2.1 Consolidated annual accounts 17 INSURANCE AND INVESTMENT CONTRACTS, REINSURANCE CONTRACTS The gross amounts for provisions for insurance and investment contracts, net of reinsurance (i.e. the provision for ING’s own account) is presented in the balance sheet gross under ‘Insurance and investment contracts’ and ‘Reinsurance contracts’.
Changes in the composition of the group –15,050 –3,475 –25 2 –15,075 –3,473
Prior year provisions: – benefit payments to policyholders –24,626 –21,933 –719 –82 –25,345 –22,015
– valuation changes for risk of policyholders –32,408 5,612 –32,408 5,612 – effect of changes in discount rate assumptions –1 –1 – effect of changes in other assumptions –32 2 –32 2
Changes in the composition of the group in 2008 relate mainly to the sale of ING Life Taiwan. Reference is made to Note 21 ‘Other liabilities’.
Included in Changes in the composition of the group in 2007 is EUR 4,017 million relating to the disposal of portfolios in connection with the sale of the Belgian broker and employee benefit insurance business as disclosed in Note 29 ‘Companies acquired and companies disposed’.
Where discounting is used in the calculation of life insurance provisions, the rate is within the range 3.1% to 6.0% (2007: 2.9% to 6.0%) based on weighted averages.
Insurance provisions include a provision for the estimated cost of the agreement with regard to unit-linked policies. For more information reference is made to Note 30 ‘Legal proceedings’.
Premiums earned during the year –4,719 –5,701 –190 –326 –4,909 –6,027 Exchange rate differences –231 15 –1 –10 –232 5
Where discounting is used in the calculation of the claims provisions, based on weighted averages, the rate is within the range of 3.0% to 4.0% (2007: 3.8% to 4.3%).
Opening balance 23,652 20,750 Changes in the composition of the group –548 –277
Prior year provisions – payments to contract holders –8,472 –9,697 – interest accrual 268 408 – valuation changes investments –1,535 576
ING Group Annual Report 2008 18 AMOUNTS DUE TO BANKS Amounts due to banks include non-subordinated debt due to banks, other than amounts in the form of debt securities. As at 31 December 2008, liabilities concerning securities sold in repurchase transactions amounted to EUR 41,336 million (2007: EUR 29,604 million).
Netherlands International Total 19 CUSTOMER DEPOSITS AND OTHER FUNDS ON DEPOSIT
Savings accounts 263,637 275,127 Credit balances on customer accounts 174,141 161,204 Corporate time deposits 80,230 86,151
No funds have been entrusted to the Group by customers on terms other than those prevailing in the normal course of business. As at 31 December 2008, Customer deposits and other funds on deposit included liabilities with regard to securities sold in repurchase transactions amounting to EUR 5,759 million (2007: EUR 3,725 million).
Trading liabilities 152,616 148,988 Non-trading derivatives 21,773 6,951 Designated as at fair value through profit and loss 14,009 13,882
Derivatives used in: – fair value hedges 8,912 958 – cash flow hedges 6,089 3,188 – hedges of net investments in foreign operations 370 352 Other non-trading derivatives 6,402 2,453
Designated as at fair value through profit and loss by type
The amount that ING Group is contractually required to pay at maturity to the holders of financial liabilities designated as at fair value through profit and loss is EUR 14,336 million (2007: EUR 13,845 million).
Deferred tax liabilities 3,602 3,432 Income tax payable 940 877 Pension benefits 609 425 Post-employment benefits 219 232 Other staff-related liabilities 342 355 Other taxation and social security contributions 1,104 1,123 Deposits from reinsurers 909 427 Accrued interest 17,552 13,606 Costs payable 3,764 2,744 Amounts payable to brokers 89 114 Amounts payable to policyholders 2,231 2,283 Reorganisation provision 583 619 Other provisions 969 781 Share-based payment plan liabilities 11 14 Property under development for third parties 175 284 Amounts to be settled 3,753 4,156 Dividend payable 425 Taiwan – liabilities held for sale 15,020
Comprising: – deferred tax liabilities 3,432 3,602 – deferred tax assets –2,723 –8,034 709 –4,432
Other in Net liability 2006 and Change through equity in 2007 mainly relates to the cash flow hedge reserve in equity.
Opening balance 619 335 Changes in the composition of the group –22
The provision for reorganisations as at 31 December 2008 includes EUR 360 million for the restructuring of the retail business of Postbank and ING Bank.
The provision for reorganisations as at 31 December 2007 includes EUR 252 million for the restructuring of the retail business of Postbank and ING Bank and EUR 100 million for the global wholesale restructuring. The remaining term of the provision for reorganisations is generally not more than five years.
Changes in the composition of the group –1 13 8 47 7 60
Included in Other provisions in 2008 is a provision for a loss of EUR 292 million relating to the agreed disposal of ING Life Taiwan as disclosed in Note 29 ‘Companies acquired and companies disposed’.
Included in Other provisions in 2007 is a provision for a loss of EUR 129 million relating to the agreed disposal of NRG as disclosed in Note 29 ‘Companies acquired and companies disposed’.
Unrecognised past service costs –5 –3 Unrecognised actuarial gains/(losses) –2,072 198 –687 –1,778
Unrecognised past service costs 2 4 10 –6 Unrecognised actuarial gains/(losses) 7 8 –2 –27
Presented as: The Group maintains defined benefit retirement plans in its major countries of operation. These plans generally cover all employees and provide benefits that are related to the remuneration and service of employees upon retirement. The benefits in some of these plans are subject to various forms of indexation. The indexation is, in some cases, at the discretion of management; in other cases it is dependent upon the sufficiency of plan assets.
Certain group companies sponsor defined contribution pension plans. The assets of all ING Group’s defined contribution plans are held in independently administered funds. Contributions are generally determined as a percentage of pay. These plans do not give rise to balance sheet provisions, other than relating to short-term timing differences included in current liabilities. The amount incurred in 2008 was EUR 68 million (2007: EUR 68 million).
The actual return on the plan assets amounted to EUR –1,761 million (2007: EUR 80 million).
No plan assets are expected to be returned to ING Group during 2009.
Pension investment strategy The primary financial objective of ING Employee Benefit Plans (the Plans) is to secure participant retirement benefits. As such, the key objective in the Plans’ financial management is to promote stability and, where appropriate, growth in funded status (i.e. the ratio of market value of assets to liabilities). The investment strategy for the Plans’ portfolios of assets (the Funds) balances the requirement to generate returns with the need to control risk. The asset mix is recognised as the primary mechanism to influence the reward and risk structure of the Funds in an effort to accomplish the Plans’ funding objectives. Desirable target allocations amongst identified asset classes are set and within each asset class, careful consideration is given to balancing the portfolios among industry sectors, geographical areas, interest rate sensitivity, dependence on economic growth, currency and other factors affecting investment returns. The assets are managed by professional investment firms. They are bound by precise mandates and are measured against specific benchmarks. Factors considered by the fund managers include balancing security concentration, investment style, and reliance on particular active investment strategies. The asset mixes of the Funds are reviewed on a regular basis. Generally, the Funds’ asset mixes will be rebalanced to the target mixes as individual portfolios approach their minimum or maximum levels.
Expected cash flows During 2009 the expected contributions to pension plans are EUR 1,014 million (2008: EUR 633 million). Additionally ING Group has committed to make an additional contribution of EUR 814 million. This contribution is payable in the first quarter of 2009.
Insurance and investments contracts 14,294 Financial liabilities at fair value through profit and loss 126 Other liabilities 600 Taiwan – liabilities held for sale 15,020
ING Group Annual Report 2008 22 ASSETS AND LIABILITIES BY CONTRACTUAL MATURITY
Customer deposits and other funds on deposit 438,451 18,801 49,951 12,843 2,737 522,783 Financial liabilities at fair value through profit and loss
(1) Investments for risk of policyholders are managed on behalf of policyholders on a fair value basis. Although individual instruments may (or may not) have a maturity depending on their nature, this does not impact the liquidity position of ING. (2) Included in remaining assets where maturities are not applicable are: – property and equipment – real estate investments – investments in associates.
– designated as at fair value through profit and loss 873 771 2,395 5,912 3,931 13,882
(1) Investments for risk of policyholders are managed on behalf of policyholders on a fair value basis. Although individual instruments may (or may not)
have a maturity depending on their nature, this does not impact the liquidity position of ING. (2) Included in remaining assets where maturities are not applicable are: – property and equipment – real estate investments – investments in associates.
Amounts presented in this table by contractual maturity are on an undiscounted basis, excluding interest receivable/payable.
For the year ended 31 December 2008, ING Group recognised EUR –5,492 million (2007: EUR 697 million) of fair value changes on derivatives designated under fair value hedge accounting in the profit and loss account. This amount was partly offset by EUR –5,697 million (2007: EUR 663 million) fair value changes recognised on hedged items. This resulted in EUR 205 million (2007: EUR 34 million) net accounting ineffectiveness recognised in the profit and loss account. As at 31 December 2008, the fair values of outstanding derivatives designated under fair value hedge accounting was EUR –5,050 million (2007: EUR 994 million), presented in the balance sheet as EUR 3,862 million (2007: EUR 1,952 million) positive fair values under assets and EUR 8,912 million (2007: EUR 958 million) negative fair values under liabilities.
As at 31 December 2008, the fair values of outstanding non-derivatives designated under net investment hedge accounting was EUR –881 million (2007: EUR –1,318 million), presented in the balance sheet as negative fair values under liabilities. Non-derivatives designated as hedging instruments consist mainly of loan agreements.
Accounting ineffectiveness recognised in the profit and loss account for the year ended 31 December 2008 on derivatives and nonderivatives designated under net investment hedge accounting was EUR –6 million (2007: EUR –14 million).
ING Group Annual Report 2008 24 MAXIMUM CREDIT EXPOSURE ING’s maximum credit exposure as at 31 December 2008 and 2007 is represented as follows: Maximum credit exposure
Off-balance sheet credit commitments – commitments – Insurance 4,221 4,477 – guarantees – Insurance 2,460 173 – discounted bills – Bank 1 1 – guarantees – Bank 22,391 19,018 – irrevocable letters of credit – Bank 10,458 11,551 – other – Bank 453 350 – irrevocable facilities 89,081 100,707 Maximum credit exposure off balance sheet 129,065 136,277
25 ASSETS NOT FREELY DISPOSABLE The assets not freely disposable consist primarily of interest bearing securities pledged to secure deposits from De Nederlandsche Bank (the Dutch central bank) and other banks and serve to secure margin accounts or are used for other purposes required by law. The assets not freely disposable and the items for which they are held are as follows: Assets not freely disposable
Guarantees relate both to credit and non-credit substitute guarantees. Credit substitute guarantees are guarantees given by ING Group in respect of credit granted to customers by a third party. Many of them are expected to expire without being drawn on and therefore do not necessarily represent future cash outflows. The guarantees are generally of a short-term nature. In addition to the items included in contingent liabilities, ING Group has issued guarantees as a participant in collective arrangements of national industry bodies and as a participant in government required collective guarantee schemes which apply in different countries.
Collateralised debt obligations (CDO)-transactions Within ING Group, SPEs are used for CDO transactions. In a typical CDO transaction an SPE is used to issue structured, rated securities which are backed (or collateralised) by a pool of transferable debt securities. Besides investing in CDOs ING often has different roles in these transactions: the arranger of the transaction; ING structures the SPE, acquires the assets for the SPE and sells the CDOs to investors;• collateral manager of the assets in the SPE; ING manages the assets based on strict conditions of the SPEs charter.•
ING as investor As part of its investment activities, ING invests in securitisations by purchasing notes from securitisation SPEs. For certain own asset securitisation programmes ING acts as a market maker and holds limited positions in this capacity.
Companies treated as part of the banking operations ING Bank N.V. The Netherlands ING Bank Nederland N.V. The Netherlands Bank Mendes Gans N.V. The Netherlands ING Lease Holding B.V. The Netherlands ING Corporate Investments B.V. The Netherlands ING Vastgoed Management Holding B.V. The Netherlands InterAdvies N.V. The Netherlands Nationale-Nederlanden Financiële Diensten B.V. The Netherlands ING Commercial Finance B.V. The Netherlands Postbank N.V. The Netherlands Postbank Groen N.V. The Netherlands Westland Utrecht Hypotheekbank N.V. The Netherlands ING België N.V. Belgium ING Bank Slaski S.A. Poland ING Bank Deutschland A.G. Germany ING Financial Holdings Corporation United States of America ING Middenbank Curaçao N.V. Netherlands Antilles ING Vysya Bank Ltd. India ING Direct N.V. Canada, Germany, Spain, Australia, France, United States of America, Italy, United Kingdom ING Bank A.S. Turkey
29 COMPANIES ACQUIRED AND COMPANIES DISPOSED The initial accounting for the fair value of the net assets of the companies acquired during the year has been determined only provisionally. The initial accounting shall be completed within a year of acquisition.
Minority interests Net assets acquired 112 116 41 47 –9 307
EUR 1,329 million as disclosed in Note 9 ‘Intangible assets’. (2) Cash outflow/inflow on group companies in the cash flow statement includes cash outflows/inflows on individually immaterial acquisitions and real estate portfolios in addition to the cash flows presented herein.
In January 2008, ING closed the final transaction to acquire 100% of Banco Santander’s Latin American pension and annuity businesses through the acquisition of the pension business in Chile. See Acquisitions effective in 2007 (see page 152) for full details of the entire deal.
Cash in company disposed 12 26 38 Cash inflow on disposal (1) 260 924 1,184
(2) The gain/loss on disposal comprises the sales proceed, the net assets disposed, the expenses directly related to the disposal and the realisation of unrealised reserves.
In July 2008, ING announced it had completed the sale of part of its Mexican business, Seguros ING SA de CV and subsidiaries, to AXA as announced in February 2008, for a total consideration of EUR 950 million (USD 1.5 billion). The sale resulted in a gain of EUR 182 million.
Additional information to the consolidated balance sheet of ING Group (continued)
As mentioned in Acquisitions effective in 2007 ING acquired the AFJP Pension (Origenes AFJP S.A.) company in Argentina as part of the Santander transaction. In November 2008 the Government of Argentina passed legislation to nationalise the private pension system (AFJPs). Under the law, all client balances held by the private pension system would be transferred to the Argentina Government and AFJP’s pension business would be terminated. The law became effective in December 2008 when the Argentine Social Security Administration (ANSES) took ownership over the affiliate accounts. The nationalisation impacted the pension assets only, thus leaving ING responsible for the ongoing operating costs and liabilities including severance obligations. This resulted in a loss of EUR 188 million being recognised in 2008.
In February 2009, ING announced that it had agreed to sell its 70% stake in ING Canada for net proceeds of approximately EUR 1,265 million (CAD 2,163 million). The transaction was closed on 19 February 2009 and will be booked in 2009. This transaction will result in a decrease in Total assets of approximately EUR 5,471 million and a decrease of Total liabilities of approximately EUR 3,983 million.
Costs directly attributable to the acquisition 2 8 2 1 13
Liabilities Insurance and investment contracts 500 500 Amounts due to banks 632 632 Customer deposits and other funds on deposit 5,369 5,369
Disposals effective in 2007 In June 2007, ING sold its investment in Nationale Borg, a specialist provider of guarantee insurance, to HAL Investments BV and Egeria.
In July 2007, ING sold its entire shareholding in ING Regio B.V., a subsidiary of Regio Bank N.V. to SNS REAAL for EUR 50.5 million, resulting in a gain of EUR 26 million. This entity conducts most of the business of Regio Bank. The legal entity Regio Bank N.V. itself was not part of the transaction.
Profit since date of acquisition –1 1 8 8 Income if acquisition effected at start of year 2 33 131 166 (1) Goodwill recognised in 2006 on immaterial acquisitions and real estate portfolios was EUR 74 million, resulting in total Goodwill recognised in 2006 of EUR 169 million as disclosed in Note 9 ‘Intangible assets’.
In October 2006, ING acquired 56% of Summit Real Estate Investment Trust (Summit REIT) for an amount of EUR 2,132 million. Summit REIT owns a portfolio of high-quality light industrial properties in major markets across Canada.
In October 2006, ING acquired 100% of ABN AMRO Asset Management (Taiwan) Ltd, a registered Securities Investment Trust Enterprise, for EUR 65 million. The purchase will strengthen ING’s existing position as the Taiwanese largest overall asset manager.
These proceedings include complaints and lawsuits concerning the performance of certain interest sensitive products that were sold by a former subsidiary of ING in Mexico. These matters are being defended vigorously; however, at this time, we are unable to assess their final outcome. In addition, a subsidiary is a garnishee in proceedings in the United States brought by judgement creditors of the Republic of Argentina who seek to levy on assets that were managed by that subsidiary before the Republic nationalised the private pension business in Argentina. Appropriate steps are being taken to address this matter. Further, litigation commenced in February 2009, purportedly on behalf of classes, challenges the adequacy of the disclosures made in connection with the 2007 and 2008 issuance and sale of the ING’s Perpetual Hybrid Capital Securities, and additional purported class litigation challenges the operation of the ING’s American Savings, ESOP and 401(k) Plans. These matters are at very preliminary stages, and while we are not able to assess their final outcome, we intend to vigorously defend against them.
Loans and advances to key management personnel amounts in thousands of euros Amount outstanding 31 December Average interest rate Repayments
The total number of stock options on ING Groep N.V. shares held by the Executive Board members amounted to 3,436,583 as at 31 December 2008 (2007: 2,744,887). As at 31 December 2008, members of the Executive Board held 250,969 ING Groep N.V. shares (2007: 201,252). As at 31 December 2008, members of the Supervisory Board held 8,940 ING Groep N.V. shares (2007: 17,370).
Financial assets Cash and balances with central banks 22,045 12,406 22,045 12,406 Amounts due from banks 48,308 48,461 48,447 48,875 Financial assets at fair value through profit and loss
– designated as at fair value through profit and loss 8,277 11,453 8,277 11,453 Investments
The estimated fair values correspond with the amounts at which the financial instruments at our best estimate could have been traded at the balance sheet date between knowledgeable, willing parties in arm’s length transactions. The fair value of financial assets and liabilities is based on quoted market prices, where available. Because substantial trading markets do not exist for all of these financial instruments various techniques have been developed to estimate their approximate fair values. These techniques are subjective in nature and involve various assumptions about the relevant pricing factors. Changes in these assumptions could significantly affect the estimated fair values. Consequently, the fair values presented may not be indicative of the net realisable value. In addition, the calculation of the estimated fair value is based on market conditions at a specific point in time and may not be indicative of future fair values.
Financial assets at fair value through profit and loss The fair values of securities in the trading portfolio and other assets at fair value through profit and loss are based on quoted market prices, where available. For those securities not actively traded, fair values are estimated based on internal valuation techniques.
Investments The fair values of equity securities are based on quoted market prices or, if unquoted, on estimated market values generally based on quoted prices for similar securities as determined by management. Fair values for fixed interest securities are based on quoted market prices, where available. For those securities not actively traded, fair values are determined by management based on an analysis of available market inputs, which may include values obtained from one or more pricing services or by discounting expected future cash flows using a current market rate applicable to the yield, credit quality and maturity of the investment. Reference is made to the comments on investments in asset backed securities in the United States in Sensitivities of fair values below.
