Transitional arrangements upon first time adoption of IFRS In general, a company is required to determine its IFRS accounting polices and apply these retrospectively to determine its opening balance sheet under IFRS. However, International Financial Reporting Standard 1, First-Time Adoption of International Financial Reporting Standards (IFRS1) allows a number of exemptions to this general principle upon adoption of IFRS. The Group has taken advantage of the following transitional arrangements: Business combinations The Group has elected not to apply retrospectively the provisions of International Financial Reporting Standard 3, Business Combinations, to business combinations that occurred prior to 1 January 2004. At the date of transition no adjustment was made between UK GAAP and IFRS shareholders’ funds for any historical business combination.
Employee benefits All cumulative actuarial gains and losses on the Group’s defined benefit pension schemes have been recognised in equity at the transition date.
Acquired value of in-force business and other intangible assets 488 – 488
Equity Share capital 764 – 764 Capital reserves 3,859 – 3,859 Shares held by employee trusts (1) – (1) Revaluation and other reserves – 568 568
Liability for investment contracts – 57,445 57,445 Unallocated divisible surplus 8,443 1,730 10,173 Pension obligations and other provisions
Assets Intangible assets: Goodwill 40 40 Acquired value of in-force business and other intangible assets –
Notes to the analysis of adjustments to the balance sheet at 1 January 2004 as a result of the transition to IFRS The UK GAAP balance sheet has been presented in a format consistent with IFRS. The only significant change in heading is that the Fund for Future Appropriations is now called Unallocated Divisible Surplus. The basis for the material adjustments between UK GAAP and IFRS are as follows: Note 1: Investment valuation The adjustments in respect of investment valuation arise from the following: £m
(a) Debt securities Under UK GAAP, equity securities and unit trusts are carried at current value. Debt and other fixed income securities are carried at current value, with the exception of many non-linked long-term business debt securities and fixed income securities, which are carried at amortised cost.
(b) Commercial mortgages backing certain annuity business Under IFRS, the Group has chosen to move certain of its commercial mortgage portfolio to an active fair valuation basis in accordance with IAS39, which has increased the value of investments by £113 million. The annuity liabilities which are backed by these assets have been correspondingly revalued, with the result that there is an insignificant impact on shareholders’ funds at 1 January 2004.
The above requirements have resulted in a transfer from retained earnings of £568 million into separate revaluation reserves at 1 January 2004.
(a) Product classification International Financial Reporting Standard 4, Insurance Contracts (IFRS4) requires all products issued to be classified for accounting purposes into either insurance or investment contracts, depending on whether significant insurance risk exists. In the case of a life contract, insurance risk exists if the amount payable on death differs from the amount payable if the policyholder survives. The Group has deemed insurance risk to be significant if the difference exceeds 5% of the policy value, though the classification would be similar if a 10% test had been used.
This product classification change results in technical provisions being allocated between insurance and investment contracts. As described in note 8, the “other” column includes £57,445 million of liabilities being classified as investment contracts.
(b) Non-participating investment contracts As noted above, the liability for contracts classified as non-participating investment contracts is valued in accordance with IAS39. This generally requires all financial liabilities to be valued at amortised cost unless previous company regulations permitted a fair valuation of liabilities to be used, such as in the case of unit-linked liabilities. The majority of the Group’s contracts classified as non-participating investment contracts are unit-linked contracts and have been valued at fair value. For unit-linked contracts the fair value liability is deemed to equal the current unit fund value, plus positive non-unit reserves if required on a fair value basis. This replaces the reserve held under UK GAAP which equals the unit fund value plus any positive or negative non-unit reserves determined on the local valuation basis, which differs from that required on a fair value basis.
In addition to the change in liability valuation, the accounting for deferred acquisition costs has been revised in accordance with IAS18. This restricts the types of acquisition costs that can be deferred leading to a reduction in deferred acquisition costs as compared to UK GAAP.
The net impact on shareholders’ funds of the above changes is a reduction of £55 million.
In addition to the above, IFRS now requires that any front end fees received on non-participating investment contracts are included within an explicit deferred income reserve within creditors. Under UK GAAP, any deferred acquisition cost asset created would have been net of these fees. This has led to an increase in “Other assets” and “Other liabilities” of £100 million.
(c) Equalisation provision An equalisation provision is recorded in the accounts of individual general insurance companies in the UK and in a limited number of other countries, to eliminate, or reduce, the volatility in incurred claims arising from exceptional levels of claims in certain classes of business. The provision is required by law even though no actual liability exists at the balance sheet date and is included in the UK GAAP consolidated balance sheet. The annual change in the equalisation provision is recorded in the UK GAAP profit and loss account. Under IFRS, no equalisation provision is recorded, as no actual liability exists at the balance sheet date. There is an increase of £364 million in shareholders’ funds as a result of the removal of the equalisation provision.
(d) Reinsurance treaties Following a full review of all our reinsurance contracts, a small number of the Group’s long-term reinsurance treaties have been revalued under IFRS, leading to a reduction in the value of reassurance assets of £134 million. The majority of these changes relate to participating contracts and so these value changes affect principally the unallocated divisible surplus rather than shareholders’ funds.
