Sampo Group’s Operations, Risks and Earnings Logic
Sampo Group is engaged in three business areas. P&C insurance and life insurance are conducted by subsidiaries If P&C Insurance Holding Ltd and Mandatum Life Insurance Company Ltd that are wholly owned by parent company Sampo plc. In addition to the insurance subsidiaries, Group’s parent company Sampo plc held, as at 31 December 2012, an equity stake of 21.25 percent in Nordea Bank AB (publ) through which Sampo Group is engaged in banking business and exposed to respective risks. Nordea is Sampo plc’s associated company thus affecting the Group’s profits and risks substantially. However, Nordea operates independently and the company’s risk management is not covered in Sampo Group’s annual report.
As a Nordic insurance group If P&C underwrites policies that cover various risks of individuals and corporations on a geographically diverse area. If P&C mainly underwrites insurance risks in the Nordic and Baltic countries, as well as policies for Nordic clients with operations outside the Nordic countries. In addition to geographical diversification, the business is well-diversified over lines of business. Mandatum Life operates in Finland and Baltic countries and offers savings and pension policies with life risk features as well as policies covering mortality, morbidity and disability risks.
There are virtually no overlaps between the subsidiaries’ insurance businesses and therefore the companies are managed and developed mainly as separate units. Investment activities, on the other hand, are centralized. The persons responsible for managing the subsidiaries’ investments report directly to Sampo Group’s Chief Investment Officer. Also the IT system architecture used in investment activities is the same throughout the Group. The analysis and reporting of investment risks is therefore similar in the subsidiaries and the risks can easily be assessed also at Group level. Furthermore, the same basic principles are primarily followed in the investment activities of both subsidiaries, although the risk level of If P&C’s investment portfolio is held significantly lower than the risk level Mandatum Life’s investment portfolio.
Sampo plc is a holding company and it has no business operations of its own, with the exception of the management of its own capital structure and liquidity position. The parent company’s liquidity position varies significantly throughout the calendar year as the dividend distributions of the subsidiaries and the parent company often take place at different points in time. In addition, the issues and repayments of the parent company’s debt securities create fluctuations in cash flows.
Sampo Group’s main risks are illustrated in the figure Risk categories in Sampo Group. The risk categorization is mostly based on sources of risks, with the exception of P&C insurance underwriting risk in which the categorization is based on the administration practices of risks. This categorization distinguishes the risk of claims which have already happened in the past (reserve risk) from the risk of claims which will happen in the future (premium and catastrophe risk). Independent of this categorization, however, the unique risk sources such as fire accidents, motor accidents, windstorms and catastrophic events are similarly causing the deviations from the expected values also in the case of P&C insurance underwriting risks. Risks such as ALM risk, concentration risk and reputation risk are by their nature linked to various risk factors simultaneously.
Risk Categories in Sampo Group
P&C insurance underwriting risk:
Premium risk is the risk of loss due to inadequate pricing, risk concentration, improper reinsurance coverage or random fluctuations in frequency and/or size of claims.
Catastrophe risk is the risk of low frequency, high severity events, such as natural catastrophes. These events lead to significant deviation in actual claims from the total expected claims. Catastrophe risk is not defined as a separate risk, but it can be seen as an extreme case of premium risk.
Reserve risk results from fluctuations in the timing and amount of claim settlements.
Life insurance underwriting risk:
Biometric risks refer to the risk that the company has to pay more mortality, disability or morbidity benefits than expected or the company has to keep paying pension payments to the pension policy holder for a longer time (longevity risk) than expected when pricing the policies. The specific case in which a single event of major magnitude leads to a significant deviation in actual benefits and payments from the total expected payments is called catastrophe risk. In life insurance, catastrophe events include single events or series of events. These events can occur within short time period or be, by nature, long-lasting events.
Policyholder behavior risks arise from the uncertainty related to the behavior of policyholders. Policyholders have a right to cease paying premiums (lapse risk) and may have a possibility to interrupt their policies (surrender risk).
Expense risk arises from the fact that the timing and/or the amount of expenses incurred differs from those expected at the timing of pricing. As a result expense charges originally assumed may not be enough to cover the realized expenses.
