Market Risks and Investment Performance
This section covers market risk related to the Mandatum Life’s with profit business i.e. that part of the business where Mandatum Life carries investment risk.
In Mandatum Life, the approach to market risk management is based on an analysis of technical provisions’ expected cash flows, interest level and current solvency position. A common feature for all with profit technical provisions is the guaranteed rate and bonuses. The cash flows of Mandatum Life's technical provisions are relatively well predictable because in most of the company’s with profit policies, surrenders and extra investments are not possible.
Mandatum Life’s market risks arise mainly from equity investments and interest rate risk related to fixed income assets and insurance liabilities with a guaranteed interest rate. The most significant interest rate risk in the life insurance business is that fixed income investments will not, over a long period of time, generate a return at least equal to the guaranteed interest rate of technical provisions. The probability of this risk increases when market interest rates fall and stay at a low level. The duration gap between balance sheet’s technical provisions and fixed income investments is constantly monitored and managed. Control levels based on internal risk capacity model are used to manage and ensure adequate capital in different market situations
Mandatum Life has prepared for low interest rates on the liability side by e.g. reducing the minimum guaranteed interest rate in new contracts and by supplementing the technical provisions by applying a lower discount rate. In addition, existing contracts have been changed to accommodate improved management of reinvestment risk. Guarantees and other main features of with profit liabilities are presented in Section Underwriting risks and performance.
Fixed income investments and listed equity instruments form a major part of the investment portfolio, but the role of alternative investments - real estate, private equity, biometric and other alternative investments – is also material being 11.7 per cent.
Investment allocations and average maturities of fixed income investments as at year-end 2017 and 2016 are presented in the table Investment Allocation Mandatum Life, 31 December 2017 and 31 December 2016.
Investment Allocation Mandatum Life, 31 December 2017 and 31 December 2016
|Mandatum Life||Mandatum Life|
|31 Dec 2017||31 Dec 2016|
|Asset Class||Market value, EURm||Weight||Average maturity, years||Market value, EURm||Weight||Average maturity, years|
|Fixed income total||3,953||63%||2.5||3,938||60%||2.7|
|Money market securities and cash||904||14%||0.0||859||13%||0.5|
|Credit bonds, funds and loans||2,994||48%||3.2||3,009||46%||3.3|
|Investment grade bonds and loans||1,793||29%||2.8||1,586||24%||2.7|
|High-yield bonds and loans||760||12%||3.2||884||13%||3.7|
|Subordinated / Tier 2||55||1%||7.3||52||1%||8.1|
|Subordinated / Tier 1||223||4%||6.6||310||5%||4.7|
|Listed equity total||1,578||25%||-||1,737||26%||-|
|Alternative investments total||731||12%||907||14%||-|
|Asset classes total||6,263||100%||-||6,582||100%||-|
|FX Exposure, gross position||679||0%||-||833||-||-|
|*Private Equity also includes direct holdings in non-listed equities|
Annual Investment Returns at Fair Values since 2008 Mandatum Life
Market Risks of Fixed Income and Equity Exposures
Fixed income and equity exposures are presented by Sector, Asset Class and Rating together with counterparty risk exposures relating to reinsurance and derivative transactions. Counterparty default risks are described in more detail in section Counterparty Default Risks. Due to differences in the reporting treatment of derivatives, the figures in the table may not be fully comparable with other tables in this annual report.
Exposures by Sector, Asset Class and Rating Mandatum Life, 31 December 2017
|D||Non-rated||Fixed income total||Listed equities||Other||Counterparty risk||Total||Change
|Public Sector, Other||0||37||42||0||0||0||0||80||0||0||0||80||9|
|Technology and Electronics||15||0||44||0||27||0||11||96||119||0||0||215||-17|
|Change 31 Dec 2016||-22||-223||485||-90||-220||0||84||14||-159||-176||-21||-342|
The role of non-investment grade bonds is material in Mandatum Life’s portfolio although it has decreased from its highs. Within fixed income investments part of the money market securities issued by Nordic banks and cash in Nordic banks form a liquidity buffer within fixed income investments. At the moment the total amount of these investments is higher than what is needed for liquidity purposes.
Nordic equity exposure include almost only direct investments to Finnish equities and they account for almost one third of equity exposure. Two thirds of equity investments are globally allocated consisting mainly of fund investments, but the role of direct investments are increasing in that part of the portfolio as well.
Breakdown of Listed Equity Investments by Geographical Regions Mandatum Life, 31 December 2017 and 31 December 2016
|31 Dec 2017||31 Dec 2016|
The role of alternative investments has been material in Mandatum Life over the years. The current allocation weight is 12 per cent. The weight of these investments will be maintained at current levels.
Within total portfolio the size of private equity investments has declined. At the same time Mandatum Life has increased its commitments in selectively picked high yield credit funds. These asset classes have been managed, in most cases, by external asset managers with the exception of the real estate portfolio which is managed by Sampo Group’s own real estate management unit. The real estate portfolio includes both direct investments in properties and indirect investments in real estate funds as well as in shares of real estate companies and it has been quite stable.
