Aviva 2014 Annual Report Download - page 306

Aviva plc Annual report and accounts 2014
Shareholder information continued
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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 team to deliver strong
investment performance depends in large part on our 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. This could adversely affect the management
and incentive fees that we earn on assets under management.
Failure to comply with client contractual requirements and/or
guidelines could result in damage awards against us and our
fund management operations and loss of revenues due to
client terminations.
When clients retain us to manage assets on their behalf, we
must comply with contractual obligations and guidelines agreed
with such clients in the provision of our services. A failure to
comply with these guidelines or contractual requirements could
result in damage to our reputation or in our clients seeking to
recover losses, withdrawing their funds or terminating their
contracts, any of which could cause our revenues and earnings
to decline.
Failure to manage risks in operating securities lending of
Group and third party client assets could adversely affect our
results of operations and financial condition and for our fund
management operations lead to a loss of clients and a decline
in revenues and liquidity.
In operating securities lending of Group and third party client
assets, our fund management operations must manage risks
associated with (i) ensuring that the value of the collateral held
against the securities on loan does not decline in value or become
illiquid and that our nature and value complies with regulatory
requirements and investment requirements; (ii) the potential that a
borrower defaults or does not return a loaned security on a timely
basis; and (iii) errors in the settlement of securities, daily mark-to-
market valuations and collateral collection. The failure of our fund
management controls to mitigate these risks could result in
financial losses for us and third party clients that participate in our
securities lending programmes.
Liquidity risks relating to Aviva’s business
Adverse capital and credit market conditions may adversely
affect our financial flexibility in addressing liquidity needs, as
well as access to and the cost of capital which could
adversely affect our results of operations or financial
condition.
At Group level, we need some of our invested assets to be liquid
to pay our operating expenses, taxes, interest on our debt,
dividends on our capital stock and to repay maturing debt. At
an operational level we also need liquidity to meet insurance
claims. Without sufficient liquidity, we could be forced to curtail
our operations and our business would suffer. The principal
sources of our liquidity are insurance premiums, annuity
considerations, deposit funds and cash flow from our
investment portfolio and assets, consisting mainly of cash or
assets that are readily convertible into cash. Sources of liquidity
in normal markets also include a variety of short and long-term
instruments, including repurchase agreements, commercial
paper, medium and long-term debt, junior subordinated debt,
securities, capital securities and stockholders’ equity.
We hold certain investments that may lack liquidity such as
privately placed fixed-maturity securities, and unlisted equities.
The valuations of such assets are based on inputs which are not
directly observable in the market. The inputs used reflect the
assumptions that we consider market participants would
normally use based on a combination of independent third party
evidence and internally developed models, intended to be
calibrated to market observable data where possible. These are
known as Level 3 asset classes in our fair value hierarchy and
represented 17% of total financial assets and investment
properties held at fair value as of 31 December 2014. As has
been the case across the industry, even some higher-quality
assets have been more illiquid as a result of the recent
challenging market conditions.
The reported value of our relatively illiquid types of
investments, our investments in the asset classes described in
the paragraph above and, at times, our higher-quality, generally
liquid asset classes, do not necessarily reflect the lowest current
market price for the asset. If we were forced to sell certain of
our assets in the current market, there can be no certainty that
we would be able to sell them for the prices at which we have
recorded them and we may be forced to sell them at
significantly lower prices.
We may refinance existing financing arrangements and may,
in exceptional circumstances, need to seek additional financing
to supplement liquidity available from internal resources. The
availability of additional financing will depend on a variety of
factors such as market conditions, the general availability of
credit, the overall availability of credit to the financial services
industry and the market’s perception of our financial condition.
Disruptions and uncertainty or volatility in the capital and credit
markets, as has been experienced in the last few years, in
particular throughout the eurozone, may exert downward
pressure on availability of liquidity and credit capacity for certain
issuers and, if access to liquidity is constrained for a prolonged
period of time, may limit our access to capital required to
operate and grow our business at a sustainable cost. Although
we do not currently anticipate any severe disruptions to the
capital and credit markets, there can be no assurance that any
302 | Aviva plc Annual report and accounts 2014