Contribution made by the market segments to the consolidated result

The following industry segments were identified in order to facilitate management of the PZU Group:

• corporate insurance (non-life insurance) – this segment covers a broad scope of property and casualty insurance products, other liability and motor insurance customized to a client’s needs entailing individual underwriting offered by PZU and TUW PZUW;
• mass insurance (non-life insurance) – this segment consists of property and casualty, accident, other liability and motor insurance products. PZU and LINK4 provide insurance to individuals and entities from the SME sector;
• life insurance: group and individually insurance – PZU Życie offers it to employee groups and other formal groups. Persons under a legal relationship with the policyholder (e.g. employer, trade union) enroll in the insurance agreement and individually continued insurance in which the policyholder acquired the right to individual continuation during the group phase. This spans the following types of insurance: protection, investment (however, not investment contracts) and health insurance;
• individual life insurance – PZU Życie provides those products to retail clients. The insurance agreement applies to a specific insured who is subject to individual underwriting. These products include protection, investment (which are not investment contracts) and health insurance;
• investments – reporting according to PAS – the revenues of the investments segment comprise the investments of the PZU Group’s own funds, understood as the surplus of investments over technical provisions in the PZU Group insurance companies based in Poland (PZU, Link4 and PZU Życie) plus the surplus of income earned over the risk-free rate on investments reflecting the value of technical provisions of PZU, Link4 and PZU Życie in insurance products, i.e. the surplus of investment income of PZU, Link4 and PZU Życie over the income allocated at transfer prices to insurance segments. Additionally, the segment includes income from other free funds in the PZU Group, including consolidated mutual funds;
• banking segment – a broad range of banking products offered to corporate and retail clients alike by Pekao and Alior Bank.
• Baltic States segment – includes non-life insurance and life insurance products provided in the territories of Lithuania, Latvia and Estonia;
• investment contracts – include PZU Życie products that do not transfer material insurance risk and do not satisfy the definition of insurance contract. These are some of the products with a guaranteed rate of return and some products in unit-linked form;
• other – include consolidated companies that are not classified in any of the above segments.

Corporate insurance

Insurance result in the corporate insurance segment (PLN million)

In 2018, the corporate insurance segment earned an insurance profit of PLN 268 million, which is 40.3% more than in the corresponding period last year.

The following factors had a key impact on this segment’s performance in 2018:

• a 16.0% increase in net earned premium associated with a 13.1% increase in gross written premium in comparison to 2017. The PZU Group posted the following under sales:
• higher premiums in motor insurance (+6.9% y/y) offered to leasing companies and in fleet insurance as a consequence of the higher average premium coupled with the lower number of motor own damage insurance (this decline is particularly noticeable in the insurance group for leasing),
• higher sales of insurance against fire and other damage to property and other TPL following the execution of several contracts (including long-term contracts) with high unit values and development of the medical entity insurance portfolio in TUW PZUW,
• development of the insurance portfolio containing various financial risks, including of several high-value contracts and the higher premium from the insurance of GAP financial losses;
• net claims and benefits grew 20.3% compared to the corresponding period of 2017, which, together with a 16.0% increase in net earned premium, means that the loss ratio deteriorated by 2.4 p.p. to 68.4%. The loss ratio moved up in the following areas:
• motor TPL as an outcome of rising annuity benefits, the observed increase in the average payment and remeasurement in Q1 2018 of the provision for claims for pain and suffering, 
• third party liability insurance.
  These changes were partially offset by the dip in the loss ratio in the motor own damage insurance portfolio as a result of the net earned premium growth being much higher than the growth in claims and benefits, despite the observed increase in average payout and in the insurance against fire and other damage to property (despite several large claims under inward reinsurance);
• income from investments allocated to this segment was up 32.9% to PLN 113 million, which was caused in particular by the 3.1% appreciation of the EUR exchange rate vs. PLN, compared to a 5.7% depreciation in the corresponding period last year;
• acquisition expenses (without reinsurance commissions) reached PLN 477 million, signifying 12.2% growth versus the ones incurred in 2017, mainly due to higher direct acquisition expenses (the effect of the higher pace of sales coupled with the change in the average commission rate in key distribution channels);
• administrative expenses decreased 4.4%, which, given the fact that the earned premium went up 16.0%, translated into an improvement in the administrative expense ratio by 1.2 percentage points. The decline in the expense ratio was due to lower costs of project activity and current operations by consistently maintaining cost discipline.

