Munich Re Group Annual Report 2006 (PDF, 1.8

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Munich Re Group Annual Report 2006 Risk management processes and exposures We adopt a holistic risk management approach, the main objective of which is to analyse and control the interdependencies between risks on the asset and liability sides, and between strategic and operational risks. This entails considering economic parameters as well as the requirements and expectations of clients, shareholders, supervisory authorities and rating agencies. Market risks Risk management processes In the Munich Re Group we are guided by the following ALM principles. In a first step, we structure our investments so that they match the characteristics of our liabilities as closely as possible. We allow in this step for the economic structure of the liabilities as well as any regulatory restrictions on the determination of those liabilities. We call this the “neutral position” for the liabilities. In a second step, the Munich Re Group exploits its expertise in international financial markets to deliver a commensurate return for the risk taken by deviating from the neutral position. Such market risk is taken in a way that is commensurate with the risk-bearing capacities of the Munich Re Group, the skills and expertise of our asset managers, and the strategic level of asset-liability mismatch that is set by the Board or its Risk Committees. The investment process for the Group’s investments is controlled by the individual companies of the Munich Re Group according to uniform rules. In line with our assetliability management (see page 98), we follow a liabilitydriven investment approach, i.e. we match the outflows implied by the insurance operations with appropriate investments, e.g. by matching currencies, durations and, where relevant, convexity. Our asset-liability mismatch risks are mainly steered on an economic basis, meaning that the pure accounting effects must be treated with caution, as the financial statements prepared in accordance with the applicable accounting rules do not always fully reflect the economic situation. Besides these aspects, our investment strategy also considers requirements relating to supervisory regulations, accounting and tax purposes. Furthermore, for individual reinsurance products involving explicit market risks, such as interest-rate or 128 Management report_Risk report currency risks, asset-liability management principles are applied at micro (e.g. treaty) level when the products are being designed and priced. This is especially important for life business and long-tail property-casualty business, where long time horizons are involved. The companies entrusted with our asset management, in particular MEAG, are given mandates by the insurance and reinsurance companies in the Munich Re Group based on uniform investment criteria (General Investment Guidelines) established by the Board of Management. Market risks are measured and limited using a valueat-risk (VaR) approach for the asset-liability mismatch risk, which is also employed in our strategic investment planning to model the optimal investment portfolio according to our risk preference. This asset-liability mismatch risk approach measures the possible adverse changes in economic surplus resulting from changes in assets and the valuation of liabilities. Within this VaR, all important sources of the market risks of assets are considered, i.e. equity, interest rate, credit spread, and currency and real estate risks. As far as equity investments are concerned, we model diversified equities using appropriate indices, whereas concentrated equity investments are modelled by name. Besides this, the change in valuation of liabilities with respect to changes in interest rates, FX rates and inflation is included. When modelling these risks, state-of-the-art models are used which allow, for example, for “fat tails” in equity market risk distributions or all different shapes of interestrate curves within the interest-rate modelling. Our stochastic modelling is supplemented by applying stress tests, sensitivity and duration analyses. In our real estate investments, we are constantly optimising the return and risk profile. We are achieving this by rejuvenating our portfolio on an ongoing basis, diversifying internationally and investing in top-class commercial real estate primarily located in major European cities. In addition, we are pursuing the aim of reducing the concentration of our real estate investments in Germany, of which we sold a significant package in 2006. To mitigate the risk of loss of rental income, we structure our portfolio by selecting tenants of high credit-standing. We only run currency risks to a small extent, since we practise a policy of currency matching. This means that we
Munich Re Group Annual Report 2006 Management report_Risk report match the currencies of our underwriting liabilities with assets in the same or similar currencies. Mismatches are strictly limited from an accounting as well as an economic aspect. We use derivative financial instruments to achieve a better match for our liabilities, to hedge parts of the asset portfolio against market price fluctuations, and to prepare planned purchases and sales. We also hold these instruments for trading purposes in order to enhance earnings, albeit only to a limited degree. As part of our asset-liability management, we have hedged financial options and guarantees embedded in our primary life liabilities using derivative financial instruments. Credit derivatives are only employed in our investment portfolio to a limited extent. Changes in value of derivative financial instruments are accounted for at market price and are fully recognised in the income statement on the respective balance sheet dates. Therefore large fluctuations in their prices may impact our income materially, even though they have no effect on our economic value. We show the volumes of all derivatives on page 171 f. Risk exposures The market value of our fixed-interest securities as at 31 December 2006 totalled €98.0bn, representing 54.9% of the market value of the Munich Re Group’s overall investments. These securities thus make up the largest portion of our investments available for sale and our investments held to maturity in accordance with assetliability-management criteria. The market value of our equity investments, including participating interests, amounted to €26.1bn at 31 December 2006. As at 31 December 2006, on a market value basis and taking hedging transactions into account, our ratio of equities to total investments amounted to 14.1% (31 December 2005: 13.4%). The market value of our real estate, including buildings on land owned by third parties, amounted to €6.3bn at 31 December 2006. In the year under review, impairment losses and depreciation on the overall portfolio totalled €162m, depreciation accounting for the major share. The following sensitivity analyses for market risks serve to estimate potential changes in the value of investments under hypothetically possible market scenarios. The review is based on the investments of the Munich Re Group at 31 December 2006. The investments of Group companies that write a substantial part of their business in foreign currencies are subject to currency risks, as exchange rates fluctuate against the euro. However, these risks are balanced by partially similar changes in the value of the liabilities. The changes in share price assumed in these scenarios, ±10% and ±20% respectively, a corresponding shift in the interest-rate curve of ±100 and ±200 basis points (bp) respectively, and a fluctuation in exchange rates of ±10%, would produce the following changes in the market value of the investments: Market risk – Share prices Change in share prices Change in market value of investments sensitive to share prices Increase of 20% +€5.076bn Increase of 10% +€2.582bn Decrease of 10% –€2.552bn Decrease of 20% Market value as at –€5.074bn 31 December 2006 €26.592bn Market risk – Interest rates Change in interest rates Change in market value of investments sensitive to interest rates Increase of 200 bp –€14.398bn Increase of 100 bp –€7.749bn Decrease of 100 bp +€8.849bn Decrease of 200 bp Market value as at +€18.797bn 31 December 2006 €130.871bn Market risk – Exchange rates Change in exchange rates Change in market value of investments sensitive to exchange rates Increase of 10% +€4.228bn Decrease of 10% Market value as at –€4.228bn 31 December 2006 €42.278bn 129
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Munich Re Group Annual Report 2006
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The Munich Re Group Our operations
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Munich Re Group in 2006 Tireless an
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Quarterly figures Balance sheet 31.
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© 2007 Münchener Rückversicherun
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