Overview 2 The Aviva group at a glance 4 Chairman’s statement 6 Group chief executive’s review 8 Business segment 8 Long-term savings and fund management 10 General insurance and health 12 A responsible company and employer 12 Corporate social responsibility 13 Employees
Our strategy To offer a superior range of long-term savings, investment and protection products in markets that offer significant opportunities for growth.
During 2005, we have produced another set of excellent results, while acquiring and integrating RAC into our general insurance business. We continue to create strong returns for our shareholders and are in a good position to generate further growth.
Knowledge gained from HPI, digital flood mapping and our Pay As You Drive™ scheme has allowed us to improve our pricing decisions. Our Canadian business is now serviced by more than 150 staff in India, benefiting from cost and service advantages already seen in the UK.
As a result, Aviva’s actual future financial condition, performance and results may differ materially from the plans, goals and expectations set forth in Aviva’s forward-looking statements. Aviva undertakes no obligation to update the forward-looking statements contained in this review or any other forward-looking statements we make.
Interest on our direct capital instrument of £42 million (2004: nil) is not included in unallocated interest because it is treated as an appropriation of profits retained in the period. In accordance with IFRS, the appropriation was charged upon declaration and settlement in November 2005. The coupon payment attracts tax relief at 30%. The net impact of the appropriation on the profit attributable to ordinary shareholders was £29 million.
Under IFRS, dividends are only recognised in the financial statements once the shareholders’ right to receive payment is established. For the final dividend this right is only established when the dividend has been approved at the Annual General Meeting. Consequently, the cost of the final dividend for 2005 is not recorded in these accounts but will be recorded in the 2006 accounts. The total cost of dividends for 2005 incorporates the 2004 final dividend and the 2005 interim dividend.
We have a multi-distribution strategy, selling insurance products through brokers, partners such as banks and building societies, and direct to our customers. NU Direct is one of the UK’s leading online insurers and we are looking to build further our partnership capability and mutually beneficial intermediary relationships. We deliver high levels of service, with consistently strong customer satisfaction scores. Our headquarters are in Norwich and we operate from over 40 UK locations, with overseas operations in India and Sri Lanka.
Our results have benefited from lower claims frequency compared to historical norms on our motor business. However, these benefits were offset by the storm losses in Ontario in August, the secondlargest ‘catastrophe’ loss in Canadian history, impacting our property class results in the second half of the year. Our longer-term investment return rose to £112 million (2004: £96 million), reflecting a higher asset base and positive cash inflow in 2005. Our net written premiums increased slightly to £1,324 million (2004: £1,202 million) in spite of legislative automobile reforms that have led to lower premium rates. The reduction in premium rates has been matched by lower claim costs, and has improved our renewal retention level. We have maintained our underwriting discipline as rates in the commercial market have continued to decrease.
The transaction completed in two phases. Phase I completed in February 2005 and included all businesses listed above except for Malaysia, Indonesia, Macau, Marianas, Taiwan, Hong Kong and the Philippines. Phase II completed in November 2005, when the last of these businesses was sold.
From 1 January 2005, we are required to monitor our capital in accordance with the requirements of the Prudential Sourcebook (PSB), as set out by the FSA. We have established risk and governance frameworks to monitor compliance and finalised the parameters and assumptions that underpin the individual capital assessment (ICA). From 1 January 2006, we are required to have a positive IGD basis solvency level at all times. Our risk management process verify that adequate review of our IGD solvency at all times.
Reduction in CO2 emissions in 2005 >£800m Value of our SRI managed funds
Our people strategy, delivered against a backdrop of constant change, captures a need to: – Attract and retain top talent while complying with corporate governance best practice
The financial data contained in the report and accounts has been prepared using the group’s accounting policies under IFRS set out on pages 78 to 86. These policies are in accordance with standards issued by the IASB and endorsed by the EU, including early adoption of certain standards detailed in policy A on page 78.
Our underwriting strategy is agreed by the executive committee and communicated by specific policy statements and guidelines.
The issued ordinary share capital of the Company was increased by 113.3 million ordinary shares during the year. 87.9 million new shares were allotted in part consideration for the acquisition of RAC plc, which completed on 4 May 2005. The balance of 25.4 million shares was allotted under the Group’s employee share and incentive plans and the Aviva Scrip Dividend Scheme. At 31 December 2005 the issued ordinary share capital totalled 2,395.7 million shares. Details of the share capital and shares under option as at 31 December 2005, and shares issued during the year, are given in note 27 on page 141.
