Economic items had a neutral net impact on profit in 2007, with favourable investment variances in the Europe region largely offset by negative effects in the USA and UK. In Europe, positive variances related mainly to realisation of capital gains on securities in the Netherlands and France. In the USA, realised and unrealised losses on investments were driven by the widening of credit spreads on debt securities, while in the UK there was a negative investment variance on surplus assets backing annuity business due to interest rate changes.
This compares to a significantly positive net impact of economic items on profit in 2006. In 2006 the positive investment variance was driven primarily by favourable equity market performance worldwide and increases in market interest rates in the Euro zone. In particular, there was a significant reduction in the cost of investment guarantees in the Netherlands as market interest rates increased.
Notes to the consolidated financial statements continued 8 – Long-term business economic volatility continued
The expected return on investments for both policyholder and shareholders funds is based on opening economic assumptions applied to the expected funds under management over the reporting period. Expected funds under management are equal to the opening value of funds under management, adjusted for sales and purchases during the period arising from expected operating experience. The actual investment return is affected by differences between the actual and expected funds under management and changes in asset mix. To the extent that these differences arise from the operating experience of the long-term business, or management decisions to change asset mix, the effect is included in the operating profit. The residual difference between actual and expected investment return is included in investment variances.
Where fixed interest securities are classified as available for sale, 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: General insurance and health business £m £m
Net investment income (note 4a(ii)) 827 1,299 Internal charges included under other headings 18 (77)
Analysed between: Longer term investment return 1,029 1,073 Short-term fluctuation in investment return (184) 149
Actual return attributable to shareholders 4,779 Longer term return credited to operating results (4,136)
The number of persons employed by the Group was: At 31 December Average for the year
Notes to the consolidated financial statements continued 10 – Employee information continued Total staff costs were: £m £m
12 – Auditors’ remuneration This note shows the total remuneration payable by the Group to our principal auditors, Ernst & Young.
In addition to the above amounts payable to the principal auditors, fees for audit services of £3.8 million (2006: £2.1 million) were payable to other firms. The total fees payable for audit services were therefore £14.0 million (2006: £11.3 million).
Current tax For this year 888 1,022 Prior year adjustments (94) (287)
(ii) The Group, as a proxy for policyholders in the UK, Ireland and Australia, is required to record taxes on investment income and gains each year. Accordingly, the tax benefit or expense attributable to UK, Irish and Australian life insurance policyholder returns is included in the tax charge. The tax expense attributable to policyholders’ returns included in the charge above is £15 million (2006: £346 million).
(iv) Unrecognised tax losses and temporary differences of previous years were used to reduce current tax expense and deferred tax expense by £51 million and £6 million, respectively (2006: £73 million and £24 million, respectively).
(v) Deferred tax (credited)/charged to the income statement represents movements on the following items: £m £m
(i) The profit attributable to ordinary shareholders is: Operating Adjusting Operating Adjusting Restated profit items Total profit items Total £m £m £m £m £m £m
Tax attributable to shareholders’ profits (607) 270 (337) (645) 57 (588)
Profit attributable to ordinary shareholders 1,376 (103) 1,273 1,731 430 2,161
Before tax and DCI Per share Before tax and DCI per share £m £m p £m £m p
Operating profit attributable to ordinary shareholders 2,228 1,376 53.2 2,609 1,731 70.1 Non-operating items: Investment return variances and economic assumption changes on long-term business (note 8) 15 79 3.1 401 336 13.6
Short-term fluctuation in return on investments backing general insurance and health business (note 9b) (184) (38) (1.5) 149 189 7.7
Profit on the disposal of subsidiaries and associates (note 3b) 49 52 2.0 222 235 9.5
Integration and restructuring costs (note 3c) (153) (114) (4.4) (246) (188) (7.7)
Profit attributable to ordinary shareholders 1,842 1,273 49.2 2,977 2,161 87.5
(iii) The calculation of basic earnings per share uses a weighted average of 2,588 million (2006: 2,469 million) ordinary shares in issue, after deducting shares owned by the employee share trusts. The actual number of shares in issue at 31 December 2007 was 2,622 million (2006: 2,566 million).
15 – Dividends and appropriations This note analyses the total dividends and other appropriations we have paid during the year. The table below does not include the final dividend proposed after the year end because this is not accrued in these financial statements. The impact of scrip dividends is shown separately in note 35.
Interim 2007 – 11.90 pence per share, paid on 16 November 2007 (Interim 2006 – 10.82 pence per share, paid on 17 November 2006) 309 275
This note analyses the changes to the carrying amount of goodwill during the year, and details the results of our impairment testing on both goodwill and intangible assets with indefinite lives.
Impairment losses (10) (94) Disposals 9 – Foreign exchange rate movements (14) 3
Long-term business (see (iv) below) 101 91 – – 101 91 General insurance and health (see (v) below) 81 74 – – 81 74
Netherlands (see (vii) below) 212 163 – – 212 163 Spain (long-term business) (see (viii) below) 552 518 – – 552 518
As explained in accounting policy N, the carrying amount of goodwill and intangible assets with indefinite useful lives is reviewed at least annually or when circumstances or events indicate there may be uncertainty over this value. The tests led to impairment of goodwill of £10 million.
(i) UK (general insurance and health) The recoverable amount of the UK general insurance 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 10.17% (2006: 10.45%). Cash flows beyond that three year period have been extrapolated using a steady 0% growth rate (2006: 3%). The recoverable amount significantly exceeds the carrying value of the cash-generating unit including goodwill and intangible assets with indefinite useful lives and a reasonably possible change in a key assumption will not cause the carrying value of the cash-generating unit to exceed its recoverable amount.
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 UK general insurance industry.
(ii) RAC (non-insurance operations) The recoverable amount of the RAC (non-insurance operations) has also 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 9.98% (2006: 10.32%). Cash flows beyond that three year period have been extrapolated using a steady 2% growth rate. The recoverable amount significantly exceeds the carrying value of the cash generating unit including goodwill and intangible assets with indefinite useful lives and a reasonably possible change in a key assumption will not cause the carrying value of the cash-generating unit to exceed its recoverable amount.
(iii) France (long-term business) The recoverable amount of the indefinite life intangible asset has been assessed as part of the recoverable amount of the French long-term business cash generating unit and has been determined based on a fair value less costs to sell calculation. The first step of the test was to compare the carrying value of the business, including indefinite life intangible assets, to the European Embedded Value (EEV). If the EEV is less than the carrying value of the business, the present value of profits from expected new business is considered.
(iv) Ireland (long-term business) The recoverable amount of the Irish long-term business has been determined based on a fair value less costs to sell calculation. The first step of the test was to compare the carrying value of the business, including goodwill, to the European Embedded Value (EEV). If the EEV is less than the carrying value of the business the present value of profits from expected new business is considered.
The EEV of the Irish long-term business is greater than its carrying value so the recoverable value will be significantly in excess of its carrying value, including goodwill. A reasonably possible change in a key assumption will not cause the carrying value of the cash generating unit to exceed its recoverable amount. Key assumptions used for the calculation were: – Embedded value represents the shareholder interest in the life business and is calculated in accordance with the European Embedded Value (EEV) principles. The embedded value is the total of the net worth of the life business and the value of the in-force business. The underlying methodology and assumptions have been reviewed by the Group’s auditors.
(v) Ireland (general insurance and health) The recoverable amount of the Irish general insurance 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 8.07% (2006: 8.07%). Cash flows beyond that three year period have been extrapolated using a steady 4.6% growth rate (2006: 4.6%). The recoverable amount significantly exceeds the carrying value of the cash generating unit including goodwill and a reasonably possible change in a key assumption will not cause the carrying value of the cash generating unit to exceed its recoverable amount.
