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    PZU   PLPZU0000011

POWSZECHNY ZAKLAD UBEZPIECZEN SA

(PZU)
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Powszechny Zaklad Ubezpieczen : Solvency and financial condition report  as at and for the financial year ended 31 December 2019

05/28/2020 | 02:41pm EST

Powszechny Zakład Ubezpieczeń

Spółka Akcyjna Group

Solvency and financial condition report

as at and for the financial year ended 31 December 2019

Powszechny Zakład Ubezpieczeń Spółka Akcyjna Group

Solvency and financial condition report as at and for the financial year ended 31 December 2019

Table of contents

Glossary ...............................................................................................................................................

4

Summary .............................................................................................................................................

7

Basis for preparation..........................................................................................................................................................

7

Operating activity and results of the PZU Group ..............................................................................................................

7

System of governance........................................................................................................................................................

9

Risk profile..........................................................................................................................................................................

9

Valuation for solvency purposes......................................................................................................................................

10

Capital management .......................................................................................................................................................

10

A.

Business and operating results ..............................................................................................

11

A.1.

Business................................................................................................................................................................

11

A.2.

Operating result ...................................................................................................................................................

14

A.3.

Result on investment activity ..............................................................................................................................

17

A.4.

Result on other operating income and expenses................................................................................................

19

A.5.

Additional information.........................................................................................................................................

19

B.

System of governance.............................................................................................................

23

B.1.

General information on the system of governance.............................................................................................

23

B.2.

Fit and proper requirements................................................................................................................................

30

B.3.

Risk management system, including own risk and solvency assessment .........................................................

32

B.4.

Internal control system ........................................................................................................................................

36

B.5.

Internal audit function .........................................................................................................................................

38

B.6.

Actuarial function.................................................................................................................................................

39

B.7.

Outsourcing ..........................................................................................................................................................

39

C.

Risk profile...............................................................................................................................

41

C.1.

Actuarial risk.........................................................................................................................................................

46

C.2.

Market risk ............................................................................................................................................................

52

C.3.

Credit risk/counterparty default risk ...................................................................................................................

53

C.4.

Liquidity risk .........................................................................................................................................................

54

C.5.

Operational risk....................................................................................................................................................

56

C.6.

Other significant risks ..........................................................................................................................................

56

D.

Measurement of assets and liabilities ....................................................................................

61

D.1.

Assets ....................................................................................................................................................................

61

D.2.

Technical provisions ............................................................................................................................................

66

D.3.

Other liabilities .....................................................................................................................................................

72

D.4.

Alternative methods for valuation.......................................................................................................................

77

D.5.

Additional information.........................................................................................................................................

80

E.

Capital management ..............................................................................................................

81

E.1.

Own funds.............................................................................................................................................................

81

2

Powszechny Zakład Ubezpieczeń Spółka Akcyjna Group

Solvency and financial condition report as at and for the financial year ended 31 December 2019

E.2. Solvency capital requirement and minimum capital requirement ....................................................................

86

E.3. Use of the duration-based equity price risk sub-module to calculate the solvency capital requirement ........

87

E.4. Differences between the standard formula and the applied internal model ....................................................

87

E.5.

Inconsistency with the minimum capital requirement and inconsistency with the solvency capital requirement

..............................................................................................................................................................................

87

E.6.

Additional information.........................................................................................................................................

87

Attachments ......................................................................................................................................

89

3

Powszechny Zakład Ubezpieczeń Spółka Akcyjna Group

Solvency and financial condition report as at and for the financial year ended 31 December 2019

Glossary

  1. BFG - Bank Guarantee Fund [Polish: Bankowy Fundusz Gwarancyjny];
  2. Economic balance sheet - balance sheet of the PZU Group prepared in accordance with the measurement principles of the SII System;
  3. DAC - deferred acquisition costs;
  4. SII Directive - Directive 2009/138/EC of the European Parliament and of the Council of 25 November 2009 on the taking-up and pursuit of the business of Insurance and Reinsurance (Solvency II);
  5. EIOPA - European Insurance and Occupational Pensions Authority;
  6. WSE - Warsaw Stock Exchange;
  7. PZU Group - PZU as the parent company together with its subsidiaries, including subsidiary companies within the meaning of the applicable provisions of accounting law;
  8. PZU Group business unit - PZU or subsidiary;
  9. Subsidiary - business unit (also a non-corporate business unit such as a civil-law partnership or a mutual fund) directly or indirectly controlled by PZU; the fact of the exercise of such control results from the grounds laid down in International Financial Reporting Standard 10 "Consolidated Financial Statements";
  10. KNF, regulatory authority - Polish Financial Supervision Authority;
  11. PZU Group Financial Conglomerate - financial conglomerate within the meaning of the Act of 15 April 2005 on Supplementary Oversight over Credit Institutions, Insurance Undertakings, Reinsurance Undertakings and Investment Firms Comprising a Financial Conglomerate (consolidated text: Journal of Laws of 2019, Item 2146, as amended), in which PZU acts as the leading entity;
  12. Commercial Company Code - Commercial Company Code of 15 September 2000 (consolidated text: Journal of Laws of 2019 Item 505, as amended);
  13. MCR - minimum capital requirement in the SII system;
  14. IFRS - International Financial Reporting Standards, as endorsed by the European Commission, published and in force as at 31 December 2019;
  15. NBP - National Bank of Poland;
  16. PZU branches - field outlets of PZU and PZU Życie carrying out insurance activities in the area of direct client service, including product sales;
  17. ORSA (own risk and solvency assessment) - assessment of general needs regarding solvency, consistent compliance with capital requirements and technical provisions requirements and materiality with which the risk profile deviates from the assumptions underlying the solvency capital requirement, carried out on the basis of the "Own risk and solvency assessment policy in the PZU Group, PZU SA and PZU Życie SA", in accordance with the Insurance Activity Act and EIOPA guidelines;
  18. PIU - Polish Insurance Association;
  19. PAS - Polish Accounting Standards, as laid down in the Accounting Act and in the executive regulations thereto, in particular in the Finance Minister's Regulation of 12 April 2016 on the accounting policies of insurance and reinsurance undertakings (Journal of Laws 2016 Item 562) and the Finance Minister's Regulation of 12 December 2001 on the detailed principles of recognition, valuation methods, scope of disclosure and presentation of financial instruments (consolidated text: Journal of Laws of 2017 No. 277, as amended); in matters not regulated in the Accounting Act and in the executive regulations thereto, National Accounting Standards or IFRS are applied accordingly;
  20. PZU - Powszechny Zakład Ubezpieczeń Spółka Akcyjna;
  21. PZU Życie - Powszechny Zakład Ubezpieczeń na Życie Spółka Akcyjna;

4

Powszechny Zakład Ubezpieczeń Spółka Akcyjna Group

Solvency and financial condition report as at and for the financial year ended 31 December 2019

  1. SCR - solvency capital requirement in the SII system, which pursuant to Article 336 of the Delegated Regulation consists of the following positions: a solvency capital requirement calculated on the basis of consolidated data following the rules laid down for the standard formula, the proportional share of the capital requirement (including hypothetical requirements) of undertakings from other financial sectors, the requirement for affiliated entities not consolidated by the full method;
  2. SII System - the entirety of legal requirements as set out in the SII Directive and regulations issued on its basis. The SII Directive has been incorporated in Polish legislation by the Insurance Activity Act;
  3. QRT - quarterly and annual quantitative reporting templates;
  4. Capital Requirements Regulation, CRR - Regulation (EU) No 575/2013 of the European Parliament and of the Council of

26 June 2013 on prudential requirements for credit institutions and investment firms and amending Regulation (EU) No 648/2012;

  1. Delegated Regulation - delegated regulation of 10 October 2014, supplementing Directive 2009/138/EC of the European Parliament and of the Council on the taking-up and pursuit of the business of Insurance and Reinsurance (Solvency II), as amended;
  2. implementing regulation applicable to the SFCR - Commission Implementing Regulation (EU) 2015/2452 of 2 December 2015 laying down implementing technical standards with regard to the procedures, formats and templates of the solvency and financial condition report in accordance with Directive 2009/138/EC of the European Parliament and of the Council;
  3. SFCR - PZU Group's solvency and financial condition report;
  4. consolidated financial statements - consolidated financial statements of the PZU Group prepared in accordance with IFRSs;
  5. PZU Group strategy - PZU Group strategy for 2017-2020- "The New PZU - More Than Insurance";
  6. CJEU - Court of Justice of the European Union;
  7. unit-linked - an investment insurance product with a unit-linked fund, in which the policyholder bears the investment risk;
  8. Act on Statutory Auditors - Act on Statutory Auditors, Audit Firms and Public Supervision of 11 May 2017 (Journal of Laws of 2019 Item 1421, as amended);
  9. Insurance Activity Act - Act of 11 September 2015 on Insurance and Reinsurance Activity (consolidated text: Journal of Laws of 2020, Item 895);
  10. Act on Mutual Funds - Act on Mutual Funds and Management of Alternative Investment Funds of 27 May 2004 (consolidated text: Journal of Laws of 2020, Item 95, as amended);
  11. Act on Trading in Financial Instruments - Act on Trading in Financial Instruments of 29 July 2005 (consolidated text: Journal of Laws of 2020, Item 89, as amended);
  12. Act on Competition and Consumer Protection - Act on Competition and Consumer Protection Act of 16 February 2007 (consolidated text: Journal of Laws of 2019, Item 369, as amended);
  13. Accounting Act - Accounting Act of 29 September 1994 (consolidated text: Journal of Laws of 2019, Item 351), as amended);
  14. Act on the Rules for Shaping the Compensation of Persons Managing Certain Companies - Act of 9 June 2016 on the Rules for Shaping the Compensation of Persons Managing Certain Companies (consolidated text: Journal of Laws of 2019 Item 1885, as amended);
  15. Act on Rules for Managing State Property - Act on Rules for Managing State Property of 16 December 2016 (consolidated text: Journal of Laws of 2019, Item 1302, as amended);
  16. Banking Law - Act of 29 August 1997 entitled Banking Law (consolidated text: Journal of Laws of 2019, Item 2357, as amended);
  17. EIOPA guidelines - EIOPA guidelines pertaining to public disclosures and reporting;
  18. Corporate Governance Rules - Corporate Governance Rules for Supervised Institutions issued by KNF, in effect since 1 January 2015;
  19. Names of business units:
  1. AAS Balta - Apdrošināšanas Akciju Sabiedrība Balta.
  2. Alior Bank - Alior Bank SA

5

Powszechny Zakład Ubezpieczeń Spółka Akcyjna Group

Solvency and financial condition report as at and for the financial year ended 31 December 2019

  1. CM Medica - Centrum Medyczne Medica sp. z o.o.
  2. CM św. Łukasza - Centrum Medyczne św. Łukasza sp. z o.o.
  3. Elvita - Przedsiębiorstwo Świadczeń Zdrowotnych i Promocji Zdrowia ELVITA - Jaworzno III sp. z o.o.
  4. FCM - FCM Zdrowie sp. z o.o. (formerly Falck Centra Medyczne sp. z o.o.)
  5. Gamma - Centrum Medyczne Gamma sp. z o.o.
  6. Alior Bank Group - Alior Bank with its subsidiaries: Alior Services sp. z o.o., Alior Leasing sp. z o.o., Meritum Services ICB SA, Alior TFI SA, New Commerce Services sp. z o.o., Absource sp. z o.o., Serwis Ubezpieczeniowy sp. z o.o., Corsham sp. z o.o., RBL_VC sp. z o.o.
  7. Pekao Group - Pekao with its subsidiaries: Pekao Bank Hipoteczny SA, Pekao Leasing sp. z o.o., Pekao Investment Banking SA, Pekao Faktoring sp. z o.o., Pekao Powszechne Towarzystwo Emerytalne SA in liquidation, Pekao TFI SA, Centrum Kart SA, Pekao Financial Services sp. z o.o., Pekao Direct sp. z o.o., Pekao Property SA in liquidation, FPB - Media sp. z o.o. in liquidation, Pekao Fundusz Kapitałowy sp. z o.o. in liquidation, Pekao Investment Management SA, Dom Inwestycyjny
    Xelion sp. z o.o.
  8. Link4 - Link4 Towarzystwo Ubezpieczeń SA.
  9. Pekao - Bank Pekao SA.
  10. Proelmed - Przedsiębiorstwo Usług Medycznych PROELMED sp. z o.o.
  11. Prof-med - Specjalistyczna Przychodnia Przemysłowa Prof-Med sp. z o.o.
  12. PTE PZU - Powszechne Towarzystwo Emerytalne PZU SA.
  13. PZU LT GD - UAB PZU Lietuva Gyvybes Draudimas.
  14. PZU CO - PZU Centrum Operacji SA.
  15. PZU Ukraine - PrJSC IC PZU Ukraine.
  16. PZU Ukraine Life - PrJSC IC PZU Ukraine Life Insurance.
  17. SU Krystynka - Sanatorium Uzdrowiskowe "Krystynka" sp. z o.o.
  18. TFI PZU SA - Towarzystwo Funduszy Inwestycyjnych PZU SA.
  19. Tomma - Tomma Diagnostyka Obrazowa SA.
  20. TUW PZUW - Towarzystwo Ubezpieczeń Wzajemnych Polski Zakład Ubezpieczeń Wzajemnych.

6

Powszechny Zakład Ubezpieczeń Spółka Akcyjna Group

Solvency and financial condition report as at and for the financial year ended 31 December 2019

Summary

Basis for preparation

The obligation to disclose this SFCR report follows from Article 412 of the Insurance Activity Act implementing the requirements of the SII Directive into the national legislation. The layout of this report is consistent with annex XX to the Delegated Regulation, with the reservation that only information relevant to PZU Group's business is disclosed.

The SFCR has been prepared in accordance with the provisions of:

  • Insurance Activity Act;
  • Delegated Regulation;
  • EIOPA guidelines;
  • implementing regulation applicable to the SFCR.

Assets, liabilities and own funds have been measured by applying the provisions of the Insurance Activity Act, the Delegated Regulation, the EIOPA guidelines on the recognition and measurement of assets and liabilities other than technical provisions, the EIOPA guidelines on the measurement of technical provisions and the EIOPA guidelines on the classification of own funds, in consideration of requirements applicable to corporate groups.

SCR is calculated pursuant to Article 336 of the Delegated Regulation and consists of the following positions: a solvency capital requirement calculated on the basis of consolidated data following the rules laid down for the standard formula, the proportional share of the capital requirement (including hypothetical requirements) of undertakings from other financial sectors, the requirement for affiliated entities not consolidated by the full method. The main goal of SCR is to reflect, to the fullest extent possible, the risks associated with the conducted activity.

Unless noted otherwise, all amounts presented in this report are stated in millions of Polish zloty.

Operating activity and results of the PZU Group

PZU Group led by PZU is the largest financial institution in Poland and Central and Eastern Europe.

The PZU Group's consolidated assets under IFRS total PLN 343,340 million. The PZU Group renders its services in five countries.

PZU Group companies actively offer not only life and non-life insurance but also banking, investment, pension and healthcare products. They render assistance services to retail clients and businesses through strategic partnerships.

It is the PZU Group's strategic ambition to pursue an approach aimed at building client relations, thereby leading to the integration of all operating areas with the client at the focal point. This makes it possible to deliver products and services that are well-matched to client needs at the appropriate time and place and respond to other client needs on a comprehensive basis. This process will be supported by harnessing tools rooted in artificial intelligence, big data and mobile solutions that contribute to building an entrenched technological advantage in integrated client service.

PZU's ambitions will be achieved through the following 12 key initiatives underpinning the PZU Group Strategy:

  • data base merger and creation of a single joint customer relationship management (CRM) system in the PZU Group/full client picture (360 degree view);
  • better matched price to risk and price sensitivity (Tariff setting 3.0);
  • implementation of solutions employing artificial intelligence;
  • development of cooperation with banks;
  • simplifying the product offering, also meaning simple language;
  • conversion of the sales network into general sales;
  • development of sales in PZU Zdrowie SA;

7

Powszechny Zakład Ubezpieczeń Spółka Akcyjna Group

Solvency and financial condition report as at and for the financial year ended 31 December 2019

  • development of sales and consolidation in PZU Investments
  • implementation of a new "moje.pzu.pl" portal
  • development of the direct offering
  • implementation of a loyalty program at the PZU Group level
  • integrated service model for SMEs.

The PZU Group has two banks in its structure: Alior Bank (in the PZU Group since 2015) and Pekao (in the PZU Group since 2017) playing an important role on the domestic financial market.

In individual operating result items, the PZU Group posted in 2019:

  • a 3.1% increase in gross written premium compared to 2018, to PLN 24,191 million. The increase was driven predominantly by unit-linked and protection insurance sold in cooperation with banks, growth of sales in foreign companies and higher sales of insurance against fire and other damage to property in the corporate insurance segment, including the acquisition, in Q4 2019, of a high-unit-value inward reinsurance contract. After considering the reinsurers' share and movement in the provision for unearned premiums, the net earned premium was PLN 23,090 million and was 3.3% higher than in 2018;
  • increase in investment income after factoring in interest expenses. Investment income in 2019 and 2018 was PLN 9,211 million and PLN 7,849 million, respectively. Growth was posted in investment income in banking activity and net of banking activity. The growth in the result on banking activity was driven in particular by improved sales of credit products at Pekao and Alior Bank, partly due to the favorable economic climate and the low level of interest rates, somewhat offset by the adverse impact of the CJEU judgment (the Court ruled that in the event of premature loan amortization a consumer is entitled to a reduction of all the costs forming part of the overall cost of the loan). Investment income excluding banking activity increased primarily thanks to a higher result earned on listed equity instruments. This was partly caused by the improved sentiments on the Warsaw Stock Exchange reflected in a slight increase of the WSE main index in 2019 vis-à-vis a strong decline the year before. The favorable market conditions on the Warsaw Stock Exchange translated also into the investment income in the portfolio of assets to cover investment products, which does not affect the PZU Group's overall net result, because these assets are offset by an increase in provisions recognized in claims and benefits paid;
  • higher level of claims and benefits paid. They amounted to PLN 15,695 million, which means a 7.8% increase compared with 2018. The increase pertained in particular to life insurance in connection with the better result on investing activity in most unit-linked portfolios compared to the negative results generated last year (this effect has no impact on the PZU Group's total net result, because the increase in claims and benefits paid is counterbalanced by the changes in the net result on investing activity in the portfolio of assets to cover investment products). In addition, the higher level of claims and benefits paid in insurance against fire and other damage to property resulted from above-average number of losses caused by atmospheric phenomena;
  • higher acquisition expenses (a PLN 233 million y/y increase) in the mass and corporate client segments alike. The increase was driven mainly by a change in the structure of sales channels in PZU, growth of sales and changes in the structure of the portfolio in the mass and corporate segments toward a greater share of non-motor products;
  • maintenance of administrative expenses at a level similar to last year (PLN 6,606 million compared to PLN 6,609 million in the corresponding period of 2018). Administrative expenses in the banking activity segment (net of adjustments on account of valuation of assets and liabilities to fair value) dropped by PLN 139 million thanks to maintaining cost discipline in both banks and reversal of a portion of the provision for deferred compensation components in Alior Bank. At the same time, the administrative expenses of the insurance segments in Poland were PLN 96 million higher compared to the previous year. This change largely resulted from higher personnel costs in connection with the wage pressure on the market;
  • higher negative balance of other operating income and expenses of PLN 2,832 million. The change resulted chiefly from the higher charges to the Bank Guarantee Fund, the adverse impact of the CJEU judgment on consumer loans and the higher levy on financial institutions due to the increase in the value of assets subject to taxation (the tax rates did not change). The charges to the Bank Guarantee Fund increased from PLN 372 million in 2018 to PLN 611 million in 2019, a provision was created for disputed claims and potential liabilities due to the adverse impact of the CJEU judgments on consumer loans and mortgage loans in CHF in the amount of PLN 294 million and the PZU Group's liabilities on account of the levy on financial institutions (on insurance and banking business alike) in 2019 was PLN 1,134 million vs. PLN 1,092 million in 2018.

8

Powszechny Zakład Ubezpieczeń Spółka Akcyjna Group

Solvency and financial condition report as at and for the financial year ended 31 December 2019

The PZU Group features a high level of security in its business. This is corroborated both by its high solvency ratios and by the A- investment grade rating awarded by the US rating agency S&P Global Ratings.

On 14 June 2019, S&P Global Ratings, a US-based rating agency raised PZU's rating outlook from stable to positive. On 6 April 2020, due to the COVID-19 pandemic and the resulting deterioration of financial and business situation in Poland, S&P Global Ratings downgraded the rating outlook for PZU from positive to stable. PZU's financial strength and credit rating remained at A-.

The dividend per share to be paid (on 5 September 2019) from 2018 earnings is PLN 2.80 per share, up 12.0% y/y.

System of governance

The system of governance in place in the PZU Group business units, including its organization, is commensurate with the scale of operations, the extent of realized functions and the scale and complexity of risks, and it effectively supports the achievement of strategic objectives as well as immediate business and operating goals.

The system of governance in PZU Group companies comprises in particular the organizational structures and formal and process solutions required by the laws and following from the uniqueness of regulatory requirements applicable to each type of company. The division of powers in the Management Board's organizational structures between individual persons participating in business unit management is defined by the internal regulation and power-of-attorney system.

Model solutions are worked out and implemented on the PZU level. They are implemented in PZU Group business units taking into account the scale, uniqueness and nature of the activity their conduct.

The system of governance comprises in particular solutions designed to ensure the PZU Group company's adherence to regulatory requirements and the effectiveness and efficiency of its operations and to safeguard the availability and reliability of financial and non-financial information.

In the reporting period, no significant changes to the system of governance took place in the PZU Group.

Risk profile

PZU Group's risk profile results from the PZU Group's strategy and business plans; it is subject to periodical monitoring and control. The most significant risks are actuarial risk and market risk, which is a consequence of the scale of activity of the PZU Group's business unit and the value of funds obtained from its core line of business and allocated to investments.

In compliance with the applicable provisions of the SII system, the PZU Group it calculates its SCR reflecting the value of eligible own funds that would enable the PZU Group to cover significant unforeseen losses within one year, thus ensuring a sufficient degree of protection of the interests of the insureds.

In the light of the nature of business and the significant risks involved, the standard formula proposed by the provisions of the SII system is a proper reflection of the solvency requirement and as such is applied by the PZU Group.

The risks covered by PZU Group's SCR include: actuarial risk, counterparty insolvency risk, operational risk and the adjustment related to the capacity of deferred income tax to cover losses. Also, a separate category of the capital requirement takes into account requirements for subsidiaries that are not subject to consolidation using the full method, in particular requirements for subsidiaries from financial sectors other than the insurance sector.

At yearend 2019, the SCR was PLN 10,398 million, up 2% from yearend 2018. The increase was driven mainly by the higher market risk and actuarial risk.

The increase in the capital requirement for market risk was primarily a consequence of the increase in capital requirements in the credit spread risk sub-module, which resulted from the adopted investment strategy aimed at increasing exposure to foreign corporate bonds.

In 2019, the capital requirement for actuarial risk in non-life insurance and for actuarial risk in health insurance went up by PLN 85 million and PLN 34 million, respectively. These changes resulted predominantly from the expansion of the portfolio of these insurance segments and the update of statistical assumptions at PZU Życie.

9

Powszechny Zakład Ubezpieczeń Spółka Akcyjna Group

Solvency and financial condition report as at and for the financial year ended 31 December 2019

In 2019, actuarial risk in non-life insurance increased slightly due to growth of the non-life insurance business.

Valuation for solvency purposes

For solvency purposes, the PZU Group measures its assets and liabilities other than technical provisions at fair value. The fair value is calculated using market prices quoted on active markets for the same assets or liabilities. In cases where there is no such active market, alternative measurement methods are used, as provided for by the provisions of the SII system: mark-to-market measurement, income-based measurement or cost-based measurement.

The most significant asset groups according to the PZU Group's economic balance sheet are: debt securities, interests in related parties, assets for life insurance in which the benefit is determined on the basis of specified indices or other base values and for life insurance linked to a unit-linked fund, loans, deposits other than cash equivalents and real estate.

The main differences in the measurement of these assets compared to their measurement in the financial statements prepared according to IFRS pertain to debt securities and loans. These differences stem mostly from the fact that in the economic balance sheet the said assets are measured at fair value, whereas the financial statements according to IFRS are prepared using measurement methods based on historical cost.

The most significant liability groups according to the PZU Group's economic balance sheet are: technical provisions, subordinated liabilities, deferred tax liability and other liabilities.

In the case of subordinated liabilities, the difference between values according to IFRS and measurement for solvency purposes follows from the application of different measurement methods: according to IFRS at amortized cost, while for the purposes of the economic balance sheet they are presented at fair value but without adjusting own credit spread from the date of the emergence of the liability.

The PZU Group measures technical provisions at the value which another insurance undertaking or reinsurance undertaking (reference undertaking) could be expected to demand for taking over and fulfilling the insurance and reinsurance liabilities. Technical provisions consist of the best estimate and the risk margin, in compliance with Article 225 of the Insurance Activity Act.

During the reporting period, the most important change to the method of measurement of assets and liabilities other than technical provisions was the recognition of right-of-use assets of a leased object and the obligation to make a lease payment in the economic balance sheet in compliance with the new IFRS 16 Leases standard, which entered into force on 1 January 2019. With regard to best estimate measurement, in 2019, the risk-free rate applied for discounting cash flows was changed along with assumed best estimates in life insurance as well as assumptions on mortality, accident incidence and lapse rates.

Capital management

PZU Group's capital and dividend policy is aimed at zeroing in on the rate of return for shareholders through efficient capital management while maintaining the existing security level and preserving capital resources for the purposes of strategic development through acquisitions.

In 2019, the PZU Group satisfied the solvency requirements and held eligible own funds to cover the solvency capital requirement. As at 31 December 2019, the SCR for the PZU Group was PLN 10,398 million, while eligible own funds to cover the SCR were PLN 25,467 million, including category 1 basic own funds of PLN 22,129 million and category 2 basic own funds of PLN 3,338 million, which ensured the ratio of SCR coverage with eligible own funds at a level of 245%. The MCR was PLN 3,870 million, while eligible own funds to cover the MCR were PLN 16,285 million, including category 1 basic own funds of PLN 15,511 million and category 2 basic own funds of PLN 774 million, which ensured the ratio of MCR coverage with eligible own funds at a level of 421%.

The increase in authorized own funds compared to 2018 was PLN 2,717 million (up 12%), driven by KNF's expectations regarding the retention of all profit generated in 2019 and, as a consequence, the recognition of expected dividends at zero in the calculation of own funds.

In 2019, the SCR went up 2% compared to 2018, which was mainly due to the decline in market risk and actuarial risk. The MCR decreased 2% compared to 2018. It was caused by the decline in PZU Życie's MCR attributable to the decrease in its SCR.

10

Powszechny Zakład Ubezpieczeń Spółka Akcyjna Group

Solvency and financial condition report as at and for the financial year ended 31 December 2019

  1. Business and operating results

A.1. Business

A.1.1. Name and legal form

The parent company in the PZU Group is PZU, Al. Jana Pawła II 24, 00-133 Warsaw, Poland.

PZU has been entered in the National Court Register kept by the District Court for the Capital City of Warsaw in Warsaw, 12th Commercial Division of the National Court Register, under file number KRS 0000009831.

A.1.2. Regulatory authority supervising the PZU Group

Regulatory authority in charge of exercising financial supervision over the PZU Group:

Polish Financial Supervision Authority, ul. Piękna 20, 00-549 Warsaw.

A.1.3. Statutory auditor of the PZU Group

Justyna Zań, registration no. 12750, acting on behalf of KPMG Audyt Spółka z ograniczoną odpowiedzialnością sp.k., an entity authorized to audit financial statements, license no. 3546, ul. Inflancka 4A, 00-189 Warsaw, Poland.

A.1.4. Shareholders holding significant stakes in PZU

As at 31 December 2019, the PZU shareholding structure was as follows:

No.

Shareholder's name

Number of shares and votes at

Percentage held in the share capital and in

the Shareholder Meeting 1)

the total number of votes at the

Shareholder Meeting

1

State Treasury

295,217,300

34.1875%

2

Other shareholders

568,305,700

65.8125%

Total

863,523,000

100.0000%

  1. According to the Current Report No. 22/2019 on the list of shareholders holding at least 5% of the number of votes at the PZU Extraordinary Shareholder Meeting that took place on 6 September 2019.

11

Powszechny Zakład Ubezpieczeń Spółka Akcyjna Group

Solvency and financial condition report as at and for the financial year ended 31 December 2019

A.1.5. PZU Group's legal structure

The PZU Group's capital structure as at 31 December 2019 is presented in Attachment 1 to this SFCR1.

The information about all PZU Group business units is presented in form S.32.01.22 constituting attachment 2 to the SFCR.

A.1.6. PZU Group's significant lines of business and relevant geographies of the PZU Group's

operations

PZU Group is the largest financial institution in Poland and Central and Eastern Europe. PZU heads up the group and its traditions date back to 1803 when the first insurance company was established in Poland. The PZU Group's consolidated assets under IFRS total PLN 343,340 million. The PZU Group renders its services in five countries. PZU Group business units are active not only in life and non-life insurance but also in banking, investment, pension and healthcare products.

For over 200 years the PZU Group's identity has been shaped by insurance activity which concentrates on providing the insured with peace of mind and feeling of safety through offering a comprehensive insurance cover in all key areas of private, public and business life. PZU Group business units offering insurance in Poland include: PZU, Link4 and TUW PZUW (non-life insurance) and PZU Życie (life insurance).

PZU offers an extensive array of non-life insurance products in Poland and internationally, including motor insurance, property insurance, casualty insurance, agricultural insurance and third party liability insurance. At yearend 2019, motor insurance was the most important group of products offered by PZU, both in terms of the number of insurance contracts and its premium stated as a percentage of total gross written premium.

The PZU Group operates in Poland under two brands: more traditional one - PZU brand and the Link4 brand addressed to clients preferring electronic sales channels. Link4 was the first insurance undertaking offering products by phone; it still continues to be one of the leaders on the direct insurance market, extending its cooperation with multi-agencies, banks and strategic partners. Link4 offers an extensive array of non-life insurance products, including motor insurance, property insurance, casualty insurance and third party liability insurance.

TUW PZUW offers its clients flexible insurance programs to optimize their costs and scope of cover. It sells and handles commercial insurance products targeted at clients from various industries, focusing predominantly on cooperation with large enterprises, medical centers (hospitals and clinics), local government units and church entities.

In the PZU Group, the operations in the life insurance market are conducted by PZU Życie, offering an extensive range of life insurance products, which for management purposes are reported and analyzed broken down into the following three segments: group and individually continued insurance, individual insurance and investment contracts.

Dynamically developing the products and services portfolio, PZU, Link4, TUW PZUW together have retained the leading position in the Polish non-life market (34.7%2 market share) and life insurance market (45.9% - PZU Życie's share in the regular premium segment - data after 4 quarters of 2019).

