Aeroflot Group is working to build a unified system of risk management at all its companies based on the approaches used by JSC Aeroflot, the largest asset in the Group.

Aeroflot has an efficient integrated risk management system that enables the rapid identification and assessment of risks and timely reaction to them, so that any negative impact of the risks can be minimised or eliminated. The Company uses a probabilistic approach to risk assessment, analysing the impact of risks on business results by means of mathematical models.

Risk management is carried out at all levels of Company management and in all of the Company’s functional and project spheres. Risk management functions are allocated between the Board of Directors, the Management Board, the Audit Committee, the Risk Management division and other divisions of JSC Aeroflot.

The company divides risks into four main groups: financial, operational, legal and business risks.

Aeroflot uses a policy based on advanced planning in order to minimise risks, relying on such mechanisms as insurance, hedging, setting of limits and coverage requirements. Staff training, operations with an up-to-date aircraft fleet, and the use of advanced technologies for the purposes of flight safety, market risk management, pilot training, and other measures help to minimise risks. The Company’s risk management efforts are complex in nature and are intended not only to minimise negative consequences from the occurrence of various risks, but also to reduce the probability of adverse events and the level of Company exposure to all kinds of risk.

Type of risk

Description

Measures to minimise the risk

Financial risks

Risks that arise from changes in market indicators, such as foreign exchange rates and interest rates. Financial risks can significantly reduce the company’s profits.

Aeroflot takes carefully planned steps to reduce the potential adverse effect of financial risks or to eliminate them.

Market risks

Risk of lowering of the value of assets due to change of market factors.

Price risk

Risk of change in prices for aviation fuel, which are linked to world oil prices. Aviation fuel accounts for more than 30% of total Company expenditures, so price fluctuations have material impact on overall Company costs.

Aeroflot uses financial instruments to hedge its price risk. At the beginning of 2014 approximately 70% of monthly planned consumption of aviation fuel during 2014 and 25% of planned consumption in 2015 was hedged. The hedging structure used by Aeroflot is consistent with the practice of many international airlines.

Foreign exchange risk

Risks arising from currency fluctuations. JSC Aeroflot operates in international markets and carries out operations in various currencies. Change in the exchange rate can substantially affect the financial results of the Company and the Group.

The company hedged 80% of its planned open currency positions in the euro for 2014. Exchange rate trends in late 2013 and early 2014 were favourable for JSC Aeroflot.

Interest rate risk

The risk of exchange rate changes, which can lead to relative increase in the cost of borrowing (increase of Company spending on interest payments). The risk relates primarily to leasing contracts for which the Company is subject to a floating LIBOR rate. Change of the LIBOR rate on the international market may lead to an increase of interest payments under lease agreements.

In order to reduce interest rate risks, Aeroflot concluded an interest rate swap agreement in 2011, by which the Company receives sums tied to the floating LIBOR rate, but pays at a fixed rate. In 2014, this tool covers about 15% of the Company’s payments under finance leases tied to LIBOR. Aeroflot regularly assesses the situation on the interest rate market and is ready to increase the share of interest rate hedging if necessary.

Credit risks

Risks associated with inability of counterparties to meet their financial obligations to Aeroflot.

JSC Aeroflot distinguishes the following sources of credit risk:

  • Risk associated with receivables from agents carrying out the sale of passenger and freight transport under agent agreements.
  • Operations with bank counterparties, which bear credit risk (placement of deposits, guarantees, derivatives transactions).

Aeroflot manages and minimises its credit risk using a systematic approach, which has been enshrined in the Company’s internal regulatory documents.

In order to reduce receivables risk sellers of air transportation are required to provide financial security in the form of bank guarantees or deposits. The size of the financial security is recalculated on a monthly basis and depends on the financial condition of the agent, as well as the agent’s payment discipline and sales volume. Monitoring of the credit risk of Aeroflot agents is carried out every ten days. A system of credit risk limits is used for bank counterparties. The limit depends on the term and determines the amount of potential payments by the bank in favour of the Company. The results of financial analysis and expert assessment of credit institutions are taken into account when determining credit risk limits. Information on all companies within Aeroflot Group is used when calculating the degree of use of credit facilities and remaining available credit. The financial condition of counterparty banks and size of their limits are reviewed on a quarterly basis. Non-financial information from various sources, including, media and the official websites of state bodies (the Bailiff Service, Federal Tax Service, Supreme Commercial court, etc.) is also monitored regularly. At the end of 1990 about 90 institutions were included on the register of banks with which JSC Aeroflot cooperates. Thanks to timely monitoring and management of credit risk, Aeroflot did not incur any financial losses from transactions with counterparties during 2013.

