b. INTEREST RATE RISK
i. Nature of the risks and how managed
Interest rate risk is the risk of loss arising from an unfavourable movement in market interest rates. Fixed interest rate assets and
liabilities are exposed to changes in market value derived from mark-to-market revaluations. Financial assets and liabilities with
floating interest rates create exposure to cash flow volatility.
Interest rate risk arises primarily from investments in interest bearing securities. Interest bearing liabilities are exposed to interest rate
risk but as they are measured at amortised cost and are not traded they therefore do not expose the Group to fair value interest rate
risk. In addition, interest bearing liabilities bearing fixed interest rates (subject to some reset conditions) reduce the Group's exposure
to cash flow interest rate risk. Movements in market interest rates therefore impact the price of the securities (and hence their fair
value measurement), however have a limited effect on the contractual cash flows of the securities.
Exposure to interest rate risk is monitored through several measures that include value-at-risk analysis, position limits, scenario testing
and stress testing, and managed by asset and liability matching using measures such as duration. Derivatives are used to manage
interest rate risk. The interest rate risk arising from money market securities is managed using interest rate swaps and futures. For
information regarding the notional contract amounts associated with these derivative financial instruments together with a maturity
profile and reporting date fair values, refer to the derivatives note.
The underwriting of general insurance contracts creates exposure to the risk that interest rate movements may materially impact the
value of the insurance liabilities. Movements in interest rates should have minimal impact on the insurance profit or loss due to the
Group’s policy of investing in assets backing insurance liabilities principally in fixed interest securities broadly matched to the expected
payment pattern of the insurance liabilities. Movements in investment income on assets backing insurance liabilities broadly offset
the impact of movements in discount rates on the insurance liabilities.
ii. Sensitivity
The sensitivity analysis provided in the following table demonstrates the effect of a change in a key assumption while other
assumptions remain unchanged. In reality, there is a correlation between the assumptions and other factors. The sensitivities do not
include interdependencies among variables, but rather show isolated interest rate movements.
The investments in interest bearing securities are recognised on the balance sheet at fair value. Movements in market interest rates
impact the price of the securities (and hence their fair value measurement) and so would impact profit or loss. The impact on the
measurement of the interest bearing securities held at reporting date of a change in interest rates by +1% or -1% on profit before tax,
net of related derivatives, is shown in the following table:
CONSOLIDATED
2015
2014
$m
$m
Impact to
profit
Impact to
profit
Investments - interest bearing securities and related interest rate derivatives
+1%
(366)
(328)
-1%
389
351
The majority of the interest bearing securities are expected to be held to maturity and so movements in the fair value are expected to
reverse upon maturity of the instruments.
c. PRICE RISK
i. Nature of the risk and how managed
Price risk is the risk that the fair value of future cash flows of a financial instrument will fluctuate due to changes in market prices
(other than those arising from interest rate or foreign exchange risk), whether those changes are caused by factors specific to the
individual financial instrument or its issuer, or factors affecting all similar financial instruments traded on the market. The Group has
exposure to equity price risk through its investment in equities (both directly and through certain trusts) and the use of equity related
derivative contracts.
Exposure to equity price risk is monitored through several measures that include value-at-risk analysis, position limits, scenario testing
and stress testing.
For information regarding the notional amounts associated with equity related derivative contracts together with the associated
maturity profiles and reporting date fair values, refer to the derivatives note.
ii. Sensitivity
The impact on the measurement of the investments held at reporting date of a change in equity values by +10% or -10% on profit
before tax, net of related derivatives, is shown in the table below:
CONSOLIDATED
2015
2014
$m
$m
Investments – equity and trust securities and related equity derivatives
+10%
-10%
115
(115)
138
(138)
58 IAG ANNUAL REPORT 2015
