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PZU Group’s risk profile

Annual Report 2019 > PZU Group’s risk profile
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Major risks in the PZU Group


The major risks to which the PZU Group is exposed include the following: actuarial risk, market risk, credit risk, concentration risk, liquidity risk, operational risk, model risk and compliance risk.

The major risks associated with the operation of Alior Bank and Bank Pekao include the following risks: credit risk (including the risk of loan portfolio concentration), operational risk and market risk (involving interest rate risk, FX risk, commodity price risk and financial instrument price risk). The overall risk of the banking sector entities accounts for approximately 33% of the PZU Group’s total risk (Q3 2019), while the largest contribution is in credit risk.

Actuarial risk

This is the likelihood of a loss or an adverse change in the value of liabilities under the existing insurance contracts and insurance guarantee agreements, due to inadequate assumptions regarding premium pricing and creating technical provisions.

This is the likelihood of a loss or an adverse change in the value of liabilities under the existing insurance contracts and insurance guarantee agreements, due to inadequate assumptions regarding premium pricing and creating technical provisions:

  • this is the likelihood of a loss or an adverse change in the value of liabilities under the existing insurance contracts and insurance guarantee agreements, due to inadequate assumptions regarding premium pricing and creating technical provisions;
  • an analysis of the general terms and conditions of insurance with respect to the accepted risk and compliance with the existing laws;
  • an analysis of the general/specific terms and conditions of insurance or other model agreements with respect to the relevant actuarial risk being undertaken;
  • identification of potential risks related to a given product, for the purposes of subsequent measurement and monitoring;
  • analyzing the impact exerted by the introduction of new insurance products on capital requirements and risk margin computed using the standard formula;
  • verifying and validating modifications to insurance products;
  • an assessment of actuarial risk with reference to similar existing insurance products;
  • monitoring of existing product;
  • analyzing the policy of underwriting, tariffs, technical provisions and reinsurance and the claims and benefits handling process.

The assessment of actuarial risk consists in the identification of the degree of the risk or a group of risks that may lead to a loss, and in an analysis of risk elements in order to make an underwriting decision.

The measurement of actuarial risk is performed in particular using:

  • an analysis of selected ratios;
  • the scenario method - an analysis of impairment arising from an assumed change in risk factors;
  • the factor method - a simplified version of the scenario method, reduced to one scenario per risk factor;
  • statistical data;
  • exposure and sensitivity measures;
  • application of the expertise of the Company’s employees.

The monitoring and control of actuarial risk includes a risk level analysis by means of a set of reports on selected ratios.

Reporting aims to engage in effective communication regarding actuarial risk and supports management of actuarial risk at various decision-making levels from an employee to the supervisory board. The frequency of each report and the scope of information provided are tailored to the information needs of each decision-making level.

The management actions contemplated in the actuarial risk management process are performed in particular by doing the following:

  • defining the level of tolerance for actuarial risk and monitoring it;
  • business decisions and sales plans;
  • calculation and monitoring of the adequacy of technical provisions;
  • tariff strategy, monitoring of current estimates and assessment of the premium adequacy;
  • the process of assessment, valuation and acceptance of actuarial risk;
  • application of tools designed to mitigate actuarial risk, including in particular reinsurance and prevention.

Moreover, to mitigate the actuarial risk inherent in current operations the following actions in particular are undertaken:

  • defining the scopes of liability in the general / specific terms and conditions of insurance or other model agreements;
  • co-insurance and reinsurance;
  • application of an adequate tariff policy;
  • application of the appropriate methodology for calculating technical provisions;
  • application of an appropriate procedure to assess underwriting risk;
  • application of a correct claims or benefits handling procedure;
  • sales decisions and plans;
  • prevention.

Market risk

This is the risk of a loss or an adverse change in the financial situation resulting, directly or indirectly, from fluctuations in the level and in the volatility of market prices of assets, credit spread, as well as value of liabilities and financial instruments.

The risk management process for the credit spread and concentration risk has a different set of traits from the process of managing the other sub-categories of market risk and has been described in a subsequent section (Credit risk and concentration risk) along with the process for managing counterparty insolvency risk.