(vii) Netherlands (long-term, general insurance and health) The recoverable amount of the Netherlands life and general insurance and health cash generating units have 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.
Financial statements 17 – Acquired value of in-force business (AVIF) and intangible assets This note shows the movements in cost and amortisation of the in-force business and intangible assets acquired when we have purchased subsidiaries.
AVIF on AVIF on assets assets with insurance investment with finite indefinite contracts* contracts** useful lives useful lives Total £m £m £m £m £m
Intangible assets with indefinite useful lives comprise: (i) the RAC and BSM brands, and the value of the Union Financière de France Banque distribution channel, where the existing lives of the assets and their competitive position in, and the stability of, their respective markets support this classification; and
Share of profit after tax – 462 – 462 Acquisitions and additions – 372 113 485 Disposals and reduction in Group interests – (127) – (127) Reclassification to subsidiaries – (93) – (93) Dividends received – (59) – (59) Foreign exchange rate movements – (2) – (2)
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
(ii) The balances at 31 December comprised: Goodwill and Equity 2007 intangibles interests Loans Total 2007 £m £m £m £m
Property management undertakings – 2,519 241 2,760 Long-term business undertakings – 35 – 35
Airport Property Partnership 50.0% 50.0% Apia Regional Office Fund Limited Partnership 50.0% 58.8% Ashtenne Industrial Fund Limited Partnership 66.7% 38.0% The Junction Limited Partnership 50.0% 46.0% The Mall Limited Partnership 50.0% 33.5% Queensgate Limited Partnership 50.0% 50.0% Quercus Healthcare Property Partnership Limited 50.0% 53.3%
Financial statements 18 – Interests in, and loans to, joint ventures continued
AVIVA-COFCO Life Insurance Co. Limited Ordinary shares of RMB1each 50.0% China AvivaSA Emeklilik ve Hayat A.S,. Ordinary shares of YTL1each 49.7% Turkey CIMB Aviva Assurance Berhad Ordinary shares of RM1each 49.0% Malaysia CIMB Aviva Takaful Berhad Ordinary shares of RM1each 49.0% Malaysia First-Aviva Life Insurance Co., Ltd. Ordinary shares of NT$10 each 49.0% Taiwan
As consideration for its shareholding, the Group contributed the business of Aviva HE to the joint venture and paid £49 million to Aksigorta. The transaction has been accounted for as an acquisition of a 49.7% joint venture and the disposal of 50.3% of Aviva HE. Goodwill arising of £45 million, included in the carrying value of the joint venture, has been calculated as follows: (a) Acquisition of shareholding in joint venture Purchase cost: £m
Fair value of 50.3% of Aviva HE (see below) 85 Cash paid 49 Attributable costs 2
The carrying value of the joint venture at the date of acquisition was as follows: £m
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 profit after tax – 35 – 35 Acquisitions and additions (see below) 26 270 – 296
Dividends received – (32) – (32) Foreign exchange rate movements 4 33 – 37
Aviva Life Insurance Company India Private Limited Insurance Ordinary shares of RS1 each 26.0% India Banca Network Investimenti SpA Product distribution Ordinary shares of 11 each 49.75% Italy Cyrte Fund I CV Investment fund Partnership share 13.04% Netherlands Cyrte Fund II BV Investment fund Ordinary shares of 11 each 16.00% Netherlands Cyrte Fund III CV Investment fund Partnership share 17.91% Netherlands RBSG Collective Investments Limited Investment Ordinary shares of £1 each 49.99% Great Britain RBS Life Investments Limited Insurance Ordinary shares of £1 each 49.99% Great Britain
All investments in principal associates are unlisted and are held by subsidiaries.
In June 2007, the Group sold its holdings in The British Aviation Insurance Company Limited to Berkshire Hathaway for £15 million, resulting in a loss on disposal of £7 million.
20 – Property and equipment This note analyses our tangible fixed assets, which are primarily properties occupied by Group companies and computer equipment.
Disposals – (78) (78) (99) (72) (327) Transfers to investment property – (6) – – – (6)
Reversal of impairment losses (see note 34) – (2) – – – (2) Fair value gains (see note 34) – 26 – – – 26
Foreign exchange rate movements – – – (14) (14) (28) Other movements – – – – (3) (3)
If owner-occupied properties were stated on a historical cost basis, the carrying amount would be £301 million (2006: £368 million).
Transfers from property and equipment 6 – 6 Foreign exchange rate movements (41) (6) (47)
Capitalised expenditure on existing properties 138 11 149 Acquisitions of subsidiaries 4 – 4 Disposals of subsidiaries (3) – (3) Fair value losses (648) (97) (745)
Transfers from property and equipment 10 31 41 Foreign exchange rate movements 210 39 249
Future contractual aggregate minimum lease rentals receivable under the non-cancellable portion of the above leases are given in note 51(b)(i).
The change in fair value of these loans during the year, attributable to a change in credit risk, was a loss of £210 million (2006: £nil). The cumulative change attributable to changes in credit risk to 31 December 2007 was a loss of £210 million (2006: £nil).
(b) Collateral The Group holds collateral in respect of loans where it is considered appropriate, in order to reduce the risk of nonrecovery. 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 amount of collateral received with respect to loans which the Group is permitted to sell or repledge in the absence of default was £6,282 million (2006: £2,129 million). The value of collateral that was actually sold or repledged in the absence of default was £nil (2006: £nil).
23 – Securitised mortgages and related assets 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 rate, floating rate and index-linked notes by the ERF companies.
(ii) Netherlands and Belgium In three subsidiaries, Delta Lloyd Levensverzekering NV (DLL), Amstelhuys NV (AMS), and Delta Lloyd Bank 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 rate, floating rate and index-linked notes.
All the shares in the securitisation companies are held by independent trustee companies. Although DLL, AMS and DLB do not own, directly or indirectly, any of the share capital of the securitisation companies or their parent companies, they retain control of the residual or ownership risks related to them, and these companies have therefore been treated as subsidiaries in the consolidated financial statements. DLL, AMS and DLB have no right, nor any obligation, to repurchase the benefit of any of the securitised mortgage loans before the optional call date, other than in certain circumstances where they are in breach of warranty.
(b) Carrying values The following table summarises the securitisation arrangements: Securitised Securitised Securitised Securitised assets borrowings assets borrowings £m £m £m £m
Total loan notes issued, as above 1,691 5,989 1,856 5,367 Less: Loan notes held by Group companies (17) (369) (21) (134)
Loan notes held by third-parties (note 47(c)) 1,674 5,620 1,835 5,233
(a) Carrying amount Financial investments comprise: At fair value through profit or loss
Other than Available Trading trading for sale Total £m £m £m £m
Less assets classified as held for sale – (80) – (80)
Other investments Unit trusts and other investment vehicles 4 35,364 181 35,549 Derivative financial instruments 1,609 – – 1,609 Deposits with credit institutions 114 502 – 616 Minority holdings in property management undertakings – 977 – 977
Less assets classified as held for sale – (316) – (316)
Other investments Unit trusts and other investment vehicles 5 28,860 147 29,012 Derivative financial instruments 1,325 – – 1,325 Deposits with credit institutions – 381 – 381 Minority holdings in property management undertakings – 542 – 542
Unit trusts and investment vehicles 32,827 3,106 (384) 35,549 Derivative financial instruments – 1,609 – 1,609 Deposits with credit institutions 616 – – 616 Minority holdings in property management undertakings 977 – – 977
The gains related to AFS investments recognised in equity in 2007 were £149 million (2006: £347 million) and the gains recognised in the income statement on disposals were £391 million (2006: £162 million gain). (See notes 5 and 34.)
