b. Financial investment risk disclosures

The following section describes Amlin’s investment risk management from a quantitative and qualitative perspective.

The Group has two main categories of assets both of which have to be invested in accordance with the regulations applicable to where the underwriting business is being written. The asset categories are as follows:

Policyholders’ funds

These are the premiums received and held to meet future insurance claims. For the London operations these are referred to as syndicate assets. For Bermuda they are referred to as underwriting assets.

Corporate assets

These are the capital required by the regulators to support the underwriting business plus working capital or surplus funds. Currently London’s corporate assets are predominantly charged to the Corporation of Lloyd’s to support the underwriting in that market. Unlike the policyholders’ funds the corporate assets do not have specific current liabilities attached to them.

Risk management

Investment frameworks

Amlin manages its investments in accordance with investment frameworks that are set by the Boards of Amlin plc and its subsidiaries. These frameworks determine investment policy and the management of investment risk. They are reviewed on a regular basis to ensure that the Boards’ fiduciary and regulatory responsibilities are being met. The Boards delegate responsibility for the management of the investments to the Investment Management Executive and the Investment Advisory Panel.

The Investment Management Executive comprises the Chief Executive, Finance Director, Underwriting Director and Chief Investment Officer. They meet monthly to determine investment tactics to ensure that asset allocation is appropriate for current market conditions and is in accordance with the investment frameworks. The Investment Management Executive appoints and monitors the external Investment Managers as well as monitoring the custodians that are responsible for the safekeeping of the assets.

The Investment Advisory Panel, which consists of external investment professionals as well as members of the Investment Management Executive, meets quarterly. The Panel has been delegated responsibility to monitor and critique investment strategy and tactics. In addition Group Compliance provides advice on investment regulations.

Risk tolerance

The investment process is led by the risk tolerance, which is determined by the underwriting cycle and the requirements of the capital providers. In a hard underwriting market capital preservation is paramount in order to support the insurance business and, therefore, the risk tolerance for the corporate assets will be low. Conversely, the risk tolerance for the policyholders’ funds under these circumstances will be relatively high due to the strong cash flows. In a soft underwriting market the opposite applies.

Strategic benchmarks

The strategic benchmarks form part of the investment frameworks and set the neutral asset allocation for each category of assets. For the London operations the expected timescale for future claims in each currency is calculated by our Group Actuarial team. These durations form the basis for the strategic benchmarks for the policyholders’ funds against which the assets are invested. Due to the nascent nature of the Bermudian operations the policyholders’ funds are currently all held in money market funds. The strategic benchmarks for corporate assets for both London and Bermuda are set by using a Value at Risk (VaR(1)) model, to determine the optimum asset allocation for the current risk tolerance and to ensure that appropriate solvency levels are maintained. In both cases the investment frameworks provide tactical ranges around these strategic benchmarks to provide sufficient flexibility to ensure that the appropriate risk/reward balance is maintained in changing investment markets. Tactical asset allocation changes are made by moving funds to and from the relevant specialist fund managers.

Asset allocation

Investment management

Specialist external investment managers are used to manage each asset class on a segregated, pooled or commingled basis(2). The Overseas Deposits are managed by the Corporation of Lloyd’s in commingled funds. Otherwise manager selection is based on a range of criteria that leads to the expectation that the managers will add value to the funds. Investment guidelines are set for each manager to ensure that they comply with the investment frameworks. The Managers have discretion to manage the funds on a day-to-day basis within these guidelines. The managers are monitored on an ongoing basis and are reviewed periodically using Watson Wyatt Investment Consulting.

(2)Segregated funds are managed separately for Amlin. Pooled funds are collective investment vehicles in which Amlin and other investors purchase units. Commingled funds combine the assets of several clients.

