36.1 Accounting policies and material estimates

The assessment of existence of objective evidence of impairment of a financial asset or group of financial assets is carried out at the end of each reporting period.

If there is objective evidence of impairment arising from events occurring after the initial recognition of financial assets and causing a decrease in expected future cash flows then appropriate impairment losses are recognized against costs of the current period.

Objective evidence of impairment includes information on:

• significant financial difficulties of the issuer or debtor;
• failure to comply with the terms of the contract, e.g. failure to repay or default in repayment of interest or principal;
• the lender granting the borrower forbearance (for economic or legal reasons, resulting from the borrower’s financial difficulties) which the lender would otherwise not grant;
• high likelihood of liquidation, bankruptcy or other financial reorganization of the borrower;
• lack of an active market for a given financial asset caused by the issuer's financial difficulties;
• observed data pointing to a measurable decrease of estimated future cash flows associated with a group of financial assets from the time of their first recognition, although it is not yet possible to determine the decrease for a single asset from the group of financial assets, including:
• negative changes pertaining to the status of the borrowers’ payments in the group (e.g. increased number of delayed payments) or
• adverse changes in the economic condition in a specific industry, region, etc. contributing to the deterioration of the debtors’ capacity for repayment;
• significant or prolonged decline in the fair value of investments in an equity instrument below the purchase cost;
• adverse changes in the technology, market, economic, legal or other environment in which the issuer of an equity instrument operates indicating that costs of investment in that equity instrument may not be recovered.

36.1.1. Rules applicable as of 1 January 2018 

IFRS 9 introduced an obligation to recognize not only incurred losses, as in the case of IAS 39, but also expected credit loss (ECL). This means a significant increase in the probability weighted estimates of expected credit loss.

The new impairment model is applied to the following financial assets that are not measured at fair value through profit or loss:

• loan receivables from clients;
• debt securities;
• lease receivables;
• lending commitments and issued financial guarantees (previously impairment losses were recognized in accordance with IAS 37 Provisions, Contingent Liabilities and Contingent Assets).

For debt assets measured at amortized cost and at fair value through other comprehensive income, impairment is measured as:

• Lifetime ECL – the expected credit losses that result from all possible default events over the expected life of a financial instrument;
• 12-month ECL – the portion of lifetime expected credit losses that represent the expected credit losses that result from default events on a financial instrument that are possible within the 12 months after the reporting date.

The PZU Group measures allowances for expected credit losses at an amount equal to lifetime ECL, except for the following instruments, for which 12-month ECL is recognized instead:

• financial instruments for which credit risk has not increased significantly since initial recognition,
• debt securities featuring low credit risk at the reporting date. Low credit risk debt securities are those securities that have been assigned an external investment-grade rating.

Change of the approach to calculation of impairment losses has significant consequences in the case of modeling of the credit risk parameters and final amount of the charges made. The loss identification period or IBNR charge are longer be used. The charge is calculated in three categories:

• basket 1 – portfolio with low credit risk – 12-month ECL is recognized;
• basket 2 – portfolio in which a significant increase of credit risk occurs – lifetime ECL is recognized;
• basket 3 – portfolio of impaired loans – lifetime ECL is recognized.

The impairment loss calculation method also impacts the method of recognizing interest income – for baskets 1 and 2 interest income is determined on the basis of gross exposures, and in basket 3 on the net basis. If credit risk increases significantly (basket 2), then the expected credit losses are recognized earlier, which contributes to higher impairment losses and consequently affects the financial result.

The PZU Group recognizes the cumulative changes in lifetime ECL since initial recognition as a loss allowance for ECL from purchased or originated credit-impaired financial assets (POCI).

Changes in the value of allowances for expected credit losses is recognized in the consolidated profit and loss account in the “Movement in allowances for expected credit losses and impairment losses on financial instruments” item.

