(a)(i) Application of the risk management framework
The Group’s risk management activities support the creation of long-term value by ensuring well-informed risk-reward decisions are taken in pursuit of the Group’s business plan. This includes defining and observing qualitative risk appetite statements for the different risks faced by the Group where these statements clearly articulate the aggregate level and types of uncertainty that the Group is willing to accept in order to achieve the business plan. For certain specific exposures, these statements are supported by quantitative risk limits to ensure that the Group’s risk profile remains balanced and within target ranges.
The risk management framework used by the Group in 2013 to identify, assess, control and monitor risks is set out in the
Corporate governance report. This includes information on the use of qualitative risk appetite statements and quantitative risk limits in order to manage the Group’s risks.
The risk metrics used by the Group in managing the business allows the Group to monitor how exposure to different types of risks impacts the shareholder. In pursuing the Group’s business plan, the Group is exposed to the following key risks:
Risk Definition
Market The risk that arises from the Group’s exposure to market movements which could result in the value of income, or the value of financial assets and liabilities, or the cash flows relating to these, fluctuating by differing amounts.
Credit The risk of exposure to loss if a counterparty fails to perform its financial obligations, including failure to perform those obligations in a timely manner. It also includes the risk of a reduction in the value of assets due to a widening of mortgage, bond and swap spreads.
Demographic The risk that arises from the inherent uncertainties as to the occurrence, amount and timing of future cash flows due to demographic experience differing from that expected. This class of risk includes risks that meet the definition of insurance risk under IFRS 4 Insurance Contracts and other financial risks.
Expense The risk that expense levels are higher than planned or revenue falls below that necessary to cover actual expenses. Liquidity The risk that the Group is unable to realise investments and other assets in order to settle its financial obligations when they fall due, or can do so only at excessive cost. Operational The risk of adverse consequences for the Group’s business resulting from inadequate or failed internal processes, people or systems, or from external events. This includes conduct risk as defined below. Conduct The risk that through our culture, strategies, decision-making and behaviours we do not deliver good outcomes for our customers. Strategic The risk associated with the robustness of the planning process and threats to achieving the Group’s strategy. The Group’s appetite for each of the risks is set out in Section 1.5 – Risk management of the Strategic report. This section of the Strategic report also outlines the main sources of these risks for the Group and specific actions taken to manage the Group’s exposure to each risk during the year.
The assets and liabilities on the Group’s consolidated statement of financial position can be split into four categories (risk segments) which give the shareholder different exposures to the risks listed previously. These categories are:
Shareholder business
Shareholder business refers to the assets and liabilities to which the shareholder is directly exposed. For the purposes of this Note, the shareholder refers to the equity holders of the Company.
Participating business
Participating business refers to the assets and liabilities of the participating funds of the life operations of the Group. It includes the liabilities for insurance features and financial guarantees contained within contracts held in the HWPF that invest in unit linked funds. It does not include the liabilities for insurance features contained in contracts invested in the GWPF or GSMWPF. Such liabilities are included in shareholder business.
Unit linked and segregated funds
Unit linked and segregated funds refers to the assets and liabilities of the unit linked and segregated funds of the life operations of the Group. It does not include the cash flows (such as asset management charges or investment expenses) arising from the unit linked or segregated fund contracts or the liabilities for insurance features or financial guarantees contained within the unit linked or segregated fund contracts. Such cash flows and liabilities are included in shareholder business or participating business.
Third party interest in consolidated funds and non-controlling interests
Third party interest in consolidated funds and non-controlling interests refers to the assets and liabilities recorded on the Group’s consolidated statement of financial position which belong to third parties. The Group controls the entities which own the assets and liabilities but the Group does not own 100% of the equity or units of the relevant entities.
The following table sets out the link between the reportable segments set out in Notes 2 and 3 and the risk segments.
