The weighted average share price at the date of exercise for options exercised during 2006 is EUR 32.02.
The aggregate intrinsic value of options outstanding and exercisable at 31 December 2006 was EUR 579 million and EUR 264 million, respectively.
The fair value of options granted is recorded as an expense under staff expenses and is allocated over the vesting period of the options. The fair values of the option awards have been determined by using a Monte Carlo simulation. This model takes the risk free interest rate into account (3.55% to 4.04%), as well as the expected life of the options granted (0.5 years to 6.5 years), the exercise price, the current share price (EUR 32.77 – EUR 33.92), the expected volatility of the certifi cates of ING Group shares (23% – 41%) and the expected dividends yield (3.57% to 3.69%).
As of 31 December 2006 there were EUR 88 million (2005: EUR 81 million; 2004: EUR 51 million) of total unrecognised compensation costs related to share awards. These costs are expected to be recognised over a weighted average period of 1.8 years (2005: 1.9 years; 2004: 2.2 years).
Result before taxation 9,940 8,894 7,740 Statutory tax rate 29.6% 31.5% 34.5% Statutory tax amount 2,942 2,802 2,670
Associates exemption –255 –386 –460 Other income not subject to tax –336 –222 –10 Expenses not deductible for tax purposes 121 37 1 Differences caused by different foreign tax rates –78 29 –120 Adjustment to prior periods –41 –77 Change in tax rates –170 –2 Deferred tax benefit from previously unrecognised amounts –30 –413 Current tax benefit from previously unrecognised amounts –278 –418 Write down/reversal of deferred tax assets –6 2
Notes to the consolidated profi t and loss account of ING Group continued 48 EARNINGS PER ORDINARY SHARE
Effect of dilutive securities: Warrants 7.6 Stock option and share plans 14.4 22.0
Per ordinary share (in euros) 1.32 1.18 1.07 Total amount of dividend paid (in millions of euros) 2,865 2,588 2,359
(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 1.32 per share for the year 2006. 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 3 May 2007.
50 PRIMARY REPORTING FORMAT – BUSINESS SEGMENTS ING Group’s business segments relate to the internal segmentation by business lines. These include the business lines: Insurance Europe, Insurance Americas, Insurance Asia/Pacifi c, Wholesale Banking, Retail Banking and ING Direct. Other mainly includes items not directly attributable to the business lines.
The accounting policies of the business segments are the same as those described under Accounting policies for the consolidated balance sheet and profi t and loss account. Transfer prices for inter-segment transactions are set at arm’s length. Corporate expenses are allocated to business lines based on time spent by head offi ce personnel, the relative number of staff, or on the basis of income and/or assets of the segment. With regard to capital gains on the share portfolio, a fi xed return of 3% is allocated to the insurance business lines. The differences between the actual capital gains on the shares portfolio and the allocated return are included in Other.
Insurance Insurance Insurance Wholesale Retail ING Total 2006 Europe Americas Asia/Pacific Banking Banking Direct Other segments Eliminations Total
Insurance Insurance Insurance Wholesale Retail ING Total 2004 Europe Americas Asia/Pacific Banking Banking Direct Other segments Eliminations Total
Divestments –91 –281 71 –7 –308 –308 Special items –11 41 –375 –345 –345
Insurance Insurance Insurance Wholesale Retail ING 2006 Europe Americas Asia/Pacific Banking Banking Direct Other Total
Insurance Insurance Insurance Wholesale Retail ING 2005 Europe Americas Asia/Pacific Banking Banking Direct Other Total
2.1 Consolidated annual accounts 51 SECONDARY REPORTING FORMAT – GEOGRAPHIC SEGMENTS ING Group’s six business lines operate in seven main geographical areas: Netherlands, Belgium, Rest of Europe, North America, Latin America, Asia and Australia. Geographical distribution of income is based on the origin of revenue.
Rest of North Latin 2006 Netherlands Belgium Europe America America Asia Australia Other Eliminations Total
Cost incurred in 2006 to acquire property, equipment, and intangibles 1,506 62 253 228 40 75 46 2,210
Rest of North Latin 2004 Netherlands Belgium Europe America America Asia Australia Other Eliminations Total
Cost incurred in 2004 to acquire property, equipment, and intangibles 1,183 97 175 108 31 34 30 18 1,676
(1) Mainly related to reinsurance premiums ceded between group companies in different geographical areas.
(1) Including commission and other income. (2) Mainly related to reinsurance premiums ceded between group companies in different geographical areas.
Geographical analysis of claims, cost ratio and combined ratio for non-life insurance policies
Provision for Provision for life insurance for life insurance for risk of company risk of policyholders Claims provisions Other Total
53 BORROWED FUNDS AND DEBT SECURITIES Borrowed funds and debts securities of EUR 20,500 million (2005: EUR 7,842 million) includes Proceeds from borrowed funds and debt securities of EUR 304,228 million (2005: EUR 237,340 million) and Repayments of borrowed funds and debts securities of EUR 283,728 million (2005: EUR 229,498 million). Gross proceeds and repayments are high, mainly due to the issue, repayment and renewal of short term certifi cates of deposits and commercial paper.
Interest and dividend received and paid 55 CASH AND CASH EQUIVALENTS
Included in cash and cash equivalents – amounts due to banks –26,498 –25,441 –15,207 – amounts due from banks 6,044 4,120 5,300 –20,454 –21,321 –9,907
Not included in cash and cash equivalents – amounts due to banks –94,341 –96,793 –80,671 – amounts due from banks 33,824 43,346 39,784 –60,517 –53,447 –40,887
Cash and cash equivalents include amounts due to/from banks with a term of less than 3 months from the date on which they were acquired.
The following principles support this objective: 1. Products and portfolios are structured, underwritten, priced, approved and managed appropriately and internal and external rules and guidelines are complied with.
Board risk oversight ING Group has a two-tier Board structure consisting of the Executive Board and the Supervisory Board; both bodies play a crucial role in managing and monitoring the risk management framework.
Risk Management organisation- ‘three lines of defence’ To ensure that the risk framework is effective and clear on responsibilities, ING Group adopted the three lines of defence concept. This concept provides a clear allocation of responsibilities for the ownership and management of risk, to avoid overlaps and/or gaps in risk governance. Business line management and the regional and local managers have primary responsibility for the day to day management of risk and belong to the fi rst line of defence. Risk management, both at corporate and regional/local level, belongs to the second line of defence. All risk managers in the business lines have a functional reporting line to the Corporate Risk Managers. The Internal Audit function provides independent and objective assurance on the effectiveness of the overall system of internal control, including fi nancial, operational, compliance and risk management and forms the third line of defence.
Group risk committees The Group risk committees described below are part of the second line of defence. They act within the overall risk policy and delegated authorities granted by the Executive Board. These committees have an advisory role to the CFO and ensure a close link between the business lines and the Group risk management function through representation of the business heads and the Corporate Risk Managers on each committee.
– ING Group Credit Committee – Policy (GCCP): Advises on policies, methodologies and procedures related to credit, insurance, market and operational risks within ING Group. The GCCP meets on a monthly basis.
