(vi) Aviva Investors comprises the Aviva Investors UK, France, the United States, Canada, and the international fund management businesses.
As part of this review, the Group concluded that estimating our latent claim provisions on an undiscounted basis, and discounting back to current values, represented an improvement to the existing estimation technique. This approach is in line with best practice for long-term liabilities and moves the measurement of latent claims onto a more economic basis, consistent with our internal model for economic capital and the measurement model being proposed for both IFRS Phase II and Solvency II. This approach also improves consistency with the reporting of other long-tail classes of business which are already being discounted, namely certain London Market latent claims and our Dutch Permanent Health and Injury Business.
The impact of the change in accounting policy on the general insurance and health claims provisions and our results for the year ended 31 December 2007 and the opening 1 January 2007 position is set out below.
The impact on shareholders’ funds after tax was £107 million and £112 million at 31 December 2007 and 1 January 2007 respectively.
(ii) Consolidation of managed funds The Group manages a number of specialised investment vehicles around the world, in which our insurance and investment funds have invested. The Group’s percentage ownership in these vehicles can fluctuate from day to day according to the Group’s and third party participation in them, and control is determined based on an analysis of the guidance in IAS 27. During 2008, we identified that certain such vehicles required consolidation in accordance with IAS 27 which therefore results in grossing up assets and liabilities for the effect of the third party participation.
In addition, certain property investment vehicles, which were consolidated in accordance with IAS 27, required restatement in the year ended 31 December 2007 to reanalyse amounts previously classified as minority interests to net asset value attributable to unitholders. This change recognises that the property investment vehicles are unit trusts and, as a result, the third party holding should have been recognised as a liability rather than as a non-controlling interest. Prior year comparatives have been restated with a reduction in minority interests and an increase in amounts due to unitholders of £758 million at 31 December 2007 and £431 million at 1 January 2007.
None of these adjustments has any impact on profit for the period, operating profit or earnings per share in the full year 2007, nor on retained earnings, net assets or total equity at either 1 January 2007 or 31 December 2007.
This note provides details of the acquisitions and disposals of subsidiaries that the Group has made during the year, together with details of businesses held for sale at the year end. The principal Group subsidiaries are listed on pages 328 to 329.
The estimated book and fair values of the assets and liabilities at the date of acquisition were: Book value £m
Assets Reinsurance assets 30 – 30 Cash and cash equivalents 27 – 27 Receivables and financial assets 32 – 32 Other assets 2 – 2
Liabilities Insurance liabilities (49) – (49) Payables and other financial liabilities (35) – (35) Other liabilities (1) – (1)
Liabilities Insurance liabilities (2,267) 67 (2,200) Borrowings (31) – (31) Payables and other financial liabilities (56) – (56) Other liabilities (12) (18) (30)
The results of UBI Vita have been included in the consolidated financial statements of the Group with effect from 18 June 2008, and have contributed £2 million loss to the consolidated loss before tax.
(iii) Swiss Life Belgium On 30 June 2008, the Group acquired 100% of the shares in Swiss Life Belgium, a multi-line insurer, from SNS REAAL for £112 million. By combining Swiss Life Belgium with our Belgian insurance operation, managed through our Dutch subsidiary Delta Lloyd, the Group will further strengthen its position in the Belgian life insurance market.
The acquisition of this shareholding has given rise to goodwill on acquisition of £48 million, calculated as follows: Purchase cost: £m
The results of Swiss Life Belgium have been included in the consolidated financial statements of the Group with effect from 30 June 2008, and have contributed £35 million loss to the consolidated loss before tax.
Addition to existing shareholding in Cajamurcia 3 Other goodwill arising 23
Addition to existing shareholding in Cajamurcia Vida As disclosed in the 2007 financial statements, on 6 June 2007 the Group acquired 5% of the share capital of Caja Murcia Vida y Pensiones, de Seguros y Reaseguros SA (Cajamurcia Vida) from the Spanish savings bank Caja de Ahorros de Murcia (Cajamurcia). Cajamurcia Vida was fully consolidated as a subsidiary from that date, as the Group has the power to govern its financial and operating policies, through having the majority vote at meetings of the company’s board of directors.
On signing the shareholders’ agreement, Cajamurcia granted the Group a call option over a further 45% of the shares in Cajamurcia Vida. On 27 March 2008, the Group exercised this option and acquired 45% of the shares for £81 million. The fair value of the net assets of the company at the date the option was exercised was £176 million, and the acquisition of the additional shareholding gave rise to additional goodwill of £3 million.
(vi) Unaudited pro forma combined revenues and profit Shown below are unaudited pro forma figures for combined revenues and profit as though the acquisition date for all business combinations effected during the year had been 1 January 2008, after giving effect to purchase accounting adjustments and the elimination of intercompany transactions. The pro forma financial information is not necessarily indicative of the combined results that would have been attained had the acquisitions taken place at 1 January 2008, nor is it necessarily indicative of future results.
United Kingdom (see (i) below) (38) (7) Turkey – 71 Offshore operations (see (iii) below) 14 – Other small operations 31 (15)
Liabilities Payables and other financial liabilities (20) Other liabilities (28) Tax liabilities and other provisions (17)
Consideration: Cash consideration 67 Non-cash consideration 15 Less: transaction costs (5)
(ii) Luxembourg life operations On 5 November 2008, the Group’s Dutch subsidiary, Delta Lloyd NV, exchanged its 100% holding in Commercial Union International Life SA (CUIL) for a 15% shareholding in NewPEL SA, a Luxembourg-registered investment company. No profit or loss was realised on disposal.
The assets and liabilities of CUIL at the date of disposal were: Assets Intangible assets 5 Investments 373 Cash and cash equivalents 5 Other assets 16
(c) Operations and assets classified as held for sale Assets held for sale as at 31 December 2008 comprise: £m
Property and equipment held for sale (see (i) below) 102 – Assets of operations classified as held for sale (see (ii) below) 1,448 1,128
(iii) Dutch health insurance business On 16 July 2007, the Group announced that its Dutch subsidiary, Delta Lloyd Group (“DL”), had reached an agreement to sell its health insurance business to OWM CZ Groep Zorgverkeraar UA (“CZ”), a mutual health insurer, and create a long-term alliance for the cross-selling of insurance products. Under the terms of the agreement, CZ will purchase the DL health insurance business and take on its underwriting risk and policy administration. DL will continue to market and distribute health insurance products from CZ to its existing customers and continue to provide asset management for the transferred business. DL will also have exclusive rights to market life, general insurance and income protection products to CZ’s customers. The transaction completed on 1 January 2009.
(iv) UK non-core operations In 2008, the Group decided to sell, and was actively marketing, certain companies as part of its strategy to exit certain UK non-core operations. As at 31 December 2008, The British School of Motoring Limited and its subsidiaries had yet to be sold and, as a result, their relevant assets and liabilities have been classified as held for sale, at their carrying values, in the consolidated balance sheet as at 31 December 2008. On 11 February 2009, these companies were sold to Arques Consulting GmbH, realising a loss on disposal of £9 million which has been provided for within exceptional items in these financial statements.
Dutch Law changed in October 2004 to ensure that Supervisory Board directors in Dutch companies were henceforth to be elected by a company’s shareholders voting on nominations made by its Supervisory Board and the Works Council. Under the previous system, Supervisory Board directors appointed their own successors. In 2006, Delta Lloyd commenced proceedings against Aviva plc to try to compel the Company to adhere to the system that existed prior to the change in the law, on the basis of agreements they say were entered into in 1973 when the Group acquired Delta Lloyd. The Company disputes these claims and does not expect the litigation, whatever its outcome, to have any adverse effect on the financial or operational performance of Delta Lloyd or the Group. The court gave a judgement in 2008, requiring Aviva to adhere to the previous system of appointment, which Aviva is appealing.
(a) Operating segments As explained in note 2(a), the Group has determined its operating segments along regional lines. These reflect the management structure whereby a member of the Executive Management team is accountable to the Group Chief Executive for the operating segment for which he is responsible. The activities of each operating segment are described below: United Kingdom The United Kingdom comprises two operating segments – UK Life and UK General Insurance (UK GI). The principal activities of UK Life are life insurance, long-term health and accident insurance, savings, pensions and annuity business, whilst UK GI provides insurance cover to individuals and to small and medium-sized businesses, for risks associated mainly with motor vehicles, property and liability, such as employers’ liability and professional indemnity liability, and medical expenses. UK GI also includes the RAC motor recovery business, the group reinsurance result and the results of run off business.
Europe Activities reported in the Europe operating segment exclude operations in the UK and include those in Russia and Turkey. Principal activities are long-term business in France, the Netherlands, Ireland, Italy, Poland and Spain, and general insurance in France, the Netherlands, Ireland and Italy.
Other Group activities Investment return on centrally held assets and head office expenses, such as Group treasury and finance functions, together with certain taxes and financing costs arising on central borrowings are included in “Other Group activities”. Similarly, central core structural borrowings and certain tax balances are included in “Other Group activities” in the segmental balance sheet. Also included here are consolidation and elimination adjustments.
(ii) profit or loss from operations before tax attributable to shareholders, adjusted for non-operating items outside the segment management’s control, including investment market performance and fiscal policy changes.
(i) Segmental income statement for the year ended 31 December 2008
Gross written premiums 8,108 5,496 15,529 6,486 587 – – 36,206 Premiums ceded to reinsurers (612) (498) (442) (214) (75) – – (1,841) Internal reinsurance revenue – 26 (21) (4) (1) – – –
Net written premiums 7,496 5,024 15,066 6,268 511 – – 34,365 Net change in provision for
Claims and benefits paid, net of recoveries from reinsurers (8,620) (3,944) (13,411) (2,912) (464) – (2) (29,353)
Change in insurance liabilities, net of reinsurance 2,674 280 3,409 (2,774) 296 – – 3,885
Amortisation of deferred acquisition costs and acquired value of in-force business – – (44) (285) (4) – – (333)
Depreciation and other amortisation expense (70) (108) (120) (51) (5) (5) – (359)
(Loss)/profit before tax (1,180) (391) (1) (338) (56) 72 (474) (2,368) Tax attributable to policyholders’
** Impairment losses, and reversal of such losses, recognised directly in equity were £830 million and £nil.
Adjusted for non-operating items: Reclassification of corporate costs and unallocated interest 7 (71) 54 15 – – (5) –
Investment return variances and economic assumption changes on long-term business 694 – 400 433 104 – – 1,631
Economic assumption changes on general insurance and health business – 91 3 – – – – 94
Operating profit/(loss) before tax attributable to shareholders 723 541 1,141 149 36 114 (407) 2,297
(ii) Segmental income statement for the year ended 31 December 2007
Net earned premiums 5,666 5,550 13,109 4,386 601 – – 29,312 Fee and commission income 246 385 638 30 168 299 (6) 1,760 5,912 5,935 13,747 4,416 769 299 (6) 31,072 Net investment income 5,186 699 2,761 875 286 (15) (103) 9,689 Inter-segment revenue – – – – – 199 – 199 Share of profit/(loss) of joint ventures and associates (304) 3 6 – (9) – – (304) Profit/(loss) on the disposal of
Change in investment contract provisions (694) – (1,091) (153) (35) (45) – (2,018)
Change in unallocated divisible surplus 1,882 – 1,040 – – – – 2,922
Depreciation and other amortisation expense (24) (104) (53) (45) (6) (17) – (249)
Other operating expenses (1,110) (2,723) (2,318) (545) (251) (289) (15) (7,251) Impairment losses** – – (50) (7) – – – (57) Inter-segment expenses (141) (4) (18) (32) (3) – (1) (199) Finance costs (405) (10) (527) (19) – – (256) (1,217)
Profit/(loss) before tax 573 142 1,316 (38) 44 132 (322) 1,847 Tax attributable to policyholders’
** Impairment losses, and reversal of such losses, recognised directly in equity were £nil and £1 million.
† Aviva Investors comprises the Aviva Investors UK, France, the United States, Canada and International fund management businesses.
Adjusted for non-operating items: Reclassification of corporate costs and unallocated interest (6) (63) 33 19 – – 17 – Investment return variances and economic assumption changes on long-term business 112 – (309) 181 (1) 2 – (15)
Impairment of goodwill – – 1 – – 9 – 10 Amortisation and impairment of intangibles 4 28 21 40 3 7 – 103 (Profit)/loss on the disposal of subsidiaries and associates – 7 5 – – – (61) (49) Integration and restructuring costs 8 114 12 19 – – – 153
Operating profit before tax attributable to shareholders 682 313 1,197 229 37 147 (389) 2,216
Unearned premiums 173 2,966 670 959 22 – – 4,790 Other insurance liabilities – 91 182 91 – – – 364 Liability for investment contracts 35,109 – 65,106 3,403 1,643 2,298 – 107,559 Unallocated divisible surplus 2,727 – (405) – 3 – – 2,325 Net asset value attributable to unitholders 986 – 3,304 – 175 – 2,453 6,918 External borrowings 2,716 11 6,970 163 – – 5,341 15,201 Other liabilities, including inter-
Goodwill 71 1,276 1,053 642 40 – – 3,082 Acquired value of in-force business and intangible assets 65 349 1,164 1,579 28 12 – 3,197 Interests in, and loans to, joint ventures and associates 2,972 – 594 1 215 – – 3,782 Property and equipment 177 317 374 28 37 7 2 942 Investment property 10,415 252 3,061 – 25 966 672 15,391 Loans 20,153 900 13,895 1,206 39 – – 36,193 Financial investments 83,489 3,679 103,430 17,227 3,934 1,993 2,658 216,410 Deferred acquisition costs 1,477 1,212 914 830 45 4 5 4,487 Other assets 10,535 5,157 16,086 2,804 500 667 2,093 37,842
Capital expenditure (excluding business combinations) 30 140 106 10 5 6 2 299
(i) Segmental income statement – products and services for the year ended 31 December 2008
Net earned premiums 23,228 – 11,414 – 34,642 Fee and commission income 753 567 160 405 1,885 23,981 567 11,574 405 36,527 Net investment (expense)/income (16,671) 3 425 200 (16,043) Inter-segment revenue – 185 – – 185 Share of loss of joint ventures and associates (1,089) (12) (5) (22) (1,128) Profit on the disposal of subsidiaries and associates – – – 7 7
Profit/(loss) before tax attributable to shareholders (243) 81 (106) (1,032) (1,300) Adjusted for non-operating items 1,937 42 1,304 314 3,597
† Other includes the RAC non-insurance operations, our banking business, head office expenses, such as Group treasury and finance functions, and certain financing costs and taxes not allocated to business segments.
Net written premiums 18,764 – 10,569 – 29,333 Net change in provision for unearned premiums – – (21) – (21)
Segmental income 27,688 682 11,550 738 40,658 Segmental expenses (26,139) (521) (10,843) (1,308) (38,811) Tax attributable to policyholder returns (15) – – – (15)
Profit before tax attributable to shareholders 1,534 161 707 (570) 1,832 Adjusted for non-operating items 76 18 314 (24) 384
Fee and commission income Fee income from investment contract business 487 416 Fund management fee income 556 576 Other fee income 577 481 Reinsurance commissions receivable 176 223 Other commission income 110 110 Net change in deferred revenue (21) (46)
Net investment income Interest and similar income From financial instruments designated as trading and other than trading 7,302 6,611 From AFS investments and financial instruments at amortised cost 2,012 1,485 9,314 8,096 Dividend income 2,444 2,100 Other income from investments designated as trading Realised gains and losses 1,039 49 Unrealised gains and losses (policy J) 108 65 1,147 114 Other income from investments designated as other than trading Realised gains and losses (1,181) 5,055 Unrealised gains and losses (see policy J) (25,213) (6,244) (26,394) (1,189) Realised gains on AFS investments 126 391 Net income from investment properties Rent 959 846 Expenses relating to these properties (33) (27) Realised gains on disposal 14 105 Fair value (losses) on investment properties (note 21) (3,137) (757) (2,197) 167 Realised gains on loans 7 7 Foreign exchange gains and losses on investments other than trading (395) 11 Other investment income/(expenses) (95) (8)
This note gives further detail on the items appearing in the second section of the consolidated income statement.
Claims and benefits paid Claims and benefits paid to policyholders on long-term business Insurance contracts 16,986 14,743 Participating investment contracts 5,085 5,604 Non-participating investment contracts 115 64 Claims and benefits paid to policyholders on general insurance and health business 8,696 7,779 30,882 28,190 Less: Claim recoveries from reinsurers Insurance contracts (1,447) (1,056) Participating investment contracts (82) (13)
Claims and benefits paid, net of recoveries from reinsurers 29,353 27,121
Change in investment contract provisions Investment income allocated to investment contracts (6,957) 885 Other changes in provisions Participating investment contracts (note 39) (3,088) 1,025 Non-participating investment contracts (591) 90 Change in reinsurance asset for investment contract provisions 7 18
Other expenses Other operating expenses Staff costs and other expenses (note 10) 3,090 2,724 Central costs and sharesave schemes 141 163 Depreciation (note 20) 131 129 Impairment of goodwill on subsidiaries (note 16a) 48 10 Amortisation of acquired value of in-force business on insurance contracts (note 17) 333 160 Amortisation of intangible assets (note 17) 113 106 Net impairment of acquired value of in-force business (note 17) 2 – Impairment/reversal of impairment of intangible assets (note 17) 13 4 Integration and restructuring costs (see below) 326 153 Exceptional items (see below) 247 –
Notes to the consolidated financial statements continued 6 – Details of expenses continued £m £m
Impairments Net impairment on loans 50 9 Net impairment on financial investments 973 49 Net impairment on receivables and other financial assets 17 1 Net impairment on non-financial assets – (1)
Integration and restructuring costs Integration and restructuring costs incurred in the year amounted to £326 million (2007: £153 million). This includes £287 million for the cost savings initiatives in the UK life and general insurance businesses and Europe, which have delivered £337 million annualised cost savings in the year. Also included are integration costs of £39 million which mainly relate to the work to set up our global asset management operation, Aviva Investors.
Exceptional items We have reported exceptional items of £551 million (2007: £nil) in the year. These include £142 million for closing or exiting non-core business operations such as the lifetime wrap platform and The British School of Motoring in the UK and the structured settlement business in the United States. The costs also include £304 million after reinsurance for the discounted cost of strengthening our latent claims provisions, mainly in the UK, and £126 million for the settlement agreed by our Netherlands life business for its unit-linked policyholders, following an industry-wide challenge on the level of fees. The remaining balance relates to brand migration costs of £37 million offset by £58 million benefit from settlement of a disputed Australian tax liability and the consequent release of a provision for interest charges.
Impairment of financial investments Group policy is to recognise an impairment on available for sale (AFS) equity securities when there has been a prolonged or significant decline in their fair value below their cost. Although management believes that these equity securities will ultimately recover their value, there can be no certainty that this will happen as, unlike fixed maturity securities, the value of an equity security cannot be recovered in full by holding it to maturity.
Interest expense on operational borrowings Amounts owed to credit institutions 82 38 Securitised mortgage loan notes At amortised cost 125 105 At fair value 325 220 450 325
These are analysed as: Allocated interest and similar charges 1,168 854 Group debt costs and other interest 379 363 8 – Long-term business economic volatility
(a) Definitions Operating profit for long-term business is based on expected investment returns on financial investments backing shareholder and policyholder funds over the reporting period, with consistent allowance for the corresponding expected movements in liabilities. Operating profit includes the effect of variance in experience for non-economic items, such as mortality, persistency and expenses, and the effect of changes in non-economic assumptions. Changes due to economic items, such as market value movements and interest rate changes, which give rise to variances between actual and expected investment returns, and the impact of changes in economic assumptions on liabilities, are disclosed separately outside operating profit.
