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Thomas C. Wilson, Chief Risk Officer

Risk Management:
One CRO’s thoughts
CASS-CAPCO Fourth Annual Risk Management Conference
London, 14 April, 2011
How does Risk Management add value?
                   Asking the right questions…
Risk                • Is Allianz’s risk profile and strategy understood
communication         by the market and reflected in our valuation
                      multiple and required capital?
Risk strategy       • Does Allianz have a clear risk and solvency
                      strategy and optimize its risk / reward profile
                      accordingly?
                    • Are delegated authorities set consistent with this
                      strategy?
Risk controlling    • Is the risk profile of Allianz transparent to
                      management?
                    • Is it within delegated authorities?




                                                                                 © Allianz SE 2009
Risk                • Are the risks which we want to take appropriately
underwriting          structured, underwritten and priced?
                    • Are all other risks (e.g. operational / reputational
                      risk) appropriately identified and managed?            2
How does Risk Management add value?
Questions…         … answering them correctly,
                     acting on the decisions
Risk
communication

                                          Processes
Risk strategy
                             Goverance

Risk controlling

                                          Information
Risk                                       & Systems




                                                            © Allianz SE 2009
underwriting



                                                        3
Standard Committee Structure




                                                                    © Allianz SE 2009
* For details of standard local RiCo agenda see Appendix   Page 4
Target Operating Model for OE Risk Organization

     Standard operating model to ensure that responsibilities and
     authorities of Risk function are adequate

        3       Blueprint for risk management and
                recommendation for department organization                                                                   3
                                                                                                                                     Risk
                                                                                                                                  Management



                                                                                  Risk
                                                                               Management



                                Risk                                                     Insurance          Financial             Risk policies
                                                 ORM/SOX           Credit risk                                                    and guide-
                                controlling                                              risk               risk                  lines
     § Scope of                § Exposure        § SOX and         § Management         § Management       § Management          § Risk policy
       activities                and limit        ORM                  and develop-       and develop-       and develop-          and
       mandatory                 controlling      – Design             ment of credit     ment of in-        ment of Fin-          guidelines
       under the               § Satisfaction       central            risk models        surance risk       ancial risk           development
       governance of             of Reporting       processes          and mea-           models and         models and          § Risk
       the CFO                   requirements     – Setup              surement           measurement        measure-              commi ttee
     § Split by                  – Group            annual                              § Risk capital       ment                  facilitation
       department                   interfaces      control plan                          calculation      § Limit setting
       into sub-                 – Local re-                                              and allocation
       departments                  quirements                                          § Risk
       recommended,                                                                       aggregation
       but not
                               § Reconcilia-
                                 tion of input                                            Life/Health
       mandatory                                                                          and P&C
                                 and output
                                                                                        § Solvability
                                                                                          moni toring

                                                         § In-depth understanding of risk profile




                                                                                                                                                           © Allianz SE 2009
                                                         § Control of large risk acceptance, critical positions
                                                         § Commentary to risk reports

         Source: OTP Finance                                                                                                                23




* For details please see separate TOM and relevant OTP documentation

                                                                                                                                                  Page 5
Group Risk Appetite and Limit Framework

Allianz Group’s Risk Appetite consists of three pillars outlined below:
§ Allocating capital and defining minimum (target) capital ratios
§ Defining risk tolerance and quantitative limits
§ Managing liquidity to ensure flexibility

Examples                    Group limits                        OE limits set by Group

Solvency limits             Solvency target & corridor

                            Solvency Capital: Economic,
Capital limits                                                  OE Risk Capital
                            Rating agency, Regulatory

Concentration limits        Counterparty/Obligor exposure and VaR (Market and Credit Risk)


Investment limits           Strategic Asset Allocation          Strategic Asset Allocation

                            Group-wide                          OE specific
Nat Cat limits




                                                                                             © Allianz SE 2009
                            Nat Cat limit                       Nat Cat limits
Risk Identification and Assessment processes




             Top Risk
            Assessment                       COSO framework

                                             1. Risk identification

                                             2. Prioritization
                             Emerging Risk
                               Initiative    3. Assessment
                                                (frequency,
                                                severity)

          Risk Controlled                    4. Mitigating controls
          Self-Assessment




                                                                      © Allianz SE 2009
                                             5. Testing
Example: L/H product approval process



          Local OE product approval and                                                     Existing
Start                                                                                       products
              monitoring processes
                                                                                           with a low
                                                                                           or negative
                                                                                               NBM*




                                      Gate 1: Acceptability                          Gate 2: Profitability

                                             Checks on                                    NBM* check
                                          certain products                                   against                  Launch new
           All new products
                                           (VA, EIA) and                                 thresholds and             products / retain
                                                                       PASS                approval of       PASS      or modify
                                            features (AL
                                            mismatches,                                      limits if                  existing
                                             riders, …)*                                   appropriate                 products


                                                 FAIL                                           FAIL




                                                                                                                                        © Allianz SE 2009
                                             Escalation                                     Escalation
                                               option                                         option


 * VA = Variable Annuities, FIA = Fixed Index Annuities, AL = Asset / liability, NBM = New Business Margin
Embedding risk management in medium term
planning


                                                              Financial & Risk
          TDI                     SD               PD            Controlling

§ Capital              § CapCo approval   § SD decisions     § On-going
  requirements           of Group cumul     reconfirmed        monitoring of
  projected on a         risk limits      § Lower level        capital positions
  statutory,                                segment SAA        and limit
  economic and                              approved by        adherence as
  rating agency                             FiCo and CapCo     part of
  basis                                                        controlling
§ Guidance for
  cumul risk limits:




                                                                                   © Allianz SE 2009
  NatCat, Country
  Risk, SAA risks,
  etc.
RAI - System Architecture Framework

  Central Risk Platform Algorithmics

    Market data                          Valuation, Risk Capital, Scenarios, Sensitivities
      MinD                Risk Engine: MC-Simulation - Inter / Intra Risk-Aggregation Model


  Web-based User Interface
  § Market Value
  § Balance Sheet        Market Risk         Insur. Risk    Credit Risk    Oper. Risk        Cost Risk
  § Available Capital     Replicating         Marginal       Marginal      Marginal       Marginal
  § Limits               portfolio tool/       dist. /        dist. /       dist. /        dist. /
                           Greeks            Parameters     Parameters    Parameters     Parameters
  § Hierarchies
  § Tax calculation
  § Minorities

                                                                                         Feeder Systems
  Local Systems                                                                          ˜ Partially locally developed




                                                                                                                                  © Allianz SE 2009
                            ALIM CF                                                           and parameterized models
                                               PRISM          MKMV        OR System
     Replicating             Models                                                      ˜    Centrally developed,
                                                                                              parameterized and
     Scenarios              Life/P&C
                                             PRISM R/I
                                                             Investment     Business          controlled models
                           Asset Input                      Data System       Risk       ˜    Centrally developed, locally
                                                                                              parameterized models



                                                                                                                             10
Qualitative Reporting

§ Standardized quarterly reporting on:
                                                                                       XXX Risk report – Q1 2009


  - Governance & Compliance with Group
                                                                    XXX Risk report OE Contact: XXX
                                                                                    – Q1 2009
    Standards                                                                            Group Risk Contacts: Stuart Robinson, Ioannis Kotsianos


                                                   XXX Risk report – Q1 2009    1. Governance & Group Standards Compliance

  - General Risk Issues                                          2. General Risk Issues

                                                                     R
                                                                                         Y   Reserve Governance Update (Yellow in Q4)
                                                                          Internal Transactions Update Actuarial has raised concerns that reserving decisions are effectively made at BU
                                                                                             n Group (Red in Q4)
                                                                                                 level and the Reserve Committee role and authority to challenge decisions needs to be
                                                                          n   Several XXX insurance entities have purchased shares of AZ money market funds at the
                                                                                                strengthened.

  - Regulatory & Legal Issues                      Y   Life Cancellation Option (New NAV price to support fund liquidity.

                                                       n
                                                                              official Issue):
                                                                                                 –    Action 1: Completion of the Finance Unit organization project in order to better enhance
                                                           Deficiencies in the In a secondprovided toefficiency, life policyholders in the past and bonds (floaters) from these
                                                                          n
                                                                               information stage, AGF Vie purchased EUR 600mn of corporate a new
                                                                                                        individual including non-life actuarial reserving processes.
                                                           insurance law enacted at at the mark-to-model price in December 2008, with unit-linked delta versus
                                                                               funds the end of 2005 will require AGF to contact existing a significant
                                                                               contributed option to Q1 (the difference between the Finance Unitprice and the project price
                                                                                                   prices Status: Presentation on        official NAV organization model to union
                                                           policyholders and give them anmarket– cancel their policies. Policyholders will have 30
                                                                                                       representatives completed, enforcement decision still subject to union representative
                                                           days to request a refund of their originalAGI).
                                                                               being subsidized by premium.

  - Market Environment & Competitive Risks             n
                                                                                                      answer. Update on implementation to be included in Q2.
                                                           The worst case exposure, assuming 100% cancellation was estimated in March 2009 duethe growing
                                                                          n Further support from AGF Vie was provided again at EUR 315 mn at to
                                                           end of Q1. AGF has booked a reserve of to an 9.6 mn as purchase of EURa492mn of corporate bonds fromEnd of Q4 2009
                                                                               redemptions, leading EUR additional of Q1, assuming 3.6%
                                                                                                        Owners: XXX
                                                           cancellation rate would apply to a worst case exposure of EUR 260 mn (this value is lower
                                                                               these funds.
                                                                                                                                                             Due Date:
                                                           than total unrealized losses on unit linked because policyholders have been identified to
                                                                                          Y action plan to send suitable information
                                                           whom a letter had beenliquidation Product Approval Update (Yellow in Q4)to policyholders ultimate estimated
                                                                          n Full sent). An of the AGI France Money Market funds could lead to an
                                                           by registered mail is being prepared. The plan may trigger higher cancellations in current
                                                                               need for EUR 733mn of additional liquidity support.
  - New Product & Underwriting Approvals               n
                                                           market conditions ; therefore it willn A risk review of new products is always carried out, but process governance needs to be
                                                                                                 need to be monitored carefully.
                                                           Group Risk is concernedStrategy actual Issue) rate after the mailing campaign may be far formalized sign-off process,
                                                                                                  further reinforced in 2009 (risk review before launch,
                                                                     Y Crediting that the (New lapse
                                                                                                  independent actuarial review).
                                                           higher than the expected 3.6%, although no action would potentially leave the worst case
                                                           loss at much higher levels if markets deteriorate. 2: Global process for new product design to be reengineered by Technical Area,
                                                                                                       Action
                                                                          n   XXX has indicated to Group Risk that the current internal working assumption is for an
                                                                                                  –
                                                                              average bonus of 3.50% in 2009. This assumptionreviewsmean paying out c. EUR 1,450mn
                                                                                                    including Risk and Actuarial would before launch.

