Annual Financial Report 2010 and AGM 2011 - Part 5

RNS Number : 1804E

Old Mutual PLC

04 April 2011

 



Ref 33/11 (Part 5)

RISK AND CAPITAL MANAGEMENT

One of our major strategic objectives for 2010 was to align capital management more closely with our risk profile at both Group and business unit level, thus enhancing our capability to create value within a clearly defined risk appetite. Our revised operating model, in conjunction with a more robust risk management framework, has enabled us to make more informed decisions to take risks in areas where we:

·      Understand the nature of the risks we are taking and the consequences of those risks

·      Demonstrate the ability to accurately determine the capital required to assume these risks

·      Model and validate the range of returns that we can earn on the capital required to back these risks

·      Optimise the risk adjusted rate of return we can earn by reducing the range of adverse outcomes and increasing the range of acceptable return.

We have made significant progress in implementing a model framework where risk, capital and value are fully aligned with commercial objectives and the new European Solvency II regulations taking effect from 1 January 2013. This has been driven by our integrated Capital, Risk and Financial Transformation (iCRaFT) programme, which will deliver significant benefits to the business - including compliance with the Solvency II requirements. Our progress was recognised in August 2010 when the Financial Services Authority accepted us into its Internal Model Approval Process, enabling us to give both shareholders and stakeholders assurance of our capability to deliver Solvency II readiness in line with corporate objectives.

This section of the report describes the progress made by our Group during 2010 in developing our risk and capital modelling frameworks. Risk management is integral to the Group's corporate vision and is an expression of how we consider potential downside outcomes and upside value-creating opportunity in the context of sustainable, high-quality returns on capital utilised, to deliver financial value for our shareholders and peace of mind to our customers. We have strengthened operational, strategic and financial risk processes to ensure that where we accept risk we do so within an appetite and control environment supported by a clearly defined 'three lines of defence' model:

First line of defence: day-to-day management of risk is the responsibility of senior management in our businesses and plays an integral part in their decision-making process.

Second line of defence: risk oversight is provided by the Group and business unit Chief Risk Officers and Board and Management Risk Committees, whose role is to provide robust challenge to the management teams based on quantitative and qualitative metrics. These committees are supported by the specialist risk management and compliance functions across the Group.

Third line of defence: independent verification and challenge of the adequacy and effectiveness of the internal risk and control management framework is provided by the Group and business unit Internal Audit teams.

The pursuit of value requires us to balance risk assumed with capital required - aiming to provide higher certainty of risk-adjusted returns within an acceptable level of risk assumed and capital required, without exposing ourselves to unacceptably high risk of capital depletion in the event of adverse outcomes. In 2010 we completed one of the key steps towards achieving this objective and bringing risk 'alive' by defining a clear risk strategy. This outlines the risks that we believe give the Group the appropriate risk/capital balance; it is aligned with the Group's objectives and will be reviewed annually. The integration of risk with performance and business strategy will build long-term value and ensure that we avoid following short-term gain with later disappointments.

We continually strive to enhance risk and capital management methodologies by quantifying risk more consistently to identify threats, uncertainties and opportunities and in turn develop mitigation and management strategies that achieve optimal outcomes.

Within our model, the Group's capital is quantified according to the metrics described below under the heading "Risk Appetite". Businesses plan their capital consumption using internally agreed targets, which have been set to ensure that strategic objectives can be delivered under a wide range of market and trading conditions. Business units need to consider these capital requirements against the potential margin that can be earned from their activities, and the resulting risk exposures are assessed on the basis of the expected variance in key metrics in response to specific risk events, covering the full range of risks to which the Group is exposed.

Risk management forms an integral part of the strategic planning process and is directly linked to the Group's corporate objectives. It provides a group-wide overview that links all business units within a single framework. This process enhances the Group's capability to assess strategic allocation of capital and the ability to identify, monitor and manage emerging risks.

We view risk not only as a threat or uncertainty, but also as an opportunity to grow and develop the business, within the context of our risk appetite. So our approach to risk management is not limited to considering downside impacts or risk avoidance; it also encompasses taking risk knowingly for competitive advantage. Solvency II will require companies to consider their approach to risk, capital and value management more robustly, and we believe that our initiatives to date fit well with this.

Risk management is integral to the Group's decision-making and management processes. The Group's ambition, which we continue to embed through iCRaFT, is to make effective risk management part of all our day-to-day roles, thus enhancing the quality of strategic, capital allocation and day-to-day business decisions. This has to be driven from the top of our organisation, and we made significant progress in 2010 by starting the cultural change process through extensive education and training sessions across our businesses at all levels, including at Board level. This was aided in 2010 by the Group Remuneration Committee, which requested explicit reports on the extent to which risk exposures have linked into results delivered, and whether these risk exposures have complied with the agreed risk appetite. This information has been used as a factor in determining incentive payments.

I believe we have continued to make great strides in 2010 on our journey towards achieving and embedding best practice standards in risk management - and applying and integrating them with governance, capital, financial and performance management. I believe the activities outlined in this report will give you a better understanding of the progress we have made, provide insight into how we intend to continue our journey towards better outcomes, and ensure we fulfil the requirements of Solvency II.

Andrew Birrell

Group Risk and Actuarial Director

Optimising the upside and managing the downside

Risk management is an integral part of our management's decision-making process, enabling us to manage adverse impacts by helping to ensure that:

·      Risk-taking is a consciously chosen strategic decision and not accidental

·      Risk management is optimal and capital is effectively employed

·      The frequency and severity of surprises are reduced by timely measurement, mitigation and control.

Successful risk management does not mean that downside events will never occur, but that they happen infrequently and with low severity.  The Group also manages upside risk by exploring and exploiting risk opportunities, while ensuring that risks associated with these opportunities are fully understood and acceptable. This allows the Group:

·      Greater flexibility for reallocation of capital and risk capacity when opportunities arise

·      Competitive advantage through greater understanding of risk types, pricing and management.

Achievements in 2010 and objectives for the future

The following section sets out the progress we made in 2010 and our objectives for the future, as we instil risk management techniques to generate value.

Achievements in 2010

During the last 12 months we made significant progress towards embedding the 'strategic controller' operating model across the Group by revising the governance structure and processes, clarifying roles and responsibilities of Group and business units, and increasing the Group presence on business unit Boards and committees. We introduced revised governance committees and mandates in line with the recommendations made by the Walker Review of corporate governance. We set up dedicated Board Risk Committees in the major subsidiaries by separating the risk component from the previously combined Audit and Risk Committees. Heads of control functions in business units have an additional reporting line to their equivalent Group function head. Any concerns or issues raised by a business unit Chief Risk Officer will also be addressed at equivalent Group level.

In June 2010 the new Old Mutual Group Risk Strategy was completed and ratified by the Group Board. This is an integral part of the business planning process in which business units are required to ensure that plans align with strategy and reflect risk appetite limits. Over the past 12 months we made significant progress in developing and rolling out the tools that will help embed risk management more deeply during 2011 - including a system to monitor and to report on risks, issues and controls and their management, and a system for monitoring counterparty credit exposures.

Learning from any previous errors and issues is vital in the continuing development of risk frameworks and management. The reduction in operational losses, compared with the previous year, reflects how well this was embedded throughout the organisation in 2010. We will continue striving to reduce these losses further throughout 2011.

Our consistent group-wide 'three lines of defence' approach has enabled us to quantify exposures and, where appropriate, implement strategies to mitigate levels of risk deemed to be beyond our appetite. Where risk exposures are higher than our determined appetite we have implemented arrangements that allow us to monitor exposures continuously, implement proactive measures and ensure that they do not increase further.

Risk management system

We firmly believe that robust IT is a vital aid to embedding risk management in the Group. We have moved to implement our long-term strategy for a Group risk assessment and modelling tool in light of Solvency II and the iCRaFT vision. This tool has been designed to record qualitative data for all risk types and help calculate the capital required for operational risk. A centrally-hosted version has been piloted and will be embedded across the Group in 2011, providing a consistent group-wide platform for rapid collation and analysis of risks.

We have developed risk and control self-assessment, loss event and key risk indicator functionality, which will be implemented across the business by Q3 2011. All business units will be trained on the new system and methodology refinements. In the longer term we expect the risk tool to enable us to align our methodologies for risk management and financial controls. As the system can only be as good as the data in it, we are paying particular attention to reviewing and cleansing all risk data before moving it to the new system. In the first half of the year we will introduce the ability to calculate the capital required for the operational risks we have in the business; and this system will align with the capital modelling tool for all risks which is also due for completion in H1 2011.

Objectives for the year ahead

We are committed to building on our accomplishments in risk management to date in order to ensure best practice standards in our risk management framework. The iCRaFT programme is key to our aim of embedding a culture of 'managing for value'. We began it in April 2008 and it remains on target to be fully delivered by the end of 2012. As a business owned initiative, rather than a risk and actuarial programme, it will deliver positive benefits to the Group - including, we believe, full compliance with Solvency II requirements.

Our focus in 2011 is on embedding a consistent risk framework in the business units' first line of defence, with increased emphasis on risk considerations in strategic decision making through business planning, to obtain better outcomes in terms of returns, capital and risk exposure. This will be achieved through education and cultural change, using the tools developed in the iCRaFT programme.

Integrated Capital, Risk and Financial Transformation (iCRaFT) programme and Solvency II

The group-wide iCRaFT business change programme is designed to deliver the tools and processes that support management in achieving its key objectives by improving risk management standards and capital modelling techniques, and integrating them with strategic business performance management. By linking risk to business performance and capital management, the iCRaFT programme will deliver a platform that enables business units to maximise long-term value, and evidence Solvency II compliance, by January 2013.

Over the past 12 months the iCRaFT programme has focused on developing an internal model capable of meeting these key business requirements:

Strategic planning and capital management

·      The calculation of a Solvency Capital Requirement (SCR) that accurately reflects the risk profile of the business at legal entity level

·      The completion of an Own Risk and Solvency Assessment (ORSA) that accurately reflects the risks in the business and the economic capital required to deliver the Group's strategic objectives

·      A capital control framework aimed at allocating capital more effectively within the Group, which is capable of responding dynamically to changing capital needs.

Capital modelling

·      Measurement, projection, reporting and scenario testing capability for solvency and economic capital.

Improved oversight and governance

·      An embedded risk and control self-assessment process giving us the capability to monitor all risks and associated events across all risk categories

·      Defined key risk indicators (KRIs)

·      Strong asset and liability management incorporating embedded risk escalation mechanisms.

Risk Appetite

·      The ability to monitor risk limits against risk appetite by risk type at business unit and Group level

·      An embedded credit and investment concentration risk process capable of delivering accurate group-wide credit and counterparty data and a combined credit and concentration risk exposure across the Group.

Risk optimisation

·      Enhanced ability to optimise risk positions.

Management information

·      Timely, consistent quantitative measurement and reporting of risks across the Group.

