Aviva 2013 Annual Report Download - page 121

Strategic report Governance IFRS Financial statements Other information
Aviva plc
Annual report and accounts 2013
119
Accounting policies continued
AFS equity securities: An AFS equity security is considered
impaired if there is objective evidence that the cost may not be
recovered. In addition to qualitative impairment criteria, such
evidence includes a significant or prolonged decline in fair value
below cost. Unless there is evidence to the contrary, an equity
security is considered impaired if the decline in fair value relative
to cost has been either at least 20% for a continuous six-month
period or more than 40% at the end of the reporting period, or
been in an unrealised loss position for a continuous period of
more than 12 months at the end of the reporting period. We
also review our largest equity holdings for evidence of
impairment, as well as individual equity holdings in industry
sectors known to be in difficulty. Where there is objective
evidence that impairment exists, the security is written down
regardless of the size of the unrealised loss.
For securities identified as being impaired, the cumulative
unrealised loss previously recognised within the investment
valuation reserve is transferred to realised losses for the year
with a corresponding movement through other comprehensive
income. Any subsequent increase in fair value of these impaired
securities is recognised in other comprehensive income and
recorded in the investment valuation reserve.
Reversals of impairments on any of these assets are only
recognised where the decrease in the impairment can be
objectively related to an event occurring after the write-down
(such as an improvement in the debtor’s credit rating), and are
not recognised in respect of equity instruments.
(U) Derivative financial instruments
and hedging
Derivative financial instruments include foreign exchange
contracts, interest rate futures, currency and interest rate swaps,
currency and interest rate options (both written and purchased)
and other financial instruments that derive their value mainly
from underlying interest rates, foreign exchange rates, credit or
equity indices, commodity values or equity instruments.
All derivatives are initially recognised in the statement of
financial position at their fair value, which usually represents
their cost. They are subsequently remeasured at their fair value,
with the method of recognising movements in this value
depending on whether they are designated as hedging
instruments and, if so, the nature of the item being hedged. Fair
values are obtained from quoted market prices or, if these are
not available, by using valuation techniques such as discounted
cash flow models or option pricing models. All derivatives are
carried as assets when the fair values are positive and as
liabilities when the fair values are negative. Premiums paid for
derivatives are recorded as an asset on the statement of
financial position at the date of purchase, representing their fair
value at that date.
Derivative contracts may be traded on an exchange or over-
the-counter (OTC). Exchange-traded derivatives are standardised
and include certain futures and option contracts. OTC derivative
contracts are individually negotiated between contracting
parties and include forwards, swaps, caps and floors. Derivatives
are subject to various risks including market, liquidity and credit
risk, similar to those related to the underlying financial
instruments. Many OTC transactions are contracted and
documented under International Swaps and Derivatives
Association (ISDA) master agreements or their equivalent, which
are designed to provide legally enforceable set-off in the event
of default, reducing the Group’s exposure to credit risk.
The notional or contractual amounts associated with
derivative financial instruments are not recorded as assets or
liabilities on the statement of financial position as they do not
represent the fair value of these transactions. These amounts
are disclosed in note 59(b).
The Group has collateral agreements in place between the
individual Group entities and relevant counterparties.
Accounting policy W below covers collateral, both received and
pledged, in respect of these derivatives.
Interest rate and currency swaps
Interest rate swaps are contractual agreements between two
parties to exchange fixed rate and floating rate interest by
means of periodic payments, computed on a specified notional
amount and defined interest rates. Most interest rate swap
payments are netted against each other, with the difference
between the fixed and floating rate interest payments paid by
one party. Currency swaps, in their simplest form, are
contractual agreements that involve the exchange of both
periodic and final amounts in two different currencies. Both
types of swap contracts may include the net exchange of
principal. Exposure to gain or loss on these contracts will
increase or decrease over their respective lives as a function of
maturity dates, interest and foreign exchange rates, and the
timing of payments.
Interest rate futures, forwards and options contracts
Interest rate futures are exchange-traded instruments and
represent commitments to purchase or sell a designated security
or money market instrument at a specified future date and
price. Interest rate forward agreements are OTC contracts in
which two parties agree on an interest rate and other terms that
will become a reference point in determining, in concert with an
agreed notional principal amount, a net payment to be made by
one party to the other, depending what rate in fact prevails at a
future point in time. Interest rate options, which consist
primarily of caps and floors, are interest rate protection
instruments that involve the potential obligation of the seller to
pay the buyer an interest rate differential in exchange for a
premium paid by the buyer. This differential represents the
difference between current rate and an agreed rate applied to a
notional amount. Exposure to gain or loss on all interest rate
contracts will increase or decrease over their respective lives as
interest rates fluctuate.
Foreign exchange contracts
Foreign exchange contracts, which include spot, forward and
futures contracts, represent agreements to exchange the
currency of one country for the currency of another country at
an agreed price and settlement date. Foreign exchange option
contracts are similar to interest rate option contracts, except
that they are based on currencies, rather than interest rates.
Exposure to gain or loss on these contracts will increase or
decrease over their respective lives as currency exchange and
interest rates fluctuate.
Derivative instruments for hedging
On the date a derivative contract is entered into, the Group
designates certain derivatives as either:
(i) a hedge of the fair value of a recognised asset or liability
(fair value hedge);
(ii) a hedge of a future cash flow attributable to a recognised
asset or liability, a highly probable forecast transaction or a
firm commitment (cash flow hedge); or
(iii) a hedge of a net investment in a foreign operation (net
investment hedge).
Hedge accounting is used for derivatives designated in this way,
provided certain criteria are met. At the inception of the
transaction, the Group documents the relationship between the
hedging instrument and the hedged item, as well as the risk
management objective and the strategy for undertaking the
hedge transaction. The Group also documents its assessment
of whether the hedge is expected to be, and has been, highly
effective in offsetting the risk in the hedged item, both at
inception and on an ongoing basis.