Note 3: Employee benefits (a) Pensions Under the Group’s UK GAAP pension policy, as set out in Statement of Standard Accounting Practice, Accounting for Pension Costs (SSAP24), the cost of providing pension benefits is expensed using actuarial valuation methods which gives a substantially even charge over the expected service lives of employees and results in either a prepayment or an accrual to the extent that this charge does not equate to the cash contributions made into the schemes. Under International Accounting Standard 19, Employee Benefits (IAS19), the projected benefit obligation is matched against the fair value of the underlying assets and other unrecognised actuarial gains and losses in determining the pension expense for the year. Any pension asset or obligation must be recorded in the balance sheet. Aviva does not currently intend to apply the “corridor approach” to valuing pension deficits in the future.
“Pension obligations and other provisions” as stated under UK GAAP 336 Less: SSAP24 pension obligation (78) Add: Pension deficit measured in accordance with IAS19 1,436 Less: Non-transferable investment in life funds included in insurance liabilities (598)
Pension deficit disclosed under FRS17 838 Adjustments to other provisions arising under IFRS (included in note 8) 111
Under IFRS2, Share-based Payment, compensation costs for stock-based compensation plans that were granted after 7 November 2002, but had not yet vested at 1 January 2005, are determined based on the fair value of the share-based compensation at grant date, which is recognised in the income statement over the period of the expected life of the share-based instrument.
Note 4: Goodwill Under International Accounting Standards 36, Impairment of Assets (IAS36), goodwill is no longer amortised but is tested for impairment, at least annually. Any goodwill previously amortised or, for goodwill arising before 1 January 1998, eliminated against shareholders’ funds has not been reinstated. Negative goodwill previously recognised under UK GAAP, has been recognised directly in retained earnings at 1 January 2004, increasing shareholders’ funds by £40 million.
Note 6: Deferred taxes Under UK GAAP, provision is made for deferred tax assets and liabilities, using the liability method, arising from timing differences between the recognition of gains and losses in the financial statements and their recognition in a tax computation. No provision is made for tax that might arise on undistributed earnings of subsidiaries unless a binding agreement for distribution exists. Deferred tax is recognised as a liability or asset if the transactions or events that give the entity an obligation to pay more tax in future or a right to pay less tax in future have occurred by the balance sheet date. The Group policy is to discount its deferred tax balances.
Under International Accounting Standard 12, Income Taxes (IAS12) deferred taxes are provided under the liability method for all relevant temporary differences, being the difference between the carrying amount of an asset or liability in the balance sheet and its value for tax purposes. IAS12 does not require all temporary differences to be provided for, in particular the Group does not provide for deferred tax on undistributed earnings of subsidiaries where the Group is able to control the timing of the distribution and the temporary difference created is not expected to reverse in the foreseeable future. Deferred tax assets are recognised for unused tax losses and other deductible temporary differences to the extent that it is probable that future taxable profit will be utilised against the unused tax losses and credits. Discounting is prohibited under IAS12.
Deferred tax impact of the removal of the equalisation provision 108 Deferred tax impact of other changes to technical provisions, valuation of investments and other sundry adjustments 133
Note 7: Borrowings and cash IFRS requires a number of presentational changes to borrowings and cash. The most significant change is that the linked presentation can no longer be adopted for the Group’s borrowing securitised on certain of its mortgage portfolios. This increases borrowings and investments by £3,143 million. In addition, £3,307 million of the Group’s investments meet the definition of cash equivalents and so have been reclassified to “cash and cash equivalents”.
Note 8: Other items The other changes that arise as a result of the transition to IFRS are principally reclassifications and presentational changes. The total effect of the other changes to shareholders’ funds is £71 million, which mainly represents the pre-tax impact of consolidating certain entities, such as real estate companies in France, for the first time.
The other significant reclassification and presentational changes which have no impact on shareholders’ funds are: • Assets held to cover linked liabilities of £40,665 million are no longer disclosed in a single line but have been reported in the various asset classifications. Of this amount assets of £3,343 million have been netted off technical liabilities, reducing the gross assets and investment contract liabilities of the Group. There is no impact on profit or shareholders’ funds as a result of this change; • Technical provisions are disclosed as either insurance contracts or investment contracts, reflecting the product classification included in note 2(a). The Group held investment contracts of £57,445 million at 1 January 2004; • The assets and liabilities of the banking business are no longer disclosed entirely in “other debtors” and “other creditors” but have been reported in the appropriate balance sheet classifications; • Owner occupied properties have been reclassified from “investment property” to property and equipment. We continue to hold these properties at fair value.
• Though the industry is still debating the treatment of mutual funds, we have chosen to consolidate those vehicles that meet the definition of a subsidiary. This has resulted in an increase in gross assets of £1,606 million, representing the part of the funds owned by third parties. This third party interest is recorded in the line “net assets attributable to unitholders” within liabilities. The consolidation of mutual funds has no impact on shareholders’ funds or profit after tax.
Accounting policies The principal accounting policies adopted in the preparation of the restated preliminary IFRS opening balance sheet are set out below. Full accounting policies for the income statement have not been included and will be published with our interim announcement in August 2005.
A – Basis of presentation The restated preliminary IFRS opening balance sheet has been prepared in accordance with International Financial Reporting Standards (IFRS) expected to be applicable at 31 December 2005. The Standards themselves are subject to possible amendment by interpretative guidance from the IASB or other external bodies and are therefore subject to change prior to publication of the Group’s first IFRS results in August 2005.
Items included in the financial statements of each of the Group’s entities are measured in the currency of the primary economic environment in which that entity operates (“the functional currency”). The restated IFRS opening balance sheet is stated in sterling, which is the Company’s functional and presentation currency.
