Aviva 2013 Annual Report Download - page 279

Strategic report Governance IFRS Financial statements Other information
Aviva plc
Annual report and accounts 2013
277
Risk and capital management continued
Low interest rate environment
We are required to disclose the impact of the continued low
interest rate environment on our operations.
Some of the Group’s products, principally participating
contracts, expose us to the risk that changes in interest rates will
impact on profits through a change in the interest spread (the
difference between the amounts that we are required to pay
under the contracts and the investment income we are able to
earn on the investments supporting our obligations under those
contracts). The primary markets where Aviva is exposed to this
risk are the UK, France and Italy.
The low interest rate environment in a number of markets
around the world has resulted in our current reinvestment yields
being lower than the overall current portfolio yield, primarily for our
investments in fixed income securities and commercial mortgage
loans. Although we think it is reasonably likely that interest rates
will rise, we still anticipate that they may remain below historical
averages for some time. Investing activity will continue to decrease
the portfolio yield as long as market yields remain below the current
portfolio level. We expect the decline in portfolio yield will result in
lower net investment income in future periods.
Certain of the Group’s product lines, such as protection, are not
significantly sensitive to interest rate or market movements. For
unit-linked business, the shareholder margins emerging are typically
a mixture of annual management fees and risk/expense charges.
Risk and expense margins will be largely unaffected by low interest
rates. Annual management fees may increase in the short term as
the move towards low interest rates increases the value of unit
funds. However, in the medium term, unit funds will grow at a
lower rate which will reduce fund charges. For the UK annuities
business interest rate exposure is mitigated by closely matching the
duration of liabilities with assets of the same duration.
The UK participating business includes contracts with
features such as guaranteed surrender values, guaranteed
annuity options, and minimum surrender and maturity values.
These liabilities are managed through duration matching of
assets and liabilities and the use of derivatives, including
swaptions. As a result, the Group’s exposure to sustained low
interest rates on this portfolio is not material. The Group’s key
exposure to low interest rates arises through its other
participating contracts, principally in Italy and France. Some of
these contracts also include features such as guaranteed
minimum bonuses, guaranteed investment returns and
guaranteed surrender values. In a low interest rate environment
there is a risk that the yield on assets might not be sufficient to
cover these obligations. For certain of its participating contracts
the Group is able to amend guaranteed crediting rates. Our
ability to lower crediting rates may be limited by competition,
bonus mechanisms and contractual arrangements.
Details of material guarantees and options are given in note
43 of the IFRS financial statements. In addition, the following
table, which includes amounts held for sale, summarises the
weighted average minimum guaranteed crediting rates and
weighted average book value yields on assets as at 31
December 2013 for our Italian and French participating
contracts, where the Group’s key exposure to sustained low
interest rates arises.
Weighted
average
minimum
guaranteed
crediting
rate
Weighted
average
book value
yield on
assets
Participating
contract
liabilities
£m
France 0.78% 3.99% 63,407
Italy 2.21% 3.80% 11,246
Other1 N/A N/A 41,073
Total N/A N/A 115,726
1 “Other” includes UK participating business
Profit before tax on General Insurance and Health Insurance
business is generally a mixture of insurance, expense and
investment returns. The asset portfolio is invested primarily in fixed
income securities and the reduction in interest rates in recent years
has reduced the investment component of profit. The portfolio
investment yield and average total invested assets in our general
insurance and health business are set out in the table below.
Portfolio
investment
y
ield1
Average
assets
£m
2011 3.9% 18,978
2012 3.7% 18,802
2013 3.1% 18,352
1 Before realised and unrealised gains and losses and investment expenses
The nature of the business means that prices in certain
circumstances can be increased to maintain overall profitability.
This is subject to the competitive environment in each market.
To the extent that there are further falls in interest rates the
investment yield would be expected to decrease further in
future periods.
Further information on the Group’s sensitivity to a reduction
in interest rates is included in the sensitivity analysis in note 58
of the IFRS Financial Statements. This analysis shows an initial
benefit to profit before tax and shareholders’ equity from a 1%
decrease in interest rates due to the increase in market value of
the backing fixed income securities. However, in subsequent
years the reduction in portfolio yield would result in lower net
investment income.
Capital management
Capital management objectives
The primary objective of capital management is to optimise the
balance between return and risk, whilst maintaining economic
and regulatory capital in accordance with risk appetite. Aviva’s
capital and risk management objectives are closely interlinked,
and support the dividend policy and earnings per share growth,
whilst also recognising the critical importance of protecting
policyholder and other stakeholder interests.
Overall capital risk appetite, which is reviewed and approved
by the Aviva Board, is set and managed with reference to the
requirements of a range of different stakeholders including
shareholders, policyholders, regulators and rating agencies. Risk
appetite is expressed in relation to a number of key capital and
risk measures, and includes an economic capital risk appetite of
holding sufficient capital resources to enable the Group to meet
its liabilities in extreme adverse scenarios, on an ongoing basis,
calibrated at a level consistent with a AA range credit rating.
In managing capital we seek to:
 maintain sufficient, but not excessive, financial strength in
accordance with risk appetite, to support new business
growth and satisfy the requirements of our regulators and
other stakeholders giving both our customers and
shareholders assurance of our financial strength;
 manage our overall debt to equity structure to enhance our
returns to shareholders, subject to our capital risk appetite and
balancing the requirements of the range of stakeholders;
 retain financial flexibility by maintaining strong liquidity,
including significant unutilised committed credit facilities
and access to a range of capital markets;
 allocate capital across the Group, to drive value adding
growth through optimising risk and return; and
 declare dividends with reference to factors including growth
in cash flows and earnings.
In line with these objectives, the capital generated and invested
by the Group’s businesses and its conversion to cash is a key
management focus. Operating capital generation, which
measures net capital generated after taking into account capital
invested in new business (before the impact of non-operating
items) is a core regulatory capital based management