Aviva 2014 Annual Report Download - page 305

Aviva plc Annual report and accounts 2014
301
interest rates, profitability may suffer as the result of a decrease
in the spread between interest rates credited to policyholders
and returns on our investment portfolio.
Increases in market interest rates could also negatively affect
our profitability. This could arise as the accommodative
monetary policies of central banks, in particular the US Federal
Reserve and the Bank of England, are wound down or stopped.
Surrenders of life insurance policies and fixed annuity contracts
may increase as policyholders seek higher returns and higher
guaranteed minimum returns. Obtaining cash to satisfy these
surrenders may require us to liquidate fixed maturity
investments at a time when market prices for those assets are
depressed which may result in realised investment losses.
Regardless of whether we realise an investment loss, these cash
payments would result in a decrease in total invested assets, and
may decrease our net income. Premature withdrawals may also
cause us to accelerate amortisation of policy acquisition costs,
which would also reduce our net income.
Our mitigation efforts with respect to interest rate risk are
primarily focused on maintaining an investment portfolio with
diversified maturities that has a weighted average duration
approximately equal to the duration of our estimated liability
cash flow profile. However, it may not be possible to hold assets
that will provide cash flows to exactly match those relating to
policyholder liabilities, in particular in jurisdictions with less
developed bond markets and in certain markets where
regulated surrender value or maturity values are set with
reference to the interest rate environment prevailing at the time
of policy issue. This is due to the duration and uncertainty of the
liability cash flows and the lack of sufficient assets of suitable
duration. This results in a residual asset/liability mismatch risk
that can be managed but not eliminated. In addition, our
estimate of the liability cash flow profile may be inaccurate for
other reasons, such as varying mortality, morbidity or general
insurance claims, and we may be forced to liquidate investments
prior to maturity at a loss in order to cover the liability. Such a
loss could have a material adverse effect on our results of
operations and financial condition.
Changes in short or long term inflation may cause
policyholders to surrender their contracts, increase the size of
our claims payments and expenses and reduce the value of
our investments, which could adversely affect our results of
operations and financial condition.
We are subject to inflation risk through our holdings of fixed
interest and other investments and as a result of the potential
for the cost of claims and expenses to rise faster than
anticipated in our pricing or reserving. Changes in inflation
could also affect the value perceived to be offered by our
policies and so adversely affect persistency levels.
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 on-going
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 and commercial mortgage-backed securities 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 2014, more
than half 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.
Other information
Aviva plc Annual report and accounts 2014 |301