34. Risk management
Financial risk management policies and objectives
The Board establishes the overall governance framework for risk management and sets the risk appetite and philosophy for the Group.
The principal financial risks that the Group manages are as follows:
- Credit risk: is the risk arising from the possibility that the Group will incur losses from the failure of customers to meet their obligations.
- Liquidity risk: is the risk that the Group is unable to meet its obligations as they fall due.
- Market risk: the Group is exposed to market risk because of positions held in its trading portfolios and its non-trading businesses.
- Insurance risk: the Group is exposed to insurance risk, either directly through its businesses or through using insurance as a tool to mitigate other risk exposures.
Credit risk
The objective of credit risk management is to enable the Group to achieve appropriate risk versus reward performance whilst maintaining credit risk exposure in line with approved risk appetite.
The key principles for credit risk management as defined in the Group’s Credit Risk Management Framework are set out below.
- Approval of all credit exposure is granted prior to any advance or extension of credit.
- An appropriate credit risk assessment of the customer and credit facilities is undertaken prior to approval of credit exposure. This includes a review of, amongst other things, the purpose of the credit and sources of repayment, compliance with affordability tests, repayment history, capacity to repay, sensitivity to economic and market developments and risk-adjusted return.
- The Board delegates authority to Advances Committee, Group Credit Committee and divisional credit committees.
- Credit risk authority must be specifically granted in writing to all individuals involved in the granting of credit approval, whether this is exercised personally or collectively as part of a credit committee. In exercising credit authority, the individuals act independently.
- Where credit authority is exercised personally, the individual has no responsibility or accountability for related business revenue origination.
- All credit exposures, once approved, are effectively monitored and managed and reviewed periodically against approved limits. Lower quality exposures are subject to a greater frequency of analysis and assessment.
- Customers with emerging credit problems are identified early and classified accordingly. Remedial actions are implemented promptly to minimise the potential loss to the Group.
- Portfolio analysis and reporting is used to identify and manage credit risk concentrations and credit risk quality migration.
Credit approval process
Different credit approval processes exist for each customer type in order to ensure appropriate skills and resources are employed in credit assessment and approval. Credit authority is not extended to relationship management.
Credit risk models
Credit risk models are used throughout the Group to support the analytical elements of the credit risk management framework, in particular the risk assessment part of the credit approval process, ongoing monitoring as well as portfolio analysis and reporting. Credit risk models used by the Group can be broadly grouped into four categories.
- Probability of default (“PD”)/customer credit grade – these models assess the probability that the customer will fail to make full and timely repayment of credit obligations over a one year time horizon. Each customer is assigned an internal credit grade which corresponds to a probability of default. There are a number of different credit grading models in use across the Group, each of which considers particular characteristics of customer types in that portfolio. The credit grading models use a combination of quantitative inputs, such as recent financial performance and customer behaviour, and qualitative inputs, such as company management performance or sector outlook.
Every customer credit grade across all grading scales in the Group can be mapped to a Group level credit grade which uses a five band scale from AQ1 to AQ5.
- Exposure at default (“EAD”) – these models estimate the expected level of utilisation of a credit facility at the time of a borrower’s default. The EAD will typically be higher than the current utilisation (e.g. in the case where further drawings are made on a revolving credit facility prior to default) but will not normally exceed the total facility limit. The methodologies used in EAD modelling recognise that customers may make more use of their existing credit facilities in the run up to a default.
- Loss given default (“LGD”) – these models estimate the economic loss that may be suffered by the Group on a credit facility in the event of default. The LGD of a facility represents the amount of debt which cannot be recovered and is typically expressed as a percentage of the EAD. The Group’s LGD models take into account the type of borrower, facility and any risk mitigation such as security or collateral held. The LGD may also be affected by the industry sector of the borrower, the legal jurisdiction in which the borrower operates as well as general economic conditions which may impact the value of any assets held as security.
- Credit risk exposure measurement – these models calculate the credit risk exposure for products where the exposure is not 100% of the gross nominal amount of the credit obligation. These models are most commonly used for derivative and other traded instruments where the amount of credit risk exposure may be dependent on external variables such as interest rates or foreign exchange rates.