Liquidity risks

Liquidity risk refers to possible inability of the Company to perform its obligations to counterparties.

To reduce the risk of loss of liquidity, Aeroflot’s financial departments follow a carefully planned schedule of cash inflow and outflow in order to identify shortfalls in advance and rectify them through short-term borrowing from credit institutions.

Operating risks

Risks associated with the operations of Aeroflot. Such risks may arise due to faults in internal processes, the actions of employees, failures of automated systems or outside factors.

Efficient work by Aeroflot to minimise operating risks avoids potential losses for the Company.

The Company insures the bulk of its operating risks. Risks that cannot be insured against (other operating risks) are classified by their origin as internal or external.

Aviation risks

Includes the risk of destruction or disappearance or damage to the aircraft, its parts and/or assemblies, the risk of civil air carrier liability and military risks.

Aeroflot insures all of its aviation risks. Spending for insurance of aviation risk represents over 2/3 of total insurance spending by the Company.

Aviation insurance contracts were renewed as planned in 2013. Subsidiaries of JSC Aeroflot (Orenburg Airlines, Rossiya Airlines Vladivostok Air, Donavia and SAT Airlines) are included in consolidated reinsurance coverage , which contributes to lower rates for JSC Aeroflot and Aeroflot Group as a whole. Stabilisation of the international aviation insurance market also contributed to lower rates. Aviation risk insurance rates decreased by 25% on average. As a result, the overall premium for insurance of aviation risks remained unchanged. Compared with the previous period of insurance, despite a significant increase in the value of the aircraft fleet, the number of passengers and number of take-off and landing cycles.

The direct insurer in the new policy period, as in the previous two years, was the Alfa Insurance. On Western markets, Aeroflot was reinsured by the world’s leading aviation broker, Willis Ltd. A co- broker, AON, was appointed in 2013 for the first time in Aeroflot’s history. The appointment of a co-broker for risk placement made the intellectual capital of two brokers available to help obtain transparent pricing and receive additional recommendations for improving and expanding current coverage, and obtaining suggestions for placement of the insurance programme .

  • Operational risks

Risks of destruction or disappearance or damage to the aircraft, its parts and/or assemblies

  • Civil liability risk

Risks associated with harm to the life and health of passengers, and destruction (loss), partial loss or damage (harm) to the baggage and personal items of passengers, and of harm to the owners or dispatchers of baggage.

  • Military risks

Risks associated with the country to which the airline operates its flights. Primarily risks associated with war, revolution, civil war, coup, etc., as well as actions that may entail malicious acts, sabotage, nationalisation, confiscation and terrorist acts against the property of the airline.

Non-aviation risks

Risks not related to the operation of aircraft, but which influence the day-to-day business of the Company, including medical risks, and risks of accidents at work.

Non-aviation risks are also subject to insurance.

  • Medical risks

Risks related to the state of health of Company employees and their families.

Health insurance accounts for about 30% of total insurance costs. Aeroflot provides comprehensive voluntary medical insurance of all Company employees, their families, pensioners and also employees of foreign representative offices and their families in more than 45 countries. Company’s partner in health insurance provision is RESO-Guarantee Insurance Company in Russia and Alfa Insurance abroad. More than 28,000 people are insured, including more than 17,000 Company employees. In 2013, more than a thousand people benefited from periods at sanatoria and holiday resorts as directed by the Aeroflot Medical Centre.