Business planning

·      An economic profit metric which reflects risk-adjusted business performance and is embedded into all Group reporting, planning and incentive targets.

Product design, pricing and underwriting

·      Forecasting risk-adjusted profitability and portfolio effects in product design and profitability

·      A risk/reward balance in product design that minimises unwanted risks

·      Risk-adjusted technical pricing and primary profitability metrics.

Training

·      Education and training materials around the iCRaFT concepts, tools and management information process

·      An iCRaFT 'simulator', demonstrating how risk-adjusted metrics will be used to support decision-making, to facilitate learning and participation at all levels of the organisation.

External communications

·      Capability to meet Pillar 3 (public) minimum disclosure requirements

·      Clear, consistent and proportional risk and capital disclosures to inform external stakeholder understanding.

We believe our investment in iCRaFT will bring a new level of maturity and robustness to our risk management processes and internal controls. Once complete, it will give the Board and other management bodies enhanced tools for meeting their responsibilities to shareholders and customers by ensuring that the Group is always operating to its target best-practice standards.  'Managing for value' is at the heart of what iCRaFT is trying to achieve. It will show that whilst we must be prepared to take on risks, we will manage them in an integrated and consistent way with proper care for our customers, shareholders and staff.

Robust, evolving Enterprise Risk Management

During the past 12 months we have strengthened our risk management framework, embedding a risk appetite process into the first line of defence and increasing challenge on risks and management actions. We have developed a process and accompanying dashboards to assess the effectiveness of the embedded framework in business units. We have reviewed and revised the Group top risks to better reflect the risk profile and developed processes for continuous review.

We continually review our risk management framework, including risk assessment and modelling tools, against Solvency II and longer term requirements. We have aligned our risk categorisation model with our internal capital model framework and developed key risk indicators for the Group's top risks. A clearly defined escalation process for all risk-related matters is now firmly embedded in business units.

We have enhanced our operational loss data collection and analysis processes, enabling business units to focus on action to prevent recurrences as well as remediation. We have put thresholds in place for reporting losses to appropriate committees, and a greater emphasis on analysing losses by category has enabled us to take more streamlined action. The enhanced risk reporting framework provides better quality management information and the introduction of standard risk reports has ensured consistency of reporting to committees. Snapshot reporting outlines key risk information in each business unit and supports the Executive Committee's decision making processes. Policies will be amended in line with the revised strategic controller model, risk management categories and Solvency II.

The following sections set out our risk management framework, illustrating how each layer of tools and systems gives us assurance to manage the upside of risks better by maximising opportunities while minimising the downsides or threats. In this context, this section covers:

·      Risk management governance

·      Group oversight, including

- Strategy and business planning
- Risk appetite Stress and scenario testing
- Policy setting

·      The risk framework employed by each of our business units to provide consistent information.

Risk management governance

We strengthened our risk governance framework in 2010 with the introduction of clearly defined risk appetite reporting, which allows us to rapidly identify and respond to changes in risk exposure. Developments expected in Q2 2011 will enable Group Risk and business units to model a number of different scenarios against risk appetite and align these scenarios with investment decisions. Focus will now move towards more active risk-based steering of the business.

We consolidated our 'three lines of defence' approach to provide greater clarity within each of the lines. Changes included:

·      Reviewing and enhancing the Group's risk governance structure by strengthening the mandate of the risk committees

·      Dual reporting of business unit Chief Risk Officers to line management and the Group Risk and Actuarial Director

·      Segregation of the Board Risk Committee and Board Audit Committee in accordance with the recommendations in the Walker Report

·      Adoption of a 'strategic controller' model.

The governance framework is designed to align the risk/reward balance with corporate governance objectives and ensure it promotes effective risk management. The framework includes a remuneration policy for determining risk tolerances that do not encourage risk taking outside the Group's risk appetite. The remuneration policy has been designed to eliminate conflicts of interest and support business strategy, objectives, values, and the long-term interests of the Group.

The policy is overseen by a Remuneration Committee which is appointed by the Board and consists of at least three non-executive directors with relevant experience and a good knowledge of the Company and the environment in which it operates. This enables the committee to exercise competent judgement on compensation policies and the incentives for managing risk, value and capital in line with stakeholders' expectations.

In this report, we focus on the responsibilities of the second line of defence committees: Board Risk Committee, Group Executive Risk Committee and Group Capital Management Committee. The responsibilities and remit of the first- and third-line forums can be found in the governance report.

Group Board Risk Committee

This committee's primary purpose is to review, on behalf of the Board, managements' recommendations on risk in relation to the structure and implementation of the Group's risk framework. This includes the quality and effectiveness of the internal controls, risk appetite limits, risk profile and capital management processes.

The committee reports to the Board any significant risks to the Group where it considers actions or improvements are needed, and makes recommendations as to the adequacy of the risk mitigation plans. The committee works closely with the Group Audit Committee in assessing the effectiveness of risk managements systems and internal controls. Additionally, the committee provides advice to the Board and Remuneration Committee on the appropriate targets for risk adjusted performance measures and relationship between performance objectives, remuneration decisions and risk profile. The committee meets at least four times a year and otherwise as required, to review any significant issues that occur outside its scheduled meetings.

The committee monitors, reviews and provides advice to the Board on the following key areas:

·      The effectiveness of the Group's risk framework and the risk and regulatory operating plans

·      Alignment of the risk appetite to the Group's strategy, including approving actions plans to bring risk exposures within appetite

·      Optimisation of risk by reviewing, monitoring and challenging the Group's risk profile in terms of risk exposures, risk trends, risk concentration and performance versus appetite

·      The impact and management of significant issues and losses to the Group

·      Proposed strategic acquisitions and disposals of assets

·      Allocation of capital within the Group and within businesses to ensure compliance with regulatory requirements and consistency with risk appetite limits

·      The Group's resilience to unforeseen economic and other shocks, as evidenced via stress and scenario testing exercises

·      Regulatory compliance processes including changes to the regulatory environment and the adequacy of management actions to correct regulatory breaches

·      Effectiveness of the Group's policy suite and any changes necessary to evidence compliance with the Group's minimum standards.

The committee also provides advice to the Board on a number of inherent risks within the business and is required to act independently to investigate any activity within its terms of reference. The committee is authorised by the Board to obtain external legal, accounting or other independent professional advice it considers necessary. In addition to an internal reporting line to the Group Finance Director, the Group Risk and Actuarial Director has a reporting line to the committee, with direct access to the Chairman on a regular basis.

The committee, including its chairman, is appointed by the Board and includes the Group Finance Director and independent non-executive directors, at least one of whom must have recent and relevant risk experience.

Group Executive Risk Committee (GERC)

This committee provides support and assurance to the Group Risk and Actuarial Director on the implementation of the Group's risk framework including the quality and effectiveness of internal controls, risk appetite, risk profiles and capital modelling processes. The committee forms part of the second line of defence at Group level and is not responsible for any first line activities.

The committee comprises senior Group executives from Risk, Actuarial, Capital, Compliance, and Internal and External Audit. Its main responsibility is to support the Group Executive Committee in understanding and overseeing the implementation of the Group's risk framework, including risk appetite and capital management.

The committee's other key responsibilities are:

·      Monitoring and reviewing the Group's risk profile including losses and control breakdowns

·      Proposing risk appetite limits for approval by the Group Board Risk Committee, allocating these to the Group's respective business units to optimise results

·      Providing assurance that effective risk optimisation is being fully achieved both within business units and across the Group

·      Providing oversight of capital management to ensure allocation is consistent with risk appetite limits.

The committee receives reports from Group Risk and Actuarial, Group Finance, Treasury and iCRaFT. It provides input to the Group Executive Committee and the Group Audit and Risk Committees. It also works closely with the Group Capital Management Committee.

Group Capital Management Committee

This committee ensures that the Group's capital is managed in a consistent manner, aligned to the expectations of our shareholders, and that this capital is provided on an appropriate risk/return basis, as identified by the GERC. It is the mechanism by which the Group ensures that capital is allocated to business units in line with Group strategy, and that appropriate return rates are set and monitored. If necessary it will reallocate capital for greater reward.

The committee comprises senior Group executives, including the Group Chief Executive, Group Finance Director and Group Risk and Actuarial Director, and representatives from Capital, Treasury, Strategy and Compliance.

The committee's key responsibilities are:

·      Recommending to the Board the Group's capital allocation and structure and investment strategy

·      Setting an appropriate framework for managing capital

·      Issuing guidelines and/or recommending targets to ensure the appropriate management of capital within the agreed risk appetite limits.

Group risk profile

The Group risk profile is defined by the level of each risk type and the balance between them inherent in the business. Corporate guidance is provided to senior management to set clear parameters and balance capital and value on a forward-looking risk-sensitive basis.

These parameters determine our risk appetite and provide a basis for business units to plan and control business activities by setting clearly defined boundaries, aligning capital, risk and return on a basis proportionate to stakeholder expectations. They are a critical path within our policy framework which supports the Group's corporate objectives by providing a consistent high-level approach to managing the risks that we face.

Risk strategy

A project to formalise the Group's risk strategy was completed in May 2010. It identified five key elements for strategic management of risk in the Group:

·      Risk philosophy

·      Approach to measuring and managing risk

·      Risk and return preferences

·      Current risk profile

·      Target risk profile for the future.

Business unit risk strategies have now been formalised as part of 2011-13 business planning process. Quarterly business reports provide a check that limits are embedded within the business process following formal implementation. Old Mutual's Group risk strategy is intended to have a lifespan of three to five years and is aligned with Group strategic targets.

Risk philosophy

Our Group risk strategy starts by considering the type of business that we are, our business strategy and its implications for the way we think about risk.

We are a risk intermediary, in the business of taking on (and in most cases repackaging) risks and capital market solutions for customers where we can manage them efficiently, through diversification, access to markets and economies of scale. We will accept the risks implicit in this, where we are rewarded for doing so and where we have the skills to manage these risks. However, we will not take on other significant risks on our own account, or risks that would threaten our future ability to act as a risk intermediary.

We will focus on risks where we believe we can provide value to policyholders and depositors, and for which they are willing to pay us the correct amount to protect them. These risks primarily relate to liability, business, investment and operational risks in respect of insurance entities, business risk in respect of asset management entities and credit (loan), business and operational risks in respect of banking entities in the Group. We will not take on pure market risk on our own account, nor exposure to significant catastrophe risk, which we have neither the skills nor the capital to manage.

We will take a group-wide perspective on risk when making decisions. This is aligned with our shareholders' view: they invest in Old Mutual as a Group and so we should think and act as a Group. In line with the Group operating model, the Group functions will achieve this through discussion and the right of veto, in particular through the business planning process, rather than centralised control.

