Deferred tax liabilities 3,432 4,042 Income tax payable 877 923 Pension and post-employment liabilities 657 1,208 Other staff-related liabilities 355 247 Other taxation and social security contributions 1,123 1,147 Deposits from reinsurers 427 462 Accrued interest 13,606 10,556 Costs payable 2,744 2,353 Amounts payable to brokers 114 238 Amounts payable to policyholders 2,283 3,105 Reorganisation and other provisions 1,400 1,055 Share-based payment plan liabilities 7 5 Property under development for third parties 284
On a distribution of a dividend ING Groep N.V. is required to withhold an income tax on dividends at a rate of 15%.
Loans and advances to customers 102 5 –7 –1 –3 96 Unused tax losses carried forward –909 –15 –26 1 76 –59 –932
In 2006, the deferred tax changes through equity includes a deferred tax charge of EUR –1,583 million relating to unrealised valuations, EUR –242 million relating to changes in the cash fl ow hedge reserve, EUR 486 million relating to transfers to insurance liabilities and DAC, and nil relating to stock options and share plans. These items are presented in the Deferred tax by origin table in investments and insurance provisions respectively. Other changes in deferred tax are included in the profi t and loss.
Deferred income tax assets are recognised for tax loss carry forwards and unused tax credits only to the extent that realisation of the related tax benefi t is probable. The uncertainty of the recoverability of the tax losses and tax credits is taken into account in establishing the deferred tax assets. The following tax loss carry forwards and tax credits will expire as follows at 31 December: Total unused tax losses carried forward analysed by expiry terms
Changes in the composition of the group –6 60 4 60 -2
The provision for reorganisations 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 5 years.
employment healthcare benefi ts and discounts on ING products provided to employees and former employees.
Certain group companies sponsor defi ned contribution pension plans. The assets of all ING Group’s defi ned 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 2007 was EUR 68 million (2006: EUR 45 million).
Unrecognised past service costs –3 4 10 –6 1 10 –6 Unrecognised actuarial gains/(losses) 198 –687 –1,778 8 –2 –27 206 –689 –1,805
Actuarial gains and losses for the year ended 31 December 2007 includes EUR –789 million (2006: EUR –180 million; 2005: EUR 873 million) experience gain adjustments for assets and EUR 83 million (2006: EUR –163 million; 2005: EUR 116 million) experience gain adjustments for liabilities.
During 2006 certain plans were reclassifi ed from Other to Pension benefi ts. This reclassifi cation did not have an effect on total pension liabilities and other staff related liabilities. This reclassifi cation is included in the line Changes in the composition of the group and other changes in the tables below.
Opening balance 14,361 12,937 Expected return on plan assets 869 820 Employer’s contribution 816 776 Participants contributions 6 5 Benefi ts paid –540 –476 Actuarial gains and losses –789 –180 Changes in the composition of the group and other changes 176 597 Exchange rate differences –191 –118 Closing balance 14,708 14,361
The actual return on the plan assets amounted to EUR 80 million (2006: EUR 613 million).
Target allocation Percentage of plan assets Weighted average expected long term rate of return
Determination of Expected Return on Assets An important element for fi nancial reporting is the assumption for return on assets (ROA). The ROA is updated at least annually, taking into consideration the Plans asset allocations, historical returns on the types of assets held in the Funds, and the current economic environment. Based on these factors, it is expected that the Funds assets will earn an average percentage per year over the long term. This estimation takes into account a reduction for administrative expenses and non-ING investment manager fees paid from the Funds. For estimation purposes, it is assumed the long term asset mixes will be consistent with the current mixes. Changes in the asset mixes could impact the amount of recorded pension income or expense, the funded status of the Plans, and the need for future cash contributions.
Customer deposits and other funds on deposit 463,995 23,988 26,864 8,369 2,000 525,216 Financial liabilities at fair value through profi t and loss
– designated as at fair value through profi t and loss 873 771 2,395 5,912 3,931 13,882
(1) Trading assets and trading liabilities have been presented in the above table as maturity not applicable, because they are held for short term profi t taking.
– designated as at fair value through profi t and loss 187 420 1,435 874 3,509 6,425 Investments
– designated as at fair value through profi t and loss 617 581 2,081 6,285 4,138 13,702
23 DERIVATIVES AND HEDGE ACCOUNTING Use of derivatives and hedge accounting As described in the Risk management section, ING Group uses derivatives (principally interest rate swaps and cross currency interest rate swaps) for economic hedging purposes in the management of its asset and liability portfolios and structural positions. The objective of economic hedging is to enter into positions with an opposite risk profi le to an identifi ed exposure to reduce that exposure. The impact of ING Group’s hedging activities is to optimise the overall cost to the Group of accessing debt capital markets and to mitigate the market risk which would otherwise arise from structural imbalances in the duration and other profi les of its assets and liabilities. In addition, hedging activities are undertaken to hedge against the interest rate risk in the mortgage offer period in relation to retail mortgages and to lock-in the interest margin in relation to interest bearing assets and the related funding.
The accounting treatment of hedge transactions varies according to the nature of the instrument hedged and whether the hedge qualifi es under the IFRS-EU hedge accounting rules. Derivatives that qualify for hedge accounting under IFRS–EU are classifi ed and accounted for according to the nature of the instrument hedged and the type of IFRS-EU hedge model that is applicable. The three models applicable under IFRS-EU are: fair value hedge accounting, cash fl ow hedge accounting and net investment hedge accounting. These are described under the relevant headings below. The company’s detailed accounting policies for these three hedge models are set out in section ‘Principles of valuation and determination of results’.
Gains and losses on derivatives designated under fair value hedge accounting are recognised in the profi t and loss account. The effective portion of the fair value change on the hedged item is also recognised in the profi t and loss account. As a result, only the net accounting ineffectiveness impacts the net profi t.
Gains and losses on the effective portions of derivatives designated under cash fl ow hedge accounting are recorded in Shareholders’ equity. Interest cash fl ows on these derivatives are recognised in the profi t and loss account in interest income consistently with the manner in which the forecast cash fl ows affect net profi t. The gains and losses on ineffective portions of such derivatives are recognised immediately in the profi t and loss account.
At 31 December 2007, the fair values of outstanding derivatives designated under cash fl ow hedge accounting was EUR 229 million (2006: EUR 1,921 million), presented in the balance sheet as EUR 3,417 million (2006: EUR 3,617 million) positive fair values under assets and EUR 3,188 million (2006: EUR 1,696 million) negative fair values under liabilities.
At 31 December 2007, the fair values of outstanding derivatives designated under net investment hedge accounting was EUR –71 million (2006: EUR –4 million), presented in the balance sheet as EUR 281 million (2006: EUR 3 million) positive fair values under assets and EUR 352 million (2006: EUR 7 million) negative fair values under liabilities.
Cash and balances with central banks 12,406 14,326 Amounts due from banks – loans and advances to banks 45,790 36,411 – cash advances, overdrafts and other balances 3,098 3,461 Trading assets – debt securities 37,345 38,287 – loans and receivables 116,164 118,459
The manner in which ING manages credit risk and determines credit risk exposures for that purpose is explained in the ‘Risk management’ section.
Customer deposits and other funds on deposit and debt securities in issue Banks Other contingent liabilities
Banks includes Amounts due from banks and balances with central banks. ING Bank N.V. has an obligation to maintain a reserve with an average monthly balance with the Dutch Central Bank. In December 2007 the required monthly average was EUR 5,676 million (2006: EUR 5,295 million). On 31 December 2007 the balance on this reserve was EUR 1,375 million (2006: EUR 4,076 million).
Banking operations Contingent liabilities in respect of – discounted bills 1 3
Future rental commitments for operating lease contracts years after 2012 339 27 SPECIAL PURPOSE ENTITIES AND SECURITISATION Securitisation ING as originator ING Group enters into synthetic securitisation programmes in order to reduce credit risk on certain assets. In synthetic securitisations ING enters into a credit default swap with securitisation Special Purpose Entities (SPEs), in relation to which ING purchases credit protection in respect of residential mortgage loans and loans to small and medium-sized enterprises. The SPEs have in turn hedged their exposure with investors through the issue of credit linked notes or credit linked commercial paper. As a result of these transactions, ING Group has transferred a substantial part of the credit risk related to these loan portfolios to third-party investors. In general, the third-party investors in securities issued by the SPE have recourse only to the assets of the SPE and not to ING Group.
Loans to small and medium-sized enterprises 8,946 8,859 Asset backed securities 7,126 Corporate loans 430 4,851
The winding down of two conduits in 2007 caused a decrease in Assets under securitisation programmes amounting to EUR 10,968 million.
ING as investor As part of its investment activities ING invests in securitisations by purchasing notes from securitisation SPEs. For certain own asset securitisation programs ING acts as a market maker and holds limited positions in this capacity.
Date of acquisition 31 July 2007 4 December 2007 31 December 2007 15 November 2007
Cash outfl ow on acquisition (2) 228 672 1,830 141 2,871
Profi t since date of acquisition 1 8 –1 8 Income if acquisition effected at start of year 15 209 38 262 Profi t if acquisition effected at start of year (3) 4 46 80 –2 128 (1) Goodwill recognised in 2007 on immaterial acquisitions and real estate portfolios was EUR 222 million, resulting in total Goodwill recognised in 2007 of EUR 2,040 million as disclosed in Note 9 ‘Intangible assets’.
Acquisitions effective in 2007 In September 2007 ING paid EUR 20 million to increase its shareholding in ING Piraeus Life (the joint venture between ING and Piraeus Bank) from 50 to 100%.
In July 2007 ING announced that it had reached agreement to acquire full ownership of Landmark Investment Co Ltd, the twelfth largest asset manager in Korea. The purchase price paid for Landmark was EUR 255 million.
In November 2007 ING acquired 100% of Sharebuilder Corporation, a Seattle-based brokerage company for EUR 152 million, to extend its retail investment products range and geographical spread in the United States.
In November and December 2007 ING acquired the Latin American pension businesses of Banco Santander in Mexico for EUR 349 million, Columbia for EUR 88 million, Uruguay for EUR 20 million and Argentina for EUR 235 million. The pension business in Chile was acquired in January 2008 for EUR 450 million. The total cost of the entire deal was approximately EUR 1,142 million.
In December 2007 ING announced the completion of the acquisition of 100% of the shares in Oyak Bank for an amount of EUR 1,903 million. Oyak Bank is a leading bank in the Turkish market, offering a full range of banking services with a focus on retail banking. Goodwill of EUR 1,015 million was recognised on acquisition. There was no signifi cant difference in the carrying values of the net assets acquired immediately before the acquisition and their fair values. The profi t for the year (before amortisation of the intangibles recognised on purchase accounting) was approximately EUR 80 million, but no profi t or loss was included in the ING Group net profi t in 2007.
Belgian Broker & employee benefi ts ING Trust ING Regio B.V. Total
Cash in company disposed 11 11 Cash infl ow on disposal (1) 766 25 51 842
Gain/loss on disposal 418 7 26 451 (1) Cash outfl ow/infl ow on group companies in the cash fl ow statement includes cash outfl ows/infl ows on individually immaterial disposals in addition to the cash fl ows presented.
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 ING Trust to management and Foreman Capital, an independent investment company based in the Netherlands. The sale is part of ING’s strategy to focus on its core banking, insurance and asset management businesses.
In July 2007 ING sold its entire shareholding in ING Regio B.V., a subsidiary of Regio Bank NV 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 NV itself was not part of the transaction.
In September 2007 ING sold its Belgian Broker and Employee Benefi ts insurance business to P&V Verzekeringen for EUR 777 million, resulting in a gain of EUR 418 million.
Date of acquisition 27 October 2006 1 July 2006 5 October 2006
Amounts due from banks 1 1 Financial assets at fair value through profi t and loss 2 793 795 Miscellaneous other assets 332 34 366
Profi t 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’.
(2) Cash outfl ow/infl ow on group companies in the cash fl ow statement includes cash outfl ows/infl ows on individually immaterial acquisitions and real estate portfolios in addition to the cash fl ows presented herein.
In July 2006 ING acquired 100% of Appleyard Vehicles Contracts, a U.K. based car leasing company. The purchase price paid for Appleyard was EUR 110 million.
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.
Loans and advances to customers 228 16,884 2,334 19,446 Amounts due from banks 14 5,928 187 6,129 Financial assets at fair value through profi t and loss 5 3,280 162 3,447
(1) Cash outfl ow/infl ow on group companies in the cash fl ow statement includes cash outfl ows/infl ows on individually immaterial disposals in addition to the cash fl ows presented.
In December 2006 ING sold its stake in Degussa Bank, a unit of ING-DiBa specialising in worksite banking for private customers. The sale results in a loss of EUR 23 million.
Loans and advances to customers 819 819 2,196 2,196 Amounts due from banks 286 286 1,419 1,419
Liabilities Insurance and investment contracts 1,503 1,503 Amounts due to banks 7 7 68 68 Customer deposits and other funds on deposit 1,384 1,384 2,470 2,470 Miscellaneous and other liaibilities 1,231 1,231 910 910
In March 2005, ING Group acquired 19.9% of Bank of Beijing for an amount of EUR 166 million. Bank of Beijing is the second largest city commercial bank in China and the third largest bank in Beijing.
In December 2005 ING Group sold Arenda Holding BV to ZBG, a Dutch private equity fi rm. Arenda is a provider of consumer fi nance products.
