ING Direct 2008 Annual Report Download - page 227

The adjustment of the MVS for the illiquidity of our insurance liabilities impacts the market risk in our Economic Capital model in
the following ways:
Interest Rate Risk: The illiquidity spread applied on our liability cash flows effectively reduces the duration of our liabilities and •
therefore reduces the duration mismatch between our assets and liabilities resulting in a reduced interest rate risk;
Credit Spread Risk: The Economic Capital model stresses both the asset spreads and the illiquidity spread on our liabilities. •
The netting of asset spread risk with illiquidity liability spread risk results in a lower credit spread risk;
Foreign Exchange Risk: The adjustment of the MVS for illiquidity results in a reduced net exposure to foreign currency movements •
and in particular US dollar. This results in a lower foreign exchange risk.
The MVL consist of the Financial Component of Liabilities (FCL) and a Market Value Margin (MVM) for non-hedgeable risks (e.g. insurance
risk). The MVM is calculated using a Cost-of-Capital approach based on an estimate of required shareholder return on Economic Capital.
The following fundamental principles have been established for the model:
Economic Capital requirements are calculated to achieve a target AA rating for policyholder liabilities;•
All sources of risk should be considered;•
The best estimate actuarial assumptions should be as objective as possible and based on a proper analysis of economic, industry, •
and company-specific statistical data. There is one set of best-estimate assumptions per product to be used for all purposes at ING;
Valuation of assets and liabilities is based on fair value principles. Where complete and efficient markets exist, fair value is equal to •
market value;
The Economic Capital and valuation calculations should reflect the embedded options in insurance contracts;•
The Economic Capital and valuation calculations are on a pre-tax basis and do not consider the effect of local regulatory accounting •
and solvency requirements on capital levels. Capital is assumed to be fully transferable between legal entities;
The framework does not include any franchise value of the business. It does, however, include the expense risk associated with the •
possibility of reduced sales volume in the coming year.
ING quantifies the impact of the following types of risk in its Economic Capital model:
Market risk for ING Insurance is the change in value based on changes in interest rates, equity prices, real estate prices, credit spreads, •
implied volatilities (interest rate and equity), and foreign exchange rates. It occurs when there is less than perfect matching between
assets and liabilities. Market risk may exist in the insurance activities as a result of selling products with guarantees or options
(guaranteed crediting rates, surrender options, profit sharing, etc.) that cannot be hedged given the assets available in a certain market.
Market risk may also occur when there is an intentional mismatch between asset and liability cash flows even when it is possible to
match or hedge the cash flows;
Credit risk is the risk of changes in the credit quality of issuers due to defaults or credit migration of securities (in the investment •
portfolio), counter parties (e.g. on reinsurance contracts, derivative contracts or deposits given) and intermediaries to whom ING has
an exposure. In addition to credit risk, ING includes a calculation of transfer risk for the risk of being unable to repatriate funds when
required due to government restrictions;
Business risk is defined as the exposure to the possibility that experience differs from expectations with respect to expenses, the runoff •
of existing business (persistency) and future premium re-rating;
Operational risk is defined as the risk of direct or indirect loss resulting from inadequate or failed internal processes, people and systems •
or from external events. Operational risk capital is difficult to quantify, since it is driven by infrequent events of high severity, and can be
significantly mitigated or exacerbated by the quality of internal controls and guidelines. It may be partially managed through the
purchase of insurance;
Life risk relates to deviations in timing and amount of the cash flows (premium payments and benefits) due to the incidence or •
non-incidence of death. The risk of non-incidence of death is also referred to as longevity risk to distinguish it from the risk associated
with death protection products. ING notes risks due to uncertainty of best estimate assumptions concerning level and trend of
mortality rates, volatility around best estimates, and potential calamities and recognises external reinsurance;
Morbidity risk is the risk of variations in claims levels and timing due to fluctuations in policyholder morbidity (sickness or disability) •
recognising external reinsurance. A wide variety of policy classes are subject to morbidity risk, including disability, accidental death
and disability, accelerated death benefits, workers compensation, medical insurance, and long-term care insurance;
P&C risk comprises the risk of variability of size, frequency and time to payment of future claims, development of outstanding claims •
and allocated loss adjustment expenses for P&C product lines recognising external reinsurance.
Strategic business risk has been excluded from the EC calculations of ING Insurance.
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ING Group Annual Report 2008