Outside Poland, the PZU Group provides insurance services through the following companies: Lietuvos Draudimas AB (Lithuania), AAS Balta (Latvia) and PZU Kindlustus (a branch of Lietuvos Draudimas AB in Estonia), PZU Ukraine (non-life

1The chart included in the attachment does not include:

  • mutual funds: PZU SFIO Universum, PZU FIZ Dynamiczny, PZU FIZ Sektora Nieruchomości, PZU FIZ Sektora Nieruchomości 2, PZU FIZ Aktywów Niepublicznych BIS 1, PZU FIZ Aktywów Niepublicznych BIS 2, PZU FIO Globalny Obligacji Korporacyjnych, PZU FIZ Akcji Combo, inPZU Inwestycji Ostrożnych, inPZU Obligacje Polskie, inPZU Akcje Polskie, inPZU Akcji Rynków Rozwiniętych, inPZU Obligacji Rynków Rozwiniętych, inPZU Obligacji Rynków Wschodzących; inPZU Goldman Sachs ActiveBeta Akcji Rynków Wschodzących; inPZU Goldman Sachs ActiveBeta Akcji Amerykańskich Dużych Spółek; inPZU Akcji CEEplus;
  • subsidiary companies established under commercial law as special-purpose vehicles controlled by the funds: PZU FIZ Sektora Nieruchomości and PZU FIZ Sektora Nieruchomości 2, which included 18 companies for each fund as at both 31 December 2018 and 31 December 2019;

controlled by the PZU Group as at 31 December 2019 in light of IFRS 10 "Consolidated financial statements".

2 According to KNF's report for Q4 2019; the market and market shares including PZU's inward reinsurance from Link4 and TUW PZUW.

12

Powszechny Zakład Ubezpieczeń Spółka Akcyjna Group

Solvency and financial condition report as at and for the financial year ended 31 December 2019

insurance) and PZU Ukraine Life and PZU LT GD (life insurance). In 2019, the PZU Group ranked first in terms of gross written premium in the non-life insurance market in Lithuania and second in Latvia.

The PZU Group has two banks in its structure: Alior Bank (since 2015) and Pekao (since 2017) playing an important role on the domestic financial market.

Pekao was established in 1929. It is a universal commercial bank offering a full range of banking services provided to individual and institutional clients operating chiefly in Poland.

Alior Bank is a universal deposit and loan bank that was established in 2008 as a start-up. In its operations Alior Bank combines the principles of traditional banking with innovative solutions and consequently it sets new trends in financial services.

Cooperation with banks has opened up enormous growth opportunities for the PZU Group, especially in terms of integrating and focusing its services on clients at every stage of their personal and professional development. Cooperation with the banking segment forms an additional plane for PZU to build lasting client relations.

As part of the areas complementary to the insurance business, the PZU Group offers an extensive range of investment products is offered under the PZU Investments brand, namely open and closed-end mutual funds and pension products: an open-end pension fund, individual retirement accounts, individual retirement security accounts with a voluntary pension fund, employee pension plans. TFI PZU SA also invests the PZU Group's own funds.

In its efforts to ensure greater and more complete satisfaction of its client needs, the PZU Group has been actively developing the health insurance market with accompanying health care services under the PZU Zdrowie brand. The health business includes two types of activity:

  • sale of health products in the form of insurance and sale of non-insurance products (occupational medicine, medical subscriptions, partnerships and prevention programs);
  • development of the medical infrastructure in Poland to ensure the best accessibility of provided medical services.

Detailed information on premiums, claims and benefits and costs broken down by lines of business in the SII system and by countries was included in QRT forms S.05.01.02 and S.05.02.01 constituting attachments 3 and 4 to the SFCR, respectively.

A.1.7. All significant events of a business and other nature that occurred during the reporting period and had a significant impact on the PZU Group

A.1.7.1. Dividends paid

As regards distribution of profit for 2018 and previous years, only the profit captured in the PZU standalone financial statements prepared in accordance with PAS is subject to distribution.

On 24 May 2019, PZU's Ordinary Shareholder Meeting distributed PZU's net profit for the year ended 31 December 2018 totaling PLN 2,712 million by earmarking:

  • PLN 2,418 million as a dividend payout to shareholders, i.e. PLN 2.80 per share;
  • PLN 287 million as supplementary capital;
  • PLN 7 million to the Company Social Benefit Fund;

The record date was set at 14 August 2019 and the dividend payout date was set for 5 September 2019.

13

Powszechny Zakład Ubezpieczeń Spółka Akcyjna Group

Solvency and financial condition report as at and for the financial year ended 31 December 2019

A.1.7.2. Acquisition transactions

Tomma

On 29 October 2019, PZU Zdrowie signed with THC SICAV-RAIF SA a preliminary agreement and on 9 December 2019 the final agreement on the purchase of 150,000 shares in Tomma with a par value of PLN 1 each, representing 100% of the company's share capital and carrying the right to 100% votes at its shareholder meeting. At the same time, PZU Zdrowie, and thus also PZU, became an indirect owner of the following subsidiaries of Tomma: Asklepios Diagnostyka sp. z o.o. and Bonus-Diagnosta sp. z o.o., in which Tomma holds a 100% stake in the share capital and 100% of votes at the shareholder meeting.

FCM

On 13 March 2019 PZU Zdrowie SA entered into a preliminary agreement and on 3 June 2019 a final agreement with Falck Danmark A/S to acquire 403,551 shares in FCM, which constituted 100% of the share capital and offering 100% of votes at the shareholder meeting, with par value of PLN 50 each. At the same time, PZU Zdrowie SA, and thereby also PZU, became the indirect owner of Starówka sp. z o.o. in which FCM has a 100% equity stake.

Alergo-Med Tarnów sp. z o.o.

On 31 January 2019, PZU Zdrowie acquired 1,432 shares in Alergo - Med Tarnów sp. z o.o. representing 100% of the share capital and 100% of the votes at the shareholder meeting with a par value of PLN 500 each.

Corsham sp. z o.o.

On 4 February 2019 Alior Bank acquired 100 shares in Corsham sp. z o.o. representing 100% of the share capital and 100% of votes at the shareholder meeting with a par value of PLN 50 each.

Spółdzielcza Kasa Oszczędnościowo - Kredytowa Jaworzno

On 31 January 2019, the KNF decided that Alior Bank would take over Spółdzielcza Kasa Oszczędnościowo-Kredytowa Jaworzno (SKOK Jaworzno). In line with KNF's decision, starting on 1 February 2019, Alior Bank assumed management over the assets of SKOK Jaworzno, which was acquired by Alior Bank as of 1 April 2019.

A.1.8. Simplified PZU organizational structure chart

The PZU organizational structure chart constitutes Attachment 5 to the SFCR.

A.2. Operating result

Premiums, claims paid and costs broken down by lines of business are presented in form QRT S.05.01.02 constituting Attachment 3 to the SFCR.

All information presented in this chapter is consistent with IFRS, except for the information about the premiums presented in section A.2.2.1, disclosed in accordance with the segment information presented in the consolidated financial statements prepared in accordance with the local accounting standards in force in the company's country of establishment.

14

Powszechny Zakład Ubezpieczeń Spółka Akcyjna Group

Solvency and financial condition report as at and for the financial year ended 31 December 2019

A.2.1. Key factors affecting the operating results achieved by the PZU Group

The operating profit of the PZU Group in 2019 was PLN 7,084, down by PLN 3 million compared to the result generated in 2018. Operating profit was driven in particular by the following factors:

  • gross written premium at a level of PLN 24,191 million, including a rapid increase in sales in foreign companies, in life insurance in Poland, an increase in premiums on protection products offered in own channels and in the bancassurance channel, growth of investment products in the bancassurance channel and the portfolio of group health products. In non- life insurance in Poland, an increase in premiums in the non-motor insurance business, including on insurance against fire and other damage to property;
  • higher result on listed equities, among others due to better conditions on the Warsaw Stock Exchange;
  • lower profitability in the mass insurance segment - the effect of an increase in the loss ratio in insurance against fire and other damage to property as a result of an above-average number of losses caused by atmospheric phenomena;
  • higher underwriting result in the corporate insurance segment, including improvement in profitability in the motor TPL insurance group;
  • higher result on individual insurance due to the expanding portfolio of high-margin protection insurance, in both own channels and bancassurance channels;
  • lower profitability in group and individually continued insurance with a growing health insurance portfolio as a result of an increase in the loss ratio of certain risks in the group protection portfolio and an increase in operating expenses;
  • higher profitability in foreign companies due to the rapid growth of sales and significantly greater investment income;
  • squeezed results in the banking segment due to, among others, higher contributions to the Bank Guarantee Fund and the unfavorable impact of the CJEU judgment on consumer loans.

Key figures of the PZU Group operating

2019

2018

result (PLN million)

(restated)3

Gross written premiums

24,191

23,470

Net earned premiums

23,090

22,350

Net revenues from commissions and fees

3,279

3,355

Net investment result

11,340

9,895

Net insurance claims and benefits paid

(15,695)

(14,563)

Acquisition expenses

(3,363)

(3,130)

Administrative expenses

(6,606)

(6,609)

Interest expenses

(2,129)

(2,046)

Other operating income and expenses

(2,832)

(2,165)

Operating profit (loss)

7,084

7,087

A.2.2. Income

A.2.2.1. Premiums

In 2019, the PZU Group collected gross premiums in a record-breaking amount of PLN 24,191 million, or 3.1% (PLN +721 million) more than in 2018.

3 Information on restatement of the 2018 data is presented in section 5.3. of the Consolidated financial statements of the Powszechny Zakład Ubezpieczeń Spółka

Akcyjna Group for the year ended 31 December 2019, prepared in accordance with the International Financial Reporting Standards.

15

Powszechny Zakład Ubezpieczeń Spółka Akcyjna Group

Solvency and financial condition report as at and for the financial year ended 31 December 2019

The change in gross written premium (net of inter-segment premiums) was affected chiefly by:

  • a PLN 235 million increase in premiums in the individual insurance segment (+17.5% y/y), driven mainly by the still increasing level of premiums in unit-linked protection products and term products offered in own channels coupled with growth of the insurance portfolio of unit-linked and protection products in the bancassurance channel. Following a period of rapid growth, the segment's gross written premium reached the second largest value since PZU's IPO;
  • premium increase in the corporate client segment by PLN 205 million compared to 2018 (+6.7%), to a record level of PLN 3,264 million, chiefly in insurance against fire and other damage to property, partly as a result of the acquisition, in Q4 2019, of a high-unit-value contract under inward reinsurance;
  • sales in foreign companies increased by PLN 199 million (+10.8%) compared to 2018, resulting in the highest ever sales value of PLN 2,048 million. The increases were particularly noticeable in motor and health insurance in the Baltic States;
  • higher sales in the group and individually continued insurance segment - the premium went up PLN 75 million (+1.1%) y/y to the highest level in PZU's history of PLN 6,966 million, in particular as a result of signing new contracts in health insurance in group form and active up-selling of other insurance riders in individually continued products;
  • sales in the mass client segment in Poland was at a record level of PLN 10,332 million, up PLN 7 million compared to 2018. The increase in premium in the non-life business was partially offset by the lower premium in the mass insurance segment caused by a decline in written premium in motor TPL insurance (a decrease in the number of policies coupled with a slight decrease in the average premium).

Gross written premium (external) in the insurance segment

2019

2018

(PLN millions), local GAAP

TOTAL

24,191

23,470

Total non-life insurance - Poland (external gross written premium)

13,596

13,384

Mass insurance - Poland

10,332

10,325

Motor TPL

4,383

4,610

Motor MOD

2,572

2,524

Other products

3,377

3,191

Corporate insurance - Poland

3,264

3,059

Motor TPL

814

845

Motor MOD

827

878

Other products

1,623

1,336

Total life insurance - Poland

8,547

8,237

Group and individually continued insurance - Poland

6,966

6,891

Individual insurance - Poland

1,581

1,346

Total non-life insurance - Ukraine and Baltic States

1,897

1,729

Non-life insurance - Ukraine

256

202

Non-life insurance - Baltic States

1,641

1,527

Total life insurance - Ukraine and Baltic States

151

120

Life insurance - Ukraine

79

55

Life insurance - Baltic States

72

65

A.2.2.2. Net revenues from commissions and fees

Net revenues from commissions and fees in 2019 stood at PLN 3,279 million, or were PLN 76 million lower than in the previous year, mainly as a result of higher commission costs in banking activity. They included mainly:

  • net revenues from commissions and fees in the banking business of PLN 2,603 million (including mainly: brokers' commissions, revenues and expenses related to the service of bank accounts, payment and credit cards, fees charged for intermediation in insurance sales);
  • income on OFE asset management of PLN 143 million;

16

Powszechny Zakład Ubezpieczeń Spółka Akcyjna Group

Solvency and financial condition report as at and for the financial year ended 31 December 2019

  • revenues and fees received from funds and mutual fund companies in the amount of PLN 528 million, or PLN 34 million less than in the previous year.

A.2.3. Costs

A.2.3.1. Claims paid and technical provisions

Net claims and benefits (including the movement in technical provisions) reached PLN 15,695 million and were 7.8% higher than in the previous year. The following factors contributed to the increase in the net claims and benefits category:

  • in life insurance, the increase pertained in particular to life insurance in connection with the better result on investing activity in most unit-linked portfolios compared to the negative results generated last year (this effect has no impact on the
    PZU Group's total net result, because the increase in claims and benefits paid is counterbalanced by the changes in the net result on investing activity in the portfolio of assets to cover investment products);
  • in insurance against fire and other damage to property - above-average number of losses caused by atmospheric phenomena.

On the other hand, a decrease in the net claims and benefits category was recorded in connection with remeasurement, in the corresponding period of the previous year in the motor insurance group in the corporate client segment and the mass client segment, of the provision for claims for general damages for the pain caused by a relative being in a vegetative state because of being injured in an accident.

A.2.3.2. Acquisition and administrative expenses

In 2019, acquisition expenses went up PLN 233 million compared to the previous year. The increase was driven mainly by a change in the structure of sales channels in PZU, growth of sales and changes in the structure of the portfolio in the mass and corporate segments toward a greater share of non-motor products.

The Group's administrative expenses in 2019 were PLN 6,606 million compared to PLN 6,609 million in 2018, i.e. down PLN 3 million over the previous year. Administrative expenses in the banking activity segment (net of adjustments on account of valuation of assets and liabilities to fair value) dropped by PLN 139 million thanks to maintaining cost discipline in both banks and reversal of a portion of the provision for deferred compensation components in Alior Bank. At the same time, the administrative expenses of the insurance segments in Poland were PLN 96 million higher compared to the previous year. This change largely resulted from higher personnel costs in connection with the wage pressure on the market.

A.3. Result on investment activity

A.3.1. Net investment result and interest expenses

In 2019, the net investment result4 including interest expenses was PLN 9,211 million compared to PLN 7,849 million in 2018. After the contribution of Pekao and Alior Bank is netted out, the net investment result after factoring in interest expenses in 2019 was PLN 1,995 million and was PLN 1,091 million higher than in the previous year.

4 Net investment result includes: net investment income, net result on realization of financial instruments and investments, movement in allowances for expected credit losses and impairment losses on financial instruments and net movement in fair value of assets and liabilities measured at fair value.

17

Powszechny Zakład Ubezpieczeń Spółka Akcyjna Group

Solvency and financial condition report as at and for the financial year ended 31 December 2019

The following factors affected the income:

  • higher result on listed equities, partly caused by the improved sentiments on the Warsaw Stock Exchange reflected in a slight increase of the WSE main index in 2019 vis-à-vis a strong decline the year before;
  • high performance of real estate funds due to the settlement of property development profits in the fourth quarter;
  • limitation of volatility in the results of the PZU Global Macro EUR portfolio in connection with shortening the portfolio's investment horizon, mostly covering the liabilities on the issue of own bonds denominated in EUR which matured in mid- 2019;
  • higher investment income in the portfolio of assets to cover investment products, even though it does not affect the PZU
    Group's overall net result because it is offset by the higher level of net insurance claims and benefits.

A.3.2. Securitization

With a view to securing a sustainable growth of the scale of its business, in 2019, Alior Bank expanded the available capital base by reinvesting all the profits it had generated and at the same time worked hard on optimizing the value of risk-weighted assets, using in this respect instruments that transfer the loan portfolio risk.

In particular, as regards credit risk, on 7 June 2019, Alior Bank operationally launched a synthetic securitization transaction of a business client loan portfolio with the European Investment Fund and the European Investment Bank as a counter-guarantor. As

18

Powszechny Zakład Ubezpieczeń Spółka Akcyjna Group

Solvency and financial condition report as at and for the financial year ended 31 December 2019

a result of this transaction, Alior Bank's capacity to provide additional funding to the small and medium-sized enterprise segment increased, including the capacity to provide loans on more favorable terms, in the form of lower interest rates.

The transaction structure is broken down into three tranches, i.e. junior, mezzanine and senior, where the risk of the junior tranche remains with Alior Bank, while the risk of the mezzanine and senior tranches is transferred to the European Investment Fund and the European Investment Bank.

This was the first transaction of this type in Poland executed in accordance Capital Requirements Regulation.

Moreover, in 2019, Alior Leasing Sp. z o.o. carried out a securitization transaction of a portion of its debt portfolio worth PLN 500 million. Under this transaction, a special purpose vehicle ("Issuer") with its registered office in Ireland purchased from Alior Leasing sp. z o.o. a portfolio of receivables arising from loan and lease contracts, paying for it with funds obtained from a private bond issue. The bonds issued by the Issuer (72% of the value of the securitized portfolio of receivables) were subscribed for by ING Bank Śląski. The guarantor of the bond issue is the European Investment Fund. The transaction was arranged jointly by UniCredit Bank AG and ING Bank N.V. The securitization will permit diversification of funding sources by Alior Leasing sp. z o.o. and obtaining new funds for its business in the amount of PLN 360 million. For the purposes of the transaction, Alior Leasing sp. z o.o. granted the Issuer a subordinated loan of PLN 140 million.

A.4. Result on other operating income and expenses

In 2019, the balance of other operating income and expenses was negative and stood at PLN 2,832 million, compared to the balance in 2018, which was also negative at a level of PLN 2,165 million.

The following contributed to this result:

  • increase in the BFG charges from PLN 372 million in 2018 to PLN 611 million in 2019 as a result of a higher charge towards compulsory restructuring;
  • establishment of a provision for disputed claims and potential liabilities in connection with the CJEU judgments on consumer loans and CHF mortgage loans in the amount of PLN 294 million, decrease in established and reversed provisions for guarantees and sureties granted by banks by PLN 78 million;
  • levy on financial institutions - the PZU Group's liability on account of this levy (combined on insurance and banking activity) in 2019 was PLN 1,134 million compared to PLN 1,092 million in the previous year. The higher burden was attributable to banking activity and resulted from the increase in value of assets forming the taxable base (the rate of the levy did not change).

A.5. Additional information

A.5.1. Legal, governance and organizational structure of the PZU Group, including all subsidiaries, material related undertakings within the meaning of Article 256a of the SII Directive and significant branches within the meaning of Article 354(1) of the Delegated Regulation

The information about the legal structure of the PZU Group is presented on a chart constituting attachment 1 to the SFCR. The governance and organization of the PZU Group is described in section B.1. The information about all PZU Group business units is presented in form S.32.01.22 constituting attachment 2 to the SFCR.

19

Powszechny Zakład Ubezpieczeń Spółka Akcyjna Group

Solvency and financial condition report as at and for the financial year ended 31 December 2019

A.5.2. Significant transactions with parties related by equity

A.5.2.1. Payment of dividend from PZU Życie

On 30 April 2019, the Ordinary Shareholder Meeting of PZU Życie adopted a resolution to pay out a dividend of PLN 1,332 million to PZU, which is the sole shareholder. The payment was made on 3 September 2019.

A.5.2.2. Payment of dividend from Pekao

On 26 June 2019, the Ordinary Shareholder Meeting of Pekao adopted a resolution to pay out a dividend. The amount of the dividend to PZU was PLN 347 million. The payment was made on 30 July 2019.

A.5.2.1. Payment of dividend from Lietuvos Draudimas AB

On 18 April 2019, the Ordinary Shareholder Meeting of Lietuvos Draudimas AB adopted a resolution to pay out a dividend of EUR 9 million (PLN 36 million) to PZU, its sole shareholder. The payment was made on 15 May 2019.

A.5.2.2. Loan granted by PZU to PZU Zdrowie SA

The value of the loan agreement with annexes executed between PZU and PZU Zdrowie SA before 1 January 2019 was PLN 295 million, of which PZU Zdrowie SA had utilized PLN 220 million. On 28 May 2019, PZU Zdrowie utilized the last installment of the loan in the amount of PLN 75 million. The loan will be repaid in installments by 31 December 2030.

On 1 July 2019, PZU and PZU Zdrowie SA executed another loan agreement for the maximum amount of PLN 95 million. The loan bears interest calculated as WIBOR 12M plus a margin of 2.56%. The loan will be repaid in a single transaction on 30 May 2024. The first tranche of the loan in the amount of PLN 30 million was disbursed on 6 December 2019.

On 6 December 2019, PZU Życie granted a loan to PZU Zdrowie in the total amount of PLN 195 million, in accordance with the loan agreement of 17 October 2019. The loan bears interest calculated as WIBOR 12M plus a margin of 2.56%. The loan will be repaid in a single transaction on 31 October 2024.

A.5.2.3. Loan granted by PZU to Link4

On 16 September 2019, PZU granted a subordinated loan of PLN 20 million to Link4 (under the agreement of 4 September 2019). The loan bears interest calculated as WIBOR 6M plus a margin of 3.5%. The loan includes funds from the subordinated loan of PLN 30 million granted to Link4 in 2014, which matured on 16 September 2019. Link4 will repay the loan in the amount of PLN 20 million plus interest on 19 September 2029. As a result, Link4 subordinated debt to PZU decreased by PLN 10 million.

A.5.2.4. Reinsurance

In 2019 reinsurance agreements were concluded between PZU as the reinsurer and its subsidiaries as cedents. The related gross written premiums under the 2019 reinsurance agreements, broken down by reinsured subsidiary, was:

  • Link4 - PLN 649 million,
  • TUW PZUW - PLN 381 million,
  • PZU Ukraine - PLN 44 million,
  • Lietuvos Draudimas AB - PLN 33 million,

20

Powszechny Zakład Ubezpieczeń Spółka Akcyjna Group

Solvency and financial condition report as at and for the financial year ended 31 December 2019

  • AAS Balta - PLN 16 million.

As a result of the concluded agreements, PZU incurs the costs of paying claims and handling claims from the subsidiaries. In 2019, they amounted to:

  • Link4 - PLN 339 million,
  • TUW PZUW - PLN 96 million,
  • PZU Ukraine - PLN 24 million,
  • Lietuvos Draudimas AB - PLN 1 million,
  • AAS Balta - PLN 162 million.

In connection with the concluded reinsurance agreement, in 2019 PZU incurred the cost of reinsurance commissions to its subsidiaries:

  • Link4 - PLN 188 million,
  • TUW PZUW - PLN 43 million,
  • PZU Ukraine - PLN 10 million,
  • Lietuvos Draudimas AB - PLN 1 million,
  • AAS Balta - PLN 1 million.

A.5.2.5. Exposure to bank deposits and accounts

In 2019, the PZU Group entities conducting insurance activity invested their funds in current accounts and bank deposits in Alior Bank and Pekao. As at 31 December 2019, PZU Życie showed significant exposure to Alior Bank on account of opened accounts and bank deposits in the amount of PLN 368 million.

A.5.2.6. Redemption of participation units by mutual funds

On 17 December 2019, PZU SFIO Universum redeemed its participation units from PZU Życie for the price of PLN 400 million.

On 29 March 2019, PZU FIZ Forte redeemed its participation units from PZU for the price of PLN 103 million.

A.5.2.7. Other material transactions

PZU CO provides services to PZU Życie in respect to the servicing of group employee insurance products. The consideration paid by PZU Życie to PZU CO on this account was PLN 231 million in 2019.

PZU Zdrowie SA provides medical services to PZU Życie's insureds under health insurance arrangements. The amount of revenues earned by PZU Zdrowie SA on this account was PLN 176 million in 2019.

PZU provides comprehensive claims handling and assistance services to TUW PZUW. In 2019, PZU generated revenue from fees for its services in the amount of PLN 6 million.

TUW PZUW provides non-life insurance services to Pekao. In 2019, gross written premium was EUR 14 million.

A.5.3. Significant differences in the scope of the PZU Group in the consolidated financial statements and in the scope of consolidated data defined in accordance with Article 335 of the Delegated Regulation

The information about the composition of the PZU Group is presented in form S.32.01.22 constituting attachment 2 to the SFCR. The list of business units comprising the PZU Group and the associates listed in the form correspond to the scope presented in

21

Powszechny Zakład Ubezpieczeń Spółka Akcyjna Group

Solvency and financial condition report as at and for the financial year ended 31 December 2019

the consolidated financial statements. Irrespective of the above, there are differences in the consolidation methods used for the purposes of the consolidated financial statements and for the purposes of SFCR.

The scope of consolidation by the full method in the SFCR is limited, as compared to the consolidated financial statements, to the business units conducting insurance activity and the business units, which are ancillary services undertakings within the meaning of Article 1(53) of the Delegated Regulation.

Until 2018, the PZU Group treated certain mutual funds as ancillary services undertakings and, in accordance with Article 335(1)(a) of the Delegated Regulation, consolidated them using the full method. On 18 June 2019, the Delegated Regulation was amended, whereby collective investment undertakings and investments operated as funds should be included in the economic balance sheet in accordance with Article 13 of the Delegated Regulation, that is at fair value. The amendments to the Delegated Regulation resulted in the cessation of consolidation of mutual funds for the purposes of the economic balance sheet by the PZU Group. This change resulted in a significant increase in the line item "Shares in related parties, including equity interests", in which most participation units or investment certificates are recognized, measured in accordance with Article 13 of the Delegated Regulation. At the same time, the following items decreased: "Loans and mortgage-backed loans", "Debt securities", "Real property (other than used for own needs)" and "Cash and cash equivalents". On the liabilities side, the decrease was recognized predominantly in "Other liabilities (trade liabilities, other than those from insurance activity)".

The entities comprising the PZU Group were presented in the SFCR in accordance with the methods specified in Article 335 of the Delegated Regulation:

  • the following were fully consolidated:
    o insurance undertakings - PZU, PZU Życie, Link4, Lietuvos Draudimas AB, AAS Balta, PZU LT GD, TUW PZUW;
    o ancillary services undertakings - PZU CO, PZU Pomoc SA, PZU Zdrowie SA, CM Medica, Prof-Med, SU Krystynka, Elvita,
    Proelmed, Gamma, Polmedic sp. z o.o., CM św. Łukasza, Ogrodowa-Inwestycje sp. z o.o., Tower Inwestycje sp. z o.o., PZU Finanse sp. z o.o., PZU Finance AB, Alergo-Med. Tarnów sp. z o.o., FCM, Starówka sp. z o.o. Tomma, Bonus- Diagnosta sp. z o.o., Asklepios Diagnostyka sp. z o.o.,
  • the method of PZU Group's proportional share in the own funds of these undertakings calculated according to the relevant sectoral rules was used to value Alior Bank and Pekao as credit institutions together with their subsidiaries, TFI PZU SA as a management company of undertakings for collective investment in transferable securities (UCITS) and PTE PZU as a non- regulated entity carrying out financial activities. The companies set out above were consolidated in the consolidated financial statements.
  • fair value was used to measure mutual funds (consolidated in the consolidated financial statements);
  • the adjusted equity method was also used to measure the remaining PZU Group companies that were not classified as ancillary services undertakings as well as Ukrainian insurance undertakings: PZU Ukraine, PZU Ukraine Life and LLC SOS Services Ukraine, which are excluded from full consolidation for solvency purposes under Article 389 of the Insurance Activity Act. The companies set out above were consolidated in the consolidated financial statements.

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Solvency and financial condition report as at and for the financial year ended 31 December 2019

  1. System of governance

B.1. General information on the system of governance

Corporate governance performs tasks resulting from the ownership rights vested in PZU over its subsidiaries. Corporate governance is the sum of corporate governance activities relating to matters arising from laws applicable in the European Union, domestic laws applicable in the area of operation of a subsidiary, internal acts and corporate governance principles (best practices).

The main objectives of corporate governance in the PZU Group include:

  • ensuring transparency and compliance with the law of subsidiaries and their corporate bodies;
  • using PZU's corporate powers to attain the objectives of the PZU Group Strategy;
  • increasing efficiency of operation, effectiveness of management and the shareholder value of subsidiaries.

The proper functioning of the corporate bodies in the subsidiaries, i.e. the shareholder meeting and the supervisory and managing bodies is critical for achieving the corporate governance objectives.

Additionally, within the system of governance at the PZU Group level, PZU and its subsidiaries conclude and perform cooperation agreements. One of them is the framework cooperation agreement of 21 March 2017 ("Cooperation Agreement"), which sets out the general principles of cooperation within the PZU Group. The Parties to the Cooperation Agreement have undertaken to work together in the areas of cooperation identified by PZU.

Pursuant to the Cooperation Agreement, PZU compiled a list of 23 areas of cooperation and the competent PZU units responsible for regulating their business areas for the entire PZU Group.

Until yearend 2019, the PZU Management Board confirmed 23 policies (including two in accounting area) that were subsequently implemented5 in the subsidiaries. Last area has been regulated in March 2020.

The parent company exercises owner's rights over its subsidiaries by way of decisions made in accordance with the procedure applicable to PZU's governing bodies.

Within the framework of PZU Group's system of governance, PZU among others recommends to the subsidiaries that they implement certain tools, procedures and methods for allocating responsibilities in order to ensure consistency and uniformity of solutions used in the PZU Group and adequate supervision over the system of governance in subsidiaries which, in the process of implementing the recommended solutions, apply the so-called principle of proportionality, which means that they implement recommendations taking into account the scale and nature of their operations, as well as the requirements of national or European law and guidelines or recommendations of regulatory authorities.

B.1.1. PZU Supervisory Board

In accordance with PZU's Articles of Association, the Supervisory Board is composed of seven to eleven members. The number of Supervisory Board members is specified by the Shareholder Meeting. Members of the Supervisory Board are appointed by the Shareholder Meeting for a joint term of office which lasts three consecutive full financial years.

5 Due to the fact that foreign companies operate under a different governing law and therefore it is not possible to implement the regulations in the same form, the relevant policies are implemented by incorporating them in internal regulations of the PZU Group entities, to the extent that they do not conflict with the provisions of local law (this mechanic is similar to the process of implementing European directives into the legislation of the Member States).