30 LEGAL PROCEEDINGS ING Group companies are involved in litigation and arbitration proceedings in the Netherlands and in a number of foreign jurisdictions, including the United States, involving claims by and against them which arise in the ordinary course of their businesses, including in connection with their activities as insurers, lenders, employers, investors and taxpayers. In certain of such proceedings, very large or indeterminate amounts are sought, including punitive and other damages. While it is not feasible to predict or determine the ultimate outcome of all pending or threatened legal and regulatory proceedings, management does not believe that their outcome will have a material adverse effect on the Group’s fi nancial position or results of operations.
These legal proceedings included a dispute over certain hurricane damages claimed by a Mexican fertilizer producer Grupo Fertinal (‘Fertinal’) against ING Comercial América (now known as Seguros ING S.A. de C.V. and referred to hereinafter as ‘Seguros’), a wholly owned subsidiary of ING Group. Fertinal claimed EUR 204 million (USD 300 million), the maximum coverage under the insurance policy of their mining operations. A judge in Mexico ruled in favour of Fertinal. This decision was appealed to a Mexican Court of Appeal, which reduced the judgment to EUR 64 million (USD 94 million) plus interest. This decision was appealed by all parties involved. Seguros’ appeal was rejected and the decision of the Court of Appeal regarding the amount owed was affi rmed. Seguros has paid the principal and interest into court, bringing the case to a close. Seguros also has been the subject of complaints and suits concerning the performance of certain interest sensitive life insurance products. These matters are being defended vigorously; however, at this time, we are unable to assess their fi nal outcome.
In November 2006, the issue of amongst others the costs charged by the insurance industry to customers in respect of universal life insurance products (commonly referred to as ‘beleggingsverzekeringen’, ‘beleggingspolissen’ or ‘beleggingshypotheken’) has received attention both in the Dutch public media and from the Dutch regulator for the insurance industry and consumer protection organisations. The Dutch insurance industry (including subsidiaries of the ING Groep N.V., primarily Nationale-Nederlanden) sold these products to customers either directly or through intermediaries. In July 2007 a class action was lodged against Nationale-Nederlanden in relation to these products. The subject of this procedure is not a specifi c claim for compensation, but a request to the judge to pronounce that Nationale-Nederlanden provided clients with incomplete or misleading information about costs and risks. Such legal proceedings can also be lodged against other subsidiaries of ING Groep N.V. involved. Discussions are ongoing between the insurance industry and consumer organisations to fi nd an out of court solution. Early March 2008 the Ombudsman Financial Services published a recommendation for an industrywide solution. This recommendation is not binding on the parties involved. While ING believes that it has complied with all relevant laws and regulations regarding consumer rights and consumer protection, ING’s Dutch insurance companies will accept the recommendation. A provision has been taken to contribute to this possible solution. As consumer organisations criticize the recommendation and the policy holders have not formally agreed with the proposed solution, it is diffi cult to predict when and how the issue will be solved.
Like many other companies in the mutual funds, brokerage, investment, and insurance industries, several of our companies have received informal and formal requests for information from various governmental and self-regulatory agencies or have otherwise identifi ed issues arising in connection with fund trading, compensation, confl icts of interest, anti-competitive practices, insurance risk transfer and sales practices. ING is responding to the requests and working to resolve issues with regulators. We believe that any issues that have been identifi ed thus far do not represent a systemic problem in the ING businesses involved and in addition that the outcome of the investigations will not have a material effect on ING Group.
Because of the geographic spread of its business, ING may be subject to tax audits in numerous jurisdictions at any point in time. Although ING believes that it has adequately provided for all its tax positions, the ultimate resolution of these audits may result in liabilities which are different from the amounts recorded.
31 JOINT VENTURES Joint ventures are included proportionally in the consolidated fi nancial statements as follows: Most signifi cant joint ventures 2007 Interest held (%) Assets Liabilities Income Expenses
Most signifi cant joint ventures 2006 Interest held (%) Assets Liabilities Income Expenses
Pacifi c-Antai Life Insurance Company Ltd 50 136 106 37 36 32 RELATED PARTIES In the normal course of business, the Group enters into various transactions with related companies. Parties are considered to be related if one party has the ability to control or exercise signifi cant infl uence over the other party in making fi nancial or operating decisions. Transactions have taken place on an arm’s length basis and include rendering or receiving of services, leases, transfers under fi nance arrangements and provisions of guarantees or collateral.
Transactions with key management personnel (Executive Board and Supervisory Board) and post-employment benefi t plans are transactions with related parties. These transactions are disclosed in more detail in the remuneration report in the annual report. For the post-employment benefi t plans see Note 21 ‘Other liabilities’.
Key management personnel compensation amounts in thousands of euros Executive Board Supervisory Board Total
Base salary and short-term bonus 16,898 18,250 673 578 17,571 18,828
The total number of stock options on ING Groep N.V. shares held by the Executive Board members amounted to 2,744,887 at 31 December 2007 (2006: 2,176,641). As at 31 December 2007, members of the Executive Board held 201,252 ING Groep N.V. shares (2006: 80,055). Part of these shares are held in a trust. As at 31 December 2007, members of the Supervisory Board held 17,370 ING Groep N.V. shares (2006: 15,370).
There are no signifi cant provisions for doubtful debts or individually signifi cant bad debt expenses.
– designated as at fair value through profi t and loss 13,882 13,702 13,882 13,702
The following methods and assumptions were used by ING Group to estimate the fair value of the fi nancial instruments.
Financial assets Cash and balances with central banks The carrying amount of cash approximates its fair value.
Amounts due from banks The fair values of receivables from banks are generally based on quoted market prices or, if unquoted, on estimates based on discounting future cash fl ows using available market interest rates offered for receivables with similar characteristics.
Non-trading derivatives The fair values of derivatives held for non-trading purposes are based on quoted market prices. For those securities not actively traded, fair values are estimates based on valuation techniques.
Financial assets at fair value through profi t and loss The fair values of securities in the trading portfolio and other assets at fair value through profi t 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.
Financial liabilities Subordinated loans The fair value of the subordinated loans is estimated using discounted cash fl ows based on interest rates that apply to similar instruments.
Investment contracts For investment contracts for risk of company the fair values have been estimated using a discounted cash fl ow approach based on interest rates currently being offered for similar contracts with maturities consistent with those remaining for the contracts being valued. For investment contracts for risk of policyholder the fair value generally equals the fair value of the underlying assets.
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 by discounting expected future cash fl ows using a current market rate applicable to the yield, credit quality and maturity.
Methods applied in determining fair values of fi nancial assets and liabilities
This category includes instruments for which a model is used to determine fair value instead of using an externally available quoted price, but for which a quoted price is available and the outcome of the model is evaluated regularly against that quoted price, resulting in no or only an insignifi cant deviation from the quoted price. Furthermore, it also includes fi nancial 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). 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. In 2006, these were reported under ‘valuation technique not supported by market inputs’ (EUR 37,229 million at 31 December 2006), as ING then did not take into account market inputs becoming available at very short notice. Consistent with the classifi cation in 2007, these have been reclassifi ed in the 2006 comparatives.
Valuation technique supported by market inputs This category includes fi nancial instruments whose fair value is determined using a valuation technique (a model), where inputs in the model are taken from an active market or are market observable. If certain inputs in the model are not market observable, but all signifi cant inputs are, the instrument is still classifi ed in this category, provided that the impact of those elements on the overall valuation is insignifi cant. Included in this category are items whose value is derived from quoted prices of similar instruments, but for which the prices are (more than insignifi cantly) modifi ed based on other market observable external data.
Valuation technique not supported by market inputs This category includes fi nancial assets/liabilities whose fair value is determined using a valuation technique (model) for which more than an insignifi cant level of the input in terms of the overall valuation are not market observable.
Interest income on loans 26,390 21,970 18,912 Interest income on impaired loans –26 13 –23 Total interest income on loans 26,364 21,983 18,889
Reinsurance assumed premiums written gross 24 54 57 1,562 1,664 1,501 1,586 1,718 1,558
Income from real estate investments 80 184 206 252 134 194 332 318 400
Realised gains/losses on disposal of debt securities –9 –56 245 138 93 60 129 37 305 Reversals/Impairments of available-for-sale debt securities –76 36 34 –57 –133 36 34 Realised gains/losses and impairments of debt securities –85 –20 279 81 93 60 –4 73 339
Change in fair value of real estate investments 75 108 143 93 67 59 168 175 202 37 COMMISSION INCOME
Change in fair value of derivatives relating to: – cash-fl ow hedges (ineffective portion) –5 –4 –7 –1 –9 –7 –1 – hedges of net investment in foreign entities
Net result on non-trading derivatives –999 –259 –81 956 587 –130 –43 328 –211
The portion of trading gains and losses for the year ended 31 December 2007 that related to trading securities still held at 31 December, amounts to EUR –60 million (2006: EUR –121 million; 2005: EUR 7 million).
The majority of the risks involved in the security and currency trading is economically hedged with derivatives. The results on security trading is partly offset by results on these derivatives. The result of these derivatives is included in Other and amounts to EUR 408 million (2006: EUR 1,662 million).
Gross underwriting expenditure 51,818 53,065 54,594 Investment income for risk of policyholders –1,079 –2,702 –5,074 Reinsurance recoveries –1,906 –2,175 –2,400
Reinsurance recoveries –157 –470 –775 Change in provision for unearned premiums 79 65 –46 Change in claims provision 13 –209 –49 Costs of acquiring insurance business 979 1,043 1,012 Other underwriting expenditure –50 –71 –52
Distributions on account of interest or underwriting results –133 458 1,824 Bonuses added to policies 411 369 379 Deferred profi t sharing expense 146 –26 11
The investment income and valuation results regarding investments for risk of policyholders of EUR 1,079 million (2006: EUR 2,702 million; 2005: EUR 5,074 million) has not been recognised in Investment income and valuation results on assets and liabilities designated at fair value through profi t and loss but is recognised in Underwriting expenditure together with the equal amount of change in insurance provisions for risk of policyholders.
ING transferred part of their 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 2007 was EUR 15 million (2006: EUR 32 million; 2005: EUR 34 million). The cumulative amortisation as at 31 December 2007 was EUR 81 million (2006: EUR 66 million; 2005: EUR 34 million).
Other impairment losses and reversals of impairments recognised in the profi t and loss account
Property under development for third parties 41 19 –43 –2 19
Share-based compensation arrangements includes an amount of EUR 110 million (2006: EUR 109 million; 2005: EUR 63 million) relating to equity-settled share-based payment arrangements and EUR 17 million (2006: EUR 4 million; 2005: EUR 6 million) relating to cashsettled share-based payment arrangements.
Pension benefi ts Post-employment benefi ts other than pensions Other Total
Expected return on assets –869 –820 –710 –22 –869 –820 –732 Amortisation of unrecognised past service cost –5 –5 –5 –5 Amortisation of unrecognised actuarial (gains)/losses 29 22 4 33 22 Effect of curtailment or settlement –32 –6 –12 –147 –396 4 –3 –32 –149 –411 Other –62 –7 1 –68
ING Group holds its own shares in order to fulfi l the 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 2007, 36,028,881 own shares (2006: 52,722,755; 2005: 38,722,934) were held in connection with the option plan compared to 76,888,553 options outstanding (2006: 74,175,909; 2005: 85,128,950). 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.
In March 2008 shares will be issued in relation to the vesting of share plans. The actual number of shares to be issued is dependent on ING’s TSR ranking. Reference is made to the remuneration report on page 76 up to and including page 86 in the annual report.
The aggregate intrinsic value of options outstanding and exercisable at 31 December 2007 was EUR 230 million and EUR 183 million, respectively.
As of 31 December 2007 there was EUR 69 million of total unrecognised compensation costs related to stock options (2006: EUR 90 million; 2005: EUR 50 million). These costs are expected to be recognised over a weighted average period of 1.7 years (2006: 1.9 years; 2005: 2.0 years). Cash received from stock option exercises for the year ended 31 December 2007 was EUR 131 million (2006: EUR 355 million; 2005: nil).
44 OTHER INTEREST EXPENSES Other interest expenses mainly consist of interest in connection with the insurance operations, including interest on the perpetual subordinated loans.
As of 2007, the reconciliation is prepared on the basis of the weighted average statutory tax rate. Until 2006 , it was prepared on the basis of the Dutch statutory tax rate for the entire Group. The 2006 and 2005 comparatives have been restated to refl ect this change.
Diluted profi t per share data are computed as if the stock options and warrants outstanding at year-end were exercised at the beginning of the period. It is also assumed that ING Group uses the cash thus received for stock options and warrants exercised to buy its own shares against the average market price in the fi nancial year. The net increase in the number of shares resulting from the exercise of warrants and stock options is added to the average number of shares used for the calculation of net profi t per share.
Per ordinary share (in euros) 1.48 1.32 1.18 Total amount of dividend declared (in millions of euros) 3,180 2,865 2,588 (1) The Executive Board, with the approval of the Supervisory Board, has proposed, subject to the ratifi cation by the General Meeting of Shareholders, a cash dividend of
EUR 1.48 per share for the year 2007. Following the decision of the General Meeting of Shareholders with regard to the profi t appropriation, the fi nal cash dividend will become payable on 5 May 2008.
Other mainly includes items not directly attributable to the business lines.
Cost incurred in 2007 to acquire property, equipment, and intangibles 219 766 122 177 1,227 296 344 3,151 3,151
– Addition to loan loss provision –115 172 68 125 125
Cost incurred in 2006 to acquire property, equipment, and intangibles 1,322 243 90 226 182 144 3 2,210 2,210
Wholesale Banking Retail Banking ING Direct Other Total 50 SECONDARY REPORTING FORMAT – GEOGRAPHICAL SEGMENTS ING Group’s six business lines operate in seven main geographical areas: the Netherlands, Belgium, Rest of Europe, North America, Latin America, Asia and Australia. Geographical distribution of income is based on the origin of revenue.
