Life Underwriting Risk
Life and health underwriting risks derive from the Group’s core insurance business in the life and health segment.
The life portfolio is mostly given by traditional business, which mainly includes insurance with profit participation. Unit-linked products represent a secondary component of the Group portfolio, although their incidence is increasing.
Group’s life underwriting business key figures are provided in the Section Details on insurance and investment contracts in the Notes.
The prevailing component of traditional savings business includes products with insurance coverages linked to the policyholders’ life and health; it also includes pure risk covers, with related mortality risk, and some annuity portfolios, with the presence of longevity risk. The vast majority of the insurance coverages includes legal or contractual policyholder rights to fully or partly terminate, surrender, decrease, restrict or suspend insurance cover or permit the insurance policy to lapse; or to fully or partially establish, renew, increase, extend or resume the insurance or reinsurance cover. For this reason, the products are subject to lapse risk.
Life and health underwriting risks can be distinguished in 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 taken into account in the insurance liability valuations. Operating risks derive from the uncertainty regarding the amount of expenses and the adverse exercise of contractual options by policyholders. Policy lapse is the main contractual option held by the policyholders, together with the possibility to reduce, suspend or partially surrender the insurance coverage.
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. Mass lapse events are also considered;
- 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 PIM1.
The SCR for life underwriting risk before diversification amounts to € 4,017 million, with an incidence of 12% to the overall SCR before diversification. 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 risk categories.
Life underwriting risk management is based on two main processes:
- accurate pricing and
- ex-ante selection of risks through underwriting.
Product pricing consists of setting product features and assumptions regarding expenses, biometric and policyholders’ behaviour 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, it 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 upto- 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 biometric risks are 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, Generali Group adopts 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.
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.
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, 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 undertaken.
Finally, 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.
Non-life Underwriting Risk
Non-life underwriting risks arise from the Group’s insurance business in the P&C segment.
Volumes of premiums and related geographic breakdown are provided in the Property&Casualty segment indicators by country in the Management Report, technical provisions in the Section Details on insurance and investment contracts in the Notes.
Non-life underwriting risks 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. In particular:
- the pricing and the catastrophe risks derive from the possibility that premiums are not sufficient to cover future claims, also in connection with extremely volatile events and contract expenses;
- the reserving risk relates to the uncertainty of the claims reserves (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 measured by means of the Group PIM2. 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 SCR for non-life underwriting risk before diversification amounts to € 5,011 million, with an incidence of 14% to the overall SCR before diversification. 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.
Moreover, the Group uses additional indicators for risk concentrations. This is specifically the case for catastrophe risks and commercial risks, which are both coordinated at central level as they generally represent a key source of concentration.
In terms of CAT risk, the Group’s largest 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.
At the same time, there is a constant on-going improvement to consider risk metrics within profitability metrics and to use risk adjusted KPIs in decision making processes.
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 Group RAF.
Reinsurance is the key mitigating technique 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 Group RAF on the one side and taking into account the reinsurance market on the other one.
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.
Given the trend of 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 analysed and implemented. As an example, in addition to traditional reinsurance, a protection was placed during the year on the capital market to reduce the impact of an unexpectedly high Loss Ratio for 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 honouring future obligations to policyholders and generating value for its shareholders.
As a result, the Group is exposed to the financial risks driven by either:
- invested assets not performing as expected because of falling or volatile market prices;
- reinvested proceeds of existing assets being exposed to unfavourable market conditions, such as lower interest rates.
Generali’s traditional life savings business is a long-term business, therefore the Group holds mostly longterm investments which have the ability to withstand 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”16, and strives to optimize the return of its assets while minimizing the negative impact of short term market fluctuations on its solvency position.
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”, 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 assets’ selection is performed by taking into consideration the risk profile of the liabilities held in order to satisfy the need to have appropriate and sufficient assets to cover the liabilities. This selection process aims to guarantee the security, quality, profitability and liquidity of the overall portfolio, providing an adequate diversification of the investments.
The asset portfolio is then invested and rebalanced according to the asset class and duration weights.
One of the main risk mitigation techniques used by the Group is the use of liability-driven management of the assets and the regular use of rebalancing.
