In the following we present our Group-wide internal risk capital related to market risks, as calculated pursuant to our internal risk capital model. The figures presented take into account diversification effects, but do not include minority interests.
Allocated internal risk capital by business segment and source of risk(1)
– total portfolio before minority interests –
As of December 31,
2006
€ mn
2005
€ mn
Property-Casualty
Market risks
8,379
8,717
thereof: Interest rate
427
642
Equity
7,300
7,408
Real estate
617
631
Currency2)
35
36
Life/Health
Market risks
3,244
3,668
thereof: Interest rate
383
917
Equity
2,615
2,544
Real estate
246
207
Currency2)
—
—
Banking
Market risks
2,090
2,092
thereof: Interest rate
55
38
Equity
1,865
2,050
Real estate3)
165
—
Currency2)
5
4
Asset Management4)
Market risks
—
—
thereof: Interest rate
—
—
Equity
—
—
Real estate
—
—
Currency2)
—
—
Corporate
Market risks
3,744
3,793
thereof: Interest rate
394
639
Equity
2,010
1,774
Real estate
55
33
Currency2)
1,285
1,347
Total
17,457
18,270
Non-trading portfolios
The Allianz Group’s non-trading portfolios contain all non-trading activities of the Banking segment as well as the financial assets and liabilities of the Property-Casualty and Life/Health segments. The Allianz Group holds and uses many different financial instruments in managing its businesses.
Property-Casualty, Life/Health and Corporate segments Most of the Allianz Group’s insurance-related equity investments are intended to be held for the long-term, where our internal risk capital model is used to regularly align the insurance business’ risk-bearing capacity with the economic risks it faces by taking into account short-term market developments.
The Property-Casualty and Life/Health segments are exposed to interest rate risk due to their investments in fixed income instruments, in particular bonds, loans and mortgages serving as collateral for policyholder obligations that are different in terms of maturity and size. Our internal risk capital model provides management with information regarding the cash flow profiles of the segments’ liabilities, which allows for active asset-liability management and monitoring. While the potential cash flow payments related to our liabilities in the Property-Casualty segment are typically shorter in nature than the financial assets backing them, the opposite usually holds true for our Life/Health segment, which provides us with a natural hedge at the Allianz Group level. In our Life/Health segment, risks are mitigated by policyholder participation, though there exist guarantees in that we must credit minimum rates for individual contracts. The valuation of these guarantees, which take into account the interaction of assets and policyholder obligations, forms an integral part of our risk management framework. Our primary interest rate exposure is the risk that interest rates in Germany, France, United States, Italy and South Korea may fall below the guaranteed credit minimums for certain of our Life/Health policies in those markets. In 2006, this interest rate risk decreased as interest rates increased in the Euro-zone and the United States and as the difference between interest rates and the average guaranteed levels also increased.
Interest rate risk in the Corporate segment primarily arises in connection with securities issued to fund the capital requirements of the Allianz Group. These securities include structured products that might be partly repaid in the form of equity participations held in our asset portfolio. Some of the securities issued qualify as eligible capital for existing regulatory solvency requirements to the extent they constitute subordinated debt or are perpetual in nature.
The primary exposures for foreign exchange risk are related to the U.S. Dollar, Swiss Franc and Korean Won. Local laws generally require that the insurance policy obligations of the Allianz Group’s subsidiaries and the investments covering them are in the same currency. When this is not the case (e.g. in Switzerland, obligations to policyholders resulting from life insurance contracts are partly backed by Euro-dominated bonds), the resulting foreign exchange risk is generally hedged against the local currency. Hedge efficiency is monitored by the local risk managers. As a result, currency fluctuations in connection with foreign subsidiaries have only aminor impact on the Property-Casualty and Life/Health segments’ risk management strategies locally, and active management of currency risks is performed centrally at the Allianz Group level within the Corporate segment.