Credit risk assets
Credit risk assets are an internal risk measure of the Group’s exposure to customers. These consist of loans and advances (including overdraft facilities), instalment credit, finance lease receivables, debt securities and other traded instruments.
Credit risk asset quality
Internal reporting and oversight of risk assets is principally differentiated by credit ratings. Internal ratings are used to assess the credit quality of borrowers. Customers are assigned credit ratings, based on various credit grading models that reflect the probability of default. All credit ratings across the Group map to a Group level asset quality scale.
Provision analysis
The Group’s consumer portfolios, which consist of small value, high volume credits, have highly efficient, largely automated processes for identifying problem credits and very short timescales, typically three months, before resolution or adoption of various recovery methods.
Corporate portfolios consist of higher value, lower volume credits, which tend to be structured to meet individual customer requirements. Provisions are assessed on a case by case basis.
Early and active management of problem exposures ensures that credit losses are minimised. Specialised units are used for different customer types to ensure that appropriate risk mitigation is taken in a timely manner.
Portfolio provisions are reassessed regularly as part of the Group’s ongoing monitoring process.
Provisions methodology
Provisions for impairment losses are assessed under three categories as described below:
Individually assessed provisions are the provisions required for individually significant impaired assets which are assessed on a case-by-case basis, taking into account the financial condition of the counterparty and any guarantor. This incorporates an estimate of the discounted value of any recoveries and realisation of security or collateral. The asset continues to be assessed on an individual basis until it is repaid in full, transferred to the performing portfolio or written-off.
Collectively assessed provisions are the provisions on impaired credits below an agreed threshold which are assessed on a portfolio basis, to reflect the homogeneous nature of the assets, such as credit cards or personal loans. The provision is determined from a quantitative review of the relevant portfolio, taking account of the level of arrears, security and average loss experience over the recovery period.
Latent loss provisions are the provisions held against the estimated impairment in the performing portfolio which has yet to be identified as at the balance sheet date. To assess the latent loss within the portfolio, the Group has developed methodologies to estimate the time that an asset can remain impaired within a performing portfolio before it is identified and reported as such.
Liquidity risk
Liquidity management within the Group focuses on both overall balance sheet structure and the control, within prudent limits, of risk arising from the mismatch of maturities across the balance sheet and from undrawn commitments and other contingent obligations. It is undertaken within limits and other policy parameters set by Group Asset and Liability Management Committee (GALCO).
The structure of the Group’s balance sheet is managed to maintain substantial diversification, to minimise concentration across its various deposit sources, and to contain the level of reliance on total short-term wholesale sources of funds within prudent levels.
The degree of maturity mismatch within the overall long-term structure of the Group’s assets and liabilities is managed within internal policy guidelines, to ensure that term asset commitments may be funded on an economic basis over their life. In managing its overall term structure, the Group analyses and takes into account the effect of retail and corporate customer behaviour on actual asset and liability maturities where they differ materially from the underlying contractual maturities. The short-term maturity structure of the Group’s liabilities and assets is managed on a daily basis to ensure that all material cash flow obligations, and potential cash flows arising from undrawn commitments and other contingent obligations, can be met as they arise from day to day, either from cash inflows from maturing assets, new borrowing or the sale or repurchase of debt securities held.
Short-term liquidity risk is managed on a consolidated basis for the whole Group including the Greenwich companies but excluding the activities of Citizens and insurance businesses, which are subject to regulatory regimes that necessitate local management of liquidity.
Internal liquidity mismatch limits are set for all other subsidiaries and non-UK branches which have material local treasury activities in external markets, to ensure those activities do not compromise daily maintenance of the Group’s overall liquidity risk position within the Group’s policy parameters.
The level of large deposits taken from banks, corporate customers, non-bank financial institutions and other customers and significant cash outflows therefrom are also reviewed to monitor concentration and identify any adverse trends.
Market risk
Market risk is defined as the risk of loss as a result of adverse changes in risk factors including interest rates, foreign currency and equity prices together with related parameters such as market volatilities.
