Aviva 2009 Annual Report Download - page 256

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Aviva plc Notes to the consolidated financial statements continued
Annual Report and Accounts 2009
56 – Risk management continued
The Group has developed economic capital models that support the measurement, comparison and monitoring of our risks. The
results of the modelling are incorporated into key decision making processes. These models show the relative impact to economic
capital from the risks we face. In turn this supports the assessment of appropriate and effective mitigating strategies where risks
are outside of appetite.
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 scenario analysis which consider the impact on capital from
variations in financial circumstances on either a remote scenario, or to changes from the central operating scenario. Both
assessments consider the management actions that may be taken in mitigation of the change in circumstances.
Stress and scenario testing help give an indication of the size of losses that could be experienced in extreme but plausible
events and complements other risk measurement techniques. It helps identify concentration risk across businesses and portfolios
and is a useful tool for management to use in their capital planning process. A number of stress tests and economic scenarios have
been developed to capture the adverse impact on the businesses of extreme events. The stress tests are designed to cover major
asset classes and insurance risks. The stress tests are produced at least monthly and are reviewed and discussed by senior
management.
The sensitivity of Group earnings to changes in economic markets is regularly monitored through sensitivities to investment
rate and investment return and asset values in IFRS and MCEV reporting.
The Financial Services Authority (FSA) requires Aviva to assess its economic capital requirements to ensure that it adequately
reflects business and control risks. In turn this analysis supports our strategic planning and decision-making processes.
(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 Assets Committee and
ultimately the Group Asset Liability Committee. For each of the major components of market risk, described in more detail below,
the Group has put in place additional processes 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 businesses, regions and at Group level. Businesses manage market risks
locally using the Group market risk framework and within local regulatory constraints. Businesses 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
Assets Committee is responsible for managing market risk at Group level, and a number of investment-related risks, in particular
those faced by shareholder funds throughout the Group.
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 minimise 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.
In addition, where the Group’s long-term savings businesses have written insurance and investment products where the
majority of investment risks are borne by its policyholders, these risks are managed in line with local regulations and marketing
literature, in order to satisfy the policyholders’ risk and reward objectives.
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; and
— Its interest in the free estate of long-term with profits funds.