Balance between Risks, Capital and Earnings
One of the most important objectives of risk management in Sampo Group is to ensure the adequacy of the available capital in relation to the risks arising from the business activities and operating environment, as well as to ensure that expected returns are in balance with risk taking.
Various activities within this area are conducted and related procedures fine-tuned continuously in different parts of the organization. The figure Illustration of managing the balance between risks, capital and earnings in Sampo Group depicts the risk and capital management actions in Sampo Group on a general level.
Illustration of Managing the Balance between Risks, Capital and Earnings in Sampo Group
Independent Measurement and Control – Capital Adequacy Assessment
In addition to the statutory financial statements and solvency figures, Sampo Group companies also use internal performance, risk and capital measures which are based generally on fair values of assets and liabilities.
Sampo Group considers that there is a need to assess capitalization internally, because regulatory and rating agency models have to fit for all and hence cannot take the specific features of different companies into account accurately enough.
Capital adequacy is assessed internally by comparing the amount of available capital (called adjusted solvency capital in Sampo Group) to the amount of capital needed. Adjusted solvency capital includes, in addition to the capital components compliant with Solvency I framework, items that absorb effectively potential losses (equalization reserves, discounting effects). These items will most probably be part of capital in Solvency II framework.
The assessment of capital needed includes the following illustrative phases:
- Economic capital methodology is used to define the capital needed for current activities;
- Less quantifiable risks (e.g. low probability and high impact events, risks arising from general business environment) and potential model risks are taken into account in the buffer set over the economic capital;
- Earnings are seen as the first buffer against potential losses, therefore expected profitability is also taken into account when considering the capital need.
What are economic capital and adjusted solvency capital in Sampo Group?
Sampo Group uses economic capital as an internal measure of capital required for risks the Group is exposed to. Sampo Group defines economic capital as the amount of capital required to protect the solvency over a one year time horizon with a probability of 99.5 per cent.
Economic capital accounts for market, credit, insurance and operational risks, as well as the diversification effect between these risks. Economic capital is calculated using a set of calculation methods, which have been developed for the specific needs of each business area. When assessing the economic capital need arising from Nordea, Sampo plc uses the economic capital calculated by Nordea multiplied by the proportion of Sampo plc’s share in Nordea (21.25 per cent at the end of 2012). This figure is converted from confidence level 99.97 per cent to 99.5 per cent.
In Sampo Group, economic capital is considered to be a good estimate of the capital required to cover risks that can be measured in a reliable way and within a normal business environment. In the assessment of the adequacy of capital the effects of potential changes in the business environment as well as the effects of low probability risks are taken into account.
Different stakeholders have different views when assessing the available capital. Regulators have defined which items can be included into the solvency capital and rating agencies have their own definitions for capital. As an internal measure of available capital, Sampo Group uses adjusted solvency capital. The basis for adjusted solvency capital is capital items included in the regulatory solvency capital. On top of those, other risk absorbing items such as the difference between the book value and market value (including a risk margin) of technical provisions are added.
The economic capital and adjusted solvency capital as well as the regulatory and rating agency capital measures are reported internally at least on a quarterly basis and based on them capitalization is controlled by the subsidiaries’ and Sampo plc’s Boards of Directors, respectively. Internal and regulatory capitalization figures are disclosed quarterly as well.
Continuous Analysis of Opportunities – Risk and Capital Planning
When assessing the future business opportunities and respective capital requirements, the views of the management and different stakeholders – regulators and supervisors, rating agencies, debt investors, policyholders and shareholders – are considered. Managements’ views and forecasts regarding the future development of the insurance and investment activities are used when analyzing the earnings potential and future capital requirement. The results of these considerations, as well as external stakeholders’ views on the capitalization of Sampo Group, are reflected in risk management and capitalization recommendations to the business management and the Board of Directors.
Actions – Risk and Capital Management Actions
Prudent assessment of capital adequacy and realized profitability and careful forecasting of profitability, risk and capital are important phases when forming an understanding of the actions that maintain a proper balance between profitability, risks and capital. In Sampo Group, the proactive management of profitability, risks and capitalization is seen as the most important phase in the risk and capital management process. Hence, risk policies and limits and decision making authorizations are set up in a way that they, together with profitability targets, facilitate business and investment units to take well-considered risks.