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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 quoted on exchanges;

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 recoveries 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 available 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 1m2 of relevant space or for one 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.
Measured assets	Unobservable data	Description	Impact on measurement
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 3 of the fair value hierarchy.	Negative correlation.
Equity instruments not quoted on an active market		Quotations of financial services

note_9.2_tab_1_pzu_en.xlsx

9.2.1 Assets and liabilities measured at fair value

Assets and liabilities measured at fair value	31 December 2017				31 December 2016 (restated)
	Level I	Level II	Level III	Total	Level I	Level II	Level III	Total
Assets
Financial assets available for sale	30,027	17,081	1,411	48,519	8,113	2,887	652	11,652
Equity instruments	210	156	298	664	132	264	38	434
Debt securities	29,817	16,925	1,113	47,855	7,981	2,623	614	11,218
Financial instruments measured at fair value through profit or loss – classified as such upon first recognition	6,143	464	43	6,650	12,555	1,882	42	14,479
Equity instruments	1,802	127	18	1,947	2,837	97	17	2,951
Debt securities	4,341	337	25	4,703	9,718	1,785	25	11,528
Financial instruments measured at fair value through profit or loss – held for trading	7,392	8,008	197	15,597	1,882	5,333	188	7,403
Equity instruments	526	4,091	-	4,617	745	3,321	-	4,066
Debt securities	6,837	2,042	97	8,976	1,119	1,202	135	2,456
Derivatives	29	1,875	100	2,004	18	810	53	881
Hedge derivatives	-	347	-	347	-	72	-	72
Investment property	-	151	2,203	2,354	-	149	1,589	1,738
Assets held for sale	-	44	247	291	-	49	1,081	1,130
Liabilities
Derivatives	22	2,532	52	2,606	31	724	26	781
Hedge derivatives	-	868	-	868	-	6	-	6
Liabilities to members of consolidated mutual funds	-	420	-	420	-	1,544	-	1,544
Investment contracts for the client’s account and risk (unit-linked)	-	312	-	312	-	329	-	329
Liabilities on borrowed securities (short sale)	737	13	-	750	654	-	-	654

note_9.2.1_tab_1_pzu_en.xlsx

Change in assets and liabilities classified as Level III of the fair value hierarchy, in the year ended 31 December 2017	Financial assets available for sale		Financial assets measured at fair value through profit or loss – classified as such upon first recognition		Financial assets measured at fair value through profit or loss – held for trading		Investment properties	Financial liabilities – Derivatives
	Equity	Debt	Equity	Debt	Debt	Derivatives
Beginning of the period	38	614	17	25	135	53	1,589	26
Purchase/opening of the position	6	-	21	-	290	32	63	23
Reclassification from Level II	-	662 ¹⁾	-	-	4	-	-	-
Reclassification from own properties and properties held for sale	-	-	-	-	-	-	830	-
Profit or loss recognized in the profit and loss account as:	-	31	2	2	3	37	(101)	19
- net investment income	-	31	5	-	-	(1)	-	-
- net result on realization and impairment losses on investments	-	-	-	-	-	-	-	-
- net movement in fair value of assets and liabilities measured at fair value	-	-	(3)	2	3	38	(101)	19
Net movement in fair value of assets and liabilities measured at fair value, recognized in other comprehensive income	(10)	(26)	-	-	-	-	-	-
Reclassification to own properties and properties held for sale	-	-	-	-	-	-	(196)	-
Change in the composition of the Group	267	252	-	-	45	-	22	-
Foreign exchange translation differences	(3)	-	-	-	-	-		-
Sale and settlements	-	(437)	(22)	(2)	(380)	(22)	(4)	(16)
Other	-	17	-	-	-	-	-	-
End of the period	298	1,113	18	25	97	100	2,203	52

1) Municipal bonds were reclassified to level III; for those bonds, a parameter implied from historical data (credit spread) used in the valuation model exerts a significant influence on measurement.

