LIQUIDITY RISK

Introduction

Liquidity risk is the risk that Momentum will encounter difficulty in raising funds to meet commitments to policyholders under policy contracts and in respect of other obligations.

Liquidity risk governance

The Asset and Liability committee which is a subcommittee of Momentum Risk committee provides market risk oversight for interest rate risk, funding and liquidity risk assumed on Momentum’s balance sheet.

Investments are made in assets which are expected to provide cash flows that match liability outflows as and when they are expected to occur – this is monitored by the Momentum Investment committee.

Liquidity risk management

Guaranteed policyholder benefits

Where possible, the expected liability outflow is matched by assets that provide the required cash flows as and when they become payable. Examples of guaranteed benefits that are matched by suitable assets include annuities and guaranteed endowments.

Unitised and smoothed bonus policyholder benefits

These benefits are determined mainly by the market value of underlying assets. On maturity of policy contracts, assets are disposed of in the market, but only to the extent that cash flows into the fund are insufficient to cover the outflow. Assets are generally easy to realise, as they consist mainly of large listed equity counters, government securities or funds on deposit.

Maturity dates are normally known in advance and cash flow projections are performed to aid in portfolio and cash flow management. Where the product design allows for the payment of an early termination value (ie a benefit payment before the contractual maturity date), such value is not normally guaranteed, but is determined at the company’s discretion (subject to certain minima prescribed by legislation). This limits the loss on early termination. If underlying assets are illiquid, the terms of the policy contract normally allows for a staggered approach to early termination benefit payments. Examples of the latter are contracts that invest in unlisted equity and certain property funds.

When a particular policyholder fund is contracting (ie outflows exceed inflows), care is taken to ensure that the investment strategy and unit pricing structure of the fund are appropriate to meet liquidity requirements (as determined by cash flow projections). In practice, such a fund is often merged with cash flow positive funds, to avoid unnecessary constraints on investment freedom.

Other policyholder benefits

Policyholder contracts that provide mostly lump sum risk benefits do not normally give rise to significant liabilities (compared to policies that provide mostly savings benefits). Funds supporting risk benefits normally have substantial cash inflows, from which claims can be paid. Accrued liabilities are matched by liquid assets, to meet cash outflows in excess of expected inflows.

On certain large corporate policy contracts, the terms of each individual contract takes into account the relevant liquidity requirements. Examples of such contractual provisions include the payment of benefits in specie, or a provision for sufficient lag times between the termination notification and payment of benefits.

Shareholder funds

The only significant shareholders’ liability is the callable bond issued during 2005. Momentum shareholders’ funds include sufficient cash resources to fund the coupon payments under this bond, and the nominal amount, which is callable in 2014, will be funded from cash resources at that time.

Liquidity risk – policyholders  

The following tables indicate the liquidity needs in respect of obligations arising under long term insurance and investment contracts (as defined under IFRS 4). The amounts in the table represent the excess of claims and expenses over premium income, expressed in present value terms (ie adjusted for the time value of money). Only contractual expected cash flows from the current in-force book have been modelled. Future new business has been ignored. Non contractual cash flows (eg those arising from early terminations of policy contracts) have also been ignored.

Cash flows relating to specific policy contract types have been apportioned between future time periods in the following manners:

i. Annuities, guaranteed endowments and PHI claims in payment
These contracts have clearly defined future payment dates. The present values of expected future payments, taking into account expected future life expectancy and guarantee terms, have been apportioned according to when they become payable.

ii. Unitised and smoothed bonus savings contracts
These contracts provide mainly savings benefits, but may contain elements of death or disability cover. The savings benefits mostly have clearly defined maturity dates. They make up the bulk of the liability in respect of this class of business. Policy - holder liabilities at the reporting date have therefore been apportioned according to contractual maturity dates of the savings benefits. For policies without defined maturity dates, the liability has been apportioned according to the earliest possible date when benefits can be paid without regulatory restrictions.

Early termination payments and lump sum risk benefits have not been treated as contractual obligations.

