Market risk

Market risk is the risk that volatility in the financial markets will impact our results of operations and thus our financial position. We define the asset mix based on the instructions approved by the Supervisory Board, including limits on types of assets and the geographic distribution and risk profile of bonds, equities and real property for each company in the Group. Our asset mix and investment activities focus mainly on interest rate risk, security and liquidity.

Interest rate risk

Fluctuating interest rate levels is a very important market risk to which we are exposed. Interest rate changes affect our investment assets as well as our provisions for claims, both of which are stated at market values. If interest rates fall, the value of the Group’s bond portfolio would rise, while a lower interest rate would at the same time cause the provisions for claims to rise. Fluctuating interest rates thus impact the financial results in two opposite directions, and the risk of profit variations depends on the degree to which these two movements offset each other.

Our portfolio of fixed-interest securities stood at DKK 30.3bn at 31 December 2007, while the provisions for claims discounted using a market rate amounted to DKK 19.7bn, net of reinsurance. The respective durations were 1.9 and 3.0 years. The variation in duration is attributable to our bond portfolio being significantly larger than the discounted provisions. A parallel shift of interest rates of 1% would reduce the market value of our securities by DKK 568m, while the opposite impact on provisions would be DKK 547m, triggering a net impact of DKK 21m.

In connection with the switch to discounting annuities in Danish workers’ compensation using a market rate, the average duration of provisions discounted using a market rate increased by 0.7 years to 3.0 years per 31 December 2007 with a corresponding increase in the duration of the bond portfolio to ensure continued matching interest rate sensitivity for assets and liabilities.

Other market risk

The equity and real property portfolios are exposed to changes in equity markets and real property markets, respectively. We manage such risk through investment limits for various asset classes. In certain circumstances, we also use interest rate and equity derivatives in our investment activities.

The equity portfolio primarily focuses on the large, liquid equity markets in Europe, the USA and Japan. We have defined a strategy with relatively little exposure in the Nordic region (around 23% at 31 December 2007) in order to reduce company risk, because a few companies account for large parts of the markets in the two countries. Furthermore, we have tied each equity mandate to a recognised benchmark, which we monitor closely. As shown in the graph on the previous page, the Group’s portfolio tracks the benchmark, even outperforming it over time. The 25 largest equities in our portfolio account for some 31% of the total listed equity portfolio.

Currency risk

We are not subject to any significant currency risk. The Group’s premium income in foreign currency is mostly matched by claims and expenses in the same currencies, primarily NOK, EUR, SEK and USD. We do not hedge the remaining, limited currency risk in connection with future cash flows in foreign currencies.

We use currency derivatives to hedge the risk of loss of value of balance sheet items due to exchange rate fluctuations in accordance with a general hedge ratio of 90-100 for each currency. We aim to hedge 98-100% of the net book value of the Norwegian entity.

Based on the actual amount of balance sheet items in foreign currencies and hedging as at 31 December 2007, 15% depreciation in the exchange rate of an exposed currency relative to DKK would result in a net loss of DKK 39m because the loss on the balance sheet items of DKK 729m would be offset by a gain of DKK 690m on the currency hedging.