Strategic Report | Governance | Financial Statements | 185
20. FAIR VALUE OF FINANCIAL ASSETS AND LIABILITIES continued Sensitivity analysis Reasonably possible alternative assumptions for unobservable inputs used in the valuation model could give rise to significant changes in the fair value of the assets. The Group has estimated the impact on fair value to changes to these inputs as follows:
Immediate property price fall -10%
Future property price growth -0.5%
Future property price volatility +1%
Maintenance expenses +10%
Base mortality -5%
Mortality improvement +10%
Voluntary redemptions +10%
Liquidity premium +10bps
Loans secured by residential mortgages net increase/(decrease) in fair value (£m)
2023 2022
(5) (5)
(15) (14)
(3) (4)
(83) (75)
(50) (49)
(34) (32)
19 20
(49) (48)
The sensitivity factors are applied via financial models either as at the valuation date or from a suitable recent reporting period where appropriate to do so. The analysis has been prepared for a change in each variable with other assumptions remaining constant. In reality such an occurrence is unlikely due to correlation between the assumptions and other factors. It should be noted that some of these sensitivities are non-linear and larger or smaller impacts should not be simply interpolated or extrapolated from these results. For example, the impact from a 5% fall in property prices would be slightly less than half of that disclosed in the table above. The mortality improvement sensitivity applies a multiplicative adjustment to improvement rates. The impact on insurance liabilities of sensitivities to mortality is included in note 26(h). Other limitations in the above sensitivity analysis include the use of hypothetical market movements to demonstrate potential risk that only represents the Group’s view of reasonably possible near-term market changes that cannot be predicted with any certainty. (iv) Loans secured by commercial mortgages Loans secured by commercial mortgages are valued using discounted cash flow analysis using assumptions based on the repayment of the underlying loan. Principal assumptions underlying the calculation of loans secured by commercial mortgages Credit spreads The valuation model discounts the expected future cash flows using a discount rate which includes a credit spread allowance associated with that asset. Sensitivity analysis Reasonably possible alternative assumptions for unobservable inputs used in the valuation model either as at the valuation date or from a suitable recent reporting period where appropriate to do so could give rise to significant changes in the fair value of the assets. The sensitivity of the valuation of commercial mortgages is determined by reference to movement in credit spreads. The Group has estimated the impact on fair value to changes to these inputs as follows:
Loans secured by commercial mortgages net increase/(decrease) in fair value (£m)
Credit spreads +100bps
2023 2022
(27) (19)
(v) Long income real estate Long income real estate is valued using discounted cash flow analysis using assumptions based on the repayment of the underlying loan. Principal assumptions underlying the calculation of long income real estate In determining the credit spreads for the valuation of residential ground rents, the Group has taken a market participant approach, which requires consideration of the assumptions, including those about risk, that a market participant would make at the balance sheet date for valuing such assets. The Group notes the significant uncertainty regarding the outcome of the Government consultation regarding restriction of residential ground rents as explained on page 67 and has included an adjustment to the valuation of its residential ground rents portfolio to reflect this uncertainty in the fair value that a market participant would be willing to exchange such assets at the balance sheet date. The value of these assets has been adjusted to reflect an expected increase in credit spread and consequential increase the credit risk deduction for defaults. Credit spreads The valuation model discounts the expected future cash flows using a discount rate which includes a credit spread allowance associated with that asset.
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