  - Financial Risk Exposure & Limit Adhere         G   Regulatory Fines (Newto policyholders relative to a minimum guarantee cost of c. EUR 950mn.

                                                       n
                                                                             Issue):
                                                                                                –    Q1 Status: Presentation on the new Product Process to Executive Committee
                                                          SOCA (an Oddo subsidiary) received a EUR 50k penalty for failing to comply set-up competitive and AGF is under
                                                                         n Group Risk recognizessuccessfully completed. Practical withis to be rolled-out. Update on implementation to
                                                                                                      that the French life insurance market insurance
                                                          law while acting aspressure to maintain bonuses to attract new business and minimize surrenders.
                                                                              a broker. There is no immediate consequence for AGF entities.
                                                                                                     be included in Q2.
                                                                     n However, Group Risk is concerned that AGF may have reached a tipping point on bonus
                                                                                                 Owners: XXX                                         Due Date: End of Q2 2009

  - Solvency II Implementation                     4. Market Environment sustainability given the current market environment. In order to make the planned 3.50%

                                                   R
                                                                         & Competitive Risks
                                                                              payment, XXX would need to reduce current UAR reserves by EUR 500 mn (42% based on
                                                                                        Y Partnerships Update (Red in Q4)
                                                       Financial Crisis Impactyear-end 2008 UAR figures). This will have a material adverse impact on O&G costs,
                                                                               Update (Red in Q4)
                                                                              MCEV, NBM figures, Risk Capital, Statutory Solvency and the general sustainability of the
                                                       n                                      n Control of life JVs needs to P&C and L&H businesses.
                                                                                high for L&H business, and real estate risk for be strengthened so that XXX can effectively monitor compliance
                                                           Equity risk remainstraditional business.
                                                           Liquidity is also under pressure due toand ensure governance is robust. Regulatory and reputational risks are the main concern.
                                                                                                    money market fund support and surrenders for UL

  - L&H appendix: new product approvals,                   business where illiquid Action 4: Group Risk and UL products. Structured with AGFplanned with 1 FTE. Agreement reached that
                                                                               –    assets are backingQ1 Status: Local internal control position to quantify the impact on the
                                                                                                   –
                                                                                                        some Group Actuarial to work credit exposures
                                                           in the Allianz Banque trading portfolio are still on the balance sheet (with the risk mostly
                                                                                    above items of different crediting strategies.approval process will apply for JVs. Update on implementation
                                                                                                       the general XXX product
                                                           realized). The independent asset valuation review performed by Moody’s will be maintained
                                                           in 2009 at the request of AGF and ABRM. to be included in Q2.
                                                                                    Owners: Philippe Léglise CRO, GR, GA                 Due Date: End of Q2 2009

    negative margin products, guarantee levels &   Y
                                                       n
                                                                                                      Owners: XXX
                                                       Hospitaliers Pension Scheme Update (Green in Q4)
                                                                     G Madoff Exposure Update (Red in Q4)
                                                           Initial decisions have been taken on 2009 annuity revaluation under planned targets and
                                                                                                                                                           Due Date: End of Q2 2009

                                                                                           G General Governance (Green in Q4)
                                                           according to agreement governance. Projection updates to has remained almost unchanged, estimated at
                                                                           n Exposure in various AZ French entities be produced in June. At present,


    new money rates                                        equity losses and low interest raten No have2008), mainly through the AAAM Policy
                                                                               EUR 47mn (30 levels major deviations from the Group Riskof the
                                                                                                November seriously damaged the capacity alternative funds “Phenix
                                                           pension scheme toAlternativelife annuity coverage by 2028 also through thoughAM “GAP” an
                                                                                reach full Holding” and “Licorne”, and as planned, Oddo this is not funds. About half of
                                                           XXX liability (annuity rights generated before 2008 are currently limited to and AVIP), and half for various Life
                                                                               this exposure is for UL assets (mostly Generation Vie 8 years).
                                                       n   AGF Vie exposure and P&C portfolios.also increased due to the low interest rate and equity
                                                                               to market risks has
                                                           environment, and transfer of buffers generated by new pension rights toward in-force ones.
                                                                          n   Decisions have been made during Q1 to notify UL clients of their entitlement to any

§ Progress on resolution of issues is tracked                                 recoverable assets from Madoff defeasance (side-pockets) extracted from some of their UL
                                                   5. New Products & Group Insurance Committee Approvals closed Madoff funds (Luxalpha, Thema). No
                                                                        funds, and of the disappearance of several
                                                                              subsidization of losses should be supported by Allianz Life Operating Entities in principle.
                                                   R   New Product Process Failure (New Issue) seen as moderate, but could increase due to some complaints already
                                                                        n Reputational risk is


§ Reports are circulated to OE and Group




                                                                                                                                                                                                  © Allianz SE 2009
                                                       n
                                                                              registered, as surrenders cannot be paid for a few suspended funds. Subsidization of
                                                           The new “Fipavie Diversifié” product (Generation Vie / Life Partnerships) was launched
                                                           before risk review /Madoff losses insufficient prior evidence that an appropriate process had in all cases, which
                                                                               approval with even in one case might be an argument used for payment
                                                           been established to manage this completely new product. 24mn for AGF France.
                                                                               would result in a worst case loss of EUR
                                                           –   Action 7: Product review to be completed post-launch with a local RiCo opinion. Proper
                                                               controls to be put in place before the next version of the product is launched.

  management ensuring transparency                         –   Q1 Status: Review is now 90% complete. The main risks identified to date are: (1) the
Addressing the issues                                              - Examples -


