Our Accounts 89
Notes to the Financial Statements continued
31 December 2012
Insurance contract-related assets and liabilities
This section presents information relating to insurance contract-related assets and liabilities held by the Society and Group. The
assumptions used in the valuation of the insurance contract liabilities are disclosed within Note 25 with sensitivities to these
assumptions disclosed separately within Note 3.
21. Insurance contract liabilities
Accounting for insurance contract liabilities
Participating business
The liability is calculated in accordance with the FSA’s ‘realistic’ liability regime. In particular, provision is made for all bonus payments
(declared and future, reversionary and terminal) estimated, where necessary, in a manner consistent with the relevant fund’s Principles
and Practices of Financial Management (PPFM). The liability includes an allowance for the time and intrinsic value of options and
guarantees granted to policyholders and for possible future management actions.
The realistic liabilities are based on the aggregate value of policy asset shares reflecting past premiums, investment return, expenses
and charges applied to each policy. Allowance is also made for policy-related liabilities such as guarantees, options and future bonuses
calculated using a stochastic model simulating investment returns, asset mix, expense charges and bonuses.
Since the realistic liabilities include an allowance for future bonuses to participating contract policyholders that will be payable out of
returns on non participating business, an amount within the participating contract fund is recognised representing the value of non-
participating business. Such an amount is not recognised for business written outside participating contract funds.
In determining the realistic value of liabilities for participating contracts, indirect account is taken of the value of future profits on non-
participating business written out of participating contract funds. This is separately identifiable and is all in respect of policyholder liabilities.
The excess of the value of those future profits has been deducted from the realistic liabilities rather than recognising it as an asset.
Non-participating business
Statements and Reviews
The liability is calculated to comply with the reporting requirements under the FSA’s Integrated Prudential Sourcebook using a gross
premium valuation method or a method at least as prudent as the gross premium method. The principal assumptions are given in the
notes to the financial statements. The Society and relevant subsidiaries have adopted the modified statutory solvency basis in the
valuation of provisions for non-participating business.
Liabilities for non-participating business are either included within the long-term insurance contract liabilities or the investment contract
liabilities, depending upon the product classification.
General insurance claims and insurance contract liabilities
Our Businesses
Claims incurred comprise claims and related internal and external claims handling costs paid in the year and changes in the provisions
for outstanding claims, including provisions for claims incurred but not reported and related claims handling costs, together with any
other adjustments to claims from previous years. Where applicable, deductions are made for recoveries from other parties.
Provision is made for the estimated cost of claims incurred but not settled, including the cost of claims incurred but not reported.
The estimated cost of claims includes expenses to be incurred in settling claims and a deduction for the expected value of recoveries.
However, given the inevitable uncertainty in establishing claims provisions, it is likely that the final outcome will prove to be different from
the original liability established. Provisions are adjusted at the Statement of Financial Position date to represent a best estimate of the
Risk Management
expected outcome. Provisions are calculated allowing for reinsurance recoveries and a separate asset is recorded for the reinsurers’
share of the provision.
Unexpired risks
For general insurance contracts, provision is made, if required, for any anticipated claims and claims handling costs that are anticipated
to exceed the unearned premiums, net of deferred acquisition costs. An estimate is made for future investment income arising from the
unearned premiums, and used to reduce the unexpired risk provision. Unexpired risk surpluses and deficits are offset where business
classes are managed together and a provision is made if an aggregate deficit arises.
Corporate Governance
Significant accounting estimates and judgements
Valuation of investment and long-term insurance contract liabilities
The liability is based on assumptions reflecting the best estimate at the time allowing for a margin of risk and adverse deviation.
All contracts are subject to a liability adequacy test, which reflects management’s best current estimate of future cash flows.
The assumptions used for mortality, morbidity and longevity are based on standard industry or reinsurers’ tables, adjusted where
appropriate to reflect the Group’s own experience. In particular, for impaired annuities the mortality assumptions are based on reinsurers’
tables with an individual loading applied depending on the nature of the impairment. The assumptions used for investment returns,
Our Accounts
expenses, lapse and surrender rates are based on current market yields, product characteristics, and relevant claims experience.
The assumptions used for discount rates are based on current market risk rates, adjusted for the Group’s own risk exposure.
Due to the long-term nature of these obligations, the estimates are subject to significant uncertainty.