Market - factors that may affect the PZU Group in 2022

Due to the scope of PZU Group’s business (insurance sector in Poland, the Baltic States and Ukraine, mutual and pension funds sector, banking), the main factors that will shape the environment in which the Group will operate and may have a direct impact on the development and results of the Group in the medium term, in particular in 2022, may be divided into the following three categories:

• macroeconomic and geopolitical;
• legal and regulatory;
• market factors, specific to individual sectors or businesses in which the Group is involved.

Macroeconomic and geopolitical factors

The growth rate, level and structure of the key macroeconomic factors in Poland and abroad (GDP, inflation interest rates) translate into the growth rate of business in all sectors in which the PZU Group operates and their profitability. They determine, directly or indirectly, albeit with a certain time lag, the gross written premium growth rate in non-life insurance, changes in demand for credit, accumulation of deposits and inflow of assets into funds. Moreover, they influence the loss ratio in non-life insurance and the investment result. They also determine the fund management results and key measures affecting the performance of the banking sector (interest margin and costs of risk).

In 2022, the armed conflict between Russia and Ukraine poses a particular threat and may exert an adverse impact on economic growth, primarily due to the increased level of uncertainty and the increase in gas and oil prices (and, to a lesser extent, as a result of disruptions in trade with Russia, Belarus and Ukraine). Natural gas is broadly used in many energy-intensive production processes. Additionally, the cost of gas is an important part of the budgets of households. The shock of rising prices may contribute to a deeper than currently expected weakening of the rate of growth in consumption and may suppress the GDP growth rate. Increased uncertainty may, in turn, exacerbate sentiments among investors. The increase in gas and oil prices – depending on the magnitude and persistence of this growth – will also push the inflation rate even higher. The increase in risk aversion, on a regional and global level, due to the Russia-Ukraine conflict may result in at least a temporary outflow of foreign capital, decreases in stock market indices, a temporary depreciation of the Polish zloty and may also contribute to an increase in bond yields. If, in this situation, the National Bank of Poland deems that the risk of an increase in inflation is too serious in the medium term, it may be forced to impose even greater interest rate hikes, thus hampering demand in the domestic economy. If the supply shocks pose a threat of a major deceleration of GDP growth – and the risk of a persistently high inflation in the medium term clearly diminishes – the NBP may opt for a more dovish monetary policy.

The war between Russia and Ukraine also has a direct impact on the PZU Group’s business and results. This impact is currently difficult to estimate, but may include the loss of some insurance revenues and increased operating expenses on the part of the PZU Group companies operating in Ukraine. As at 31 December 2021, total net assets of the PZU Group companies in Ukraine included in consolidation, less liabilities and adjusted for mutual interests between PZU Ukraine and PZU Ukraine Life, amounted to PLN 70 million. The assets of those companies, net of mutual interests between PZU Ukraine and PZU Ukraine Life, amounted to PLN 554 million, or 0.14% of the Group's total assets.

An additional geopolitical risk factor is a potential resumption of the migration crisis on the border with Belarus. This may lead to additional disruptions of supply chains for Polish companies.

Other threats that may materialize include the possible prolonging of the COVID-19 pandemic and the scale of constraints affecting economic activity as a result of upholding the necessary sanitary restrictions in Poland and in relations with the country’s trading partners. In this context, the risk includes a possible emergence of new SARS-CoV-2 variants resistant to the existing vaccines as well as an insufficient pace of vaccinations. Disruptions associated with the pandemic may pose the strongest hit to the service sector, transport, trade, restaurant and hotel services, and the broadly construed cultural and entertainment sector. This can generate additional challenges for insurers, banks and financial institutions in terms of their ability to offer products and aftersales service.

A risk factor, which may cause a weakening of economic activity in Poland, as well as in other countries, is a possible continuation of the disruptions in supply chains and transport and the related strong increase in the prices of raw materials, components and finished products. In particular, expansion of the Omicron variant in Asia and continuation of the sanitary restrictions in China may cause an intensification of such disruptions.

Whatever the cause, the persistence of high inflation can affect future claims paid on issued policies. Inflation also creates a problem for customers with depreciation of insurance benefits in long-term products.