Cost incurred in 2007 to acquire property, equipment, and intangibles 370 61 1,215 316 679 113 56 341 3,151
The claims ratio is the claims, including claims handling expenses, expressed as a percentage of net earned premiums. The expense ratio is the costs expressed as a percentage of net premiums written. The claims ratio and the expense ratio together form the combined ratio. A combined ratio of more than 100% does not necessarily mean that there is a loss on non-life insurance policies, because the result also includes the allocated investment income.
Notes to the consolidated statement of cash fl ows of ING Group amounts in millions of euros, unless stated otherwise
– Key Developments Risk Management 2007 – ING Group Risk Governance ING Group Risk Profi le – ING Bank ING Bank Risk Profi le ING Bank – Credit Risks ING Bank – Market Risks ING Bank – Liquidity Risk – ING Insurance ING Insurance Risk Profi le ING Insurance – Market Risks ING Insurance – Insurance Risks ING Insurance – Credit Risks – Compliance and Operational Risks Compliance Risk Operational Risks – Model Disclosures
KEY DEVELOPMENTS RISK MANAGEMENT 2007 Taking measured risks is part of ING’s business. Like other fi nancial services companies, ING faces several categories of risk, including credit, interest rate, real estate, equity, insurance and liquidity. Beyond that, there are also operational, information, security and compliance risks attached to doing business.
Effects of market developments during 2007 Throughout 2007, signifi cant market turmoil was experienced in the credit markets, beginning with concerns over US sub-prime mortgages and then widening into a general banking liquidity crisis. For the year ended 31 December 2007, this crisis had only limited impact on the profi t and loss account as a result of ING’s investments in pressurised assets classes e.g. US sub-prime and Alt-A residential mortgage backed securities (RMBS), Collateralized Debt Obligations (CDOs) and Collateralized Loan Obligations (CLOs). Unrealised gains (losses) relating to available for sale (fi xed income) asset backed securities, including RMBS, are taken to the revaluation reserve in shareholders equity, unless there is evidence of impairment, in which case the negative revaluation reserve is recognised in the profi t and loss account.
ING’s risk management organisation and its liquidity position helped it to manage the problems that occurred in the credit and other fi nancial markets in 2007. It has been ING’s policy to maintain a high quality and well diversifi ed portfolio. To that effect ING has limits and investment policies in place which are defi ned in mandates for every portfolio. Investment and trading decisions are based on internal research, and not only on published ratings. Some limits were set at more stringent levels since early 2007, in anticipation of a potential downturn of the market. As a result ING’s exposure to pressurised asset classes is of high quality and has not led to major impairments. The total direct pre-tax negative impact on ING’s 2007 profi t and loss account was EUR 255 million as a result of exposures in pressurised asset classes and leveraged fi nance as well as monoline insurers, Structured Investments Vehicles (SIVs) and Asset-Backed Commercial Paper. Pre-tax revaluation (via equity) for the pressurised asset classes (US subprime RMBS, Alt-A RMBS and CDOs/CLOs) at year-end 2007 was EUR –1,377 million. This runs through shareholders’ equity in the balance sheet on an after-tax basis.
The Group’s total exposure to US sub-prime assets, representing less than 0.2% of total assets, relates to non originated loans acquired as investments in RMBS. At 31 December 2007 approximately 96% 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 securitisations (MBS) contain (residential) mortgages that are not classifi ed as sub-prime.
ING’s approach to liquidity management requires a surplus of liquid assets, contingency plans and close monitoring of market conditions. Since the start of the market turmoil in August 2007, ING’s Liquidity Crisis Committee has met on a regular basis in line with ING’s liquidity policy. The Committee discusses ING’s liquidity and funding profi le and is chaired by the Chief Risk Offi cer. Other members include the Chief Financial Offi cer, all the main treasurers of ING Group, the head of Market Risk Management and the head of Corporate Communications and Affairs. The Liquidity strategy and market conditions are monitored on a daily basis. Large buffers of liquidity were retained throughout 2007, and as a result, contingency funding plans, in place at all levels, were not required to be executed as ING’s liquidity position remained sound during the year.
The mission of ING Group’s risk management function is to build a sustainable competitive advantage by fully integrating risk management into daily business activities and strategic planning. This mission is fully embedded in ING Group’s business processes.
and the regional and local managers have primary responsibility for the day-to-day management of risk and form the fi rst line of defence. The risk management function, both at corporate and regional/local level, belongs to the second line of defence and has the primary responsibility to align risk taking with strategic planning e.g. in limit setting. Risk managers in the business lines have a functional reporting line to the Corporate Risk General Managers described below. The internal audit function provides an ongoing independent (i.e. outside of the risk organisation) and objective assessment of the effectiveness of internal controls, including fi nancial, operational, compliance and risk management and forms the third line of defence.
The risk organisation is structured independently from the business lines and is organised through fi ve 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 and market risk management of ING Insurance; Corporate Operational, Information and Security Risk Management (COISRM) is responsible for managing operational, information, and security risks within ING Bank and ING Insurance; Group Compliance Risk Management assists, supports and advises Management in fulfi lling its compliance responsibilities, advises employees on their (personal) compliance obligations and oversees the embedding of Compliance Policies in both ING Bank and ING Insurance.
The heads of these departments (Corporate Risk General Managers) report to the CRO and bear direct responsibility for risk (mitigating) decisions at the Group level. The Corporate Risk General Managers and the CRO are responsible for the harmonisation and standardisation of risk management practices. The risk management function assists with the formulation of risk appetite, strategies, policies and limits. It also provides a review, oversight and support function throughout the Group on risk related issues.
Group Risk Committees The Group risk committees described below are also part of the second line of defence. They act within the overall risk policy and delegated authorities granted by the Executive Board and have an advisory role to the CRO. To ensure a close link between the business lines and the risk management function, the business line heads and the respective General Managers Corporate Risk are represented on each committee.
(including issuer investment risk). The GCCTA meets two times a week; ING Provisioning Committee (IPC): Discusses and approves specifi c and collective loan loss provisions fi gures for ING Group. The IPC meets on a quarterly basis. The membership of the IPC, which is chaired by the CFO, consists of both Risk and Finance representatives and refl ects the responsibilities of both departments; 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 profi le of all ING Bank’s market risks that occur in its Wholesale Banking, Retail Banking and ING Direct activities. ALCO Bank defi nes 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.
In addition, a Finance and Risk Committee has been established as a platform for the CRO and the CFO, along with their respective staff, to discuss and decide on issues that relate to both the fi nance and risk domains.
Executive Board uses the risk dashboard to monitor and manage the actual risk profi le 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 accounting earnings over the next year relative to expected accounting earnings, during a moderate (i.e. ‘1 in 10’) stress scenario. Maintaining a high quality of earnings safeguards against ING being downgraded by the rating agencies; Capital at Risk; the potential reduction of the current net asset value (based on fair values) balance sheet 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.
The main differences and similarities between the risk metrics are illustrated below; Earnings at Risk Capital at Risk Economic Capital
Potential value reduction of net value during a ‘moderate’ stress scenario (i.e. 1 in 10)
Potential value reduction of net value during an ‘extreme’ stress scenario
When interpreting the Earnings and Capital at Risk metrics it is important to note that these are not loss estimates of a specifi c adverse scenario. Further, the metrics do not take into account discretionary management intervention in a specifi c crisis situation, and are based on instantaneous shock scenarios.
Risk types ING’s risk profi le measures the following main types of risks that are associated with its business activities: Credit risk: the risk of potential loss due to default by ING’s debtors (including bond issuers) or trading counterparties; Market risk: the risk of potential loss due to adverse movements in market variables, such as equity prices, real estate prices, interest rates and foreign exchange rates. These four market risks cover all market risks identifi ed in ING’s businesses; Insurance risk: risks such as mortality, morbidity and property and casualty associated with the claims under insurance policies it issues/underwrites; specifi cally, the risk that premium rate levels and provisions are not suffi cient to cover insurance claims.
Operational and business risk are summarised as non-fi nancial risk in the risk profi les: Operational risk: 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; Business risk: the exposure to value loss due to fl uctuations in volumes, margins and costs. These fl uctuations can occur because of internal, industry, or wider market factors. It is the risk inherent to strategy decisions and internal effi ciency.
The above risk metrics do not cover liquidity risk: the risk that ING or one of its subsidiaries cannot meet its fi nancial liabilities when they fall due, at reasonable cost and in a timely manner. ING has a separate liquidity management framework in place to manage this risk. This framework is discussed in the ING Bank Liquidity Risk section below.
A description of the models, and underlying assumptions and key principles used by ING for calculating Earnings at Risk, Capital at Risk and Economic Capital is provided in the Model Disclosure section below.
An increase in credit risk (mainly Wholesale Banking) was more than compensated for by higher diversifi cation benefi ts allocated to credit and transfer risk, leading to a slight decrease in 2007. The higher diversifi cation benefi t allocated to credit risk was a result of its reduced contribution to the overall risk profi le, as real estate and equity risk grew much more relative to credit risk. In total, the overall diversifi cation benefi t between all major risk types remained stable in 2007.
Capital at Risk The level of Capital at Risk (CaR) measured against ING’s fi nancial position provides understanding as to whether ING can maintain a robust fi nancial position under a ‘moderate’ (i.e. 1 in 10) stress scenario. The risk appetite set by the Executive Board defi nes the maximum potential value reduction over the next year during a (non extreme) stress scenario as a percentage of Available Financial Resources (AFR) (the defi nition of AFR is provided in the Capital Management section below).The tables below show the Capital at Risk per risk type.
The Capital at Risk fi gure tends to be dominated by ING insurance, mainly due to interest rate risk related to long-term client guarantees and equity risk.
The overall risk appetite for ING Group in 2007, measured as CaR/AFR, for ING Group increased to 21% (17% in 2006) as CaR increased more than AFR. This increase is mainly due to ING Insurance, where CaR grew while AFR decreased (for more information on AFR refer to the Capital Management section below).
The CaR fi gures show notable increases in equity and interest rate risks for both ING Bank and ING Insurance partly offset by a decrease in foreign exchange risk for ING Insurance. The decrease in foreign exchange risk within ING Insurance was largely due to a further alignment of business unit input with corporate aggregation in FX translation risk measurement and the positive impact of a US dollar hedge. The increase in equity risk in ING Bank is attributed to stakes in Bank of Beijing (IPO), the Indian Kotak Mahindra Bank and the TMB while ING Insurance’s increase is largely related to refi ned risk modelling at a unit level rather than changes in actual equity risk taking. In addition, the diversifi cation at group level decreased due to higher equity risk concentration, lower interest rate risk netting between ING Bank and ING Insurance, particularly in Europe and Americas, and changes to risk aggregation parameters.
Capital at Risk and Earnings at Risk by line of business (Group diversifi ed)
For ING Bank, both CaR and EaR of Wholesale Banking increased as a result of higher credit and transfer risk and higher real estate risk. The increased Corporate Line Bank is mainly due to higher equity risk driven by recent acquisitions, e.g. TMB. For Retail Banking and ING Direct, the CaR in 2007 is higher, while EaR decreased compared to 2006. These differences are mostly driven by various enhanced modelling for amongst others credit risk, as well as the accounting asymmetries for equity and interest rate risk. Examples of this asymmetry include the increase in equity risk at Retail Banking due to the Bank of Beijing IPO, and different dynamics in interest rate risk netting between earnings and value. For earnings (EaR) ING Bank and Insurance exhibit similar interest rate risk sensitivities, while for value (CaR) ING Bank and ING Insurance sensitivities net each other. For ING Direct, the EaR decrease is also caused by a larger percentage of assets repricing within 1 year.
ING’s Group Economic Capital and Bank-Insurance diversifi cation benefi t is determined by applying one common aggregation approach to bank and insurance. As a result, a best-estimate diversifi cation benefi t of approximately 15% for ING Bank and Insurance is applied for 2007 (2006: conservative estimate applied of 10%). Due to inherent uncertainties associated with correlation assumptions and changes in risk exposures the calculations are subjected to extensive sensitivity tests. Combining the 2007 reported ING Bank and ING Insurance Economic Capital fi gures and the above diversifi cation benefi ts results in a combined Bank - Insurance Economic Capital of EUR 35.0 billion for 2007 (2006: EUR 34.5 billion based on 10% bank-insurance diversifi cation benefi t).
On the Group level an additional net risk capital estimate of EUR 1.0 billion (2006: EUR 1.0 billion) is added to refl ect any Economic Capital specifi cally allocated to the Group, leading to a total Group Economic Capital amount of EUR 36.0 billion (2006: EUR 35.5 billion; see also the AFR/EC reconciliation in the Capital Management section below). The potential risk capital impact for ING Group of the ING employee pension liability is currently not included in the aggregated group risk metrics. However, the standalone Economic Capital impact for ING employee pension liabilities is calculated separately. From a capital management perspective there is currently no need to reserve any additional capital for ING pension liabilities.
Risk measurement ING Bank and ING Insurance The overall ING Group risk appetite is translated into specifi c operational limits which are cascaded down into the organisation, e.g.
ING BANK RISK PROFILE Economic Capital ING Bank One of the core risk management tools for ING Bank is Economic Capital which is used to determine the amount of capital that a transaction or business unit requires to support the economic risks it faces. ING Bank implemented Economic Capital for internal use in 1998. Since 1999 ING Bank has been disclosing Economic Capital information externally. The tables below provide ING Bank’s Economic Capital by risk type and business line. Figures shown refl ect all diversifi cation effects within ING Bank, including risk reduction between the risk categories. Diversifi cation effects that arise as a result of combining ING Bank and ING Insurance activities are not taken into account. Business risk is included in the non-fi nancial risk category to cover unexpected losses that may arise as a result of changes in volumes, margins and costs.
