135
FINANCIAL STATEMENTS
17 FAIR VALUE continued The sensitivities above 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 this asset and hence the valuation discount rate used to determine liabilities. For these sensitivities, the impact on the value of insurance liabilities and hence profit before tax is included in note 23(e). 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-termmarket changes that cannot be predicted with any certainty. 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 assumption underlying the calculation of loans secured by commercial mortgages Redemption and defaults The redemption and default assumptions used in the valuation of loans secured by commercial mortgages are derived from the assumptions for the Group’s bond portfolio. The impact of COVID-19 on the timing of future cash flows, and on expected defaults, has been taken into account in the calculation of fair value at 31 December 2020, with no significant impacts noted to fair values. Sensitivity analysis Reasonable possible alternative assumptions for unobservable inputs used in the valuation model could give rise to significant changes in the fair value of the assets. Interest rates are the most significant assumption applied in calculating the fair value of the loans secured by commercial mortgages. The sensitivity of the valuation of commercial mortgages to changes in interest rates is determined by reference to the movement in credit spreads. The Group has estimated the impact on fair value to changes to these inputs as follows:
Credit spreads +100bps
Loans secured by commercial mortgages net increase/(decrease) in fair value (£m)
2020 2019
(52.9) (22.9)
Other loans Other loans classified as Level 3 are infrastructure loans and commodity trade finance loans. These are valued using discounted cash flow analyses. Principal assumptions underlying the calculation of other loans classified as Level 3 Redemption and defaults The redemption and default assumptions used in the valuation of Level 3 loans are similar to the Group’s bond portfolio. Due to the nature of these assets and the sectors in which they operate, being primarily local authorities, renewable energy generation and housing associations sectors, the Group has assessed that there is no significant impact from COVID-19 on the valuation at 31 December 2020. Sensitivity analysis Reasonable 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 sensitivity of the valuation of other loans to the default assumption 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:
Credit spreads +100bps
Other loans net increase/(decrease) in fair value (£m)
2020 2019
(91.5) (75.7)
Recoveries from reinsurers on investment contracts Recoveries from reinsurers on investment contracts represent fully reinsured funds invested under the Flexible Pension Plan. During 2019 the Group closed its Flexible Pension Plan product to new business and completed the transfer of the business to an external provider. Investment contract liabilities Principal assumptions underlying the calculation of investment contract liabilities Valuation discount rates The valuation model discounts the expected future cash flows using a contractual discount rate derived from the assets hypothecated to back the liabilities. The discount rate used for the fixed term annuity product treated as investment business is 2.34% (2019: 3.01%). Sensitivity analysis The sensitivity of fair value to changes in the discount rate assumptions in respect of investment contract liabilities is not material. Deposits received from reinsurers Deposits from reinsurers which have been unbundled from their reinsurance contract and recognised at fair value through profit or loss are measured in accordance with the reinsurance contract and taking into account an appropriate discount rate for the timing of expected cash flows of the liabilities. Principal assumptions underlying the calculation of deposits received from reinsurers Discount rate The valuation model discounts the expected future cash flows using a contractual discount rate derived from the assets hypothecated to back the liabilities at a product level. The discount rates used for individual retirement and individual care annuities were 2.21% and 0.06% respectively (2019: 2.89% and 0.92% respectively).
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