Risk management

Risk management (Online Only)

18 Swiss Re | Financial Report 2020 Risk management Swiss Re | Financial Report 2020 19 Risk management

Internal control system and risk model

regulatory requirements which Swiss Re is subject to, including compliance, legal and tax Internal control system • Effectiveness and efficiency of The internal control system is overseen by operations − addressing basic business the Board of Directors of Swiss Re Ltd and objectives, including performance and the Group Executive Committee. It aims to profitability goals, and the safeguarding provide reasonable oversight and assurance of assets covering significant market, in achieving three objectives: credit, liquidity, , technology • Reliability of reporting − addressing the and other risks preparation of reliable reporting arrangements as well as related data Operationally, the internal control system is covering significant financial, economic, based on Swiss Re’s three lines of control regulatory and other reporting risks and comprises five components: • Compliance with applicable laws and regulations − addressing legal and

RISK ASSESSMENT CONTROL INFORMATION & MONITORING ACTIVITIES ACTIVITIES COMMUNICATION ACTIVITIES Processes to identify Risk mitigation activities Capturing and sharing Ongoing evaluation of control and assess risks established in policies and information for risk control effectiveness procedures and management decisions • Performed by risk takers • Performed by risk takers (1st • Performed by all lines of • Risk controlling by Risk (1st line of control) line of control) control Management and • Based on Global Operational • Based on Global Control • All incidents logged in central Compliance (2nd line of Risk Register Catalogue repository control) • Assurance by Internal Audit and Compliance (3rd line of control) CONTROL ENVIRONMENT • Standards, processes and structures that provide the basis for carrying out internal control (eg, tolerance) • Risk culture, including Swiss Re’s corporate values, governance oversight and roles and responsibilities, as well as performance measures, incentives, and rewards that drive accountability for performance

20 Swiss Re | Financial Report 2020 Risk tolerance and appetite Based on internal and external information, assessment of plan Swiss Re identifies risks such as: Risk oversight of planning aims to ensure • Previously unidentified risks that the Group and major legal entities fully • Known non-material risks that have understand the risk implications of the become material risks business and financial plan, and that the • Known material risks that have changed planning approach is based on sound following a reassessment or increased assumptions. The plan represents the understanding of the nature of the risk implementation of Swiss Re’s strategy • Changes in risk exposure from increased under the baseline scenario. It is used to understanding of interdependencies assess the risk and capital implications of between risks the plan within the expected economic and business environment. Risk takers have primary responsibility for identifying risk, including emerging risks, by Risk Management provides both input into assessing all risk exposures arising from and risk oversight of the business and active positions (ie, assets and financial planning process. It does so by underwriting) and operational processes as reviewing and challenging key assumptions well as the risk factors underlying these supporting the plan as well as by assessing exposures. Risk takers are also charged with potential risks and threats that may arise providing Risk Management with all from its implementation. Risk Management relevant information about their risk factors also provides transparency on detailed risk and exposures. Where a risk is relevant for implications of the plan and works with multiple Swiss Re entities, it is generally Finance to test its adherence to risk appetite assessed in cooperation with Group Risk and risk tolerance, and determine whether it Management. complies with the relevant capital and liquidity limits and targets. Adherence of the Risk measurement plan to risk tolerance is also subject to Risk measurement enables Swiss Re to quarterly review based on updated plan assess the magnitude of its risk exposures information. Execution of the plan is subject and set quantitative controls that limit to the risk control framework. risk-taking.