The market risk in the PZU Group originates from three major sources:

  • operations associated with asset and liability matching (ALM portfolio);
  • operations associated with active allocation, i.e. designating the optimum medium-term asset structure (AA portfolios);
  • banking operations – in conjunction with them the PZU Group has a material exposure to interest rate risk.

Numerous documents approved by supervisory boards, management boards and dedicated committees govern investment activity in the PZU Group entities.

Market risk identification involves recognizing the actual and potential sources of this risk. The process of identifying market risk associated with assets commences at the time of making a decision to start entering into transactions on a given type of financial instruments. Units that make a decision to start entering into transactions on a given type of financial instruments draw up a description of the instrument containing, in particular, a description of the risk factors. They convey this description to the unit responsible for risk that identifies and assesses market risk on that basis.

The process of identifying the market risk associated with insurance liabilities commences with the process of developing an insurance product and involves an identification of the interdependencies between the magnitude of that product’s financial flows and market risk factors. The identified market risks are subject to assessment using the criterion of materiality, i.e. does the materialization of risk entail a loss capable of affecting its financial condition.

Market risk is measured using the following risk measures:

  • VaR, value at risk: a measure of risk quantifying the potential economic loss that will not be exceeded within a period of one year under normal conditions, with a probability of 99.5%;
  • standard formula;
  • exposure and sensitivity measures;
  • accumulated monthly loss.

In the case of banking entities suitable measures are employed in accordance with the regulations applicable to this sector and best market practices.

When measuring market risk, the following stages, in particular, are distinguished:

  • collection of information on assets and liabilities that generate market risk;
  • calculating the value of risk.

The risk is measured:

  • daily – for exposure and sensitivity measures of the instruments in systems used by particular PZU Group companies;
  • monthly – when using the value at risk model for market risk or a standard formula.

Monitoring and control of market risk involves an analysis of the level of risk and of the utilization of the designated limits.

Reporting involves communicating the level of market risk, the effects of monitoring and control to various decision-making levels. The frequency of each report and the scope of information provided therein are tailored to the information needs at each decision-making level.

Management actions in respect of market risk involve in particular:

  • execution of transactions serving the purpose of mitigation of market risk, i.e. selling a financial instrument, closing a position on a derivative, purchasing a derivative to hedge a position;
  • diversification of the assets portfolio, in particular with respect to market risk categories, maturities of instruments, concentration of exposure in one entity, geographical concentration;
  • setting market risk restrictions and limits.

The application of limits is the primary management tool to maintain a risk position within the acceptable level of risk tolerance. The structure of limits for the various categories of market risk and also for the various organizational units is established by dedicated committees in such a manner that the limits are consistent with risk tolerance as agreed by the management boards of the subsidiaries. Banking sector entities are in this respect subject to additional requirements in the form of sector regulations.

Credit risk and concentration risk

Credit risk is grasped as the risk of loss or adverse change in the financial situation, resulting from fluctuations in the credit standing of issuers of securities, counterparties and any debtors, which materializes in the form of a counterparty’s default on a liability or an increase in credit spread. The following risk categories are distinguished in terms of credit risk:

  • spread;
  • counterparty default risk;
  • credit risk in financial insurance.

Concentration risk is grasped as the possibility of incurring loss stemming either from lack of diversification in the asset portfolio or from large exposure to default risk by a single issuer of securities or a group of related issuers.

Credit risk and concentration risk are identified at the stage of making a decision on an investment in a new type of financial instrument or on accepting credit exposure. Identification involves an analysis of whether the contemplated investment entails credit risk or concentration risk, what its level depends on and what its volatility over time is. Actual and potential sources of credit risk and concentration risk are identified.

Risk assessment consists of estimating the probability of risk materialization and the potential impact exerted by risk materialization on a given entity’s financial standing.

Credit risk is measured using:

  • measures of exposure (gross and net credit exposure and maturity-weighted net credit exposure);
  • capital requirement calculated using the standard formula.

Concentration risk for a single entity is calculated using the standard formula.

A measure of total concentration risk is the sum of concentration risks for all entities treated separately. In the case of related parties, concentration risk is calculated for all related parties jointly.

