58 | Aviva plc Annual report and accounts 2014
Risk continued

Principal risk types
The types of risk to which the Group is exposed, described in the table below, have not changed significantly over the year.
The principal impact on the Group’s risk profile of the planned acquisition of Friends Life, subject to successful completion,
will be to increase our exposure to equity price risk and UK life insurance risks, in particular persistency risk. The operationalrisks of integration will also require close management.
Risk type

Risk preference

Mitigation

Credit risk

We take on credit risk as we believe
we have the expertise to manage it.
As an insurer, we benefit frombeing able to invest for the longterm due to the relative stability andpredictability of our cash outflows.

• Risk appetites set to limit overall level of credit risk
• Credit limit framework imposes limits on credit concentration byissuer, sector and type of instrument• Investment restrictions on sovereign and corporate exposure to someeurozone countries• Credit risk hedging• Specific asset de-risking

We actively seek some market risks
as part of our investment andproduct strategy. We have a limited
appetite for interest rate, foreignexchange and inflation risks as we
do not believe that these are
adequately rewarded.

• Risk appetites set to limit exposures to key market risks• Active asset management and hedging in business units• Scaleable Group-level equity and foreign exchange hedging
programme• Pension fund de-risking• Asset and liability duration matching limits impact of interest ratechanges and actions taken to manage guarantee risk, throughproduct design

We take measured amounts of lifeand health insurance risks where wehave the appropriate core skills inunderwriting. We like longevity andmortality risks as they diversify well(i.e. have little or no correlation)
against other risks we retain.

• Risk appetites set to limit exposures to key life and health insurancerisks• Risk selection and underwriting on acceptance of newbusiness• Product design that ensures products and propositions meetcustomer needs• Use of reinsurance to mitigate mortality/morbidity risks• Staff pension scheme longevity swap covering approximately£5 billion of pensioner in payment liabilities

We take general insurance risk inmeasured amounts for explicit
reward, in line with our core skills in
underwriting and pricing. We havea preference for those risks that weunderstand well, that are
intrinsically well managed andwhere there is a spread of risks inthe same category. GI risk
diverisifies well with our life
insurance and other risks.

• Risk appetites set to limit exposures to key general insurance risks• Extensive use of data, financial models and analysis to improvepricing and risk selection• Underwriting limits linked to delegations of authority that govern
underwriting decisions• Product development in management framework that ensures
products and propositions meet customer needs• Documented claims management philosophies and procedures• Use of reinsurance to reduce the financial impactof a catastrophe and manage earnings volatility

Liquidity risk

The relatively illiquid nature of
insurance liabilities is a potential
source of additional investment
return by allowing us to invest in
higher yielding, but less liquid,
assets such as commercialmortgages.

• Maintaining committed borrowing facilities (£1.55 billion)1 frombanks• Asset liability matching methodology develops optimal asset
portfolio maturity structures in our businesses to ensure cash flows
are sufficient to meet liabilities• Commercial paper issuance• Contingency Funding Plan in place to address liquidity funding
requirements in a significant stress scenario

Asset management
risk

Risks specific to asset management
should generally be reduced to as
low a level as is commerciallysensible, on the basis that taking onthese risks will rarely provide us withan upside.

• Product development and review process• Investment performance and risk management oversight and review
process• Propositions based on customer needs• Client relationship teams managing client retention risk

Operational risk should generally bereduced to as low a level as iscommercially sensible, on the basisthat taking operational risk will rarely
provide us with an upside, andoperational failures may adversely
impact our reputation, impairing ourability to attract new business, orlead to poor customer outcomes.

• Application of enhanced business standards covering key processes• Monitoring of controls through assurance activity and informationon the operation of the control environment from management,internal audit and risk functions, supported by operational risk andaudit registers and first line control logs
• Scenario based approach to determine appropriate level of capitalfor operational risks• Conduct risk management framework• Credit spread anddefault

Market risk
• Equity price• Property• Interest rate
• Foreign exchange• Inflation

Life and healthinsurance risks• Longevity• Persistency• Mortality• Morbidity• Expenses• New business

General insurancerisk• GI catastrophe• GI reserving (latent andnon-latent)• GI underwriting / newbusiness• Retention• New business• Expenses

Operational risk
• Conduct & reputation• Legal & regulatory• People• Process• Data security• Technology

Aviva’s top three risks ranked by economic capital at risk in a 1-200 year loss event over a one year time horizon.
1

As at 31 December 2014.