– ING Provisioning Committee (IPC): Advises on specifi c and collective loan loss provisions fi gures for ING Group. The IPC meets on a quarterly basis.
– Asset & Liability Committee ING Bank (ALCO Bank): Advises on the overall risk profi le of all ING Bank’s non-trading market risk that occurs in its Wholesale Banking, Retail Banking and ING Direct activities. ALCO Bank defi nes the policy regarding funding, liquidity, interest rate mismatch and solvency of ING Bank. ALCO Bank meets on a monthly basis.
The organisation chart below illustrates the functional reporting lines within the ING Group Risk organisation.
The heads of these departments (Corporate Risk Managers) report to the Deputy CRO and bear direct responsibility for risk (mitigating) decisions. The Corporate Risk Managers and the Deputy CRO advise the CFO and are responsible for the harmonisation and standardisation of risk management practices. The respective risk functions assist in the formulation of risk appetite, policies and limit structures for the management of risk and provide objective challenge, oversight and support of risk management activity across the business.
In addition the Group Risk Function has an independent Model Validation Unit. This department is responsible for the management of model risk, which is the risk created by ING’s dependence on its own risk projections. The foundation of model governance is model validation: the offi cial determination by an independent person that a model is acceptable for a given purpose. The department carries out periodical model validations of all risk models used by ING. The head of this department reports to the Deputy CRO.
Group risk policies The various risk management functions have each designed and issued a framework of risk management policies and procedures providing the lines of business guidance on how to manage risk. Policies and procedures are regularly reviewed and updated via the relevant Group risk committees.
GROUP RISK APPETITE AND STRATEGY ING Group’s risk appetite is determined by the Supervisory Board and the Executive Board who aim for a balance between risk, return and capital. The process is such that at least once annually, the Executive Board formulates the Strategic Plan and reports on the risks associated with the plan to the Supervisory Board for approval. As part of the planning process, strategic limits are explicitly discussed and planned. Since ING Group is committed to Enterprise Wide Risk Management, bank and insurance risks are integrated into one single view to align Group level risk taking with the Group level risk appetite. The strategic risk appetite is captured in different dimensions and is defi ned explicitly through key metrics that represent: – Maximum potential impact on IFRS earnings under ‘normal’ stress scenarios (i.e. 1 in 10). – Maximum potential impact on value (i.e. our economic balance sheet) both under ‘normal’ (i.e. 1 in 10) and ‘extreme’
From these overall risk appetite statements, operational limits cascade down into the organisation, e.g. – Credit risk limits for bank and insurance business – Market Value at Risk limits for insurance business – ALM/Value at Risk limits for bank operations
General 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 Lines of Business 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. Within the Insurance companies, the goal is to maintain a low risk, well diversifi ed credit risk portfolio that meets or exceeds market based benchmark returns.
Measurement Credit risk Credit risk is the risk of loss from default by debtors (including bond issuers) or counterparties. Credit risks arise in ING’s lending, presettlement and investment activities, as well as in its trading activities. Credit risk management is supported by dedicated credit risk information systems and internal rating methodologies for debtors and counterparties.
Country risk Country risk is the risk specifi cally attributable to events in a specifi c country (or group of countries). Country risk is identifi ed in lending (corporate and counterparty), trading and investment activities. All transactions and trading positions generated by ING include country risk. Country risk is further divided into economic and transfer risk. Economic risk is the concentration risk relating to any event in the risk country which may affect transactions and other exposure in that country, regardless of the currency. Transfer risk is the risk incurred through the inability of ING or its counterparties to meet their respective foreign currency obligations due to a specifi c country event.
In countries where ING is active, the relevant country’s risk profi le is regularly evaluated, resulting in a country rating. Country limits are based on this rating and ING’s risk appetite. Exposures derived from lending and investment activities are then measured and reported against these country limits on a daily basis. Country risk limits are assigned for transfer risk generally only in emerging markets.
Collateral policies As with all fi nancial institutions and banks in particular, ING is in the business of taking credit risks. As such, the creditworthiness of our customers, trading partners and investments is continually evaluated for their ability to meet their fi nancial obligations to ING. During the assessment process of creating new loans, trading limits, or investments, as well as reviewing existing loans trading positions and investments, ING determines the amount and type of collateral, if any, that a customer may be required to pledge to ING. Generally, the lower the perceived creditworthiness of a borrower or fi nancial counterparty, the more collateral the customer or counterparty will have to provide. Within counterparty trading activities, ING actively enters into various legal arrangements whereby ING and/or counterparties may have to post collateral to one another to cover market fl uctuations of their relative positions. Laws in various jurisdictions also affect the type and amount of collateral that ING can receive or pledge. Additionally, ING will sometimes enter into credit default swaps, and other similar instruments, in order to reduce the perceived credit risk on a given borrower or portfolio. The type of collateral which is held as security for loans is determined by the structure of the loan. Consequently, since ING’s portfolio is diversifi ed the profi le of collateral it receives is also diversifi ed in nature and does not refl ect any particular collateral type more than others.
Past-due obligations ING continually measures its portfolio in terms of payment arrears. Particularly the retail portfolios are closely monitored on a monthly basis to determine if there are any signifi cant changes in the level of arrears. Generally, an obligation is considered ’past-due’ if a payment of interest or principal is more than one day late. In practice, the fi rst 5–7 days after an obligation becomes past due are considered to constitute operational risk. After this period, letters will be sent to the obligor reminding the obligor of its (past due) payment obligations. If the arrear still exists after 90 days, the obligation is usually transferred to one of the ’problem loan’ units. In order to reduce the number of arrears, ING banking units encourage their obligors to set up automatic debits from their (current) accounts to ensure timely payments.
ING Bank’s credit exposure is mainly related to traditional lending to individuals and businesses followed by investments in bonds and other securitised assets. Loans to individuals are mainly mortgage loans secured by residential property. Loans (including guarantees issued) to businesses are often collateralised, but can be unsecured based on internal analysis of the borrowers’ creditworthiness. Bonds in the investment portfolio are generally unsecured. Securitised assets such as Mortgage Backed Securities (MBS) and Asset Backed Securities (ABS) are secured by the pro rata portion of the underlying pool of assets held by the issuer of the securitised bond. The last major area of credit risk involves pre-settlement credit exposures which arise from trading activities, including derivatives, repurchase transactions and securities lending/borrowing and foreign exchange transactions.
(1) Based on lending (wholesale and retail), fi nancial markets and investment activities.
ING Banking units have continued to implement and improve risk rating models in preparation for new regulatory requirements. This has led to improvements in the average credit quality in all lines of business in 2006. Within Retail Banking, there was a small shift downward from BBB to BB related to the introduction of improved rating models in the Benelux. Hence the movement mainly represents a reclassifi cation between risk rating classes and not a deterioration of the underlying credit risk profi le.
Implementation IAS 32/39 –592 Changes in the composition of the group –78 –23 –101 –4 Write-offs –404 –236 –51 –691 –842
ING Bank’s risk costs continued to be low in 2006, as a result of the low infl ow of new problem loans and continued improvement of the average risk profi le of our credit portfolio refl ecting both the strength of the economy in our core markets in wholesale and the low risk growth strategy in Retail Banking and ING Direct.