Risk segment
Reportable segment Shareholder business Participating business segregated fundsUnit linked and 1
UK and Europe SLAL – SHF
SLAL – PBF (excluding unit linked funds and Canadian branch) SLS SLCM Vebnet Group SLIL (excluding unit linked funds)2
SLW
SLAL – HWPF SLAL – GWPF SLAL – GSMWPF SLAL – UKSMWPF
SLAL – PBF unit linked funds SLIL unit linked funds2
Standard Life Investments SLIH and all its subsidiaries n/a n/a
Canada SLCC (excluding segregated
funds and participating fund) SLAL – PBF Canadian branch
SLCC participating fund SLCC segregated funds
Asia and Emerging Markets SLIL (excluding unit linked funds)3
SLA (excluding unit linked funds) Interests in Indian and Chinese JVs
n/a SLIL unit linked funds3
SLA unit linked funds
Other Company n/a n/a
SLAL = Standard Life Assurance Limited
SLIH = Standard Life Investments (Holdings) Limited SLCC = The Standard Life Assurance Company of Canada SLIL = Standard Life International Limited
SLA = Standard Life (Asia) Limited SLW = Standard Life Wealth Limited SLS = Standard Life Savings Limited
SLCM = Standard Life Client Management Limited
HWPF = Heritage With Profits Fund PBF = Proprietary Business Fund GWPF = German With Profits Fund
GSMWPF = German Smoothed Managed With Profits Fund SHF = Shareholder Fund
UKSMWPF = UK Smoothed Managed With Profits Fund
1 As discussed in Note 3 and above, unit linked and segregated funds does not include cash flows arising from unit linked or segregated fund contracts or the liabilities for insurance features or financial guarantees contained within the unit linked or segregated fund contracts. Such cash flows and liabilities are included in
shareholder or participating business. 2 Related to SLIL’s International Bond business.
3 Related to SLIL’s business excluding International Bond business.
SLW will be managed as part of the Standard Life Investments reportable segment from 1 January 2014. For the years ending 31 December 2013 and 2012 SLW was managed as part of the UK and Europe reportable segment.
3. Financial information – Notes to the Group financial statements continued
41. Risk management continued
(a) Overview continued
(a)(i) Application of the risk management framework continued
The table below sets out how the shareholder is exposed to market, credit, demographic, expense and liquidity risk at the reporting date, arising from the assets and liabilities of the four risk segments:
Risk Shareholder business Participating business Unit linked and segregated
funds Third party interest in consolidated funds and non-controlling interests (TPICF & NCI)
Market The shareholder is directly exposed to the impact of movements in equity and property prices, interest rates and foreign exchange rates on the value of assets held by the shareholder business and the associated movements in the value of liabilities.
The shareholder is exposed to the market risk that the assets of the with profits funds are not sufficient to meet their obligations. If this situation occurred the shareholder would be exposed to the full shortfall in the funds.
Assets are managed in accordance with the mandates of the particular funds and the financial risks associated with the assets are borne by the policyholder. The
shareholder’s exposure arises from the changes in the value of future profits earned on unit linked and segregated funds due to market movements. Further information on this exposure is provided in the EEV financial statements.
The shareholder is not exposed to the market risk from assets in respect of TPICF & NCI since the financial risks of the assets are borne by third parties.
Credit The shareholder is directly exposed to credit risk from holding cash, debt
securities, loans, derivative financial instruments and reinsurance assets and the associated movement in the value of liabilities.
The shareholder is exposed to the credit risk on the assets which could cause the with profits funds to have insufficient resources to meet its obligations. If this situation occurred the shareholder would be exposed to the full shortfall in the funds.
Assets are managed in accordance with the mandates of the particular funds and the financial risks associated with the assets are expected to be borne by the policyholder. The shareholder’s exposure is limited to changes in the value of future profits earned on unit linked and segregated funds due to market movements. Further information on this exposure is provided in the EEV financial statements.
The shareholder is not exposed to the credit risk from assets in respect of TPICF & NCI since the financial risks of the assets are borne by third parties.
Risk Shareholder business Participating business Unit linked and
segregated funds Third party interest in consolidated funds and non-controlling interests (TPICF & NCI) Demographic
and expense exposed to longevity and The shareholder is mortality risk on annuity contracts and universal life contracts held by UK and Europe and Canada, and mortality risk on contracts held in non-participating funds by UK and Europe, Canada and Asia and Emerging Markets including those containing insurance features that are invested in unit linked or segregated funds or in the GWPF or GSMWPF. The shareholder is also exposed to expenses and persistency being different from expectation on these contracts.
The shareholder receives recourse cash flows and certain other defined payments in accordance with the Scheme of Demutualisation and other relevant agreements. The recourse cash flows are based on several different components of which some are sensitive to demographic and expense risk.
The shareholder is exposed to demographic and expense risk arising on components of a unit linked or segregated fund contract, but it is not the assets or liabilities of the fund which gives rise to this exposure.
TPICF & NCI are not exposed to demographic and expense risk.
Liquidity The shareholder is directly exposed to the liquidity risk from the shareholder business.