The Group is exposed to market risk because of positions held in its trading portfolios as well as its non-trading business including the Group’s treasury operations.
Value-at-risk (“VaR”)
VaR is a technique that produces estimates of the potential negative change in the market value of a portfolio over a specified time horizon at given confidence levels. For internal risk management purposes, the Group’s VaR assumes a time horizon of one day and a confidence level of 95%. The Group uses historical simulation models in computing VaR. This approach, in common with many other VaR models, assumes that risk factor changes observed in the past are a good estimate of those likely to occur in the future and is, therefore, limited by the relevance of the historical data used. The Group’s method, however, does not make any assumption about the nature or type of underlying loss distribution. The Group typically uses the previous 500 trading days market data. The Group’s VaR should be interpreted in light of the limitations of the methodology used. These limitations include:
- Historical data may not provide the best estimate of the joint distribution of risk factor changes in the future and may fail to capture the risk of possible extreme adverse market movements which have not occurred in the historical window used in the calculations.
- VaR using a one-day time horizon does not fully capture the market risk of positions that cannot be liquidated or hedged within one day.
- VaR using a 95% confidence level does not reflect the extent of potential losses beyond that percentile.
The Group largely computes the VaR of trading portfolios at the close of business and positions may change substantially during the course of the trading day. Controls are in place to limit the Group’s intra-day exposure; such as the calculation of the VaR for selected portfolios. These limitations and the nature of the VaR measure mean that the Group cannot guarantee that losses will not exceed the VaR amounts indicated.
Trading
The principal focus of the Group’s trading activities is client facilitation – providing products to the Group’s client base at competitive prices. The Group also undertakes: market making – quoting firm bid (buy) and offer (sell) prices with the intention of profiting from the spread between the quotes; arbitrage – entering into offsetting positions in different but closely related markets in order to profit from market imperfections; and proprietary activity – taking positions in financial instruments as principal in order to take advantage of anticipated market conditions. The main risk factors are interest rates, credit spreads and foreign exchange. Financial instruments held in the Group’s trading portfolios include, but are not limited to, debt securities, loans, deposits, securities sale and repurchase agreements and derivative financial instruments (futures, forwards, swaps and options). For a discussion of the Group’s accounting policies for derivative financial instruments, see Accounting policies on pages 135 and 136.
The VaR for the Group’s trading portfolios segregated by type of market risk exposure, including idiosyncratic risk, is presented in the table below.
| 2006 | 2005 | |||||||
| Trading | Average £m |
Period end £m |
Maximum £m |
Minimum £m |
Average £m |
Period end £m |
Maximum £m |
Minimum £m |
| Interest rate | 8.7 | 10.2 | 15.0 | 5.7 | 7.3 | 7.4 | 10.9 | 5.1 |
| Credit spread | 13.2 | 14.1 | 15.7 | 10.4 | 11.4 | 11.8 | 14.4 | 8.8 |
| Currency | 2.2 | 2.5 | 3.5 | 1.0 | 1.8 | 1.4 | 10.7 | 0.5 |
| Equity and commodity | 1.4 | 1.6 | 4.3 | 0.6 | 0.5 | 0.7 | 1.1 | 0.2 |
| Diversification | (12.8) | (8.5) | ||||||
| Total trading VaR | 14.2 | 15.6 | 18.9 | 10.4 | 13.0 | 12.8 | 16.5 | 9.9 |
Non-trading
The principal market risks arising from the Group’s non-trading activities are interest rate risk, currency risk and equity risk. Treasury activity and mismatches between the repricing of assets and liabilities in its retail and commercial banking operations account for most of the non-trading interest rate risk. Non-trading currency risk derives from the Group’s investments in overseas subsidiaries, associates and branches. The Group’s venture capital portfolio and investments held by its general insurance business are the principal sources of non-trading equity price risk. The Group’s portfolios of non-trading financial instruments mainly comprise loans (including finance leases), debt securities, equity shares, deposits, certificates of deposit and other debt securities issued, loan capital and derivatives. To reflect their distinct nature, the Group’s long-term assurance assets and liabilities attributable to policyholders have been excluded from these market risk disclosures.