The following table provides the Economic Capital break down by risk category including diversifi cation benefi ts proportionally allocated to the risk types: Economic Capital (Bank diversifi ed only) by risk category
In 2007 the Economic Capital models for the bank were reassessed following an enhancement program that was driven by preparation for Basel II and the further alignment with other risk measurement developments, such as the introduction of the ING Insurance economic capital models and the ING Group risk dashboard. This has lead to several changes and improvements that mainly relate to credit risk, real estate risk (part of market risk) and diversifi cation. The fi gures reported for 2007 are based on the best estimate risk profi le at the reporting date, whereas previously reported economic capital fi gures were based on year-to-date averages that are also used for RAROC performance measurement.
The overall increase in Economic Capital is mainly due the acquisition of Oyak Bank and the taking of several strategic equity interests. The latter, as well as the Bank of Beijing IPO, mainly explain the increase in market risk capital. The change in non-fi nancial risk results predominantly stems from the diversifi cation methodology adjustment.
The Retail Banking Economic Capital fi gure increased predominantly as a result of the acquisition of Oyak Bank and the Bank of Beijing IPO. This increase is partly offset by the methodology enhancements for credit risk and the decrease of non-fi nancial risks. Contrary to the portfolio growth of ING Direct the Economic Capital experienced a decrease mainly as a result of model enhancements following the Basel II implementation. The increase of the Economic Capital allocated to the Corporate Line can be explained by the increase in strategic equity interests.
ING BANK – CREDIT RISKS Credit risk is the risk of loss from default by debtors (including bond issuers) or trading counterparties. Credit risks can be split into fi ve principal risk categories: a) lending (including guarantees and letters of credit); b) investments; c) pre-settlement (derivatives, securities fi nancing and foreign exchange trades); d) money markets and e) settlement. Corporate Credit Risk Management (CCRM) is responsible for the measurement and management of credit risk incurred by all ING Group entities, including country-related risks. CCRM is organised along the three business lines of ING Bank (e.g. Retail Banking, Wholesale Banking and ING Direct) and ING Insurance. The CCRM General Manager is functionally responsible for the global network of credit risk staff, while the heads of the risk management functions for the business lines report directly to him.
ING Group’s credit policy is to maintain an internationally diversifi ed 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 borrowers and borrower groups. The aim within the banking sector is to expand relationship-banking activities, while maintaining stringent internal risk/return guidelines and controls.
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 fi nancial obligation that the customer has to repay to ING, excluding any accrued and unpaid interest, or discount/premium amortisations.
Investment risk Investment risk is the credit default and migration risk that is associated with ING’s investments in bonds, commercial paper, securitizations, and other similar publicly traded securities. Investment risk arises when ING purchases a (synthetic) bond with the intent to hold the bond for a longer period of time (generally through maturity). Bonds that are purchased with the intent to re-sell in a short period of time are considered to be trading risks, which are measured and monitored by the Corporate Market Risk Management department.
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.
Settlement risk Settlement risk arises when there is an exchange of value (funds, instruments or commodities) for the same or different value dates and receipt is not verifi ed 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. Settlement risk can most commonly be contained and reduced by entering into transactions with deliveryversus -payment (DVP) settlement methods, as is common with most clearing houses, or settlement netting agreements.
Problem loans Renegotiated Loans ING’s credit restructuring activities focus on managing the client relationships, improving the borrower’s risk profi le, maximising collection opportunities and, if possible, avoiding foreclosure or repossession. These activities are (pro-) actively pursued and primarily relate to Wholesale and SME borrowers (‘Business’), which are not yet in default. Common actions taken include, but are not limited to, revising or extending repayment arrangements, assisting in fi nancial reorganisation and/or turnaround management plans, deferring foreclosure, modifying loan conditions and deferring certain payments pending a change in circumstances. For consumer and mortgage loans (‘Consumer’) the approach is more portfolio oriented.
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 (less than 1 week) which are subsequently refl ected in the risk rating of 18-19 (or comparable status based on an increased probability of default). A watch list indication may develop into a restructuring status (rating 15-19) or even a recovery (20-22) status. Most borrowers with a watch list indication return to a regular status. 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 refl ected below: ING Bank renegotiated loans that would otherwise be past due or impaired
From restructuring (18-19) to regular (1-17) status 1,170 877 From recovery (20-22) to regular or restructuring status (1-19) 4,359 4,004 Total of renegotiated loans 5,529 4,881
From restructuring (18-19) to regular (1-17) status 1,170 877 From recovery (20-22) to regular or restructuring status (1-19) 1,414 1,996 Total of renegotiated Business loans 2,584 2,873
The increase in the total amount of renegotiated consumer and mortgage loans is a refl ection of the growth of the portfolio and of ING’s proactive (portfolio) management approach involving the automation of reminder and warning letters to Consumer borrowers who may otherwise be facing fi nancial diffi culties. Consumer borrowers do not have a restructuring status.
Neither past due nor impaired 750,049 644,318 Past due but not impaired (1-90 days) (1) 5,416 3,879
Aging analysis (past due but not impaired): ING Bank portfolio, outstandings (1,2)
Past due for 1-30 days 4,709 3,143 Past due for 31-60 days 633 548 Past due for 61-90 days 74 188
(1) Based on lending (consumer loans and residential mortgages only). (2) The amount of past due but not impaired fi nancial assets in respect of non-lending activities was not material.
There is no signifi cant concentration of a particular type of loan structure in the past due or the impaired loan portfolio.
ING tracks past due but not impaired loans most closely for the consumer loan and residential mortgage portfolios. Generally, all loans with past due fi nancial obligations of more than 90 days are automatically reclassifi ed 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 fi nancial obligations, or the customer fi ling for bankruptcy or bankruptcy protection. In some cases, a material breach of fi nancial covenants will also trigger a reclassifi cation of a loan to the impaired category.
Construction, Infrastructure and Real Estate 635 964 Financial Institutions 538 639 Food, Beverages and Personal Care 264 366 General Industries 270 399
Collateral As part of its securities fi nancing 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 120.2 billion at 31 December 2007 and EUR 95.2 billion at 31 December 2006. 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.
Risk classes are defi ned based upon the quality of the exposures in terms of creditworthiness, varying from investment grade to problem grade expressed in S&P equivalents.
ING banking units completed the implementation of Basel II compliant risk rating models in 2007 which led to small improvements in the average reported credit quality. During 2007 the residential mortgage portfolio of ING Direct grew signifi cantly, most notably in Germany and the United States, while the size of its investment portfolio showed a moderate decrease in particular with respect to exposure regarding Public Administration and certain ABS sub-classes. As a result of ING’s close management of its liquidity placements as a result of the general market turmoil experienced in the latter half of 2007, ING experienced a shift to higher quality counterparties for its money market activities. The increase in BB rated Money Market outstandings is largely due to the Oyak Bank acquisition.
Measurement ING Wholesale Banking uses the Value-at-Risk (VaR) methodology as its primary risk measure. The VaR for market risk quantifi es, with a one-sided confi dence level of 99%, the maximum overnight loss that could occur due to changes in risk factors (e.g. interest rates, foreign exchange rates, equity prices, credit spreads, implied volatilities) if positions remain unchanged for a time period of one day. The impact of historical market movements on today’s portfolio is estimated, based on equally weighted observed market movements of the previous 250 business days. ING uses VaR with a 1-day horizon for internal risk measurement, control and backtesting, and VaR with a 10-day horizon for determining regulatory capital. ING’s VaR model has been approved by the Dutch Central Bank to be used for the regulatory capital calculation of its most important trading activities.
Market risk management for the fi xed income and equity markets is split into two components: general market risk and specifi c market risk. The general market risk component estimates the VaR resulting from general market-value movements (e.g. interest rate movements). The specifi c market risk component estimates the VaR resulting from market-value movements that relate to e.g. the underlying issuer of securities in the portfolios. This specifi c risk relates to all value movements not related to general market movements.
The VaR for linear portfolios is calculated using a variance – covariance approach. The market risk of all the important option portfolios within ING is measured by Monte Carlo and historical simulation methods.
Backtesting Backtesting is a technique for the ongoing monitoring of the plausibility of the VaR model in use. Although VaR models estimate potential future results, estimates are based on historical market data. In a backtest, the actual daily result is compared with the 1-day VaR. In addition to using actual results for backtesting, ING also uses hypothetical results, which measures results excluding the effect of intraday trading, fees and commissions. When the actual or hypothetical loss exceeds the VaR an ‘occurrence’ has taken place. Based on ING’s one-sided confi dence level of 99% an occurrence is expected once in every 100 business days at maximum. In 2007, there was no occurrence (2006: none) where a daily trading loss exceeded the daily consolidated VaR of ING Wholesale Banking. ING reports the results of this backtesting to the Dutch Central Bank on a quarterly basis.
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 profi t 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 specifi c 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 defi ned stress parameters per country and per market (fi xed 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. If and when necessary, ING evaluates specifi c stress scenarios, as an addition to its structured stress tests. These specifi c scenarios relate to current concerns, like political instability in certain regions, terrorist attacks or extreme movements in energy prices.
Other risk limits VaR and event risk limits are the most important limits to control the trading portfolios. Furthermore, ING uses a variety of other limits to supplement VaR and event risk. Position and sensitivity limits are used to prevent large concentrations in specifi c issuers, sectors or countries. In addition to this, other risk limits are set with respect to the activities in exotic derivatives trading. The market risk of these products is controlled by product specifi c limits and constraints.
Development of trading market risks The following chart shows the development of the overnight VaR under a 99% confi dence interval and a 1-day horizon. The overnight VaR is presented for the ING Wholesale Banking trading portfolio which was managed by CMRM Trading during 2006 and 2007. Several banking books are governed by the trading risk process and are therefore excluded from the non-trading risk table and included in the trading risk graph and table below.
During 2006 and 2007 the overnight VaR for the ING Wholesale Banking trading portfolio stayed within the range of EUR 26-48 million.
The average exposure over 2007 was higher than 2006 (average VaR 2007: EUR 34 million and average VaR 2006: EUR 31 million). The VaR remained well within the ING Wholesale Banking trading limit. Trading positions with interest rate exposures provided the largest contribution to the trading VaR. In the second half of December the trading VaR increased substantially to EUR 47 million. This increase is related to a counterparty downgrade in the structured credit trading book. As the transactions with this counterparty served as a hedge for other exposures in this book, the downgrade of this counterparty resulted in a rise of the trading VaR.
More details on the VaR of the ING Wholesale Banking trading portfolio for 2007 and 2006 are provided in the table below.
(1) The total VaR for the columns Minimum and Maximum can not be calculated by taking the sum of the individual components since the observations for both the individual markets as well as total VaR may occur on different dates. Note: the above captions are consistent with those used for internal risk management purposes and do not relate to fi nancial statement captions.
The following table shows the largest trading positions in foreign exchange, interest rate and corporate credit spread positions.
Apr 06 Jul 06 Oct 06 Jan 07 Apr 07 Jul 07 Jan 08Oct 07
Foreign exchange US dollar –171 Russian rouble 108 Japanese yen –80 Ukrainian Hryvnia 58 Swiss Franc 52
Credit Spread (Bpv (1)) Eurozone –1.2 Mexico –0.2 United States –0.2 Russia –0.2 United Kingdom –0.2 (1) Bpv (or basis point value) refers to profit and loss account sensitivity per 1bp increase in the interest rate or credit spread.
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 enable clear assignment of 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: ING Bank
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 of ING Bank.
Earnings at Risk (EaR) EaR measures the impact on accounting earnings (pre tax) 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 fi gures 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, demand deposits 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, refl ects the interest risk profi le of the investments only. This 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.
By Currency Euro –125 –232 US dollar 9 –80 Pound sterling –13 –4 Other –58 –48 Total –187 –364 (1) The impact of the newly acquired Oyak Bank has not been included in the tables for interest rate risk in the banking books
By Business Line ING Wholesale Banking –442 –559 ING Retail Banking –222 –134 ING Direct –234 –377 ING Bank Corporate Line –892 –818 ING Bank Total –1,790 –1,888
The end-of-year overall NPV-at-Risk fi gure as result of an upwards shock of the market rates of 1% is in line with the prior year. Within ING Direct the NPV-at-Risk fi gure decreased mainly because of the reduction of the duration of the investments. Within ING Retail Banking this fi gure increased mainly due to the larger impact of prepayment risk as result of newly produced mortgages with longer repricing tenors.
Euro –15,165 US dollar –2,055 Pound Sterling 778 Other 706 Total –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. Again, under the view that this capital is not sensitive to interest movements. 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 briefl y explained below.
Commercial banking business Every business unit hedges the FX risk as result of their commercial activities into the base currency of the unit. Consequently assets and liabilities are matched in terms of currency.
Foreign investments in US dollars decreased substantially due to the repatriation of capital out of the United States.
The net position in US dollars decreased in 2007 for two reasons. Firstly due to the issuance of 1,545 million Tier 1 capital denominated in US dollars. Secondly, in anticipation of the lower number of US dollar risk-weighted assets under the Basel II rules (starting January 1st, 2008), the net position was decreased.
Real Estate Price Risk in Banking Books Real Estate price risk arises from the possibility that real estate prices will fl uctuate affecting both the value of real estate assets and earnings related to real estate activities.
Third, ING Bank is the largest real estate investment management company in the world in terms of assets under management. For most of its real estate funds, ING Bank has co-invested seed capital. A decrease in real estate prices will cause the value of this seed capital to decrease and will lower the level of third party assets under management, which in turn will reduce the fee income from this activity.
