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9.2 Fair value hierarchy

Annual Report 2019 > 9.2 Fair value hierarchy
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On the basis of the input data for fair value measurement, the individual assets and liabilities for which fair value has been presented have been classified to the following levels:

  • Level I – assets and liabilities measured based on quoted prices (unadjusted) from active markets for identical assets and liabilities. This level includes:
  •  liquid quoted debt securities;
  •  shares and investment certificates quoted on exchanges;
  •  derivatives listed on stock exchanges;
  •  liabilities on borrowed securities quoted on exchanges (short sale).
  • Level II – assets and liabilities whose measurement is based on input data other than quoted prices included within level I, which can be observed on the market, either directly (as prices) or indirectly (derived from prices). This level includes:
  • quoted debt securities carried on the basis of the valuations published by an authorized information service;
  •  derivatives – among others FX Swap, FX Forward, IRS, CIRS, FRA;
  •  participation units in mutual fund;
  • investment properties or properties held for sale measured using the comparative method, including free land free land for development and certain smaller and less valuable buildings (such as residential units, garages, etc.);
  • liabilities to members of consolidated mutual funds;
  • investment contracts for the client’s account and risk.
  • Level III – assets measured based on input data unobserved on the existing markets (unobservable input data). This level includes:
  • unquoted debt securities and non-liquid quoted debt securities (including non-treasury debt securities issued by other financial entities, local government and non-financial entities), measured using models based on discounted cash flows;
  • investment properties or properties held for sale measured using the income method or the residual method;
  • loan receivables from clients and liabilities to clients under deposits;
  • options embedded in certificates of deposit issued by PZU Group companies and options concluded in the interbank market to hedge embedded option positions.

In a situation in which the measurement of an asset or liability is based on input data classified in different levels of the fair value hierarchy, the measured asset is assigned to the lowest level from which the input data are taken, provided that they have a significant impact on the overall measurement.

The value of the measurement of components of assets or liabilities qualified in level III is affected to significant extent by unobservable input data.

Measured assets Unobservable data Description Impact on measurement
Loan receivables from clients Liquidity margin and current margin from the sale of the product group Fair values are estimated using valuation techniques, with an assumption that when the loan is granted, the fair value is equal to the carrying amount. The fair value of loans without recognized impairment is equal to the sum of future expected cash flows discounted at the balance sheet date less expected credit loss. The cash flow discounting rate is the appropriate risk-free market rate plus the liquidity margin and current sales margin for the loan’s product group. The margin is determined by product group and by maturity. For the purpose of estimating the fair value of foreign currency loans, the liquidity margin for PLN loans is used, adjusted by quotations of FX swap and basis-swap transactions. The fair value of loans with recognized impairment is equal to the sum of future expected salvage discounted using the effective interest rate, since the average expected recoveries fully reflect the credit risk component. For loans that do not have a repayment schedule (current account loans, overdrafts and credit cards), the fair value is assumed to be equal to the carrying amount. Negative correlation.
Liabilities to clients under deposits Sales margin Fair values are estimated using valuation techniques, with an assumption that when the deposit is accepted, the fair value is equal to the carrying amount. The fair value of term deposits is equal to the sum of future expected cash flows discounted at the balance sheet date. The cash flow discounting rate is the appropriate risk-free market rate plus the current sales margin. The margin is determined on the basis of deposits accepted in the last quarter, by product group and by maturity. For short-term deposits (current deposits, overnight deposits and savings accounts), the carrying amount is taken as fair value. Negative correlation.
Options embedded in certificates of deposit issued by PZU Group companies and options concluded in the interbank market to hedge embedded option positions. Model parameters Embedded instruments are plain vanilla options and exotic options for individual shares, indices, commodities and other market indicators, including interest rate indices and exchange rates and their baskets. All separated options are offset on an ongoing basis on the interbank market. Currency options are measured based on the Garman-Kohlhagen option pricing model (and in the case of barrier and Asian options based on the so-called extended Garman-Kohlhagen model). Exotic options embedded in deposit agreements and their offsets are measured using the Monte-Carlo technique, assuming a geometric Brownian motion model for risk factors.  
Non-liquid bonds and loans Credit spreads Spreads are observed on all bonds (their series) or loans of the same issuer or a similar issuer. These spreads are observed on the dates of issue of new bond series, dates of conclusion of new loan agreements and dates of market transactions on the receivables following from such bonds and loans. Negative correlation.
Investment property and property designated for sale Capitalization rate Capitalization rate is determined through analysis of rates of return obtained in transactions for similar properties. Negative correlation.
  Construction costs Construction costs are determined based on market construction costs less costs incurred as at the date of measurement. Positive correlation.
  Monthly rental rate per 1 m2 of relevant space or per parking space Rental rates are observed for similar properties of similar quality, in similar locations and with a similar size of leased space. Positive correlation.
Derivatives Model parameters Currency options are measured based on the Garman-Kohlhagen option pricing model (and in the case of barrier and Asian options based on the so-called extended Garman-Kohlhagen model). Exotic options embedded in deposit agreements and their offsets are measured using the Monte-Carlo technique, assuming a geometric Brownian motion model for risk factors.  
Own issues and subordinated loans Issue spread above the market curve If historical issue spread above the market curve is used, these issues are classified at level III of the fair value hierarchy. Negative correlation.
Equity instruments not quoted on an active market   Quotations of financial services, current value of future forecasted profit or loss of the company or measurement models based on available market data.  