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Solvency and financial condition report as at and for the financial year ended 31 December 2019

The Articles of Association give the State Treasury the right to appoint and dismiss one member of the Supervisory Board by way of a written statement submitted to the Management Board. This right will expire once the State Treasury ceases to be a PZU shareholder. A candidate for a Supervisory Board member named by the State Treasury should meet the requirements set forth in Article 19 of the Act on Rules for Managing State Property.

The Supervisory Board adopts the Rules and Regulations of the Supervisory Board which define its organization and manner of acting. The Rules and Regulations define the composition and manner of appointing members to the Supervisory Board, tasks and scope of its operations as well as the procedure for convening and conducting meetings.

The Supervisory Board elects from among its members the Chairperson and Deputy Chairperson.

The Supervisory Board Chairperson manages the work of the Supervisory Board. In the event of absence of the Supervisory Board Chairperson, including a temporary hindrance which prevents him from discharging his/her function and in a situation when the mandate of the Supervisory Board Chairman has expired and the new Supervisory Board Chairman has not been appointed yet, all rights and duties of the Supervisory Board Chairman are exercised and performed by the Supervisory Board Deputy Chairman, excluding the right to resolve the wording of a Supervisory Board resolution in the event of an equal number of votes.

The Supervisory Board may elect the Supervisory Board Secretary from among its members. The Supervisory Board Secretary supports the Supervisory Board Chairperson or, during his/her absence, the Supervisory Board Deputy Chairperson, in discharging his/her duties specified in the Bylaws, in particular by:

  1. organizing the work of the Supervisory Board;
  2. supervising over the organizational and technical support for Supervisory Board meetings;
  3. ensuring that minutes of meetings of the Supervisory Board are kept;
  4. presenting draft reports prepared by the Supervisory Board as required by PZU's Articles of Association.

The Supervisory Board may delegate its members to perform specific oversight functions individually. Each delegation requires a Supervisory Board resolution naming the delegated person(s) and specifying a detailed scope of the oversight functions and the delegation period. Supervisory Board members delegated to perform specific oversight functions individually will submit written reports of their activity to the Supervisory Board at the Supervisory Board meeting following any individual performance of oversight function. During the reporting period, the Supervisory Board did not exercise the above right.

The Supervisory Board exercises constant supervision over PZU's activities in all aspects of its business. The PZU Supervisory Board's powers include in particular:

  1. evaluating the PZU Management Board's report on the Company's activity and the Management Board's report on the activity of the PZU Group and PZU's financial statements and consolidated financial statements for the previous financial year for compliance with the accounting ledgers and documents as well as the facts;
  2. approving the PZU and the PZU Group's solvency and financial condition report;
  3. evaluating the PZU Management Board's motions to distribute the profit or cover the loss;
  4. submitting a written report to the Shareholder Meeting on the results of the evaluation referred to in items 1 and 3, a concise annual evaluation of the PZU's standing with an assessment of its internal control system and the PZU's system for managing significant risks and an annual report on the work of the PZU Supervisory Board;
  5. concluding, terminating and amending agreements with PZU Management Board members and setting the rules for their compensation, giving consideration to the rules defined by the Shareholder Meeting, in accordance with § 18 item 12 of the
    Articles of Association of PZU;
  6. appointing, suspending and dismissing the President of the PZU Management Board, Management Board members or the entire Management Board of PZU and making decisions to discontinue such a suspension;
  7. granting consent to transferring an insurance portfolio in its entirety or in part;
  8. accepting motions submitted by the PZU Management Board to purchase, subscribe for or sell ownership interest and shares in companies and on the PZU's participation in other entities - the PZU Supervisory Board may define the maximum amount, the terms and conditions and the procedure that the PZU Management Board may use to conduct the foregoing activities without the obligation to obtain approval from the PZU Supervisory Board, except in cases where the decision in this respect is made by the PZU Shareholder Meeting pursuant to § 18a of the Articles of Association;

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Solvency and financial condition report as at and for the financial year ended 31 December 2019

  1. seconding members of the PZU Supervisory Board to perform temporarily the functions of members of the PZU Management Board who have been dismissed, resigned or cannot perform their functions for other reasons,
  2. accepting instructions on how PZU's representatives should vote at Shareholder Meetings of PZU Życie SA in the following matters: increasing or decreasing the share capital, issuing bonds, selling or leasing PZU Życie SA's enterprise or establishing a usufruct right on the enterprise, dividing PZU Życie SA, merging PZU Życie SA with another company, liquidating or dissolving PZU Życie SA;
  3. selecting the audit firm to carry out the mandatory audit of the financial statements, including the annual financial statements of PZU and the annual consolidated financial statements, the solvency and financial condition report of PZU and the PZU Group and reviews of the financial statements in accordance with the obligations following from the prevailing laws;
  4. deciding on the consolidated text of the amended Articles of Association of PZU;
  5. granting consent to purchase or sell real property, perpetual usufruct or share in real property or in perpetual usufruct, whose gross value exceeds the equivalent of EUR 3 million;
  6. granting consent for PZU to conclude, with a related party, an agreement whose subject matter has the value of at least
    10% of PZU's equity, excluding typical agreements concluded by PZU on market terms as part of its operational activity;
  7. granting consent for PZU to conclude an agreement with an underwriter as referred to in Article 433 § 3 of the Commercial
    Company Code;
  8. granting consent to pay out an interim dividend towards an expected dividend;
  9. granting consent to establish or close the regional branches referred to in § 2 section 2 of the Articles of Association and foreign branches;
  10. approving the PZU's long-term development plans and annual financial plans prepared by the PZU Management Board;
  11. approving the Rules and Regulations of the PZU Management Board;
  12. performing tasks resulting from the guidelines or recommendations of regulatory authorities, in particular the KNF, adopted in PZU;
  13. examining and consulting matters submitted by the PZU Management Board for deliberation during the Shareholder Meeting.

At present, the following committees operate as part of the PZU Supervisory Board:

  • Audit Committee;
  • Nomination and Compensation Committee,
  • Strategy Committee.

The Audit Committee is an advisory and consultative body to the PZU Supervisory Board and is appointed to increase the effectiveness of supervisory activities performed by the Supervisory Board with regard to monitoring financial reporting, financial audit activities and effectiveness of internal control, internal audit and risk management systems in PZU. In addition, the Audit Committee may request the Supervisory Board to request specific control activities in PZU, whereby the requested activities may be performed by an internal unit of PZU or an external entity.

The Audit Committee meets the legal requirement so that at least one of its members holds accounting or financial audit qualifications within the meaning of and based on the requirements of the Act on Statutory Auditors. Furthermore, in accordance with the said Act, the majority of the Audit Committee members, including the chairperson, meet the statutory independence criteria (independent member) concerning, among others, professional ties with PZU Group entities or family ties, especially to managers or supervisors of PZU Group entities. An independent supervisory board member is obligated to present a written declaration on satisfying all the independence criteria and advise PZU of ceasing to satisfy these criteria.

The Nomination and Compensation Committee is an advisory and consultative body to the PZU Supervisory Board and is appointed to improve the effectiveness of the Supervisory Board's supervision over the development of the management structure, including organizational solutions, the remuneration principles and the selection of properly qualified staff.

The Strategy Committee is an advisory and consultative body to the PZU Supervisory Board and is appointed to improve the effectiveness of the PZU Supervisory Board's oversight activities related to issuing opinions on all strategic documents

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Powszechny Zakład Ubezpieczeń Spółka Akcyjna Group

Solvency and financial condition report as at and for the financial year ended 31 December 2019

presented by the PZU Management Board (in particular, the PZU's development strategy) and providing the Supervisory Board with recommendations on planned investments that materially impact PZU's assets.

In accordance with the Rules and Regulations of the Supervisory Board, apart from appointing the Audit Committee and the Nomination and Compensation Committee, provided for in the Articles of Association to properly perform its supervision, the PZU Supervisory Board may appoint other permanent advisory and consultative committees whose competence, composition and manner of operation are laid down in the rules and regulations of the committee in question adopted by the PZU Supervisory Board. The Rules and Regulations provide for the possibility for the PZU Supervisory Board and its appointed committees to use the services provided by experts and consulting firms.

B.1.2. PZU Management Board

In accordance with PZU's Articles of Association, the PZU Management Board is composed of three to eight members appointed for a joint term of office spanning three consecutive full financial years.

Management Board Members, including the President of the Management Board, are appointed and dismissed by the Supervisory Board. Such appointment takes place following a recruitment procedure designed to verify and evaluate qualifications of the candidates and to select the best candidate. The President of the Management Board of the new term of office appointed before the current term elapses has the right to submit a motion to the Supervisory Board requesting appointment of the remaining Management Board members of the new term of office before the current term elapses.

The Management Board exercises any and all rights related to managing PZU which are not otherwise reserved by law or the provisions of the Articles of Association to the Shareholder Meeting or the Supervisory Board. Two Management Board members acting jointly or one Management Board member acting jointly with an attorney-in-fact are authorized to represent PZU. The Management Board adopts its rules and regulations, which are approved by the Supervisory Board. The President of the Management Board directs the work of the Management Board.

A directive of the President of the Management Board defines the division of organizational oversight duties at PZU among the Management Board members and assigns the functions of the Heads of Divisions.

PZU has in place the positions of PZU Group Directors. Those positions have been established to ensure a consistent and effective management model for PZU and PZU Życie based on a functional division of responsibilities among the members of the Management Boards of PZU and PZU Życie. The positions of PZU Group Directors are filled with persons performing the functions of Members of the PZU Życie Management Board. PZU Group Directors exercise direct oversight over the same areas of activities as they have oversight over in PZU Życie as Management Board members.

What follows is a presentation of the scope of responsibilities of the members of the PZU Management Board and the PZU Group Directors as at the end of 2019.

Name

Function in the PZU Group

Scope of responsibilities

Additional duties during the

at yearend 2019

year

internal audit, compliance, reinsurance,

management of and corporate

governance in the Company

President of the PZU

corporate communication, sponsoring, strategy

and the PZU Group,

Management Board

and projects, PZU Group's business

Paweł Surówka

administration, assurbanking,

from 13 April 2017

development, corporate sales, cooperation with

innovation, development of

to 12 March 2020

the brokerage channel, individual health

mobile applications and

products

digital processes

Member of the PZU

Tomasz Kulik

Management Board

actuarial, finance and investments

-

since 14 October 2016

Member of the PZU

Maciej Rapkiewicz

Management Board

risk

-

since 22 March 2016

Member of the PZU

supervision over PZU Group's foreign

Małgorzata Sadurska

Management Board

companies, assurbanking, bancassurance,

real property

since 13 June 2017

strategic partnership programs, procurement

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Powszechny Zakład Ubezpieczeń Spółka Akcyjna Group

Solvency and financial condition report as at and for the financial year ended 31 December 2019

Name

Function in the PZU Group

Scope of responsibilities

Additional duties during the

at yearend 2019

year

Member of the PZU

management and corporate governance in the

development of mobile

Marcin Eckert

Management Board

Company and the PZU Group, administration, IT,

applications and digital

since 28 March 2019

innovations, insurance operations

processes

Elżbieta Häuser-

Member of the PZU

retail sales, CRM, remote sales, digital services,

Management Board

-

Schöneich

development of mobile apps

since 25 May 2019

Member of the PZU

mass products and insurance programs,

actuarial pricing, product analysis, effectiveness

Adam Brzozowski

Management Board

-

of the retail sales network and commission

since 25 May 2019

systems

Member of the PZU

Management Board

from 24 October 2019 to 19

February 2020 / PZU Group

Director at PZU

from 25 March 2016

to 23 October 2019,

Aleksandra Agatowska

reappointed as PZU Group

marketing, client relations, health insurance

-

Director at PZU since 20

February 2020 /

Member of the PZU

Management Board since 25

March 2016, Acting President of

the PZU Życie Management

Board since 19 February 2020

PZU Group Director at PZU

prevention, CSR, customer communication, real

marketing, corporate

Dorota Macieja

communication, sponsoring,

since 15 March 2017

estate

client relations

Bartłomiej Litwińczuk

PZU Group Director at PZU

HR, security, advisory services and legal services

-

since 19 August 2016

PZU Group Director at PZU

from 15 February 2016

to 12 March 2020 /

President of the PZU Życie

Management Board

claims and benefits handling, assistance,

Roman Pałac

from 26 April 2017

customer service, management of the PZU

health insurance

to 19 February 2020 / Member

branch network, digital processes

of the PZU Życie SA

Management Board from 20

February 2020 to 12 March

2020

Moreover, in 2019 Roger Hodgkiss acted as a PZU Management Board Member and Tomasz Karusewicz as a PZU Group Director. Presented below are their scopes of responsibility in 2019:

Name

Function in the PZU Group

Areas of responsibility in 2019

Member of the PZU

corporate sales, retail sales, CRM, direct sales, mass products and insurance

Management Board

Roger Hodgkiss

programs, actuarial pricing, product analysis, effectiveness of the retail sales

since 19 January 2016

network and commission systems

to 24 May 2019

PZU Group Director at PZU

Tomasz Karusewicz

since 29 January 2016

IT, insurance operations

to 30 April 2019

In 2019, in addition to the committees established at the level of the PZU Supervisory Board, the following committees operated at PZU:

  • PZU Group's Risk Committee;
  • Investment Risk Committee
  • Investment Committee

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Solvency and financial condition report as at and for the financial year ended 31 December 2019

  • Asset and Liability Management Committee;
  • Data Governance Committee;
  • Sponsorship, Prevention and CSR Committee;
  • Innovations Committee;
  • PZU Pricing Committee;
  • Property Sales Committee;
  • Procurement Committee;
  • Initiatives Management Committee;
  • Cost Committee;
  • Crisis Task Force.

B.1.3. Duties and responsibilities of persons overseeing key functions

Persons overseeing the key functions in the PZU Group are obligated to cooperate and share information to the extent required for each one of them to complete his or her objectives. Persons overseeing key functions to procure the ability to perform their duties in an objective, accurate and independent manner are provided direct access to the management board, supervisory board and employees, have the necessary authorizations, resources and experience and an unlimited access to all the information necessary to perform their assigned duties.

The way in which the key functions in the PZU Group are organized, where the areas of responsibility are clearly and duly divided, ensures their operational independence.

The persons overseeing key functions in PZU Group's insurance companies take part in meetings of management board or supervisory board members, during which they submit statements or reports on the supervised areas, with particular consideration of risks identified in those areas. They also give advice to the management board or the supervisory board in matters pertaining to the ongoing activity of that PZU Group entity.

The PZU Group has implemented policies and procedures to ensure that the persons holding and overseeing key functions have the appropriate educational background, qualifications, experience and that they meet all the necessary regulatory requirements.

In principle, the persons in charge of the key functions do not participate in the implementation of processes and tasks going beyond those key functions. The functions are performed so as to ensure impartiality and independence from operational processes.

B.1.4. Material changes to the system of governance which took place during the reporting period

In the reporting period, no significant changes to the system of governance took place in the PZU Group.

At PZU Życie, a model similar to that in place at PZU was adopted in 2019 in respect of PZU Group Directors, namely that positions of PZU Group Directors were entrusted to members of the PZU Management Board. PZU Group Directors at PZU Życie exercised direct oversight of the same areas of activity as those they were responsible for at PZU as members of its Management Board. As at 31 December 2019, PZU Życie had one position of PZU Group Director consistent with this model.

As at the date of the SFCR, the following persons comprised the PZU Management Board:

  1. Beata Kozłowska-Chyła - Acting President of the PZU Management Board;
  2. Ernest Bejda - Member of the PZU Management Board;
  3. Adam Brzozowski - Member of the PZU Management Board;
  4. Marcin Eckert - Member of the PZU Management Board;
  5. Elżbieta Häuser-Schöneich - Member of the PZU Management Board;

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Solvency and financial condition report as at and for the financial year ended 31 December 2019

  1. Tomasz Kulik - Member of the PZU Management Board;
  2. Maciej Rapkiewicz - Member of the PZU Management Board;
  3. Małgorzata Sadurska - Member of the PZU Management Board.

This Solvency and Financial Condition Report was accepted by the PZU Management Board in the composition given above.

B.1.5. Information on the principles and practices of compensating members of the Supervisory Board, the Management Board and employees

Members of the PZU Supervisory Board do not receive variable compensation pegged to PZU's performance. The compensation rules applicable to the Supervisory Board members are set directly by the Shareholder Meeting. In 2019, members of the PZU Supervisory Board received fixed monthly compensation in the amount set by a resolution of PZU's Extraordinary Shareholder Meeting adopted on 8 February 2017, which was aligned with the reference range defined pursuant to Article 10 of the Act on the Rules for Shaping the Compensation of Persons Managing Certain Companies.

The rules for compensating Management Board members are shaped by the Supervisory Board and stipulate that the total compensation payable to a PZU Management Board member for rendering management services and discharging other obligations ensuing from the Management Services Provision Agreement consists of the following:

  • fixed compensation - flat monthly base compensation (for a calendar month) that cannot exceed the reference range established pursuant to Article 4(2) of the Act on the Rules for Shaping the Compensation of Persons Managing Certain Companies without prejudice to the situations outlined in Article 4(3) of the said Act;
  • variable compensation - supplementary compensation for a given financial year depending on the extent to which management objectives are attained. The variable compensation for a given financial year may not exceed the percentage, set out in the aforementioned act, of the annual fixed compensation in the previous financial year for which the amount of variable compensation due is to be calculated. In addition, a significant portion of the variable compensation is awarded in the form of deferred variable compensation. Deferred variable compensation is subject to deferral for 3 years. 12, 24 and 36 months, respectively from the date of allocation, a Management Board member may acquire the right to 1/3 of the deferred variable compensation for a given year subsequent to satisfying the conditions defined in the Management Services Provision Agreement.

PZU has defined the rules of compensating employees, in particular the persons carrying out the key functions. The rules applicable to those persons are an element of an effective risk management at PZU and contain the rules of remuneration applicable to insurance market entities as stipulated by the existing law, the Corporate Governance Rules, the Delegated Regulation and the Insurance Activity Act.

Pursuant to the remuneration policy, variable compensation is determined individually for employee groups or individuals. Its amount is linked to the financial performance of PZU and the individual's work performance. The rules for awarding variable compensation are designed to support proper and effective risk management, discourage excessive risk-taking beyond the limits accepted by the PZU Supervisory Board, as well as to support the implementation of the business strategy and avert conflicts of interest. Variable compensation may be subject to limitations in respect to the maximum amount that can be awarded. The Policy also provides for the option of deferring the disbursement of a significant portion of variable compensation. The remuneration policy does not include an employee scheme of rights to shares, share options, additional pension and disability plans or else early retirement plans for the members of the Management Board, Supervisory Board of PZU or other persons overseeing the key functions.

The compensation rules applicable in other subsidiaries conducting insurance activity are adapted to comply with the local legal requirements and are based on the rules described above that are in place at PZU.

B.1.6. Information on material transactions concluded during the reporting period with shareholders and members of the Management Board or Supervisory Board

In 2019, PZU paid a dividend to the shareholders, as described in section A.1.7.1.

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B.2. Fit and proper requirements

B.2.1. Requirements regarding skills, qualifications and professional expertise of the persons who effectively run a PZU Group entity or have other key functions

In the PZU Group entities conducting insurance activity, the requirements regarding the skills, qualifications and professional expertise of the persons who effectively run a PZU Group entity or have other key functions are applied relative to their respective scopes of responsibilities, the existing law and internal regulations. The requirements mentioned above in the individual PZU Group entities are based on the rules implemented in PZU, as described above.

There are 4 groups of people distinguished within the group of the persons who effectively run PZU and have other key functions:

  1. members of the PZU Supervisory Board, whose applicable requirements regarding skills, qualifications and professional expertise are regulated by PZU's Articles of Association;
  2. managers, i.e. persons acting as a PZU Management Board Member or a PZU Group Director who concurrently serves as a
    PZU Życie Management Board Member;
  3. persons overseeing key functions, i.e. persons designated as heads of the individual key functions by force of a directive of the President of the PZU Management Board;
  4. persons with key functions in PZU, i.e. persons employed in PZU's organizational structures who, according to the organizational rules and regulations of that structure in PZU, hold key functions in that structure.

The requirements for Managers, persons overseeing key functions and persons holding key functions, respectively, are regulated separately.

In particular, a Manager must satisfy the following requirements:

  1. meets the requirements set out in the PZU's Articles of Association;
  2. gives a guarantee PZU's affairs are run with due care;
  3. has full capacity to execute legal transactions;
  4. was not convicted for a premeditated crime or intentional crime against tax regulations, under a legally binding court ruling;
  5. is not a member of a governing body of: o a reinsurance undertaking,
    o a mutual fund company or an alternative investment fund manager within the meaning of the Act on Mutual Funds, operating under a valid license,
    o an entity conducting brokerage activity within the meaning of the Act on Trading in Financial Instruments or any other financial instrument trading activity in the meaning of that Act,
    o a universal pension fund company, o a bank.
  6. has proven knowledge of the Polish language, as required by the Insurance Activity Act;
  7. has professional experience and knowledge which are adequate to his or her function, in particular as regards: o the insurance and financial markets,
    o the system of governance,
    o financial and actuarial analysis,
    o principles, rules and requirements under the laws applicable to PZU's operations, including the skills to adapt to changes in law.

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A person overseeing a key function must in particular satisfy the following requirements:

  1. holds a university degree obtained in the Poland or another country in the meaning of the relevant laws in effect in that country, unless KNF issues a consent to forgo that requirement in view of the person's professional experience;
  2. meets the requirements set forth for Managers, referred to in items 2, 3, 4 and 7 above.

A key function holder must meet the requirements defined in his or her job description. Job descriptions for individual functions are drawn up based on PZU's organizational rules and regulations and the rules and regulations of a given organizational unit fulfilling the key function. The core requirements applicable to the aforementioned group of persons, broken down by key function, are described below:

  1. for positions in the actuarial function, the requirements include: knowledge of insurance and financial mathematics and professional experience and education which are adequate to perform the tasks required in the individual position;
  2. for positions in the risk management function, the requirements include: knowledge of underwriting risk assessment and underwriting risk provisioning, asset and liability management, capital investments - in particular in derivative instruments and similar financial instruments, liquidity and concentration risk management, operational risk management, reinsurance and other techniques of risk mitigation, as well as professional experience and education which are adequate to perform the relevant tasks;
  3. for positions in the internal audit function, the requirements include: knowledge of risk assessment, process analysis and designation, audit work methodology, good practices for business processes, skills of providing recommendations based on audit findings collected in the course of a planned audit, as well as professional experience and education which are adequate to perform the relevant tasks;
  4. for positions in the compliance function: the Company requires knowledge of compliance risk management, assessment of compliance risk, skills of developing system-based solution in the area of compliance risk as well as professional experience and education which are adequate to perform the relevant tasks.

B.2.2. Evaluation of competence and reputation of the persons who effectively run a PZU Group entity or have other key functions

In the PZU Group's insurance undertakings, the rules for evaluating competence and reputation of the persons who effectively run a PZU Group entity or have other key functions are applied relative to their respective levels of responsibility, the existing law and internal regulations. These rules are based on the regulations and processes that PZU has in place, as described below.

The principles governing the evaluation of competence and reputation of Managers, persons overseeing key functions and persons holding key functions are regulated separately.

In keeping with the foregoing, the bodies responsible for the fit and proper evaluation are:

  1. for Managers - the PZU Supervisory Board in the case of PZU Management Board Members and the PZU Management Board in the case of PZU Group Directors;
  2. for persons overseeing key functions - the PZU Management Board;
  3. for persons holding key functions - their direct supervisors. The evaluation of competence and reputation is conducted prior to the appointment to a key function or whenever the person is suspected of having acted in contravention with the law, which could result in particular in the subsidiary's non-compliance with the law or a financial crime.

The evaluation of competence and reputation of Managers and persons overseeing key functions is conducted prior to the appointment to be a Management Board Member or a PZU Group Director or to a position involving oversight over a key function. The assessment is verified on an annual basis as well as whenever the person is suspected of having acted in contravention with the law, which could result in particular in PZU's non-compliance with the law, financial crime or a threat to PZU's sound management.

The criteria applied in the above mentioned assessments are defined pursuant to the existing law, PZU's internal regulations and the relevant job description. The individual criteria are evaluated individually and form the basis for evaluating the person. The assessment is carried out based on the documents provided by the applicant confirming his or her compliance with the

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requirements, an assessment of his or her behavior and attitudes shown in the performance of professional duties, as well as information from other sources.

Every year, the PZU Management Board issues a report on the annual review of the fit and proper evaluation of the persons overseeing key functions in PZU. This Report has been prepared on the basis of § 3 sec. 2 item 3 of the Principles for conducting the fit and proper evaluation and review of persons overseeing key functions in PZU SA and PZU Życie SA.

Such reports are prepared on the basis of information and statements submitted or completed by persons overseeing key functions in PZU. During the review of the fit and proper evaluation, the obligated employees complete or confirm the documents and statements submitted earlier.

Based on the collected documents and also on the basis of knowledge as at the date of preparing the Report, if no indications arise that may change the fit and proper evaluation of the respective individuals, the HR Management Department recommends that the previous evaluation in this respect is upheld. If the HR Management Department at PZU learns of any circumstances that may affect its recommendation, it will immediately update it.

B.3. Risk management system, including own risk and solvency assessment

B.3.1. Description of the risk management system

PZU exercises supervision over the PZU Group's risk management system on the basis of cooperation agreements entered into with material subsidiaries. These agreements form the cooperation framework, among others for the risk management process in the PZU Group, enable the collection and processing of information necessary for adequate and effective management of risk at the PZU Group level. They also guarantee that the various risks generated by the individual companies in the PZU Group are assessed and are based on the same standards, taking into account the requirements and restrictions arising from the applicable law. The method of implementing the systems in the individual PZU Group companies matches their size, materiality of risks, sectoral regulations and specific regulations in effect in the respective countries.

The PZU Management Board has adopted the PZU Group's risk management strategy, in order to:

  • enhance value for all shareholders through active and deliberate management of the extent of risk taken;
  • prevent the acceptance of risk at a level that could pose a threat to the financial stability of the PZU Group or the PZU Group Financial Conglomerate.

Risk management in the PZU Group is based on analyzing risk in all processes and units and it is an integral part of the management process.

The risk management system in the PZU Group is based on the following:

  • split of duties and tasks performed by governing bodies, committees and organizational structures taking part in the risk management process;
  • risk management process, including risk identification, measurement and assessment, monitoring and control methods, risk reporting and undertaking management actions.

The consistent split of duties and tasks in the PZU and in individual subsidiaries is based on four decision-making levels. The first three entail the following:

  • supervisory boards, supervising the risk management process and assessing its adequacy and effectiveness, by way of decisions specified in the articles of association of the PZU Group entities and in their rules and regulations. In order to increase effectiveness of supervision performed by supervisory boards, among others in respect to the monitoring of effectiveness of the risk management system, supervisory boards may appoint audit committees;
  • management boards, which organize and ensure the operation of the risk management system by adopting risk management strategies and policies, defining the appetite for risk, the risk profile and tolerance for individual categories of risk;
  • committees, which make decisions to mitigate individual risks to a level determined by the risk appetite. The committees adopt procedures and methodologies for mitigating the individual risks and accept individual risk limits. The PZU Group

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Risk Committee provides support (for supervisory boards and management boards of subsidiaries) in the implementation of an effective risk management system consistent across the whole PZU Group. The operational objective of the PZU Group Risk Committee is to coordinate and supervise activities related to the Group's risk management system and processes.

The fourth decision-making level pertains to operational measures and is divided into three lines of defense:

  • the first line of defense - entails ongoing risk management at the level of organizational structures of individual PZU Group companies and decision-making as part of the risk management process, including the adopted limits. The management is responsible for the implementation of an effective risk management system in the supervised area of the activity, in particular for designing and ensuring efficient operation of identification and monitoring actions as integral components of operating processes, ensuring appropriate response to existing risks;
  • the second line of defense - risk management by specialized organizational structures of PZU Group companies responsible for identification, measurement, monitoring and reporting of risk and controlling the limits. Within the second line of defense, certain units in the PZU Head Office play a special role by coordinating the process among PZU Group entities: Risk Department, Compliance Department, Security Department, Planning and Controlling Department, Actuarial Department, Reinsurance Department, Legal Department and HR Department;
  • the third line of defense - internal audit which conducts independent audits of the individual elements of the risk management system, as well as of control activities embedded in operations of that PZU Group company. This function is performed by the internal audit unit.

The risk management process consists of the following stages:

  1. Identification of risks

The process commences with a proposal to start developing an insurance product, buying a financial instrument, modifying an operating process, as well as whenever some other event occurs that may potentially lead to the emergence of risk. The identification process continues until the expiration of liabilities, receivables or activities associated with the risk. Risk identification involves identification of actual and potential sources of risk, which are later analyzed in terms of significance.

  1. Risk measurement and assessment

Risk measurement and assessment are carried out depending on the nature of the given type of risk and the level of its importance. Risk measurement is carried out by specialized organizational structures within the respective PZU Group units. They are responsible for the development of tools and the measurement of risk in terms of risk appetite, risk profile and risk tolerance.

  1. Risk monitoring and control

Risk monitoring and control consists in the ongoing analysis of deviations from benchmarks (limits, threshold values, plans, figures from prior periods, recommendations and guidelines).

  1. Reporting

Reporting allows for effective communication on risk and supports risk management on various decision-making levels;

  1. Management actions

The management actions include among others: risk avoidance, risk transfer, risk mitigation, determination of risk appetite, acceptance of risk level, as well as the use of tools supporting such actions.

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Chart of the organizational structure for the risk management system

Supervisory boards

Audit Committees

Management

boards

1st line of defense

2nd line of defense

3rd line of defense

Organizational

Risk management

Internal audit

structure of the PZU

Compliance

Group

Security

Supervisory boards supervise over the risk management process and assessing its adequacy and effectiveness, by way of decisions specified in the articles of association of the PZU Group entities and in their rules and regulations.

Management boards organize and ensure the operation of the risk management system by adopting strategies, policies, setting the risk appetite, defining the risk profile and tolerance for individual categories of risk.

The committees make decisions to mitigate the various types of risk to a level based on risk appetite. The committees adopt the procedures and methodologies for mitigating various risks and they accept limits to mitigate the various types of risk. The structure of committees in each PZU Group entity matches the size and risk profile of that entity.

Specialized cells:

On-going risk

risk identification,

Independent audit of the

measurement and

management

risk management system

assessment, monitoring and

controlling and reporting

The risk management function at the PZU Group level is run by the Risk Department at PZU, which develops the risk management process by preparing and updating the relevant internal regulations relating to risk management (including recommendations for subsidiaries) and performs various activities related to risk management process, in particular:

  • the development and implementation of a risk management strategy and management policies for individual types of risk;
  • the development of measurement methods for individual types of risk;
  • the design and development of tools to support the risk management process;
  • the identification, measurement and assessment, monitoring and controlling of risks;
  • risk reporting and proposals of risk mitigating measures;
  • drafting the proposals regarding the limits and restrictions grid and the key risk indicators (KRI);
  • drafting control reports and monitoring the utilization of limits and restrictions;
  • preparation of risk management rules and methodologies;
  • preparation of risk information for the regulatory authority and rating agencies;
  • stress-testing;
  • acting as a competence center for risk management.

