Aviva 2009 Annual Report Download - page 266

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Aviva plc Notes to the consolidated financial statements continued
Annual Report and Accounts 2009
56 – Risk management continued
Management of life insurance risks
The individual life insurance risks are managed as follows:
— Mortality and morbidity risks are mitigated by use of reinsurance. The Group allows business units to select reinsurers, from
those approved by the Group, based on local factors, but assesses the overall programme to manage group-wide risk exposures
and monitor the aggregation of risk ceded to individual reinsurers is within appetite for credit risk.
— Longevity risk is carefully monitored against the latest external industry data and emerging trends. Whilst individual businesses
are responsible for reserving and pricing for annuity business, the Group monitors the exposure to this risk and the capital
implications to manage the impact on the group-wide exposure and the capital funding that businesses may require as a
consequence. The Group has used reinsurance solutions to reduce the risks from longevity where possible and desirable and
continually monitors and evaluates emerging market solutions to mitigate this risk further.
— Persistency risk is managed at a business unit level through frequent monitoring of company experience, benchmarked against
local market information. Generally, persistency risk arises from customers lapsing their policies earlier than has been assumed.
Where possible the financial impact of lapses is reduced through appropriate product design. Businesses also implement specific
initiatives to improve retention of policies which may otherwise lapse. The Group Life Insurance Committee has developed
guidelines on persistency management.
— Product Design and Pricing risk arises from poorly designed or inadequately priced products and can lead to both financial loss
and reputation damage from the Group. Guidelines have been developed to support the businesses through the complete cycle
of the product development process, financial analysis and pricing.
— Expense risk is primarily managed by the business units through the assessment of business unit profitability and frequent
monitoring of expense levels.
Apart from the ICA, sensitivity testing is widely used to measure the capital required and volatility in earnings due to exposure to
life insurance risks, typically through MCEV reporting (examples of which are contained elsewhere in this report). This assessment is
taken at both business unit level and at Group level where the impact of aggregation of similar risks can be measured. This enables
the Group to determine whether action is required to reduce risk, or whether that risk is within the overall risk appetite.
Concentration risk
The Group writes a diverse mix of business in worldwide markets that are all subject to similar risks (mortality, persistency etc). The
Group assesses the relative costs and concentrations of each type of risk through the ICA capital requirements and material issues
are escalated to and addressed at the Life Insurance Committee. This analysis enables the Group to assess whether accumulations
of risk exceeds risk appetite.
One key concentration of life insurance risk for the Group is improving longevity risk from pensions in payment and deferred
annuities in the UK and the Netherlands where the Group has material portfolios. The Group continually monitors this risk and the
opportunities for mitigating actions through reinsurance, improved asset liability matching, or innovative solutions that emerge in
the market.
When looking at concentrations of risk, for example market risk, the risk within Aviva staff pension schemes is also considered.
ICA analysis and MCEV sensitivity testing help identify both concentrations of risk types and the benefits of diversification of risk.
Embedded derivatives
The Group has exposure to a variety of embedded derivatives in its long-term savings business due to product features offering
varying degrees of guaranteed benefits at maturity or on early surrender, along with options to convert their benefits into different
products on pre-agreed terms. The extent of the impact of these embedded derivatives differs considerably between business units.
Examples of each type of embedded derivative affecting the Group are:
— Options: call, put, surrender and maturity options, guaranteed annuity options, options to cease premium payment, options for
withdrawals free of market value adjustment, annuity options, and guaranteed insurability options.
— Guarantees: embedded floor (guaranteed return), maturity guarantee, guaranteed death benefit, and guaranteed minimum rate
of annuity payment.
— Other: indexed interest or principal payments, maturity value, loyalty bonus.
The impact of these is reflected in ICA and MCEV reporting and managed as part of the asset liability framework.