Strategic Report Governance
Financial Statements
133
Key audit matter
How our audit addressed the key audit matter
Valuation of certain hard to value investments (Group) Refer to Group Audit Committee Report, Accounting policy 1.13 Financial investments and note 16 Fair value of financial assets and liabilities. The valuation of the investment portfolio involves judgement and continues to be an area of inherent risk. The valuation risk is not uniform for all investment types and is greatest for certain hard to value assets categorised as level 3 under the fair value methodology. This is due to the level of complexity involved and the significant judgement required in the selecting and applying of key assumptions and unobservable inputs, and the resulting sensitivities on the reported amounts. The asset classes that we consider for this risk are: 1. Lifetime mortgages (LTM);
We performed the following audit procedures in respect of Lifetime Mortgages: • Tested the design and operating effectiveness of controls related to the accuracy and completeness of data used in the modelling of LTMs; • For a sample of mortgages, agreed data used in the modelling of LTMs to policyholder documentation; • Tested the design and operating effectiveness of controls in place over the determination of the valuation of LTMs, including those relating to model inputs, model operation and extraction and consolidation of results from the valuation models; • Engaged our actuarial specialists, applied our industry knowledge and experience to assess the appropriateness of the methodology, models and assumptions used to assess the allowance for the no negative Equity Guarantee (nnEG) against recognised actuarial practices, including any changes made during the year, taking into account the impact of current economic conditions; • Performed testing over the actuarial model calculations relating to the nnEG and tested the analysis of change in modelled results, to assess whether the model continues to operate as expected. • Evaluated the appropriateness of significant economic assumptions, including the property price inflation assumption and property price volatility assumptions used within the valuation process, with reference to market data and industry benchmarks where available, and taking into account the impact of current economic conditions; • Assessed the appropriateness of current property prices derived using Automated Valuation Model (AVM); • Tested the key judgements involved in the preparation of the manually calculated components of the asset balance, and the accuracy of the calculations; • Evaluated the Group’s historic data used to prepare the Group’s mortality, morbidity and voluntary redemptions experience analysis, taking into account the impact of current economic conditions for voluntary redemptions together with industry data on expectations of future mortality improvements and assess whether this supports the assumptions adopted; and • Considered the adequacy of the Group’s disclosures in relation to the valuation of those assets designated Level 3, in particular the sensitivity of the valuations adopted to alternative outcomes. We performed the following audit procedures to test the valuation of other hard to value investments classified as Level 3 (excluding Lifetime mortgages): • Tested the design and operating effectiveness of controls related to the valuation of investments; • Obtained independent confirmations from third party asset managers (where relevant); • Engaged our valuation experts to perform independent valuations for a sample of commercial mortgages, long income real estate, and other illiquid debt instruments which included assessing the reasonableness and appropriateness of the valuation methodology applied; and investigated any variances outside of our tolerable threshold; • Tested inputs into the valuation to external sources, where possible; and • Tested the disclosures made by management in the financial statements. Based on the work performed and the evidence obtained, we consider the valuation of hard to value investments to be appropriate.
2. Loans secured by commercial mortgages; 3. Long income real estate (which includes residential ground rents); and 4. Other illiquid debt instruments.
The setting of voluntary redemptions (persistency), as well as key economic assumptions, applied in the valuation of LTMs (including current property values, house price inflation and volatility) are impacted by the uncertainty in the current economic environment.
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