The large decrease in German exposure within Wholesale Banking is the result of the divestiture of DHB, which was somewhat offset by organic growth at DiBa within ING Direct. With the exception of minor decreases in Canada and the UK, all of the major countries experienced growth in 2006.
The methodology of calculating risk capital is linked to the risk defi nitions with respect to determining where the country risk occurs. Emerging market countries with low and medium risk that have not defaulted require no mandatory provisions for transfer risk. Instead of provisions, additional capital is allocated to transactions that incur country risk. The amount of additional capital allocated is a function of the risk of the country as well as the risk of the transaction itself. This is called Transfer Risk Capital which is an estimate of the maximum transfer loss (above the level of Expected Transfer Loss) within a certain time period on a portfolio of assets given a certain confi dence level.
Overall credit risk limits are established by ALCO Insurance based on risk classes and the perceived creditworthiness of the underlying obligor. Issuer limits are determined based on the obligor’s rating. These limits are managed in the region where the parent company is domiciled. In addition each Insurance company has one or more investment mandates that specify credit risk appetite by issuer, type and quality.
(1) The 2005 fi gures exclude the residential mortgage portfolios in the Americas and Asia/Pacifi c.
(1) The 2005 fi gures exclude the residential mortgage portfolios in the Americas and Asia/Pacifi c. These are included under Private Individuals.
Insurance Americas Insurance Europe Insurance Asia/Pacific Total ING Insurance amounts in billions of euros 2006 2005 2006 2005 2006 2005 2006 2005
The country concentrations in the Insurance portfolio did not change signifi cantly in 2006. The growth in most countries is related to the growth of the underlying insurance companies investment portfolios in the respective markets. Italian, German, French and British portfolios are principally related to government bonds held by insurance companies in the Netherlands and Belgium.
MARKET RISK IN TRADING PORTFOLIOS Organisation Corporate Market Risk Management (CMRM) Trading focuses on the management of trading market risks in the Wholesale Banking business. Specifi cally, CMRM Trading is responsible for the development and implementation of trading risk policies and risk measurement methodologies, reporting and monitoring of risk exposures against approved trading limits and validation of pricing models. CMRM also reviews trading mandates and limits, and performs the gatekeeper role in the product review process. Management of trading market risk is performed at various organisational levels, from CMRM Trading overall down to specifi c business areas and trading offi ces.
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 at least 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 interval 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. The VaR also serves as a basis for the calculation of the regulatory capital and economic capital that ING needs to hold to cover possible losses from trading activities.
Apr 05 Jul 05 Oct 05 Jan 06 Apr 06 Jul 06 Jan 07Oct 06
Development of trading market risks The following chart shows the development of the overnight VaR for the ING Wholesale Banking trading portfolio which was managed by CMRM Trading during 2005 and 2006. 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 2005 and 2006 the overnight VaR for the ING Wholesale Banking trading portfolio was continuously within the range of EUR 21– 37 million.
More details on the VaR of the ING Wholesale Banking trading portfolio for 2006 and 2005 are provided in the table below.
Within ING Bank, the Bank’s own funds and the investments of these own funds are isolated under the ING Bank Corporate line. ALCO Bank determines the target maturity profi le over which ING Bank’s own funds must be invested. This maturity profi le refl ects the long term nature of the rate of return required by its investors and aims for both earnings maximisation and stabilisation. ALCO Bank considers a well balanced portfolio of long-dated fi xed investments as the risk neutral position. The risk data presented in the following market risk tables provide a regulatory view on equity. They directly refl ect the risk of the investments under the assumption that ING Bank’s own funds are not sensitive to market rate changes.
The outright interest rate risk that arises due to the repricing mismatch of the bank’s originated assets and liabilities is transferred from the commercial banking books to the ALM books. These ALM books are managed within ING Wholesale Banking and contain the strategic interest rate risk position of the bank. The main objective is to maximise the economic value of the book and to generate adequate and stable yearly earnings by hedging the risk that arises from the bank’s commercial banking activities and taking the strategic interest rate position it desires within the risk appetite of the bank.
After transferring the outright interest rate risk position to the ALM books, the residual interest rate risk that remains in the commercial banking books is caused by basis risk and optionality. The commercial business units bear responsibility for the residual interest rate risks that result from banking products of which future cash fl ows depend on client behaviour (e.g. optionality in mortgages) and from banking products of which the client rate earned and paid imperfectly correlate with the changing market rates (basis risk). Examples of products in which these risks are inherent are demand deposits, saving accounts and mortgages. Within ING Direct the interest rate risk from the ALM books and the commercial banking books are managed and measured on an integrated level.
In the following tables, the risk fi gures for interest rate risk in the banking books are presented. ING Bank uses several measures to control interest rate risk both from an earnings and a value perspective. The most important of these measures are Earnings-at-Risk (EaR) and NPV-at-Risk.
By Business Line ING Wholesale Banking –19 ING Retail Banking –107 ING Direct –260 ING Bank Corporate Line 22 ING Bank Total –364
As compared to the EaR calculations presented in the 2005 Annual Accounts, the size of the applied shock to the interest rates has been reduced from 2% to 1%. This has been done as the 1% scenario is more likely to occur in the current low interest rate environment than the 2% scenario. Applying the 2% instantaneous upward parallel shock to the year end 2006 fi gures results in an EaR fi gure of EUR –640 million, compared to EUR –733 million presented in 2005. The reduction of the EaR fi gure in 2006 is mainly due to the fact that the EaR calculations have been changed this year in order to better align with the profi t and loss account recognition under IFRS. This year’s EaR calculations furthermore capture the convexity resulting from the embedded prepayment and offered rate options of the large Dutch mortgage portfolios.
In line with the EaR calculations the interest rate scenario has also been changed for the NPV-at-Risk calculations. For comparison purposes the 2006 NPV-at-Risk numbers have also been calculated for the 2% shock scenario. The NPV-at-Risk under this scenario is EUR –4,261 million. Compared to the year end 2005 NPV-at-Risk of EUR –3,203 million, the NPV-at-Risk shows a large increase this year. The increase in the NPV-at-Risk numbers is mainly caused by ING Direct USA who has an increasingly convex interest rate risk position. In addition diversifi cation effects between ING Direct Canada and other portfolios decreased, further increasing ING Direct’s NPV-at-Risk. In practice the portfolio will be rebalanced in case of an upward interest rate move, signifi cantly mitigating NPV losses.
FX 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-euro 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.
Realised Results Every unit hedges realised results to the base currency of the unit. On a monthly basis the central Capital Management department hedges the non-euro results to euro. ING does not hedge the future euro value of projected results in non-euro currencies.
FX Translation Result ING’s strategy is to protect the Tier 1 ratio against unfavourable currency fl uctuations. The protection is largely achieved by the issuance of US dollar and Pound sterling denominated capital, and furthermore by taking structural foreign currency positions. In general, open positions are deliberately taken in order to achieve protection of the Tier 1 ratio by aligning non-euro denominated capital with risk weighted assets in these currencies. The US dollar, Pound sterling, Polish zloty, Australian dollar and Canadian dollar are the main currencies in this respect. For other currencies the objective is to fully hedge the translation risk.