(b) Economic volatility The investment variances and economic assumption changes excluded from the long-term business operating profit are as follows: Long-term business £m
The deepening global financial crisis has led to significantly negative investment variances in 2008. The variances primarily relate to debt securities, where the unprecedented widening of credit spreads drove down market values, and to a lesser extent from falling equity and property values. For with-profits and unit-linked business the decline in asset values is largely offset by a corresponding reduction in liabilities. However for other non-profit business and surplus shareholder funds, the reduction in asset values was only partly mitigated by movements in liabilities. Although equity markets suffered major downturns, the profit impact was limited by hedging activity in the Netherlands and limited shareholder exposure elsewhere in the Group.
This compares to a broadly neutral net impact on profit in 2007, when favourable investment variances in the Europe region were largely offset by negative effects in the USA and UK.
Where fixed interest securities are classified as available for sale, such as in the United States, the expected investment return comprises the expected interest or dividend payments and amortisation of the premium or discount at purchase.
(b) The longer term investment return and short-term fluctuation are as follows: Non-long-term business £m
Analysed between: Longer term investment return, reported within operating profit 1,268 1,317 Short-term fluctuation in investment return, reported outside operating profit (819) (184)
Notes to the consolidated financial statements continued 9 – Longer term investment return and economic assumption changes for non-long-term business continued
The principal assumptions underlying the calculation of the longer term investment return are: Longer term rates of return
(f) The table below shows the sensitivity of the Group’s non-long-term business operating profit before tax to changes in the longer term rates of return: Movement in investment return for By Change in 2008 £m
(g) The economic assumption changes arise from movements in the rate used to discount latent claims. As explained in accounting policy K, provisions for latent claims are discounted, using rates based on the relevant swap curve, in the relevant currency at the reporting date, having regard to the duration of the expected settlement of the claims. The discount rate is set at the start of the accounting period, with any change in rates between the start and end of the accounting period being reflected below operating profit as an economic assumption change. The range of discount rates used is disclosed in note 38(c).
This note shows where our staff are employed throughout the world and analyses the total staff costs.
United Kingdom operations* 28,424 32,872 29,996 32,746 Europe 16,501 15,989 16,283 15,769 North America 5,627 4,634 4,990 4,775 Asia Pacific 2,376 2,052 2,220 2,005 Aviva Investors 1,298 967 1,061 962 Corporate centre 532 497 507 497 * 2007 employee numbers include staff in the offshore operations in Sri Lanka and India. These operations were sold in 2008 and therefore these are not included in the 2008 closing numbers.
Wages and salaries 2,114 1,831 Social security costs 258 229 Post-retirement obligations Defined benefit schemes (note 46d) 175 191 Defined contribution schemes (note 46d) 58 63 Profit sharing and incentive plans 172 169 Equity compensation plans (note 29d) 39 50 Termination benefits 57 9
Fees for Supplementary reporting are in respect of the audit of the Group’s MCEV and EEV reporting. Although embedded value is a primary management reporting basis and our disclosures require a full audit, the relevant fees are not classified as being for statutory audit. These fees have increased in 2008 due to the work undertaken on the Group’s MCEV restatement that was published in February 2009.
In February 2009 an Australian tax court case was settled in our favour resulting in the release of tax provisions of £63 million, which has reduced the tax charge in the income statement.
(iii) The tax (credit)/charge can be analysed as follows: £m £m
(iv) Unrecognised tax losses and temporary differences of previous years were used to reduce current tax expense and deferred tax expense by £139 million and £19 million, respectively (2007: £51 million and £6 million, respectively).
Current tax (16) (19) Deferred tax In respect of pensions and other post-retirement obligations (15) 269 In respect of unrealised losses on investments (204) (71) (219) 198
(ii) The tax credit attributable to policyholders’ returns included above is £nil (2007: £nil).
(c) Tax reconciliation The tax on the Group’s profit before tax differs from the theoretical amount that would arise using the tax rate of the home country of the Company as follows: £m £m
Total tax (credited)/charged to income statement (note 13a) (1,483) 349 14 – Earnings per share
This note shows how we calculate earnings per share, based both on the present shares in issue (the basic earnings per share) and the potential future shares in issue, including conversion of share options granted to employees (the diluted earnings per share). We have also shown the same calculations based on our operating profit as we believe this gives a better indication of operating performance.
Profit/(loss) before tax attributable to shareholders’ profits 2,297 (3,597) (1,300) 2,216 (384) 1,832
Profit/(loss) for the year 1,810 (2,695) (885) 1,612 (114) 1,498 Amount attributable to minority interests (91) 61 (30) (191) 13 (178) Cumulative preference dividends for the year (17) – (17) (17) – (17) Coupon payments in respect of direct capital instruments (DCI) (net of tax) (40) – (40) (37) – (37)
Operating profit attributable to ordinary shareholders 2,297 1,662 62.9 2,216 1,367 52.8
Impairment of goodwill (note 16a) (66) (66) (2.5) (10) (10) (0.4) Amortisation and net impairment of intangibles (note 17) (117) (89) (3.4) (103) (72) (2.8) Profit on the disposal of subsidiaries and associates (note 3b) 7 7 0.3 49 52 2.0 Integration and restructuring costs and
Operating profit attributable to ordinary shareholders 1,662 2,643 62.9 1,367 2,588 52.8
The impairment losses charged to exceptional items arise in the United Kingdom long-term business (see (b)(i) below). Of the other impairment losses charged to expenses, £46 million arises in the Netherlands (see (b)(viii) below) and £2 million arises in the Italy long-term business (see (b)(vi) below). Together with impairment charges of £18 million recognised in respect of goodwill within interests in joint ventures and associates (notes 18 and 19), the total goodwill impairment loss charged to non-exceptional expenses was £66 million.
United Kingdom Long-term business (see (i) below) 52 71 – – 52 71 General insurance, RAC and health
(see (ix) below) 652 552 – – 652 552 Other 24 19 – – 24 19 North America United States (long-term business)
(i) Long-term business The United Kingdom long-term business goodwill balance is split across five cash generating units, with no individual balance exceeding £25 million.
As disclosed in note 6, the wrap platform of the United Kingdom long-term business was terminated during the year. As a result of this termination, the goodwill relating to this business was impaired and a charge of £20 million has been recognised as an exceptional item in the income statement.
Notes to the consolidated financial statements continued 16 – Goodwill continued The recoverable amount of the UK general insurance, RAC and health unit has been determined based on a value in use calculation. The calculation uses cash flow projections based on business plans approved by management covering a three year period and a risk adjusted discount rate of 10.2%. Cash flows beyond that three year period have been extrapolated using a steady 2.5% growth rate. The recoverable amount exceeds the carrying value of the cash-generating unit including goodwill and intangible assets with indefinite useful lives.
Key assumptions used for the calculation were: – Budgeted operating profit represents the operating profit in the business plans, approved by management, and as such reflects the best estimate of future profits based on both historical experience and expected growth rates for the relevant UK industry sectors; – Some of the assumptions that underline the budgeted operating profit include market share, customer numbers, premium rate and fee income changes, claims inflation and commission rates; and
As disclosed in note 17(d), as a result of the classification of The British School of Motoring Limited and its subsidiaries as held for sale, an impairment charge of £20 million in respect of intangible assets with indefinite useful lives has been recognised.
Long-term business The recoverable amount of long-term business cash generating units in the Europe region, with the exception of the Netherlands, has been determined based on a value in use calculation. The first step of the test was to compare the carrying value of each cash generating unit, including goodwill, to the Market Consistent Embedded Value (MCEV) of that cash generating unit. If the MCEV is less than the carrying value of a cash generating unit the present value of profits from expected new business for that cash generating unit is considered.
For European long-term business cash generating units a key assumption used for the calculation was: – Embedded value represents the shareholder interest in the life business and is calculated in accordance with the Market Consistent Embedded Value (MCEV) principles. The embedded value is the total of the net worth of the life business and the value of the in-force business.
General insurance, health and other The recoverable amount of general insurance, health and other non-life cash generating units in the Europe region has been determined based on a value in use calculation. Value in use is calculated for each cash generating unit using a discounted cash flow projection based on business plans and growth assumptions approved by management for each cash generating unit and discounted at a risk discount rate appropriate for each cash generating unit.
Key assumptions used for the calculation were: – Budgeted operating profit for an initial three year period represents the operating profit in the business plans, approved by management and as such reflects the best estimate of future profits based on both historical experience and expected growth rates for the Irish economy. Some of the assumptions that underline the budgeted operating profit include market share, premium rate changes, claims inflation and commission rates; – Growth rate of 4.6% represents the rate used to extrapolate future cash flows beyond the business plan period. Prices are assumed to remain static in the foreseeable future and volumes are assumed to increase in line with real GDP; and
Key assumptions (in addition to MCEV principles) used for the calculation were: – New business contribution represents the present value of projected future distributable profits generated from business written in a period. This is initially based on the most recent three year business plans approved by management; – Growth rate represents the rate used to extrapolate new business contributions beyond the business plan period, and is based on management’s estimate of future growth of 2.0%; and
– Risk adjusted discount rate of 10.2% represents the rate used to discount expected profits from future new business. The discount rate includes a risk-free rate and a risk margin to make prudent allowance for the risk that experience in future years for new business may differ from that assumed.
(viii) Netherlands (long-term, general insurance, health and fund management) The recoverable amount of the Netherlands life and general insurance and health cash generating units has been determined on the basis of a value in use calculation. This calculation is an appraisal value and is based on the discounted expected future cash flows from the operations over a 25-year period. Expected cash flows for future periods have been obtained from the plan figures for a three year period. Expected cash flows for later periods have been extrapolated, taking into account the growth rate.
Key assumptions used for the calculation were: – Expected cash flows for future periods have been obtained from the plan figures for a three year period; – Growth rate of 2.0% represents the rate applied to extrapolate new business contributions beyond the business plan period, for the life and general insurance business. In the fund management business growth rates are based on management's prudent best estimate of future growth; and
– Risk-adjusted discount rate of 9.2% for long-term, general insurance and health business, and 11.53% for fund management business represents the rate used to discount expected profits from future new business. The discount rate includes a risk margin to make prudent allowance for the risk that experiences in future years may differ from those assumed.
Key assumptions (in addition to MCEV principles) used for the calculation were: – New business contribution represents the present value of projected future distributable profits generated from business written in a period. This is initially based on the most recent three year business plans approved by management; – Growth rate represents the rate used to extrapolate new business contributions beyond the business plan period, and is based on management’s conservative estimate of future growth of 3.0%. This growth rate is in line with industry expectations; and
– Risk adjusted discount rate of 10.1% represents the rate used to discount expected profits from future new business. The discount rate is a combination of a risk-free rate and a risk margin to make prudent allowance for the risk that experience in future years for new business may differ from that assumed.
(x) United States (long-term business) The recoverable amount of the United States long-term cash generating unit has been determined based on a value in use calculation.
Key assumptions used for the calculation were: – Embedded value represents the shareholder interest in the life business and is based on projected cash flows of the business including expected investment returns.
– Risk adjusted discount rate of 10% is used to calculate the embedded value; – New business contribution represents the present value of projected future distributable profits generated from business written in a period. This is initially based on the most recent three year business plans approved by management; – Growth rate represents the rate used to extrapolate new business contributions beyond the business plan period, and is based on management’s estimate of future growth of 5% for life and annuity business; and
– Risk adjusted discount rate of 12% represents the rate used to discount expected profits from future new business. The discount rate includes an additional margin to make prudent allowance for the risk that experience in future years for new business may differ from that assumed.
Gross amount At 1 January 2007 2,185 101 752 263 3,301 Additions 24 – 48 – 72 Acquisition of subsidiaries 29 – 205 386 620 Disposals – – (8) – (8) Transfers – – (54) 54 – Foreign exchange rate movements 35 9 62 6 112
(a) Additions to gross AVIF on insurance contracts in 2008 includes £327m for the movement in the shadow adjustment made to the carrying value of AVIF in Aviva USA.
(ii) the bancassurance distribution agreement with Banco Popolare, signed in December 2007, which is initially for ten years, with five-year automatic renewal periods. It is expected to be renewed indefinitely, due to the unfavourable terms of the put option for failure to renew.
(d) As disclosed in note 6, the wrap platform of the United Kingdom long-term business was terminated during the year. As a result of this termination the intangible asset relating to this business was impaired and a charge of £32 million has been recognised as an exceptional item in the income statement.
The impairment of intangible assets with indefinite useful lives relates to the classification of The British School of Motoring Limited and its subsidiaries as held for sale. This has been recognised as an exceptional item in the income statement.
Share of loss after tax – (339) – (339) Acquisitions and additions 196 453 126 775 Disposals and reduction in Group interests – (267) – (267) Reclassification to financial investments – (208) (42) (250) Fair value gains taken to equity – 9 – 9 Loans repaid – – (159) (159) Foreign exchange rate movements 1 10 1 12
Share of results before tax – (1,029) – (1,029) Share of tax – (3) – (3)
Acquisitions and additions – 175 182 357 Disposals and reduction in Group interests – (131) – (131) Fair value losses taken to equity – (12) – (12) Loans repaid – – (52) (52) Foreign exchange rate movements 7 30 – 37
Property management undertakings – 1,080 297 1,377 Long-term business undertakings 198 158 – 356 General insurance undertakings – 4 – 4
Airport Property Partnership 50.0% 50.0% Ashtenne Industrial Fund Limited Partnership 66.7% 37.4% The Junction Limited Partnership 50.0% 46.0% The Mall Limited Partnership 50.0% 53.8% Queensgate Limited Partnership 50.0% 50.0% Quercus Healthcare Property Partnership Limited 50.0% 39.6% The 20 Gracechurch Limited Partnership 50.0% 50.0%
All investments in the above companies are unlisted and are held by subsidiaries except for the shares in AvivaCOFCO Life Insurance Co. Limited, which are held by the Company. The Group’s share of net assets of that company are £57 million (2007: £44 million) and have a fair value of £61 million (2007: £52 million).
Key assumptions used for the calculation were: – The calculations use cash flow projections based on the policy portfolio existing at the valuation date and the future sales based on plans approved by management covering the subsequent three year period. The cashflows from existing policy portfolio is calculated using best estimate assumptions, which have been supported by experience investigation where available and prudent estimates typical for the market where experience investigations are not available; – The calculations use a risk adjusted discount rate of 10.5%; and
– New sales beyond the three year period have been extrapolated using a growth rate of 7.5%.
AvivaSA Emeklilik ve Hayat A.S. The Group’s investment in AvivaSA Emeklilik ve Hayat A.S. has been tested for impairment by comparing its carrying value (which includes goodwill which arose on its acquisition) with its recoverable amount.
The recoverable amount has been determined based on a value in use calculation.
This calculation is an actuarially-determined appraisal value and is based on the embedded value of the business together with the present value of expected profits from future new business. The recoverable amount exceeds the carrying value of the cash generating unit including goodwill.
Income, including unrealised (losses)/gains on investments (876) 242 Expenses (153) (579)
Notes to the consolidated financial statements continued 19 – Interests in, and loans to, associates
This note analyses our interests in entities which we do not control but where we have significant influence.
Share of results before tax – 51 – 51 Share of tax – (4) – (4)
Additions in 2008 comprise additional capital invested in Aviva Life Insurance Company India Limited, Banca Network Investimenti SpA, RBSG Collective Investments Limited, and RBS Life Investments Limited.
RBS Life Investments Limited Insurance Ordinary shares of £1 each 49.99% Great Britain
19 – Interests in, and loans to, associates continued Although the Group’s holding in the three Cyrte funds is less than 20%, it has significant influence through ownership of the fund manager, Cyrte Investments BV, a subsidiary of which acts as general partner to the funds, and through membership of its investment committee.
RBS Life Investments Limited and RBSG Collective Investments Limited The Group’s investments in RBS Life Investments Limited and RBSG Collective Investments Limited have been tested for impairment by comparing their carrying values (which include goodwill which arose on their acquisition) with their recoverable amounts.
The recoverable amounts for both investments have been determined based on value in use calculations, using an appraisal value methodology. The appraisal value comprises MCEV and a value of future new business. Future new business is valued using a similar approach as used for the in-force business. The value of 2009 planned new business is based on planned volumes, planned margins for manufactured business and current margins for adopted business all approved by management. This value is then multiplied by an annuity in perpetuity factor to give the value of all years of future new business and then discounted from mid-2009 back to the valuation date. The annuity factor allows for new business growth of 4.5% and a risk discount rate of 7.3%. This value is adjusted to allow for future expense over-runs and under-runs, based on the projected expenses and sales volumes.
Banca Network Investimenti SpA The Group’s investment in Banca Network Investimenti SpA has been tested for impairment by comparing its carrying value (which includes goodwill which arose on its acquisition) with its recoverable amount.
Notes to the consolidated financial statements continued 20 – Property and equipment
Cost or valuation At 1 January 2007 65 499 13 702 359 1,638 Additions 27 9 3 92 96 227 Acquisitions of subsidiaries – 10 1 1 2 14 Disposals (16) (60) (4) (37) (14) (131) Transfers (27) (14) – – – (41) Transfers (6) 6 – – – – Fair value gains (see note 34) – 23 – – – 23 Foreign exchange rate movements 2 26 1 14 19 62 Other movements – – – – 4 4
At 31 December 2007 45 499 14 772 466 1,796 Additions 22 7 1 97 89 216 Acquisitions of subsidiaries – 37 – 1 2 40 Disposals (15) (31) (3) (34) (24) (107) Transfers to owner occupied property (4) 4 – – – – Fair value losses (see below) – (49) – – – (49) Foreign exchange rate movements 13 106 2 40 72 233
Depreciation and impairment At 1 January 2007 – – (8) (499) (227) (734) Charge for the year – (1) (1) (97) (30) (129) Disposals – – 2 32 8 42 Impairment losses charged to restructuring costs – (2) – – – (2) Foreign exchange rate movements – – – (14) (14) (28) Other movements – – – – (3) (3)
At 31 December 2007 – (3) (7) (578) (266) (854) Charge for the year – (1) (2) (93) (35) (131) Disposals – 1 1 33 14 49 Impairment losses charged to restructuring costs – (2) – (8) (40) (50) Foreign exchange rate movements – – – (29) (48) (77)
20 – Property and equipment continued Owner-occupied properties are stated at their revalued amounts, as assessed by qualified external valuers or by local qualified staff of the Group in overseas operations, all with recent relevant experience. These values are assessed in accordance with the relevant parts of the current RICS Appraisal and Valuation Standards in the UK, and with current local valuation practices in other countries. This assessment, on the basis of Existing Use Value and in accordance with UK Practice Statement 1.3, is the estimated amount for which a property should exchange on the date of valuation between a willing buyer and a willing seller in an arm’s-length transaction, after proper marketing wherein the parties had acted knowledgeably, prudently and without compulsion, assuming that the buyer is granted vacant possession of all parts of the property required by the business and disregarding potential alternative uses. The valuation assessment adopts market-based evidence and is in line with guidance from the International Valuation Standards Committee and the requirements of IAS 16, Property, Plant and Equipment, for all but specialised-use properties which are valued on a depreciated replacement cost (DRC) basis as permitted by paragraph 33 of IAS 16.
Investment properties are stated at their market values as assessed by qualified external valuers or by local qualified staff of the Group in overseas operations, all with recent relevant experience. Values are calculated using a discounted cash flow approach and are based on current rental income plus anticipated uplifts at the next rent review, assuming no future growth in rental income. This uplift and the discount rate are derived from rates implied by recent market transactions on similar properties. Further details of the fair value methodology are given in note 24(b).
The fair value of investment properties leased to third parties under operating leases at 31 December 2008 was £13,764 million (2007: £14,616 million). Future contractual aggregate minimum lease rentals receivable under the non-cancellable portion of these leases are given in note 51 (b)(i).
