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External factors that may affect the conditions of operations and the PZU Group’s

Annual Report 2018 > MARKET > External factors that may affect the conditions of operations and the PZU Group’s
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Due to the scope of PZU Group’s business (insurance sector in Poland, 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 influence on the development and results of the Group in the medium term, in particular in 2019, can be divided into three categories: macroeconomic and geopolitical, legal and regulatory, and market factors, specific to individual sectors / 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 the profitability of individual sectors. On one hand, they determine, directly or indirectly, and with a certain time lag, the gross written premium growth rate in non-life insurance, changes in demand for credit and accumulation of deposits, and funds’ asset inflows. On the other hand, they impact the loss ratios in non-life insurance, investment performance, determine fund management performance and the key measures affecting the performance of the banking sector (interest margin and costs of risk).

In the Polish economy there are presently no clear signs of disruption to the balance where during the upcoming quarters they could lead to a material, cyclical slowdown. The situation in the labor market and the government’s announcements regarding extension of the 500+ program and payout of the “thirteenth pension” in 2019 will drive consumption, although its growth rate may slacken. Among the internal factors thatmay curtail GDP growth in Poland, one should cite problems with hiring properly qualified staff, possible decline in the willingness to invest in businesses or a higher than expected increase in inflation eroding households’ real income (though the regulations on electricity prices introduced at the end of 2018 contain that risk).

The consumption growth rate in 2019 will remain robust. Public investments should continue to grow markedly, though the shortage of qualified employees and higher costs may lead to delays in the execution of some projects. Cyclical factors presently support growth in the investments of businesses, though the external situation may exert an unfavorable impact. For GDP growth in and around the Polish economy clearly started to slow down at the end of 2018. Especially the growth rate of industrial production in the euro area and Germany fell off. The adverse impact of protectionism on business expectations and decisions is becoming evident and the probability of imposing US customs duties on cars imported from the EU has increased recently. The slowdown in global trade is visible. Uncertainty related to relations between the US and China and to Brexit continues to persist. Concerns linked to the deterioration of Italy’s budget situation and its cohesiveness with the rules of the Stability and Growth Pact and to the resilience of the financial sector in the euro area may reappear if there is a stronger slowdown in the euro area economy. It therefore appears that the possibility of a serious slowdown in GDP growth in the euro area and the overall global economy, and hence the occurrence of unfavorable phenomena on the financial markets, is the most important macroeconomic risk in 2019. We expect that the pace of GDP growth in Poland in 2019 will be approximately 3.7%.

The uncertainty related to Brexit is an important factor adversely affecting economic growth in the euro area at the threshold of 2019. A “disorderly” Brexit – leading to more commercial barriers, disruptions in transport and the probable decline in the United Kingdom’s GDP would also be a shock to the Polish economy. For the United Kingdom is the second largest importer of our goods and services following Germany. The pool of EU funds of which Poland is a beneficiary would also be reduced. The direct adverse impact exerted by such a scenario on GDP in Poland is usually estimated to be several tenths of a percentage point. However, considering the indirect impact exerted, among others, by slower GDP growth in the euro area, the repercussions would probably be more pronounced.

Forecast for the Polish economy 2019* 2018 2017 2016 2015
Real GDP growth in % (y/y) 3.7 5.1 4.8 3.1 3.8
Increase in individual consumption in % (y/y) 4.2 4.6 4.9 3.9 3
Gross fixed capital formation in % (y/y) 5.1 7.3 3.9 -8.2 6.1
Increase in prices of consumer goods and services in % (y/y, end of period) 1.6 1.6 2 -0.6 -0.9
Nominal wage growth in national economy in % (y/y) 6.9 7 5.7 3.7 3.5
Unemployment rate in % (end of period) 5.6 5.8 6.6 8.2 9.7
NBP base rate in % (end of period) 1.5 1.5 1.5 1.5 1.5

*Estimate as of 28 February 2019
Source: Macroeconomic Analysis Office PZU

These macroeconomic factors and the global geopolitical situation (on top of Brexit, populism is on the rise in Europe, tensions in the Middle East, intensification of global protectionism, in particular the course of the US-China trade conflict) and in Poland (two sets of elections: EU and national parliamentary elections in the spring and autumn 2019, respectively) may affect the behavior of global central banks and, as a consequence, the overall conditions in the global and national financial market. The climate and direction of the changes in the financial markets are, in turn, important for the attractiveness of the products offered by the PZU Group, in particular unit-linked funds, and affects the level of assets and management fees charged by Group companies for asset management.