With profits funds are normally expected to meet their obligations through liquidating assets held in the respective with profits fund. If a with profits fund cannot meet its obligations as they fall due, the shareholder will be required to provide liquidity to meet the policyholder claims and benefits as they fall due.
Unit linked and segregated funds are normally expected to meet their obligations through liquidating the underlying assets in which they are invested. If a unit linked or segregated fund cannot meet its
obligations in this way, the shareholder may be required to meet the obligations to the policyholder.
The shareholder is not exposed to the liquidity risk from these liabilities, since the financial risks of the obligations are borne by third parties.
The shareholder is exposed to operational and strategic risk arising across the four risk segments and any losses incurred are typically borne by the shareholder.
The shareholder is also exposed to certain risks relating to defined benefit pension plans operated by the Group. These include: • Market risks through the potential impact of market movements on the value of assets held in the defined benefit pension plans • Credit risks through the potential impact of widening credit spreads or credit losses on the assets held in the defined benefit
pension plans
• Longevity risk through the risk that members of the defined benefit pension plans live longer than expected. (a)(ii) Consolidated financial position by risk segment
In previous reporting periods, the Standard Life SICAV funds managed by Standard Life Investments, which held assets of £9.8bn at 31 December 2012, were consolidated in accordance with the Group’s accounting policies. During the year to 31 December 2013, the Group’s holding in these funds fell below 50% and therefore the funds are not consolidated at 31 December 2013. All assets and liabilities of these funds were previously included on a line-by-line basis. The Group’s holdings in the SICAV funds are now reflected in equity securities and interests in pooled investment funds. The statement of financial position categories
materially impacted by the change are debt securities, equity securities and interests in pooled investment funds, cash and cash equivalents and third party interest in consolidated funds.
The table that follows provides an analysis of the consolidated statement of financial position showing the Group’s assets and liabilities by risk segment. This categorisation has been used to present the information in this note.
3. Financial information – Notes to the Group financial statements continued
41. Risk management continued
(a) Overview continued
(a)(ii) Consolidated financial position by risk segment continued
Shareholder
business Participating business segregated fundsUnit linked and
Third party interest in consolidated funds and
non-controlling interests Total
2013 restated2012 1 2013 2012 2013 2012 2013 2012 2013 restated2012 1
£m £m £m £m £m £m £m £m £m £m
Intangible assets 298 210 2 4 - - - - 300 214
Deferred acquisition costs 842 829 63 75 - - - - 905 904
Investments in associates and joint
ventures 328 324 - - - 3 - 1 328 328
Investment property 431 521 1,995 2,048 4,829 4,701 1,290 1,295 8,545 8,565
Property, plant and equipment 93 77 126 79 - - - - 219 156
Pension and other post-retirement
benefit assets 432 339 - - - - - - 432 339
Deferred tax assets 121 192 - (64) - 49 - - 121 177
Reinsurance assets 182 175 5,991 6,737 - - - - 6,173 6,912
Loans 2,549 2,855 199 226 176 218 - - 2,924 3,299
Derivative financial assets 111 63 652 1,106 739 681 265 300 1,767 2,150
Equity securities and interests in
pooled investment funds at FVTPL 195 197 14,692 9,079 69,955 53,019 5,474 3,517 90,316 65,812
Debt securities:
At FVTPL 11,133 12,049 23,578 30,005 22,944 24,823 3,701 6,050 61,356 72,927
At available-for-sale 683 374 - - - - - - 683 374
Receivables and other financial assets 469 515 94 496 415 550 64 156 1,042 1,717
Other assets 89 86 41 43 128 146 11 9 269 284
Assets held for sale 29 - - - 59 - 33 - 121 -
Cash and cash equivalents 953 1,537 1,028 1,494 5,467 5,461 1,656 1,450 9,104 9,942
Total assets 18,938 20,343 48,461 51,328 104,712 89,651 12,494 12,778 184,605 174,100
Non-participating insurance contract
liabilities 9,172 10,107 11,124 12,233 8,016 6,710 - - 28,312 29,050
Non-participating investment contract
liabilities 2,392 2,600 - - 95,267 81,601 - - 97,659 84,201
Participating insurance contract
liabilities - - 15,060 15,919 - - - - 15,060 15,919
Participating investment contract
liabilities - - 14,707 14,993 - - - - 14,707 14,993
Unallocated divisible surplus - - 680 706 - - - - 680 706
Reinsurance liabilities 316 381 - - - - - - 316 381
Deposits received from reinsurers - - 5,589 6,136 - - - - 5,589 6,136
Third party interest in consolidated
funds - - - - - - 11,803 12,037 11,803 12,037
Borrowings 58 29 9 9 27 44 1 26 95 108
Subordinated liabilities 1,861 1,868 - - - - - - 1,861 1,868
Pension and other post-retirement
benefit provisions 104 130 - - - - - - 104 130
Deferred income 244 268 72 84 - - - - 316 352
