2. Risk management
2.1 Risk management principles
2.1.1 Purpose of risk management
The purpose of Suomi Mutual's risk management is to ensure that the risks which are under the company's control do not jeopardise the attainment of the company's objectives.
2.1.2 Management of Suomi Mutual operations
Suomi Mutual employs 12 people. The day-to-day management of the company's domestic operations has largely been outsourced. The Suomi Mutual staff is responsible for ensuring that the company's operations, organised in this manner, meet policyholders' requirements and that the outsourced operations fulfil the financial and qualitative targets set for them.
In foreign operations, Suomi Mutual acts through its subsidiaries. The Suomi Mutual staff responsible for this area manage and steer the operations in such a manner that the value of the foreign subsidiaries develops as set out in the objectives.
2.1.3 Risk identification
Suomi Mutual identifies in advance the risks threatening its operations and objectives and lists them in a separate risk management plan. The company applies methods for measuring risks and their probabilities and for preventing risks or at least dampening down their effect on operations to a level within the company's financial capacity. The company understands that sufficiently good financial results can only be obtained through controlled risk-taking.
Risk management at Suomi Mutual is a continuous activity. The company is prepared to change the contents and scope of its risk management to correspond to the company's state and operational environment at any given time.
2.1.4 Risk management responsibilities
The company's Board of Directors and President bear the overall responsibility for the company's risk management. The Board of Directors annually reviews the risk management principles and approves a risk management plan covering the operations of the whole company. The company's senior management is responsible for the implementation of risk management.
The risk management duties of Suomi Mutual have been scheduled to take place annually at regular times. The follow-up of identified risks has been entrusted to employees responsible for the area concerned.
2.2 Risk management of insurance operations
The Finnish Insurance Contracts Act sets strict responsibility for the accuracy of information given by an insurance company to its customers. Even though Suomi Mutual no longer underwrites new business, the risk pertaining to this area is still significant. The risk now concerns information given on contracts that are in force. Owing to the significance of the risk, all written customer information is approved at Suomi Mutual before it is used, even in cases where the preparation and delivery of such information has been outsourced.
The sufficiency of technical provisions is continuously monitored through various analyses. The risk pertaining to the adequacy of technical provisions is also related to the level of insurance premiums. In the majority of the company's insurance contracts, premium increases are not possible. As the company has started to grant special additional benefits to its customers, it is difficult to justify premium increases even in situations where the insurance contracts would allow them. By ensuring that technical provisions are kept at an adequate level, the company establishes the right basis for determining special additional benefits. The company's equalisation provision also ensures that the technical provisions and premiums are adequate. The company's technical provisions include additional liabilities, particularly in relation to medical expenses insurance, because of a forecast future deficit in this area.
Currently, the main risk affecting the performance of insurance operations is the longevity risk. The risk pertains to pension insurance. The pension periods in deferred annuity insurance are usually short and they are mainly applied between the ages of 60 and 65 years. The insurance policies often include a death benefit, which reduces the significance of the risk of longer life expectancy. The pension benefits of group pension insurance last, on average, for a much longer period. They usually do not include a death benefit cover to compensate for the effect of increasing longevity. For group pension reserving, a new generation mortality has been adopted. In this way, increasing longevity is taken into account effectively. In addition, the integration of liabilities with the new earnings-related pension legislation reduced the company's risk slightly in this respect. Suomi Mutual monitors the development of life expectancy with various annual analyses.
Breakdown of Suomi Mutual's technical provisions and the average duration of technical provisions in each insurance line are shown in the below table:|
Technical provisions |
Technical provisions |
Those entitled | |||
| Dec 31, 2005 | Dec 31, 2005 |
to special |
Duration | ||
| EUR million | EUR million | % | benefits | *** | |
|
Life insurance |
|||||
| - Technical interest rate 4.5% | 1,228.8 | 1,164.8 | 21.9 | 98 % | 9 |
| Capital redemption contracts | |||||
| - Technical interest rate 4.5% | 228.4 | 211.0 | 4.0 | 0 % | 2 |
| - Technical interest rate 3.5% | 364.3 | 293.8 | 5.5 | 0 % | 3 |
| Deferred annuity insurance | |||||
| - Technical interest rate 4.5% | 2,203.0 | 2,376.3 | 44.7 | 73 % | 8 |
| Group pension insurance | |||||
| - Technical interest rate 4.5% | 3.8 | 3.7 | 0.1 | 0 % | - |
| - Technical interest rate 3.5% * | 785.9 | 818.3 | 15.4 | 0 % | 12 |
|
Other provisions |
|||||
| - Technical interest rate reserve ** | 402.0 | 357.3 | 6.7 | - | - |
|
- Expense loading reserve |
38.7 | 37.6 | 0.7 | - | - |
| - Other |
47.5 | 44.2 | 0.8 | - | - |
| - Future additional benefits | 1.8 | 11.6 | 0.2 | - | - |
| Total | 5304.0 | 5318.6 | 100.0 | 8 | |
| * = The discount rate for technical provisions is
3.5% in all policies, but contractual interest in some contracts deviates from this (4.25% or 4.5%). |
|||||
| ** = In the technical
interest reserve, the annual liability for the technical interest rate is covered to the extent that it exceeds 3.25%. |
|||||
| *** = In accordance with liabilities accrued, i.e. excluding the impact of future payments. | |||||
The day-to-day management of insurance policies has been outsourced. As per the agreements, the company responsible for managing the insurances is entitled to develop the management processes, provided that the quality of management is maintained and that the financial performance of operations is not impaired as a result, for example, of the simplification of the processes. The attainment of desired objectives through outsourcing is continuously monitored by following the development of the loss ratio and customer feedback.
