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Allianz Annual Report 2012

Annual Report 2012    Allianz Group Detailed discussions of risk capital movements are pro- vided in the sections that follow. Internal risk capital framework We define internal risk capital as the capital required to protect us against unexpected, extreme economic losses. On a quarterly basis, we calculate and aggregate internal risk capital across all business segments – providing a common standard for measuring and comparing risks across the wide range of different activities that we under- take as an integrated financial services provider. General approach We apply an internal risk capital model for the manage- ment of our risk and solvency position and are working to- wards meeting the forthcoming Solvency II internal model requirements. Our model is based on a best practice tech- nicalplatformwithanup-to-datemethodologycoveringall modeled sources of quantifiable risks. This forms the inte- gral part of our internal risk capital framework. The implementation of this framework incorporates our internal approach towards managing risks while aiming at following the Solvency II standards. The model framework isbeingassessedbyEuropeanregulatorsinthecourseofthe internal model pre-application process and will be adjusted in accordance with the final Solvency II rules. The updates to the model that were implemented during 2012 are de- scribed in the section Model updates in 2012. Internal Risk Capital Model Our internal risk capital model is based on a Value-at-Risk (VaR) approach using the Monte Carlo simulation. Follow- ing this approach, we determine the maximum loss in the portfolio value of our businesses in the scope of the model within a specified timeframe (“holding period”) and prob- ability of occurrence (“confidence level”). We assume a confidence level of 99.5 % following the anticipated Solvency II parameterization. We apply a holding period of one year because it is generally assumed that it may take up to one year to identify a counterparty to which we can transfer the assets and liabilities in our portfolio – an assumption con- sistent with the anticipated Solvency II rules. Using a Monte Carlo simulation based on 50,000 scenarios we consider market, credit, insurance and other business events (“sources of risk”) and calculate the portfolio value based on the net fair value of assets and liabilities under potentially adverse conditions. This determines the port­ folio value distribution taking the holding period into ­account. The required internal risk capital is defined as the differ- ence between the current portfolio value and the portfolio value under adverse conditions dependent on the 99.5 % confidence level. Because we consider the impact of a neg- ative event on all sources of risks and covered businesses at the same time, all diversification effects across sources of risk and regions are taken into account. The results of our Monte Carlo simulation allow us to ana- lyze our exposure to each source of risk, both separately and in aggregate. In addition, for market risks we analyze several pre-defined stress scenarios either based on histor­ ically observed market movements or based on hypothetical market movement assumptions. Our internal risk capital model makes use of various quan- titative methods which require a significant number of ­assumptions applied to risk and financial data, derived internally and externally. We use four specific sets of as- sumptions which are discussed below in more detail. Yield curve and liquidity premium assumptions When calculating the fair values of assets and liabilities, the assumptions regarding the underlying risk-free yield curve are crucial in determining future cash flows and how to discount them. We apply the same methodology as pro- vided by the European Insurance and Occupational Pen- sions Authority (EIOPA) in the fifth quantitative impact study (QIS 5) – except for the Euro yield curve where we ­follow their latest guidance on Solvency II. In addition we adjust the risk-free yield curves for the Life/ Health segment to make allowance for a liquidity premium consistent with QIS 5. Valuation assumption: replicating portfolios Since efficient valuation and advanced, timely analysis is desired, we use a replicating portfolio technique to repre- sent the liabilities of our Life/Health insurance business via standard financial instruments. Using the replicating port- folio we determine and revalue these liabilities under 50,000 potentially adverse Monte Carlo scenarios, including guarantees embedded in these products.   378  Yield Curve Extension   377  Replicating Portfolio C Group Management Report Risk Report and Financial Control 184 Risk Report 214 Controls and Procedures 189