The Group receives collateral in order to reduce the credit risk of these arrangements. 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 certain markets, the Group or the Group’s appointed stock lending managers obtain legal ownership of the collateral received and can re-pledge it as collateral elsewhere or sell outright in the absence of default. The carrying amounts of financial assets received and pledged in this manner at 31 December 2007 were £23,779 million and £4 million respectively (2006: £16,902 million and £nil respectively). The value of collateral that was actually sold or re-pledged in the absence of default was £nil (2006: £nil).
Amounts owed by contract holders 2,554 1,921 Amounts owed by intermediaries 1,417 1,258 Deposits with ceding undertakings 1,163 1,028 Amounts due from reinsurers 701 707 Amounts due from brokers for investment sales 326 89 Amounts receivable for collateral pledged (notes 24c(i) and 56e) 21 – Other financial assets 3,001 3,184
Total deferred acquisition costs 4,321 3,222 Surpluses in the staff pension schemes (note 46e(vii)) 27 56 Other assets 139 198
Deferred acquisition costs on long-term business are generally recoverable in more than one year whereas such costs on general insurance and health business are generally recoverable within one year after the balance sheet date.
(b) Movements in the year The movements in deferred acquisition costs during the year were: £m £m
Impairment losses 36 – Impact of assumption changes 32 – Foreign exchange rate movements 97 (49) Other movements 48 72
Amortisation of deferred acquisition costs include £nil (2006: £271 million) for the effect of adjusting to the PS06/14 realistic basis.
The carrying values of assets backing unit-linked liabilities are as follows: £m £m
The authorised share capital of the Company at 31 December 2007 was: 3,000,000,000 (2006: 3,000,000,000) ordinary shares of 25 pence each 750 750
The allotted, called up and fully paid share capital of the Company at 31 December 2007 was: 2,621,792,828 (2006: 2,565,753,431) ordinary shares of 25 pence each 655 641
(b) During 2007, a total of 56,039,397 ordinary shares of 25 pence each were allotted and issued by the Company as follows: Share Share Number capital premium of shares £m £m
Shares issued under the Group’s Employee and Executive Share Option Schemes 14,871,901 4 44 Shares issued in lieu of dividends 41,167,496 10 (10)
(iii) Deferred bonus plan options These are options granted in 1999 and 2000 under the CGU Deferred Bonus Plan. Participants who deferred their annual cash bonus in exchange for an award of shares of equal value also received a matching award over an equal number of share options. The exercise of these options is not subject to the attainment of performance conditions. These options are exercisable up to the tenth anniversary of their grant.
(v) Deferred bonus plan awards These awards have been made under the Aviva Deferred Bonus Plan, and are described in section (b) below and in the Directors’ remuneration report. The Group has established various employee share trusts to facilitate the delivery of shares under the above schemes. Details of these trusts are given in note 30.
Option price Number RAC Executive Share Option Scheme p of shares Normally exercisable
The following table summarises information about options outstanding at 31 December 2007: Weighted average Weighted remaining average
(ii) Share awards At 31 December 2007, 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
(c) Movements in the year A summary of the status of the option plans as at 31 December 2007 and 2006, and changes during the years ended on those dates, is shown below.
Granted during the year 6,289,583 563.00 3,912,011 593.00 Exercised during the year (5,144,763) 437.82 (5,665,668) 394.93 Expired during the year (5,681,907) 594.60 (6,693,883) 569.15
(d) Expense charged to the income statement The total expense recognised for the year arising from equity compensation plans was as follows: £m £m
(e) Fair value of options and awards granted after 7 November 2002 The weighted average fair values of options and awards granted during the year, estimated by using the Black-Scholes option-pricing model, were £2.13 and £6.17 (2006: £2.35 and £6.70) respectively.
(ii) Share awards The fair value of the awards was estimated on the date of grant, based on the following weighted average assumptions: Weighted average assumption 2007 2006
The risk-free interest rate was based on the yields available on UK government bonds as at the date of grant. The bonds chosen were those with a similar remaining term to the expected life of the options.
30 – Shares held by employee trusts We satisfy awards and options granted under the executive incentive plans partly through shares purchased in the market and held by employees share trusts. This note gives details of the shares held in these trusts.
Acquired in the year 1,556,583 10 – – Distributed in the year (717,721) – (1,141,586) –
The shares are owned by employee share trusts in the Company and a subsidiary undertaking to satisfy awards under the Group’s Long-Term Incentive Plan and Deferred Bonus Plans. Details of the features of the plans can be found in the Directors’ renumeration report.
The preference share capital of the Company at 31 December 2007 was: £m £m
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 5m 1m 700,000,000 Euro preference shares of 11 each 700 700 £m £m
Notional amount £m £m 5.9021% £500 million direct capital instrument 500 500 4.7291% 1700 million direct capital instrument 490 490
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 all (but not some only) 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 all (but not some only) 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.
Currency occupied Investment Hedging Equity translation properties valuation instruments compensation reserve (see reserve (see reserve (see reserve (see reserve (see accounting accounting accounting accounting accounting policy E) policy O) policy S) policy T) policy AA) Total £m £m £m £m £m £m
Equity shares in subsidiaries 1,418 850 Share of earnings 429 284 Share of other reserves 450 308
Balance at 1 January 1,698 1,128 Profit for the year attributable to minority interests 178 174 Minority share of movements in other reserves 1 1 Foreign exchange rate movements 118 (19) Recognised income and expense attributable to minority interests 297 156 Capital contributions from minority shareholders 307 397 Minority share of dividends declared in the year (66) (75) Minority interest in acquired subsidiaries 317 92
Provision arising from liability adequacy tests (24) – (24) (49) – (49)
Less amounts classified as held for sale 627 – 627 – – –
38 – Insurance liabilities This note analyses our insurance contract liabilities by type of product and describes how we calculate these liabilities and what assumptions we have used.
Long-term business provisions Participating 66,093 – 66,093 63,705 – 63,705 Unit-linked non-participating 20,601 – 20,601 21,004 – 21,004 Other non-participating 48,618 – 48,618 41,905 – 41,905
Outstanding claims provisions 727 10,842 11,569 696 10,165 10,861 Provision for claims incurred but not reported – 2,300 2,300 – 2,553 2,553
Under the net premium method, the premium taken into account in calculating the provision is determined actuarially, based on the valuation assumptions regarding discount rates, mortality and disability. The difference between this premium and the actual premium payable provides a margin for expenses. This method does not allow for voluntary early termination of the contract by the policyholder, and so no assumption is required for persistency. Explicit provision is made for vested bonuses (including those vesting following the most recent fund valuation), but no such provision is made for future regular or terminal bonuses. However, this method makes implicit allowance for future regular or terminal bonuses already earned, by margins in the valuation discount rate used.
For a small proportion of business, the retrospective approach is not available or is inappropriate, so a prospective valuation approach is used instead, including allowance for anticipated future regular and final bonuses.
The principal assumptions underlying the cost of future policy related liabilities are as follows: Future investment return A “risk-free” rate equal to the spot yield on gilts, plus a margin of 0.1% is used. The rates vary, according to the outstanding term of the policy, with a typical rate as at 31 December 2007 being 4.72% for a policy with ten years outstanding.
Equities 25% (NUL&P)/23.5% (other WP funds) 17% (for UK stocks) Property 15% 15% Gilts 3.75% 3.25% (NUL&P)/ 4.5% (other WP funds) Corporate bonds 5.75% 5.25% (NUL&P)/6.5% (other WP funds)
Future regular bonuses Annual bonus assumptions for 2008 have been set consistently with the year end 2007 declaration. Future annual bonus rates reflect the principles and practices of the fund. In particular, the level is set with regard to the projected margin for final bonus and the change from one year to the next is limited to a level consistent with past practice.
Mortality Mortality assumptions are set with regard to recent company experience and general industry trends. Most assumptions are unchanged from 2006 but for some endowment and whole life business the basis has been strengthened although the base mortality tables are unchanged.