The person overseeing the risk management function is the Director of the Risk Department at PZU, who reports to a PZU Management Board Member responsible for risk management. The Risk Department at PZU is responsible for the risk management regime; in that process the Department collaborates with the relevant structures in the PZU Group.

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B.3.2. Own risk and solvency assessment

The own risk and solvency assessment (ORSA) process is an integral part of the financial planning process and consists of the following stages:

  • drafting and approval of the process assumptions in the given year;
  • drafting and approval by the relevant organizational structures of a PZU Group entity and then forwarding to the cells responsible for risk in that entity, of data consistent with the valuation adopted in the SII system and consistent with the PZU Group Strategy and financial plans of the PZU Group;
  • analysis and assessment of risks;
  • analysis of the fulfillment of requirements concerning technical provisions;
  • conducting an assessment of the capital required to implement the assumptions of the financial plan;
  • assessment of the capital condition of the PZU Group (aggregated) through stress testing;
  • analysis of the consistency with risk appetite and the risk profile;
  • proposal of changes regarding reduction in the risk exposure or increase of own funds, where necessary;
  • changes to the financial plan or draft financial plan, where necessary;
  • approval of the results of own risk and solvency assessment and initiation of possible management measures;
  • documenting the results of own risk and solvency assessment in the form of a report;
  • drafting of the own risk and solvency assessment protocol;
  • provision to the regulatory authority of the own risk and solvency assessment report for the authority's purposes.

The own risk and solvency assessment process, and the analysis it involves, have been designed to ensure support for the financial planning process in terms of risk profile analysis and evaluation of compliance with the capital requirements within the planned time horizon and the financial plan assumptions. It also constitutes the summary and review of efficiency of the measures taken in the risk management process.

The structure of the own risk and solvency assessment process and the responsibilities of its individual participants in the PZU Group have been adjusted to complement the obligations of the individual PZU Group units based on their decision-making powers specified in the system of governance and on the financial planning process. The PZU Management Board is responsible for organizing and ensuring efficient functioning of the own risk and solvency assessment process. Management Board members in subsidiaries overseeing the units participating in the process oversee the activities related to the own risk and solvency assessment process in their reporting areas and approve the data and analyses prepared in their areas that are required to conduct the own risk and solvency assessment. The Risk Department at PZU develops the PZU Group's own risk and solvency assessment process, coordinates the assessment as it is conducted and conducts an assessment of own solvency needs, continuous compliance with capital requirements and deviation of the risk profile from the assumptions underlying the calculation of the solvency capital requirement. All the prognostic data are delivered to the Risk Department at PZU through the intermediation of the PZU Planning and Controlling Department, which is responsible for their internal consistency and consistency with financial plans.

ORSA is conducted regularly, at least once a year or ad hoc, after the occurrence of material changes to the risk profile arising from changes in internal operations or changes in the business environment. The frequency of the own risk and solvency assessment process is consistent with the frequency of revisions of financial plans and the accompanying new business development projections corresponding to the implementation of the PZU Group Strategy and incorporating the changes resulting from portfolio growth and changes in the business environment.

The results of ORSA are documented in the form of a report. The report is subject to an independent review by the Internal Audit Department at PZU and then, after the PZU Group's Risk Committee issues its opinion on the report, it is subject to approval by the PZU Management Board.

The assessment of general solvency needs is conducted for all the risks identified as material in the PZU Group Strategy and the individual risk management policies, i.e. actuarial risk, market risk, counterparty insolvency risk and operational risk. The analysis also covers compliance risk and liquidity risk.

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The assessment of general solvency needs in 2019 covered the 3-year forecast horizon, taking into account the timeframe of the current PZU Group Strategy and the accompanying financial plans and the supervisory requirement for the minimum forecast horizon (three years). As part of the assessment of general solvency needs, analyses have been conducted to determine whether, with the current business strategy, the PZU Group would maintain the necessary capital level that is adequate to the risk it is currently exposed to and to which it may be exposed in the future (including in the case of sudden events reflected in stress-test scenarios). The tested scenarios have been designed on the basis of the PZU Group's risk profile, allowing for a review of its capital needs in new situations involving significant changes in the macroeconomic environment and also shocks typical for the insurance sector. Moreover, the analysis includes scenarios that affect both assets and liabilities.

If the own risk and solvency assessment identifies a potential decline in the solvency ratio below the acceptable level or an overrun of the risk profile limits, Director of the PZU Risk Department, in cooperation with Director of the PZU Planning and Controlling Department, presents the possible measures, including changes to financial plans, in order to mitigate the risk or to increase own funds. Those measures are then submitted for approval to the Member of the PZU Management Board overseeing the PZU Risk Department, in consultation with the Member of the PZU Management Board overseeing the PZU Planning and Controlling Department.

B.4. Internal control system

B.4.1. Description of the internal control system

The internal control system in the PZU Group comprises supervision, overall administrative and accounting procedures, organizational structures, reporting systems, solutions implemented in IT systems, the compliance function and other control mechanisms contributing to the attainment of the PZU Group's objectives and security and stability of its operations, implemented to ensure the following in a reasonable manner:

  • efficiency and effectiveness of the operating activity;
  • reliability of information communicated inside and outside the Company and assurance of availability and reliability of such information, in particular information affecting the financial statements;
  • adequacy and effectiveness of risk controls (control operations should be commensurate with the level of risk involved in the operations and processes under control);
  • responsible and transparent management,
  • compliance of the Company's activity with the law, internal regulations and the accepted standards of conduct;
  • efficient acquisition and transfer of any data and information that may be important to supplementary oversight.

The internal control system supports the attainment of objectives; as a result, the system must focus on the following areas:

  • internal control environment, i.e. promoting the importance of control among employees and promoting management supervision, management style, including delegation of tasks, honesty, ethical values and employee development;
  • risk identification and assessment, including containment at an acceptable level;
  • control activities and split of responsibilities;
  • quality and communication of information, i.e. ensuring the flow of information that enables the Company to run and control its operations;
  • monitoring of the efficiency of control mechanisms.

Relative to the type of tasks, the scope of internal control includes in particular:

  • completeness, up-to-dateness and compliance of the Company's relevant internal regulations with the existing law;
  • correctness, completeness and timeliness of activities, including document circulation;
  • correctness or organization and allocation of work;
  • observance of powers-of-attorney, authorizations, limits and other control elements, especially relating to: o signing of internal and external correspondence;

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  • o entering into transactions, which result in incurring liabilities; o business decision-making;

    o use of IT systems;

  • correctness of processes;
  • correctness of accounting records;
  • safety of IT systems and IT communication networks;
  • safety of protected information, within the meaning of the applicable internal regulations.

If an employee identifies irregularities found as a result of an inspection, the employee is obligated to document and notify them to his/her direct superior. At the same time, the employee is obligated to report irregularities in accordance with the applicable internal regulations.

B.4.2. Compliance function

PZU's Compliance Department is responsible for shaping the PZU Group's compliance system while ensuring its consistency across all levels within the PZU Group. PZU's Compliance Department reports to the Company's Management Board and Supervisory Board on all events occurring at the level of both PZU and the subsidiaries with which agreements on cooperation and exchange of information have been entered into. Recommendations issued by the Compliance Department at PZU as part of its activities and compliance analyses are subject to the monitoring process.

In each PZU Group company, the compliance function is arranged based on uniform and consistent standards developed at the PZU level in consideration of the 'proportionality principle', that is while taking into account the scale and specific nature of the pertinent PZU Group company. The internal regulations in place delineate the extent and nature of activities of the compliance function, including regular reporting by the subsidiaries' compliance units to PZU's Compliance Department, and then by PZU's Compliance Department to the PZU Management Board and Supervisory Board. This notwithstanding, the subsidiaries' compliance units also report to their own management boards or supervisory boards. The compliance function in PZU Group companies is objective and independent.

The most significant powers of PZU's Compliance Department in the area of compliance risk in the PZU Group are as follows:

  • analyzing and participating in the process of deploying systemic solutions in all functional areas of PZU Group companies and ongoing business processes in terms of compliance risk;
  • initiating and recommending changes in systemic solutions and analyzed processes in place at PZU Group companies ensuing from compliance analyses;
  • ensuring coordination and uniform solutions in deploying the compliance function and managing compliance risk in the PZU Group;
  • consulting and cooperating with subsidiaries in order to ensure uniform solutions in deploying the compliance function in the PZU Group, fulfilling reporting obligations arising from the Supplementary Oversight Act and adopting a consistent approach of the PZU Group's regulated subsidiaries to the preparation of responses to inquiries sent by the Polish Financial Supervision Authority systemically to regulated entities;
  • consulting and exchanging information with subsidiaries in order to ensure consistency in the process of compliance risk identification and assessment;
  • conducting systemic compliance analyses in PZU Group companies based on internal regulations, cooperation agreements and policies;
  • system-levelreporting on compliance risk in the PZU Group;
  • monitoring observance of the standards of conduct, including ethical standards, in consideration of the best practices adopted in PZU Group companies.

As part of the exchange of information and cooperation with subsidiaries in the area of the compliance function, PZU's Compliance Department participates in the deployment, in these companies, of uniform standards and key methodological solutions. The formal basis for cooperation in the area of the compliance function is provided by agreements on cooperation

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and exchange of information and the provisions of the PZU Group's Compliance Policy which define in detail the rules, extent and nature of such cooperation between PZU and its subsidiaries.

B.5. Internal audit function

B.5.1. Description of the implementation of the internal audit function

PZU's Internal Audit Department coordinates the operation of the internal audit function in PZU Group companies through creating uniform standards and exchanging information pertaining to internal audit. Internal audit obtains information from PZU Group companies, with which cooperation agreements have been signed, regarding the adequacy and effectiveness of their risk management and internal control systems. Key methodological solutions of PZU's Internal Audit Department have been introduced in PZU Group companies (taking into consideration their formal and legal context, specific nature and scale of business).

With respect to the PZU Group, the main tasks of PZU's Internal Audit Department are as follows:

  • harmonizing the rules of operation of internal audit;
  • coordinating the preparation of audit plans;
  • executing audit tasks;
  • obtaining information from internal audit units in PZU Group companies;
  • compiling information on PZU Group companies in reports on the activities of PZU's Internal Audit Department to the PZU Management Board and to the Audit Committee of the PZU Supervisory Board.

Internal audit in PZU Group companies may be pursued by:

  • internal audit units in PZU Group companies;
  • PZU's Internal Audit Department, in keeping with the rules resulting from the cooperation agreements entered into with PZU Group subsidiaries.

The scope of internal audit includes: an independent risk assessment, an examination of all organizational structures in PZU Group companies, products, systems, business processes and risk management processes, with a frequency that depends on the identified risk areas and the materiality of risks as well as on the role and effectiveness of internal control in mitigating those risks.

B.5.2. Independence and impartiality of internal audit

The internal audit function is impartial and independent of operational functions. The scope of audit activities performed in the individual audits and the post-audit evaluations are autonomous decisions of the auditors involved. The tasks are allocated in such a manner so as to prevent potential and actual conflicts of interest. Each employee is obligated to notify their superior if a conflict of interest occurs. Information on potential conflicts of interests is collected from internal audit employees and, where necessary, tasks are reallocated. Furthermore, an auditor cannot audit activities they have themselves performed or managed before one year has elapsed. PZU has implemented the Auditor's Code of Ethics, based on the Institute of Internal Auditors (IIA) Code of Ethics. The purpose of the Code is to promote best practices and models for ethical behavior, and to motivate the need for continuous professional improvement and development of the proper image of internal auditors. Internal auditors may not accept responsibility for any operational activity that is assessed by internal audit.

The independence of the internal audit function is guaranteed by the provisions of the pertinent internal regulations.

The PZU Group's auditors are a team of high professional and ethical qualifications, having the knowledge, skills and expertise in auditing.

To ensure the proper execution of their tasks, auditors have access to the necessary information, explanations, documents and data, allowing for the timely and correct performance of their duties, taking into account the restricted access to information prescribed by the generally applicable provisions of law.

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The Internal Audit Department at PZU prepares annual activity reports which include:

  • information on audits performed (including the achievement of the audit plan);
  • evaluation of the internal control system and the risk management system.

The Internal Audit Department at PZU also prepares quarterly reports covering he following issues in particular:

  • information on the progress in implementing the audit plan;
  • information on the findings of internal audits and on the recommendations made and rejected (risk acceptance);
  • information on recommendation monitoring results.

The reports are provided to the PZU Management Board and the Audit Committee of the PZU Supervisory Board and include information reported by internal audit units of PZU Group companies.

B.6. Actuarial function

PZU Group companies involved in the conduct of insurance business are separate entities and have their own actuarial functions in place. The tasks of actuarial functions are uniform across the PZU Group. Due to peculiarities of specific markets, certain methodological differences may exist between the activities undertaken by these functions in various companies. To the maximum extent possible, the functions in question operate on an independent basis. However, they remain in constant contact with each other and consult each other on their various doubts. The actuarial function at PZU plays the role of the coordinator and advisor of highest instance. Supervision over all issues in this area is exercised by the person overseeing the actuarial function at PZU.

Cooperation in the field of actuarial services in the PZU Group is aimed at optimizing the standards of operation and execution of business processes, ensuring the seamless flow of information between PZU and its insurance subsidiaries and guaranteeing the security of information provided. The subsidiaries exercise due care to ensure that their operations comply with the rules of cooperation in the PZU Group, without losing sight of their specific nature of activity and their particular legal or business considerations. The subsidiaries retain autonomy of their actuarial function, except that PZU plays a coordinating and advisory role in this field in relation to them, hence, on an as-needed basis, may interfere with their actuarial activities. In principle, PZU's cooperation with the subsidiaries is pursued on an ongoing basis by way of mutual consultations, with the reservation that PZU may provide guidelines, assumptions, rules, procedures and recommendations if it sees fit to do so in the interests of the PZU Group. The subsidiaries, within the time limits, in the form and manner defined sufficiently in advance, provide the following:

  • information necessary for the fulfillment, by PZU's actuarial function, of information or reporting duties imposed on PZU in accordance with the applicable provisions of law;
  • information, plans, materials and documents pertaining to the subsidiary and its subsidiaries along with explanations regarding such documentation, if necessary. The subsidiaries obtain from their own subsidiaries information and documents necessary to fulfill this duty;

Notwithstanding the above duties, the subsidiaries fulfill the information obligations required by the applicable laws and conduct their own information policy.

Accordingly, the extent of cooperation covers the broadly construed actuarial activities necessary to fulfill the duties of the actuarial function. The principles of cooperation were included in the "PZU Group Cooperation Policy in the Actuarial Area" implemented in 2018.

B.7. Outsourcing

The PZU Group's insurance companies have adopted the outsourcing rules, which also govern the outsourcing of activities that the Group considers core or important.

PZU and its insurance subsidiaries do not entrust to any third parties the performance of functions forming part of the management system (the risk management function, the actuarial function, the compliance function or the internal audit function).

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Outsourcing of basic or vital activities is justified in particular by the need to optimize costs and ensure high-quality customer service experience. These objectives are pursued by the PZU Group's insurance subsidiaries by entrusting the execution of selected processes to entities specializing in the provision of the services of a given kind.

Moreover, intra-Group outsourcing agreements have been entered into (between PZU Group companies), under which certain core or important activities are entrusted, for instance: investing funds, handling claims, providing benefits, including assistance services, investment portfolio management and rendering insurance administration services. Such intra-Group outsourcing agreements for core or important activities are entered into on a long-term basis, in keeping with the applicable outsourcing rules, especially in the area of risk assessment, and the required contractual provisions, including those securing the possibility of inspecting the performance of the contract by the entity entrusting the execution of activities.

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  1. Risk profile

PZU Group's risk profile results from the PZU Group's Strategy and financial plans; it is subject to periodical monitoring and control. Given the scale of insurance operations by the PZU Group companies and the amount of funds earmarked for investment, the most significant risks are actuarial risk, market risk and the risk associated with the activity of undertakings operating in other financial sectors. In the last item, credit risk is the most important.

The PZU Group has developed and implemented a risk management system that is focused on both controlling risk as well as on maintaining the appropriate capitalization level. Through identification, measurement, assessment, monitoring, control and reporting of risks related to its operating activity and taking management actions to address these risks, the PZU Group is able to fulfill its obligations to clients and business partners and comply with the requirements arising from existing laws and external regulations. In the PZU Group companies operating in the financial sector, the risk management system described in section B has been deployed and is based on the following stages:

  • identification;
  • measurement and assessment;
  • monitoring and control;
  • reporting;
  • management actions.

The process is standardized across the PZU Group. The method of its implementation in the subsidiaries matches their size, materiality of risks, sectoral regulations and specific regulations in effect in the respective countries.

The table below presents the risk categories defined as material and identified in the internal regulations at the PZU Group level:

No.

Risk category

Definition

the likelihood of a loss or an adverse change in the value of liabilities under the existing insurance

1

actuarial risk

contracts and insurance guarantee agreements, due to inadequate assumptions regarding premium

pricing and technical provisions

the risk of a loss or an adverse change in the financial situation resulting, directly or indirectly, from

2

market risk

fluctuations in the level and in the volatility of market prices of assets, credit spread, as well as value

of liabilities and financial instruments

counterparty default risk is the risk of a loss or an adverse change in the financial situation resulting

3

counterparty default risk

from fluctuations in the reliability and creditworthiness of issuers of securities, counterparties and all

debtors, materializing in the form of the counterparty's default on a liability

4

operational risk

operational risk is the risk of a loss resulting from improper or erroneous internal processes, human

activities, system failures or external events.

the risk of incurring financial losses, incorrectly estimating data reported to the regulatory authority,

5

model risk

taking incorrect decision or losing reputation as a result of errors in the development,

implementation or application of models

compliance risk is the risk that PZU, its subsidiaries or persons related thereto may infringe on the

existing law, internal regulations and standards of conduct adopted by PZU or its subsidiaries,

6

compliance risk

including ethical standards, which results or may result in PZU, its subsidiaries or persons acting on

their behalf being subject to legal sanctions, or incurring financial loss or else loss of reputation or

credibility

For the PZU Group Financial Conglomerate's purposes, given the share of credit risk tied to the banking sector entities, a credit risk definition was adopted. It is defined as risk of a loss or an adverse change in the financial standing to which the PZU Group Financial Conglomerate is exposed, resulting from fluctuations in the trustworthiness and creditworthiness of securities issuers, business partners and all debtors, materializing through the counterparty's default on a liability or an increase in credit spread. This definition also includes credit risk in a regulated entity.

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Powszechny Zakład Ubezpieczeń Spółka Akcyjna Group

Solvency and financial condition report as at and for the financial year ended 31 December 2019

The credit risk management process covers the following risk categories:

  • credit spread risk - the possibility of incurring loss as a result of changes in the value of assets, liabilities and financial instruments, caused by changes in the level or in the volatility of credit spreads over the term structure of the interest rates on debt securities issued by the State Treasury;
  • counterparty default risk - the possibility of incurring a loss as a result of unexpected default of counterparties and debtors or deterioration of their credit rating;
  • credit risk in banking activity - credit risk resulting from activity in the banking sector, associated mainly with the possibility that a debtor or borrower defaults on their obligations;
  • credit risk in financial insurance - possibility of incurring a loss resulting from business operations conducted in the financial insurance sector, related mainly to the possibility that a PZU Group customer defaults on its obligations to a third party, or a debtor/borrower defaults on its obligations to a PZU Group customer. This threat may result from failure to complete an undertaking or adverse influence of the business environment.

When managing each type of risk, the PZU Group identifies, measures and monitors risk concentration; for the banking sector, these processes occur at the level of respective PZU Group entities, according to requirements in the sector.

SCR of the PZU Group is calculated pursuant to Article 336 of the Delegated Regulation and consists of the following positions: a solvency capital requirement calculated on the basis of consolidated data following the rules laid down for the standard formula, the proportional share of the capital requirement (including hypothetical requirements) of undertakings from other financial sectors, the requirement for affiliated entities not consolidated by the full method. The solvency capital requirement is calculated on the basis of consolidated data and comprises the following 8 modules: market risk, counterparty default risk, actuarial risk in non-life insurance, actuarial risk in life insurance, actuarial risk in health insurance, intangible assets risk, operational risk and adjustment of technical provisions and deferred income taxation to cover losses. The first five modules are subject to the diversification effect; combined with the intangible assets risk, which is or marginal significance in Poland and equals zero at the PZU Group, the risks form the so-called basic solvency capital requirement (BSCR). In its SCR calculation, the PZU Group does not apply the transitory provisions.

The table below presents the value of the solvency capital requirement SCR and BSCR before and after the diversification effect as at 31 December 2019 and compared to the preceding year.

Sub-module name

Value (in million PLN)

Change 2019/2018

2019

2018

(PLN million)

%

Market risk

3,221

3,105

116

4%

Counterparty default risk

361

460

(99)

(22%)

Actuarial life insurance risk

2,555

2,470

85

3%

Actuarial risk in health insurance

253

219

34

16%

Actuarial non-life insurance risk

4,032

3,918

114

3%

Basic solvency capital requirement before diversification

10,422

10,172

250

2%

Diversification

(3,549)

(3,463)

(86)

2%

Basic solvency capital requirement after diversification

6,873

6,709

164

2%

Operational risk

753

731

22

3%

Adjustment for the loss-absorbing capacity of deferred taxes

(974)

(924)

(50)

5%

Solvency capital requirement calculated on the basis of

6,652

6,516

136

2%

consolidated data

Capital requirement for other financial sectors

3,728

3,626

102

3%

Requirement for non-consolidated related business units

18

87

(69)

(79%)

PZU Group SCR

10,398

10,229

169

2%

The SCR for the PZU Group increased by PLN 169 million on an annual basis. The increase was driven mainly by the higher market risk and actuarial risk. The reasons for the SCR changes for specific types of risk are described in the relevant chapters below.

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Powszechny Zakład Ubezpieczeń Spółka Akcyjna Group

Solvency and financial condition report as at and for the financial year ended 31 December 2019

Basic solvency capital requirement

2%

Actuarial non-life insurance risk

3%

Market risk

25%

39%

Actuarial health insurance risk

Counterparty default risk

31%

Actuarial health insurance risk

The PZU Group implemented internal procedures which transpose the obligations resulting from the principle of the prudent investor. As a result, the PZU Group invests its funds exclusively into assets and financial instruments for which it is able to measure, monitor and consequently manage the risks involved and properly incorporate them into the assessment of the overall solvency needs. Having ensured an adequate level of investment liquidity, the PZU Group invests into low-risk assets of sufficient quality and profitability. When investing assets covering the technical provisions for solvency purposes, the PZU Group takes into account the nature and duration of the existing insurance contracts, in keeping with the policyholder interests. The PZU Group diversifies and disperses its assets in order to avoid over-exposure to one single asset class, issuer or geographical area.

Stress-testing and sensitivity analyses

At the PZU Group level, sensitivity analyses have been conducted for market, credit and actuarial risks as well as for other material risks and events according to the scenarios prepared for the purposes of ORSA. Sensitivity analysis is, in principle, not applicable to the risks described in part C.6 because of the nature and specificity of those risks.

As part of the analyses, the PZU Group also conducts a liquidity assessment, which involves estimation of the possibilities of financing the payouts of claims and benefits as a result of insurable events of extraordinary nature. Stress testing results indicate that such events can be financed.

Under the own risk and solvency assessment (ORSA), the sensitivity analysis for the PZU Group covered stress tests of both assets and liabilities. The stress tests selected for execution as part of ORSA cover the major areas of insurance activity and the PZU Group's risk profile and correspond to the assessment of the key risks in its activity.

The stress tests were carried out based on the principles contained in Solvency II. Each test was conducted independently, with the assumed change of the designated elements in the tests and maintenance of the remaining ratios at the base scenario level. A stress test takes into account a change in own funds and in the solvency capital requirement in order to examine its total impact on the PZU Group's capital standing.

The test results do not reflect the impact of potential actions taken by the management boards of PZU Group companies to mitigate the impact of a materialized scenario. In fact, given the risk management system in place in the PZU Group, in particular the system of limits and restrictions, the management boards of PZU Group companies, especially PZU as the parent company, may take appropriate actions to prevent or mitigate the impact should the scenario materialize.

The stress test results show that, in 2019, the PZU Group held sufficient own funds to maintain the solvency ratio above the levels required by the KNF after a test scenario materializes.

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Powszechny Zakład Ubezpieczeń Spółka Akcyjna Group

Solvency and financial condition report as at and for the financial year ended 31 December 2019

The table below presents the sensitivity analysis tests performed for the purposes of ORSA. The tests were carried out in 2019 as part of the prospective assessment of the PZU Group's capital standing in the ORSA process and refer to the solvency ratio levels at the end of 2019 projected when the stress tests were carried out.

Change to the

No.

Stress tests / sensitivity analysis

Risk impact

value of base

solvency ratio

(in p.p.)

1

Increase in interest rates (+200 bps)

Market risk

2

2

Reduction in interest rates (-200 bps)

Market risk

(17)

3

Change of the shape of the interest rate curve (based on the curve generated

Market risk

-

by the value at risk calculation model for market risk in the 1 of 200 scenario)

4

Decrease in share prices (-50%)

Market risk

(3)

5

Decrease in real estate prices (-30%)

Market risk

(9)

6

Increase in FX rate (+30%)

Market risk

(2)

7

Decrease in FX rate (-30%)

Market risk

(1)

8

Counterparty default (the test assumes insolvency of two counterparties with

Counterparty default risk

(15)

the PZU Group's highest exposure among BB and lower rated counterparties)

9

Higher loss ratio (+10 percentage points)

Actuarial risk

(7)

10

Increase in the gross claims provision (+10%+max(PNR,0)) excluding the

Actuarial risk

(11)

provision for annuities

11

Catastrophic loss - single

Actuarial risk

(3)

12

Catastrophic loss - multiple

Actuarial risk

(7)

13

Extraordinary loss

Actuarial risk

(18)

14

Concurrent reduction in interest rates (-200 basis points) and higher loss ratio

Actuarial risk / market risk

(24)

by 10 percentage points

15

Concurrent increase in interest rates (+200 basis points) and higher loss ratio

Actuarial risk / market risk

(4)

by 10 percentage points

16

Increase in mortality rates (+15%)

Actuarial risk

(12)

17

Reduction in mortality rates (-20%)

Actuarial risk

(4)

18

Increase in morbidity rates (+35%)

Actuarial risk

(7)

19

Increase in costs used to calculate technical provisions (+10)

Actuarial risk

(5)

20

Increase in lapse rates (+80%)

Actuarial risk

-

21

Decrease in lapse rates (-80%)

Actuarial risk

(2)

Combined scenarios - the most severe changes for the individual business

22

lines resulting from scenarios 16, 18, 19 (maximum decline of premiums,

Actuarial risk

(26)

increase in benefits and increase in costs)

23

Concurrent reduction in interest rates (-200 basis points), decrease in stock

Actuarial risk / market risk

(31)

prices (-50%) and increase in mortality rates (+15%)

24

Concurrent increase in interest rates (+200 basis points), decrease in stock

Actuarial risk / market risk

1

prices (-50%) and higher mortality rate (+15%)

Exposure to risk arising from off-balance sheet items

As at 31 December 2019, the value of off-balance sheet items included in the capital requirements calculations was PLN 174,124 million and included in particular: collateral held and granted, guarantees received and contingent liabilities.

44

Powszechny Zakład Ubezpieczeń Spółka Akcyjna Group

Solvency and financial condition report as at and for the financial year ended 31 December 2019

Risk concentration

Within actuarial risk, the PZU Group identifies concentration risk in terms of locations in Poland with regard to possible losses caused by natural disasters, such as, in particular, floods and cyclones. The table below presents sums insured in the assigned ranges by geographic locations in the territory of Poland. The highest risk concentration is seen in Mazowieckie voivodeship. With regard to the exposure to the risk of floods and cyclones, the risk management system in the PZU Group allows to monitor it regularly and the reinsurance program in place reduces significantly the potential net catastrophic loss levels.

Exposure to catastrophic losses in

Sum insured (in PLN m)

property insurance

0-0,2

0.2 -0.5

0.5 -2

2 -10

10 -50

above 50

Total

as at 31 December 2019

Dolnośląskie

1.1%

1.5%

1.2%

0.6%

0.4%

2.1%

6.9%

Kujawsko-Pomorskie

0.6%

0.7%

0.5%

0.4%

0.3%

1.4%

3.9%

Lubelskie

0.6%

0.6%

0.3%

0.2%

0.1%

1.8%

3.6%

Lubuskie

0.3%

0.3%

0.2%

0.2%

0.1%

0.4%

1.5%

Łódzkie

0.7%

1.0%

0.7%

0.3%

0.3%

4.9%

7.9%

Małopolskie

0.8%

1.6%

0.9%

0.5%

0.4%

1.7%

5.9%

Mazowieckie

1.7%

2.5%

2.1%

0.9%

1.0%

9.6%

17.8%

Opolskie

0.3%

0.4%

0.3%

0.1%

0.1%

1.2%

2.4%

Podkarpackie

0.6%

0.8%

0.3%

0.2%

0.2%

0.8%

2.9%

Podlaskie

0.3%

0.4%

0.3%

0.2%

0.1%

0.3%

1.6%

Pomorskie

0.6%

0.9%

0.8%

0.5%

0.5%

3.8%

7.1%

Śląskie

1.2%

1.5%

0.9%

0.5%

0.3%

3.3%

7.7%

Świętokrzyskie

0.4%

0.5%

0.2%

0.1%

0.1%

0.8%

2.1%

Warmińsko-Mazurskie

0.4%

0.4%

0.3%

0.2%

0.1%

0.6%

2.0%

Wielkopolskie

1.1%

1.6%

1.3%

0.7%

0.6%

3.0%

8.3%

Zachodniopomorskie

0.3%

0.4%

0.4%

0.4%

0.4%

2.8%

4.7%

Lithuania and Estonia

0.8%

1.8%

2.5%

0.9%

1.2%

2.2%

9.4%

Latvia

0.1%

0.6%

0.8%

0.4%

0.4%

0.8%

3.1%

Ukraine

0.1%

0.0%

0.1%

0.1%

0.1%

0.6%

1.0%

Norway

0.0%

0.0%

0.0%

0.0%

0.0%

0.2%

0.2%

Total

12.0%

17.5%

14.1%

7.4%

6.7%

42.3%

100.0%

In addition, within the portfolio of the PZU Group's clients, we identify significant concentrations on high corporate risks which are subject to facultative reinsurance reducing possible net losses to acceptable levels, not threatening the PZU Group's financial stability.