The implications of the business and Swiss Re uses a full internal risk model to financial plan are further assessed against determine the required to selected sensitivities, as well as by support the risks on the company‘s books, projecting the risk, capital and liquidity as well as to allocate risk-taking capacity to positions under alternative scenarios. The the different lines of business. The model insights gained from scenario analysis also provides the basis for capital cost enable senior management to prepare a allocation in Swiss Re‘s Economic Value response to adverse events as they occur. In Management framework, which is used for some cases, this may lead to preventative pricing, profitability evaluation and actions being carried out in advance, while compensation decisions. In addition to in other cases management may react to these internal purposes, the model is used events as they unfold, taking into to determine regulatory capital consideration the insights gained during the requirements under economic solvency planning process. frameworks such as the Swiss Solvency Test (SST) and Solvency II. Risk identification Risk identification is an ongoing process to The internal model provides a meaningful establish transparency around all potentially assessment of the risks to which the material risks in order to make those risks company is exposed and is an important controllable and manageable. This provides tool for managing the business. Swiss Re‘s a basis for exposure monitoring, risk model has a history of more than 20 years measurement, monitoring of capital of development and continuous requirements and reporting. All quantifiable improvement driven both by the company‘s risks must be reflected in costing, specific risk profile and by changing underwriting, reserving, capital and requirements as a globally operating steering models. reinsurer.

Risk management Swiss Re | Financial Report 2020 21 Risk management

While economic solvency regimes such as expected value of annual losses likely to SST and Solvency II offer standard models occur with a frequency of less than once in for calculating regulatory requirements, one hundred years, thus capturing the such models are generally geared towards potential for severe, but rare, aggregate regulating the local or regional re/insurance losses. market and thus do not take sufficient account of Swiss Re‘s broad geographic In addition, the model is used to calculate and diversified portfolio structure. Swiss (VaR) measures including Re‘s model uses the Monte Carlo simulation 99.5% VaR, which is used in other method to estimate a joint multivariate regulatory regimes such as Solvency II. distribution of all relevant risk factors, rather 99.5% VaR represents the loss likely to be than a limited set of deterministic scenarios exceeded in only one year out of two and factors. It therefore provides more hundred and is thus more severe than the detailed results than standard formulas, 99% VaR measure, which estimates the loss which are often based on simplified likely to be exceeded in one year out of one industry-wide common denominators. hundred. For Swiss Re‘s loss distribution, the 99% expected shortfall (tail VaR) Swiss Re‘s internal model is based on two measure is generally larger than the 99.5% important principles. First, it applies an VaR measure. asset-liability management approach, which measures the net impact of risk on Separate risk modules are used to model the economic value of both assets and the individual risk factors of Swiss Re’s core liabilities. Second, it adopts an integrated risks (see Swiss Re’s risk landscape). perspective, recognising that a single risk Depending on the underlying risk and factor can affect different sub-portfolios and available historic experience, Swiss Re that different risk factors can have mutual applies different modelling approaches: dependencies. Swiss Re’s internal model is • Non-life insurance risk – Swiss Re’s fully stochastic and is based on a separation model comprises several components for of risk factors and exposure functions. non-life risks: one main contributor is costing and reserving risk; this is The model generates a probability modelled based on a statistical model distribution for economic profit and loss, approach which derives its assessment of specifying the likelihood that the outcome future uncertainty from the observation of will fall within a given range. past volatility. Another key component of non-life insurance risks are natural In line with the SST, the Group measures its catastrophes: Swiss Re has developed its economic risk capital requirement as the own proprietary natural catastrophe 99% expected shortfall (or tail value at risk) models, which are used for costing as level. This represents an estimate of the well as risk assessment. In addition, Swiss