Financial liabilities Subordinated loans The fair value of the subordinated loans is estimated using discounted cash flows based on interest rates that apply to similar instruments.
Financial liabilities at fair value through profit and loss The fair values of securities in the trading portfolio and other liabilities at fair value through profit and loss are based on quoted market prices, where available. For those securities not actively traded, fair values are estimated based on internal valuation techniques.
Debt securities in issue and other borrowed funds The fair value of debt securities in issue and other borrowed funds is generally based on quoted market prices or, if unquoted, on estimated prices by discounting expected future cash flows using a current market rate applicable to the yield, credit quality and maturity.
ING Group has categorised its financial instruments into a three level hierarchy based on the priority of the inputs to the valuation. The fair value hierarchy gives the highest priority to quoted prices in active markets for identical assets or liabilities and the lowest priority to unobservable inputs. An active market for the asset or liability is a market in which transactions for the asset or liability occur with sufficient frequency and volume to provide reliable pricing information on an ongoing basis.
The fair values of the financial instruments carried at fair value were determined as follows: Methods applied in determining fair values of financial assets and liabilities
Financial assets designated at fair value through profit and loss 3,658 2,746 1,873 8,277
Financial liabilities designated at fair value through profit and loss 5,591 8,354 64 14,009 Investment contracts (for contracts carried at fair value) 11,182 99 11,281
Methods applied in determining fair values of financial assets and liabilities
Financial assets designated at fair value through profit and loss 5,012 4,608 1,833 11,453
This category includes financial instruments for which it is market convention to price these based on a single published reference rate (e.g. a published yield curve in the case of plain vanilla interest rate swaps). The total amount of these types of financial instruments is EUR 4,786 million in assets and EUR 4,996 million in liabilities. Certain reverse repos with a very short tenor (i.e. a matter of days) for which the valuation is based on the actual prices on issuance and maturity, are included in this category on the basis that their valuation is highly objective and based on a third-party source.
The total amount of changes in fair value estimated using a valuation technique not supported by market inputs recognised in net result in 2008 was EUR –261 million (2007: EUR 74 million).
Sensitivities of fair values Reasonably likely changes in the assumptions used in the valuation techniques not supported by recent market transactions would not have a significant impact on equity and net result, other than explained below for investments in asset backed securities in the United States.
Assets classified in Valuation technique not supported by market inputs consist mainly (approximately 87%) of investments in asset backed securities in the United States. These assets are valued using external price sources that are obtained from third party pricing services and brokers. As at 31 December 2007, these assets were classified in Reference to published price quotations in active markets as valuation was based on independent quotes and trading in the relevant markets was active at that time. During 2008, the trading volumes in the relevant markets reduced significantly and these have now become inactive. The dispersion between prices for the same security from different price sources increased significantly. As a result, an amount of EUR 25 billion of asset backed securities in the United States was reclassified from Reference to published price quotations in active markets to Valuation technique not supported by market inputs in the third quarter of 2008. In order to ensure that the most accurate and relevant sources available are used in determining the fair value of these securities, the valuation process was further enhanced during 2008 by using information from more pricing sources and enhancing the process of selecting the most appropriate price.
Generally up to four different pricing services are utilised. Management carefully reviews the prices obtained in conjunction with other information available, including, where relevant, trades in the market, quotes from brokers and internal evaluations. If the dispersion between different prices for the same securities is limited, a hierarchy exists that ensures consistent selection of the most appropriate price. If the dispersion between different prices for the same security is significant, additional processes are applied to select the most appropriate price, including an internally developed price validation matrix and a process to challenge the price source.
These are indicators of sensitivity and not alternatives for fair value under IFRS-EU.
Reference is made to the ‘Risk management’ section with regard to the exposure of these asset backed securities as at 31 December 2008 and the impact from these asset backed securities on net result in 2008.
Interest income on loans 31,174 26,390 21,970 Interest income on impaired loans –24 –26 13 Total interest income on loans 31,150 26,364 21,983
Interest expense on deposits by banks 4,856 5,131 3,559 Interest expense on customer deposits and other funds on deposit 19,594 18,563 15,107
In 2008, the growth in average total assets led to an increase of the interest result amounting to EUR 811 million (2007: EUR 753 million; 2006: EUR 1,040 million). The increase of the interest margin by 13 basis points led to an increase of the interest result with EUR 1,440 million (in 2007 the decrease of the interest margin by 12 basis points led to a decrease of the interest result with EUR 1,051 million; in 2006 the decrease of the interest margin by 10 basis points led to a decrease of the interest result with EUR 867 million).
Reinsurance ceded –196 –306 –339 –1,802 –1,968 –2,004 –1,998 –2,274 –2,343
Income from real estate investments 75 80 184 196 252 134 271 332 318
Income from investments in debt securities and loans 8,080 8,784 8,756 18 8,080 8,784 8,774
Other include commission fees of EUR 21 million (2007: EUR 26 million; 2006: EUR 42 million) in respect of underwriting syndication loans.
Change in fair value of assets and liabilities (hedged items) 164 223 211 5,533 –886 –203 5,697 –663 8 Valuation results on assets and liabilities designated as at fair value through profit and loss (excluding trading) –432 89 127 56 –247 –305 145 –247 39 NET TRADING INCOME
The portion of trading gains and losses for the year ended 31 December 2008 relating to trading securities still held as at 31 December amounted to EUR –246 million (2007: EUR –60 million; 2006: EUR –121 million).
The majority of the risks involved in security and currency trading is economically hedged with derivatives. The securities trading results are partly offset by results on these derivatives. The result of these derivatives is included in Derivatives trading results.
Income from real estate development projects 124 95 220 124 95 220
– effect of investment result risk of policyholders –32,408 1,079 2,702
The investment income and valuation results regarding investment result for risk of policyholders of EUR –32,408 million (2007: EUR 1,079 million; 2006: EUR 2,702 million) have not been recognised in Investment income and valuation results on assets and liabilities designated at fair value through profit and loss but are recognised in Underwriting expenditure together with the equal amount of change in insurance provisions for risk of policyholders.
Expenditure from investment contracts Costs of acquiring investment contracts 9 19 31 Profit sharing and rebates 16 64 Other changes in investment contract liabilities –905 985 1,272
Distributions on account of interest or underwriting results –576 –133 458 Bonuses added to policies 131 411 369 Deferred profit sharing expense 29 146 –26
Underwriting expenditure includes an amount of EUR 3,804 million in 2008 (2007: EUR 4,275 million; 2006: EUR 4,141 million) in respect of commission paid and payable with regard to the insurance operations. Amortisation of deferred acquisition costs amounted to EUR 2,026 million in 2008 (2007: EUR 1,552 million; 2006: EUR 1,444 million).
ING transferred part of its life insurance business to Scottish Re in 2004 by means of a co-insurance contract. A loss amounting to EUR 160 million was recognised in Underwriting expenditure in 2004 on this transaction. This loss represented the reduction of the related deferred acquisition costs. In addition, an amount of EUR 240 million is being amortised over the life of the underlying business, starting in 2005 and gradually decreasing in subsequent years as the business tails off. The amount amortised in 2008 was EUR 12 million (2007: EUR 15 million; 2006: EUR 32 million). The cumulative amortisation as at 31 December 2008 was EUR 96 million (2007: EUR 81 million; 2006: EUR 66 million). On 23 January 2009, Hannover Re and Scottish Re announced that Hannover Re has agreed to assume the ING individual life reinsurance business originally transferred to Scottish Re in 2004.
Software and other intangible assets 71 15 10 71 15 10
Share-based compensation arrangements includes EUR 98 million (2007: EUR 110 million; 2006: EUR 108 million) relating to equitysettled share-based payment arrangements and EUR 26 million (2007: EUR 17 million; 2006: EUR 4 million) relating to cash-settled share-based payment arrangements.
Remuneration of senior management, Executive Board and Supervisory Board The information on share-based payment plans and remuneration of the members of the Executive Board and the Supervisory Board is included in the remuneration report in the annual report. This information is considered to be an integral part of the audited annual accounts.
ING Group holds its own shares in order to fulfil its obligations with regard to the existing stock option plan and to hedge the position risk of the options concerned (so-called delta hedge). As at 31 December 2008, 32,367,870 own shares (2007: 36,028,881; 2006: 52,722,755) were held in connection with the option plan compared to 87,263,381 options outstanding (2007: 76,888,553; 2006: 74,175,909). As a result the granted option rights were (delta) hedged, taking into account the following parameters: strike price, opening price, zero coupon interest rate, dividend yield, expected volatility and employee behaviour. The hedge is rebalanced regularly at predetermined points in time.
Exposure arising out of the share plan is not hedged. The obligations with regard to these plans will in the future be funded either by cash or shares from the delta hedge portfolio at the discretion of the holder. On 31 March 2008, 1,786,762 million own shares were issued in relation to the vesting of share plans.
Every year, the ING Group Executive Board will decide whether the option and share schemes are to be continued and, if so, to what extent.
The weighted average share price at the date of exercise for options exercised during 2008 is EUR 24.07 (2007: EUR 32.48).
The fair value of share awards granted is recognised as an expense under staff expenses and is allocated over the vesting period of the share awards. The fair values of share awards have been determined by using a Monte Carlo simulation based valuation model. The model takes into account the risk free interest rate, the current stock prices, expected volatilities and current divided yields of the performance peer group used to determine ING’s Total Shareholder Return (TSR) ranking.
Other interest expenses include EUR 1 million and EUR 94 million dividends paid on preference shares and trust preferred securities (2007: EUR 7 million and EUR 92 million; 2006: EUR 10 million and EUR 101 million).
Other operating expenses include lease and sublease payments in respect of operating leases of EUR 172 million (2007: EUR 156 million; 2006: EUR 229 million) in which ING is the lessee. Other operating expenses also include EUR 85 million related to integration costs of CitiStreet and EUR 143 million related to premium taxes.
Result before taxation –1,487 11,043 9,940 Weighted average statutory tax rate 49.9% 28.7% 30.9% Weighted average statutory tax amount –742 3,169 3,071
Attribution to non-voting equity securities –425 Earnings – after attribution to non-voting equity securities –1,154 9,241 7,692 2,042.7 2,141.1 2,155.0 –0.56 4.32 3.57
Diluted earnings per share data are computed as if the stock options and warrants outstanding at year-end had been exercised at the beginning of the period. It is also assumed that ING Group uses the cash received from exercised stock options and warrants exercised or non-voting equity securities converted to buy its own shares against the average market price in the financial year. The net increase in the number of shares resulting from exercising warrants and stock options or converting non-voting equity securities is added to the average number of shares used for the calculation of net earnings per share.
Each business line is headed by a member of the Executive Board. The Executive Board sets the performance targets and approves and monitors the budgets prepared by the business lines. Business lines formulate strategic, commercial and financial policies in conformity with the strategy and performance targets set by the Executive Board.
ING Group evaluates the results of its business segments using a financial performance measure called underlying result before taxation. Underlying result before taxation is defined as result before taxation excluding the impact of divestments and special items.
– Increase in provisions for Insurance and investment contracts 2,113 7,098 7,339 –187 16,363 16,363
– Addition to loan loss provision 596 401 283 1,280 1,280
Impairments on investments are presented within Investment income, which is part of Total income. In 2008, total impairments of EUR 4,820 million are included in the following segments: EUR 2 million in Insurance Europe, EUR 692 million in Insurance Americas, and EUR 79 million in Insurance Asia Pacific, EUR 267 million in Wholesale Banking, EUR 4 million in Retail Banking, EUR 1,891 million in ING Direct and EUR 1,885 million in Other.
Share in profit or loss of associates 316 191 212 26 –5 740 740
As at 31 December 2007, the segment Insurance Asia/Pacific had a net reserve inadequacy using a prudent (90%) confidence level. This inadequacy was offset by reserve adequacies in other segments, so that at Group level there is a net adequacy at the prudent (90%) confidence level. Following the agreement to sell ING Life Taiwan the inadequacy in Insurance Asia/Pacific was eliminated as at 31 December 2008.
Interest income (external) and interest expense (external) breakdown by business line
Cost incurred to acquire property, equipment and intangibles 1,506 62 253 228 40 75 46 2,210
Geographical analysis of claims, expense ratio and combined ratio for non-life insurance policies
Included in cash and cash equivalents – amounts due to banks –13,738 –42,154 –26,498 – amounts due from banks 15,955 8,807 6,044 2,217 –33,347 –20,454
Despite the fact that the ongoing crisis claims most of the management attention on a daily basis throughout the risk management organisation, ING Group continued its long-term investments in risk management, including investments in people, governance, processes, measurement tools and systems. The Non-Financial Risk Dashboard, which was introduced internally and piloted in 2007 was implemented and presented to the Executive Board and the Audit Committee for the first time in November 2008.
Risk mitigation To counter the implications of the financial crisis ING Group decided to take several measures over the course of the year to reduce risk: Deleveraging • ING is working to reduce the bank balance sheet by 10% by decreasing the non-lending part by 25%. ING intends to reduce the available for sale portfolio over time as proceeds from maturing securities will be used to fund ING-originated loans. Reducing trading activities, deposits at other banks and reverse-repos are expected to make up most of the remaining reduction. At the same time, lending activities will be maintained with focus on the Corporate and Retail business. Reduction of credit risk • In January 2009, ING Group entered into an Illiquid Assets Back-up Facility term sheet with the Dutch State covering ING’s Alt-A residential mortgage backed securities (RMBS) portfolio. Through this transaction, which is expected to close in the first quarter of 2009, subject to final documentation and regulatory approval, the Dutch State will become the economic owner of 80% of the Alt-A RMBS portfolio. This transaction is expected to be concluded at 90% of the par value with respect to the 80% portion of the portfolio
of which the Dutch State will become the economic owner. Par value of the portfolio is approximately EUR 30 billion. Following the deteriorated economic outlook in the third and fourth quarter market prices for these securities had become depressed as liquidity dried up, which had an impact on ING’s results and equity far in excess of estimated credit losses. The transaction with the Dutch State is expected to significantly reduce the uncertainty regarding the impact on ING of any future losses in the portfolio. As condition to the Facility ING will commit to support the growth of the Dutch lending business for an amount of EUR 25 billion at market-conforming conditions. The Dutch State will also acquire certain consent rights with respect to the sale or transfer of the 20% proportion of the Alt-A RMBS portfolio that is retained by ING. Reduction of equity exposure (available-for-sale) • Direct public exposure was reduced from EUR 15.8 billion at the end of 2007 to EUR 5.8 billion at year-end 2008. The reduction in exposure was due to negative revaluations, and sales. ING Insurance holds EUR 3.9 billion balance sheet exposure which was partially hedged against further market losses. In addition, a temporary hedging programme was put in place to reduce earnings volatility resulting from potential DAC (Deferred Acquisition Cost) unlocking. Reduction of interest rate risk• ING sold ING Life Taiwan which resulted into a significant reduction of its interest rate risk exposure. This divestment was in line with the strategy to allocate capital to those businesses that generate the highest return. In addition, ING lengthened its asset duration in order to mitigate the impact of declining interest rates, herewith further reducing its interest rate risk exposure.
US Subprime RMBS 1,778 –839 –120 –52 2,789 –307 US Alt-A RMBS 18,847 –6,538 –2,064 –33 27,482 –936
ING Group’s total EUR 1.8 billion exposure to US sub-prime assets relates to non originated loans acquired as investments in RMBS • and represents 0.1% of total assets. At 31 December 2008 approximately 77% of ING’s US sub-prime portfolio was rated AA or higher. ING Group does not originate sub-prime mortgages. The vast majority of the total mortgage backed securities (MBS) are (residential) mortgages that are not classified as sub-prime. ING Group’s total US Alt-A RMBS exposure at 31 December 2008 was EUR 18.8 billion. About 65% of this portfolio was AAA rated. • The majority of the exposure (EUR 16.3 billion) was held by ING Direct. ING’s Available-for-Sale Alt-A investments are measured at fair value in the balance sheet. The substantial amount of negative pre-tax revaluation and impairments on this portfolio are mainly caused by the illiquid market. Net investments in CDOs/CLOs at 31 December 2008 were 0.3% of total assets. The vast majority of the CDOs/CLOs has investment • grade corporate credit as underlying assets, only EUR 1 million has US subprime mortgages underlying. Other changes includes purchases and sales of CDOs/CLOs, as well as foreign currency effects.
EUR 23.7 billion of the EUR 24.1 billion exposure on US Subprime RMBS, US Alt-A RMBS and CDOs/CLOs is booked at fair value. An analysis of the method applied in determining the fair values of financial assets and liabilities is provided in Note 33 ‘Fair value of Financial Assets and Liabilities’. At 31 December 2008 the fair value of US Subprime RMBS, US Alt-A RMBS and CDOs/CLOs was as follows: Fair value of US subprime RMBS, US Alt-A RMBS and CDOs/CLOs
Fair value of US subprime RMBS, US Alt-A RMBS and CDOs/CLOs
Impact on other asset classes Negative impact on results 2008 (pre-tax) from private equity and alternative assets amounted to EUR 399 million. Negative impact on results 2008 (pre-tax) from debt securities other than mentioned above amounted to EUR 292 million.
Impact on counterparty risk In the third quarter a number of financial institutions were no longer expected to fulfil their obligations. ING incurred EUR 483 million pre-tax losses (excluding loan losses) on Lehman Brothers, Washington Mutual and the Icelandic banks. The loss included impairments of debt securities, trading losses and derivative positions, including the costs to replace derivatives on which the banks were counterparty.
Impact on Liquidity profile Due to the financial crisis liquidity became scarce and central banks around the world provided funding to prevent the interbank market drying up. ING’s liquidity position remained within internally set limits. ING Bank has a favourable funding profile as the majority of the funding stems from client deposits.
While we continue to monitor our exposures in this area, in the light of the ongoing market environment and the resulting uncertainties concerning valuations, there can be no assurances that we will not experience further negative impacts on our shareholders’ equity or profit and loss accounts from such assets in future periods.
The following paragraphs provide a high level overview of the risk management governance and risk profile from an ING Group perspective. This is followed by a more detailed overview, split into the different risk types (credit, market, liquidity, insurance, operational and compliance risk) both for ING Bank and ING Insurance. The section concludes with disclosures on models for Earnings at Risk (EaR), Capital at Risk (CaR) and Economic Capital (EC).
The following principles support this objective: Products and portfolios are structured, underwritten, priced, approved and managed appropriately and compliance with internal • and external rules and guidelines is monitored; ING Group’s risk profile is transparent, has ’no surprises’, and is consistent with delegated authorities;• Delegated authorities are consistent with the overall Group strategy and risk appetite;• Transparent communication to internal and external stakeholders on risk management and value creation.•
The risk organisation is structured independently from the business lines and is organised through five risk departments: Corporate Credit Risk Management (CCRM) is responsible for the credit risk management of ING Bank and ING Insurance;• Corporate Market Risk Management (CMRM) is responsible for the market risk management and liquidity risk management of ING Bank;• Corporate Insurance Risk Management (CIRM) is responsible for the insurance, market and liquidity risk management of ING Insurance;• Corporate Operational Risk Management (CORM) is responsible for the operational risk management of ING Bank and ING Insurance;• Group Compliance Risk Management (GCRM) supports and advises management in fulfilling its compliance responsibilities, advises • employees on their (personal) compliance obligations and oversees and reports on the embedding of Compliance policies in both ING Bank and ING Insurance.
