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Notes to the consolidated
financial statements
continued
3 Management of risk continued
3.2 Financial risk continued
(e) Currency risk
The Group operates internationally and its exposures to foreign exchange risk arise primarily with respect to the US Dollar, Pound Sterling
and the Euro. These exposures may be classified in two main categories:
1) Structural foreign exchange risk through consolidation of net investments in subsidiaries with different functional currencies
within the Group results; and
2) Operational foreign exchange risk through routinely entering into insurance, investment and operational contracts, as a Group
of international insurance entities serving international communities, where rights and obligations are denominated in currencies
other than each respective entity's functional currency.
The Group’s exposure to structural foreign exchange risk primarily relates to the US Dollar net investments made in its domestic operation
in Bermuda and its overseas operation in Guernsey and the US. Other structural exposures also arise on a smaller scale in relation to net
investments made in European operations. The Group’s risk appetite permits the acceptance of structural foreign exchange movements
within defined aggregate limits and exchange rate parameters which are monitored centrally. Exchange rate derivatives are used when
appropriate to shield the Group against significant movements outside of a defined range.
At a consolidated level, the Group is exposed to foreign exchange gains or losses on balances held between Group companies where
one party to the transaction has a functional currency other than Pound Sterling. To the extent that such gains or losses are considered
to relate to economic hedges and intragroup borrowings, they are disclosed separately in order for users of the financial statements
to obtain a fuller understanding of the Group’s financial performance (note 14).
Up to 6 May 2008 the Group financed a portion of its net investment in the Bermuda and Guernsey insurance operations using US Dollar
borrowings to which hedge accounting was applied (see note 20). There were no items qualifying for hedge accounting in the current year.
The Group has the ability to draw on its current borrowing facility in any currency requested, enabling the Group to match its funding
requirements with the relevant currency.
Operational foreign exchange risk is controlled within the Group’s operations. The assets of the Group’s overseas operations are
generally invested in the same currencies as their underlying insurance and investment liabilities producing a natural hedge. Due
attention is paid to local regulatory solvency and risk based capital requirements.
Details of all foreign currency derivative contracts entered into with external parties are given in note 22. All foreign currency derivative
transactions with external parties are managed centrally. Included in the tables below are net non-monetary liabilities of £240 million
(2008: £225 million) which are denominated in foreign currencies.
As a result of the accounting treatment for non monetary items, the Group may also experience volatility in its income statement during
a period when movements in foreign exchange rates fluctuate significantly. In accordance with IFRS, non monetary items are recorded at
original transaction rates and are not remeasured at the reporting date. These items include unearned premiums, deferred acquisition costs
and reinsurers’ share of unearned premiums. Consequently, a mismatch arises in the income statement between the amount of premium
recognised at historical transaction rates, and the related claims which are retranslated using currency rates in force at the reporting date.
The Group considers this to be a timing issue which can cause significant volatility in the income statements. Further details of the impact
of the accounting treatment is provided in note 13.
The currency profile of the Group’s assets and liabilities is as follows:
At 31 December 2009
Sterling
£000
US Dollar
£000
Euro
£000
Other
£000
Total
£000
Intangible assets 44,105 6,308 – – 50,413
Property, plant and equipment 13,678 7,893 673 – 22,244
Investments in associates 6,728 – 590 – 7,318
Deferred tax – 14,077 – – 14,077
Deferred acquisition costs 42,376 71,678 23,125 4,326 141,505
Financial assets carried at fair value 580,797 1,623,276 166,629 42,598 2,413,300
Reinsurance assets 54,976 320,424 27,375 17,351 420,126
Loans and receivables including insurance receivables 127,361 259,539 88,480 13,402 488,782
Current tax – – – – –
Cash and cash equivalents 93,096 97,754 57,998 10,799 259,647
Total assets 963,117 2,400,949 364,870 88,476 3,817,412
68 Notes to the consolidated financial statements Hiscox Ltd Report and Accounts 2009