Assurances, pure endowments and deferred Nil or AM92/AF92 Nil or AM92/AF92 annuities before vesting
Pensions business after vesting and pensions PCMA00/PCFA00 PCMA00/PCFA00 annuities in payment adjusted plus allowance adjusted plus allowance for future mortality for future mortality improvement improvement
38 – Insurance liabilities continued For unit-linked and some unitised with-profit business, the provisions are valued by adding a prospective non-unit reserve to the bid value of units. The prospective non-unit reserve is calculated by projecting the future non-unit cash flows on the assumption that future premiums cease, unless it is more onerous to assume that they continue. Where appropriate, allowance for persistency is based on actual experience.
Valuation discount rate assumptions are set with regard to yields on the supporting assets and the general level of longterm interest rates as measured by gilt yields. An explicit allowance for risk is included by restricting the yields for equities and properties with reference to a margin over long-term interest rates or by making an explicit deduction from the yields on corporate bonds, mortgages and deposits, based on historical default experience of each asset class. A further margin for risk is then deducted for all asset classes.
Valuation discount rates are largely unchanged since 2006, reflecting the yields on the supporting assets. Valuation discount rates
Deferred annuities Non-profit – in deferment 3.9% to 4.1% 3.9% to 4.1% Non-profit – in payment 4.3% 4.3%
Annuities in payment Conventional annuity 4.3% to 4.9% 4.3% to 4.9%
Assurances Non-profit AM80/AF80 or AM92/AF92 AM80/AF80 or AM92/AF92 or TM92/TF92 or TM92/TF92 adjusted for smoker status adjusted for smoker status and age/sex specific factors and age/sex specific factors
Pure endowments and Nil or AM80/AF80 or Nil or AM80/AF80 or deferred annuities before vesting AM92/AF92 adjusted AM92/AF92 adjusted
Pensions business PCMA00/PCFA00 adjusted PCMA00/PCFA00 adjusted or IML00/IFL00 adjusted plus or IML00/IFL00 adjusted plus allowance for future allowance for future mortality improvement mortality improvement
Annuities in deferment and in payment Actual swap rate GBM/V 76-80, GBM/V 85-90, GBM/V 95-00,
Carrying amount at 1 January 126,614 114,430 Provisions in respect of new business 10,470 8,750 Expected change in existing business provisions (6,280) (5,678) Variance between actual and expected experience (877) 1,209 Effect of adjusting to PS06/14 realistic basis (60) (800) Impact of other operating assumption changes 95 (333) Impact of economic assumption changes (909) (1,727) Effect of special bonus to with-profit policyholders (note 59) 1,728 – Other movements (324) 314 Change in liability recognised as an expense 3,843 1,735 Effect of portfolio transfers, acquisitions and disposals 571 12,454 Foreign exchange rate movements 4,284 (2,005)
Provisions for outstanding claims Delays occur in the notification and settlement of claims and a substantial measure of experience and judgement is involved in assessing outstanding liabilities, the ultimate cost of which cannot be known with certainty at the balance sheet date. The reserves for general insurance and health are based on information currently available. However, it is inherent in the nature of the business written that the ultimate liabilities may vary as a result of subsequent developments.
Netherlands Permanent health and injury 3.87% 3.61% 8 years 9 years
The gross outstanding claims provisions before discounting were £13,439 million (2006: £12,768 million). The period of time which will elapse before the liabilities are settled has been estimated by modelling the settlement patterns of the underlying claims.
38 – Insurance liabilities continued 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.
The effect of changes in the main assumptions is given in note 42.
Gross cumulative claim payments At end of accident year (3,029) (2,952) (2,819) (2,971) (3,345) (3,653) (4,393)
Four years later (5,966) (5,466) (5,258) Five years later (6,121) (5,618) Six years later (6,223)
Estimate of gross ultimate claims At end of accident year 6,590 6,250 6,385 6,891 7,106 7,533 8,530
(iii) Net of reinsurance After the effect of reinsurance, the loss development table is: Accident year £m £m £m £m £m £m £m £m £m
Net cumulative claim payments At end of accident year (2,970) (2,913) (2,819) (2,870) (3,281) (3,612) (4,317)
Estimate of net ultimate claims At end of accident year 6,186 6,037 6,218 6,602 6,982 7,430 8,363
The loss development tables above include information on asbestos and environmental pollution claims provisions from business written before 2001. The claim provisions, net of reinsurance, in respect of this business at 31 December 2007 were £323 million (2006: £312 million). The movement in the year reflects strengthening of provisions by £20 million (2006: £9 million), foreign exchange rate movements and timing differences between claim payments and reinsurance recoveries.
Movements The following changes have occurred in the provision for unearned premiums (UPR) during the year: £m £m
Changes in UPR recognised as expense/(income) 24 (89) Gross portfolio transfers and acquisitions 87 3 Foreign exchange rate movements 191 (113)
Long-term business Participating contracts 53,609 49,400 Non-participating contracts at fair value 43,608 38,081 Non-participating contracts at amortised cost 1,027 877
Many investment contracts contain a discretionary participation feature in which the contract holder has a contractual right to receive additional benefits as a supplement to guaranteed benefits. These are referred to as participating contracts and are measured according to the methodology and group practice for long-term business liabilities as described in note 38. They are not measured at fair value as there is currently no agreed definition of fair valuation for discretionary participation features under IFRS. In the absence of such a definition, it is not possible to provide a range of estimates within which a fair value is likely to fall. The IASB has deferred consideration of participating contracts to Phase II of its insurance contracts project.
Investment contracts that do not contain a discretionary participation feature are referred to as non-participating contracts and the liability is measured at either fair value or amortised cost.
In the United States, funding agreements consist of one to ten year fixed rate contracts. These contracts may not be cancelled by the holders unless there is a default under the agreement, but may be terminated by Aviva at any time. The weighted average interest rates for fixed-rate and floating-rate funding agreements in 2007 were 5.21% and 5.15% (2006: 5.07% and 5.55%) respectively. The funding agreements are measured at fair value equal to the present value of contractual cash flows.
Carrying amount at 1 January 49,400 47,258 Provisions in respect of new business 3,009 3,001 Expected change in existing business provisions (1,978) (2,237) Variance between actual and expected experience (404) 2,131 Effect of adjusting to PS06/14 realistic basis – (105) Impact of operating assumption changes (3) (43) Impact of economic assumption changes 178 (125) Effect of special bonus to with-profit policyholders (note 59) 399 – Other movements (176) 51 Change in liability recognised as an expense 1,025 2,673 Effect of portfolio transfers, acquisitions and disposals – 125 Foreign exchange rate movements 3,184 (656)
Carrying amount at 1 January 38,958 30,051 Provisions in respect of new business 8,575 5,695 Expected change in existing business provisions (1,094) (163) Variance between actual and expected experience (3,231) 265 Impact of operating assumption changes (2) 15 Impact of economic assumption changes 20 (5) Other movements 61 56 Change in liability 4,329 5,863 Effect of portfolio transfers, acquisitions and disposals 254 3,396 Foreign exchange rate movements 1,094 (352)
40 – Financial guarantees and options This note details the financial guarantees and options we have given for some of our insurance and investment products.
As a normal part of their operating activities, various Group companies have given guarantees and options, including investment return guarantees, in respect of certain long-term insurance and fund management products. Further information on assumptions is given in notes 38 and 39.
In addition, while these do not constitute guarantees, the with-profit fund companies have made promises to certain policyholders in relation to their with-profit mortgage endowments. Subject to certain conditions, top-up payments will be made on these policies at maturity to meet the mortgage value up to a maximum of the 31 December 1999 illustrated shortfall.