In the case of banking entities suitable measures are employed in accordance with the regulations applicable to this sector and best market practices. In particular, credit risk is measured using a set of loan portfolio quality metrics.

Monitoring and control of credit risk and concentration risk involves an analysis of the current risk level, assessment of creditworthiness and calculation of the degree of utilization of existing limits. Such monitoring is performed, without limitation, on a daily and monthly basis.

The following are subject to monitoring:

  • exposures to financial insurance;
  • exposures to reinsurance;
  • exposure limits and VaR limits;
  • loan exposures (this pertains to banking entities).

Reporting involves communicating the levels of credit risk and concentration risk and the effects of monitoring and control to various decision-making levels. The frequency of each report and the scope of information provided therein are tailored to the information needs at each decision-making level.

Management actions in respect of credit risk and concentration risk involve in particular:

  • setting limits to curtail exposure to a single entity, group of entities, sectors or countries;
  • diversification of the portfolio of assets and financial insurance, especially with regard to country and sector;
  • acceptance of collateral;
  • execution of transactions to mitigate credit risk, i.e. selling a financial instrument, closing a derivative, purchasing a hedging derivative, restructuring a debt;
  • reinsurance of the financial insurance portfolio.

The structure of credit risk limits and concentration risk limits for various issuers is established by dedicated committees in such a manner that the limits are consistent with the adopted risk tolerance determined by the management boards of the individual subsidiaries and in such a manner that they make it possible to minimize the risk of ‘infection’ between concentrated exposures.

In banking activity the provision of credit products is accomplished in accordance with loan granting methodologies appropriate for a given client segment and type of product. The assessment of a client’s creditworthiness preceding a credit decision is performed using tools devised to support the credit process, including a scoring or rating system, external information and the internal databases of a given PZU Group bank. Credit products are granted in accordance with the binding operational procedures stating the relevant actions performed in the lending process, the units responsible for that and the tools used.

To minimize credit risk, adequate collaterals are established in line with the credit risk incurred. The establishment of a collateral does not waive the requirement to examine the client’s creditworthiness.

Liquidity risk

Financial liquidity risk means the possibility of losing the capacity to settle, on an ongoing basis, the PZU Group’s liabilities to its clients or business partners. The aim of the liquidity risk management system is to maintain the capacity of fulfilling the entity’s liabilities on an ongoing basis. Liquidity risk is managed separately for the insurance part and the banking part.

The risk identification involves analysis of the possibility of occurrence of unfavorable events, in particular:

  • shortage of liquid cash to satisfy the current needs of the PZU Group entity;
  • lack of liquidity of financial instruments held;
  • the structural mismatch between the maturity of assets and liabilities.

Risk assessment and measurement are carried out by estimating the shortage of cash to pay for liabilities. The risk estimate and measurement is carried out from the following perspectives:

  • liquidity gaps (static, long-term financial liquidity risk) – by monitoring a mismatch of net cash flows resulting from insurance contracts executed until the balance sheet date and inflows from assets to cover insurance liabilities in each period, based on a projection of cash flows prepared for a given date;
  • potential shortage of financial funds (medium-term financial liquidity risk) – through analysis of historical and expected cash flows from the operating activity;
  • stress tests (medium-term financial liquidity risk) – by estimating the possibility of selling the portfolio of financial investments in a short period to satisfy liabilities arising from the occurrence of insurable events, including extraordinary ones;
  • current statements of estimates (short-term financial liquidity risk) – by monitoring demand for cash reported by other business units of a given insurance undertaking in the PZU Group by the date defined in regulations which are in force in that entity.

The banks in the PZU Group employ the liquidity risk management metrics stemming from sector regulations, including Recommendation P issued by the Polish Financial Supervision Authority.

To manage the liquidity of the banks in the PZU Group, liquidity ratios are used for different periods ranging from 7 days, to a month, to 12 months and to above 12 months.

Within management of liquidity risk, banks in the PZU Group also perform analyses of the maturity profile over a longer term, depending to a large extent on the adopted assumptions about development of future cash flows connected with items of assets and equity and liabilities. The assumptions take into consideration:

  • stability of equity and liabilities with indefinite maturities (e.g. current accounts, cancellations and renewals of deposits, level of their concentration);
  • possibility of shortening the maturity period for specific items of assets (e.g. mortgage loans with an early repayment option);
  • possibility of selling items of assets (liquidity portfolio).

