Annual Report 2022KLP Group, Sustainability, KLP

The ongoing IBOR reform has not led to any significant changes in value for KLP. A small number of interest rate swaps in USD-NOK have had their valuation method changed, with the base yield curve between the currencies changing in line with the new market practice. This change has to do with the methodology and has no material effect on value. USD Libor will cease in June 2023, when four interest rate swaps will have to be terminated or changed. A change also has to be made to the valuation method for foreign exchange contracts. This will have no material impact on valuations.

KLP has a fund bond denominated in Japanese yen with a fixed USD interest rate which can be redeemed in 2023. If KLP chooses not to exercise its right to redeem the loan, the credit margin on the loan will be based on a future JPY-LIBOR rate. The interest terms at the end of 2022 are unchanged; see Note 21 for more details of the fund bond issue.

There are no other IFRSs or IFRIC interpretations not yet in force that are expected to have a significant impact on the financial statements.

There are changes to standards and interpretations that will have an effect on financial statements beginning after 1 January 2023 which have not been applied to these financial statements. Details of the most important of these that KLP has chosen not to apply early are provided below.

IFRS 9 Financial Instruments covers the classification, measurement and recognition of financial assets and liabilities, and introduces new rules for hedge accounting and a new impairment model for financial assets.

Based on the amended regulations to the Annual Accounting Regulations for life insurance companies of 20 December 2018, Norwegian life insurance companies were not allowed to implement the international accounting standard for financial instruments, IFRS 9. As a result, KLP uses IAS 39 for the recognition and rating of financial instruments as it was before it was amended on 01.01.2018.

In June 2020, changes to IFRS 4 on the extension of the temporary exemption to apply IFRS 9 were published. IFRS 9 will be introduced for all life insurance companies on 1 January 2023. Note 37 in this report describes the most important accounting principles according to IFRS 9, as well as the transition effect the standard will have on KLP’s accounts on the time of transition.

There are no other IFRSs or IFRIC interpretations not yet in force that are expected to have a significant impact on the financial statements.

c) Other changes

The wording of Section 3-7 of the Annual Accounts Regulations for life insurance companies has been amended. The change applies where a group reporting according to IFRS comprises both a life insurance company and a non-life insurance company, with the former as the parent company. In the life insurance company’s accounts, the investment in the subsidiary is reported by the equity method, applying uniform accounting principles. While the life insurer is not allowed to apply IFRS 17 (Insurance Contracts) in its company accounts, IFRS 17 is mandatory in the non-life accounts. The new wording states that it is not necessary in such cases to revise the accounting principles where the equity method is used.

Rules on a merged buffer fund covering all customers were introduced for municipal pension schemes from 01.01.2022 together with some other changes for guaranteed pension products. The new buffer fund replaces the earlier supplementary reserves and securities adjustment fund. The table below shows the reworked opening balance:

A further NOK 554 million was moved from the securities adjustment fund to the risk equalisation fund as of 01.01.2022.

In 2021 and at the beginning of 2022, KLP was in discussions with the Financial Supervisory Authority of Norway on certain allocations that were made in the annual accounts for 2020. The annual accounts for 2021 showed these changes, and the effects were incorporated into the figures. In February 2022, KLP again received a letter from the FSA stating that its equity must contribute 20 per cent of the amount from the risk result from 2020 used to boost the reserves for increased longevity. This amounted to NOK 229 million, and is recognised directly in the balance sheet, split between equity and premium funds.

If the tax effect of the items posted directly to the Group’s equity for buffer funds and reserves is taken into account, postings directly to equity amounted to NOK 243 million as of 01.01.2022.

On 7 April 2021, the Financial Supervisory Authority of Norway sent an identical letter to all life insurance companies and pension funds concerning pension providers’ treatment of remuneration paid to asset management companies and other managers of mutual funds. In the letter, the FSA stated that the management fee paid by a fund to the management company and other managers must be taken into account when determining the price tariff, and included in the pension provider’s expenses (gross accounting). The corresponding amount had to be added to the return on customer funds. This did not accord with KLP’s practice which is net accounting.

The requirement for gross recognition has been disputed, and the industry therefore asked the Ministry of Finance to clarify the issue. On 9 January 2023, the Ministry of Finance explained that there is insufficient legal basis for requiring pension schemes to include such management remuneration in their price tariffs.

No changes have been made to the financial statements compared to previous periods.

