Internal risk capital, which is the capital required to protect against unexpected economic losses, is a key parameter of our EVA®-approach, consistently applied to all segments. In 2006, we used an integrated internal risk capital model to assess and allocate quantitative risk for ourmajor insurance companies as well as for our banking subsidiary, Dresdner Bank. This process allows us to consistently aggregate risk capital for all segments on the Group level within our internal risk capital framework. By using our internal risk capital model, we endeavor to evaluate risks more precisely in an effort to optimize allocation of capital within the Allianz Group.
Value-at-risk approach
Our internal risk capital model is based on the value-at-risk approach. This model, consistent with value-at-risk determinations, calculates a maximum loss in the value of our portfolio of assets and liabilities within a given timeframe and with a certain specified probability, or frequency, in the event of adverse market movements. More specifically, for each risk category, we calculate the net fair value of our assets and liabilities in terms of (i) a best estimate under currentmarket conditions and (ii) an adverse value under adverse market conditions over a certain holding period. The required internal risk capital per risk category is then defined as the difference between the best estimate and adverse value of the portfolio. In order to calculate both of these values, we revalue options and guarantees under current and adverse market conditions using statistical models. Internal risk capital results per category are aggregated in a manner that takes diversification effects across risk categories and/or regions into account. The required internal risk capital is determined on a quarterly basis.
Assumptions
On the Allianz Group level, our objective is to maintain capital according to a confidence level or solvency probability of 99.97% over a holding period of one year, which is equivalent to an “AA” rating of Standard & Poor’s. The time horizon over which the change in value is measured on the Allianz Group level is set at one year, as it is generally assumed that it may take a year to find a counterparty to whom to transfer the liabilities in our portfolio. In support of the Allianz Group’s objective to ensure a solvency probability of 99.97% over a holding period of one year at the Group level, we require our local operating units to hold risk capital allowing them to remain solvent with a certainty of 99.93% over a holding period of one year and take into account the diversification effects resulting from balancing our portfolio risks.
The Allianz Group’s policy is that all loans and deposits in foreign currencies should generally be funded and reinvested in investments in the same currency with matching maturities. Therefore, our residual foreign currency risk results primarily from the net fair value base of financial instruments denominated in foreign currency and the net asset value of our local non-Euro operating units. This currency market risk is generally managed centrally at the Allianz Group level and is, therefore, allocated to the Corporate segment.
Scope
Our internal risk capital covers the specific assets and liabilities listed below:
Assets Bonds, mortgages, investment funds, loans, floating rate notes, equities, real estate, conventional options, and swaps,
Liabilities Cash flow profile of all technical reserves as well as deposits and issued securities.
The model takes substantially all of our derivatives into account, in particular when such instruments are entered into as part of the operating unit’s regular business model (e.g. Dresdner Bank or Allianz Life Insurance Company of North America) or if they are of such a magnitude that they have a significant impact on the resulting risk capital (e.g. hedges of Allianz SE or in the Life/Health segment, if material obligations to policyholders are hedged through financial derivatives).
Our internal risk capital model quantifies the following risk categories:
Market risks Possible losses caused by changes in interest rates, exchange rates, share prices, real estate values and other relevant market prices (such as commodities);
Credit risks Possible losses caused by the inability to pay or a downgrade in the credit rating of debtors or counterparties;
Actuarial risks Unexpected financial losses from the sale of insurance protection; and
Business risks Cost and lapse risks, as well as operational risks including risks associated with external events or arising from insufficient or failing internal processes, procedures and systems.
The internal risk capital model allows us to evaluate the risk to which we are exposed by using statistically-based methods. The individual characteristics of our operating units and the specific nature of their risks are taken into account by reflecting local management rules such as investment strategies and policyholder participation rules in the Life/Health segment and establishing risk parameters based on past developments affecting each such unit.