Business units will be required to hold and manage to local capital standards and we will not operate a 'group support' system that takes account of diversification between business units. This avoids any potential concerns over contagion and gives Group and business units maximum freedom to manage their businesses without constraints. However, the Group functions will monitor risks group-wide and encourage mitigation at a level appropriate for the Group as a whole rather than for individual business units. Group functions will facilitate intra-group risk transfers and mitigation, and the efficient use of available financial resources across and between Group entities to the extent allowed by the Board and regulatory considerations. In particular, Group functions will facilitate the use of financial resources around the Group to support risks wherever they may occur, and will take advantage of group diversification to obtain maximum flexibility in capital raising and management.

In designing products, making investments and deciding the business strategy, the Group and each business unit will seek to optimise the risk/return/capital trade-off (as opposed to taking a purely loss-minimisation approach). Risk should be considered in terms of both the potential reward it brings and the threat it presents. In particular, the risk must be appropriately rewarded, allowing for all its characteristics, for the expected return and the relative upside and downside it brings. The expected reward for the opportunity must at a minimum exceed the return available to shareholders directly for exposure to similar risks through other means, having fully allowed for all costs of management and risk capital. We need to ensure that we earn the required minimum return on the capital that we put at risk (usually the capital required in order to underwrite the risks) and that we at all times have adequate capital to cover the requirements from business activities.

We recognise that business units have the choice of whether or not to take on only certain risks - a product exposes the Group to a bundle of risks, and it may not be possible to price them all at a profit or even to know the split of charges made by risk. However, business units must be clear that overall their business is profitable, understand what risks they are exposed to, and be clear on the cost of providing specific features, regarding the reasons, implications of and benefits gained should the price charged to the customer be below cost. These questions should be explicitly considered in pricing, product design and business planning. This extends to lines of business that are supported by cross-selling or renewals. Such products may appear unprofitable on a standalone basis but be value-adding in total. However, in writing such business it is necessary to be clear as to where such cross-subsidies exist, and how they are managed to ensure that business which provides subsidies is sustained over time.

The risks in any business must be well understood and we need to have the appropriate skills and systems to manage them. To the extent that this is not the case, we will limit exposure to such risks until we have developed appropriate expertise.

As an overarching principle, risks accepted must not fundamentally threaten the Group's ability to continue writing new business freely, since we are in the business of providing risk intermediation and repackaging, not of taking off-strategy bets with our capital.

We consider the risk assumed, capital required and value created in the business from a market consistent economic perspective, recognising that regulatory and accounting systems can impose additional constraints. While seeking to mitigate these constraints we will not make decisions that are fundamentally uneconomic. This means that business and pricing decisions will be made on a 'market-consistent' basis, fully allowing for the additional costs of holding risk and regulatory capital. This view is aligned with best practice in the financial services industry and also the Basel II regulations for banks and Solvency II regulations for EEC insurance companies due to be introduced in January 2013.

Our approach to measuring and managing risk

We will continue to measure and manage risk using the same risk metrics that we currently use: earnings at risk, economic capital at risk and cash flow at risk. As Solvency II becomes a reality, economic capital at risk is likely to become the dominant measure. In addition, we closely track operational losses as an indicator of operational risk, to ensure that there are no repeatedly-occurring inherent weaknesses in systems and controls.

However, we will refine the way that we set risk limits around these targets. In particular, we will make limit-setting an iterative part of the business planning process, and ensure that local risk limits are an output of this process, reflecting local business plans rather than set in a purely top-down fashion. As part of this we will set risk limits by risk type at both Group and business unit level.

Group risk preferences

As a Group we want to accept risks that we are rewarded for assuming, and which we have the skills to manage. We wish to avoid risks where we earn less than our cost of capital (after allowing for all costs) or where we expose ourselves to very volatile or extreme potential outcomes, which would threaten our ability to continue acting as a risk intermediary. Finally, we wish to write business which diversifies well against our current book. By acting in accordance with these preferences we will enhance overall capital efficiency and returns, and will hence maximise economic profit and value creation for all stakeholders.

Risk type	Old Mutual risk preference	Marginal impact of extra exposure on economic capital at Group level	Expected return relative to target*
Liability (insurance underwriting)	Strongly for	11%	Excellent
Asset liability management (policyholder)	For	86%	Excellent
Business	Neutral	47%	Good
Credit	Against **	64%	Neutral
Market (shareholder)	Against	78%	Poor
Currency	Against	81%	Poor
Operational	Strongly against	42%	Very poor

* Assumes risk is correctly priced,

** Unless taken in the form of well governed and managed banking related credit risk

Marginal contribution to Group economic capital: for every £100 of economic capital that a business unit has to set aside to underwrite a risk type, the Group has to set aside the percentage in brackets per risk type: so for every £100 of additional economic capital for liability risk, the Group needs to hold £11 on a diversified basis, and for every £100 of asset liability management-related economic capital risk in a business unit, the Group needs to set aside £86 on a diversified basis. Thus when we consider economic profit (see below for definition), if we are earning a given IFRS-adjusted operating profit (AOP), and have a given cost of capital, we can maximise economic profit by minimising economic capital. Hence we have certain preferences for activities that will maximise AOP, yet minimise economic capital on a Group diversified basis.

Economic profit = AOP - (cost of capital x allocated capital)

Risk profile - current and target

In order to better align the Group's risk profile with our stated risk preferences and to ensure the Group achieves a good level of diversification, we have defined a target risk profile based on economic capital exposure without any allowance for diversification benefit. We will steer the business towards this profile over the next three to five years. This target profile is preferred to the current profile as it better matches our risk preferences and is also well diversified across risk types. The current and target profiles are shown below.

We aim to increase liability risk by increasing the volume of protection products written and to reduce operational risk. The anticipated disposal of US Life will significantly reduce the Group's credit risk exposure and hence assist with the move towards the target risk profile. This will provide capacity to take on additional ALM risk, in markets where we believe we can earn acceptable risk-adjusted returns on the capital invested in such products.

Current Risk Profile

ALM                             26%

Business                       24%

Credit Nedbank              7%

Credit Other                   15%

Currency                       4%

Liability                         8%

Market                          4%

Operational                    12%

Target Risk Profile

ALM                             35%

Business                       24%

Credit Other                   6%

Currency                       5%

Liability                         17%

Market                          3%

Operational                    10%

Note: The current risk profile is based on the Group's present structure, prior to any disposals, and since it is expressed on a standalone basis, ignores diversification between risks and between business units.  Later tables refer to post diversification exposures.

Risk appetite

We continue to develop our risk appetite methodology to ensure that there is a seamless transition of economic capital at risk into a Solvency II compliant internal model calculation, which will include:

·      Moving away from the use of market consistent embedded value as a proxy to estimate changes in assets and liabilities in stress scenarios, towards a direct calculation of the results of these stresses

·      Redefining hard available financial resources to be compliant with a Solvency II market-value balance sheet calculation

·      Reviewing risk-factor stress assumptions and the approach to modelling diversification benefits, with methodology changes required to ensure a statistically robust approach

·      Internal model initiatives will transition to business as usual reporting during Q3 2011, to show that they are used in decision-making within our business.

Throughout the year, business units calculate their risk exposures against the appetite set by the Group. The five quantitative measures we use to express our risk appetite limits and exposures are:

·      Economic capital at risk (ECaR)

·      Financial Group Directive (FGD) surplus capital at risk (FCaR)

·      Earnings at risk (EaR)

·      Cash flow at risk (CFaR)

·      Operational risk (OpRisk)

Risk appetite results

	Total Group Results
	Jun-10	Dec-09	Effect of US Life Disposal on June 2010
AFR*	8,692	8,258	8,719
ECaR (7-10,000)	6,869	6,849	5,452
Solvency Ratio	127%	121%	160%
EaR (1-in-10)	807	872	703
CFaR (1-in10)	613	726	513
OpRisk (1-in-10)	165	162	162
FGD Surplus	1,953	1,504	1,892
Post stress FGD Surplus (1-10)	1,232	751	1,247

* AFR - Available Financial Resources that can be used to cover the Economic Capital requirement

Economic capital at risk (ECaR)

ECaR is defined as the reduction in post-tax economic value (broadly defined as market consistent embedded value for life companies and IFRS equity for non-life companies) over a one-year forward-looking time horizon that should only be exceeded seven times in 10,000 years (99.93% confidence level).

ECaR helps us to optimise risk-based decisions. The stress tests underlying ECaR allow us to monitor our exposures and deepen our understanding of where the business could further improve its capital allocation.

We have set risk appetite limits for economic capital based on the ratio of available financial resources to economic capital. The Group risk appetite is for this ratio not to fall below 100%.

This is an economic measure of capital requirements similar to the Solvency Capital Requirement measure in Solvency II and has been calculated and reported within the Group for more than five years.

FGD surplus capital at risk (FCaR)

FCaR is defined as the reduction in Financial groups directive surplus over a one-year forward-looking time horizon that should only be exceeded once in 10 years (90% confidence level).

We recognise that FGD is a key regulatory measure which is particularly important to monitor in volatile economic conditions where our policyholder and shareholder assets can significantly impact our position - particularly since we hold these assets in a variety of currencies.

We have set risk appetite limits for FGD surplus capital based on the minimum surplus capital that the Group would tolerate. The Group risk appetite for this metric, given the current composition of the Group, is that the FGD surplus should not fall below £1 billion more than once in 10 years.

Earnings at risk (EaR)

EaR is defined as the reduction in pre-tax IFRS adjusted operating profit (AOP) over a one-year forward-looking time horizon that should only be exceeded once in 10 years (90% confidence level).

We have set risk appetite limits for EaR as a percentage of pre-tax AOP. The Group risk appetite is for this percentage not to rise above 30% of planned earnings over the next year.

Cash flow at risk (CFaR)

CFaR is defined as the reduction in the cash portion of earnings over a one-year forward-looking time horizon that should only be exceeded once in 10 years (90% confidence level).

We have set risk appetite limits for CFaR based on the maximum reduction in cash earnings that the Group would tolerate. The Group risk appetite is that this reduction should not exceed £500 million.

Operational risk (Op Risk)

The operational risk metric is defined as the reduction in post-tax economic value due to one-in-10 unexpected operational loss events (90% confidence level) and expected day-to-day losses, including reputational risk impacts.

We have set risk appetite limits for this metric as a percentage of pre-tax AOP. The Group risk appetite is for this percentage not to rise above 10% of planned earnings over the next year.

In addition to quantitative risk appetite limits, we also use qualitative risk appetite principles and statements to provide guidance to our business units and help to improve the clarity of our risk strategy in line with the Group's appetite for risk. During 2010 we continued to refine the basis under which limits are set and developed the link between operational risk loss data through the alignment of key risk indicators and risk appetite limits. We continually strive to refine the models and assumptions we use to increase the robustness of these calculations. Risk appetite limits are now fully integrated into our strategic decision making process and support the business planning and quarterly business review process including the robustness and governance of the action plans to reduce risk exposure.

The embedding of our risk appetite methodology is a cornerstone of our risk analysis capability. Using the economic capital at risk metric as an example, our economic capital calculations provide a long-term view of the risks in the business and oversight of the key threats facing the Group if an extreme event occurs.

