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Allianz Annual Report 2013

C Group Management Report Risk and Opportunity Report and Financial Control 105 Risk and Opportunity Report 123 Controls over Financial Reporting and Risk Capital Annual Report 2013    Allianz Group 109 Scope By design, our internal risk capital model takes into account the fol- lowing risk categories: market risk, credit risk, underwriting risk, busi- ness risk and operational risk whenever these risks are present. A further breakdown of the risk categories can be found in the section Quantifiable risks in the internal capital model. With the exception of the Asset Management business segment all business segments are exposed to the full range of stated risk categories. By contrast, the Asset Management business segment is mainly exposed to market, credit and operational risk. Our internal risk capital model covers: −− All of our major insurance operations. −− Our assets (including bonds, mortgages, investment funds, loans, equities and real estate) and liabilities (including the cash flow run-off profile of all technical reserves as well as deposits and issued securities). −− For the Life/Health insurance products, options and guarantees embedded in insurance contracts including policyholder partici­ pation rules.1 For our Asset Management business segment we assign internal risk capital requirements based on the sectoral regulatory capital requirements envisaged in Solvency II. The capital requirements of smallerinsuranceoperatingentities,thathaveanimmaterialimpact on the Group’s risk profile, are based on local regulatory require- ments. We allocate these requirements to the risk categories of our internal risk capital model, thereby allowing a consistent aggregation of internal risk capital for all business segments at Group level. Internal risk capital related to our European banking operations is allocated to the Corporate and Other business segment, based on the approach applied by banks under the local requirements with respect to the Basel regulation (Basel II/III standards). It represents an insignificant amount of approximately 1.7 % (2012: 1.6 %) of total pre-diversifiedinternalriskcapital.Therefore,riskmanagementwith respect to banking operations is not discussed further. Limitations Our internal risk capital model expresses the potential “worst-case” amount in economic value that we might lose at a certain confidence level. However, there is a statistically low probability of 0.5 % that actual losses could exceed this threshold at Group level in the course of one year. We use model and scenario parameters derived from historical data, where available, to characterize future possible risk events. If 1 For further information about participating life business, please refer to note 20 to the consolidated finan- cial statements. future market conditions differ substantially from the past, for exam- ple in an unprecedented crisis, our VaR approach may be too conser- vative or too liberal in ways that are too difficult to predict. In order to mitigate reliance on historical data we complement our VaR anal- ysis with stress testing. Our ability to back-test the model’s accuracy is limited because of the high confidence level of 99.5 %, the one-year holding period, as well as only limited data for some insurance risk events – such as natural catastrophes – being available. Furthermore, as historical data is used where possible to calibrate the model, it cannot be used for validation. Instead, we validate the model and parameters through sensitivity analyses, independent internal peer reviews and, where appropriate, external reviews by independent consulting firms focusing on methods for selecting parameters and control processes. Overall, we believe that our validation efforts are effective and that our model adequately assesses the risks to which we are exposed. As described previously, insurance liability values are derived from replicating portfolios of standard financial market instruments in order to allow for effective risk management. This replication is subject to the set of available replicating instruments and might therefore be too simple or restrictive to capture all factors affecting the change in value of liabilities. Nevertheless, we believe that the liabilities are adequately represented by the replicating portfolios due to our stringent data and process quality controls. Since internal risk capital takes into account the change in the economic fair value of our assets and liabilities, it is crucial to accu- rately estimate the market value of each item. For some assets and liabilities, it may be difficult, if not impossible – notably in distressed financial markets – to obtain either a current market price or to apply a meaningful mark-to-market approach. For certain assets and liabil- ities, where a market price for that instrument or similar instruments is currently not available, we apply a mark-to-model approach. Non- standardized derivative instruments – such as derivatives embedded in structured financial products – are represented by the most com- parable standard derivative types, because the volume of non-stan- dard instruments is not material at either the local or Group level. For some of our liabilities, the accuracy of fair values depends on the quality of the actuarial cash flow estimates. Despite these limitations, we believe the estimated fair values are appropriately assessed. Model updates in 2013 In 2013 we kept the central risk capital models for all risk categories stable and performed only the regular exposure and assumption updates. The only local model update with material impact at Group level is the introduction of Surplus funds together with a Going Con- cernReserveat­AllianzLebensversicherungs-AGinlinewith­Solvency II and BaFin methodology. The introduction increases the Group’s capital requirement by € 0.4 bn, mainly affecting equity and credit spread risk.

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