C – Consolidation principles Subsidiaries Subsidiaries are those entities (including Special Purpose Entities) in which the Group, directly or indirectly, has power to exercise control over financial and operating policies in order to gain economic benefits. Subsidiaries are consolidated from the date on which effective control is transferred to the Group and are excluded from consolidation from the date of disposal. All inter-company transactions, balances and unrealised surpluses and deficits on transactions between Group companies have been eliminated.
When the Group’s share of losses in an associate or joint venture equals or exceeds its interest in the entity, the Group does not recognise further losses unless it has incurred obligations or made payments on behalf of the entity.
F – Premiums earned Premiums on long-term insurance contracts and participating investment contracts are recognised as income when receivable, except for investment-linked premiums which are accounted for when the corresponding liabilities are recognised. For single premium business, this is the date from which the policy is effective. For regular premium contracts, receivables are taken at the date when payments are due.
H – Other fee and commission income Other fee and commission income consists primarily of investment fund management fees, distribution fees from mutual funds, commission revenue from the sale of mutual fund shares, and transfer agent fees for shareholder record keeping. Revenue from investment management fees, distribution fees and transfer agent fees is recognised when earned. Reinsurance commissions receivable and other commission income are recognised on the trade date.
I – Net investment income Dividends on equity securities are recorded as revenue on the ex-dividend date. Interest income is recognised as it accrues, taking into account the effective yield on the investment. It includes the interest rate differential on forward foreign exchange contracts. Rental income is recognised on an accruals basis.
The long-term business provisions are calculated separately for each life operation, based on local regulatory requirements and actuarial principles consistent with those applied in the UK. Each calculation represents a determination within a range of possible outcomes, where the assumptions used in the calculations depend on the circumstances prevailing in each life operation. Within the long-term business provisions, explicit allowance is made for vested bonuses, including those added following the current valuation, but allowances are not generally made for future reversionary or terminal bonuses.
The liability in respect of guaranteed benefits for participating insurance contracts is calculated in accordance with local actuarial principles, using a deterministic approach and a prudent set of valuation assumptions.
General insurance and health provisions (i) Outstanding claims provisions General insurance and health outstanding claims provisions are based on the estimated ultimate cost of all claims incurred but not settled at the balance sheet date, whether reported or not, together with related claims handling costs and a reduction for the expected value of salvage and other recoveries. Significant delays are experienced in the notification and settlement of certain types of general insurance claims, particularly in respect of liability business, including environmental and pollution exposures, the ultimate cost of which cannot be known with certainty at the balance sheet date. Provisions for certain claims are discounted, using rates having regard to the returns generated by the assets supporting the liabilities. Any estimate represents a determination within a range of possible outcomes.
(iii) Liability adequacy At each reporting date, the Group carries out a liability adequacy test for any overall excess of expected claims and deferred acquisition costs over unearned premiums, using the current estimates of future cash flows under its contracts after taking account of the investment return expected to arise on assets relating to the relevant general business provisions. If these estimates show that the carrying amount of its insurance liabilities (less related deferred acquisition costs and additional value in force) is insufficient in light of the estimated future cash flows, the Group recognises the deficiency in the income statement by setting up a provision in the consolidated balance sheet.
The fair value liability is in principle established through the use of prospective discounted cash flow techniques. For unit-linked contracts, the fair value liability is equal to the current unit fund value, plus additional non-unit reserves if required on a fair value basis.
L – Reinsurance The Group assumes and cedes reinsurance in the normal course of business, with retention limits varying by line of business. Premiums on reinsurance assumed are recognised as revenue in the same manner as they would be if the reinsurance were considered direct business, taking into account the product classification of the reinsured business. The cost of reinsurance related to long-duration contracts is accounted for over the life of the underlying reinsured policies, using assumptions consistent with those used to account for these policies. Gains or losses on buying retroactive reinsurance are recognised in the income statement immediately at the date of purchase and are not amortised. Premiums ceded and claims reimbursed are presented on a gross basis in the restated IFRS opening balance sheet.
Reinsurance contracts that principally transfer financial risk are accounted for directly through the balance sheet and are included in reinsurance assets or liabilities. A deposit asset or liability is recognised, based on the consideration paid or received less any explicitly identified premiums or fees to be retained by the reinsured.
If a reinsurance asset is impaired, the Group reduces the carrying amount accordingly and recognises that impairment loss in profit and loss. A reinsurance asset is impaired if there is objective evidence, as a result of an event that occurred after initial recognition of the reinsurance asset, that the Group may not receive all amounts due to it under the terms of the contract, and the event has a reliably measurable impact on the amounts that the Group will receive from the reinsurer.
Under UK GAAP, goodwill previously written off to shareholders’ funds is taken back through the profit and loss account when calculating the profit and loss account in the event of any subsequent disposal of the underlying investment. There is no requirement for this adjustment under IFRS.
Acquired value of in-force business (AVIF) The present value of future profits on a portfolio of long-term insurance and investment contracts, acquired either directly or through the purchase of a subsidiary, is recognised as an intangible asset. If this arises through the acquisition of an investment in an associate, the AVIF is held within the carrying amount of that associate. In all cases, the AVIF is amortised over the useful lifetime of the related contracts in the portfolio on a systematic basis. The rate of amortisation is chosen by considering the profile of the additional value of in-force business acquired and the expected depletion in its value. The value of the acquired in-force long-term business is reviewed annually for any impairment in value and any reductions are charged as expenses in the income statement.