In addition two staff departments report to the CRO: The Risk Integration and Analytics department is responsible for inter-risk aggregation processes and for providing group-wide risk • information to the CRO and Executive Board; The Model Validation department reviews the performance of all material risk models applied within ING. This department carries • out periodic model validations of all material risk models used by ING. To ensure independence from the business and the other risk departments, the head of this department reports directly to the CRO.
ING Group Credit Committee – Policy (GCCP): Discusses and approves policies, methodologies and procedures related to credit, • country and reputation risks within ING Group. The GCCP meets on a monthly basis; ING Group Credit Committee – Transaction Approval (GCCTA): Discusses and approves transactions which entail taking credit risk • (including issuer investment risk). The GCCTA meets two times a week; ING Group Investment Committee (GIC): Discusses and approves investment proposals for ING Real Estate. The GIC meets on a • monthly basis; Asset and Liability Committee ING Bank (ALCO Bank): Discusses and approves the overall risk profile of all ING Bank’s market risks that • occur in its Wholesale Banking, Retail Banking and ING Direct activities. ALCO Bank defines the policy regarding funding, liquidity, interest rate mismatch and solvency for ING Bank. ALCO Bank meets on a monthly basis; Asset and Liability Committee ING Insurance (ALCO Insurance): Discusses and approves all risks associated with ING’s Insurance • activities. This includes volatility (affecting earnings and value), exposure (required capital and market risk) and insurance risks. ALCO Insurance meets six times a year; Operational and Residual Risk Committee (ORRC): Discuss and approve issues related to Methods, Models and Parameters related to • Operational risk, Business risk in Banking, inter-risk diversification and consistency across risk types and businesses. The committee meets at least twice a year.
Board level risk oversight At the highest level of the ING organisation, there are board committees which oversee risk taking, and have ultimate approval authority. ING Group has a two-tier board structure consisting of the Executive Board and the Supervisory Board; both tiers play an important role in managing and monitoring the risk management framework.
The CRO makes sure that the board committees are well informed and understand ING Group’s risk position at all times. Every quarter the CRO reports to the board committees on ING’s risk appetite levels and on ING Group’s risk profile. In addition the CRO briefs the board committees on developments in internal and external risk related issues and makes sure the board committees understand specific risk concepts.
ING has integrated risk management into the annual strategic planning process. This process aligns strategic goals, business strategies and resources throughout ING Group. The process is such that the Executive Board issues a Planning Letter which provides the organisation with the corporate strategic direction, and addresses key risk issues. Based on this Planning Letter the business lines and business units develop their business plans which align with the Group’s strategic direction. The process includes a qualitative and quantitative assessment of the risks involved in the plans. It is part of the process to explicitly discuss strategic limits and group risk appetite levels. At each level, strategies and metrics are identified to measure success in achieving objectives and to assure adherence to the strategic plan. Based on the business unit and line of business plans, the Executive Board formulates the Group Strategic Plan which is submitted to the Supervisory Board for approval.
Group risk policies ING has a framework of risk management policies, procedures and standards in place to create consistency throughout the organisation, and to define minimum requirements that are binding on all business units. The governance framework of the business units aligns with the Group level framework and meets local (regulatory) requirements. Senior Management is responsible to ensure policies, procedures and standards are implemented and adhered to. Employees globally have access to the Group’s governance framework through an internal website. Policies, procedures and standards are regularly reviewed and updated via the relevant risk committees to reflect changes in markets, products and emerging best practices.
ING GROUP RISK PROFILE ING Group uses an integrated risk management approach. The risk dashboard captures the risks in all Banking and Insurance business lines in terms of Earnings at Risk and Capital at Risk, and shows the impact of diversification across the Group. The Executive Board uses the risk dashboard to monitor and manage the actual risk profile in relation to the Group risk appetite. It enables the Executive Board to identify possible risk concentrations and to support strategic decision making. The risk dashboard is reported to the Executive Board on a quarterly basis and is subsequently presented to the Audit Committee.
ING Group risk metrics The Group’s risk appetite is captured in three different metrics which are disclosed below: Earnings at Risk; the potential reduction in IFRS earnings over the next year relative to expected IFRS earnings, during a moderate • (i.e. ‘1 in 10’) stress scenario. Maintaining a high quality of earnings helps ING to safeguard against being downgraded by the rating agencies; Capital at Risk; the potential reduction of the current net asset value (based on fair values) over the next year relative to the expected • value during a moderate (i.e. ‘1 in 10’) stress scenario; Economic Capital; the amount of capital that is required to absorb unexpected losses in times of severe stress given ING Group’s ‘AA’ • target rating.
Potential value reduction of net value during an ‘extreme’ stress scenario (i.e. 1 in 2000)
Operational and business risk are summarised as other risks in the risk profile: Operational risk is the risk of direct or indirect loss resulting from inadequate or failed internal processes, people and systems • or from external events. It includes the risk of reputation loss, as well as legal risk; whereas strategic risks are not included; Business risk: the exposure to value loss due to fluctuations in volumes, margins and costs. These fluctuations can occur because • of internal, industry, or wider market factors. It is the risk inherent to strategy decisions and internal efficiency.
Given the October 2008 announced sale of ING Life Taiwan to Fubon Financial Holdings Co Ltd, this business is excluded from all 2008 risk disclosures in this section. The sale has been finalised on 11 February 2009.
Capital at Risk The level of Capital at Risk (CaR) measured against ING’s financial position provides understanding as to whether ING can maintain a sound financial position under a ‘moderate’ (i.e. 1 in 10) stress scenario. The risk appetite set by the Executive Board defines the maximum potential value reduction over the next year during a (non extreme) stress scenario as a percentage of Available Financial Resources (AFR) (the definition of AFR is provided in the Capital Management section below).The tables below show the Capital at Risk per risk type.
(1) Total ING Group is comprised of ING Bank and ING Insurance, excluding core debt of EUR 7,170 million within ING Group.
The credit and transfer risk increase is mainly due to downgrades and lower initial ratings for unrated facilities. These increases will be only partially offset by the risk reducing impact of the Illiquid Assets Back-up Facility through which the Dutch State will become the economic owner of 80% of the Alt-A Portfolio. This transaction is expected to close in the first quarter of 2009 subject to final documentation and regulatory approval. The effect of this deal has already been included since the dashboard is forward looking.
The decrease in equity risk is the result of the declining equity markets and de-risking activities and hedges put in place near the end of 2008.
Capital at Risk and Earnings at Risk by line of business (Group diversified)
Overall Capital at Risk decreased with a significant decrease in ING Insurance and an increase in ING Bank. Credit migration explains most of the increase in CaR Wholesale Banking and in ING Direct.
Economic Capital ING Group Since 1999 ING Bank has been disclosing Economic Capital information externally, whereas ING Insurance disclosed Economic Capital information for the first time in 2007. Although the fundamental principles are the same, ING Bank and ING Insurance Economic Capital information is currently calculated based on (partly) separately developed models (see Model Disclosure section below) that may differ in the calculation and aggregation approach due to different market practices and standards used in the banking and insurance industries.
ING’s Group Economic Capital is determined by applying one common aggregation approach to bank and insurance. ING Group Economic Capital is 15% lower than the sum of the parts (bank and insurance). Three different factors contribute to this consolidation benefit: 1. offsetting positions between bank and insurance: especially on the interest rate risk side, where the long duration assets of the bank are offset by the long duration liabilities of the Insurance 2. diversification between bank and insurance asset classes based on observed correlations: e.g. less than 1 correlation between insurance equity positions and bank real estate positions 3. diversification between bank and insurance risk drivers based on expert opinion correlations: e.g. less than perfect correlation between operational risk incidents at the bank and interest rate risk in insurance
ING has calculated this consolidation benefit to be 15% (2007: 15%). The table below shows the contribution of the different risk drivers to the consolidation benefit: Contribution to consolidated Benefit
Interest Rate risk 60% Equity risk 7% Foreign Exchange risk 1% Real Estate risk 4% Credit risk 3% Other risks* 25% Total 100%
ING Bank 22.4 18.7 ING Insurance 13.7 23.2 Consolidated Benefit –5.4 –5.9 Total ING Group Economic Capital 30.7 36.0 * In 2007 a group add-on of EUR 0.8 billion related to investments backing Bank Equity was added at Group Level and is now included in Bank EC. The remaining EUR 0.2 billion add-on in 2007 is no longer applicable in 2008 (for comparison it was included in the diversification benefit).
Risk measurement ING Bank and ING Insurance The overall ING Group risk appetite is translated into specific limits which are cascaded down into the organisation, e.g.
The ING Bank Economic Capital model is described in more detail in the Model Disclosure section.
The following table provides the Economic Capital break down by risk category including diversification benefits proportionally allocated to the risk types: Economic Capital (Bank diversified only) by risk category
Credit risk (including Transfer risk) 8,686 7,503 Market risk 10,349 7,407
The overall increase in Economic Capital is mainly due to the inclusion of the core equity investments in market risk Economic Capital Bank, whereas previously it was taken as an add-on at Group level. Furthermore the increased Economic Capital can be explained by credit migrations, increased market volatility and model enhancements.
Credit analysis is risk/reward-oriented in that the level of credit analysis is a function of the risk amount, tenor, structure (e.g. covers received) of the facility, and the risks entered into. For credit risk management purposes, financial obligations are classified into lending, investments, pre-settlement, money market and settlement. ING Bank applies a Risk Adjusted Return on Capital framework (RAROC) which measures the performance of different activities and links to shareholder value creation. The use of RAROC increases focus on risks versus rewards in the decision making process, and consequently stimulates the use of scarce capital in the most efficient way. More sophisticated RAROC-based tools are used internally to ensure a proper balance of risk and reward within the portfolio and concentration parameters. ING’s credit analysts make use of publicly available information in combination with in-house analysis based on information provided by the customer, peer group comparisons, industry comparisons and other quantitative techniques.
Lending risk Lending risk arises when ING grants a loan to a customer, or issues guarantees on behalf of a customer. This is the most common risk category, and includes term loans, mortgages, revolving credits, overdrafts, guarantees, letters of credit, etc. The risk is measured at the notional amount of the financial obligation that the customer has to repay to ING, excluding any accrued and unpaid interest, discount/ premium amortisations or impairments.
Determination of credit risk outstandings Figures associated with Money Market and Lending activities are generally the nominal amounts, while amounts associated with Investment activities are based on the original amount invested less repayments. Off-Balance Sheet exposures include the letters of credits and guarantees, which are associated with the Lending Risk Category. Additionally, Off-Balance Sheet exposures include a portion of the unused limits, associated with the statistically expected use of the unused portion of the limit between the moment of measurement and the theoretical moment of statistical default. Collectively, these amounts are called ‘credit risk oustandings’. Exposures associated with Securitisations (Asset Backed Financing, Commercial/Residential Mortgage Backed Securities and Covered Bonds) are shown separately. These amounts also relate to the amount invested prior to any impairment activity or mark-to-market adjustments. This amount is also considered to be ‘outstandings’.
Collateral policies As with all financial institutions and banks in particular, ING is in the business of taking credit risks in an informed and measured fashion. As such, the creditworthiness of our customers, trading partners and investments is continually evaluated for their ability to meet their financial obligations to ING. During the assessment process of creating new loans, trading limits, or making investments, as well as reviewing existing loans trading positions and investments, ING determines the amount and type of collateral, if any, that a customer may be required to pledge to ING. Generally, the lower the perceived creditworthiness of a borrower or financial counterparty, the more collateral the customer or counterparty will have to provide. Within counterparty trading activities, ING actively enters into various legal arrangements whereby ING and/or counterparties may have to post collateral to one another to cover market fluctuations of their relative positions. Laws in various jurisdictions also affect the type and amount of collateral that ING can receive or pledge. Additionally, ING will sometimes enter into credit default swaps, and other similar instruments, in order to reduce the perceived credit risk on a given borrower or portfolio. The type of collateral which is held as security is determined by the structure of the loan or position. Consequently, since ING’s portfolio is diversified, the profile of collateral it receives is also diversified in nature and does not reflect any particular collateral type more than others.
Restructuring activities for Business borrowers normally start with a watch list indication. Borrowers on the watch list maintain their rating (1-19). A watch list indication may develop into a restructuring status (15-19) or even a recovery status (20-22). Most borrowers with a watch list indication return to a regular status. For Consumer clients the watch list of ‘potential problem loan’ status is usually caused by payment arrears (more than 1 month) which are subsequently reflected in the risk rating of 18-19 (or comparable status based on an increased probability of default). Following restructuring relationship management is either transferred to the regular commercial banking departments or terminated. ING’s renegotiated loans that would otherwise be past due or impaired are reflected below: ING Bank renegotiated loans that would otherwise be past due or impaired (outstandings)
From restructuring (18-19) to regular (1-17) status 1,183 1,414 From recovery (20-22) to regular or restructuring status (1-19) 3,556 3,123 Total of renegotiated loans 4,739 4,537
For Business clients, ING has taken a proactive approach to restructuring loans that may have otherwise experienced financial difficulties, which has led to an increase in the level of restructuring loans returning to a regular status. Restructuring is generally a time consuming process that can take several years. Through early 2008, ING’s inventory of problem loans and restructuring clients declined at a steady pace which is then reflected in the level of restructured Business Loans in 2008.
Renegotiated consumer and mortgage loans that would otherwise be past due or impaired (outstandings)
From recovery (20-22) to regular or restructuring status (1-19) 2,578 1,953
Past due for 1-30 days 5,844 4,709 Past due for 31-60 days 1,223 633 Past due for 61-90 days 157 74
(1) Based on lending (consumer loans and residential mortgages only). (2) The amount of past due but not impaired financial assets in respect of non-lending activities was not material.
ING tracks past due but not impaired loans most closely for the consumer loan and residential mortgage portfolios. Generally, all loans with past due financial obligations of more than 90 days are automatically reclassified as impaired. For the wholesale lending portfolios and securities obligations, there are generally reasons for declaring a loan impaired prior to being 90 days past due. These include, but are not limited to, ING’s assessment of the customer’s perceived inability to meet its financial obligations, or the customer filing for bankruptcy or bankruptcy protection. In some cases, a material breach of financial covenants will also trigger a reclassification of a loan to the impaired category.
Changes in the composition of the group 2 2 95 1 2 98 Write-offs –260 –593 –399 –302 –69 –57 –728 –952
After three years of declining annual risk costs, the trend turned in 2008 as a result of the global credit crisis. Other changes includes a provision reclassification of mid-sized corporates and wholesale SME from Wholesale Banking to Retail Banking.
Collateral As part of its securities financing business, ING entities actively enter into agreements to sell and buy back marketable securities. These transactions can take many legal forms. Repurchase and reverse repurchase agreements, buy/sellback and sell/buyback agreements, and securities borrowing and lending agreements are the most common. The amount of marketable securities that ING held as collateral under these types of agreements was EUR 82.1 billion at 31 December 2008 and EUR 120.2 billion at 31 December 2007. The reduction is commensurate with the overall decline in open securities financing trades at year end 2008 compared to year end 2007. These amounts exclude the cash leg of the respective transactions, as well as any pledges of securities under Tri-Party agreements (as the underlying is not directly pledged to or owned by ING). As a general rule, the marketable securities that have been received under these transactions are eligible to be resold or repledged in other (similar) transactions. ING is obliged to return equivalent securities in such cases.
(1) Based on credit risk measurement contained in lending, pre-settlement, money market and investment activities. The ratings reflect probabilities of default and does not take collateral into consideration.
ING Direct continued to increase its diversifications into residential mortgages, while proportionally reducing its securitisation and bond portfolios. During 2008, ING reclassified the Mid-Corporate portfolio from Wholesale Banking to Retail Banking, which proportionally decreased the Retail Banking concentration in Private Individuals and created a wider distribution across other economic sectors. This was partially offset by the purchase of EUR 4.5 billion in residential mortgages from Nationale Nederlanden Hypotheek Bedrijf (NNHB, residential mortgages). All other industries not shown in the table above have less than 2.0% concentrations.
Wholesale Banking Retail Banking ING Direct Total ING Bank amounts in billions of euros 2008 2007 2008 2007 2008 2007 2008 2007
The growth in most countries presented above followed the growth pattern of the portfolio as a whole. The growth at ING Direct in Germany, the United States and Spain was principally driven by own originated mortgages (Germany + EUR 6.3 billion, USA + EUR 7.3 billion, Spain + EUR 1.4 billion). Retail Banking in the Netherlands, Belgium and Turkey grew through organic growth as well as the shift of Mid-Corporates from Wholesale Banking to Retail Banking. The decline in the United Kingdom is driven by exchange rate effects.
The Corporate Market Risk Management department (CMRM) is the designated independent department that is responsible for the design and execution of the bank’s market risk management functions in support of the ALCO function. The CMRM structure recognises that risk management to a large extent occurs at the regional/local level. Bottom-up reporting allows each management level to fully assess the market risk relevant at the respective levels.
CMRM Trading focuses on the management of market risks in the trading portfolios of Wholesale Banking (mainly Financial Markets) as this is the only business line where significant trading activities take place. Trading activities include facilitation of client business, market making and proprietary position taking in cash and derivatives markets. CMRM Trading is responsible for the development and implementation of trading risk policies and risk measurement methodologies, the reporting and monitoring of risk exposures against approved trading limits and the validation of pricing models. CMRM also reviews trading mandates and limits, and performs the gatekeeper role in the product review process. The management of trading market risk is performed at various organisational levels, from CMRM Trading overall down to specific business areas and trading offices.
Stress testing Stress tests are used for the monitoring of market risks under extreme market conditions. Since VaR in general does not produce an estimate of the potential losses that can occur as a result of extreme market movements, ING uses structured stress tests for monitoring the market risk under these extreme conditions. Stress scenarios are based on historical and hypothetical extreme events. The result of the stress testing is an event risk number, which is an estimate of the profit and loss account effect caused by a potential event and its world-wide impact for ING Wholesale Banking. The event risk number for the ING Wholesale Banking trading activity is generated on a weekly basis. Like VaR, event risk is limited by ALCO Bank. The event-risk policy (and its technical implementation) is specific to ING as there is no event risk calculation method that is generally accepted by other banks and regulators (like the Value-at-Risk model). ING’s event risk policy basically consists of defined stress parameters per country and per market (fixed income, equity, foreign exchange, credit and related derivative markets). The scenarios and stress parameters are back-tested against extreme market movements that actually occurred in the markets. The market developments in 2008 will be taken into account in the definition of scenarios and stress parameters during 2009. If and when necessary, ING evaluates specific stress scenarios, as an addition to its structured stress tests. These specific scenarios relate to current concerns, like political instability in certain regions, terrorist attacks or extreme movements in energy prices.
During 2007 and 2008 the overnight VaR for the ING Wholesale Banking trading portfolio ranged from EUR 29 to EUR 72 million.
The following table shows the largest trading positions in foreign exchange, interest rate and corporate credit spread positions. The corporate credit spread sensitivities are furthermore split in different risk classes and sectors.
Interest Rate (Bpv (1)) Eurozone –1.272 Mexico –0.289 United States 0.241 South Korea –0.111 Taiwan 0.060
Credit Spread (Bpv (1)) Eurozone –0.247 United States –0.187 Mexico –0.097 Japan –0.056 United Kingdom –0.032 (1) Bpv (or basis point value) refers to profit and loss account sensitivity per 1bp increase in the interest rate or credit spread.