The internal risk and control profile of the business is effective and continues to improve. Credit risk has reduced significantly as the investment portfolio continues to be de-risked on a capital neutral basis. Although exposure to corporate bonds still exceeds our risk appetite, we have continued to improve the investment grade of the portfolio in line with our target operating model. Market yields have improved, enabling better matching of new assets to sales. Yields are still below desired levels and continue to place pressure on long-term guarantees. Surrenders and lapses in excess of pricing assumptions adversely affect our ability to achieve target profit margins and recover expenses.

Stress and scenario testing

The Group performs ongoing stress and scenario testing and sensitivity analysis to monitor the robustness of our regulatory and economic capital position. These assessments help to inform management understanding of the capital that would be required in the event of any of the scenarios crystallising. The outputs of these tests help management to prepare for significant changes in the environment and protect shareholders and investors from unexpected loss.

The Group's current economic capital framework is a stress test calculated at the 99.93% confidence level, based on shocks calibrated to a 7 in 10,000 severity. Shock calculations are performed every six months: they are modelled as occurring instantaneously at the beginning of a period, with the impact assessed at the end of the period. Thus there is a high level of prudence built into the shocks. Allowances are made for diversification benefits, since not all shocks occur simultaneously, although the level of independence of shocks varies according to the factors.

Tests are performed to model the aggregation of impacts on:

·      Business risk (primarily related to expense and persistency risks)

·      Asset/liability management risk (the interaction of changes in markets on policyholder assets and liabilities)

·      Operational risk (risks related to people, systems and processes and changes in the environment)

·      Credit risk (non-payment on credit instruments and counterparty concentration risk)

·      Liability risk (related to underwriting insurance risks such as mortality)

·      Market risk (shocks to shareholder assets)

·      Currency risk (risks related to our reporting currency).

The Group's risk appetite is tested twice annually on the same basis as economic capital described above, in terms of impacts to earnings, FGD surplus, cash flow and operational risk, at a 90% (1-in-10) confidence level.

Management uses these calculations to determine whether the business is resilient to a 1-in-10 and 7-in-10,000 instantaneous shock, and the impact of management actions on the risk appetite framework of the business (to ensure that the business remains within the chosen risk appetite). We have developed the capability of our suite of tools to regularly test the Group's resilience to a 1980's V-shaped single-dip recession and recovery and the more recent regulatory recommended reverse stress test (testing to completely deplete regulatory capital).

Information on stress testing is reported to the Board Risk Committee and to management so that decision making is based on an understanding of potential impacts.

Risk appetite in action

Example 1

Old Mutual South Africa (OMSA) has in recent years leveraged investments in carefully chosen credit assets with the capability of delivering more attractive returns to clients, based on market trends. Ongoing analysis of the risk of overexposure to credit risk, in light of the recent economic crisis, identified the need to limit the amount of new exposure to credit risk from annuity and guaranteed products. The new limits look at the contribution of credit risk to overall OMSA risk exposure and economic capital and also at the exposure to credit risk from new business volumes.

Example 2

A business unit recently proposed to launch a new product with guarantees. In line with the Group product approval policy, this had to be signed off by the Group Chief Actuary. Analysis revealed that the maturity guarantee risk for one of the variants was excessive, and there were surrender guarantees that had not been properly considered. The profile was not compliant with the Group risk appetite and approval for this variant was denied. The business unit acknowledged this was the correct decision and the product was launched without the variant concerned.

Example 3

The US Life business was exposed to credit risk as a result of significant holdings of corporate bonds. Although improvements were made to the quality of the investment portfolio the overall Group exposure to credit risk exceeded the Group risk appetite. A strategic decision to divest our interests in US Life (expected to close in March 2011) will bring Group credit risk exposure within the determined risk appetite limits and in line with Group operating model objectives.

Conclusion

Setting risk appetite limits across the business has proved a valuable management tool and will ensure that going forward we grow our exposure in a controlled manner.

Solvency II Quantitative Impact Study 5 (QIS5)

Old Mutual successfully participated in the fifth Quantitative Impact Study (QIS5), as part of the ongoing Solvency II industry consultation led by the Committee of European Insurance and Occupational Pension Scheme Supervisors (CEIOPS). This was based on our 31 December 2009 balance sheet and involved an assessment of the Group's solvency position under technical specifications to test assumptions and dependency structures underlying Solvency II proposals.

We discussed our economic capital methodology in the previous section. As part of the iCRaFT programme we are implementing a new Internal Capital Model, which will give us the ability to calculate and aggregate group-wide shocks more rapidly. This model will be rolled out across the Group by Q3 2011. The QIS5 results were in line with our FGD Solvency I ratio and the results from our current economic capital internal model when equivalently calibrated to a 99.5% confidence level. Notwithstanding this, we believe that the QIS5 calibration is not completely appropriate for our business and so we will be seeking approval of our internal capital model before Solvency II begins, to ensure that the most appropriate model is in place to describe our risks, accurately calibrated for the markets we operate in.

A number of technical industry issues have been raised with the European Insurance and Occupational Pension Scheme Authority (EIOPA, previously CEIOPS) and the European Commission. Clarification on these issues - which include contract boundaries, treatment of expected profits on future premiums and grandfathering of hybrid debt - needs to be provided before the final impact of Solvency II can be understood.

Old Mutual's strategy has already considered the likely impact of the current Solvency II proposals on our Group and we do not presently anticipate that we would be required to raise additional capital as a consequence.

Policy setting

The policy framework supports our corporate purpose by providing a consistent high level approach to managing the risks we face in pursuit of our strategic objectives. Group risk policy statements set out the minimum standards that must be applied consistently across the Group. Their purpose is to ensure that risks are managed in line with the risk appetite and that businesses operate effectively and efficiently, in compliance with all applicable laws and regulations.

Business units ensure that their local policies and procedures are aligned to the Group Policy Suite. In many cases business unit policies include requirements beyond the Group's mandatory minimum requirements and incorporate applicable local regulations. Policies are subject to regular review to reflect changes in circumstances and the Group risk appetite. Group policies in place cover a range of topics, including liquidity risk, market risk, new product and business approval, capital and treasury risk and business continuity.

These policies are agreed by the GERC and approved by the Board Risk Committee. The Group policies are mapped to our risk categorisation model and form a key part of our governance framework. Their implementation allows the Group to establish a common framework of control across the business units.

Consistent business unit risk methodology

During 2010 we made a number of changes to the risk governance framework. One of the core requirements was further streamlining of techniques and tools to identify, monitor and mitigate risk in accordance with the Group's risk appetite. OpenPages was chosen as the designated risk management and reporting tool employed across the Group to ensure consistency of the risk management process and the determination of operational risk capital requirements.

The creation of a central data store for all risk information is a key part in transferring accountability for risk management into the first line of defence. The use of this tool will:

·      Provide greater insight and transparency of risk within the business units and at an overall Group level

·      Show where risk exposures lie in relation to risk appetites across the Group

·      Provide relevant management information more efficiently and improve the consistency of risk trends and the development of appropriate controls

·      Provide a more consistent way of continuously identifying, monitoring and measuring risk across the first line in all business units

·      Support the escalation of issues within business units and Group

·      Support risk-based business decisions by management

·      Link risk indicators to events and management actions in order to reduce the likelihood of risks occurring in the future

·      Calculate the capital required to offset operational risk and feed into the internal capital model.

Extensive training of the risk tool began in 2010. By the end of December 2010 most business units had been trained to use the tool, including the risk methodology, and one was actively using it. The roll out of a further release of OpenPages functionality (which will include the operational risk capital modelling capability), is planned to be completed at the end of Q2 2011. We have attached great importance to importing cleansed data into OpenPages and business unit senior management, Chief Risk Officers and Group Risk will be required to sign-off the data being migrated to the system.

Product development process

Risk assumption starts with the product development process, where new products are designed, priced, implemented on administration systems and sold to customers. Following our experience with guarantees in the Old Mutual Bermuda business, the Board implemented, in 2008, a centralised approval process for all products which may have implicit or explicit guarantees requiring sign-off from the Group Chief Actuary. The new process aims to ensure that product design is better understood and for aspects such as pricing, administration arrangements, marketing material and investment requirements to be rigorously challenged by an independent party, particularly in order to ensure that we fully understand product and capital consequences in the event of substantial product and market shocks.

Risk categorisation

Risk categorisation has promoted the consistent use of a common risk language across the Group, allowing meaningful aggregation and comparison of risks and issues and enhanced risk reporting to the Audit and Risk Committees and data sharing between business units. Risk categorisation will be used to introduce commonality of risk events within both the risk and control self-assessment and capital modelling processes.

Risk and control self-assessment (RCSA)

This industry standard approach to identifying, assessing and controlling risk is used by our business units to consider all risks consistently. Each business unit completes RCSAs regularly and escalates any significant new risks or issues to senior management immediately. This gives Group management an up-to-date view of risks and ensures that decision-makers are aware of areas of concern promptly so that appropriate action can be taken.

The RCSA process incorporates:

·      Ongoing identification of risks that threaten the achievement of objectives

·      Assessing these risks in terms of financial and qualitative impacts such as reputational, regulatory or customer

·      Determining whether the level of risk being taken is acceptable

·      Determining and implementing management action plans to bring risk exposures to an acceptable level if required

·      Ongoing monitoring and reporting of risks, control effectiveness and actions.

RCSA has strengthened our Group oversight and enhanced the flow of information, resulting in increased transparency, timely identification of risk trends across the Group and control improvements. The improved consistency of risk assessments in business units has enabled aggregation at a Group level to gain a much better informed picture of the overall Group profile.

Monitoring

Operational risk event data

We have successfully improved transparency and data sharing by rolling out the formal loss data collection standards developed in 2008 for the operational and strategic risk categories and embedding them across the Group. Standardisation of loss information across the Group has facilitated early identification of trends leading to control improvements, enhanced risk mitigation and improved aggregation of losses.

Our aim is to mitigate further operational risk events that lead to losses, within reasonable expectations, and to learn from all losses to improve processes and prevent recurrence.

The Group has subscribed to a database outlining significant operational losses in other companies. Data from this source helps us to take mitigating actions proactively, to avoid incurring similar losses.

Loss data collection has provided us with excellent ways to improve our customer experience. For example, during 2009 we observed a number of operational losses resulting from simple process errors. By collecting data systematically and consistently we have been able to pinpoint repetitive process failures and actively improve controls in these areas. This is an area that we are now focusing on, to make changes that will provide a better customer experience and reduce unexpected costs.

Key risk indicators (KRIs)

KRIs provide data on whether a risk is trending up, down, or is stable, both now and in the future. This acts as an early warning system, enabling management to take action to prevent the risk materialising.

During 2010 we identified KRIs against each of the Group's top risks. We see KRIs as a vital step forward in making risk information more transparent, and have begun data collection from the business units. In 2011 we will continue to enhance these processes through trend analysis and threshold setting.