With respect to credit and market risks, concentration of risk in the PZU Group is identified jointly at the level of groups, sectors of the economy and countries. The analysis covers exposures from the portfolio of assets of consolidated entities, corporate insurance, PZU financial insurance and exposures of banking sector entities.

45

Powszechny Zakład Ubezpieczeń Spółka Akcyjna Group

Solvency and financial condition report as at and for the financial year ended 31 December 2019

As at 31 December 2019, the following risk concentrations were identified with respect to specific sectors, at the level of a percentage in the total amount of the analyzed exposure (taking into account the exposures from the portfolio of assets of consolidated entities, PZU financial insurance and exposures of banking sector entities):

Industry segment

%

Public administration and defense

30.54%

Financial and insurance activities

9.81%

Manufacturing

13.20%

Wholesale and retail trade; repair of motor vehicles

11.29%

Real estate activities

8.07%

Construction

4.79%

Transportation and storage

4.62%

Production and supply of electricity, gas, steam, hot water

4.50%

Information and communication

2.33%

Other professional, scientific and technical activity

2.56%

Mining and quarrying

1.01%

Other sectors

7.28%

Total

100.00%

The PZU Group also identifies significant and particularly significant risk concentrations with respect to counterparties for which thresholds are set for significant concentrations at the lower of the following levels: 3% of the best estimate of provisions or 10% of the PZU Group's SCR, and for particularly significant concentrations at the lower of the following levels: 6% of the best estimate of provisions or 20% of the PZU Group's SCR. Significant concentrations are reported annually, while particularly significant concentrations - whenever a threshold is exceeded.

No concentration risk was identified within operational risk and other significant risks.

To meet the regulatory obligations imposed on groups identified as financial conglomerates, numerous initiatives were undertaken in 2019 to implement a model to manage significant risk concentration in the PZU Group Financial Conglomerate in keeping with the requirements of the Supplementary Oversight Act. A portion of this work will also be continued in 2020.

C.1. Actuarial risk

In accordance with the standard formula for calculating capital requirements for actuarial risk, the PZU Group applies: actuarial risk module in non-life insurance, actuarial risk module in life insurance and actuarial risk module in health insurance. Sales of health insurance products was not assigned to a separate distribution channel and is handled by separate sales networks of non-life and life insurance companies. In view of separate management models for health insurance products in both types of sales networks and slight actuarial risk of health insurance, no separate risk management systems were distinguished for health insurance. Products similar in their properties to life insurance products are managed as life insurance, whereas other ones are managed as non-life insurance.

C.1.1. Actuarial risk in life insurance

Risk identification commences with an insurance product development process and continues until the expiry of the related liabilities. The identification of actuarial risk is performed, among others, as follows:

  • an analysis of the general terms and conditions of insurance with respect to the accepted risk and compliance with the existing laws;
  • analyzing the general / specific terms and conditions of insurance or other model agreements with respect to the actuarial risk accepted on their basis;
  • recognizing the potential risks related to a given product to measure and monitor them at a later time;
  • analyzing the impact exerted by the introduction of new insurance products on capital requirements and risk margin computed using the standard formula;

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Powszechny Zakład Ubezpieczeń Spółka Akcyjna Group

Solvency and financial condition report as at and for the financial year ended 31 December 2019

  • verifying and validating modifications to products;
  • assessing actuarial risk through the prism of similar existing products;
  • monitoring of existing product;
  • analyzing the policy of underwriting, tariffs, provisions, reinsurance and the claims and benefits handling process.

The assessment of actuarial risk consists in the identification of the degree of the risk or a group of risks that may lead to a loss, and in an analysis of risk elements in order to make an underwriting decision that results in a liability. The scope of granted insurance cover and the set amount of insurance premium should be taken into account while assessing actuarial risk. The assessment of actuarial risk refers to two basic types of insurance products - individual and group insurance. In the case of individual insurance products, the aim of assessing actuarial risk is to reduce adverse selection, i.e. entering into insurance agreements by high-risk persons for whom the frequency of occurrence of insurable events (e.g. an accident, disease, disability or death) is higher than average, having no cash to pay for insurance costs or wanting to enter into an insurance agreement for an economically unjustified sum insured. The objective of actuarial risk assessment in group insurance products is assessment of future loss ratio of the group and reduction of adverse selection, i.e. so that high-risk persons for whom the frequency rate of occurrence of insurable events exceeds the assumed level do not enter into insurance agreements.

The actuarial risk assessment process undergoes continual evolution designed to adapt the applied measures to the changing external environment, achieve more effective product profitability management and organizational changes and modify the product offering.

The measurement of actuarial risk is performed in particular by the way of:

  • an analysis of selected ratios;
  • the scenario method - an analysis of impairment arising from an assumed change in risk factors;
  • the factor method - a simplified version of the scenario method, reduced to one scenario per risk factor;
  • statistical data;
  • exposure and sensitivity measures;
  • application of the expertise of the Company's employees.

Monitoring and controlling actuarial risk involves a regular analysis of the level of risk and determining the degree of utilization of the established borderline values of actuarial risk tolerance and limits.

The purpose of reporting is to engage in effective communication on actuarial risk and to support management of this risk at various decision-making levels from an employee to the supervisory boards of PZU Group companies. The frequency of each report and the scope of information provided therein are tailored to the information needs at each decision-making level.

The management actions taken in the course of the actuarial risk management process are performed in particular by the way of:

  • defining tolerance for actuarial risk and monitoring it;
  • business decisions and sales plans;
  • calculation and monitoring of the adequacy of technical provisions;
  • tariff strategy, monitoring of current estimates and assessment of the premium adequacy;
  • the process of assessment, valuation and acceptance of actuarial risk;
  • application of tools designed to mitigate actuarial risk, including in particular reinsurance and prevention. In PZU, actuarial risk is mitigated mainly through the following activities:
  • definition of the scope of liability in the general terms and conditions of insurance;
  • definition of the exclusion of liability in the general terms and conditions of insurance;
  • reinsurance actions;
  • application of an adequate tariff policy;
  • application of the appropriate methodology for calculating technical provisions;
  • application of an appropriate procedure to assess underwriting risk;

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Powszechny Zakład Ubezpieczeń Spółka Akcyjna Group

Solvency and financial condition report as at and for the financial year ended 31 December 2019

  • application of a correct benefits handling procedure;
  • sales decisions and plans;
  • prevention.

In 2019, there was an increase in actuarial risk in life insurance, resulting predominantly from portfolio development and update of statistical assumptions. Details can be found in the tables in part C.1.3.

C.1.2. Actuarial risk in non-life insurance

Risk identification commences with an insurance product development process and continues until the expiry of the related liabilities. The identification of actuarial risk is performed, among others, as follows:

  • an analysis of the general terms and conditions of insurance with respect to the accepted risk and compliance with the existing laws;
  • an analysis of the general/specific terms and conditions of insurance or other model agreements with respect to the relevant actuarial risk being undertaken;
  • identification of potential risks related to a given product for the purposes of subsequent measurement and monitoring;
  • an analysis of the impact exerted by the introduction of new insurance products on the capital requirements and risk margin computed according to the standard formula;
  • verification and validation of changes to products;
  • an assessment of actuarial risk with reference to similar existing insurance products;
  • monitoring of existing product;
  • an analysis of the underwriting, tariff, provisioning and reinsurance policies and the claims and benefits handling process.

The assessment of actuarial risk consists in the identification of the degree of the risk or a group of risks that may lead to a loss, and in an analysis of risk elements in order to make an underwriting decision.

The actuarial risk assessment process undergoes continual evolution designed to adapt the applied measures to the changing external environment, achieve more effective product profitability management and organizational changes and modify the product offering. Any changes that occurred in 2019 were not material.

The measurement of actuarial risk is performed in particular by the way of:

  • an analysis of selected ratios;
  • the scenario method - an analysis of impairment arising from an assumed change in risk factors;
  • the factor method - a simplified version of the scenario method, reduced to one scenario per risk factor;
  • statistical data;
  • exposure and sensitivity measures;
  • application of the expertise of the Company's employees.

The monitoring and control of actuarial risk includes a risk level analysis by means of a set of reports on selected ratios.

The purpose of reporting is to engage in effective communication on actuarial risk and to support management of this risk at various decision-making levels from an employee to the supervisory boards of PZU Group companies. The frequency of each report and the scope of information provided therein are tailored to the information needs at each decision-making level.

The management actions taken in the course of the actuarial risk management process are performed in particular by the way of:

  • identification of the tolerance level for actuarial risk and its monitoring;
  • business decisions and sales plans;
  • calculation and monitoring of the adequacy of technical provisions;
  • tariff strategy, monitoring of current estimates and assessment of the premium adequacy;

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Powszechny Zakład Ubezpieczeń Spółka Akcyjna Group

Solvency and financial condition report as at and for the financial year ended 31 December 2019

  • the process of assessment, valuation and acceptance of actuarial risk;
  • application of tools designed to mitigate actuarial risk, including in particular reinsurance and prevention. In PZU, actuarial risk is mitigated mainly through the following activities:
  • definition of the scope of liability in the general terms and conditions of insurance and other model agreements;
  • co-insuranceand reinsurance;
  • application of an adequate tariff policy;
  • application of the appropriate methodology for calculating technical provisions;
  • application of an appropriate procedure to assess underwriting risk;
  • application of a correct claims handling procedure;
  • sales decisions and plans;
  • prevention.

In the area of premium and provisioning risk, the following actions are carried out:

  • active monitoring of the combined ratio;
  • an analysis of the impact of changes in the external environment on the statistical data used to calculate premiums and provisions;
  • proactive monitoring of results achieved on individual products;
  • a reinsurance program designed to mitigate potential financial losses resulting from an unexpected increase in loss ratio. As regards catastrophic risk in non-life insurance, the following actions are carried out:
  • monitoring of changes in portfolio exposure;
  • monitoring of the reinsurance program's volume and deductible, including potential modification thereof in order to mitigate losses resulting from catastrophic events;
  • exposure map for non-life insurance;
  • creation of a flooding risk model, to be used in a wide spectrum of business applications (including underwriting, tariff- setting) and a flooding exposure map.

In 2019, actuarial risk in non-life insurance increased slightly due to growth of the non-life insurance business. Details can be found in the tables in section C.1.3.

Reinsurance protection in the PZU Group secures insurance activity, limiting the consequences of the occurrence of catastrophic phenomena that could adversely affect the financial standing of PZU Group.

C.1.3. Quantitative data about actuarial risk

The table below presents the capital requirements for actuarial risk and its sub-modules as at the end of 2019, compared to 2018.

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Powszechny Zakład Ubezpieczeń Spółka Akcyjna Group

Solvency and financial condition report as at and for the financial year ended 31 December 2019

Actuarial risk in non-life insurance

Value (in million PLN)

Change 2019/2018

Sub-module name

2019

2018

(PLN

%

Comments

million)

Premium and provisioning

Increase in the planned premium and cash flows in

3,643

3,569

74

2%

connection with development of the non-life insurance

risk

business

Increase in the exposure to catastrophic risk and planned

Catastrophic risk

888

776

112

14%

premium in connection with development of the non-life

insurance business

Lapse risk

763

789

(26)

(3%)

Adjustment of expectations regarding the combined ratio

Diversification

(1,262)

(1,216)

(46)

4%

Actuarial non-life risk

4,032

3,918

114

3%

Actuarial risk in non-life insurance

Premium and provisioning risk

14%

17%

Catastrophic risk

69%

Lapse risk

Actuarial risk in life insurance

Value (in million PLN)

Change 2019/2018

Sub-module name

2019

2018

(PLN

%

Comments

million)

Mortality risk

1,563

1,523

40

3%

Development of the life insurance portfolio along with expansion of

actuarial models and update of statistical assumptions

Longevity risk

370

321

49

15%

Growth in annuity liabilities arising from non-life insurance and

change of the discount curve

Morbidity risk

659

651

8

1%

Development of the life insurance portfolio along with expansion of

actuarial models and update of statistical assumptions

Lapse risk

653

631

22

3%

Development of the life insurance portfolio along with expansion of

actuarial models and update of statistical assumptions

Development of the life insurance portfolio along with expansion of

Cost risk

520

479

41

9%

actuarial models and update of statistical assumptions pertaining

to costs

Risk of disability pension

147

134

13

10%

Growth in disability pension liabilities arising from non-life and

revision

accident insurance

Catastrophic risk

522

516

6

1%

Development of the life insurance portfolio along with expansion of

actuarial models and update of statistical assumptions

Diversification

(1,879)

(1,785)

(94)

5%

Actuarial risk in life

2,555

2,470

85

3%

insurance

50

Powszechny Zakład Ubezpieczeń Spółka Akcyjna Group

Solvency and financial condition report as at and for the financial year ended 31 December 2019

Actuarial risk in life insurance

Mortality risk

8% 3%

Morbidity risk

12%

35%

Lapse risk

12%

Catastrophic risk

Cost risk

15%

15%

Longevity risk

Risk of disabilty pension revision

Health underwriting risk

Value (in million PLN)

Change 2019/2018

Sub-module name

2019

2018

(PLN

%

Comments

million)

Development of the portfolio of health insurance treated

Health life risk

84

71

13

18%

as life insurance along with expansion of actuarial

models and update of statistical assumptions

Increase in the planned premium for loss of income

Health non-life risk

186

161

25

16%

insurance as a result of development of the health

insurance business

Health catastrophic risk

37

37

-

0%

Stable level

Diversification

(54)

(50)

(4)

8%

Actuarial health risk

253

219

34

16%

Health underwriting risk

Health non-life risk

12%

27%

Health life risk

61%

Health catastrophic risk

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C.2. Market risk

Market risk identification consists in the identification of actual and potential sources of this type of risk. For assets, the market risk identification process begins with the decision to commence transactions in a given type of financial instrument. Organizational structures in PZU Group companies that make the decision to commence transactions in a given type of financial instrument draw up a description of the instrument, containing, in particular, a description of the risk factors involved, and provide it to the risk cell, which proceeds with the identification and assessment of the market risk.

The process of market risk identification associated with insurance liabilities commences with the process of developing an insurance product and involves identification of the relationship between the cash flows generated by that product and the relevant market risk factors. The identified market risks are subject to assessment using the criterion of materiality, i.e. whether the materialization of risk entails a loss capable of affecting the financial condition of the relevant PZU Group company.

Market risk is measured using the following risk measures:

  • VaR, value at risk: a measure of risk quantifying the potential economic loss that will not be exceeded within a period of one year under normal conditions, with a probability of 99.5%;
  • standard formula;
  • exposure and sensitivity measures;
  • accumulated monthly loss.

When measuring market risk, the following particular stages can be identified:

  • collection of information on assets and liabilities that generate market risk;
  • calculation of the value of the risk.

The risk is measured:

  • daily - for exposure and sensitivity measures of the instruments in systems used by particular PZU Group companies;
  • monthly - when using the value at risk calculation model for market risk or a standard formula.

Market risk is monitored and controlled internally in the organizational units responsible for operational management of market risk and - in parallel - independently by the risk cell. The monitoring of market risk consist in an analysis of the level of risk and of the utilization of the designated limits. The risk is monitored on a daily and monthly basis, in accordance with the defined limits.

Reporting involves communicating the level of market risk, the effects of monitoring and control to various decision-making levels. The frequency of each report and the scope of information provided therein are tailored to the information needs at each decision-making level.

Management actions in respect to market risk involve in particular:

  • transactions to mitigate market risk, i.e. selling a financial instrument, closing a derivative, or purchasing a hedging derivative;
  • diversification of the assets portfolio, in particular with respect to market risk categories, maturities of instruments, concentration of exposure in one entity, geographical concentration;
  • setting market risk restrictions and limits.

The application of limits is the primary management tool to maintain a risk position within the acceptable level of risk tolerance. The structure of limits for the various categories of market risk and also for the various business units is established in such a manner that the limits are consistent with the risk profile and risk tolerance set by the management boards of subsidiaries.

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The table below presents the capital requirements for market risk and its sub-modules as at the end of 2019, compared to 2018.

Sub-module name

Value (in million PLN)

Change 2019/2018

2019

2018

(PLN million)

%

Equity price risk

720

626

94

15%

Concentration risk

195

257

(62)

(24%)

Foreign exchange risk

872

1,100

(228)

(21%)

Property price risk

909

905

4

0%

Interest rate risk

472

498

(26)

(5%)

Credit spread risk

1,280

1,058

222

21%

Diversification

(1,227)

(1,339)

112

(8%)

Market risk

3,221

3,105

116

4%

Market risk

Credit spread risk

11%

4%

29%

Property price risk

Currency risk

16%

20%

20%

Equity price risk

Interest rate risk

Concentration risk

The largest portion of the market risk module at the end of 2019 was credit spread risk, real property price risk and currency risk.

In 2019, market risk SCR increased 4%, driven mainly by the higher capital requirements in the credit spread risk sub-module. The increase in SCR for the credit spread risk was a consequence of the adopted investment strategy aimed at increasing exposure to foreign corporate bonds. The decrease in currency risk was associated with improved efficiency and scope of the use of derivatives as techniques for mitigating the risk associated with credit instruments.

C.3. Credit risk/counterparty default risk

Credit risk is identified at the stage of making a decision on an investment in a new type of financial instrument or on accepting credit exposure to a new entity. Such identification involves an analysis of whether the contemplated investment entails credit risk, what its level depends on and what its volatility over time is. Both actual and potential sources of credit risk are identified.

Underwriting consists of estimating the probability of realization of a specific risk and estimating the potential impact of its realization on the financial standing.

Credit risk is measured using:

  • measures of exposure (gross and net credit exposure and maturity-weighted net credit exposure);
  • capital requirement calculated using the standard formula.

Monitoring and control of credit risk involves an analysis of the current risk level, assessment of creditworthiness and calculation of the degree of utilization of existing limits.

At the PZU Group, monitoring is conducted in the following cycles:

  • monthly - for financial insurance exposures;

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  • quarterly - for outward reinsurance exposures;
  • monthly - for risk limits based on the values calculated using the standard formula;
  • daily - for other exposure limits.

Reporting involves communicating the levels of credit risk and concentration risk and the effects of monitoring and control to various decision-making levels. The frequency of each report and the scope of information provided therein are tailored to the information needs at each decision-making level.

Management actions in respect of credit risk in the insurance part of the PZU Group involve in particular:

  • setting limits to curtail exposure to a single entity, group of entities, sectors or states;
  • diversification of the portfolio of assets and financial insurance, especially with regard to state, sector;
  • acceptance of collateral;
  • execution of transactions serving the purpose of mitigation of credit risk, i.e. selling a financial instrument, closing a derivative, purchasing a hedging derivative, restructuring a debt;
  • reinsurance of the financial insurance portfolio.

To mitigate credit risk, the banks in the PZU Group apply such restrictions as:

  • limit of exposures to single entities or entities related by capital or organizational ties;
  • limit of exposures to entities from the same industry, economic sector, conducting the same business activity or trading in similar commodities;
  • limit of exposures to entities from the same voivodeship and particular countries or groups of countries;
  • limit of exposures secured by the same collateral or secured by the same collateral supplier (including the risk following from collateral on securities of similar nature);
  • limit of exposures in the same currency.

The structure of credit risk limits for each issuer is established such a manner that the limits are consistent with the risk profile and risk tolerance approved by the management boards of each PZU Group company. In the case of other exposures, credit risk concentration is mitigated by setting limits to reduce the exposure to single entities, groups of entities and credit limits for sectors and states other than Poland by appropriate committees.

In 2019, counterparty default risk (CDR) was 3.5% of the total value of the PZU Group's SCR. Compared to 2018, the above percentage decreased by 1 p.p. The decline in the counterparty default risk resulted mainly from the lower level of financial receivables under outstanding transactions on financial instruments.

Credit risk includes counterparty default risk, credit spread risk and asset concentration risk. In accordance with the requirements defined by the SII Directive, credit spread risk and concentration risk are included in the market risk module and the data for the capital requirement are presented there. In 2019, no significant changes were made to assessment methods of credit risk and counterparty default risk.

In the case of other exposures, credit risk concentration is mitigated by setting limits to reduce the exposure to single entities, groups of entities and credit limits for sectors and states other than Poland by the Investment Risk Committee and the Investment Committee.

The PZU Group performs regular reviews of the set limits together with an analysis of concentration risk.

C.4. Liquidity risk

Financial liquidity risk means the possibility of losing the capacity to settle, on an ongoing basis, the PZU Group's liabilities to its clients or business partners. Liquidity risk is managed separately for the insurance part and the bancassurance part. The aim of the liquidity risk management system is to maintain the capacity of fulfilling the Company's liabilities on an ongoing basis.

The risk identification involves analysis of the possibility of occurrence of unfavorable events, in particular:

  • shortage of liquid cash to satisfy the current needs of the given PZU Group company;
  • lack of liquidity of financial instruments held;

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  • the structural mismatch between the maturity of assets and liabilities.

In the insurance portion, risk measurement and assessment are carried out from the following perspectives:

  • liquidity gaps (static, long-term financial liquidity risk) - by monitoring a mismatch of net cash flows resulting from insurance contracts executed until the balance sheet date and inflows from assets to cover insurance liabilities in each period, based on a projection of cash flows;
  • potential shortage of financial funds (medium-term financial liquidity risk) - through analysis of historical and expected cash flows from the operating activity;
  • stress tests (medium-term financial liquidity risk) - by estimating the impact of selling the portfolio of financial investments in a short period to satisfy liabilities arising from the occurrence of extraordinary insurable events;
  • current statements of estimates (short-term financial liquidity risk) - by monitoring demand for cash reported by other business units in the organizational structure of the given insurance undertaking from the PZU Group by the date defined in regulations which are in force in that unit.

The banks in the PZU Group employ the liquidity risk management metrics stemming from sector regulations, including Recommendation P issued by the KNF.

To manage the liquidity of the banks in the PZU Group, liquidity ratios are used for different periods ranging from 7 days, to a month, to 12 months and to above 12 months.

Within management of liquidity risk, banks in the PZU Group also perform analyses of the maturity profile over a longer term, depending to a large extent on the adopted assumptions about development of future cash flows connected with items of assets and equity and liabilities. The assumptions take into consideration:

  • stability of equity and liabilities with indefinite maturities (e.g. current accounts, cancellations and renewals of deposits, level of their concentration);
  • possibility of shortening the maturity period for specific items of assets (e.g. mortgage loans with an early repayment option);
  • possibility of selling items of assets (liquidity portfolio).

Monitoring and controlling financial liquidity risk involves analyzing the utilization of the defined limits.

Reporting involves communicating the level of financial liquidity risk to various decision-making levels. The frequency of each report and the scope of information provided therein are tailored to the information needs at each decision-making level.

The following measures aim to reduce financial liquidity risk:

  • maintaining cash in a separate liquidity portfolio at a level consistent with the limits for the portfolio value;
  • maintaining sufficient cash in a foreign currency in portfolios of investments earmarked for satisfying insurance liabilities denominated in the given foreign currency;
  • provisions of the Agreement on managing portfolios of financial instruments entered into between TFI PZU SA and specific PZU Group companies regarding limitation of the time for withdrawing cash from the portfolios managed by TFI PZU SA to at most 3 days after a request for cash is filed;
  • keeping open credit facilities in banks and/or the possibility of performing sell-buy-back transactions on treasury securities held until maturity;
  • centralization of management of portfolios/funds by TFI PZU SA;
  • limits of liquidity ratios in the banks belonging to the PZU Group.

Monitoring financial liquidity risk involves analyzing the utilization of defined limits. Reporting involves communicating the level of financial liquidity to various decision-making levels.

The PZU Group does not estimate liquidity risk by taking into account the amount of expected profit from future premiums as referred to in Article 295(5) of the Delegated Regulation. Since this report is required to disclose the amount of expected profit on future premiums, as at 31 December 2019, this amount was PLN 5,798 million.

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C.5. Operational risk

Operational risk is identified in particular by:

  • accumulation and analysis of information on operational risk incidents and the reasons for their occurrence;
  • self-assessmentof operational risk;
  • scenario analysis.

Operational risk is assessed and measured by:

  • calculating the effects of the occurrence of operational risk incidents;
  • estimating the effects of possible occurrence of operational risk incidents.

Both banks in the PZU Group, upon KNF's consent, apply advanced individual models to measure operational risk and to estimate capital requirements on account of this risk.

Monitoring and control of operational risk is performed mainly through an established system of operational risk indicators enabling assessment of changes in the level of operational risk over time and assessment of factors that affect the level of this risk in the business.

Reporting involves communicating the level of operational risk, the effects of monitoring and control to various decision-making levels. The frequency of each report and the scope of information provided therein are tailored to the information needs at each decision-making level.

Management actions involving reactions to any identified and assessed operational risks involve, in particular:

  • risk mitigation by taking actions aimed at minimizing risks, for instance by strengthening the internal control system;
  • risk transfer - in particular, by entering into insurance agreements;
  • risk avoidance by refraining from undertaking or withdrawing from a particular type of business in cases where too high a level of operational risk is ascertained and where the costs involved in risk mitigation are unreasonable;
  • risk acceptance - approval of consequences of a possible realization of operational risk unless they threaten to exceed the operational risk tolerance level.

No significant changes to the operational risk profile of the PZU Group were found in the reporting period. No material concentrations were identified in the area of operational risk in the present reporting period. Neither any grounds were identified that could indicate the possibility of such concentrations to appear in the future.

C.6. Other significant risks

The risk categories defined as material in the PZU Group's internal regulations include also the compliance risk and model risk. These risks are, by their nature, not included in the standard formula applied to calculate capital requirements. These risks are managed through ensuring adequate and effective control mechanisms, using appropriate organizational and procedural solutions.

Compliance risk includes, in particular, the risk that the operations performed by the PZU Group will be out of line with the changing legal environment (both in the area of law, regulatory requirements as well as the standards and best practices adopted to be followed). This risk may materialize as a result of delayed implementation or absence of clear and unambiguous laws, or the so called 'legal loophole'. This may cause irregularities in the business of the PZU Group, which may then lead to an increase in costs (for instance, due to the imposition of administrative penalties) and an increase in the level of reputation risk, thus in a drop of the PZU Group's trustworthiness on the market (resulting in a possible financial loss).

Compliance risk regarding failure to adjust or delay in the adjustment of business to the changing legal environment increases because of the dynamics and scale of amendments to law (both in Poland and internationally), which have a material impact, in particular on the PZU Group's regulated activity.

The identification and assessment of compliance risk is performed for each internal process by the heads of organizational cells or units, in accordance with the allocation of responsibility for reporting. Moreover, compliance units identify compliance risk on

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the basis of its own actions and information obtained, also from notifications to the register of conflicts of interest, gifts and benefits and irregularities, as well as from inquiries sent to them.

Compliance risk is assessed and measured by calculating the effects of risk materialization of the following types:

  • financial, resulting, without limitation, from administrative penalties, court judgments, contractual penalties and claims paid;
  • non-financial,pertaining to a loss of reputation, including damage to the image and brand.

Compliance risk is monitored, in particular, through:

  • compliance analyses;
  • systemic analysis of cyclic reports received from the heads of organizational cells;
  • reviews of regulatory requirements;
  • participation in legislative work aimed at amending the existing laws of general application;
  • performing diverse activities in industry organizations;
  • coordination of external control processes;
  • coordination of reporting requirements arising from the stock exchange regulations and the law;
  • reviewing the implementation of recommendations issued by the compliance units. Management actions in the area of response to compliance risk include in particular:
  • acceptance of the risk arising, without limitation, from legal and regulatory changes;
  • mitigation of the risk, including by: adjustment of procedures and processes to changing regulatory requirements, evaluation and design of internal regulations to suit compliance needs, participation in the process of agreeing on marketing activities;
  • avoidance of the risk by preventing any involvement in activities that are out of compliance with the applicable regulatory requirements or best market practices or activities that may have an unfavorable impact on the entity's image.

In the reporting period, no significant changes to the methods of assessing compliance risk occurred. Neither any significant concentrations of risks - because of nature of the described risks - were identified either.

Model risk has been defined as the risk of incurring financial losses, incorrectly estimating data reported to the regulatory authority, taking incorrect decision or losing reputation as a result of errors in the development, implementation or application of models. In 2019, the formal process of identification and measurement of the risk was continued. The process aims to ensure high quality of risk management practices applied to this risk and is currently being developed by PZU and PZU Życie. Within the framework of this process, the models were monitored and independently validated in 2019.

In the entities from the banking sector, given the high materiality of model risk, the management of this risk has already been implemented for some years in the course of adaptation to the requirements of Recommendation W issued by the KNF. Both banks have defined standards for the model risk management process, including the rules for developing models and evaluating the quality of their operation and have ensured appropriate corporate governance solutions.

Additionally, as part of own risk and solvency assessment in the risk analysis process and identification of key risks, the PZU Group identifies and assesses risks that are not defined as material in its internal regulations. All identified risks are assessed from the perspective of frequency and severity of materialization (taking into account the financial severity and impact on reputation). Based on the aforementioned process, the following risk categories were included in 2019 in the group of material risks:

  • competition risk, defined as a risk of market changes (conditions of competition) having an adverse impact on the entity,
  • business risk, defined as the possibility of incurring a loss or unfavorable change of the value of liabilities, associated with an incorrect business model, including related to a failure to attain the assumed and necessary economic objectives due to failure in market competition.

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C.6.1. Impact of the COVID-19 pandemic on PZU's solvency

The PZU Group's operations were affected by the pandemic of the COVID-19 virus ("COVID-19") which reached Poland in March 2020.

In light of these new circumstances, the Polish government made a number of decisions, including:

  • since 12 March 2020, all institutions of higher education, schools, preschools and nurseries have been closed as a preventive measure;
  • since 15 March 2020, the Polish borders have been closed for air and rail traffic, passport controls have been imposed and only Polish citizens have been allowed to enter the country from abroad, provided that after crossing the border they go under a 14-day quarantine (these regulations have subsequently been extended until 13 April 2020), all stores except for grocery stores, drugstores and pharmacies have been closed;
  • since 25 March 2020, new safety rules have been in place, including a ban on the movement of people, except for the performance of professional activities or business tasks and the fulfillment of necessary needs related to matters of everyday life, gatherings of more than 2 people have been banned, restrictions on the use of public transport and movement on foot have been imposed;
  • on 1 April 2020, additional restrictions were introduced, including the following: limit on the number of customers in stores and service outlets to no more than three times the number of cash registers (twice the number of counters in post offices), obligation for store customers to use protective gloves, suspension of business of barber and hairdressing parlors, beauty and tattoo salons, closure of parks, boulevards and forests, ban on the movement of persons under the age of 18 in public areas without the supervision of an adult;
  • on 16 April 2020, the obligation to cover the mouth and nose with a mask, clothing or a part thereof in public areas was introduced for almost everyone above the age of 4 years.