The liability driven investment helps granting the comprehensive management of assets whilst taking into account the liability structure; while, at the same time, the regular rebalancing redefines target weights for the different assets classes and durations, alongside the related tolerance ranges defined as investment limits. This technique contributes to an appropriate mitigation of financial risks.
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.
In addition to that, controls on assets and liabilities matching and compliance with the limits defined in the ALM&SAA, as well as on the overall monitoring risk limits, are also performed regularly by the Group.
This process is underpinned by a close interaction between the Investment, Finance, Actuarial, Treasury and Risk Management Functions to ensure that the ALM&SAA process remains consistent with the Group 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 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 mainly centralized their management and monitoring. These kinds 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 Group also uses derivatives with the aim of mitigating the risk present in the asset and/or liability portfolios. The derivatives help the Group to improve the quality, liquidity and profitability of the portfolio, according to the business planning targets. Operations in derivatives are likewise subject to a regular monitoring and reporting process.
In addition to the risk tolerance limits set on the Group solvency position within the Group RAF, the current Group risk monitoring process is also integrated by the application of the Group Investments Risk Guidelines (GIRG). The GIRG include general principles, quantitative risk limits (with a strong focus on credit and market concentration), authorization processes and prohibitions that Group entities need to comply 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, potentially, long period. Should the yields generated by the financial investments be lower than the guaranteed return, then the Group shall compensate the shortfall for those contractual guarantees. In addition, independently on the achieved asset returns, the Group has to secure that the value of the financial investments backing the insurance contracts remains sufficient to meet the value of its obligations.
Unit-Linked business typically does not represent a source of direct financial risk for insurers (except when there are guarantees embedded in the contracts), 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 the following generic financial risk types:
- 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 or to insurance products sold with embedded guarantees whose market consistent value is sensitive to the level of equity volatility;
- 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 costly 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.
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 PIM17. 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 any 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 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 SCR for financial risk before diversification amounts to € 13,364 million, with an incidence of 39% to the overall SCR before diversification. This is mainly driven by equity risk, followed by interest rate, property and currency risk.
The Group is exposed to credit risks related to invested assets and also arising from other counterparties (e.g. cash, reinsurance).
Credit risks include the following two categories:
- spread widening risk, defined as the risk of adverse changes in the market value of debt security assets. 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.
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 PIM18. 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 derivatives, reinsurance and other transactions on the value of the Group’s assets. 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).
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, which treats bonds issued by EU Central Governments and denominated in domestic currency as exempt from credit risk.
The SCR for credit risk before diversification amounts to € 9,850 million, with an incidence of 28% to the overall SCR before diversification. Credit risk is mostly driven by 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 and ratings need to be renewed at least annually. This process applies even where an external rating is available. 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 liability-driven 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 alleviates the losses that the Group might suffer as a result 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-attacks 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 purpose of Operational Risk Management within Generali Group is to generate awareness of the operational risks in all Generali companies and foster a risk culture amongst all employees and to learn from past operational errors and events that either did or could have resulted in an operational loss.
Moreover, the Operational Risk Management approach ensures the identification and assessment of the operational risk also developing a forward-looking mechanism, to reduce operational losses and other indirect consequences, including reputational damage and missed opportunities, resulting from the occurrence of operational risk events and to enable management to conclude on the effectiveness of the internal control system related to operational risk management.
Generali Group accepts that some level of operational risk needs to be tolerated in order to conduct business, according to Group RAF. Group companies define and review risk tolerance limits both from a forward-looking perspective and for a backwards perspective, setting up effective escalation mechanism in case of limits violations.
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 where 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 create awareness among the risk owners upon risks that actually impact 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 initiatives.
Based on the last assessments, the most relevant scenarios at Group level are related to cyber-attacks and the regulatory evolutions.
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 management measures triggered across the Group as a result of control testing, 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 may affect the business. This initiative helps the Group to better cope with the growing threat represented by cyber risk.
The SCR for operational risk before diversification amounts to € 2,286 million, with an incidence of 7% to the overall SCR before diversification. The SCR for operational risk is calculated based on standard formula.
1For the scope of the Group PIM please refer to the Executive Summary. Entities not included in the PIM scope calculate the capital requirement based on standard formula.
2For the scope of the Group PIM please refer to the Executive Summary. Entities not included in the PIM scope calculate the capital requirement based on standard formula.