Other intangible assets Other intangible assets consist primarily of access to distribution networks. These are amortised over their useful lives using the straight-line method.
Investment properties under construction are included in property and equipment until completion, and are stated at cost less provision for any impairment in their values.
Where the carrying amount of an asset is greater than its estimated recoverable amount, it is written down immediately to its recoverable amount.
All borrowing costs are expensed as they are incurred. Repairs and maintenance are charged to the income statement during the financial period in which they are incurred. The cost of major renovations is included in the carrying amount of the asset when it is probable that future economic benefits in excess of the most recently assessed standard of performance of the existing asset will flow to the Group, and that the renovation replaces an identifiable part of the asset.
O – Investment property Investment property is held for long-term rental yields and is not occupied by the Group. Completed investment property is stated at its fair value, which is supported by market evidence, as assessed by qualified external valuers or by local qualified staff of the Group in overseas operations. Changes in fair values are recorded in the income statement within net investment income.
The fair values of investments are based on quoted bid prices or amounts derived from cash flow models. Fair values for unlisted equity securities are estimated using applicable price/earnings or price/cash flow ratios refined to reflect the specific circumstances of the issuer. Equity securities for which fair values cannot be measured reliably are recognised at cost less impairment.
Derivative instruments for hedging On the date a derivative contract is entered into, the Group designates certain derivatives as either: (i) a hedge of the fair value of a recognised asset or liability (fair value hedge); (ii) a hedge of a future cash flow attributable to a recognised asset or liability, a highly probable forecast transaction or a firm commitment (cash flow hedge); or
(iii) a hedge of a net investment in a foreign operation (net investment hedge).
S – Loans Loans with fixed maturities, including policyholder loans, mortgage loans on investment property, securitised mortgages and collateral loans, are recognised when cash is advanced to borrowers. The majority of these loans are carried at their unpaid principal balances and adjusted for amortisation of premium or discount, non-refundable loan fees and related direct costs. These amounts are deferred and amortised over the life of the loan as an adjustment to loan yield using the effective interest rate method. Loans with indefinite future lives are carried at unpaid principal balances or cost.
Certain mortgages which back long-term business have been classified at fair value through profit or loss in order to match the movement in those liabilities. Those loans are revalued to fair value at each period end, with movements in valuation being taken to the income statement.
T – Deferred acquisition costs The costs directly attributable to the acquisition of new business for insurance and participating investment contracts are deferred to the extent that they are expected to be recoverable out of future margins in revenues on these contracts. For non-participating investment and investment fund management contracts, incremental acquisition costs that are directly attributable to securing an investment management service are also deferred. Where such business is reinsured, an appropriate proportion of the deferred acquisition costs is attributed to the reinsurer, and is treated as a separate liability.
Long-term business deferred acquisition costs are amortised systematically over a period no longer than that in which they are expected to be recoverable out of these margins. Deferrable acquisition costs for non-participating investment and investment fund management contracts are amortised over the period in which the service is provided. General business deferred acquisition costs are amortised over the period in which the related revenues are earned. The reinsurers’ share of deferred acquisition costs is amortised in the same manner as the underlying asset.
U – Cash and cash equivalents Cash and cash equivalents consist of cash at banks and in hand, deposits held at call with banks, treasury bills and other short-term highly liquid investments with less than 90 days’ maturity from the date of acquisition.
V – Leases Leases where a significant portion of the risks and rewards of ownership is retained by the lessor are classified as operating leases. Payments made as lessees under operating leases (net of any incentives received from the lessor) are charged to the income statement on a straight-line basis over the period of the lease.
There are no material finance leases affecting the Group as either lessor or lessee.
X – Employee benefits Employee entitlements to annual leave and long-service leave are recognised when they accrue to employees. A provision is made for the estimated liability for annual leave and long-service leave as a result of services rendered by employees up to the balance sheet date.
Pension obligations The Group operates a number of defined benefit and defined contribution plans throughout the world, the assets of which are generally held in separate trustee-administered funds. The pension plans are generally funded by payments from employees and by the relevant Group companies, taking account of the recommendations of qualified actuaries.
For defined contribution plans, the Group pays contributions to publicly or privately administered pension plans. Once the contributions have been paid, the Group, as employer, has no further payment obligations. In some countries, the pension schemes have invested in the Group’s life funds, details of which are given on page 119.
Other post-retirement obligations Some Group companies provide post-retirement healthcare or other benefits to their retirees. The entitlement to these benefits is usually based on the employee remaining in service up to retirement age and the completion of a minimum service period. None of these schemes is material to the Group. The costs of the Dutch and Canadian schemes are included within pension obligations and other provisions. For such schemes in other countries, provisions are calculated in line with local regulations, with movements being charged to the income statement within staff costs.
Equity compensation plans The Group offers share award and option plans over the Company’s ordinary shares for certain employees, including a Save As You Earn plan (the “SAYE plan”).
Deferred tax is provided on temporary differences arising from investments in subsidiaries, associates and joint ventures, except where the timing of the reversal of the temporary difference can be controlled and it is probable that the difference will not reverse in the foreseeable future.
Deferred taxes are not provided in respect of temporary differences arising from the initial recognition of goodwill, or from goodwill for which amortisation is not deductible for tax purposes, or from the initial recognition of an asset or liability in a transaction which is not a business combination and affects neither the accounting profit nor taxable profit or loss at the time of the transaction.
