The Crédit Agricole Group operates in the insurance sector through French and foreign subsidiaries that market savings and personal risk insurance policies.
Most of the Group’s insurance liabilities (92% of the total at 31 December 2008) concern the savings activities of the life insurance company Predica.
Predica manages and monitors four types of risk:
• market risks, principally of an asset-liability nature. These can derive from interest rate risks, equity risks, surrender risks, etc. They must be evaluated on the basis of the guarantees given to policyholders (minimum guaranteed return, minimum pay-out guarantee, etc.);
• counterparty risks on assets in the portfolio (issuer quality) and on reinsurers;
• insurance underwriting risks, particularly related to pricing and medical selection in personal risk insurance;
• operational risks, particularly relating to the execution of processes.
I. Risk supervision and management
Risk assessment is based on an internal model that measures the company’s risks in accordance with the CFO Forum standards, by simulating the asset/liability balance using economic methods. The model includes the framework devised as part of the European Solvency II project.
The internal model is focused on the savings and pensions business. It reflects the impact of the insurer’s strategy (in terms of asset allocation, policy revaluation, margin deductions, etc.) and policyholder behaviour (mortality tables, simulation of structural and cyclical surrenders, etc.) under various market conditions. Naturally, it takes regulatory constraints into account (minimum policyholder profit-sharing, additions to regulatory reserves, limitations on assets, etc.).
A risk strategy has been formulated and validated by Crédit Agricole S.A.’s risk management bodies. This strategy sets risk targets and limits for the various businesses, including counterparty limits, matching limits, allocation limits, underwriting rules and coverage rules. It has been implemented using risk measurements established with the internal model.
These risks are reviewed quarterly by Predica’s Executive Management and by the Group as part of its consolidated supervision system.
Predica’s ALM Strategy Committee meets quarterly to examine risk reports and formulate proposals for managing these risks. These proposals are then put to the Board of Directors.
All of the company’s important commercial decisions (product policy, policyholder returns etc.), financial decisions (asset allocation, coverage programme etc.) and insurance decisions (reinsurance programme) are now simulated using the internal model. These simulations contribute to the discussions that are part of the governance process.
Accordingly, the company started reducing its exposure to equities in June 2007 and continued to do so in 2008, as it has done in the property market since 2005.
During 2008, risk strategy deployment was finalised:
• risks of an asset-liability nature are now managed according to stress tests that are part of Predica’s internal model to minimise the company’s vulnerability;
• the process and risk mapping projects launched in 2007 were completed, with the deployment of risk management and the associated permanent control programmes;
• risks are supervised and consolidated in the context of authorisation limits granted to the group’s asset managers. A risk management and monitoring system appropriate to Predica’s risk strategy was deployed, strengthening this process.
These stress tests are carried out half-yearly on the principal risk factors: drop in equity markets, increase in volatility, increase in surrender rates, etc. They include analysis of the impact on profitability and on solvency, according to a methodology compatible with Solvency II regulatory project.
II. Market risk
Predica constantly seeks to control financial risks by managing the overall volatility of its investment portfolio value through diversification across all asset classes (bonds, equities, alternative investments, real estate), in order to benefit from their partially decorrelated performance.
• Interest-rate risk corresponds to the risk of a change in the value of the bond portfolio as a result of a change in interest rates. Variable-rate investments expose the company to fluctuations in future cash flows, while fixed-rate investments expose it to the risk that instruments in the portfolio will see a fall in fair value.
Predica has adopted hedging and risk management rules covering:
- the risk of a fall in interest rates, particularly given the presence of liabilities that benefit from guaranteed minimum rates. This risk is managed by setting a minimum 65% weighting for bonds, of which at least 50% must be fixed-rate, and by using hedging instruments (swaps, swaptions, floors);
- the risk of a rise in interest rates, to protect the company in the event of a rise in surrender rates in response to a sharp, sustained increase in long-term yields, making the company’s savings policies less competitive in comparison with other savings products. This risk is managed by using instruments (caps) that hedge against the risk of an increase in interest rates, corresponding to 20-35% of bond portfolio outstandings, and by ensuring that around 30% of assets react to rising interest rates.
• Equity market risk corresponds to the risk that equity investments will fall in value as a result of a decline in stockmarket indexes.