Deferred tax liabilities 50 43 77 - 51 - - - 178 43
Current tax liabilities 7 87 (5) 6 47 50 6 7 55 150
Derivative financial liabilities 41 23 129 48 463 548 162 234 795 853
Other financial liabilities 914 855 693 912 611 445 149 111 2,367 2,323
Other liabilities 86 86 21 33 27 14 14 17 148 150
Total liabilities 15,245 16,477 48,156 51,079 104,509 89,412 12,135 12,432 180,045 169,400
Net inter-segment assets/(liabilities) 534 493 (305) (249) (203) (239) (26) (5) - -
Net assets 4,227 4,359 - - - - 333 341 4,560 4,700
1 Comparatives for the year ended 31 December 2012 have been restated to reflect retrospective application of changes to accounting policies as a result of an amendment to IAS 19 – Employee Benefits. Refer to Group accounting policies – (a) Basis of preparation.
(b)
Market risk
As described in the table on pages 178 to 179, the shareholder is exposed to market risk from the shareholder and participating businesses and as a result the following quantitative market risk disclosures are provided in respect of the financial assets of the shareholder and participating businesses.
Quantitative market risk disclosures are not provided in respect of the assets of the unit linked and segregated funds since the shareholder is not exposed to market risks from these assets. The shareholder’s exposure to market risk on these assets is limited to variations in the value of future profits earned on the contracts as fees are based on a percentage of the fund value. The sensitivity to market risk analysis includes the impact on those statement of financial position items which are affected by changes in future profits due to the market stresses changing the value of assets held by the unit linked and segregated funds. The shareholder is also not exposed to the market risk from the assets held by third parties in consolidated funds and non-controlling interests and therefore they have been excluded from the following quantitative disclosures.
The Group manages market risks through the use of a number of controls and techniques including:
• Defined lists of permitted securities and/or application of investment constraints and portfolio limits
• Clearly defined investment benchmarks for policyholder and shareholder funds
• Stochastic and deterministic asset/liability modelling
• Active use of derivatives to improve the matching characteristics of assets and liabilities.
The specific controls and techniques used to manage the market risks in the shareholder and participating businesses are discussed below:
Shareholder business
Assets in the shareholder business are managed against benchmarks that ensure they are diversified across a range of asset classes, instruments and geographies that are appropriate to the liabilities or are held to match the cash flows anticipated to arise in the business. A combination of limits by name, sector and credit rating are used where relevant to reduce concentration risk among the assets held.
Participating business
The assets of the participating business are principally managed to support the liabilities of those funds and are appropriately diversified by both asset class and geography.
The key considerations in the asset and liability management of the participating business are:
• The economic liability and how this varies with market conditions
• The need to invest the assets in a manner consistent with participating policyholders' reasonable expectations and, where appropriate, the Scheme of Demutualisation and the Principles and Practices of Financial Management (PPFM)
• The need to ensure that regulatory and capital requirements are met.
In practice, an element of market risk arises as a consequence of the need to balance these considerations, for example, in certain instances participating policyholders may expect that equity market risk will be taken on their behalf and derivative instruments may be used to manage these risks.
(b)(i) Elements of market risk
The main elements of market risk to which the Group is exposed are equity and property risk, interest rate risk and foreign currency risk, which are discussed on the following pages.
As a result of the diversity of the products offered by the Group and the different regulatory environments in which it operates, the Group employs different methods of asset and liability management across its business units.
Information on the methods used to determine fair values for each major category of financial instrument and investment property measured at fair value is presented in Note 42 – Fair value of assets and liabilities and Note 18 – Investment property.
(b)(i)(i) Group exposure to equity risk
The Group is subject to equity price risk due to daily changes in the market values and returns on the holdings in its equity securities portfolio. The Group’s shareholders are exposed to the following sources of equity risk:
• Direct equity shareholdings in the shareholder business and the Group defined benefit pension funds
• Burnthrough from the with profits funds where adverse movements in the market values and returns on holdings in the equity