Aviva 2006 Annual Report Download - page 61

Overview Business review Governance Financial statements Other information
Aviva plc
Annual Report and Accounts 2006 57
Risk and capital management
Webelieve that the measurement of economic capital provides
aclear and consistent way to monitor and compare the risks
in our businesses.
We have developed a capital management framework using
Individual Capital Assessment (ICA) principles for identifying the
risks that business units, and the group as a whole are exposed
to, quantifying their impact on economic capital.
Our ICA estimates how much capital is needed to mitigate the
risk of insolvency to a selected remote level, based on a number
of stress tests applied to the capital position of the business.
These tests, covering both investment and insurance scenarios,
are specified centrally to provide consistency between business units
to achieve a minimum standard. Additionally, business units can
supplement the tests with others applicable to their own situation.
The events that are tested may not occur at the same time;
therefore we allow for the degree of correlation between them
that we might expect. Wealso allow for diversification benefits
(ie when two very different risks have offsetting impacts if they
happen at the same time) when aggregating risks, or when
aggregating business unit results. This means that the sum of
the risks is less than the total of all the individual risks.
The ICA works to a 99.5% confidence level of solvency over one
year (equivalent to events occurring in one out of 200 years), in line
with UK Financial Services Authority (FSA) regulatory requirements.
An ICA has been developed for all material parts of the group,
and the results of financial and operating experience tests are
linked to our risk reporting model. We also produce projections of
the ICA requirement over a number of years to show how the
economic capital position is likely to evolve.
ICAs have now been produced for a number of years and the
results are used as a basis for discussion with the FSA. ICA analysis
is now used in our key decision making processes.
Our ICA uses a mixture of scenario-based testing and risk-based
capital models. We are continuing to develop our risk-based
capital modelling capability for all of our businesses as part of our
longer term program to introduce more complex risk modelling
techniques. These risk-based capital techniques will provide a
moredetailed assessment of the capital needs of the business
over a range of probabilities of insolvency and different time
horizons. We intend to operate our business increasingly by
reference to economic and risk-based capital (RBC) requirements.
Wealso use financial condition reports (FCRs). FCRs cover
the medium-term financial outlook of the business, including
forecasts of the overall financial position and key performance
indicators under a variety of economic and operating scenarios,
allowing for new business sales, to inform our capital and risk
management decisions.
We monitor specific risks on a regular basis through our
risk-monitoring framework. Our businesses are required to disclose
all material risks along with information on the likelihood and
severity of these risks and the mitigating actions taken or planned.
This process enables us to assess the overall risk exposure of the
group, to develop a group-wide risk map identifying concentrations
of risk and to define the risks that we are prepared to accept.
This risk map is continually monitored and is refreshed quarterly.
The risks facing Aviva
Our ICA models inform us about the relative impact on economic
capital from the risks we face, enabling us to formulate mitigating
strategies. The types of risks in our business and the way in which
we manage them arediscussed in detail below.
M arket risk
We are exposed to considerable potential adverse financial impact
from changes in the values of our investments, caused by changes
to interest rates, property prices, and foreign exchange rates.
Our business has market risk from fluctuations in both the values
of assets held and the value of liabilities. At a group level, we have
market risk from owning a portfolio of international businesses
whose values can change, and from assets that support the
liabilities of our staffpension scheme.
We recognise that such risk is inevitable from the businesses that
we run, and that a certain level of market risk is acceptable in order
to deliver benefits to both policyholders and shareholders.
For each type of market risk, we have developed clear policies and
procedures on how that risk should be monitored and managed,
either within our business units or at a group level. Our group
investment committee (GIC) is responsible for overseeing market
risk and asset liability management.
For example, the GIC identifies the levels of market movement at
which mitigating actions should be taken. Actions could include
buying downside protection against movements in equity prices or
interest rates. The GIC also considers aggregation of market risk,
including indirect market risk exposurefrom our staff pension
schemes, and formulates risk appetite decisions for the amounts
invested in different types of asset.