note_9.2.1_tab_2_pzu_en.xlsx

Change in assets and liabilities classified as Level III of the fair value hierarchy, in the year ended 31 December 2016 (restated data)	Financial assets available for sale		Financial assets measured at fair value through profit or loss – classified as such upon first recognition		Financial assets measured at fair value through profit or loss – held for trading		Investment properties	Financial liabilities – Derivatives
	Equity	Debt	Equity	Debt	Debt	Derivatives
Beginning of the period	17	653	26	28	74	55	1,055	35
Purchase/opening of the position	4	37	27	-	64	19	139	10
Reclassification from own properties and properties held for sale	-	-	-	-	-	-	300	-
Profit or loss recognized in the profit and loss account as:	-	(14)	(36)	(3)	2	3	98	-
- net investment income	-	-	-	-	-	-	-	-
- net result on realization and impairment losses on investments	-	(8)	-	-	-	-	-	-
- net movement in fair value of assets and liabilities measured at fair value	-	(6)	(36)	(3)	2	3	98	-
Profit or loss recognized in other comprehensive income	-	-	-	-	-	-	-	2
Change in the composition of the Group	17	-	-	-	-	-	-	-
Sale and settlements	-	(62)	-	-	(5)	(24)	(3)	(21)
End of the period	38	614	17	25	135	53	1,589	26

note_9.2.1_tab_3_pzu_en.xlsx

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

In 2017, 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.

To reflect the fair value more precisely, as of 30 June 2016, for some financial assets (primarily debt financial instruments listed in foreign markets), the fair value is determined on the basis of the valuations published by an authorized information service rather than as previously: on the basis of quotations from the interbank market. The PZU Group concluded that, because of the low activity of the inter-bank market, the change of the source of valuation makes it possible to take into account, when estimating fair value, a broader range of information on transactions and offers from multiple markets on which the financial instrument is quoted. The assets for which the source of valuation was changed were reclassified from Level I to Level II fair value.

9.2.1.2 Investment property classified as Level III fair value

Investment property classified as Level III	31 December 2017	31 December 2016
Office properties	710	902
Commercial properties	102	-
Warehousing properties	1,365	681
Other	26	6
Total investment property classified as Level III	2,203	1,589

