Aviva 2013 Annual Report Download - page 251

Strategic report Governance IFRS Financial statements Other information
Aviva plc
Annual report and accounts 2013
249
Financial and operating performance continued
sold in 2013, driven by the impact of favourable equity market
performance on embedded derivatives.
With-profits business
With-profits products are mainly written in our UK & Ireland
operating segment, with small funds in France and Singapore.
These funds enable policyholders to participate in a large pool
of diverse investments, therefore reducing their exposure to
individual securities or asset classes. The investment pool is
managed by us with returns to with-profits policyholders paid
through bonuses which are added to the value of their policy.
In order to provide an element of stability in the returns to
policyholders, bonuses are designed to reduce policyholders’
exposure to the volatility of investment returns over time and to
provide an equitable share of surplus earned, depending on the
investment and operating performance of the fund.
Shareholders also have a participating interest in the with-profits
funds and any declared bonuses. Generally, policyholder and
shareholder participation in with-profits funds in the UK is
split 90:10.
Shareholders’ profits arising on with-profits business under
IFRS depend on the total bonuses declared to policyholders on
an annual basis.
The level of bonuses declared to policyholders is influenced
by the actual returns on investments and our expectation of
future rates of return. Whilst bonuses can never be negative,
a predicted sustained fall in equity markets could lead to a
reduction in regular and final bonus rates, thereby reducing
both policyholder returns and shareholders’ profit under IFRS.
In 2013 and 2012 we made increases in the majority of final
bonus rates.
General insurance and health underwriting cycle
Our general insurance and health business is comprised of our
property and casualty insurance and health insurance
operations. In 2013, general insurance and health sales
accounted for 43% of Group net written premiums (NWP) from
continuing operations. Demand for general insurance is usually
price-sensitive because of the limited degree of product
differentiation inherent in the industry. As a result, the price of
insuring property and casualty risks is subject to a cycle (called
an underwriting cycle). In periods when the price of risk is high,
the high profitability of selling insurance attracts new entrants
and hence new capital into the market. Increased competition,
however, drives prices down. Eventually the business becomes
uneconomic and some industry players, suffering from losses,
exit the market whilst others fail, resulting in lower capital
invested within the market. Decreased competition leads to
increasing prices, thereby repeating the cycle. Our various
general insurance markets are not always at the same stage
of the underwriting cycle.
In the UK, the personal motor market has seen further rate
reductions in 2013 reflecting intense competition and regulatory
change. This follows a period of rate increases in previous
periods in response to rising claims costs and frequencies.
Challenging rating conditions also apply to other UK classes
of business.
We expect the underwriting cycle to continue in the future
but to be less pronounced than in the past because of structural
changes to the industry over the past decade. Capital markets
are imposing financial discipline by being increasingly more
demanding about performance from insurance companies
before extending new capital. Such discipline, together with the
increased concentration of competitors within the market,
recent natural disasters and the adoption of more advanced
pricing methods, is expected to make the underwriting cycle less
pronounced in the future.
Natural and man-made disasters
Our general insurance business results are affected by the
amount of claims we need to pay out which, in turn, can be
subject to significant volatility depending on many factors,
including natural and man-made disasters. Natural disasters
arise from adverse weather, earthquakes and other such natural
phenomena. Man-made disasters include accidents and
intentional events, such as acts of terrorism. These events are
difficult to predict with a high degree of accuracy, although
they generally occur infrequently at a material level. Our
exposure to large disasters is somewhat reduced through our
focus on personal lines business and small to medium sized
commercial risks in the general insurance business. The Group
cedes much of its worldwide catastrophe risk to third-party
reinsurers but retains a pooled element for its own account
gaining diversification benefit. See ‘IFRS Financial statements –
note 58 – Risk management’.
In 2013 our operations in Canada suffered from losses
related to the Toronto and Alberta floods (see ‘Market
performance – Canada’ below for further details) and our
operations in France were impacted by hail storms.
Government policy and legislation
Changes in government policy and legislation applicable to our
business in many of the markets in which we operate,
particularly in the UK, may affect the results of our operations.
These include changes to the tax treatment of financial products
and services, government pension arrangements and policies,
the regulation of selling practices and the regulation of solvency
standards. Such changes may affect our existing and future
business by, for example, causing customers to cancel existing
policies, requiring us to change our range of products and
services, forcing us to redesign our technology, requiring us to
retrain our staff or increase our tax liability. As a global business,
we are exposed to various local political, regulatory and
economic conditions, and business risks and challenges which
may affect the demand for our products and services, the value
of our investments portfolio and the credit quality of local
counterparties. Our regulated business is subject to extensive
regulatory supervision both in the UK and internationally.
For details please refer to the section ‘Shareholder information
– Regulation’.
Exchange rate fluctuations
We publish our consolidated financial statements in pounds
sterling. Due to our substantial non-UK operations, a significant
portion of our operating earnings and net assets are denominated
in currencies other than sterling, most notably the euro,
Canadian dollar and the US dollar. As a consequence, our
results are exposed to translation risk arising from fluctuations
in the values of these currencies against sterling. Total foreign
currency translation recognised in the income statement was a
gain of £187 million (2012: £128 million gain).
We generally do not hedge foreign currency revenues, as
we retain local currency in each business to support business
growth, to meet local and regulatory market requirements and
to maintain sufficient assets in local currency to match local
currency liabilities.
Movements in exchange rates may affect the value of
consolidated shareholders’ equity, which is expressed in sterling.
Exchange differences taken to other comprehensive income
arise on the translation of the net investment in foreign
subsidiaries, associates and joint ventures. This aspect of foreign
exchange risk is monitored centrally against limits that we have
set to control the extent to which capital deployment and
capital requirements are not aligned. We use currency
borrowings and derivatives when necessary to keep currency
exposures within these predetermined limits, and to hedge
specific foreign exchange risks when appropriate; for example,
in any acquisition or disposal activity.