ING Direct 2013 Annual Report Download - page 325

Risk management continued NN Group
Interest rate risk
Interest rate risk is the impact of interest rate changes on available capital as a result of the associated change in the value of the assets
and liabilities. NN generally uses swap curves as benchmark interest rate curves when assessing interest rate risk.
Risk profile
The table below provides an overview of NN’s general account undiscounted policyholder liability cash flows (net of expenses and
commissions) by maturity.
General account liabilities’ annual undiscounted cash flows (net of expenses and commissions) (1)
Liabilities originated in
Eurozone EUR Japan JPY (2) Other Currencies (2)
Maturities 2013 2012 2013 2012 2013 2012
0-1 –4,627 –4,010 222 138 –183 –143
1-2 –4,148 –3,971 –84 –174 –177 –306
2-3 –5,235 –4,317 –307 –329 –168 –209
3-5 –7,452 –7,356 –870 –938 –352 –561
5-10 –15,076 –15,109 –2,204 –2,285 –786 –927
10-20 –23,545 –23,219 –2,357 –2,718 –1,087 –1,208
20-30 –15,422 –15,977 –907 –973 –413 –489
30+ -14,752 –16,976 –577 –515 –82 –95
Total –90,257 –90,935 –7,084 –7,794 –3,248 –3,938
(1) The ‘minus’ sign in the table mean cash outflow from NN to the policyholders
(2) Japan and Other liabilities are presented at constant FX of 31December 2013. Other includes CZK, HUF, PLN, RON, and USD.
To effectively match its assets to liabilities, NN looks at the undiscounted liability cash flows and then determines which assets to purchase
to reduce interest rate risk. As can be seen in the table, the EUR denominated liabilities have a significant amount of long-term liability cash
flows, which relate primarily to the pension business in the Netherlands.
Liability valuations depend on the discount rate applied and are sensitive to movements in that discount rate, particularly given that
approximately one third of the liability cash outflows occur from year 20. Different policyholder liability discount rates apply depending on
the accounting or regulatory framework; thus, the interest rate risk differs by accounting regime.
• IFRS result before tax. Under IFRS-EU, NN values its general account policyholder liabilities using a discount rate that is set when the
policies are sold, and subjects them to a reserve adequacy test using current interest rates. As a result, changes in interest rates do not
affect IFRS earnings through liability valuations, unless the adequacy of the reserves of a segment falls below the 50th percentile level.
As of 1 January 2014, NN’s reserves for all segments are adequate at the 90th percentile. Apart from a few exceptions, interest rate
movements do not impact IFRS result before tax as investment income for fixed income assets is recorded as amortised cost value. A
few derivative instruments not subject to hedge accounting could cause volatility in IFRS result before tax due to interest rates. See
‘-IFRS result before tax sensitivities’.
• Available regulatory capital (outside the Netherlands). For the purposes of available regulatory capital in all jurisdictions outside
the Netherlands in which NN operates, general account policyholder liabilities are valued at a single discount rate set when the policies
are sold. General account fixed income assets are typically held at the same value as is reported on the IFRS balance sheet, although in
several jurisdictions such as Japan, Spain and Greece, certain assets can be held at amortised cost on the regulatory balance sheet.
Changes in interest rates affect available regulatory capital in these jurisdictions when fixed income assets are valued at market value,
and the liability valuations are insensitive to interest rate movements
• Available regulatory capital (Netherlands). For the purposes of available regulatory capital in the Netherlands, general account
policyholder liabilities are measured at fair market value based on the DNB swap curve. In 2013 NN moved from the discount curve
based on the ECB AAA yield curve to the DNB swap curve, which, amongst other things, is more liquid and less subject to dislocations.
Since mid-2012, the DNB curve has been adjusted to include an ultimate forward rate (UFR), extrapolating the curves beginning in year
20 to an ultimate forward rate of 4.2% at year 60. General account fixed income assets are held at market value, thereby creating
interest rate sensitivities in the available regulatory capital, which are the same as the liability sensitivities for matching cash flows up to
20 years. However, mismatches occur for longer-term cash flows due to the application of the UFR.
• Economic capital. To determine economic capital, NN uses a swap curve plus an illiquidity premium to discount the insurance
liabilities. The illiquidity premium is treated as part of the credit spread risk. NN extrapolates the EUR swap curve from the 30 year point
onwards to the UFR, as swap markets tend to be highly illiquid for durations longer than 30 years. To determine economic capital, all
assets are valued at market value and therefore subject to interest rate risk. The economic capital for interest rate risk therefore primarily
depends on the level of cash flow matching between assets and liabilities.
Risk mitigation
NN hedges its economic interest rate exposure by investing in long-term bonds matching liability maturities and further reduces the
remaining interest rate gap through purchases of receiver swaps and swaptions. Interest rate risk is also mitigated through a disciplined
pricing and renewal strategy in the Dutch corporate pensions business.
323ING Group Annual Report 2013
1 Who we are 2 Report of the Executive Board 3 Corporate governance 4 Consolidated annual accounts 5 Parent company annual accounts 6 Other information 7 Additional information