C _ Group Management Report With Solvency II being the regulatory regime relevant for the using the standard formula, the market risk is based on aggregating Group as of 1 January 2016, our risk profile is measured and steered the losses under specified standard formula shock scenarios. based on our approved Solvency II internal model1. We have Strategic asset allocation benchmarks and risk limits, including introduced a target solvency ratio range in accordance with financial VaR, stand-alone interest rate and equity sensitivity limits, Solvency II, based on pre-defined stress scenarios for both the Group and foreign exchange exposure limits, are defined for the Group, and related undertakings, supplemented by ad-hoc scenarios, Allianz SE, and other related undertakings. Limits are closely historical and reverse stress tests, and sensitivity analyses. monitored and, if a breach occurs, countermeasures are implemented In addition, central elements of Allianz’s dividend policy are linked which may include escalation to the respective decision-making to Solvency II capitalization based on the internal model. This helps us bodies and/or the closing of positions. to ensure a consistent view on risk steering and capitalization in line Furthermore, we have put in place standards for hedging with the Solvency II framework. activities, due to the exposure to fair-value options embedded in our Allianz steers its portfolio taking a comprehensive view at risk and life insurance products. In addition, we optimize our in-force portfolio return, which is based on the internal model and is supported by through transactional levers, such as divesting discontinued products scenario analyses. Risk and concentrations are actively restricted by and businesses partly or entirely, structural levers, such as adjusting the limits based on our internal model, and there is a comprehensive product mix, and operational levers, such as partnering with specialists analysis of the return on risk capital2 (RoRC). The RoRC is an indicator for managing these books of legacy products, also called life back for new business that allows us to identify profitable lines of business books. and products on a sustainable basis, reflecting the capital Finally, guidelines are provided by the Group regarding certain commitment over the lifetime of the products, and is a key criterion for investments, new investment products, and the use of derivatives. capital allocation decisions. Compliance with these guidelines is controlled by the risk and As a consequence, the internal model is fully integrated in controlling functions at Allianz SE and the other operating entities. business steering, and its application satisfies the so-called “use test” requirement, under Solvency II. Interest rate risk Allianz is a liability-driven investor. We may suffer an economic loss in the event of falling interest rates as we reinvest maturing assets at As an inherent part of our insurance operations, we collect premiums lower rates prior to the maturity of liability contracts, if the duration of from our policyholders and invest them in a wide variety of assets; the our assets is shorter than our liabilities. This risk is higher for long-dated resulting investment portfolios back the future claims payments and life investment and savings products as well as for internal pensions, benefits to our customers. In addition, we also invest shareholders’ with a significant part of the Life/Health business segment’s interest capital, which is required to support the business. Finally, we use rate risk coming from Western Europe, mainly from traditional life derivatives, mostly to hedge our portfolio against adverse market insurance products with guarantees. Conversely, opportunities may movements (for example, protective puts) or to reduce our arise when interest rates increase, as this may result in returns from reinvestment risk (for example, by using forwards, swaps, or reinvestments being higher than the guaranteed rates. Interest rate swaptions). Asset/liability management (ALM) decisions are taken risk is managed within our asset/liability management process and based on the internal model, considering both the risks and the returns controlled via interest rate sensitivity and duration mismatch limits for on the financial market. the Group and the local entities. As the fair values of our investment portfolios and liabilities depend on the changes observed in the financial markets, we are Inflation risk exposed to the risk of adverse financial market developments. The As an insurance company, we are exposed to changing inflation rates, long-dated liabilities in our Life/Health business segment and those predominantly due to our Property-Casualty insurance obligations but attributable to internal pensions contribute to interest rate risk, in also due to inflation-indexed internal pension obligations. While particular when they cannot be fully matched by available inflation assumptions are taken into account in our product investments due to long maturities. In addition, we are also exposed to development and pricing, unexpected rising rates of inflation will adverse changes in equity and real estate prices, credit spread levels, increase both future claims and expenses, leading to higher liabilities; inflation, implied volatilities, and currencies, which might impact the conversely, if future inflation rates were to be lower than assumed, value of our portfolios. liabilities would be lower than anticipated. The risk that inflation rates To measure these market risks, real-world stochastic models3 for deviate from inflation assumptions is incorporated in our internal the relevant risk factors are calibrated using historical time series to model. Potential severe structural breaks are monitored via historical generate possible future market developments. After the scenarios for and ad-hoc stress tests. all the risk factors are generated, the asset and liability positions are revalued under each scenario. The worst-case outcome of the sorted portfolio profit and loss distribution at a certain confidence level (99.5 %) defines the market Value at Risk (VaR). For entities modeled 1_From a formalistic perspective, the German Supervisory Authority deems our model to be “partial” to entities that use the internal model, or descriptions focusing on processes with respect to the internal because not all of our entities use the internal model. Some of our smaller entities report under the model components. standard formula and others under the deduction and aggregation approach. Without loss of generality, 2_The return on risk capital is defined as the present value of future real-world profits on the capital we might use the term internal model in the following chapters, e.g., in case of descriptions also referring requirement (including buffer to regulatory requirements) held at the local level. 3_Internal pensions are evaluated and modeled based on deterministic models, following IAS 19 principles. 100 Annual Report 2021 − Allianz Group