38.1 Accounting policy 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;
• 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.

In the case of assets which are not measured at fair value through profit or loss, the PZU Group recognizes the expected credit loss – ECL. This concerns:

• loan receivables from clients;
• loans;
• debt securities;
• buy-sell-back transactions;
• lease receivables;term deposits with credit institutions;
• lending commitments and issued financial guarantees.

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 and
• exposures to banks and the NBP.

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 – impaired portfolio – lifetime ECL is recognized.

The method of calculation of the allowance for expected credit losses 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 exposure basis. 

The PZU Group recognizes the cumulative changes in lifetime ECL since initial recognition as a loss allowance for ECL from purchased or granted 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.

Provisions for legal risk pertaining to FX mortgage loans in Swiss francs

In connection with the CJEU ruling of 3 October 2019, the PZU Group identifies legal risk pertaining to FX mortgage loans in Swiss francs. 

For exposures outstanding as at 31 December 2020 the PZU Group considers that the legal risk impacts the expected cash flows from the credit exposure and the provision amount is an element of the credit loss, i.e. the difference between the expected cash flows from the given exposure and the contractual cash flows. 

Consequently, the PZU Group recognizes the amount of the provision pertaining to credit exposures outstanding as at 31 December 2020 (comprising existing and possible future statements of claim) in the impairment losses for loan receivables from clients and, accordingly, in the “movement in allowances for expected credit losses and impairment losses”.

Additional information on estimation of the provisions associated with the legal risk pertaining to FX mortgage loans in Swill francs is presented in section 47.3.

38.1.1. Changes in the calculation of expected credit losses due to the COVID-19 pandemic

The COVID-19 pandemic resulted in an economic downturn in Poland and its environment. Its negative impact on the economy (among others suspension or limitation of activity in some sectors, disruptions of the supply chain, unavailability and dismissal of employees, changes in consumer behaviors, economic slowdown at business partners) may lead to a significant deterioration of the financial standing of some borrowers. The PZU Group is taking steps to reduce credit risk and support its clients. Such activities include, among others, intensified monitoring of the loan portfolio, with particular emphasis on increased-risk industries, strengthening the instruments mitigating credit risk, including legal collateral established on receivables, both at the stage of financing and monitoring, verification of the procedures in the area of financing individual business lines and their adaptation to the existing situation, granting loans with BGK guarantees securing up to 80% of the exposure value, postponing payments of principal and interest installments at the client’s request for up to 6 months, deferring the application of sanctions resulting from failure to fulfill the contractual clauses.

The PZU Group has modified its approach to the calculation of expected credit losses by adopting solutions appropriate for the specific nature of each relevant entity. Due to the uniqueness of the current situation associated with the COVID-19 pandemic, the calculation of expected credit losses is subject to particular uncertainty, and the adopted expert assumptions may be modified in subsequent periods. 

The PZU Group endeavors to adequately reflect the potential deterioration of the quality of the credit portfolio in the expected credit losses for basket 1 and basket 2 and to calculate appropriate charges for the non-performing portfolio (basket 3), considering the possible difficulties with raising funds. An increase in the charges results largely from the projections of future changes in the quality of the credit portfolio, taken into account in the calculation of expected credit losses but not in the current evolution. The PZU Group has not identified any material increase in the scale of client defaults, resulting in a significant increase in non-performing loans. 

The starting point for estimation of the expected credit losses are the forecasts for the macroeconomic situation. According to preliminary estimates of the Central Statistical Office (GUS), GDP in 2020 declined by 2.7 % relative to 2019. At the same time, the PZU Group assumes economic growth of approx. 4% in 2021. The unemployment rate increased to approx. 6.2% at the end of 2020 (compared to 5.2% in December 2019). The PZU Group expects that this indicator will stabilize in 2021. 

The expected deterioration of the macroeconomic situation in 2020 was reflected in a modification of the risk parameters (PD and LGD) applied in the calculation of expected credit losses based on an analysis of historical data, backed up with expert assessment (on account of the unique nature of the current situation) – pertaining to, among others, the scale of the economic slowdown, support from the government and state institutions. Due to the unique nature of the current situation, the scale of the expert judgment in the credit risk assessment is increased relative to previous periods. 

The PZU Group did not change its approach to identifying significant deteriorations in credit risk, constituting the basis for classifying exposures into basket 2. However, these criteria are applied in a manner commensurate with the current situation, in accordance with the EBA Guidelines. According to these guidelines, the granting of a loan moratorium period or other mitigation measures for the COVID-19 pandemic does not automatically reclassify exposures to basket 2. However, such reclassification may be triggered by an increase in credit risk arising from problems experienced by a specific debtor. In the case of identification of material deterioration of the economic and financial standing of a client operating in industries at risk, the exposure was reclassified to basket 2 or 3. 

The cost of impairment losses on expected credit losses and impairment losses on loan receivables from clients in 2020 was PLN 1,672 million. According to the PZU Group’s estimates, a portion of this amount is associated with the COVID -19 pandemic, and its causes include the deterioration of the PD and LGD parameters, an increase in impairment losses due to reclassification to basket 2 triggered by industry reviews and similar activities, and an increase in impairment losses due to a drop in potential future recoveries.  It should be noted that some of the risks (including the reclassification of exposures due to industry reviews or the increase in impairment losses due to the smaller potential future recoveries) would have materialized irrespective of the COVID-19 pandemic and it is not possible to resolve whether the additional charge recognized resulted only from the COVID-19 pandemic or also from the situation which would have occurred regardless of it.