Examples
Risk          • Regulatory filings
communication • Rating agency disclosures
              • Public disclosures: Annual Report, Investor Day
Risk strategy    • Risk appetite: EaR, CaR, Risk Capital
                 • Strategic Planning, not Budgeting: TDI, SD, PD
Risk controlling •   Capital solvency, EaR and CaR reporting
                 •   Individual risk reporting
                 •   Associated limit systems
                 •   Separation of duties
Risk             •   Product approval processes
underwriting     •   A/L or Strategic Asset Allocation processes




                                                                                © Allianz SE 2009
                 •   Pricing guidelines, u/w minimum standards
                 •   Risk Controlled Self-Assessment, Top Risk
                     Assessment
                                                                           12
Asking the right questions, answering them and acting
on the decisions
Examples

Risk
communication                              Processes

                            Goverance
Risk strategy


Risk controlling                           Information
                                            & Systems


Risk




                                                                   © Allianz SE 2009
underwriting
                    Focusing on the foundations of good
                   ERM is an important first step…but is it
                                sufficient?                   13
Outward signs of ERM: Necessary. . .but not sufficient!
Warren Specter, co-COO Bear Stearns, to the Senate Financial Crisis Inquiry Committee

You have also asked me to address risk management practices.
Risk at Bear Stearns was managed through a system of checks and balances. Each business unit was
responsible for managing its risk, and the head of each division was then responsible for managing the
aggregate risk within its units. The Executive Committee approved explicit limits for all areas of the firm
- at the trading book level, and also by unit and by department - which were monitored by department
heads. These limits were reviewed and monitored by the Risk Management Group, which was an
independent unit that reported to the Executive Committee and met regularly with the Board's Risk
Committee. This group, headed by Bear Stearns' Chief Risk Officer, served as an independent check on
the business units' own risk management function. It distributed daily P&L statements that highlighted
any significant gains and losses. It also provided daily written reports to senior management
commenting on changes in exposure, any unusual trades, and any concentrated positions. The Risk
Committee held weekly meetings, and the Risk Management Group made monthly presentations to the
Executive Committee. At the weekly meetings, trading managers reported on their positions and their
risk, and the risk management teams were present to verify the accuracy of these reports and to express
their views. In this way, the Risk Committee and the business units served as constant checks on each
other. There was an active dialogue among senior management about the firm's overall risk appetite,
which we reviewed during both weekly and monthly meetings.
In my opinion, Bear Stearns' risk management practices were robust and




                                                                                                              © Allianz SE 2009
effective. During my tenure on the Executive Committee I found the Risk
Management team to be highly trained and very experienced. Overall, I thought
Bear Stearns was well-managed, and I was saddened and disappointed when
the firm collapsed.
Signs of a dysfunctional risk culture:
Golden Rule

Symptom: Make the gold, make the rules (and should not be challenged!)


Case study: AIG FP
•   PwC, AIG's auditor, concluded that the ability to access AIG FP by the risk
    management and other control functions "may require strengthening".
•   Federal Office of Thrift Supervision (OTS), AIG FP’s regulator, sent a letter
    which said that the unit "was allowed to limit access of key risk control groups
    while material questions relating to the valuation of the [swap portfolio] were
    mounting".
•   Rep. Gary Peters (D., Mich.) asked AIG CEO Edward Liddy during a
    congressional hearing, "Where was the risk management of your company?
    Where was the failure of your own internal risk-management procedures?"




                                                                                       © Allianz SE 2009
    Mr. Liddy’s response, "We had risk-management practices in place. They
    generally were not allowed to go up into the financial-products business.”
Signs of a dysfunctional risk culture:
„Dancing while the music is playing“


Symptom: Following the market, even when standards are deteriorating


Case study: US mortgage market
•   Chuck (Charles) Prince, ex-CEO of Citigroup: “When the music stops,
    in terms of liquidity, things will be complicated. But as long as the
    music is playing, you've got to get up and dance. We're still dancing.”
•   When compared to the behaviour of a lemming at an FCIC hearing,
    Mr. Prince’s reply was, "It would have been impossible to say to
    bankers, we’re not going to participate … and expect to have any
    people left."




                                                                              © Allianz SE 2009
Signs of a dysfunctional risk culture:
Arbitraging the system

Symptom: Building a business based on the flaws in our models

Case study: Lehman Brothers
• ‘Repo 105’ transactions were considered a sale of the assets under English
  law.
• Court appointed examiner’s report said these deals created "a materially
  misleading picture of the firm’s financial condition in late 2007 and 2008” and
  were “actionable balance sheet manipulation” and “nonculpable errors of
  business judgment”,
• Condoned by senior management of the firm, as the email excerpt illustrates:
   - “It’s basically window-dressing.”
   - “I see … so it’s legally do-able but doesn’t look good when we actually do it? Does
     the rest of the street do it? Also is that why we have so much BS [balance sheet] to




                                                                                            © Allianz SE 2009
     Rates Europe?”
   - “Yes, No and yes. :)”
How much can we rely on compensation to steer
culture?