Insurance result in the corporate insurance segment (PLN million)

Mass insurance

In 2018, the mass insurance segment generated an insurance profit of PLN 1,725 million, which is 30.0% more than in the corresponding period last year. The following factors drove this segment’s performance in 2018:

• a 6.9% increase in net earned premium combined with a 3.3% increase in gross written premium in comparison to 2017. The PZU Group posted the following under sales:
• growth in gross written premium in motor insurance as a result of the higher average premium coupled with a stable level in the number of motor TPL insurance policies,
• growth in the premium for insurance against fire and other damage to property, chiefly in household property insurance and small and medium-sized enterprise insurance coupled with a similar level of sales of agricultural insurance despite the fierce competition on the market,
• higher written premium in other TPL insurance (+5.6% y/y) and accident and other (11.5% y/y), mainly assistance and accident insurance;
• higher net insurance claims and benefits in 2018 by 1.7%, which when coupled with net earned premium being up 6.9%, translated into the loss ratio improving by 3.1 percentage points compared to 2017. This change resulted mainly from the following:
• a decline in the loss ratio in insurance against fire and other damage to property, including crop insurance due to the lower number of damage claims caused by forces of nature (in the corresponding period, damage caused by gusty wind and rainfall);
• lower loss ratio of the motor insurance portfolio due to considerable improvement in motor own damage insurance and slight change in TPL insurance – remeasurement of the provision for claims for pain and suffering for pain caused by the vegetative state of a relative injured in an accident (Supreme Court ruling). After netting out the effect of movement in the provision for pain and suffering, high profitability was maintained in motor TPL insurance and motor own damage insurance;
• income from investments allocated to the mass insurance segment based on transfer prices was PLN 526 million, up 9.1% year on year, mostly due to appreciation of the EUR to PLN exchange rate of 3.1% faced with depreciation of 5.7% in the corresponding period last year;
• acquisition expenses (without reinsurance commissions) rose to PLN 1,890 million and were up by PLN 145 million or 8.3% year on year, which when coupled with the net earned premium being up by 6.9% signifies growth of acquisition expenses by 0.2 p.p. The factor driving the evolution in the level of acquisition expenses was the higher level of direct acquisition expenses due to the expanding portfolio and the change in the mix of sales channels (rising percentage of the multi-agency and dealer channels featuring higher selling expenses);
• administrative expenses in this segment totaled PLN 594 million, down PLN 14 million, or 2.3% since the year before, driven primarily by the outcome of cost discipline in non-staff areas in current and project activity and higher staff costs as a response to the clear signs of salary pressure on the market.

Insurance result in the mass insurance segment (PLN million)

Group and individually continued insurance

Insurance result in the group and individually continued insurance amounted to PLN 1,543 million in 2018 and was PLN 93 million, or 6.4%, higher than in the previous year. Individual constituent elements of the insurance result were as follows:

• gross written premium was higher than in the corresponding period of the previous year by PLN 36 million (0.5%), which was mainly the result of the following:
• acquiring more contracts in group or individually continued health insurance products (new clients in outpatient insurance and sales of different options of the medicine product). At the end of 2018, PZU Życie had more than 1.8 million contracts of this type in force. In Q1 2018 PZU Życie introduced a new rider to continued insurance under the name “PZU Uraz ortopedyczny [PZU orthopedic injury]”,
• active up-selling of other riders in individually continued insurance products, including in particular together with the offering of the basic agreement in PZU branches and increase of amounts insured during the terms of the agreements. In addition to the aforementioned rider, in Q4 PZU Życie introduced another product – heart attack or Stroke Rider – providing for financial support in the event of heart attack or a stroke.
• At the same time, revenues from group protection products remained under pressure of increased departures from groups (work establishments) due to the legal reduction of the retirement age in Q4 2017.
• the investment result consists of income allocated using transfer prices and income on investment products. In the group and individually continued insurance segment, investment income fell PLN 139 million mainly due to the lower income on unit-linked products as a result of worse conditions on the equity market – the WIG index fell by 9.5% compared to a 23.2% increase in the corresponding period of last year. Income allocated based on transfer prices increased due to an increase in the value of portfolios replicating insurance liabilities;
• insurance claims and benefits and the net movement in other net technical provisions totaled PLN 4,931 million (down 4.1% y/y). This change was driven by the following factors in particular:
  • a decrease in technical provisions in Employee Pension Plans (EPP, a third pillar retirement security product) compared to an increase in the previous year, due to negative investment results this year, compared to an increase last year, coupled with a stable level of client contributions to and withdrawals from unit-linked insurance accounts;
  • lower level of benefits this year in the group protection products portfolio;
  • lower than last year increase in mathematical provisions in continued products as a result of the previous changes in indexation principles and the share of “old” and “new” continuation both among the persons joining and remaining in the insured portfolio: in the “new” continuation, the unit cost of recognizing mathematical provisions for future benefit payments is lower.
  These effects have been partially offset by the slower pace of converting long-term insurance policies into yearly-renewable term business in type P group insurance exerted an influence on the size of the provisions. As a result of the conversion, in 2018, provisions were released for PLN 17 million, i.e. PLN 18 million less than in the corresponding period of 2017. Additionally, the level of medical benefits under health products is increasing following the dynamic growth of this portfolio.
• acquisition expenses in the group and individually continued insurance segment in 2018 were PLN 349 million, increasing by PLN 17 million (5.1%) compared to last year. The factor driving these expenses was the increasing remuneration for insurance intermediaries, especially for selling health products as the portfolio increased, and also the cost of communication mailed to clients (mainly offers of individual continuation riders);
• administrative expenses in 2018 amounted to PLN 604 million. The PLN 17 million increase (by 2.9%) were driven mainly by expenditures related to organizational changes in sales divisions and an increase in personnel costs caused by salary pressures on the market.

Adjusting for the one-off effect related to conversion of long-term contracts into renewable contracts in type P group insurance, the segment’s insurance result amounted to PLN 1,526 million in 2018, compared to PLN 1,415 million in 2017 (up 7.8%). This was driven mainly by constantly growing insurance portfolio, the lower level of benefits in the group protection products and the lower than last year increase in mathematical provisions in continued products as a result of the previous changes in indexation principles and the share of “old” and “new” continuation both among the persons joining and remaining in the insured portfolio.

Insurance result in the group and individually continued insurance segment (PLN million)

Individual insurance

In 2018, the insurance result in the individual life insurance segment was PLN 227 million, PLN 18 million, or 8.6%, more than last year. The main factors affecting the segment’s insurance result are described below:

• the decline in gross written premium compared to 2017 by PLN 318 million (19.1%) down to PLN 1,346 million resulted chiefly from lower contributions to unit-linked accounts in single-payment unit-linked products offered jointly with banks, which is in line with the trends in the entire life insurance market. At the same time, positive factors were also at play, such as:
• constantly rising level of premiums on protection products in endowments and term insurance offered in own channels – the level of sales and premium indexation under the agreements in the portfolio exceeds the value of lapses,
• growth of the insured portfolio in protection products in the bancassurance channel, including particularly the introduction of new products together with Alior Bank and Bank Pekao in H2 2018;
• the investment result consists of income allocated using transfer prices and income on investment products. In the individual insurance segment, it fell PLN 360 million y/y mainly due to the lower income on unit-linked products as a result of worse conditions on the equity market. At the same time, the segment’s income from the management fee charged on assets accumulated in unit-linked products increased by PLN 5 million y/y (following an increase in the average assets value). Income allocated according to transfer prices dropped as a result of lower market interest rates;
• net insurance claims and benefits together with the movement in other net technical provisions were PLN 976 million, reflecting the decrease in costs by PLN 696 million compared to 2017. This was driven mainly by the significantly lower investment result on most unit-linked product portfolios in this period. In the product offered in the Bank Millennium network, it additionally resulted from lower client contributions to the accounts. From the insurance result point of view, these factors are not significant – they are balanced by other relevant items of the profit and loss account;
• in 2018, acquisition expenses decreased in the individual insurance segment by PLN 9 million to PLN 126 million. Lower commissions on the sale of unit-linked products in the bancassurance channel (due to lower sales with the commission paid upfront) were partly offset by the increasing costs of sales support and remuneration to intermediaries for selling protection products, in the latter case also in the bancassurance channel;
• administrative expenses in 2018 increased to PLN 69 million compared to PLN 61 million in the previous year. This was influenced by the strategic investments in the exclusive sales network aimed at increasing sales in this segment and, to a smaller extent, an increasing level of remuneration for the handling of unit-linked products in the bancassurance channel (growing assets of such products).