In addition, in an environment of recovering demand and an improving labor market, the higher inflation is already resulting in tighter monetary policy. There is a risk that the reaction of the NBP, but also other central banks, will prove too strong, causing excessive cooling of the economy. In turn, too weak a response from central banks could mean an extended period of high inflation. The uncertainty about the level of inflation in Poland in 2022 is also related to the possibility that the government will extend the Anti-Inflation Shields.

The economic environment, in particular the actions of the Monetary Policy Council with respect to interest rates and the reserve requirement, play a key role in the functioning of the banking sector. A very low interest rate environment has a negative effect on the sector’s performance (by affecting the banks’ net interest income), which could be felt in 2021. However, the interest rate hike cycle starting in late 2021 should be more beneficial to the performance of the banking sector. The relatively high level of inflation and the need to bring it down makes it much more likely that the NBP will continue to raise interest rates rather than lower them in 2022. On March 8, the MPC raised interest rates for the third time in 2022. The reference rate rose to 3.50%,i.e. the highest level in nine years.

On the one hand, an increase in market interest rates contributes to financial stability, because it helps improve profitability and financial standing of banks and insurers. On the other hand, however, it carries risks to financial stability by contributing to a deterioration of the quality of banks’ loan portfolios.

The coming into life of the economic recovery scenario and a reduction in the level of uncertainty across the financial markets may result in a slight appreciation of the Polish zloty. This would help reduce expenses related to the prices of spare parts in motor insurance. However, in the conditions of the current account deficit of the balance of payments, persisting geopolitical tensions and the risk of postponing the disbursement of European funds under the National Reconstruction Plan - the risk of weakening of the Polish zloty remains - at least temporarily - relatively high.

On the other hand, slower-than-expected GDP growth in Poland may result in reduced household and corporate spending, including on purchases of motor insurance policies (for instance, due to softer sales of new cars), lower sales of loans and associated borrowers’ insurance products and a slump in demand for life insurance products, in particular as a result of a smaller pool of benefits offered by companies. Poorer financial standing of companies may result in an increase in credit risk (in particular in the banking segment) and higher loss ratio on the financial insurance portfolio, weakening of the growth rate of new mortgage loans and a weaker growth rate of consumer loans

Legal and regulatory factors

The PZU Group’s activity and operations are subject to the impact of both national regulations and European legislation.

From the perspective of the insurance business, the Group’s activity has been affected by all regulations and the case-law that affects the level of premiums and claims paid by insurance companies.

As regards property insurance, the changes to the Road Traffic Law and the Civil Code may be particularly relevant. They concern, among other things, the possibility for insurance companies to link the amount of tariffs in motor insurance to the type of offences committed by the driver and the possibility to grant general damages to the closest family members of the victim in certain situations.

The PZU Group's unit-linked life insurance business is affected by the decision of the Polish Financial Supervision Authority taken as part of the product intervention, which came into force on 1 January 2022. PZU Życie has implemented the necessary measures that ensured adaptation to the product intervention, in particular it assured that the updated product offer included solely and exclusively products that meet all the criteria set forth in the decision issued by the regulatory authority.

One of the more important factors in 2022 in the context of banks is still the issue of foreign currency mortgage loans. A risk factor is the potential necessity of establishing additional provisions to cover customer claims in litigations related to Swiss franc loans. After the CJEU confirmed that domestic courts have the ultimate power for identifying “unfair” clauses in FX loan agreements, the judgments of the Polish Supreme Court will be of key importance in this matter. The judgments of the Supreme Court will determine the domestic line of judgments in the matter of Swiss franc loans and consequently the scale of provisioning required from domestic banks to cover the claims of CHF clients for the use of unfair contractual clauses in FX mortgage loan agreements. Because the exposure of the PZU Group’s banks to foreign currency loans is scarce compared to other banks operating in Poland, the direct impact of this risk on the Group will be limited.

The resolution of the Bank Guarantee Fund (BFG) Board of February 22, 2022 will also have a significant impact on the results of the banking sector. The BFG Board set the total bank contributions to the BGF in 2022 at PLN 3,701 million, compared to PLN 2,230 million in 2021 and PLN 3,175 million in 2020. This means an increase of 66% compared to 2021 and 16.6% compared to 2020.