The amount of US dollar denominated risk-weighted assets increased substantially in 2006. In order to maintain the protection of the Tier 1 ratio, the net US dollar position increased accordingly.
Pound sterling denominated Tier-1 paper was issued in 2006 in order to better protect the Tier 1 ratio against movements in the GBP/EUR exchange rate.
EQUITY PRICE RISK IN THE BANKING BOOKS Equity price risk arises from the possibility that equity security prices will fl uctuate, affecting the value of equity securities and other instruments of which the price reacts similarly to a particular security, a defi ned basket of securities, or a securities index. ING Bank maintains a substantial equity exposure in its banking books. This equity exposure mainly consists of the investments in associates of EUR 1,223 million (2005: EUR 1,188 million) and equity securities held in the Available-for-sale portfolio of EUR 1,898 million (2005: EUR 2,147 million). The value of equity securities held in the Available-for-sale portfolio is directly linked to equity security prices. Investments in associates are measured in accordance with the equity method of accounting and the balance sheet value is therefore not directly linked to equity security prices.
The second component is to maintain an adequate mix of funding sources. ING Bank aims for a well diversifi ed funding mix in terms of instrument types, fund providers, geographic markets and currencies. Sources of liquidity are widely distributed over the entire ING Bank. ING has a broad base of core retail funding, which mainly consists of current accounts, savings and retail deposits. Although these accounts can be withdrawn immediately or at short notice, the accounts are considered to form a stable resource of funding because of the broad customer base. The retail funding is, from a geographical point of view, widely spread, with most of the funding located in the euro zone.
The fourth component of ING’s liquidity strategy is to have adequate and up-to-date contingency funding plans in place throughout the organisation. The contingency funding plans are established for addressing temporary and long term liquidity disruptions caused by a general event in the market or an ING specifi c event. These plans ensure that all roles and responsibilities are clearly defi ned and all necessary management information is in place. The main objective of ING’s contingency funding plan is to enable senior management to act effectively and effi ciently at times of crisis.
ING regularly monitors the solvency level for the total insurance business at a prudent level. ING Corporate Insurance Risk Management instructs and supervises all ING entities to make sure that ING Insurance total insurance liabilities (both reserves and capital) are tested for adequacy including the insurance premium rate levels and the uncertainty of future returns on investments. This includes valuing the insurance liabilities on current best estimate actuarial assumptions plus a risk margin. Thus, the reserves are reviewed to ensure they remain adequate based on current assumptions. ING believes its solvency level is adequate.
Where DAC amortisation is based on expected gross profi ts, the sensitivity analyses below include the impact on amortisation of DAC as a result of changes in expected gross profi ts.
Reserve adequacy – Taiwan The adequacy of the provision for life policy liabilities (net of DAC and VOBA) is evaluated regularly. ING’s policy for reserve adequacy testing is disclosed under ’Principles of valuation and determination of results’.
As at 31 December 2006, the inadequacy for Taiwan is EUR 2.4 billion based on a 90% confi dence interval, on a Taiwan reserve level (net of DAC and VOBA) of EUR 10 billion. The inadequacy results from a material exposure in Taiwan to a sustained low interest rate environment. This is due to long term interest rate guarantees of 6–8% embedded in the life and health contracts sold by the business until 2001. These long term guarantees and the future premiums (which have a present value of approximately EUR 19 billion (2005: EUR 20 billion) create a liability for the portfolio with an effective duration of approximately 30, compared to an asset duration of approximately 10. ING stopped selling these high guarantees in its Taiwan life insurance products since 2002. The post 2001 business is adequate at a 90% confi dence level, which partially ompensates inadequacy related to the business sold until 2001. Furthermore, ING has over time strengthened reserves by EUR 682 million (2005: EUR 420 million) for this exposure and increased the internal capital allocation for this business.
Management’s best estimate, based on a 50% confi dence level, is that Taiwan has a marginal adequacy of EUR 298 million (2005: EUR 165 million) which represents a 57% (2005: 53%) confi dence level as at 31 December 2006. Under the Group’s accounting policy, any inadequacy below the 50% level would be charged to the profi t and loss account immediately.
The sensitivity to interest rates changes is explained below under ING Insurance – Interest rate sensitivity. If the interest rates as at 31 December 2006 would have been 1% lower, Taiwan would have been inadequate at the 50% confi dence level and, consequently, an amount of approximately EUR 1.5 billion after tax (2005: EUR 1.7 billion) would have been included as a charge in the profi t and loss account, refl ecting the amount necessary to bring reserves to a best estimate level. If the interest rates at both 31 December 2006 and 31 December 2005 would have been 1% higher, Taiwan would be suffi ciently adequate at the 50% confi dence level, but would still have been inadequate at the 90% confi dence level. Consequently, the charge currently included in the profi t and loss would likely have been reduced. The Taiwan regulator currently allows mortality profi ts to be offset against losses from negative interest rate experience, thus eliminating the need to pay mortality dividends, and this practice is refl ected in the reserve adequacy test.
Measurement Profi t and losses stemming from adverse claims in ING’s insurance portfolios are managed by setting insurance risk tolerance levels which are reviewed annually by the Executive Board. ING Group has established actuarial and underwriting risk tolerance levels in specifi c areas of its insurance operations.
Overall exposures and concentrations are actively managed through the purchase of external reinsurance from approved high creditworthy reinsurers within the credit risk policy of ING. In case of the existence of exposures higher than the risk tolerance levels as defi ned above, appropriate procedures are in place, including third party reinsurance covers. Particularly for the property and casualty portfolio, ING purchases protection through which the exposure due to natural catastrophes is substantially mitigated. ING believes that the credit risks to which it is exposed under reinsurance contracts are minor.
Through scenario analyses, ING Insurance measured the potential changes in the realised after tax earnings of the insurance operations from an increase/decrease of the insurance risk factors over the year 2006. These changes to net profi t can relate to realised claims or any other net profi t item that would be affected by the change of these factors. In addition, ING has estimated the impact on the 31 December 2006 shareholders’ equity of ING Insurance from the same change in insurance risk factors. The differentiation of sensitivities before and after risk mitigation typically refers to mitigation of the risks by reinsurance. ING assumes that not all these shifts presented below will happen everywhere at the same time.
Effect on ING Insurance Effect on ING Insurance Shareholders’ Shareholders’ Net profit equity Net profit equity Before After Before After Before After Before After risk risk risk risk risk risk risk risk mitigation mitigation mitigation mitigation mitigation mitigation mitigation mitigation 2006 2005
The sensitivities represent a one-time increase/decrease of the realised claims of P&C and morbidity and an increase/decrease of the mortality rates over 2006.
General Market risks arise when the market value of assets and liabilities do not move consistently as fi nancial markets change. Changes in interest rates, equity prices, foreign exchange rates and real estate prices can impact present and future earnings of the insurance operations as well as the shareholders’ equity.