ING BANK – LIQUIDITY RISK As with bank market risk, liquidity risk falls under the supervision of the ALCO function within ING bank with ALCO Bank as the highest approval authority.
Defi nition Liquidity risk is the risk that ING Bank or one of its subsidiaries cannot meet its fi nancial liabilities when they come due, at reasonable costs and in a timely manner. Liquidity risk can materialise both through trading and non-trading positions. Within ING Bank the liquidity risk framework has been determined by ALCO Bank, which bears the overall responsibility for liquidity risk. The liquidity risk framework is further cascaded down the organisation under the responsibility of the regional and local ALCO’s. The main objective of ING’s liquidity risk framework is to maintain suffi cient liquidity in order to ensure safe and sound operations. For this purpose liquidity risk is considered from three different angles namely from a structural, tactical and a contingency point of view.
Structural liquidity risk Structural liquidity risk is the risk that the structural, long term balance sheet can not be fi nanced timely or at a reasonable cost. In this view of liquidity risk the total on and off balance sheet positions are considered from a structural asset and liability management perspective. For this purpose a working group consisting of Corporate Market Risk Management, Capital Management and Financial Markets focuses on liquidity risk aspects from a going concern perspective. The main objective of the working group is to maintain a sound liquidity profi le through: Maintaining a well diversifi ed mix of funding sources in terms of instrument types, fund providers, geographic markets and currencies; Actively managing access to the capital markets by regularly issuing public debt in all material markets and the maintenance of investor relations; Holding a broad portfolio of highly marketable assets that can be used to obtain secured funding; Maintaining an adequate structural liquidity gap taking into account the asset mix and both the secured and unsecured funding possibilities of ING Bank; Maintaining a funds transfer pricing methodology in which ING Bank’s cost of liquidity is adequately refl ected both under a going concern and a contingency perspective.
Within Financial Markets the focus is mainly on the daily and intraday cash and collateral positions and it is policy to suffi ciently stagger day-to-day funding requirements. For this purpose the Treasury function monitors all maturing cash fl ows along with expected changes in core business funding requirements.
Topics: Structural liquidity gap Funding mix Marketable assets Central Bank eligibility Securitizations Funds transfer pricing
Topics: Stress testing and reporting Cash and collateral reporting Daily and intraday funding & Liquidity risk management
Delegated Responsible: ING Crisis team consisting of the CFO, CRO, Head of CMRM, Head of Capital Management, all main Treasurers of ING Group (and ING Insurance), Head of Corporate Communications
ING INSURANCE ING is engaged in selling a broad range of life and non-life insurance products. Risks from these products arise with respect to the adequacy of insurance premium rate levels and provisions for insurance liabilities and capital position, as well as uncertainty as to the future returns on investments of the insurance premiums. Risks are classifi ed as insurance risk (actuarial and underwriting), market risk, credit risk, business risk and operational risk.
The responsibility for measurement and management of credit risk and operational risk resides with Corporate Credit Risk Management (CCRM) and Corporate Operational Information and Security Risk Management respectively. Corporate Insurance Risk Management (CIRM) is responsible for insurance (actuarial and underwriting) and market risk measurement and management, business risk measurement, as well as for ensuring that investment mandates adequately address credit portfolio risk.
Risk management governance ING’s Insurance Risk Management (IRM) is organised along a functional line comprising three levels within the organisation: the corporate, business line and business unit levels. As the General Manager of CIRM (Corporate IRM), the Chief Insurance Risk Offi cer (corporate CIRO) heads the functional line, reporting into the Corporate CRO. Each of the business lines and business units has a similar function headed by a Chief Insurance Risk Offi cer (business line and business unit CIRO). This layered, functional approach ensures consistent application of guidelines and procedures, regular reporting and appropriate communication vertically through the risk management function, as well as providing ongoing support for the business. The scope, roles, responsibilities and authorities of the risk management function at different levels are clearly described in an Insurance Risk Management Governance Framework to which all consolidated business units and business lines must adhere.
A critical aspect of risk management is that all new products are designed, underwritten and priced appropriately. This is explicitly covered by the Standard of Practice for the Product Approval and Review Process (PARP). This standard includes requirements related to risk profi le, traditional and value-oriented pricing metrics and targets and documentation. In addition for insurance and market risks, the requirements also refer to operational risk, legal and compliance risk etc. For these risks, the IRM network works together with the other, relevant risk departments. The PARP also includes requirements to assess sensitivities to changes in fi nancial markets and insurance risk (e.g. mortality and claims development), as well as assessment of the administration and accounting aspects of the product.
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 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.
Reserve adequacy CIRM instructs and supervises all ING entities so as to make sure 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.
ING’s policy for reserve adequacy testing is disclosed in the ’Principles of valuation and determination of results’ section. As of 31 December 2007 (and 31 December 2006), reserves for ING’s life insurance businesses in aggregate are adequate at a 90% confi dence level. All business lines are adequate on a stand alone basis at a 90% confi dence level. Although the Asia/Pacifi c business line reserves were adequate as a whole at the end of 2007 at a 90% confi dence level, there is a reserve inadequacy in Taiwan at the 90% confi dence level. At the end of 2006 the inadequacy in Taiwan caused the reserves of the business line Asia/Pacifi c to be inadequate by EUR 1.0 billion.
The post 2001 business is adequate at a 90% confi dence level, which partially compensates for the inadequacy related to the business sold until 2001. Furthermore, ING has over time strengthened reserves by EUR 828 million (2006: EUR 770 million) for this exposure and increased the internal capital allocation for this business.
The outcome of the reserve adequacy test for Taiwan is inherently uncertain given the use of various assumptions and the long term nature of the liability. The outcome can only be reliably estimated within broad ranges which are bound to vary signifi cantly from period to period. The outcome of the test for Taiwan is especially sensitive to (changes in) interest rate assumptions. The reserve adequacy test at 31 December 2007 is based on the current 10-year swap rate in Taiwan at 31 December 2007 of 2.68% (2006: 2.21%), with the assumption that, in the long term, this swap rate will move to 5.75% (2006: 5.75%).
Credit risk (including Transfer risk) 1,021 1,411 Market risk 15,258 14,555 Insurance risk 3,293 3,110 Non-fi nancial risk (2) 3,627 3,334 Total insurance operations 23,199 22,410 (1) The Economic Capital outcomes do not refl ect any potential tax benefi t resulting from the loss that occurs under the specifi ed circumstances. (2) Non-fi nancial risk includes operational risk as well as business risk (covering expense risk and lapse risk).
Total diversifi cation across these risk types is 31% for 2007 (31% for 2006).
Real Estate 669 480 Implied Volatility 2,091 2,154 Foreign Exchange 2,108 1,949
Interest rate and equity risks are the largest market risks for ING Insurance. Interest rate risks are most signifi cant in Taiwan, United States, and Europe. In all cases, the primary exposure is to falling interest rates. The equity risk relates to both direct and indirect exposure. Direct exposure relates to the holding of shares and is most signifi cant for ING in the Netherlands. Indirect exposure relates to the potential loss of fee income from unit linked, variable annuity, and pension fund business across all regions. Direct exposure represents approximately 60–70% of the equity risk. The table shows a notable increase in equity risk during 2007, but this is related to improved modelling of risk during 2007 and not in material changes to actual risk taking.
Credit spread risk relates to potential increases in credit spreads from investments in fi xed income securities. ING Insurance does not adjust the market value of liabilities for credit spread widening. 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 accordingly most of the exposure relates to the risk of change in the market value surplus of non-euro businesses.
ING has implemented Market Value at Risk (MVaR) limits to manage the market and credit risks resulting from its global Insurance operations. On at least an annual basis, ALCO Insurance sets an aggregate MVaR limit for ING Group Insurance and sub-limits for each of the business lines, which are ultimately allocated to the business units. The MVaR limit is measured in a manner consistent with the Economic Capital measure, i.e. based on a 99.95% confi dence level over a one-year horizon.
CIRM consolidates and monitors the MVaR exposures of the business lines including diversifi cation effects on a quarterly basis. Together with ING Capital Management, MVaR is managed within the limits. In 2007 and 2006 there were no breaches of the overall ING Insurance MVaR limit.
Complementing Economic Capital, which is based on a market value analysis, ING Insurance also measures risk based on accounting earnings. More specifi cally, using scenario analysis, ING Insurance measures the potential sensitivity of realised pre tax earnings of the insurance operations to an increase/decrease of different risk factors over a full year. These earnings sensitivities are used as input into the ING Group Earnings at Risk measure, where these sensitivities are fully diversifi ed with the Bank. Interpretation of the underlying earnings sensitivities must be done individually as ING does not assume that all of the scenarios presented below will happen concurrently.
Note: The table above includes similar sensitivities to the 2006 Risk management section, but the fi gures represent different impacts than in 2006. Specifi cally, the fi gures include fully forward looking twelve month sensitivities, have different shock percentages, and are pre-tax. In addition,the interest rate risk sensitivities for 2006 and 2007 refl ect the change in accounting policy for evaluating reserve adequacy at the business line level.
The previous table presents fi gures before diversifi cation 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 and Taiwan businesses, a shock of 0.5% is applied since these businesses operate 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 fl uctuations can have a relatively large impact on earnings since all price volatility is fully refl ected in earnings for real estate investments. The impact on earnings of interest rates and equity price changes are normally lower than the economic and shareholder’s equity impact given current accounting rules. The sensitivity results do refl ect the impacts of asymmetric accounting whereby the hedges must be marked-to-market through the earnings while the liability value is not.
The increase in earnings at risk from a 15% downward equity shock is mostly due to four factors: Potential impairments of individual direct holdings; Improved modelling of DAC/VOBA impacts for US business units; Refi ned modelling of earnings sensitivities for the Japan SPVA hedging program; These are offset by the market value change from put options held at the Corporate Line Insurance.
ING INSURANCE – INSURANCE RISKS General Actuarial and underwriting risks are risks such as mortality, longevity, morbidity, adverse motor or home claims development, etc., which result from the pricing and acceptance of insurance contracts. In general, these risks cannot be hedged directly in the fi nancial markets and tend to be mitigated by diversifi cation across large portfolios. They are therefore primarily managed at the contract level through standard underwriting policies, product design requirements as set by ING’s IRM function, independent product approval processes and risk limitations related to insurance policy terms and conditions with the client.
Measurement For portfolio risks which are not mitigated by diversifi cation, the risks are managed primarily through concentration and exposure limits and through reinsurance and/or securitization. Aggregate portfolio level limits and risk tolerance levels are set in reference to potential losses stemming from adverse claims in ING’s insurance portfolios which are reviewed annually by the ING Group Executive Board. ING Group has established actuarial and underwriting risk tolerance levels in specifi c areas of its insurance operations as described below. For non-life insurance, risk tolerance levels are set by line of business for catastrophic events (e.g. natural perils such as storms, earthquakes and fl oods) and for individual risks.
For the main non-life units (in the Benelux, Canada, Mexico) the risk tolerance for property and casualty (P&C) business is generally set at 2.5% of the Group’s after-tax earnings. For 2007, this translated into an aggregated (pre-tax) risk tolerance level of EUR 235 million (2006: EUR 190 million). The aggregate risk tolerance limit relating to events was translated into separate risk tolerance levels for Mexico and the Benelux respectively (in 2007 EUR 235 million each). For Canada the pre-tax risk tolerance level is set at EUR 214 million (derived from the above EUR 235 million but allowing for outside interests) (2006: EUR 169 million). For motor business a sub-limit of EUR 10 million is applied (2006: EUR 7.5 million).
For the smaller non-life units, the (pre-tax) risk tolerance level for catastrophe related events for 2007 was set at EUR 5 million (2006: EUR 5 million) per event per business unit.
With respect to life business, ING Group’s (pre-tax) risk tolerance level for 2007 was set at EUR 22 million (2006: EUR 22 million) per insured life for mortality risk. While life insurance risks are considered to be naturally diversifi able by virtue of each life being a separate risk, group contracts may result in signifi cant exposures. For potential losses, resulting from signifi cant mortality events (e.g. pandemics or events affecting life insurance contracts involving multiple lives), ING applies a separate risk tolerance level which equalled EUR 750 million in 2007 (2006: EUR 750 million). ING continues to model the possible impact of pandemics based on studies published by respected international organisations.
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. In addition, 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.
Regarding catastrophic losses arising from events such as terrorism, ING believes that it is not possible to develop models that support inclusion of such events in underwriting in a reliable manner. The very high uncertainty in both the frequency and severity of these events makes them, in ING’s opinion, uninsurable. For the non-life business, losses that result from these events are generally not covered unless required by law. In various countries industry pools have been established to mitigate the terrorism risk to which the individual insurers are nevertheless still exposed. ING participates in such pools.
The largest exposure is for morbidity risk and is the risk, mostly in Taiwan, of future health claims exceeding current best estimate actuarial assumptions. In Taiwan, ING has a legacy block of guaranteed premium health riders that provide benefi ts for 30-60 years into the future. The mortality risk relates to the potential for increasing deaths (life risk) or decreasing deaths (longevity risk). This risk relates to a potential mortality catastrophe or to changes in long term mortality rates. As noted, ING manages these risks via limits and external reinsurance. Finally, property and casualty risk exists primarily in Canada, Mexico, and the Benelux. The increase in P&C Economic Capital during 2007 is mostly due to an improvement in the correlation model between P&C risks and not increased risk taking.