AA – Share capital and treasury shares Dividends Dividends on ordinary shares are recognised in equity in the period in which they are declared and, for the final dividend, approved by shareholders. Dividends on preference shares are recognised in the period in which they are declared and appropriately approved.
(ii) the instrument will not be settled by delivery of a variable number of shares or is a derivative that can be settled other than for a fixed amount of cash, shares or other financial assets.
Treasury shares Where the Company or its subsidiaries purchase the Company’s share capital or obtains rights to purchase its share capital, the consideration paid (including any attributable transaction costs net of income taxes) is shown as a deduction from total shareholders’ equity.
AB – Fiduciary activities Assets and income arising thereon, together with related undertakings to return such assets to customers, are excluded from the IFRS financial statements where the Group has no contractual rights in the assets and acts in a fiduciary capacity such as nominee, trustee or agent.
Independent auditors’ report to Aviva plc on the preliminary IFRS consolidated financial statements at 1 January 2004
To the Board of Directors of Aviva Plc We have audited the accompanying preliminary International Financial Reporting Standards IFRS consolidated financial statements of Aviva plc at 1 January 2004 which comprise the preliminary opening IFRS consolidated balance sheet as at 1 January 2004, the analysis of adjustments to the consolidated balance sheet at 1 January 2004 as a result of the transition to IFRS and related accounting policies notes set out on pages 114 to 126.
Respective responsibilities of directors and auditors These preliminary IFRS consolidated financial statements are the responsibility of the Company’s directors and have been prepared as part of the Group’s conversion to IFRS. They have been prepared in accordance with the basis of preparation and transitional arrangements upon first time adoption of IFRS on pages 114 and 115. These describe how IFRS have been applied under IFRS1, including the assumptions management has made about the standards and interpretations expected to be effective, and the policies expected to be adopted, when management prepares its first complete set of IFRS consolidated financial statements as at 31 December 2005.
Basis of audit opinion We conducted our audit in accordance with UK Auditing Standards issued by the Auditing Practices Board. Those Standards require that we plan and perform the audit to obtain reasonable assurance about whether the preliminary IFRS consolidated financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the preliminary IFRS consolidated financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the preliminary IFRS consolidated financial statements. We believe that our audit provides a reasonable basis for our opinion.
Emphasis of matter Without qualifying our opinion, we draw attention to the fact that, as outlined in the basis of preparation on page 114, the preliminary opening IFRS consolidated financial statements may require adjustment before constituting the final IFRS consolidated financial statements. Moreover, we draw attention to the fact that, under IFRSs only a complete set of financial statements with comparative financial information and explanatory notes can provide a fair presentation of the Group’s financial position, results of operations and cash flows in accordance with IFRSs.
Summarised consolidated profit and loss account – EEV basis For the year ended 31 December 2004
3,198 Operating profit before tax 2,175 1,803 831 Variation from longer-term investment return 565 779
3,254 Profit on ordinary activities before tax 2,213 2,453 (957) Tax on operating profit – before amortisation of goodwill and exceptional items (651) (563)
Earnings per share – EEV basis For the year ended 31 December 2004 2004 Restated*
**Stated before the effect of foreign exchange movements, which are reported within the foreign exchange line.
Reconciliation of movements in consolidated shareholders’ funds – EEV basis For the year ended 31 December 2004
Shareholders’ funds at the beginning of the year, as originally reported on an achieved profits basis 9,668
1 Movement in shares held by employee trusts 1 – 37 Increase in share capital 25 2 1,456 Issue of direct capital instrument 990 – (13) Issue costs of direct capital instrument (9) – 151 Shares issued in lieu of dividend 103 – 248 Other movements 169 –
18,221 Shareholders’ funds at the end of the year on an EEV basis 12,937 10,752 * Restated for the effect of implementing European Embedded Value principles.
Minority interest 1,182 953 Additional retained profit on an EEV basis 4,617 4,198 Subordinated debt 2,823 2,814
Total liabilities, capital, reserves and subordinated debt 237,145 213,020 * Restated for the effect of implementing European Embedded Value principles.
Segmentation of summarised consolidated balance sheet – EEV basis As at 31 December 2004
Total assets before acquired additional value of in-force long-term business 200,205 31,614 231,819 177,953 30,239 208,192
Shareholders’ funds on an EEV basis 12,937 10,752 Minority interests 1,182 953
Total capital, reserves and subordinated debt 16,942 14,519 * Restated for the effect of implementing European Embedded Value principles.
The Group has replaced the Achieved Profits basis with the EEV basis of reporting as its main measure of performance for life and related businesses and comparative figures for the Group’s 31 December 2003 supplementary financial statements have been restated accordingly. The impact on the Group’s consolidated supplementary reporting is to reduce shareholders’ funds as at 31 December 2003 by £413 million from £11,165 million to £10,752 and to reduce the Group’s consolidated profit after tax and minority interest for the 2003 financial year by £49 million to £1,593 million. The full impact of the adoption of the EEV principles on the Group’s results for the periods ending 31 December 2003 and 30 June 2004 is shown in the release to the market on 13 January 2005, “Restatement of Aviva’s supplementary reporting to the European Embedded Value (EEV) basis”.
Covered business The EEV 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 venture operations including our arrangement with The Royal Bank of Scotland Group (RBSG) and our operations in India and China. For our joint venture with RBSG, the goodwill arising on the acquisition of the associate company, RBS Life Investments Limited, is included within the “Amortisation of goodwill” on page 128.