ING implemented Market Value at Risk (MVaR) limits to manage the market and credit risks resulting from the Insurance operations world-wide. ALCO Insurance has set an MVaR limit for ING Group Insurance and each of the business lines that relates to the market value based economic capital of ING Group Insurance. The MVaR is based on a 99.95% confi dence level over a one-year horizon.
These limits are further allocated to the ING Insurance business units through MVaR sublimits by the business lines. These limits are managed by an ALCO Insurance structure on the respective organisational levels. Limit breaches by business lines are reported to ALCO ING Group Insurance and resolved in accordance with policy within the next quarter.
Measurement At an ING Group level, CIRM is responsible for implementing and monitoring asset and liability management (ALM) practices and for consistency of the MVaR calculation methods world-wide.
The net profi t impact related to a 1% change in current interest rates is asymmetric due to the need to increase reserves for ING’s business in Taiwan if interest rates were 1% lower. The IFRS profi t impact on Taiwan of 1% lower interest rates at 31 December 2006 is EUR 1.5 billion (2005: EUR 1.7 billion). This is the amount necessary to bring reserves to a best estimate (50%) level in this sensitivity. There is not a corresponding benefi t for rising interest rates in 2006 since the additional benefi t from a rising interest scenario is not recognised in profi t through unlocking of reserves.
ALM risk – equity risk ING’s insurance operations are exposed to changes of prices in equity markets on two levels: (1) business units that have direct equity holdings in their general accounts; and (2) products where the revenues of the insurance operations are linked to the value of underlying equity funds, since this has an impact on the level of charges deducted for unit-linked and variable business.
Through scenario analyses ING Insurance measured the potential changes in earnings of the insurance operations resulting from an instantaneous increase/decrease in equity markets of 10%. These changes to net profi t can relate to fee income, unrealised or realised gains and losses, amortisation of DAC or any other net profi t item that would be affected by a substantial change to equity markets. The effect of equity market changes is different by business line and by product. In addition, ING has estimated the impact on the 31 December 2006 shareholders’ equity of ING Insurance from such a change in equity markets.
The sensitivities represent an instantaneous increase/decrease in equity markets as of 31 December 2006. The net profi t sensitivity refl ects the related effect on net profi t after tax for the year if equity markets remain 10% higher (or lower) for at least 12 months. Sensitivity disclosures include the effect of embedded derivatives contained in insurance contracts. The largest exposures to equity movements are in the ING business units in The Netherlands, United States, Canada and Belgium.
ALM risk – foreign exchange risk Foreign exchange risk in the investments backing ING’s insurance and investment contract liabilities is dealt with in the investment management processes in each business unit. An immaterial portion of the investment portfolio backing insurance liabilities is invested in assets of a different currency from that of the liabilities.
Effect on ING Insurance Effect on ING Insurance Net Shareholders’ Net Shareholders’ profit equity profit equity 10% Increase of euro versus all other currencies –26 –1,014 –81 –950 10% Decrease of euro versus all other currencies 29 1,031 87 1,041
The sensitivities represent an instantaneous increase/decrease in the euro on 31 December 2006. The net profi t sensitivity refl ects the related effect on net profi t after tax for the year 2006 if the foreign exchange rate of euro against the other currencies remain 10% higher (or lower) for at least 12 months. Sensitivity disclosures include the effect of embedded derivatives contained in insurance contracts.
Through scenario analyses, ING Insurance measured the potential changes in the earnings of the insurance operations resulting from an instantaneous increase/decrease in real estate markets of 10%. In addition, ING has estimated the impact on the 31 December 2006 shareholders’ equity of ING Insurance from such a change in real estate markets.
Increase of real estate of 10% 480 490 509 525 Decrease of real estate of 10% –480 –490 –513 –525
Liquidity risk decreases as the time frame allowed for generating cash increases. Longer time frames increase the probability of fi nding a buyer for some of the company’s non-maturing or less liquid assets or securing external fi nancing. Expected liquidity demands within ING Insurance are managed through a combination of treasury, investment and asset-liability management guidelines, which are monitored on an ongoing basis. Unexpected liquidity demands are managed through a combination of product design, diversifi cation limits on liabilities, investment strategy, systematic monitoring and advance contingency planning. CIRM has issued formal guidelines requiring all insurance businesses to regularly assess, monitor and report on their liquidity risk profi le. The guidelines require an analysis of liabilities that increase liquidity risk, a review of the investment portfolio to ensure adequate liquidity, and analysis of the expected asset and liability cash fl ows in regards to the ability of the business to meet cash demands.
General The aim of the Group and local Operational Information and Security Risk Management departments is to support general management of the business lines (fi rst line of defence) which is responsible for managing operational information and security risk (hereafter referred to as operational risk). This is done by raising operational risk awareness and insight, increasing operational risk and loss transparency, improving early warning information and allocating risk ownership and responsibilities. This contributes to more stable business processes and lower operational risk costs. Furthermore, implementing an operational risk management function has led to more effective risk management and has prepared ING for the Basel II regulations, applicable from 31 December 2007, as well as for the future requirements of Solvency II.
ING is promoting effective management of operational risk (ORM) by requiring business units to demonstrate that the appropriate steps have been taken to control operational risk. ING applies scorecards for this purpose. The purpose of the semi-annual scorecards is to measure the quality of ORM processes within a business. Scoring is based on the ability to demonstrate that the required risk management processes (risk governance, identifi cation, measurement, monitoring and mitigation) 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 ORM and the control measures taken.
Basel II ING Bank is preparing for the Basel II implementation through its Basel II group program (including the Basel II project for operational risk). ING Bank is preparing to qualify for the Advanced Measurement Approach (most advanced method) for calculating operational risk capital on a consolidated level and is well positioned to meet the operational risk requirements of Basel II on time.
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, the United States 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, which is ongoing, ING Bank N.V. has been reporting to DNB and it is not possible to predict at this time the outcome thereof. ING Bank N.V. is committed to proactively addressing any issues raised by the review.
A priority for ING during 2006 has been to increase compliance awareness Group-wide and to implement the ING Group Compliance Policy. The implementation of the ING Group Compliance Policy has been a key performance target for all senior managers. Senior management received updates on compliance-related issues and on the progress made in implementing the policy. Further embedding in procedures and processes Group-wide has high priority to be completed in 2007.
In 2006, in the context of changing legislation, regulation and regulatory scrutiny ING revised, amongst other policies, its Financial Economic Crime Policy to comply with the third EU Anti-Money Laundering directive and other applicable laws and regulations. As a result of the revision of the Financial Economic Crime Policy, a review of all customer fi les, to assist ING to prevent its businesses and systems from being used to launder money or fi nance terrorist activities, is in progress. An additional benefi t of reviewing customer fi les is that increased knowledge of its customers enables ING to provide services that are better tailored to customer needs.
Expenses in the Wholesale Banking segment were adversely impacted in 2006 by compliance-related costs of EUR 79 million. These expenses are related to investments in and improvements to compliance and customer identifi cation process and systems, including the ongoing review ING has undertaken following the discussions with DNB concerning transactions involving countries subject to sanctions.
