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FINANCIAL STATEMENTS
Key audit matter
How our audit addressed the key audit matter
Valuation of insurance contract liabilities – Credit default assumptions (Group) Refer to Audit Committee Report, Accounting policy 1.22 Insurance liabilities and note 23 Insurance contracts and related reinsurance.
The Group’s portfolio consists of annuities in payment or deferral and therefore the credit default assumptions have a significant impact on the insurance contract liabilities and requires expert judgement. The Group’s asset portfolio also includes a material amount of illiquid assets, including Lifetime Mortgages.
We performed the following to test the credit default assumptions: • Assessed the methodologies used to derive the assumptions (including prudential margin) with reference to relevant rules and actuarial guidance and by applying our industry knowledge and experience; • Validated significant assumptions used by management against market observable data (to the extent available and relevant) and our experience of market practices (including developments from the Prudential Regulation Authority in the context of holdings in illiquid assets); • Considered the impact of COVID-19, including whether recent defaults and downgrades are appropriately allowed for in data used by management, and whether any changes in future expected levels are appropriately reflected; • Compared the assumptions selected against those adopted by peers using our annual survey of the market (to the extent available); • Assessed the appropriateness of the IFRS prudence margin for each asset class individually and its consistency over time; and • Assessed the disclosure of the credit default risk assumptions and the commentary to support the profit arising, if any, from changes in these assumptions over the period. Based on the work performed and the evidence obtained, we consider the assumptions used for credit default risk to be appropriate.
Valuation of insurance contract liabilities – Expense assumptions (Group) Refer to Audit Committee Report, Accounting policy 1.22 Insurance liabilities and note 23 Insurance contracts and related reinsurance.
Future maintenance expenses and expense inflation assumptions are used in the measurement of the insurance contract liabilities. The assumptions reflect the expected future expenses that will be required to maintain the in-force policies at the balance sheet date, including an allowance for unavoidable project costs and a margin for prudence. The assumptions used require judgement, particularly with respect to the allocation of expenses to future maintenance.
We performed the following to test the expense assumptions: • Validated the completeness and accuracy of the total cost base and allocation of expenses to the appropriate cost centre; • Assessed the methodology used by management to derive the assumptions with reference to relevant rules and actuarial guidance and by applying our industry knowledge and experience; • Assessed the appropriateness of significant judgements in application of the methodology, including excluded costs (for example, due to costs either not relating to the insurance business or being non-recurring in nature), the split of expenses between acquisition and maintenance costs and the allocation of costs to products; • Assessed the appropriateness of the IFRS prudence margin and its consistency over time; • Tested the policy counts used in the derivation of per policy expense assumptions and considered whether any adjustments are required to reflect changes in future expected policy volumes, for example, to allow for diseconomies of scale; and • Assessed the disclosure of the maintenance assumptions and the commentary to support the profit arising, if any, from changes in these assumptions over 2020. Based on the work performed and the evidence obtained, we consider the expense assumptions to be appropriate.
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