Post balance sheet events There have been no material events between 31 December 2005 and the date of this report which are required to be brought to the attention of shareholders.
The Combined Code requires that at least half the Board, excluding the Chairman, should comprise independent non-executive directors as determined by the Board. The Nomination Committee performs an annual review of directors’ interests in which all potential or perceived conflicts, including time commitments, length of service and other issues relevant to their independence, are considered. It is the Board’s view that, in addition to being free of any conflicts, an independent non-executive director also needs to be able to present an objective, rigorous and constructive challenge to management, drawing on his/her wider experiences to question assumptions and viewpoints and where necessary defend their beliefs. To be effective, an independent director requires a sound understanding of the insurance industry and the Company so as to be able to properly evaluate the information provided. Having considered the matter carefully the Board is of the opinion that all of the current non-executive directors are independent and free from any relationship or circumstances that could affect, or appear to affect their independent judgement.
Similarly, arrangements can be made for major shareholders to meet with newly appointed directors.
The Remuneration Committee The purpose of the Committee is to review and recommend to the Board the Company’s remuneration policy and strategy and within the policy to set the individual remuneration terms and packages for the executive directors and the Chairman. The Committee also sets the remuneration structure and terms for the Company’s other senior executives and exercises the powers of the Board in relation to the executive incentive and all-employee share plans. The full terms of reference for the Committee can be found on the Company’s website www.aviva.com and are available from the Group Company Secretary.
From 1 April 2005, all members of the defined benefit section of the Scheme were required to contribute 5% of their total gross basic salary to the Scheme.
Non-executive appointments The non-executive directors, including the Chairman, have letters of appointment which set out their duties and responsibilities. Whilst the appointments are for a maximum of three years they can be terminated at any time by either party giving one month’s written notice without the payment of compensation. The dates of the appointments/reappointments for the current directors are as follows.
6. Payments to former directors. Since his retirement as a director in 2003, Anthony Wyand has served as a consultant and as a director on the boards of some of the Group’s European operations. Under this arrangement, a fee of £126,000 was paid to him in 2005. During the year, shares granted to certain former executive directors under the Company’s incentive plans vested. Details of these awards were fully disclosed in the year of grant.
Basis of audit opinion We conducted our audit in accordance with International Standards on Auditing (UK and Ireland) issued by the Auditing Practices Board. An audit includes examination, on a test basis, of evidence relevant to the amounts and disclosures in the financial statements and the part of the Directors’ Remuneration Report to be audited. It also includes an assessment of the significant estimates and judgments made by the directors in the preparation of the financial statements, and of whether the accounting policies are appropriate to the group’s and company’s circumstances, consistently applied and adequately disclosed.
Under UK GAAP, goodwill previously written off to shareholders’ funds is taken back through the profit and loss account when calculating the profit or loss in the event of any subsequent disposal of the underlying investment. There is no requirement for this adjustment under IFRS.
The fair values of investments are based on quoted bid prices or amounts derived from cash flow models. Fair values for unlisted equity securities are estimated using applicable price/earnings or price/cash flow ratios refined to reflect the specific circumstances of the issuer. Equity securities for which fair values cannot be measured reliably are recognised at cost less impairment. When securities classified as AFS are sold or impaired, the accumulated fair value adjustments are transferred out of the investment valuation reserve to the income statement.
(Y) Employee benefits Employee entitlements to annual leave and long service leave are recognised when they accrue to employees. A provision is made for the estimated liability for annual leave and long-service leave as a result of services rendered by employees up to the balance sheet date.
Where loan notes have been issued in connection with securitised equity release mortgages, the Group has taken advantage of the revised fair value option under IAS39 to present the mortgages, associated liabilities and derivative financial instruments at fair value, since they are managed as a portfolio on a fair value basis and presentation at fair value provides more relevant information and eliminates any accounting mismatch.
Consolidated balance sheet As at 31 December 2005 1m Note £m £m
Cash flows from investing activities Acquisitions of subsidiaries, joint ventures and associates, net of cash acquired 48b (629) (794) (1,423) (540) Disposals of subsidiaries, joint ventures and associates, net of cash transferred 48c 50 414 464 308 Loans to joint ventures and associates (128) – (128) – Purchases of property and equipment (26) (180) (206) (127) Proceeds on sale of property and equipment 41 9 50 122 Purchases of intangible assets (44) (16) (60) (5)
The above requirements have resulted in transfers from retained earnings into separate revaluation reserves of £543 million and £736 million at 1 January 2004 and 31 December 2004 respectively.