Market risks refer to fluctuations in the financial results and capital caused by changes in market values of financial assets and liabilities as well as in insurance liabilities. Market values change together with underlying tradable market risk variables of which the following ones are currently the most important for Sampo Group: interest rates, inflation, credit spreads, foreign exchange rates, share prices and their volatilities.
The company is exposed to ALM risk when changes in different market risk variables (e.g. interest rates, inflation, credit spreads, foreign exchange rates, share prices and their volatilities) cause a change in the value of investment assets that is of different size than the respective change in the economic value of insurance liabilities. ALM risk also includes a component of uncertainty related to technical provisions. The cash flows of technical provisions are modeled estimates and therefore uncertain in relation to both their timing and amount.
Credit risk (default) refers to the negative impact in the financial results arising from defaults of debtors (issuer risk) or other counterparties (counterparty risk in derivatives and reinsurance contracts). Credit risk may be realized when the cash flows agreed with the debtor or counterparty fail to materialize. In the case of issuer risk the final loss depends on the company’s holding in the security and the recovery rate. In the case of counterparty risk, final loss depends on potential positive mark-to-market value at the time of default together with recovery rate.
Liquidity risk is the risk that insurance undertakings are unable to conduct their regular business activities in accordance with the strategy, or in extreme cases, are unable to settle their financial obligations when they fall due. Liquidity risk deals with potential illiquidity of investments and non-renewal of insurance policies. Also the availability and price of refinance and financial derivatives affect the company’s ability to carry out regular business.
Operational risk refers to the risk of loss resulting from inadequate or failed processes or systems, from personnel and systems or from external events. This definition includes legal risk but excludes risks resulting from strategic decisions. Compliance risk is the risk of legal or regulatory sanctions, material financial loss or loss of reputation an undertaking may suffer as a result of not complying with laws, regulations and administrative provisions as applicable to its activities. A compliance risk is often the consequence of a legal or operational risk and hence it can be seen as a part of operational risk.
General business risk:
General business risk is the risk of losses due to changes in the competitive environment or internal flexibility. Unexpected changes in general business environment can cause bigger than expected fluctuations in financial results. Such changes include the general economic development, changes in the institutional environment, technological innovations, changes in legislation and competitive factors such as new competitors and changes in margins and volumes.
Concentration risk arises when the company’s risk exposures are not diversified enough and as a result of this an individual claim or market event could threaten the solvency or the financial position of the company. Concentration risk may materialize also when the profitability and capital position is reacting similarly to general economic development or to structural changes in institutional environment in different areas of business.
Reputational risk, which is not categorized as an operational or a compliance risk, is the risk of reputational damage due to an action or event.
Sampo Group companies operate in business areas where profit generation based on risk taking and active management of risks is a key component of earnings logic. Core competencies to manage the balance between risks, capitalization, liquidity and profitability in these business areas can be summarized as follows:
Appropriate selection and pricing of insurance risks
- Insurance risks are selected carefully and priced reflecting the inherent risk levels
- Insurance products are developed proactively
Effective management of insurance exposures
- Diversification is sought actively
- Reinsurance is used effectively to reduce exposures
Careful selection and execution of investment transactions
- Risk-return-ratios of separate investments are analyzed carefully
- Transactions are executed effectively at right time
Effective management of investment portfolios and balance sheet
- Balance between expected returns and risks in investment portfolios and the balance sheet are optimized, taking into account the features of insurance liabilities, solvency, regulatory asset coverage rules and rating requirements
Effective Management of Consequential Risks
- Credit and liquidity risks are managed by selecting counterparties carefully, using risk mitigation techniques and increasing diversification
- High quality and cost efficient business processes are maintained and continuity of operations is planned and recovery is ensured
Common prerequisite for all above mentioned core competencies is continuous development of employees’ knowledge and skills. In Sampo Group’s business, data and analytical tools converting the data into information to be used in different business and risk management processes are as well of paramount importance.
An illustration of the most significant risks in Sampo Group is presented in the figure Key risks in Sampo Group. The most significant risks when Nordea’s figures are included are credit risk, market risk, insurance risk and operational risk. The figure is for illustrative purposes only.
Key Risks in Sampo Group
The most significant risk arising from the operations of the insurance subsidiaries is market risk. On the Group level, the most significant risks are market risk and credit risk. This is due to Sampo plc’s holding in Nordea whose business activities in banking result in credit risk being a key risk.