Interest rate risk
Non-trading interest rate risk arises from the Group’s treasury activities and retail and commercial banking businesses.
Treasury
The Group’s treasury activities include its money market business and the management of internal funds flow within the Group’s businesses. Money market portfolios include cash instruments (principally debt securities, loans and deposits) and related hedging derivatives.
Retail and commercial banking
Non-trading interest rate risk is calculated in each business on the basis of establishing the repricing behaviour of each asset, liability and off-balance sheet product. For many products, the actual interest rate repricing characteristics differ from the contractual repricing. In most cases, the repricing maturity is determined by the market interest rate that most closely fits the historical behaviour of the product interest rate. For non-interest bearing current accounts, the repricing maturity is determined by the stability of the portfolio. The repricing maturities used are approved by Group Treasury and divisional asset and liability committees at least annually. Key conventions are reviewed annually by GALCO.
A static maturity gap report is produced as at the month-end for each division, in each functional currency based on the behaviouralised repricing for each product. It is Group policy to include in the gap report, non-financial assets and liabilities, mainly property, plant and equipment and the Group’s capital and reserves, spread over medium and longer term maturities. This report also includes hedge transactions, principally derivatives.
Any residual non-trading interest rate exposures are controlled by limiting repricing mismatches in the individual balance sheets. Potential exposures to interest rate movements in the medium to long term are measured and controlled using a version of the same VaR methodology that is used for the Group’s trading portfolios but without discount factors. Net accrual income exposures are measured and controlled in terms of sensitivity over time to movements in interest rates.
Risk is managed within limits approved by GALCO through the execution of cash and derivative instruments. Execution of the hedging is carried out by the relevant division through the Group’s treasury function. The residual risk position is reported to divisional asset and liability committees, GALCO and Board.
Currency risk
The Group does not maintain material non-trading open currency positions other than the structural foreign currency translation exposures arising from its investments in foreign subsidiaries and associated undertakings and their related currency funding. The Group’s policy in relation to structural positions is to match fund the structural foreign currency exposure arising from net asset value, including goodwill, in foreign subsidiaries, equity accounted investments and branches, except where doing so would materially increase the sensitivity of either the Group’s or the subsidiary’s regulatory capital ratios to currency movements. The policy requires structural foreign exchange positions to be reviewed regularly by GALCO. Foreign exchange differences arising on the translation of foreign operations are recognised directly in equity together with the effective portion of foreign exchange differences arising on hedging liabilities.
The tables below set out the Group’s structural foreign currency exposures.
| 2006 | Net investments in foreign operations £m |
Foreign currency borrowings hedging net investments £m |
Structural foreign currency exposures £m |
|
| US dollar | 15,036 | 5,278 | 9,758 | |
| Euro | 3,059 | 1,696 | 1,363 | |
| Swiss franc | 462 | 457 | 5 | |
| Chinese RMB | 3,013 | — | 3,013 | |
| Other non-sterling | 132 | 107 | 25 | |
| 21,702 | 7,538 | 14,164 | ||
| 2005 | ||||
| US dollar | 15,452 | 6,637 | 8,815 | |
| Euro | 2,285 | 139 | 2,146 | |
| Swiss franc | 431 | 430 | 1 | |
| Chinese RMB | 914 | — | 914 | |
| Other non-sterling | 76 | 72 | 4 | |
| 19,158 | 7,278 | 11,880 |
The exposure in Chinese RMB arises from the Group’s strategic investment in Bank of China.
Equity risk
Non-trading equity risk arises principally from the Group’s strategic investments, its venture capital activities and its general insurance business.
VaR is not an appropriate risk measure for the Group’s venture capital investments, which comprise a mix of quoted and unquoted investments, or its portfolio of strategic investments. These investments are carried at fair value with changes in fair value recorded in profit or loss, or equity.
Insurance risk
The Group is exposed to insurance risk, either directly through its businesses or through using insurance as a tool to reduce other risk exposures.
Insurance risk is the risk of fluctuations in the timing, frequency or severity of insured events, relative to the expectations of the Group at the time of underwriting.