•   „Dick Fuld (CEO) is also, in some sense, a victim. He’d held on to 10
    million shares of Lehman stock until the end and lost almost $1
    billion“
•   „Mr Prince, whose exit was sealed late last week, already owns 1.61
    million shares in Citi“ which decreased in value from USD 50 to USD
    5 between 2007-2009.
•   On March 14, 2008, CNBC reported that „the value of Jimmy Cayne's
    (CEO) holdings in Bear Stearns had declined from $993 million to …
    less than $15 million as a result, effectively removing him from the list
    of the wealthiest individuals in the country.“




                                                                                © Allianz SE 2009
Three lines of defense

   First line of    Second line of      Third line of
    defense:          defense:           defense:

    Business is     Functions which    Ensure that the
  responsible for   define framework    framework is
  both profit and      within which      adhered to
   loss, risk and       business is
      returns        allowed to work

                      Risk, Legal,         Audit
       OEs            Compliance




                                                              © Allianz SE 2009
                                                         19
Three lines of defense

   First line of        Second line of         Third line of
    defense:             Management has to take
                          defense:              defense:
                         responsibility, our frameworks
    Business is        Functions whichplace, but that the
                         have to be in       Ensure
  responsible for     definethe next crisis, our models will
                          In framework        framework is
  both profit and        within which probability 1 to
                          be wrong with        adhered
   loss, risk and         business is
                          All frameworks can (and will) be
      returns          allowed to work
                          arbitraged

       OEs               Risk, Legal, can anticipate all
                         No framework          Audit
                         new businesses
                         Compliance




                                                                      © Allianz SE 2009
                      e.g. pricing & underwriting guidelines,
                    risk measures & limits, capital allocation   20
What does „risk management“ really mean
in the context of the second line of defense?
Management lever     Risk controlling            Risk management
Risk communication
                       Risk controlling
                       § Define frameworks within which business can
                         be done
Risk strategy          § Control risk and limits and provide transparency
                       § Provide technical analysis to support business
                         decisions
                       Risk management
Risk controlling       § Have a deep, professional understanding of the
                         business (not just the models!)
                       § Be close to the business, discussing key




                                                                                 © Allianz SE 2009
                         decisions before they are taken
Risk underwriting      § Exercise professional judgement, occasionally
                         saying „no“ if our frameworks are inadequate, if
                         they are being arbitraged
                                                                            21
Culture…the missing piece
Examples                                         Processes

Risk                             Goverance
communication

Risk strategy                      Culture       Information
                                                  & Systems


Risk controlling

                   US Supreme Court Justice Potter Stewart (on risk
Risk               culture??), 1964 Jacobellis vs. Ohio
                   “I shall not today attempt further to define the kinds of




                                                                                    © Allianz SE 2009
underwriting
                   material I understand to be embraced within that
                   shorthand description; and perhaps I could never
                   succeed in intelligibly doing so. But I know it when I
                   see it…”                                                    22

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Risk Management: One CRO’s thoughts