Market consistent embedded value (MCEV)

In addition to the other tools described here, we use MCEV extensively for forward-looking assessment and monitoring of risk in the Group's life insurance companies. By analysing the source of MCEV operating earnings we can assess where emerging experience is significantly different from expectations. This allows senior management to identify emerging risks and trends quickly and take remedial action where necessary. The MCEV sensitivities allow us to understand the impact of changes in economic, demographic and operating conditions on the Group's embedded value. Finally, the market consistent value of new business provides information on the extent of investment risk that is embedded in new products. For further details, see the MCEV supplementary information in this report.

Understanding and identifying significant risks to Old Mutual

Old Mutual has previously experienced downside surprises due to a combination of imprudent lending decisions, insufficient reserving for claims and complex financial products. We have sought to learn from our experiences to ensure they do not recur. All financial service organisations are required to act quickly in tough environments and the recent financial crisis, aftershocks of which are still being felt, has brought many shortcomings to light. The consequence is that it is even more critical for organisations to ensure they fully understand the risks they are taking on - and the interdependencies between them - in order to hold sufficient capital and liquidity to cover a combination of risks occurring at once.

These are some of the most significant risks the Group faced during 2010:

Examples of identified KRIs

KRI	Risk type addressed	What it tells us
Expense levels - actual v forecast	Business risk	If trending up, Group's costs will be higher than planned, which if not compensated by a rise an income will mean profits will be lower than forecast. This trend will also show an increased exposure to business risk. The indicator allows proactive analysis to identify the reasons for the increase in expenses and guide appropriate management action.
Level (%) of voluntary turnover in key jobs	Operational risk	If trending up, this indicator can highlight a failure to retain top talent, which could drive recruitment costs higher than planned and prevent the Company from delivering on business plans. The exposure for the risk increases with the time key jobs are left vacant. The indicator allows analysis of the reasons people leave and guides corrective action.
Assets in excess of local regulatory capital requirements	Solvency risk	If trending up, this indicates that the Group's solvency position is worsening and the risk of regulatory intervention is increasing. The reasons for the reduction in surplus assets can be identified and strategic decisions considered to ensure the trend does not continue.

Significant risks to Old Mutual

Risk type	Risk as a threat and uncertainty	Mitigating actions and opportunities
Business risk	We operate in a highly competitive environment. If we are not able to compete successfully there is a risk of reduced market share, revenues or profitability. Business risks arise where business performance falls below projections as a result of negative variances in new business volumes, margin, lapse experience and expenses. The profitability of our businesses could be adversely affected by a worsening of economic conditions. Changes to the distribution environment (for example through regulation or failure of distribution providers) could have an impact on our business.	We offer innovative products to suit different clients and needs, enabling us to find opportunities even in challenging market conditions. Business units pay great attention to product strategy, with increased focus on product profitability and improved persistency. We closely monitor lapse rates and persistency information, adapting our business approach as necessary. Old Mutual is diversified across geographies and product lines, minimising the impact of sector- or territory-specific economic downturns. We monitor developments in the distribution sectors across all geographies and our strategic planning and research teams help position us to reduce this risk.
Credit risk	The Group is exposed to the risk of credit defaults. This includes counterparty risk where an asset (in the form of a monetary claim against counterparty) is not repaid in accordance with the terms of the contract. Credit risk also encompasses lending risk (for example within our banking businesses), where a borrower may be unable to repay amounts owed. Credit risk also arises from financial guarantees that the banking businesses have to act on where clients default on their obligations with respect to the financial guarantees.	The Group has adopted a policy of only dealing with approved counterparties and obtaining sufficient collateral where appropriate as a means of mitigating the financial loss from defaults. We continuously monitor the Group's exposure and the credit ratings of counterparties. As part of getting ready for Solvency II regulations, developments are underway to enable reporting on and analysing credit exposure holistically across the Group.
Market risk	The risk that adverse changes in market values of assets and liabilities negatively impact future earnings. Market volatility is a specific concern for us insofar as the Group may be unprepared in conditions of extreme market volatility resulting in unexpected capital calls and stressed liquidity. Some of our life assurance businesses contain investment guarantees and options. A reduction in interest rates and equity markets can cause more of these to be in-the-money, with a potentially adverse impact on profit.	The upside presented by market risk is evident when equity values rise or interest rates move favourably. Then the Group is well positioned to gain over and above the benchmark, particularly in retail and institutional asset management products and activities, since fee income will rise faster than associated expenses. Business units exposed to downside market risk as a consequence of the liabilities they have underwritten are required to take account of the structure of their asset and liability portfolios as well as the local regulatory environment and Group policy requirements. Actions used by individual business units to manage market risk include asset-liability matching, interest rate swaps and hedges to manage interest rate risk, equity hedges to manage equity risk and currency swaps, currency borrowings and forward foreign exchange contracts to mitigate currency risk.
Risk type	Risk as a threat and uncertainty	Mitigating actions and opportunities
Liquidity risk	Liquidity risk for the Group could materialise where we are unable to sell assets in an illiquid market - leading to potential asset liability matching problems and depleting capital. Liquidity risk could also pose potential losses where the Group is unable to meet its obligations as they fall due (as a result of counterparties providing short-term funding or where they withdraw or do not roll-over the funding).	We aim to maintain a prudent level of liquidity consistent with regulatory expectations. Our group-wide liquidity policy sets out the parameters within which all business units must operate in order to identify, measure and manage liquidity risk. The Group Capital Management function reviews capital and liquidity positions, with the Group Executive Risk Committee providing additional oversight and challenge. By monitoring our liquidity position prudently, we are well positioned to identify surplus liquid assets available. Liquidity headroom is a key risk indicator and control for managing Group liquidity risk. It ensures we have sufficient liquidity to cover both asset liquidity risk and finding liquidity risk.
Operational risk	The risk arising from operational activities, for example a failure of a major system, or losses incurred as a consequence of people and or process failures, including external events. Specific examples include the ability to attract and retain key staff with the necessary skills to help the Group meet its objectives, and adequate protection of people, premises and data (including IT sustainability and infrastructure).	Taking greater operational risk rarely gives the Group greater reward and therefore we aim to minimise our operational risk exposure across the Group. The Group has developed OpenPages as its strategic risk management system which is currently being rolled out and embedded across the various business units. This will increase our understanding of the operational risks in the business and facilitate improvement in the controls to reduce losses. Operational risk is one of the metrics in our risk appetite framework: it is continuously monitored and we take action if it approaches the limit.
Liability risk	Liability risk for long-term insurance business arises through exposure to unfavourable claims experience on life assurance, critical illness and other protection business. For general insurance it also includes the risk of loss from fire, accident or other claim sources. This is the risk that there are more claims than expected or claims are more severe than expected. Liability risk includes underwriting risk, which is the misalignment of policyholders to the appropriate pricing basis or impact of anti-selection, resulting in a loss. The business units which incur significant liability risk are Emerging Markets, which provides long-term insurance, and M&F, which provides short-term insurance.	Liability risk is managed by:   Maintenance and use of sophisticated management information systems which provide current data on the risks to which we are exposed   Use of actuarial models to calculate premiums and monitor claims patterns using past experience and statistical methods   Guidelines for concluding insurance contracts and assuming liability risks - such as underwriting principles and product pricing procedures   Reinsurance to limit our exposure to large single claims and catastrophes   An effective mix of assets that back insurance liabilities based on the nature and term of these liabilities.
Strategic risk	The risk that discretionary decisions will adversely affect future earnings and the sustainability of the business. Specific exposures include the ability of the Group to successfully implement the current levels of change experienced. Another possible risk could be from external constraints imposed by regulatory or government bodies impacting on our ability to deliver our strategy.	We actively monitor our strategic implementation portfolio for any material changes. Progress and activities are co-ordinated with the Group strategy to ensure that the 2011 strategy can be tracked. This includes actively working with the different business units and Group Executive Committee on change capability development.

The term 'insurance risks' in the notes to the accounts is defined, for accounting purposes, as the risks other than financial risk that influence the insurance liabilities associated with insurance contracts. For the long-term insurance businesses these arise through exposure to unfavourable claims experience on life assurance, critical illness and other protection business and exposure to unfavourable operating experience in respect of factors such as persistency levels and management expenses. For general insurance it also includes the risk of loss from fire, accident or other claim sources. These risks are included within the liability risk and business risk categories described above under the heading "Significant risks to Old Mutual".

Group risk profile

The table below shows the significant risks to the Group, in order of importance. These figures are stated after allowing for the benefit of diversification between risk types and between business units. The overall diversification benefit gives rise to a reduction of 38% in the risk exposures when compared to the standalone exposures, since the correlation between risk types and different geographies is less than 100%, which limits the likelihood of multiple risks occurring simultaneously.

Significant risk exposures by business unit and risk type

	Long-term savings	Banking	US Life	Legacy	Short-term insurance (M&F)	US Asset Management	GHO
1. Asset liability management risk (policyholder)	19%	0%	6%	6%	0%	0%	0%
2. Credit risk	3%	8%	14%	1%	0%	0%	0%
3. Business risk	18%	3%	0%	0%	0%	1%	0%
4. Operational risk	4%	1%	0%	0%	0%	1%	1%
5. Currency risk	0%	0%	0%	0%	0%	0%	7%
6. Market risk (shareholder)	2%	3%	0%	0%	1%	0%	0%
7. Liability risk	1%	0%	0%	0%	0%	0%	0%

Credit risk

Business units are responsible for establishing appropriate systems and governance structures to ensure that they actively monitor credit risk in a manner consistent with Group policies and principles. Business units are responsible for ensuring that their credit risk exposures remain within the appetite limits set by the Group. As part of our plans to enhance the Group's credit risk management framework, we are reviewing the Group's credit risk policy, limits, and reporting systems. We are introducing improvements to allow the Group to adopt a more dynamic and timely approach to identifying and managing credit risk exposures. The Group Executive Risk Committee monitors and challenges large exposure concentrations across the Group.

Group Credit Exposures by Sector 31 December 2010

Banks & Financial Services                    39.67%

National & Local Government                  14.58%

Real Estate                                           7.52%

Telecommunications Services                 5.27%

Mining                                                   3.79%

Insurance                                              3.17%

Oil & Gas                                              3.13%

Electricity                                              2.53%

General Retailers                                   2.33%

Other                                                    18.01%

The top five exposures by sector remain unchanged from 2009, although there has been an increase in our total exposure to banks and financial services, offset by a reduction in exposure to national and local government. This mirrors the shift in credit risk to sovereigns from the financial sector throughout 2010. Most of the exposure to the banks and financial services sector stems from the non-banking book, while the banking book accounts for the largest portion of the national and local government sector. This is driven by the substantial amount of South African government debt which Nedbank is required to hold as a minimum reserve requirement.

The Group's exposure to the European peripheral economies is not deemed significant and is primarily to highly-rated institutions. As at the date of writing, the Group had less than £10m of exposure to the sovereign debt of European peripheral economies. We intend to maintain our exposures at low levels and to continue to monitor further developments in this region. Looking ahead, the planned disposal of US Life in 2011 is expected to reduce the Group's credit risk exposure significantly, particularly in the banks and financial services sector.