Underwriting and pricing risk
The Group manages underwriting and pricing risk through the use of underwriting guidelines which detail the class, nature and type of business that may be accepted; pricing policies by product line and by brand; and centralised control of policy wordings and any subsequent changes.
Claims management risk
The risk that claims are handled or paid inappropriately is managed using a range of IT system controls and manual processes conducted by experienced staff. These, together with a range of detailed policies and procedures ensure that all claims are handled in a timely, appropriate and accurate manner.
Reinsurance risk
Reinsurance is used to protect against the impact of major catastrophic events or unforeseen volumes of, or adverse trends in, large individual claims and to transfer risk that is outside the Group’s current risk appetite.
Reinsurance of risks above the Group’s risk appetite is only effective if the reinsurance premium makes economic sense and the counterparty is financially secure. Acceptable reinsurers are rated A- or better unless specifically authorised.
Reserving risk
Reserving risk relates to both premiums and claims. It is the risk that reserves are assessed incorrectly such that insufficient funds have been retained to pay or handle claims as the amounts fall due. Claims development data provides information on the historical pattern of reserving risk.
| Accident year | |||||||
| Insurance claims – gross | 2001 £m |
2002 £m |
2003 £m |
2004 £m |
2005 £m |
2006 £m |
Total £m |
| Estimate of ultimate claims costs: | |||||||
| At end of accident year | 2,395 | 3,013 | 3,658 | 3,710 | 4,265 | 4,269 | 21,310 |
| One year later | (70) | 91 | (140) | (186) | (92) | — | (397) |
| Two years later | 20 | 1 | (106) | (88) | — | — | (173) |
| Three years later | 12 | (12) | (55) | — | — | — | (55) |
| Four years later | (40) | (17) | — | — | — | — | (57) |
| Five years later | (1) | — | — | — | — | — | (1) |
| Current estimate of cumulative claims | 2,316 | 3,076 | 3,357 | 3,436 | 4,173 | 4,269 | 20,627 |
| Cumulative payments to date | (2,189) | (2,805) | (2,853) | (2,707) | (3,093) | (1,962) | (15,609) |
| 127 | 271 | 504 | 729 | 1,080 | 2,307 | 5,018 | |
| Liability in respect of prior years | 126 | ||||||
| Claims handling costs | 103 | ||||||
| Gross general insurance claims liability | 5,247 | ||||||
| Accident year | |||||||
| Insurance claims – net of reinsurance | 2001 £m |
2002 £m |
2003 £m |
2004 £m |
2005 £m |
2006 £m |
Total £m |
| Estimate of ultimate claims costs: | |||||||
| At end of accident year | 2,011 | 2,584 | 3,215 | 3,514 | 4,168 | 4,215 | 19,707 |
| One year later | (61) | 59 | (106) | (168) | (67) | — | (343) |
| Two years later | 22 | (12) | (103) | (90) | — | — | (183) |
| Three years later | 13 | (3) | (53) | — | — | — | (43) |
| Four years later | (41) | (21) | — | — | — | — | (62) |
| Five years later | 1 | — | — | — | — | — | 1 |
| Current estimate of cumulative claims | 1,945 | 2,607 | 2,953 | 3,256 | 4,101 | 4,215 | 19,077 |
| Cumulative payments to date | (1,841) | (2,412) | (2,520) | (2,584) | (3,021) | (1,925) | (14,303) |
| 104 | 195 | 433 | 672 | 1,080 | 2,290 | 4,774 | |
| Liability in respect of prior years | 79 | ||||||
| Claims handling costs | 103 | ||||||
| Net general insurance claims liability | 4,956 | ||||||
Claims reserves
It is the Group’s policy to hold undiscounted claims reserves (including reserves to cover claims which have been incurred but not reported (IBNR reserves)) for all classes at a sufficient level to meet all liabilities as they fall due.
The Group’s focus is on high volume and relatively straightforward products, for example home and motor. This facilitates the generation of comprehensive underwriting and claims data, which are used to accurately price and monitor the risks accepted.
