2 Our risk landscape.

The products that we write, the investment assets we hold to meet our obligations to our customers and the environment in which we operate give rise to a broad range of risks. To ensure that these risk are managed within acceptable tolerances, our risk framework, which we describe overleaf, seeks to ensure that we are only exposed to those residual risks for which we have an appetite.

MARKET RISK

Investment performance

We invest in a range of investment assets including equities, bonds and property to meet the obligations from our insurance products; however, there is a risk that the income and value of these investment assets may fluctuate relative to required targets.

Interest rates and inflation

Interest rate movements and inflation can impact the value of the investment assets we hold to meet our obligations, as well as the value of the obligations themselves.

Currency

Fluctuations in exchange rates can vary both the value and income from investment assets denominated in foreign currencies, as well as the profits and value of our overseas businesses.

CREDIT RISK

Bond default

We hold a significant portfolio of corporate bonds to back our annuity business. The portfolio is diversified across a range of sectors and geographies, but inherently is exposed to the risk of default.

Property counterparties

We also hold property lending and sales and leaseback investments and are inherently exposed to the risk of default by a borrower or tenant, although we protect our interests by taking security over underlying property.

Banks and the issuers of financial instruments

Banking and money market counterparties, the issuers of financial instruments and the providers of settlement and custody services may default on their obligations to us.

Reinsurance contracts

A reinsurer default would require business written with the counterparty to be re-brokered potentially on less advantageous terms, or for the reinsured risks to be borne directly.

INSURANCE RISK

Longevity, mortality and morbidity

The pricing of long-term life insurance business requires assumptions to be made for future trends in the life expectancy and general health of those that we insure; with the risk that actual experience may diverge to our assumptions.

Catastrophe

We also make assumptions about the likelihood of catastrophic events that could cause a widespread loss of life or disability within the pool of the lives that we insure.

Persistency

We are exposed to the risks that acquisition costs may not be recovered from product margins if policies lapse earlier than we anticipated within our pricing assumptions.

Expense

Product pricing must also take account of the future costs of product servicing, with deviations in actual costs presenting the risk of reduced product profitability.

Weather events

In the pricing of our household insurance products, we make assumptions about the likelihood of weather events, with the risk that actual experience may diverge from our assumptions.

OPERATIONAL RISK

People, process, systems and external events

Our business processes can be complex, with significant reliance placed upon a combination of IT systems and manual processes. Weakness or failure of these systems or processes could result in financial loss or adversely affect our customers.

Regulation and legislation

The markets in which we operate are highly regulated. A breach of legislative or regulatory requirements may expose us to financial penalties and damage our reputation.

LIQUIDITY RISK

Contingent events

Low probability and typically extreme events that if not adequately planned for can result in unanticipated requirements for liquidity.

Collateral

Failure to hold sufficient cash or suitable liquid assets to meet collateral requirements for financial instruments.

Notes 7 (‘Asset risk’), 15 (‘Insurance risk’) and 25 (‘Operational risk’) to the financial statements further describe how the above risks relate to our core products and the specific control techniques we apply to ensure that the risks are appropriately managed.