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Earnings Logic and Risks

Sampo Group has three business areas: P&C insurance (If P&C) and life insurance (Mandatum Life) are wholly owned by the holding company (Sampo plc) and in addition to the insurance subsidiaries, Sampo plc also holds 20,54 per cent in Nordea AB (publ) at December 31, 2010. Nordea is an associated company affecting Sampo Group´s profits and risks substantially. Nordea is an independent company whose risk management is not covered in Sampo Group´s annual report.

Sampo plc as a parent company does not have any own business operations. Sampo plc guides the activities of subsidiaries by setting financial and capitalisation targets for the subsidiaries and defining the group level risk management principles. The subsidiaries independently organize their operations and risk management according to these principles, taking into account the special characteristics that arise from the company specific earnings logic and risks.

Sampo plc also aims to ensure that the activities of the subsidiaries do not lead to unwanted risk concentrations. Thus, the concentrations are first pro-actively prevented by careful division of risk-taking between subsidiaries, and the rest of the concentrations are monitored and the risk profiles are changed if needed.

As a pan-Nordic insurance group If P&C underwrites policies that cover various risks of individuals and corporations on a geographically diverse area. If P&C mainly underwrites insurance risks in the Nordic and Baltic countries, as well as policies for Nordic clients with operations outside the Nordic countries. The business written is well-diversified over insurance classes, client segments and geographical areas. Mandatum Life operates in Finland and Baltic countries and offers savings insurance and pension policies as well as policies covering only insurance risks.

If P&C and Mandatum Life are exposed to various risks, which are selected carefully and priced reflecting the risks. Reinsurance is used to handle low frequency, but high impact events. A critical success factor is also the companies´ ability to maximise investment returns while taking into account all investment risks as well as the features of technical provisions, solvency, regulatory asset coverage rules and rating requirements. The core competence in Sampo Group's businesses is the pricing of risks and the proper management of the arising risk exposures.

Sampo Group's main risks are illustrated in figure "Classification of risks in Sampo Group". The risk classification is based on the major risk factors that affect Sampo Group. Moreover, risks such as ALM risk, concentration risk and reputation risk are by their nature linked to various risk factors.

Classification of Risks in Sampo Group

P&C InsuranceLife InsuranceMarket
Credit
LiquidityOperationalOther

P&C Insurance risk

Premium risk is the risk that the claims cost for future claims exceeds the expected level. This could be due to e.g. inadequate pricing, risk concentration, improper reinsurance coverage or due to unexpected deviations in the frequency of claims (i.e. the number of claims incurred during the period being higher than expected) and / or in the size of claims (i.e. claims when they occur being larger than anticipated).

Reserve risk is the risk that technical provisions are not sufficient to cover the cost for already incurred claims and results from fluctuations in the timing and amount of claim settlements.

Catastrophe risk is the risk of low frequency, high severity events, such as natural catastrophes, that are not captured adequately by the premium risk or reserve risk.

Life Insurance risk

Biometric risks in life insurance refer to the risk that the company has to pay larger mortality, disability or morbidity benefits than expected or the company has to keep paying pension payments to the pension policy holder for a longer time (longevity risk) than expected when pricing the policies. The uncertainty in the amount of the future benefit payments relates also to the adequacy of technical provisions. The discount rate risk, however, is a more significant factor for the adequacy of technical provisions than the risk described above.

Other risks in life insurance arise from the uncertainty related to the behaviour of the policyholders. The policyholders have the right to cease paying premiums (lapse risk) and the possibility to interrupt their policies (surrender risk).

Market risk

Market risks refer to fluctuations in the financial results and capital caused by changes in market values of financial assets and liabilities as well as technical provisions. Market values change together with underlying tradable market risk variables of which the following ones are currently the most important for Sampo Group: interest rates, inflation, credit spreads, foreign exchange rates, share prices and their volatilities.

Credit risk

Credit risk (default) refers to the negative impact in the financial results arising from defaults of debtors (issuer risk) or other counterparties (counterparty risk in derivatives and reinsurance contracts). Credit risk may realize when the cash flows agreed with the debtor or counterparty fail to materialize. In the case of issuer risk the final loss depends on the company’s holding in the security and the recovery rate. In the case of counterparty risk, final loss depends on potential positive mark-to-market value at the time of default together with recovery rate.

Liquidity risk

Liquidity risk is the risk that insurance undertakings are unable to conduct their regular business activities in accordance with the strategy, or in extreme cases, are unable to settle their financial obligations when they fall due. Liquidity risk deals with potential illiquidity of investments and non-renewal of insurance policies. Also the availability and price of refinance and financial derivatives affect the company´s ability to carry out regular business.

Operational risk

Operational risk refers to the risk of loss resulting from inadequate or failed processes or systems, from personnel and systems or from external events. This definition includes legal risk but excludes risks resulting from strategic decisions.

Other risk

Business risk is the risk of losses due to changes in the competitive environment or internal flexibility. Unexpected changes in general business environment can cause bigger than expected fluctuations in financial results. Such changes include the general economic development, changes in the institutional environment, technological innovations and competitive factors such as new competitors and changes in margins and volumes.

Compliance risk is the risk of legal or regulatory sanctions, material financial loss or loss of reputation an undertaking may suffer as a result of not complying with laws, regulations and administrative provisions as applicable to its activities. A compliance risk is often the consequence of a legal or operational risk.