This note analyses the loans our Group companies have made, the majority of which are mortgage loans.
(a) Carrying amounts The carrying amounts of loans at 31 December 2008 and 2007 were as follows: At fair value through profit or loss other than trading £m
Policy loans 265 1,861 2,126 215 1,316 1,531 Loans to banks – 6,415 6,415 – 7,576 7,576 Securitised mortgage loans (see note 23) UK 1,861 – 1,861 1,777 – 1,777 Netherlands 4,936 2,262 7,198 3,699 1,911 5,610 6,797 2,262 9,059 5,476 1,911 7,387 Non-securitised mortgage loans 14,406 7,266 21,672 12,849 4,747 17,596 Loans and advances to bank customers – 1,886 1,886 – 1,307 1,307 Loans to brokers and other intermediaries – 98 98 – 80 80 Other loans – 981 981 – 716 716
(b) Collateral The Group holds collateral in respect of loans where it is considered appropriate, in order to reduce the risk of non-recovery. This collateral generally takes the form of liens or charges over properties and, in the case of policy loans, the underlying policy, for the majority of the loan balances above. In the event of a default, the Group is able to sell or repledge the collateral.
The Group has loans receivable, secured by mortgages, which have then been securitised through non-recourse borrowings, in our UK Life and Dutch businesses. This note gives details of the relevant transactions.
(i) United Kingdom In a long-term business subsidiary (NUER), the beneficial interest in certain portfolios of lifetime mortgages has been transferred to five special purpose securitisation companies (“the ERF companies”), in return for initial consideration and, at later dates, deferred consideration. The deferred consideration represents receipts accrued within the ERF companies after meeting all their obligations to the noteholders, loan providers and other third parties in the priority of payments. The purchases of the mortgages were funded by the issue of fixed and floating rate notes by the ERF companies.
(ii) Netherlands and Belgium In three subsidiaries, Delta Lloyd Levensverzekering NV (DLL), Amstelhuys NV (AMS), and Delta Lloyd Bank (Belgium) NV/SA (DLB), the principal benefits of certain portfolios of mortgage loans have been transferred to a number of special purpose securitisation companies, which were funded primarily through the issue of fixed and floating rate notes.
UK Securitised mortgage loans – At fair value (note 22) 1,861 (1,614) 1,777 (1,691) Other securitisation assets/(liabilities) 78 (325) 23 (109)
This note analyses our financial investments by type and shows their cost and fair value. These will change from one period to the next as a result of new business written, claims paid and market movements.
Equity securities Ordinary shares Public utilities – 3,933 1 3,934 Banks, trusts and insurance companies – 5,525 2,332 7,857 Industrial miscellaneous and all other 9 28,182 2,989 31,180
Of the above total, £176,752 million (2007: £154,732 million) is expected to be recovered more than one year after the balance sheet date.
Fixed maturity securities Debt securities UK government – 18,767 – 18,767 UK local authorities – 81 – 81 Non-UK government 35 28,278 936 29,249 Public utilities – 3,922 1,003 4,925 Convertibles and bonds with warrants attached – 856 – 856 Other 144 51,774 12,276 64,194 179 103,678 14,215 118,072 Certificates of deposit – 3,291 26 3,317 Redeemable preference shares – 3 – 3
Total financial investments 1,952 196,557 18,217 216,726 Less assets classified as held for sale Fixed maturity securities – (80) – (80) Equity securities – (236) – (236) – (316) – (316)
Internal models with significant observable market parameters – (“Level 2”) Inputs to Level 2 fair values are inputs other than quoted prices included within Level 1 that are observable for the asset, either directly or indirectly. If the asset has a specified (contractual) term, a Level 2 input must be observable for substantially the full term of the asset. Level 2 inputs include the following: – Quoted prices for similar (ie not identical) assets in active markets; – Quoted prices for identical or similar assets in markets that are not active, the prices are not current, or price quotations vary substantially either over time or among market makers, or in which little information is released publicly; – Inputs other than quoted prices that are observable for the asset (for example, interest rates and yield curves observable at commonly quoted intervals, volatilities, prepayment spreads, loss severities, credit risks, and default rates); – Inputs that are derived principally from, or corroborated by, observable market data by correlation or other means (market-corroborated inputs).
(iii) The tables below show movements in the assets measured at fair value based on valuation techniques for which any significant input is not based on observable market data (Level 3 only). Total funds are then further analysed between policyholder funds, participating funds and shareholder funds.
The Group receives collateral in order to reduce the credit risk of these arrangements. Collateral must be in a readily realisable form, such as listed securities, and is held in segregated accounts. Transfer of title always occurs for collateral received, although no market risk or economic benefit is taken. The level of collateral held is monitored regularly, with further collateral obtained where this is considered necessary to manage the Group’s risk exposure.
In September 2008, a counterparty default led to the sale of the collateral held and the purchase of securities lent to that counterparty. This process was completed without any loss to the Group.
(ii) Stock repurchase arrangements Included within financial investments are £383 million (2007: £358 million) of debt securities and other fixed income securities which have been sold under stock repurchase arrangements. The obligations arising under these arrangements are shown in note 48.
Amounts owed by contract holders 2,303 2,554 Amounts owed by intermediaries 1,649 1,417 Deposits with ceding undertakings 1,747 1,163 Amounts due from reinsurers 802 701 Amounts due from brokers for investment sales 120 326 Amounts receivable for collateral pledged (notes 24d and 56e) 1 21 Reimbursements due from government health insurance 147 402 Corporate owned life insurance 162 112 Dividends receivable 183 152 Finance lease receivables 121 111 Other banking assets 237 50 Other financial assets 2,730 2,164
Total 10,202 9,173 Less: Amounts classified as held for sale (386) (554)
Deferred acquisition costs in respect of: Insurance contracts – Long-term business 3,306 1,473 Insurance contracts – General insurance and health business 1,489 1,583 Participating investment contracts – Long-term business 87 112 Non-participating investment contracts – Long-term business 1,062 1,126 Retail fund management business 22 27
Total deferred acquisition costs 5,966 4,321 Surpluses in the staff pension schemes (note 46e(vii)) – 27 Other assets 182 139
Carrying amount at 1 January 2,711 1,583 27 4,321 Acquisition costs deferred during the year 1,513 2,660 4 4,177 Amortisation (682) (2,828) (9) (3,519) Impairment losses (100) – – (100) Impact of assumption changes (281) (4) – (285) Effect of portfolio transfers, acquisitions and disposals 3 (1) – 2 Foreign exchange rate movements 808 79 – 887 Shadow adjustment 483 – – 483
The shadow adjustments relate to deferred acquisition costs on business in the United States backed by investments classified as available for sale. As explained in accounting policy K, unrealised gains and losses on the AFS investments and the shadow adjustments above are both recognised directly in shareholders’ equity.
(c) Other assets Other assets include £1 million (2007: £66 million) that is expected to be recovered more than one year after the balance sheet date.
Certain unit-linked products have been classified as investment contracts, while some are included within the definition of an insurance contract. The assets backing these unit-linked liabilities are included within the relevant balances in the consolidated balance sheet, while the liabilities are included within insurance and investment contract provisions. This note analyses the carrying values of assets backing these liabilities.
This note gives details of Aviva plc’s ordinary share capital and shows the movements during the year.
Schemes 8,429,587 2 18 Shares issued in lieu of dividends 27,479,209 7 (7)
(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 UK and in Ireland. Options are normally exercisable during the six month period following either the third, fifth or seventh anniversary of the start of the relevant savings contract.
(v) Annual bonus plan awards These awards have been made under the Aviva Annual Bonus Plan 2005, and are described in Section (b) below and in the Directors’ remuneration report.
(vi) “One Aviva, twice the value” bonus plan awards These are conditional awards first granted under the Aviva Annual Bonus Plan 2005 in 2008, and are described in section (b) below and in the Directors’ remuneration report.
Normally exercisable 664 67,015 2008 491 3,155,679 2008, 2010 or 2012 401 788,469 2009 593 1,648,754 2009, 2011 or 2013 406 1,102,589 2008 or 2010 563 2,648,189 2010, 2012 or 2014 428 629,626 2009 or 2011 410 10,902,889 2011, 2013 or 2015
Normally exercisable 965.00 7,425 2002 to 2009 960.00 33,104 2003 to 2010 870.83 28,437 2002 to 2009 1,035.00 483,888 2004 to 2011 919.00 264,517 2002 to 2009 516.00 784,712 2005 to 2012 822.00 44,939 2003 to 2010 512.00 983,026 2006 to 2013 972.33 9,538 2003 to 2010 526.00 700,122 2007 to 2014
The following table summarises information about options outstanding at 31 December 2008: Range of exercise prices
(ii) Share awards At 31 December 2008, awards issued under the Company’s executive incentive plans over ordinary shares of 25 pence each in the Company were outstanding as follows: Aviva Long-Term Incentive Plan 2005 Number of shares Vesting period Number of shares Vesting period
“One Aviva, twice the value” Bonus Plan Number of shares Vesting period
Aviva Annual Bonus Plan 2005 Number of shares Vesting date Number of shares Vesting date
From March 2003 to July 2008, it was generally the Company’s practice to satisfy the awards granted after March 2003 by the issue of new shares at the time of vesting.
However, since July 2008, it is the Company’s practice to satisfy all awards and options using shares purchased in the market and held by employee trusts except where local regulations make it necessary to issue new shares. Further details are given in note 30.
Outstanding at 1 January 22,999,532 534.70 27,536,619 514.54 Granted during the year 12,392,826 410.00 6,289,583 563.00 Exercised during the year (2,344,424) 420.90 (5,144,763) 437.82 Expired during the year (6,769,711) 561.62 (5,681,907) 594.60
(i) Share options The fair value of the options was estimated on the date of grant, based on the following weighted average assumptions: Weighted average assumption 2008 2007
Share price 518p 733.5p Exercise price 410p 563p Expected volatility 32.6% 24% Expected life 5.00 years 4.07 years Expected dividend yield 5.5% 3.83% Risk-free interest rate 4.4% 5.09%
Share price 608p 778.5p Expected volatility* 25% 18.35% Expected volatility of comparator companies’ share price* 26% 19% Correlation between Aviva and competitors’ share price* 65% 53% Expected life 2.78 years 2.20 years Expected dividend yield 4.5% 3.83% Risk-free interest rate* 3.9% 5.36%
We satisfy awards and options granted under the executive incentive plans primarily through shares purchased in the market and held by employees share trusts. This note gives details of the shares held in these trusts.
These shares were purchased in the market and are carried at cost less amounts charged to the income statement in prior years. At 31 December 2008, they had an aggregate nominal value of £2,158,896 (2007: £380,266) and a market value of £33,678,770 (2007: £10,236,761). The trustees have waived their rights to dividends on the shares held in the trusts.
Authorised 200,000,000 cumulative irredeemable preference shares of £1 each 200 200 1,000,000,000 Sterling preference shares of £1 each 1,000 1,000 €m 700,000,000 Euro preference shares of €1 each 700 700 £m
Issued and paid up 100,000,000 83/8% cumulative irredeemable preference shares of £1 each 100 100 100,000,000 83/4% cumulative irredeemable preference shares of £1 each 100 100
In addition, under certain circumstances defined in the terms and conditions of the issue, the Company may at its sole option: (i) substitute at any time not less than all of the DCIs for, or vary the terms of the DCIs so that they become, Qualifying Tier 1 Securities or Qualifying Upper Tier 2 Securities; (ii) substitute not less than all of the DCIs for fully paid non-cumulative preference shares in the Company. These preference shares could only be redeemed on 28 November 2014 in the case of the euro DCIs and on 27 July 2020 in the case of the sterling DCIs, or in each case on any dividend payment date thereafter. The Company has the right to choose whether or not to pay any dividend on the new shares, and any such dividend payment will be non-cumulative.
This note analyses the movements in the merger reserve during the year.
Balance at 1 January 3,271 3,271 Movement in the year – –
This note gives details of the various reserves forming part of the Group’s consolidated equity, and shows the movements during the year.
Movements in the year comprised: Currency translation reserve (see accounting policy E) £m
(note 29d) – – – – 50 50 Shares issued under equity compensation plans (note 35) – – – – (34) (34) Foreign exchange rate movements 760 – – (141) – 619 Aggregate tax effect – shareholders’ tax – – 73 – – 73
Impairment losses on revalued assets taken to income statement – – 830 – – 830
This note analyses the movements in the consolidated retained earnings during the year.
Balance at 1 January restated 6,338 5,194 (Loss)/profit for the year attributable to equity shareholders (915) 1,320 Actuarial (losses)/gains on pension schemes (note 46e(iv)) (929) 648 Actuarial losses/(gains) on pension schemes transferred to unallocated divisible surplus (note 43) 78 (61) Dividends and appropriations (note 15) (975) (871) Shares issued in lieu of dividends 170 301 Shares issued under equity compensation plans (note 34) 15 34 Shares distributed by employee trusts (note 30) (6) – Fair value (losses)/gains realised from reserves (note 34) (1) 25 Aggregate tax effect 31 (252)
This note gives details of the Group’s minority interests and shows the movements during the year.
Equity shares in subsidiaries 695 660 Share of earnings 673 429 Share of other reserves 577 450 1,945 1,539 Preference shares in General Accident plc 250 250 Preference shares in other subsidiaries 9 6
Balance at 1 January as reported 2,553 1,698 Prior year adjustment (note 2b(ii)) (758) (431)
Balance at 1 January restated 1,795 1,267 Profit for the year attributable to minority interests 30 178 Minority share of movements in other reserves – 1 Foreign exchange rate movements 471 100 Recognised income and expense attributable to minority interests 501 279 Capital contributions from minority shareholders 36 – Minority share of dividends declared in the year (106) (66) Minority interest in acquired subsidiaries 43 315 Changes in minority interest in existing subsidiaries (65) –
The following notes explain how we calculate our liabilities to our policyholders for insurance and investment products we have sold to them. Notes 38 and 39 cover these liabilities and note 40 details the financial guarantees and options given for some of these products. Note 41 details the reinsurance recoverables on these liabilities whilst note 42 shows the effects of the assumptions we have changed during the year.
Long-term business Insurance contracts (156,188) 4,466 (151,722) (135,312) 4,298 (131,014) Participating investment contracts (65,278) 52 (65,226) (53,609) 22 (53,587) Non-participating investment contracts (42,281) 1,047 (41,234) (44,635) 1,461 (43,174)
Totals (284,520) 7,894 (276,626) (252,735) 8,054 (244,681) Less: Amounts classified as held for sale 709 – 709 627 – 627
This note analyses our insurance contract liabilities by type of product and describes how we calculate these liabilities and what assumptions we have used.
Outstanding claims provisions 907 11,842 12,749 727 10,842 11,569 Provision for claims incurred but
Amounts classified as held for sale – (709) (709) – (627) (627)
(i) Business description The Group underwrites long-term business in a number of countries as follows: – In the UK mainly in
In the Provident Mutual and With-Profit sub-funds in NUL&P, this is offset by the expected cost of charges to WPBR to be made in respect of guarantees.
The cost of future policy-related liabilities is determined using a market-consistent approach and, in the main, this is based on a stochastic model calibrated to market conditions at the end of the reporting period. Non-marketrelated assumptions (for example, persistency, mortality and expenses) are based on experience, adjusted to take into account future trends.
Volatility of investment return Volatility assumptions are set with reference to implied volatility data on traded market instruments, where available. These are term-dependent, with specimen values for ten year terms as follows: Volatility
Equity returns 34.6% 25.5% Property returns 15% 15% Fixed interest yields 15.9% 10.9%
The table above shows the volatility of fixed interest yields, set with reference to 20 year at-the-money swaption volatilities.
(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. Where liabilities are based on current market interest rates and assets are valued at market value, the margin in the liability adequacy test is determined by comparison of the liabilities with the present value of best estimate cash flows. For 2008 the yield curve basis has been revised from swap rates to a curve constructed from yields on collateralised AAA bonds; this is to avoid distortion from extremities observed in the swap curve under the dislocated market conditions.
Market risk-free yield curves, based on iBoxx index for collateralised AAA bonds (2007: based on DNB swap rates)
GBM/V 76-80, GBM/V 85-90, GBM/V 95-00, Coll 1993/2003 and DIL 98, plus further allowance for future mortality improvement
The liability for future policy benefits for traditional life insurance is computed using the net level method, based on guaranteed interest and mortality rates as used in calculating cash surrender values. Reserve interest assumptions ranged from 2.00% to 7.50% in 2008 (2007: 2.00% to 7.50%). The weighted average interest rate for all traditional life policy reserves in 2008 was 4.47% (2007: 4.46%).
Carrying amount at 1 January 135,312 126,614 Provisions in respect of new business 13,414 10,470 Expected change in existing business provisions (6,423) (6,280) Variance between actual and expected experience (9,401) (877) Effect of adjusting to PS06/14 realistic basis (40) (60) Impact of other operating assumption changes (812) 95 Impact of economic assumption changes (604) (909) Effect of special bonus to with-profit policyholders (note 43b) – 1,728 Other movements (527) (324) Change in liability recognised as an expense (4,393) 3,843 Effect of portfolio transfers, acquisitions and disposals 1,872 571 Foreign exchange rate movements 23,397 4,284
Provisions for outstanding claims are established to cover the outstanding expected ultimate liability for losses and loss adjustment expenses (LAE) in respect of all claims that have already occurred. The provisions established cover reported claims and associated LAE, as well as claims incurred but not yet reported and associated LAE.
In most cases, no explicit assumptions are made regarding future rates of claims inflation or loss ratios. Instead, the assumptions used are those implicit in the historical claims development data on which the projections are based. Additional qualitative judgement is used to assess the extent to which past trends may not apply in the future, for example, to reflect one-off occurrences, changes in external or market factors such as public attitudes to claiming, economic conditions, levels of claims inflation, judicial decisions and legislation, as well as internal factors such as portfolio mix, policy conditions and claims handling procedures in order to arrive at the estimated ultimate cost of claims that represents the likely outcome, from the range of possible outcomes, taking account of all the uncertainties involved.
(iii) Movements The following changes have occurred in the general insurance and health claims provisions during the year: £m
Carrying amount at 1 January restated 12,941 12,504 Impact of changes in assumptions 120 (1) Claim losses and expenses incurred in the current year 8,720 8,273 Decrease in estimated claim losses and expenses incurred in prior years (828) (956) Exceptional strengthening of general insurance latent claims provisions (see below) 356 –
Changes in claims reserve recognised as an expense (322) (392) Effect of portfolio transfers, acquisitions and disposals 128 175 Foreign exchange rate movements 1,613 654
Discount rate The discount rate that has been applied to latent claims reserves is based on the relevant swap curve in the relevant currency having regard to the expected settlement dates of the claims. The range of discount rates used depends on the duration of the claims and is given in the table in section (i) above. The duration of the claims span over 35 years, with the average duration being between 9 and 15 years depending on the geographical region. Any change in discount rates between the start and the end of the accounting period is reflected below operating profit as an economic assumption change. The sharp decline in interest rates in the second half of 2008 has resulted in an increase in the net discounted provision of £94 million.
Exceptional strengthening of latent claims provisions Separately and in addition to the decision to discount latent claims, our estimation of latent claims reserves in 2008 has been revised to reflect increasing market trends observed in mesothelioma claims. The majority of the Group’s latent claims reserves relate to mesothelioma based risks in the UK.