Following a detailed review, 61% of life policy reserves on an modified statutory solvency basis (MSSB) at 31 December 2003 (31 December 2004: 59%) have been classified as insurance and 24% (at both dates) have been classified as participating investment contracts (being those investment contracts containing a discretionary participating feature as defined within IFRS 4). Both classes will continue to be accounted for under the Group’s existing accounting policies. The remaining 15% (31 December 2004: 17%) have been classified as non-participating investment contracts and therefore are required to be accounted for under IAS 39 and IAS 18, Revenue. Virtually all our general insurance products are classified as insurance.
This change in accounting has not resulted in any material changes to the balance sheets at 1 January 2004 or 31 December 2004.
UK GAAP changes changes (note 6) LTIR changes £m £m £m £m £m
Of these changes, the most significant impact occurs on our UK Life business, where profit falls by £90 million as a result of the adoption of IAS 39. On the basis of 2004 gross written premiums, 44% of our total life business within the UK is classified as non-participating investment contracts and includes unit-linked bonds and unit-linked pension contracts. IAS 39 reduces the level of deferred acquisition costs that can be recognised, as well as requiring the removal from technical provisions of positive or negative non-unit reserves determined on the local valuation basis held over and above the unit fund value. The effect of these changes is that the profits on a non-participating investment contract will arise later in the contract term under IFRS than under UK GAAP.
(e) Other information Principal subsidiaries at 31 December 2005 are listed on page 222.
11 – Auditors’ remuneration The total remuneration payable by the Group, excluding VAT and any overseas equivalent thereof, to its principal auditors, Ernst & Young LLP, in respect of the audit of these accounts is shown below, together with fees payable in respect of other work.
Audit-related supplementary reporting is in respect of the audit of the Group’s EEV figures on pages 200 to 221. Although EEV is the Group’s primary management reporting basis and our disclosures require a full audit, the relevant fees cannot be classified as being for statutory audit.
Notes to the consolidated financial statements continued 13 – Earnings per share (a) Basic earnings per share (i) The profit attributable to ordinary shareholders is: £m £m
(iii) The profit attributable to ordinary shareholders in the table above is calculated as follows: Operating Adjusting Operating Adjusting profit items Total profit items Total £m £m £m £m £m £m
Total of shares Per share Total of shares Per share £m m p £m £m p
The remaining £22 million related to other small European businesses. The 2004 impairment charge of £41 million comprise £21 million on one non-insurance Dutch operation, £17 million on other small European businesses and £3 million on other operations.
Of the £392 million of intangibles acquired in the RAC group, £310 million relating to subsidiaries is included in the acquisitions figure above and £82 million relating to joint ventures is dealt with in note 17(a). Note 3(a)(i) gives details of the nature of these assets, some of which have indefinite lives, and of the amortisation periods adopted.
Airport Property Partnership 50.0% 50.0% Apia Regional Office Fund 50.0% 70.0% Ashtenne Industrial Fund Limited Partnership 66.7% 40.2% The Global Switch Limited Partnership 25.0% 25.0% The Junction Limited Partnership 50.0% 48.8% The Mall Limited Partnership 50.0% 38.2% Paddington Central 1 Limited Partnership 50.0% 50.0% Queensgate Limited Partnership 50.0% 50.0% Quercus Property Partnership Limited 50.0% 66.4%
All the above entities perform property ownership and management activities, and are incorporated and operate in Great Britain. The Global Switch Limited Partnership has subsidiaries in several European countries which carry out property ownership and management activities locally. All these investments are held by subsidiary entities.
Capitalised expenditure on existing assets 19 13 – – – 32 Acquisitions of subsidiaries – – – – 7 7
Transfers from property and equipment 3 – 3 Foreign exchange rate movements 11 – 11
22 – Securitised mortgages and related assets continued All the shares in the Arena companies are held by independent trustee companies. Although DLL and AMS do not own, directly or indirectly, any of the share capital of the securitisation companies or their parent companies, these companies have been treated as subsidiaries in the consolidated financial statements. DLL and AMS have no right, nor any obligation, to repurchase the benefit of any of the securitised mortgage loans, other than in certain circumstances where they are in breach of warranty.
