ALM Risks

At the total balance sheet level, ALM risks contribute considerably to economic values of insurance liabilities, market value of assets, risks and capital need. ALM risks and exposures are analyzed actively and the risks are taken into account when making capitalization decisions, managing investments and developing insurance products. According to Sampo’s definition ALM risks also include liquidity risk and other risks that may cumulate at the balance sheet level.

Risk definitions related to ALM risks may be found in Appendix 2 (Risk Definitions).

Principles of Asset and Liability Management

In Sampo Group, insurance liabilities are the starting point for investment management. Insurance liabilities are modelled and analyzed to form an understanding of their expected future cash flows and their sensitivities to changes in factors such as inflation, interest rates and foreign exchange rates.

The solvency position and risk appetite define the general capacity and willingness for risk taking. The stronger the solvency position and the higher the risk appetite, the more the investment portfolio can potentially differentiate from a portfolio replicating cash flows of insurance liabilities.

Rating targets and regulatory requirements are major external factors affecting market and liquidity risk taking in general at the balance sheet level, and specifically at the investment portfolio level.

ALM in If P&C

The ALM risk in If P&C is managed in accordance with Sampo Group’s principles. ALM is taken into account through the risk appetite framework and is governed by If P&C’s Investment Policies.

In the financial accounts most of the technical provisions are nominal, while a significant part, namely the annuity and annuity IBNR reserves, are discounted using interest rates in accordance with regulatory rules. Thereby If P&C is, from an accounting perspective, mainly exposed to changes in inflation and the regulatory discount rates. From an economic perspective, in which the cash flows of insurance liabilities (technical provisions) are discounted with prevailing interest rates, If P&C is exposed to changes both in inflation and nominal interest rates. For more information see the table Sensitivities of Technical Provisions, If P&C, 2016 in the Non-life Underwriting Risks section.

To maintain the ALM risk within the overall risk appetite, the cash flows of insurance liabilities (technical provisions) are matched by investing in fixed income instruments and by using currency derivatives.

ALM in Mandatum Life

The Board of Directors of Mandatum Life annually approves the Investment Policies for both segregated assets and other assets regarding the company’s investment risks. These policies set principles and limits for investment portfolio activities.

The Investment Policy for segregated assets defines the risk bearing capacity and the corresponding control levels. Since the future bonus reserves of the segregated group pension portfolio is the first buffer against possible investment losses, the risk bearing capacity is also based on the amount of the future bonus reserve. Different control levels are based on the fixed stress scenarios of assets.

The Investment Policy for other investment assets defines the control levels for the maximum acceptable risk and respective measures to manage the risk. The control levels are set above the Solvency II SCR and are based on predetermined capital stress tests. The general objective of these control levels and respective guidelines is to maintain the required solvency.

When the above mentioned control levels are breached, the ALCO reports to the Board which then takes responsibility for the decisions related to the capitalization and the market risks in the balance sheet.

The cash flows of Mandatum Life’s with profit technical provisions are relatively predictable, because in most of the company’s with profit products, surrenders and premiums are restricted. The company’s claims costs do not contain a significant inflation risk element.

The long-term target for investments is to provide sufficient return to cover the guaranteed interest rate plus bonuses based on the principle of fairness as well as the shareholder’s return requirement with an acceptable level of risk. In the long run, the most significant risk is that fixed income investments will not generate an adequate return compared to the guaranteed rate. In addition to investment and capitalization decisions, Mandatum Life has implemented active measures on the liability side to manage the balance sheet level interest rate risk. The company has reduced the minimum guaranteed interest rate in new contracts, supplemented the technical provisions with discount rate reserves and adjusted policy terms and conditions as well as policy administration processes to enable more efficient interest rate risk management.

Interest Rate Risk of Balance Sheet

Sampo Group is negatively affected when rates are decreasing or staying at low levels, because the duration of liabilities in Sampo Group companies is longer than the duration of assets. If P&C has successfully decreased its combined ratio over the years to counteract falling interest rates. Mandatum Life’s strategic balancing factor has been the increasing proportion of non-interest rate sensitive Wealth-management business. At Group level interest rate risks have been partly mitigated by having the major portion of Sampo’s debt tied to short term interest rates.

Liquidity Risks

Liquidity risk is relatively immaterial in Sampo Group’s businesses because liability cash flows in most lines of business are fairly stable and predictable and an adequate share of the investment assets are in short-term money market instruments and liquid government bonds. Sampo Group companies manage the liquidity risk on a daily basis. In addition both the parent company’s and the subsidiaries’ creditworthiness and reputation are proactively managed.

In Sampo Group, liquidity risk is managed by the legal entities, which are responsible for liquidity planning and maintaining adequate liquidity buffers. Liquidity risk is monitored based on the expected cash flows resulting from assets, liabilities and other business. In the subsidiaries, the adequacy of liquidity buffers is dependent on the underwriting cash flows. In the parent company, the adequacy of liquidity buffers is dependent also on potential strategic arrangements. A high liquidity is generally preferred. At the end of 2016, the liquidity position in each legal entity was in accordance with internal requirements.

In If P&C, liquidity risk is limited, since premiums are collected in advance and large claims payments are usually known a long time before they fall due. Liquidity risks are managed by cash management functions which are responsible for liquidity planning. Liquidity risk is reduced by having investments that are readily tradable in liquid markets. The available liquid financial assets, being that part of the assets which can be converted into cash at a specific point in time, are analyzed and reported to the ORSA (Own Risk Solvency Assessment) Committee.

In Mandatum Life, a large change in surrender rates could influence the liquidity situation. However, only a relatively small part of the insurance policies can be surrendered and it is therefore possible to forecast short-term cash flows related to claims payments with a very high accuracy.

The maturities of technical provisions and financial assets and liabilities are presented in the table Cash Flows According to Contractual Maturity, If P&C, Mandatum Life and Sampo plc, 31 December 2016. The table shows the financing requirements resulting from expected cash inflows and outflows arising from financial assets and liabilities as well as technical provisions.

Cash Flows According to Contractual Maturity If P&C, Mandatum Life and Sampo plc, 31 December 2016

Sampo Group has a relatively low amount of financial liabilities and thus Group’s respective refinancing risk is relatively small. During 2016, Sampo issued two public bonds amounting to EUR 1.05 billion and several private placements targeted to Mandatum Life’s retail clients. If also issued two tranches of subordinated liabilities amounting to SEK 2 billion in 2016. Sampo Group companies have business relationships with several creditworthy counterparties which mitigate the risk that Group is not able to enter into reinsurance or derivative transactions when needed.

Since there is no unambiguous technique to quantify the capital need for liquidity risk, it is not directly taken into account in the capital need estimates. Thus only the interest rate risk part of the ALM risks is accounted for in the economic capital framework.