The Group aims to maintain strong reserves in respect of its non-life and health business in order to protect against adverse future claims experience and development. As claims develop and the ultimate cost of claims become more certain, the absence of adverse claims experience will then result in a release of reserves from earlier accident years, as shown in the loss development tables. However, in order to maintain overall reserve adequacy, the Group establishes strong reserves in respect of the current accident year (2008) where the development of claims is less mature and there is much greater uncertainty attaching to the ultimate cost of claims. The release from prior accident year reserves during 2008 is also due to an improvement in the estimated ultimate cost of claims.
All prior years £m 2002 £m £m £m £m £m £m £m Total £m
Present value 2,939 278 337 440 558 892 1,268 1,785 4,581 13,078 Cumulative effect of
(iii) Net of reinsurance After the effect of reinsurance, the loss development table is: Accident year
All prior years £m 2003 £m £m £m £m £m £m Total £m
Movements The following changes have occurred in the provision for unearned premiums (UPR) during the year: Carrying amount at 1 January 5,484 5,182 Premiums written during the year 11,934 11,369 Less: Premiums earned during the year (12,322) (11,345)
(a) Carrying amount The liability for investment contracts at 31 December comprised: Long-term business Participating contracts 65,278 53,609 Non-participating contracts at fair value 39,509 43,608 Non-participating contracts at amortised cost 2,772 1,027 42,281 44,635
Carrying amount at 1 January 53,609 49,400 Provisions in respect of new business 3,391 3,009 Expected change in existing business provisions (1,909) (1,978) Variance between actual and expected experience (4,661) (404) Impact of operating assumption changes (166) (3) Impact of economic assumption changes 244 178 Effect of special bonus to with-profit policyholders (note 43b) – 399 Other movements 13 (176) Change in liability recognised as an expense (3,088) 1,025 Effect of portfolio transfers, acquisitions and disposals 2,181 – Foreign exchange rate movements 12,576 3,184
The negative variance between actual and expected experience relates mainly to lower than expected investment returns on unit funds.
This note details the financial guarantees and options we have given for some of our insurance and investment products.
(i) Guaranteed annuity options Similar options to those written in the with-profit fund have been written in relation to non-profit products. Provision for these guarantees does not materially differ from a provision based on a market-consistent stochastic model, and amounts to £27 million at 31 December 2008 (2007: £36 million).
Guaranteed death and maturity benefits In France, the Group has also sold unit-linked policies where the death and/or maturity benefit is guaranteed to be at least equal to the premiums paid. The reserve held in the Group’s consolidated balance sheet at the end of 2008 for this guarantee is £113 million (2007: £30 million). The reserve is calculated on a prudent basis and is in excess of the economic liability. At the end of 2008, total sums at risk for these contracts were £1,279 million (2007: £63 million) out of total unit-linked funds of £14 billion (2007: £15 billion). The average age of policyholders was approximately 53. It is estimated that this liability would increase by £59 million (2007: £17 million) if yields were to decrease by 1% per annum and by £22 million (2007: £7 million) if equity markets were to decline by 10% from year end 2008 levels. These figures do not reflect our ability to review the tariff for this option.
Guaranteed minimum return at maturity In the Netherlands, it is market practice to guarantee a minimum return at maturity on traditional savings and pension contracts. Guarantees on older lines of business are 4% per annum while, for business written since 1 September 1999, the guarantee is 3% per annum. On Group pensions business, it is often possible to recapture guarantee costs through adjustments to surrender values or to premium rates.
Guaranteed annuity options Products with similar GAOs to those offered in the UK have been issued in Ireland. The current net of reinsurance provision for such options is £180 million (2007: £160 million). This has been calculated on a deterministic basis, making conservative assumptions for the factors which influence the cost of the guarantee, principally annuitant mortality option take-up and long-term interest rates.
Guaranteed investment returns and guaranteed surrender values The Group has also written contracts containing guaranteed investment returns and guaranteed surrender values in both Spain and Italy. Traditional profit-sharing products receive an appropriate share of the investment return, assessed on a book value basis, subject to a guaranteed minimum annual return of up to 6% in Spain and 4% in Italy on existing business, while on new business the maximum guaranteed rate is lower. Liabilities are generally taken as the face value of the contract plus, if required, an explicit provision for guarantees calculated in accordance with local regulations. At 31 December 2008, total liabilities for the Spanish business were £5 billion (2007: £4 billion) with a further reserve of £19 million (2007: £16 million) for guarantees. Total liabilities for the Italian business were £5 billion (2007:£4 billion), with a further provision of £55 million (2007: £48 million) for guarantees. Liabilities are most sensitive to changes in the level of interest rates. It is estimated that provisions for guarantees would need to increase by £59 million (2007: £66 million) in Spain and £5 million (2007: £14 million) in Italy if interest rates fell by 1% from end 2008 values. Under this sensitivity test, the guarantee provision in Spain is calculated conservatively, assuming a long-term market interest rate of 1.6% and no lapses or premium discontinuances.
Notes to the consolidated financial statements continued 40 – Financial guarantees and options continued The risk adjustment calculation is based on market spreads on senior long-term unsecured Aviva plc debt with a reduction to reflect policyholder priority over other creditors in case of default. The amount of change in the fair value of these embedded options resulting from the risk adjustment in 2008 is £514 million, and is principally attributable to market factors rather than instrument specific credit risk. There were no significant gains or losses attributable to the risk adjustment or instrument specific credit risk for these embedded options in 2007. At 31 December 2008, the total liabilities for indexed products were £15 billion (2007: £8 billion), including liabilities for the embedded option of £1.9 billion (2007: £1.2 billion). If interest rates were to increase by 1%, the provision for embedded options would decrease by £138 million (2007: £89 million) and, if interest rates were to decrease by 1%, the provision would increase by £155 million (2007: £86 million). The Group has certain products that credit interest based on a total return strategy, whereby policyholders are allowed to allocate their premium payments to different asset classes within the general account. The Group guarantees a minimum return of premium plus approximately 3% interest over the term of the contracts. The linked general account assets are fixed maturity securities, and both the securities and the contract liabilities are carried at fair value. At 31 December 2008, the liabilities for total return strategy products were £1.5 billion (2007: £1.2 billion).
The Group offers an optional lifetime guaranteed income benefit focused on the retirement income segment of the deferred annuity marketplace to help customers manage income during both the accumulation stage and the distribution stage of their financial life. At 31 December 2008, a total of £3.2 billion (2007: £0.7 billion) in indexed deferred annuities have elected this benefit taking steps to guarantee retirement income.
This note details the reinsurance recoverables on our insurance and investment contract liabilities.
General insurance and health Outstanding claims provisions 1,737 1,634 Provisions for claims incurred but not reported 29 29 1,766 1,663 Provision for unearned premiums 418 511 Other technical provisions – 5
Of the above total, £6,097 million (2007: £4,796 million) is expected to be recovered more than one year after the balance sheet date.
(b) Assumptions The assumptions, including discount rates, used for reinsurance contracts follow those used for insurance contracts.
(c) Movements The following movements have occurred in the reinsurance asset during the year: (i) In respect of long-term business provisions
Carrying amount at 1 January as published 1,663 1,738 Prior year adjustment – impact of discounting on latent claims (note 2b(i)) – (61)
Impact of changes in assumptions 21 – Exceptional strengthening of latent claims provisions (see below) 52 – Reinsurers’ share of claim losses and expenses Incurred in current year 228 169 Incurred in prior years 12 12 Reinsurers’ share of incurred claim losses and expenses 240 181 Less: Reinsurance recoveries received on claims Incurred in current year (107) (75) Incurred in prior years (257) (223) Reinsurance recoveries received in the year (364) (298) Unwind of discounting 24 26
Change in reinsurance asset recognised as income (27) (91) Effect of portfolio transfers, acquisitions and disposals 27 39 Foreign exchange rate movements 105 42 Other movements (2) (4)
Notes to the consolidated financial statements continued 41 – Reinsurance assets continued
Carrying amount at 1 January 511 484 Premiums ceded to reinsurers in the year 798 800 Less: Reinsurers’ share of premiums earned during the year (909) (797) Changes in reinsurance asset recognised as income (111) 3 Reinsurers’ share of portfolio transfers and acquisitions 8 18 Foreign exchange rate movements 10 6
Certain estimates and assumptions used in determining our liabilities for insurance and investment contract business were changed from 2007 to 2008, and this affected the profit recognised for the year with an equivalent effect on liabilities. This note analyses the effect of the changes.
The impact of interest rates for long-term business relates primarily to the UK, Ireland and the Netherlands, driven by the market level of risk-free rates. Lower valuation interest rates in 2008 had the effect of increasing liabilities for traditional business and hence a negative impact on profit. This follows an increase in market interest rates in 2007 which had the reverse effect. The overall impact on profit also depends on movements in the value of assets backing the liabilities, which is not included in this disclosure.
Favourable impacts from expense and mortality assumption changes for insurance contracts relate mainly to the UK. Other assumption changes include further implementation of FSA Policy Statement PS06/14 for non-profit business and expense inflation adjustments in the UK, and reserve releases in Asia, partly offset by compensation for unit-linked policies in the Netherlands.
(a) Movements The following movements have occurred in the year: Carrying amount at 1 January 6,785 9,465 Change in participating contract assets (12,022) 2,463 Change in participating contract liabilities 7,699 (3,244) Effect of special bonus to with-profit policyholders (see below) (89) (2,127) Other movements (70) (14) Change in liability recognised as an expense (4,482) (2,922) Effect of portfolio transfers, acquisitions and disposals – 3 Movement in respect of change in pension scheme deficit (note 46c(i)) (78) 61 Foreign exchange rate movements 88 173 Other movements 12 5
(b) Special bonus declared by UK Life business On 5 February 2008, the Group’s UK long-term business operation, Norwich Union Life, announced a one-off, special bonus worth an estimated £2.3 billion, benefiting around 1.1 million with-profit policyholders in its CGNU Life and CULAC with-profit funds. The bonus is being used to enhance policy values by around 10% in total, in three instalments, with the qualifying dates being 1 January 2008, 1 January 2009 and 1 January 2010. In accordance with the way the funds are managed, the bonus distribution is being split on a 90/10 basis between policyholders and shareholders. Over the three years, policyholders will receive a total currently estimated as £2,127 million and shareholders will receive a total currently estimated as £236 million.
As explained in accounting policies F and K, the Group’s insurance and participating investment contract liabilities are measured in accordance with IFRS 4, Insurance Contracts, and FRS 27, Life Assurance. The latter requires liabilities for with-profit funds falling within the scope of the UK’s Financial Services Authority’s capital regime to be determined in accordance with this regime, adjusted to remove the shareholders’ share of future bonuses. This required us to recognise planned discretionary bonuses within policyholder liabilities at 31 December 2007, even if there was no constructive obligation at the time. As a result of the announcement made above, a transfer of £2,127 million was made in 2007 from the UDS in order to increase insurance liabilities by £1,728 million (note 38(b)) and participating investment contract liabilities by £399 million (note 39(c)). Of the £236 million due to shareholders, £89 million has been transferred from the UDS in 2008 (2007: £nil).
44 – Tax assets and liabilities continued (iii) The movement in the net deferred tax liability was as follows: Net liability at 1 January (1,942) (1,878) Acquisition and disposal of subsidiaries (13) (185) Amounts credited to profit (note 13a) 1,726 442 Amounts credited/(charged) to equity (note 13b) 219 (198) Exchange differences (101) (37) Other movements (267) (86)
In addition, the Group has an unrecognised capital loss of £556 million (2007: £409 million). This tax loss can be offset against future capital gains and has no expiry date.
Deficits in the staff pension schemes (note 46e(vii)) 613 205 Other obligations to staff pension schemes – insurance policies issued by Group companies
Total IAS 19 obligations to staff pension schemes 2,015 1,230 Restructuring provision 253 135 Other provisions 722 572 Less amounts held for sale (6) –
Of the total, £2,328 million (2007: £1,277 million) is expected to be settled more than one year after the balance sheet date.
Notes to the consolidated financial statements continued 45 – Provisions continued
At 1 January 2007 234 501 735 Additional provisions 198 174 372 Unused amounts reversed – (11) (11) Change in the discounted amount arising from passage of time – 5 5
A full actuarial valuation of each of the defined benefit schemes is carried out at least every three years for the benefit of scheme trustees and members. Actuarial reports have been submitted for each scheme within this period, using appropriate methods for the respective countries on local funding bases.
(b) Membership The number of scheme members at 31 December 2008 was as follows: United Kingdom Netherlands Canada Ireland
Active members 9,972 10,532 4,920 5,048 889 960 1,180 1,157 Deferred members 53,376 53,953 5,739 5,015 529 617 842 830 Pensioners 27,749 27,176 3,014 2,815 1,280 1,350 682 674
(i) Defined benefit section of the ASPS The Company works closely with the trustees who are required to consult it on the funding of the scheme and its investment strategy. Following each actuarial valuation, the Company and the trustees agree the level of contributions needed. At 31 March 2006, the date of the last actuarial valuation, this section of the scheme had an excess of obligations over available assets, on a funding basis, of £1,019 million. The Company has agreed with the trustees a funding plan through to March 2014, over which it will aim to eliminate the funding deficit. Funding levels are monitored on an annual basis.
The employing companies’ contributions to the defined benefit section of the ASPS throughout 2008 were 39% of employees’ pensionable salaries, together with the cost of redundancies during the year, and additional deficit funding payments totalling £369 million. As this section of the scheme is closed to new entrants and the contribution rate is determined using the projected unit credit method, it is expected that the percentage cost of providing future service benefits will continue to increase as the membership ages, leading to higher pension costs, and the number of members falls, leading to a higher charge per member. The employers’ contribution rate for 2009 has therefore been increased to 41% of pensionable salaries (expected to be £147 million), pending finalisation of the March 2009 valuation. Active members of this section of the ASPS contribute 5% of their pensionable salaries, increasing to either 6% or 7.5% from 1 July 2009.
In 2006, the Group’s UK life business carried out an investigation into the allocation of costs in respect of funding the ASPS, to identify the deficit that arose in respect of accruals prior to the introduction of the current management services agreements (MSAs) and to propose a split between individual product companies based on an allocation of the deficit into pre- and post-MSA amounts. The results of this review were agreed by the relevant company boards and accepted by the UK regulator. Consequently, with effect from 1 January 2006, the Company’s UK with-profit product companies are liable for a share, currently 12%, of the additional payments for deficit funding referred to above. This has resulted in movements between the unallocated divisible surplus (UDS) and retained earnings via the statement of recognised income of £78 million in 2008 (2007: £61 million) to reflect actuarial movements in the deficit during the year and therefore a change in the amount recoverable from the with-profit product companies.
There were no significant contributions outstanding or prepaid as at either 31 December 2008 or 2007.
(e) IAS 19 disclosures Disclosures under IAS 19 for the material defined benefit schemes in the UK, the Netherlands, Canada and Ireland are given below. Where schemes provide both defined benefit and defined contribution pensions, the assets and liabilities shown exclude those relating to defined contribution pensions. Total employer contributions for these schemes in 2009 are expected to be £241 million.
Alternative measurement methods There are alternative methods of measuring liabilities, for example by calculating an accumulated benefit obligation (the present value of benefits for service already rendered but with no allowance for future salary increases) or on a solvency basis, using the cost of securing the benefits at a particular date with an insurance company or one of the growing market of alternative buy-out providers. This could take the form of a buy-out, in which the entire liability will be settled in one payment with all obligations transferred to an insurance company or buy-out provider, or a buy-in, in which annuities or other insurance products are purchased to cover a part or all of the liability. A valuation of the liabilities in either of these cases will almost always result in a higher estimate of the pension deficit than under an ongoing approach, as they assume that the sponsor immediately transfers the majority, if not all, of the risk to another provider who would be seeking to make a profit on the transaction. However, there are only a limited number of organisations that would be able to offer these options for schemes of the size of those in our Group. The full buy-out cost would only be known if quotes were obtained from such organisations but, to illustrate the cost of a buy-out valuation, an estimate for the main UK scheme is that the year end liabilities of £6.8 billion could be valued some £3.7 billion higher, at £10.5 billion.
PA92U2009MC with a one year age rating deduction and including an allowance for future improvements 60 (29.3) (32.2) (31.7) (33.8)
CRC8b, which includes allowance for future improvements up to 2050 65 (18.3) (19.9) (21.1) (21.8)
UP1994 projected to 2015, using Scale AA 65 (19.0) (19.0) (21.6) (21.6)
PA92C2020 (current pensioners)/ 2040 (future pensioners) with allowance for future improvements 65 (19.4) (20.7) (22.4) (23.7)
The scheme liabilities have an average duration of between 20 and 23 years in the UK schemes and between 12 and 17 years in the overseas schemes.
(iv) Pension expense As noted above, plan assets in the UK and Dutch schemes include insurance policies with other Group companies. To avoid double-counting of investment income on scheme assets and the assets backing the underlying policies, adjustments have been made to the former in the current year as shown in the tables below.
The total pension expense for these schemes comprises: Recognised in the income statement £m
Current service cost (162) (173) Past service cost (1) – Gain on curtailments (3) (15)
Expected return on scheme assets 706 614 Less: Income on insurance policy assets accounted for elsewhere (see (iii) above) (64) (49)
Actuarial losses on scheme assets (1,951) (210) Less: losses on insurance policy assets accounted for elsewhere (see (iii) above) 58 72
(v) Experience gains and losses The following disclosures of experience gains and losses give a five year history. Scheme assets exclude insurance policies with Group companies and income on the assets underlying them.
Amount of (gains)/losses 1,893 138 (251) (798) (184) Percentage of the scheme assets at the end of the year 23.8% 1.6% 3.1% 10.9% 3.4% Experience (gains)/losses on scheme liabilities
(excluding changes in assumptions) Amount of (gains)/losses (105) 80 (63) 86 (12) Percentage of the present value of scheme liabilities 1.0% 0.8% 0.6% 0.9% 0.2%
Notes to the consolidated financial statements continued 46 – Pension obligations continued Interest rate risk – falling interest rates leading to an increase in liabilities significantly exceeding the increase in the value of assets.
During 2008, there has been a reduction in the proportion of assets invested in equities, thereby mitigating the equity risk. In addition, the trustees have taken measures to partially mitigate inflation and interest rate risks, including entering into inflation and interest rate swaps.
(vii) Balance sheet recognition The assets and liabilities of the schemes, attributable to defined benefit members, including investments in Group insurance policies (see footnote below), at 31 December 2008 were: UK Netherlands Canada Ireland Total £m 2008 £m £m £m £m £m £m
Total fair value of assets 7,287 8,103 1,409 1,028 182 231 460 477 9,338 9,839
Other assets comprise cash at bank, derivative financial instruments, receivables and payables.
Plan assets in the table above include investments in Group-managed funds in the consolidated balance sheet of £99 million (2007: £150 million) in the UK scheme, and insurance policies of £150 million and £1,402 million (2007: £143 million and £1,025 million) in the UK and Dutch schemes respectively. Where the investment and insurance policies are in segregated funds with specific asset allocations, they are included in the appropriate line in the table above, otherwise they appear in “Other”. The Dutch insurance policies are considered nontransferable under the terms of IAS 19 and so have been treated as other obligations to staff pension schemes within provisions (see note 45).
46 – Pension obligations continued The total IAS 19 obligations and strict IAS 19 assets (ie excluding the non-transferable insurance policies) of the schemes give a net deficit of £1,971 million (2007: £1,203 million), as shown in the following table.