Potentially significant impact on the financial market may be exerted by the bill, currently in the legislative process, amending certain acts in connection with commitment to develop the financial market and protect investors in that market. According to its authors, it aims to organize and streamline the functioning of financial market institutions, in particular to eliminate barriers to access to the financial market, strengthen the supervision of the financial market, better protect customers of financial institutions, minority shareholders, and increase the level of digitization in the implementation of supervisory responsibilities by the Polish Financial Supervision Authority. As regards the Insurance Activity Act, the bill provides, among other things, for extension of the group of authorities upon the request of which an insurance undertaking is obliged to provide information constituting a secret concerning individual insurance contracts. The bill also extends the list of persons on whom the regulatory authority will be able to impose financial penalties to include persons who, at the time of the violation, were members of the supervisory board of an insurance or reinsurance undertaking. The amount of potential penalties that KNF could impose on such persons was also significantly increased - up to PLN 20 million.

Also the draft amendments to the Labor Code, regulating the way of performing remote work, is in the legislative process (the existing regulations in this regard were adopted only for the duration of the SARS-CoV2 virus epidemic). In accordance with bill, the principles of remote work need to be agreed upon at the workplace level in consultation with trade unions. If no agreement is reached between the parties to the negotiations, the employer may unilaterally issue internal rules and regulations governing the provision of remote work in its establishment. The employer will also be required to equip employees with tools and materials necessary to perform their work remotely and to compensate employees for part of the costs incurred by them in connection with performing the remote work.

The increased regulatory burden on financial institutions due to increased awareness of sustainable financing, climate change and environmental issues will be compounded in 2022 by the introduction of the Regulation of the European Parliament and of the Council on the establishment of a framework to facilitate sustainable investment ("Taxonomy”) and its delegated acts. The new regulations that particularly result in increased obligations to disclose how and to what extent a company's activities are related to business activities that qualify as environmentally sustainable.

Factors specific to the sectors in which the PZU Group operates

The PZU Group's operating conditions and results are affected by factors and conditions specific to the sectors in which the Group companies operate. Currently, the most important of these are the impact of the COVID-19 pandemic, climate change, demographic changes and the level of competition in the product groups that form the core of the Group's business.

In the last 2 years, the global COVID-19 pandemic has been a phenomenon that has determined the functioning of the markets in which the PZU Group operates. Although national vaccination programs and the easing of the restrictions related to the epidemiological situation stimulated the recovery in 2021 - allowing insurers worldwide to expect strong growth in 2022 – there is still conditions of uncertainty.

In life insurance, the most visible consequence of the pandemic visible to insurers is an increase in mortality. The restrictions that were imposed during the earliest waves of the disease also reduced the overall provision of medical services. Patients postponed their scheduled appointments and treatments for other, initially unspecified, dates. Although in 2021 patients returned to the provision of services postponed in previous months, the problem of the so-called healthcare backlog still remains. The long tail of the epidemic, in the form of deteriorating health for many people and the resulting complications, may drag on for years. The possible overlap of the long-term effects of the SARS-Cov-2 coronavirus outbreak and the effects of not treating other diseases will be an additional risk factor.

The rapid growth of telemedicine is another outcome of the COVID-19 pandemic changing the healthcare market. Telemedicine has proven to be an essential component of healthcare delivery during successive waves of the pandemic. However, many solutions combining the elements of telecommunications, IT and medicine have become a permanent feature of the medical market.

In the early phase of the pandemic, in connection with the lockdown periods affecting the Polish economy and restrictions in the movement of people, the loss ratio decreased in the key market segment of non-life insurance, namely motor own damage insurance and motor third party liability insurance. However, with the increase of collective immunity and the subsiding of the pandemic, an increase of mobility is expected, among others due to the return of some employees to offices. Increased traffic on the roads may cause an increase in motor insurance loss ratio, which may potentially affect the profitability of this line of the non-life insurance business and, consequently, may lead to price increases.