Aviva plc Annual report and accounts 2014 | 59

We also manage and monitor risks andcausal factors which may impact ourlonger term profitability and viability, inparticular our ability to write profitable
new business. For example, such risks
and factors include:• Climate change – potentially resulting
in higher than expected weather-related
claims and inaccurate pricing of generalinsurance risk.
• New technologies – failure tounderstand and react to the impact
of new technology and its effect on
customer behaviour and how we
distribute products could potentially resultin our business model becoming obsolete.
• Regulatory change – our businesses
face considerable regulatory change asa result of Solvency II, our designation by
the Financial Stability Board as a Global
systemically important insurer (G-SII) anddevelopments in conduct regulation,
which will affect how much capital wehold, how we operate and how we selland distribute our products. Whileongoing consultations on implementing
standards and supervisory guidelines
have reduced the level of uncertainty
over the final capital impact on ourbusiness of Solvency II (effective1 January 2016), some uncertainty
remains, including over the outcomeof the Group’s application to use aninternal model to calculate our capitalrequirements.
• Political risk – governments in themarkets in which we operate incentivise
long-term saving and private pension
provision through tax benefits, while also
providing an alternative through stateprovision. In some markets there are (orcould be in the future) restrictions andcontrols on premium rates, rating factors
and charges. Any change in public policy
could influence the demand for, andprofitability of, our products. For example,in March 2014 the UK Government
announced the end of compulsory
annuitisation, which has significantly
reduced demand for individual annuities.
The diversity of our product offering andthe geographies in which we operate
partly mitigates this risk.
• Cyber crime – criminals may attempt toaccess our IT systems to steal or utilise
company and customer data, or plantmalware viruses, in order to accesscustomer or company funds, and/or
damage our reputation and brand. While
we have IT security and data encryption
to prevent this happening, the increasing
sophistication of criminals and the focus
on digital automation as part of ourstrategy make this an increasing risk.

Strategic reportEmerging risks andcausal factors

Case study

Being prepared forthe worst
The Group and its businesses havecontingency plans in place to ensure aswift and effective response in case risks
crystallise into major loss events, including:• Financial Event Response Plans – toensure we can respond promptly to severe
adverse financial events (e.g. equity market
crash, sovereign default etc.) that may
weaken the financial position of Aviva• Business Continuity Plans – to ensure
we can continue to operate and serve
our customers in the event of terrorism,pandemic, cyber-attack or other events
disrupting our operations• Major Incident Response Plans – toensure we can maintain our level ofcustomer service in response to a spike indemand resulting from a major weather
event (e.g. floods, windstorms) or otherloss event.
We use ‘war-gaming’ to test theeffectiveness of our plans in the eventthese risks crystallise.

• Prolonged low interest rateenvironment – if current low interest
rates continue for a prolonged period itwill adversely affect the ‘spread’ we canearn between the returns we can offer
customers and the return we earn on
our investments, as well as theattractiveness of the returns we can offerto new customers.
• Macroeconomic growth – theslowdown in economic growth in Asia,
and re-emerging concerns over theeconomic performance of the eurozone,
could precipitate a wider global economic
slowdown, which could adversely impact
our investments, customer retention andnew business levels.
• New and emerging latent claims– new claims on policies written a longtime in the past may arise as a result of
future court judgements extending
liability, new legislation, new historic
evidence and interpretation, emerging
medical science on health effects oflong-term exposures to chemicals etc.
Examples over the last 30 years include
asbestosis, repetitive strain injury andindustrial deafness.
• Medical advances and healthier life
styles – medical advances and healthierlife styles may increase life expectancy of
our annuitants and thus future payments
over their lifetime may be in excess of theamounts we currently expect. Historic
examples include the positive impact onlife expectancy of reduced rates ofsmoking over the last 40 years.
• Pandemics, new diseases andantibiotic resistance – the adverse
impact on mortality could negatively
impact the profitability of our life
protection products, increase private
health insurance claims, and even affectgeneral insurance claims. A pandemic
might also disrupt our operations.
• Big Data – failure to keep pace withthe use of data to price more accurately
and to detect insurance fraud could
lead to loss of competitive advantage
and financial losses.
• Changes in customer behaviour– changes in the legal environment or
as a result of advances in technology
may change the rates at whichcustomers exercise options embeddedin their contracts or enable them to takeadvantage of additional information
available to them to exercise options ina way that is adverse to us.
See pages 18 and 52 on how we address
the risks of new technologies and climatechange through our business strategies
and corporate responsibility respectively.