Included in other assets (note 26) – – – – – – – 27 – 27
(viii) Movements in the scheme deficits and surpluses Movements in the pension schemes’ deficits and surpluses comprise: Scheme assets £m
Net deficits in the schemes at 1 January 9,839 (10,017) (178) (1,025) (1,203) Employer contributions 620 – 620 (70) 550 Employee contributions 24 (24) – (7) (7) Benefits paid (368) 368 – 39 39 Current and past service cost (see (iv) above) (5) (158) (163) – (163) Losses on curtailments (see (iv) above) – (3) (3) – (3) Credit/(charge) to investment income (see (iv) above) 706 (585) 121 (64) 57 Other actuarial gains/(losses) (see (iv) above) (1,951) 964 (987) 58 (929) Buy-outs and other transfers (1) 1 – 1 1 Exchange rate movements on foreign plans 474 (497) (23) (334) (357)
Net deficits in the schemes at 31 December 9,338 (9,951) (613) (1,402) (2,015)
Notes to the consolidated financial statements continued 46 – Pension obligations continued 2007
Net deficits in the schemes at 1 January 9,223 (10,196) (973) (1,086) (2,059) Employer contributions 297 – 297 (41) 256 Employee contributions 23 (23) – (4) (4) Benefits paid (339) 339 – 33 33 Current and past service cost (see (iv) above) (4) (169) (173) – (173) Losses on curtailments (see (iv) above) – (15) (15) – (15) Credit/(charge) to investment income (see (iv) above) 614 (515) 99 (49) 50 Acquisitions 72 (91) (19) (15) (34) Other actuarial gains/(losses) (see (iv) above) (210) 822 612 72 684 Buy-outs and other transfers 6 (6) – (2) (2) Changes in asset admissibility – – – 152 152 Exchange rate movements on foreign plans 157 (163) (6) (85) (91)
Net deficits in the schemes at 31 December 9,839 (10,017) (178) (1,025) (1,203)
Core structural borrowings, at amortised cost 5,525 4,311 Operational borrowings, at amortised cost 4,233 3,347 Operational borrowings, at fair value 5,443 5,011 9,676 8,358 15,201 12,669 Less amounts classified as held for sale – (12)
Within 1 year £m 1–5 years £m 5–10 years £m 10–15 years £m
Subordinated debt 6.125% £700 million 689 £ – – – – 700 700 subordinated notes 2036 5.750% €800 million 772 € – – – 773 – 773 subordinated notes 2021 5.250% €650 million 593 € – – – 628 – 628 subordinated notes 2023 5.700% €500 million undated 480 € – – – – 483 483 subordinated notes 6.125% £800 million undated 790 £ – – – – 800 800 subordinated notes Floating rate US$300 million 208 US$ – – 209 – – 209 subordinated notes 2017 6.875% £400 million 394 £ – – – – 400 400 subordinated notes 2058 6.875% £200 million 199 £ – – – – 200 200 subordinated notes 2058 6.875% €500 million 481 € – – – – 483 483 subordinated notes 2038
Debenture loans 9.5% guaranteed bonds 2016 199 £ – – 200 – – 200 2.5% subordinated perpetual loan notes 166 € – – – – 474 474 Other loans 14 various – 14 – – – 14
Total contractual undiscounted cash flows for core structural borrowings 885 1,260 1,907 2,740 6,198 12,990
Subordinated debt 6.125% £700 million subordinated notes 2036 689 £ – – – – 700 700 5.750% €800 million subordinated notes 2021 586 € – – – 588 – 588 5.250% €650 million subordinated notes 2023 474 € – – – – 477 477 5.700% €500 million undated subordinated notes 364 € – – – – 367 367 6.125% £800 million undated subordinated notes 790 £ – – – – 800 800 Floating rate US$300 million subordinated notes 2017 151 US$ – – 151 – – 151
Where subordinated debt is undated or loan notes are perpetual, the interest payments have not been included beyond 15 years. Annual interest payments for these borrowings are £89 million (2007: £79 million).
Within 1 year £m 1–5 years £m 5–10 years £m 10-15 years £m
UK lifetime mortgage business 1,590 £ 9 40 66 – 1,529 1,644 Dutch domestic
Total contractual undiscounted cash flows 882 3,029 2,726 2,614 23,035 32,286
Within 1 year £m 1-5 years £m 5-10 years £m years £m
UK lifetime mortgage business 1,674 £ – 14 125 – 1,613 1,752 Dutch domestic
All the above borrowings are stated at amortised cost, except for the loan notes issued in connection with the UK lifetime mortgage business £1,590 million (2007: £1,674 million) and £3,842 million (2007: £3,337 million) of the loan notes issued in connection with the Dutch domestic mortgage business, which are carried at fair value. These have been designated at fair value through profit and loss in order to present the relevant mortgages, borrowings and derivative financial instruments at fair value, since they are managed as a portfolio on a fair value basis. This presentation provides more relevant information and eliminates any accounting mismatch.
(i) Subordinated debt A description of each of the subordinated notes is set out in the table below: Notional amount Issue date Redemption date Callable at par at option of the Company from
In the event the Company does not call the notes, the coupon will reset at each applicable reset date to £700 million 14 Nov 2001 14 Nov 2036 16 Nov 2026 5 year Benchmark Gilt + 2.85% €800 million 14 Nov 2001 14 Nov 2021 14 Nov 2011 3 month Euribor + 2.12% €650 million 29 Sep 2003 02 Oct 2023 02 Oct 2013 3 month Euribor + 2.08% €500 million 29 Sep 2003 Undated 29 Sep 2015 3 month Euribor + 2.35% £800 million 29 Sep 2003 Undated 29 Sep 2022 5 year Benchmark Gilt + 2.40% US$300 million 19 Dec 2007 19 Jun 2017 19 Jun 2012 3 month US LIBOR + 0.84% £400 million 20 May 2008 20 May 2058 20 May 2038 3 month LIBOR + 3.26% £200 million 8 Aug 2008 20 May 2058 20 May 2038 3 month LIBOR + 3.26% €500 million 22 May 2008 22 May 2038 22 May 2018 3 month Euribor + 3.35%
The 2.5% perpetual subordinated loan notes were issued by a Dutch subsidiary to finance the acquisition of NUTS OHRA Beheer BV in 1999. They are convertible into ordinary shares in Delta Lloyd NV, should there be a public offering of those shares. These loan notes have a face value of €489.9 million but, because they are considered to be perpetual, their carrying value is €172.4 million, calculated in 1999 and based on the future cash flows in perpetuity discounted back at a market rate of interest. The rate of interest paid on the notes is being gradually increased to a maximum of 2.76% in 2009.
(iii) Commercial paper The commercial paper consists of £535 million in the Company (2007: £918 million) and £5 million in France (2007: £4 million). All of this is considered core structural funding.
(b) Certain Irish policyholder investment funds and unit trusts, which have been fully consolidated in accordance with accounting policy D, have raised borrowings with external credit institutions. The borrowings are secured on the funds, with the only recourse on default being the underlying investments in these funds and unit trusts. The lenders have no recourse whatsoever to the shareholders’ funds of any companies in the Aviva Group. These loans run for a period of five years, with interest rates fixed monthly and based on a fixed margin above the euro inter-bank rate. The amount of these loans can be varied without any penalty being charged, subject to a maximum of 50% Loan to Value and a maximum facility of €72 million.
(v) Securitised mortgage loan notes Loan notes have been issued by special purpose securitisation companies in the UK and the Netherlands. Details of these securitisations are given in note 23.
All movements in fair value in 2008 and 2007 on securitised mortgage loan notes designated as fair value through profit or loss were attributable to changes in market conditions. These loan notes have external credit ratings which have not changed since the inception of the loans.
(f) Undrawn borrowings The Group and Company have the following undrawn committed central borrowing facilities available to it, of which £1,000 million (2007: £1,000 million) is used to support the commercial paper programme: £m
Payables arising out of direct insurance 1,716 1,731 Payables arising out of reinsurance operations 499 410 Deposits and advances received from reinsurers 1,014 1,294 Bank overdrafts 605 621 Derivative liabilities (note 56d) 1,839 606 Bank customer accounts 4,510 2,460 Bank deposits received from other banks 1,780 1,288 Amounts due to brokers for investment purchases 757 901 Obligations for repayment of collateral received (notes 24d(i) & 56e) 5,497 6,545 Obligations under stock repurchase arrangements (note 24d(ii)) 383 358 Other financial liabilities 2,262 1,918 20,862 18,132 Less: Amounts classified as held for sale (22) (72)
This note analyses our other liabilities at the end of the year.
Expected to be settled within one year 3,176 2,914 Expected to be settled in more than one year 1,380 851
Notes to the consolidated financial statements continued 50 – Contingent liabilities and other risk factors
(c) Guarantees on long-term savings products As a normal part of their operating activities, various Group companies have given guarantees and options, including interest rate guarantees, in respect of certain long-term insurance and fund management products. Note 40 gives details of these guarantees and options. In providing these guarantees and options, the Group’s capital position is sensitive to fluctuations in financial variables including foreign currency exchange rates, interest rates, property values and equity prices. Interest rate guaranteed returns, such as those available on guaranteed annuity options (GAOs), are sensitive to interest rates falling below the guaranteed level. Other guarantees, such as maturity value guarantees and guarantees in relation to minimum rates of return, are sensitive to fluctuations in the investment return below the level assumed when the guarantee was made. The directors continue to believe that the existing provisions for such guarantees and options are sufficient.
(d) Pensions mis-selling The pensions review of past sales of personal pension policies which involved transfers, opt outs and non-joiners from occupational schemes, as required by the Financial Services Authority (FSA), has largely been completed. A provision of some £18 million at 31 December 2008 (2007: £23 million) remains to meet the outstanding costs of the very few remaining cases, the anticipated cost of any guarantees provided, and potential levies payable to the Financial Services Compensation Scheme. It continues to be the directors’ view that there will be no material effect either on the Group’s ability to meet the expectations of policyholders or on shareholders.
In May 2002, in accordance with FSA requirements, the Group commenced sending out the second phase of endowment policy update letters, which provide policyholders with information about the performance of their policies and advice as to whether these show a projected shortfall at maturity. The Group will send these updates annually to all mortgage endowment holders, in accordance with FSA requirements. The Group has made provisions totalling £38 million at 31 December 2008 (2007: £96 million) to meet potential mis-selling costs and the associated expenses of investigating complaints. It continues to be the directors’ view that there will be no material effect either on the Group’s liability to meet the expectations of policyholders or on shareholders.
50 – Contingent liabilities and other risk factors continued In August 2004, the Group confirmed its intention to introduce time barring on mortgage endowment complaints, under FSA rules. The Group now includes details of its endowment policyholders’ time bar position within the annual re-projection mailings. Customers will be given at least 12 months’ individual notice before a time bar becomes applicable – double the six months’ notice required by the FSA.
The impact of any such finding (whether in the UK or overseas) could have a negative impact on the Group’s reported results or on its relations with current and potential customers. Regulatory action against a member of the Group could result in adverse publicity for, or negative perceptions regarding, the Group, or could have a material adverse effect on the business of the Group, its results of operations and/or financial condition and divert management’s attention from the day-to-day management of the business.
(h) Other In the course of conducting insurance and investment business, various Group companies receive liability claims, and become involved in actual or threatened related litigation. In the opinion of the directors, adequate provisions have been established for such claims and no material loss will arise in this respect.
The Company and several of its subsidiaries have guaranteed the overdrafts and borrowings of certain other Group companies. At 31 December 2008, the total exposure of the Group and Company is £nil (2007: £7 million) and £88 million (2007: £113 million) respectively but, in the opinion of the directors, no material loss will arise in respect of these guarantees and indemnities.
The Group's insurance subsidiaries pay contributions to levy schemes in several countries in which we operate, Given the economic environment, there is a heightened risk that the levy contributions will need to be increased to protect policyholders if an insurance company falls into financial difficulties. The directors continue to monitor the situation but are not aware of any need to increase provisions at the balance sheet date.
This note gives details of our commitments to capital expenditure and under operating leases.
Within 1 year 590 644 Later than 1 year and not later than 5 years 1,761 1,879 Later than 5 years 2,880 3,265
Within 1 year 207 161 Later than 1 year and not later than 5 years 626 555 Later than 5 years 971 1,107
The total of future minimum sub-lease payments expected to be received under noncancellable sub-leases. 89 159
(Loss)/profit before tax (2,368) 1,847 Adjustments for: Share of losses/(profits) of joint ventures and associates 1,128 304 Dividends received from joint ventures and associates 87 32 (Profit)/loss on sale of: Investment property (14) (105) Property and equipment – (4) Subsidiaries, joint ventures and associates (7) (49) Investments 9 (5,502) (12) (5,660) Fair value (gains)/losses on: Investment property 3,137 757 Investments 25,510 6,447 Borrowings (404) (268) 28,243 6,936 Depreciation of property and equipment 131 129 Equity compensation plans, equity settled expense 39 50 Impairment of: Goodwill on subsidiaries 68 10 Financial investments, loans and other assets 1,040 58 Acquired value of in-force business and intangibles 67 4 1,175 72 Amortisation of: Premium or discount on debt securities (12) 32 Premium or discount on loans (20) (7) Premium or discount on borrowings 2 2 Premium or discount on participating investment contracts 13 – Financial instruments (245) – Acquired value of in-force business and intangibles 433 266 171 293 Change in unallocated divisible surplus (4,482) (2,922) Interest expense on borrowings 1,547 1,208 Net finance income on pension schemes (121) (99) Foreign currency exchange losses/(gains) 327 (45) Changes in working capital Decrease in reinsurance assets 1,543 75 (Increase)/decrease in deferred acquisition costs (328) (906) (Decrease)/increase in insurance liabilities and investment contracts (15,320) 8,739 (Decrease)/increase in other assets and liabilities (381) 7,830 (14,486) 15,738 Net purchases of operating assets Purchases of investment property (1,846) (2,027) Proceeds on sale of investment property 1,164 1,398 Net purchases of financial investments (1,902) (12,310) (2,584) (12,939)
Cash consideration for subsidiaries, joint ventures and associates acquired 437 857 Less: Cash and cash equivalents acquired with subsidiaries (101) (88)
Of the total cash and cash equivalents shown above, £493 million has been classified as held for sale (2007: £96 million) (see note 3d).
(a) Capital management objectives Aviva’s capital management philosophy is focused on capital efficiency and effective risk management to support a progressive dividend policy and earnings per share growth. Rigorous capital allocation is one of our primary strategic priorities and is ultimately governed by the Group Executive Committee.
Overall capital risk appetite is set and managed with reference to the requirements of a range of different stakeholders including shareholders, policyholders, regulators and rating agencies. In managing capital we seek to: – maintain sufficient, but not excessive, financial strength to support new business growth and satisfy the requirements of our regulators and other stakeholders, and thus give both our customers and shareholders assurance of our financial strength; – optimise our overall debt to equity structure to enhance our returns to shareholders, subject to our capital risk appetite and balancing the requirements of the range of stakeholders; – retain financial flexibility by maintaining strong liquidity, including significant unutilised committed credit lines and access to a range of capital markets; – allocate capital rigorously across the Group, to drive value adding growth in accordance with risk appetite; and
(b) Capital resources The primary sources of capital used by the group are equity shareholders’ funds, preference shares, subordinated debt and borrowings. We also consider and, where efficient to do so, utilise alternative sources of capital such as reinsurance and securitisation in addition to the more traditional sources of funding. Targets are established in relation to regulatory solvency, ratings, liquidity and dividend capacity and are a key tool in managing capital in accordance with our risk appetite and the requirements of our various stakeholders.
In February, the Standard & Poors (S&P) rating committee downgraded NU Life from AA to AA-, which is now aligned with the other 'core' group subsidiaries. At the same time S&P have changed the outlook on NU Life's ratings from “negative” to “stable”. There are no changes to any of the group's other ratings or outlooks. The Group's financial strength rating from Moody's is Aa3 (“excellent”) with a stable outlook and A+ ("superior") with a stable outlook from AM Best.
(c) Capital allocation Capital allocation is undertaken based on a rigorous analysis of a range of financial, strategic, risk and capital factors to ensure that capital is allocated efficiently to value adding business opportunities. A clear management decision-making framework, incorporating ongoing operational and strategic performance review, periodic longer term strategic and financial planning and robust due diligence over capital allocation is in place, governed by the Group Executive Committee and Group Asset Committee. These processes incorporate various capital profitability metrics, including an assessment of return on capital employed and internal rates of return in relation to hurdle rates to ensure capital is allocated efficiently and that excess business unit capital is repatriated where appropriate.
(d) Different measures of capital In recognition of the requirements of different stakeholders, we measure capital on a number of different bases, all of which are taken into account when managing and allocating capital across the group. These include measures which comply with the regulatory regimes within which we operate and those which the directors consider appropriate for the management of the business. The primary measures are: (i) Accounting bases We report our results on both an IFRS and a Market Consistent Embedded Value (MCEV) basis. The directors consider that the MCEV principles provide a more meaningful measure of the long term underlying value of the capital employed in our life and related businesses. This basis allows for the impact of uncertainty in the future investment returns more explicitly and is consistent with the way the life business is priced and managed. Accordingly, in addition to IFRS, we analyse and measure the net asset value and total capital employed for the group on this basis. This is the basis on which group return on equity is measured.
(ii) Regulatory bases Individual regulated subsidiaries measure and report solvency based on applicable local regulations, including in the UK the regulations established by the Financial Services Authority (FSA). These measures are also consolidated under the European Insurance Groups Directive (IGD) to calculate regulatory capital adequacy at an aggregate group level. We fully complied with these regulatory requirements during the year.
(iii) Rating agency bases Agency ratings are an important indicator of financial strength and maintenance of these ratings is one of the key drivers of capital risk appetite. Certain rating agencies have proprietary capital models which they use to assess available capital resources against capital requirements as a component of their overall criteria for assigning ratings. In addition, rating agency measures and targets in respect of gearing and fixed charge cover are also important in evaluating the level of borrowings utilised by the group. While not mandatory external requirements, in practice rating agency capital measures tend to act as one of the primary drivers of capital requirements, reflecting the capital strength required in relation to our target ratings.
(iv) Economic bases We also measure capital using an economic capital model that takes into account a more realistic set of financial and non-financial assumptions. This model continues to be developed and is increasingly relevant in the internal management and external assessment of our capital resources. The economic capital model is used to assess capital strength in accordance with the Individual Capital Assessment (ICA) requirements established by the FSA. Further developments are planned to meet the emerging requirements of the Solvency II framework and other external agencies.
On 13 May 2008 we issued £0.8 billion equivalent of Lower Tier 2 hybrid in a dual-tranche transaction (£400 million and €500 million). £0.6 billion of the proceeds was used to repay short-term commercial paper borrowings. On 8 August 2008 we issued a further £0.2 billion of lower tier 2 hybrid debt. These transactions have a positive impact on group IGD solvency and economic capital measures.
FRS 27 requires us to produce a capital statement which sets out the financial strength of our Group entities and provides an analysis of the disposition and constraints over the availability of capital to meet risks and regulatory requirements. The capital statement also provides a reconciliation of shareholders’ funds to regulatory capital.
Adjustments onto a regulatory basis: Shareholders’ share of accrued bonus (195) (198) (363) (756) – (756) – (756) – (756) (1,192)
5. Goodwill and other intangibles includes goodwill of £603 million in JVs and associates.
Notes to the consolidated financial statements continued 54 – Capital statement continued
Available capital resources at 1 January 1,433 1,206 1,821 4,460 2,511 6,971 8,666 15,637
Variance between actual and expected experience (591) (279) 7 (863) 20 (843) (3,627) (4,470)
Effect of operating assumption changes (15) (104) 101 (18) 381 363 (18) 345
Effect of changes in management policy (14) (1) 86 71 – 71 8 79
The analysis of movements in capital provides an explanation of the movement in available capital of the Group's life business for the year. This analysis is intended to give an understanding of the underlying causes of changes in the available capital of the Group's life business, and provides a distinction between some of the key factors affecting the available capital.