Problem Grade) –21 –2 No rating –19 –28 (1) Bpv (or basis point value) refers to profit and loss account sensitivity per 1bp increase in the credit spread.
Market risk in Non-Trading Portfolios Organisation Within ING Bank, positions are either labelled as trading or non-trading (banking book) positions. The most important aspect in segregating the banking from the trading books is the intent of the positions held in these books. The banking book positions are intended to be held for the long-term (or until maturity) or for the purpose of hedging other banking positions emerging from commercial business, as for instance in the mortgage book.
Interest rate risk in banking books The interest rate risk of the banking books is the risk that ING Bank’s earnings or market value resulting from the non-trading positions is negatively impacted by movements in interest rates. To assign clear responsibilities for risk and return within the banking book structure an Asset and Liability Management (ALM) framework has been implemented by ALCO Bank. This framework enables a clear separation of three types of activities: the investment of own capital, the commercial business and the management of the bank’s strategic interest rate risk position in the designated ALM books. The figure below presents the ALM framework of ING Bank within which the interest rate risk is measured and monitored: ING Bank’s capital management positions, i.e. the own funds (core capital) and the investments of these own funds, are isolated in the ING Bank corporate line. ALCO Bank determines the target maturity profile over which ING Bank’s own funds must be invested. This maturity profile reflects the long term nature of the rate of return required by ING Bank’s investors and aims for both earnings maximisation and stabilisation. ALCO Bank considers a well balanced portfolio of long-dated fixed income investments as the risk neutral position in its internal risk transfer framework.
The ALM books are managed within ING Wholesale Banking and contain the strategic interest rate risk position of ING Bank. The main objective is to maximise the economic value of the book and to generate adequate and stable yearly earnings within the risk appetite boundaries of ING Bank.
In the following sections, the risk figures for interest rate risk in the banking books are presented. In line with the group risk metrics, ING Bank uses several risk measures to manage interest rate risk both from an earnings and a value perspective. Earnings-at-Risk (EaR) is used to provide the earnings perspective and the Net Present Value (NPV)-at-Risk and Basis Point Value (BPV) figures provide the value perspective. Several banking books are governed by the trading risk process and are therefore excluded from the following non-trading risk tables and are included in the trading risk graph and table under ‘Market Risk in Trading Books’.
Earnings at Risk (EaR) EaR measures the impact on (pre tax) IFRS earnings resulting from changes of market rates over a time period of one year. Changes in balance sheet dynamics and management interventions are not incorporated in these calculations. The EaR figures in the table below are determined on the basis of an instantaneous upward 1% parallel shock in market rates. This shock is assumed to take place at the beginning of the year and the market rates are assumed to remain stable for the remainder of the year. For the ALM books EaR measures the potential loss of earnings due to the structural mismatch in interest rate positions. The calculations for the ALM books capture the EaR resulting from the current positions. For the commercial banking books the EaR captures the interest rate risks resulting from savings, current accounts and the main mortgage portfolios. The impact of new business is included in the EaR calculations for the savings and demand deposits portfolios, as it is most relevant for these portfolios. The EaR of the Corporate Line, i.e. the investment of ING Bank’s own funds, reflects the interest risk profile of the investments only. This is in line with the accounting based definition of (pre tax) EaR.
Note: Compared to EaR figures in the group risk dashboard, the above figures exclude diversification with other bank risk types and group/insurance risks.
The total EaR figure, as result of an upward shock of the market rates of 1%, improved compared to last year by EUR 45 million to EUR –142 million. Especially the last quarter in 2008 was dominated by a decreasing interest rate environment due to substantial interest rate cuts of central banks. This was of strong influence on the lower EaR under this scenario as several units within Retail Banking and ING Direct invested assets more short term and, as a consequence, will benefit more from increasing interest rates.
This dynamic in mainly non-EUR units is also the main driver for the strong increase in the positive EaR generated by USD exposure to EUR 80 million (from EUR 9 million) and the strong improvement in negative EaR in other currencies to EUR –7 million (from EUR –58 million). The negative EaR based on the EUR exposure substantially increased by EUR 95 million to EUR –220 million mainly driven by Wholesale Banking ALM positions that were, in comparison to year end 2007, more positioned to benefit from interest rate decreases.
Net Present Value-at-Risk (NPV) The Net Present Value (NPV)-at-Risk figures represent the full value impact (i.e. including convexity) to the banking books resulting from changing interest rates. This full value impact cannot be linked directly to the balance sheet or profit and loss account as the fair value movements in banking books are generally not reported through the profit and loss account or through equity. The largest part, namely the value mutations of the amortised cost balances, is neither recognised in the balance sheet nor directly in the profit and loss account. These mutations would be expected to materialise over time in e.g. the profit and loss account, if interest rates develop according to forward rates throughout the remaining maturity of the portfolio. The NPV-at-Risk figures in the table below are determined on the basis of an instantaneous upward 1% parallel shock of market rates in line with the EaR calculations. For the ALM books the NPV-at-Risk figures again capture the potential change of value due to the structural mismatch in interest rate positions. For the commercial banking books the NPV-at-Risk calculations capture the convexity resulting from the optionality in the main mortgage portfolios, e.g. the option for clients to prepay in case of moving house. In these calculations it is assumed that savings and other demand deposits of Retail and Wholesale Banking are perfectly represented via the replicating methods and therefore are fully hedged. The NPV-at-Risk of the Corporate Line again only reflects the interest risk profile of the investments of the bank’s own funds.
By Business Line ING Wholesale Banking –674 –442 ING Retail Banking –100 –222 ING Direct –232 –234 ING Bank Corporate Line –1,388 –892 ING Bank Total –2,394 –1,790
By Currency Euro –2,105 –1,498 US dollar –238 –439 Pound sterling –40 74 Other –11 73 Total –2,394 –1,790
Basis Point Values (BPV) The Basis Point Value (BPV) figures below represent the value impact to the banking books resulting from a change in interest rates of 1 basis point. The BPV figures represent the directional position under a small upward shift in interest rates and do not capture the convexity resulting from the optionality in mortgages under larger interest rate movements.
Euro –19,176 –15,165 US dollar 337 –2,055 Pound sterling –582 778 Other –373 706 Total –19,794 –15,736
The outright interest rate risk that is represented through the BPV positions in the table above is mainly caused by the investments of the Bank’s core capital. This only holds under the view that this capital is not sensitive to interest movements but ignores ALCO Bank’s assumption that its shareholders expect ING Bank to invest the funds in such a way that it produces a long-term and stable income. The remaining outright risk is mainly maintained in the Bank’s ALM books in which the strategic position is maintained.
Foreign exchange risk in non-trading books Foreign exchange (FX) exposures in non-trading books result from commercial banking business (business units doing business in other currencies than their base currency), realised non-EUR results and FX translation risk on foreign currency investments. The policy regarding these exposures is briefly explained below.
The net position in Australian dollar dropped by EUR 762 million. This is a consequence of a large drop in risk-weighted assets under Basel II (compared to Basel I).
The FX risk in the non-trading books is measured by using the Value-at-Risk methodology as explained in the trading risk section. The VaR for FX quantifies with a one-sided confidence interval of 99%, the maximum overnight loss in 99% of the cases that could occur due to changes in foreign exchange rates.
Equity Price Risk in Banking Books Equity price risk arises from the possibility that equity security prices will fluctuate, affecting the value of equity securities and other instruments whose price reacts similarly to a particular security, a defined basket of securities, or a securities index. ING Bank maintains a strategic portfolio with substantial equity exposure in its banking books. This equity exposure mainly consists of the investments in associates of EUR 1,813 million (2007: EUR 2,010 million) and equity securities held in the Available-for-Sale portfolio of EUR 1,863 million (2007: EUR 3,627 million). The value of equity securities held in the Available-for-Sale portfolio is directly linked to equity security prices with increases/decreases being recognised (except in the case of impairment) in the revaluation reserve. During the year ended 31 December 2008 the revaluation reserve relating to equity securities held in the Available-for-Sale portfolio fluctuated between a month-end low amount of EUR 776 million (2007: EUR 518 million) and a high amount of EUR 1,969 million (2007: EUR 2,580 million). Investments in associates are measured in accordance with the equity method of accounting and the balance sheet value is therefore not directly linked to equity security prices.
Real Estate Real estate price risk arises from the possibility that real estate prices will fluctuate affecting both the value of real estate assets and earnings related to real estate activities.
ING Bank has three different categories of real estate exposure on its banking books. First, ING Bank owns buildings it occupies. Second, ING Bank has a Real Estate Development company for which results are dependent on the overall real estate market, although the general policy is to mitigate risk by pre-sale agreements where possible.
For the third category mentioned above real estate price shocks will have a direct impact on reported net profit. As of Q4 2008 ING Bank has EUR 7.0 billion of real estate related investments (corrected for Canadian minority stake). ING Bank’s real estate exposure (i.e. including leverage and committed purchases) is EUR 8.9 billion of which EUR 4.9 billion is revalued through P&L and EUR 4.0 billion is not revalued through P&L, but is either booked at cost or is revalued through equity.
Contingency liquidity risk Contingency liquidity risk relates to the organisation and planning for liquidity management in times of stress. Within ING a specific crisis team is responsible for the liquidity management in times of crisis. This crisis team consists of the CRO, the CFO, the Executive Board member responsible for Wholesale Banking, the Directors of CMRM and Capital Management and all the main treasurers of both ING Bank and ING Insurance. Within ING it is policy to have adequate and up-to-date contingency funding plans in place throughout the organisation. The main objective of ING’s contingency funding plans is to enable senior management to act effectively and efficiently at times of crisis. The contingency funding plans are established for addressing temporary and long-term liquidity disruptions caused by a general event in the market or an ING specific event. These plans ensure that all roles and responsibilities are clearly defined and all necessary management information is in place. The contingency funding plans are regularly tested both on consolidated and local level in order to be best prepared for potential liquidity risk issues.
The responsibility for measurement and management of credit risk and operational risk resides with Corporate Credit Risk Management (CCRM) and Corporate Operational Risk Management (CORM) respectively. Corporate Insurance Risk Management (CIRM) is responsible for insurance risk (actuarial and underwriting) market risk and liquidity risk measurement and management, business risk measurement, as well as ensuring that investment mandates adequately address credit portfolio risk.
Risk management policies and tools To ensure appropriate risk management, CIRM in close co-operation with the business line CIROs, has developed Standards of Practice guidelines and tools to manage risks. While these standards are principle based, they include mandatory requirements to which the business unit CIRO must adhere.
ING Insurance has developed an Economic Capital approach similar to that used within ING Bank as one of its core risk measurement tools. More details on the Economic Capital model are described below. In 2007, ING Insurance introduced ECAPS, a new intranet-based Economic Capital reporting system which is based on replicating portfolio techniques. The ECAPS system provides a well controlled and automated basis for Economic Capital and risk reporting, and also provides greatly enhanced market risk analysis tools for business units and corporate reporting purposes. ECAPS relies on an innovative replicating portfolio methodology. CIRM expects this system to be the foundation of its internal fair value and solvency model, including the calculation of capital requirements following the introduction of Solvency II. Through 2008 the system has been enhanced and functionality expanded.
Reserve adequacy CIRM instructs and supervises all ING entities to ensure that the total insurance liabilities of ING Insurance (both reserves and capital) are tested for adequacy taking into account the insurance premium rate levels and the uncertainty of future returns on investments. This is done by evaluating insurance liabilities on current best estimate actuarial assumptions plus a risk margin, ensuring that the reserves remain adequate based on current assumptions. The assumed investment earnings are a combination of the run-off of portfolio yields on existing assets and new money and reinvestment rates. For new money and reinvestments long-term best estimate assumptions are taken into account, although current new money rates are used for the short-term reinvestments. For most products stochastic testing is required, taking the 90% point as the testing outcome. In the case where deterministic testing is used the 90% confidence level is achieved by subtracting risk margins of 20% of the best-estimate interest rates or 1%, whichever is higher.
ING’s policy for reserve adequacy testing is disclosed in the ’Principles of valuation and determination of results’ section. As of 31 December 2008 (and 31 December 2007), reserves for ING’s insurance businesses in aggregate are adequate at a 90% confidence level. All business lines are adequate on a stand alone basis at a 90% confidence level as well. However, as a result of the severe economic downturn during late 2008 and its effects on products that are sensitive to interest and equity markets movements, the net insurance liabilities for US retail annuity products and ING Life Japan were insufficient at both the 90th percentile and 50th percentile level of the stochastic test. For US retail annuity the inadequacy was EUR 1.6 billion (90th percentile) and EUR 0.6 billion (50th percentile). For ING Life Japan the inadequacy was EUR 0.4 billion at the 90th percentile and less than EUR 0.1 billion at the 50th percentile. In both cases management is investigating various actions to improve the reserve adequacy, including de-risking the variable annuity products.
ING INSURANCE RISK PROFILE Economic Capital ING Insurance The objective of the ING Insurance Economic Capital framework is to achieve an advanced risk and capital measurement and management structure that: Covers all the risks in the business units and is applied consistently across all risks and business units;• Facilitates and encourages adequate risk and capital management, including the proper pricing of products and sound capital • allocation decisions.
Economic Capital disclosures relating to ING Insurance include diversification benefits that arise within ING Insurance. The following table provides an Economic Capital break down by risk category with diversification benefits proportionally allocated to the risk types: Economic Capital break-down ING Insurance by risk category (1)
Total insurance operations 13,682 23,199 (1) The Economic Capital outcomes do not reflect any potential tax benefit resulting from the loss that occurs under the specified circumstances. (2) Other risk includes operational risk as well as business risk (covering expense risk and lapse risk).
Also the EC model has been changed to reflect the illiquidity in the insurance portfolios resulting from current dislocated markets. The change is described in more detail in the model disclosure section.
Insurance Americas 6,049 6,541 Insurance Asia/Pacific 2,817 7,033 Insurance Europe 2,985 5,890 Corporate Line Insurance (1) 1,831 3,735 Total insurance operations 13,682 23,199 (1) Corporate Line includes funding activities at ING Insurance level, explicit internal transactions between business unit and Corporate Line, managed by Capital
Management, and corporate reinsurance. The responsibility (and risk) of free assets located within the business line for which there is no explicit transfer via a Corporate Line transaction remain at the business unit level.
While the figures above are shown by business line, the diversification of risks across ING businesses is calculated across business units. Total diversification between ING Insurance’s business units and the Corporate Line Insurance is 39% for 2008 (33% in 2007).
The corporate line risk relates mostly to foreign exchange translation risk related to the potential loss of market value surplus in non-EUR denominated business units.
Interest rate risk 2,739 6,021 Credit spread risk 880 1,012 Equity risk 1,293 3,357 Real estate risk 252 669 Implied volatility risk 1,857 2,108 Foreign exchange risk 1,434 2,091
Credit spread risk relates to potential increases in credit spreads from investments in fixed income securities. Real estate risk exists mostly in the Netherlands and relates in a large part to direct real estate investments. Implied volatility risk is the risk that market values of assets or liabilities change due to movements in market option prices. In general, ING is exposed to increases in implied volatility as the guarantees provided to customers become more expensive. Foreign exchange risk is small in the business units. Hence, most of the exposure relates to the risk of change in the market value surplus of non-EUR businesses.
Real Estate Real Estate price risk arises from the possibility that real estate prices will fluctuate affecting the value of real estate assets.
As of Q4 2008 ING Insurance has EUR 4.1 billion of real estate related investments. ING Insurance’ real estate exposure (i.e. including leverage) is EUR 6.6 billion of which EUR 4.9 billion is revalued through P&L and EUR 1.7 billion is not revalued through P&L, but is either booked at cost or is revalued through equity.
Interest rate (1% up) –67 –161 Interest rate (1% down) 82 125 Equity (15% down) –795 –613 Real Estate (8% down) –525 –570 Foreign Exchange (10% worst case) –224 –338
The table presents figures before diversification between risks. For interest rate risk, we present the effect of a parallel shock of 1% across all regions and take the sum of the shocks. For the Japan business, a shock of 0.5% is applied since this business operates in a lower interest rate environment. Foreign exchange risk includes the sum of both local business currency risk plus translation risk for earnings of non-Euro business units.
The table shows that real estate fluctuations can have a relatively large impact on earnings since all price volatility is fully reflected in earnings for real estate investments. The impact on earnings of interest rates and equity price changes are normally lower than the economic and shareholders’ equity impact given current accounting rules. The sensitivity results do reflect the impacts of asymmetric accounting whereby the hedges must be marked-to-market through the earnings while the liability value is not.
Earnings at Risk is an indicator of future earnings at risk in case markets deteriorate. Earnings can deteriorate significantly when certain thresholds have been reached for impairment and DAC unlocking. At the moment the increase in equity Earnings at Risk – despite de-risking – is driven by DAC unlocking and negative revaluations being close to or at hitting impairment triggers. Offset from the hedging programs existing at year-end is taken into account. Further hedges have been put in place since 31 December 2008.
ING INSURANCE – LIQUIDITY RISK As with other ING Insurance market risk, liquidity risk falls under the supervision of the ALCO function. Liquidity risk is the risk that ING Insurance or one of its subsidiaries cannot meet its financial liabilities when they come due, at reasonable cost and in a timely manner. ING Insurance monitors structural, tactical and contingency liquidity risk and tests adverse scenarios to measure its resiliency against these risks. The severe economic downturn in late 2008 has caused liquidity risk to increase substantially. To manage these risks, ING Insurance has increased its allocation to liquid assets.
For the main non-life units (in the Benelux and Canada) the risk tolerance for property and casualty (P&C) business is generally set at 2.5% of the Group’s expected after-tax earnings. For 2008, this translated into an aggregated (pre-tax) risk tolerance level of EUR 265 million for the Benelux (2007: EUR 235 million). For Canada the pre-tax risk tolerance level is set at EUR 244 million (derived from the above mentioned EUR 265 million, but allowing for outside interests) (2007: EUR 214 million). For the first half of 2008 the risk tolerance limit of EUR 265 million also applied to Mexico.
For the smaller non-life units, the (pre-tax) risk tolerance level for catastrophe related events for 2008 was set at EUR 5 million (2007: EUR 5 million) per event per business unit.
Overall exposures and concentrations are actively managed within limits and risk tolerance levels through the purchase of external reinsurance from approved reinsurers in accordance with ING’s reinsurance credit risk policy. Particularly for the property and casualty portfolio, ING purchases protection which substantially mitigates ING’s exposure due to natural catastrophes. ING believes that the credit risks to which it is exposed under reinsurance contracts are minor, with exposures being monitored regularly and limited by a reinsurance credit risk policy.
Earnings sensitivities are defined on a shock scenario at the 90% confidence level on pre-tax IFRS earnings, projected one year forward from the calculation. Therefore the table below provides earnings sensitivities to an instantaneous shock at the 90% confidence level projected through to 31 December 2008. The EaR information does not include ING Canada which was divested in January.
The ratings reflect probabilities of default and does not take collateral into consideration.