At the same time, on 16 April 2020, the Polish government announced a gradual easing of restrictions, broken down into four stages, each with a specific limited scope. As at the date of approval of this report, the restrictions scheduled to be lifted in the first stage (16 April 2020), second stage (4 May 2020) and third stage (18 May 2020) have been removed, including in respect of: initially, easing certain restrictions on retail trade (the maximum number of persons in the store), opening parks, boulevards and forests, allowing people above 13 years of age to move in public areas without an adult; then, opening shopping malls, hotels, museums and libraries under the new sanitary regime; then, opening restaurants, barber, hairdressing and beautician parlors under a strictly defined sanitary regime.

The situation has no precedent and its impact on the economy is enormous. The first sectors of the economy that have been affected the most are those that depend on the mobility of the population, such as the transport, hotel, tourist and retail trade sectors. This supply and demand shock resulted in a sudden slowdown of business activity on a scale incomparable with any experience of the Polish economy after the transformation period.

Colossal economic uncertainty has emerged, manifesting itself in massive slumps in the prices of equities, increases in the yields of corporate debt instruments and depreciation of emerging economy currencies (including the Polish zloty), followed by persistently high volatility levels.

On 2 March 2020, the Sejm of the Republic of Poland adopted the Act on Special Solutions Associated with Preventing, Counteracting and Combating COVID-19, Other Infectious Diseases and Crises Caused by Them (Journal of Laws of 2020, Item 374, as amended), forming an element of the so-called special statutes (legislation governing in a particular manner a specific field, usually due to the ineffectiveness of general regulations or administrative processes in the relevant area), which was subsequently amended on several occasions.

The Polish government, much like the governments of many other countries across the world, has announced the introduction of a government assistance plan ("Anti-crisis Shield") the objectives of which include protection of jobs and provision of assistance to commercial undertakings.

The NBP reference rate was reduced twice (in March and April 2020) by 50 bps (100 bps in total) and currently stands at 0.50%. The Monetary Policy Council also made a decision to lower the loan loss reserve for banks from 3.5% to 0.5%. Moreover, the NBP has also been conducting operations to provide banks with liquidity through repo transactions and has implemented large-scale

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purchases on the secondary market for treasury bonds and bonds guaranteed by the State Treasury (including bonds issued by the Polish Development Fund and Bank Gospodarstwa Krajowego).

The Office of the Polish Financial Supervision Authority has developed a Supervisory Incentive Package for Security and Development in the insurance market, containing a collection of measures devised to strengthen the Polish insurance sector, in particular by ensuring protection of clients and reducing the impact of market fluctuations on the insurance sector.

The Business Continuity Plans that PZU had in place did not provide for an epidemic scenario of the COVID-19 type. After the announcement of a crisis situation in PZU on 25 February 2020, the Crisis Management Team has taken action to supplement the contingency plans, including in respect of transition to and performance of remote work and levels of response in the event of an epidemiological threat at PZU. At the same time, action has been taken to expand, reconfigure and scale up the capacity of the VPN environment as well as make developmental changes in the IT systems while maintaining business continuity and securing the interests of insurance clients.

Another component of these activities was an information campaign targeted at clients and dubbed "We operate remotely, but always near you", encouraging the remote use of the PZU Group's services: via the website, the "my PZU" mobile application or the hotline. Clients have been offered the option to postpone the date of payment of their premiums, break down the payment into installments or have the insurer temporarily take over the payment of premiums. The claims handling process has been simplified. The scale of PZU Zdrowie's medical services provided remotely (over the phone or via a video call) has been expanded.

Activities associated with ensuring the safety of employees and clients of the PZU Group aimed at preventing new infections have resulted in additional costs.

Macroeconomic factors exert a strong impact on the PZU Group's growth and performance in the medium term - the most significant factors affecting the PZU Group are: the GDP growth rate, the level and rate of change in interest rates and the exchange rates.

The economic slowdown will have a delayed impact on the insurance area. The weaker GDP growth, the declines in consumption and industrial production will translate into lower demand for individual and corporate insurance.

As regards the non-life insurance portfolio, the following are some of the specific risks that have been identified:

  • risk of the loss of liquidity and bankruptcies among clients, which may translate into defaults in the payment of insurance premiums;
  • payment backlogs and a deteriorated ability to make payments may translate into a higher volume of claims paid under contract guarantees and all forms of payment insurance as well as materialization of risks related to business continuity insurance;
  • medical TPL insurance, where client claims may appear;
  • increase in claims handling expenses related to motor insurance, partly due to higher prices of imported spare parts as a result of the weaker Polish zloty.

At the same time, in motor insurance, the decrease in traffic caused by officially imposed restrictions on the movement of people translates into a lower risk, and in travel insurance the risk of payouts is limited by the provisions of the GTCI regarding the occurrence of a pandemic.

As regards the life insurance portfolio, the following are some of the specific risks that have been identified:

  • increase in benefits due to the higher morbidity and mortality rates, the risk of lapses and an increase in surrenders of unit- linked insurance.

In the investment area:

  • lower interest rates will translate into the portfolio performance, because the return on a significant portion of debt assets directly depends on the level of interest rates (corporate bonds and loans, certain treasury bonds);
  • in the longer term, as debt exposures acquired in the past with higher interest rates mature, the risk of reinvestment will increase;

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  • volatility in financial markets will have a limited impact on the PZU Group's results, because the Group, in anticipation of a deterioration in the financial markets, has prepared its portfolio for a slowdown ahead of time by significantly reducing its exposure to the most volatile assets;
  • in the short term, the weaker Polish zloty should not significantly affect the results of those PZU Group companies that actively balance and hedge their currency positions (for the currency in question, liabilities correspond to assets).

In the banking area:

  • the expected economic slowdown, the lower rate of growth of GDP, consumption, industrial output and investments, and the likely increase in unemployment will translate into weaker demand for bank loans;
  • the challenging situation of households and enterprises will result in higher costs of credit risk (loan losses);
  • the low interest rate environment will translate directly into lower net interest income generated by banks (their revenues will be reduced due to the lower NBP reference rate, because most loans are based on a variable interest rate; on the other hand, banks have limited options when it comes to reducing the costs of deposits, especially current ones, because their cost even before the rate cuts was already close to zero);
  • the deterioration of the situation in the whole Polish banking sector may cause the need to launch sectoral initiatives (e.g. in respect of bad loan banks, forced restructuring of other banks, additional charges for the Bank Guarantee Fund), the costs of which will directly burden the whole sector.

The situation surrounding the spread of COVID-19 has been developing rapidly and its impact on the PZU Group's solvency is currently difficult to estimate. The PZU Group keeps monitoring on an ongoing basis how the changing environment affects all identified risks.

This notwithstanding, the PZU Management Board has evaluated the ability of PZU Group to continue as a going concern, taking into account a number of factors, including: high solvency, potential impact of COVID-19 on the operating activity of PZU Group companies, including additional costs to be incurred, the planning of business continuity of both PZU Group companies and their business partners, the structure of offered products and related risks, assessment of the liquidity and stability of funding, potential impairment of financial and non-financial assets, etc.

Based on its analysis, the PZU Management Board confirms its finding that there are no known material uncertainties arising from events or circumstances that might call into question the ability of PZU Group to continue as a going concern during a period of at least 12 months following 31 December 2019.

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  1. Measurement of assets and liabilities

Quantitative information on assets and liabilities measured in accordance with the SII system is included in form QRT S.02.01.02 which constitutes Attachment 6 to the Solvency and Financial Condition Report.

D.1. Assets

Assets for solvency purposes are measured at fair value and the table below presents the grounds, methods and major assumptions used when measuring assets.

Assets

Description of the grounds, methods and key assumptions used for measurement for solvency

purposes

The fair value of real property is determined using the alternative measurement method described in part

Real property

D.4. Right-of-use assets are carried using alternative measurement methods, in compliance with the rules

laid down in IFRS 16 'Leases'.

The measurement method consistent with the provisions of Article 335 and the hierarchy described in

Article 13 of the Delegated Regulation:

Equities held in related parties which are credit institutions, companies managing undertakings for

collective investment in transferable securities and non-regulated entities carrying out financial activities

are measured by applying the method of proportional share in such undertakings' own funds calculated

according to the relevant sectoral rules.

Shares in related parties, including

Equities in related parties not quoted on active markets are measured using the adjusted equity method.

equity interests

The adjusted equity method requires measurement of equity interests held in related parties based on the

share held in the related entity's surplus of assets over liabilities. When calculating a surplus of assets over

liabilities for related parties, particular assets and liabilities of the given entity are measured in accordance

with the principles of the SII system.

Participation units in mutual funds which the PZU Group classifies as participation units in related parties

are measured using the alternative measurement method described in part D.4 for participation units and

investment certificates in collective investment undertakings.

Quoted shares and interests

The fair value is considered to be the closing price as at the balance sheet date.

Fair values of debt securities are determined on the basis of quotations publicly available on an active

market and if there are no such quotations - valuations published by an authorized information service;

and if there are no such quotations either - using valuation models containing references to published price

quotations of the underlying financial instruments, interest rates and stock exchange indices.

Debt securities, loans

The PZU Group conducts an internal review of the valuations published by the authorized information

service comparing them to the valuations available from other sources based on data which can be

observed on the market.

The fair value of debt securities for which an active market does not exist and of loans is measured using

the alternative measurement method described in part D.4.

Participation units and investment

The fair value of participation units and investment certificates of mutual funds are measured using the

certificates in collective

alternative measurement method described in part D.4.

investment undertakings

For derivatives quoted on an active market, the fair value is considered to be the closing price as at the

Derivatives

balance sheet date.

The fair value of derivatives not quoted on an active market, including forward contracts and interest rate

swaps is measured using the alternative measurement method described in part D.4.

Deposits other than cash

The fair value of deposits is measured using the alternative measurement method described in part D.4.

equivalents

Assets for life insurance in which

the benefit is determined on the

Fair value measurement is calculated following similar rules to those for financial instruments held by the

basis of specified indices or other

PZU Group at its own risk.

base values and for life insurance

linked to a unit-linked fund

Receivables from insurance and

The fair value has been measured using the alternative measurement method described in part D.4. In

receivables from the insured and insurance intermediaries only these receivables are presented whose

from insurance intermediaries

maturity dates have already passed. Due and future premium installments are taken into consideration

61

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Solvency and financial condition report as at and for the financial year ended 31 December 2019

Assets

Description of the grounds, methods and key assumptions used for measurement for solvency

purposes

when defining the best estimate liability as cash flows - inflows.

Other receivables (trade

receivables other than those from

insurance activity) and amounts

The fair value has been measured using the alternative measurement method described in part D.4.

due and payable from reinsurance

agreements for liabilities resulting

from insurance

Cash

Measurement at nominal value, increased, in justified cases, by the accrued interest.

The table on the following page presents an explanation, in quantitative terms, of differences between data on assets calculated in accordance with the principles used for measurement for solvency purposes (described in the table above) and data calculated in accordance with the principles used for the needs of consolidated financial statements. The column entitled "Amount from the financial statements" presents values from the consolidated financial statements for the year ended 31 December 2019 in accordance with their economic content, but without making adjustments that would be necessary to make the numbers fit the format and presentation required in the SII system. Total assets in the column "Value from the financial statements" correspond to the total from the consolidated financial statements.

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Value from

Adjustment of

deferred acquisition

Adjustment

Measure-

Measure-

Change in

the

Reclassi

Assets as at 31 December 2019

consolidated

costs

of

ment of

ment of

fication

Defer-

the scope of

Other

Solvency II

(data in PLN million)

financial

and deferred

intangible

invest-

provi-

of items

red tax

consolida-

value

statements

reinsurance

assets

ments

sions

tion

commission

Goodwill

4,053

-

(1,038)

-

-

-

-

(3,015)

-

-

Deferred acquisition costs

1,574

(1,608)

-

-

(1)

1

-

34

-

-

Intangible assets

3,096

-

(754)

-

-

-

-

(2,342)

-

-

Deferred tax assets

2,319

-

-

-

-

5

(31)

(2,285)

-

8

Surplus on the pension benefits fund

-

-

-

-

-

-

-

-

-

-

Property, plant and equipment (tangible fixed assets) used for own needs

4,259

-

-

108

-

-

-

(2,910)

-

1,457

Investments (other than assets for life insurance in which the benefit is

determined on the basis of specified indices or other base values and for life

108,458

-

-

3,395

-

(5,879)

-

(52,365)

-

53,609

insurance linked to a unit-linked fund)

Real property (other than used for own needs)

2,478

-

-

1

-

-

-

(2,299)

-

180

Shares in related parties, including equity interests

11

-

-

-

-

1

-

19,827

-

19,839

Shares and interests

1,363

-

-

-

-

(379)

-

(971)

-

13

Shares and interests - quoted

1,015

-

-

-

-

(378)

-

(627)

-

10

Shares and interests - unquoted

348

-

-

-

-

(1)

-

(344)

-

3

Debt securities

95,225

-

-

3,385

-

(1,116)

-

(65,304)

-

32,190

Government bonds

71,078

-

-

3,378

-

(1,101)

-

(44,378)

-

28,977

Corporate bonds

24,147

-

-

7

-

(15)

-

(20,926)

-

3,213

Structured securities

-

-

-

-

-

-

-

-

-

-

Hedged securities

-

-

-

-

-

-

-

-

-

-

Participation units and investment certificates in collective investment

4,820

-

-

-

-

(4,307)

-

(177)

-

336

undertakings

Derivatives

3,107

-

-

-

-

(43)

-

(3,007)

-

57

Deposits other than cash equivalents

1,454

-

-

9

-

(35)

-

(434)

-

994

Other investments

-

-

-

-

-

-

-

-

-

-

Assets for life insurance in which the benefit is determined on the basis of

specified indices or other base values and for life insurance linked to a unit-

-

-

-

-

-

5,879

-

-

-

5,879

linked fund

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Solvency and financial condition report as at and for the financial year ended 31 December 2019

Value from

Adjustment of

deferred acquisition

Adjustment

Measure-

Measure-

Change in

the

Reclassi

Assets as at 31 December 2019

consolidated

costs

of

ment of

ment of

fication

Defer-

the scope of

Other

Solvency II

(data in PLN million)

financial

and deferred

intangible

invest-

provi-

of items

red tax

consolida-

value

statements

reinsurance

assets

ments

sions

tion

commission

Loans and mortgage-backed loans

203,423

-

-

15

-

-

-

(201,703)

-

1,735

Loans against pledged policies

-

-

-

-

-

-

-

-

-

-

Loans and mortgage-backed loans for natural persons

105,912

-

-

-

-

-

-

(105,912)

-

-

Other loans and mortgage-backed loans

97,511

-

-

15

-

-

-

(95,791)

-

1,735

Amounts due and payable from reinsurance agreements for liabilities

1,856

-

-

-

(1,552)

-

-

(86)

-

218

resulting from:

Insurance other than life insurance and health insurance treated as non-life

1,680

-

-

-

(1,525)

-

-

(90)

-

65

insurance

Insurance other than life insurance products (excluding health

1,653

-

-

-

(1,493)

-

-

(90)

-

70

insurance)

Health insurance treated as non-life insurance

27

-

-

-

(32)

-

-

-

-

(5)

Life insurance and health insurance with life insurance features, excluding

health insurance and insurance, in which a benefit is determined based on

176

-

-

-

(27)

-

-

4

-

153

specified indices or other base values and insurance with a mutual fund

Health insurance treated as life insurance

-

-

-

-

(1)

-

-

-

-

(1)

Life insurance, except for health insurance and the insurance in which a

benefit is determined on the basis of specified indices or other base

176

-

-

-

(26)

-

-

4

-

154

values and unit-linked life insurance

Life insurance in which the benefit is determined on the basis of specified

-

-

-

-

-

-

-

-

-

-

indices or other base values and unit-linked life insurance

Deposits with ceding companies

-

-

-

-

-

-

-

-

-

-

Receivables from insurance and from insurance intermediaries

2,736

-

-

-

(2,101)

-

-

17

-

652

Outward reinsurance receivables

54

-

-

-

(6)

(26)

-

(20)

-

2

Other receivables (trade receivables other than those from insurance activity)

2,961

-

-

-

-

(12)

-

(2,746)

-

203

Treasury shares (held directly)

-

-

-

-

-

-

-

-

-

-

Amounts due on account of own funds or initial capital called up but not paid

-

-

-

-

-

-

-

-

-

-

up yet

Cash and cash equivalents

7,822

-

-

-

-

(18)

-

(7,503)

-

301

Other assets (not included in other items)

729

(4)

(53)

13

(331)

31

-

39

(117)

307

Total assets

343,340

(1,612)

(1,845)

3,531

(3,991)

(19)

(31)

(274,885)

(117)

64,371

64

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Solvency and financial condition report as at and for the financial year ended 31 December 2019

D.1.1. Qualitative description of material differences between measurement for solvency purposes and measurement according to IFRS

D.1.1.1. Valuation of assets

  1. Related parties: the difference between values according to IFRS and measurement for solvency purposes follows from different methods of recognition in the balance sheet. According to IFRS, subsidiaries are subject to consolidation whereas associates are measured using the equity method. The scope of consolidation for the purposes of the economic balance sheet is limited in comparison with the consolidated financial statements. Subordinated entities that are not consolidated in the economic balance sheet are measured at fair value using the adjusted equity method or the method of proportional share in such undertakings' own funds. Detailed information on the method of measurement applied to each subordinated entity is presented in item A.5.3.
  2. Debt securities, deposits, loans: the difference between valuation according to IFRS and valuation for solvency purposes follows from different methods of measuring instruments valued according to IFRS at amortized cost, taking into account allowances for the possible credit losses, taking into account the allowance for expected credit losses that, for the purposes of the economic balance sheet, are measured at fair value.
  3. Goodwill: the reason for the difference is that goodwill is valued at zero for solvency purposes, whereas in accordance with IFRS goodwill is recognized in the amount of the surplus of the fair value of the payment as at the acquisition date, the value of all non-controlling interests and the fair value of the stake in the equity of the acquired entity before obtaining control over the net fair value of acquired assets and assumed liabilities as at the acquisition date.
  4. Intangible assets: the difference results from the fact that, for solvency purposes, intangible assets are measured at zero, while in accordance with IFRS they are measured at purchase price or production cost less amortization charges and impairment losses.
  5. Changes in the value of individual items of assets and liabilities in the economic balance sheet compared to the values presented in the consolidated financial statements also result from the change in the scope of consolidation for the purposes of the economic balance sheet, as described in item A.5.3.

D.1.1.2. Assessment criteria for an active market

Whether a financial instrument is quoted on an active market is determined at the moment of establishing the carrying amount of the instrument on the date ending the calendar year based on data about the number and trading volume of transactions executed on the instrument in the last month of the year. The analysis is performed on a set of data collected from the Bloomberg system, including information about transactions executed in the period. The above rule does not apply to instruments admitted for trading on the Treasury Bond Spot market, for which it is assumed that they are quoted on an active market because of the criterion referred to in item 2 below.

A given instrument is considered to be quoted on an active market if:

  1. available data about the number and trading volume of transactions coming from at least one of the markets referred to in the next paragraph, make it possible to state that, on average, on each day of the month of the year, at least five transactions were executed on the instrument or the total volume of transactions executed in the period was higher by 1% of the number of instruments admitted for trading on the market or
  2. regulations in force on one of the markets referred to in the next paragraph impose on selected participants the requirement to present quotations, based on which the fixing rate is set by the market's arranger on each day of the last month of the year.

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Solvency and financial condition report as at and for the financial year ended 31 December 2019

An analysis of the activity of markets is based on information coming from the markets on which a transaction might be executed involving the sale of the instrument in regular circumstances. In particular, these include the following markets:

  1. markets on which transactions have already been executed, or
  2. markets dedicated to trading in debt securities or
  3. the biggest markets among the markets of a given country, or
  4. global markets earmarked for institutional clients.

What is additionally verified during the conducted market activity analysis is correctness of information about executed transactions by comparing the test set defined from data coming from the Bloomberg system with data presented on the official website of the given market. While defining the test set, the following criteria are taken into consideration:

  1. possibility of obtaining data - historical data from the official website of the given market must be obtained free of charge;
  2. diversity with regard to the type of issuer of financial instrument - a test set must include data (if possible) about at least two treasury instruments and two corporate ones;
  3. diversity with regard to the market from which data come - a test set must include data (if possible) from at least three markets.

D.1.2. Changes to the bases used for recognition, measurement or estimates in the reporting period

During the reporting period, the most significant changes in the asset valuation method concerned the following:

  • discontinuation of the consolidation of mutual funds (and as a consequence - their subsidiaries). Collective investment undertakings and investments operated as funds have been included in the economic balance sheet in accordance with Article 13 of the Delegated Regulation, that is at fair value. For more information on this matter, see section A.5.3.
  • recognition of right-of-use assets related to leases in the economic balance sheet in compliance with the new IFRS 16 "Leases", which entered into force on 1 January 2019. As a result, the PZU Group as the lessee recognizes the right-of-use assets for commercial properties and properties used for own needs in the economic balance sheet.

Except for the aforementioned changes, no other changes to the principles of recognition or measurement or estimates were made with regard to measurement of assets.

D.2. Technical provisions

Technical provisions consist of the best estimate and the risk margin or are determined on the basis of a reliably determined total market value of financial instruments that reflect future cash flows related to liabilities arising from executed insurance contracts, in compliance with Article 225 of the Insurance Activity Act.

The value of technical provisions, including the amount of the best estimate and the risk margin, broken down by lines of business, is presented in the following tables.

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Solvency and financial condition report as at and for the financial year ended 31 December 2019

Technical provisions for non-life insurance (in PLN million) along with a comparison to the value of technical provisions according to IFRS as at 31 December 2019:

Gross best

Value of

No. of the

estimate -

Gross best estimate

technical

Line of business

line of

provisions for

- provisions for

Risk margin

provisions

business

unearned

claims and benefits

according to

premiums

IFRS*

Medical expense insurance

1, 13

23

14

3

64

Income protection insurance

2, 14

25

72

5

437

Motor vehicle third party liability insurance

4, 16

1,711

5,395

499

9,642

Other motor insurance

5, 17

1,270

609

84

3,042

Marine, aviation and transport insurance

6, 18

(35)

44

5

142

Insurance against fire and other damage to property

7, 19

179

662

107

2,618

General TPL insurance

8, 20

49

1,190

98

2,328

Credit and suretyship insurance

9, 21

110

50

11

239

Legal protection cost insurance

10, 22

1

4

-

15

Assistance insurance

11, 23

62

42

10

360

Insurance of various financial losses

12, 24

(104)

88

4

358

Non-proportional reinsurance of other casualty

26

1

7

3

9

insurance

Non-proportional reinsurance of marine, aviation

27

-

-

-

1

and transport insurance

Non-proportional reinsurance of property insurance

28

5

59

2

70

Total non-life insurance liabilities

3,297

8,236

831

19,325

* this column does not include data for PZU Ukraine as it is excluded from consolidation according to Solvency II pursuant to Article 389 of the Insurance Activity Act

Technical provisions for life insurance and health insurance treated as life insurance (in PLN million) along with a comparison to the value of technical provisions according to IFRS as at 31 December 2019:

Value of

No. of the

Gross best

Risk

Technical

technical

Line of business

line of

provisions

provisions

estimate

margin

business

calculated jointly

according to

IFRS*

Insurance with profit participation

30

2,491

94

-

2,972

Insurance in which a benefit is determined on the basis of

specified indices or other base values and unit-linked life

31

5,623

18

103

5,848

insurance

Other life insurance

32

5,655

1,284

-

14,183

Annuities from insurance contracts other than life

insurance contracts and connected with insurance

34

5,054

327

-

5,000

liabilities other than health insurance liabilities

Inward reinsurance - annuities from insurance contracts

other than life insurance contracts and connected with

36

-

8

-

-

insurance liabilities other than health insurance liabilities

Health insurance (direct insurance business)

29

(96)

15

-

3

Total liabilities on account of life insurance and health

18,727

1,746

103

28,006

insurance treated as life insurance

  • this column does not include data for PZU Ukraine Life as it is excluded from consolidation according to Solvency II pursuant to Article 389 of the Insurance Activity Act

The most important rules applicable to best estimate calculations are presented below. All the cash flows are discounted with the risk-free rate published by EIOPA.

The risk margin is calculated in accordance with the assumptions set forth in Article 38 of the Delegated Regulation. The PZU Group uses simplification in its risk margin calculations. Simplifications are used to approximate the value of elements of the future capital requirements using the identified risk carriers.

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Solvency and financial condition report as at and for the financial year ended 31 December 2019

Best estimate - non-life insurance

The best estimate does not include payments on account of salvage and subrogation. Estimates of those payments are presented in the assets of the economic balance sheet in connection with Article 28(g) of the Delegated Regulation. The best estimate is determined by discounting forecast cash flows with the risk-free rate.

The main assumption made for defining the best estimate is the adequacy of historical experience for the purposes of anticipating the future. The table below presents the grounds, methods and major assumptions used when measuring assets for solvency purposes for the most significant lines of business.

Line

Description of the grounds, methods and major assumptions used for measurement

of business

For claims provisions, cash flows are determined based on triangles of losses, with the application of standard actuarial

4 and 5

methods such as Chain Ladder. Cash flows from the provision for unearned premiums are determined based on the provision

for unearned premiums according to IFRS, adjusted for forecast lapse rate and anticipated combined ratio. The cash flows also

include outstanding premium receivables, adjusted in accordance with historical receivable collection indicators.

The uncertainty of the best estimate follows for the most part from the fact that the forecast flows may diverge, perhaps significantly, from the historical trends. Some of the divergences may be random in nature (e.g. the occurrence of large claims), while other may result from changes to the (business, economic, legal, etc.) environment or changes to the procedures of handling liabilities. Additional uncertainty is connected with a long term of performing third party liability insurance liabilities, especially provisions for annuities, which depend to a significant extent on the applied discount rate. While estimating general damages for dismemberment, the uncertainty of the estimate is relatively high because of the absence of historical data for such claims. The uncertainty refers in particular to the degree of permanent dismemberment in the injured party, the group of entitled persons and the very compensation amount.

In calculating the best estimate, no major simplifications are applied.

Best estimate - life insurance

The value of the best estimate of liabilities is determined as an expected present value of future cash flows, with the application of a relevant risk-free interest rate term structure.

Forecasts of cash flows used to calculate the best estimate of liabilities take into consideration all the proceeds and expenditures required to settle insurance liabilities for all of their term. Proceeds include all the premiums guaranteed in agreements, but voluntary premiums are not taken into account. A forecast of expenditures includes both expenditures resulting from future events as well as benefit payments resulting from past events which are not regulated as at the measurement date of the best estimate of liabilities.

Cash flows resulting from past events include liabilities resulting from events not reported or paid until the measurement date. The liabilities are subsumed under claims provisions as at the measurement date, while the cash flows resulting from them are forecast in accordance with the predicted dates of benefit payouts.

Cash flow forecasts resulting from future events are prepared for each product (or product group) separately, using appropriate models reflecting the special character of the product and its characteristics, adjusted to the nature and complexity of risks present in the product. Within the forecasts for individual products, the best estimate is determined separately for individual contracts or groups of contracts constituting homogeneous risk groups, taking into account the best assumptions based on the assessment of current and past observations (best estimate assumptions).

Cash flows resulting from future events are determined in a deterministic manner, based on a forecast of the number of agreements (insureds) remaining in the portfolio in consecutive calendar months and a forecast of events causing the payout of benefits or change in the status of agreements. Below, the manner in which individual components of cash flows are determined is presented:

  • insurance premiums are determined on the basis of the number of agreements forecast in each month and the average premium, taking into account the assumed indexation factor and deadlines for premium payment;

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Solvency and financial condition report as at and for the financial year ended 31 December 2019

  • the benefits are the sum of benefits from individual insurable events (whether terminating an insurance contract or not) and, depending on the benefit type, may be determined as:
    o the product of the number of events giving rise to the payout of benefits and the amount of benefit for a selected risk (in particular, this refers to deaths, surrenders and cases of reaching the endowment age);
    o the product of the sum insured for the risk and the average loss ratio (most often where the insurable event does not result in agreement termination);
    o the product of the premium for the risk and the average loss ratio;
  • costs and commissions consist of:
    o costs of service forming the product of unit costs for the given product and the number of the insured, taking into account cost inflation; contribution to the KNF, PIU and the Financial Ombudsman as well as asset management costs for assets managed by third parties, determined as the product of the values of funds and the management fee indicator;
    o commissions calculated as the product of the commission coefficient and the gross written premium as well as additional initial commissions and sales bonuses if the product structure provides for such payments;
  • other proceeds - partial reimbursements of management fees in unit-linked insurance with funds managed by third parties
    ('kick-back') and commission refunds ('clawback') in protection bancassurance with single premium payment in connection with premature agreement termination.

The adopted method of deterministic forecast of continued progress of the contract is based on best estimate assumptions and the resulting financial cash flow forecast while applying an appropriate interest rate term structure leads to taking into account the value of money over time and finding the best estimate as the probability-weighted average present value of future cash flows.

It should be noted, though, that in each business line, forecasts of future financial cash flows are determined with the use of certain simplifications which may concern both the assumptions made about the occurrence of future events as well as costs and they may also concern the very manner of modeling:

  1. in the case of annual renewable protection insurance products, in particular in the case of group employee insurance, cash flows are not determined individually for each contract but collectively for the whole product based on the current number of the insureds, average guaranteed benefits and premiums and average probabilities of the occurrence of insurable events or average loss ratio on the product. The projection period set in months corresponds to the average duration of contract remaining from the end of the year to the end of its term. The simplifications, because of the short-term nature of the contracts but also because of the scale of the portfolio of employee group insurance, do not lead to any deformations of the results of the forecasts at the level of the entire portfolio;
  2. in the case of riders to individually continued insurance agreements, to each type of rider separately, uniform assumptions about their durability are applied. This way, instead of separate assumptions about mortality and lapse rates, a uniform indicator of contract losses in the entire portfolio is applied. Also here, considering the scale of the contracts and their short-term nature, such a simplification does not lead to deformations of the results of the whole forecast;
  3. in all cases of individual continuation contracts, applying the assumption that all the insureds were born exactly in the middle of the year;
  4. in other cases, the most frequent simplification is to make the same assumptions about mortality for each age and sex group for similar products, which results from the absence of individual experience about mortality precisely different for each product.

When calculating the best estimate, the amounts due for reinsurance were not taken into account because of the small scale of reinsurance programs, in particular their specific and very narrow scope, limited mostly to catastrophic cases exceeding a certain relatively high cumulative level. These programs do not translate directly or significantly into an individual reduction in liabilities measured under the best estimate.

Deterministic best estimate calculations are based on a single economic scenario. Such a scenario does not show, however, the complete impact arising from the existence of options and financial guarantees in insurance contracts. These options may contribute to the asymmetry between the values of future cash flows in "beneficial" and "detrimental" economic scenarios,

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Solvency and financial condition report as at and for the financial year ended 31 December 2019

affecting future capital gains on account of investments. Such a situation occurs in traditional insurance products, since they feature the profit-sharing right (option/insurance guarantee).

