Solvency Position

Risk and capital management are closely integrated processes aimed at managing the Group’s solvency position and the Group’s risk profile.

The regulatory solvency position is defined as the ratio between Group Own Funds (GOF) and SCR.

The preliminary¹ Regulatory Solvency ratio stands at 208% as at 31 December 2017, with an increase of +30 p.p. in respect of previous year. The strengthening reflects the increase of the GOF (+12% to € 46,309 million) and the SCR decrease (-4% to € 22,224 million), mainly driven by the generation of Solvency II Capital and positive financial market trends (in terms of interest rate increase, credit spread reduction and positive equity trend).

SCR and Minimum Consolidated Group SCR (MCR) data hereby reported are based on a preliminary estimate.

Regulatory SCR Coverage

1. Group Own Funds

Group Own Funds (GOF) are calculated as a sum of:

• the excess of assets over liabilities following Solvency II valuation;
• subordinated liabilities eligible in Own Funds;
• foreseeable dividends are then deducted.

GOF are obtained considering the impact of other regulated entities (sectoral) and additional own funds related to unrealized capital gains from French pension activities arising from the application of the IORP² transitory regime. These additional own funds are authorized by the Supervisory Authority from 2016 to 2022, a period during which the proportion of the eligible unrealized capital gains will decrease gradually.

Group Own Funds (GOF)

Reconciliation between IFRS Equity and Group Own Funds

The following template provides the reconciliation between IFRS Net Equity and Group Own Funds:

IFRS Equity Reconciliation to Group Own Funds

The main elements of reconciliation from the IFRS Equity (€ 26,177 million) to the Group Own Funds (€ 46,309 million) are the following:

• Intangibles (€ 10,767 million) are eliminated because not recognized under Solvency II;
• Mark to Market of Assets: this adjustment (€ 9,884 million) is primarily due to the fair valuation of real estate (€ 7,499 million) and to the fair value adjustment of bonds classified as held to maturity (€ 1,386 million);
• Mark to Market of Liabilities: this adjustment (€ 21,807 million) is primarily due to Net Technical Provisions (€ 22,400 million deriving from the difference between IFRS4 and Solvency II evaluation), slightly compensated by the SII valuation of Senior/Subordinated Liabilities (€ -991 million). The remaining part (€ +397 million) derives from the positive fair value change in other liability items (like reinsurance deposits);
• Impact of Net Deferred Taxes (€ -7,207 million) derives from the changes to fair value of above reported items;
• Subordinated Liabilities (€ 8,931 million) are recognized as Group Own Funds under Solvency II;
• Foreseeable dividends are deducted for an amount of € -1,330 million;
• Sectoral, Fungibility Filters and Other Deductions (€ -2,887 million) include fungibility and transferability filters required by the regulation to deduct items which are not considered available at Group level and the impact of the sectoral entities;
• Unrealized capital gains from French pension activities benefitting from IORP transitory regime (€ 1,703 million), as explained above

Group Own Funds Tiering

Own Funds (OF) are classified into Tiers, representing different levels of quality with respect to lossabsorbing capacity³ criteria.

The Group Own Funds classification by tiers is composed as follows:

• Tier 1 Unrestricted Own Funds including ordinary share capital and the related share premium account; the reconciliation reserve consequent to Solvency II evaluation and additional Own Funds from French IORP activities and Surplus Funds from German and Austrian business;
• Tier 1 restricted includes Undated Subordinated Liabilities;
• Tier 2 includes the remaining part of Subordinated Liabilities which are classified as Dated;
• Tier 3 includes Net Deferred Tax Assets, which are characterized by lower capital quality being not immediately available to absorb losses.

In the following table, the split by tiers for Group Own Funds is reported:

Total GOF to meet the SCR

2. SOLVENCY CAPITAL REQUIREMENT

The SCR covers underwriting, financial, credit and operational risks as follows:

Regulatory SCR split by risk

The above SCR breakdown highlights that:

• financial and credit risks, account for the 67% of the total SCR before diversification, due to the predominance of traditional life business;
• life/health and non-life underwriting risks, accounting for respectively 12% and 14% of the total SCR before diversification; within this CAT risks remain limited thanks to a comprehensive reinsurance program;
• operational risks contribute to the Group SCR for 7%. This contribution is calculated using the standard formula.

Each risk category is further detailed in section Risk Profile.

Minimum Capital Requirement (MCR) Coverage

In addition to SCR coverage, the Group calculates the Minimum Capital Requirement (MCR) coverage.

Under Solvency II, the MCR calculation is required to determine the minimum level of capital, under which the Group would be exposed to an unacceptable level of risk when allowed to continue its operations.

The preliminary⁴ Minimum Solvency ratio stands at 241% as at 31 December 2017, with an increase of 33 p.p. in respect of previous year. In the following table, the regulatory MCR coverage is reported.

Copertura MCR regolamentare

To define MCR coverage, stricter OF eligibility rules are applied compared to the ones previously used for the SCR11. In the following table, the split by tiers of the Own Funds covering the MCR is reported:

Total EOF to meet the MCR

Economic Solvency Ratio

In addition to the Regulatory Solvency Ratio data reported above, the Group calculates the Economic Solvency Ratio (ESR). For the ESR calculation the Internal Model framework is applied to all Group insurance entities⁶.

The Economic Solvency ratio stands at 230% as at 31 December 2017, with an increase of 36 p.p. in respect of previous year.

The Economic Solvency Ratio is hereafter reported.

Economic SCR Coverage

Group Partial Internal Model (Group PIM)

Generali deems the Group PIM to be the most appropriate way of assessing the Group SCR. It represents the best way of capturing the risk profile of the entire Group and of the companies in scope in terms of granularity, calibration and correlation of the various risk factors.