On this class of business, death or disability before the contractual maturity will cause acceleration of the maturity payment. Such contingent benefit payments have been ignored, as their timing is uncertain and they comprise only a small portion of the total liability on this class of business.

iii. Employee benefits investment business
Liabilities have been classified as being payable in less than one year.

iv. Employee benefits risk business
These are mostly short term contracts. It has been assumed that all future liabilities will be extinguished between one and five years from the reporting date.

v. Individual risk policies
The bulk of this class of business comprises whole life policies, providing lump sum death or disability benefits. The liabilities in respect of this class of business have been assumed to fall due between five and ten years after the reporting date.

vi. Credit life and funeral policies
Claims on these classes of business are mostly met from future premium inflows. Liabilities are small, relative to risk exposure, and have been assumed to fall due within one year.

The following maturity profiles have been presented as discounted and estimated analysis in accordance with the management of these financial instruments:

The maturity profile of policyholder liabilities under insurance contracts is set out below:

Period when cash flow becomes due (insurance contracts) (audited)

			2009
R million	Total	Shorter than   1 year	Between   1 and 5 years	Between   5 and 10 years	Longer than   10 years
Linked (market related) business
Individual	12 630	648	3 027	2 477	6 478
Employee benefits	–	–	–	–	–
Smoothed bonus business
Individual	8 228	391	1 915	1 755	4 167
Employee benefits	–	–	–	–	–
Non profit business
Individual	(16)	188	88	(849)	557
Employee benefits	1 550	–	1 550	–	–
Annuity business	16 677	1 203	7 517	2 916	5 041
Total policyholder liabilities under insurance contracts	39 069	2 430	14 097	6 299	16 243
			2008
R million	Total	Shorter than   1 year	Between   1 and 5 years	Between   5 and 10 years	Longer than   10 years
Linked (market related) business
Individual	15 547	817	3 580	2 643	8 507
Employee benefits	46	46	–	–	–
Smoothed bonus business
Individual	9 917	548	2 095	2 144	5 130
Employee benefits	–	–	–	–	–
Non profit business
Individual	817	131	62	61	563
Employee benefits	1 677	–	1 677	–	–
Annuity business	13 978	1 075	5 995	2 398	4 510
Total policyholder liabilities under insurance contracts	41 982	2 617	13 409	7 246	18 710

 

The maturity of policyholder liabilities under investment contracts is set out below

Period when cash flow becomes due (investment contracts) (audited)

			2009
R million	Total	Shorter than   1 year	Between   1 and 5 years	Between   5 and 10 years	Longer than   10 years
Linked (market related) business
Individual	56 893	8 806	18 622	6 390	23 075
Employee benefits	38 290	38 265	17	4	4
Smoothed bonus business
Individual	7 094	461	2 855	1 462	2 316
Employee benefits	5 285	5 285	–	–	–
Non profit business
Individual	1 927	359	1 451	21	96
Employee benefits	–	–	–	–	–
Annuity business	738	103	199	13	423
Total policyholder liabilities under investment contracts	110 227	53 279	23 144	7 890	25 914
			2008
R million	Total	Shorter than   1 year	Between   1 and 5 years	Between   5 and 10 years	Longer than   10 years
Linked (market related) business
Individual	59 089	7 402	21 355	6 683	23 649
Employee benefits	36 760	36 751	9	–	–
Smoothed bonus business
Individual	8 040	753	2 524	2 068	2 695
Employee benefits	5 212	5 212	–	–	–
Non profit business
Individual	1 752	623	963	29	137
Employee benefits	–	–	–	–	–
Annuity business	823	95	156	12	560
Total policyholder liabilities under investment contracts	111 676	50 836	25 007	8 792	27 041
Net cash outflows expected in respect of insurance and investment contracts
30 June 2009	149 856	56 269	37 241	14 189	42 158
30 June 2008	153 658	52 892	38 416	16 039	45 752

 

The following is the expected maturity analysis of the policyholder assets:

