Aviva 2006 Annual Report Download - page 203

Overview Business review Governance Financial statements Other information
Aviva plc
Annual Report and Accounts 2006 199
50 – Risk management continued
Interest rate risk
Interest rate risk arises primarily from the Group’s investments in long-term debt and fixed income securities, which are exposed to
fluctuations in interest rates. Exposure to interest rate risk is monitored through several measures that include Value-at-Risk analysis,
position limits, scenario testing, stress testing and asset and liability matching using measures such as duration.
Interest rate risk also exists in products sold by the group, in particular from 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. However where any mismatch is within our risk appetite, the impact is monitored through economic
capital measures such as ICA.
On short-term business such as general insurance business the Group requires a close matching of assets and liabilities by duration to
minimise this risk.
The impact of exposure to sustained low interest rates is regularly monitored.
Interest rate risk is also managed using a variety of derivative instruments, including futures, options and swaps, caps and floors,
in order to provide a degree of hedging against unfavourable market movements in interest rates inherent in the assets backing
technical liabilities.
At 31 December 2006, 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.
Asensitivity to changes in interest rates is given in section (g) below.
Further information on borrowings is included in note 43.
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 aredenominated in a variety of currencies, of which the largest areeuro, sterling, and US dollars. The Group does not hedge
foreign currency revenues as these aresubstantially 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 regulatory capital requirements by currency.Limits are set to control the extent to which the deployment of capital is not aligned
fully with the Group’scapital requirement for each major currency. Currency borrowings and derivatives are used to manage exposures
within the limits that have been set.
At 31 December 2006, the Group’s total equity deployment by currency was:
Sterling Euro US$ Other Total
£m £m £m £m £m
Capital 31 December 2006 3,289 7,698 1,508 1,569 14,064
Capital 31 December 2005 1,772 7,458 177 1,685 11,092
Net assets arestated after taking account of the effect of currency swaps and forwardforeign exchange contracts.
A10% change in sterling to euro/US$ foreign exchange rates would have had the following impact on net assets. Apart from the impact
on financial instruments covered below, the changes arise from retranslation of Business Unit balance sheets from their functional
currencies into sterling, with movements being taken through the currency translation reserve. These movements in exchange rates
therefore have no impact on profit.
10% 10% 10% 10%
increase in decrease increase decrease
sterling/ in sterling/ in sterling/ in sterling/
eurorate eurorate US$ rate US$ rate
£m £m £m £m
Net assets at 31 December 2006 (770) 770 (151) 151
Net assets at 31 December 2005 (746) 746 (18) 18
The Group has minimal exposureto currency risk from financial instruments held by Business Units in currencies other than their
functional currencies, as nearly all such holdings are backing either unit-linked or with-profit contract liabilities. For this reason,
no sensitivity analysis is given for these holdings.