Non-AFER contracts with guaranteed surrender values had liabilities of £8 billion (2006: £6 billion) at 31 December 2007 and all guaranteed annual bonus rates are between 0% and 4.5%. For non-AFER business, the accounting income return exceeded guaranteed bonus rates in 2007.
The total liabilities for traditional business at 31 December 2007 are £10 billion (2006: £8 billion) analysed as follows: Liabilities Liabilities Liabilities Liabilities 3% guarantee 3% guarantee 4% guarantee 4% guarantee £m £m £m £m
Delta Lloyd has certain unit-linked contracts which provide a guaranteed minimum return at maturity from 4% pa to 2% pa.
(iii) Ireland 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 £160 million (2006: £152 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.
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 2007, the liabilities for total return strategy products were £1.2 billion (2006: £1.4 billion).
41 – Reinsurance assets This note details the reinsurance recoverables on our insurance and investment contract liabilities.
(a) Carrying amounts The reinsurance assets at 31 December comprised: £m £m
(b) Assumptions The assumptions used for reinsurance contracts follow those used for insurance contracts.
Change in asset (4) (713) Effect of portfolio transfers, acquisitions and disposals 24 1,639 Foreign exchange rate movements 227 (98)
Reinsurers’ share of claim losses and expenses Incurred in current year 169 102 Incurred in prior years 32 78
Change in reinsurance asset recognised as income (97) (157) Effect of portfolio transfers, acquisitions and disposals 39 (5) Foreign exchange rate movements 41 (32) Other movements (3) 18
42 – Effect of changes in assumptions and estimates during the year Certain estimates and assumptions used in determining our liabilities for insurance and investment contract business were changed from 2006 to 2007, and this affected the profit recognised for the year with an equivalent effect on liabilities. This note analyses the effect of the changes.
Assumptions Long-term insurance business Interest rates 850 947 Expenses (13) 16 Persistency rates (2) 45 Mortality for assurance contracts 16 25 Mortality for annuity contracts 11 60 Tax and other assumptions 60 (17) Investment contracts Interest rates 12 23 Expenses 5 87 Persistency rates – 2 Tax and other assumptions 7 (4) General insurance and health business Change in loss ratio assumptions – (2) Change in discount rate assumptions 3 – Change in expense ratio assumptions (4) –
The impact of interest rates for long-term business relates primarily to the UK and the Netherlands. This results from the use of higher valuation interest rates for the UK annuities and Dutch traditional business, reflecting the rise in market interest rates over the year. The mortality impacts relate to assumption changes in the UK. The impact on existing business of applying FSA Policy Statement 06/14, Prudential Changes for Insurers, in 2007 is £60 million, relating to UK income protection business. This is reflected in reductions in insurance contract liabilities of £60 million (see note 38(b)). The impact on new business in 2007 is £4 million, giving a total increase in pre-tax profit for the year of £64 million.
Carrying amount at 1 January 9,465 8,978 Change in participating contract assets 2,463 8,614 Change in participating contract liabilities (3,244) (7,640) Impact of change in management policy – (286) Transfer in respect of pension scheme deficit funding (note 46c(i)) – (130) Effect of special bonus to with-profit policyholders (note 59) (2,127) – Other movements (14) – Change in liability recognised as an expense (2,922) 558 Effect of portfolio transfers, acquisitions and disposals 3 – Movement in respect of change in pension scheme deficit (note 46c(i)) 61 30 Foreign exchange rate movements 173 (101) Other movements 5 –
Net liability at 1 January (1,878) (1,440) Acquisition of subsidiaries (185) (182) Amounts credited/(charged) to profit (note 13a) 442 (199) Amounts charged to equity (note 13b) (198) (14) Exchange differences (37) 16 Other movements (83) (59)
In addition, the Group has an unrecognised capital loss of £409 million (2006: £468 million). This tax loss can be offset against future capital gains and has no expiry date.
Deferred tax liabilities of £666 million (2006: £527 million) have not been established for temporary differences associated with investments in subsidiaries and interests in joint ventures and associates (including tax payable on remittance of overseas retained earnings) because the Group can control the timing of the reversal of these differences and it is probable that they will not reverse in the foreseeable future. Such unremitted earnings totalled £4,258 million at 31 December 2007 (2006: £2,552 million).
45 – Provisions This note details the non-insurance provisions that the Group holds, and shows the movements in these during the year.
Total IAS 19 obligations to staff pension schemes 1,230 2,115 Restructuring provision 136 234 Other provisions 571 501
Of the total, £1,277 million (2006: £2,262 million) is expected to be settled more than one year after the balance sheet date.
46 – Pension obligations This note describes the Group’s pension arrangements for its employees and explains how our obligations to these schemes are calculated.
(b) Membership The number of scheme members at 31 December 2007 was as follows: UK Netherlands Canada Ireland Number Number Number Number
The employing companies’ contributions to the defined benefit section of the ASPS throughout 2007 were 37% of employees’ pensionable salaries, together with the cost of redundancies during the year, and additional deficit funding payments totalling £83 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 2008 has therefore been increased to 39% of pensionable salaries (expected to be £114 million), pending finalisation of the April 2007 valuation. The Group is also expecting to make further contributions of £320 million into the ASPS prior to March 2008 and £49 million later in the year. Active members of this section of the ASPS contribute 5% of their pensionable salaries.
There were no significant contributions outstanding or prepaid as at either 31 December 2007 or 2006.
Including the deficit funding in the UK schemes discussed above, total employer contributions for these schemes in 2008 are expected to be £568 million.
Valuations and assumptions The valuations used for accounting under IAS 19 have been based on the most recent full actuarial valuations, updated to take account of that standard’s requirements in order to assess the liabilities of the material schemes at 31 December 2007. The updating was made by actuaries in each country who, other than the actuary of the Aviva Staff Pension Scheme and Dutch arrangements, were independent of the Group. Scheme assets are stated at their fair values at 31 December 2007.
UK PA92U08MC with a one year age rating deduction and an allowance for 87.8 88.9 90.7 91.7
Canada UP1994 projected to 2005, using Scale AA 83.2 83.2 86.2 86.2
The assumptions above are based on commonly-used mortality tables. In the UK, the standard mortality tables have been adjusted to reflect recent research into mortality experience. However, the extent of future improvements in longevity is subject to considerable uncertainty and judgement is required in setting this assumption. In the UK schemes, which are by far the most material to the Group, the assumptions include an allowance for future mortality improvement, based on the actuarial profession’s medium cohort projection table. The effect of assuming all members were one year younger would increase the above schemes’ liabilities by £199 million.
The scheme liabilities have an average duration of 22 years in the UK schemes and between 14 and 28 years in the overseas schemes.
(iii) Investments in Group-managed funds and insurance policies Plan assets in the UK and Dutch schemes include investments in Group-managed funds and insurance policies with other Group companies. Their treatment in the relevant parts of the financial statements is as follows : Plan assets – The treatment of these funds and policies in the consolidated balance sheet is described in section (vii) below.
Current service cost 173 196 Past service cost – 3 Loss/(gain) on curtailments 15 (39)
Expected return on scheme assets (614) (530) Less: Income accounted for elsewhere (see (iii) above) 49 40
Fair value of scheme assets at the end of the year 8,814 8,137 7,334 5,473 Present value of scheme liabilities at the end of the year (10,017) (10,196) (9,680) (7,179)
During 2007, there has been a reduction in the proportion of assets invested in equities, thereby mitigating the equity risk. There is also an exposure to currency risk where assets are not denominated in the same currency as the liabilities. The majority of this exposure has been removed by the use of hedging instruments.
Other schemes The other schemes are considerably less material but their risks are managed in a similar way to those in the main UK scheme.
(Deficits)/surplus in the schemes (126) (974) (21) (10) (58) (45) 27 56 (178) (973)
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 £1,203 million (2006: £2,059 million), as shown in the following table.