Overall risk concentrations remained stable in 2008 for ING Insurance with a small shift towards Commercial Banks as a result of increased equity derivatives trading business at Insurance Europe. Private Individuals in Europe decreased, due to the sale of EUR 4.5 billion in residential mortgages to Retail Banking (Nationale Nederlanden Hypotheek Bedrijf). Food, Beverages and Personal Care accounted for 2.5% in 2007, but fell below the 2.0% threshold in 2008. All other industries not shown in the table above have less than 2.0% concentrations.
The portfolio in the Netherlands decreased principally due to the sale of residential mortgages to Retail Banking (Nationale Nederlanden Hypotheek Bedrijf). There were no other significant shifts in the portfolio concentration.
The CORM function consists of functional departments for operational risks & risk reporting, for Information (Technology) risks, for Security & Investigations and for SOX testing. The CORM function is responsible for developing and communicating ING’s operational risk framework, policies, minimum standards and guidelines. The corporate function advises the business line ORM staff, monitors the quality of operational risk management and co-ordinates the group-wide reporting of operational risks to the Executive Board.
C o m m u n ic at io n 8. R isk m o n ito rin g 2. Objective setting 3. Event identification 4. Risk assessment 5. Risk response
At all levels in the organisation Operational Risk Committees (ORCs) are established that identify, measure and monitor the operational risks of the region or business unit with appropriate quality of coverage (granularity) and to ensure that appropriate management action is taken by the responsible line managers at the appropriate level of granularity. ORCs, chaired by the business management, steer the risk management activities of the first and second line of defence in their entities. On a group level the Operational & Residual Risk Committee approves the operational risk capital model.
The operational risk appetite within ING is defined as the acceptable and authorised maximum level of risk, in each of the operational risk areas that must be adhered to in order for ING to achieve its business plan within approved budgets. This risk appetite is monitored quarterly through the Non-Financial Risk Dashboard which reports the key risk exposures.
Based on the results of the risk assessment, response measures must be determined for the identified risks. Risk response actions balance the expected cost for implementing these measures with the expected benefits regarding the risk reduction. Risk response can be achieved through several combinations of mitigation strategies, for example reducing likelihood of occurrence, reducing impact, risk avoidance, risk acceptance or through the transfer of risk. Tracking takes place through the global Audit Outstanding scan system.
Control activities are defined as the control measures that have been implemented and are maintained. Generic mandatory controls are described in the ORM policy house.
Management at all levels in the organisation periodically need information on their key operational risks (including compliance and legal risks) and mitigating actions. In order to make it easier for management to access this kind of information, the Non-Financial Risk Dashboard (NFRD) was developed and rolled out in 2008 to all business units.
Developments in 2008 Enhancements of the Non-financial Risk Dashboard The introduction of a Non-financial Risk Dashboard (NFRD) was given priority by the Chief Risk Officer (CRO) with the aim to keep focus on the key risk exposures when looking at the risk faced by business. The objective of the NFRD is to deliver comprehensive and integrated risk information on Operational, Compliance and Legal Risk, using a consistent approach and risk language at all levels in the organisation. It gives management an overview of all key risks within their jurisdiction with forced ranking and a clear description of the risks and responses so that they can balance priorities. This supports the ING strategy for making things ‘easier’ whereby management is better able to manage risk and give priority where it is necessary.
Corporate Operational Risk Management, in close coordination with Group Compliance Risk Management and Corporate Legal, has been rolling out the NFRD in the ING organisation. The NFRD covers all BUs in the ING organisation. A number of existing risk reports, e.g. the IT Risk & Control report, Compliance report and the Incident report, have been integrated into the NFRD.
Product Approval Process ING has revised the Product Approval Process (PAP) Minimum Standard to ensure that adequate risk assessment procedures are executed prior to the development and/or launch of new or modified products. The PAP ensures that adequate controls are put in place to manage the inherent risks associated with new products, related processes and system implementation, and other initiatives.
Continuity risk As a risk response to mitigate the risk of power supply failure in one of the data centres ING accelerated an improvement programme for the business continuity and disaster recovery capability and platform security of its data centres.
Refreshment of policies and standards ORM policies and Minimum Standards have been further enhanced to fully encompass the integrated approach of Operational, Compliance and Legal risks (between risk departments and along functional lines). All major IT risk policies and standards have been re-assessed against the current internal and external threats and adapted consequently.
COMPLIANCE RISK Compliance Risk is defined as the risk of damage to ING’s integrity as a result of failure (or perceived failure) to comply with relevant laws, regulations, internal policies and procedures or ethical standards. In addition to reputational damage, failure to effectively manage Compliance Risk can expose financial institutions to fines, civil and criminal penalties, payment of damages, court orders and suspension or revocation of licenses. A failure (or perceived failure) can adversely impact customers, staff and shareholders of ING.
Clear and accessible policies and procedures are required to be implemented in ING business processes in all Business Lines. An infrastructure is in place to enable management to track current and emerging Compliance Risk issues, to communicate these to internal and external stakeholders, and to drive continuous improvement. ING understands that good Compliance Risk Management involves understanding and delivering on the expectations of customers and other stakeholders, thereby improving the quality of key relationships based on honesty, integrity and fairness.
ING separates Compliance Risk into four conduct-related integrity risk areas, shown below with examples of sub-risks in each risk area: Client Related Integrity Risk Personal Conduct Related Integrity Risk
Organisational conflicts of • interest, market abuse and insider trading Anti-trust/competition law• New or modified products • and services (e.g. customer base, design) and governance changes Agreed sector/industry • standards Regulatory registration and • reporting requirements
Marketing, sales & • trading conduct Conduct of advisory business• Complaint handling• Transparency of product • offerings (e.g. costs, disclosures) Data protection/privacy• Third party intermediaries • as representatives of ING
To ensure that staff is protected when raising issues and to help identify Compliance Risks, ING has a Whistleblower procedure which encourages staff to speak up if they know of or suspect a breach of external regulations or internal policies or business principles.
The organisation of Compliance Risk Management The Chief Compliance Officer (CCO) reports directly to the CRO and is responsible for developing and establishing the company-wide Compliance Risk Management Charter & Framework. The CCO also establishes the Minimum Standards for managing Compliance Risks and assists and supports the Executive Board in managing ING’s Compliance Risks. The Compliance Risk Management function is organised hierarchically at the Corporate Level and along functional reporting lines in the Business Lines. It is part of the second line in ING’s three lines of defence model.
To avoid potential conflicts of interests, it is imperative that the Compliance Officer is impartial and objective when advising business management on Compliance Risk in their Business Unit, region, division or Business Line. To facilitate this, a strong functional reporting line to the next higher level Compliance Officer is in place. The functional reporting line has clear accountabilities relating to objective setting, remuneration, performance management and the appointment of new Compliance Risk Management staff as well as vetoing and escalation.
Compliance Risk Management Policies and Tools The responsibility of the Compliance Risk Management function is, in accordance with the Charter and Framework, to proactively: Identify, assess, monitor and report on the Compliance Risks faced by ING;• Assist, support and advise management in fulfilling its responsibilities to manage Compliance Risks;• Advise any employee or officer with respect to their (personal) obligations to manage Compliance Risks.•
The Framework consists of three key components: the Compliance Chart, an Advisory component and the Scorecard as illustrated below
A. The Chart The Chart is an output from five key activities carried out in accordance with the requirements of the Framework: 1. Identification of Compliance Risk Obligations; 2. Risk Assessment; 3. Compliance Risk Mitigation (includes Training and Education); 4. Compliance Risk Monitoring (includes Action Tracking); 5. Compliance Risk Reporting (includes Incident Management).
B. Advisory Compliance Officers proactively advise their CEO, Management, local boards and committees, the next higher level Compliance Officer, and employees on Compliance Risk, responsibilities, obligations and concerns.
Developments in 2008 – ING Compliance Risk Management’s revised Charter and Framework In August the Executive Board of ING issued the ING Group Compliance Risk Management Charter and Framework (‘Charter and Framework’) to help businesses more effectively manage their Compliance Risks expectations. The fundamental requirements of the 2005 ‘Compliance Policy and Minimum Standards’ remain and are enhanced in terms of changing Board and stakeholder expectations. The Charter states the roles and responsibilities for managing Compliance Risk.
The FEC Minimum Standards are the basis for (local) procedures covering: Customer Due Diligence and Know Your Customer;• Anti-Money Laundering and Anti-Terrorist Financing.•
worldwide during 2008/2009. Managers attending the training will not only gain a deeper understanding of the effective embedding of ING’s three lines of defence model and the strategic value of Compliance Risk Management, but also learn practically what actions they can take to strengthen the management of Compliance Risk as well as how to apply the Framework and tools.
2. ‘MLRO Master Class’. This new training programme targeted approximately 200 Money Laundering Reporting Officers. The course aims to strengthen our MLROs’ understanding of the enhanced FEC and regulatory policy requirements.
3. ‘Compliance Officer Training’. This programme is designed for all Compliance Officers worldwide (approximately 750), across, and in cooperation with, all Business Lines. The training programme has sections on technical knowledge, personal effectiveness and skills.
– Enhanced Business Aligned Communications To ensure continued awareness of the importance of effectively managing Compliance Risk a campaign entitled ‘Play to Win, Know the Rules’ was launched. The key message of the campaign is that managing Compliance Risk is an integral part of managing business and must be embedded into daily practice and business strategy. The campaign helps further drive understanding and behaviours relating to the management of Compliance Risk. It includes a one-pager with key messages for business teams, as well as a PowerPoint presentation and short videos by each Executive Board member stating why they believe managing Compliance Risk is integral to building sustainable businesses.
to meet applicable standards in these areas could result in, among other things, suspension or revocation of ING’s licenses, cease and desist orders, fines, civil or criminal penalties and other disciplinary action which could materially damage ING’s reputation and financial condition, and accordingly ING’s primary focus is to support good business practice through its Business Principles and group policies.
Discontinuation of business with certain countries As a result of our frequent evaluation of all businesses from economic, strategic and risk perspectives ING continues to believe that for business reasons doing business involving certain specified countries should be discontinued, which includes that ING has a policy not to enter into new relationships with clients from these countries and processes remain in place to discontinue existing relationships involving these countries. At present these countries include Myanmar, North Korea, Sudan, Syria, Iran and Cuba. ING Bank N.V. is now in the final stages of liquidating the Netherlands Caribbean Bank, which is now a 100% owned subsidiary.
MODEL DISCLOSURES The risk profile of ING Group, as described in the risk management section is captured by three key risk metrics: Earning at Risk;• Capital at Risk;• Economic Capital.•
The basic data input for the group risk dashboard is provided along 13 major risk types (e.g. equity risk Europe; see table below) and diversified within ING Bank or ING Insurance.
(Note numbers in parentheses indicate the number of risk types distinguished (total of 13)).
Principal assumptions of EaR and CaR measurement CaR and EaR figures should always be viewed in the context of principal assumptions made to enable both comparability and updated measurement of ING Group’s risk profile: Risk dynamics are based on historic observation; historical events are used as a proxy for future risk estimates e.g. price changes, • defaults, dependencies of markets; Point-in-time risk profile of in-force business is presented; in general risk measurement does not include future volumes and margins;• Discretionary management interventions are not explicitly modelled unless their measurement can be based on historical performance • tracking (e.g. regular or planned actions); Correlation factors between risk types used for diversification are based on best estimate assumptions supported by statistical analysis • of historical data, ING risk expert judgement, external benchmark studies and common logic; Behavioural assumptions for clients are included in risk measurement where applicable e.g. variable savings, embedded mortgage • options or lapse ratios.
Reporting Framework All data for each risk type and business line, as well as the empirical Group risk distributions, are uploaded to a web-based risk dashboard program. The aggregation and simulation steps, as described above, are performed in a secure server based environment.
Further details are provided in the relevant model descriptions for each risk area.
For allocation of Economic Capital to units and products, diversification factors are calculated for each risk type. These factors are applied consistently throughout ING Bank. The level of diversification benefit is dependent on both the inter-risk correlations as well as the relative size of the undiversified Economic Capital exposure for each risk type.
Reporting Framework For each business unit and product line, the gross Economic Capital for each risk type is delivered to MISRAROC – the financial data warehouse for RAROC and Economic Capital reporting of ING Bank. The net Economic Capital figures are calculated by taking the product of the gross Economic Capital and one minus the diversification factor. Total Economic Capital is calculated as the sum of the net Economic Capital for each risk type at all reporting levels.
The underlying formulas and models that are used for determining Economic Capital for credit and transfer risk are the same as those used for determining the level of regulatory capital that is required under Basel II (Pillar 1). Despite the fact that the same underlying formulas are used, (internal) Economic Capital and regulatory capital are not the same, due to various specific rules imposed by Basel II, such as regulatory caps and floors, and the use of the standardised approach for certain portions of ING’s portfolio. These differences are permitted under the Basel II guidelines.
Credit Risk Capital Measurements Methodology Location Confidence level Inputs Purpose Regulatory Capital Basel II Formula Vortex Basel Engine
Vortex Risk Engine (‘VRE’) in the Central Risk Database 99.95% Basel II model outputs excluding Basel II caps and floors, maturity, repayment schedules, correlation factors, migration matrix. Some inputs come from EC-MC portfolio calculator but with 99.95% confidence level country and industry.
For the model applied to mortgage portfolios a similar rationale is employed. The quality of the hedge depends on assumptions with respect to prepayment behaviour. If these assumptions are wrong, the funding may be either too long or too short term. Similar to the above, the Economic Capital model for market risk is based on the estimated 99% confidence prepayment model error and the 99% confidence adverse interest rate change.
OPERATIONAL RISK Operational risk is the risk of direct or indirect loss resulting from inadequate or failed internal processes, people and systems or from external events. It includes the risk of reputation loss, as well as legal risk, whereas strategic risks are not included. While operational risk can be limited through management controls and insurance, many incidents still have a substantial impact on the profit and loss account of financial institutions. The capital model, an actuarial model, consists of a combination of three techniques: Loss Distribution approach (LDA), which applies statistical analysis to historical loss data;• Scorecard approach, which focuses on the quality of risk control measures within a specific business unit;• ‘Bonus/Malus’ approach, which focuses on the actual operational incidents of a specific business unit.•
As relatively short data series are available, a capital floor and cap are included in order to prevent the business risk capital from being under- or overestimated. The minimum (floor: 20%) and maximum (cap: 80%) are specified as a percentage of the operating costs and as such link business risk capital for units that operate at the floor to cost efficiency.
ECONOMIC CAPITAL ING INSURANCE Economic Capital, ‘EC’, is defined by ING as the amount of assets that needs to be held in addition to the market value of liabilities to assure a non-negative surplus at a 99.95% level of confidence on a 1 year time horizon. ING measures Economic Capital by quantifying the impact on the market value surplus (MVS) as a result of adverse events that occur with a specified probability related to the AA rating. Therefore ING’s Economic Capital model is based on a ‘Surplus-at-Risk’ concept. The confidence level consistent with an AA rating has been defined as the 99.95% one-sided confidence level over a one-year horizon. The change in market value surplus (MVS) is the combined effect of changes in Market Value of Assets (MVA) minus market value of liabilities (MVL) and an adjustment for illiquidity spreads due to current dislocated asset markets. The MVS is adjusted to correct this asymmetry by applying an illiquidity spread to the insurance liability cash flows.
The following fundamental principles have been established for the model: Economic Capital requirements are calculated to achieve a target AA rating for policyholder liabilities;• All sources of risk should be considered;• The best estimate actuarial assumptions should be as objective as possible and based on a proper analysis of economic, industry, • and company-specific statistical data. There is one set of best-estimate assumptions per product to be used for all purposes at ING; Valuation of assets and liabilities is based on fair value principles. Where complete and efficient markets exist, fair value is equal to • market value; The Economic Capital and valuation calculations should reflect the embedded options in insurance contracts;• The Economic Capital and valuation calculations are on a pre-tax basis and do not consider the effect of local regulatory accounting • and solvency requirements on capital levels. Capital is assumed to be fully transferable between legal entities; The framework does not include any franchise value of the business. It does, however, include the expense risk associated with the • possibility of reduced sales volume in the coming year.
ING quantifies the impact of the following types of risk in its Economic Capital model: Market risk for ING Insurance is the change in value based on changes in interest rates, equity prices, real estate prices, credit spreads, • implied volatilities (interest rate and equity), and foreign exchange rates. It occurs when there is less than perfect matching between assets and liabilities. Market risk may exist in the insurance activities as a result of selling products with guarantees or options (guaranteed crediting rates, surrender options, profit sharing, etc.) that cannot be hedged given the assets available in a certain market. Market risk may also occur when there is an intentional mismatch between asset and liability cash flows even when it is possible to match or hedge the cash flows; Credit risk is the risk of changes in the credit quality of issuers due to defaults or credit migration of securities (in the investment • portfolio), counter parties (e.g. on reinsurance contracts, derivative contracts or deposits given) and intermediaries to whom ING has an exposure. In addition to credit risk, ING includes a calculation of transfer risk for the risk of being unable to repatriate funds when required due to government restrictions; Business risk is defined as the exposure to the possibility that experience differs from expectations with respect to expenses, the runoff • of existing business (persistency) and future premium re-rating; Operational risk is defined as the risk of direct or indirect loss resulting from inadequate or failed internal processes, people and systems • or from external events. Operational risk capital is difficult to quantify, since it is driven by infrequent events of high severity, and can be significantly mitigated or exacerbated by the quality of internal controls and guidelines. It may be partially managed through the purchase of insurance; Life risk relates to deviations in timing and amount of the cash flows (premium payments and benefits) due to the incidence or • non-incidence of death. The risk of non-incidence of death is also referred to as longevity risk to distinguish it from the risk associated with death protection products. ING notes risks due to uncertainty of best estimate assumptions concerning level and trend of mortality rates, volatility around best estimates, and potential calamities and recognises external reinsurance; Morbidity risk is the risk of variations in claims levels and timing due to fluctuations in policyholder morbidity (sickness or disability) • recognising external reinsurance. A wide variety of policy classes are subject to morbidity risk, including disability, accidental death and disability, accelerated death benefits, workers compensation, medical insurance, and long-term care insurance; P&C risk comprises the risk of variability of size, frequency and time to payment of future claims, development of outstanding claims • and allocated loss adjustment expenses for P&C product lines recognising external reinsurance.
In 2007, ING Insurance has introduced ECAPS as an intranet-based Economic Capital reporting system utilising replicating portfolio techniques. The ECAPS system provides a well controlled and automated basis for Economic Capital and risk measurement. Each business unit enters the risk characteristics of its assets and liabilities into the ECAPS system on a regular basis. These risk characteristics are then translated to a uniform basis in the form of replicating portfolios of standardised financial instruments. Based on the constellation of replicating portfolios (including representations of non-market risks), the ECAPS system then is capable of calculating Economic Capitals at every level of aggregation. The following is a brief description of the model.
1. Market Data and Scenario Generation 2. Stochastic Cash flows and Non-market Risk Capital 3. Replicating Portfolio 4. Economic Capital Calculation
Since ING Insurance operates in many developing financial markets, extrapolation algorithms are in place for extending beyond observable market data when this is needed for the calculation of the Market Value Liabilities and the Economic Capital. These algorithms are based on comparable data in mature markets.
