Aviva 2013 Annual Report Download - page 303

Strategic report Governance IFRS Financial statements Other information
Aviva plc
Annual report and accounts 2013
301
Shareholder information continued
Falls in equity or property prices could have an adverse
impact on our investment portfolio and impact on our results
of operations and shareholders’ equity.
We are subject to equity and property price risk due to holdings
of equities and investment properties in a variety of locations
worldwide. Downturns in equity markets will depress equity
prices and have a negative impact on our capital position in that
unrealised losses in our net investment portfolio will increase,
and our defined benefit pension scheme surplus/deficit will
reduce/increase as the market value of scheme assets invested
in equities decreases.
Downturns and volatility in equity markets can have a
material adverse effect on the revenues and returns from our
unit-linked, participating and fund management business. The
unit-linked and fund management business depends on fees
related primarily to the value of assets under management and
would therefore be reduced by declines in equity and property
markets. Profit could also be reduced as a result of current
investors withdrawing funds or reducing their rates of ongoing
investment with our fund management companies, or switching
to lower risk funds generating lower income, or as a result of
our fund management companies failing to attract funds from
new investors. Similarly, bonuses credited to participating
policyholders will reduce following declines in equity and
property markets and this will generally also lead to reductions
in transfers to shareholders.
Downturns in equity markets may also have a material
adverse effect on our regulatory capital surplus as measured
under the EU Insurance Groups Directive and under the
Individual Capital Assessment required by the PRA in the UK.
We provide certain guarantees within some of our products
that protect policyholders against significant downturns in the
equity markets. In volatile or declining equity market conditions,
we may need to increase liabilities for future policy benefit and
policyholder account balances, negatively affecting net income.
For property investment, we are subject to counterparty, valuation
and liquidity risks. These investments may be adversely affected by
weakness in property markets and increased mortgage
delinquencies. We are also subject to property risk indirectly in our
investments in residential mortgage-backed securities (“RMBS”)
and commercial mortgage-backed securities (“CMBS”) and
covered bonds. There is the risk that the underlying collateral may
fall in value causing the investment in securities to fall in value.
The markets for these property investments and instruments can
become illiquid, and issues relating to counterparty credit ratings
and other factors may increase pricing and valuation
uncertainties. We are indirectly exposed to property risk through
our UK commercial finance lending.
Fluctuations in currency exchange rates may adversely affect
our results of operations and financial condition.
We operate internationally and are exposed to foreign currency
exchange risk arising from fluctuations in exchange rates of
various currencies. For the year ended 31 December 2013, 60%
of our premium income from continuing operations arose in
currencies other than sterling, and our net assets were
denominated in a variety of currencies, of which the largest are
the euro, sterling and Canadian dollar. In managing our foreign
currency exposures, we do not hedge revenues as these are
substantially retained locally to support the growth of the
business and meet local regulatory and market requirements.
Nevertheless, the effect of exchange rate fluctuations on local
operating results could lead to significant fluctuations in our
consolidated financial statements upon translation of the results
into sterling. Although we take certain actions to address this
risk, foreign currency exchange rate fluctuation could materially
adversely affect our reported results due to unhedged positions
or the failure of hedges to effectively offset the impact of the
foreign currency exchange rate fluctuation. Any adverse foreign
currency exchange fluctuation may also have a material adverse
effect on our regulatory capital surplus based on the EU
Insurance Groups Directive and under the Individual Capital
Assessment required by the PRA in the UK.
Market fluctuations may cause the value of options and
guarantees embedded in some of our life insurance products
to exceed the value of the assets backing their reserves,
which could adversely affect our results of operations or
financial condition.
As a normal part of their operating activities, various Group
companies have given guarantees and options, including
interest rate and investment return guarantees, in respect of
certain long-term insurance and fund management products. In
providing these guarantees and options, our capital position is
sensitive to fluctuations in financial variables, including foreign
currency exchange rates, interest rates, property values and
equity prices.
Interest rate guaranteed returns, such as those available on
guaranteed annuity options (“GAOs”), are sensitive to interest
rates falling below the guaranteed level. Other guarantees, such
as maturity value guarantees and guarantees in relation to
minimum rates of return, are sensitive to fluctuations in the
investment return below the level assumed when the guarantee
was made.
Periods of significant and sustained downturns in equity
markets, increased equity volatility or reduced interest rates
could result in an increase in the valuation of the future policy
benefit or policyholder account balance liabilities associated
with such products, resulting in a reduction to net income. We
use reinsurance in combination with derivative instruments to
mitigate some of the liability exposure and the volatility of net
income associated with these liabilities, and while we believe
that these and other actions mitigate the risks related to these
benefit, we remain liable for the guaranteed benefit in the event
that reinsurers or derivative counterparties are unable or
unwilling to pay.
We are also subject to the risk that the cost of hedging
these guaranteed minimum benefit increases, resulting in a
reduction to net income. In addition, we are subject to the risk
that unanticipated policyholder behaviour or mortality,
combined with adverse market events, produces economic
losses beyond the scope of the risk management techniques
employed. These, individually or collectively, may have a
material adverse effect on our results of operations, financial
condition or liquidity.
Asset management risks relating to Aviva’s business
Our fund management business may be affected by the poor
investment performance of the funds we manage.
Poor investment returns in our investment management
business, due either to general market conditions or
underperformance (relative to competitors or to benchmarks) by
funds or accounts that we manage, may adversely affect our
ability to retain existing assets and to attract new clients or
additional assets from existing clients. The ability of our
investment teams to deliver strong investment performance
depends in large part on their ability to identify appropriate
investment opportunities in which to invest client assets. If the
investment team for any of our strategies is unable to identify
sufficient appropriate investment opportunities for existing and
new client assets on a timely basis, the investment performance
of the strategy could be adversely affected. The risk that
sufficient appropriate investment opportunities may be
unavailable is influenced by a number of factors, including
general market conditions, and is likely to increase as our assets
under management increase, particularly if these increases occur
very rapidly. This could adversely affect the management and
incentive fees that we earn on assets under management.