For financial assets that are not rated at fair value, an assessment is made on the balance sheet date whether objective indications exist as to whether a financial asset or a group of financial assets has declined in value. A certain degree of discretion is assigned to this assessment, as well as factors related to credit, market and liquidity risk.

For the company's portfolio of long-term bonds, including long-term bonds held to maturity, impairment is assessed on an individual basis each quarter. Impairment is calculated as the value of the originally expected cash flow and the new expected cash flow. There will be uncertainty attached to the calculation of a new expected cash flow. No factors or events have been found that would indicate impairment due to a predominant risk of loss in the company's portfolio of long-term bonds.

The insurance provisions are set at the right level of expectation, with the addition of safety margins. KLP can add up to half a year's positive risk results to a risk equalisation fund. This fund can be used to meet unexpected fluctuations in risk results.

For disability risks in the collective pension sector, assumptions are used based on the company's disability experience in the period 2015 - 2019. For other risk elements in the collective pension sector, the assumptions from the calculation basis K2013 are used, with safety margins, according to the minimum standard set by the Financial Supervisory Authority of Norway in 2013. For men, KLP uses its own life expectancy assumptions that assume a greater life expectancy improvement than K2013. In the Pension Scheme for Nurses, the same formulas and parameters are used but with an enhanced safety margin due to significantly longer life spans in these schemes. For the Pension Scheme for Hospital Doctors, K2013 is used with an enhanced safety margin for both genders.

The trend in insurance risk has been relatively stable over the last decade. Although there is some unpredictability associated with annual fluctuations and long-term developments, we generally use the insights gained from analyses in the future pricing of risk. Since the start of the coronavirus pandemic, it has been less clear that insights from recent history can tell us anything about the normal state of affairs. In the early phase of the pandemic, there was lower mortality in the population, but this increased towards the end of 2021 and into 2022.

For disability, there are a number of pandemic factors that could come into play. Some people are touched directly by the long-term effects of Covid-19, while others have suffered extra stress through two years of pandemic, such as workers in the health and care sectors, schools and kindergartens.

The development of the company's insurance risk is monitored on an ongoing basis. Risk results and future expectations for the development of insured risks are based on observations from the holdings and forecasts from Statistics Norway. These form the basis for the pricing of the risk element of the premium. Premiums are determined annually.

KLP currently only has collective products without the possibility to choose the scope of the insurance cover for the individual insured. Based on this limitation, the size of the company and resulting large risk-bearing ability, the overall assessment is that the need to have reinsurance in KLP is small. KLP currently has no reinsurance agreements.

The effect of an immediate 20 per cent increase in the incidence of disability would, with current numbers, involve a negative effect of NOK 443 million on the risk result for the year. The effect on the premium reserve of a corresponding permanent change in the incidence of disability would be an increase of NOK 770 million.

An immediate 10 per cent reduction in mortality would, with current numbers, mean a negative effect of NOK 328 million on the risk result for the year. The effect on the premium reserve of a corresponding permanent change in mortality would be an increase of NOK 11.519 million.

The Company's large numbers within group public sector pensions help to stabilize the insurance risk and the claim estimates. Deviations are related primarily to non-insurable magnitudes that do not affect the result.

The company's large numbers within group public sector pensions help to stabilize the insurance risk and the claim estimates. Deviations are related primarily to non-insurable magnitudes that do not affect the result.

Liquidity risk is the risk that the Company does not have adequate liquidity to cover short-term debt/residual liabilities not called in and current operations without substantial extra costs arising in the form of price falls on assets that have to be realized. The liquidity strategy contains various requirements and limits in order to comply with the desired liquidity risk profile. In addition division of responsibilities and contingency planning are covered. The liquidity strategy is operated at the senior management level and the liquidity is managed internally in accordance with mandates.

The need for liquidity in KLP is first and foremost associated with payments to pensioners and meeting current operating costs. Liquidity is also required for providing security in connection with currency and derivative trades. The KLP liquidity need is primarily satisfied by contractual receipts from customers. At all times the Company has a liquidity holding sufficient to meet current costs, including pension payments. In the event of liquidity needs beyond the current liquidity holdings, liquidity can normally be released through the sale of liquid financial assets.

KLP's aims to have liquidity buffers corresponding to 3 months' expected liquidity needs.

Not-called-in residual obligations of NOK 28.767 million comprise committed, not paid in sums against private equity and property funds and approved lending that has not been paid out. In addition, surety of NOK 2 million is included under contingent liabilities. The total is specified in detail in Note 34 Contingent liabilities.