36.1.1.1 Calculation of PD and LGD parameters 

PZU Group uses the following parameters to estimate allowances for expected credit losses:

• Probability of Default (PD) – probability of default of a counterparty over a specified time horizon;
• Loss Given Default (LGD) – loss given default, expressed as a percentage of the total exposure in case of a counterparty insolvency.

For issuers and exposures that are externally rated, PDs is assigned on the basis of the average market default rate for the rating classes concerned. First, the internal rating of an entity/issue is determined in accordance with the internal rating methodology. The tables published by external rating agencies are used to estimate average PD.

The Moody’s RiskCalc model is used for issuers of corporate bonds and corporate loans, for which no external rating is available. The EDF parameter (expected default frequency) is used to estimate PD. When estimating lifetime PD for exposures with maturity above 5 years (in the RiskCalc model, the forward EDF curve refers to a 5-year period), it is assumed that in subsequent years PD is constant and corresponds to the value determined by the model for the 5th year.

For loan receivables from clients PD is estimated based on internal models depending on the segment group, individual credit quality of the customer, and the exposure lifecycle phase.

For issuers of corporate bonds and corporate loans, 12-month LGD is determined based on the Moody’s RiskCalc model (LGD module). When estimating lifetime LGD for exposures with a maturity above 5 years, it is assumed that in subsequent years LGD is constant and corresponds to the value determined by the module for the 5th year.

If a credit rating agency has allocated a separate recovery rate to the instrument concerned then this parameter is used. For a given RR (recovery rate) parameter, the formula: LGD = 1-RR is applied.

Where the RiskCalc model cannot be used to estimate LGD levels and where the instrument does not have an LGD awarded by an external rating agency, then the average RR should be used, based on market data (properly differentiating the corporate and sovereign debt classes) supplied by external rating agencies using the following formula: LGD = 1-RR. When lifetime LGD must be estimated, the value of this parameter is assumed to be constant. The degree of subordination of debt is taken into account when selecting data for LGD.

36.1.1.2 Change in credit risk since initial recognition

At each reporting date, the PZU Group shall assesses whether the credit risk on a financial instrument has increased significantly since initial recognition. When making the assessment, the PZU Group should use the change in the risk of a default occurring over the expected life of the financial instrument instead of the change in the amount of expected credit losses. To make that assessment, the Group compares the PD for the financial instrument as at the reporting date with the PD as at the date of initial recognition and consider reasonable and supportable information, that is available without undue cost or effort.

It is recognized that the credit risk on a financial instrument has not increased significantly at initial recognition and on the reporting date if the financial instrument features low credit risk (that is, it has an external investment-grade rating).

The PZU Group assesses whether the credit risk of financial instruments has increased significantly by comparing the PD parameter for the rest of its lifetime on the reporting date with the PD parameter for the rest of its lifetime estimated at the time of initial recognition.

The PZU Group regularly monitors the effectiveness of the criteria used to identify a significant increase in credit risk, in order to confirm that:

• the criteria allow for identification of a significant increase in credit risk before the impairment of the exposure occurs;
• the average time between identifying a significant increase in credit risk and impairment is reasonable;
• exposures are in principle not transferred directly from basket 1 (12-month ECL) to basket 3 (impairment);
• there is no unreasonable volatility of allowances for expected credit losses resulting from transfers between 12-month ECL and lifetime ECL.

In the case of loan receivables from clients, the identification of a significant credit risk growth is based on an analysis of qualitative (such as the occurrence of a 30-day past due period, customer’s classification in the watch list, forbearance) and quantitative premises.

36.1.1.3. Identified impaired financial assets (basket 3)

The PZU Group classifies financial assets to basket 3 when the premises for impairment losses, such as among others delay in payment of more than 90 days, are satisfied with simultaneous satisfaction of the unpaid amount materiality threshold, exposure being included in the restructuring process or occurrence of an individual premise of impairment losses.