Assets backing policyholder liabilities (audited)

			2009
R million	Total	Shorter than   1 year	Between   1 and 5 years	Between   5 and 10 years	Longer than   10 years
Cash and short term funds	4 014	4 014	–	–	–
Money market investments	36 953	27 987	6 248	2 466	252
Accounts receivable	6 385	6 383	2	–	–
Investment securities	107 167	82 086	11 282	1 715	12 084
Derivative financial instruments	9 455	1 915	2 905	4 422	213
Reinsurance assets	8 143	7 854	152	47	90
Total	172 117	130 239	20 589	8 650	12 639
			2008
R million	Total	Shorter than   1 year	Between   1 and 5 years	Between   5 and 10 years	Longer than   10 years
Cash and short term funds	4 872	4 133	368	371	–
Money market investments	26 234	21 899	4 039	296	–
Accounts receivable	2 148	2 084	64	–	–
Investment securities	126 930	82 422	10 321	34 187	–
Derivative financial instruments	10 892	1 324	6 945	2 623	–
Reinsurance assets	550	250	139	161	–
Total	171 626	112 112	21 876	37 638	–
Net liquidity gap on policyholder liabilities
30 June 2009	(110 227)	(53 278)	(23 144)	(7 890)	(25 915)
30 June 2008	(111 676)	(50 836)	(25 007)	(35 834)	–

 

The following table represents the expected cash flows to be made on shareholder liabilities:

Liquidity risk –shareholders(audited)

			2009
R million	Total	Shorter than   1 year	Between   1 and 5 years	Between   5 and 10 years
Accounts payable (including insurance payables)	16 647	15 362	1 285	–
Liabilities arising as a result of consolidating collective investment schemes	8 114	8 114	–	–
Derivative financial instruments	1853	1 003	309	541
Interest bearing borrowings	–	–	–	–
Other financial liabilities	1 623	–	148	1 475
Provisions	326	283	38	5
Employee benefit liabilities	47	–	1	46
Deferred revenue liability	322	72	250	–
Total	28 932	24 834	2 031	2 067
			2008
R million	Total	Shorter than   1 year	Between   1 and 5 years	Between   5 and 10 years
Accounts payable (including insurance payables)	9 426	8 722	704	–
Liabilities arising as a result of consolidating collective investment schemes	7 283	7 283	–	–
Derivative financial instruments	4 190	3 884	235	71
Interest bearing borrowings	114	27	87	–
Other financial liabilities	974	–	129	845
Provisions	246	204	42	–
Employee benefit liabilities	179	99	80	–
Deferred revenue liability	296	21	275	–
Total	22 708	20 240	1 552	916

 

The following represents the expected cash flows at the expected maturity dates for the shareholders’ assets:

Shareholder asset cash flow at maturity (audited)

		2009
R million	Total	Shorter than   1 year	Between   1 and 5 years	Between   5 and 10 years
Cash and short term funds	36	36	–	–
Money market investments	–	–	–	–
Accounts receivable	22	22	–	–
Investment securities	31	31	–	–
Total	89	89	–	–
		2008
R million	Total	Shorter than   1 year	Between   1 and 5 years	Between   5 and 10 years
Cash and short term funds	47	47	–	–
Money market investments	–	–	–	–
Accounts receivable	9	9	–	–
Investment securities	31	31	–	–
Total	87	87	–	–

 

Undiscounted maturity analysis

The following table represents the contractual undiscounted amounts payable in respect of liabilities at the earliest date on which those liabilities are payable for all liabilities, except policyholder liabilities under insurance and investment contracts which have been included in the section on liquidity risk for policyholders.