Market risk is the risk of losses as a result of changes in market prices of various assets such as shares, bonds, property and other securities. The market risk depends on how large an exposure there is to the various assets and on the volatility in the market prices. Developments in the Norwegian and international securities markets generally have major significance for KLP's results.

Risk of a fall in the value of various assets is the biggest financial risk in the short term. Of the risk in regard to assets, equity exposure is the largest financial risk factor, but also the market risk associated with interest, credit (spread) and property has a significant loss potential. KLP's interest rate risk associated with a prolonged low interest rate level is however limited. With the current formulation of the rules, technical provisions are not affected by changes in market interest rates. On the future transition to market value for the liabilities, annual pricing of the interest guarantee will mean the customers bear the risk of the interest rate level being lower than the basic interest rate. Since KLP provides pension schemes exclusively to the public sector, KLP will price the return guarantee right up until the insured dies, which means the return guarantee arising from the insurance obligations is limited.

KLP exchange-rate hedges the majority of international exposure. Financial hedging of currency exposure is done through derivatives. In principle all of KLP's fixed-income investments and property investments in foreign currency are hedged back to NOK. For equity investments in foreign currency the hedge ratio in 2022 has been between 50-70 per cent.

All equity and interest rate exposures are included in a risk measurement system that enables simulation and monitoring of equity and interest rate risk across the portfolios. Active risk is managed through defined benchmarks relative to the index for each portfolio.

To reduce the risk of negative results from asset management the Company uses CPPI rules for customer portfolios for daily monitoring the market risk. This strategy helps to ensure that the risk is adjusted to the Company's risk capacity. The CPPI rules gives a return profile wich fits the overall target to have a satisfactory solvency margin owners' equity and preserve the risk capacity over time. In addition KLP has a high proportion of long-term (hold-to-maturity) bonds and fixed-interest lending that contributes to stability in returns.

In KLP's asset management, derivatives are principally used for risk reduction for cost and time-effective implementation of changes in risk and for currency hedging.

The main purpose of the European prudential framework for insurance companies, Solvency II, is to protect and safeguard the interests of insurance customers. KLP carries out quarterly calculations of financial strength in accordance with the provisions in the solvency regulations.

At the end of 2022, 29.0 per cent of the assets in KLP’s common portfolio were invested in equities (measured by exposure) and 14.8 per cent in property. Other funds were invested in interest-bearing current and noncurrent assets, including lending.

Details of KLP’s solvency capital requirement, regulatory capital and solvency capital coverage are provided in Note 32. The solvency capital coverage ratio is well above the Company’s target of at least 150 per cent.

Several sensitivity analyses relating to solvency capital coverage have been carried out. It is estimated that the solvency capital coverage will increase by 6 percentage points if interest rates rise by 50 basis points, and fall by 10 percentage points if the rates fall by 50 basis points. A 25 per cent fall in the equity market reduces solvency capital coverage by slightly less than 4 percentage points. Here, the effect on solvency capital coverage is limited by the size of the buffer fund.

Emphasis is placed on diversification of credit exposure to avoid concentration of credit risk against individual debtors. To monitor credit risk in lending and investments a special credit committee has been established, meeting regularly. The limits for credit risk against the individual debtor are set by the committee. Changes in debtors' credit assessments are monitored and followed up.

KLP has good balance between Norwegian bonds and international bonds and has a portfolio of exclusively good credit notes. Of the total credit exposure, 39 per cent is rated AA- or higher.

KLP has a lending portfolio of high quality, with limited credit risk and historically very low losses. In the main KLP provides loans secured on housing with a mortgage level of less than 80 per cent, loans to local authorities and loans with local authority guarantees. Lending secured through mortgages on housing amounts to about NOK 3.0 billion. The value of the mortgages represents a greater value than the lending since a large part of the mortgages were established earlier in time and the price rise in housing in recent years has been substantial.

KLP has limited concentration risk. Because no exposures exceed the threshold values defined in the Solvency II regulations, KLP has no capital requirements for concentration risk under the standard method. The way in which the fixed interest and equity portfolios are managed will generally help to limit concentration risk through extensive use of index management. KLP sets explicit limits for lending which restrict concentration on specific individuals and groups. Sector concentration is monitored via monthly and quarterly reporting.

Although the KLP’s investments are well diversified, there is a clear preponderance of investments in Norway. This is a deliberate and a natural consequence of dealing mainly with public-sector occupational pensions.