In addition, the results of Group companies providing administration, investment 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 sales of new contracts during the period; • Non-contractual additional premiums, including future Department of Work and Pensions (DWP) rebate premiums; and
• Expected renewals on the new contracts and expected future contractual alterations to the new contracts.
Foreign exchange adjustments Embedded value and other balance sheet items denominated in foreign currencies have been translated to sterling using the appropriate closing exchange rate. New business contribution and other profit and loss items have been translated using an average exchange rate for the relevant period. The exchange rates adapted in this announcement are shown on page 76.
Value of in-force covered business The value of in-force covered business is the present value at the appropriate risk discount rate (which incorporates a risk margin) of the distributable profits to shareholders arising from the in-force covered business projected on a best estimate basis, less a deduction for the cost of holding the required level of capital.
In the UK shareholders’ distributable profits arise when they are released following actuarial valuations. These valuations are carried out in accordance with statutory requirements designed to ensure and demonstrate solvency in long-term business funds. Future distributable profits will depend on experience in a number of areas such as investment return, discontinuance rates, mortality, administration costs, as well as management and policyholder actions. Releases to shareholders arising in future years from the in-force covered business and associated required capital can be projected using best estimate assumptions of future experience. In overseas businesses generally there are similar requirements restricting payments to shareholders from life businesses.
The cost of holding required capital is the difference between the required capital and the present value at the appropriate risk discount rate of the projected release of the required capital and investment earnings on the assets deemed to back the required capital. Where the required capital is covered by policyholder assets, for example in the UK with-profits funds, there is no impact of cost of capital on shareholder value. The assets regarded as covering the required capital are those that the operation deems appropriate.
Risk discount rates for our life businesses have been calculated using a risk margin based upon a Group Weighted Average Cost of Capital (WACC). The Group WACC is calculated using a gross risk-free interest rate, an equity risk margin, a market-assessed risk factor (beta), and an allowance for the gearing impact of debt financing (including subordinated debt). The market-assessed risk rate captures the market’s view of the effect of all types of risk on our business, including operational and other non-economic risk.
At each valuation date, the risk margin is reassessed based on the current economic factors and is updated only if a significant change has occurred. In particular, changes in risk profile arising from movements in asset mix are allowed for via the update risk margin calculation.
Participating business Future regular bonuses on participating business are projected in a manner consistent with current bonus rates and expected future returns on assets deemed to back the policies.
As the EEV methodology incorporates the impact of profits and losses arising from subsidiary companies providing administration, investment management and other services to the Group’s life companies, the equivalent profits and losses have been removed from the relevant segment (non-insurance or fund management) and are instead included within the results of life and related businesses. In addition, the underlying basis of calculation for these profits has changed from the modified statutory basis to the EEV basis.
The capitalised value of the future profits and losses from such service companies are included in the embedded value and new business contribution calculations for the relevant territory, 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 modified statutory 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.
Components of life EEV return The life EEV return comprises the following components: • New business contribution written during the period including value added between the point of sale and end of the period; • Profit from existing business equal to: – the expected return on the value of the in-force covered business at the beginning of the period,
The life EEV operating return comprises the first three of these components and is calculated using economic assumptions as at the start of the year and operating (demographic, expenses, tax and other) assumptions as at the end of the year.
– experience variances (15) (31) – operating assumption changes (7) 19
Investment return variances 501 696 Effect of economic assumption changes (318) (55)
New business contribution The following tables set out the premium volumes and contribution from new business written by the life and related businesses, consistent with the definition of new business set out on page 132.
Annual premium equivalent** Present value of new business premiums the effect of required capital the effect of required capital
Total (after the effect of required capital) 516 474 516 474 * Restated for the effect of implementing European Embedded Value principles.
New business contribution before the effect of required capital includes minority interests in 2004 of £121 million (2003: £109 million). This comprises minority interests in France of £7 million (2003: £3 million), Italy £27 million (2003: £25 million), Netherlands £10 million (2003: £8 million), Poland £2 million (2003: £1 million) and Spain £75 million (2003: £72 million).
Operating assumption changes Changes in operating assumptions are made when the assumed future levels of expenses, mortality or other operating assumptions are expected to change permanently.
Other Europe 22 18 * Restated for the effect of implementing European Embedded Value principles.
New business contribution (after the effect of required capital) 215 54 16 34 43 9 121 – 24 516
– experience variances: – operating assumption changes: Expected return on shareholders’ net worth 108 63 13 14 60 7 8 5 20 298
Life EEV operating return before tax 551 286 40 79 277 93 180 22 83 1,611 1. Maintenance expenses in the UK reflect the benefit of cost saving initiatives undertaken.
2. Exceptional expenses in the UK reflect costs of £65 million for the restructuring of one business service division and one-off project costs of £88 million associated with the pace of regulatory change.
3. Mortality experience across our major businesses continues to be better than our assumptions for protection and annuity business in the UK and protection in continental Europe.
4. Lapse experience in the UK has been adverse and mainly relates to bonds, protection schemes and pension products.
France includes the benefit of tax assumption changes. France has historically recorded favourable tax operating experience as a result of better than assumed tax on dividend income because the tax assumptions had been set at full corporation tax for all future profits, whereas in fact dividend income from subsidiaries is tax exempt. In 2004, the calculation has been refined such that the future tax benefit arising from dividend from subsidiaries has now been recognised. This change results in a £39 million benefit.
