FINANCIAL STATEMENTS
STRATEGIC REPORT
GOVERNANCE
33 FINANCIAL AND INSURANCE RISK MANAGEMENT continued
Less than one year £m
One to five years £m
Five to ten years £m
Over ten years £m
No fixed term £m
Total £m
2020
Units in liquidity funds
1,128.5
–
– –
– –
– 1,128.5
Investment funds
37.0
139.1
–
176.1
Debt securities and other fixed income securities
789.3 1,823.4 2,322.7 6,126.0
– 11,061.4
Deposits with credit institutions
99.7 11.1
–
–
–
– –
99.7
Derivative financial assets
35.0
84.9
669.0
800.0
Loans secured by residential mortgages Loans secured by commercial mortgages
–
–
–
– 8,261.1 8,261.1
36.0
270.5
221.2
64.4
– – – –
592.1 114.9 945.0
Loans secured by ground rents
– –
– –
–
114.9 791.1
Infrastructure loans
153.9
Other loans
0.4
81.7
3.2
5.7
91.0
Total
2,102.0 2,349.7 2,785.9 7,771.1 8,261.1 23,269.8
A sensitivity analysis of the impact of interest rate movements on profit before tax is included in note 23(e). (ii) Property risk
The Group’s exposure to property risk arises from indirect exposure to the UK residential property market through the provision of lifetime mortgages. A substantial decline or sustained underperformance in UK residential property prices, against which the Group’s lifetime mortgages are secured, could result in proceeds on sale being exceeded by the mortgage debt at the date of redemption. Demand may also reduce for lifetime mortgage products through reducing consumers’ propensity to borrow and by reducing the amount they are able to borrow due to reductions in property values and the impact on loan-to-value limits. The risk is mitigated by ensuring that the advance represents a low proportion of the property’s value at outset and independent third party valuations are undertaken on each property before initial mortgages are advanced. Lifetime mortgage contracts are also monitored through dilapidation reviews. House prices are monitored and the impact of exposure to adverse house prices (both regionally and nationally) is regularly reviewed. Further mitigation is through management of the volume of lifetime mortgages, including disposals, in the portfolio in line with the Group’s LTM backing ratio target, and the establishment of the NNEG hedges. The Group has managed its property risk exposure in the year via a reduction in the LTM backing ratio, additional LTM portfolio sales and further NNEG hedging. A sensitivity analysis of the impact of property price movements is included in note 17 and note 23(e). These notes also discuss the Group’s consideration of the impact of COVID-19 on property assumptions at 31 December 2021. (iii) Inflation risk Inflation risk is the risk of fluctuations in the value of, or income from, specific assets or liabilities or both in combination, arising from relative or absolute changes in inflation or in the volatility of inflation. Exposure to inflation occurs in relation to the Group’s own management expenses and its matching of index-linked Retirement Income products. Its impact is managed through the application of disciplined cost control over its management expenses and through matching its index-linked assets and index-linked liabilities for the inflation risk associated with its index-linked Retirement Income products. (iv) Currency risk Currency risk arises from fluctuations in the value of, or income from, assets denominated in foreign currencies, from relative or absolute changes in foreign exchange rates or in the volatility of exchange rates. Exposure to currency risk could arise from the Group’s investment in non-sterling denominated assets. The Group invests in fixed income securities denominated in US dollars or other foreign currencies for its financial asset portfolio. All material Group liabilities are in sterling. As the Group does not wish to introduce foreign exchange risk into its investment portfolio, derivative or quasi-derivative contracts are entered into to eliminate the foreign exchange exposure as far as possible. (c) Credit risk Credit risk arises if another party fails to perform its financial obligations to the Group, including failing to perform them in a timely manner. Credit risk exposures arise from: • Holding fixed income investments where the main risks are default and market risk. The risk of default (where the counterparty fails to pay back the capital and/or interest on a corporate bond) is mitigated by investing only in higher quality or investment grade assets. Market risk is the risk of bond prices falling as a result of concerns over the counterparty, or over the market or economy in which the issuing company operates. This leads to wider spreads (the difference between redemption yields and a risk-free return), the impact of which is mitigated through the use of a “hold to maturity” strategy. Concentration of credit risk exposures is managed by placing limits on exposures to individual counterparties and limits on exposures to credit rating levels. • The Group also manages credit risk on its corporate bond portfolio through the appointment of specialist fund managers, who execute a diversified investment strategy, investing in investment grade assets and imposing individual counterparty limits. Current economic and market conditions are closely monitored, as are spreads on the bond portfolio in comparison with benchmark data. • Counterparties in derivative contracts – the Group uses financial instruments to mitigate interest rate and currency risk exposures. It therefore has credit exposure to various counterparties through which it transacts these instruments, although this is usually mitigated by collateral arrangements (see note 28).
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