Another effect of the pandemic is a higher level of customer awareness and a sense of uncertainty, which is associated with an expected increase in demand for life and health insurance. Similarly, the global fashion for healthy, active yet safe living is increasing interest in insurance and medical products. Therefore changing customer expectations will affect the business and performance of the PZU Group in each of its areas of activity. In particular, this concerns the personalization of the offering and the provision of a quick and easy access to a comprehensive ecosystem of financial services.

The pandemic and its associated restrictions have contributed to the rapid growth of remote customer service processes. Further transfer of clients from traditional to remote channels can be expected. The change in customer habits which, under normal circumstances, would have taken several years, was a consequence of the lockdowns, which forced the transition to remote work. These factors accelerated the digitization and the use of advanced technologies, especially in the insurance sector. Remote forms of sale, inspection and claims handling became popular relatively rapidly.

New technologies have enabled insurers to continue operations during individual lockdowns, and have set new standards for customer service. However, the development of new technologies entails several challenges that insurers and financial institutions will have to face in the near future.

One of them is to effectively manage the solutions implemented rapidly at the onset of the pandemic. Two years have passed since the first information about the emergence of the coronavirus in Poland, and although many of the introduced solutions were long-awaited by customers, it is extremely important to skillfully assess their further usefulness, scale and improve the introduced technologies, as well as adjust them to the long-term strategies of insurance companies. Insurers must be cautious as customer preferences are changing dynamically - it will become extremely important to balance service processes in such a way that the human factor is retained where it is necessary and expected by customers, and the part of the processes that will not cause a deterioration of service quality is automated.

Another challenge is the supply of skilled workers with expertise and skills in areas related to cybersecurity, artificial intelligence, machine learning and data analytics. The rapid growth of these fields has resulted in an increased demand for employees who can assist companies in leveraging their technological potential. The risk associated with the shortage of employees with appropriate skills in new technologies is one of the main problems associated with the implementation of technological advances.

Technological progress has also led to the emergence of so-called insurtechs and fintechs , which are already influencing and will continue to influence the transformation of the insurance and banking industries over the long term.

The PZU Group's business and results are also increasingly affected by factors related to climate change. Natural catastrophe events such as fires, storms, hail, flash floods, cyclones, tornadoes, and heat waves, which have been on the rise over the past few decades, have contributed to increasing the loss ratios in the property insurance sector. The increasing number of claims is weighing on the performance of insurers and reinsurers across the globe, focusing increasing attention on the issue of climate change. Current underwriting methods are based on past events and do not capture well the nature of the dynamic global climate changes. The complex nature of climate risk presents insurers with the challenge of developing new insurance products which will adequately reflect the frequency of catastrophic events and translate into the premium levels. The climate change risk also affects the level of capital requirements for insurance undertakings and the cost of reinsurance schemes.

At the same time, insurers and financial institutions are increasingly expected to take responsibility for delivering a just transition to a low-emission economy. This influences the development of “green” insurance and loan offerings for, among others, large corporations and smaller businesses, supporting sustainable development. At the same time, financial institutions, including insurers and banks, should increasingly incorporate responsible investment principles taking into account ESG factors into their investment activities. This is determined not only by regulatory issues, but also by society's changing expectations of financial institutions and corporations - customers want large companies to take a proactive stance in the fight for a better planet.

Customers themselves are also increasingly opting for eco-friendly solutions that contribute to combating climate change. The quest for convenience and the increasing environmental awareness result in a rapid development of the shared mobility industry. City dwellers increasingly frequently choose means of transport which allow them to quickly and efficiently move around and change the means of transport depending on the situation on the road - this is the so-called shared mobility. This global trend includes not only cars but also scooters, segways, skymasters and electric unicycles, rented via smartphone apps. Insurers' offerings should meet customer expectations and include products dedicated to shared mobility.

Other factors that will affect PZU's operations over the long term include demographic trends, mainly the aging population, mortality, morbidity, especially of civilization diseases, and fertility rates. As the population continues to decline, coupled with the simultaneous aging of the population, the demand for health care and long-term care to senior citizens increases. Similarly, other global trends, such as the sharing economy or the Internet of Things (IoT), and trends in the insurance industry, such as open insurance and building thematic ecosystems for customers, will influence the direction of insurers' business models and their product offerings.