Market risk

We define market risk as the risk of changes in the value of our financial assets or liabilities arising from changes in equity, bond and real estate prices, interest rates and foreign exchange rates, in the way they impact on shareholder assets. The impact of such movements on policyholder assets and liabilities are defined under ALM-related risks, which can cover mismatches of assets relative to liabilities, and also the impact of a change in fund related management fees earned from client portfolios as a consequence of movements in asset markets.

Market risk arises differently across the Group's businesses, depending on the types of financial assets and liabilities held.

Market equity risk is the most significant market risk type across the Group. We monitor our market exposures for early identification and management of these risks. We conduct separate analyses to understand the impacts on both shareholder and policyholder assets.

In respect of the investment of shareholders' funds, equity price risks are addressed in the Group's various investment policies, which tightly limit the opportunity for business units to invest their own capital in equities or equity funds. As a result, the shareholder assets invested to back the statutory capital requirements across the Group are typically invested in sovereign bonds and cash. There is some remaining shareholder exposure to equity markets within OMSA. To mitigate the risk of falling equity markets adversely impacting the shareholder capital position, we use extensive equity hedging. We regularly evaluate the value and protection offered by the hedges that we operate in order to decide the appropriate level.

Sensitivities to adverse impacts of changes in market prices arising in our insurance operations are set out in the Old Mutual market consistent embedded value supplementary information section of this Annual Report. For our insurance operations, equity and property price risk and interest rate risk are modelled in accordance with the Group's risk-based capital practices, which require sufficient capital to be held in excess of the statutory minimum to allow us to manage significant exposures in line with the Group risk appetite.

Each of the Group's business units has its own policies, principles and governance to manage its market risk in accordance with local regulatory requirements. These are supplemented by group-level monitoring as part of the risk appetite framework. The impacts of changes in market risk are monitored and managed using sensitivity analyses, through the business units' own regulatory processes, with reference to the Group's risk appetite framework, and by other means. This work is complemented by the Group's reporting processes, which include assessments of the sensitivity of our capital position and embedded value to various market changes.

Business risk

A significant component of the monthly management information communicated at Group level relates to ongoing measurement of the level of sales of each business, the level of expenses in that business against those planned and in previous years, as well as the level of surrender activity.

All new life assurance product developments with financial guarantees within the Group are subject to a rigorous approval process, culminating in the Group Risk and Actuarial Director either approving or rejecting the product before launch. In all cases a series of product development committees and stringent requirements must be passed before the new product can proceed to launch. This has been supplemented during 2010 with the establishment of the Long-Term Savings (LTS) product team, who are responsible for reviewing all product proposals from the LTS business units as well as leveraging synergies across product developments within the Group. This provides additional mitigation against the risk of poor product performance and design.

Many of these additional requirements have been introduced following experience relating to the Old Mutual Bermuda UGO Variable Annuity product. All potential risks to the Group as a result of writing the new product are considered before the product is escalated to the Group Risk and Actuarial Director for approval. These risks include, but are not limited to: investment, expense, surrender, mortality and operational risk (including reputational effects). An assessment of the cost of offering the financial guarantee is also included. Extensive scenario and stress testing is undertaken for all new product developments, so that the new business margin and market-consistent value of new business can be assessed under a range of different adverse scenarios, including a worst-case scenario as well as the base case. We also evaluate all new product developments in light of our commitment to treat customers fairly.

Quarterly group-led business reviews with each of the businesses ensure regular dialogue and oversight of business performance. At each meeting, business risk is monitored and, where appropriate, actions are agreed to mitigate negative trends. We make particular use of MCEV to monitor experience as it emerges.

Liability (insurance underwriting) risk

The Group assumes liability (also referred to as insurance underwriting risk) risk by issuing insurance contracts under which it agrees to compensate the policyholder or other beneficiary if a specified uncertain future event affecting the policyholder occurs. This risk includes mortality and morbidity risk in the LTS business units and a risk of loss from fire, accident and other sources in M&F, our short-term insurance business unit.

Our liability risk exposure is relatively low as we manage it effectively through:

·      The relatively weak correlation of liability risk with our other risk types, which reduces our exposure after diversification over several insurance classes and a number of geographical segments

·      Maintenance and use of sophisticated management information systems which provide current data on the risks to which we are exposed

·      Use of actuarial models to calculate premiums and monitor claims patterns using past experience and statistical methods

·      Guidelines for concluding insurance contracts and assuming liability risks, such as underwriting principles and product pricing procedures

·      Reinsurance to limit our exposure to large single claims and catastrophes

·      An effective mix of assets that back insurance liabilities based on the nature and term of those liabilities.

Long-term insurance

The table below shows our key liability risks associated with long-term insurance, along with risk management actions within the LTS business units:

Risk	Definition	Risk management
Underwriting risk	Misalignment of policyholders to the appropriate pricing basis or impact of anti-selection, resulting in a loss	Experience is closely monitored. For universal life business, mortality rates can be reset. Underwriting limits, health requirements, spread of risks and training of underwriters all mitigate the risk.
HIV/AIDS risk	Impact of HIV/AIDS on mortality rates and critical illness cover	Wherever possible we write products that allow for regular repricing or are priced to allow for the expected effects of HIV/AIDS. We require tests for HIV/AIDS and other tests for lives insured above certain values: a negative test result is a pre-requisite for acceptance at standard rates.
Medical developments (longevity) risk	Possible increase in annuity costs due to policyholders living longer	For non-profit annuities, improvements to mortality are allowed for in pricing and valuation. Experience is closely monitored. For with-profit annuity business, the mortality risk is carried by policyholders and any mortality profit or loss is reflected in the bonuses declared.
Catastrophe risk	Natural and non-natural disasters, including war and terrorism, could result in increased mortality risk and pay-outs on policies	We have a catastrophe stop loss and excess of loss reinsurance treaty in place which covers claims from one incident occurring within a specified period between a range of limits.

General insurance

Reinsurance plays an extremely important role in the management of liability risk and exposure at M&F. The Group makes use of a combination of proportional and non-proportional reinsurance to limit the impact of both individual and event losses and to provide insurance capacity.

The majority of the Group's general insurance contracts are classified as 'short-tailed', meaning that any claim is settled within a year after the loss date. This contrasts with 'long-tailed' classes where claims costs take longer to materialise and settle. Our long-tailed business is generally limited to personal accident, third-party motor liability and some engineering classes; in total it comprises less than 5% of an average year's claim costs.

Operational risk

The Group's size and complexity mean that operational risk represents a significant proportion of our risk profile (approximately 12%, with a target of 10%). This risk could result in losses from internal failures relating to processing, systems and people as well as losses relating to external triggers such as external fraud or retrospective changes in legislation. By its nature, operational risk is difficult to eliminate entirely. But we aim to keep it to a minimum and certainly within our risk appetite as we are unlikely to gain significant reward from taking operational risk. That is why operational risk is one of the metrics in our risk appetite framework.

Our operational risk exposures for M&F and Old Mutual Bermuda are above appetite. M&F has increased exposure as a result of processing errors and losses and Old Mutual Bermuda is exposed to trade execution errors and outsourcing failures. All other divisions and business units are currently within their operational risk appetite.

The Group RCSA process places responsibility directly onto line management for identifying, monitoring and managing operational risk within each business unit. We further enhanced the RCSA process in 2010 by beginning the roll out of our OpenPages strategic risk management system which records, consolidates and reports risks, controls and losses at business unit and Group level. The improvement in the quality of data generated will facilitate identification of areas where controls need to be more robust. Identifying the level of losses in relation to a particular risk will start to help us assess more accurately the potential impact of any further occurrences and improve the accuracy of the RCSA assessment. Our management of risk will only be effective if the RCSA and loss event recording drives management action, often in the area of process re-engineering, to minimise the scope for recurrence.

The RCSA process remains the key driver to assess, escalate and prioritise significant operational risks across the Group. These risks are then reassessed and monitored by the GERC and the Group Executive on at least a quarterly basis.

The principal operational risks Old Mutual faces are listed in the table below.

Risk description	2010 trend		2010 commentary			Key mitigating actions
Regulatory risk Regulatory requirements and changes are increasing, and are likely to continue to do so over the time ahead. Compliance with the new Solvency II requirements is due at the beginning of 2013. If we do not correctly assess the impact of these changes or implement them in a timely manner a fine, penalty or regulatory censure could result.	Increasing		The regulatory environment is increasing in intensity, particularly in the areas of customer protection in developing markets, and information security/privacy. While banking and asset management related regulation was already very intense, there has been further tightening in the wake of the financial crisis. Many of the new requirements are still evolving. In addition, Solvency II will create a step change for insurance prudential regulation, with its focus on internal risk and capital management and the more proactive nature of Group supervision under the internal model approval process			Old Mutual is well positioned to meet increased regulatory expectations. Dedicated Group and business unit compliance teams closely monitor new and changing regulatory developments and liaise regularly with their local regulators. The Group provides a co-ordination role in relation to the FSA, which is the lead regulatory authority for Old Mutual plc under the Financial Groups Directive. The iCRaFT project is designed to deliver all Solvency II requirements, as a minimum. It has been progressing well during 2010 and project deliverables are on target.
Processing risk Our businesses rely on their systems, operational processes and infrastructure to help process numerous transactions daily across various different markets. With a large number of such processes comes significant operational risk arising from process breakdowns, human error or IT systems issues.	Stable		The roll-out of the Group Risk Strategy during 2010 highlighted the need for improved processes and reporting on operational losses.			We have established a number of Group strategic implementation programmes to review, evaluate and document key business processes, facilitating a thorough understanding of the relationships between these processes and highlighting areas where process or control improvements are required. The new risk management framework and tool has been developed and is being rolled out across the Group. This provides an opportunity to embed the ERM processes which should lead to greater consistency of assessment and assumptions applied across all business units. This should also enable effective comparison and challenge of the operational risk capital derived by business units.
Risk description		2010 trend		2010 commentary	Key mitigating actions
IT and data security IT sustainability and infrastructure is a concern across the Group, particularly in Skandia UK and M&F. There is a risk that if these issues are not resolved within an appropriate timescale we could experience problems with the current IT systems.		Stable		An LTS Chief Information Officer has been appointed in the drive to consolidate and enhance IT infrastructure and exploit IT synergies. Physical and information security are areas of increasing risk and regulatory focus - particularly in relation to information security, where the UK and Europe have seen increasing intensity in fines and enforcement activity. New privacy and consumer protection laws have also been introduced in South Africa, although the practical regulatory enforcement bodies are still evolving.	We have established a Group strategic implementation programme to address these issues and identify and implement IT synergies across the Group. This will be further supported by the iCRaFT initiative, and will be tested on the risk management system as one of the initial group-wide IT roll outs. Work has started and is co-ordinated with the LTS Chief Information Officer to embed Information Security within LTS IT strategy, including adoption and embedding of Group standards and benchmarking of business units against those standards. Group information security standards are based on good practice and data privacy obligations.
HR risk The lack of leadership and talent throughout the organisation at the levels required to deliver the business strategy and achieve the necessary culture change.		Stable		The year saw changes in the regulatory requirements surrounding remuneration policy. Turnover among the key leadership roles reduced for the second consecutive year. During 2010 a number of initiatives were delivered to improve senior talent attraction, retention and development. New CEOs started in Nordic in 2010, and M&F and USAM in early 2011. This increased the risk of staff turnover increasing and initiatives slowing until the new CEOs were firmly established. However, no material increases in turnover occurred in those businesses in the interim periods.	New long-term incentive plans for Group senior executives were implemented together with consistent approaches to short-term (annual) incentive structures across business units. To support governance requirements revised remuneration principles have been implemented across the Group. A set of required leadership actions was introduced and leadership programmes were modified to target development needs. The year ahead will see more focus on the behavioural changes required to ensure our culture is aligned to the business strategy and reflects what matters most to our employees.

