Interest rate risk is managed through the investment strategy and accordingly debt and fixed interest securities are predominantly invested in high quality corporate and government backed bonds. These investments typically have a short duration and terms to maturity comparing favourably to the maturity profile of liabilities. Also the Association’s financing structure includes perpetual subordinated capital securities which pay a fixed interest rate. The Association has no debt with interest payments which vary with changes in interest rate.
Sensitivity analysis
It is estimated that the value of the Association’s investment would decrease for the following amounts if market interest rates had increased by 100 basis points at the balance sheet dates and all assumptions had remained unchanged.
Amounts in $000 As at 20 February 2011 As at 20 February 2010
Effect on investment valuation 15,788
11,291
Equity and hedge fund price risk The Association is exposed to price risk through its holding of equities and “fund of fund” hedge funds. The exposure through equities is limited to a controlled proportion of the overall portfolio. At the year end the holding in equity instruments amounted to 17 per cent (2010: 14 per cent).
The aim of the investment in the “fund of funds” is to reduce volatility through diversification. The exposure to this investment is limited by investment guidelines and at the year end amounted to $90 million (2010: $93 million).
Where available, the Association uses closing bid market values to determine the fair value of an investment holding. Unquoted investments are valued by reference to recent observable market transactions. The carrying value of non quoted equity holdings at the year end amounted to $17.7 million (2010: $16.8 million).
Sensitivity analysis
A 10 per cent increase in equity values would be estimated to have increased the surplus before tax and reserves at the year end by $19.9 million.
Currency risk The Association is exposed to currency risk in respect of liabilities under policies of insurance denominated in currencies other than US Dollars. The most significant currencies to which the Association is exposed are Sterling and the Euro. In order to manage this risk, the Association holds a proportion of its investments in each currency at a level to match expected future claim payments in that currency. In addition, from time to time, the Association uses forward currency contracts to protect currency exposures and maintain investment policy benchmarks.
The profile of the Association’s assets and liabilities, categorised by settlement currency, at their translated carrying amount, is set out below. Certain amounts, either due to their nature, notably reinsurer’s share of outstanding claims, or the existence of forward contracts, may depend on a different underlying currency.
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