The assessment of existence of objective evidence of impairment of a financial asset or group of financial assets is carried out at the end of each reporting period.
If there is objective evidence of impairment arising from events occurring after the initial recognition of financial assets and causing a decrease in expected future cash flows then appropriate impairment losses are recognized against costs of the current period.
Objective evidence of impairment includes information on:
- significant financial difficulties of the issuer or debtor;
- failure to comply with the terms of the contract, e.g. failure to repay or default in repayment of interest or principal;
- the lender granting the borrower forbearance (for economic or legal reasons, resulting from the borrower’s financial difficulties) which the lender would otherwise not grant
- high likelihood of liquidation, bankruptcy or other financial reorganization of the borrower;
- lack of an active market for a given financial asset caused by the issuer's financial difficulties;
- observed data pointing to a measurable decrease of estimated future cash flows associated with a group of financial assets from the time of their first recognition, although it is not yet possible to determine the decrease for a single asset from the group of financial assets, including:
- negative changes pertaining to the status of the borrowers’ payments in the group (e.g. increased number of delayed payments) or
- adverse changes in the economic condition in a specific industry, region, etc. contributing to the deterioration of the debtors’ capacity for repayment;
- adverse changes in the technology, market, economic, legal or other environment in which the issuer of an equity instrument operates indicating that costs of investment in that equity instrument may not be recovered.
In the case of assets which are not measured at fair value through profit or loss, the PZU Group recognizes the expected credit loss – ECL. This applies to:
- loan receivables from clients;
- loans;
- debt securities;
- buy-sell-back transactions;
- lease receivables;
- term deposits with credit institutions;
- lending commitments and issued financial guarantees.
For debt assets measured at amortized cost and at fair value through other comprehensive income, impairment is measured as:
- Lifetime ECL – the expected credit losses that result from all possible default events over the expected life of a financial instrument;
- 12-month ECL – the portion of lifetime expected credit losses that represent the expected credit losses that result from default events on a financial instrument that are possible within the 12 months after the reporting date.
The PZU Group measures allowances for expected credit losses at an amount equal to lifetime ECL, except for the following instruments, for which 12-month ECL is recognized instead:
- financial instruments for which credit risk has not increased significantly since initial recognition,
- debt securities featuring low credit risk at the reporting date. Low credit risk debt securities are those securities that have been assigned an external investment-grade rating and
- exposures to banks and the NBP.
The charge is calculated in three categories:
- basket 1 – portfolio with low credit risk – 12-month ECL is recognized;
- basket 2 – portfolio in which a significant increase of credit risk occurs – lifetime ECL is recognized;
- basket 3 – portfolio of impaired loans – lifetime ECL is recognized.
The method of calculation of the allowance for expected credit losses also impacts the method of recognizing interest income – for baskets 1 and 2 interest income is determined on the basis of gross exposures, and in basket 3 on the net exposure basis.
The PZU Group recognizes the cumulative changes in lifetime ECL since initial recognition as a loss allowance for ECL from purchased or originated credit-impaired financial assets (POCI).
Changes in the value of allowances for expected credit losses is recognized in the consolidated profit and loss account in the “Movement in allowances for expected credit losses and impairment losses on financial instruments” item.
Provisions for legal risk pertaining to FX mortgage loans in Swiss francs
In connection with the CJEU ruling of 3 October 2019, the PZU Group has identified legal risk pertaining to FX mortgage loans in Swiss francs.
For exposures outstanding as at 31 December 2019 the PZU Group considers that the legal risk impacts the expected cash flows from the credit exposure and the provision amount is an element of the credit loss, i.e. the difference between the expected cash flows from the given exposure and the contractual cash flows.
Consequently, the PZU Group recognizes the amount of the provision pertaining to credit exposures outstanding as at 31 December 2019 (comprising existing and possible future statements of claim) in the impairment losses for loan receivables from clients and, accordingly, in the “movement in allowances for expected credit losses and impairment losses”.
Additional information on estimation of the provisions associated with the legal risk pertaining to FX mortgage loans in Swill francs is presented in section 43.3.
37.1.1. Calculation of PD and LGD parameters
PZU Group uses the following parameters to estimate allowances for expected credit losses:
- Probability of Default (PD) – probability of default of a counterparty over a specified time horizon;
- Loss Given Default (LGD) – loss given default, expressed as a percentage of the total exposure in case of a counterparty insolvency.
For issuers and exposures that are externally rated, PDs is assigned on the basis of the average market default rate for the rating classes concerned. First, the internal rating of an entity/issue is determined in accordance with the internal rating methodology. The tables published by external rating agencies are used to estimate average PD.