Legal and regulatory factors

The PZU Group’s activity is subject to the impact of local regulations and European legal acts. From the perspective of the insurance business, the Group’s activity will be affected by any legal changes that may bump up the burden borne by insurance companies, e.g. court verdicts on payout of general damages under TPL insurance. Currently, legislative work is underway on the act on rendering services to pursue compensatory claims. The bill aims to regulate the rules for commercial undertakings active in the business of pursuing compensatory claims to conduct their business, which may affect the claims paid by the Group.

Also, all resolutions regarding insurance rates (e.g. in Ukraine) will have an impact on the Group’s activity. Some legal acts that influenced insurance activity in 2018 and that will also affect trends in 2019 include IDD and MIFID II. Introduction of the Employee Capital Schemes Act (as of July 2019) is an important legal change that may affect the shape and functioning of life insurance and third pillar pension products available so far. It is also expected that the pension system review planned for 2019 will define the rules of operation of the second pension pillar. SECTION 2.6 REGULATIONS PERTAINING TO THE INSURANCE MARKET AND THE FINANCIAL MARKETS IN POLAND

Factors specific to the sectors in which the PZU Group operates

In addition to the above factors influencing the conditions of operation and the Group’s results, the situation in individual areas of business is influenced by sector-specific factors and evolution therein.

The most important one is the level of competition in individual product groups constituting the PZU Group’s core business. Due to the positive technical result recorded in the non-life insurance market (mainly in Poland but also in the Baltic States), it is plausible that in 2019 a more active pricing policy and more stringent competition to attract clients will emerge. Also, life insurance and health products are expected to see further price competition in 2019.

The situation in the insurance and banking sector may also change in connection with new entrants and trends associated with the development of new technologies, among others, operators of big databases / clients and insurtechs / fintechs10. Additionally, client expectations change – they largely shift toward personalized offers in the insurance and health segments alike.

PZU Group’s activity and results in the short and longer time horizon will be shaped by demographic trends, mortality and fertility rates (life insurance segment) and factors of chance – the occurrence of catastrophic phenomena, such as floods, hurricanes etc. (non-life insurance segment).

A detailed description of the factors that may influence the Group’s activity in 2019 broken down into individual operating segments is presented in SECTION 3 OPERATION OF THE PZU GROUP.

PZU Group grasps how new technologies are changing the insurance and banking industry, carefully keeps track of the dynamic social and demographic changes and constantly analyzes the threats and opportunities affecting the development of the markets in which it operates. The PZU strategy for 2017-2020 published on 9 January 2018 and entitled “The New PZU – More Than Insurance” is also our response to the ongoing changes. PZU’s goal is to take advantage of the opportunities ensuing from the transformation of the insurance market, address our current clients’ needs better and enhance their satisfaction as well as reach those segments that value digital solutions SECTION 4 PZU 2020 - MORE THAN INSURANCE

The new approach to building relationships with clients, resulting in integration of all areas in the company around the client, drives the gradual transformation of insurers from focusing primarily on valuation and transfer of risk toward being an advisory and service company (operating on the basis of technological know-how). This will enable clients to optimize their decisions at all stages of their lives. It will ultimately translate into growing trust and loyalty placed in PZU as the brand of first choice when it comes to insurance, finance and health services. SECTION 5 BUSINESS MODEL


10 Fintech - sector of the economy encompassing companies operating in the financial and technological industry. Fintech companies most frequently provide financial services through the web. It is also a term for all types of technological or financial innovations. Insurtech is one of the areas of the fintech industry encompassing new technological solutions in insurance.

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