The following table indicates the diversity of risks underwritten and the corresponding loss ratios for each major class of business, gross and net of reinsurance.
| 2006 | 2005 | 2004 | ||||||
| Earned premiums £m |
Claims incurred £m |
Loss ratio % |
Earned premiums £m |
Loss ratio % |
Earned premiums £m |
Loss ratio % |
||
| Residential property | Gross | 1,121 | 627 | 56 | 1,098 | 55 | 1,090 | 55 |
| Net | 1,061 | 624 | 59 | 1,037 | 56 | 990 | 58 | |
| Personal motor | Gross | 3,384 | 2,854 | 84 | 3,312 | 79 | 3,179 | 79 |
| Net | 3,279 | 2,802 | 85 | 3,257 | 80 | 2,976 | 79 | |
| Commercial property | Gross | 218 | 81 | 37 | 212 | 39 | 191 | 40 |
| Net | 198 | 76 | 38 | 193 | 40 | 173 | 42 | |
| Commercial motor | Gross | 90 | 62 | 69 | 102 | 53 | 93 | 76 |
| Net | 88 | 60 | 68 | 96 | 46 | 87 | 68 | |
| Other | Gross | 842 | 396 | 47 | 853 | 63 | 954 | 60 |
| Net | 833 | 409 | 49 | 761 | 67 | 827 | 59 | |
| Total | Gross | 5,655 | 4,020 | 71 | 5,577 | 70 | 5,507 | 69 |
| Net | 5,459 | 3,971 | 73 | 5,344 | 71 | 5,053 | 70 | |
The Group has no interest rate exposure from general insurance liabilities because provisions for claims under short-term insurance contracts are not discounted.
Frequency and severity of specific risks and sources of uncertainty
Most general insurance contracts written by the Group are issued on an annual basis, which means that the Group’s liability extends for a 12 month period, after which the Group is entitled to decline or renew or can impose renewal terms by amending the premium, terms and conditions, or both.
The following paragraphs explain the frequency and severity of claims and the sources of uncertainty for the key classes that the Group is exposed to:
a) Motor insurance contracts (personal and commercial)
Claims experience is quite variable, due to a wide range of factors, but the principal ones are age, sex and driving experience of the driver, type and nature of vehicle, use of vehicle and area.
There are many sources of uncertainty that will affect the Group’s experience under motor insurance, including operational risk, reserving risk, premium rates not matching claims inflation rates, the weather, the social, economic and legislative environment and reinsurance failure risk.
b) Property insurance contracts (residential and commercial)
The major causes of claims for property insurance are theft, flood, escape of water, fire, storm, subsidence and various types of accidental damage.
The major source of uncertainty in the Group’s property accounts is the volatility of weather. Weather in the UK can affect most of the above perils. Over a longer period, the strength of the economy is also a factor.
c) Other commercial insurance contracts
Other commercial claims come mainly from business interruption and loss arising from the negligence of the insured (liability insurance). Business interruption losses come from the loss of income, revenue and/or profit as a result of property damage claims. Liability insurance includes employers liability and public/products liability. Liability insurance is written on an occurrence basis, and is subject to claims that are identified over a substantial period of time, but where the loss event occurred during the life of the policy.
Fluctuations in the social and economic climate are a source of uncertainty in the Group’s business interruption and general liability accounts. Other sources of uncertainty are changes in the law, or its interpretation, and reserving risk. Other uncertainties are significant events (for example terrorist attacks) and any emerging new heads of damage or types of claim that are not envisaged when the policy is written.
Life business
The Group’s three regulated life companies, National Westminster Life Assurance Limited, Royal Scottish Assurance plc (“RSA”) and Direct Line Life Insurance Company Limited, are required to meet minimum capital requirements at all times under the Financial Service Authority’s Prudential Sourcebook. The capital resources covering the regulatory requirement are not transferable to other areas of the Group. To ensure that the capital requirement is satisfied at all times, each company holds an additional voluntary buffer above the regulatory minimum.
The Group is not exposed to price, currency, credit, or interest risk on unit linked life contracts but it is exposed to variation in management fees. A decrease of 10% in the value of the assets would reduce the asset management fees by £5 million per annum (2005 – £5 million). The Group also writes insurance contracts with minimum guaranteed death benefits that expose it to the risk that declines in the value of underlying investments may increase the Group’s net exposure to death risk.