Based on the market data from GMDB, ING calibrates two economic scenario generators: Risk Neutral Economic Scenario Generator (RN ESG): capable of generating multiple equity indices and exchange rates, consistent • with a multi-currency dynamic term structure model. Scenarios are used in the cash flow projection to determine replicating portfolios. RN ESG scenarios are consistent with observed market prices of equity, FX and interest options; Real World Economic Scenario Generator (RW ESG): capable of jointly simulating all risk types, i.e. all market risks, credit risk, business • risk, operational risk, life risk, morbidity risk and P&C risk. Diversification between risks is taken into account through a Gaussian copula, allowing for different marginal probability distributions at the risk driver level. RW ESG scenarios are consistent with historical time series of the market risk drivers using 5 years of weekly data observations. The volatilities are scaled from weekly to quarterly and the weekly correlations are used directly as estimates of quarterly correlations.
Stochastic Cash Flows and Non-Market Risk Capital The market risks in assets and liabilities are captured in and represented by stochastic cash flows in 500 scenarios. Business Units are responsible for generating these cash flows, the modelling of embedded options and guarantees and a proper mapping of risk drivers in the scenario set to cash flow determinants such as policyholder behaviour and management actions restricted to dynamic hedge programs and setting of crediting rates/profit sharing. To better capture the behaviour in the tails of the distribution, the set of scenarios consist of 300 Risk Neutral scenarios and 200 ‘Risk Volatile’ scenarios with double volatilities. The average of the 300 Risk Neutral scenarios provides a check on the market value of the replicating portfolio. It should be noted that this serves only as a check, and that the actual market value of liabilities is derived directly from the replicating portfolio. The 200 Risk Volatile scenarios ensure that the replicating portfolio is calibrated against enough extreme scenarios such that it can be used safely in Economic Capital calculations.
For the calculation of Economic Capital, ING uses a one-year time horizon. In practice, the model calculates instantaneous quarterly shocks and then annualises the resulting VaR statistic to determine an annualised EC. The quarterly shock is used to stabilise the results, to ensure the shocks are within a range that can be more credibly valued for assets and liabilities, to better capture the impact of dynamic hedge strategies, to more reasonably use weekly correlations of risk factors, and to get closer to actual risk practices and reporting cycles.
Using Monte-Carlo simulation, ING’s Economic Capital model generates 20,000 possible ‘states-of-the-world’, by randomly simulating all risk drivers – simultaneously. For each state-of-the-world, the market value of assets and liabilities are recalculated and the change in value of the Market Value Surplus (MVS) is stored. All these changes in MVS are then sorted, and the 99.95% worst-case change in MVS is identified, to provide the Economic Capital level for the given level of aggregation.
ECONOMIC CAPITAL GROUP ING’s Group Economic Capital and Bank-Insurance diversification benefit is determined by applying one common aggregation approach to the banking and insurance businesses. The starting point is the actual reported Economic Capital figures for ING Bank and ING Insurance, excluding inter-risk diversification. In addition an aligned set of best-estimate correlation assumptions is constructed by applying the weighted average of the Bank and Insurance specific inter-risk correlation assumptions for each of the five major risk types i.e. credit, market, insurance, business, and operational (See also Economic Capital model sections of Bank and Insurance).
The group diversification benefit is calculated by applying a ‘Gaussian-copula’ simulation approach. Due to the inherent uncertainties around correlation assumptions and changes in risk exposures the results are put to extensive sensitivity tests.
OBJECTIVES ING Group Capital Management (Capital Management) is responsible for the sufficient capitalisation of ING Group entities at all times in order to manage the risk associated with ING’s business activities. This involves the management, planning and allocation of capital within ING Group. ING’s Corporate Treasury is part of Capital Management. It executes the necessary capital market transactions, term (capital) funding and risk management transactions. Capital Management monitors and plans capital adequacy on a consolidated basis at three levels: ING Group, ING Insurance and ING Bank. The rating objective for these three entities is AA. Capital Management takes into account the metrics and requirements of regulators (EU Solvency, Tier-1 and BIS ratios and limits for hybrid capital), rating agencies (leverage ratios, Adjusted Equity) and internal risk management models and market value balance sheets (Economic Capital (EC) and Available Financial Resources (AFR)).
ING applies three main capital definitions: AFR – This is a market value concept, defined as market value of assets (MVA) less the market value of liabilities (MVL) on the balance • sheet. The liabilities do not include the hybrid capital and core Tier-1 securities which are included in AFR as equity. The valuation of ING Insurance includes an adjustment for portfolio illiquidity. In the absence of a full market value balance sheet for ING Bank, AFR Bank is defined as IFRS Equity including several adjustments (see table in this section). AFR of ING Group is defined as AFR Bank plus AFR Insurance minus core debt ING Group. AFR is used as the measure of available capital in comparison with EC employed. EC, or Economic Capital, is the amount of capital that is required to absorb unexpected losses in times of severe stress given ING Group’s ‘AA’ target rating. Adjusted Equity – This rating agency concept is defined as shareholders’ equity plus core Tier-1 securities, hybrid capital, prudential • filters and an adjustment for Value in Force and Deferred Acquisition Cost. See ‘Capital Base’ disclosures in this section. This capital definition is applied in comparing available capital to core debt (leverage) for ING Group and ING Insurance. Core Tier-1 capital, Tier-1 capital and total BIS capital are regulatory concepts applicable to ING Bank. Tier-1 capital is defined as • shareholders’ equity plus hybrid capital less certain prudential filters and deductible items. Tier-1 and BIS capital divided by risk weighted assets equals the Tier-1 and BIS ratio respectively. Core Tier-1 capital is equal to Tier-1 capital excluding hybrid capital.
Increasingly Capital Management considers AFR and EC employed when managing capital. AFR should exceed EC and for ING Group as a whole there should be a prudent buffer. The target for the buffer at Group level is 20%.
Plus hybrid capital (2) 2,934 2,202 Plus Mark-to-Market, tax adjustments and illiquidity adjustment –366 2,597 Total AFR ING Insurance 14,456 22,710 (1) IFRS Equity 2008 adjusted for EUR 5 million shares of ING Group held by ING Insurance. (2) Hybrid capital at market value.
ING continues to adjust AFR to reflect the illiquidity in its insurance portfolios as reporting AFR with MVLs discounted at the swap rates results in an asymmetry between the assets and liabilities in terms of reflection of illiquidity premiums. In addition to valuing assets at current market values, total portfolio illiquidity risk profile has been proxied by applying a AAA covered bond spread (128 bps over swaps) to the valuation of insurance liabilities cash flows. This adjustment has been applied to all business (excluding mainly unit-linked/variable business) except for the US and Japanese businesses where the AAA covered bond spread is further adjusted by the differential between local AAA corporate bond spreads and AAA European corporate bond spreads (further +72 bps and -21 bps over swaps for the US and Japan respectively). If a similar methodology had been applied at 31 December 2007, AFR at that time would have been EUR 26.7 billion. At year-end 2007 the swap rate was used.
IFRS Equity 22,889 25,511 Revaluation Reserve Debt Securities 5,185 1,097 Revaluation Reserve cash flow hedge 128 –428 Goodwill –1,636 –1,428
Deduction (1) –1,084 Hybrid capital 7,085 6,397 Total AFR ING Bank 34,849 31,733 (1) Difference between loan loss provisions and expected loss is no longer deducted from AFR in 2008.
AFR/EC Ratio 137% 138% Surplus/(deficit) 11,460 13,715 (1) AFR ING Bank, amounting to EUR 34,849 million (2007: EUR 31,733 million) plus AFR ING Insurance, amounting to EUR 14,456 million (2007: EUR 22,710 million) less core debt ING Group, amounting to EUR 7,170 million (2007: EUR 4,728 million). (2) EC Insurance plus EC Bank less 15% diversification effect (15% in 2007). (3) EC of the ING Group parent company in 2007 mainly included market risk on share-based payment plans and market risk on the assets backing ING Bank equity. In 2008 the market risk on the assets backing ING Bank equity is included in ING Bank EC, and additional EC for share-based payment plans is zero in 2008.
(1) Tier-1 instruments issued by ING Group (e.g. perpetual debt securities and preference shares) at nominal value. Group hybrid Tier-1 instruments other than preference shares are provided as hybrid capital to ING Insurance or ING Bank. (2) Investments in subsidiaries less equity of the Group holding company (including core Tier-1 securities). This net debt position is provided as equity to ING
Insurance and ING Bank. (3) Includes mainly EUR –1,019 million (2007: EUR –2,358 million) in participations (e.g. Kookmin, Bank of Beijing) and other equity investments, EUR –615 million
Shareholders’ equity (parent) 22,889 25,511 Minority interests 1,198 1,668 Subordinated loans qualifying as Tier-1 capital (1) 7,085 6,397 Goodwill and intangibles deductible from Tier-1 –1,636 –1,428 Deductions Tier-1 (as of 2007) –1,040 –93 Revaluation reserve (2) 3,523 –2,283 Available capital – Tier-1 32,019 29,772
Supplementary capital – Tier-2 (3) 12,910 14,199 Available Tier-3 funds Deductions –1,040 –2,407 BIS capital 43,889 41,564
ING Insurance European Union directives require insurance companies established in member states of the European Union to maintain minimum capital positions. The ING Insurance companies outside the EU have to comply with their respective local requirements. ING Insurance’s companies comply with local regulatory requirements. The table below shows the global required capital position of ING Insurance measured on the basis of the European Union requirement. This requirement is compared with ING Insurance consolidated available capital.
Ratio of available versus required capital 256% 244% (1) For breakdown of available capital see Capital base table.
Shareholders’ equity (parent) 17,334 37,208 Core Tier-1 securities 10,000 Excluding: Revaluation reserves (1) 10,044 1,457 Group hybrid capital 11,655 8,620 Goodwill and intangibles deductible from Tier-1 –3,275 –2,420
Subordinated loans ING Bank N.V. (included in Tier-2) 11,879 11,154 Subordinated loans ING Verzekeringen N.V. 2,250 2,250 Capital base including subordinated loans 61,480 60,592
Basel II BIS ratio (Bank) Year-end actual BIS ratio 12.78% 10.32% Regulatory minimum BIS ratio 8.00% 8.00% Target BIS ratio 10.80% 10.80%
ING Bank – short term A-1+ P-1 F1+ – long term AA Aa2 AA – financial strength B (1) The Standard & Poor’s and Fitch ratings have a negative outlook and the Moody’s ratings have a stable outlook.
ING Insurance – short term A-1+ P-1 – long term AA- A2 A+
ING Bank – short term A-1+ P-1 F1+ – long term AA Aa3 AA- – financial strength C+ (1) The Standard & Poor’s and Fitch ratings have a negative outlook. The Moody’s Bank financial strength rating has a negative outlook. The other Moody’s ratings have a stable outlook. The Fitch rating for ING Bank has a stabe outlook, those for ING Insurance and ING Group have a negative outlook.
SUBSEQUENT EVENTS On 26 January 2009 ING Group and the Dutch government (‘State’) announced that they have reached an agreement on an Illiquid Assets Back-Up Facility (‘Facility’) term sheet. The transaction is expected to close in the first quarter of 2009, but the closing is dependent on the completion of final documentation and the approval of various regulators. The Facility covers the Alt-A portfolios of both ING Direct US and ING Insurance Americas, with a par value of approximately EUR 30 billion. Under the Facility, ING is expected to transfer 80% of the economic ownership of its Alt-A portfolio to the Dutch State. As a result, an undivided 80% interest in the risk and rewards on the portfolio will be transferred to the Dutch State. ING will retain the legal ownership of its Alt-A portfolio. The transaction price for the 80% of the economic ownership is expected to be approximately EUR 22 billion, being 90% of the par value with respect to the 80% proportion of the portfolio of which the Dutch State will become the economic owner. The transaction price will remain payable by the State to ING and will be redeemed over the remaining life. Furthermore, under the Facility other fees will have to be paid by both ING and the State. As a result of the transaction, 80% of the Alt-A portfolio will be derecognised from the balance sheet in 2009 and a receivable on the Dutch State will be recognised. The transaction is expected not to have a significant impact on net result in the first quarter 2009. The transaction will result in a reduction of the negative revaluation -and therefore increase equity- by approximately EUR 5 billion (after tax). The valuation method of the Alt-A securities in the IFRS balance sheet as at 31 December 2008 is not impacted by this transaction. The same applies to the 20% that will remain after the transaction. The methodology used to determine fair value for these assets in the balance sheet under IFRS is disclosed in Note 33 ‘Fair value of financial assets and liabilities’.
Jan H.M. Hommen, chairman Eric F. Boyer de la Giroday, acting CEO Eric Bourdais de Charbonnière, vice-chairman Dick H. Harryvan Henk W. Breukink John C.R. Hele, CFO Peter A.F.W. Elverding Eli P. Leenaars Claus Dieter Hoffmann Tom J. McInerney Piet Hoogendoorn Hans van der Noordaa Piet C. Klaver Koos (J.V.) Timmermans, CRO Wim Kok Jacques M. de Vaucleroy Godfried J.A. van der Lugt Harish Manwani Aman Mehta Joan Spero Jackson P. Tai Karel Vuursteen
Parent company balance sheet of ING Group as at 31 December before appropriation of result amounts in millions of euros 2008 2007
Equity 3 Share capital 495 534 Share premium 9,182 8,739 Non-voting equity securities 10,000 Legal reserves (1) –9,670 5,103 Other reserves 18,056 13,591 Unappropriated result –729 9,241
Total equity and liabilities 48,308 52,567 (1) Legal reserves includes Share of associates reserve of EUR –8,719 million (2007: EUR 6,053 million) and Currency translation reserve of EUR –951 million (2007: EUR –950 million).
Accounting policies for the parent company balance sheet and profit and loss account of ING Group
BASIS OF PRESENTATION The parent company accounts of ING Group are prepared in accordance with the financial reporting requirements included in Part 9 of Book 2, of the Dutch Civil Code. The accounting policies applicable to presentation and disclosures are in accordance with the financial reporting requirements included in Part 9 of Book 2, of the Dutch Civil Code. The principles of valuation and determination of results stated in connection with the consolidated balance sheet and profit and loss account are also applicable to the parent company balance sheet and profit and loss account with the exception of Investments in group companies and investments in associates which are initially recognised at cost and subsequently accounted for using the equity method of accounting.
A list containing the information referred to in Section 379 (1), Book 2, of the Dutch Civil Code has been filed with the Netherlands Authority for the Financial Markets and the office of the Commercial Register of Amsterdam, in accordance with Section 379 (5), Book 2, of the Dutch Civil Code.
A statutory reserve is carried at an amount equal to the share in the results of associates since their first inclusion at net asset value less the amount of profit distributions to which rights have accrued in the interim. Profit distributions which can be repatriated to the Netherlands without restriction are likewise deducted from the Share of associates reserve.
Opening balance 41,864 42,607 Revaluations –13,709 –5,364 Result of the group companies –569 9,299 Capital contribution 12,720 2,227 Dividend –7,050 –5,900
Share capital 495 534 Share premium 9,182 8,739 Non-voting equity securities 10,000 Share of associates reserve –8,719 6,053 Currency translation reserve –951 –950 Other reserves 17,327 22,832
The Share of associates reserve includes the following components: Reserve for non-distributable profit of associates of EUR 726 million (2007: EUR 1,202 million) and Revaluation reserve of associates of EUR – 9,445 million (2007: EUR 4,851 million).
Issued share capital as at 31 December 2006 2,205,093 530 Issue of shares 5,569 1 Exercise of B warrants 15,783 3 Issued share capital as at 31 December 2007 2,226,445 534
Result for the year 9,241 9,241 Unrealised revaluations after taxation 1 1 1 Changes in treasury shares –2,304 –2,304 –2,304 Dividend –2,999 –2,999 Transfer to share of associates reserve –174 –174 –174 Transfer to retained earnings 4,693 4,693 –4,693 Employee stock option and share plans 104 104 104
As at 31 December 2008, the Share of associates reserve included an amount of EUR 566 million (2007: EUR 566 million) related to Regio Bank N.V. (formerly Stichting Regio Bank) that cannot be freely distributed.
The total amount of Equity in the parent company annual accounts equals Shareholders’ equity (parent) in the consolidated annual accounts. Certain components within equity are different, as a result of the following presentation differences between the parent company accounts and consolidated accounts: Unrealised revaluations within consolidated group companies, presented in the Revaluation reserve in the consolidated accounts, • are presented in the Share of associates reserve in the parent company accounts; Foreign currency translation on consolidated group companies, presented in the Currency translation reserve in the consolidated • accounts, is presented in the Share of associates reserve in the parent company accounts; Revaluations on investment property and certain participations recognised in income and consequently presented in Retained earnings • in the consolidated accounts, is presented in the Share of associates reserve in the parent company accounts.
Cancelled –4,904 –183,158,017 Share-based payments –22 –201 –1,250,394 –6,751,515 Other –107 4 PREFERENCE SHARES See Note 13 ‘Preference shares’ to the consolidated financial statements.
Debenture loans 7,488 6,370 Amounts owed to group companies 1,254 174 Other amounts owed and accrued liabilities 815 357
The number of debentures held by group companies as at 31 December 2008 was 49,540 with a balance sheet value of EUR 4 million (2007: 348,920 with a balance sheet value of EUR 34 million).
Guarantees As at 31 December 2008, ING Group had no guarantees given on behalf of third parties (2007: nil). ING Group has issued statements of liabilities in connection with Section 403, Book 2 of the Dutch Civil Code and other guarantees for a number of group companies.
Jan H.M. Hommen, chairman Eric Bourdais de Charbonnière, vice-chairman Henk W. Breukink Peter A.F.W. Elverding Claus Dieter Hoffmann Piet Hoogendoorn Piet C. Klaver Wim Kok Godfried J.A. van der Lugt Harish Manwani Aman Mehta Joan Spero Jackson P. Tai Karel Vuursteen
Eric F. Boyer de la Giroday, acting CEO Dick H. Harryvan John C.R. Hele, CFO Eli P. Leenaars Tom J. McInerney Hans van der Noordaa Koos (J.V.) Timmermans, CRO Jacques M. de Vaucleroy
REPORT ON THE ANNUAL ACCOUNTS We have audited the annual accounts 2008 of ING Groep N.V., Amsterdam (as set out on pages 84 to 244). The annual accounts consist of the consolidated annual accounts and the parent company annual accounts. The consolidated annual accounts comprise the consolidated balance sheet as at 31 December 2008, the profit and loss account, statement of changes in equity and statement of cash flows for the year then ended, and a summary of significant accounting policies and other explanatory notes. The parent company annual accounts comprise the parent company balance sheet as at 31 December 2008, the parent company profit and loss account for the year then ended and the notes.
An audit involves performing procedures to obtain audit evidence about the amounts and disclosures in the annual accounts. The procedures selected depend on the auditor’s judgment, including the assessment of the risks of material misstatement of the annual accounts, whether due to fraud or error. In making those risk assessments, the auditor considers internal control relevant to the entity’s preparation and fair presentation of the annual accounts in order to design audit procedures that are appropriate in the circumstances. An audit also includes evaluating the appropriateness of accounting policies used and the reasonableness of accounting estimates made by management, as well as evaluating the overall presentation of the annual accounts.
REPORT ON OTHER LEGAL REQUIREMENTS Pursuant to the legal requirement under 2:393 sub 5 part f of the Dutch Civil Code, we report, to the extent of our competence, that the report of the Executive Board is consistent with the annual accounts as required by 2:391 sub 4 of the Dutch Civil Code.
