Our Accounts 63
Notes to the Financial Statements continued
31 December 2012
2. Capital management (continued)
Financial guarantees and options
a) Participating insurance contracts
As a normal part of operating activities, the Society has given guarantees and options, including interest rate guarantees, in respect of certain
long-term insurance contracts.
Provision is made for such guarantees and options within the FSA realistic liabilities of the Group’s participating insurance contract funds. Under
the FSA’s rules these must be measured at fair value using market consistent stochastic models. A stochastic approach includes measuring the
time value of guarantees and options, which represents the additional cost arising from uncertainty surrounding future economic conditions. The
time value is evaluated by projecting a large number of possible future outcomes under a wide range of economic scenarios, for example possible
outcomes for interest rates and equity returns. These realistic liabilities have been included within the Statement of Financial Position.
The material guarantees and options in the participating insurance contract funds are:
i) Guaranteed annuity options - the RNPFN participating insurance contract fund has written individual pensions which contain guaranteed annuity
rate options (GAOs), where the policyholder has the option to take the benefits from a policy in the form of an annuity based on guaranteed
conversion rates.
ii) Maturity value guarantees - many of the Group’s participating insurance contracts have minimum maturity values reflecting the sums assured
plus declared annual bonus.
iii) Money-back guarantees - some of the policies written within the Group provide a guarantee or option to pay out all the premiums paid in (at a
certain point in time).
b) Non participating insurance contracts
The Group has also written contracts which include guarantees and options within its non participating insurance contract funds. These funds
are not subject to the requirements of the FSA’s realistic reporting regime and liabilities are evaluated by reference to statutory reserving rules.
Provision for guarantees and options in the non participating funds has been included within liabilities.
The material guarantees and options in the non participating insurance contract funds are guaranteed annuity options. Similar options to those
written in the participating insurance contract fund have been written in relation to non participating contracts. Provision for these guarantees
Statements and Reviews
does not materially differ from a provision based on a market consistent stochastic model.
c) No Negative Equity Guarantees
The Group has made promises to certain policyholders in relation to equity release mortgages that payments on these policies will meet the
mortgage value covered. Further details on these are disclosed within Note 15.
3. Risk management and control
The Group seeks to create value for its members by maintaining an appropriate balance between the capital available to support risk and the
level and type of risk it takes on in order to achieve returns for policyholders. The principal types of risk, which are detailed below, have been
Our Businesses
identified and risk appetite for each of these has been set based on the amount necessary to meet the FSA’s capital requirements. The Group
recognises the critical importance of having efficient and effective risk management systems in place and these take the form of:
– Board and Executive committees with clear terms of reference
– Financial and non-financial committees
– A clear organisation structure with documented allocation of responsibilities
– A uniform methodology of risk assessment, which is embedded within all companies in the Group so that they operate within agreed
tolerances and with appropriate controls in place
Risk Management
– Regular reviews of risks by senior managers, where frequency of review is determined by the potential impact of the risk and its likelihood.
a) Insurance risk
Insurance risk is the risk that arises from the inherent uncertainties as to the occurrence, amount and timing of insurance liabilities. Long-term
insurance risk arises from mortality, morbidity, persistency and expense variances. General insurance risk arises from risks in general insurance
contracts which lead to significant claims in terms of quantity or value. These would include significant weather events, subsidence, substantial
medical claims and major accidents on a single policy. Systems are in place to measure, monitor and control exposure to all these risks. These
are documented in policies for underwriting, pricing, claims and reinsurance. To mitigate risk in the life and general insurance businesses the
Corporate Governance
Group places reinsurance.
Long-term insurance contracts
Protection and annuity business is at risk from adverse changes in mortality experience from the time when the policies were underwritten. In the
case of policies that pay out on death, the risk is that mortality experience worsens, whereas for annuities, the risk is that mortality experience
improves. These two types of business therefore to some extent offset each other in a risk sense. On protection business, the Group uses
underwriting procedures, backed up with medical screening if appropriate, designed to price accurately for such risks and reinsurance is in place
to limit the quantum of risk retained on each policy. The Group’s annuity business is partially reassured.
Our Accounts