Aviva 2007 Annual Report Download - page 225
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Please find page 225 of the 2007 Aviva annual report below. You can navigate through the pages in the report by either clicking on the pages listed below, or by using the keyword search tool below to find specific information within the annual report.55 – Risk management continued
(b) Market risk
Market risk is the risk of adverse financial impact due to changes in fair values or future cash flows of financial instruments
from fluctuations in interest rates, equity prices, property prices, and foreign currency exchange rates. Market risk arises in
business units due to fluctuations in both the value of liabilities and the value of investments held. At Group level, it also
arises in relation to the overall portfolio of international businesses and in the value of investment assets owned directly by
the shareholders.
The Group has established a policy on market risk which sets out the principles that businesses are expected to adopt in
respect of management of the key market risks to which the Group is exposed. The Group monitors adherence to this
market risk policy and regularly reviews how business units are managing these risks locally, through the Group Investment
Committee and ultimately to the Asset Liability Management committee. For each of the major components of market
risk, described in more detail below, the Group has put in place additional policies and procedures to set out how each risk
should be managed and monitored, and the approach to setting an appropriate risk appetite.
The management of market risk is undertaken in both business units and at Group level. Business units manage market
risks locally using their market risk framework and within local regulatory constraints. Business units may also be
constrained by the requirement to meet policyholders’ reasonable expectations and to minimise or avoid market risk in a
number of areas. The Group Investment committee is responsible for managing market risk at Group level, and a number
of investment related risks, in particular those faced by them shareholder funds throughout the Group.
The financial impact from changes in market risk (such as interest rates, equity prices and property values) is examined
through stress tests adopted in the Individual Capital Assessments (ICA) and Financial Condition Reports (FCR), which both
consider the impact on capital from variations in financial circumstances on either a remote scenario, or to changes from
the central operating scenario. Both consider the management actions that may be taken in mitigation of the change in
circumstances.
The sensitivity of Group earnings to changes in economic markets is regularly monitored through sensitivities to investment
returns and asset values in EEV reporting.
The Group market risk policy sets out the minimum principles and framework for matching liabilities with appropriate
assets, the approaches to be taken when liabilities cannot be matched and the monitoring processes that are required.
The Group has criteria for matching assets and liabilities for all classes of business to minimize the impact of mismatches
between the value of assets and the liabilities due to market movements. The local regulatory environment for each
business will also set the conditions under which assets and liabilities are to be matched.
The Group writes unit-linked business in a number of its operations. In unit-linked business, the policyholder bears the
investment risk on the assets held in the unit-linked funds, as the policy benefits are directly linked to the value of the
assets in the fund. The shareholders’ exposure to market risk on this business is limited to the extent that income arising
from asset management charges is based on the value of assets in the fund.
Equity price risk
The Group is subject to equity price risk due to daily changes in the market values of its equity securities portfolio.
The Group’s shareholders are exposed to the following sources of equity risk:
– direct equity shareholdings in shareholder funds and the Group defined benefit pension funds;
– the indirect impact from changes in the value of equities held in policyholders’ funds from which management charges
or a share of performance are taken;
– its interest in the free estate of long-term funds.
At business unit level, equity price risk is actively managed in order to mitigate anticipated unfavourable market
movements where this lies outside the risk appetite of either the company in respect of shareholder assets or the fund in
respect of policyholder assets concerned. In addition local asset admissibility regulations require that business units hold
diversified portfolios of assets thereby reducing exposure to individual equities. The Group does not have material holdings
of unquoted equity securities.
Equity risk is also managed using a variety of derivative instruments, including futures and options.
Businesses actively model the performance of equities through the use of stochastic models, in particular to understand
the impact of equity performance on guarantees, options and bonus rates.
The Investment Committee actively monitors equity assets owned directly by the Group, which may include some material
shareholdings in the Group’s strategic business partners. Concentrations of specific equity holdings (eg the strategic
holdings) are also monitored monthly by the Capital Management Committee.
A sensitivity to changes in equity prices is given in section (g) below.
Aviva plc
Annual Report and
Accounts 2007
221
Financial
statements