In order to capture this effect in the valuation, the deterministic best estimate valuation should be supplemented by the time value of options and guarantees (TVOG). This value is calculated as the difference between the best estimate calculated on the basis of several scenarios generated in the stochastic model and the best estimate obtained in the deterministic model.

According to the analyses and estimates carried out so far, the value of TVOG depends mainly on the interest rate term structure, but is low due to the relatively short term to maturity of these agreements, fairly good security of future benefits with existing assets, reducing the reinvestment volume and thus the uncertainty of future rates of return, as well as the very manner in which the insured participate by the annual indexation of sums insured and premiums. That value was finally omitted as immaterial from the results of the valuation of the best estimate of liabilities.

In the case of line of business no. 34 (annuities from insurance contracts other than life insurance contracts and connected with insurance liabilities other than health insurance liabilities), cash flows are determined individually for each annuity recipient based on his/her demographic features, the up-to-date annuity amount and selected features that are significant from the perspective of forecasting the annuity increase. Annuity increase is forecast based on historical data, using the GLM and GAMLSS models. For the calculation, life expectancy tables from the Central Statistical Office (GUS) are taken.

D.2.1. Qualitative description of material differences between measurement for solvency purposes and measurement according to IFRS

Non-life insurance

The grounds, methods and assumptions applied to the measurement of technical provisions for the solvency purposes under the SII system do not differ significantly from the grounds, methods or assumptions applied to the measurement of these provisions for the purposes of the consolidated financial statements. Differences to the amounts of technical provisions result from different measurement rules for specific items of provisions according to the SII system and IFRS. What contributes to these differences is a somewhat different product granulation and the fact that SII values are best estimates, while IFRS values are calculated based on the application of safety markups (e.g. the stochastic method in the motor TPL insurance). The table below is a summary of the most important differences in the rules of measuring provisions for solvency purposes according to the SII system and for the purposes of the consolidated financial statements.

Line of

Technical provisions according to the SII system

Technical provisions according to IFRS

business

Provision for unearned premiums reduced by the future

Provision for unearned premiums reduced by the future

profit

profit

Future premiums are included

Future premiums are not included

1-12

At a discounted value

At an undiscounted value

Overheads are included

Overheads are not included

Salvage and subrogation are not included

Future salvage and subrogation are included

Risk margin

No risk margin

Life insurance

Certain life insurance products do not fulfill the definition of insurance contract included in IFRS 4 "Insurance Contracts" and, as a result, are recognized in the consolidated financial statements as investment contracts, in accordance with IFRS 9, for which technical provisions are not calculated but liabilities are recognized on account of investment contracts at the fair value of assets covering the liabilities of the unit-linked fund associated with the given contract or the current value of expected future cash flows (in the case of contracts with guaranteed and fixed terms and conditions).

The risk margin, which is part of technical provisions measured for solvency purposes, has no direct equivalent in the technical provisions (hereinafter: "TP") calculated for financial reporting purposes under IFRS. The differences in the best estimate value

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and the provisions calculated for the purposes of consolidated financial statements are a consequence of the different methodologies used to calculate them, the method of recognizing certain elements and the assumptions made:

  • for unit-linked (insurance and investment) contracts, TP or liabilities on account of investment contract are recognized in the amount corresponding to the value of funds accumulated on insureds' accounts, without future premium payments. In turn, the best estimate is generally calculated as the present value of cash flows expected in the future along with future premiums, if payable;
  • The TP shall be determined without lapse rates, but in an amount not lower than the guaranteed surrender amount on the measurement date. In the case of the best estimate, it is assumed that additional disbursements will be made on account of surrenders only to the extent that such surrenders are expected. At the same time, the adoption of earlier lapse assumptions results in a reduction of disbursements on account of deaths and cases of reaching the endowment age, which are included at the full amount in the calculation of the TP;
  • TP in life insurance are calculated using the so-called net premium method, where the current value of expected benefits is reduced by the current value of expected premiums adjusted by the mark-ups on cost and possible profit assumed in the pricing. In turn, the best estimate is calculated as the difference between the amount of expected benefits, future costs of service and commissions and the full amount of premiums;
  • in the TP calculation, the assumptions concerning mortality, cost level, commissions, etc. are determined at the time of product launch and are valid for the entire duration of the policies. In the best estimate calculation, the assumptions are adopted every time based on the current and historical data and are updated regularly;
  • in the case of TP, the discount used to calculate the present value of premiums and benefits is set during the tariff-setting process, taking into account the limitations arising from the provisions of law setting forth the "maximum technical rate" announced from time to time by the regulatory authority. In the case of the best estimate, the discount is determined each time on the basis of the current term interest rate structure published by EIOPA.

The difference between TP and technical provisions calculated for solvency purposes recognized in this report is mainly caused by the fact that values according to the SII system are best estimates, while IFRS values are calculated using the methods and assumptions that include safety markups.

Also, the table below summarizes the major differences in the rules of measuring provisions for solvency purposes according to the SII system and for the purposes of the consolidated financial statements for business line no. 34.

Line of

Technical provisions according to SII

Technical provisions according to IFRS

business

Variable discount rate

Fixed discount rate

34

Variable growth rate

Fixed growth rate

Risk margin

No open risk margin

D.2.2. Matching adjustment, volatility adjustment, transitional risk-free interest rate term structure, transitional deductions

As at 31 December 2019, neither the matching adjustment referred to in Article 227 of the Insurance Activity Act, the volatility adjustment mentioned in Article 229 of the Insurance Activity Act, transitional risk-free interest rate term structure mentioned in Article 496 of the Insurance Activity Act nor the transitional deduction mentioned in Article 497 of the Insurance Activity Act were applied.

D.2.3. The amounts due under reinsurance treaties and from special-purpose vehicles (special-purpose entities).

The amounts due and payable under reinsurance treaties are determined on the basis of the gross best estimate and assignment indicators for technical provisions according to IFRS. The amounts due and payable under reinsurance treaties also include future cash flows of premiums and reinsurance commissions measured according to IFRS. The amounts due and payable from

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reinsurers are adjusted for the probability of the reinsurer's bankruptcy. Reinsurance treaties are executed with companies with a sufficiently high rating (in most cases, at least A-). The PZU Group does not execute agreements with special purpose vehicles that which would result in the emergence of receivables on that account.

D.2.4. Changes to assumptions adopted for calculating technical provisions as compared to the previous reporting period

Non-life insurance

With regard to economic assumptions, in 2019, the risk-free rate applied for discounting cash flows was changed. No changes were made to non-economic assumptions.

Life insurance

Significant changes to assumptions adopted for calculating technical provisions in 2019 as compared to the previous reporting period pertained to economic assumptions as well as other-than-economic assumptions. With regard to economic assumptions, in 2019, the risk-free rate applied for discounting cash flows was changed. The effect of changes to other-than-economic assumptions was attributable to changes to assumptions for loss ratio, the cost assumptions and the assumptions for resignations.

D.2.5. Statements on matching adjustment, volatility adjustment, transitional risk-free interest rate term structure, transitional deductions

As at 31 December 2019, PZU Group did not apply the matching adjustment referred to in Article 227 of the Insurance Activity Act, the volatility adjustment mentioned in Article 229 of the Insurance Activity Act, transitional risk-free interest rate term structure mentioned in Article 496 of the Insurance Activity Act or the transitional deduction mentioned in Article 497 of the Insurance Activity Act.

D.3. Other liabilities

Liabilities for solvency purposes are measured at fair value and the table below presents the grounds, methods and major assumptions used when measuring liabilities.

Liabilities

Description of the grounds, methods and key assumptions used for measurement for solvency

purposes

Other provisions (other than

technical provisions) and pension

The fair value of other provisions and pension benefit liabilities payable to employees are measured using

benefit liabilities payable to

the alternative measurement method described in part D.4.

employees

The amount of deferred tax liabilities is calculated using the balance sheet method, as a positive difference

between the amounts of balance sheet items recognized and measured in accordance with the rules set

forth in the Insurance Activity Act and the Delegated Regulation and the amounts of balance sheet items

Deferred tax liability

according to the valuation for tax purposes taking into account the CIT rates, which are expected to apply

when the liability is realized.

In the economic balance sheet, deferred tax liabilities and assets are presented after compensation on the

level of individual companies subject to consolidation (on a net basis).

Derivatives

They are measured based on the derivatives measurement method described in Section D.1. Negative

measurement is presented as liability.

Financial liabilities other than

Fair value is measured using the alternative measurement method described in part D.4.

liabilities to credit institutions

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Liabilities

Description of the grounds, methods and key assumptions used for measurement for solvency

purposes

Insurance liabilities and liabilities

Fair value is measured using the alternative measurement method described in part D.4.

In insurance and inward reinsurance liabilities only these liabilities are recognized whose maturity dates

to insurance intermediaries and

have already passed. Current and future liabilities are taken into consideration when determining the best

other liabilities (trade, other than

estimate as cash flows - outflows.

those from insurance activity, not

The Other liabilities item includes: accrued payroll expenses and bonuses for employees, prepayments to

recognized in other items)

business partners, other deferred revenue.

Subordinated liabilities

Fair value is measured using the alternative measurement method described in part D.4.

The table on the following page presents an explanation, in quantitative terms, of differences between data of liabilities calculated in accordance with the principles used for measurement for solvency purposes (described in the table above) and data calculated in accordance with the principles used for the needs of consolidated financial statements. The column entitled "Amount from the financial statements" presents values from the consolidated financial statements in accordance with their economic content, but without making adjustments that would be necessary to make the numbers fit the format and presentation required in the SII system. Total liabilities in the column "Amount from the financial statements" correspond to the amount from the consolidated financial statements.

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Value from

Adjustment

the

Measurement

Change in the

Commitments as at 31 December 2019

consolidated

of deferred

of

Measurement

Reclassification

Deferred

scope of

Other

Solvency

(data in PLN million)

financial

acquisition

investments

of provisions

of items

tax

consolidation

II value

costs

statements

Technical provisions - non-life insurance

19,706

-

-

(7,210)

-

-

(132)

-

12,364

Technical provisions - non-life insurance (excluding health insurance)

19,205

-

-

(6,851)

-

-

(132)

-

12,222

Technical provisions calculated jointly

19,205

-

-

(19,073)

-

-

(132)

-

-

Best estimate

-

-

-

11,400

-

-

-

-

11,400

Risk margin

-

-

-

822

-

-

-

-

822

Technical provisions - health insurance (treated as non-life insurance)

501

-

-

(359)

-

-

-

-

142

Technical provisions calculated jointly

501

-

-

(501)

-

-

-

-

-

Best estimate

-

-

-

134

-

-

-

-

134

Risk margin

-

-

-

8

-

-

-

-

8

Technical provisions in life insurance (except for the insurance in which a benefit is

determined on the basis of specified indices or other base values and unit-linked life

22,033

-

-

(7,077)

-

-

(124)

-

14,832

insurance)

Technical provisions in health insurance (treated as life insurance)

3

-

-

(84)

-

-

-

-

(81)

Technical provisions calculated jointly

3

-

-

(3)

-

-

-

-

-

Best estimate

-

-

-

(96)

-

-

-

-

(96)

Risk margin

-

-

-

15

-

-

-

-

15

Technical provisions in life insurance (except for health insurance and the insurance

in which a benefit is determined on the basis of specified indices or other base values

22,030

-

-

(6,993)

-

-

(124)

-

14,913

and unit-linked life insurance)

Technical provisions calculated jointly

22,030

-

-

(21,906)

-

-

(124)

-

-

Best estimate

-

-

-

13,200

-

-

-

-

13,200

Risk margin

-

-

-

1,713

-

-

-

-

1,713

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Value from

Adjustment

the

Measurement

Change in the

Commitments as at 31 December 2019

of deferred

Measurement

Reclassification

Deferred

Solvency

(data in PLN million)

consolidated

acquisition

of

of provisions

of items

tax

scope of

Other

II value

financial

costs

investments

consolidation

statements

Technical provisions - insurance in which a benefit is determined on the basis of

5,848

-

-

(104)

-

-

-

-

5,744

specified indices or other base values and unit-linked life insurance

Technical provisions calculated jointly

5,848

-

-

(5,745)

-

-

-

-

103

Best estimate

-

-

-

5,623

-

-

-

-

5,623

Risk margin

-

-

-

18

-

-

-

-

18

Other technical provisions

-

-

-

-

-

-

-

-

-

Contingent liabilities

-

-

-

-

-

-

-

-

-

Other provisions (other than technical provisions)

1,084

-

-

-

-

-

(920)

-

164

Employee pension benefit liabilities

319

-

-

-

-

-

(291)

-

28

Liabilities under deposits of reinsurance undertakings

-

-

-

-

-

-

-

-

-

Deferred tax liability

740

-

-

-

5

2,399

(94)

-

3,050

Derivatives

3,018

-

-

-

-

-

(3,008)

-

10

Liabilities to credit institutions

7,203

-

-

-

-

-

(7,203)

-

-

Financial liabilities other than liabilities to credit institutions

229,321

-

-

-

-

-

(229,047)

-

274

Insurance liabilities and liabilities to insurance intermediaries

665

-

(4)

(43)

(349)

-

18

-

287

Outward reinsurance liabilities

186

-

-

(151)

-

-

(30)

-

5

Other liabilities (trade liabilities, other than those from insurance activity)

4,668

-

-

(3)

(27)

-

(4,046)

20

612

Subordinated liabilities

6,700

-

81

-

-

-

(4,421)

-

2,360

Subordinated liabilities not included in basic own funds

-

-

-

-

-

-

-

-

-

Subordinated liabilities included in basic own funds

6,700

-

81

-

-

-

(4,421)

-

2,360

Other liabilities (not included in other items)

2,561

(70)

-

(1,115)

352

-

(721)

(2)

1,005

Total liabilities

304,052

(70)

77

(15,703)

(19)

2,399

(250,019)

18

40,735

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Solvency and financial condition report as at and for the financial year ended 31 December 2019

D.3.1. Qualitative description of material differences between measurement for solvency purposes and measurement according to IFRS

D.3.1.1. Valuation of liabilities

Financial liabilities and subordinated liabilities: the difference between the value according to IFRS and the measurement for solvency purposes follows from different methods of measuring financial and subordinated liabilities valued according to IFRS at amortized cost which, for the purposes of the economic balance sheet, are presented at fair value but without adjusting own credit spread from the date of the emergence of the liability.

D.3.2. Sources of the deferred tax liability

The PZU Group sets off deferred tax assets and liabilities for each business unit (tax group) comprising the PZU Group separately. Deferred tax assets carried in the PZU Group's balance sheet constitute the sum of deferred tax assets of the business units for which deductible temporary differences and tax losses to be settled in the coming years are higher than taxable temporary differences. For the purposes of calculating the PZU Group's own funds, a full set-off of deferred tax assets and liabilities is performed, regardless of the business unit to which such assets and liabilities pertain. Analysis of recoverability of deferred tax assets is performed on the basis of forecast future tax flows.

The following table presents the sources of deferred tax assets and liabilities after setting off negative and positive taxable temporary differences as at 31 December 2019.

The decisive part of the temporary differences follows from overestimating medium- and long-term financial assets and technical provisions.

Sources of the deferred tax assets and liabilities

Amount of the deferred tax assets and

liabilities (PLN million)

Financial instruments

989

Property, plant and equipment and intangible assets

(117)

Real property

31

Other provisions and accruals and deferred income

(193)

Technical provisions

2,351

Tax losses carried forward

(12)

Other differences

(7)

Deferred tax liability for the purpose of calculation of own funds, total

3,042

Deferred tax assets carried in the balance sheet

(8)

Deferred tax liability carried in the balance sheet

3,050

D.3.3. Changes to the bases used for recognition, measurement or estimates in the reporting period

During the reporting period, the most important change to the method of measurement of liabilities other than technical provisions was associated with the recognition of lease liabilities, i.e. future lease payments, in the economic balance sheet in compliance with the new IFRS 16 Leases, which entered into force on 1 January 2019. As a result, the PZU Group as the lessee recognizes lease liabilities in the economic balance sheet under financial liabilities.

Except for the aforementioned change, no changes to the principles of recognition, measurement or estimates were made with regard to measurement of liabilities other than technical provisions.

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D.3.4. The nature of duties, expected schedule of outflow of economic benefits, uncertainty and the manner of taking into consideration of the risk of measurement deviation

Subordinated liabilities

On 30 June 2017, PZU issued subordinated bonds with a total nominal value of PLN 2,250 million. The final maturity of the bonds is 29 July 2027 with an early repayment option on 29 July 2022.

Parameters of outstanding bonds:

Parameter

Value

Total nominal value of the bonds

PLN 2,250 million

Nominal value and issue price of one bond

PLN 100,000

Bond final maturity date

29 July 2027

Interest rate

WIBOR 6M + 1.80% margin

Interest payment days

29 January and 29 July each year,

from 29 January 2018 until 29 July 2027

Possibility of redeeming bonds before final maturity

29 July 2022

Security

None

The bonds are not in the form of documents and are registered in the securities depository maintained by Krajowy Depozyt Papierów Wartościowych SA [National Depository for Securities] and listed in alternative trading systems run by BondSpot SA and the Warsaw Stock Exchange. As at 31 December 2019, the carrying amount of subordinated bonds according to IFRS was PLN 2,279 million, while their fair value was PLN 2,360 million.

The risk measure is taken into consideration in the model for measuring fair value. For the above items, the basis point value (BPV) is calculated which is a measure of sensitivity to a change of interest rates. The BPV measures how much the value of an asset/a liability will change when the interest rate changes by 1 basis point.

D.4. Alternative methods for valuation

The assets and liabilities to which alternative measurement methods apply along with the justification for applying such methods are presented in the following table.

Assets and liabilities

measured using the

Description of the alternative measurement method along with the justification for its application

alternative method

Due to the absence of an active market, real properties are valued by licensed property appraisers in accordance

with generally applicable provisions of law and applicable professional standards, in most cases using the

comparative method or the income method. The acceptance of each completed measurement is additionally

subjected to the assessment of compliance with the order by PZU Group employees to eliminate any potential

Real property

typographical or accounting errors. Any concerns arising during the process are clarified on an ongoing basis with

the author of the appraisal report or opinion.

The right-of-use assets are measured in compliance with IFRS 16, i.e. using the cost less depreciation and

impairment model or at fair value (in the case of assets being investment properties);

Right-of-use assets are depreciated using the straight-line method from the lease commencement date to the

earlier of the end of the useful life or the end of the lease period.

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Assets and liabilities

measured using the

Description of the alternative measurement method along with the justification for its application

alternative method

The fair value of debt securities for which an active market does not exist is measured based on valuations

published by an authorized information service and, if there are none, using the discounted cash flow method. For

loans, the fair value is determined using the discounted cash flow method. Discount rates are determined on the

basis of the yield curve for government bonds adjusted by the credit spread. It is calculated on a calibration date,

Debt securities, loans

which is the date of the most recent issue or market transaction or each day of the averaging period of the spreads

calculated from the most recent market data. Such a spread leads to parallel shifting of the yield curve for

government bonds by a fixed amount along its whole length or as the difference between the yield of listed debt

securities of issuers with a similar rating operating in similar industries and the yield of government bonds

(German government bonds for bonds denominated in EUR) multiplied by a ratio determined as at the calibration

date, taking into account issuer-specific risk in the discount curve.

The fair value of derivatives not quoted on an active market, including forward contracts and IRS (interest rate

swaps) is measured using the discounted future cash flow method. For the discounting of cash flows, interest

Derivatives

rates are used from the yield curves assigned to the relevant type of financial instrument and currency, shaped on

the basis of available market data.

The fair value of options is measured as the expected value of the option payoff function discounted as at the

valuation date. The expected value of the payoff function is calculated using the Monte Carlo modeling method.

Due to the absence of an active market, the fair value of deposits is measured as the value of discounted cash

flows resulting from the terms of executed deposit agreements. For discounting, a base curve is used adjusted for

Deposits

the credit spread quantifying the credit risk of counterparty banks with which long-term deposit agreements have

been entered into in the relevant period. For each currency of the deposits, an appropriate discount curve is used.

For a given currency of the deposit, discount curves are used specific to the counterparty bank in which the

deposit has been made.

Due to the absence of an active market, participation units and investment certificates are measured using prices

Participation units and

published by mutual fund companies determined on the basis of net asset value of the funds measured in

accordance with the accounting principles for funds. As at the date of preparation of the SFCR, the prices

investment certificates in

published by mutual fund companies were verified with the audited financial statements of the funds. The

collective investment

valuation of participation units issued by subsidiary funds is subject to adjustment in cases where the fund's

undertakings

assets are not presented at fair value in the fund's financial statements and the difference between the fair value

and the valuation amount in the fund's financial statements is significant.

Receivables on insurance

and from insurance

intermediaries, other

Due to the absence of an active market, receivables on insurance and from insurance intermediaries and other

receivables (trade

receivables are measured using the discounted cash flow method. The valuation of these receivables is based on a

receivables other than those

historical analysis of the receivables payment ratio, and the projected cash flows are discounted using the current

from insurance activity) and

market discount rate, as announced by EIOPA. Due to the higher rate of collecting receivables in the first several

amounts due and payable

months of debt recovery, the discount effect is insignificant for the calculation of fair value.

from reinsurance

agreements for liabilities

resulting from insurance

Due to the absence of an active market, the fair value of other provisions is calculated as the expected present

value of anticipated cash flows in accordance with IAS 37 "Provisions, Contingent Liabilities and Contingent

Pension benefit liabilities

Assets".

payable to employees and

The value of the provision for unused vacation time is recognized in accordance with IAS 19 "Employee Benefits"

other provisions (other than

on an accrual basis.

technical provisions)

The costs of retirement severance pay and post-mortem benefits estimated using actuarial methods are

measured using actuarial

recognized on an accrual basis in accordance with IAS 19 by applying the forecast specific entitlements method.

methods

Provisions for retirement severance pays and post-mortem benefits are estimated using actuarial methods by

applying appropriate actuarial techniques and assumptions (discount rates, mortality rates, anticipated wage

growth rate, employee turnover rate and disability rate).

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Assets and liabilities

measured using the

Description of the alternative measurement method along with the justification for its application

alternative method

The fair value of financial liabilities for which an active market does not exist and the fair value of subordinated

liabilities and loans which are the PZU Group's liabilities are measured using the discounted cash flow method.

Such liabilities are measured based on credit spread in relation to a risk-free curve, calculated in such a way that

the instrument price at the issue date resulting from the model equals the issue price. In accordance with the

Financial liabilities other

measurement rules for liabilities in the SII system, the own credit spread calculated in the above manner is not

subsequently changed.

than liabilities to credit

institutions, subordinated

Lease liabilities are measured in compliance with IFRS 16 "Leases". On initial recognition at the present value of

liabilities

the outstanding lease payments, including fixed lease payments less any applicable lease incentives, variable

lease payments that depend on an index or rate, the amounts that the lessee expects to pay within the

guaranteed residual value, the exercise price of the call option, if likely to be exercised, and penalties for

terminating the lease if the option is available. In subsequent periods these liabilities are measured at amortized

cost.

Insurance liabilities and

Due to the absence of an active market, insurance liabilities and liabilities to insurance intermediaries and other

liabilities are measured using the discounted cash flow method. The valuation of these liabilities is based on a

liabilities to insurance

historical analysis of the liabilities payment ratio, and the projected cash flows are discounted using the current

intermediaries, other

market rate.

liabilities

Owing to their short expected payment dates, their nominal value is a reasonable approximation of fair value.

D.4.1. Assumptions and assessments on important sources of uncertainty of estimating fair value

The following coefficients are applied to measure uncertainty in measurement of financial instruments:

  • BPV (basis point value) - this coefficient indicates what the change will be in the value of the instrument if the discount and projection curve is shifted by 1 b.p. for bonds, loans, deposits and structured securities;
  • sensitivity to a change in credit spread - this coefficient indicates what the change will be in the value of the instrument if the credit spread is shifted by 1 b.p. for bonds, loans, deposits and structured securities;
  • delta - this coefficient indicates the percentage change in the value of an option if the price of the underlying asset changes by 1%.

The measurement adequacy is compared on regular basis by calibrating the spread (if possible) applied in the valuation with available market prices and comparing the model-based valuation with a valuation based on the adjusted purchase price for bonds, loans, deposits and structured securities.

Uncertainty in measurement of assets and liabilities other than technical provisions, except for financial instruments, is assessed mainly through:

  • price volatility;
  • standards of technical wear and tear;
  • cash flow volatility;
  • volatility of the economic environment;
  • volatility of market interest rates.

The PZU Group regularly verifies the adequacy of measurements, in particular by comparing them with other models or historical results performed on actual transactions.

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D.5. Additional information

The PZU Group does not have any material intangible assets or material lease agreements.

As at 31 December 2019, employee benefit liabilities did not constitute a material class of liabilities and as such, they have not been described in detail.

The principles of measurement applied by the business units to the measurements carried out for solvency purposes are not different than the principles applied on the level of the PZU Group.

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  1. Capital management

E.1. Own funds

The PZU Group endeavors to manage capital effectively and maximize the rate of return on equity for PZU's shareholders, in particular by maintaining the level of security and retaining capital resources for strategic growth objectives through acquisitions.

The capital management policy rests on the following principles:

  • the PZU Group's capital management (including excess capital) is conducted at the level of PZU as the parent company;
  • sustain target solvency ratios at the level of 200% for the PZU Group, PZU and PZU Życie;
  • sustain the PZU Group's financial leverage ratio at a level no higher than 0.35;
  • ensure funds for growth and acquisitions in the coming years;
  • PZU will not issue any new shares for the duration of this Policy.

The dividend amount proposed by the PZU Management Board for the financial year is determined on the basis of the PZU Group's consolidated financial result attributable to the parent company, where:

  • no more than 20% will be earmarked as retained earnings (supplementary capital) for goals associated with organic growth and innovations as well as execution of growth initiatives;
  • no less than 50% is subject to payment as an annual dividend;
  • the remaining part will be paid in the form of annual dividend or will increase retained earnings (supplementary capital) if in the given year significant expenditures are incurred in connection with execution of the PZU Group Strategy, including in particular, mergers and acquisitions;
  • according to the PZU Management Board's plans and PZU's risk and solvency self-assessment, own funds of PZU and the PZU Group following the declaration or payment of a dividend will remain at a level that will ensure fulfillment of the conditions specified in the capital management policy;
  • when determining the dividend, KNF's recommendations concerning dividends are taken into consideration.

To monitor and maintain capital on the level adequate to the assumed risk and to ensure continuous fulfillment of capital requirements, the capital limits system has been introduced. Furthermore, if the PZU Group's financial standing deteriorates, the PZU Group Capital and Dividend Policy provides for an early warning system, described in detail in the Plan of Corrective Measures of the PZU Group. It includes, among others, threshold values of financial parameters at which corrective measures should be undertaken to prevent the overrun of the final limit.

The early warning system is based on the accepted risk appetite level. Management actions are subject to the current and anticipated coverage level of the solvency capital requirement for the PZU Group:

  • Green zone (over 170%);
  • Yellow zone (120% to 170%);
  • Red zone (below 120%);
  • Final limit (below 100%).

In Alior Bank and Pekao, the capital adequacy ratio and the Tier 1 ratio are computed on the basis of CRR and also the various types of risk identified in the Internal Capital Adequacy Assessment Process (ICAAP).

In accordance with the Plan of Corrective Measures of the PZU Group, what is additionally taken into consideration when the measures are started is the PZU Group's return on equity (ROE), the amount of the net financial result of the PZU and the PZU Group, the level of the PZU's combined ratio, its rating and a number of parameters concerning other important PZU Group entities.

81

Powszechny Zakład Ubezpieczeń Spółka Akcyjna Group

Solvency and financial condition report as at and for the financial year ended 31 December 2019

Management actions aiming at increasing the level of own funds include in particular the following:

  • increasing subordinated liabilities;
  • discontinuing or temporarily suspending the surrender of instruments classified to own funds if the terms and conditions of the issue or the agreement provide for such possibility;
  • retaining part or the entire profit through decreasing the amounts of dividends paid out;
  • co-paymentsas part of supplementary own funds;
  • capital increase.

Management actions in the area of risk profile include in particular the following:

  • risk avoidance - not getting involved or stopping to get involved in the activities which increase exposure to risk;
  • risk transfer - transfer of part of exposure to risk onto a third party;
  • risk mitigation - reduction of likelihood of materialization of the risk or reduction of its impact;
  • acceptance of the risk level - acceptance of risk retention if other management actions are not available or the cost of their implementation is too high as compared to benefits to be obtained;
  • deployment of tools supporting other management actions, including in particular the following: limits, reinsurance programs, regular review of policies of accepting the risk for insurance (underwriting).

The extent of corrective measures undertaken depends on current and anticipated capital position as well as the timing of performance of the solvency assessment. If the analysis is conducted on the planning stage, the implemented corrective measures could be milder (e.g. making changes to the business plan) than if the analysis were to be conducted on the monitoring stage - in such case, it may be necessary to take immediate actions. The selection of corrective measures is also influenced by the following factors: issues related to reputation risk, possibility of practical application of the given corrective measure, time necessary for implementation of the given corrective measure, quality of own funds in case of increasing the capital for covering the risk, impact on the PZU Group's activity (e.g. profitability, market share).

Decisions with regard to application of the above-described methods shall be made by the given company's management board.

A significant portion of the PZU Group's capital is allocated to PZU Życie (that company's standalone surplus of assets over liabilities is PLN 12,451 million). PZU believes that PZU Życie's own funds may be transferred to PZU through disbursement of dividends, reinsurance and liquidity loans granted among those companies. Capital surpluses of other insurance-activity- conducting subsidiaries are not significant from the point of view of the PZU Group as a whole.

The supervisory boards and management boards of the PZU Group's insurance undertakings receive regular reports on the current level of solvency (at least once a quarter or on an ongoing basis if any of the capital thresholds have been exceeded).

Capital planning takes place within the framework of own risk and solvency assessment which is performed on at least an annual basis. It forms an integral part of the business strategy and is taken into consideration in the strategic decision-making process. The period of planning the capital position spans the time horizon of the current PZU Group Strategy but no less than 3 years. Since the time of publication of the previous solvency and financial condition report, there have been no significant changes concerning the management of own funds.

E.1.1. Structure, value and quality of own funds

The PZU Group's solvency was calculated with use of method 1 (the basic method) on the basis of consolidated financial statements. The PZU Group's own funds were calculated on the basis of the surplus of assets over liabilities originating from the consolidated economic balance sheet drawn up according to the principles of SII, taking into account the exclusions of intraGroup transactions of the PZU Group companies subject to consolidation.

As at 31 December 2019, the PZU Group had PLN 25,467 million of eligible own funds (including own funds from other financial sectors) to cover the consolidated solvency capital requirement and PLN 16,285 million of eligible own funds to cover the minimum consolidated capital requirement.