36.1.1.4. Financial assets impaired due to credit risk (POCI) 

Financial assets impaired due to credit risk (POCI) is assets with impairment losses determined at the time of the initial recognition. The POCI classification does not change over the life of the instrument until derecognition.

POCI assets arise from:

• acquisition of a contract satisfying the definition of POCI (e.g. on combination with another entity or purchase of a portfolio);
• conclusion of a POCI contract on the initial granting (e.g. granting of a loan to a client in a poor financial condition),
• modification of a contract (e.g. in the course of restructuring) resulting in excluding an asset from the balance sheet and recognizing a new asset satisfying the definition of POCI.

As at the initial recognition, POCI assets are recognized at the fair value, without recognizing credit risk impairment.

36.1.1.5. Allocation of financial assets taken over as part of Pekao and Alior Bank acquisition deals

The financial assets acquired in the transactions to acquire Pekao and Alior Bank were classified solely to basket 1 or as POCI, respectively as of the date of acquisition (assets that were covered by impairment losses).

The financial assets that were classified as POCI as at the date of implementing IFRS 9 (assets that would be classified in the bank to basket 3 or as POCI as at the acquisition date) do not change their classification on subsequent balance sheet dates. The following standards have been endorsed for the other exposures:

• The PZU Group maintains the banks’ classification in respect of exposures that were in basket 1 in the bank on the date of acquisition;
• a check is done of the exposures that were in basket 2 in the banks on the date of acquisition to see whether the loan quality deteriorated after the date of acquisition. If not – these assets are classified as basket 2, also at the PZU Group level; otherwise – the PZU Group upholds the classification to basket 1;
• the bank’s classification to basket 3 is accepted for exposures for which an impairment has been identified after the date of acquisition.

The assignment of all the financial assets recognized by banks after the date of acquisition to baskets at the PZU Group level is consistent with the classification used at the level of the bank’s financial statements.

36.1.1.6. Receivables from policyholders 

A simplified model, in which impairment losses are estimated at the expected credit loss amount over the entire lifetime, is applied for receivables from policyholders.

Where any evidence is found that indicates the possibility of impairment of an individual receivable, an assessment is made of the debtor’s economic standing and assets and the probability of repayment of the receivables. Following such analysis, a specific impairment loss may be recognized for such individual receivable item.

In the case of receivables from debtors against whom liquidation or bankruptcy proceedings have been launched, the impairment loss is recognized up to the amount of the receivable that is not covered by a guarantee or other collateral. If a petition for the debtor’s bankruptcy has been dismissed and the debtor’s assets are not sufficient to cover the costs of the bankruptcy procedure, the impairment loss is recognized at the full amount of the receivable.

A specific impairment loss is increased if information is received that the estimated recoverable amount has fallen or the amount of receivables for which the impairment loss was recognized, has increased. A previously recognized specific impairment loss is reversed if it is estimated that the recoverable amount is higher than it was previously estimated or if full or partial payment of the receivable amount has been confirmed. A specific impairment loss is used if the receivable has been forgiven or written down in full.

To the extent that no individual assessment has been made, a collective assessment is conducted. Receivables are grouped by similar credit risk characteristics. For receivables before maturity, the value of the receivable that is likely to become due is determined based on a historical analysis of the percentage of the ratio of receivables that are not paid before maturity. The amount of write-off for expected credit losses is determined on the basis of the uncollectibility ratio for matured receivables with the shortest past due period.

For matured receivables, an age structure is prepared, depending on the past due period. For this group, the value of the allowance for expected credit losses is calculated in separate ranges of past due periods, based on the uncollectibility ratios determined through historical analysis.

36.1.2. Rules applicable until 31 December 2017

The evidence of impairment for credit exposures may be divided into evidence relating to:

• the client, including:
• individual client – consumer bankruptcy, death, lack of information about the customer’s whereabouts, loss of employment, client’s financial problems;
• business client – receivership, bankruptcy/liquidation, significant deterioration of internal scoring/rating, significant deterioration of the economic and financial standing;
• both individual and business clients – significant delay in payment or unauthorized debit, client’s assets not being disclosed.
• account – launch of court proceedings, launch of enforcement proceedings, effective termination of the agreement, restructuring, exposure challenged by the debtor through litigation, identified fraud.