Through scenario analyses, ING Insurance measures the sensitivity of pre tax earnings of the insurance operations to an increase/decrease of the insurance risk factors over a one year period. These changes to earnings can relate to realised claims or any other profi t item that would be affected by these factors. ING assumes that not all the shifts presented below will happen at the same time.
ING INSURANCE – CREDIT RISKS The credit risks in the general accounts portfolio within ING Insurance are subject to the same principles, policies, defi nitions and measurement as those of the banking operations. The credit risks are measured and monitored by Corporate Credit Risk Management (CCRM) as well as local credit risk managers within the various locations were credit risk is taken within ING Insurance and ING Investment Management. Within ING Insurance, the goal is to maintain a low risk, well diversifi ed credit risk portfolio that meets or exceeds market based benchmark returns.
Overall portfolio credit risk limits are established and integrated into investment mandates by ALCO Insurance based on asset or investment category and risk classes. Individual issuer limits are determined based on the obligor’s rating. These limits are managed by the region where the parent company is domiciled but may be sub-allocated to regional or local portfolios. In addition, each Insurance company has one or more investment mandates that may differ by insurance portfolio specify credit risk appetite by issuer type and quality.
Food, Beverages and Personal Care 1.9% 1.9% 4.1% 3.8% 0.6% 0.7% 2.5% 2.5%
amounts in billions of euros Insurance Americas Insurance Europe Insurance Asia/Pacifi c Total ING Insurance
The portfolio in The Netherlands decreased principally due to the sale of Nationale Nederlanden Hypotheek Bedrijf (NNHB residential mortgages) to ING Bank. The decrease in Italy resulted from a reduction of ING’s position in government bonds. Exposure to Spain amounted to EUR 5.2 billion in 2006, but decreased below the EUR 5 billion threshold in 2007. There were no other signifi cant shifts in the portfolio concentration.
COMPLIANCE AND OPERATIONAL RISKS ING believes that good compliance management is in the best interest of its customers, shareholders and staff, and is important for the way ING does business. Complementary to this, effective control and management of operational risks leads to more stable business processes and lower operational risk costs.
COMPLIANCE RISK Compliance risk is defi ned 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. In addition to reputation damage, failure to effectively manage compliance risk can expose fi nancial institutions to fi nes, 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.
The following Compliance risk areas have been defi ned and highlighted for particular attention: Client related integrity risk; this includes Financial Economic Crime – money laundering, terrorist fi nancing, other external crime and fraud. Following Customer and Business Partner Due Diligence processes and monitoring business transactions are key contributors to how this risk is managed; Personal conduct related integrity risk; this includes market abuse and personal insider trading. Business principles and (local) codes of conduct and specifi c policies on outside positions by ING offi cers, inducements, including gifts and entertainment assist with management of these risks; Financial services conduct related integrity risk; the primary focus of this area of compliance risk is on marketing, sales and trading conduct, conduct of advisory business, transparency of product offerings, customer interest and protection. To assist with management of these risks ING has complaint handling processes, internal standards with respect to new product approval and product review and policies for data protection and privacy; Organisational conduct related integrity risk covers; confl icts of interest, anti-trust and relationships with third parties and intermediaries. Policies and measures in place to manage this risk include confl icts of interest policies and procedures including Chinese Walls, regulatory registration requirements and outsourcing and Merger and Acquisition policies and due diligence processes.
ING has a Whistleblower Policy and 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 Whistleblower Policy ensures that staff is protected when raising issues.
To avoid potential confl icts of interests, it is imperative that the Compliance Offi cer is impartial and objective when advising business management on compliance matters in their business unit, region, division or business line. To facilitate this, a strong functional reporting line to the next higher level Compliance Offi cer is in place. The functional reporting line has clear accountabilities around objective setting remuneration, performance management, and the appointment of new Compliance staff.
Compliance Management Policies and Tools The responsibility of the Compliance Function is to proactively: Identify, assess and monitor the compliance risks faced by ING; Assist, support and advise management in fulfi lling its compliance responsibilities; Advise any employee or offi cer with respect to their (personal) compliance obligations.
ING Bank N.V. has been in discussions with its Dutch bank regulator De Nederlandsche Bank (DNB) related to transactions involving persons in countries subject to sanctions by the EU, US and other authorities. These discussions prompted ING Bank N.V. to engage in a review regarding transactions involving sanctioned parties. In connection with this review and related discussions ING Bank has undertaken to complete the global implementation of enhanced compliance and risk management procedures, and to monitor the implementation of such procedures on an ongoing basis, as instructed by DNB. ING Bank also remains in discussions with authorities in the US and in other jurisdictions concerning these matters, and it is not possible to predict at this time the outcome thereof.
As a result of our frequent evaluation of all businesses from economic, strategic and risk perspectives, ING Bank N.V. has closed its representative offi ce in Cuba. The Netherlands Caribbean Bank, which is now a 100% ING subsidiary, is being liquidated. In addition, ING has concluded that for business reasons doing business involving certain specifi ed countries should be discontinued, which includes that ING will not enter into new relationships with clients from these countries while a process has started to discontinue existing relationships involving these countries. At present these countries include Myanmar, North Korea, Sudan, Syria, Iran and Cuba.
The capability and capacity of the Corporate Compliance function have been increased, including a staff increase of 55% and the creation of a central team focusing on Financial Economic Crime and anti-money laundering policies and procedures.
Risk management governance ING OISRM is organised along a functional line comprising three levels within the organisation: the corporate, business line and business unit levels. The General Manager of COISRM (Corporate OISRM) heads the functional line, reporting to the CRO. Each business unit has an OISRM manager that reports to the business line head of OISRM. This layered, functional approach ensures consistent application of guidelines and procedures, regular reporting and appropriate communication as well as the ongoing support for the business. The governance structure is implemented according to the Basel II requirements. The mandate, roles and responsibilities at different levels are clearly described in the OISRM policy house.
Management ING has developed a comprehensive framework supporting the process of identifying, measuring and monitoring operational, information and security risks.
– Compliance program – Product Approval process – Risk awareness training
Risk Measurement – Incidents Reporting and Analysis – RAROC – Quality of Control Scorecards
Risk Mitigation – (Information) Security plans and implementation – Crisis management planning – Personal and physical security planning
ING promotes effective management of operational, information and security risk by requiring business units to demonstrate that the appropriate steps have been taken to control operational risk. ING applies scorecards to measure the quality of operational, information and security risk processes within a business. Scoring is based on the ability to demonstrate that the required risk management processes are in place with the business units. The scorecards indicate the level of control with the business units. The scoring results in a decrease or increase of the risk capitals, depending on both the maturity of implemented operational, information and security risk and the control measures taken.
Personal and physical security ING has established policies on Personal and Physical Security. Entities need to ensure that all policy requirements are maintained. The ING Corporate Physical Security policy and minimum determine functional requirements about the areas of physical access security, theft protection, fi re protection, cash and valuables protection, utilities and infrastructure protection and supporting security devices. Security plans per location are based on a risk assessment. All (major) ING assets (e.g. premises, information, equipment and valuables) must have a nominated asset-owner, which is accountable for the adequate protection of its entrusted ING asset. Each ING location has to be divided into classifi ed security zones (compartmentalisation) to locate classifi ed assets. Each ING entity must have an appointed physical security manager who is accountable for the implementation of physical security within its location(s).
The corporate policy on Personal Security states how ING’s employees should be protected against exposure to the risks or the consequences of criminal and environmental threats. The policy includes minimum standards and some guidelines on business travelling (travel, accommodation and lodging), expatriates (e.g. selection process and accommodation), events by ING and projects in order to create and maintain a safe and secure environment for ING staff and visitors within ING locations and the availability, integrity and reliability of ING assets within and outside ING locations.
Crisis Management Crisis management includes the process to detect, assess, solve and evaluate a crisis. The ING Crisis Management policy provides a cohesive overview of crisis management governance in relation to crisis management offi cer roles and responsibilities across the whole of ING Group. It does not address roles associated with ING customers or other third parties however.
Measurement The operational risk measurement model uses both external and internal loss data (exceeding EUR 1 million) within an actuarial model. The model is adjusted for the scorecard results, taking into account the specifi c quality of internal control in a business line and the occurrence of large incidents (‘bonus/malus’). This provides an incentive to business unit management to better manage operational risk. The outcome is periodically challenged and benchmarked. The capital calculation model meets industry standards.
ING is member of the Operational Risk data eXchange Association (ORX), the world’s leading operational risk loss data consortium for the fi nancial services industry. In order to protect ING against fi nancial consequences of uncertain operational events ING has acquired insurance policies issued by third-party insurers, with world-wide cover for (Computer) Crime, Professional Liability, Directors and Offi cers Liability, Employment Practices Liability and Fiduciary Liability. The portion of the risks that ING retains is of a similar magnitude to the risk retained for casualty business-related catastrophe exposures.
Developments in 2007: In 2007 ING obtained DNB’s approval to implement the advanced measurement approach for the operational risk capital calculation. ING has applied the AMA calculation as of 1 January 2008. Local implementation of Basel II is supported by the corporate OISRM function; The adjusted scorecard approach monitors the compliancy with the Compliance and OISRM framework and its controls while taking the maturity of the business units into account; The Anti-fraud Policy has been further upgraded. Defi ned measures include anti-fraud training, pre-employment screening, additional organisational controls, automated detection as well as reporting and response procedures. OISRM Policy house has been refreshed and refl ects all OISRM policies; A powersupply issue in one of the datacentres (in the Netherlands) has prompted ING to accelerate an improvement programme for the business continuity and disaster recovery capability and platform security of its datacenters. The Non-Financial risk dashboard has been introduced and piloted; The integration of the operational, information and security functions at all levels within ING has lead to an organisation which consists of around 900 FTE’s at the end of 2007.
This model disclosure section explains the models applied in deriving these three metrics. The methodology to derive the Earnings at Risk and Capital at Risk metrics, as presented in the ING Group risk dashboard, is described fi rst. Thereafter, the methodologies used to determine Economic Capital for ING Bank, ING Insurance and ING Group are described.
MODEL VALIDATION In 2007 all risk models used for the Economic Capital Bank calculations and the ING Group risk dashboard have been reviewed and validated by the internal Model Validation department. The review of the models underlying Economic Capital for ING Insurance is planned for 2008.
Capital at Risk The Capital at Risk (CaR) measures the potential reduction of the net asset value (based on fair values) over the next year relative to expected value. CaR is measured using a 90% confi dence level (i.e. ‘1 in 10’ stress scenario). Discretionary Management interventions are not explicitly modelled unless their measurement can be based on historical performance tracking (e.g. regular or planned actions).
Economic value is defi ned as the marked-to-market net asset value (assets less liabilities). For each major risk type the value sensitivities are calculated based on the existing Economic Capital methodology, applying the 90% confi dence level. CaR risk appetite is measured against available fi nancial resources.
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 diversifi ed within ING Bank or ING Insurance.
The fi rst aggregation step is between ING Bank and ING Insurance for each major risk type. All risk capitals, except for credit risk that is already aggregated for ING Bank and ING Insurance are delivered on a standalone basis for ING Bank and ING Insurance. These risk capitals are aggregated between ING Bank and ING Insurance using a variance-covariance approach. Depending on the accounting treatment the Bank - Insurance correlation factors used for EaR may differ from CaR correlation factors (e.g. for interest rate risk). The result of this aggregation step are Group diversifi ed EaR and CaR fi gures for each major risk type.
Risk type Distribution used Credit and transfer risk (2) KMV distribution Market risk (8) – Interest rate risk Europe, Asia and America – Equity risk Europe, Asia and America – FX risk – Real estate risk Normal distribution Insurance risk (1) Normal distribution Business risk (1) Normal distribution Operational risk (1) Empirical distribution
Principal assumptions of EaR and CaR measurement CaR and EaR fi gures should always be viewed in the context of principal assumptions made to enable both comparability and updated measurement of ING Group risk profi le: 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 profi le 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 diversifi cation are based on best estimate assumptions supported by statistical analysis of historical data, ING risk expert judgement, external benchmark study and common logic; Behavioural assumptions for clients are included in risk measurement where applicable e.g. variable savings, embedded mortgage options or lapse ratios.
ECONOMIC CAPITAL ING BANK Economic Capital is defi ned as the amount of capital that a transaction or business unit requires in order to support the economic risks it originates. In general Economic Capital is measured as the unexpected loss above the expected value or loss at a given confi dence level. Specifi c measurement by risk type is described in greater detail in the separate risk type sections; i.e. credit and transfer and operational risk as well as market and business risk bank.
Aggregation model The main processes executed in the ING Bank Economic Capital aggregation model are depicted in the fl owchart below. The white boxes show the processes performed by the model while the shaded box indicates inputs from other corporate risk departments.
As a foundation the correlations in the risk dashboard are applied based on a 90% confi dence level, i.e. they correspond to the correlations observed in the 10% largest downward movements (a ‘1 in 10’ event). As shown in the fl ow-chart, these correlation factors are stressed upwards where necessary to account for potential measurement inaccuracy in extreme events due to limited historic data observations. For aggregating non-fi nancial risks (business and operational) expert opinion is used.
Reporting Framework For each business unit and product line, the gross Economic Capital for each risk type is delivered to MISRAROC - the fi nancial data warehouse for RAROC and Economic Capital reporting of ING Bank. The net Economic Capital fi gures are calculated by taking the product of the gross Economic Capital with one minus the diversifi cation factor. Total Economic Capital is calculated as the sum of the net Economic Capital for each risk type at all reporting levels.