The managers as at 31 December 2006 were as follows:

Manager	Asset class
Segregated funds
Aberdeen Asset Management	US dollar bonds
AEGON Asset Management	Sterling bonds
Insight Investement Management	Sterling bonds
Morley Fund Management	Property manager of managers
Robeco Investment Management	US and Canadian dollar bonds
Taube Hodson Stonex Partners	Global equities
Western Asset Management	US dollar and Euro bonds
Pooled vehicles
Barclays Global Investors	Sterling, Euro and US dollar money market funds
Goldman Sachs Asset Management	Sterling, Euro and US dollar money market funds
HSBC Asset Management	US dollar money market funds
Insight Investment Management	Sterling money market fund
JP Morgan Asset Management	US dollar money market funds
PIMCO	High alpha sterling and US dollar bonds
Western Asset Management	US dollar money market fund
Commingled funds
Corporation of Lloyd’s Treasury Services	US dollar, Canadian dollar, Australian dollar,
	South African and Japanese bonds
Union Bank of Switzerland	Canadian and US dollar liquid funds

The funds under management with each manager as at 31 December 2006

Fair value

All investments are marked to market. Prices are obtained by the investment managers and custodians using recognised market sources. Prices are checked by Amlin for reasonableness by using Bloomberg data feeds.

Valuation risk

Amlin’s earnings are directly affected by changes in the valuations of the investments held in the portfolios. These valuations vary according to the movements in the underlying markets. Factors affecting markets include changes in the economic and political environment, risk appetites, interest rates and exchange rates. These factors have an impact on all Amlin’s investments and are taken into consideration when setting strategic benchmarks and tactical asset allocation. The impact of interest rates and exchange rates are discussed in more detail below.

The price of holdings can also vary due to specific risks, such as the corporate strategy and companies’ balance sheet structure, which may impact the value of individual equity and corporate bond holdings. This is mitigated by holding diversified portfolios, as specified in the investment guidelines given to the fund managers. These limit the exposure to any one company. In addition the equity mandate limits the exposure to any one geographic region or industrial sector.

If the value of Amlin’s equity portfolio was to fall by 10% the impact on the overall assets as at 31 December 2006, pre-tax, would be a decline of £24.8 million.

Interest rates

Investors’ expectations for interest rates will impact bond yields(3). The value of Amlin’s bond holdings is therefore subject to fluctuation as bond yields rise and fall. If the yield falls the capital value will rise, and vice versa. The sensitivity of the price of a bond is indicated by its duration(1). The greater the duration of a security, the greater its price volatility. Typically the longer the maturity of a bond the greater its duration. The maturity bands of the Group’s bond holdings at 31 December 2006 are shown below.

	Syndicate £m	Corporate £m	Corporate £m	total
Less than 1 year	106.7	65.3	88.5	260.5
1-2 years	105.2	27.1	7.3	139.6
2-3 years	106.2	28.9	18.7	153.8
3-4 years	153.7	13.0	9.0	175.7
4-5 years	388.2	36.1	69.2	493.5
Over 5 years	257.0	12.8	119.8	389.6
	1,117.0	183.2	312.5	1,612.7

Note: The table above excludes pooled investments.

There are no direct bond holdings in the Bermudian underwriting assets.

Amlin London sets the duration of its policyholders’ assets by setting the duration ranges of its bond portfolios with reference to the duration of the underlying liabilities.

The duration of the bond and cash portfolios as at 31 December 2006 was as follows:

	Assets Years	Liablities Years	Assets Years	Liabilities Years
London
Sterling	2.4	2.5	2.2	2.5
US dollars	3.0	3.1	2.8	3.1
Euro	3.3	3.0	2.5	3.0
Canadian dollars	3.0	3.2	2.1	3.2
Bermuda
Sterling	0.0	–	–	–
US dollars	0.0	–	–	–
Euro	0.0	–	–	–

Due to the short-tail nature of much of the underwriting portfolio this means that the duration of the assets is at the shorter end of the yield curve. Cash is raised, or the duration of the portfolio reduced, if it is believed that yields may rise, and therefore capital values fall.