Cor A.J. Herkströter, Chairman Eric Bourdais de Charbonnière, Vice-Chairman Luella Gross Goldberg Paul F. van der Heijden Claus Dieter Hoffmann Jan H.M. Hommen Piet C. Klaver Wim Kok Godfried J.A. van der Lugt Karel Vuursteen
2.2 Parent company annual accounts amounts in millions of euros 2006 2005
Result of group companies after taxation 7,704 7,194 Other results after taxation –12 16 Net profit 7,692 7,210
Parent company profi t and loss account of ING Group for the years ended 31 December
Dividend –147 –2,534 –2,681 Purchases/sales of treasury shares –520 –520 Exercise of warrants and options 5 5
(1) Other reserves includes Retained earnings, Treasury shares and Other reserves.
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 2006 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.
Accounting policies for the parent company balance sheet and profi t and loss account of ING Group
Name of investee ING Bank N.V. 20,868 20,490 ING Verzekeringen N.V. 21,902 20,607 Other –163 391
Other includes certain intercompany elimations between ING Bank N.V. and ING Verzekeringen N.V.
Opening balance 41,488 28,062 Change in accounting policies 4,510 Repayments to/from group companies 24 Disposals of group companies –587 Revaluations –2,994 4,205 Result of the group companies 7,704 7,194 Dividend –3,450 –2,296
Share capital 530 530 Share premium 8,348 8,343 Share of associates reserve 11,528 14,143 Currency translation reserve –950 –692 Other reserves 18,810 14,412
Notes to the parent company balance sheet of ING Group amounts in millions of euros, unless stated otherwise
Issued share capital as at 31 December 2004 2,204,720 530 Issue of shares 214 Issued share capital as at 31 December 2005 2,204,934 530
As at 31 December 2006, Share of associates reserve included an amount of EUR 566 million (2005: EUR 583 million) related to the former Stichting Regio Bank that cannot be freely distributed. The decrease refl ects the loss for the year.
The total amount of non-distributable reserves is EUR 12,478 million (2005: EUR 14,835 million).
Opening balance 868 563 38,722,934 29,787,165 Purchased 1,030 381 30,858,427 13,013,029 Share based payments 462 76 15,722,126 3,203,303 Other 873,957 4 PREFERENCE SHARES See Note 13 Preference shares to the consolidated fi nancial statements.
Notional amount in original Interest rate Year of issue Due date currency Balance sheet value
Debenture loans 5,230 3,740 Amounts owed to group companies 35 991 Other amounts owed and accrued liabilities 493 409
The number of debentures held by group companies as at 31 December 2006 was 29,288 with a balance sheet value of EUR 29 million (2005: 2,519 with a balance sheet value of EUR 3 million).
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 74 up to and including page 86). This information is considered to be an integral part of the audited annual accounts.
We have audited the annual accounts 2006 of ING Groep N.V., Amsterdam (as set out on pages 88 to 217). The annual accounts consist of the consolidated annual accounts and the parent company annual accounts. The consolidated annual accounts comprise the consolidated balance sheet as at 31 December 2006, the profi t and loss account, statement of changes in equity and statement of cash fl ows for the year then ended, and a summary of signifi cant accounting policies and other explanatory notes. The parent company annual accounts comprise the parent company balance sheet as at 31 December 2006, the parent company profi t and loss account for the year then ended and the notes.
Management’s responsibility Management of the company is responsible for the preparation and fair presentation of the annual accounts 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, and for the preparation of the report of the Executive Board in accordance with Part 9 of Book 2 of the Dutch Civil Code. This responsibility includes: designing, implementing and maintaining internal control relevant to the preparation and fair presentation of the annual accounts that are free from material misstatement, whether due to fraud or error; selecting and applying appropriate accounting policies; and making accounting estimates that are reasonable in the circumstances.
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 2006, 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.
The profi t is appropriated pursuant to Article 38 of the Articles of Association of ING Groep N.V., the relevant stipulations of which state that the part of the profi t remaining after the Executive Board, with the approval of the Supervisory Board, has determined the appropriation to reserves, shall be at the disposal of the General Meeting of Shareholders.
It is proposed to declare a dividend of EUR 1.32 per ordinary share of EUR 0.24.
On 17 August 2006, an interim dividend of EUR 0.59 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 0.73 per ordinary share. The fi nal dividend will be paid entirely in cash and will be made payable on 3 May 2007.
Shareholders’ equity and net profi t on the basis of US GAAP amounts in millions of euros, except for amounts per share
The following statement provides a reconciliation of the shareholders’ equity and net profi t on the basis of IFRS-EU to US GAAP
Tax effect of the adjustments 434 493 –464 188 204 Minority interests in adjustments (after tax) 233 122 –13 99 26 Total adjustments after tax 4,184 4,883 –865 –234 933
Foreign currency translation Under IFRS-EU, foreign currency translation results on translating the amortised cost of available-for-sale debt securities is included in the profi t and loss account. The difference between fair value and amortised cost as translated into the functional currency is included in the revaluation reserve in equity. Under US GAAP all foreign currency translation results on available-for-sale debt securities are recognised in shareholders’ equity as part of the fair value adjustment (revaluation reserve).
Realised gains/losses on disposal of investments in fi xed-interest securities Under IFRS-EU excluding IAS 39 (2004), the result on disposal of investments in fi xed-interest securities, i.e. the difference between the proceeds from sale and the book value, is treated as a yield difference. These yield differences are taken to the profi t and loss account over the remaining term of the investment portfolio. Under US GAAP, the result on disposal is immediately recognised in the profi t and loss account.
Derivatives and hedge accounting (2004) Under IFRS-EU excluding IAS 39 (2004), derivative fi nancial instruments, primarily interest rate swap contracts, used to manage interest rate risk are accounted for as off-balance sheet transactions. The related interest income and expense is accounted for on a basis in conformity with the hedged position, primarily on an accrual basis. Transactions qualify as hedges if these transactions are identifi ed as such and there is a negative correlation between the hedging results and the results of the position being hedged. Under US GAAP, derivatives are carried at fair value with changes in fair value recorded in income unless specifi ed criteria are met to obtain hedge accounting treatment. Under US GAAP, the Group has opted to not applying hedge accounting subject to items specifi cally designated as a hedge under US GAAP (including certain hedges of net investments in foreign operations). Accordingly, under US GAAP all derivatives other than those designated as hedges are marked-to-market through the income statement and no adjustments to hedged items are recognised.
Fair value option Under IFRS-EU, certain fi nancial instruments are designated as ‘at fair value through profi t and loss’. For US GAAP, these fi nancial instruments are reported as either available-for-sale instruments with movements in fair value recognised in shareholders’ equity or as loans and receivables which are carried at amortised cost.
Provision for insurance liabilities Under IFRS-EU the provision for life policy liabilities is calculated on the basis of a prudent prospective actuarial method, having regard to the conditions of current insurance contracts. Under IFRS-EU specifi c methodologies may differ between business units as they may refl ect local regulatory requirements and local practices. The differences between IFRS-EU and US GAAP relate mainly to reserve adequacy and the treatment of initial expenses and the assumptions which are made in calculating the provisions with regard to the yield on the investments.