Monitoring and controlling financial liquidity risk involves analyzing the utilization of the defined limits.

Reporting involves communicating the level of financial liquidity to various decision-making levels. The frequency of each report and the scope of information provided therein are tailored to the information needs at each decision-making level.

The following measures aim to reduce financial liquidity risk:

  • maintaining cash in a separate liquidity portfolio at a level consistent with the limits for the portfolio value;
  • maintaining sufficient cash in a foreign currency in portfolios of investments earmarked for satisfying insurance liabilities denominated in the given foreign currency;
  • provisions of the Agreement on managing portfolios of financial instruments entered into between TFI PZU and PZU regarding limitation of the time for withdrawing cash from the portfolios managed by TFI PZU to at most 3 days after a request for cash is filed;
  • keeping open credit facilities in banks and/or the possibility of performing sell-buy-back transactions on treasury securities, including those held until maturity;
  • centralization of management of portfolios/funds by TFI PZU;
  • limits of liquidity ratios in the banks belonging to the PZU Group.

Operational risk

Operational risk is the risk of suffering a loss resulting from improper or erroneous internal processes, human activities, system failures or external events.

Operational risk is identified in particular by:

  • accumulation and analysis of information on operational risk incidents and the reasons for their occurrence;
  • self-assessment of operational risk;
  • scenario analyses.

Operational risk is assessed and measured by:

  • calculating the effects of the occurrence of operational risk incidents;
  • estimating the effects of potential operational risk incidents that may occur in the business.

Both banks in the PZU Group, upon KNF’s consent, apply advanced individual models to measure operational risk and to estimate capital requirements on account of this risk.

Monitoring and control of operational risk is performed mainly through an established system of operational risk indicators and limits enabling assessment of changes in the level of operational risk over time and assessment of factors that affect the level of this risk in the business.

Reporting involves communicating the level of operational risk and the effects of monitoring and control to various decision-making levels. The frequency of each report and the scope of information provided therein are tailored to the information needs at each decision-making level.

Management actions involving reactions to any identified and assessed operational risks involve, in particular:

  • risk mitigation by taking actions aimed at minimizing risks, for instance by strengthening the internal control system;
  • risk transfer – in particular, by entering into insurance agreements;
  • risk avoidance by refraining from undertaking or withdrawing from a particular type of business in cases where too high a level of operational risk is ascertained and where the costs involved in risk mitigation are unreasonable;
  • risk acceptance – approval of consequences of a possible realization of operational risk unless they threaten to exceed the operational risk tolerance level.

The business continuity plans in PZU Group entities are kept up to date and tested regularly.

Model risk

Taking into account the growing importance of the scope of use of models and the fact that model risk was classified as material risk for the PZU Group; the formal process of identifying and evaluating this risk was continued in 2019. The process aims to ensure high quality of risk management practices applied to this risk. It is currently being developed in PZU and PZU Życie. Within the framework of this process, the models were monitored and independently validated in 2019.

Model risk has been defined as the risk of incurring financial losses, incorrectly estimating data reported to the regulatory authority, taking incorrect decision or losing reputation as a result of errors in the development, implementation or application of models.

In the entities from the banking sector, given the high materiality of model risk, the management of this risk has already been implemented for some years in the course of adaptation to the requirements of Recommendation W issued by the KNF. Both banks have defined standards for the model risk management process, including the rules for developing models and evaluating the quality of their operations and have ensured appropriate corporate governance solutions.

Compliance risk

Compliance risk is the risk that PZU Group entities or persons related to PZU Group entities may fail to adhere to or violate the applicable provisions of law, internal regulations or standards of conduct, including ethical standards, adopted by PZU Group entities, which will or may result in the PZU Group or persons acting on its behalf suffering legal sanctions, financial losses or a loss of reputation or trustworthiness.