IAS 19 net (deficits)/surplus in the schemes (126) (1,126) (1,046) (944) (58) (45) 27 56 (1,203) (2,059)
(viii) Movements in the scheme deficits and surpluses Movements in the pension schemes’ deficits and surpluses comprise: Adjust for Pension Group IAS 19
Deficits in the schemes at 1 January 9,223 (10,196) (973) (1,086) (2,059)
Deficits in the schemes at 1 January 8,209 (9,680) (1,471) (875) (2,346)
47 – Borrowings Our borrowings are either core structural borrowings, such as subordinated debt, debenture loans and most commercial paper, or operational borrowings, such as bank loans and financing for securitised mortgage loan notes. This note shows the carrying values and contractual maturity amounts of each type, and explains their main features and movements during the year.
(b) Core structural borrowings The following table provides information about the carrying amounts and maturity periods of these borrowings. Borrowings are considered current if the contractual maturity dates are within a year.
(c) Operational borrowings The following table provides information about the carrying amounts and maturity periods of these borrowings. Borrowings are considered current if the contractual maturity dates are within a year.
Total contractual undiscounted cash flows for operational borrowings 749 1,712 2,144 1,661 15,988 22,254
All the above borrowings are stated at amortised cost, except for the loan notes issued in connection with the UK lifetime mortgage business £1,674 million (2006: £1,836 million) and £3,337 million (2006: £3,265 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.
The subordinated notes were issued by the Company. They rank below its senior obligations and ahead of its preference shares and ordinary share capital. The dated subordinated notes rank ahead of the undated subordinated notes. The fair value of these notes at 31 December 2007 was £3,006 million (2006: £3,076 million), calculated with reference to quoted prices.
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 1489.9 million but, because they are considered to be perpetual, their carrying value is 1172.4 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.
The 5.95% Senior Notes had been issued by a United States subsidiary prior to acquisition by the Group. On 23 February 2007, the subsidiary exercised its option to redeem the notes early for an amount not significantly different to their carrying value. As a result, these notes have been shown in table (b) for 2006 as maturing within one year.
Fixed rate borrowings comprise £335 million (2006: £521 million) of the total carrying value of £335 million (2006: £521 million). The fair value of debenture loans at 31 December 2007 was £395 million (2006: £580 million), calculated with reference to quoted prices or discounted future cash flows as appropriate.
(iii) Commercial paper The commercial paper consists of £918 million in the Company (2006: £733 million) and £4 million in France (2006: £4 million). All of this is considered core structural funding.
All commercial paper is repayable within one year and is issued in a number of different currencies, primarily sterling, euros and US dollars. Its fair value is considered to be the same as its carrying value.
Non-recourse Loans to property partnerships (see (a) below) 485 123 Loans to Irish investment funds (see (b) below) 74 – RBS securitisation arrangement (see (c) below) – 199 Other non-recourse loans 16 15
(b) Certain Irish policyholder investment funds and unit trusts, which have been fully consolidated in accordance with accounting policy C, 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 1378 million.
For the Dutch securitised mortgage loan notes carried at amortised cost of £2,283 million (2006: £2,038 million), their fair value is £2,283 million (2006: £2,006 million), calculated based on the future cash flows discounted back at the market rate of interest.
New borrowings drawn down, net of expenses 4,780 1,542 6,322 Repayment of borrowings (4,799) (1,201) (6,000)
Net cash inflow (19) 341 322 Foreign exchange rate movements 133 499 632
47 – Borrowings continued Movements in borrowings during the previous year were: Total Core structural Operational 2006 £m £m £m
Net cash inflow 174 727 901 Foreign exchange rate movements (76) (107) (183) Borrowings acquired for non-cash consideration – 11 11 Acquisitions 303 139 442 Fair value movements – (52) (52) Amortisation of discounts and other non-cash items 5 – 5
(b) Asbestos, pollution and social environmental hazards In the course of conducting insurance business, various companies within the Group receive general insurance liability claims, and become involved in actual or threatened related litigation arising therefrom, including claims in respect of pollution and other environmental hazards. Amongst these are claims in respect of asbestos production and handling in various jurisdictions, including the UK, Australia and Canada. Given the significant delays that are experienced in the notification of these claims, the potential number of incidents which they cover and the uncertainties associated with establishing liability and the availability of reinsurance, the ultimate cost cannot be determined with certainty.
However, the Group’s net exposure to such liabilities is not significant and, on the basis of current information and having regard to the level of provisions made for general insurance claims, the directors consider that any costs arising are not likely to have a material impact on the financial position of the Group.
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 £96 million at 31 December 2007 (2006: £128 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.
The Company and several of its subsidiaries have guaranteed the overdrafts and borrowings of certain other Group companies. At 31 December 2007, the total exposure of the Group and Company is £7 million (2006: £7 million) and £113 million (2006: £109 million) respectively but, in the opinion of the directors, no material loss will arise in respect of these guarantees and indemnities.
Contractual obligations for future repairs and maintenance on investment properties are £nil (2006: £3 million).
Later than 1 year and not later than 5 years 1,879 1,597 Later than 5 years 3,265 3,423
(ii) Future contractual aggregate minimum lease and associated payments under non-cancellable operating leases are as follows: £m £m
(a) The reconciliation of profit/(loss) before tax to the net cash inflow from operating activities is: Restated £m £m
Depreciation of property and equipment 129 122 Equity compensation plans, equity settled expense 50 48 Impairment of: Goodwill on subsidiaries 10 94 Other investments and loans 58 (5) Acquired value of in-force business and intangibles 4 26 Non-financial assets – 5
Amortisation of: Premium or discount on debt securities 32 278 Premium or discount on loans (7) – Premium or discount on borrowings 2 5 Acquired value of in-force business and intangibles 266 130
Purchases and sales of investment property, loans and financial investments are included within operating cash flows as the purchases are funded from cash flows associated with the origination of insurance and investment contracts, net of payments of related benefits and claims.
(b) Cash flows in respect of the acquisition of subsidiaries, joint ventures and associates £m £m
(d) Cash and cash equivalents in the Cash flow statement at 31 December comprised: Restated £m £m
53 – Group capital structure The Group maintains an efficient capital structure from a combination of equity shareholders’ funds, preference capital, subordinated debt and borrowings, consistent with our overall risk profile and the regulatory and market requirements of our business. This note describes the way we manage our capital and shows where this is employed.
(b) Capital resources The primary sources of capital used by the Group are equity shareholder’s 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.
(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 Group’s Directive (“IGD”) to calculate regulatory capital adequacy at an aggregate Group level. The Group fully complied with these regulatory requirements during the year.
(iii) Rating agency bases The Group’s 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.
net assets AVIF net assets net assets AVIF net assets £m £m £m £m £m £m
(i) “Corporate” net liabilities represent the element of the pension scheme deficit held centrally.
(ii) In addition to our external funding sources, we have certain internal borrowing arrangements in place which allow some of the assets that support technical liabilities to be invested in a pool of central assets for use across the Group. These internal debt balances allow for the capital allocated to business operations to exceed the externally sources capital resources of the Group. Although intra-group in nature, they are included as part of the capital base for the purpose of capital management. These arrangements arise in relation to the following: – Certain subsidiaries, subject to continuing to satisfy standalone capital and liquidity requirements, loan funds to corporate and holding entities, these loans satisfy arms length criteria and all interest payments are made when due.
CGNU CULAC NUL&P UK life Other Total Overseas with-profit with-profit with-profit with-profit UK life UK life life Total life Other 2007 2006 fund fund fund3 funds operations operations operations operations operations4 Total Total £m £m £m £m £m £m £m £m £m £m £m
Other non-participating life insurance 1,218 1,851 341 3,410 15,751 19,161 29,159 48,320 – 48,320 41,515
The changes in management policy shown in CGNU and CULAC with-profit funds relate to the special bonus announced on 5 February 2008.