9.2.1.  Assets and liabilities measured at fair value

Assets and liabilities measured at fair value 31 December 2019 31 December 2018
  Level I Level II Level III Total Level I Level II Level III Total
Assets                
Investment financial assets measured at fair value through other comprehensive income 32,595 15,555 7,061 55,211 22,200 9,329 7,208 38,737
Equity instruments 271 1 246 518 309 1 212 522
Debt securities 32,324 15,554 6,815 54,693 21,891 9,328 6,996 38,215
Investment financial assets measured at fair value through profit or loss 4,985 4,996 286 10,267 12,758 4,684 252 17,694
Equity instruments 613 6 226 845 1,105 - 115 1,220
Participation units and investment certificates 111 4,690 19 4,820 102 4,182 14 4,298
Debt securities 4,261 300 41 4,602 11,551 502 123 12,176
Loan receivables from clients - - 1,624 1,624 - - 1,814 1,814
Measured at fair value through other comprehensive income - - 1,381 1,381 - - 1,511 1,511
Measured at fair value through profit or loss - - 243 243 - - 303 303
Financial derivatives 4 2,985 118 3,107 35 2,384 68 2,487
Investment property - 153 1,828 1,981 - 141 1,556 1,697
Liabilities                
Derivatives 3 2,947 68 3,018 34 3,295 36 3,365
Liabilities to members of consolidated mutual funds - 90 - 90 - 266 - 266
Investment contracts for the client’s account and risk (unit-linked) - 259 - 259 - 266 - 266
Liabilities on borrowed securities (short sale) 293 - - 293 120 - - 120
 
Movement in assets and liabilities classified as Level III of the fair value hierarchy in the year ended 31 December 2019 Investment financial assets measured at fair value through other comprehensive income Investment financial assets measured at fair value through profit or loss Derivatives – assets Derivatives – liabilities Loan receivables from clients measured at fair value Investment property
  Equity Debt Equity Investment certificates Debt     through other comprehensive income through profit or loss  
Balance at the beginning of the period 212 6,996 115 14 123 68 36 1,511 303 1,556
Posting of right-of-use assets (IFRS16) - - - - - - - - - 44
Purchase/opening of the position/granting - 997 - - 573 26 21 167 - 195
Reclassification from Level II1 - 545 - - - 1 - - - -
Reclassifications from assets held for sale to investment property - - - - - - - - - 1
Profit or loss recognized in the profit and loss account as: - 176 111 3 6 57 36 29 (2) 48
– net investment income - 170 - - - - - 29 (2) -
– net result on realization - 6 - - 1 - - - - -
– net movement in fair value of assets and liabilities measured at fair value - - 111 3 5 57 36 - - 48
Profits or losses recognized in other comprehensive income 34 35 - - - - - 16 - -
Sales/settlements/repayments - (1,851) - - (661) (34) (25) (342) (58) (4)
Reclassification to assets held for sale - - - - - - - - - (12)
Reclassification to Level II - (83) - - - - - - - -
Foreign exchange differences - - - 2 - - - - - -
Balance at the end of the period 246 6,815 226 19 41 118 68 1,381 243 1,828

