Aviva 2005 Annual Report Download - page 188

Notes to the consolidated financial statements continued
50 – Risk management policies continued
(vi) Sensitivity analysis and capital management
The Group uses a number of sensitivity test-based risk management tools to understand the volatility of earnings, the volatility of its
capital requirements and to manage its capital more efficiently. Primarily, FCRs are used, and increasingly ICA. However, sensitivities to
economic and operating experience are regularly produced on all of the Group’s financial performance measurements as part of the
Group’s decision making and planning process, and to set the framework for identifying and quantifying the risks that each of its business
units, and the Group as a whole are exposed to.
For example, under ICA, an estimate of how much capital is needed to mitigate the risk of insolvency from events occurring within a
selected remote level of probability is measured. This high level risk appetite parameter is then used to calibrate a series of core stress and
scenario tests of both an economic and operating nature to be examined by each business unit. Business units satisfy themselves that the
range and level of these tests is appropriate to their local risk profile, and supplement the core tests where necessary. Business units also
perform an assessment of the operational risk; this assessment is subject to central review and challenge by Group to verify consistency
across business units and to identify aggregate exposures. The businesses are then able to assess the capital requirements within this risk
appetite framework. The Group uses both results at a business unit level and aggregated results to assess the benefits of diversification of
risk in the Group, and to assess capital requirements of the types of risk it is exposed to. These results enable the Group to assess whether
its risk appetite is appropriate and whether mitigating action is required.
Life insurance and Investment contracts The nature of long-term business is such that a number of assumptions are made in compiling
these financial statements. Assumptions are made about investment returns, expenses, mortality rates, and persistency in connection with
the in-force policies for each business unit. Assumptions are best estimates based on historic and expected experience of the business.
A number of the key assumptions for the Group’s central scenario are disclosed elsewhere in these statements.
General insurance and health business General insurance and health claim liabilities are estimated by using standard actuarial claims
projection techniques. These methods extrapolate the claims development for each accident year based on the observed development
of earlier years. In most cases, no explicit assumptions are made as projections are based on assumptions implicit in the historic claims
development on which the projections are based. As such, in the analysis below, the sensitivity of general insurance claim liabilities is
primarily based on the financial impact of changes to the reported loss ratio.
Some results of sensitivity testing for long-term business and general insurance and health business are set out below. For each sensitivity
test the impact of a change in a single factor is shown, with other assumptions left unchanged.
Sensitivity Factor Description of sensitivity factor applied
Interest rate and investment return The impact of a change in market interest rates by ± 1% (e.g. if a
current interest rate is 5%, the impact of an immediate change to 4%
and 6%). The test allows consistently for similar changes to investment
returns and movements in the market value of backing fixed interest
securities.
Expenses The impact of an increase in maintenance expenses by 10%.
Assurance mortality/morbidity (life insurance only) The impact of an increase in mortality/morbidity rates for assurance
contracts by 5%.
Annuitant mortality (life insurance only) The impact of a reduction in mortality rates for annuity contracts by 5%
Gross loss ratios (non-life insurance only) The impact of an increase in gross loss ratios for general insurance and
health business by 5%.
The above sensitivity factors are applied using actuarial and statistical models, with the following pre-tax impacts on profit and
shareholders’ equity at 31 December 2005:
Long-term business – impact on profit before tax (£m)
Interest rates Interest rates Expenses Assurance Annuitant
+1% -1% +10% mortality +5% mortality -5%
Insurance participating 5 (35) (5) – –
Insurance non-participating 60 (350) (5) (30) (295)
Investment participating 10 (50) – – –
Investment non-participating –––––
Total 75 (435) (10) (30) (295)
Aviva plc 2005 Financial statements
186 Financial statements continued