property and bond portfolios is assessed.
The Economic SCR for financial risk before diversification amounts to € 11,327.4 million. This is mainly given by equity risk, followed by property, interest rate and currency risk. Concentration risk contribution to the risk
profile remains negligible.
The Group is exposed to credit risks related to invested assets and also arising from other counterparties (i.e. reinsurance). Similarly to financial risk, the Group has to grant that the value of assets does not fall below the value of insurance obligations.
Credit risks include the following two categories:
- Spread widening risk, defined as the risk of adverse changes in the market value of assets due to changes in the market value of non-defaulted credit assets. The decrease in the market value of an asset due to spread widening can be linked either to the market’s assessment of the creditworthiness of the specific obligor (often implying also a decrease in rating) or to a market-wide systemic reduction in the price of credit assets;
- Default risk, defined as the risk of incurring in losses because of the inability of a counterparty to honour its financial obligations. Distinct modelling approaches have been implemented to model default risk for the bond portfolio (i.e. credit default risk) and the risk arising from the default of counterparties in cash deposits, risk mitigation contracts (such as reinsurance), and other types of exposures (i.e. counterparty default risk).
For the overall volume of assets subject to credit risk please refer to the volumes of bonds and receivables (including reinsurance recoverable) provided within the Section Investments of the Notes.
Credit risks are measured by means of the Group PIM. In particular:
- Credit spread risk models the possible movement of the credit spread levels for bond exposures of different rating, industrial sector and geography based on the historical analysis of a set of representative bond indices. Spread-sensitive assets held by the Group are associated with specific indices based on the characteristics of their issuer and currency;
- Default risk models the impact of default of bond issuers or counterparties to derivative, reinsurance and other transactions on the value of the Group’s assets.
The Group PIM’s credit risk model evaluates spread risk and default risk also for sovereign bond exposures. This approach is more prudent than the Standard Formula, set by EIOPA. Under the EIOPA Standard Formula bonds issued by EU Central Governments and denominated in domestic currency are not subject to credit risk.
The Economic SCR for credit risk before diversification amounts to € 12,791.3 million. Credit risk is mostly deriving from fixed income securities, while the contribution to SCR of the counterparty risk (including reinsurance default) remains more limited.
The credit risk assessment is based on the credit rating assigned to counterparties and financial instruments. To limit the reliance on external rating assessments provided by rating agencies, an internal credit rating assignment framework has been set within the Group Risk Management Policy.
Within this framework additional rating assessments can be performed at counterparty and/or financial instrument level. This applies even where an external rating is available. The additional rating assessment has to be renewed at least annually. Moreover, additional assessments shall be performed each time the parties involved in the process possess any information, coming from reliable sources, that may affect the creditworthiness of the issuer/issues.
The most important strategy for the mitigation of credit risk used by the Group is the application of a liabilitydriven SAA, which can limit the impact of the market spread volatility. In addition, the Group is actively mitigating counterparty default risk by using a collateralisation strategy that strongly mitigates the losses that the Group might suffer because of the default of one or more of its counterparties.
Operational risk is the risk of loss arising from inadequate or failed internal processes, personnel or systems, or from external events. Losses from events such as fraud, litigation, damages to Generali premises, cyber-attack and failure to comply with regulations are therefore covered in the definition. It also includes financial reporting risk but excludes strategic and reputational risks.
Although ultimate responsibility for managing the risk sits in the first line, the so-called risk owners, the Risk Management Function with its methodologies and processes ensures an early identification of the most severe threats across the Group. In doing so, it provides management at all levels with a holistic view of the broad operational risk spectrum that is essential for prioritizing actions and allocating resources in most risk related critical areas.
The target is achieved by adopting methodologies and tools in line with industry best practices and by establishing a strong dialogue with the first line of defence.
Furthermore, since 2015, the Group has been exchanging operational risk data in an anonymized fashion through the “Operational Risk data eXchange Association (ORX)”, a global association of operational risk practitioners with whom the main industry players also participate. The aim is to use the data to improve internal controls and to anticipate emerging trends. In addition, since losses are collected by the first line, the process contributes to creating awareness among the risk owners upon the risks that are actually hitting the Group. In this sense, a primary role is played by Group-wide forward-looking assessments that aim to estimate the evolution of the operational risk exposure in a given time horizon, supporting in the anticipation of potential threats, in the efficient allocation of resources and related mitigation initiatives.
Based on the last assessments, the most relevant scenarios at Group level are related to cyber and compliance.
The risks related to non-compliance are addressed by a dedicated and independent Group Compliance Function that provides guidance to the local teams and monitors the execution of the Group Compliance Program.
To further strengthen the internal control systems and in addition to the usual risk owners’ responsibilities for managing their risks, the Group established specialised units within the first line of defence with the scope of dealing with specific threats (e.g. cyber risk, fraud, financial reporting risk) and that act as a key partner for the Risk Management Function.
Another benefit from this cooperation is constituted by a series of risk-mitigating measures triggered across the Group as results of the controls testing, the assessments, and the collection of operational risk events.
An example is the creation of a dedicated unit for the management and coordination of the Group-wide IT Security that steers the evolution of the IT security strategy and operating model, ensuring a timely detection and fixing of the vulnerabilities that occasionally affect the business. This initiative helps the Group to better cope with the growing threat represented by cyber risk.
The Economic SCR for operational risk before diversification amounts to € 2,166.5 million, calculated based on Standard Formula.
(1)IThe “Prudent Person Principle” set out in Article 132 of Directive 2009/138/EC requires the company to only invest in assets and instruments whose risk can be identified, measured, monitored, control and reported as well as taken into account in the company overall solvency needs. The adoption of this principle is ruled in the Group Investment Governance Policy (GIGP).