Aviva 2013 Annual Report Download - page 305

Strategic report Governance IFRS Financial statements Other information
Aviva plc
Annual report and accounts 2013
303
Shareholder information continued
Insurance risks relating to Aviva’s business
The cyclical nature of the insurance industry may cause
fluctuations in our results.
Historically, the insurance industry has been cyclical and
operating results of insurers have fluctuated because of volatile
and sometimes unpredictable developments, many of which are
beyond the direct control of any insurer. Although we have a
geographically diverse group of businesses providing a wide
range of products, we expect to experience the effects of this
cyclical nature, including changes in sales and premium levels.
The unpredictability and competitive nature of the general
insurance business has contributed historically to significant
quarter-to-quarter and year-to-year fluctuations in underwriting
results and net earnings.
The use of inaccurate assumptions in pricing and reserving
for insurance business may have an adverse effect on our
business profitability.
Our life insurance companies are required to make a number of
assumptions in relation to the business written, including the
mortality and morbidity rates of our customers (the proportion
of customers dying or falling sick), the development of interest
rates, persistency rates (the proportion of customers retaining
existing policies up to their maturity dates) and future levels of
expenses. These assumptions may turn out to be incorrect.
When establishing their liabilities, our life insurance
companies allow for changes in the assumptions made, monitor
their experience against the actuarial assumptions used and
assess the information gathered to refine their long-term
assumptions, together with taking actual claims experience into
account. However, it is not possible to determine precisely the
total amounts that will ultimately be paid under the policies
written by the business as amounts may vary from estimates.
Changes in assumptions may also lead to changes in the level of
capital required to be maintained, meaning that we may need
to increase the amount of our reserves. This could have a
material adverse impact on our value, the results of our
operations and financial condition.
Additionally, our management of the general insurance
business requires the general insurance companies to make a
number of assumptions in relation to the business written.
These assumptions include the costs of writing the business
and settling claims, and the frequency and severity of claims.
The assumptions may turn out to be incorrect, thereby
adversely impacting on our profit. Man-made disasters,
including accidents and intentional events, are particularly
difficult to predict with a high degree of accuracy. These
would also have an adverse impact on our profit due to higher
than expected claims.
Furthermore, outstanding claims provisions for the general
insurance business are based on the best-estimate ultimate cost
of all claims incurred but not settled at a given date, whether
reported or not, together with related claims handling costs.
Any provisions for re-opened claims are also included. A range
of methods, including stochastic projections, may be used to
determine these provisions. Underlying these methods are a
number of explicit or implicit assumptions relating to the
expected settlement amount and settlement pattern of claims.
If the assumptions underlying the reserving basis were to prove
incorrect, we might have to increase the amount of the general
insurance provisions, which would adversely impact our financial
condition or results of operations.
We have a significant exposure to annuity business and a
significant life insurance risk is associated with longevity.
Longevity statistics are monitored in detail, compared with
emerging industry trends, and the results are used to inform
both the reserving and pricing of annuities. It is likely that
uncertainty will remain in the development of future longevity
that cannot be mitigated.
A strengthening in the longevity assumption, either to reflect
changes in the underlying life expectancy of the population
or of our particular portfolio used to calculate our long-term
business liabilities, would result in an increase in these reserves
and reduce shareholders’ equity.
If our business does not perform well or if actual experience
versus estimates used in valuing and amortising Deferred
Acquisition Costs (“DAC”) and Acquired value of in-force
business (“AVIF”) varies significantly, we may be required to
accelerate the amortisation and/or impair the DAC and AVIF
which could adversely affect our results of operations or
financial condition.
We incur significant costs in connection with acquiring new and
renewal business. Those costs that vary with and are driven by
the production of new and renewal business are deferred and
referred to as DAC. The recovery of DAC is dependent upon the
future profitability of the related business. The amount of future
profit or margin is dependent principally on investment returns
in excess of the amounts credited to policyholders, mortality,
morbidity, persistency and expenses to administer the business.
Of these factors, investment margins and general insurance
underwriting profit are most likely to impact the rate of
amortisation of such costs. The aforementioned factors enter
into management’s estimates of gross profit or margins, which
generally are used to amortise such costs. If the estimates of
gross profit or margins were overstated, then the amortisation
of such costs would be accelerated in the period the actual
amount is known and would result in a charge to income.
Significant or sustained equity market declines could result in an
acceleration of amortisation of the DAC related to unit-linked
business, resulting in a charge to income. Such adjustments
could have a material adverse effect on the results of operations
or financial condition.
AVIF reflects the estimated present value of future profit
that will emerge over the remaining life of certain in-force
contracts in a life insurance company, acquired either directly or
through the purchase of a subsidiary, and represents the portion
of the purchase price that is allocated to the value of the right
to receive future cash flows from the insurance and investment
contracts in-force at the acquisition date. AVIF is based on
actuarially determined projections. Actual experience may vary
from the projections. Revisions to estimates result in changes to
the amounts expensed in the reporting period in which the
revisions are made and could result in impairment and a charge
to income. Where AVIF is amortised, an acceleration of the
amortisation of AVIF would occur if the estimates of gross profit
or margins were overstated in the period in which the actual
experience is known and would result in a charge to net
income. Such adjustments could have an adverse effect on our
results of operations or financial condition.
Catastrophic events, which are often unpredictable by
nature, could result in material losses and abruptly and
significantly interrupt our business activities.
Our business is exposed to volatile natural and man-made
disasters such as pandemics, hurricanes, floods, windstorms,
earthquakes, terrorism, riots, fires and explosions. Over the past
several years, changing weather patterns and climatic conditions
have added to the unpredictability and frequency of natural
disasters in certain parts of the world and created additional
uncertainty as to future trends and exposure.
Our life insurance operations are exposed to the risk of
catastrophic mortality, such as a pandemic or other event that
causes a large number of deaths. The effectiveness of external
parties, including governmental and non-governmental
organisations, in combating the spread and severity of such
a pandemic could have a material impact on the losses
experienced by us.