Amounts owed by contract holders 1,873 1,949 Amounts owed by intermediaries 1,543 1,711 Deposits with ceding undertakings 1,050 984 Amounts due from reinsurers 820 736 Other financial assets 2,488 2,129
25 – Deferred acquisition costs and other assets (a) The carrying amount comprises: General Long-term insurance Total Total business and health 2005 2004 £m £m £m £m
Notes to the consolidated financial statements continued 28 – Equity compensation plans (a) Description of the plans The Group maintains a number of active stock option and award schemes. These are as follows: (i) Savings-related options These are options granted under the Inland Revenue – approved Save As You Earn (SAYE) share option schemes in the United Kingdom and in Ireland. Options are normally exercisable during the six-month period following either the third, fifth or seventh anniversary of the relevant savings contract.
Option price Number Option price Number RAC Executive Share Option Scheme p of shares Normally exercisable p of shares Normally exercisable
(ii) Share awards At 31 December 2005, awards issued under the Company’s executive incentive plans over ordinary shares of 25 pence each in the Company were outstanding as follows: Number Aviva Long-Term Incentive Plan of shares Vesting period
30 – Preference share capital The preference share capital of the Company at 31 December 2005 was: £m £m
The principal assumptions underlying the cost of future policy related liabilities are as follows: Future investment return A “risk-free” rate equal to the spot yield on gilts, plus a margin of 0.1% is used. The rates vary, according to the outstanding term of the policy, with a typical rate as at year end 2005 being 4.23% for a policy with ten years outstanding.
The changes in the valuation discount rates since 2004 reflect the changes in the yields on the supporting assets. Valuation discount rates
(c) Netherlands On transition to IFRS, the valuation of most long-term insurance and participating investment contracts was changed from existing methods that generally used historic assumptions to an active basis using current market interest rates. A liability adequacy test is performed in line with IFRS requirements, using investment values and future investment income. Where assets are valued at market value, then the future investment income is based on expected market-based investment yields.
Carrying amount at 31 December 5,381 4,923 36 – Reinsurance assets (a) Carrying amounts (i) The reinsurance assets at 31 December comprised: £m £m
(ii) No market valuation reduction (MVR) guarantees – For unitised business, there are a number of circumstances where a “no MVR” guarantee is applied, for example on certain policy anniversaries, guaranteeing that no market value reduction will be applied to reflect the difference between the guaranteed value of the policy and the market value of the underlying assets.
Delta Lloyd has certain unit-linked contracts which provide a guaranteed minimum return at maturity from 4% pa to 2% pa. Provisions consist of unit values plus an additional reserve for the guarantee. The additional provision for the guarantee was £127 million (2004: £118 million). An additional provision of £77 million (2004: £27 million) in respect of investment return guarantees on group segregated fund business is held. It is estimated that the provision would increase by £293 million (2004: £234 million) if yields were to reduce by 1% pa and by £44 million (2004: £49 million) if equity markets were to decline by 10% from year end 2005 levels.
These guarantees are currently out-of-the-money by £84 million (2004: £79 million). This has been calculated on a deterministic basis as the excess of the current policy surrender value over the discounted value (excluding terminal bonus) of the guarantees. The value of these guarantees is sensitive to the performance of investments held in the with-profit fund. Amounts payable under these guarantees are determined by the bonuses declared on these policies. It is estimated that the guarantees would be out-of-the-money by £74 million (2004: £80 million) if yields were to increase by 1% per annum and by £39 million (2004: £40 million) if equity markets were to decline by 10% from year end 2005 levels.
UK defined benefit schemes 141 106 UK defined contribution schemes 33 31 Overseas defined benefit schemes 17 52 Overseas defined contribution schemes 14 16
The discount rate is the assumption that has the largest impact on the value of the liabilities. A 1% increase in this rate would reduce the liabilities by £1.7 billion.
Payables arising out of direct insurance 1,639 1,769 Payables arising out of reinsurance operations 618 444 Deposits received from reinsurers 883 1,519 Loans from associates 3 15 Bank overdrafts 690 653 Other financial liabilities 5,748 2,840 Less: Amounts classified as held for sale (96) –
In addition the Group is developing a risk-based capital model for its businesses that will provide a more detailed assessment of the capital needs of the business.
Apart from ICA and FCR, sensitivity testing is widely used to measure the capital required and volatility in earnings due to exposure to life insurance risks. This assessment is taken at both business unit level and at Group level where the impact of aggregation of similar risks can be measured. This enables the Group to determine whether action is required to reduce risk, or whether that risk is within the overall risk appetite.
