184 | Just Group PLC | Annual Report and Accounts 2023
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS continued
20. FAIR VALUE OF FINANCIAL ASSETS AND LIABILITIES continued Principal assumptions underlying the calculation of loans secured by residential mortgages
All gains and losses arising from loans secured by mortgages are largely dependent on the term of the mortgage, which in turn is determined by the longevity of the customer. Principal assumptions underlying the calculation of loans secured by mortgages include the items set out below. These assumptions are also used to provide the expected cash flows from the loans secured by residential mortgages which determine the yield on this asset. This yield is used for the purpose of setting valuation discount rates on the liabilities supported, as described in note 26(b). Maintenance expenses Assumptions for future policy expense levels are based on the Group’s recent expense analyses. The assumed future expense levels incorporate an annual inflation rate allowance of 3.6% (2022: 3.9%). Mortality Mortality assumptions have been derived with reference to England and Wales population mortality using the CMI 2022 (2022: CMI 2021) model for mortality improvements. These base mortality and improvement tables have been adjusted to reflect the expected future mortality experience of mortgage contract holders, taking into account the medical and lifestyle evidence collected during the sales process and the Group’s assessment of how this experience will develop in the future. This assessment takes into consideration relevant industry and population studies, published research materials and management’s own experience. The Group has considered the possible impact of the COVID-19 pandemic on its mortality assumptions and has included an allowance for the expected future direct and indirect impacts of this and wider UK mortality trends, updated from that which applied at 31 December, 2022. Further details of the matters considered in relation to mortality assumptions at 31 December 2023 are set out in note 26(b). Property prices The approach in place at 31 December 2023 is to calculate the value of a property by taking the latest Automated Valuation Model “AVM” result, or latest surveyor value if more recent, indexing this to the balance sheet date using Nationwide UK house price indices and then making a further allowance for property dilapidation since the last revaluation date. To the extent that this reflects market values as at 31 December 2023, no additional short-term adjustment is allowed for. The appropriateness of this valuation basis is regularly tested on the event of redemption of mortgages. The sensitivity of loans secured by mortgages to a fall in property prices is included in the table of sensitivities below. Future property price In the absence of a reliable long-term forward curve for UK residential property price inflation, the Group has made an assumption about future residential property price inflation based upon available market and industry data. These assumptions have been derived with reference to the long-term expectation of the UK consumer price inflation, “CPI”, plus an allowance for the expectation of house price growth above CPI (property risk premium) less a margin for a combination of risks including property dilapidation and basis risk. An additional allowance is made for the volatility of future property prices. This results in a single rate of future house price growth of 3.3% (2022: 3.3%), with a volatility assumption of 13% per annum (2022: 13%). The setting of these assumptions includes consideration of future long and short-term forecasts, the Group’s historical experience, benchmarking data, and future uncertainties including the possible impacts of the COVID-19 pandemic and a higher interest and inflation rate economic environment on the UK property market. House price reductions have been experienced across much of the UK over the year, albeit these have been more modest than some forecasts for the period. As such, at this stage our view is that there is no clear indication of a change in the long-term prospects of the housing market. In light of this, the future house price growth and property volatility assumptions have been maintained at the same level as assumed at 31 December 2022. The sensitivity of loans secured by mortgages to changes in future property price growth, and to future property price volatility, are included in the table of sensitivities below. Voluntary redemptions Assumptions for future voluntary redemption levels are based on the Group’s recent analyses. The assumed redemption rate varies by duration and product line between 0.5% and 4.1% for loans in JRL (2022: 0.5% and 4.1%) and between 0.6% and 6.8% for loans in PLACL (2022: 0.6% and 6.8%). Liquidity premium The liquidity premium at initial recognition is set such that the fair value of each loan is equal to the face value of the loan. The liquidity premium partly reflects the illiquidity of the loan and also spreads the recognition of profit over the lifetime of the loan. Once calculated, the liquidity premium remains unchanged at future valuations except when further advances are taken out. In this situation, the single liquidity premium to apply to that loan is recalculated allowing for all advances. The average liquidity premium for loans held within JRL is 3.2% (2022: 3.2%) and for loans held within PLACL is 3.3% (2022: 3.5%). The movement over the period observed in both JRL and PLACL is a function of the liquidity premiums on new loan originations compared to the liquidity premiums on those policies which have redeemed over the period, both in reference to the average spread on the back book of business.
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