  • 1. Thomas C. Wilson, Chief Risk Officer Risk Management: One CRO’s thoughts CASS-CAPCO Fourth Annual Risk Management Conference London, 14 April, 2011
  • 2. How does Risk Management add value? Asking the right questions… Risk • Is Allianz’s risk profile and strategy understood communication by the market and reflected in our valuation multiple and required capital? Risk strategy • Does Allianz have a clear risk and solvency strategy and optimize its risk / reward profile accordingly? • Are delegated authorities set consistent with this strategy? Risk controlling • Is the risk profile of Allianz transparent to management? • Is it within delegated authorities? © Allianz SE 2009 Risk • Are the risks which we want to take appropriately underwriting structured, underwritten and priced? • Are all other risks (e.g. operational / reputational risk) appropriately identified and managed? 2
  • 3. How does Risk Management add value? Questions… … answering them correctly, acting on the decisions Risk communication Processes Risk strategy Goverance Risk controlling Information Risk & Systems © Allianz SE 2009 underwriting 3
  • 4. Standard Committee Structure © Allianz SE 2009 * For details of standard local RiCo agenda see Appendix Page 4
  • 5. Target Operating Model for OE Risk Organization Standard operating model to ensure that responsibilities and authorities of Risk function are adequate 3 Blueprint for risk management and recommendation for department organization 3 Risk Management Risk Management Risk Insurance Financial Risk policies ORM/SOX Credit risk and guide- controlling risk risk lines § Scope of § Exposure § SOX and § Management § Management § Management § Risk policy activities and limit ORM and develop- and develop- and develop- and mandatory controlling – Design ment of credit ment of in- ment of Fin- guidelines under the § Satisfaction central risk models surance risk ancial risk development governance of of Reporting processes and mea- models and models and § Risk the CFO requirements – Setup surement measurement measure- commi ttee § Split by – Group annual § Risk capital ment facilitation department interfaces control plan calculation § Limit setting into sub- – Local re- and allocation departments quirements § Risk recommended, aggregation but not § Reconcilia- tion of input Life/Health mandatory and P&C and output § Solvability moni toring § In-depth understanding of risk profile © Allianz SE 2009 § Control of large risk acceptance, critical positions § Commentary to risk reports Source: OTP Finance 23 * For details please see separate TOM and relevant OTP documentation Page 5
  • 6. Group Risk Appetite and Limit Framework Allianz Group’s Risk Appetite consists of three pillars outlined below: § Allocating capital and defining minimum (target) capital ratios § Defining risk tolerance and quantitative limits § Managing liquidity to ensure flexibility Examples Group limits OE limits set by Group Solvency limits Solvency target & corridor Solvency Capital: Economic, Capital limits OE Risk Capital Rating agency, Regulatory Concentration limits Counterparty/Obligor exposure and VaR (Market and Credit Risk) Investment limits Strategic Asset Allocation Strategic Asset Allocation Group-wide OE specific Nat Cat limits © Allianz SE 2009 Nat Cat limit Nat Cat limits
  • 7. Risk Identification and Assessment processes Top Risk Assessment COSO framework 1. Risk identification 2. Prioritization Emerging Risk Initiative 3. Assessment (frequency, severity) Risk Controlled 4. Mitigating controls Self-Assessment © Allianz SE 2009 5. Testing
  • 8. Example: L/H product approval process Local OE product approval and Existing Start products monitoring processes with a low or negative NBM* Gate 1: Acceptability Gate 2: Profitability Checks on NBM* check certain products against Launch new All new products (VA, EIA) and thresholds and products / retain PASS approval of PASS or modify features (AL mismatches, limits if existing riders, …)* appropriate products FAIL FAIL © Allianz SE 2009 Escalation Escalation option option * VA = Variable Annuities, FIA = Fixed Index Annuities, AL = Asset / liability, NBM = New Business Margin
  • 9. Embedding risk management in medium term planning Financial & Risk TDI SD PD Controlling § Capital § CapCo approval § SD decisions § On-going requirements of Group cumul reconfirmed monitoring of projected on a risk limits § Lower level capital positions statutory, segment SAA and limit economic and approved by adherence as rating agency FiCo and CapCo part of basis controlling § Guidance for cumul risk limits: © Allianz SE 2009 NatCat, Country Risk, SAA risks, etc.
  • 10. RAI - System Architecture Framework Central Risk Platform Algorithmics Market data Valuation, Risk Capital, Scenarios, Sensitivities MinD Risk Engine: MC-Simulation - Inter / Intra Risk-Aggregation Model Web-based User Interface § Market Value § Balance Sheet Market Risk Insur. Risk Credit Risk Oper. Risk Cost Risk § Available Capital Replicating Marginal Marginal Marginal Marginal § Limits portfolio tool/ dist. / dist. / dist. / dist. / Greeks Parameters Parameters Parameters Parameters § Hierarchies § Tax calculation § Minorities Feeder Systems Local Systems ˜ Partially locally developed © Allianz SE 2009 ALIM CF and parameterized models PRISM MKMV OR System Replicating Models ˜ Centrally developed, parameterized and Scenarios Life/P&C PRISM R/I Investment Business controlled models Asset Input Data System Risk ˜ Centrally developed, locally parameterized models 10
  • 11. Qualitative Reporting § Standardized quarterly reporting on: XXX Risk report – Q1 2009 - Governance & Compliance with Group XXX Risk report OE Contact: XXX – Q1 2009 Standards Group Risk Contacts: Stuart Robinson, Ioannis Kotsianos XXX Risk report – Q1 2009 1. Governance & Group Standards Compliance - General Risk Issues 2. General Risk Issues R Y Reserve Governance Update (Yellow in Q4) Internal Transactions Update Actuarial has raised concerns that reserving decisions are effectively made at BU n Group (Red in Q4) level and the Reserve Committee role and authority to challenge decisions needs to be n Several XXX insurance entities have purchased shares of AZ money market funds at the strengthened. - Regulatory & Legal Issues Y Life Cancellation Option (New NAV price to support fund liquidity. n official Issue): – Action 1: Completion of the Finance Unit organization project in order to better enhance Deficiencies in the In a secondprovided toefficiency, life policyholders in the past and bonds (floaters) from these n information stage, AGF Vie purchased EUR 600mn of corporate a new individual including non-life actuarial reserving processes. insurance law enacted at at the mark-to-model price in December 2008, with unit-linked delta versus funds the end of 2005 will require AGF to contact existing a significant contributed option to Q1 (the difference between the Finance Unitprice and the project price prices Status: Presentation on official NAV organization model to union policyholders and give them anmarket– cancel their policies. Policyholders will have 30 representatives completed, enforcement decision still subject to union representative days to request a refund of their originalAGI). being subsidized by premium. - Market Environment & Competitive Risks n answer. Update on implementation to be included in Q2. The worst case exposure, assuming 100% cancellation was estimated in March 2009 duethe