Barclays 2006 Annual Report Download - page 96

Barclays PLC
Annual Report 2006
92
Risk management
Insurance risk management
Insurance risk is the risk that the Group will have to make higher than
anticipated payments to settle claims arising from its long-term and
short-term insurance businesses.
Long-term insurance business
For long-term insurance contracts where death is the insured risk, the
most significant factors that could detrimentally affect the frequency
and severity of claims are the incidence of disease, such as AIDS, or
general changes in lifestyle, such as in eating, exercise and smoking.
Where survival is the insured risk, advances in medical care and social
conditions are the key factors that increase longevity. The Group
manages its exposure to risk by operating in part as a unit linked
business, prudent product design, applying strict underwriting criteria,
transferring risk to reinsurers, managing claims and establishing
prudent reserves.
Short-term insurance business
For payment protection contracts where inability to make payments
under a loan contract is the insured risk, the most significant factors are
the health of the policyholder and the possibility of unemployment
which depends upon, among other things, long-term and short-term
economic factors. The Group manages its exposure to such risks
through prudent product design, efficient claims management, prudent
reserving methodologies and bases, regular product, economic and
market reviews and regular adequacy tests on the size of the reserves.
Absa insures property and motor vehicles, for which the most
significant factors that could affect the frequency and severity of claims
are climatic change and crime. Absa manages its exposure to risk by
diversifying insurance risks accepted and transferring risk to reinsurers.
See page 236 for further information.
Reinsurer credit risk
For the long-term business, reinsurance programmes are in place to
restrict the amount of cover to any single life. The reinsurance cover is
spread across highly rated companies to diversify the risk of reinsurer
solvency. Net of insurance reserves include a margin to reflect reinsurer
credit risk.
For the short-term business a quota-share programme is in place for
selected in-force policies. The structure of the treaty ensures that the
underlying assets are bankruptcy remote in the event of credit problems
with the reinsurer.
Disclosures about certain trading activities (including
non-exchange traded commodity contracts)
The Group delivers a fully integrated service to clients for base metals,
precious metals, oil and oil-related products, power, natural gas and
other related commodities.
The Group’s commodity business continues to expand, as market
conditions allow, through the addition of new products and markets,
with the 2006 expansion of business being driven by both organic
growth and acquisitions of portfolios.
The Group offers both over the counter (OTC) and exchange traded
derivatives in these commodities. The Group’s base metals business
also enters into outright metal purchases and sale transactions, while
the power and gas business trades both physical forwards and
derivative contracts. The Group does not maintain any physical
exposures in oil or oil related products. The Group continues to develop
and offer a range of commodity-related structured products.
The Group’s principal commodity related derivative contracts are swaps,
options, forwards and futures, which are all similar in nature to such
non-commodity related contracts. Commodity derivative contracts
include commodity specification and delivery location as well as
forward date and notional value.
The fair values of commodity physical and derivative positions are
determined through a combination of recognised market observable
prices, exchange prices, and established inter-commodity relationships.
The fair value of OTC commodity derivative contracts is determined
primarily by using valuation models which are based on assumptions
supported by prices from observable market transactions in the same
instrument or are based on available observable market data.
Where a valuation model is used, the fair value is determined based on
the expected cash flows under the terms of each specific contract,
discounted back to present value. The expected cash flows for each
contract are either determined using market parameters such as
commodity price curves, commodity volatilities, commodity
correlations, interest rate yield curves and foreign exchange rates,
or other market prices.
Where possible, fair values generated by models are independently
validated with reference to market price quotes or price sharing with
other institutions. Where all significant model inputs can be validated to
observable market data at the inception of the contract the valuation of
the contract is based on the model value output.
However, where no observable market parameter is available then the
contract is valued at transaction price at inception. Following initial
recognition, the process of calculating fair value from a valuation model
may require estimation of certain pricing parameters, assumptions or
model characteristics. These estimates are calibrated against industry
standards, economic models and observed transaction prices. The
valuation model used for a particular instrument, the quality and
liquidity of market data used for pricing, other fair value adjustments
not specifically captured by the model, market data and any
assumptions or estimates are all subject to internal review and approval
procedures and consistent application between accounting periods.
The tables on page 93 analyse the overall fair value of the commodity
derivative contracts by movement over time and source of fair value.
Additionally, the positive fair value of these contracts is analysed by
counterparty credit risk rating.