To manage the volatility of the equity portfolio and optimise its risk/return profile, Predica diversifies its equity holdings broadly, according to geographical, sectoral and investment style criteria.
Starting with end-2006 valuations, stress tests were carried out on the various types of risk (liquidity, yield and solvency and the limits of the risk strategy). These led to a reduction in equity market allocations beginning in the first half of 2007 and accelerating in early January 2008.
As such, in terms of managing risk exposure, the measures implemented in 2007 enabled the Group to withstand the financial crisis of 2008:
- liquidity risk was correctly managed through the available assets limitation (money-market, variable-rate and fixed-rate of two years or more) to around 20% of available assets at end-2008 and by keeping cash balances inside a “tunnel” of ±5% of outstandings.
On this basis, in a stress scenario wherein surrenders were to triple between October 2008 and December 2009, available cash at end-2009 would still be positive. During the last quarter of 2008, surrenders doubled in October then returned to normal in November and December,
- credit risk was contained, as dispersion criteria by issuer and by rating were applied. Exposure to subprimes was very low and exposure to US brokers remained limited, as they had been put on watch in June 2007 with the intention of reducing exposure.
Consequently, provisions for impairment on counterparty risk related to subprimes was €19 million at end- 2008 (90% provisioned) and €48 million on Lehman Brothers and IKB,
- asset valuation risk was limited by continued changes in the equities portfolio (4% reduction in carrying amount with a net capital gain on sales of 9%), but all assets used to diversify the portfolio were simultaneously impacted starting in September 2008.
III. Credit or counterparty risk
The second type of financial risk managed by Predica is counterparty risk, i.e. the risk of default by one or more issuers of bonds held in the investment portfolio.
Since 2002, Predica has used an enhanced prudential method for managing counterparty risk, with multiple limits on global portfolio risk and individual risks.
The first method of managing counterparty risk is by setting global limits based on issuer ratings. In the absence of any agency ratings, the rating used is an internal rating awarded by Crédit Agricole - Asset Management’s Risk Management Division based on analysis from Crédit Agricole S.A.
Rating Authorised limits
AAA (and euro zone sovereign issuers) No limit
BBB + A + AA (excluding euro zone sovereign issuers) 50% maximum
BBB + A 20% maximum
BBB and unlisted 5% maximum
Predica’s rules forbid direct ownership of securities rated lower than BBB, except in the exceptional event that a downgrade takes place after purchase and provided the issuer still has the ability to make payments. At end-December 2008, the weighting of this asset class was 0.39%.
In addition, Predica limits the counterparty risk authorised for each issuer, and sets a utilisation rate based on the rating of the counterparty and on the company’s gross non-consolidated shareholders’ equity at 31 December of the previous year (excluding unrealised capital gains and earnings for the current year). In order to achieve diversification among the BBB-rated issuers whose bonds are held in the portfolio, the Board of Directors has decided to limit the weighting of the top 10 BBB outstandings (at purchase price) to 75% of Predica’s non-consolidated prudential equity capital.
At end-2008, the average rating of the bond portfolio (outstandings of €115 billion) was AA-, with 84% of assets consisting of AAA-rated, AA-rated or eurozone sovereign issues. Provisions for lasting impairment due to counterparty default totalled €118 million.
As regards reinsurance, the policy for monitoring counterparties is based on the following principles: • diversification of counterparties, with several reinsurers each potentially taking a portion of a single risk; • reinsurer solvency, through financial ratings and pledging of reinsured reserves;
• continuity of relationships, based on expertise and underwriting partnerships.
IV. Liquidity risk
Liquidity risk is the risk that the company may not be able to cover liabilities when they fall due. It may arise from:
• illiquid investments. For this reason, Predica has defined a prudential framework for selecting investments that focuses on their liquidity.
At end-2008, more than 87% of the portfolio consisted of liquid assets listed on liquid, organised markets. Listed real-estate investment companies account for 13.4% of the portfolio;
• a maturity mismatch between investments and insurance policy liabilities. To address this, Predica has defined a prudential framework for managing liquidity as part of its ALM policy.
Predica carries out a payability test to give an initial indication of its liquidity in the event of large-scale policy surrenders (three times the actual level). This report showed that Predica can withstand large-scale surrenders in extreme cases, by carrying out limited sales of its assets.