In August 2008, an interim dividend of EUR 0.74 per ordinary share of EUR 0.24 was made payable. This interim dividend was paid in cash. Accordingly it is proposed that no final dividend will be paid.
Net result –729 Deduction from reserves pursuant to Article 37 (4) of the Articles of Association –2,654 Payable on non-voting equity securities 425 At the disposal of the General Meeting of Shareholders pursuant to Article 37 (5) of the Articles of Association 1,500
SUBSEQUENT EVENTS On 26 January 2009 ING Group and the Dutch government announced that they have reached an agreement on an Illiquid Assets Back-Up Facility. Reference is made to section ‘Subsequent events’ in the consolidated annual accounts.
RISKS RELATED TO THE FINANCIAL SERVICES INDUSTRY Because we are an integrated financial services company conducting business on a global basis, our revenues and earnings are affected by the volatility and strength of the economic, business and capital markets environments specific to the geographic regions in which we conduct business. The ongoing turbulence and volatility of such factors have adversely affected, and may continue to adversely affect the profitability of our insurance, banking and asset management business.
The capital and credit markets have been experiencing extreme volatility and disruption for more than eighteen months. In the second half of 2008, the volatility and disruption reached unprecedented levels. In some cases, market developments have resulted in restrictions on the availability of liquidity and credit capacity for certain issuers. We need liquidity in our day-to-day business activities to pay our operating expenses, interest on our debt and dividends on our capital stock; maintain our securities lending activities; and replace certain maturing liabilities. The principal sources of our liquidity are insurance premiums, annuity considerations, deposit funds, cash flow from our investment portfolio and assets, consisting mainly of cash or assets that are readily convertible into cash. Sources of liquidity in normal markets also include a variety of short- and long-term instruments, including repurchase agreements, commercial paper, medium- and long-term debt, junior subordinated debt securities, capital securities and stockholders’ equity.
Disruptions, uncertainty or volatility in the capital and credit markets may also limit our access to capital required to operate our business. Such market conditions may limit our ability to raise additional capital to support business growth, or to counter-balance the consequences of losses or increased regulatory capital requirements. This could force us to delay raising capital, issue capital of different types or under different terms than we would otherwise, or incur a higher cost of capital than in a more stable market environment. This would have the potential to decrease both our profitability and our financial flexibility. Our results of operations, financial condition, cash flows and regulatory capital position could be materially adversely affected by disruptions in the financial markets. In the course of 2008 governments around the world, including the Dutch government, have implemented measures providing assistance to financial institutions, in certain cases requiring (indirect) influence on or changes to governance and remuneration practices. In certain cases governments have even nationalised companies or parts thereof. The measures adopted in the Netherlands consist in both liquidity provision and capital reinforcement, and a Dutch Capital Guarantee Scheme. The liquidity and capital reinforcement measures apply for a period of one year as of 10 October 2008, while the Dutch Credit Guarantee Scheme is scheduled to run through 31 December 2009. So far we have been able to benefit from these measures. Going forward, the Dutch authorities will look at each application individually. Potential future transactions with the Dutch government or any other government or actions by such government regarding ING could adversely impact the position or rights of shareholders.
Because we operate in highly regulated industries, laws, regulations and regulatory policies or the enforcement thereof that govern activities in our various business lines could have an effect on our reputation, operations and net results.
In light of current conditions in the global financial markets and the global economy, regulators have increased their focus on the regulation of the financial services industry. Most of the principal markets where we conduct our business have adopted, or are currently considering, major legislative and/or regulatory initiatives in response to the financial crisis. In particular, governmental and regulatory authorities in the Netherlands, the United Kingdom, the United States and elsewhere are implementing measures to increase regulatory control in their respective financial markets and financial services sectors, including in the areas of prudential rules, capital requirements, executive compensation and financial reporting, among others. Most recently, governments in the Netherlands and abroad have intervened on an unprecedented scale, responding to stresses experienced in the global financial markets. Some of the measures adopted subject us and other institutions for which they were designed to additional restrictions, oversight or costs. For restrictions related to the 2.4 Additional information
As a result of the ongoing and unprecedented volatility in the global financial markets in 2007 and 2008, we have incurred negative revaluations on our investment portfolio, which have impacted our earnings and shareholders’ equity. Furthermore, we have incurred impairments and other losses, which have impacted our profit and loss accounts. Reserves for insurance liabilities are overall adequate at the Group and Business line level. Inadequacies in certain product areas have developed.
Such impacts have arisen primarily as a result of valuation issues arising in connection with our investments in real estate and private equity, exposures to US mortgage-related structured investment products, including sub-prime and Alt-A Residential and Commercial Mortgage-Backed Securities (CMBS and RMBS), Collateralised Debt Obligations (CDOs) and Collateralised Loan Obligations (CLOs), monoline insurer guarantees, Structured Investment Vehicles (SIVs) and other investments. In many cases, the markets for such investments and instruments have become highly illiquid, and issues relating to counterparty credit ratings and other factors have exacerbated pricing and valuation uncertainties. Valuation of such investments and instruments is a complex process involving the consideration of market transactions, pricing models, management judgment and other factors, and is also impacted by external factors such as underlying mortgage default rates, interest rates, rating agency actions and property valuations. While we continue to monitor our exposures in this area, in light of the ongoing market environment and the resulting uncertainties concerning valuations, there can be no assurances that we will not experience further negative impacts to our shareholders’ equity or profit and loss accounts from such assets in future periods.
Because we operate in highly competitive markets, including our home market, we may not be able to increase or maintain our market share, which may have an adverse effect on our results of operations.
General Third-parties that owe us money, securities or other assets may not pay or perform under their obligations. These parties include the issuers whose securities we hold, borrowers under loans originated, customers, trading counterparties, counterparties under swaps, credit default and other derivative contracts, clearing agents, exchanges, clearing house and other financial intermediaries. Defaults by one or more of these parties on their obligations to us due to bankruptcy, lack of liquidity, downturns in the economy or real estate values, operational failure, etc., or even rumours about potential defaults by one or more of these parties or regarding the financial services industry generally, could lead to losses for us, and defaults by other institutions. In addition, with respect to secured transactions, our credit risk may be exacerbated when the collateral held by us cannot be realised, or is liquidated at prices not sufficient to recover the full amount of the loan or derivative exposure due us. We also have exposure to a number of financial institutions in the form of unsecured debt instruments, derivative transactions and equity investments. There is no assurance that losses on, or impairments to the carrying value of these assets would not materially and adversely affect our business or results of operations.
Reinsurers Our insurance operations have bought protection for risks that exceed certain risk tolerance levels set for both our life and non-life businesses. This protection is bought through reinsurance arrangements in order to reduce possible losses. Because in most cases we must pay the policyholders first, and then collect from the reinsurer, we are subject to credit risk with respect to each reinsurer for all such amounts. As a percentage of our (potential) reinsurance receivables as of 31 December 2008, the greatest exposure after collateral to an individual reinsurer was approximately 32%, approximately 68% related to four other reinsurers and the remainder of the reinsurance receivables balance related to various other reinsurers. The inability or unwillingness of any one of these reinsurers to meet its financial obligations to us, or the insolvency of our reinsurers, could have a material adverse effect on our net results and our financial results.
The establishment of insurance provisions, including the impact of minimum guarantees which are contained within certain variable annuity products, the adequacy test performed on the provisions for life policies and the establishment of DAC and VOBA are inherently uncertain processes involving assumptions about factors such as court decisions, changes in laws, social, economic and demographic trends, inflation, investment returns, policyholder behaviour (e.g. lapses, persistency, etc.) and other factors, and, in the life insurance business, assumptions concerning mortality and morbidity trends.
Ratings are important to our business for a number of reasons. Among these are the issuance of debt, the sale of certain products and the risk weighting of Bank assets. Downgrades could have an adverse impact on our operations and net results.
We obtain credit ratings from Standard & Poor’s, Moody’s and Fitch. While we aim to maintain a senior unsecured rating of AA, each of the rating agencies reviews its ratings and rating methodologies on a recurring basis and may decide on a downgrade at any time. In the event of a downgrade the cost of issuing debt will increase, having an adverse effect on net results.
Claims paying ability, at the Group or subsidiary level, and financial strength ratings are factors in establishing the competitive position of insurers. A rating downgrade could elevate lapses or surrenders of policies requiring cash payments, which might force us to sell assets at a price that may result in realised investment losses. Among others, total invested assets decreases and deferred acquisition costs might need to be accelerated, adversely impacting earnings. A downgrade may adversely impact relationships with distributors of our products and services and customers, which may affect new sales and our competitive position.
Our businesses depend on the ability to process a large number of transactions efficiently and accurately. Losses can result from inadequate personnel, inadequate or failed internal control processes and systems or from external events that interrupt normal business operations. We also face the risk that the design of our controls and procedures prove to be inadequate or are circumvented. We have suffered losses from operational risk in the past and there can be no assurance that we will not suffer material losses from operational risk in the future.
Our business may be negatively affected by adverse publicity, regulatory actions or litigation with respect to the Company, other well-known companies or the financial services industry in general.
Adverse publicity and damage to ING’s reputation arising from its failure or perceived failure to comply with legal and regulatory requirements, financial reporting irregularities involving other large and well known companies, increasing regulatory and law enforcement scrutiny of ‘know your customer’ anti-money laundering, prohibited transactions with countries subject to sanctions, and bribery or other anti-corruption measures and anti-terrorist-financing procedures and their effectiveness, regulatory investigations of the mutual fund, banking and insurance industries, and litigation that arises from the failure or perceived failure by ING to comply with legal, regulatory and compliance requirements, could result in adverse publicity and reputation harm, lead to increased regulatory supervision, affect our ability to attract and retain customers, maintain access to the capital markets, result in cease and desist orders, suits, enforcement actions, fines and civil and criminal penalties, other disciplinary action or have other material adverse effects on us in ways that are not predictable.
Because we are a Dutch company and because the Stichting ING Aandelen holds more than 99% of our Ordinary shares, the rights of our shareholders may differ from the rights of shareholders in other jurisdictions, which could affect your rights as a shareholder.
While holders of our bearer receipts are entitled to attend and speak at the General Meeting, voting rights are not attached to the bearer depositary receipts. Stichting ING Aandelen (‘the Trust’) holds more than 99% of our Ordinary shares, and exercises the voting rights attached to the Ordinary shares (for which bearer receipts have been issued). Holders of bearer receipts who attend – in person or by proxy – the General Meeting must obtain voting rights by proxy from the Trust. Holders of bearer receipts and holders of the ADSs (American Depositary Shares) representing the bearer receipts, who do not attend the General Meeting, may give binding voting instructions to the Trust. The Trust is entitled to vote on any Ordinary shares underlying the bearer depositary receipts for which the Trust has not granted voting proxies, or voting instructions have not been given to the Trust. In exercising its voting discretion, the Trust is required to make use of the voting rights attached to the Ordinary shares in the interest of the holders of bearer receipts, while taking into account: our interests;• the interests of our affiliates; and• the interests of our other stakeholders.•
The share price of our bearer receipts and our ADSs has been volatile in the past, in particular over the past year. The share price and trading volume of our bearer receipts and our ADSs may continue to be subject to significant fluctuations due, in part, to the high volatility in the securities markets generally and more particular in shares of financial institutions. Other factors, besides our financial results, that may impact our share price include, but are not limited to: market expectations of the performance and capital adequacy of financial institutions in general;• investor perception of the success and impact of our strategies;• a downgrade or review of our credit ratings;• potential litigation or regulatory action involving ING Group or sectors we have exposure to through our insurance and banking • activities; announcements concerning financial problems or any investigations into the accounting practices of other financial institutions; and• general market circumstances. •
Our agreements with the Dutch State impose certain restrictions regarding the issuance or repurchase of our shares and the compensation of certain senior management positions.
For so long as the Dutch State holds at least 25% of the Core Tier-I Securities issued by us on 12 November 2008, or for so long as any of the government guaranteed senior unsecured bonds issued by ING Bank N.V. successively on 30 January 2009 and 20 February 2009 under the Credit Guarantee Scheme of the Dutch State (the ‘Government Guaranteed Bonds’) are outstanding, whichever expires last, we are prohibited from issuing or repurchasing any of our own shares (other than as part of regular hedging operations and the issuance of shares according to employment schemes) without the consent of the Dutch State’s nominees on the Supervisory Board (see below). In addition, under the terms of these agreements with the Dutch State and the Illiquid Assets Back-up Facility between ourselves and the Dutch State described in the termsheet of 26 January 2009, we have agreed to institute certain restrictions on the compensation of the members of the Executive Board and Senior Management, including incentives or performance-based compensation. These restrictions could hinder or prevent us from attracting or retaining the most qualified management with the talent and experience to manage our business effectively. In connection with these transactions, the Dutch State was granted the right to nominate two candidates for appointment to the Supervisory Board. The Dutch State’s nominees have veto rights over certain material transactions.
The issuance of the Core Tier-I Securities to the Dutch State has increased the cumulative change of ownership for United States tax purposes to approximately 42% as per 12 November 2008. Future increases of capital or other ownership changes may bring ING over the 50% threshold; in which case limitations to the future use of tax loss carry forwards as well as certain so-called built-in-losses may adversely affect net result and equity.
Section 382 of the United States Internal Revenue Code contains a so-called loss limitation rule, the general purpose of which is to prevent trafficking in tax losses (i.e. it is an anti-abuse rule). The rule is triggered when the ownership of a company changes by more than 50% (measured by value) on a cumulative basis in any three year period. If triggered, restrictions may be imposed on the future use of realised tax losses as well as certain losses that are built into the assets of the company at the time of the ownership change and that are realised within the next five years. The issuance of EUR 10 billion of securities by ING to the Dutch State on 12 November 2008 brought ING’s (cumulative) change of ownership as per that date to approximately 42%. As a result, future increases in capital or other changes of ownership may adversely affect the net result or equity of ING, unless relief from the loss limitation rules is obtained, which may or may not be possible.
RAROC is calculated as the risk-adjusted return divided by economic capital. The risk-adjusted return is based on similar valuation policies as applied in the financial accounts, with two important exceptions. The actual credit-risk provisioning is replaced by expected losses reflecting statistically calculated average credit losses over the entire economic cycle. In addition the profit and loss account is adjusted for effects that relate to replacing actual book capital by economic capital.
NEW CAPITAL ADEQUACY RULES – BASEL II ACCORD The rules on capital adequacy, also referred to as Regulatory Capital (RECAP), express the regulators’ and legislators’ opinions of how much capital a bank and other regulated credit institutions must retain in relation to the size and the type of risk taking expressed in the form of risk-weighted assets. The most important part of the capital base is the shareholders’ equity. In addition to equity, the institution may issue certain liabilities such as subordinated loans to be included in the capital base. The legal minimum requirement stipulates that the capital base must correspond to at least 8% of the Risk-Weighted Assets (RWA).
The Dutch government adopted the Capital Requirements Directive (CRD), the European reflection of the Basel II capital accord in December 2006. Since the new regulations adopt a ‘risk-based approach’ to determine the required capital base, there is a significant difference in the measurement of capital compared to the former rules. Therefore, the Dutch government adopted legislation to implement the new rules in stages. For 2008, the capital base may not fall below 90% of the amount that would have been applicable under the former rules, called Basel I. For 2009, the floor reduces to 80%. No floor is applied after year end 2009.
Portfolios subject to advanced IRB approach – Central governments and central banks 309 – Institutions 1,680 – Corporate 9,366 – Residential mortgages 3,062 – Other retail 885 Total portfolios subject to advanced IRB approach 15,302
Market risk Standardised approach 449 Internal models approach – trading book 587 Total market risk 1,036
CREDIT RISK BASIS OF PRESENTATION FOR CREDIT RISK The following paragraphs address the risk information for Pillar 3 reporting.
Figures associated with Money Market and Lending activities are generally the nominal amounts, while amounts associated with Investment activities are based on the original amount invested less repayments. Off-Balance Sheet exposures include the letters of credits and guarantees, which are associated with the Lending Risk Category. Additionally, Off-Balance Sheet exposures include a portion of the unused limits, associated with the statistically expected use of the unused portion of the limit between the moment of measurement and the theoretical moment of statistical default. Collectively, these amounts are called ‘credit risk outstandings’.
CREDIT RISK AT ING ING Bank’s credit policy is to maintain an internationally diversified loan and bond portfolio, while avoiding large risk concentrations. The emphasis is on managing business developments within the business lines by means of top-down concentration limits for countries, individual obligors and obligor groups. The aim is to expand relationship-banking activities, while maintaining stringent internal risk/ return guidelines and controls.
ING Bank’s credit exposure is mainly related to traditional lending to individuals and businesses, bonds held in the investment portfolios and financial markets trading activities. Loans to individuals are mainly mortgage loans secured by residential property. Loans to businesses are often collateralised, but can be unsecured based on internal analysis of the obligors’ creditworthiness. Financial Markets activities include derivatives trading, securities financing, and Foreign Exchange (FX) transactions, which we collectively refer to as Pre-Settlement risks. ING uses various market pricing and measurement techniques to determine the amount of credit risk on presettlement activities. These techniques estimate ING’s potential future exposure on individual and portfolios of trades. Master agreements and collateral agreements are frequently entered into to reduce these credit risks.
One of the key elements of the Basel II Accord is the ‘Use Test’, which requires ING to use Basel concepts in its day-to-day activities. The diagram below illustrates where ING has incorporated the Basel II concepts into its daily activities, both globally and locally: Loan Pricing
Exposure at Default (EAD): • The second element is the obligor’s exposure at default. These models are intended to estimate the outstanding amount or obligation at the moment of default in the future. Since the fact that an obligor will go into default is not known, and the level of outstandings that may occur on that date is also not known, ING uses a combination of statistical, expert and hybrid models to estimate the Exposure at Default. With the exception of guarantees and letters of credit, the EAD is always equal to or higher than the associated credit risk outstandings, under the assumption that obligors tend to absorb liquidity from available credit resources before financial problems become apparent to the obligor’s creditors.
Loss Given Default (LGD): • The third element is the loss given default. These models are intended to estimate the amount ING will lose when liquidating collateral pledged in association with a given loan or financial obligation, or alternatively, liquidating the company as a whole, as part of a workout process. LGD models are based on cover types, estimated recovery rates given orderly liquidation, and (in)direct cost of liquidation.
Types of Credit Risk Modelling Within ING Bank, there are three types of modelling which form the foundation of the PD, EAD and LGD models used throughout the bank.
Expert models• are based on the knowledge of experts from both Risk Management and Front Office staff and literature from rating agencies, supervisors and academics. These kinds of models are especially appropriate for portfolios for which limited historical defaults exists thereby reducing the reliability of a statistical model. These portfolios are also often referred to as ‘Low Default Portfolios’; Statistical models• are created where a large set of default or detailed loss data is available. They are characterised by a sufficient number of data points which facilitate meaningful statistical estimation of the model parameters. The model parameters are estimated with statistical techniques based on the data set available.
Hybrid models • contain characteristics of both expert and statistical models.
Next to the model choice, the definition of default is an important starting point for model building. ING uses a framework that integrates elements of the regulatory definition of ‘Default’ and the loan loss provisioning indicators under IAS 39. The rationale is that several indicators are very close to the indications of an obligor’s ‘unlikeliness to pay’ under Basel II and similar regulations.
