Aviva 2005 Annual Report Download - page 185

50 – Risk management policies continued
(iii) Market risk
Market risk is the risk of adverse financial impact due to changes in fair values of financial instruments from fluctuations in foreign
currency exchange rates, interest rates, property prices and equity prices. Market risk arises in business units due to fluctuations in the
value of liabilities and the value of investments held. At Group level, it also arises in relation to the overall portfolio of international
businesses and in the value of investment assets owned directly by the shareholders.
The management of market risk is undertaken in both business units and at Group level. Business units manage market risks locally using
their ALM framework and within local regulatory constraints. Business units may also be constrained by the requirement to meet
policyholders’ reasonable expectations and to minimise or avoid market risk in a number of areas. At Group level, market risk is the
responsibility of the Investment Committee which has a remit to manage a number of investment related risks, in particular those faced
by the shareholder funds throughout the Group.
For each of the major components of market risk, described in more detail below, the Group has put in place policies and procedures to
set out how each risk should be managed and monitored, and the approach to setting an appropriate risk appetite.
At Group level, the financial impact from changes in market risk (such as interest rates, equity prices and property values) is examined
through stress tests adopted in the ICA and FCR.
Currency risk
The Group operates internationally and as a result is exposed to foreign currency exchange risk arising from fluctuations in exchange rates
of various currencies. Approximately half of the Group’s premium income arises in currencies other than sterling and the Group’s net
assets are denominated in a variety of currencies, of which the largest are euro and sterling. The Group does not hedge foreign currency
revenues as these are substantially retained locally to support the growth of the Group’s business and meet local regulatory and market
requirements.
The Group’s foreign exchange policy requires that each of the Group’s subsidiaries maintain sufficient assets in their local currencies to
meet local currency liabilities. Therefore, capital held by the Group’s business units should be able to support local business activities
regardless of foreign currency movements. However, such movements may impact the value of the Group’s consolidated shareholders’
equity which is expressed in sterling. This aspect of foreign exchange risk is monitored and managed centrally, against pre–determined
limits. The Group’s foreign exchange policy is to manage these exposures by aligning the deployment of capital by currency, with the
Group’s capital requirements by currency. Limits are set to control the extent to which the deployment of capital is not aligned fully with
the Group’s capital requirement for each major currency. Currency borrowings and derivatives are used to manage exposures within the
limits that have been set.
At 31 December 2005 the Group’s total equity deployment by currency was:
Sterling Euro Other Total
£m £m £m £m
Capital 31.12.2005 1,772 7,458 1,862 11,092
Capital 31.12.2004 1,437 6,045 1,511 8,993
Net assets are stated after taking account of the effect of currency swaps and forward foreign exchange contracts.
Interest rate risk
Interest rate risk arises primarily from the Group’s investments, long-term debt and fixed income securities.
Interest rate risk also exists in policies that carry investment guarantees on early surrender or at maturity, where claim values can become
higher than the value of backing assets when interest rates rise or fall.
The Group manages this risk by adopting close asset liability matching criteria, to minimise the impact of mismatches between the value
of assets and liabilities from interest rate movements. Interest rate risk is also controlled through the use of a variety of derivative
instruments, including futures, options and swaps, in order to hedge against unfavourable market movements in interest rates inherent in
the underlying assets and liabilities.
The impact of exposure to sustained low interest rates is regularly monitored.
At 31 December 2005, the Group had entered into a number of interest rate swap agreements to mitigate the effects of potential
adverse interest rate movements, and to enable close matching of assets and liabilities.
Property price risk
The Group is subject to property price risk due to holdings of investment properties in a variety of locations worldwide. The investment in
property is managed at business unit level, and will be subject to local regulations on asset admissibility, liquidity requirements and the
expectations of policyholders. At 31 December 2005, no material derivative contracts had been entered into to mitigate the effects of
changes in property prices.
Financial statements
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