An indication of the potential sensitivity of the value of the bond funds to changes in yield

Liquidity

Liquidity in the event of a major disaster is tested regularly using internal cash flow forecasts and realistic disaster scenarios. In addition, the policyholders’ funds investment guidelines require at least 25% of the funds to be held in government bonds and/or cash equivalents, which are highly liquid. As discussed above, the corporate assets are not matched to liabilities. However, if a major insurance event occurs the investment strategy is reviewed to ensure that sufficient liquidity is also available in the corporate funds.

Cash flow

It is important to ensure that claims are paid as they fall due. Levels of cash are therefore managed on a daily basis. Buffers of liquid assets are also held in excess of the immediate requirements. The policy of limiting the extent of duration divergence between the policyholders’ assets and the liabilities helps to reduce the risk of a cash flow mismatch.

Foreign exchange

Currently policyholders’ assets are held in the base currencies of sterling, Euros, US dollars and Canadian dollars, which represent the majority of the Group’s liabilities by currency.

However, as the sales for each year of account are spread over the time period up to its close it is open the cumulative average rates achieved as at the 31 December 2006 for the 2004 year of account, to be distributed to the Group in 2007 were: US dollars 1.86, euros 1.45 and Canadian dollars 2.19.

Amlin will occasionally transact currencies on a forward basis. These are carried out with well rated banks, so as to limit counterparty risk. The transactions are not designed as specific hedges and therefore realised and unrealised gains and losses are recorded in the profit and loss account of the period in which they occur. As at 31 December 2006 Amlin had no direct forward contracts outstanding. The investment managers did hold some forward foreign exchange contracts in their portfolios at the year end in order to hedge non-base currency investments. These are marked to market in their valuations.

As Amlin reports its financial statements in sterling it is subject to foreign exchange risk due to the impact of changes in the sterling/US dollar exchange rate on the converted sterling value of Bermuda’s dollar net assets. As this exchange rate impact is purely translational the exposure is not currently hedged.

Further foreign exchange risk arises until non-sterling profits are converted into sterling. It is Amlin Group policy to mitigate foreign exchange risk by systematically converting its syndicate non-sterling profits into sterling. Given the inherent volatility in some business classes a cautious approach is adopted on the speed and level of sales, but we seek to extinguish all currency risk on earned profit during the second year after the commencement of each underwriting year. The intention is to time the currency transactions in order to optimise the conversion rates. This approach is part of Amlin’s risk management strategy as it avoids the inherent dangers of ‘lumpier’ sales. It is not the intention to take speculative currency positions in order to make currency gains. A summary of the sales for 2006 is shown in the table below.

	Total (millions)	Average rate	Total (millions)	Average rate	Total (millions)	Average rate
31 December 2006	73	1.92	21	1.45	9	2.07

Foreign exchange exposure also arises when business is written in non-base currencies. These transactions are converted into sterling or US dollars (depending on whether the business is written out of London or Bermuda) at the prevailing spot rate once the premium is received. Consequently there is exposure to currency movements between the exposure being written and the premium being converted. Payments in non-base currencies are converted back into the underlying currency at the time a claim is to be settled; therefore Amlin is exposed to exchange rate risk between the claim being made and the settlement being paid.

Other

Amlin’s investments are subject to credit risk as discussed below, but otherwise no other investment risks were identified as at 31 December 2006.

(1) VaR is a statistical measure, which calculates the possible loss over a year, in normal market conditions. As VaR estimates are based on historical market data this should not be viewed as an absolute gauge of the level of risk to the investments.
(2) Segregated funds are managed separately for Amlin. Pooled funds are collective investment vehicles in which Amlin and other investors purchase units. Commingled funds combine the assets of several clients.
(3) The yield is the rate of return paid if a security is held to maturity. The calculation is based on the coupon rate, length of time to maturity and the market price. It assumes coupon interest paid over the life of the security is reinvested at the same rate.
(4) The duration is the weighted average maturity of the security’s cash flows, where the present values of the cash flows serve as the weights.
(5) This assumes a parallel shift in the yield curve.

© Copyright Amlin 2006