Aviva 2014 Annual Report Download - page 130

Aviva plc Annual report and accounts 2014
Accounting policies continued
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agreed notional principal amount, a net payment to be made by
one party to the other, depending what rate in fact prevails at a
future point in time. Interest rate options, which consist
primarily of caps and floors, are interest rate protection
instruments that involve the potential obligation of the seller to
pay the buyer an interest rate differential in exchange for a
premium paid by the buyer. This differential represents the
difference between current rate and an agreed rate applied to a
notional amount. Exposure to gain or loss on all interest rate
contracts will increase or decrease over their respective lives as
interest rates fluctuate. Certain contracts, known as swaptions,
contain features which can act as swaps or options. These
contracts are categorised according to the type of contract they
most closely resemble in practice.
Foreign exchange contracts
Foreign exchange contracts, which include spot, forward and
futures contracts, represent agreements to exchange the
currency of one country for the currency of another country at
an agreed price and settlement date. Foreign exchange option
contracts are similar to interest rate option contracts, except
that they are based on currencies, rather than interest rates.
Exposure to gain or loss on these contracts will increase or
decrease over their respective lives as currency exchange and
interest rates fluctuate.
Derivative instruments for hedging
On the date a derivative contract is entered into, the Group
designates certain derivatives as either:
(i) a hedge of the fair value of a recognised asset or liability
(fair value hedge);
(ii) a hedge of a future cash flow attributable to a recognised
asset or liability, a highly probable forecast transaction or a
firm commitment (cash flow hedge); or
(iii) a hedge of a net investment in a foreign operation (net
investment hedge).
Hedge accounting is used for derivatives designated in this way,
provided certain criteria are met. At the inception of the
transaction, the Group documents the relationship between the
hedging instrument and the hedged item, as well as the risk
management objective and the strategy for undertaking the
hedge transaction. The Group also documents its assessment of
whether the hedge is expected to be, and has been, highly
effective in offsetting the risk in the hedged item, both at
inception and on an ongoing basis.
Changes in the fair value of derivatives that are designated
and qualify as net investment or cash flow hedges, and that
prove to be highly effective in relation to the hedged risk, are
recognised in other comprehensive income and a separate
reserve within equity. Gains and losses accumulated in this
reserve are included in the income statement on disposal of the
relevant investment or occurrence of the cash flow as
appropriate.
Changes in the fair value of derivatives that are designated
and qualify as fair value hedges are recognised in the income
statement. The gain or loss on the hedged item that is
attributable to the hedged risk is recognised in the income
statement. This applies even if the hedged item is an available
for sale financial asset or is measured at amortised cost. If a
hedging relationship no longer meets the criteria for hedge
accounting, the cumulative adjustment made to the carrying
amount of the hedged item is amortised to the income
statement, based on a recalculated effective interest rate over
the residual period to maturity. In cases where the hedged item
has been derecognised, the cumulative adjustment is released to
the income statement immediately.
For a variety of reasons, certain derivative transactions, while
providing effective economic hedges under the Group’s risk
management positions, do not qualify for hedge accounting
under the specific IFRS rules and are therefore treated as
derivatives held for trading. Their fair value gains and losses are
recognised immediately in net investment income.
(V) Loans
Loans with fixed maturities, including policyholder loans,
mortgage loans on investment property, securitised mortgages
and collateral loans, are recognised when cash is advanced to
borrowers. Certain loans are carried at their unpaid principal
balances and adjusted for amortisation of premium or discount,
non-refundable loan fees and related direct costs. These
amounts are deferred and amortised over the life of the loan as
an adjustment to loan yield using the effective interest rate
method. Loans with indefinite future lives are carried at unpaid
principal balances or cost.
However, for the majority of mortgage loans, the Group has
taken advantage of the fair value option under IAS 39 to
present the mortgages, associated borrowings and derivative
financial instruments at fair value, since they are managed as a
portfolio on a fair value basis. This presentation provides more
relevant information and eliminates any accounting mismatch
that would otherwise arise from using different measurement
bases for these three items. The fair values of these mortgages
are estimated using discounted cash flow models, based on a
risk-adjusted discount rate which reflects the risks associated
with these products. They are revalued at each period end, with
movements in their fair values being taken to the income
statement.
At each reporting date, we review loans carried at amortised
cost for objective evidence that they are impaired and
uncollectable, either at the level of an individual security or
collectively within a group of loans with similar credit risk
characteristics. To the extent that a loan is uncollectable, it is
written down as impaired to its recoverable amount, measured
as the present value of expected future cash flows discounted at
the original effective interest rate of the loan, taking into
account the fair value of the underlying collateral through an
impairment provision account. Subsequent recoveries in excess
of the loan’s written-down carrying value are credited to the
income statement.
(W) Collateral
The Group receives and pledges collateral in the form of cash or
non-cash assets in respect of stock lending transactions, certain
derivative contracts and loans, in order to reduce the credit risk
of these transactions. Collateral is also pledged as security for
bank letters of credit. The amount and type of collateral
required depends on an assessment of the credit risk of the
counterparty.
Collateral received in the form of cash, which is not legally
segregated from the Group, is recognised as an asset in the
statement of financial position with a corresponding liability for
the repayment in financial liabilities (note 60). However, where
the Group has a currently enforceable legal right of set-off and
the ability and intent to net settle, the collateral liability and
associated derivative balances are shown net, in line with
market practice. Non-cash collateral received is not recognised
in the statement of financial position unless the Group either (a)
sells or repledges these assets in the absence of default, at
which point the obligation to return this collateral is recognised
as a liability; or (b) the counterparty to the arrangement
defaults, at which point the collateral is seized and recognised
as an asset.
Collateral pledged in the form of cash, which is legally
segregated from the Group, is derecognised from the statement
of financial position with a corresponding receivable recognised
for its return. Non-cash collateral pledged is not derecognised
from the statement of financial position unless the Group
defaults on its obligations under the relevant agreement, and
126 | Aviva plc Annual report and accounts 2014