The Group PIM is structured around a Risk Map, which contains all quantifiable risks that Generali has identified as relevant to its business, allowing for the calculation of the SCR at single risk level and at higher aggregation levels.

Group PIM Methodology

In implementing the PIM, the Group has adopted the so-called Monte-Carlo approach with “proxy functions” to determine the Probability Distribution Forecast (PDF) of the changes in the Basic Own Funds over a 1-year horizon.

The Own Funds probability distribution allows to determine the potential losses at any percentile for risks in scope and, in particular, the SCR corresponding to the 99.5th percentile. The risk measure applied is the VaR (Value at Risk). Monte-Carlo methods are used in the industry to obtain sound numerical results using the embedded characteristics of repeated random sampling to simulate the more complex realworld events. Proxy functions are mathematical functions that mimic the interaction between risk drivers and insurance portfolios to obtain the most reliable results.

The calibration procedure involves quantitative and qualitative aspects. The aggregation process uses advanced mathematical techniques following market best practices.

During 2017, with the purpose of better capturing stresses over negative rates, the Interest Rate and Interest Rate Volatility modelling have been revised and duly approved by the College of Supervisors, following the process defined in the Group Internal Model Change Policyi.

Group PIM Governance

Governance and processes regarding the Group PIM are defined in the Group Internal Model Governance Policy, ensuring that:

• models and components are appropriate for their purpose;
• procedures are in place to design, implement, use and validate new models and model changes;
• the appropriateness of models on an ongoing basis is confirmed.

To rule the activities related to the Internal Model developments necessary to ensure its appropriateness over time and, more in general, to support the Internal Model change process, the Group Internal Model Change Policy has been also defined with the aim to specify roles and responsibilities in the implementation of major and minor changes.

A dedicated committee, the Internal Model Committee, has been established to approve Group PIM calibrations, to support decision making on Group PIM developments or model changes and to control the full model lifecycle, assuring proper compliance with the Group Internal Model Governance Policy.

This Committee is chaired by the Model Design Authority, which is responsible for ensuring the overall consistency and reliability of the Group PIM.

The Group Chief Risk Officer (GCRO) defines the processes and controls to ensure the ongoing appropriateness of the design and operations of the Group PIM, so that it continues to appropriately reflect the Group risk profile. The GCRO is also responsible for defining the methodology of each model component, on the basis of the Group Internal Model Committee’s proposals, as well as for the results production and ultimately for submitting the relevant Internal Model supporting documentation to the BoD.

The BoD, assisted by the Risk and Control Committee, ensures the ongoing appropriateness of the design and operations, the ongoing compliance of the Group PIM and also that the Group PIM continues to appropriately reflect the risk profile of the Group.

These roles are generally mirrored within the organizational structure of each company within PIM scope.

Group PIM Validation

The Group PIM is subject to regular independent validation on an ongoing basis, which aims to gain assurance of the completeness, robustness and reliability of the processes and results of the Group PIM as well as their compliance with the Solvency II regulatory requirements.

The validation process follows the principles and procedures defined within the Group Internal Model Validation Policy and related guidelines.

In particular, the validation outputs are designed to support Senior Management and BoD in understanding the appropriateness of the PIM, including areas of weaknesses and limitations, especially with regards to its use.

To ensure an adequate level of independence, the resources performing the validation activities are not involved in the development and operation of the Group PIM.

Within the validation process also results obtained during previous validation cycles are taken into account, as well as developments within internal and external business environment, financial market trends and Group PIM changes. The Internal Model validation process excludes those aspects already covered by the assurance work of the Actuarial Function (i.e. technical provisions and related IT systems, actuarial platforms and their governance).

Furthermore, the regular validation procedures also serve as an incentive mechanism to ensure timely and accurate incorporation of modelling refinements.

In order to warrant the appropriateness of the array of elements contained within the Group PIM, the validation covers both the quantitative and qualitative aspects of the Model, and is therefore not limited to the calculation engine and methodology. Other important items such as data quality, documentation and uses of the Model are validated accordingly.

The validation process is carried out on regular annual basis and when requested by the BoD or Senior Management, such as in case of PIM changes.

¹On the basis of IVASS Provvedimento n. 53, 2016, the SCR and MCR calculations to be disclosed in the Annual Report can rely on a preliminary estimate. More details on the Solvency Ratio will be disclosed in the Solvency and Financial Condition Report.
²IORP stands for Institutions for Occupational Retirement Provisions.
³To grant a high quality of capital available, the amounts of Tier 2 and Tier 3 items eligible to cover the SCR are subject to the following limits. The eligible amount of Tier 1 items shall be at least one half of the SCR; in case of admissible subordinated liabilities and preference shares, exceeding 20% of total Tier 1, it is downgraded towards Tier 2. The eligible amount of Tier 3 items shall be less than 15% of the SCR. The sum of the eligible amounts of Tier 2 and Tier 3 i tems shall not exceed 50% of the SCR.
⁴On the basis of IVASS Provvedimento n. 53, 2016, the SCR and MCR calculations to be disclosed in the Annual Report can rely on a preliminary estimate. More details on the Regulatory Solvency Ratio will be disclosed in the Solvency and Financial Condition Report.
⁵The amounts of Tier 2 and Tier 3 items eligible to cover the MCR are subject to stricter quantitative limits. The eligible amount of Tier 1 items shall be at least 80% of the MCR; the same limitation on subordinated liabilities and preference shares is set. The eligible amounts of Tier 2 items shall not exceed 20% of the MCR. No Tier 3 items are allowed to cover the Minimum Capital Requirement. No capital from sectoral is considered.
⁶When determining the ESR, only a residual set of entities calculate the SCR based on the standard formula.