2.3 Risk management of investment operations
The impact of the results generated by investment operations on the aggregate results of Suomi Mutual is vital. The technical guaranteed interest of the company's insurance contracts varies from 3.5% to 4.5%, depending on the contract. The technical interest defined here is high in relation to the current interest rate level. In order to adequately ensure the benefits under contracts with long maturities, Suomi Mutual decided in 2005 to take account of the fall in interest rates. This was carried out by reserving a specific amount in technical provisions, determined by estimating the amount, by line of insurance, which would be needed to lower the technical interest of the line concerned to 3.25%. The increased amount of technical provisions only covers the liabilities accrued by the end of 2005. As of 2006, this portion of the technical provisions is accrued by a 3.25% interest rate and reduced, by insurance line, by the amount corresponding to the difference between the previous technical interest for each insurance line and the 3.25% interest rate. Any decision about a reserve in technical provisions accruing after the end of 2005 will be made separately each year. Due to the increased interest rate level, the technical provisions accrued in 2006 were not increased. This raises the average discount rate of technical provisions, which, at the end of 2006, was just under 3.4%. Regardless of the increase in the technical provisions, the technical interest with which customers are credited will remain at the level determined in their insurance contracts.
In addition to the technical interest, the company should be able to credit insurance savings with a competitive customer bonus, the amount of which is dependent on the customers' reasonable return targets, the general interest rate level, the technical interest and the company's profitability. The company's objective is also to obtain a 12 per cent return on its solvency capital.
Through the return targets set for different liability items as specified above, the company determines the return target for its investment operations.
Suomi Mutual uses a tool called the market risk ratio for measuring the risk level of the company's investment operations. The market risk ratio is a stress test where the investment risk is expressed as one figure by adding together the risks of different investment instruments. These risks are obtained by multiplying the aggregate amount of investments made in each instrument by the risk factor related to the instrument concerned. The aggregate market risk obtained is then compared with the company's non-restricted risk capital, which is the amount by which the company's solvency capital exceeds the minimum capital requirement as specified in the EU standards. When determining the market risk ratio, the company also takes account of the difference between the general interest rate level and the average discount rate used in calculating technical provisions and the normal customer bonuses determined in accordance with the company's customer bonus practice.
Suomi Mutual has set its basic solvency target at 18 per cent. By making efficient use of the risk carrying capacity determined on the basis of the market risk ratio, the company finds an investment allocation with an expected return that reaches, at a minimum, the return target for the company's investments as determined above. As a result of fluctuations in the investment market, the company's investment return and, consequently, solvency fluctuate. While Suomi Mutual seeks to obtain as high investment returns as possible, at the same time it aims to maintain the aggregate amount of the technical interest on customers' insurance savings and of normal customer bonuses reasonably stable relative to the interest rate level. When the need for solvency capital decreases, the requirement for maintaining a stable level for special additional benefits and customer bonuses to be declared is lower. Maintaining a sufficiently stable level for additional benefits is obtained by allowing the company's solvency ratio to vary within the solvency limits determined around the basic solvency target when the company's investment results fluctuate.