The compliance risk management process at the PZU and PZU Życie level covers both systemic activities carried out by the Compliance Department and ongoing compliance risk management activities which are the responsibility of the heads of organizational units or cells in the Companies. Compliance risk is identified and assessed for each internal process at PZU and PZU Życie, in line with the demarcation of reporting responsibilities. Moreover, the Compliance Department identifies compliance risk on the basis of information obtained from the legislative process, from notifications to the register of conflicts of interest, gifts and irregularities, and from inquiries received by the Department.

The systemic activities include, in particular:

  • development and implementation of systemic assumptions and internal regulations consistent with those assumptions;
  • recommending to other PZU Group entities solutions for the application of a consistent compliance function and a systemic approach to compliance risk management;
  • monitoring of the compliance risk management process, including in particular: performing compliance risk analyses, reviewing the degree of implementation of guidelines provided by external entities in respect of compliance risk management;
  • consulting on and issuing interpretations and guidelines for the application of the adopted standards of conduct and compliance risk management;
  • planning and delivery of training and internal communication in the field of compliance;
  • preparation of compliance risk reports and information.

In turn, activities of the heads of organizational cells and units related to ongoing management of compliance risk, include in particular:

  • identification and evaluation of compliance risk in the supervised area;
  • measurement of compliance risk in the supervised area;
  • determining the instruments to provide protection and limit the number and scale of irregularities;
  • reporting any threats and events in the compliance risk area to the Compliance Department;
  • taking actions to mitigate compliance risk;
  • ongoing monitoring of compliance risk in the supervised area.

Moreover, the Compliance Department at PZU level makes efforts aimed at ensuring adequate and uniform standards of compliance solutions in all PZU Group entities and monitors compliance risk throughout the PZU Group.

In 2019 the PZU Group entities had compliance systems adapted to the standards designated by PZU.

The provision of full information on compliance risk in each member of the Group is the responsibility of compliance units of these entities. These units are required to assess and measure compliance risk and take appropriate remedial actions aimed at mitigating the likelihood of realization of this risk.

PZU Group entities are obligated to report compliance risk to the Compliance Department at PZU and PZU Życie on an on-going basis. In turn, the tasks of the Compliance Department include the following:

  • analysis of monthly and quarterly reports received from compliance units of each member of the Group;
  • assessment of the impact of compliance risk on the PZU Group as a whole;
  • analysis of the performance of compliance-related instructions given to entities;
  • support of the PZU Group’s entities’ compliance business units when assessing compliance risk;
  • reporting to the PZU Management Board and Supervisory Board.

Compliance risk includes, in particular, the risk that the operations performed by PZU Group entities will be out of line with the changing legal environment. This risk may materialize as a result of delayed implementation or absence of clear and unambiguous laws, or what is known as a legal gap. This may cause irregularities in the PZU Group’s business, which may then lead to higher costs (for instance, administrative penalties, other financial penalties) and a heightened level of loss of reputation risk.

Due to the broad spectrum of the PZU Group’s business, reputation risk is also affected by the risk of litigation whose value varies, which is predominantly inherent in the Group’s insurance companies and banks.

The identification and assessment of compliance risk in the Group’s entities is performed for each internal process of these entities by the heads of organizational units, in accordance with the allocation of responsibility for reporting. Moreover, compliance units in PZU Group entities identify compliance risk on the basis of information obtained from notifications to the register of conflicts of interest, gifts and irregularities, and from inquiries sent to them.

Compliance risk is assessed and measured by calculating the consequences of the following types of risk materializing:

  • financial risks, resulting among others from administrative penalties, court judgments, decisions issued by UOKiK, contractual penalties and damages;
  • intangible risks pertaining to a loss of reputation, including damage to the PZU Group’s image and brand.

Compliance risk is monitored, in particular, through:

  • systemic analysis of the regular reports received from the heads of organizational units and cells;
  • monitoring of regulatory requirements and adaptation of the business to the changing legal environment of PZU Group entities;
  • participation in legislative work aimed at amending the existing laws of general application;
  • performing diverse activities in industry organizations;
  • coordination of external control processes;
  • coordination of the fulfillment of reporting duties imposed by the stock exchange (in respect of PZU) and by statute;
  • increasing the level of knowledge among PZU Group staff in the field of competition law and consumer protection, tailored to the specific business areas;
  • monitoring of anti-monopoly jurisprudence and proceedings conducted by the President of UOKiK;
  • reviews of the implementation of recommendations issued by the PZU Group’s compliance unit;
  • ensuring uniform standards and consistent implementation of the compliance function within the PZU Group.