note_9.2.1.2_tab_1_pzu_en.xlsx

No.	Property name	Fair value as at 31 December 2017	Fair value as at 31 December 2016	Type of space	Scope of data unobservable on an active market as at 31 December 2017	Scope of data unobservable on an active market as at 31 December 2016
Property measured by the income approach using the investment method and the income stream discounting technique
1.	Office complex, Wrocław	250	282	Office	EUR 14.00 – 16.00	EUR 11.25 – 14.50
2.	Warehouse/office buildings, Łódź	248	263¹⁾	Office in warehouse facilities Warehouse	EUR 6.50 – 9.00 EUR 2.40 – 3.60	EUR 7.00 – 9.00 EUR 2.40 – 3.80
3.	Warehouse park, Bielany Wrocławskie	224	233	Office Warehouse Construction costs	EUR 6.50 – 9.00 EUR 2.90 – 3.30²⁾	EUR 7.00 – 9.00 EUR 3.00 – 3.60²⁾
4.	Office complex, Gdańsk	151	165	Office	EUR 11.00 – 14.50	EUR 13.00 – 15.00
5	Warehouse and office buildings, Gdańsk	129	138¹⁾	Office in warehouse facilities Warehouse	EUR 6.50 – 9.00 EUR 2.80 – 3.20	EUR 7.00 – 9.00 EUR 2.80 – 3.20
6.	Office complex, Warsaw	120	130	Office Parking lot	EUR 12.5 – 19.18 EUR 35.00 – 119.88	EUR 6.33 – 15.00 EUR 65.00 – 90.00
7.	Warehouse and office building, Nowa Wieś Wrocławska	114	124¹⁾	Office in warehouse facilities Warehouse	EUR 6.50 – 9.00 EUR 2.90 – 3.50	EUR 7.00 – 9.00 EUR 3.00 – 3.60
8.	Warehouse park under construction, Komorniki	108	116	Office Warehouse Construction costs	EUR 6.50 – 9.00 EUR 2.75 – 3.60²⁾	EUR 7.00 – 9.00 EUR 3.00 – 3.50 ²⁾
9.	Office building, Warsaw	104	111	Office Parking lot	EUR 8.00 – 18.00 EUR 65.00 – 90.00	EUR 8.00 – 16.50 EUR 50.00 – 80.00
10.	Shopping Center, Pabianice	76	88¹⁾	Commercial (depending on size of leased space)	³⁾	³⁾
11.	Shopping gallery, Iława	71	70¹⁾	Commercial (depending on size of leased space)	³⁾	³⁾
12.	Warehouse/office buildings, Łódź	63	66¹⁾	Office in warehouse facilities Warehouse	EUR 6.50 – 9.00 EUR 2.40 – 3.60	EUR 7.00 – 9.00 EUR 2.40 – 3.80
13.	Warehouse and office building, Nowa Wieś Wrocławska	61	65¹⁾	Office in warehouse facilities Warehouse	EUR 6.50 – 9.00 EUR 2.90 – 3.50	EUR 7.00 – 9.00 EUR 3.00 – 3.60
14.	Warehouse and office complex, Błonie	37	39¹⁾	Office in warehouse facilities Warehouse	EUR 6.50 – 9.00 EUR 2.50 – 3.60	EUR 7.00 – 9.00 EUR 2.50 – 3.80
15.	Shopping gallery, Lubin	31	34¹⁾	Commercial (depending on size of leased space)	³⁾	³⁾
Property measured by the mixed approach using the residual method
16.	Warehouse park under construction, Sosnowiec Pieńki	260	217	Office Warehouse Construction costs	EUR 6.50 – 9.00 EUR 2.40 – 3.60 ²⁾	EUR 7.00 – 9.00 EUR 2.89 – 3.60 ²⁾
17.	Warehouse park under construction, Sosnowiec	122	116	Office Warehouse Construction costs	EUR 6.50 – 9.00 EUR 2.80 – 3.50 ²⁾	EUR 7.00 – 9.00 EUR 2.89 – 3.60 ²⁾
11.	Other	34	219 ⁴⁾	n/a	n/a	n/a
	Total – investment property	2,203	1,589
	TOTAL – held for sale (as classified as at 31 December 2016)	-	887
	TOTAL	2,203	1,589

1) As at 31 December 2016, the properties were classified as assets held for sale.
2) Construction costs were determined based on market construction costs less costs incurred as at the date of measurement.
3) Market rent for the real property was determined on the basis of an analysis of the commercial space market in facilities with similar locations and characteristics as the property being measured.
4) Due to the change of use, the investment property, whose value as at 31 December 2016 was PLN 165 million, was reclassified to own property, while the investment property, whose value as at 31 December 2016 was PLN 34 million was reclassified to assets held for sale.

note_9.2.1.2_tab_2_pzu_en.xlsx

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 2017				31 December 2016 (restated)
	Level I	Level II	Level III	Total	Level I	Level II	Level III	Total
Assets
Entities measured by the equity method – EMC	-	20	-	20	-	37	-	37
Financial assets held to maturity	17,631	305	5,582	23,518	15,531	15	3,520	19,066
Loans
Debt securities	1	8,153	5,500	13,654	1	1	2,467	2,469
Loan receivables from clients	-	-	169,393	169,393	-	-	44,866	44,866
Buy-sell-back transactions	-	553	333	886	-	583	2,296	2,879
Term deposits with credit institutions	-	838	1,005	1,843	-	583	1,698	2,281
Loans	-	-	3,744	3,744	-	-	1,705	1,705
Liabilities
Liabilities to banks	-	1,161	4,092	5,253	-	399	124	523
Liabilities to clients	-	-	201,605	201,605	-	-	51,364	51,364
Liabilities on the issue of own debt securities	-	2,808	6,584	9,392	-	-	6,545	6,545
Subordinated liabilities	-	1,257	4,108	5,365	-	-	1,027	1,027
Investment contracts with guaranteed and fixed terms and conditions	-	1	-	1	-	67	-	67

note_9.2.2_tab_1_pzu_en.xlsx

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9.2 Fair value hierarchy

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