Aviva 2013 Annual Report Download - page 226

Aviva plc
Annual report and accounts 2013
224
Notes to the consolidated financial statements continued
58 – Risk management continued
Profit before tax on General Insurance and Health Insurance business is generally a mixture of insurance, expense and investment
returns. The asset portfolio is invested primarily in fixed income securities and the reduction in interest rates in recent years has
reduced the investment component of profit. The portfolio investment yield and average total invested assets in our general
insurance and health business are set out in the table below.
Portfolio
investment
y
ield1
Average
assets
£m
2011 3.9% 18,978
2012 3.7% 18,802
2013 3.1% 18,352
1 Before realised and unrealised gains and losses and investment expenses
The nature of the business means that prices in certain circumstances can be increased to maintain overall profitability. This is
subject to the competitive environment in each market. To the extent that there are further falls in interest rates the investment
yield would be expected to decrease further in future periods.
Sensitivity to changes in interest rates is given in section ‘(j) risk and capital management’ below. This analysis shows an initial
benefit to profit before tax and shareholders’ equity from a 1% decrease in interest rates due to the increase in market value of the
backing fixed income securities. However, in subsequent years the reduction in portfolio yield will result in lower net investment
income. Further information on borrowings is included in note 50.
(iv) Inflation risk
Inflation risk arises primarily from the Group’s exposure to general insurance claims inflation, to inflation linked benefits within the
defined benefit staff pension schemes and within the UK annuity portfolio and to expense inflation. Increases in long-term inflation
expectations are closely linked to long-term interest rates and so are frequently considered with interest rate risk. Exposure to
inflation risk is monitored through economic capital modelling, sensitivity testing and stress and scenario testing. The Group
typically manages inflation risk through its investment strategy and, in particular, by investing in inflation linked securities and
through a variety of derivative instruments, including inflation linked swaps.
(v) Currency risk
The Group has minimal exposure to currency risk from financial instruments held by business units in currencies other than their
functional currencies, as nearly all such holdings are backing either by unit-linked or with-profit contract liabilities or hedging.
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, sterling and Canadian dollars.
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.
Businesses aim to maintain sufficient assets in local currency to meet local currency liabilities, however 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. These exposures are managed by aligning the deployment of
regulatory capital by currency with the Group’s regulatory capital requirements by currency. Currency borrowings and derivatives
are used to manage exposures within the limits that have been set.
At 31 December 2013 and 2012, the Group’s total equity deployment by currency including assets ‘held for sale’ was:
Sterling
£m
Euro
£m
CAD$
£m
Other
£m
Total
£m
Capital 31 December 2013 4,942 4,178 987 910 11,017
Capital 31 December 2012 4,445 4,648 1,119 1,148 11,360
A 10% change in sterling to euro/Canada$ (CAD) foreign exchange rates would have had the following impact on total equity.
10%
increase
in sterling/
euro rate
£m
10%
decrease
in sterling/
euro rate
£m
10%
increase in
sterling/
CAD$ rate
£m
10%
decrease in
sterling/
CAD$ rate
£m
Net assets at 31 December 2013 (260) 360 (81) 99
Net assets at 31 December 2012 (386) 411 (112) 106
A 10% change in sterling to euro/Canada$ (CAD) foreign exchange rates relative to the year-end rate would have had the
following impact on profit before tax, excluding ‘discontinued operations’.
10%
increase
in sterling/
euro rate
£m
10%
decrease
in sterling/
euro rate
£m
10%
increase
in sterling/
CAD$ rate
£m
10%
decrease
in sterling/
CAD$ rate
£m
Impact on profit before tax 31 December 2013 8 7 (5) (4)
Impact on profit before tax 31 December 2012 (32) 32 (20) 5
The balance sheet changes arise from retranslation of business unit statements of financial position from their functional currencies
into sterling, with above movements being taken through the currency translation reserve. These balance sheet movements in
exchange rates therefore have no impact on profit. Net asset and profit before tax figures are stated after taking account of the
effect of currency hedging activities.