Reserve adequacy Adequacy testing of the provisions for life policy liabilities, net of unamortised policy acquisition costs and value of business acquired, is performed similarly under both IFRS-EU and US GAAP. A reserve inadequacy (under US GAAP: a ‘premium defi ciency’) exists if the life policy liabilities plus the present value of expected future gross premiums are insuffi cient to provide for expected future policy benefi ts and expenses and to recover any unamortised policy acquisition costs and value of business acquired. Reserve strengthening is recognised as an additional provision for insurance liabilities under IFRS-EU. Premium defi ciencies are recognised under US GAAP as a reduction of the unamortised value of business acquired or deferred acquisition costs, as applicable, and then as an increase in the provision for life policy liabilities. Based on the differences in the life policy liabilities under IFRS-EU and US GAAP and the different confi dence levels used in testing reserve adequacy, a premium defi ciency may be recognised differently under US GAAP.
Furthermore, a shadow premium defi ciency may arise under US GAAP when unrealised investment gains related to available-for-sale securities are included in the US GAAP adequacy testing as if the gains had been realised. This approach results in an adjustment to equity for any shadow premium defi ciency calculated and an adjustment to the current year’s value of business acquired, deferred acquisition costs, or provision for life policy liabilities as above. This adjustment is recorded under US GAAP but is not recorded for IFRS-EU purposes.
Treatment of initial expenses and assumptions with regard to yield on investments Several differences exist between IFRS-EU and US GAAP in the treatment of initial expenses and the assumptions which are made in calculating the provisions with regard to the yield on investments. The most signifi cant are as follows: – some business units use a statutory interest rate in calculating the insurance provision under IFRS-EU, whereas under US GAAP
Equity instruments Under IFRS-EU, instruments with the legal form of equity but with fi xed or determinable repayments or dividends are classifi ed as ‘liabilities’. Under US GAAP, these instruments are classifi ed as ‘equity’.
Provision for restructuring Under IFRS-EU, certain restructuring costs relating to employee terminations are recognised when a restructuring plan has been announced. Under US GAAP, liabilities related to termination benefi ts are recognised when incurred. Employee termination costs are generally considered to be incurred when certain criteria have been met and the plan has been communicated to employees (communication date). Liabilities are recognised on the communication date unless further service (beyond a minimum retention period) is required from the employee in which case costs are recognised as benefi ts are earned.
Associates and other equity investments Differences arise between US GAAP and IFRS-EU for associates for which equity accounting is applied due to underlying differences between IFRS-EU and US GAAP in the associates’ equity and profi t and loss. These mainly relate to underlying differences in the accounting treatment for real estate.
Associates and other equity investments (2004) Differences arise between US GAAP and IFRS-EU for associates for which equity accounting is applied due to underlying differences between IFRS-EU and US GAAP in the associates’ equity and profi t and loss. These mainly relate to underlying differences in the accounting treatment for real estate.
The criteria for the recognition of gains and losses on the sale of certain equity investments are more stringent under US GAAP. As a result, profi t on sale is not always recognised in the same accounting period.
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. Economic capital is defi ned as the amount of capital required to bear the economic risks created by the activities employed and at the company’s desired level of comfort. The Economic capital is based on detailed calculations for credit, transfer, market, operational and business risk and includes a diversifi cation benefi t within the bank. ING uses a one-sided confi dence interval of 99.95% – consistent with our target debt rating (AA/Aa2 long term) – and a one year time horizon. ING Group continues to develop and refi ne the models supporting the RAROC calculations that may result in changes and restatements.
Total banking operations including divestments and special items 25.5% 27.7% 16.0 15.0
In the Annual Report 2005 RAROC and Economic Capital were reported including divestments and special items. In this Annual Report RAROC and Economic Capital are reported on an underlying basis, so excluding divestments and special items. The underlying after-tax RAROC of ING’s Total banking operations increased to 20.4% from 19.1% in 2005. The overall RAROC target that has been set by the Executive Board is 12% after-tax. The underlying after-tax RAROC performance of Wholesale Banking markedly improved from 17.3% in 2005 to 20.6%. Especially Real Estate boosted its underlying after-tax RAROC to 40.1% from 16.3% last year. Retail Banking saw a small decline in underlying after-tax RAROC to 32.5% (2005: 34.1%). At ING Direct the expansion of activities and therefore growth of Economic Capital resulted in an underlying after-tax RAROC of 11.6%, compared to 14.9% in 2005.
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 2006 sales. Future profi ts are estimated using actuarial methods and ING’s best estimates for future assumptions except for economic assumptions, which have been more aligned with market rates in 2006.
At the end of 2006, the total embedded value of ING’s life insurance operations was EUR 27,718 million compared to EUR 27,586 million at year-end 2005. This is after EUR 1,995 million in capital injections/cash dividends to the Group. Before capital injections/cash dividends, the increase in embedded value was EUR 2,128 million. Both the 2005 and 2006 fi gures are before deduction for the life insurance pension defi cit. In 2006, this defi cit was EUR 513 million, which was decreased from EUR 1,273 million of 2005.
The embedded value result refl ects increases due to an increase in the value of new business, favourable fi nancial variances and interest on free surplus. Changes in economic assumptions, particularly in Asia/Pacifi c, and currency effects adversely impacted embedded value. Cash dividend payment from the life operations also reduce the embedded value result.
Value Value Premiums of new VNB/PV Premiums of new VNB/PV Annual single IRR (1) business premiums (2) Annual single IRR (1) business premiums (2)
Free surplus 3,781 2,274 Required capital 13,873 13,691 Adjusted net worth 17,654 15,964
Present value of future (statutory) book profits 15,382 16,431 Cost of holding required capital –5,318 –4,810 Value of in force covered business 10,064 11,622
Belgium/Luxembourg 1,111 1,077 Central Europe & Spain 2,961 2,552 Insurance Europe 16,103 14,929
Major drivers of change in EV 2006 are: – Unfavourable currency movements reduced EUR 1,164 million to embedded value (compared with a positive impact of EUR 1,575 million in 2005), primarily due to strengthening of the euro against the US dollar and most currencies; – Net impact of economic assumption changes (EUR 1,534 million negative) and corresponding discount rate changes (EUR 338 million negative) was EUR 1,872 million negative, primarily due to a downward adjustment to long term risk-free rates in Taiwan from 5.75% to 3.93%; – Financial variances, especially due to investment performance in Netherlands, Poland and Korea and benefi t from lower credit default in US, increased Embedded Value by EUR 1,240 million; – Operating assumption changes, particularly the adverse effect of increased maintenance expenses in the Netherlands, decreased EV by EUR 33 million; – Value of new business of EUR 807 million, a small improvement compared to 2005; The growth markets of Asia/Pacifi c and Central Europe in particular showed signifi cant increases of 16.7%. Which were offset by decreases in the more developed markets of the US life insurance, the Netherlands and Belgium as well as Mexico; – Required return on beginning in-force (unwind of discount rate) of EUR 1,716 million; – Other items primarily investment return on free surplus (due to higher equity performance) and net cash dividends/capital injections of EUR 1,995 million explain remaining differences from total EV 2005 (in total EUR 562 million negative).
