Contaminación Ambiental

(Audited)

2012 2011 Effect on profit

for the year

Effect on total equity

Effect on profit for the year

Effect on total equity

£m £m £m £m

+ 100 basis points parallel shift in yield curves ... (3) (14) (19) (30)

– 100 basis points parallel shift in yield curves ... (21) (9) 7 19

10 per cent increase in equity prices ... 15 15 16 16

10 per cent decrease in equity prices ... (16) (16) (16) (16)

Sensitivity to credit spread increases ... – (2) (1) (4) Credit risk of insurance operations

Credit risk can give rise to losses through default and can lead to volatility in income statement and balance sheet figures through movements in credit spreads, principally on the £11.3 billion (2011: £10.6 billion) non-linked bond portfolio.

As tabulated above, the sensitivity of the net profit after tax of the group’s insurance manufacturing companies to the effects of changes in credit spreads is £nil (2011: a fall of £1 million). The sensitivity is calculated using simplified assumptions based on a one- day movement in credit spreads over a two-year period. A confidence level of 99 per cent, consistent with the Group’s VAR, has been applied.

Management of the group’s insurance manufacturing companies is responsible for the credit risk, quality and performance of their investment portfolios. The assessment of creditworthiness of issuers and counterparties is based primarily upon internationally recognised credit ratings and other publicly available information.

Investment credit exposures are monitored against limits by the local insurance manufacturing subsidiaries, and are aggregated and reported to Group Credit Risk, the Group Insurance Credit Risk Committee and the Group

Insurance Risk Management Committee. Stress testing is performed by the Group Insurance Head Office on the investment credit exposures using credit spread sensitivities and default probabilities. The stresses are reported to the Group Insurance Credit Risk Meeting. A number of tools are used to manage and monitor credit risk. These include a Credit Watch Report which contains a watch list of investments with current credit concerns and is circulated fortnightly to senior

management in the Group Insurance Head Office and to the individual Country Chief Risk Officers to identity investments which may be at greater risk of future impairment.

Credit quality

The following table presents an analysis of treasury bills, other eligible bills and debt securities within the group’s insurance business by measures of credit quality. The five credit quality classifications are defined on page 47. Only assets supporting non-linked insurance liabilities, investment contract liabilities and shareholders’ funds are included in the table, as financial risk on assets

supporting linked liabilities is predominantly borne by the policyholder. 86 per cent (2011: 93 per cent) of the assets included in the table are invested in investments rated as ‘Strong’.

Treasury bills, other eligible bills and debt securities in the group’s insurance manufacturing companies

(Audited)

At 31 December 2012 At 31 December 2011

Strong

Good/

Satisfactory Total2 _{Strong Satisfactory Total}Good/ 2

£m £m £m £m £m £m

Financial assets designated at fair value1 _{... 549 117 666 731 109 840}

– treasury and other eligible bills ... – – – 3 – 3

– debt securities ... 549 117 666 728 109 837

Financial investments ... 9,100 1,488 10,588 9,160 620 9,780

– treasury and other similar bills ... – – – 32 – 32

Reinsurers’ share of liabilities under insurance contracts

(Audited)

Strong

Good/ Satisfactory

Past due not

impaired Total1,2

£m £m £m £m

At 31 December 2012

Linked insurance contracts ... 34 – – 34

Non-linked insurance contracts ... 458 4 – 462

Total ... 492 4 – 496

Reinsurance debtors ... 5 – – 5 At 31 December 2011

Linked insurance contracts ... 29 – – 29

Non-linked insurance contracts ... 438 3 – 441

Total ... 467 3 – 470

Reinsurance debtors ... 6 – 2 8

1 No amounts reported within Reinsurers’ share of liabilities under insurance contracts were classified as sub-standard or impaired. 2 Total is the maximum exposure to credit risk in respect of reinsurers’ share of liabilities under insurance contracts.

Liquidity risk of insurance operations

It is an inherent characteristic of almost all insurance contracts that there is uncertainty over the amount of claims liabilities that may arise, and the timing of their settlement, and this creates liquidity risk.

There are three aspects to liquidity risk. The first arises in normal market conditions and is referred to as funding liquidity risk; specifically, the capacity to raise sufficient cash when needed to meet payment obligations. Secondly, market liquidity risk arises when the size of a particular holding may be so large that a sale cannot be completed at the market price. Finally, standby liquidity risk refers to the capacity to meet payment terms in abnormal conditions.

The group’s insurance manufacturing companies primarily fund cash outflows arising from claim liabilities from the following sources of cash inflows:

 premiums from new business, policy renewals and recurring premium products;

 interest and dividends on investments and principal repayments of maturing debt investments;

 cash resources; and

 monitoring investment concentrations and restricting them where appropriate, for example, by debt issues or issuers; and

 establishing committed contingency borrowing facilities.

Each of these techniques contributes to mitigating the three types of liquidity risk described above.

Every quarter, the group’s insurance manufacturing companies are required to complete and submit liquidity risk reports to the Group Insurance Head Office for collation and review by the Group Insurance Market and Liquidity Risk Committee. Liquidity risk is assessed in these reports by measuring changes in expected cumulative net cash flows under a series of stress scenarios designed to determine the effect of reducing expected available liquidity and accelerating cash outflows. This is achieved, for example, by assuming new business or renewals are lower, and surrenders or lapses are greater, than expected.

The following tables show the expected

undiscounted cash flows for insurance contract liabilities and the remaining contractual maturity of investment contract liabilities. A significant proportion of the

Report of the Directors: Risk