54 – Capital statement continued Fixed interest yields have significantly reduced especially at short duration. The movement is beneficial for CGNU/CULAC where the rise in asset values of assets outside asset share is greater than the rise in guarantee costs, but adverse for NUL&P. Credit spreads have moved materially particularly in the final quarter and this is adverse for all funds and the credit spread movement is unhedged. Implied market volatility on equity has increased significantly in the final quarter, which increases the market consistent cost of guarantees and is unhedged. The combined loss for CGNU/CULAC is £115m, and for NUL&P £208 million. Lapse rate assumptions have been changed for year end 2008 reporting to bring the assumptions more into line with experience. The changes reduced the value of the estates in all funds.
For the Overseas life operations, the negative variance between actual and expected experience is driven mainly by the widening of credit spreads and other market movements, which has led to capital depreciation of fixed interest assets and consequential reduction of the unallocated divisible surplus in France and other European businesses.
In aggregate, the Group has at its disposal total available capital of £13.6 billion (2007: £16.8 billion), representing the aggregation of the solvency capital of all of our businesses.
As the total available capital of £13.6 billion is arrived at on the basis of local regulatory guidance, which evaluates assets and liabilities prudently, it understates the economic capital of the business which is considerably higher. This is a limitation of the Group Capital Statement which, to be more meaningful, needs to evaluate available capital on an economic basis and compare it with the risk capital required for each individual operation, after allowing for the considerable diversification benefits that exist in our Group.
Notes to the consolidated financial statements continued 54 – Capital statement continued The table below provides the information on the UK with-profits funds on a realistic basis.
Estimated excess £bn Excess £bn * These realistic liabilities include the shareholders' share of future bonuses of £0.8 billion (31 December 2007: £1.2 billion). Realistic liabilities adjusted to eliminate the shareholders' share of future bonuses are £43.2 billion (31 December 2007: £48.8 billion).
The risks faced by the Group can be categorised as follows: – Financial risks cover market and credit risk, insurance risk, liquidity and capital management.
– Operational risk arises from inadequately controlled internal processes or systems, human error or noncompliance as well as from external events. Operational risks include taxation, reputation and regulatory risks, such as compliance.
The risk management framework provides the means to identify, assess, measure, manage and monitor all of the different types of risk faced by the Group to provide a single picture of the threats and uncertainties faced and opportunities that exist.
The Group sets limits to manage material risks to ensure the risk stay within risk appetite (the amount of risk the Group is willing to accept). The Group assesses the size and scale of a risk by considering how likely it is that the risk will occur and the potential impact the risk could have on our business and our stakeholders. Where risks are outside appetite actions are agreed to mitigate the exposure.
The Group’s risk management framework is designed to manage, rather than eliminate, the risk of failure to achieve business objectives and can provide only reasonable assurance against material financial misstatement or loss. New risks, which have not been identified as emerging risks, or risks we currently deem as immaterial may also impair the future achievement of business objectives.
The Group has developed economic capital models that support the measurement, comparison and further understanding of our risks. The results of the modelling are incorporated into key decision making processes. These models show the relative impact to economic capital from the risks we face. In turn this supports the assessment of appropriate and effective mitigating strategies where risks are outside of appetite.
Notes to the consolidated financial statements continued 55 – Risk management continued
The management of market risk is undertaken in both business units and at Group level. Business units manage market risks locally using their market risk framework and within local regulatory constraints. Business units may also be constrained by the requirement to meet policyholders’ reasonable expectations and to minimise or avoid market risk in a number of areas. The Group Assets Committee is responsible for managing market risk at Group level, and a number of investment-related risks, in particular those faced by shareholder funds throughout the Group.
Sensitivity to changes in equity prices is given in section (g) below.
Sensitivity to changes in property prices is given in section (g) below.
Interest rate risk Interest rate risk arises primarily from the Group’s investments in long-term debt and fixed income securities, which are exposed to fluctuations in interest rates.
Interest rate risk also exists in products sold by the Group, in particular from policies that carry investment guarantees on early surrender or at maturity, where claim values can become higher than the value of backing assets when interest rates rise or fall. The Group manages this risk by adopting close asset liability matching criteria, to minimise the impact of mismatches between the value of assets and liabilities from interest rate movements.
Sensitivity to changes in interest rates is given in section (g) below.
Currency risk The Group has minimal exposure to currency risk from financial instruments held by business units in currencies other than their functional currencies, as nearly all such holdings are backing either unit-linked or with-profit contract liabilities. For this reason, no sensitivity analysis is given for these holdings.
The Group’s foreign exchange policy requires that each of our subsidiaries maintains sufficient assets in its local currency to meet local currency liabilities. Therefore, capital held by the Group’s business units should be able to support local business activities regardless of foreign currency movements. However, such movements may impact the value of the Group’s consolidated shareholders’ equity which is expressed in sterling. This aspect of foreign exchange risk is monitored and managed centrally, against pre-determined limits. The Group’s foreign exchange policy is to manage these exposures by aligning the deployment of capital by currency with the Group’s capital requirements by currency. Limits are set to control the extent to which the deployment of capital is not aligned fully with the Group’s capital requirement for each major currency. Currency borrowings and derivatives are used to manage exposures within the limits that have been set.
Net assets at 31 December 2008 (798) 798 (213) 213 Net assets at 31 December 2007 (867) 867 (146) 146
Monitoring credit risk We have a significant exposure to credit risk through our investments in corporate bonds, commercial mortgages, and other asset backed securities. We hold these investments for the benefit of both our policyholders and shareholders.
Credit ratings Financial assets are graded according to current external credit ratings issued. AAA is the highest possible rating. Investment grade financial assets are classified within the range of AAA to BBB ratings. Financial assets which fall outside this range are classified as speculative grade. Credit limits for each counterparty are set based on default probabilities that are in turn based on the rating of the counterparty and the type of exposure concerned.
Debt securities 44.0% 16.2% 26.1% 8.4% 1.5% 3.8% 150,255 Reinsurance assets 12.9% 70.0% 8.1% 0.4% 0.2% 8.4% 7,894 Other investments 0.6% 2.7% 6.0% 0.8% – 89.9% 36,116 Loans 6.1% 5.3% 5.2% 0.3% 1.0% 82.1% 42,237
Debt securities 45.6% 19.7% 20.4% 9.0% 1.1% 4.2% 121,312 Reinsurance assets 14.7% 67.8% 7.4% 0.4% 1.2% 8.5% 8,054 Other investments 1.7% 2.3% 2.3% 2.3% – 91.4% 36,269 Loans 3.4% 17.6% 1.0% 0.7% 1.3% 76.0% 36,193
The carrying amount of assets included on the balance sheet represents the maximum credit exposure.
Other investments include: – £28,990 million of unit trusts and other investment vehicles. The underlying credit ratings of these assets are not reflected in this analysis.
– Other assets of £2,696 million which are primarily deposits linked to annuities, unit linked liabilities and investment funds.
The Group loan portfolio is principally made up of: – Policy loans which are generally collateralised by a lien or charge over the underlying policy,
The Group’s largest reinsurance counterparty is Muenchener Rueckversicherungs AG (including subsidiaries). At 31 December 2008 the reinsurance asset recoverable from Muenchener Rueckversicherungs AG was £1,693 million. This exposure is monitored on a regular basis.
Debt securities 150,141 – – – – 114 150,255 Reinsurance assets 7,867 25 – – – 2 7,894 Other investments 36,114 1 – – – 1 36,116 Loans 41,091 227 658 13 11 237 42,237 Receivables and other financial
Debt securities 121,241 – – – – 71 121,312 Reinsurance assets 8,052 – – – – 2 8,054 Other investments 36,269 – – – – – 36,269 Loans 35,937 210 11 3 15 17 36,193 Receivables and other financial
Analysis of maturity of liabilities For non-linked insurance business, the following table shows the gross liability at 31 December 2008 analysed by remaining duration. The total liability is split by remaining duration in proportion to the cash-flows expected to arise during that period, as permitted under IFRS 4, Insurance Contracts.
Almost all investment contracts may be surrendered or transferred on demand. For such contracts the earliest contractual maturity date is therefore the current balance sheet date, for a surrender amount approximately equal to the current balance sheet liability. We expect surrenders, transfers and maturities to occur over many years, and the tables reflect the expected cash flows for these products. However, contractually, the total liability for non-linked investment contracts of £60,264 million (2007: £45,492 million) would be shown in the “Within 1 year” column below. Unit-linked contracts are repayable or transferable on demand and are therefore excluded from this analysis.
Long-term business Insurance contracts – non-linked 106,758 9,480 27,726 44,305 25,247 Investment contracts – non-linked 45,492 2,957 10,263 17,205 15,067 General insurance and health 18,452 8,324 7,508 2,568 52
A maturity analysis of borrowings and derivatives is given in note 47 and 56 respectively.
Types of risk Life insurance risk in the Group arises through its exposure to mortality and morbidity insurance and exposure to worse than anticipated operating experience on factors such as persistency levels and management and administration expenses.
– Persistency risk is managed at a business unit level through frequent monitoring of company experience, benchmarked against local market information. Where possible the financial impact of lapses is reduced through appropriate product design. Businesses also implement specific initiatives to improve retention of policies which may otherwise lapse. The Group Life Insurance Committee has developed guidelines on persistency management.
– Product Design and Pricing risk arises from poorly designed or inadequately priced products and can lead to both financial loss and reputation damage from the Group. Guidelines have been developed to support the businesses through the complete cycle of the product development process, financial analysis and pricing.
– Expense risk is primarily managed by the business units through the assessment of business unit profitability and frequent monitoring of expense levels.
When looking at concentrations of risk, for example market risk, the risk within Aviva staff pension schemes is also considered.
Examples of each type of embedded derivative affecting the Group are: – Options: call, put, surrender and maturity options, guaranteed annuity options, options to cease premium payment, options for withdrawals free of market value adjustment, annuity options, and guaranteed insurability options.
The impact of these is reflected in ICA and MCEV reporting and managed as part of the asset liability framework.
The General Insurance Committee monitors and develops the management of insurance risk in the general insurance business units, and assesses the aggregate risk exposure. It is responsible for the development, implementation, and review of the Group policies for underwriting, claims, reinsurance and reserving that operate within the Group risk management framework.
The adequacy of the Group’s general insurance claims provisions is ultimately overseen by the General Insurance Committee.
Types of operational risk Operational risk is the risk of loss, resulting from inadequate or failed internal processes, people and systems or from external events. Operational risks include taxation, reputation and regulatory risks, such as compliance.
Operational risk management Our businesses are primarily responsible for identifying and managing operational risks in line with minimum standards of control set out in our policies. Each operational risk is assessed by considering the potential impact and the probability of the event occurring. Impact assessments are considered against financial, operational and reputation criteria.
The Group Operational Risk Committee (ORC) oversees the Group’s aggregate operational risk exposure on behalf of the Group Executive Committee and reports to the Board Risk & Regulatory Committee. It makes recommendations on the risk appetite that the Group can work within for operational risk, assesses and monitors overall operational risk exposures, identifying any concentrations of operational risk across the Group, and in particular verifies that mitigating action plans are implemented. The ORC operates a number of sub-committees which focus on specific areas of operational risk including business protection, IT, regulatory, people and business standards.
For long-term business in particular, sensitivities of MCEV performance indicators to changes in both economic and non-economic experience are continually used to manage the business and to inform the decision making process. More information on MCEV sensitivities can be found in the presentation of results on an MCEV basis in the supplementary section of to this report.
The impact of a reduction in mortality rates for annuity contracts by 5%.
The impact of an increase in gross loss ratios for general insurance and health business by 5%.
Long-term business Sensitivities as at 31 December 2008 Impact on profit before tax (£m)
Insurance participating (10) (165) 85 (90) (20) (5) (10) Insurance non-participating (25) 135 90 (90) (20) (25) (310) Investment participating (35) (55) 25 (20) – – – Investment non-participating (10) 10 20 (20) (5) – – Assets backing life shareholders’
Sensitivities as at 31 December 2007 Impact on profit before tax (£m)
Insurance participating 15 (10) – – (5) – – Insurance non-participating (205) 165 45 (35) (5) (20) (295) Investment participating (5) (25) – – (5) – – Investment non-participating (35) 40 65 (60) – – – Assets backing life shareholders’
The different impacts of the economic sensitivities on profit and shareholders' equity arise from classification of certain assets as available for sale in some business units, for which movements in unrealised gains or losses would be taken directly to shareholders’ equity.
The mortality sensitivities relate primarily to the UK, Netherlands and Ireland.
General insurance and health business Sensitivities as at 31 December 2008 Impact on profit before tax (£m)
Gross of reinsurance (310) 300 90 (90) (40) (435) Net of reinsurance (360) 360 90 (90) (40) (425)
Fund management and non-insurance business Sensitivities as at 31 December 2008 Impact before profit before tax (£m)
A number of the business units use passive assumptions to calculate their long-term business liabilities. Consequently, a change in the underlying assumptions may not have any impact on the liabilities, whereas assets held at market value on the balance sheet will be affected. In these circumstances, the different measurement bases for liabilities and assets may lead to volatility in shareholder equity. Similarly, for general insurance liabilities, the interest rate sensitivities only affect profit and equity where explicit assumptions are made regarding interest (discount) rates or future inflation.
This note gives details of the various derivative instruments we use to mitigate risk.
(a) Cash flow hedges The Group had no cash flow hedge activity at 31 December 2008 (2007: nil).
(c) Net investment hedges To reduce its exposure to foreign currency risk, the Group has entered into the following net investment hedges: – The Group has designated a portion of its Euro and US dollar denominated debt as a hedge of the net investment in its European and American subsidiaries. The carrying value of the debt at 31 December 2008 was £2,663 million (2007: £1,988 million) and its fair value at that date was £1,755 million (2007: £1,972 million).
Foreign exchange contracts OTC Forwards 6,164 89 (340) 9,594 24 (106) Interest and currency swaps 1,235 3 (255) 859 57 –
The notional amounts above reflect the aggregate of individual derivative positions on a gross basis and so give an indication of the overall scale of the derivative transaction. They do not reflect current market values of the open positions.
In addition to the assets included in the consolidated balance sheet, the Group manages many funds for third parties. This note details the total funds under management.
Third-party funds under management Unit trusts, OEICs, PEPs and ISAs 22,616 24,427 Segregated funds 48,104 50,018
Managed by: Aviva Investors 236,178 235,309 Other Aviva fund managers 120,054 99,906
Where applicable, the accounting policies of the Company are the same as those of the Group on pages 125 to 139. The notes (identified alphabetically on pages 281 to 285 are an integral part of these separate financial statements. Where the same items appear in the Group financial statements, reference is made to the notes (identified numerically) on pages 146 to 277.
Income Dividends received from subsidiaries 1,796 2,568 Interest receivable from Group companies 151 158 Net investment (expenses/income) (141) 4
Expenses Operating expenses B (112) (193) Interest payable to Group companies (992) (944) Interest payable on borrowings (289) (232)
Net expenses recognised directly in equity (8,095) (3,399) Profit for the year 796 1,717
Balance at 1 January 20,982 23,136 Excess of expenses over income recognised for the year (7,299) (1,682) Dividends and appropriations 15 (975) (871) Issues of share capital 28 20 48 Employee trust shares distributed in the year 30 (6) – Shares issued in lieu of dividends 35 170 301 Reserves credit for equity compensation plans 10 39 50
Assets Non-current assets Investments in subsidiaries A 16,353 24,466 Investment in joint venture 18c 61 52 Loans owed by subsidiaries 3,417 2,607 Deferred tax assets C – 9 Current tax assets 749 714 20,580 27,848 Current assets Loans owed by subsidiaries – 132 Other amounts owed by subsidiaries 2,179 1,027 Other assets 43 115 Cash and cash equivalents 78 14
Called up capital 864 855 Share premium account 28b 1,234 1,223 Merger reserve D 735 735 Investment valuation reserve D 5,770 13,883 Equity compensation reserve D 113 89 Retained earnings D 3,225 3,207 Direct capital instrument 32 990 990
(ii) At 31 December 2008, the Company has two wholly-owned subsidiaries, both incorporated in Great Britain. These are General Accident plc and Aviva Group Holdings Limited. Aviva Group Holdings Limited is an intermediate holding company, whilst General Accident plc no longer carries out this function. The principal subsidiaries of the Aviva Group at 31 December 2008 are listed on pages 328 and 329.
B – Operating expenses (i) Operating expenses Operating expenses comprise: Staff costs and other employee related expenditure (see below) 86 92 Other operating costs 109 95 Net foreign exchange losses/(gains) (83) 6
(ii) Staff costs Total staff costs were: Wages and salaries 49 46 Social security costs 7 6 Post-retirement obligations Defined benefit schemes (see (iii) below) 6 6 Defined contribution schemes 3 2 Profit sharing and incentive plans 3 13 Equity compensation plans (see (iv) below) 11 17 Termination benefits 7 2
(iii) Pension costs The Company is one of a number of UK companies being charged for its employees participating in the Aviva Staff Pension Scheme, and its contributions are affected by the financial position of the scheme. There is no contractual agreement or policy for charging the net defined benefit cost for this scheme across the participating Group entities but, instead, this cost is recognised in the financial statements of the main UK employing company. The Company therefore recognises a pension expense equal to its contributions payable in the year for its staff, together with the service cost of any unfunded benefits, within staff costs above.
(iii) Tax reconciliation The tax on the Company’s profit before tax differs from the theoretical amount that would arise using the tax rate of the home country of the Company as follows: £m
Tax calculated at standard UK corporation tax rate of 28.5% (2007: 30%) (118) (408) Adjustment to tax charge in respect of prior years 5 5 Non-assessable dividends 512 770 Disallowable expenses (6) (11) Deferred tax asset not recognised (11) – Other 1 –
Net asset at 1 January 9 9 Amounts credited to profit (9) –
The Company has unrecognised other temporary differences of £30 million (2007: nil).
Balance at 1 January 2007 735 17,303 73 2,005 Arising in the year: Profit for the year – – – 1,717 Fair value losses on investments in subsidiaries – (3,420) – – Actuarial gains on pension schemes – – – 5 Dividends and appropriations – – – (871) Reserves credit for equity compensation plans – – 50 – Shares issued in lieu of dividends – – – 301 Issue of share capital under equity compensation scheme – – (34) 34 Aggregate tax effect – – – 16
Tax of £16 million is deductible in respect of coupon payments of £56 million on direct capital instruments.
E – Borrowings The Company’s borrowings comprise: Subordinated debt 4,639 3,054 9.5% guaranteed bonds 2016 199 198 Commercial paper 535 918
Within 1 year 535 312 847 932 235 1,167 1 – 5 years – 1,163 1,163 – 799 799 5 – 10 years 409 1,449 1,858 351 998 1,349 10 – 15 years 1,402 1,250 2,652 588 867 1,455 Over 15 years 3,066 2,445 5,511 2,344 206 2,550
G – Risk management Risk management in the context of the Group is considered in note 55.
The majority of the Company’s external borrowings are at fixed rates of interest and are therefore not exposed to changes in these rates. However, for those borrowings that are at floating rates, the Company is affected by changes in these rates. Further details of the Company's borrowings are provided in notes E and 47.
H – Related party transactions The Company receives dividend and interest income from subsidiaries and pays interest and fee expense to those subsidiaries in the normal course of business. These activities are reflected in the table below.
Within 1 year 975 247 1,222 1,846 258 2,104 1-5 years 2,124 593 2,717 843 334 1,177 Over 5 years 984 164 1,148 999 341 1,340
Independent auditor’s report to the directors of Aviva plc on the consolidated Aviva Market Consistent
We have reported separately on the statutory Group financial statements of Aviva plc for the year ended 31 December 2008. The information contained in the consolidated MCEV financial statements should be read in conjunction with the financial statements prepared on an IFRS basis.