Period when cash flow becomes due (audited)

		2009
R million	Total	Shorter than   1 year	Between   1 and 5 years	Between   5 and 10 years
Liabilities
Accounts payable (including insurance payable)	16 647	15 362	1 285	–
Liabilities arising to third parties as a result of consolidating	8 114	8 114	–	–
Collective investment schemes	–	–	–	–
Derivative financial instruments	1 810	1 011	287	512
Other financial liabilities	2 249	–	167	2 082
Finance lease liabilities	–	–	–	–
Off balance sheet commitments	142	18	95	29
Total	28 962	24 505	1 834	2623

		2008
R million	Total	Shorter than   1 year	Between   1 and 5 years	Between   5 and 10 years
Liabilities
Accounts payable (including insurance payable)	9 426	8 722	704	–
Liabilities arising to third parties as a result of consolidating	7 283	7 283	–	–
Collective investment schemes	–	–	–	–
Derivative financial instruments	6 636	3 998	1 866	772
Other financial liabilities	2 130	224	321	1 585
Finance lease liabilities	114	27	87	–
Off balance sheet commitments	305	126	179	–
Total	25 894	20 380	3 157	2 357

 

The balances in the table above will not agree directly with the balances on the balance sheet for the following reasons:

• the amounts included in the table above are contractual undiscounted amounts whereas the balance sheet is prepared using the discounted amounts;
• the table includes contractual cash flows with respect to offbalance sheet items which have not been recorded on the balance sheet;
• all instruments held for economic trading purposes are included in the “call to 3 months” bucket and are not by contractual maturity because trading instruments are typically held for short periods of time; and
• cash flows relating to principal and associated future coupon payments have been included on a undiscounted basis.

Financial risk inherent in consolidated collective and
fund of alternative funds investment schemes

Momentum consolidates a number of collective and fund of alternative funds investment schemes as a result of exercising control over these schemes, and therefore Momentum’s Risk Management Framework is applicable to the risk management of the schemes.

Because of the specific nature of the business of the schemes the risk management principles may be applied differently to managing the risks relevant to the schemes to how the overall financial risks of Momentum is managed. This section describes how the financial risk management of the schemes is different from the financial risk management for Momentum overall.

The management company of the scheme has a dedicated independent risk unit that continuously monitors the overall risk of the portfolios against stated mandate limits and the portfolios’ risk appetite over time. To avoid conflicts of interest, the unit is separate from the investment team and reports directly to the COO of the management company.

When considering any new investment for a scheme, the risks and expected returns are critical elements in the investment decision. Before an instrument is included in a portfolio, risks are carefully considered at instrument and portfolio level.

A portfolio’s market risk appetite is measured as a function of current market conditions and a benchmark which translates into a targeted tracking error which is monitored by the independent risk unit.

Credit and liquidity risk are mitigated through diversification of issuers in line with the policy.

All amounts disclosed include amounts attributable to the consolidated collective and fund of alternative funds investment schemes.

STRATEGIC AND BUSINESS RISK

Introduction

Strategic risk is defined as the risk that the current or prospective earnings will be negatively impacted as a result of adverse business decisions or the improper implementation of such decisions. The risk of choosing an inappropriate strategy or failing to execute the chosen strategy appropriately is a risk inherent in all business endeavours. Momentum’s objective is to minimise this risk in the normal course of business.

Business risk is defined as the risk that the earnings and capital will be negatively affected as a result of potential changes in the business environment, client behaviour and technological progress. Business risk, ie the risk that volumes and margins may be insufficient to cover Momentum’s cost base due to factors unrelated to and not captured in other risk types is considered as a potential outcome in the strategic planning process carried out across the businesses. It is Momentum’s objective to develop and maintain a portfolio profile that delivers sustainable earnings.

Strategic risk governance

The development and execution of business level strategy is the responsibility of the individual business areas subject to approval by the board, which sets Momentum’s overall strategy and ensures that strategic objectives set at a business level are consistent with overall Momentum strategy. This includes the approval of any subsequent material changes to strategic plans, the approval of acquisitions, significant equity investments and new strategic alliances.

Strategic risk management

Business unit and executive management as well as the central ERM function review the external environment, industry trends, potential emerging risk factors, competitors’ actions and regulatory changes as part of the strategic planning process. Through this review Momentum assesses the risk to its earnings and thus the level of potential business risk it faces. Reports on the results of such exercises are discussed at various business, risk and board committees and are ultimately taken into account in the setting of risk appetite and in potential revisions to existing strategic plans.