Summing up, the most important factors driving the year-on-year change in result included lower acquisition expenses in unit-linked products and rising compensation generated by management fees in unit-linked products. Another factor contributing to the improvement in the profit margin was an increased share of protection products in revenues, since they generate much higher margins.

Insurance result in the individual insurance segment (PLN million)

Investments

The revenues of the Investments segment comprise the investments of the PZU Group’s own funds, understood as the surplus of investments over technical provisions in the PZU Group insurance companies seated in Poland (PZU, Link4 and PZU Życie) plus the surplus of income earned over the risk-free rate on investments reflecting the value of technical provisions of PZU, Link4 and PZU Życie in insurance products, i.e. surplus of investment income of PZU, Link4 and PZU Życie over the income allocated at transfer prices to insurance segments.

Additionally, the investment segment includes income from other free funds in the PZU Group (including consolidated mutual funds).

Operating income of the investment segment (based exclusively on external transactions) were lower than in the corresponding period of last year, primarily due to the worse conditions on the Warsaw Stock Exchange.

Banking segment / Banking activity

The banking activity segment consists of the following groups: Pekao, from June 2017 (effect of settling the transaction and start of consolidation) and Alior Bank.

In 2018, the banking activity segment generated PLN 4,036 million in operating profit (without amortization of intangible assets acquired as part of the bank acquisition transactions), representing an increase by PLN 1,597 million compared to 2017. Taking into consideration the commencement of consolidation of Pekao, one of the largest banks in Central and Eastern Europe, in 2017 all items of the statement of profit or loss and items of the statement of financial position for 2018 are significantly higher compared to the previous year.

In 2018, Pekao contributed PLN 3,047 million to the operating profit (without amortization of intangible assets acquired as part of the Pekao acquisition transaction) in the “Banking activity” segment, while Alior Bank’s contribution was PLN 989 million.

The key element of the segment’s income is investment income, which in 2018 increased to PLN 9,596 million y/y (up 48.2% y/y).

Investment income consists of: interest income, dividend revenue, trading result and result on impairment charges.

In 2018 very high sales of credit products were recorded in Pekao and Alior Bank, among others thanks to the favorable economic climate and the low level of interest rates.

Banks increased their net interest income (interest income less interest expenses) mainly be increasing the volume of loans to their customers. As at the end of 2018, the size of the client loan portfolio in total in both banks grew 7.1% compared to the end of 2017, and deposits from non-financial clients rose 4.4%.

Profitability of the banks in the PZU Group measured by the net interest margin amounted to 2.8% in Pekao (for the whole year) and 4.6% in Alior Bank. The difference in the level of the indicators results in particular from the structure of the loan receivables portfolio.

The net fee and commission income in the banking activity segment amounted to PLN 2 380 million and was PLN 797 million higher y/y. In addition to the consolidation of Bank Pekao newly-acquired in 2017, the improvement in this line item was boosted, as in the case of net interest income, by an increase in the sales of loans.

