105
FINANCIAL STATEMENTS
The risk
Our response
Valuation of insurance liabilities
Subjective valuation: The Group has significant insurance liabilities representing 81% (31 December 2018: 78%) of the Group’s total liabilities. This is an area that involves significant judgement over uncertain future outcomes, mainly the ultimate total settlement value of long term policyholder liabilities. The Group is required to use judgment in the selection of key assumptions covering both operating assumptions and economic assumptions. The key operating assumptions are mortality (determined by reference to the Group’s own experience and expected levels of future mortality), and the expected level of future expenses (which is based on the expected future costs of administering the underlying policies). The key economic assumption used in determining the discount rate to value the insurance liabilities is credit risk, based on the Group’s view of expected future investment defaults. The effect of these matters is that, as part of our risk assessment, we determined that the valuation of insurance liabilities has a high degree of estimation uncertainty, with a potential range of reasonable outcomes greater than our materiality for the financial statements as a whole, and possibly many times that amount. The financial statements (note 22) disclose the sensitivity estimated by the Group. Calculation error and data capture The Group uses complex actuarial models to calculate policyholder liabilities. There is a risk that the modelling does not appropriately reflect the model specifications and / or the product features due to incomplete data input into the model and / or unauthorised or erroneous changes to the models.
We used our own actuarial specialists to assist us in performing our procedures in this area. Our procedures included: Control design and performance: • Testing of the design, implementation and operating effectiveness of key controls over the processes to determine the valuation of the policyholder liabilities including the change management controls over the actuarial models. • Testing of the design, implementation and operating effectiveness of the reconciliation controls to ensure completeness of data flows from policy administration systems and data warehouses to the actuarial models. Methodology choice: • We have assessed the appropriateness of the methodology for selecting assumptions and calculating the policyholder liabilities. This included: -- Applying our understanding of developments in the business and the impact of changes in methodology on the selection of assumptions; -- Comparing changes in methodology to our expectations derived frommarket experience; and -- Evaluating the analysis of the movements in insurance liabilities during the year, including consideration of whether the movements were in line with the methodology and assumptions adopted. Benchmarking assumptions and sector experience: • Evaluating the Group’s historicmortality data used to prepare the Group’smortality experience analysis, together with industry data on expectations of futuremortality improvements and assessing whether this supports the assumptions adopted. • Assessing the credit risk assumptions and appropriateness of the Group’smethodology used to determine the liquidity premiumapplied to the risk-free rate, by reference to industry practice and our expectations derived frommarket experience. • Assessing whether the expense assumptions reflect the expected future costs of administering the underlying policies by analysing current year unit costs, considering the expected future level of expense inflation and testing the appropriateness of the Group’s best estimate of future cost savings based onmanagement actions and forecast budgets. Independent reperformance: • Using our own valuation models to calculate the insurance liability balance for a sample of policies across the reserves and comparing to the balances recorded by the Group. Assessing transparency: • Considering whether the Group’s disclosures in relation to the assumptions used in the calculation of insurance liabilities appropriately represent the sensitivities of these assumptions to alternative scenarios and inputs. Our findings We found the resulting estimate to be balanced (2018: balanced) and the related disclosures to be proportionate (2018: proportionate).
(2019: £19,004 million, 2018: £17,274 million) The risk compared to the prior year is unchanged. Refer to page 72 (Audit Committee report), page 122 (accounting policy) and pages 123 to 156 (financial disclosures)
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