OPERATIONAL RISK  

Introduction  

Momentum defines operational risk as the risk of loss resulting from inadequate or failed internal processes, people and systems or from external events. This definition includes legal risk but excludes strategic and reputational risk.

Operational risk governance

Ownership of and accountability for operational risk management is of primary importance. Management and staff at every level of the business are accountable for the day to day identification, management and monitoring of operational risks.

ERM provides oversight of the effectiveness of Momentum’s operational risk management processes and assists business unit managers by facilitating the identification and assessment of risks within the business units and subsidiaries.

Independent assurance is provided on the management of operational risks by the FirstRand Internal Audit team. The FirstRand Internal audit function follows a risk based audit approach.

Operational risk is managed in terms of the Operational Risk Management Framework (“ORMF”), which is a subframework of the Risk Management Framework.

The Risk forums in the business units of Momentum are established to oversee the operational risk management process. Monitoring of operational risk occurs through a number of functions across Momentum.

Operational risk management

A number of operational risk management methodologies have been developed to deal with the practical implementation of operational risk management challenges. These methodologies are supplemented by a number of risk tools. These include:

• Risk self assessments – self assessment to identify and assess risks within the business processes in the business units and subsidiaries.
• Internal operational loss data and incident reporting – a process to record and analyse the root cause of losses and incidents.
• Key Risk Indicators (“KRIs”) – a process whereby measurable, quantifiable metrics are tracked to assess the level of operational risk and provide early warning indications of potential breakdowns.

Operational risk quantification and capital calculation

The Actuarial Society of South Africa issued revised professional guidance, applicable from 31 December 2008, which addresses the shortcomings in the old statutory capital adequacy requirement (“CAR”) formulae. The revised CAR formulae allow explicitly for credit and operational risks.

The profession guidance note requires the statutory actuary to use his professional judgement in the quantification of the operational risk capital requirements. The amount of capital required for operational risks is determined using the formulae suggested in the fourth Quantitative Impact Study (“QIS4”) conducted by the authors of the new Solvency II capital regime that will apply to insurers in the European Union.

Momentum is currently busy with the development of an internal model for quantifying operational risk based on a combination of statistical distribution models (for frequency and severity) applied to internal data and statistical models derived from extreme risk scenarios. The requirements of the Solvency II draft directive are also being taken into account during the development of this model.

As indicated in a preceding section, the ERM function also oversees a number of areas closely related to or integrated with the operational risk management processes. These are described in the following subsections.

Business continuity management

Business continuity management in Momentum focuses on improving the resilience of business operations in order to withstand unexpected disruptions and disasters. Business continuity management is an ongoing process of assessing needs, identifying weaknesses and single points of failure, developing strategies and keeping plans current and tested. The approach involves following a well established annual cycle of actions, designed to ensure plans and associated measures are kept relevant and tested.

These risks are monitored by Risk forums within the business units and subsidiaries and are escalated to the Momentum Risk committee as appropriate.

Information risk

Momentum defines information risk as the possibility of harm being caused to a business as a result of a loss of confidentiality, integrity or availability of information.

Information risk management establishes appropriate good practice and control measures to protect the information assets of Momentum and to ensure confidentiality, integrity and availability of Momentum’s information. Information risk manage - ment assists and drives business entities of Momentum to establish appropriate good practice and control measures to protect the information assets of Momentum.

The Information Technology Governance and Information Security Framework (“IT Risk Management Framework”) is a customisation of ISACA’s Control Objectives for Information and related Technology (“COBIT®”) framework and the Information Security Forum’s Standard of Good Practice for Momentum.

Due to the changing nature of information risk and information security, Momentum constantly faces new threats and challenges. The risk management structure for information risk is specifically structured to enable and support the measure - ment of status and the resolution of issues.

These risks are monitored by Risk forums within the business units and subsidiaries and are escalated to the Momentum Risk committee as appropriate.