Banking segment The Banking segment’s interest rate risk arises from its non-trading portfolio of loans and deposits, issued securities, interest rate-related investment securities, as well as corresponding hedges of Dresdner Bank and the other banks forming part of the Allianz Group. The market risk in the non-trading portfolio is also primarily interest rate risk that results from long-term fixed rate loans funded in part by short-term deposits. As is the case for Dresdner Bank’s trading portfolio, Dresdner Bank manages this risk by setting value-at-risk limits. As of December 31, 2006, the value-at-risk, with a 99% confidence level and 10-day holding period, for interest rate risks at Dresdner Bank amounted to € 15.5 million, compared to € 14.0 million as of December 31, 2005.(1) The value-at-risk in Dresdner Bank’s non trading book increased due to increases in market volatility and lower diversification effects between asset classes.
Dresdner Bank limits currency risks by applying the Allianz Group-wide policy that all loans and deposits in foreign currencies are refinanced or reinvested in the same currency with matching maturities.
Asset Management segment The internal risk capital calculation for the Asset Management segment at Group level is based on a standard model of Standard & Poor’s. This approach does not provide separate risk capital figures for market risk.
Approximately 99% of the investments held by the Asset Management segment’s units are held for the benefit of third parties and, therefore, do not result in significant market risk for Allianz. As a result, the risk capital calculated for the Asset Management segment is allocated to business risk in its entirety.
Trading portfolios
The trading portfolios of the Allianz Group contain all assets and liabilities classified as “held for trading” positions. In terms of activity and absolute volumes they relate primarily to the Banking segment. While our Banking segment business is separated into a designated trading portfolio and a non-trading portfolio, trading activities in the Property-Casualty, Life/Health and Corporate segments relate mainly to the hedging of insurance liabilities not internally classified as trading. Trading activities in the Asset Management segment are immaterial. In our worldwide trading activities, the Allianz Group uses financial derivatives both as non-standardized financial instruments for the individual management of market risks and as a component of structured financial transactions. The Allianz Group’s derivative trading activities focus on interest-bearing financial instruments, predominately interest rate swaps. The Allianz Group also uses currency, credit and equity/index derivatives. Property-Casualty, Life/Health and Corporate segments The Allianz Group’s insurance business does not generally engage in trading activities. With the adoption of IAS 39, however, we are exposed to market risks due to trading positions not only in respect of the banking business but also in respect of the insurance business. However, derivatives used in the Allianz Group’s insurance operations are principally used for portfolio hedging and not for trading purposes.
Banking segment The Banking segment is active in trading equities, interest rate instruments, foreign exchange and commodities. The Banking segment uses derivatives in its trading portfolios primarily to meet customer demands as well as to hedge market and credit risk. Derivatives are also used to take advantage of market opportunities. Dresdner Bank has expanded its use of credit derivatives in line with market growth in order to meet client demands in this product field. In terms of volume, the primary derivative products held by the Allianz Group are interest rate swaps, futures and options as well as foreign exchange forwards and equity related options. The primary exposures in foreign currencies are U.S. Dollars and British Pounds.
The value-at-risk model, which is used to evaluate capital adequacy for regulatory purposes and which forms the basis for our internal risk capital model, must take into account market fluctuations that can occur at a confidence level of 99% and a 10-day holding period. The value-at-risk model is supplemented by stress tests that estimate the potential loss under extreme market conditions.
For the purpose of setting internal limits and risk management, Dresdner Bank calculates a value-at-risk with a confidence level of 95% and a one-day holding period.While the value-at-risk for regulatory purposes is based on volatilities derived from equally weighted time series, the value-at-risk for internal use is based on volatilities derived from exponentially weighted time series, which assigns a greater weight to the most recent market developments. Therefore, unlike the value-at-risk calculation required by the BaFin, which is based on historical market data, we thus assign greater weight to the most recent market fluctuations. By doing so, we endeavor to reflect current market trends in the value-at-risk calculation on a timely basis.
Market risks within Dresdner Bank’s trading portfolio had a value-at-risk, with a 99% confidence level and a 10-day holding period, of € 57 million as of December 31, 2006, compared to € 66 million as of December 31, 2005. Market risk from trading activities declined in comparison to last year mainly due to the lower interest rate risk.
(1) Last year’s disclosure value has been restated for reasons of comparability with current value-at-risk figure, which according to new methodology includes for the first time equity positions (without participation intention).
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