The Company's own funds in the amount of PLN 22,129 million fulfilled the conditions of Article 245 (2) of the Insurance Activity Act in consideration of the factors referred to in Article 245(3) of that Act, thus were classified into unlimited category 1. The

82

Powszechny Zakład Ubezpieczeń Spółka Akcyjna Group

Solvency and financial condition report as at and for the financial year ended 31 December 2019

amount of PLN 3,338 million, constituting the PZU Group's subordinated liability (of which PLN 2,360 million is the subordinated liabilities of PZU and PLN 978 million are the subordinated liabilities of other financial sectors), was classified into category 2 own funds.

The minority shareholders' equity of PLN 3 million was considered to be unavailable for coverage of the PZU Group's consolidated capital requirements.

Pursuant to Article 389 of the Insurance Activity Act, the PZU Group's own funds were also reduced by own funds on account of shares in PZU Ukraine and PZU Ukraine Life in the amount of PLN 80 million.

Information on own funds is included in the QRT S.23.01.22 form forming Attachment 7 to the SFCR. Its summary and a comparison with the data as at 31 December 2018 is presented below:

Value according to the

Value according to the

Components of the PZU Group's own funds

SII system as at

SII system as at

change

% change

31 December 2019

31 December 2018

(in PLN million)

(in PLN million)

Total eligible own funds for coverage of consolidated SCR

25,467

22,750

2,717

11.94%

The reconciliation provision after deduction of equity

interests in other financial sectors and after deduction made

pursuant to Article 389 of the Insurance Activity Act on

14,886

12,473

2,413

19.35%

account of equity interests in business units for which the

regulatory authority does not have credible information

Other available items of basic own funds

624

624

-

0.00%

Subordinated liabilities

2,360

2,311

49

2.12%

Own funds of other financial sectors

7,597

7,342

255

3.47%

On 26 March 2020, PZU received a letter from the Polish Financial Supervision Authority in which the regulatory authority, bearing in mind the current situation resulting from the state of epidemic announced in Poland and the possible adverse economic consequences that may arise from it, conveyed its expectation that insurance undertakings will retain all of their profit generated in 2019. In compliance with KNF's expectation, the PZU Group set the expected dividend for 2019 at zero in its calculation of own funds. The amount of own funds was reduced only by the expected allowances to the Company Social Benefit Fund. The PZU Management Board took into account KNF's expectations by submitting a motion to PZU Shareholder Meeting with the following proposed allocation of PLN 2,651 million in net profit for 2019: PLN 2,644 million to supplementary capital and PLN 7 million to the Company Social Benefit Fund. On 28 April 2020, the PZU Supervisory Board issued a favorable opinion on the Management Board's motion. On 26 May 2020, the PZU Shareholder Meeting distributed PZU's net profit for the year 2019 according to the Management Board's motion.

This approach resulted in an increase in the value of available and eligible own funds to cover the solvency capital requirement and the minimum capital requirement compared to 2018. In 2018, the PZU Group reduced the value of its available own funds by the amount of the dividend set by the Shareholder Meeting in a resolution adopted before the date of the "Solvency and financial condition report as at and for the financial year ended 31 December 2018".

83

Powszechny Zakład Ubezpieczeń Spółka Akcyjna Group

Solvency and financial condition report as at and for the financial year ended 31 December 2019

The basic categories of own funds and solvency capital requirement coverage are presented in the table below:

Category

31 December 2019

(PLN million)

Total eligible own funds for coverage of the group's consolidated SCR, including:

25,467

total own funds of other financial sectors

7,597

Total eligible own funds to fulfill the requirement of the group's minimum consolidated SCR

16,285

Group's consolidated SCR, including:

10,398

capital requirement for other financial sectors

3,728

Minimum capital requirement (MCR)

3,870

Ratio of coverage of the Group's consolidated SCR with eligible own funds (excluding other financial sectors)

268%

Ratio of coverage of the Group's consolidated SCR with eligible own funds (including other financial sectors)

245%

Ratio of coverage of the Group's minimum consolidated SCR with eligible own funds

421%

E.1.1.1.

Reconciliation provision

The structure of significant items in the reconciliation provision is presented in the following table.

Reconciliation provision

31 December 2019

(PLN million)

Surplus of assets over liabilities, including:

23,636

Equity according to IFRS

39,288

SII measurement and change in the scope of consolidation

(15,652)

Anticipated dividends, disbursements and charges, including:

329

Anticipated dividend

-

Anticipated tax of financial institutions for the next 12 months for insurance undertakings

319

Charge for the Company Social Benefit Fund

10

Treasury stock

8

Other items of basic own funds

627

Share capital

86

Share premium account associated with share capital

538

Minority interest

3

Total reconciliation provision

22,672

84

Powszechny Zakład Ubezpieczeń Spółka Akcyjna Group

Solvency and financial condition report as at and for the financial year ended 31 December 2019

E.1.2. Differences between the equity presented in the consolidated financial statements and the surplus of assets over liabilities calculated for solvency purposes

The titles of individual differences presented on the chart below are attributable to different rules of measuring assets and liabilities for solvency purposes, and in accordance with the IFRS as well as a different scope of consolidation - a detailed description of differences is presented in part D. of the SFCR.

E.1.3. Deferred taxes

As at 31 December 2019, the PZU Group reported, after a set-off (on a net basis), a deferred tax liability of PLN 3,042 million. Consequently, the PZU Group did not report an amount corresponding to the value of net deferred tax assets in Category 3 of own funds.

The value of the deferred tax asset and liability is calculated using the balance sheet method, as a difference between the values assigned to economic balance sheet items recognized and measured in accordance with the methodology set forth in Solvency II and the values assigned to economic balance sheet items recognized and measured for tax purposes taking into account the CIT rates which are expected to apply when the asset is realized in accordance with the provisions of tax law enacted in the state of establishment of the relevant PZU Group company before the end of the reporting period.

A deferred tax asset is recognized only in situations where it is probable that future taxable profit will be available for use against the deferred tax asset.

The PZU Group sets off deferred tax assets and liabilities for each business unit (tax group) comprising the PZU Group separately.

85

Powszechny Zakład Ubezpieczeń Spółka Akcyjna Group

Solvency and financial condition report as at and for the financial year ended 31 December 2019

E.2. Solvency capital requirement and minimum capital requirement

SCR of the PZU Group is calculated pursuant to Article 336 of the Delegated Regulation and consists of the following positions: a solvency capital requirement calculated on the basis of consolidated data following the rules laid down for the standard formula, the proportional share of the capital requirement (including hypothetical requirements) of undertakings from other financial sectors, the requirement for affiliated entities of the PZU Group not consolidated by the full method.

The amounts of PZU Group's solvency capital requirement and minimum capital requirement at the end of the reporting period along with the amount of the solvency capital requirement broken down into risk modules are presented in form QRT S.25.01.22 constituting attachment 8 to the SFCR.

The following table presents the MCR and SCR values as at 31 December 2019 and the corresponding period of the previous year.

Indicator

Value (in million PLN)

Change 2019/2018

31 December 2019

31 December 2018

(PLN million)

%

MCR

3,870

3,949

(79)

(2%)

SCR

10,398

10,229

169

2%

The SCR for the PZU Group increased by PLN 169 million on an annual basis. The increase was driven mainly by the higher market risk and actuarial risk.

In 2019, the MCR value declined due to the fall in PZU's MCR attributable to the decrease in its SCR.

The PZU Group does not apply any simplifications or specific parameters pursuant to Article 104(7) of the SII Directive.

The data for computation of the minimum capital requirement are sourced from PZU Group companies' internal IT systems and are subject to internal controls relevant to the reporting process. The PZU Group's data quality assurance process is governed through, among other things, specification of roles and responsibilities in the SII system processes as well as the principles for management of quality of data, including the principles of monitoring the quality of data, and collection, processing and updating of data. The responsibility for strategic coordination of information management processes rests with the management board of each PZU Group company. The PZU Group's insurance undertakings apply a standard formula to calculate the SCR. The computation of solvency capital requirement is performed in accordance with the regulations applicable to the SII system, with the assumption that the individual business units are a going concern. This computation encompasses the business activity which is currently being conducted as well as new activity which is expected to be launched within the next 12 months.

The significant group diversification effects as at 31 December 2019 resulted from:

  • diversification between market risks and other risks: PLN 3,549 million;
  • diversification among individual market risks, i.e. risks related to interest rates, shares, FX, concentration and real properties: PLN 1,227 million;
  • diversification among individual actuarial risks of life insurance, i.e. mortality, longevity, morbidity, accident incidence, lapse rates, costs, revision of annuities as well as catastrophic risk: PLN 1,879 million;
  • diversification among individual actuarial risks of non-life insurance, i.e. premiums, provisions, lapse rates as well as catastrophic risk: PLN 1,262 million.

E.2.1. Loss-absorbing capacity of deferred taxes

The amount by which the solvency capital requirement was reduced on account of the loss-absorbing capacity of deferred taxes as at the end of the reporting period was PLN 974 million compared to PLN 924 million as at 31 December 2018.

The PZU Group allocates losses caused by shocks subject to the basic solvency capital requirement in line with the shares of the modules and sub-modules of the standard formula in the basic solvency capital requirement. In the reporting period it was assumed that 25% of the losses on account of operational risk have the nature of tax deductible expenses.

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Powszechny Zakład Ubezpieczeń Spółka Akcyjna Group

Solvency and financial condition report as at and for the financial year ended 31 December 2019

E.3. Use of the duration-based equity price risk sub-module to calculate the solvency capital requirement

This section is not applicable to the PZU Group.

E.4. Differences between the standard formula and the applied internal model

This section is not applicable to the PZU Group.

E.5. Inconsistency with the minimum capital requirement and inconsistency with the solvency capital requirement

During 2019, there were no instances of breach of the solvency capital requirement or the minimum capital requirement of the PZU Group or any other subsidiary conducting insurance activity.

E.6. Additional information

The PZU Group's own funds are broken down into own funds of companies and groups belonging to other financial sectors, which include the following:

  • own funds of the Pekao Group in the amount of PLN 4,627 million computed in accordance with the CRR taking into account the PZU Group's percentage share in Pekao's capital. In accordance with the banks' sectoral principles, the amount of PLN
    4,077 million was classified into category 1 of own funds, and the amount of PLN 550 million - into category 2 of own funds. Subordinated liabilities of the Pekao Group with total value of PLN 2,750 million were issued in 2017-2019, and they will mature in the period from 2027 to 2033. The funds raised from the issue were designated, after obtaining approval from the
    Polish Financial Supervision Authority (KNF), for an increase in Pekao's supplementary funds pursuant to Article 127(2)(2) of the Banking Law and Article 63 of the Capital Requirements Regulation;
  • own funds of the Alior Bank Group in the amount of PLN 2,443 million computed in accordance with the CRR taking into account the PZU Group's percentage share in Alior Bank's capital, and decreased by the value of debt securities constituting the subordinated liability of the Alior Bank Group and held by PZU Group companies. The value of those bonds as at 31
    December 2019 amounted to PLN 109 million. In accordance with the banks' sectoral principles, the amount of PLN 2,015 million was classified into category 1 of own funds, and the amount of PLN 428 million - into category 2 of own funds. Subordinated liabilities of the Alior Bank Group with the total value of PLN 1,342 million were issued in 2017-2011, and they will mature in the period from 2021 to 2025. The funds raised through the subordinated debt issue were designated - after obtaining consent from the Polish Financial Supervision Authority (KNF) - for an increase of Alior Bank's supplementary funds pursuant to Article 127(2)(2) of the Banking Law and Article 63 of the CRR;
  • own funds of TFI PZU SA in the amount of PLN 197 million, classified into category 1 of own funds;
  • own funds of PTE PZU in the amount of PLN 330 million, classified into category 1 of own funds.

Own funds of related business units not consolidated by the full method in the balance sheet according to SII rules are the component of the reconciliation provision presented in category 1 of own funds.

Pursuant to Article 336 of the Delegated Regulation, the PZU Group's SCR amounted to PLN 10,398 million and consisted of the following items:

  • solvency capital requirement calculated on the basis of consolidated data in the amount of PLN 6,652 million;
    87

Powszechny Zakład Ubezpieczeń Spółka Akcyjna Group

Solvency and financial condition report as at and for the financial year ended 31 December 2019

  • pro rata share of capital requirements (including hypothetical ones) of business units from other financial sectors in the amount of PLN 3,728 million (of which PLN 2,168 million from Pekao, PLN 1,260 million from Alior Bank, PLN 270 million from TFI and PLN 30 million from PTE);
  • the requirement for related business units not consolidated by the full method in the amount of PLN 18 million.

88

Powszechny Zakład Ubezpieczeń Spółka Akcyjna Group

Solvency and financial condition report as at and for the financial year ended 31 December 2019

Attachments

  1. PZU Group's structure
  2. Form S.32.01.22
  3. Form S.05.01.02
  4. Form S.05.02.01
  5. Organizational chart
  6. Form S.02.01.02
  7. Form S.23.01.22
  8. Form S.25.01.22

89

Powszechny Zakład Ubezpieczeń Spółka Akcyjna Group

Solvency and financial condition report as at and for the financial year ended 31 December 2019

Signatures of the PZU Management Board Members:

Name

Position

Beata Kozłowska-Chyła

Acting President of the PZU

Management Board

Tomasz Kulik

Member of the PZU

Management Board

Ernest Bejda

Member of the PZU

Management Board

Adam Brzozowski

Member of the PZU

Management Board

Marcin Eckert

Member of the PZU

Management Board

Elżbieta Häuser-Schöneich

Member of the PZU

Management Board

Maciej Rapkiewicz

Member of the PZU

Management Board

Małgorzata Sadurska

Member of the PZU

Management Board

Warsaw, 28 May 2020

90

..........................................

(signature)

..........................................

(signature)

..........................................

(signature)

..........................................

(signature)

..........................................

(signature)

..........................................

(signature)

..........................................

(signature)

..........................................

(signature)

PZU Zdrowie

Warsaw -Poland

PZU - 100,00%

Grupa Kapitałowa

Centrum Medyczne

Medica

Płock - Poland

PZU Zdrowie - 100,00%

Prof-med

Włocławek - Poland

PZU Zdrowie - 100,00%

Gamma

Warsaw -Poland

PZU Zdrowie - 60,4619%

Polmedic sp. z o.o.

Radom - Poland

PZU Zdrowie - 100,00%

CM św. Łukasza

Częstochowa - Poland

PZU Zdrowie - 100,00%

ALERGO-MEDSp. z o.o.

Tarnów - Poland

PZU Zdrowie - 100,00%

FCM Zdrowie Sp. z o.o.

Warsaw - Poland

PZU Zdrowie - 100,00%

Starówka Sp. z o.o. Warsaw - Poland

FCM Zdrowie Sp. z o.o. - 100,00%

Tomma Diagnostyka Obrazowa

SA

Poznań - Poland

PZU Zdrowie - 100,00%

Bonus Diagnosta Sp. z o.o. Poznań - Poland

Tomma - 100,00%

Asklepios Diagnostyka

Sp. z o.o.

Poznań - Poland

Tomma - 100,00%

Elvita

Jaworzno - Poland

PZU Zdrowie - 100,00%

Proelmed

Łaziska Górne - Poland Elvita - 57,00%

PZU Życie

Warsaw - Poland

PZU - 100,00%

PTE PZU

Warsaw - Poland

PZU Życie - 100,00%

TFI PZU SA

Warsaw - Poland

PZU - 100,00%

The Alior Bank Group

Warsaw - Poland

PZU - 31,9071%

Investments Funds managed by TFI PZU - 0,0252%

Pekao Investment Banking

  • 0,0003%

The Bank Pekao Group

Warsaw -Poland PZU - 20,00%

Investments Funds managed by TFI PZU SA - 0,0204%

Pekao Financial Services sp. z o.o. Warsaw - Poland

Bank Pekao - 66,4992%

PZU - 33,5008%

Tower Inwestycje sp. z o.o.

Warsaw - Poland

PZU - 27,4696%

PZU Życie - 72,5304%

Ogrodowa Inwestycje sp. z o.o. Warsaw - Poland

PZU - 100,00%

The Armatura Group

Cracow - Poland

Investments Funds managed by TFI PZU SA - 100,00%

Arm Property sp. z o.o.

Cracow - Poland

Investments Funds managed by TFI PZU SA - 100,00%

PZU

Warsaw - Poland

LINK4

Warsaw - Poland

PZU - 100,00%

TUW PZUW

Warsaw - Poland

PZU - 100,00%

PZU CO

Warsaw - Poland

PZU - 100,00%

PZU Pomoc SA

Warsaw - Poland

PZU - 100,00%

GSU Pomoc Górniczy

Klub Ubezpieczonych SA

Gliwice - Poland

PZU Pomoc - 30,00%

PZU Finanse sp. z o.o.

Warsaw - Poland

PZU - 100,00%

Ipsilon sp. z o.o.

Warsaw - Poland

PZU - 100,00%

PZU LAB SA

Warsaw - Poland

PZU - 100,00%

Omicron BIS SA

Warsaw - Poland

PZU - 100,00%

Sigma BIS SA

Warsaw - Poland PZU - 34,00%

Appendix no. 1

Lietuvos Draudimas AB

Vilnus - Lithuania

PZU - 100,00%

PZU Estonia

o. Lietuvos Draudimas AB branch Lietuvos Draudimas Tallin - Estonia

AAS Balta

Riga - Latvia

PZU - 99,9949%

PZU Ukraine

Kiev - Ukraine

PZU - 83,2292%

PZU Życie - 0,0040%

PZU Ukraine Life - 16,7668%

LLC SOS Services Ukraine z

Kiev - Ukraine

PZU Ukraine - 100,00%

PZU Ukraine Life

Kiev - Ukraine

PZU - 53,4723%

PZU Życie - 0,0053%

PZU Ukraine - 46,5224%

PZU LT GD

Vilnus - Lithuania

PZU - 99,3379%

PZU Finance AB

Stockholm - Sweden

PZU - 100,00%

PZU Corporate Member

Limited

London - England

PZU - 100,00%

PZU CASH (formerly Battersby

Investments SA)

Warsaw - Poland

PZU - 100,00%

Tulare Investments sp. z o.o.

Warsaw - Poland

PZU - 100,00%

Spółki zależne objęte konsolidacją

Spółki nieskonsolidowane

91

Names of entities:

  1. AAS Balta - Apdrošināšanas Akciju Sabiedrība Balta;
  2. Grupa Kapitałowa Centrum Medyczne Medica - Centrum Medyczne Medica sp. z o.o. with its subisidiary Sanatorium Uzdrowiskowe
    "Krystynka" Sp. z o.o.;
  3. CM św. Łukasza - Centrum Medyczne św. Łukasza sp. z o.o.;
  4. Elvita - Przedsiębiorstwo Świadczeń Zdrowotnych i Promocji Zdrowia ELVITA - Jaworzno III sp. z o.o.;
  5. Gamma - Centrum Medyczne Gamma sp. z o.o.;
  6. The Alior Bank Group- Alior Bank with its subisidiaries: Alior Services sp. z o.o., Alior Leasing sp. z o.o., Meritum Services ICB SA, Alior TFI SA, New Commerce Services sp. z o.o., Absource sp. z o.o., Serwis Ubezpieczeniowy sp. z o.o.; CORSHAM Sp. z o.o., RBL_VC Sp. z o.o. and associated PayPo sp. z o.o.
  7. The Armatura Group- Armatura Kraków SA with its subisidiaries: Aquaform SA, Aquaform Badprodukte GmbH in Liquidation,
    Aquaform Ukraine ТОW, Aquaform Romania SRL, Morehome.pl sp. z o.o. in liquidation;
  8. The Bank Pekao Group- Pekao with its subisidiaries: Pekao Bank Hipoteczny SA, Pekao Leasing sp. z o.o., Pekao Investment Banking SA, Pekao Faktoring sp. z o.o., Pekao Powszechne Towarzystwo Emerytalne SA in liquidation, Pekao TFI SA, Centrum Kart SA, Pekao Financial Services sp. z o.o., Pekao Direct sp. z o.o., Pekao Property SA in liquidation, FPB - Media sp. z o.o. (in bankruptcy), Pekao Fundusz Kapitałowy sp. z o.o. in liquidation, Pekao Investment Management SA, Dom Inwestycyjny Xelion sp. z o.o. and associated CPF Management;
  9. Link4 - Link4 Towarzystwo Ubezpieczeń SA;
  10. Proelmed - Przedsiębiorstwo Usług Medycznych PROELMED sp. z o.o.;
  11. Prof-med - Specjalistyczna Przychodnia Przemysłowa Prof-Med sp. z o.o.;
  12. PTE PZU - Powszechne Towarzystwo Emerytalne PZU SA;
  13. PZU LT GD - UAB PZU Lietuva Gyvybes Draudimas;
  14. PZU CO - PZU Centrum Operacji SA;
  15. PZU Ukraine - PrJSC IC PZU Ukraine;
  16. PZU Ukraine Life - PrJSC IC PZU Ukraine Life Insurance;
  17. PZU Zdrowie - PZU Zdrowie SA, PZU Zdrowie has 10 branches: CM Nasze Zdrowie, CM Medicus, CM Cordis, CM Warszawa, CM Kraków, CM Poznań, CM Wrocław, Artimed, Revimed, CM Warszawa Chmielna;

92

Appendix no. 2

The Capital Group of Powszechny Zakład Ubezpieczeń SA

31-12-2019

S.32.01.22

Entities of the Group

Criteria of influence

Inclusion in the

Group solvency

scope of group

calculation

Type of

% used for the

Proportional

Date of

Method used and

%

decision

Identification code of the

code of the

Category

Supervisory

% capital

establishment of

Level of

share used for

under method 1,

Country

Legal name of the undertaking

Type of undertaking

Legal form

voting

Other criteria

YES/NO

if art.

undertaking

ID of the

(mutual/non mutual)

Authority

share

consolidated

influence

group solvency

treatment of the

rights

214 is

undertaking

accounts

calculation

undertaking

applied

C0010

C0020

C0030

C0040

C0050

C0060

C0070

C0080

C0180

C0190

C0200

C0210

C0220

C0230

C0240

C0250

C0260

Polish Financial

1 -

1 - Method 1: Full

Poland

QLPCKOOKVX32FUELX240

1 - LEI

Powszechny Zakład Ubezpieczeń SA

2 - Non-life insurance undertaking

spółka akcyjna

2 - Non-mutual

Supervisory

0,00%

0,00%

0,00%

0,00%

Included in

consolidation

Authority

the scope

Powszechny Zakład Ubezpieczeń na Życie

Polish Financial

1 -

1 - Method 1: Full

Poland

549300TNSHGVU2UXO005

1 - LEI

1 - Life insurance undertaking

spółka akcyjna

2 - Non-mutual

Supervisory

100,00%

100,00%

100,00%

1 - Dominant

100,00%

Included in

SA

Authority

the scope

consolidation

Towarzystwo Ubezpieczeń Wzajemnych

towarzystwo

Polish Financial

1 -

1 - Method 1: Full

Poland

259400OXGGIASU8WOO21

1 - LEI

2 - Non-life insurance undertaking

ubezpieczeń

1 - Mutual

Supervisory

100,00%

100,00%

100,00%

1 - Dominant

100,00%

Included in

Polski Zakład Ubezpieczeń Wzajemnych

consolidation

wzajemnych

Authority

the scope

Polish Financial

1 -

1 - Method 1: Full

Poland

2594001JSECH6MFMMV96

1 - LEI

Link4 Towarzystwo Ubezpieczeń SA

2 - Non-life insurance undertaking

spółka akcyjna

2 - Non-mutual

Supervisory

100,00%

100,00%

100,00%

1 - Dominant

100,00%

Included in

consolidation

Authority

the scope

uždaroji akcinės

Lietuvos

1 -

1 - Method 1: Full

Lithuania

259400LNAAVVBAGSC732

1 - LEI

UAB PZU Lietuva Gyvybes Draudimas

1 - Life insurance undertaking

2 - Non-mutual

Respublikos

99,34%

100,00%

99,34%

1 - Dominant

100,00%

Included in

bendrovė

consolidation

Centrinis Bankas

the scope

Lietuvos

1 -

1 - Method 1: Full

Lithuania

529900SURJXJXSY5O039

1 - LEI

Lietuvos Draudimas AB

2 - Non-life insurance undertaking

akcinės bendrovė

2 - Non-mutual

Respublikos

100,00%

100,00%

100,00%

1 - Dominant

100,00%

Included in

consolidation

Centrinis Bankas

the scope

apdrošināšanas akciju

Finanšu un kapitāla

1 -

1 - Method 1: Full

Latvia

25940034Z0RI47GCPC59

1 - LEI

Apdrošināšanas Akciju Sabiedrība Balta

2 - Non-life insurance undertaking

2 - Non-mutual

tirgus komisja

99,99%

100,00%

99,99%

1 - Dominant

100,00%

Included in

sabiedrība

consolidation

(FKTK)

the scope

Private Joint-Stock

State Financial

1 -

8 - Deduction of the

participation in relation

Ukraine

QLPCKOOKVX32FUELX240UA00001

2 - Specific code

PrJSC IC PZU Ukraine

2 - Non-life insurance undertaking

Company Insurance

2 - Non-mutual

Services Regulatory

100,00%

100,00%

100,00%

1 - Dominant

0,00%

Included in

to Article 229 of

Company

Commission

the scope

Directive 2009/138/EC

Private Joint-Stock

State Financial

1 -

8 - Deduction of the

participation in relation

Ukraine

QLPCKOOKVX32FUELX240UA00002

2 - Specific code

PrJSC IC PZU Ukraine Life Insurance

1 - Life insurance undertaking

Company Insurance

2 - Non-mutual

Services Regulatory

100,00%

100,00%

100,00%

1 - Dominant

0,00%

Included in

to Article 229 of

Company

Commission

the scope

Directive 2009/138/EC

10 - Ancillary services undertaking as defined in Article

1 -

1 - Method 1: Full

Poland

QLPCKOOKVX32FUELX240PL00003

2 - Specific code

PZU Zdrowie SA

spółka akcyjna

100,00%

100,00%

100,00%

1 - Dominant

100,00%

Included in

1 (53) of Delegated Regulation (EU) 2015/35

consolidation

the scope

10 - Ancillary services undertaking as defined in Article

spółka z ograniczoną

1 -

1 - Method 1: Full

Poland

QLPCKOOKVX32FUELX240PL00014

2 - Specific code

Centrum Medyczne Medica sp. z o.o.

100,00%

100,00%

100,00%

1 - Dominant

100,00%

Included in

1 (53) of Delegated Regulation (EU) 2015/35

odpowiedzialnością

consolidation

the scope

Specjalistyczna Przychodnia Przemysłowa

10 - Ancillary services undertaking as defined in Article

spółka z ograniczoną

1 -

1 - Method 1: Full

Poland

QLPCKOOKVX32FUELX240PL00015

2 - Specific code

100,00%

100,00%

100,00%

1 - Dominant

100,00%

Included in

"PROF-MED" sp. z o.o.

1 (53) of Delegated Regulation (EU) 2015/35

odpowiedzialnością

consolidation

the scope

Sanatorium Uzdrowiskowe "Krystynka"

10 - Ancillary services undertaking as defined in Article

spółka z ograniczoną

1 -

1 - Method 1: Full

Poland

QLPCKOOKVX32FUELX240PL00016

2 - Specific code

99,09%

100,00%

99,09%

1 - Dominant

100,00%

Included in

sp. z o.o.

1 (53) of Delegated Regulation (EU) 2015/35

odpowiedzialnością

consolidation

the scope

Przedsiębiorstwo Świadczeń

10 - Ancillary services undertaking as defined in Article

spółka z ograniczoną

1 -

1 - Method 1: Full

Poland

QLPCKOOKVX32FUELX240PL00019

2 - Specific code

Zdrowotnych i Promocji Zdrowia ELVITA -

100,00%

100,00%

100,00%

1 - Dominant

100,00%

Included in

1 (53) of Delegated Regulation (EU) 2015/35

odpowiedzialnością

consolidation

Jaworzno III sp. z o.o.

the scope

Przedsiębiorstwo Usług Medycznych

10 - Ancillary services undertaking as defined in Article

spółka z ograniczoną

1 -

1 - Method 1: Full

Poland

QLPCKOOKVX32FUELX240PL00020

2 - Specific code

57,00%

100,00%

57,00%

1 - Dominant

100,00%

Included in

PROELMED sp. z o.o.

1 (53) of Delegated Regulation (EU) 2015/35

odpowiedzialnością

consolidation

the scope

10 - Ancillary services undertaking as defined in Article

spółka z ograniczoną

1 -

1 - Method 1: Full

Poland

QLPCKOOKVX32FUELX240PL00023

2 - Specific code

Centrum Medyczne Gamma sp. z o.o.

60,46%

100,00%

60,46%

1 - Dominant

100,00%

Included in

1 (53) of Delegated Regulation (EU) 2015/35

odpowiedzialnością

consolidation

the scope

10 - Ancillary services undertaking as defined in Article

spółka z ograniczoną

1 -

1 - Method 1: Full

Poland

QLPCKOOKVX32FUELX240PL00025

2 - Specific code

Polmedic sp. z o.o.

100,00%

100,00%

100,00%

1 - Dominant

100,00%

Included in

1 (53) of Delegated Regulation (EU) 2015/35

odpowiedzialnością

consolidation

the scope

10 - Ancillary services undertaking as defined in Article

spółka z ograniczoną

1 -

1 - Method 1: Full

Poland

QLPCKOOKVX32FUELX240PL00085

2 - Specific code

Centrum Medyczne św. Łukasza sp. z o.o.

100,00%

100,00%

100,00%

1 - Dominant

100,00%

Included in

1 (53) of Delegated Regulation (EU) 2015/35

odpowiedzialnością

consolidation

the scope

10 - Ancillary services undertaking as defined in Article

spółka z ograniczoną

1 -

1 - Method 1: Full

Poland

QLPCKOOKVX32FUELX240PL00092

2 - Specific code

Alergo-Med Tarnów sp. z o.o.

100,00%

100,00%

100,00%

1 - Dominant

100,00%

Included in

1 (53) of Delegated Regulation (EU) 2015/35

odpowiedzialnością

consolidation

the scope

10 - Ancillary services undertaking as defined in Article

spółka z ograniczoną

1 -

1 - Method 1: Full

Poland

QLPCKOOKVX32FUELX240PL00093

2 - Specific code

FCM Zdrowie sp. z o.o.

100,00%

100,00%

100,00%

1 - Dominant

100,00%

Included in

1 (53) of Delegated Regulation (EU) 2015/35

odpowiedzialnością

consolidation

the scope

93

Criteria of influence

Inclusion in the

Group solvency

scope of group

calculation

Type of

% used for the

Proportional

Date of

Method used and

%

decision

Identification code of the

code of the

Category

Supervisory

% capital

establishment of

Level of

share used for

under method 1,

Country

Legal name of the undertaking

Type of undertaking

Legal form

voting

Other criteria

YES/NO

if art.

undertaking

ID of the