Sensitivity embedded value to economic assumptions The tables below show the outcomes of sensitivity analysis of the Embedded Value as at 31 December 2006 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 2006. The discount rate is adjusted accordingly; – 10bp lower short term rates for the period 2007–2016: assumes a parallel shift of the yield curve for this period. 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) 16,103 10,272 1,343 27,718 1% decrease in new-money rates –913 –566 –1,764 –3,242 1% increase in new-money rates 551 46 1,565 2,162 1% increase in discount rates –757 –473 –470 –1,700 Implied market forward rates (31 Oct 2006) –211 –7 –243 –461 Lower short-term rates with 10bp –82 –13 –70 –166 1% lower equity and real estate returns –537 –192 –168 –896 10% downward shift in market values of equity and real estate investments –862 –440 –339 –1,640 Local regulatory minimum capital requirement 38 285 2,466 2,789
Net impact of: (1) 1% decrease in new-money and 1% decrease in discount rates –16 –41 –1,228 –1,285 1% increase in new-money and 1% increase in discount rates –206 –427 1,095 463
We make the following observations to above results: – The net impact of 1% decrease in new money rate (1% downward parallel shift) and discount rates is EUR 1,285 million negative, whereas these two effects are somewhat offsetting the 1% increase sensitivity (EUR 463 million). This is due to interest guarantees, which reduce margins when interest rates fall.
– The impact of using local regulatory minimum capital instead of ING capital model is positive EUR 2,789 million and primarily due to Taiwan for which ING allocates capital at a signifi cantly higher level than local regulatory level.
ING Insurance – short term A–1+ P–1 – long term AA– Aa3 AA–
ING Bank – short term A–1+ P–1 F1+ – long term AA AAA AA – financial strength B
ING measures capital adequacy on a consolidated basis at three levels: ING Group, ING Insurance and ING Bank due to the fact that it has three rating targets (all AA/Aa2). Therefore next to regulatory capital requirements, note 34 of the annual accounts, ING also measures and manages additional capital and leverage ratio’s. In the Capital Base, ING reports on its performance regarding capital management targets as approved by the Executive Board.
Adjustments to equity: – revaluation reserves fixed income & other (3) –2,097 –3,365 –1,350 –3,211 –3,352 –6,477 – revaluation reserves excluded from Tier-1 (4) –1,257 –1,128 – insurance hybrid capital (5) 2,250 2,229 – minorities 1,770 1,227 1,367 652 Available regulatory capital 25,505 22,541 25,784 23,408
(1) Tier-1 instruments issued by the Group (e.g. perpetual debt securities and preference shares), at nominal value. Group hybrid Tier-1 instruments other than preference shares are injected as hybrid capital in Insurance or Bank.
consisting of fi nancial participations and own risk remaining after securitisations. (7) Mainly includes EUR 7,701 million (2005: EUR 8,216 million) representing 50% of the present value of future profi ts generated by policies in force (Value in Force), offset by EUR 4,183 million (2005: EUR 3,813 million) which is 50% of the non-Dutch deferred acquisition costs. (8) Target Debt/Equity ratio for ING Insurance is a maximum of 15% and for ING Group is a maximum of 10%.
ASSET AND LIABILITY COMMITTEE (ALCO) Manages the balance sheet of ING, especially with regard to strategic non-trading risk. These risks comprise interest rate exposures, equity risk, real estate risk, liquidity, solvency and foreign exchange risk and fl uctuations.
ASSET BACKED SECURITIES (ABS) A type of bond or note that is based on pools of assets, or collateralised by the cash fl ows from a specifi ed pool of underlying assets.
COMPLIANCE RISK The risk of impairment of ING Group’s integrity, leading to damage to ING’s reputation, legal or regulatory sanctions, or fi nancial loss, as a result of a failure (or perceived failure) to comply with applicable laws, regulations and standards.
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
CONTROL The power to govern the fi nancial and operating policies of an entity so as to obtain benefi ts from its activities
CONVEXITY The non-linear relationship between changes in the interest rates and changes in bond prices and their NPV. It is a very important measure for portfolios containing (embedded) options.
DEFINED BENEFIT PLAN Post-employment benefi t plans other than defi ned contribution plans.
EFFECTIVE INTEREST METHOD A method of calculating amortised cost of a fi nancial asset or liability and of allocating the interest income or interest expense over the relevant period.
FINANCIAL ASSET Any asset that is: – cash – an equity instrument of another company. – a contractual right to: – receive cash or another fi nancial asset from another company; or – exchange fi nancial instruments with another company under conditions that are potentially favourable; or – certain contract that will or may be settled in ING’s own equity instruments.
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.
INTEREST BEARING INSTRUMENT A fi nancial asset or a liability for which a time-proportionate compensation is paid or received, in relation to a notional amount.
IRREVOCABLE FACILITIES Mainly constitute unused portions of irrevocable credit facilities granted to corporate clients and commitments made to purchase securities to be issued by governments and private issuers.
MARKET VALUE AT RISK (MVAR) A calculation method which measures the decrease in the market value surplus caused by movements in fi nancial markets, at a 99.95% confi dence level over a 1 year horizon.
MONTE CARLO SIMULATION A technique which uses random numbers and probability statistics to simulate future market rates (e.g. interest rates).
PLAN ASSETS Comprise assets held by a long-term employee benefi t fund and qualifying insurance policies. Assets held by a long-term employee benefi t fund are assets (other than non-transferable fi nancial instruments issued by the reporting enterprise) that: – are held by an entity (a fund) that is legally separate from the reporting enterprise and exists solely to pay or fund employee benefi ts; and
– are available to be used only to pay or fund employee benefi ts, are not available to the reporting enterprise’s own creditors (even in bankruptcy), and cannot be returned to the reporting enterprise, unless either the remaining assets of the fund are suffi cient to meet all the related employee benefi t obligations of the plan or the reporting enterprise or the assets are returned to the reporting enterprise to reimburse it for employee benefi ts already paid.
A qualifying insurance policy is an insurance policy issued by an insurer that is not a related party of the reporting enterprise, if the proceeds of the policy: – can be used only to pay or fund employee benefi ts under a defi ned benefi t plan; and – are not available to the reporting enterprise’s own creditors
PREFERENCE SHARE Similar to an ordinary share but carries certain preferential rights. These rights usually concern the guarantee of a fi xed (cumulative) return to the shareholder or a guaranteed return on the investment.
RECOGNITION The process of incorporating in the balance sheet or profi t and loss account an item that meets the defi nition of an element and satisfi es the following criteria for recognition: – it is probable that any future economic benefi t associated with the item will fl ow to or from the enterprise; and – the item has a cost or value that can be measured reliably.
TIER-1 RATIO Refl ecting the tier-1 capital of ING Bank as a percentage of its total risk weighted assets. The minimum set by the Dutch central bank is 4%.