Credit Risk Measurement

Credit risk arises from claims against obligors like borrowers, counterparties, issuers, guarantors or insurers. Losses may result in the following events:

• Failure to meet payment obligations (default risk).
• In a given country, default on government debt, temporary suspension of payment obligations (“moratorium”), deterioration of economic or political conditions, expropriation of assets, inability to transfer assets abroad due to sovereign intervention, etc. (country risk including transfer risk).
• Failure in the settlement of transactions (settlement risk).

Group Risk’s credit risk methodology is comparable to one of the most widely used approaches in this area.

We assume probability distributions and estimate their parameters for random variables such as the portion of a counterparty’s exposure that would be lost in event of default, of country or industry market-wide events or of counterparty-specific changes on the creditworthiness.

We perform Monte-Carlo simulations to obtain the loss profile of a given portfolio – its loss probability distribution. The loss profile serves as the basis of our credit risk measure.

Allocated internal risk capital by business segment and source of risk(1)
– total portfolio before minority interests –

As of December 31,				2006				2005
				€ mn				€ mn
Property-Casualty
Credit risks				1,844				1,753
thereof: Investment				521				505
Reinsurance				1,323				1,248
Life/Health
Credit risks				685				874
thereof: Investment				548				702
Reinsurance				137				172
Banking
Credit risks				3,236				3,575
thereof: Investment				3,236				3,575
Reinsurance				—				—
Asset Management2)
Credit risks				—				—
thereof: Investment				—				—
Reinsurance				—				—
Corporate
Credit risks				2				6
thereof: Investment				2				6
Reinsurance				—				—
Total				5,767				6,208

We monitor and manage credit risks pursuant to a limit system applicable to the entire Allianz Group. The limit system aggregates major risks having Group-wide significance such as credit insurance, lending and our capital investments and serves as the basis for controlling the risk on an Allianz Group-wide basis by detecting credit risks at an early stage.

Property-Casualty, Life/Health and Corporate segments

In the Property-Casualty, Life/Health and Corporate segments credit risk arising from reinsurance counterparties are considered separately from issuer and counterparty risks arising from our asset investment activities, though the same methodology is applied.

Reinsurance credit risk
We take steps to limit our liability from insurance business by ceding part of the risks we assume to the international reinsurance market. When selecting our reinsurance partners, we consider only companies with strong credit profiles. To manage this credit risk, we compile Allianz Group-wide data on receivables from insurance losses. As of December 31, 2006, approximately 80% of the Allianz Group’s reinsurance recoverables were distributed among reinsurers with an investment grade rating. Additionally,more than 79% were distributed among reinsurers that have been assigned at least an “A” rating by Standard & Poor’s. We may also require letters of credit, deposits or other financial measures to further minimize our exposure to credit risk. For further information please see pages 142 to 143. You find them in the PDF file "Notes to the Consolidated Financial Statements", which you can download on page Notes to the Consolidated Financial Statements.

Investment credit risk
We limit our fixed income investment credit risk by setting high requirements on the creditworthiness of our debtors and by diversifying our investments. Through our central credit risk management, we consolidate our exposure according to debtors and across all investment categories and business segments, and monitor the exposure of the Allianz Group on a monthly basis. As of December 31, 2006, approximately 91% of the fixed income investments of the insurance companies of the Allianz Group had an investment grade rating. More than 86% were distributed among obligors that had been assigned at least an “A” rating by Standard & Poor’s.

Banking segment

In the Banking Segment, credit risks include credit and counterparty risks in the lending business, issuer risks from our securities business, counterparty risks from trading activities and country risks.

We use our customers’ credit ratings as the central element for our approval, monitoring and control process. In this process, the various creditworthiness characteristics of our customers are represented in the form of rating classes. To categorize the default probability of a borrower, we use a system with 16 different rating classes. The first six classes correspond to “investment grade” and classes VII to XIV signify “non-investment grade”. Rating classes XV and XVI are default classes according to the Basel II definition. We assess and endeavor to improve our rating procedures on an ongoing basis.

The total credit risk exposure of Dresdner Bank of € 341 billion includes loans from lending business and market values of trading positions, in the case of derivatives it contains the positive replacement values plus risk-based add-ons. As of December 31, 2006, approximately 82% of overall counterparty limits in the trading and non-trading portfolios of Dresdner Bank were included in the rating classes I to VI, compared to 81% as of December 31, 2005. Approximately 18% of limits are included in the rating classes VII to XVI (2005: 19%). Furthermore, 97% (2005: 96%) of the counterparty limits in the trading portfolio are classified with a rating of I to VI.

Of Dresdner Bank’s lending activities measured by limits as of December 31, 2006, 29% (2005: 32%) were accounted for by the Private & Business Clients divisions and 71% (2005: 68%) by the Corporate & Investment Banking division.

Increasing loan volumes have been accompanied by a reduction of important risk parameters such as average probability of  default, expected loss and internal risk capital. Dresdner Bank has made an effort to improve its loan quality, supported by state-of-the-art loan processes, the implementation of a value-oriented growth strategy as well as better economic environment. As of December 31, 2006, approximately 68% (2005: 64%) of Dresdner Bank’s loans were with investment grade counterparties.

In line with the observed portfolio quality, our total volume of problem loans and potential problem loans (measured by usage), which are two additional indicators for the quality of the loan portfolio, decreased from approximately € 3.0 billion as of December 31, 2005 to € 2.0 billion as of December 31, 2006.

Asset Management segment

As part of the investment management process the Asset Management segment’s units assess credit risk affecting their customers’ portfolios. Though our asset management companies do not engage in any lending transactions, counterparty risks can arise in certain circumstances, such as with broker-related over-the-counter transactions. Our asset management companies analyze the creditworthiness of their counterparties and set limits per counterparty based on objective criteria.