Moratoria implemented in 2020 due to COVID-19

In 2020, due to the COVID-19 pandemic, the PZU Group introduced the following loan repayment programs:

• moratoria prepared on the initiative of the PZU Group (non-statutory moratoria) – the possibility of suspending the repayment of principal and interest installments or grace period involving suspension of the payment of principal installments with simultaneous extension of the lending period, simplified extensions of the credit limits.

The possibility of taking advantage of the moratoria by the clients depended on the timely service of their loan and the assessment of the client’s financial standing.

• moratoria prepared by the PZU Group in accordance with EBA Guidelines (statutory moratoria) – on 29 May 2020 the KNF Office notified the EBA of the banks’ position prepared under the patronage of the Polish Bank Association on the EBA Guidelines, which was introduced by the PZU Group for loan agreements concluded before 13 March 2020 on the following rules:
• for individual clients, micro and small businesses, the Group introduced the possibility of deferring principal or principal and interest installments for a period specified by the client, up to 6 months (regardless of the number of applications submitted by the given client). The application of the moratorium is dependent on the timely service of the loan by the individual client and their creditworthiness taking into account COVID-19 (in the case of businesses),
• for medium-sized enterprises (with the turnover up to EUR 50 million) the Group introduced the possibility of deferring the principal or principal and interest installments in accordance with the client’s request for a term they specify, up to: 6 months (principal installments) and 3 months (principal and interest installments), under the condition the client had creditworthiness at the end of 2019 and, for big corporations (with the turnover over EUR 50 million) the Group introduced the possibility of deferring principal installments in accordance with the client’s request, for a period they specify, up to 6 months under the condition the client had creditworthiness at the end of 2019.
• suspension of performance of the agreement pursuant to the provisions of the Act of 2 March 2020 on Special Solutions Associated with Preventing, Counteracting and Combating COVID-19, Other Infectious Diseases and Crises Caused by Them (statutory moratoria), i.e.:
• consumer clients who lost their job or other main source of income after 13 March 2020,
• during the term of the suspension of performance of the agreement the client is not obligated to make any payments under the agreement, including loan installments, except for the fees for insurance associated with such agreements and no interest is accrued

The program applies for the duration of the state of epidemic threat or state of epidemic.

All of the above moratoria were evaluated by the PZU Group with an eye to satisfying the modification criteria within the meaning of IFRS 9. Having regard for their nature, they constituted immaterial modifications. As at 31 December 2020, the gross carrying amount of the credit portfolio covered by the aforementioned moratoria was PLN 21.2 billion.

Additionally, banks from the PZU Group signed a number of portfolio guarantee agreements with BGK, limiting the effects of COVID-19.

In the PZU Group insurance segment, in the credit risk area, the impact of the COVID-19 pandemic was low; just like in 2019, no indications of impairment were identified in the portfolio, hence no exposure was classified to basket 3 (instruments for which impairment has been recognized). During 2020 the structure of the financial instruments held changed significantly; the share of corporate exposures, which in principle are characterized by higher risk parameters (PD, LGD), was reduced in favor of purchase of Polish treasury bonds or bonds guaranteed by the State Treasury. 

The share of the impairment losses in the credit portfolio (understood as the relation of accumulated impairment losses on account of the credit risk to the gross carrying amount of all PZU Group assets exposed to credit risk subject to the IFRS 9 regime) in 2020 dropped relative to 2019 due to the change of the portfolio structure to a safer one, shift of the rating structure associated with the overall improvement of the financial results of the entities, and improvement of internal macroeconomic forecasts for Poland relative to the negative scenarios associated with the COVID-19 pandemic from Q1. The value of the impairment losses in the portfolios of investment debt financial assets carried at fair value through other comprehensive income and at amortized cost and loans increased in 2020 by PLN 24 million, while the carrying amount of these assets increased during that time by PLN 29,785 million.

38.1.2. Calculation of PD and LGD parameters

PZU Group uses the PD and LGD parameters to estimate allowances for expected credit losses.

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.

38.1.3. 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). This pertains in particular to treasury bonds: 

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. 

38.1.4. 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 another qualitative premise of impairment losses.

In 2021 the PZU Group will implement the EBA/GL/2016/07 guidelines as regards qualitative premises, in accordance with which in the case of retail exposures, it will use the definition of default on the level of individual credit instruments instead of the borrower’s total liabilities (excluding overdue amounts material for the entire relationship), and in the case of commercial exposures, the definition of default on the debtor level will be applied.

38.1.5 Financial assets impaired due to credit risk (POCI)

Acquired or granted 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 statement of financial position 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 allowances for expected credit losses.

38.1.6. Receivables from policyholders

In accordance with the provisions of IFRS 9 item 5.5.15, a simplified model, in which an aggregate assessment of the impairment is carried out and the impairment losses are estimated at the expected credit loss amount over the entire lifetime, is applied for receivables from policyholders which do not contain a significant financing component.

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.