In aggregate, the Group has at its disposal total available capital of £16.8 billion (2006: £19.5 billion), representing the aggregation of the solvency capital of all of our businesses. This capital is available to meet risks and regulatory requirements set by reference to local guidance and EU directives.
For the remaining life and general insurance operations, the total available capital amounting to £12.3 billion (2006: £12.6 billion) is significantly higher than the minimum requirements established by regulators and, in principle, the excess is available to shareholders. In practice, management will hold higher levels of capital within each business operation to provide appropriate cover for risk.
54 – Capital statement continued Within the Aviva group there exist intra-group arrangements to provide capital to particular business units. Included in these arrangements is a subordinated loan of £200 million from Aviva plc to the NUL&P non-profit fund to provide capital to support the writing of new business.
2. Estimated realistic inherited estate at 31 December 2006 was £2.5 billion, £2.5 billion and £1.8 billion for CGNU Life, CULAC and NUL&P respectively.
3. The risk capital margin (RCM) is 3.5 times covered by the inherited estate (31 December 2006: 4.2 times).
4. The NUL&P fund includes the Provident Mutual (PM) fund, which has realistic assets and liabilities of £2.1 billion and therefore does not impact the realistic inherited estate.
For UK non-participating business, the relevant capital requirement is the minimum solvency requirement determined in accordance with FSA regulations. The available capital reflects the excess of regulatory basis assets over liabilities before deduction of capital resources requirement.
All businesses hold sufficient available capital to meet their minimum capital requirement.
(iv) General insurance operations – the capital requirements and corresponding regulatory capital held by overseas businesses are calculated using the locally applicable regulatory regime. The available capital resources in all these businesses are subject to local regulatory restrictions which may constrain management’s ability to utilise these in other parts of the Group. Any transfer of available capital may give rise to a tax charge, subject to availability of tax relief elsewhere in the Group.
(a) Risk management framework The Group has established a risk management framework whose primary objective is to protect the Group from events that hinder the sustainable achievement of the Group’s performance objectives, including failing to exploit opportunities. Risk is categorised as follows: – Market
– A risk management function operating throughout the group, from Group Centre, to regional support office, to business units, with clear responsibilities and objectives.
The adoption of these Group policies enables a consistent approach to management of risk at business unit level. The Group operates a number of oversight committees that monitor aggregate risk data and take overall risk management decisions.
Regulatory impact on risk and risk assessments The Group’s worldwide insurance operations are subject to numerous local regulatory requirements that prescribe the type, quality, and concentration of investments, and the level of assets to be maintained in local currency in order to meet local insurance liabilities. These requirements help to maintain the Group’s market risk at an acceptable level in each of the jurisdictions in which it operates.
In addition, where the Group’s long-term savings businesses have written insurance products where the majority of investment risks are borne by its policyholders, these risks are actively and prudently managed, in line with local regulations and marketing literature, in order to satisfy the policyholders’ risk and reward objectives.
The Group writes unit-linked business in a number of its operations. In unit-linked business, the policyholder bears the investment risk on the assets held in the unit-linked funds, as the policy benefits are directly linked to the value of the assets in the fund. The shareholders’ exposure to market risk on this business is limited to the extent that income arising from asset management charges is based on the value of assets in the fund.
At business unit level, equity price risk is actively managed in order to mitigate anticipated unfavourable market movements where this lies outside the risk appetite of either the company in respect of shareholder assets or the fund in respect of policyholder assets concerned. In addition local asset admissibility regulations require that business units hold diversified portfolios of assets thereby reducing exposure to individual equities. The Group does not have material holdings of unquoted equity securities.
Businesses actively model the performance of equities through the use of stochastic models, in particular to understand the impact of equity performance on guarantees, options and bonus rates.
A sensitivity to changes in equity prices is given in section (g) below.
At 31 December 2007, no material derivative contracts had been entered into to mitigate the effects of changes in property prices.
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. However, where any residual mismatch is within our risk appetite, the impact is monitored through economic capital measures such as ICA.
Interest rate risk is monitored and managed by the Group Investment Committee, and the Group Asset Liability Management Committee.
A sensitivity to changes in interest rates is given in section (g) below.
55 – Risk management continued Net assets are stated after taking account of the effect of currency swaps and forward foreign exchange contracts.
10% 10% 10% 10% increase decrease in increase in decrease in in sterling/ sterling/ sterling/ sterling/ euro rate euro rate US$ rate US$ rate £m £m £m £m
Derivatives risk Derivatives are used by a number of the larger businesses, within policy guidelines agreed by the Board of directors, as set out in the group policy on derivatives use. Activity is overseen by the Group Derivatives Committee, which monitors implementation of the policy, exposure levels and approves large or complex transactions proposed by businesses. Derivatives are primarily used for efficient investment management, risk hedging purposes or to structure specific retailsavings products. Derivative transactions are covered by either cash or corresponding assets and liabilities. Speculative activity is prohibited, unless approval has been obtained from the Group Derivatives Committee. Over the counter derivative contracts are entered into only with approved counterparties, in accordance with our Group credit policies, thereby reducing the risk of credit loss.The Group also manages a number of hedge funds which use derivatives extensively within a defined derivative framework.
Correlation risk The Group recognises that identified lapse behaviour and potential increases in consumer expectations are sensitive to and interdependent with market movements and interest rates. These interdependencies are taken into consideration in the ICA in the aggregation of the financial stress tests with the operational risk assessment. FCRs also consider scenarios involving a number of correlated events.
Credit ratings Financial assets are graded according to current 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 concerned.
The following table provides information regarding the aggregated credit risk exposure, for financial assets with external credit ratings, of the Group at 31 December 2007.
Reinsurance credit exposures The Group is exposed to concentrations of risk with individual reinsurers, due to the nature of the reinsurance market and the restricted range of reinsurers that have acceptable credit ratings. The Group operates a policy to manage its reinsurance counterparty exposures, by limiting the reinsurers that may be used, and the impact from reinsurer default is measured regularly, in particular through the ICA tests, and is managed accordingly. Both the Group Credit Committee and Group Reinsurance Security Committee have a monitoring role over this risk.
The Group’s largest reinsurance counterparty is National Indemnity Corporation, a member of the Berkshire Hathaway Group. At 31 December 2007 the reinsurance asset recoverable from National Indemnity Corporation was £1.1 billion. This exposure is monitored on a regular basis with the forecast to completion monitored for any shortfall in the claims history to verify that the contract is progressing as expected and that no further exposure for the Group will arise.
At 31 December 2007 Financial assets that are past due but not impaired
At 31 December 2006 Financial assets that are past due but not impaired
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. Although we expect surrenders, transfers and maturities to occur over many years, the total liability for non-linked investment contracts is shown in the Within 1 year column below. Unit-linked contracts are repayable or transferable on demand and therefore excluded from this analysis.
Total 1 year 1-5 years 5-15 years Over 15 years £m £m £m £m £m
Risk management framework The Group has developed a life insurance risk policy and guidelines on the practical application of this policy. Individual life insurance risks are managed at a business unit level.
– 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 other wise lapse. The Group Life insurance Risk Committee has developed guidelines on persistency management.
Concentration risk The Group writes a diverse mix of business in worldwide markets that are all subject to similar risks (mortality, persistency etc). The Group assesses the relative costs and concentrations of each type of risk through the ICA capital requirements and material issues are escalated to and addressed at the Life Insurance Risk Committee. This analysis enables the Group to assess whether accumulations of risk exceeds risk appetite.
Examples of each type of embedded derivative affecting the Group are: Options: call, put, surrender and maturity options, guaranteed annuity options, option to cease premium payment, options for withdrawals free of market value adjustment, annuity option, guaranteed insurability options.