Market risk is the most significant of the company's investment risks. It is managed in the way described above, by using the market risk ratio. The company has prepared for other investment risks, such as operative, liquidity and currency risks, by not taking the market risk against the minimum capital requirement as per the EU standards. The company uses continuous follow-up to ensure that the assets covering the technical provisions fulfil the requirements set by legislation and the regulations issued by the authorities. As far as the assets covering the technical provisions are concerned, the Finnish Insurance Supervisory Authority has granted the company special permission to exceed, up to a certain limit, the maximum amount set for equities under the asset cover regulations, in so far as the regulations treat as equities such fixed income funds investments in which in themselves would fall under the category of bonds or money market investments under the regulations. The risk related to a decrease in the interest rate level is taken directly into account in the market risk ratio calculations. Investment operations have been outsourced with the exception of their steering. The purpose of the steering of the company's own investment operations is to ensure that the outsourced operations fulfil the company's objectives and that the operations are, in all respects, conducted within the limits of the investment plan determined by the company's Board of Directors. The company's own investment organisation is also responsible for ensuring that the outsourcing contracts are sufficiently secure from the company's perspective.According to the risk classification used in the market risk ratio calculations, the company's investment portfolio as at December 31, 2006 was broken down as follows:
| Asset class |
Allocation %
|
|
| Money market |
12%
|
|
| - Money market |
13%
|
|
| - Derivative adjustment 1) |
-1%
|
|
| Bonds and fixed interest funds |
43%
|
|
| - Governments |
24%
|
|
| - Investment grade |
11%
|
|
| - High Yield + EMD |
3%
|
|
| - Gonvertible bonds |
4%
|
|
| - Derivatives |
1%
|
|
| Shares |
32%
|
|
| - Finland |
9%
|
|
| - Developed markets |
13%
|
|
| - Emerging markets |
5%
|
|
| - Fixed assets and unlisted |
1%
|
|
| - Private equity |
4%
|
|
| - Derivatives |
0%
|
|
| Alternative investments |
6%
|
|
| - Hedge funds |
6%
|
|
| - Commodities |
0%
|
|
| Real estate |
7%
|
|
| - Direct |
5%
|
|
| - Indirect |
2%
|
|
| Total |
100%
|
|
1) In risk reporting, the derivatives position is changed into a corresponding underlying position, and the counter value is taken into account in the money market allocation.
2.4 Foreign operations
Suomi Mutual is continuing the operations of its foreign subsidiaries, even though the company does not underwrite new business in Finland. In 2006, a decision was made to implement a merger of the Baltic subsidiaries into a European company, which will be based in Tallinn and have branch offices in all the Baltic countries. This will enhance the efficiency of Suomi Mutual's use of capital and allow for other improvements in the operations. In terms of the aggregate risk for Suomi Mutual, the foreign companies are of minor significance. The risk management of each foreign subsidiary is arranged locally on the basis of the requirements set by the business operations and authorities in the country concerned
2.5 Other risks
The company's risk management plan also includes risks related to costs, outsourcing of operations, human resources, IT systems, the company's operational environment, steering and reporting.
The main risk pertaining to costs is the sufficiency of the company's expense loading during the remaining period of the company's operations. This is continuously monitored and, if necessary, the technical provisions are increased in a manner to ensure that the aggregate expense loading is sufficient. This kind of increase in the technical provisions was carried out last in 2005.
A company engaged in operations similar to those of Suomi Mutual is mainly responsible for the outsourced functions. Therefore, Suomi Mutual must continuously identify potential conflicts of interest and avoid any problems caused by them. The quality of outsourced services is monitored by means of customer feedback and operational profitability. Outsourcing contracts are drawn up in a manner which minimises, as far as possible, risks related to their uncontrollable termination. When the Pohjola holding was sold to OKO Bank, risks related to the termination of these contracts was mitigated through agreements on lengthening certain service providers' notice periods. The longer notice periods were incorporated into the individual contracts in 2006, when the outsourcing contracts were updated between the OP Group and its various companies, and Suomi Mutual.
The scarce number of the company's staff emphasises the importance of keeping the key staff members in the company's service. By means of staff selection it has been possible to build the competence structure of the staff in such a way that the departure of a single staff member from the organisation will not cause any major problems. The number of staff does not allow for any further back-up arrangements. The company's staff turnover is improved by enhancing staff commitment, for example, through a competitive overall salary structure.
The systems for managing the company's insurance portfolio are old and based on a relatively out-dated IT technology, but they are functional and cost-effective in use. It is possible that the technical environment of the systems will, at some point, have to be replaced with a new one. A survey carried out in the company shows that the safe usage time of the systems is, for the time being, long enough for them not to be replaced immediately. There is the risk that the systems will have to be replaced and this is being monitored continuously. The systems' relatively old IT technology also increases staff-related risks concening development and maintenance work. OP Life Assurance Company Ltd is in the process of replacing its management systems. As this work progresses, Suomi Mutual aims to look into the extent to which its insurance portfolio could be managed through these replaced management systems. If this proves to be possible, the risk related to the management system will be significantly reduced.
Changes in the company's operational environment, such as changes in insurance legislation, have only a limited effect on Suomi Mutual's operations because the company no longer underwrites new business. The effects materialise mainly as increased costs, which is taken into account in the manner specified above in the section on cost-related risks.
It is important for the company to maintain a positive public image for the purpose of preserving customers' trust in the company. Risks related to public image are managed through open and clear communication, which is mainly targeted at the company's customers. A sufficient amount of communication is also directed at other groups following the insurance sector.