Aviva 2009 Annual Report Download - page 272

270
Aviva plc Notes to the consolidated financial statements continued
Annual Report and Accounts 2009
56 – Risk management continued
Sensitivities as at 31 December 2008 restated1
Impact before profit before tax (£m)
Interest Interest Equity/ Equity/
rates rates property property
+1% -1% +10% -10%
Total 15 (20) 45 (45)
1. The comparative 2008 economic sensitivities for life and non-insurance businesses have been restated to reflect modelling enhancements in Delta Lloyd.
Impact before tax on shareholders’ equity (£m)
Interest
rates
+1%
Interest
rates
-1%
Equity/
property
+10%
Equity/
property
-10%
Total — 5 90 (90)
1. The comparative 2008 economic sensitivities for life and non-insurance businesses have been restated to reflect modelling enhancements in Delta Lloyd.
Limitations of sensitivity analysis
The above tables demonstrate the effect of a change in a key assumption while other assumptions remain unchanged. In reality,
there is a correlation between the assumptions and other factors. It should also be noted that these sensitivities are non-linear, and
larger or smaller impacts should not be interpolated or extrapolated from these results.
The sensitivity analyses do not take into consideration that the Group’s assets and liabilities are actively managed. Additionally,
the financial position of the Group may vary at the time that any actual market movement occurs. For example, the Group’s
financial risk management strategy aims to manage the exposure to market fluctuations.
As investment markets move past various trigger levels, management actions could include selling investments, changing
investment portfolio allocation, adjusting bonuses credited to policyholders, and taking other protective action.
A number of the business units use passive assumptions to calculate their long-term business liabilities. Consequently, a
change in the underlying assumptions may not have any impact on the liabilities, whereas assets held at market value in the
statement of financial position will be affected. In these circumstances, the different measurement bases for liabilities and assets
may lead to volatility in shareholder equity. Similarly, for general insurance liabilities, the interest rate sensitivities only affect profit
and equity where explicit assumptions are made regarding interest (discount) rates or future inflation.
Other limitations in the above sensitivity analyses include the use of hypothetical market movements to demonstrate potential
risk that only represent the Group’s view of possible near-term market changes that cannot be predicted with any certainty; and
the assumption that all interest rates move in an identical fashion.
57 – Derivative financial instruments
This note gives details of the various derivative instruments we use to mitigate risk.
The Group uses a variety of derivative financial instruments, including both exchange traded and over-the-counter instruments,
in line with our overall risk management strategy. The objectives include managing exposure to price, foreign currency and/or
interest rate risk on existing assets or liabilities, as well as planned or anticipated investment purchases.
In the narrative and tables below, figures are given for both the notional amounts and fair values of these instruments. The
notional amounts reflect the aggregate of individual derivative positions on a gross basis and so give an indication of the overall
scale of the derivative transaction. They do not reflect current market values of the open positions. The fair values represent the
gross carrying values at the year end for each class of derivative contract held (or issued) by the Group.
The fair values do not provide an indication of credit risk, as many over-the-counter transactions are contracted and
documented under ISDA (International Swaps and Derivatives Association Inc) master agreements or their equivalent. Such
agreements are designed to provide a legally enforceable set-off in the event of default, which reduces credit exposure. In addition,
the Group has collateral agreements in place between the individual Group entities and relevant counterparties.
(a) Hedged derivatives
The Group has formally assessed and documented the effectiveness of its hedged derivatives in accordance with IAS 39, Financial
Instruments: Recognition and Measurement
. To aid discussion and analysis, these derivatives are analysed into cash flow, fair value
and net investment hedges, as detailed below.
(i) Cash flow hedges
The Group uses forward starting interest rate swap agreements in the United States to hedge the variability in future cash flows
associated with the forecasted purchase of fixed-income assets. These agreements reduce the impact of future interest rate
changes on the forecasted transaction. Fair value adjustments for these interest rate swaps are deferred and recorded in equity
until the occurrence of the forecasted transaction, at which time the interest rate swaps will be terminated. The accumulated gain
or loss in equity will be amortised into investment income as the acquired asset affects income. The Group is hedging its exposure
to the variability of future cash flows from interest rate movements for terms up to 10 years, therefore the cash flows from these
hedging instruments are expected to affect profit and loss for approximately the next 10 years. For the year ended 31 December
2009, none of the Group’s cash flow hedges was ineffective or discontinued.
The notional value of these interest rate swaps was £3 million at 31 December 2009 and their fair value was £0.1 million
liability. The Group had no cash flow hedge activity at 31 December 2008.