Reinsurance Strategy Reinsurance purchases are reviewed annually at both business unit and Group level, to verify that the levels of protection being bought reflect any developments in exposure and the risk appetite of the Group. The basis of these purchases is underpinned by extensive financial modelling and actuarial analysis to optimise the cost and risk management benefits. For the larger business units, this involves utilising externally sourced probabilistic models to verify the accumulations and loss probabilities based on the Group’s specific portfolios of business. Where external models are not available, scenarios are developed and tested using the Group’s data to determine potential losses and appropriate levels of reinsurance protection. The reinsurance is placed with providers who meet the Group’s counterparty security requirements.
Correlations between market risk and other risks The Group considers that identified lapse behaviour and potential increases in consumer expectations are sensitive to and interdependent with market movements and interest rates. These interdependencies are taken into consideration in the ICA in the aggregation of the financial stress tests with the operational risk assessment. FCRs also consider scenarios involving a number of correlated events.
In accordance with Group policies, business unit management has primary responsibility for the effective identification, management, monitoring and reporting of risks to the business unit executive management team and to Group. Business unit risk management and governance functions are responsible for implementing the Group risk management methodologies and frameworks to assist line management in this work. They also provide support and independent challenge on the completeness, accuracy and consistency of risk assessments, and the adequacy of mitigating action plans. As a result, the business unit executive management team satisfies itself that material risks are being mitigated and reported to an acceptable level.
D – Tax (i) Tax credited/(charged) to income statement: £m £m
Reconciliation of movements in consolidated shareholders’ funds – EEV basis For the year ended 31 December 2005 £m £m
Preference share capital and direct capital instrument 1,190 1,190 Minority interests 1,457 1,160
EEV methodology continued Net worth The net worth is the market value of the shareholders’ funds and the shareholders’ interest in the surplus held in the non-profit component of the long-term business funds, determined on a statutory solvency basis and adjusted to add back any non-admissible assets, and consists of the required capital and free surplus. Required capital is reported net of implicit items permitted on a local regulatory basis to cover minimum solvency margins which are assessed at a local entity basis. The level of required capital for each business, which ranges between 100% and 150% of the EU minimum solvency requirement for our main European businesses, reflects the level of capital considered by the directors to be appropriate to manage the business, allowing for our internal assessment of the level of market, insurance and operating risk inherent in the underlying products. The same definition of required capital is used for both existing and new business. The free surplus comprises the market value of shareholder assets in excess of local statutory reserves and required capital.
Investment return variances 2,288 501 Effect of economic assumption changes (406) (318)
2. Contribution stated after deducting the effect of required capital, tax and minority interests.
8. Adverse lapse assumption changes in the UK relates to unitised with-profit bonds and unit-linked bonds. In Ireland, lapse assumption changes have been made on unit-linked pensions business following recent experience.
Value of Net worth in-force covered business Embedded value £m £m £m £m £m £m
Summary Statistics The following table sets out the means and standard deviations of future euro returns at 31 December 2005 for the three most significant asset classes: equities, short-term bonds (defined to be of one-year duration) and long-term bonds (defined to be 10-year zero coupon bonds). In the accumulation of 10-year bonds, it is assumed that these are held for one-year, sold as 9-year bonds then the proceeds are reinvested in 10-year bonds, although in practice businesses follow more complex asset strategies or tend to adopt a buy and hold strategy. Correlations between asset classes have been set using the same approach as described for the UK.
Where subsidiary companies provide administration, investment management or other services to businesses included in the European Embedded Value calculations, the value of profits or losses arising from these services have been included in the embedded value and new business contribution.
Sensitivity analysis – economic assumptions The tables below show the sensitivity of the embedded value as at 31 December 2005 and the new business contribution before the effect of required capital for 2005 to: – One percentage point increase and decrease in the discount rates; – One percentage point increase and decrease in interest rates, including all consequential changes (including assumed investment returns for all asset classes, market values of fixed interest assets, risk discount rates); – One percentage point increase and decrease in the assumed investment returns for equity and property investments, excluding any consequential changes to the risk discount rate; – 10% rise and fall in market value of equity and property assets (not applicable for new business contribution); and
RAC France SA Société d’Epargne Viagére SA (75.0%) Union Financière de France Banque (Banking) (76.3%)
Ordinary Shares Ex-dividend date 8 March Record date 10 March Scrip dividend price available 15 March Dividend payment date 17 May