ING uses a series of credit risk models that can be grouped into three principal categories: Probability of Default (PD) models, which measure the standalone creditworthiness of individual debtors; Exposure at Default models (EAD) which estimate the size of the fi nancial obligation at the moment of default in the future; and Loss Given Default Models (LGD), which estimate the recovery value of the underlying collateral or guarantees received (if any) and the unsecured part. Collectively, ING uses over 100 models for credit risk. The various models can be grouped into three categories: statistical, expert and hybrid. Each model is individually reviewed and validated annually by the Model Validation department (MV), in order to determine the continued viability or need to adjust each individual model.
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 specifi c rules imposed by Basel II, such as regulatory caps and fl oors, and the use of the standardized approach for certain portions of ING’s portfolio. These differences are permitted under the Basel II guidelines. The table below summarises different capital measures used for different purposes and shows the difference in key elements and purposes.
Credit Risk Capital Measurements Methodology Location Confi dence 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 fl oors, maturity, repayment schedules, correlation factors, migration matrix. Some inputs come from EC-MC portfolio calculator but with 99.95% confi dence level country and industry.
90.00% Basel II model outputs excluding Basel II caps and correlation factors, migration matrix country and industry.
During 2007, the Economic Capital levels for credit and transfer risk were calculated on a weekly basis for most of the Wholesale Bank, for ING Direct investment portfolios and for the SME portfolios within the Retail banking operations. For consumer loans, residential mortgages, credit cards, and the insurance portfolios, the calculations are made on a monthly basis. On a quarterly basis, the Economic Capital for credit risk and transfer risk fi gures are consolidated with the corresponding Economic Capital components from other disciplines.
Governance of Economic Capital for Credit and Transfer Risk All PD, EAD and LGD models are approved by the Credit Risk Committee (CRC) after thorough review of documentation by the Model Development Steering Committee (MDSG) and MV. In addition, each model is validated on an annual basis by MV. Each model has both a credit risk and a front offi ce co-sponsor. Both the MDSG and the CRC have participation from both credit risk offi cers as well as the front offi ce to ensure maximum acceptance by the organisation.
Measurement Economic capital for market risk is calculated using internally developed methodologies with a 99.95% confi dence interval and a horizon of one year, which represents extreme events and ING’s rating. The Economic Capital for market risk for non trading portfolios is calculated for each risk type, while for trading portfolios it is calculated on a portfolio level. The calculations for Economic Capital market risk include real estate risk (including development risk), foreign exchange rate risk, equity price risk, interest rate risk and model risks.
Real estate price risk includes both the market risks in the investment portfolio and the development risk of ING Real Estate. The real estate price risk for ING Real Estate is calculated by stressing the underlying market variables. The stress scenarios at a portfolio level take into account all diversifi cation effects across regions and real estate sectors. Also, the leverage of participations in the real estate investment funds is taken into account.
For the real estate development process, in addition to price risk, the risk drivers of vacancy rate and construction delays are in addition taken into account. Furthermore the risk model differs for each development phase (i.e., research, development, and construction) to appropriately refl ect the risk taken in each phase. Using correlations, all risk drivers, and stages are used to calculate a possible market value loss representing the Economic Capital for market risk for the development portfolio.
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% confi dence prepayment model error and the 99% confi dence adverse interest rate change.
While aggregating the different Economic Capital market risk fi gures for the different portfolios, diversifi cation benefi ts are taken into account as it is not expected that all extreme market movements will appear at the same moment.
The nature of market risk economic capital, evaluating the impact of extreme stress with a 99.95% confi dence level, can sometimes be diffi cult to evidence in a statistical sound manner with the available historical data. The economic capital fi gures disclosed by ING Group are a best effort estimate based on available data and expert opinions.
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. The main risk drivers are the quality of control and the volume of cash fl ows or other operational risk control measures, e.g. legal expenditures. While operational risk can be limited through management controls and insurance, many incidents still have a substantial impact on the profi t and loss account of fi nancial institutions. Operational risk is more diffi cult to quantify than other risk types, because of the far-reaching (mostly low probability - high impact) and historic data on business performance is scarce.
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 specifi c institution; ‘Bonus/Malus’ approach, which focuses on the actual operational incidents of a specifi c institution.
Loss Distribution approach The main objective of the LDA approach is to derive an objective capital number based on the size and the risk appetite of an institution and its business units. This approach estimates the likely (fat-tailed) distribution of operational risk losses over some future horizon for each combination of business line and loss event type. The main characteristic of the LDA is the explicit derivation of a loss distribution, which is based on separate distributions for event frequency (Poisson) and severity (Inverse Gaussian). The model uses both external and internal loss data above one million EUR.
The calculation of operational risk capitals for the units follows fi ve basic principles: Principle 1: If the world gets riskier, the business units need more Economic Capital; Principle 2: If a business unit’s size increases, so does its capital; Principle 3: If the business of a business unit is more complex, it needs more capital; Principle 4: If the level of control of a business unit is higher, it needs less capital; Principle 5: If the business units’ losses from internal incidents exceed the level of expected loss accounted for in the fi rst four framework principles, it needs more capital.
The MVL consist of the Financial Component of Liabilities (FCL) and a Market Value Margin (MVM) for non-hedgeable risks (e.g. insurance risk). The MVM is calculated using a Cost-of-Capital approach based on an estimate of required shareholder return on Economic Capital.
Liquidity risk and strategic business risk have been excluded from the EC calculations of ING Insurance.
Further details on Economic Capital model Market Data and Scenario Generation ING Insurance uses ING Bank’s Global Market Database (GMDB) as a provider of market price and risk data for fi nancial risk drivers. All market data is obtained from reputable data providers such as Reuters and Bloomberg. The GMDB operational team then validates the market data and calculates relevant risk parameters. This validated data is then automatically delivered to the ECAPS system.
Since ING Insurance operates in many developing fi nancial 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.
Non-market risk Economic Capital is calculated by business units, Corporate Credit Risk Management and Corporate Operational, Information and Security Risk Management and input into ECAPS at the sub risk level. ECAPS than aggregates 21 sub-risk types (e.g. mortality and trend risk) to 9 non market risk types using a bottom-up Economic Capital diversifi cation approach based on a matrix of tail correlations. The information inputs relate to 9 sub risk types: Credit risk; Business risk; Operational risk; Life risk catastrophe; Life risk non-catastrophe; Morbidity risk catastrophe; Morbidity risk non-catastrophe; P&C risk catastrophe; P&C risk non-catastrophe.
Replicating Portfolios To handle the full complexity of calculating diversifi cation by Monte Carlo simulation, ING maps its assets and liabilities to a set of standard fi nancial instruments. The set of standard instruments consists of zero coupon bonds, market indices, equity forwards, swaptions, F/X options and equity options. Assets and the fi nancial components of the liabilities are represented by a portfolio of this standard set of instruments. A user interface allows the selection of different types of replicating instruments for different cash fl ow types. Then an optimal replicating portfolio is created that matches the risk profi le of the stochastically generated cash fl ows as good as possible. The resulting replicating portfolio is used in the calculation of Economic Capital.
The quality of the replicating portfolio is monitored by several statistical criteria including R-squared and benchmarked against market value sensitivities such as duration, convexity, and changes in value for larger interest rate and equity shocks. High quality replicating portfolios are important in several ways. First, they ensure a good refl ection of the actual risk profi le and an accurate calculation of Economic Capital. Second, they assist Business Units in hedging strategies and management of Economic Capital. Third, the process of replicating portfolio calculations increases the understanding of the complex nature of insurance liabilities in a market consistent environment.
Replicating portfolios are currently determined from a single factor RN ESG interest rate model. This limits the ability of the replicating portfolios to pick up sensitivity to non-parallel shifts of the term structure of interest rates. Hence RW ESG interest rate scenarios for the Value at Risk calculations are generated using a single factor model as well. However both RN ESG and RW ESG models are consistent with respectively, the RN ESG and RW ESG volatility structure of interest rates.
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.
ECONOMIC CAPITAL GROUP ING’s Group Economic Capital and Bank-Insurance diversifi cation benefi t is determined by applying one common aggregation approach to the banking and insurance businesses. The starting point is the actual reported Economic Capital fi gures for ING Bank and ING Insurance, excluding inter-risk diversifi cation. In addition an aligned set of best-estimate correlation assumptions is constructed by applying the weighted average of the Bank and Insurance specifi c inter-risk correlation assumptions for each of the fi ve major risk types i.e. credit, market, insurance, business, and operational; reference Economic Capital models of Bank and Insurance.
PROCESSES FOR MANAGING CAPITAL In addition to measuring capital adequacy, Capital Management also ensures that suffi cient capital is available through setting targets and limits relevant to the above mentioned metrics for ING Bank, ING Insurance and ING Group and ensuring adherence to the set limits and targets through planning and executing capital management transactions. The process is supplemented by stress testing and scenario analysis. The ongoing assessment and monitoring of capital adequacy is embedded in Capital Management’s capital planning process and results in a quarterly Capital Adequacy Assessment Report which is presented to both the ING Group Finance and Risk Committee and the ING Group Executive Board. The main objective of the assessment is to ensure that ING Group as a whole has suffi cient capital relative to its risk profi le both in the short and the medium term.
AVAILABLE FINANCIAL RESOURCES (AFR) ING Group AFR ING Group is computed as follows: Available Financial Resources – ING Group
Total AFR Bank and Insurance 54,443 52,984 less Core debt Group (1) 4,728 4,210 Total ING Group AFR 49,715 48,774 (1) Investments in subsidiaries less equity (including hybrid capital) of the Group holding company. This net debt position is provided as equity to ING Insurance and ING Bank.
ING Insurance AFR insurance is computed as follows: Available Financial Resources – ING Insurance
Plus hybrid capital 2,202 1,665 Plus Mark-to-Market and tax adjustments 3,673 3,862 Total ING Insurance AFR 22,710 27,200 (1) IFRS equity excluding goodwill. Goodwill amounted to EUR 1,076 million at 31 December 2007 (2006: EUR 245 million).
Beginning in 2007, the AFR mainly constitutes of Tier-1 capital plus the revaluation reserve for equity securities, less the difference between expected loss and loan loss provisions. Until 31 December 2006 AFR equalled Tier-1 capital. The revaluation reserve for equity securities amounted to EUR 2,952 million at 31 December 2007 (2006: EUR 1,256 million).
AFR/EC RECONCILIATION 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%. For details regarding the computation of EC see the section entitled ‘Risk management’.
(5) Tier-1 instruments issued by the ING Insurance e.g. perpetual debt securities, at nominal value. (6) Includes EUR 14,199 million (2006: EUR 12,366 million) Tier-2 capital and nil (2006: EUR 330 million) Tier-3, offset by EUR 2,407 million (2006: EUR 1,251 million)
consisting of fi nancial participations and the residual risk remaining after securitisations. (7) Mainly includes EUR 8,565 million (2006: EUR 7,701 million) representing 50% of the present value of future profi ts generated by policies in force (Value in Force), offset by EUR 4,494 million (2006: EUR 4,183 million) representing 50% of the non-Dutch deferred acquisition costs.
REGULATORY REQUIREMENTS ING Bank Capital adequacy and the use of regulatory required capital are based on the guidelines developed by the Basel Committee on Banking Supervision (The Basel Committee) and the European Union Directives, as implemented by the Dutch Central Bank (DNB) for supervisory purposes. The minimum Tier-1 ratio is 4% and the minimum total capital ratio (known as the BIS ratio) is 8% of all risk-weighted assets including off-balance sheet items and market risk associated with trading portfolios.
Supplementary capital – Tier-2 14,199 12,367 Available Tier-3 funds 329 Deductions –2,407 –1,251 Qualifying capital 41,564 37,229
ING Group According to an agreement between the Dutch Central Bank and the former Pension and Insurance Board regarding the supervision of fi nancial conglomerates, ING Group is required to have an amount of capital, reserves and subordinated loans which are at least equal to the sum of: the required capital for the banking activities; and the required capital for the insurance activities
Shareholders’ equity (parent) 37,208 38,266 Excluding: Revaluation reserves 1,457 –3,066 Preference shares 21 215 Preference shares issued by group companies 1,019 1,138 Goodwill and intangibles deductible from Tier-1 –2,420 –286 Subordinated loans 7,580 6,253 Capital base ING Group 44,865 42,520
Subordinated loans ING Bank N.V. (included in Tier-2) 11,154 11,110 Subordinated loans ING Verzekeringen N.V. 2,250 2,250 Capital base including subordinated loans 58,269 55,880
Target Ratio EC vs. AFR 120% 120% 100% 100% 100% 100%
Tier-1 ratio (Bank) Year-end actual Tier-1 ratio 7.39 7.63 Regulatory minimum Tier-1 ratio 4.00 4.00 Target Tier-1 ratio 7.20 7.20
BIS ratio (Bank) Year-end actual BIS ratio 10.32 11.02 Regulatory minimum BIS ratio 8.00 8.00 Target BIS ratio 10.80 10.80
ING Insurance – short term A-1+ P-1 – long term AA– Aa3 AA–
Equity 3 Share capital 534 530 Share premium 8,739 8,348 Share of associates reserve 6,053 11,528 Currency translation reserve –950 –950 Other reserves 13,591 11,118 Unappropriated profi t 9,241 7,692
References relate to the notes starting on page 236 which form an integral part of the parent company annual accounts.
Unrealised revaluations after taxation –1,631 428 –1,203 Realised gains/losses transferred to profi t and loss –798 –798 Transfer to insurance liabilities/DAC 820 820 Change in cash fl ow hedge reserve revaluations –696 –696 Unrealised revaluations from net investment hedges 194 194 Employee stock option and share plans 100 100 Exchange rate differences –883 –452 –1,335 Other –48 –48 Total amount recognised directly in equity –3,188 –258 480 –2,966
(1) Other reserves includes Retained earnings, Treasury shares, Other reserves and Unappropriated profi t.