The segment’s administrative expenses amounted to PLN 4 989 million and comprised Pekao’s expenses in the amount of PLN 3 389 million and Alior Bank’s expenses of PLN 1 600 million. In of 2018, Alior Bank reduced its personnel costs, which resulted from, among others, lower current operating expenses and project-related expenses.

In addition, other contributors to the operating result included other operating income and expenses, where the main components are the BFG fees (PLN 372 million) and tax from other financial institutions (PLN 770 million).

As a result, the Cost/Income ratio stood at 42% in both banks. On a separate basis, the ratio was 44% for Pekao and 39% for Alior Bank. 

Pension insurance

In 2018, the operating profit in the pension insurance segment amounted to PLN 107 million, i.e. it increased by 23% compared with 2017. The major drivers of the operating result included the following:

• revenue from commissions and fees, which amounted to more than PLN 149 million, i.e. increased by 17% compared with the previous year. This change was the result of:
• revenues up by PLN 13 million on reimbursements from the Indemnity Fund;
• management fee up by nearly PLN 5 million as a result of the higher average annual net asset value in OFE PZU, including take-over of management of OFE Pekao.
• increase in income on withdrawal of funds from the reserve account by PLN 3 million as a result of obtaining the best 3-year rate of return among funds and the maximum bonus ratio;
• acquisition and service expenses stood at PLN 6 million, having increased by 28.2% from the previous year. This resulted mainly from the increase in the sales network, commission costs incurred for distribution of IRSA, adaptation of the systems and infrastructure to support a new IRSA distributor and additional service costs associated with the take-over of the management of Pekao funds;
• administrative expenses hit PLN 40 million, i.e. they were down 9% from the previous year. This change resulted mainly from:
• lower costs due to the payment of contributions to the Indemnity Fund by PLN 8 million;
• incurring the costs associated with the take-over of management over Pekao funds, including inter alia Transfer Agent costs higher by PLN 1.5 million, the costs of migration of OFE member registers in the amount of PLN 1 million and the costs of amortization of the right to manage the funds in the amount of PLN 1 million;
• other operating expenses increased by nearly PLN 1 million, primarily as a result of restatement of the provision for refund of contributions overpaid by ZUS for previous years.

Operating profit in the pension insurance segment (PLN million)

Baltic States

In 2018, the PZU Group’s business in the Baltic states generated a positive insurance result of PLN 138 million compared to PLN 109 million in the previous year. This result was shaped by the following factors:

• increase in gross written premium. It amounted to PLN 1,592 million compared to 1,404 in the year before. The premium in non-life insurance increased by PLN 181 million y/y (or 13.4%). Such a dynamic increase was possible, among others, thanks to higher motor insurance premiums in the region, increase in the sale of property and casualty insurance – in Lithuania, Latvia and Estonia, and significant increase in the premium written in health insurance in Latvia. Premiums in life insurance increased by PLN 7 million (or 12.1%);
• decrease in investment income. In 2018, the result was PLN 2 million and was 90.0% lower than in the previous year, primarily as a result of declines in the equity markets during the last quarter;
• increase in net claims and benefits. They amounted to PLN 905 million and were higher by PLN 132 million compared to the year before. The loss ratio in non-life insurance stood at 61.2% and was similar to last year’s level. In life insurance the value of benefits stood at PLN 38 million and was 15.6% lower than in the previous year;
• higher acquisition expenses. Segment’s expenditures for this purpose were at PLN 317 million. The acquisition expense ratio calculated on the basis of net earned premium dropped by 0.6 p.p. and stood at 21.4%;
• increase in administrative expenses. They were PLN 125 million, increasing by 12.6% from the previous year. Despite a - increase in incurred expenses, the administrative expense ratio dropped to 8.4%, down 0.4 p.p. relative to 2017. Cutting the administrative expense ratio was possible due to maintaining cost discipline coupled with the growth in the scale of business.

Insurance result in the Baltic States segment (PLN million)

Ukraine

The Ukraine Segment closed 2018 with a positive insurance result of PLN 23 million, compared to PLN 11 million in 2017.