Capital modelling for operational risk

Maintaining a strong capital position is critical to the Group's ability to conduct business and withstand losses resulting from inadequate or failed internal processes, people and systems or from external events. The determined operational risk capital requirement should be sufficient to satisfy the Board's risk appetite across all operational risks faced by the Group. We are nearing the completion of a new operational risk capital model which will enable a much more robust assessment of the capital requirement.

Other risks impacting the Group risk profile

Liquidity risk

Our liquidity position remains sound at both Group holding company and business unit level. The Group holding company is funded through a combination of internal cash resources and undrawn bank credit facilities. Business units' liquidity needs are met from their own internal resources and, where appropriate, either locally arranged external lines or funding lines from the holding company.

In aggregate the holding company has £1.4 billion of cash and undrawn committed facilities as at 31 December 2010.

Risk Profiles by Segment

Long-Term Savings (LTS)

Our LTS businesses represent a significant part of the Group's earnings and capital (see the segmental disclosures in this report) and the aggregation of the primary risks to Old Mutual is naturally greatest within this segment. The most significant risks in LTS overall are market (equity and interest) and business risk. During 2010 LTS has defined its risk strategy for the next three years. This is aligned to the Group strategy and aims to optimise the trade-off between risk assumed, capital required and volatility of return. These are LTS's risk preferences:

LTS ALM risk

ALM risk is the risk that adverse changes in the market value of policyholder assets and liabilities will negatively impact LTS future earnings. The key factors that could lead to negative variances include asset prices, their volatility, interest rates and currency.

Risk management strategies designed to mitigate market risk are dependent on the type of contracts held by policyholders. Where contracts are related purely to longevity, mortality and morbidity risk, there is typically no sharing of better-than-expected or required investment returns. Under unit-linked and/or market-linked contracts, policyholders receive the full investment return on the underlying assets, less any applicable fees, and the only residual market risk relates to the fluctuation in asset-based fees as a result of fluctuations in the underlying assets.

In most other classes of investment-related contracts, investment returns are attributed to, or shared with, policyholders, in the form of vesting and/or non-vesting bonuses. Non-vesting bonuses offer an option for management action, as they can be withheld in adverse circumstances.

Smooth bonus products constitute a significant proportion of South African business. We pay particular attention to declaring bonuses in a responsible manner, retaining sufficient reserves to meet our promise to clients that returns will be less volatile over time than purely market-linked returns. Investment returns not distributed after deducting charges are credited to bonus-smoothing reserves, which are used to support subsequent bonus declarations.

For discretionary participating business underwritten in South Africa, there are well established management actions. Principles and Practices of Financial Management clearly sets out how risks and surpluses are shared, how bonuses are declared, and how these classes of businesses are managed - including the management actions that will be taken in adverse conditions. These actions are sanctioned and signed-off by the Old Mutual South Africa Board and are disclosed to the Financial Services Board of South Africa, Old Mutual South Africa's regulator.

In South Africa the stock selection and investment analysis process is supported by a well developed research function. For fixed annuities, we manage market risks where possible by investing in fixed-interest securities with a duration closely corresponding to those liabilities. Market risk on policies that include specific guarantees and where shareholders carry the investment risk resides principally in the South African guaranteed non-profit annuity book, which is closely matched with fixed interest securities. Other non-profit policies are also suitably matched, based on comprehensive investment guidelines. Market risk on with-profit policies, where investment risk is shared with investors, is mitigated by appropriate bonus declaration practices and the use of hedging.

Within Old Mutual South Africa, reductions in interest rates can lead to an increase in the value of investment guarantees and options given to policyholders, causing a reduction in earnings and shareholder capital. We hold investment guarantee resources and undertake regular and ongoing activity related to interest rate and equity hedging to mitigate this risk.

LTS business risk

Business risk is the risk that the LTS business performance will be below plan and therefore negatively impact on earnings and capital. The drivers that could result in this include negative variances in new business volumes, new business margins, lapse experience and expenses.

Lapse risk includes the risk that policyholders surrender their policies earlier than expected, resulting in loss of value. If large numbers of policies lapse, the business is exposed to losses on up-front expenses and commissions that cannot be recouped, and also to per-policy maintenance costs increasing above pricing assumptions, resulting in losses as remaining policyholder charges fail to cover the ongoing costs of maintenance. Early surrender of policies can also crystallise unrealised losses for portfolios where market values are trading below book values.

Within the Group, we examine the impact on earnings and capital by stress testing both increased and decreased lapse rates in order to understand these impacts. We also take steps to manage lapse risk in case it varies from assumption. During 2010, customer retention was a key risk to the business. Significant focus and effort from the business, coupled with improved economic and social outlook, resulted in improved persistency during the year and this trend is expected to continue into 2011.

Lower than anticipated new business volumes can lead to acquisition expense overruns, resulting in reduced earnings and shareholder capital. By contrast, significantly higher than expected new business volumes can consume large amounts of capital and may cause capital strain. Within the Group, we examine the impact on earnings and capital by stress testing both increased and decreased new business volumes in order to understand these impacts.

Business risk is particularly significant, as a proportion of total risk, in respect of the Group's unit-linked and asset management businesses, where there are few other significant risks relating to market, credit or insurance risk. Hence these risks comprise a large proportion of total risk in Wealth Management, Nordic and Retail Europe. While these risks are important in Emerging Markets, they represent a lower proportion of overall risk.

LTS credit risk

During 2010 we have made significant progress in enhancing the aggregation of credit exposures across the Group as part of the iCRaFT programme. In 2011 this will be complemented by a review and update of the credit risk policy and limits. The top five exposures by sector remain unchanged from 2009, although there has been an increase in our total exposure to banks and financial services, offset by a reduction in exposure to national and local government. This mirrors the shift in credit risk to sovereigns from the financial sector throughout 2010.

The Group's exposure to the European peripheral economies is not deemed significant and it is primarily to highly rated institutions. We intend to maintain our exposures at low levels and continue to monitor further developments in this region.

LTS exposures as a percentage of overall Group risk exposure (stated post diversification)

	Emerging Markets %	Wealth Management %	Nordic %	Retail Europe %
1 ALM risk (policyholder)	7.5	5.2	5.3	0.7
2 Business risk	5.7	5.4	5.2	1.3
3 Operational risk	1.9	1.5	0.6	0.1
4 Credit risk	1.2	0.8	0.9	0.1
5 Market (shareholder) equity	2.1	0.0	0.0	0.0
6 Liability (insurance underwriting) risk	0.6	0.0	0.0	0.0

Note: Ranked in order of importance to the Group based on economic capital figures as at June 2010.

LTS operational risk

LTS's operational risk profile is similar to the Group operational risk profile.

Banking

Banking credit risk

As our primary banking business, Nedbank carries the majority of our credit risk through its lending and other financing activities. Nedbank's financing activities contribute to its significant credit risk exposure. We expect impairment levels to remain stable or even start to reduce during 2011. This is due to a number of factors including a slowdown in lending, the introduction of tighter lending criteria and the stabilisation of economic conditions.

Nedbank manages credit risk exposures through its credit risk management framework, which encompasses comprehensive credit policies, limits, governance structures and internal risk models that are fully Basel II compliant and in line with Group policies and practices. To address the changing conditions impacting on credit risk this year, Nedbank has:

·      Closely monitored credit risk loss ratios and other key indicators through its credit risk monitoring committees

·      Tightened credit granting criteria - for example, on home loans it has tightened loan-to-value criteria, increased acceptance standards and where appropriate restructured credit risk agreements

·      Tightened controls over large payments to and from global banks

·      Increased staff to administer collections.

Banking market risk

The principal market risks in the Group's banking operations arise from:

·      Trading risk in Nedbank Capital

·      Banking book interest rate risk from repricing and/or maturity mismatches between on- and off-balance sheet components in all banking businesses.

We use a comprehensive market risk framework to ensure that market risks are understood and managed. Governance structures are in place to achieve effective independent monitoring and management of market risk.

Trading risk

We measure market risk exposures from trading activities at Nedbank Capital using value-at-risk (VaR), supplemented by sensitivity analysis and stress-scenario analysis, and set limit structures accordingly.

The VaR measure estimates the potential loss in pre-tax profit over a given holding period for a specified confidence level. The methodology is a statistically-defined, probability-based approach that takes into account market volatilities as well as risk diversification by recognising offsetting positions and correlations between products and markets. Risks can be measured consistently across all markets and products, and risk measures can be aggregated to arrive at a single risk number. The one-day 99% VaR number used by Nedbank represents the overnight loss that has less than a 1% chance of occurring under normal market conditions. By its nature, VaR is only a single measure and cannot be relied upon as a means of measuring and managing risk on its own.

Banking book interest rate risk

This arises at Nedbank because:

·      The bank writes a large quantum of prime-linked assets and raises fewer prime-linked deposits

·      Funding is prudently raised across the curve at fixed-term deposit rates that reprice only on maturity

·      Short-term demand-funding products reprice to different short-end base rates

·      Certain ambiguous maturity accounts are non-rate-sensitive

·      The bank has a mismatch in net non-rate-sensitive balances, including shareholders' funds, that do not reprice for interest rate changes

·      Nedbank uses standard analytical techniques to measure interest rate sensitivity within its banking book. This includes static reprice gap analysis and point-in-time interest income stress testing for parallel interest rate moves over a forward looking 12-month period.

Liquidity risk

There are two types of liquidity risk: funding liquidity risk and market liquidity risk. Funding liquidity risk is the risk that Nedbank Group will be unable to meet its payment obligations as they fall due. These payment obligations could arise from depositor withdrawals, the inability to roll-over maturing debt or contractual commitments to lend.

Market liquidity risk is the risk that the Nedbank Group will be unable to sell assets, without incurring an unacceptable loss, in order to generate cash required to meet payment obligations under a stress liquidity event.