This report is made solely to the Company in accordance with our engagement letter dated 28 July 2008. Our audit work has been undertaken so that we might state to the Company those matters we are required to state to them in an auditor’s report and for no other purpose. To the fullest extent permitted by law, we do not accept or assume responsibility to anyone other than the Company for our audit work, for this report, or for the opinions we have formed.
We read other information contained in the Annual Report and Accounts and consider whether it is consistent with the consolidated Aviva MCEV financial statements.
We planned and performed our audit so as to obtain all the information and explanations which we considered necessary in order to provide us with sufficient evidence to give reasonable assurance that the consolidated Aviva MCEV financial statements are free from material misstatement, whether caused by fraud or other irregularity or error. In forming our opinion we also evaluated the overall adequacy of the presentation of information in the consolidated Aviva MCEV financial statements.
Operating profit before tax attributable to shareholders’ profits 3,501 Life MCEV operating earnings 2,801 2,544 52 Fund management1 42 90 1,498 General insurance and health 1,198 1,021
9 Profit on the disposal of subsidiaries and associates 7 20 (408) Integration and restructuring costs (326) (153) (943) Exceptional items (754) –
(1,049) Tax on operating earnings (839) (924) 5,441 Tax on other activities 4,353 238 4,392 3,514 (686)
Operating earnings on an MCEV basis after tax, attributable to ordinary shareholders of Aviva plc 104.3c Basic (pence per share) 83.4p 70.4p 103.3c Diluted (pence per share) 82.7p 69.8p
(363.6)c Basic (pence per share) (290.9)p 63.8p (363.6)c Diluted (pence per share) (290.9)p 63.2p
2,504 Net income recognised directly in equity 2,003 1,533 (9,638) (Loss)/profit for the period (7,710) 1,946
Reconciliation of movements in shareholders’ equity – MCEV basis For the year ended 31 December 2008 £m £m 24,422 Balance at 1 January 23,689 20,443 (5,884) Total recognised (expense)/ income for the period (5,707) 3,479 (1,005) Dividends and appropriations (975) (871)
21 Issues of share capital 20 48 175 Shares issued in lieu of dividends 170 301 37 Capital contribution from minority shareholders 36 –
Summarised consolidated balance sheet – MCEV basis For the year ended 31 December 2008
Liabilities 180,258 Gross insurance liabilities 174,850 152,839 110,886 Gross liabilities for investment contracts 107,559 98,244 2,397 Unallocated divisible surplus 2,325 6,785 7,132 Net asset value attributable to unitholders 6,918 6,409 3,076 Provisions 2,984 1,937 3,113 Deferred tax liabilities 3,020 2,532 662 Current tax liabilities 642 1,225 15,671 Borrowings 15,201 12,657 21,485 Payables and other financial liabilities 20,840 18,060 4,696 Other liabilities 4,556 3,765 1,259 Liabilities of operations classified as held for sale 1,221 942 368,279 Total equity and liabilities 357,231 329,084
The summarised consolidated balance sheet presented above is unaltered from the corresponding IFRS summarised consolidated balance sheet, with the exception of the following: 1. Adding the excess of the Life MCEV, including minority interests, over the corresponding Life IFRS net assets represented as the additional value of in-force long-term business 2. Corresponding item within equity represented by the additional retained profit on an MCEV basis.
Reconciliation of shareholders’ equity For the year ended 31 December 2008 2008 IFRS £m
Ordinary share capital 664 – 664 Capital reserves 4,505 – 4,505 Other reserves 2,110 1,429 3,539 Shares held by employee trusts (33) – (33) Retained earnings 3,806 – 3,806 Additional retained earnings on an MCEV basis – 431 431
Ordinary share capital 655 – 655 Capital reserves 4,494 – 4,494 Other reserves 1,469 (290) 1,179 Shares held by employee trusts (10) – (10) Retained earnings 6,338 – 6,338 Additional retained earnings on an MCEV basis – 7,342 7,342
Equity attributable to ordinary shareholders of Aviva plc 12,946 7,052 19,998 Preference share capital 200 – 200 Direct capital instruments 990 – 990 Minority interests 1,795 706 2,501
Reconciliation of IFRS total equity to MCEV net worth £m £m
Net assets on an statutory IFRS net basis 14,446 15,931 Less: general business and other net assets on an statutory IFRS net basis 2,135 (1,292)
Group MCEV analysis of earnings For the year ended 31 December 2008
Equity attributable to ordinary shareholders of Aviva plc on an MCEV basis 12,912
Operating MCEV earnings 1,567 – 1,567 309 309 1,876 Non-operating MCEV earnings 52 (33) 19 (191) (224) (172)
Other movements in IFRS net equity – 124 124 316 440 440 Capital and dividend flows (829) – (829) 347 347 (482) Foreign exchange variances 851 61 912 (14) 47 898 Acquired/divested businesses 101 313 414 (414) (101) –
Total assets included in the IFRS balance sheet 307,928 46,634 354,562 280,375 40,951 321,326
Liabilities of the long-term business (291,347) – (291,347) (265,736) – (265,736) Liabilities of the general insurance and
Equity attributable to ordinary shareholders of Aviva plc on an MCEV basis 12,912 19,998
MCEV basis total equity 17,115 23,689 1. The analysis between the Group’s and minority interests’ share of the additional value of in-force long-term business is as follows: Movement in period
M1 – Basis of preparation Introduction The summarised consolidated income statement and balance sheet on pages 289 to 291 present the Group’s results and financial position for the life and related businesses on the Market Consistent Embedded Value (MCEV) basis and for its non-life businesses on the International Financial Reporting Standards (IFRS) basis. The MCEV methodology adopted is in accordance with the MCEV Principles published by the CFO Forum in June 2008 with the exception of the use of an adjusted risk-free yield due to current market conditions for immediate annuities in the UK and Netherlands and for immediate annuities, deferred annuities and all other contracts in the US.
The CFO Forum MCEV Principles were designed during a period of relatively stable market conditions. As announced on 19 December 2008, the CFO Forum has agreed to conduct a review of the impact of turbulent market conditions on the MCEV Principles, the result of which may lead to changes to the published MCEV Principles or the issuance of guidance. The particular areas under review include implied volatilities, the cost of non-hedgeable risks, the use of swap rates as a proxy for risk-free rates and the effect of liquidity premia.
Covered business The MCEV calculations cover the following lines of business: life insurance, long-term health and accident insurance, savings, pensions and annuity business written by our life insurance subsidiaries, including managed pension fund business and our share of the other life and related business written in our associated undertakings and joint ventures, as well as the equity release business written in the UK.
Covered business includes the Group’s share of our joint ventures including our arrangement with The Royal Bank of Scotland Group (RBSG) and our associated undertakings in India, China, Turkey, Malaysia, Taiwan and South Korea. In addition, the results of group companies providing significant administration, fund management and other services and of group holding companies have been included to the extent that they relate to covered business. Together these businesses are referred to as “Life and related businesses”.
New business premiums New business premiums include: − premiums arising from the sale of new contracts during the period; − non-contractual additional premiums, including future Department of Work and Pensions (DWP) rebate premiums; and
For Group products, new business includes new contracts and increases to aggregate premiums under existing contracts. Renewal premiums are based on the level of premium received during the reporting period and allow for premiums expected to be received beyond the expiry of any guaranteed premium rates.
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 the market value of assets attributed to the covered business over and above that required to back liabilities for covered business, for which distribution to shareholders is restricted. 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 level. The level of required capital for each business unit is set equal to the higher of: − The level of capital at which the local regulator is empowered to take action; − The capital requirement of the business unit under the Group’s economic capital requirements; and,
The free surplus is the market value of any assets allocated to, but not required to support, the in-force covered business at the valuation date.
Present value of future profits (PVFP) This is the present value of the distributable profits to shareholders arising from the in-force covered business projected on a best estimate basis.
However, future investment returns are uncertain and the actual impact on shareholder profits may be higher or lower. The value of in-force business needs to be adjusted for the impact of the range of potential future outcomes. Stochastic modelling techniques can be used to assess the impact of potential future outcomes, and the difference between the intrinsic value and the total stochastic value is referred to as the time value of the option or guarantee.
Where evidence exists that persistency rates are linked to economic scenarios, dynamic lapse assumptions are set that vary depending on the individual scenarios. This cost is included in the TVOG. Dynamic lapses are modelled for parts of the US and French business. Asymmetries in non-economic assumptions that are linked to economic scenarios, but that have insufficient evidence for credible dynamic assumptions, are allowed for within mean best estimate assumptions.
Frictional costs of required capital The additional costs to a shareholder of holding the assets backing required capital within an insurance company rather than directly in the market are called frictional costs. They are explicitly deducted from the PVFP. The additional costs allowed for are the taxation costs and any additional investment expenses on the assets backing the required capital. The level of required capital has been set out above in the net worth section.
The capital levels used are projected to be sufficient to cover non-hedgeable risks at the 99.5% confidence level one-year after the valuation date. The capital is equal to the capital from the ICA results for those risks considered. The capital has been projected as running off over the remaining life of the in-force portfolio in line with the drivers of the capital requirement.
In addition to the operational risk allowance, financial non-hedgeable risks and other product level asymmetries have been allowed for. These allowances are not material as significant financial non-hedgeable risks and product level asymmetries are either modelled explicitly and included in the TVOG or are included in the PVFP through the use of appropriate best estimate assumptions. Asymmetric risks allowed for in the TVOG or PVFP are described earlier in the Basis of Preparation. No allowance has been made within the cost of non-hedgeable risk for symmetrical risks as these are diversifiable by investors.
The embedded value of the US spread-based products anticipates the application of management discretion allowed for contractually within the policies, subject to contractual guarantees. This includes the ability to change the crediting rates and indexed strategies available within the policy. Consideration is taken of the economic environment assumed in future projections and returns in excess of the reference rate are not assumed. Anticipated market and policyholder reaction to management action has been considered. The anticipated management action is consistent with current decision rules and has been approved and signed off by management and legal counsel.
Consolidation adjustments The effect of transactions between group life companies such as loans and reinsurance arrangements have been included in the results split by territory in a consistent manner. No elimination is required on consolidation.
The capitalised value of the future profits and losses from such service companies are included in the embedded value and value of new business calculations for the relevant business, but the net assets (representing historical profits and other amounts) remain under non-insurance or fund management. In order to reconcile the profits arising in the financial period within each segment with the assets on the opening and closing balance sheets, a transfer of IFRS profits from life and related business to the appropriate segment is deemed to occur. An equivalent approach has been adopted for expenses within our holding companies.
The assessments of goodwill, intangibles and pension schemes relating to life insurance business utilise the IFRS measurement basis.
The results and cash flows of these operations have been translated at the average rates for that period and the assets and liabilities have been translated at the period end rates as follows: Eurozone – Average rate (€1 equals) £0.80 £0.68 – Period end rate (€1 equals) £0.97 £0.73 United States – Average rate (US$1 equals) £0.54 £0.50 – Period end rate (US$1 equals) £0.69 £0.50
Opening MCEV 3,204 6,240 8,804 18,248 3,066 5,287 8,153 16,506 New business value (1,867) 1,109 1,167 409 (1,432) 808 1,128 504 Expected existing
Transfers from VIF and required capital to the free surplus 1,926 (637) (1,289) – 1,683 (439) (1,244) –
Economic variances (3,140) (433) (4,833) (8,406) 37 112 (97) 52 Other non-operating 1. Required capital is shown net of implicit items permitted by local regulators to cover minimum solvency margins.
The components of the life MCEV earnings in the consolidated income statement have been further analysed in this note. This analysis shows the life MCEV earnings gross of both taxes and minorities analysed in total.
In this table the life and pensions MCEV earnings have been broken down into constituent parts. The life and pensions MCEV operating earnings comprise: − the value of new business written during the year; − the earnings from existing business; and,
– expected returns at the reference rate 992 877 – expected returns in excess of the reference rate 446 420
Life and pensions operating earnings before tax 2,801 2,544 Economic variances (12,422) (19) Other non-operating variances (329) –
The table above presents a summarised breakdown of the life and pensions MCEV earnings on a gross of minorities basis and gross of tax with tax shown separately. The Group favours the gross presentation for consistency with the IFRS results. The table below compares the key items on the different bases as the subsequent analysis is provided predominantly on a net of tax and minorities basis as preferred by the CFO Forum Principles.
Value of new business 409 780 504 897 Life and pensions operating earnings 1,753 2,801 1,567 2,544 Life and pensions earnings (6,885) (9,950) 1,619 2,525
New business sales are expressed as the PVNBP. The premium volumes and projection assumptions used to calculate the present value of regular premiums for each product are the same as those used to calculate the value of new business, so the components of the new business margin are on a consistent basis.
The value generated by new business written during the period is the present value of the projected stream of after tax distributable profit from that business. The value of new business has been calculated using economic assumptions at the point of sale which has been implemented with the assumptions being taken as those appropriate to the start of each quarter. For contracts that are re-priced more frequently, weekly or monthly economic assumptions have been used. The operating assumptions are consistent with those used to determine the embedded value. The value of new business is shown after the effect of the frictional costs of holding required capital, and after the effect of the costs of residual non-hedgeable risks on the same basis as for the in-force covered business.
United Kingdom 660 4.8 3,180 8,678 11,858 France 95 6.9 651 3,229 3,880 Ireland 129 4.3 557 742 1,299 Italy 132 6.0 796 1,535 2,331 Netherlands (including Belgium and Germany) 197 9.0 1,775 2,322 4,097 Poland 106 11.2 1,183 659 1,842 Spain 174 6.0 1,042 1,485 2,527 Other Europe 117 7.7 906 108 1,014 Europe 950 7.3 6,910 10,080 16,990 North America 68 8.8 600 5,115 5,715 Asia 174 5.4 941 410 1,351 Australia 60 3.6 217 152 369 Asia Pacific 234 5.0 1,158 562 1,720
United Kingdom 603 4.7 2,852 8,945 11,797 France 90 7.0 632 3,158 3,790 Ireland 139 4.4 615 1,165 1,780 Italy 107 5.7 608 2,367 2,975 Netherlands (including Belgium and Germany) 160 8.6 1,378 1,755 3,133 Poland 63 11.2 707 413 1,120 Spain 114 5.9 672 1,761 2,433 Other Europe 73 4.4 318 135 453 Europe 746 6.6 4,930 10,754 15,684 North America 71 8.2 579 3,067 3,646 Asia 114 6.0 683 458 1,141 Australia 54 3.5 191 263 454 Asia Pacific 168 5.2 874 721 1,595
United Kingdom 11,858 11,797 204 278 1.7% 2.4% France 3,880 3,790 135 144 3.5% 3.8% Ireland 1,299 1,780 15 37 1.2% 2.1% Italy 2,331 2,975 71 77 3.0% 2.6% Netherlands (including Belgium and Germany) 4,097 3,133 (73) 8 (1.8)% 0.3% Poland 1,842 1,120 65 48 3.5% 4.3% Spain 2,527 2,433 236 181 9.3% 7.4% Other Europe 1,014 453 29 7 2.9% 1.3% Europe 16,990 15,684 478 502 2.8% 3.2% North America 5,715 3,646 55 52 1.0% 1.4% Asia 1,351 1,141 30 49 2.2% 4.3% Australia 369 454 13 16 3.5% 3.5% Asia Pacific 1,720 1,595 43 65 2.5% 4.1%
United Kingdom 11,858 11,797 147 195 1.2% 1.7% France 3,281 3,157 79 81 2.4% 2.6% Ireland 974 1,335 10 26 1.0% 1.9% Italy 980 1,284 21 20 2.1% 1.6% Netherlands (including Belgium and Germany) 3,868 2,941 (67) 3 (1.7)% 0.1% Poland 1,604 966 46 34 2.9% 3.5% Spain 1,376 1,223 80 57 5.8% 4.7% Other Europe 1,014 453 24 4 2.4% 0.9% Europe 13,097 11,359 193 225 1.5% 2.0% North America 5,715 3,646 36 34 0.6% 0.9% Asia 1,344 1,133 24 39 1.8% 3.4% Australia 369 454 9 11 2.4% 2.4% Asia Pacific 1,713 1,587 33 50 1.9% 3.2%
(c) Post-tax internal rate of return on life and pension new business and payback period The new business written requires up front capital investment, due to high set-up costs and capital requirements. The internal rate of return (IRR) is a measure of the shareholder return expected on this capital investment. It is equivalent to the discount rate at which the present value of the post-tax cash flows expected to be earned over the life time of the business written, including allowance for the time value of options and guarantees, is equal to the total invested capital to support the writing of the business. The capital included in the calculation of the IRR is the initial capital required to pay acquisition costs and set up statutory reserves in excess of premiums received (“initial capital”), plus required capital at the same level as for the calculation of the value of new business.
The payback period shows how quickly shareholders can expect the total capital to be repaid. The payback period has been calculated based on undiscounted cash flows and allows for the initial and required capital.
The IRR on life and pensions new business for the Group was 11.4% (2007 restated: 12.9%)
United Kingdom 14% 157 136 293 8 France 9% 35 118 153 9 Ireland 8% 53 24 77 9 Italy 14% 9 48 57 6 Netherlands (including Belgium and Germany)1 5% 277 244 521 n/a Poland 21% 31 12 43 4 Spain 37% 28 75 103 3 Other Europe 13% 57 9 66 6 Europe1 11% 490 530 1,020 7 North America 11% 124 489 613 6 Asia 13% 64 23 87 8 Australia 12% 3 30 33 8 Asia Pacific 12% 67 53 120 8 1. In the Netherlands, the value of new business is low on a real world basis, and so it is not possible to calculate a meaningful payback period. Consequently, the total and Europe average payback periods exclude the Netherlands. On a comparable basis the total payback period in 2007 is 7 years.
United Kingdom 13% 256 149 405 8 France 12% 29 107 136 8 Ireland 11% 69 23 92 7 Italy 15% 4 52 56 6 Netherlands (including Belgium and Germany) 6% 78 181 259 22 Poland 23% 18 10 28 4 Spain 28% 24 68 92 3 Other Europe 18% 48 4 52 5 Europe 13% 270 445 715 12 North America 12% 125 280 405 6 Asia 23% 48 11 59 4 Australia 15% – 23 23 6 Asia Pacific 21% 48 34 82 4
This note sets out how the VIF generated by the in-force and new business is modelled as emerging into free surplus over future years. Cash flows are projected on a certainty equivalent basis and are discounted at risk-free rates.
(a) Total in-force business To show the profile of the VIF emergence, the value of VIF in the consolidated balance sheet has been split into five year tranches depending on the date when the profit is expected to emerge.
United Kingdom 1,574 1,209 615 345 524 4,267 4,267 Europe 2,200 1,170 736 412 332 4,850 3,946 North America 168 129 41 16 (24) 330 330 Asia Pacific 130 105 15 8 11 269 261
United Kingdom 91 74 69 50 10 294 294 Europe 219 146 103 73 250 791 630 North America 112 45 8 1 (12) 154 154 Asia Pacific 48 17 10 5 10 90 89
This note gives a geographical split of the MCEV operating earnings on a gross basis and an analysis of earnings on a net basis
Operating assumption changes: – project and other related expenses 13 – – – 9 – – – 9 – – – – 22
Earnings before tax and minority interests 883 692 78 131 187 241 286 23 1,638 201 31 48 79 2,801
– expected existing business contribution (in excess of reference rate) 190 31 8 5 132 6 23 – 205 22 2 1 3 420
Experience variances – maintenance assumption changes: – project and other related expenses1 2 (1) – – (7) – – (11) (19) – – – – (17)
Earnings before tax and minority interests 822 568 85 137 316 181 233 (17) 1,503 124 45 50 95 2,544
Operating assumption changes: – project and other related expenses 9 – – – 4 – – – 4 – – – – 13
3. Lapse experience has been volatile, in part reflecting wider economic volatility. In Poland, lapse experience continued to be better than the long-term assumptions for both life and pension products.