ING anticipates that collectively approximately 50% of the remaining standardised portfolios will migrate to the AIRB approach during 2009; in some cases migrations may require additional regulatory approvals.
ING uses the AIRB and the Internal Assessment Approach (IAA) for liquidity lines provided to Asset Backed Commercial Paper programs. For a number of portfolios that are either on an exit strategy or immaterial in terms of size and risk profile, the Standardised Approach is used.
Includes both AIRB and SA portfolios; Excludes securitisations, equities and ONCOA. Problem Loans (rating 20-22) are excluded in the figures above.
The figures above assume that loans, money market and investments in fixed income securities are fully repaid at their maturity dates and that limits are reduced in conjunction with repayment schedules contained in the associated loan documentation, without regard for potential renewal or extension, or portfolio sales or acquisitions. Pre-Settlement risks are assumed to reduce over the legal maturity of the underlying transactions. However, under mark-to-market plus add-on methodology, it is possible for exposures to increase in time, rather than decrease. This is a function of ING’s estimates of future interest rates and foreign exchange rates, as well as potential changes in future obligations that may be triggered by such events. Generally, credit risk outstandings are lower than EAD.
Further, all figures assume that no new credit risks are introduced into the portfolio and that there are no delays in repayments associated with problem loans, nor are there write offs associated with provisions or impairments. The portfolio runoff is implied by the difference in the figures between two periods.
There are three types of provisions that have to be made and accounted for: Individually Significant Financial Asset (ISFA) Provisions• for those loans where specific, individualized provisions are still required. These are generally loans that exceed the threshold amount.1 These provisions are made using an estimated future recovery methodology and then applying a net present value concept. The future cash flows are based on the restructuring officers’ best estimate of when/if recoveries will occur. Recoveries can be from any source, such as the sale of collateral, ongoing cash flows, sale of a business/subsidiary, etc. ISFA provisions are all calculated using a common tool across ING Bank.
Incurred But Not Recognised (IBNR) Provisions:• are made for the ‘performing’ loan portfolio as an estimate or proxy for the losses/ defaults that may have already occurred in the portfolio, but which ING has not yet determined or recognised. These provisions are based on a modified expected loss methodology. The primary modification is that the PD time horizon (12 months) is shortened to periods of 3, 6, or 9 months, depending on the type of obligor. Generally, the larger the obligor, the shorter the PD time horizon. IBNR provisions are calculated centrally using a common tool across ING Bank.
Individually Not Significant Financial Asset (INSFA) Provisions:• are made for acknowledged problem loans (ratings 20-22) that are below the threshold amount. Due to their small size, the IFRS rules permit a statistical approach to measuring these provisions. Therefore, the calculation is based on the same statistical formula that is used to determine IBNR Provisions and is also calculated centrally using a common tool across ING Bank.
Includes both AIRB and SA portfolios; Excludes securitisations, equities and ONCOA. Excludes impairments made directly to the equity accounts.
Economic sectors not shown in above table have past due loans of less than EUR 75 million, and are grouped under Other.
Loan Loss Provision Shortfall The Loan Loss Provision Shortfall is the difference between the EL and loan loss provisions for AIRB exposures. This difference is caused by the different PD time horizons that exist for IAS 39 Loan Provisioning (3, 6, and 9 months) and the 12 month time horizon used for EL and regulatory capital calculation. Basel II requires that the shortfall is deducted from the regulatory capital, 50% from Tier 1 and 50% from Tier 2 capital.
The Standardised Approach Unlike the AIRB approach, the standardised approach applies a fixed risk weight to each asset as dictated by the Financial Supervisory Authorities, and is based on the exposure class to which the exposure is assigned. As such, the Standardised Approach is the least sophisticated of the Basel II methodologies and is not as sensitive as the risk-based approach. Where external rating agency ratings are available, they may be used as a substitute to using the fixed risk weightings assigned by the Financial Supervisory Authorities. Because the underlying obligors are relatively small, the underlying obligors tend not to have external ratings.
Under the standardized approach there are two principal methods for reducing or mitigating credit risk: a) reduction of credit risk through the acceptance of pledged financial assets as collateral, such as marketable securities or cash; or b) mitigation or shifting of credit risks to a lower risk weighting group by accepting guarantees from unrelated third parties. The risk weighting categories are defined in Basel 2 and are interpreted by ING as follows: 0% Risk Weighting These assets fall into three categories as described below. In all of these cases, ING has developed credit risk models for the specific portfolios, but has not yet implemented the AIRB approach due to restrictions imposed by local regulators. In most cases, these portfolios are eligible to be converted to the AIRB approach in 2009.
Central government and central banks In accordance with national discretion rules, the risk weight for many central governments and central banks under the standardised approach is 0%.
50% Risk Weighting 50% Risk Weighting is applied to exposures based on their exposure class and external rating. These are generally not prime grade exposures.
75% Risk Weighting Retail exposures under the standardised approach are assigned a risk weight of 75%.
150% Risk Weighting Under the standardised approach, certain specified exposures, such as exposures to venture capital and private equity, as well as the unsecured portion of any past due obligation is assigned a risk weighting of 150%.
PORTFOLIOS UNDER THE AIRB APPROACH RISK RATING METHODOLOGY In principle all Risk Ratings are based on a Risk Rating (PD) Model that complies with the minimum requirements detailed the CRD, the DNB Supervisory Rules and CEBS guidelines. This concerns all Obligor Types and Segments, including Countries.
ING’s Probability of Default (PD) rating models are based on a 1-22 scale, which roughly corresponds to the same rating grades that are assigned by external rating agencies, such as Standard & Poor’s and Fitch. For example, an ING rating of 1 would correspond to an S&P/ Fitch rating of AAA; an ING rating of 2 would correspond to an S&P/Fitch rating of AA+, and so on.
Over 95% of ING’s credit risks have been rated using one of the in-house developed PD rating models. Within the AIRB Portfolio, the level of Basel II ratings exceeds 99% coverage by exposure. Bankwide, ING has implemented approximately 90 PD models, including various submodels that may be applicable. Some of these models are universal in nature, such as models for Large Corporate, Commercial Banks, Insurance Companies, Central Governments, Local Governments, Funds, Fund Managers, Project Finance, and Leveraged Companies. While other models are more regional or country specific, such as PD models for SME companies in Central Europe, the Netherlands, Belgium, Luxembourg, and the United Kingdom, as well as residential mortgage and consumer loan models in the various retail markets.
Rating Models for retail obligors are predominantly statistically driven and automated, such that they can be updated on a monthly or bi-monthly basis. Models for SME companies, and larger corporates, institutions and banks are manually updated, and are individually monitored on at least an annual basis.
The table above represents the weighted average LGD for each of the represented combination of PD Grade and Exposure Class. For example, the weighted average LGD for an AAA rated corporate is 34%, while the weighted average LGD for a BBB rated corporate is 29%. LGD percentages are influenced by the transactional structure of the financial obligation, the related collateral or covers provided, and the country in which the collateral (if any) would have to be recovered.
From time to time, ING extends loans for which it receives a specific financial guarantee from a non-related counterparty or obligor. The figures in this table represent the EAD that has been guaranteed by these non-related parties. It does not include non-guaranteed amounts. For example, if a given credit risk is only partially guaranteed by a third party then only the portion of the amount which is guaranteed is included in the figures above. These figures exclude any guarantees which are received from a party related to the obligor, such as a parent or sister company. The figures also exclude any guarantees that may be implied as a result of credit default swap activities. Additionally, amounts that have been guaranteed as part of a government-sponsored mortgage program are also excluded. The figures above do include amounts that are guaranteed through an unfunded risk participation construction.
Bond Financing Taken 237 993 1,230 Stock Financing Taken 658 1,634 2,292
The figures above represent the notional amount of credit risk default swaps that ING has entered into for the represented purpose. The credit risk on the counterparties associated with credit default swap protection bought is included in the pre-settlement risk calculations for the given counterparty, and not in the figures above. For credit default protection sold, ING incurs synthetic issuer risk, on which capital is calculated, depending on its purpose, either hedging or trading.
Scope The following information is prepared taking into account the ‘Industry Good Practice Guidelines on Pillar 3 disclosure requirements for securitisations’ (the Guidelines) issued by the European Banking Federation and other industry associations on 18 December 2008.
Depending on ING’s role as investor, originator, or sponsor the objectives, the involvement and the rules applied may be different. ING is primarily engaged in securitisation transactions in the role of investor (in securitisations arranged by others). To a lesser extent, ING is also an originator or sponsor of securitisations that are usually traded in the public markets.
Under the RBA, the risk-weighted assets (RWA) are determined by multiplying the amount of the exposure by the appropriate regulatory risk weights, which depend on: the external rating or an available inferred rating• the seniority of the position.•
Securitisation markets provide investment opportunities in highly rated (generally AAA), liquid and discountable bonds and are therefore an important asset class in ING Direct’s investment portfolio. At ING Direct, the investment policies define eligible product types, minimum ratings, maximum tenors and exposure amounts both at issue and issuer levels as well as for the portfolio. The dominant product classes in the investment portfolio are RMBS, Agency RMBS, Covered Bonds, and Senior Unsecured Debt issued by Banks, Other Financial Institutions as well as Sovereigns or Quasi-sovereign entities. Prior to purchase, each investment proposal from a Treasury Centre is analysed by Credit Risk Management and decided upon at the appropriate level by a treasury officer and a credit risk manager under delegated approval authorities.
Purchased Securitisation Exposures The following table gives the break down of purchased exposures by weight bands. The amount of securitisation positions purchased from third parties are based on the regulatory exposure values calculated according to the CRD after consideration of credit conversion factors (CCFs) where applicable as used for the purpose of Pillar 1, but prior to the application of credit risk mitigants on securitisation positions.
The first transactions (Moon and Memphis 2003) were repaid in 2008 with no loss for the investors. As of 31 December 2008, five transactions totalling approximately EUR 15 billion (Mars 2004, Mars 2006 and BEL SME 2006 on SME exposures, Memphis 2005 and Memphis 2006 on residential mortgages) remain outstanding, as further detailed below. Memphis 2006 transfers risk on high Loan to Value (LTV) Dutch mortgages.
Securitisations of residential mortgages release less capital under Basel II than under Basel I because the capital required for this type of exposure has been reduced under Basel II rules.
Exposures securitised as originator: All securitisations reported in this section are synthetic securitisations used to transfer risk to third parties. Transactions for liquidity/funding purpose are not included.
Outstandings EAD on 31 December 2008 of assets that were performing on the Cut-off date. Credit Events Aggregate outstandings of assets subject to a credit event reported in the twelve months period ending on the Cut-off date. Past Due Assets Outstandings on the Cut-off date of assets that are past due, but not in credit event on that date, as more fully detailed in the quarterly reports. Past due for residential mortgage transactions means ‘more than 1 monthly payment in arrears’. Past due for SME deals means ‘reference entities that are rated 20-22’.
Retained Securitisation Exposures Retained exposures on securitisation of ING’s own assets include the most senior tranches and the equity piece (first loss). Economically, on a total of about EUR 15 billion underlying exposures in the five transactions mentioned below, ING has retained approximately EUR 204 million of first loss exposure and has transferred approximately EUR 1.1 billion of mezzanine tranches (second loss) to third parties.
Securitsations originated by a company may only be considered for balance sheet derecognition when the requirements for signficant credit risk transfer have been fulfilled. However, for a securitisation transaction to be recognised as for RWA reduction, risk transfer alone is insufficient due to the increasing impact of the maturity mismatch formula. The RWA of the retained tranches for four of the transactions in the table above would be higher than the total RWA of the underlying pool before securitisation, and therefore these transactions are treated for RWA purposes as if they were not securitised. The total RWA for the fifth transaction calculated under Pillar 1 rules is EUR 230 million (retained senior and super senior tranches). In addition EUR 28 million (retained first loss) is deducted from capital.
In its role as administrative agent, ING facilitates these transactions by providing structuring, accounting, funding and operations services. ING Bank also provides support facilities (liquidity and program wide enhancement) backing the transactions funded by the conduit.
Exposures Securitised as Sponsor The total liquidity facilities, including programme wide enhancements, provided to the Mont Blanc conduit are EUR 4,867 million. The total drawn liquidity amount as of 31 December 2008 is EUR 972 million.
Interest rate risk 255 456 711 Equity position risk 80 80
MODEL APPROACH According to the Dutch regulation, regulatory capital for trading portfolios can be calculated using the standardised approach (CAD1) or an internal model approach (CAD2). In 1998, ING received approval from the Dutch Central Bank (DNB) to use an internal Value-at-Risk (VAR) model to determine the regulatory capital for the market risk in the trading book of ING Bank. Market risk capital of CAD2 trading books is calculated according to the internal VaR model, where correlations and volatilities are taken into account. On the other hand, market risk capital of CAD1 books is calculated using standardised fixed risk weights.
In 2008, ING applied the CAD2 model for most of its trading activities. The standard CAD1 model is used for some trading books in smaller locations and/or products for which the internal model is not yet CAD2 compliant. The aim of ING is to receive CAD2 status for all its trading books. It should be noted that due to the conservative nature of the CAD1 model the capital charge for the standardised approach is much larger than for the internal model approach.
For a summary of the Value-at-Risk measurement applicable to the internal model approach please refer to the Market Risk segment in the Risk Management section. It should be noted that the VaR figures in the above table only relate to the CAD2 trading books for which the internal model approach is applied. The VaR figures reported in the Risk management section relate to all books under trading governance.
The Operational Risk Capital using AMA significantly increased to EUR 3,368 million in 2008 (as stated in the operational risk part of the risk management section) due the periodic update of the external loss data, which reflected the increased uncertainty/turmoil in the financial market. Two acquisitions took place that impacted capital and the related diversification benefit as well: ING Turkey and ING Direct Interhyp.
By line of business ING Wholesale Banking –132 ING Retail Banking –101 ING Direct 5 ING Bank Corporate Line 46 Total –182
By Currency Euro –221 US Dollar 36 Pound Sterling 3 Other Total –182
In the Risk Management section a detailed description is given on the interest rate risk in the Banking book. Contrary to Pillar 3, in the Risk Management section several non-trading books are governed by the trading risk process. As a result the figures above differ from the figures in the Risk Management section.
AMORTISED COST The amount at which the financial asset or liability is measured at initial recognition less principal repayments, plus or minus the cumulative amortisation using the effective interest method of any difference between that initial amount and the maturity amount, and minus any reduction for impairment or uncollectibility.
AVAILABLE-FOR-SALE FINANCIAL ASSETS Those non-derivative financial assets that are designated as available for sale or are not classified as loans and receivables;• held-to-maturity investments; or• financial assets at fair value through profit and loss.•
DEFINED BENEFIT PLAN Post-employment benefit plans other than defined contribution plans.
DEPOSITARY RECEIPT For ordinary and preference shares, issued by the Trust, in exchange for ordinary and preference shares issued by ING Group.
EARNINGS AT RISK (EAR) Measures the impact on earnings resulting from changes in market rates over a one-year horizon.
ECONOMIC CAPITAL The minimum amount of capital that is required to absorb unexpected losses in times of severe stress. Given ING Group’s AA target rating, ING calculates economic capital requirements at a 99.95% level of confidence. This confidence level is derived from the historical default frequency of AA-rated companies (probability of default of 1 in 2000 years or 0.05%).
COMPLIANCE RISK Compliance risk is defined as the risk of damage to ING’s reputation as a result of failure (or perceived failure) to comply with relevant laws, regulations, internal policies and procedures or ethical standards.
CONVEXITY The non-linear relationship between changes in the interest rates and changes in bond prices and their Net Present Value. It is a very important measure for portfolios containing (embedded) options.
COST RATIO Underwriting costs expressed as a percentage of premiums written.
CREDIT INSTITUTIONS All institutions are subject to banking supervision by public authorities, including mortgage banks, capital market institutions, multilateral development banks and the International Monetary Fund (IMF).
INTERNAL RATE OF RETURN (IRR) Internal rate of return is the discount rate at which the present value of distributable earnings from new business equals the investment in new business (i.e. the projected return on the investment in new business) is calculated.
INTEREST RATE RISK Probability that the market interest rates will rise significantly higher than the interest rate earned on investments such as bonds, resulting in their lower market value.
INVESTMENT PORTFOLIO Comprises those assets which are intended for use on a continuing basis, and have been identified as such. These investments are held in order to cover the insurance provisions and to manage interest rate, capital and liquidity risks.
EMBEDDED VALUE (EV) Embedded value is the present value of all future cash flows from the contracts being owned today (embedded value does not take into account future sales). The discount rate used is equal to WACC.
FINANCE LEASE A lease that transfers substantially all the risks and rewards associated with ownership of an asset to the lessee. Title may or may not eventually be transferred.
receive cash or another financial asset from another company; or• exchange financial instruments with another company under • conditions that are potentially favourable; or certain contract that will or may be settled in ING’s own equity • instruments.
NON-VOTING EQUITY SECURITIES Core Tier-1 securities issued to the Dutch State in October 2008 for a total consideration of EUR 10 billion. This capital injection qualifies as core Tier-1 capital for regulatory purposes.
LIQUIDITY RISK The risk that ING Group or one of its subsidiaries cannot meet its financial liabilities when they fall due, at reasonable costs and in a timely manner.
MONEY MARKET RISK Money market risk arises when ING places short term deposits with a counterparty in order to manage excess liquidity, as such, money market deposits tend to be short term in nature (1-7 days is common). In the event of a counterparty default, ING may lose the deposit placed. Money market risk is therefore measured simply as the notional value of the deposit.
RETURN ON EQUITY (ROE) The return on equity is the net result as percentage of the average equity.
SETTLEMENT RISK Arises when there is an exchange of value (funds, instruments or commodities) for the same or different value dates or times and receipt is not verified or expected until ING has paid or delivered its side of the trade. The risk is that ING delivers, but does not receive delivery from the counterparty.
PRESSURISED ASSETS Pressurised assets have been defined as subprime ABS exposures, Alt-A ABS exposures, CDO/CLOs, SIVs, ABCP investment, leveraged finance and exposures on monoliners.
SURRENDER The termination of a life or retirement contract at the request of the policyholder after which the policyholder receives the cash surrender value, if any, on the contract.
TIER-1 CAPITAL Also referred to as the core capital of ING Bank. It comprises paid up share capital, reserves excluding revaluation reserves, retained earnings, minority interests and hybrid Tier-1.
ING Publications – Annual Report, in Dutch and English – Annual Report on Form 20-F, in English
Disclaimer Certain of the statements contained in this Annual Report are statements of future expectations and other forwardlooking statements. These expectations are based on management’s current views and assumptions and involve known and unknown risks and uncertainties. Actual results, performance or events may differ materially from those in such statements due to, among other things, (i) general economic conditions, in particular economic conditions in ING’s core markets, (ii) changes in the availability of, and costs associated with, sources of liquidity such as interbank funding, as well as conditions in the credit markets generally, including changes in borrower and counterparty creditworthiness, (iii) the frequency and severity of insured loss events, (iv) mortality and morbidity levels and trends, (v) persistency levels, (vi) interest rate levels, (vii) currency exchange rates, (viii) general competitive factors, (ix) changes in laws and regulations, and (x) changes in the policies of governments and/or regulatory authorities. ING assumes no obligation to update any forward-looking information contained in this document.