3 Management of risk continued or liabilities carrying interest rate risk, The Group Reinsurance Security
3.2 Financial risk continued other than the facilities and Letters of Credit Committee assesses the creditworthiness
(c) Interest rate risk continued outlined in note 35. of all reinsurers by reviewing credit grades
provided by rating agencies and other
31 December 2012 was £2,195 million (d) Credit risk publicly available financial information
(2011: £2,171 million). These may be analysed The Group has exposure to credit risk, detailing their financial strength and
as follows: which is the risk that a counterparty will performance. The financial analysis
suffer a deterioration in perceived financial of reinsurers produces an assessment
Nature of debt and strength or be unable to pay amounts in full categorised by Standard & Poor’s (S&P)
2012 2011
fixed income holdings % weighting % weighting when due. rating (or equivalent when not available
from S&P).
Government issued bonds
The concentrations of credit risk exposures
and instruments 34 23
held by insurers may be expected to be Despite the rigorous nature of this
Agency and government
greater than those associated with other assessment exercise, and the resultant
supported debt 12 25
industries, due to the specific nature of restricted range of reinsurance
Asset backed securities 10 11
reinsurance markets and the extent of counterparties with acceptable strength
Mortgage backed
investments held in financial markets. In both and credit credentials that emerges
instruments – agency 7 6
markets, the Group interacts with a number therefrom, some degree of credit risk
Mortgage backed
of counterparties who are engaged in similar concentration remains inevitable.
instruments – non-agency 3 5
activities with similar customer profiles,
Mortgage backed
and often in the same geographical areas The Committee considers the reputation
instruments – commercial 3 –
and industry sectors. Consequently, of its reinsurance partners and also receives
Corporate bonds 27 27
as many of these counterparties are details of recent payment history and the
Lloyd’s deposits and
themselves exposed to similar economic status of any ongoing negotiations between
bond funds 4 3
characteristics, one single localised or Group companies and these third-parties.
macroeconomic change could severely This information is used to update the
One method of assessing interest rate disrupt the ability of a significant number reinsurance purchasing strategy. Individual
sensitivity is through the examination of of counterparties to meet the Group’s operating units maintain records of the
duration-convexity factors in the underlying agreed contractual terms and obligations. payment history for significant brokers and
portfolio. Using a duration-convexity based contract holders with whom they conduct
sensitivity analysis, if market interest rates Key areas of exposure to credit risk include: regular business. The exposure to individual
had risen by 100 basis points at the balance reinsurers’ share of insurance liabilities; counterparties is also managed by other
sheet date, the fair value might have been amounts due from reinsurers in respect mechanisms, such as the right of offset
expected to decrease by £39 million (2011: of claims already paid; where counterparties are both debtors
decrease of £38 million) assuming that the amounts due from insurance contract and creditors of the Group and obtaining
only balance sheet area impacted was debt holders; and collateral from unrated counterparties.
and fixed income financial assets. counterparty risk with respect to cash Management information reports detail
and cash equivalents, and investments provisions for impairment on loans and
Duration is the weighted average length including deposits, derivative receivables and subsequent write-off.
of time required for an instrument’s cash transactions and catastrophe bonds. Exposures to individual intermediaries
flow stream to be recovered, where the and groups of intermediaries are collected
weightings involved are based on the The Group’s maximum exposure to credit within the ongoing monitoring of the controls
discounted present values of each cash risk is represented by the carrying values associated with regulatory solvency.
flow. A closely related concept, modified of financial assets and reinsurance assets
duration, measures the sensitivity of the included in the consolidated balance sheet
instrument’s price to a change in its yield to at any given point in time. The Group does
maturity. Convexity measures the sensitivity not use credit derivatives or other products
of modified duration to changes in the yield to mitigate maximum credit risk exposures
to maturity. on reinsurance assets. The Group structures
the levels of credit risk accepted by placing
Using these three concepts, scenario limits on their exposure to a single
modeling derives the above estimated counterparty, or groups of counterparties,
impact on instruments’ fair values for and having regard to geographical locations.
a 100 basis point change in the term Such risks are subject to an annual or more
structure of market interest rates. frequent review. There is no significant
concentration of credit risk with respect
Insurance contract liabilities are not directly to loans and receivables, as the Group has
sensitive to the level of market interest rates, a large number of internationally dispersed
as they are undiscounted and contractually debtors with unrelated operations.
non-interest-bearing. The Group’s debt Reinsurance is used to contain insurance
and fixed income assets are further detailed risk. This does not, however, discharge
at note 19. the Group’s liability as primary insurer. If
a reinsurer fails to pay a claim for any reason,
At 31 December 2012, no amounts were the Group remains liable for the payment
outstanding on the Group’s borrowing to the policyholder. The creditworthiness
facility (2011: £nil). The Group has no other of reinsurers is therefore continually
significant borrowings or other assets reviewed throughout the year.
Notes to the consolidated financial statements Hiscox Ltd Report and Accounts 2012 67