Market Risks of Balance Sheet
The Board of Directors of Mandatum Life annually approves the Investment Policies for both segregated assets and other assets regarding the company’s investment risks. These policies set principles and limits for investment portfolio activities and they are based on the features of insurance liabilities, risk taking capacity and shareholders return requirements.
The Investment Policy for segregated assets defines the risk bearing capacity and the corresponding control levels. Since the future bonus reserves of the segregated group pension portfolio is the first buffer against possible investment losses, the risk bearing capacity is also based on the amount of the future bonus reserve. Different control levels are based on the fixed stress scenarios of assets.
The Investment Policy for other investment assets defines the control levels for the maximum acceptable risk and respective measures to manage the risk. The control levels are set above the Solvency II SCR and are based on predetermined capital stress tests. The general objective of these control levels and respective guidelines is to maintain the required solvency. When the above mentioned control levels are breached, the ALCO reports to the Board which then takes responsibility for the decisions related to the capitalization and the market risks in the balance sheet.
The cash flows of Mandatum Life’s with profit technical provisions are relatively predictable, because in most of the company’s with profit products, surrenders and premiums are restricted. In addition the company’s claims costs do not contain a significant inflation risk element.
The long-term target for investments is to provide sufficient return to cover the guaranteed interest rate plus bonuses based on the principle of fairness as well as the shareholder’s return requirement with an acceptable level of risk. In the long run, the most significant risk is that fixed income investments will not generate an adequate return compared to the guaranteed rate.
In addition to investment and capitalization decisions, Mandatum Life has implemented active measures on the liability side to manage the balance sheet level interest rate risk. The company has reduced the minimum guaranteed interest rate in new contracts, supplemented the technical provisions with discount rate reserves and adjusted policy terms and conditions as well as policy administration processes to enable more efficient interest rate risk management.
Interest Rate Risk
Mandatum Life is negatively affected when rates are decreasing or staying at low levels, because the duration of liabilities is longer than the duration of assets. Growing part of Mandatum Life’s business, i.e. unit-linked and life and health business, is not interest rate sensitive, which partially mitigates whole company’s interest rate risk.
The average duration of fixed income investments was 2.1 years including the effect of hedging derivatives. The respective duration of insurance liabilities was around 10 years. Interest rate risk is managed at the balance sheet level by changing the duration of assets and by using interest rate derivatives.
Currency risk can be divided into transaction and translation risk. Mandatum Life is exposed to transaction risk, which refers to currency risk arising from contractual cash flows in foreign currencies. For more detailed risk definition of currency risk see Appendix 2 (Risk Definitions).
In Mandatum Life, transaction risk arises mainly from investments in currencies other than euro as the company’s technical provisions are almost completely denominated in euro. Mandatum Life does not automatically close its FX position in foreign currencies, but the currency risk strategy is based on active management of the currency position. The objective is to achieve a positive return relative to a situation where the currency risk exposure is fully hedged.
The transaction risk positions of Mandatum Life against EUR is shown in the table Transaction Risk Position, Mandatum Life, 31 December 2017. The table shows the net transaction risk exposures and the changes in the value of positions given a 10 per cent decrease in the value of the base currency.
Transaction Risk Position Mandatum Life, 31 December 2017
|Base currency||EUR||USD||JPY||GBP||SEK||NOK||CHF||DKK||Other||Total, net|
|Total transaction risk, net position, Mandatum Life||0||310||1||2||127||111||4||7||113||674|
|Sensitivity: EUR -10%||0||31||0||0||13||11||0||1||11||67|
Liquidity risk is relatively immaterial because liability cash flows in most lines of business are fairly stable and predictable and an adequate share of the investment assets are in cash and short-term money market instruments.
In life companies in general, a large change in surrender rates could influence the liquidity position. However in Mandatum Life, only a relatively small part of the insurance policies can be surrendered and it is therefore possible to forecast short-term cash flows related to claims payments with a very high accuracy.
The maturities of technical provisions and financial assets and liabilities are presented in the table Cash Flows According to Contractual Maturity, Mandatum Life, 31 December 2017. The average maturity of fixed income investments was 2.5 years in Mandatum Life.
The table shows the financing requirements resulting from expected cash inflows and outflows arising from financial assets and liabilities as well as technical provisions.
Cash Flows According to Contractual Maturity Mandatum Life, 31 December 2017
|Carrying amount total||Cash flows|
|Carrying amount without contractual maturity||Carrying amount with contractual maturity||2018||2019||2020||2021||2022||2023-2032||2033-|
|of which interest rate swaps||2||0||2||0||0||0||0||0||1||2|
|of which interest rate swaps||-1||0||-1||0||0||0||0||1||-2||0|
|Net technical provisions||4,026||0||4,026||-503||-328||-328||-300||-275||-1,908||-1,391|
|In the table, financial assets and liabilities are divided into contracts that have an exact contractual maturity profile, and other contracts. Only the carrying amount is shown for the other contracts. In addition, the table shows expected cash flows for net technical provisions, which by their nature, are associated with a certain degree of uncertainty.|
Mandatum Life has one issued financial liability and thus refinancing risk is immaterial.