Fraud and security risks

Momentum is committed to creating an environment that safeguards its people, customers and assets through policies and actions.

Momentum operates in an environment where we adopt a “zero tolerance” stance to criminal activities. Momentum enhances this environment with robust control structures and policies to safeguard the employees, clients and assets of Momentum.

In this regard Momentum relies on line management and formal structures that include risk management as well as forensic services to enforce the “zero tolerance” attitude. This attitude is further completely underwritten by the Momentum senior management and board. An independently and externally managed best practice fraud hotline (0800 737678) is also in place to provide the means to ensure that actual and/or suspected fraud or irregularities are confidentially and promptly reported.

To reach these goals, Momentum has not only a code of expected conduct that applies to all staff, but also various mechanisms to create anti-crime awareness, as well as mechanisms that assist in the detection of and formal prosecution of offenders.

Legal risk

Momentum defines legal risk as the risk of loss due to defective contractual arrangements, legal liability (both criminal and civil) incurred during operations by the inability of the organisation to enforce its rights, or by failure to address identified concerns to the appropriate authorities where changes in the law are proposed (implemented changes are dealt with as part of compliance risk).

Legal risk is managed in terms of the Legal Risk Management Framework and through activities such as monitoring of new legislation, awareness initiatives, identifying significant legal risks and by managing and monitoring the impact of these risks through appropriate processes and procedures.

Risk insurance

Risk insurance is defined as the risk that material unexpected operational losses, arising from non trading risks, are not identified and/or adequately covered by appropriate insurance risk financing structures.

Momentum forms part of FirstRand’s global insurance risk financing programme with cover limits that are commensurate with the size and stature of Momentum. The risks written into the programme are Bankers Blanket Bond, Computer Crime, Professional Indemnity, Directors’ & Officers’ Liability, Assets and various Liabilities.

Momentum will continue to monitor developments and ensure that the insurance financing programme is adapted accordingly where appropriate.

COMPLIANCE RISK

Introduction

Momentum defines compliance risk as the risk of legal or regulatory sanctions, material financial loss, or loss to reputation that the group may suffer as a result of its failure to comply with applicable laws, regulations, codes of conduct and standards of good practice.

Compliance risk governance

Compliance Risk Management is an integral part of managing the risks inherent in Momentum. Compliance risk is managed in terms of Momentum’s Compliance Risk Management Framework. The Compliance Risk Management function retains an independent reporting line to the board through the designated subcommittees.

Momentum has also established a Fair Practices committee, and where appropriate, compliance matters are escalated to this forum in addition to the above structures.

Compliance risk management

The Compliance Risk Management function has implemented appropriate structures, policies, processes and procedures to identify regulatory risks, monitor the management thereof and report on the status of compliance risk management in Momentum to the board and the regulatory authorities. This includes:

• identification through documenting which laws, regulations and supervisory requirements are applicable to Momentum;
• risk measurement through the development of compliance risk management plans;
• risk monitoring and review of remedial actions;
• risk reporting; and
• providing advice on compliance related matters.

To support the Compliance Risk Management Framework, a Momentum compliance manual has been drafted to assist the business in addressing all material compliance risks.

Although independent of other risk management and governance functions, the Compliance Risk Management function works closely with Internal Audit, Enterprise Risk Management, external audit, internal and external legal advisors, group tax, forensics, and the Company Secretariat to ensure the effective functioning of the compliance processes.

Risks arising from fiduciary activities

Momentum provides investment management and advisory services to third parties. These services result in Momentum making allocation, purchase and sale decisions in respect of a wide range of financial instruments. Those assets that are held in a fiduciary capacity are not included in the financial statements. These arrangements expose Momentum to the risk that it may be accused of misadministration or under-performance.

The asset management subsidiaries of Momentum are required to comply with the Risk Management Framework of Momentum. These subsidiaries employ risk management techniques which are considered best practice in the industry and constantly monitor actual performance against benchmarks and investigate differences.