STRATEGIC REPORT
GOVERNANCE
financial statements
33 FINANCIAL AND INSURANCE RISK MANAGEMENT This note presents information about the major financial and insurance risks to which the Group is exposed, and its objectives, policies and processes for their measurement and management. Financial risk comprises exposure to market, credit and liquidity risk. (a) Insurance risk The Group’s insurance risks include exposure to longevity, mortality and morbidity and exposure to factors such as withdrawal levels and management and administration expenses. The writing of long-term insurance contracts requires a range of assumptions to be made and risk arises from these assumptions being materially inaccurate. The Group’s main insurance risk arises from adverse experience compared with the assumptions used in pricing products and valuing insurance liabilities. Individually underwritten GIfL policies are priced using assumptions about future longevity that are based on historic experience information, lifestyle and medical factors relevant to individual customers, and judgements about the future development of longevity improvements. In the event of an increase in longevity, the actuarial reserve required to make future payments to customers may increase. Loans secured by mortgages are used to match some of the liabilities arising from writing long term insurance policies. In the event that early repayments on LTMs in a given period are higher than anticipated, less interest will have accrued on the mortgages and the amount repayable will be less than assumed at the time of sale. In the event of an increase in longevity, although more interest will have accrued and the amount repayable will be greater than assumed at the time of the sale, the associated cash flows will be received later than had originally been anticipated. In addition, a general increase in longevity would have the effect of increasing the total amount repayable, which would increase the LTV ratio and could increase the risk of failing to be repaid in full as a consequence of the no-negative equity guarantee. There is also exposure to morbidity risk as the LTM is repayable when the customer moves into long- term care.
Management of insurance risk Underpinning the management of insurance risk are: • The use of controls around the development of suitable products and their pricing; • Adherence to approved underwriting requirements;
• The development and use of medical information including PrognoSys™ for both pricing and reserving to provide detailed insight into longevity risk; • The use of reinsurance to reduce longevity risk. The Group retains oversight of the overall exposures and monitors that the aggregation of risk ceded is within the reinsurance counterparty risk appetite; • The assessment and recalibration of adequacy of risk based capital;
• Review and approval of assumptions used by the Board; • Regular monitoring and analysis of actual experience; and • Monitoring of expense levels. Concentrations of insurance risk
Improved longevity arises from enhanced medical treatment and improved life circumstances. Concentration risk to individuals groups whose longevity may improve faster than the population is managed by writing business across a wide range of different medical and lifestyle conditions to avoid excessive exposure. Reinsurance is also an important mitigant to concentrations of insurance risk. (b) Market risk Market risk is the risk of loss or of adverse change in the financial situation from fluctuations in the level and in the volatility of market prices of assets, liabilities and financial instruments, together with the impact of changes in interest rates. Market risk is implicit in the insurance business model and arises from exposure to interest rates, property markets, inflation and exchange rates. The Group is not exposed to equity risk. Some very limited equity risk exposure arises from investment into credit funds which have a mandate which allows preferred equity to be held. Changes in the value of the Group’s investment portfolio will also affect the Group’s financial position. In addition falls in the financial markets can reduce the value of pension funds available to purchase Retirement Income products and changes in interest rates can affect the relative attractiveness of Retirement Income products. In mitigation, Retirement Income product monies are invested to match the asset and liability cash flows as closely as practicable. In practice, it is not possible to eliminate market risk fully as there are inherent uncertainties surrounding many of the assumptions underlying the projected asset and liability cash flows. Just has several EUR denominated bonds that have coupons linked to EURIBOR, which are hedged into fixed GBP coupons. If EURIBOR were no longer produced, there is a risk that the bond coupons would not match the swap EUR leg payments. In mitigation, Just would restructure the related cross currency asset swap to match the new coupon rate. For each of the material components of market risk, described in more detail below, the Group’s Market Risk Policy sets out the Group’s risk appetite and management processes governing how each risk should be measured, managed, monitored and reported. (i) Interest rate risk The Group is exposed to interest rate risk arising from the changes in the values of assets or liabilities as a result of changes in risk-free interest rates. The Group seeks to limit its exposure through appropriate asset and liability matching and hedging strategies. The Group actively hedges its interest rate exposure to protect balance sheet positions on both Solvency II and economic bases in accordance with its risk appetite framework and principles. The Group’s main exposure to changes in interest rates is concentrated in the investment portfolio, loans secured by mortgages and its insurance obligations. Changes in investment and loan values attributable to interest rate changes are mitigated by corresponding and partially offsetting changes in the value of insurance liabilities. The Group monitors this exposure through regular reviews of the asset and liability position, capital modelling, sensitivity testing and scenario analyses. Interest rate risk is also managed using derivative instruments e.g. swaps.
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