The Moody’s RiskCalc model is used for issuers of corporate bonds and corporate loans, for which no external rating is available. The EDF parameter (expected default frequency) is used to estimate PD. When estimating lifetime PD for exposures with maturity above 5 years (in the RiskCalc model, the forward EDF curve refers to a 5-year period), it is assumed that in subsequent years PD is constant and corresponds to the value determined by the model for the 5th year.
For loan receivables from clients PD is estimated based on internal models depending on the segment group, individual credit quality of the customer, and the exposure lifecycle phase.
For issuers of corporate bonds and corporate loans, 12-month LGD is determined based on the Moody’s RiskCalc model (LGD module). When estimating lifetime LGD for exposures with a maturity above 5 years, it is assumed that in subsequent years LGD is constant and corresponds to the value determined by the module for the 5th year.
If a credit rating agency has allocated a separate recovery rate to the instrument concerned then this parameter is used. For a given RR (recovery rate) parameter, the formula: LGD = 1-RR is applied.
Where the RiskCalc model cannot be used to estimate LGD levels and where the instrument does not have an LGD awarded by an external rating agency, then the average RR should be used, based on market data (properly differentiating the corporate and sovereign debt classes) supplied by external rating agencies using the following formula: LGD = 1-RR. When lifetime LGD must be estimated, the value of this parameter is assumed to be constant. The degree of subordination of debt is taken into account when selecting data for LGD.
37.1.2. Change in credit risk since initial recognition
At each reporting date, the PZU Group shall assesses whether the credit risk on a financial instrument has increased significantly since initial recognition. When making the assessment, the PZU Group should use the change in the risk of a default occurring over the expected life of the financial instrument instead of the change in the amount of expected credit losses. To make that assessment, the Group compares the PD for the financial instrument as at the reporting date with the PD as at the date of initial recognition and consider reasonable and supportable information, that is available without undue cost or effort.
It is recognized that the credit risk on a financial instrument has not increased significantly at initial recognition and on the reporting date if the financial instrument features low credit risk (that is, it has an external investment-grade rating). This pertains in particular to treasury bonds:
The PZU Group assesses whether the credit risk of financial instruments has increased significantly by comparing the PD parameter for the rest of its lifetime on the reporting date with the PD parameter for the rest of its lifetime estimated at the time of initial recognition.
The PZU Group regularly monitors the effectiveness of the criteria used to identify a significant increase in credit risk, in order to confirm that:
- the criteria allow for identification of a significant increase in credit risk before the impairment of the exposure occurs;
- the average time between identifying a significant increase in credit risk and impairment is reasonable;
- exposures are in principle not transferred directly from basket 1 (12-month ECL) to basket 3 (impairment);
- there is no unreasonable volatility of allowances for expected credit losses resulting from transfers between 12-month ECL and lifetime ECL.
In the case of loan receivables from clients, the identification of a significant credit risk growth is based on an analysis of qualitative (such as the occurrence of a 30-day past due period, customer’s classification in the watch list, forbearance) and quantitative premises .
37.1.3. Identified impaired financial assets (basket 3)
The PZU Group classifies financial assets to basket 3 when the premises for impairment losses, such as among others delay in payment of more than 90 days, are satisfied with simultaneous satisfaction of the unpaid amount materiality threshold, exposure being included in the restructuring process or occurrence of an individual premise of impairment losses.
37.1.4. Financial assets impaired due to credit risk (POCI)
Financial assets impaired due to credit risk (POCI) is assets with impairment losses determined at the time of the initial recognition. The POCI classification does not change over the life of the instrument until derecognition.
POCI assets arise from:
- acquisition of a contract satisfying the definition of POCI (e.g. on combination with another entity or purchase of a portfolio);
- conclusion of a POCI contract on the initial granting (e.g. granting of a loan to a client in a poor financial condition);
- modification of a contract (e.g. in the course of restructuring) resulting in excluding an asset from the balance sheet and recognizing a new asset satisfying the definition of POCI.
As at the initial recognition, POCI assets are recognized at the fair value, without recognizing allowances for expected credit losses.
37.1.5. Receivables from policyholders
A simplified model, in which an aggregate assessment of the impairment is carried out and the impairment losses are estimated at the expected credit loss amount over the entire lifetime, is applied for receivables from policyholders.
Receivables are grouped by similar credit risk characteristics. For receivables before maturity, the value of the receivable that is likely to become due is determined based on a historical analysis of the percentage of the ratio of receivables that are not paid before maturity. The amount of write-off for expected credit losses is determined on the basis of the uncollectibility ratio for matured receivables with the shortest past due period.
For matured receivables, an age structure is prepared, depending on the past due period. For this group, the value of the allowance for expected credit losses is calculated in separate ranges of past due periods, based on the uncollectibility ratios determined through historical analysis.
