Strategic Report Governance
Financial Statements
171
Units in liquidity funds comprise wholly of units in funds which invest in very short dated liquid assets. However as they do not meet the definition of Cash available on demand, liquidity funds are reported within Financial investments. Liquidity funds do however meet the definition of cash equivalents for the purposes of disclosure in the Consolidated statement of cash flows. The majority of investments included in debt securities and other fixed income securities are listed investments. The Group also originates illiquid fixed income assets including infrastructure, real estate and private placements. Long income real estate investments are typically much longer duration and hence the cash flow profile is more appropriate to match DB deferred liabilities. Deposits with credit institutions with a carrying value of £808m (2023: £706m) have been pledged as collateral in respect of the Group’s derivative and repurchase agreement financial instruments. Amounts pledged as collateral are deposited with the derivative or repurchase agreement counterparty. Derivatives are reported within Financial investments where the derivative valuation is in an asset position, or alternatively within Payables and other financial liabilities where the derivative is in a liability position. In 2023, the Group first established an amortised cost portfolio; the Group has now invested around £4bn in long dated gilts that are held within this portfolio, to significantly reduce the Solvency II coverage ratio sensitivity to future interest rate movements, with a much reduced volatility on the IFRS position. 16. FAIR VALUE OF FINANCIAL ASSETS AND LIABILITIES This note explains the methodology for valuing the Group’s financial assets and liabilities fair value, including financial investments, and provides disclosures in accordance with IFRS 13 “Fair value measurement” including an analysis of such assets and liabilities categorised in a fair value hierarchy based on market observability of valuation inputs. (a) Determination of fair value and fair value hierarchy All assets and liabilities for which fair value is measured or disclosed in the financial statements are categorised within the fair value hierarchy described as follows, based on the lowest level input that is significant to the fair value measurement as a whole. Level 1 Inputs to Level 1 fair values are unadjusted quoted prices in active markets for identical assets and liabilities that the entity can access at the measurement date. Level 2 Inputs to Level 2 fair values are inputs other than quoted prices included within Level 1 that are observable for the asset or liability, either directly or indirectly. If the asset or liability has a specified (contractual) term, a Level 2 input must be observable for substantially the full term of the instrument. Level 2 inputs include the following: • quoted prices for similar assets and liabilities in active markets; • quoted prices for identical assets or similar assets in markets that are not active, the prices are not current, or price quotations vary substantially either over time or among market makers, or in which very little information is released publicly; • inputs other than quoted prices that are observable for the asset or liability; and • market-corroborated inputs. Level 3 Inputs to Level 3 fair values include significant unobservable inputs for the asset or liability. Unobservable inputs are used to measure fair value to the extent that observable inputs are not available, thereby allowing for situations in which there is little, if any, market activity for the asset or liability at the measurement date. However, the fair value measurement objective remains the same, i.e. an exit price at the measurement date from the perspective of a market participant that holds the asset or owes the liability. Unobservable inputs reflect the same assumptions as those that the market participant would use in pricing the asset or liability including those about risk. The sensitivity of Level 3 investments to reasonably possible alternative assumptions for unobservable inputs used in the valuation model that could give rise to significant changes in the fair value of the assets is included in section (d). The sensitivities in this note only consider the impact of the change in these assumptions on the fair value of the asset. Some of these sensitivities would also impact the yield on assets and hence the valuation discount rate used to determine insurance contract liabilities. For some of these sensitivities, the impact on the value of insurance contract liabilities and therefore the combined impact on profit before tax is included in note 22(h).
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