Specifically, if surrenders were to triple between October 2008 and December 2009, available cash at end- 2009 would still be substantially in positive territory. In the event, surrenders in October were much less than this, and in the last two months of the year, the surrender rate returned to the average of the first nine months of the year.
In addition, Predica has defined a responsiveness ratio, aimed at reflecting its ability to find short-term liquidity without risk of loss in value. This ratio is calculated as assets with a term of less than 2 years over the whole portfolio. Assets with a term of less than 2 years include cash, money-market mutual funds, variable-rate or inflation-linked bonds and fixed-rate bonds with less than 2 years to maturity. At end-2008, this ratio stood at 20%.
The redemption profile of subordinated debt is shown in the table below. For perpetual subordinated notes, the maturity is taken to be the date on which the early redemption option expires:
Subordinated debt maturities (in millions of euros)Outstanding
Less than 1 year 130
1-3 years 201
3-5 years 316
More than 5 years 1,180
V. Insurance risk
In life insurance, insurance risk relates to the pricing, when a contract is written, of risks relating to life expectancy or life’s uncertainties.
The insurance risk derives from the assumptions underlying the rates applied to insurance cover and to the financial options open to policyholders. These including primarily surrender, prolongation and switching from one contract to another.
Insurance risk breaks down into: • four elementary biometric risks:
- mortality risk (coverage in the event of death),
- longevity risk (coverage in the event the policyholder is living when the policy matures: life annuities, whole life policies etc.),
- morbidity risk (disability and long-term care benefits),
- incapacity risk (benefit in the event the policyholder is unable to work);
• behavioural risk is the risk of early surrender (or prolongation, switching, cancellation etc.) of insurance policies compared with the expected level;
• the risk of loading being insufficient to cover operating expenses and commissions paid to distributors. Insurance risk is measured on the basis of observed differences between the pricing factors used at the time of underwriting and actual annual results on the policy portfolio:
• for biometric risks, the statistical tables used are based either on national or international statistics or on statistics from insurance portfolios (experience tables);
• for surrender risk, projected distribution is based on experience for structural surrenders, and mainly on rules defined by experts for cyclical surrenders (for which there are no statistical observations);
To limit behavioural risk, the strategy for policyholder profit-sharing takes account of market conditions, using a forward-looking approach. This distribution strategy is based on sensitivity tests as a function of market conditions or loss experience.
As the Crédit Agricole Group’s life insurance unit, Predica makes little use of reinsurance, for the following reasons:
• it focuses mainly on individual insurance and savings products;
• personal risk insurance policies mainly consist of a very large number of small risks;
• Predica’s financial strength and cautious management mean that the solvency margin required to carry out its activities is comfortably covered.
Given the overall portfolio profile (in terms of aggregate risk and average capital), only catastrophe risk is liable to have a genuine impact on the results of the individual or group personal risk insurance business. Predica’s portfolio is covered by BCAC (Bureau Commun des Assurances Collectives) in both group death
insurance (loan coverage) and individual personal risk insurance (open group), along with partial, complementary coverage of invalidity risk.
As for unit-linked contracts, variations in the value of investments in unit-linked policies are borne by policyholders, depending on whether the policy includes a minimum pay-out guarantee or not. Provisions against minimum pay-out guarantees in the event of death are determined according to an economic method.
VI. Consolidation of risk
Risks are consolidated using a quarterly risk scorecard, presented at Audit Committee meetings and Predica Risk Management Committee meetings. The scorecard is developed on the basis of business line key performance indicators (asset/liability management, investments, accounting and management control), which make it possible to check that limits are correctly enforced and that the objectives of the risk strategy are achieved.
To increase its visibility, this internal control system has been reviewed quarterly in all Predica departments since the start of 2008, so as to evaluate it regularly in terms of:
• updating of the framework;
• analysis of monitoring results and follow-up on corrective action; • controlling risks.
The results of each quarterly review are presented at meetings of the Risk Management and Permanent Controls Committee.
An insurance holding company Crédit Agricole Assurances was created at the end of 2008. This will make it possible to consolidate risks over all Crédit Agricole S.A. entities in 2009 and in so doing, to manage dispersion risks.