1 Information on the restatements is presented in item 9.3.

 
Movement in assets and liabilities classified as Level III of the fair value hierarchy in the year ended 31 December 2018 Investment financial assets measured at fair value through other comprehensive income Investment financial assets measured at fair value through profit or loss Derivatives – assets Derivatives – liabilities Loan receivables from clients measured at fair value Investment property
  Equity Debt Equity Investment certificates Debt     through other comprehensive income through profit or loss  
Opening balance 221 4,855 95 - 163 100 52 1,556 365 2,204
Purchase/opening of the position/granting - 3,034 - 14 727 16 10 409 3 139
Reclassification from Level I - - 2 - - - - - - -
Reclassification from Level II1 - 190 - - - - - - - 3
Reclassification from own properties - - - - - - - - - 4
Profit or loss recognized in the profit and loss account as: - 49 14 - 3 (30) (9) 29 3 48
– net investment income - 49 - - - - - 29 - -
– net result on realization - - (2) - - (3) - - - -
– net movement in fair value of assets and liabilities measured at fair value - - 16 - 3 (27) (9) - 3 48
Profits or losses recognized in other comprehensive income (9) (12) - - - - - 31 - -
Sales/settlements/repayments - (1,056) - - (756) (18) (17) (514) (68) (11)
Reclassification to assets held for sale - - - - - - - - - (831)
Reclassification to Level II - (64) - - (14) - - - - -
Foreign exchange differences - - 4 - - - - - - -
Balance at the end of the period 212 6,996 115 14 123 68 36 1,511 303 1,556

1 Information on the restatements is presented in item 9.3.

9.2.1.1.  Change in the fair value measurement methodology for financial instruments measured at fair value

Both in 2019 and in 2018, no changes were made in the fair value measurement method for financial instruments measured at fair value that would be of material significance for the consolidated financial statements.

9.2.1.2.  Investment property classified as Level III fair value

Investment property classified as Level III Type of space 31 December 2019 31 December 2018
    Carrying amount Rental fees included in the measurement Capitalization rates included in the measurement Carrying amount Rental fees included in the measurement Capitalization rates included in the measurement
Office properties Office Parking lot 663 12.00 – 14.50 EUR 40.00 – 70.00 EUR 6.00% – 7.50% 651 EUR 12.00 – 14.25 EUR 40.00 – 73.00 5.95% – 7.75%
Warehousing properties Office Warehouse 1,119 9.00 EUR 3.20 – 3.50 EUR 5.90% – 6.45% 889 EUR 6.48 – 9.15 EUR 3.00 – 4.04 6.00% – 6.90%
Other   46     16    
Total   1,828     1,556    

9.2.2. Assets and liabilities not measured at fair value

Fair value of assets and liabilities for which it is only disclosed 31 December 2019 31 December 2018
  Level I Level II Level III Total Level I Level II Level III Total
Assets                
Entities measured by the equity method - - - - - - 14 14
Loan receivables from clients measured at amortized cost - - 193,964 193,964 - - 180,507 180,507
Investment financial assets measured at amortized cost 26,032 2,149 21,742 49,923 24,251 2,301 21,541 48,093
Debt securities 26,032 1,123 12,674 39,829 24,251 1,239 11,900 37,390
Buy-sell-back transactions - 738 3,326 4,064 - 126 3,153 3,279
Term deposits with credit institutions - 288 1,168 1,456 - 936 1,830 2,766
Loans - - 4,574 4,574 - - 4,658 4,658
Liabilities                
Liabilities to banks - 897 5,728 6,625 - 781 5,280 6,061
Liabilities to clients under deposits - - 219,233 219,233 - - 207,668 207,668
Liabilities on the issue of own debt securities1 - 6,700 2,667 9,367 - 5,295 6,800 12,095
Subordinated liabilities1 - 2,766 4,014 6,780 - 2,013 4,043 6,056
Liabilities on account of repurchase transactions - 599 - 599 - 540 - 540

1 The liabilities classified to level II are those whose measurement was not affected by unobservable parameters. They are primarily liabilities on account of bonds issued by Pekao.