growing n Further support from AGF Vie was provided again at EUR 315 mn at to end of Q1. AGF has booked a reserve of to an 9.6 mn as purchase of EURa492mn of corporate bonds fromEnd of Q4 2009 redemptions, leading EUR additional of Q1, assuming 3.6% Owners: XXX cancellation rate would apply to a worst case exposure of EUR 260 mn (this value is lower these funds. Due Date: than total unrealized losses on unit linked because policyholders have been identified to Y action plan to send suitable information whom a letter had beenliquidation Product Approval Update (Yellow in Q4)to policyholders ultimate estimated n Full sent). An of the AGI France Money Market funds could lead to an by registered mail is being prepared. The plan may trigger higher cancellations in current need for EUR 733mn of additional liquidity support. - New Product & Underwriting Approvals n market conditions ; therefore it willn A risk review of new products is always carried out, but process governance needs to be need to be monitored carefully. Group Risk is concernedStrategy actual Issue) rate after the mailing campaign may be far formalized sign-off process, further reinforced in 2009 (risk review before launch, Y Crediting that the (New lapse independent actuarial review). higher than the expected 3.6%, although no action would potentially leave the worst case loss at much higher levels if markets deteriorate. 2: Global process for new product design to be reengineered by Technical Area, Action n XXX has indicated to Group Risk that the current internal working assumption is for an – average bonus of 3.50% in 2009. This assumptionreviewsmean paying out c. EUR 1,450mn including Risk and Actuarial would before launch. - Financial Risk Exposure & Limit Adhere G Regulatory Fines (Newto policyholders relative to a minimum guarantee cost of c. EUR 950mn. n Issue): – Q1 Status: Presentation on the new Product Process to Executive Committee SOCA (an Oddo subsidiary) received a EUR 50k penalty for failing to comply set-up competitive and AGF is under n Group Risk recognizessuccessfully completed. Practical withis to be rolled-out. Update on implementation to that the French life insurance market insurance law while acting aspressure to maintain bonuses to attract new business and minimize surrenders. a broker. There is no immediate consequence for AGF entities. be included in Q2. n However, Group Risk is concerned that AGF may have reached a tipping point on bonus Owners: XXX Due Date: End of Q2 2009 - Solvency II Implementation 4. Market Environment sustainability given the current market environment. In order to make the planned 3.50% R & Competitive Risks payment, XXX would need to reduce current UAR reserves by EUR 500 mn (42% based on Y Partnerships Update (Red in Q4) Financial Crisis Impactyear-end 2008 UAR figures). This will have a material adverse impact on O&G costs, Update (Red in Q4) MCEV, NBM figures, Risk Capital, Statutory Solvency and the general sustainability of the n n Control of life JVs needs to P&C and L&H businesses. high for L&H business, and real estate risk for be strengthened so that XXX can effectively monitor compliance Equity risk remainstraditional business. Liquidity is also under pressure due toand ensure governance is robust. Regulatory and reputational risks are the main concern. money market fund support and surrenders for UL - L&H appendix: new product approvals, business where illiquid Action 4: Group Risk and UL products. Structured with AGFplanned with 1 FTE. Agreement reached that – assets are backingQ1 Status: Local internal control position to quantify the impact on the – some Group Actuarial to work credit exposures in the Allianz Banque trading portfolio are still on the balance sheet (with the risk mostly above items of different crediting strategies.approval process will apply for JVs. Update on implementation the general XXX product realized). The independent asset valuation review performed by Moody’s will be maintained in 2009 at the request of AGF and ABRM. to be included in Q2. Owners: Philippe Léglise CRO, GR, GA Due Date: End of Q2 2009 negative margin products, guarantee levels & Y n Owners: XXX Hospitaliers Pension Scheme Update (Green in Q4) G Madoff Exposure Update (Red in Q4) Initial decisions have been taken on 2009 annuity revaluation under planned targets and Due Date: End of Q2 2009 G General Governance (Green in Q4) according to agreement governance. Projection updates to has remained almost unchanged, estimated at n Exposure in various AZ French entities be produced in June. At present, new money rates equity losses and low interest raten No have2008), mainly through the AAAM Policy EUR 47mn (30 levels major deviations from the Group Riskof the November seriously damaged the capacity alternative funds “Phenix pension scheme toAlternativelife annuity coverage by 2028 also through thoughAM “GAP” an reach full Holding” and “Licorne”, and as planned, Oddo this is not funds. About half of XXX liability (annuity rights generated before 2008 are currently limited to and AVIP), and half for various Life this exposure is for UL assets (mostly Generation Vie 8 years). n AGF Vie exposure and P&C portfolios.also increased due to the low interest rate and equity to market risks has environment, and transfer of buffers generated by new pension rights toward in-force ones. n Decisions have been made during Q1 to notify UL clients of their entitlement to any § Progress on resolution of issues is tracked recoverable assets from Madoff defeasance (side-pockets) extracted from some of their UL 5. New Products & Group Insurance Committee Approvals closed Madoff funds (Luxalpha, Thema). No funds, and of the disappearance of several subsidization of losses should be supported by Allianz Life Operating Entities in principle. R New Product Process Failure (New Issue) seen as moderate, but could increase due to some complaints already n Reputational risk is § Reports are circulated to OE and Group © Allianz SE 2009 n registered, as surrenders cannot be paid for a few suspended funds. Subsidization of The new “Fipavie Diversifié” product (Generation Vie / Life Partnerships) was launched before risk review /Madoff losses insufficient prior evidence that an appropriate process had in all cases, which approval with even in one case might be an argument used for payment been established to manage this completely new product. 24mn for AGF France. would result in a worst case loss of EUR – Action 7: Product review to be completed post-launch with a local RiCo opinion. Proper controls to be put in place before the next version of the product is launched. management ensuring transparency – Q1 Status: Review is now 90% complete. The main risks identified to date are: (1) the
  • 12. Addressing the issues - Examples - Examples Risk • Regulatory filings communication • Rating agency disclosures • Public disclosures: Annual Report, Investor Day Risk strategy • Risk appetite: EaR, CaR, Risk Capital • Strategic Planning, not Budgeting: TDI, SD, PD Risk controlling • Capital solvency, EaR and CaR reporting • Individual risk reporting • Associated limit systems • Separation of duties Risk • Product approval processes underwriting • A/L or Strategic Asset Allocation processes © Allianz SE 2009 • Pricing guidelines, u/w minimum standards • Risk Controlled Self-Assessment, Top Risk Assessment 12