The Group’s long-term assurance contracts include whole-life, term assurance, endowment assurances, flexible whole life, pension and annuity contracts that are expected to remain in force for an extended period of time.
Contracts under which the Group does not accept significant insurance risk are classified as investment contracts. Long term business provisions are calculated in accordance with FRS 27 ‘Life Assurance’.
Estimations (assumptions) including future mortality, morbidity, persistency and levels of expenses are made in calculating actuarial reserves. Key metrics include:
| Assumptions | 2006 | 2005 | 2004 |
| Valuation interest rate | |||
| Term assurance | 3.00% | 2.85% | 3.00% |
| Sterling interest | 3.00% | 2.85% | 3.00% |
| Unit growth | 3.50% | 2.85% | 3.00% |
| Expense inflation | 4.00% | 4.00% | 4.00% |
Sample mortality rates, expressed as deaths per million per annum, for term assurance products (age 40).
| Mortality | |||
| Male non-smoker | 517 | 470 | 497 |
| Male smoker | 983 | 893 | 946 |
| Female non-smoker | 278 | 253 | 270 |
| Female smoker | 618 | 563 | 599 |
Expenses:
| Pre-2000 products – RSA | 2006 per annum |
2005 per annum |
2004 per annum |
| Lifestyle protection plan | £28.96 | £29.81 | £27.17 |
| Mortgage savings plan | £65.15 | £67.05 | £60.08 |
| Pre-2000 products – NatWest Life | |||
| Term assurances | £26.01 | £26.79 | £25.13 |
| Single premium unit-linked bonds | £23.17 | £23.86 | £22.38 |
| Post-2000 products | |||
| Term assurances | £23.16 | £23.97 | £22.38 |
| Guaranteed bonds | £25.71 | £26.92 | £25.13 |
Frequency and severity of claims – for contracts where death is the insured risk, the most significant factors that could increase the overall frequency of claims are epidemics or widespread changes in lifestyle, resulting in earlier or more claims than expected.
For contracts where survival is the insured risk, the most significant factor is continued improvement in medical science and social conditions that would increase longevity.
For contracts with fixed and guaranteed benefits and fixed future premiums, there are no mitigating terms and conditions that reduce the insurance risk accepted. Participating contracts can result in a significant portion of the insurance risk being shared with the insured party.
Sources of uncertainty in the estimation of future benefit payments and premium receipts – the Group uses base tables of standard mortality appropriate to the type of contract being written and the territory in which the insured person resides. These are adjusted to reflect the Group’s experience, mortality improvements and voluntary termination behaviour.
| Sensitivity factor | Description of sensitivity factor applied |
| Interest rate and investment return | Change in market interest rates of ±1%. The test allows consistently for similar changes to investment returns and movements in the market value of backing fixed interest securities. |
| Expenses | Increase in maintenance expenses of 10% |
| Assurance mortality/morbidity | Increase in mortality/morbidity rates for assurance contracts of 5% |
| Annuitant mortality | Reduction in mortality rates for annuity contracts of 5% |
The above sensitivity factors are applied via actuarial and statistical models, with the following impact on the financial statements.
| Impact on profit and equity | |||
| Risk factor | Variability | 2006 £m |
2005 £m |
| Interest rates | +1% | (19) | (16) |
| Interest rates | –1% | 23 | 20 |
| Expenses | +10% | (5) | (5) |
| Assurance mortality/morbidity | +5% | (6) | (7) |
| Annuitant mortality | –5% | — | — |
Limitations of sensitivity analysis: the above tables demonstrate the effect of a change in a key assumption whilst other assumptions remain unaffected. In reality, such an occurrence is unlikely, due to correlation between the assumptions and other factors. It should also be noted that these sensitivities are non-linear, and larger or smaller impacts should not be interpolated or extrapolated from these results. The sensitivity analyses do not take into consideration that assets and liabilities are actively managed and may vary at the time that any actual market movement occurs.
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