UK France Ireland Italy Netherlands Poland Spain Other Europe International Total Full year 2003* £m £m £m £m £m £m £m £m £m £m
New business contribution (after the effect of required capital) 212 39 26 27 29 3 122 (6) 22 474
Life EEV operating return before tax 597 228 57 70 198 99 165 18 64 1,496 * Restated for the effect of implementing European Embedded Value principles.
2. Mortality experience has typically been better than anticipated in many of the Group businesses.
3. Lapse experience has been adverse in a number of businesses including on certain savings contracts in the UK.
4. In the UK, other experience profits include exceptional profits arising from better than assumed default experience on corporate bonds. In France, profits relate to the benefit of lower tax charges on dividends from subsidiaries and to a lesser extent, one-off benefits following the utilisation of tax losses.
7. In the UK, lapse assumption changes reflect experience in savings contracts mainly on with-profits and endowment business.
8. Changes in the Netherlands primarily relate to increased annual management fees on unit-linked contracts.
The embedded value of business acquired in 2004 of £102 million represents the embedded value of Antarius, the bancassurance joint venture with Crédit du Nord, in France.
Life EEV return after tax 925 580 1,505 Exchange rate movements 222 120 342 Embedded value of businesses acquired 17 47 64 Amounts injected into life and related businesses 231 – 231 Amounts released from life and related businesses (205) – (205) Transfer to life and related businesses from other segments 29 – 29
The embedded value at the end of the year 2004 includes minority interests of £796 million (2003: £568 million). This comprises minority interests in France of £120 million (2003: £51 million), Italy £276 million (2003: £222 million), Netherlands £59 million (2003: £44 million), Poland £90 million (2003: £72 million), Spain £244 million (2003: £176 million) and Other Europe £7 million (2003: £3 million).
Present value Cost of Required capital* Free surplus of in-force required capital £m £m £m £m £m
The value of in-force covered business includes the effect of holding shareholders’ capital to support the level of required capital and allowing for projected future releases. This impact reduces the value of in-force covered business at 31 December 2004 by £1,195 million (31 December 2003: £1,049 million).
Time value of options and guarantees The following table sets out the reductions to embedded value to allow for the time value of options and guarantees relating to covered business at 31 December 2004 and 31 December 2003 by business units.
The time value of options and guarantees is most significant in the UK, France and the Netherlands. In the UK, this relates mainly to non-market value adjustment (MVA) guarantees on unitised with-profit business and guaranteed annuity rates. In France, this relates mainly to guaranteed crediting rates and surrender values on the AFER product. In the Netherlands, this relates mainly to maturity guarantees on unit-linked products and interest rate guarantees on traditional individual and Group profit sharing business.
New business contribution including effect of required capital 422 94 516 474
Pre-tax investment returns: Required capital (% EU minimum) 200%/100% 200%/100% 200%/100% 115% 115% 115%
*In the Netherlands, the tax rate assumed in determining the embedded value as at 31 December 2004 has been changed from 25%, which was the average rate of tax assumed by the intermediary division, to the full rate of corporation tax in the Netherlands. This change reflects the calculation refinements now adopted for the intermediary division, described on page 137, and the reduction in corporation tax from 34.5% to 31.5%, which was effective from 1 January 2005. In 2005, profits will be grossed up at the local corporation tax rate of 31.5% in the Netherlands, reflecting the economic basis at the start of the year, increasing both reported pre-tax profits and the corresponding tax charge.
Where there are service companies, expense inflation relates to the underlying expenses rather than the fees charged to the life company. Future returns on corporate fixed interest investments are calculated from prospective yields less an adjustment for credit risk. Required capital in the UK is 200% EU minimum for Norwich Union Annuities Ltd and 100% for other companies. Required capital in Spain is 125% EU minimum for Aviva Vida y Pensiones and 110% for bancassurance companies.
Other economic assumptions Required capital relating to with-profit business is assumed to be covered by the surplus within the with-profit funds and no effect has been attributed to shareholders. Bonus rates on participating business have been set at levels consistent with the economic assumptions and Aviva’s medium-term bonus plans. The distribution of profit between policyholders and shareholders within the with-profit funds assumes that the shareholder interest in conventional with-profit business in the UK and Ireland continues at the current rate of one-ninth of the cost of bonus.
UK Model Overall asset returns have been generated assuming that the portfolio total return has a lognormal distribution. The mean and standard deviation of the overall asset return have been calculated using the asset mix of the fund and assumptions over the mean and standard deviation of each asset class, together with correlations between them.
Asset classes The significant asset classes for UK participating business are equities, property and long-term fixed rate bonds.
Summary statistics The following table sets out the means and standard deviations (StDev) of future returns at 31 December 2004 for the three most significant asset classes: Mean* StDev**
For the UK, the statistics are the same over all projection horizons. The low assumed volatility for bonds reflects the degree of matching, by duration, with the liabilities. Assumptions are also required for correlations between asset classes. These have been set based on an internal assessment of historical data. Returns for corporate fixed interest investments in each scenario are equal to the return on Government bonds plus a fixed additional amount, based on current spreads less a margin for credit risk.
Asset classes The most important assets are fixed rate bonds of various durations. In some businesses equities are also an important asset class.