The improvement of the segment’s result was the outcome of the following factors:

• growth of gross written premium. It amounted to PLN 257 million and increased compared to the previous year by PLN 34 million (or 15.2%). The increase in non-life insurance premiums (11.6% y/y) occurred primarily in motor insurance, both as a result of increasing tariffs in mandatory insurance and in accident insurance thanks to conclusion of new contracts. Premiums in life insurance increased by PLN 13 million (or 31.0%);
• higher investment result. In this area the segment generated PLN 19 million, i.e. PLN 1 million more than in 2017;
• increase in net claims and benefits. These reached PLN 59 million and were 5.4% higher than in the previous year. In life insurance the value of benefits paid increased in relation to the previous year by PLN 2 million (or 11.8%). The loss ratio calculated on the basis of the net earned premium in non-life insurance was 40.4%, down 6.6 p.p. compared to the previous year;
• increase in acquisition expenses. They stood at PLN 82 million compared to PLN 69 million in the previous year. Due to the higher commission burden, expenditures for this purpose in life insurance increased by PLN 9 million (or 36.0%). The segment’s acquisition expense ratio went down compared to the previous year by 2.2 p.p. to 53.9%;
• higher administrative expenses. They amounted to PLN 25 million, up PLN 2 million compared to the previous year. The administrative expense ratio calculated on the basis of the net earned premium decreased by 2.3 p.p. and stood at 16.4%.

Insurance result in the Ukraine segment (PLN million)

Investment contracts

In the consolidated financial statements investment contracts are recognized in accordance with the requirements of IFRS 9.

The results of the investment contracts segment are presented according to Polish Accounting Standards, which means that they include, among other things, gross written premium, claims paid and movement in technical provisions. The above categories are eliminated at the consolidated level.

In 2018 the PZU Group earned PLN 3 million of operating profit compared with PLN 4 million in the previous year (decrease of 25.0%) on investment contracts, i.e. PZU Życie’s products which do not generate a material insurance risk and which do not meet the definition of an insurance contract (such as some products with a guaranteed rate of return and certain unit-linked products). This result in 2018 was driven by the following factors:

• gross written premium generated on investment contracts in 2018 decreased by PLN 4 million (-9.1%) compared to 2017 to PLN 40 million. The changes were caused mainly by modification of the IKZE product at the end of 2017, which allowed newly-signed contracts to be signed as insurance contracts and transferred to the individual insurance segment;
• result on investing activity in the investment contracts segment fell PLN 32 million versus the previous year, mainly as a result of a worse rate of return on individual pension security accounts (IKZEs) and unit-linked products in the bancassurance channel;
• the cost of insurance claims and benefits together with the movement in other net technical provisions decreased PLN 35 million y/y to PLN 15 million due to the negative investment income in unit-linked products in this segment in the current period, as compared to the high positive performance in the previous year;
• in the investment contract segment, no active acquisition of contracts is currently underway and only a small fee was paid in unit-linked products in the bancassurance channel;
• administrative expenses were PLN 5 million, down by PLN 2 million from the previous year as a consequence of the decreasing portfolio of contracts in this segment.

Summing up, the increase in the segment’s operating result was driven mainly by the lower operating expenses allocated to the products of this segment.

Operating result in the investment contracts segment (PLN million)

Profitability ratios

The return on equity attributable to the parent company (PZU) for the period from 1 January 2018 to 31 December 2018 was 22.1%. ROE was 1.1 p.p. higher than in the previous year. The profitability ratios achieved in 2018 by the PZU Group exceed the levels achieved by the whole market (according to the data for three quarters of 2018).

Operational efficiency ratios

One of the fundamental measures of operational efficiency and performance of an insurance company is COR – Combined Ratio – calculated, due to its specific nature, for the non-life insurance sector (Section II).

The PZU Group’s combined ratio (for non-life insurance) has been maintained in recent years at a level ensuring a high profitability of business. In 2018, this ratio remained at a low level of 87.1% despite the remeasurement of provisions for claims for general damages due to vegetative state.

The operating efficiency ratios, broken down into individual segments, were presented in the ATTACHMENT.

Operational efficiency ratios

Basic performance ratios of the PZU Group