If there no objective evidence of impairment exists for an individually assessed financial asset, whether significant or not, the asset is included in a group of financial assets with similar credit risk characteristics, which are collectively assessed for impairment. Assets that are individually assessed for impairment and for which an impairment loss has been recognized are not included in a collective assessment of impairment.

The amount of impairment loss is measured as the difference between the asset’s carrying amount and the present value of estimated future cash flows (excluding future credit losses that have not been incurred) discounted at the financial asset’s original effective interest rate (i.e. the effective interest rate computed at initial recognition). Interest income is recognized using the rate of interest used to discount the future cash flows for the purpose of measuring the impairment loss. Exposures for which evidence of impairment has been identified are divided into exposures measured individually and measured collectively in groups.

If evidence of impairment is identified for financial instruments available for sale then the losses previously recognized in the revaluation reserve are charged to profit or loss.

Impairment losses on financial instruments available for sale charged to profit or loss:

• in the case of equity instruments they cannot be reversed;
• in the case of debt instruments they can be reversed if, in a subsequent period, the fair value of the debt instrument increases and the increase can be objectively related to an event occurring after the impairment loss was recognized in profit or loss.

36.1.2.1 Loan receivables from clients 

For all on-balance sheet credit exposures (groups of on-balance sheet credit exposures) an assessment is made to identify objective indications of impairment, according to the most recent data at the remeasurement date. In order to calculate an impairment loss amount, the estimated amounts and timing of future cash flows must be assessed. The estimates are based on assumptions about many factors, so the actual results may differ. As a result, the impairment loss amount may be subject to change in the future.

Individual assessment is required for impaired exposures that exceed the accepted materiality or exposure thresholds, for which a group of assets with similar credit risk characteristics cannot be identified or where the sample is too small to estimate the group’s parameters.

Individual measurement consists in a case-by-case verification whether a credit exposure is impaired and projection of future cash flows, including cash flows from seizure of collateral less cost to seize and sell, or from other repayment sources. The value of recoveries expected in individual measurements are regularly compared with actual recoveries.

Group measurement is based on the time over which an exposure remains in an impaired state; it considers the specificity of the group in terms of expected recoveries. Collateral is taken into account at the exposure level.

Credit exposures, for which no individual indications of impairment have been identified, are grouped in accordance with the risk profile homogeneity principle and a provision is recognized for the entire group of exposures to cover losses incurred but not reported (IBNR).

36.1.2.2. Equity instruments quoted on regulated markets and participation units and investment certificates in mutual funds

Impairment losses for equity instruments quoted on regulated markets, participation units in open-end mutual funds and closed-end mutual fund certificates classified as available for sale are recognized if at least one of the two conditions is met:

• the negative difference between the present value and the purchase value is at least 30% of the purchase value;
• at the end of each of the consecutive 12 months, the value of the asset was lower than the purchase value.

36.1.2.3. Assets held to maturity and loans

Impairment losses for assets held to maturity and loans are calculated at the difference between the carrying amount of the assets and the present value of estimated future cash flows discounted by the effective interest rate determined on initial recognition (initial effective interest rate).

If an impairment loss amount decreases in a subsequent periods a result of an event that occurred after the impairment, the previously recognized impairment loss is reversed through an adjustment of the balance of impairment losses. The amount of the reversal is posted to the profit and loss account under “Net result on realization and impairment losses on investments”.

36.1.2.4. Receivables from policyholders

The model for recognizing allowances for receivables from policyholders did not differ materially from the one applicable as of 1 January 2018, except for the fact that it did not consider expected credit losses but rather losses incurred.