BASIS OF PRESENTATION The parent company accounts of ING Group are prepared in accordance with the fi nancial reporting requirements included in Part 9 of Book 2, of the Dutch Civil Code. The accounting policies with regard to presentation and disclosures are in accordance with the fi nancial 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 profi t and loss account are also applicable to the parent company balance sheet and profi t 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.
Changes in balance sheet values due to changes in the Revaluation reserve of the associates are refl ected in the Share of associates reserve, which forms part of Shareholders’ equity. Changes in balance sheet values due to the results of these associates, accounted for in accordance with ING Group accounting policies, are included in the profi t and loss account. Other changes in the balance sheet value of these associates, other than those due to changes in share capital, are included in Share of associates reserve in Other reserves.
CHANGES IN PRESENTATION The presentation of, and certain terms used in, the balance sheet, the profi t and loss account, cash fl ow statement, statement of changes in equity and certain notes has been changed in 2007 to provide additional and more relevant information. Certain comparative amounts has been reclassifi ed to conform with the current period presentation. None of the changes are signifi cant in nature.
2.2 Parent company annual accounts 1 INVESTMENTS IN WHOLLY OWNED SUBSIDIARIES
Opening balance 42,607 41,488 Repayments to/from group companies 2,227 24 Disposals of group companies –587 Revaluations –5,364 –2,994 Result of the group companies 9,299 7,704 Dividend –5,900 –3,450
Receivables from group companies 10,591 8,827 Other receivables, prepayments and accruals 112 71 3 EQUITY
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
Profi t 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
The total amount of non-distributable reserves is EUR 7,003 million (2006: EUR 12,478 million).
See Note 12 ‘Shareholders’ equity (parent)’ in the consolidated annual accounts for additional information.
Debenture loans 6,370 5,230 Amounts owed to group companies 174 35 Other amounts owed to accrued liabilities 357 493
The number of debentures held by group companies as at 31 December 2007 was 34,892 with a balance sheet value of EUR 34 million (2006: 29,288 with a balance sheet value of EUR 29 million).
Guarantees At 31 December 2007 ING Group has guarantees given on behalf of third parties of nil (2006: nil). ING Group has issued statements of liabilities in connection with Article 403 of the Dutch Civil Code and other guarantees for a number of group companies.
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 paragraph in the annual report (page 76 up to and including page 86). This information is considered to be an integral part of the audited annual accounts.
Michel J. Tilmant, chairman Eric F. Boyer de la Giroday 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
To the Shareholders, the Supervisory Board and the Executive Board of ING Groep N.V.
We believe that the audit evidence we have obtained is suffi cient and appropriate to provide a basis for our audit opinion.
Opinion with respect to the consolidated annual accounts In our opinion, the consolidated annual accounts give a true and fair view of the fi nancial position of ING Groep N.V. as at 31 December 2007, and of its result and its cash fl ows for the year then ended in accordance with International Financial Reporting Standards as adopted by the European Union and with Part 9 of Book 2 of the Dutch Civil Code.
Proposed profi t appropriation amounts in millions of euros, except for amounts per share
On 16 August 2007, an interim dividend of EUR 0.66 per ordinary share of EUR 0.24 was made payable. This interim dividend was paid in cash. Therefore, a fi nal dividend remains of EUR 0.82 per ordinary share. The fi nal dividend will be paid entirely in cash and will be made payable on 5 May 2008.
Net profi t 9,241 Addition to reserves pursuant to Article 38 (5) of the Articles of Association 6,061 At the disposal of the General Meeting of Shareholders pursuant to Article 38 (6) of the Articles of Association 3,180
PROVISIONS CONCERNING ISSUE OF SHARES It is proposed that the Executive Board be appointed as the corporate body that will be authorised, upon approval of the Supervisory Board, to issue ordinary shares, to grant the right to take up such shares and to restrict or exclude preferential rights of shareholders. This authority applies to the period ending on 22 October 2009 (subject to extension by the General Meeting of Shareholders): (I) for a total of 200,000,000 ordinary shares, plus (II) for a total of 200,000,000 ordinary shares, only if these shares are issued in connection with the take-over of a business or company.
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 fi nancial accounts, with two important exceptions. The actual credit-risk provisioning is replaced by expected losses refl ecting statistically calculated average credit losses over the entire economic cycle. In addition the profi t and loss account is adjusted for effects that relate to replacing actual book capital by economic capital.
Embedded Value is an indicator of the economic value creation as a consequence of selling and managing long-term contracts such as life insurance, annuities and pensions. Embedded value is defi ned as the sum of Adjusted Net Worth and the Value of the in-force covered business. Adjusted net worth equals the free surplus and the required capital. The value of in-force covered business is defi ned as the present value of future after-tax statutory book profi ts expected to arise from the in-force business, including new business written in the reporting period, less the cost of capital. The value of new business is the embedded value added with sales during the year, and therefore provides insight into the expected profi tability related to 2007 sales. Future profi ts are estimated using actuarial methods and ING’s best estimates for future assumptions except for economic assumptions, which are more aligned with market rates.
The European Embedded Value (EEV) Policies were published in May 2004 by the CFO Forum, a group representing the Chief Financial Offi cers of major European insurers. The Policies and associated guidance provide a framework for calculating and reporting supplementary embedded value information. ING has adopted the EEV Principles in respect of the year-end results from 2004 through 2007. This Report also takes account of the Additional Guidance on EEV Disclosures effective for 31 December 2006 reporting.
The Value of New Business for 2007 of EUR 1,113 million compares to EUR 807 million in 2006, an increase of 37.9%. The largest contributions were from the developing markets in Asia/Pacifi c and Central Europe. The largest increases were in Central Europe, where the Romania Pillar II pension funds added EUR 150 million; and the USFS, where the US Life insurance business and ING Financial Products sales increased signifi cantly, and in Mexico’s pension business. The developed markets of Belgium, the Netherlands, and Luxembourg combined for a 8.4% decline in VNB, from EUR 95 million in 2006 to EUR 87 million. Profi tability of the business sold, as measured by the internal rate of return (IRR) improved by 1.0 percentage point, to 14.3% on greater volume of business, as measured by the investment in new business. The investment in new business increased to EUR 2,093 million from EUR 1,831 million in 2006. The higher investment and IRR is consistent with the higher VNB. The expected internal rate of return in developing markets is 18.6%, compared to 17.7% in 2006.
Belgium/Luxembourg 546 1,111 Central Europe & Spain 3,887 2,961 Insurance Europe 14,156 16,103
United States 9,068 9,376 Latin America 1,565 896 Insurance Americas 10,633 10,272
Addition of business/(divested business) –431 Currency effects –996 Model changes 185 Revised starting embedded value 26,476
Required return 1,770 Investment return on free surplus 470 Discount rate changes 210 Economic assumption changes 261 Embedded value of business acquired 472 (Cash dividends and) capital injections –5,468 Ending embedded value 2007 26,993
Sensitivity embedded value to economic assumptions The tables below show the outcomes of sensitivity analysis of the Embedded Value as at 31 December 2007 to: One percentage point decrease and increase in new-money interest rates; One percentage point decrease and increase in the discount rates; New money rates based on implied market forward rates derived from the swap rates as at 31 October 2007. The discount rate is adjusted accordingly; One percentage point decrease in assumed investment returns for equity and real estate investments; Ten percent fall in market value of equity and real estate investments; and Local regulatory minimum capital requirement.
As reported – Embedded Value (net of tax) 14,156 10,633 2,204 26,993 1% decrease in new-money rates –310 –532 –1,656 –2,499 1% increase in new-money rates 279 304 1,532 2,115 1% increase in discount rates –979 –451 –446 –1,876 Implied market forward rates (31 October 2007) –2 57 17 73 1% lower equity and real estate returns –846 –190 –197 –1,233 10% downward shift in market values of equity and real estate investments –1,245 –396 –304 –1,946 Local regulatory minimum capital requirement 295 220 2,107 2,621
Net impact of (1): 1% decrease in new-money and 1% decrease in discount rates 851 –34 –1,134 –317 1% increase in new-money and 1% increase in discount rates –700 –147 1,086 239 (1) Net impact shown here is the sum of the individual sensitivities presented above. Note that this may differ from an exact calculation of changing both parameters together.
Developing markets new business value of EUR 678 million, increased by 57.7% from 2006.
INDEPENDENT OPINION Watson Wyatt Limited (‘Watson Wyatt’), an international fi rm of consulting actuaries, has reviewed the calculation of the Embedded Value of ING as at 31 December 2007 and the Value of its New Business written during 2007. All material business units were included in the review. The covered business included all life insurance and other material long-term business lines.
ACTUARIAL AND UNDERWRITING RISKS Emerge from the pricing and acceptance of insurance contracts. Actuaries play a key role in determining insurance premium rate levels and in ensuring that insurance companies have set aside enough provisions to pay claims. Actuarial risk is the risk that assumptions that actuaries input into a model to determine premium rate levels and provisions may turn out somewhat inaccurate. Underwriting risk is the risk that an issuer will receive a claim under an insurance policy it issues/underwrites. Maximum underwriting exposures are limited through exclusions, cover limits and reinsurance.
ALT-A MORTGAGE A type of US residential mortgage which is considered riskier than ‘prime’ and less risky than ‘sub-prime’ mortgages. Parameters generally taken into account are borrower credit scores, residential property values and loan-to-value ratios. Alt-A mortgages are further characterised by a limited degree of income and / or asset verifi cation.
DELTA HEDGE Minimises the exposure of the employee option scheme by holding an appropriate number of (depository receipts for) ordinary shares. The exposure is reassessed every quarter and, if necessary, ordinary shares are bought from the market (or employees).
DEPOSITORY RECEIPT For ordinary and preference shares, issued by the Trust, in exchange for ordinary and preference shares issued by ING Group.
DISCRETIONARY PARTICIPATION FEATURE A contractual right to receive, as a supplement to guaranteed benefi ts, additional benefi ts that: are likely to be a signifi cant portion of the total contractual benefi ts, whose amount or timing is contractually at the discretion of the insurer, that are contractually based on the performance of a specifi ed pool or type of contract, (un)realised investment returns on a specifi ed pool of assets held by the insurer, or the profi t of the company, fund, or other entity that issues the contract.
EARNINGS AT RISK (EAR) Measures the impact on IFRS earnings resulting from changes in market rates over a one year horizon.
CONTINGENT LIABILITIES Possible obligations that arises from past events and whose existence will be confi rmed only by the occurrence or nonoccurrence of one or more uncertain future events not wholly within the control of the entity; or a present obligation that arises from past events but is not recognised because: it is not probable that an outfl ow of resources embodying economic benefi ts will be required to settle the obligation; or the amount of the obligation cannot be measured with suffi cient reliability.
CONTROL The power to govern the fi nancial and operating policies of an entity so as to obtain benefi ts from its activities.
FINANCIAL INSTRUMENTS Contracts that give rise to both a fi nancial asset for one company and a fi nancial liability or equity instrument for another company.
FINANCIAL LIABILITY Any liability that is a contractual obligation: to deliver cash or another fi nancial asset to another company; or to exchange fi nancial instruments with another company under conditions that are potentially unfavourable; or certain contracts that will or may be settled in ING’s own equity instruments.
FORWARD CONTRACTS Commitments to exchange currencies or to buy or sell other fi nancial instruments at specifi ed future dates.
OPERATIONAL RISK The risk of direct or indirect loss resulting from inadequate or failed internal processes, people and systems or from external events.
MARKET RISK The potential loss (value or earnings) due to adverse movements in market rates, including equity prices, interest rates and foreign exchange rates.
MONETARY ASSETS AND LIABILITIES Assets and liabilities whose amounts are fi xed in terms of units of currency by contract or otherwise. Examples are cash, short or long-term accounts, notes receivable in cash and notes payable in cash.
NET ASSET VALUE Used in the equity method of accounting. The initial net asset value of the investment is determined by the fair value of the assets and liabilities of the investee. After the initial valuation of assets and liabilities of the investee at fair value, the assets and liabilities of the investee are valued in accordance with the accounting policies of the investor. The profi t and loss account refl ects the investor’s share in the results of operations of the investee.
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 verifi ed 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.
SWAP CONTRACTS Commitments to settle in cash at a specifi ed future date, based on differentials between specifi ed fi nancial indices as applied to -a notional principal amount. Generally, no cash is exchanged at the outset of the contract and no principal payments are made by either party.
TIER-1 CAPITAL Also referred to as the core capital of ING Bank. It comprises paid up share capital, reserves excluding revaluation reserves, fund for general banking risks, retained earnings, minority interests.
TRADING PORTFOLIO Comprises those fi nancial instruments which are held to obtain short-term transaction results, to facilitate transactions on behalf of clients or to hedge other positions in the trading portfolio.
PROJECTED UNIT CREDIT METHOD An actuarial valuation method that considers each period of service as giving rise to an additional unit of benefi t entitlement and measures each unit separately to build up the fi nal obligation.
REDEMPTION VALUE With respect to investments in fi xed-interest securities, the amount payable on the maturity date.
TREASURY BILLS Generally short-term debt certifi cates issued by a central government. Dutch Treasury Certifi cates are regarded as Dutch Treasury bills.
VALUE IN USE The present value of estimated future cash fl ows expected to arise from the continuing use of an asset and from its disposal at the end of its useful life.
WARRANT A fi nancial instrument that gives the holder the right to purchase ordinary shares.
This Annual Report contains the Reports of the Executive Board and Supervisory Board as well as the Annual Accounts and Other information for the fi nancial year 2007 in their original language (English).