Management actions in the area of response to compliance risk include in particular:

  • acceptance of the risk arising, without limitation, from legal and regulatory changes;
  • mitigation of risk, also through aligning procedures and processes to regulatory requirements, evaluation and design of internal regulations to suit compliance needs, participation in the process of agreeing on marketing activities;
  • avoidance of risk by preventing any involvement of PZU Group entities in activities that are out of compliance with the applicable regulatory requirements, best market practices or activities that may have an unfavorable impact on the PZU Group’s image.

As part of efforts aimed at reducing compliance risk in the PZU Group at system level and day-to-day level, the following risk mitigation actions are undertaken:

  • continuous implementation of an effective compliance function as a key management function;
  • participation in consultations with legislative and regulatory authorities (supervised entities within the PZU Group) at the stage of development of the regulations (social consultations);
  • delegating representatives of the PZU Group’s supervised entities to participate in the work of various commissions of regulatory authorities;
  • participation in implementation projects for new regulations;
  • training of staff on new regulations, standards of conduct and recommended management actions;
  • issuing opinions on internal regulations and recommending possible amendments to ensure compliance with the applicable laws and accepted standards of conduct;
  • verifying procedures and processes in the context of their compliance with the applicable laws and accepted standards of conduct;
  • aligning documentation to upcoming changes in legal requirements before they are enacted;
  •  systemic supervision exercised by PZU over the execution of the compliance function in PZU Group entities;
  • running analyses and conducting ongoing monitoring of the application of the rules for the functioning of the Chinese walls – in connection with the additional investor commitments made by PZU in connection with the proceedings under the notification on the intent to purchase Bank Pekao’s shares;
  • ongoing monitoring of changes in the legal and regulatory environment in order to identify gaps or areas requiring action to ensure compliance.

In 2019 - in connection with the PZU Group continuing to meet the criteria for treating it as a financial conglomerate, and hence the necessity for KNF to continue applying supplementary oversight to it under the Act of 15 April 2005 on supplementary oversight over credit institutions and insurance undertakings, reinsurance undertakings and investment firms comprising a financial conglomerate – compliance was involved in the work to align the Company to the requirements ensuing from this act, as well as to the requirements stemming chiefly from the following legal acts:

  • Regulation (EU) 2016/679 of the European Parliament and of the Council of 27 April 2016 on the protection of natural persons with regard to the processing of personal data and on the free movement of such data, and repealing Directive 95/46/EC (General Data Protection Regulation);
  • Directive of 15 May 2014 on Markets in Financial Instruments (MIFID II) (this regulation is material for some PZU Group entities, in particular for TFI);
  • Act of 15 December 2017 on Distribution of Insurance;
  • Act of 1 March 2018 on Combating Money Laundering and Financing of Terrorism;
  • Act of 16 October 2019 on amending the Act on Public Offerings and the Conditions for Offering Financial Instruments in an Organized Trading System and on Public Companies and some other acts.

Risk concentration

When managing the various categories of risk, the PZU Group identifies, measures and monitors risk concentration; for the banking sector, these processes are discharged at the level of the various entities according to sector-specific requirements. To meet the regulatory obligations imposed on groups identified as financial conglomerates, numerous initiatives were undertaken in 2019 to implement a model to manage significant risk concentration in a financial conglomerate in keeping with the requirements of the Supplementary Oversight Act. A portion of this work will also be continued in 2020.

At present the PZU Group identifies the following types of risk concentration:

  • within actuarial risk, it identifies risk concentration with regard to possible losses caused by catastrophic events, such as, in particular, floods and cyclones and concentration on large corporate risks, where in both cases the applicable reinsurance program facilitates reduction of the possible net losses;
  • with respect to credit risk and market risk, risk concentration is identified at the level of groups, sectors of the economy and countries;
  • no risk concentration was identified within operational risk and other significant risks.

Risk concentration in the identified areas is subject to regular measurement and monitoring.