  • 13. Asking the right questions, answering them and acting on the decisions Examples Risk communication Processes Goverance Risk strategy Risk controlling Information & Systems Risk © Allianz SE 2009 underwriting Focusing on the foundations of good ERM is an important first step…but is it sufficient? 13
  • 14. Outward signs of ERM: Necessary. . .but not sufficient! Warren Specter, co-COO Bear Stearns, to the Senate Financial Crisis Inquiry Committee You have also asked me to address risk management practices. Risk at Bear Stearns was managed through a system of checks and balances. Each business unit was responsible for managing its risk, and the head of each division was then responsible for managing the aggregate risk within its units. The Executive Committee approved explicit limits for all areas of the firm - at the trading book level, and also by unit and by department - which were monitored by department heads. These limits were reviewed and monitored by the Risk Management Group, which was an independent unit that reported to the Executive Committee and met regularly with the Board's Risk Committee. This group, headed by Bear Stearns' Chief Risk Officer, served as an independent check on the business units' own risk management function. It distributed daily P&L statements that highlighted any significant gains and losses. It also provided daily written reports to senior management commenting on changes in exposure, any unusual trades, and any concentrated positions. The Risk Committee held weekly meetings, and the Risk Management Group made monthly presentations to the Executive Committee. At the weekly meetings, trading managers reported on their positions and their risk, and the risk management teams were present to verify the accuracy of these reports and to express their views. In this way, the Risk Committee and the business units served as constant checks on each other. There was an active dialogue among senior management about the firm's overall risk appetite, which we reviewed during both weekly and monthly meetings. In my opinion, Bear Stearns' risk management practices were robust and © Allianz SE 2009 effective. During my tenure on the Executive Committee I found the Risk Management team to be highly trained and very experienced. Overall, I thought Bear Stearns was well-managed, and I was saddened and disappointed when the firm collapsed.
  • 15. Signs of a dysfunctional risk culture: Golden Rule Symptom: Make the gold, make the rules (and should not be challenged!) Case study: AIG FP • PwC, AIG's auditor, concluded that the ability to access AIG FP by the risk management and other control functions "may require strengthening". • Federal Office of Thrift Supervision (OTS), AIG FP’s regulator, sent a letter which said that the unit "was allowed to limit access of key risk control groups while material questions relating to the valuation of the [swap portfolio] were mounting". • Rep. Gary Peters (D., Mich.) asked AIG CEO Edward Liddy during a congressional hearing, "Where was the risk management of your company? Where was the failure of your own internal risk-management procedures?" © Allianz SE 2009 Mr. Liddy’s response, "We had risk-management practices in place. They generally were not allowed to go up into the financial-products business.”
  • 16. Signs of a dysfunctional risk culture: „Dancing while the music is playing“ Symptom: Following the market, even when standards are deteriorating Case study: US mortgage market • Chuck (Charles) Prince, ex-CEO of Citigroup: “When the music stops, in terms of liquidity, things will be complicated. But as long as the music is playing, you've got to get up and dance. We're still dancing.” • When compared to the behaviour of a lemming at an FCIC hearing, Mr. Prince’s reply was, "It would have been impossible to say to bankers, we’re not going to participate … and expect to have any people left." © Allianz SE 2009
  • 17. Signs of a dysfunctional risk culture: Arbitraging the system Symptom: Building a business based on the flaws in our models Case study: Lehman Brothers • ‘Repo 105’ transactions were considered a sale of the assets under English law. • Court appointed examiner’s report said these deals created "a materially misleading picture of the firm’s financial condition in late 2007 and 2008” and were “actionable balance sheet manipulation” and “nonculpable errors of business judgment”, • Condoned by senior management of the firm, as the email excerpt illustrates: - “It’s basically window-dressing.” - “I see … so it’s legally do-able but doesn’t look good when we actually do it? Does the rest of the street do it? Also is that why we have so much BS [balance sheet] to © Allianz SE 2009 Rates Europe?” - “Yes, No and yes. :)”
  • 18. How much can we rely on compensation to steer culture? • „Dick Fuld (CEO) is also, in some sense, a victim. He’d held on to 10 million shares of Lehman stock until the end and lost almost $1 billion“ • „Mr Prince, whose exit was sealed late last week, already owns 1.61 million shares in Citi“ which decreased in value from USD 50 to USD 5 between 2007-2009. • On March 14, 2008, CNBC reported that „the value of Jimmy Cayne's (CEO) holdings in Bear Stearns had declined from $993 million to … less than $15 million as a result, effectively removing him from the list of the wealthiest individuals in the country.“ © Allianz SE 2009
  • 19. Three lines of defense First line of Second line of Third line of defense: defense: defense: Business is Functions which Ensure that the responsible for define framework framework is both profit and within which adhered to loss, risk and business is returns allowed to work Risk, Legal, Audit OEs Compliance © Allianz SE 2009 19
  • 20. Three lines of defense First line of Second line of Third line of defense: Management has to take defense: defense: responsibility, our frameworks Business is Functions whichplace, but that the have to be in Ensure responsible for definethe next crisis, our models will In framework framework is both profit and within which probability 1 to be wrong with adhered loss, risk and business is All frameworks can (and will) be returns allowed to work arbitraged OEs Risk, Legal, can anticipate all No framework Audit new businesses Compliance © Allianz SE 2009 e.g. pricing & underwriting guidelines, risk measures & limits, capital allocation 20
  • 21. What does „risk management“ really mean in the context of the second line of defense? Management lever Risk controlling Risk management Risk communication Risk controlling § Define frameworks within which business can be done Risk strategy § Control risk and limits and provide transparency § Provide technical analysis to support business decisions Risk management Risk controlling § Have a deep, professional understanding of the business (not just the models!) § Be close to the business, discussing key © Allianz SE 2009 decisions before they are taken Risk underwriting § Exercise professional judgement, occasionally saying „no“ if our frameworks are inadequate, if they are being arbitraged 21
  • 22. Culture…the missing piece Examples Processes Risk Goverance communication Risk strategy Culture Information & Systems Risk controlling US Supreme Court Justice Potter Stewart (on risk Risk culture??), 1964 Jacobellis vs. Ohio “I shall not today attempt further to define the kinds of © Allianz SE 2009 underwriting material I understand to be embraced within that shorthand description; and perhaps I could never succeed in intelligibly doing so. But I know it when I see it…” 22