Probability

99.5% VaR

99% VaR

Average of 1% 1 in 100 year loss1 in 100 worst losses 1 in 200 year loss

99% Tail VaR Expected result Profit Loss

22 Swiss Re | Financial Report 2020 Re uses a number of so-called threat In order to assess the risk and provide Risk limit framework scenario models, which are used to solvency information for individual financial Swiss Re aims to carefully control exposure describe large but rare events (ie. events reporting entities within a network of from active risk-taking decisions, the that are not well represented in historical entities, it is necessary to consider the passive risk it is exposed to through its observations). Events involve the impact of intra-group relationships. For this operations, as well as the cumulative impact accumulation of simultaneous losses from purpose, the Group‘s internal risk model of its risk exposures on capital and liquidity different parts of the portfolio at the same takes the following items into account: adequacy. Risk exposures are controlled in time. Swiss Re also models claims • Intra-group transactions (including loans, all activities to: inflation risk evolving from the Group’s guarantees and retrocessions) • Facilitate informed business steering property and casualty business. Since • Intra-group and (for SST) decisions economic inflation changes the value of a potential limited liability toward • Ensure that the Group operates within its liability or an asset, it generally induces subsidiaries risk tolerance changes in claims payment. Inflation risk • Secondary effects resulting from the • Ensure that operational risks are is modelled by applying a probabilistic set potential insolvency of other reporting managed to an acceptable level of future inflation scenarios based on entities expert judgement about future inflation. The following controls govern all risk-taking • Life insurance risk – Swiss Re’s model Swiss Re’s risk model assesses the potential decisions across the Group: quantifies potential economic losses from economic loss at a specific confidence • Clearly established authorities and L&H business generated by non-financial level. There is thus a possibility that actual delegations governed by referral triggers risks. The model comprises separate losses may exceed the selected threshold. (eg quantitative and qualitative limits to sub-models based on the nature of Swiss In addition, the reliability of the model may delegated risk-taking authority) Re’s product offerings: mortality, be limited when future conditions are • Capital and liquidity adequacy limits longevity, critical illness, hospital cash difficult to predict. For this reason, the • Risk and capacity limits and income protection. Each sub-model model and its parameters are continuously is a cashflow model based on actuarial reviewed and updated to reflect changes in Risk reporting models with a consistent the risk environment and current best Regular internal risk and issue reporting structure, identifying the underlying risk practice. In addition, Swiss Re complements ensures transparency at all stages. For the factors. Some risk factors, such as the its risk models by ensuring a sound Group and key legal entities, holistic risk prevalence of certain diseases, can understanding of the underlying risks within reports are produced and provided to the influence mortality as well as critical the company and by applying robust respective management and Board illness products, hence the model internal controls. members. These reports cover qualitative captures the dependency here. and quantitative risk topics across all areas • Financial market and credit risk – Risk The risk model is governed by Swiss Re‘s of Swiss Re’s risk landscape: factors in Swiss Re’s financial market and Model and Tool Assurance Framework. This • Reporting of material risks and control credit risk models represent external includes an independent end-to-end issues including mitigation actions and realisations of market parameters that validation process that comprises recommendations; this is based on Swiss enter the economic valuation. Risk factors specification, algorithms, calibration, Re’s Group-wide risk matrix methodology, are simulated based on general market implementation, results and testing. in which key operational risks are practices, mainly by price volatilities that classified based on a standard taxonomy, are updated on a quarterly basis. Swiss As it is used for regulatory reporting and assessed for probability and residual Re’s financial model pays purposes, Swiss Re’s risk model is subject risk impact. specific attention to tail dependencies, to regulatory scrutiny. In 2017, the Swiss • Monitoring and analysis of adherence to which reflect dependencies between risk regulator, FINMA, approved Swiss Re’s risk tolerance, including adequacy of factors in adverse market situations. internal model for use for the SST report capital and liquidity, as well as the usage Changes in risk factors are evaluated on (step one approval) following the new of risk limits. assets and liabilities simultaneously. FINMA approval process that was initiated • Monitoring of exposure and other in 2016. In 2018, FINMA conducted a risk-related developments within Swiss material review of Swiss Re’s credit risk Re, for underwriting, financial and model, which was approved for use for SST operational risk, as well as assessment of 2019 and required minor adjustments for external developments with a potential SST 2020 which have now been impact on Swiss Re, such as economic implemented. In 2019, FINMA conducted a and insurance market trends, regulatory, material review of the Tropical Cyclone legal and political developments. North Atlantic component of the model which was approved for use without conditions. Furthermore, the model has been approved by the Luxembourg regulator, Commissariat aux Assurances, for the Solvency II reporting of Swiss Re's legal entities established in the EEA.

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