Premium Risk Biometric Risks Interest Rate Risk Issuer Risk of Investments Refinancing Risk Processes Business Risk
Reserve Risk Surrender and Lapse Risks Equity Risk Counterparty Risk of Reinsurance Market Liquidity Risk Personnel Compliance Risk
Catastrophe Risk Expense Risk Currency Risk Counterparty Risk of Derivatives   Systems  
    Credit Spread Risk     External Events  
          Legal Risk  

ALM risk

The company is exposed to ALM risk when changes in different market risk variables (e.g. interest rates, inflation, foreign exchange rates, equity prices) cause a change in the value of investment assets that is of different size than the respective change in the economic value of technical provisions. In addition, the cash flows of technical provisions are modelled estimates and therefore uncertain in relation to both their timing and amount. ALM risk also includes this component of uncertainty.

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Reputational risk

Reputational risk, which is not categorized as an operational or a compliance risk, is the risk of reputational damage due to an action or event.

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Concentration risk

Concentration risk arises when the company´s risks are not diversified enough and as a result of this an individual claim or market event could threaten the solvency or the financial position of the company.

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P&C Insurance risk

Premium risk is the risk that the claims cost for future claims exceeds the expected level. This could be due to e.g. inadequate pricing, risk concentration, improper reinsurance coverage or due to unexpected deviations in the frequency of claims (i.e. the number of claims incurred during the period being higher than expected) and / or in the size of claims (i.e. claims when they occur being larger than anticipated).

Reserve risk is the risk that technical provisions are not sufficient to cover the cost for already incurred claims and results from fluctuations in the timing and amount of claim settlements.

Catastrophe risk is the risk of low frequency, high severity events, such as natural catastrophes, that are not captured adequately by the premium risk or reserve risk.

Life Insurance risk

Biometric risks in life insurance refer to the risk that the company has to pay larger mortality, disability or morbidity benefits than expected or the company has to keep paying pension payments to the pension policy holder for a longer time (longevity risk) than expected when pricing the policies. The uncertainty in the amount of the future benefit payments relates also to the adequacy of technical provisions. The discount rate risk, however, is a more significant factor for the adequacy of technical provisions than the risk described above.

Other risks in life insurance arise from the uncertainty related to the behaviour of the policyholders. The policyholders have the right to cease paying premiums (lapse risk) and the possibility to interrupt their policies (surrender risk).

Market risk

Market risks refer to fluctuations in the financial results and capital caused by changes in market values of financial assets and liabilities as well as technical provisions. Market values change together with underlying tradable market risk variables of which the following ones are currently the most important for Sampo Group: interest rates, inflation, credit spreads, foreign exchange rates, share prices and their volatilities.

Credit risk

Credit risk (default) refers to the negative impact in the financial results arising from defaults of debtors (issuer risk) or other counterparties (counterparty risk in derivatives and reinsurance contracts). Credit risk may realize when the cash flows agreed with the debtor or counterparty fail to materialize. In the case of issuer risk the final loss depends on the company’s holding in the security and the recovery rate. In the case of counterparty risk, final loss depends on potential positive mark-to-market value at the time of default together with recovery rate.

Liquidity risk

Liquidity risk is the risk that insurance undertakings are unable to conduct their regular business activities in accordance with the strategy, or in extreme cases, are unable to settle their financial obligations when they fall due. Liquidity risk deals with potential illiquidity of investments and non-renewal of insurance policies. Also the availability and price of refinance and financial derivatives affect the company´s ability to carry out regular business.

Operational risk

Operational risk refers to the risk of loss resulting from inadequate or failed processes or systems, from personnel and systems or from external events. This definition includes legal risk but excludes risks resulting from strategic decisions.

Other risk

Business risk is the risk of losses due to changes in the competitive environment or internal flexibility. Unexpected changes in general business environment can cause bigger than expected fluctuations in financial results. Such changes include the general economic development, changes in the institutional environment, technological innovations and competitive factors such as new competitors and changes in margins and volumes.

Compliance risk is the risk of legal or regulatory sanctions, material financial loss or loss of reputation an undertaking may suffer as a result of not complying with laws, regulations and administrative provisions as applicable to its activities. A compliance risk is often the consequence of a legal or operational risk.

ALM risk

The company is exposed to ALM risk when changes in different market risk variables (e.g. interest rates, inflation, foreign exchange rates, equity prices) cause a change in the value of investment assets that is of different size than the respective change in the economic value of technical provisions. In addition, the cash flows of technical provisions are modelled estimates and therefore uncertain in relation to both their timing and amount. ALM risk also includes this component of uncertainty.

Reputational risk

Reputational risk, which is not categorized as an operational or a compliance risk, is the risk of reputational damage due to an action or event.

Concentration risk

Concentration risk arises when the company´s risks are not diversified enough and as a result of this an individual claim or market event could threaten the solvency or the financial position of the company.

An illustrative picture of the most significant risks in Sampo Group is presented in figure "Key risks in Sampo Group". The most significant risks when Nordea´s figures are included are credit risk, market risk, insurance risk and operational risk. The figure is for illustrative purposes only.

The most significant risk arising from the operations of the insurance subsidiaries is market risk. On the Group level, the most significant risks are market risk and credit risk. This is due to Sampo plc´s holding in Nordea whose business activities in banking results in credit risk being the key risk.

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