Liquidity risk management is a vital risk management function in all entities across all jurisdictions and currencies, and is a key focus of the Nedbank Group.

We maintain a portfolio of marketable and highly liquid assets which could be liquidated to meet unforeseen or unexpected funding requirements. The market liquidity by asset type (and for a continuum of plausible stress scenarios) is considered as part of the internal stress testing and scenario analysis process. The quantum of unencumbered assets available as collateral for stress funding is measured and monitored on an ongoing basis.

The Basel Committee on Banking Supervision issued new liquidity standards on 16 December 2010. Many of the key principles are already encapsulated in Nedbank's Liquidity Risk Management Framework. However, in order to meet the requirements of the liquidity coverage ratio by 2015 and the net stable funding ratio by 2018, Nedbank and the other South African banks are working closely with SARB and National Treasury to address the structural challenges of compliance for the local banking industry, while at the same time considering the unintended economic consequences which may arise from the proposed liquidity standards.

Nedbank's securitisation activities

Nedbank Group uses securitisation primarily as a funding diversification tool. However, these securitisation activities, which are mostly restricted to low-risk and non-complex transactions, are not significant relative to the overall Nedbank Group risk profile.

It is important to note that the Nedbank Group is fully integrated into the Old Mutual Group economic capital and risk appetite framework, which is based on a more conservative approach to calculating capital requirements. All securitisation transactions are subject to Nedbank Group Risk Committee oversight and the stringent SA Regulatory Securitisation Framework.

Business risk

Business risk is the risk of adverse outcomes resulting from a weak competitive position or from a poor choice of strategy, markets, products, activities or structures. Major potential sources of business risk include revenue volatility, owing to factors such as macro-economic conditions, inflexible cost structures, uncompetitive products or pricing, and structural inefficiencies.

The fluctuations in earnings captured in business risk are those not attributable to the influence of other risk types. The major driver or input used in the earnings-at-risk methodology is a time series of historical profit and loss, cleansed of the effects of other risk types. The volatility of this time series of historical profits and losses becomes the basis for the measurement of business risk.

Nedbank Group actively manages business risk through the various management structures, as set out in the Enterprise Risk Management framework, and an earnings-at-risk methodology similar to the Group's risk appetite metrics.

Operational risk

Nedbank's operational risk profile is similar to the Group operational risk profile.

Mutual & Federal (M&F)

The decision to acquire the minority interests and delist M&F was a key step in our strategy to rationalise and consolidate our Group structure into a focused long-term savings, protection and investment business. The delisting of M&F enabled local management to focus on stabilising the operating platform during 2010 and responding to changes in the market to continue to offer growth, profitability and value to clients.

M&F is South Africa's second largest short-term insurer and also conducts business in Botswana, Namibia and Zimbabwe. It has developed a five-year strategic programme to profitably grow its market share while introducing innovative products and entering new market segments. In 2010 it focused on the basics with the launch of new initiatives designed to stabilise the business. Early positive results include the recent move to second place for service in the Ask Africa Orange Index, from fourth a year earlier. The benefits of action plans implemented throughout 2010, which include changes to top management, should materialise in the 2011-13 planning period.

M&F's primary concern is underwriting risk, the risk that insurance products are incorrectly measured and priced. Adverse weather patterns and large numbers of commercial fires impacted our underwriting profitability in H1 2010. However, management actions taken to clean up the book, improve underwriting discipline and better manage claims costs resulted in improved underwriting results. This focus on the fundamental soundness of M&F's portfolios, diligence in rate setting and continuing adherence to responsible underwriting standards will continue into 2011.

US Asset Management

For USAM, as an asset management business, market volatility presents the greatest risk. Since we conduct our asset management activities in an agency capacity, clients take both the upside and downside risk in their portfolios. As a consequence we characterise the resulting risk as an ALM risk,

the risk that expected fees are not earned due to lower asset levels than anticipated. USAM asset management affiliates are exposed to a second order risk in respect of their asset-based management fees and performance-related fees.  Over the year, we continued to feel the impact of the financial crisis in a lower level of asset-based fees and substantially lower performance fees resulting from net cash outflows and lower asset values.

USAM's investigation of a possible partial Initial Public Offering includes multiple detailed work streams that holding company management is currently completing. While certain aspects of these IPO related activities represent business as usual activities, adding IPO related activities to management's regular daily operations raises a resource bandwidth concern.

US Life

The internal risk and control profile of the business is effective, and continues to improve. Credit risk

has reduced significantly as the investment portfolio continues to be de-risked on a capital neutral basis. Although exposure to corporate bonds still exceeds our risk appetite we have continued to improve the investment grade of the portfolio in line with our target operating model. Market yields have improved - enabling better matching of new assets to sales but lowering the unrealised gain position. Yields are still below desired levels and continue to place pressure on long-term guarantees. Surrenders and lapses in excess of pricing assumptions adversely affect our ability to achieve target profit margins and recover expenses.

The exposure to US Life credit risk has been one of the significant metrics driving the divestment of US Life from the Group. The planned disposal is expected to reduce the Group's credit risk exposure significantly, particularly in the banks and financial services sector.

Old Mutual Bermuda (legacy business)

In Old Mutual Bermuda, reductions in interest rates can cause more of the investment guarantees and

options within its life assurance businesses to be in-the-money, reducing earnings and shareholder capital. We maintain regular interest rate hedging activity to mitigate this risk

.

The guaranteed returns provided under equity indexed annuities are hedged to ensure a close matching of option or futures pay-offs to any liability growth. Hedging is largely static, with minimal

trading. For variable annuities, the guaranteed returns provided are dynamically hedged. We review hedging positions daily to readjust them as necessary. We include an assessment of our ability to hedge market movements and the effectiveness of these hedging programmes. Hedge ineffectiveness risk is the risk of hedge assets underperforming in comparison with the associated liabilities. This can arise from less than complete hedging, such as failure to hedge higher order

derivative measures and from non-hedgeable items such as basis risk.

Old Mutual Bermuda remains outside our Group risk appetite and is being actively managed to mitigate losses.

Businesses outside Group risk appetite:

M&F, Old Mutual Bermuda and US Life

Measured against the risk appetite limits set by the Group Executive Risk Committee and ratified by the Executive Committee and Board, all the Group's businesses are within the Group's appetite except M&F, Old Mutual Bermuda and US Life. It is worth noting that:

·      M&F and Old Mutual Bermuda are managing their positions to reduce the risk in their business gradually, within their capabilities and minimising loss of value

·      We have entered into a transaction to dispose of US Life

·      We established oversight committees for Old Mutual Bermuda and US Life in 2009, and both of these bodies are still in force. The committees monitor risk exposures, help optimise risk-taking within the businesses and track progress - fortnightly in US Life, and monthly in Old Mutual Bermuda. The committee members include the Group Risk and Actuarial Director, the Group Finance Director and relevant executives from the business units

·      Asset liability management has also been improved, with significant effort being spent on identifying the assets appropriate to different product lines and ensuring investment strategies match the profile of those liabilities. The oversight committees have also been directly involved in making decisions relating to the closure of unprofitable product lines and those deemed to be excessively risky relative to the Group's risk appetite

·      The Group monitors Old Mutual Bermuda's hedging and related risks daily, and the company has been closed to new business to prevent any increase in risk exposures brought on by growing the book through selling contracts with inappropriately designed and priced product structures. Over time we expect exposures to reduce significantly as policies terminate or mature and exit the book. Within the business, we continue to monitor hedging activity closely: hedging effectiveness has increased significantly as a result

·      Weekly liquidity reporting has been instigated, which includes stress-sensitivity scenarios

·      Monthly liquidity/ cash flow forecasting has been introduced, consisting of projections which include consideration of:

o  All anticipated Old Mutual Bermuda needs and sources of cash flow o  The specific timing of cash flows required to settle expected policyholder benefits o  The impact of market changes on the need for and timing of cash flows An assessment of the optimal asset strategy to ensure appropriate liquidity at all times

·      Old Mutual Bermuda's operational risk exposure is expected to increase over the period 2010-12 due to migration of transformation initiatives related to valuation systems and processes combined with recruitment of new staff

·      M&F's operational risk remains above risk appetite in 2010-11, due mainly to the uncertainty surrounding certain regulatory and legislative requirements. We expect that exposure is to reduce and fall within appetite over the plan period.

Summary

Old Mutual continued in 2010 to focus on and progress to effectively manage risk and capital in order to create value. Our progress is due to the continued emphasis the Board places on risk management through our Big Five priorities and the iCRaFT programme. The risk environment will continue to evolve: we are now focusing on embedding the use of tools that will drive the collection of data and information on integrated risk and capital management.

The Board believes that current capital and liquidity levels are adequate for a Group of our size and nature. It also confirms that the Group's internal systems of control, risk management and governance have operated as intended during 2010 and are therefore effective.

Statement of directors' responsibilities in respect of the Annual Report and the financial statements

The directors are responsible for preparing the Annual Report and the Group and Parent Company financial statements in accordance with applicable law and regulations.

Company law requires the directors to prepare Group and Parent Company financial statements for each financial year. Under that law they are required to prepare the Group financial statements in accordance with IFRSs as adopted by the EU and applicable law and have elected to prepare the Parent Company financial statements on the same basis.

Under company law the directors must not approve the financial statements unless they are satisfied that they give a true and fair view of the state of affairs of the Group and Parent Company and of their profit or loss for that period. In preparing each of the Group and Parent Company financial statements, the directors are required to:

·      Select suitable accounting policies and then apply them consistently;

·      Make judgements and estimates that are reasonable and prudent;

·      State whether they have been prepared in accordance with IFRSs as adopted by the EU; and

·      Prepare the financial statements on the going concern basis unless it is inappropriate to presume that the Group and the Parent Company will continue in business.

The directors are responsible for keeping adequate accounting records that are sufficient to show and explain the Parent Company's transactions and disclose with reasonable accuracy at any time the financial position of the Parent Company and enable them to ensure that its financial statements comply with the Companies Act 2006. They have general responsibility for taking such steps as are reasonably open to them to safeguard the assets of the Group and to prevent and detect fraud and other irregularities.

Under applicable law and regulations, the directors are also responsible for preparing a Directors' Report, Directors' Remuneration Report and Corporate Governance Statement that comply with that law and those regulations.

The directors are responsible for the maintenance and integrity of the corporate and financial information included on the Company's website. Legislation in the UK governing the preparation and dissemination of financial statements may differ from legislation in other jurisdictions.

The directors confirm that to the best of their knowledge:

·      The financial statements, prepared in accordance with the applicable set of accounting standards, give a true and fair view of the assets, liabilities, financial position and profit or loss of the Company and the undertakings included in the consolidation taken as a whole; and

·      The Directors' Report includes a fair review of the development and performance of the business and the position of Old Mutual plc and the undertakings included in the consolidation taken as a whole, together with a description of the principal risks and uncertainties that they face.

Julian Roberts	Philip Broadley
Group Chief Executive	Group Finance Director

8 March 2011

 

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