1% increase in 1% decrease in 1% increase in 1% decrease in Embedded value (net of tax) As reported discount rates discount rates interest rates interest rates 2004 £m £m £m £m £m
1% increase in 1% decrease in 10% rise in equity/ 10% fall in equity/ equity/property equity/property property market property market EU minimum
Embedded value (net of tax) As reported returns returns values values capital 2004 £m £m £m £m £m (or equivalent)
In general, the magnitude of the sensitivities will reflect the size of the embedded values, although this will vary as the sensitivities have different impacts on the different components of the embedded value. In addition, other factors can have a material impact, such as the nature of options and guarantees as well as the types of investments held. The interest rate sensitivity will vary significantly by territory, depending on the type of business written: for example, where non-profit business is well matched by backing assets, the favourable impact of reducing the risk discount rate is the dominant factor.
10% decrease in 10% decrease in maintenance 10% decrease in mortality/morbidity
We also read the other information in the Annual Report and consider the implications for our report if we become aware of any apparent misstatements or material inconsistencies with the supplementary information. The other information comprises the Highlights of the year, the Chairman’s statement, Business overview, Group chief executive’s review, Operating review, Employees, Corporate social responsibility, Financial review, Directors’ report, Corporate governance statement, Audit committee report, Nomination committee report and the unaudited part of the Directors’ remuneration report.
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 supplementary information stated on the European Embedded Value basis is 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 the supplementary information.
Independent auditors’ report to the directors of Aviva plc on the alternative method of reporting long-term business profits
UK CGNU Life Assurance Limited CGU Bonus Limited CGU Insurance plc CGU International Insurance plc CGU Underwriting Limited Commercial Union Life Assurance Company Limited General Accident plc London & Edinburgh Insurance Group Limited Morley Fund Management International Limited Morley Fund Management Limited Morley Investment Services Limited Morley Pooled Pensions Limited Morley Properties Limited Northern Assurance Company Limited, The Norwich Union Annuity Limited Norwich Union Equity Release Limited Norwich Union Healthcare Limited Norwich Union Insurance Limited Norwich Union Investment Funds Limited Norwich Union Life & Pensions Limited Norwich Union Linked Life Assurance Limited Norwich Union Personal Finance Limited
France Aviva Participations SA and its principal subsidiaries: Aviva Assurances SA Aviva Courtage SA Aviva Direct SA Aviva France SA Aviva Gestion d’Actifs Aviva Vie SA Eurofil SA Société d’Epargne Viagére SA (75.0%) Union Financière de France Banque (Banking) (76.3%) Antarius (50.0%)
Riassicurazioni SpA (50.0%) Commercial Union Vita SpA (51.0%) Eurovita Assicurazioni SpA (40.5%)
Poland Commercial Union Polska Towarzystwo Ubezpieczen Ogolnych SA (90.0%) Commercial Union Polska Towarzystwo Ubezpieczen na Zycie SA (90.0%) Commercial Union Powszechne Towarzystwo Emerytalne
Spain Aseguradora Valenciana SA, de Seguros y Reaseguros (50.0%) Aviva Vida y Pensiones SA, de Seguros y Reaseguros Bia Galicia de Seguros y Reaseguros (50.0%) Caja Espana Vida, Compania de Seguros y Reaseguros (50.0%) General Vida Sociedad Agencia de Seguros (25.0%) Unicorp Vida, Compania de Seguros y Reaseguros (50.0%)
Scrip dividend The Aviva Scrip Dividend Scheme (the “Scheme”) provides shareholders with the option of receiving new ordinary shares instead of cash dividends. The Scheme replaced the former Dividend Reinvestment Plan. Shareholders who have not already joined the Scheme but wish to do so should contact Lloyds TSB Registrars at the address on page 149 and request a mandate form. The mandate form will need to be received by Lloyds TSB Registrars no later than 25 April 2005 in order to be effective for the 2005 final dividend.
E-communications: To receive communications electronically: Log on to www.aviva.com/shareholders and register for shareholder e-communications. Shareholders will be able to access details of their Aviva shareholding online, elect to receive the Report and Accounts and other shareholder documentation electronically, update their address details online and elect to have their dividends paid directly into their bank or building society account.
To vote online at the AGM: Please refer to the explanatory notes on the accompanying voting form which details the steps to vote online.
Share price Shareholders can access the current share price of Aviva ordinary shares at www.aviva.com or alternatively can call 0906 843 2197*.
Share dealing facilities for overseas shareholders: To sell Aviva shares over the telephone, shareholders can contact Barclays Stockbrokers on +44 (0)141 352 3959. Non-UK residents will need to provide various documentation in order to use this service, details will be provided on registration. Please note that regulations prevent this service being offered to US residents. Settlement proceeds will be sent to either a UK sterling bank account or by sterling cheque.
Shareholders with disabilities Alternative versions of this publication (including braille, large print and audio-tape) are available on request from the Company’s registrar.
* Calls are currently charged at 60 pence per minute at all times. The average time to access the share price is approximately one minute.
Aviva plc on the preliminary IFRS consolidated financial statements at 1 January 2004 128 Alternative method of reporting long-term business 146 Independent auditors’ report to the directors of Aviva plc on the alternative method of reporting long-term business profits 147 Aviva Group of companies 148 Shareholder information
Banks and nominee companies 15,872 1.90 1,864,412,386 81.69 Pension fund managers and insurance companies 114 0.01 7,982,002 0.35
Ordinary shares Ex-dividend date 16 March Record date 18 March Scrip dividend price available 23 March Dividend payment date 17 May
Please quote Aviva plc, as well as the name and address in which your shares are held, in all correspondence.
General shareholding, Lloyds TSB Registrars The Causeway 0870 600 3952 administration queries Worthing and Aviva share account queries West Sussex BN99 6DA
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