  • Risks of accidents at work

These risks include: accidental death; 1st, 2nd and 3rd group of disabilities as the result of an accident; traumatic injury due to an accident; temporary or permanent inability to work resulting from an accident or illness

In compliance with the Russian Air Transport Code, JSC Aeroflot insures against accidents which may befall air crew, cabin crew, and other employees who provide flight services during execution of their duties and also insures them against accidents on their way to and from work. These expenses represent about 2% of total insurance expenses. The number of insured workers is more than 10,000, divided into three groups depending on their position and conditions of insurance. Each group has its own rights to insurance indemnification based on the age of the insured party, length of service with the Company and the risks covered.

Other operating risks subject to insurance

A wide range of non-aviation risks that may affect Company operations, including risk of abduction, theft, and damage to vehicles, the risk suffered by vehicle drivers and passengers, as well as risks associated with the operation of hazardous production facilities, risks of loss and damage to property, risks associated with management decision-making, etc.

Aeroflot implements various insurance programmes , covering a wide range of operating risks, including vehicle insurance (comprehensive and third party), extended liability insurance, liability in respect of hazardous production facilities, liability of owners of temporary storage, liability of members of the Board of Directors and Management, and property insurance.

In 2013, Aeroflot launched a programme of comprehensive insurance for airline passengers. The project enables airline customers to purchase combined air travel insurance. The product is available in the sales offices in Moscow and Moscow Region, and on the Aeroflot website.

Legal risks

Legal risks can be divided into legislative risks and geopolitical risks.

  • Legislative risks

Risks associated with changes in legal rules:

  • changes in currency regulation;
  • changes in tax laws;
  • changes in customs clearance and the level of duties;
  • changes in company law.

Aeroflot carefully monitors changes in legislation and takes an active part in work by international organisations, influencing development of the legal and regulatory environment of the air transport industry

  • Geopolitical (country and regional) risks

Risks associated with change in the geopolitical situation in regions which are part of the Aeroflot route network

The Company attaches great importance to the analysis of country-specific risks, choosing appropriate response in specific regions (suspension of flights, route changes, increased security measures, strengthening of sanitary and epidemiological control, etc.).

Operating risks

Risks which relate specifically to Aeroflot’s operations, and which apply to all players in the sector

Aeroflot’s ability to manage such operational risks depends on the quality of its management and the strategy it choses, with a strong focus on maximising safety and tight operational controls.

Competition risks

Risks associated with the activity of other market players

The level of competition from Russian and international airlines is high. Aeroflot carefully monitors and quickly responds to market trends, offering optimal prices and high-quality services. The company offers its passengers the most convenient and fastest connections between domestic and international flights, reducing waiting time for transit passengers to a minimum.

Aeroflot is developing its cooperation with members of the SkyTeam alliance through code-sharing agreements, expanding the route network and offering passengers more extensive travel opportunities.

Aeroflot maintains strong passenger satisfaction by ensuring a high level of safety, quality of service and an extensive network of routes, and also by developing a loyalty programme, all of which support the Company’s long-term competitive advantages.

Risks of fluctuations in demand

Risks associated with seasonality of demand for air transport services

The airline industry is subject to seasonal fluctuations in demand for its services. Peak demand coincides with vacation and holiday periods, when capacity utilisation on both domestic and international routes is at its peak. Aeroflot is expanding its route network to countries that are attractive to tourists year-round in order to optimise its own load. The Company also carries out a variety of promotions, including the sale of tickets at attractive rates to increase traffic in the winter months. In addition, Aeroflot flights traditionally offer convenient departure and arrival times, supporting levels of passenger traffic even in periods of decreasing demand for air travel.

Reputational risks

Risks associated with damage to the Company’s reputation

Aeroflot places considerable value on its reputation as a high-quality and safe carrier, and as a reliable business partner. The Company therefore takes all necessary steps to protect its reputation and its brand.

Management is constantly focused on the analysis and improvement of services and introduction of new passenger service technologies, including use of external contractors, which enhance customer loyalty.

Environmental risks

Risks associated with the impact of Aeroflot’s business on the environment

Aeroflot seeks to minimise adverse effects on the environment, renewing and upgrading its fleet by adding latest generation aircraft, which benefit from greater fuel efficiency and lower levels of harmful emissions. The Company has developed and approved guidelines on environmental management in accordance with the requirements of ISO 14000.

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