4. In France, other experience profits include the reduction in value arising from reductions in fees and commissions received. In Ireland, certain statutory provisions were increased following a review. The movement in the Netherlands reflects changes in gross pension scheme contributions. In the USA, other experience reflects the cost of enhancing policyholder crediting rates.
5. In the Netherlands, expense assumptions have been updated following a review of expense allocations.
M7 – Geographical analysis of MCEV operating earnings continued Net of tax and minority interests Restated 2007
– expected existing business contribution (in excess of reference rate) 133 20 5 1 95 5 9 – 135 14 1 1 2 284
Earnings after tax and minority interests 575 341 55 38 217 129 75 (12) 843 80 34 35 69 1,567 1. Project and other related expenses in the UK reflect project costs associated with strategic initiatives, including developments designed to offer simpler products to customers, and the simplification of systems and processes. In the Netherlands, project costs mainly represent one-off restructuring costs in the Dutch business.
4. Other experience profits reflect an accumulation of small items, including an increased allowance for operational risk in the USA.
5. Maintenance expense assumptions have been strengthened in the USA following investment to support the growth of the business, and in the Netherlands following a review of expenses.
7. In France, other operating assumption changes reflect increased profitability driven by product development and the increased proportion of unit-linked assets within managed funds.
8. Other operating variances in the Netherlands relate to changes in asset management fees.
This note sets out further information on the operating earnings from other operations set out in the summarised consolidated income statement.
Where subsidiaries provide services to our life business, that proportion has been excluded. These results are included within the life MCEV operating return.
M10 – Segmental analysis of life and related business embedded value Net worth 2008 Free surplus £m
United Kingdom 1,255 1,389 4,267 6,911 France 28 1,280 1,228 2,536 Ireland 159 201 465 825 Italy 208 156 125 489 Netherlands (including Belgium and Germany) 1,247 1,713 856 3,816 Poland 111 116 816 1,043 Spain 61 175 334 570 Other Europe 32 24 122 178 Europe 1,846 3,665 3,946 9,457 North America2 (70) 946 330 1,206 Asia 124 53 190 367 Australia 49 187 71 307 Asia Pacific 173 240 261 674 1. Required capital is shown net of implicit items permitted by local regulators to cover minimum solvency margins.
United Kingdom 2,470 (176) (165) (76) 2,053 France 1,779 (174) (147) (414) 1,044 Ireland 637 (10) (24) – 603 Italy 196 (22) (12) (13) 149 Netherlands (including Belgium and Germany) 856 (246) (132) (319) 159 Poland 1,074 (14) (73) (8) 979 Spain 355 (18) (32) (18) 287 Other Europe 169 (4) (4) (2) 159 Europe 5,066 (488) (424) (774) 3,380 North America (864) (15) (43) (180) (1,102) Asia 262 (20) (23) (26) 193 Australia 132 (27) (26) (10) 69 Asia Pacific 394 (47) (49) (36) 262
United Kingdom 4,698 (183) (154) (94) 4,267 France 1,713 (132) (126) (227) 1,228 Ireland 491 (9) (16) (1) 465 Italy 160 (17) (9) (9) 125 Netherlands (including Belgium and Germany) 1,422 (263) (67) (236) 856 Poland 897 (15) (60) (6) 816 Spain 378 (17) (22) (5) 334 Other Europe 128 (3) (3) – 122 Europe 5,189 (456) (303) (484) 3,946 North America 581 (105) (28) (118) 330 Asia 210 (7) (7) (6) 190 Australia 123 (30) (16) (6) 71 Asia Pacific 333 (37) (23) (12) 261
The cashflows projected are the expected future cashflows including expected investment cashflows from equities, bond and properties earning a risk premium in excess of risk free, statutory reserves and required capital. The risk premiums used are consistent with those used in the expected existing business contribution within operating earnings. As the risk premiums are positive, a discount rate higher than risk-free is required to give a value equal to the marketconsistent embedded value.
1. Where the value of in force business is negative, an IDR can not be calculated. Consequently an average total IDR is not meaningful.
M13 – Summary of minority interests in life and related businesses’ MCEV results £m Ireland £m Italy £m
Value of new business, net of tax 9 3 27 12 7 85 143 – 143 409 552
Closing covered businesses’ embedded value 304 323 727 204 177 550 2,285 15 2,300 14,089 16,389
Life MCEV earnings after tax 24 15 66 13 22 57 197 3 200 1,619 1,819
Closing covered businesses’ embedded value 235 266 551 158 154 472 1,836 12 1,848 18,248 20,096
M14 – Principal economic assumptions (a) Economic assumptions – Deterministic calculations Economic assumptions are derived actively, based on market yields on risk-free fixed interest assets at the end of each reporting period.
In setting the risk-free rate we have, wherever possible used the mid-price swap yield curve for an AA-rated bank.
The adjustments made to swap rates to derive a risk-free rate for UK and Netherlands immediate annuities and immediate annuities, deferred annuities and all other US business are shown below the reference rate table.
Reference rate – term 1 year 2.8% 5.7% 2.5% 4.8% Reference rate – term 5 years 3.2% 5.1% 3.3% 4.6% Reference rate – term 10 years 3.5% 5.0% 3.8% 4.7% Reference rate – term 15 years 3.8% 4.9% 3.9% 4.9% Reference rate – term 20 years 3.8% 4.8% 3.9% 4.9% Expense inflation 3.5% 3.6% 2.1% 2.9%
1. The economic assumptions used in the Netherlands differ from those in the Eurozone as the Dutch bank swap rate is used in the Netherlands.
In current markets, the following adjustments are made to the swap rate for UK and Netherlands immediate annuities and all US contracts. The risk-free rate is taken as the swap yield curve for the currency of the liability, adjusted by: New business Embedded value
United Kingdom 28.0% 28.0% 100%/110% 100%/110% France 34.4% 34.4% 110% 110% Ireland 12.5% 12.5% 150% 150% Italy 32.4% 32.4% 115%/184% 115%/184% Netherlands 25.5% 25.5% 168% 188% Poland 19.0% 19.0% 150% 150% Spain 30.0% 30.0% 110%/125% 110%/125% United States 35.0% 35.0% 325% 325%
1. The required capital in the United Kingdom under MCEV is 100% for unit-linked and other non-participating business and 110% for annuity business 2. Required capital in Italy under MCEV is 184% of the EU minimum for Eurovita and 115% for other companies 3. Required capital in the Netherlands is 168%. This capital level is the aggregate capital required for the Netherlands.
4. Required capital in Spain is 125% of the EU minimum for Aviva Vida y Pensiones and 110% for bancassurance companies.
M14 – Principal economic assumptions continued The total annual return on equities is calculated as the return on one-year swaps plus an excess return. This excess return is modelled using a log-normal model where volatility varies by time horizon. This allows the model to capture the term structure of implied volatilities. The model is calibrated to at-the-money options of a variety of terms. Option volatilities are taken from a survey of investment banks.
Model – Netherlands In the Netherlands, yield curves are based on De Nederlandsche Bank (DNB) yield curve data.
The interest rate model used is a short rate G2++ model. The model is calibrated to the DNB yield curve and the swaption implied volatilities. Swaption implied volatilities are taken from Bloomberg.
The equity model is a Heston model. The model considers an equity volatility surface in the market and covers strike levels between 0.8 and 1.2. The model is calibrated to the same DNB curves used in interest rate model. The option volatilities used for year-end 2007 are DJ Eurostoxx 50-quotes taken from Bloomberg. For 2008 the model was calibrated to DJ Eurostoxx 50-quotes (end of August 2008) provided by a market maker.
UK sterling 10 years n/a n/a 11.8% n/a n/a n/a 10.9% n/a 15 years n/a n/a 11.9% n/a n/a n/a 10.8% n/a 20 years n/a n/a 12.1% n/a n/a n/a 10.8% n/a 25 years n/a n/a 12.4% n/a n/a n/a 10.9% n/a Euro 10 years 11.7% 11.7% 11.7% 11.8% 11.7% 11.1% 10.6% 10.3% 15 years 10.9% 10.9% 10.4% 10.9% 11.4% 10.9% 10.5% 10.2% 20 years 10.5% 10.4% 10.4% 10.3% 10.6% 10.2% 9.9% 9.7% 25 years 10.0% 10.0% 9.9% 9.5% 10.3% 9.9% 9.6% 9.4% Netherlands 10 years 11.6% 11.6% 11.7% 11.7% 11.1% 10.9% 10.7% 10.7% 15 years 10.8% 10.7% 10.6% 10.8% 10.7% 10.4% 10.2% 10.3% 20 years 10.5% 10.3% 10.2% 10.3% 10.3% 10.0% 9.8% 9.8% 25 years 10.0% 9.8% 9.8% 9.7% 10.1% 9.8% 9.4% 9.4% US dollar 10 years 15.2% 14.4% 14.0% 14.0% 17.1% 15.0% 13.4% 12.2% 15 years 13.9% 13.0% 12.8% 12.7% 15.0% 13.2% 11.9% 10.9% 20 years 13.3% 12.4% 12.1% 12.1% 13.3% 11.8% 10.7% 10.0% 25 years 12.9% 11.9% 11.6% 11.7% 12.4% 11.2% 10.3% 9.8%
Property implied volatilities Best estimate levels of volatility have been used, in the absence of meaningful option prices from which implied levels of volatility can be derived.
Non-hedgeable risk A charge of 2.5% has been applied to the Group-diversified capital required on a 1-in-200 one-year basis over the remaining lifetime of in-force business.
Borrowings excluding non-recourse funding – MCEV basis 7,416 5,374 Less: Operational financing by businesses (1,891) (1,063)
External debt, subordinated debt, preference shares and direct capital instrument – MCEV basis 6,965 5,751
(a) Economic assumptions The following tables show the sensitivity of the embedded value and the value of new business to: − Using swap yields as the risk-free rate.
− one and two percentage point increase and decrease in the risk-free rate, including all consequential changes (including assumed investment returns for all asset classes, market values of fixed interest assets, risk discount rates); − 10% increase and decrease in market values of equity and property assets; − 25% increase in equity and swaption volatilities; − 50 basis point increase and decrease in credit spreads; and
For new business, the sensitivities reflect the impact of a change immediately after inception of the policy.
Risk free rate as swap yields £m 1% increase £m 1% decrease £m 2% increase £m
United Kingdom 4,887 (2,117) (105) 90 (215) 175 France 2,519 – (70) (60) (210) (360) Ireland 990 – (50) 55 (90) 120 Italy 645 – 5 (45) 5 (100) Netherlands (including Belgium and Germany) 2,110 (120) 560 (805) 900 (1,525) Poland 1,228 – (30) 40 (55) 95 Spain 655 – (15) 20 (35) 40 Other Europe 236 – (5) 5 (10) 10 Europe 8,383 (120) 395 (790) 505 (1,720) North America 64 (3,862) (505) 210 (845) 90 Asia 424 – 20 (35) 30 (175) Australia 331 – (15) 15 (25) 30 Asia Pacific 755 – 5 (20) 5 (145)
United Kingdom 4,887 400 (410) (25) France 2,519 145 (160) (150) Ireland 990 15 (10) – Italy 645 – – – Netherlands (including Belgium and Germany) 2,110 410 (385) (220) Poland 1,228 15 (15) – Spain 655 5 (10) (10) Other Europe 236 5 – – Europe 8,383 595 (580) (380) North America 64 – – – Asia 424 10 (10) – Australia 331 5 (5) – Asia Pacific 755 15 (15) –
M15 – Sensitivity analysis continued Corporate bond credit spreads 2008 Embedded value (net of tax and minority interest)
Risk free rates 2008 Value of new business (net of tax and minority interest)
Risk free rate as swap yields £m 1% increase £m 1% decrease £m
United Kingdom 147 (161) 17 (25) 28 (60) France 79 – 4 (7) 7 (21) Ireland 10 – 3 (3) 6 (8) Italy 21 – (1) – (2) (1) Netherlands (including Belgium and Germany) (67) (10) 30 (47) 58 (138) Poland 46 – (3) 3 (5) 7 Spain 80 – (4) 4 (8) 8 Other Europe 24 – (1) 3 (5) 8 Europe 193 (10) 28 (47) 51 (145) North America 36 (101) (61) 50 (127) 68 Asia 24 – 5 (9) 8 (31) Australia 9 – (2) 4 (5) 7 Asia Pacific 33 – 3 (5) 3 (24)
Market values 2008 Value of new business (net of tax and minority interest)
Corporate bond credit spreads 2008 Value of new business (net of tax and minority interest)
− 5% decrease in both mortality and morbidity rates disclosed separately for life assurance and annuity business.
M15 – Sensitivity analysis continued Embedded value 2008 Embedded value (net of tax)
Statement of directors’ responsibilities in respect of the Market Consistent Embedded Value (MCEV) basis
When compliance with the European Insurance CFO Forum Market Consistent Embedded Value Principles (MCEV Principles), published in June 2008, is stated, those principles require the directors to prepare supplementary information in accordance with the methodology contained in the MCEV Principles and to disclose and explain any non-compliance with the guidance included in the MCEV Principles.
In preparing this supplementary information, the directors have done so in accordance with these MCEV Principles and have also fully complied with all the guidance included therein, with the exception of the use of an adjusted risk-free yield due to current market conditions for immediate annuities in the UK and Netherlands and immediate annuities, deferred annuities and other US contracts. Specifically, the directors have: − determined assumptions on a realistic basis, having regard to past, current and expected future experience and to relevant external data, and then applied them consistently; − made estimates that are reasonable and consistent; and,
− provided additional disclosures when compliance with the specific requirements of the MCEV Principles is insufficient to enable users to understand the impact of particular transactions, other events and conditions and the Group's financial position and financial performance.
Asymmetric risk Risks that will cause shareholder profits to vary where the variation above and below the average are not equal in distribution.
Cost of non-hedgeable risks This is the cost of undertaking those risks for which a deep and liquid market in which to hedge that risk does not exist. This can include both financial risks and non-financial risks such as mortality, persistency and expense.
EU solvency The excess of assets over liabilities and the world-wide minimum solvency margins, excluding goodwill and the additional value of in-force long-term business, and excluding the surplus held in the Group's life funds. The Group solvency calculation is determined according to the UK Financial Services Authority application of EU Insurance Group’s Directive rules.
Gross risk-free yields Gross of tax yields on risk-free fixed interest investments, generally swap rates under MCEV.
Holding company A legal entity with a function of being a consolidating entity for primary financial reporting of covered business.
Life MCEV operating earnings Operating earnings on the MCEV basis relating to the lines of business included in the embedded value calculations. From continuing operations
IFRS operating profit From continuing operations on an IFRS basis, stated before tax attributable to shareholders’ profits, impairment of goodwill and exceptional items.
New business margin New business margins are calculated as the value of new business divided by the present value of new business premiums (PVNBP), and expressed as a percentage.
Present value of new regular premiums plus 100% of single premiums, calculated using assumptions consistent with those used to determine the value of new business.
Australia Aviva Australia Holdings Limited and its principal subsidiaries: Norwich Union Life Australia Limited Navigator Australia Limited
Germany Delta Lloyd Deutschland AG and its principal subsidiary: Delta Lloyd Lebensversicherung AG (99.8%)
Poland Commercial Union Polska – Towarzystwo Ubezpieczen Na Zycie SA (90.0%) Commercial Union Polska – Towarzystwo Ubezpieczen Ogolnych SA (90.0%) Commercial Union Powszechne Towarzystwo Emerytalne BPH CU WBK S.A. (88.8%)
United States Aviva USA Corporation and its principal subsidiaries: American Investors Life Insurance Company, Inc AmerUs Annuity Group Co. (AAG) Aviva Investors North America, Inc Aviva Life and Annuity Company
United Kingdom RBS Life Investments Limited (49.99%) RBSG Collective Investments Limited (49.99%)
Aviva plc’s objects can be found in the Memorandum of Association in the Memorandum and Articles
Managing your shareholding Our Registrar, Equiniti, maintains the Company’s Register of Members and if you have any queries in respect of your shareholding, please contact them directly using the contact details provided on page 332. In addition to assisting with general queries, Equiniti can also help with the following: Amalgamating your shareholding If you receive more than one copy of our communications, it could be because you have more than one record on the share register. To avoid duplicate mailings, please contact Equiniti who can arrange for your accounts to be amalgamated.
If you live overseas, an Overseas Payment Service is available for certain countries, which may allow you to receive your dividends directly in your bank account in your local currency.*
Consolidated tax vouchers If you are a private shareholder who currently receives dividends paid directly into your bank or building society account, you will receive one consolidated tax voucher each year instead of a voucher with each dividend payment, unless you request otherwise.
Dividend Reinvestment Plan (“DRIP”)/Scrip Dividend Scheme Following a review by the Board of the operation of the current DRIP, the Company intends to propose a resolution at the forthcoming AGM to reintroduce a SCRIP dividend scheme ("SCRIP Scheme"). The Board has therefore decided to withdraw the DRIP and, subject to shareholder approval, will reintroduce the SCRIP Scheme commencing with the 2008 final dividend in order to provide shareholders with the opportunity to elect to receive their dividends in the form of new shares in the Company instead of in cash. All shareholders will be contacted with full details of the relevant terms and conditions of the proposed SCRIP Scheme and details of how to join in due course.
Corporate nominee We offer a corporate nominee service, the Aviva Share Account, for shareholders who wish to remain anonymous. If you choose to join the nominee account, your personal details will not be entered on our share register but you will have the same rights as registered shareholders and will receive the same shareholder communications. To join the Aviva Share Account or find out about the terms and conditions, please contact Equiniti.
Our website – www.aviva.com Visit www.aviva.com/shareholders for up-to-date investor information including our latest financial results and key dates. An electronic copy of current and past Annual and Interim Reports can be downloaded from the website. You can also find our current and historic share prices, sharedealing information, news, updates and when available, presentations from the Group Chief Executive. You can also register to receive future shareholder communications electronically.
* Please note that a payment charge will be deducted from each dividend payment before conversion into your chosen currency.
Barclays Stockbrokers Limited† UK and overseas UK shareholders: UK shareholders: Telephone: 0870 549 3002† Telephone: 0870 549 3001†
Share price You can access the current share price of Aviva plc ordinary shares at www.aviva.com/investors or by calling FT Cityline on 09058 171 690.*
If you would like to find out the price of Aviva preference shares, please follow the link on the Aviva website to the London Stock Exchange at www.londonstockexchange.com/ en-gb/pricesnews * Calls are currently charged at 75 pence per minute from a BT landline. The average time to access the share price is approximately one minute. Other telephony provider costs may vary.
Shareholder profile The categories of ordinary shareholders and the range and size of shareholding as at 31 December 2008 are set out below: Analysis of shareholders No. of shareholders % No. of shares %
The voting results for our 2009 AGM, including proxy votes and votes withheld will be available on our website shortly after the meeting at the following address www.aviva.com/agm
Aviva plc details Registered in England Number: Registered Office: St Helen’s, 1 Undershaft, London, EC3P 3DQ
Preference shares First dividend payment for 83⁄8% cumulative irredeemable preference shares 31 March First dividend payment for 83⁄4% cumulative irredeemable preference shares 30 June Second dividend payment for 83⁄8% cumulative irredeemable preference shares 30 September Second dividend payment for 83⁄4% cumulative irredeemable preference shares 31 December * Calls to this number are charged at 8p per minute from a BT landline. Other telephony provider costs may vary.
Internet sites Aviva owns various internet sites, most of which interlink with each other: Aviva Group www.aviva.com
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