The impact of these is reflected in ICA and EEV reporting and managed as part of the asset liability framework.
The majority of the general insurance business underwritten by the Group is of a short tail nature such as motor, household and commercial property insurances. The Group’s underwriting strategy and appetite is agreed by the Executive Committee and communicated via specific policy statements and guidelines. Like life insurance risk, general insurance risk is managed primarily at business unit level with oversight at a Group level, through a number of general insurance risk committees.
The General Insurance Risk 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 handling, reinsurance and reserving that operate within the Group risk management framework. The implementation of these policies and the management of these risks is supported by subcommittees for each of these four areas of risk.
A number of business units also have periodic external reviews by local consultant actuaries (often as part of the local regulatory requirement).
Reinsurance strategy Significant reinsurance purchases are reviewed annually at both business unit and Group level, to verify that the levels of protection being bought reflect any developments in exposure and the risk appetite of the Group. Reinsurance purchases must be in line with the strategy set out in our Group reinsurance policy . The basis of these purchases is underpinned by extensive financial and capital modelling and actuarial analysis to optimise the cost and capital efficiency benefits. For the larger business units, this involves utilising externally sourced probabilistic models to verify the accumulations and loss probabilities based on the Group’s specific portfolios of business. Where external models are not available, scenarios are developed and tested using the Group’s data to determine potential losses and appropriate levels of reinsurance protection.
This definition is intended to include all risks to which the Group is exposed, other than the financial risks described previously, and strategic and Group risks that are considered elsewhere. It includes risks relating to: – Regulation, information technology, financial crime, business protection, human resources, outsourcing, purchasing, communications and legal
General insurance and health business General insurance and health claim liabilities are estimated by using standard actuarial claims projection techniques. These methods extrapolate the claims development for each accident year based on the observed development of earlier years. In most cases, no explicit assumptions are made as projections are based on assumptions implicit in the historic claims development on which the projections are based. As such, in the analysis below, the sensitivity of general insurance claim liabilities is primarily based on the financial impact of changes to the reported loss ratio.
Sensititvity test results Some results of sensitivity testing for long-term business, general insurance and health business and the fund management and non-insurance business are set out below. For each sensitivity test the impact of a reasonably possible change in a single factor is shown, with other assumptions left unchanged. Sensitivity Factor Description of sensitivity factor applied
Interest rate and investment return The impact of a change in market interest rates by ± 1% (eg if a current interest rate is 5%, the impact of an immediate change to 4% and 6%). The test allows consistently for similar changes to investment returns and movements in the market value of backing fixed interest securities.
Expenses The impact of an increase in maintenance expenses by 10%. Equity/property market values The impact of a change in equity/property market values by ± 10%. Assurance mortality/morbidity (life insurance only) The impact of an increase in mortality/morbidity rates for assurance contracts by 5%.
Gross loss ratios (non-life insurance only) 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 2007 Impact on profit before tax (£m)
Assets backing life shareholders’ funds (115) 140 180 (175) – – –
Impact before tax on shareholders’ equity (£m) Interest Interest Equity/ Equity/ Assurance Annuitant rates rates property property Expenses mortality mortality +1% --1% +10% –10% +10% +5% –5%
Assets backing life shareholders’ funds (165) 190 460 (455) – – –
Assets backing life shareholders’ funds (320) 345 290 (290) – – –
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 sensitivity to movements in equity and property market values relates mainly to holdings in the Netherlands, although the impact on IFRS profit is moderated by the classification of equities as available for sale.
The impact on the Group’s results from sensitivity to these assumptions can also be found in the EEV sensitivities included in the alternative method of reporting long-term business profits section.
General insurance and health business Sensitivities as at 31 December 2007 Impact on profit before tax (£m)
Fund management and non-insurance business Sensitivities as at 31 December 2007 Impact on profit before tax (£m)
Sensitivity of fair values not derived from market information. Assets are held at fair value in accordance with the relevant accounting policy. The majority of such assets are valued based on quoted market information or observable market data.
(a) Cash flow hedges The Group had no cash flow hedge activity at 31 December 2007 (2006: nil).
Interest and currency swaps 859 57 – 245 – (52) Options – – – – – –
56 – Derivative financial instruments continued 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.
The Group’s derivative risk management policies are outlined in note 55(b).
Within one year 151 162 Between one and two years 100 63 Between two and three years 20 7 Between three and four years 20 7 Between four and five years 21 18 After five years 516 214
58 – Related party transactions This note gives details of the transactions between Group companies and related parties which comprise our joint ventures, associates and staff pension schemes.
The total compensation to those employees classified as key management, being those having authority and responsibility for planning, directing and controlling the activities of the Group, including the executive and non-executive directors is as follows: £m £m
Salary and other short-term benefits 33 32 Post-employment benefits 1 1 Equity compensation plans 14 16 Termination benefits 2 4
59 – Post-balance sheet event 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. This special bonus has been made possible by the strength of the two with-profit funds and a change to the investment strategy for supporting policy guarantees. This has enabled the business to free up a significant part of the inherited estate (included within the unallocated divisible surplus) for payment to policyholders. This change will not affect normal policy returns, nor will it impact on policyholders’ security or alter the type of investments backing their policies.
Expenses Operating expenses B (193) (201) Interest payable to Group companies (944) (1,341) Interest payable on borrowings (232) (215)
Balance at 1 January 23,136 18,746 Total recognised income and expense for the year (1,682) 3,968 Dividends and appropriations 15 (871) (762) Issue of share capital for the acquisition of AmerUs, net of transaction costs – 892 Other issues of share capital, net of transaction costs 28 48 43 Shares issued in lieu of dividends 35 301 203 Reserves credit for equity compensation plans 10 50 48 Other movements – (2)
Financial statements of the Company Income statement For the year ended 31 December 2007
Assets Non-current assets Investments in subsidiaries A 24,466 27,886 Investment in joint venture 18c 52 35 Loans owed by subsidiaries 2,607 2,641 Deferred tax assets C 9 9 Current tax assets 714 545 27,848 31,116 Current assets Loans owed by subsidiaries 132 645 Other amounts owed by subsidiaries 1,027 3,163 Other assets 115 78 Cash and cash equivalents 14 5
Called up capital 855 841 Share premium account 28b 1,223 1,189 Merger reserve D 735 735 Investment valuation reserve D 13,883 17,303 Equity compensation reserve D 89 73 Retained earnings D 3,207 2,005 Direct capital instrument 32 990 990
Loans owed to subsidiaries 1,842 3,720 Provisions 40 31 5,134 6,886 Current liabilities
Loans owed to subsidiaries 1,846 1,031 Other amounts owed to subsidiaries 191 3,157 Other creditors 65 64
Where applicable, the accounting policies of the Company are the same as those of the Group on pages 114 to 125. The notes (identified alphabetically) on pages 239 to 243 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 132 to 235.
(ii) At 31 December 2007, 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 2007 are listed on pages 268 and 269.
Wages and salaries 46 53 Social security costs 6 6 Post-retirement obligations
Tax calculated at standard UK corporation tax rate of 30% (2006: 30%) (408) 163 Adjustment to tax charge in respect of prior years 5 76 Non-assessable dividends 770 259 Disallowable expenses (11) (12) Non-taxable profit on sale of subsidiary – 28 Deferred tax asset not recognised – 7
Net asset at 1 January 9 2 Amounts credited to profit – 7
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
Subordinated debt 3,054 2,937 9.5% guaranteed bonds 2016 198 198 Commercial paper 918 733
Where subordinated debt is undated, the interest payments have not been included beyond 15 years. Annual interest payments for these borrowings are £70 million (2006: £68 million).
F – Derivative financial instruments Non-hedge derivatives The Company’s non-hedge derivative activity at 31 December 2007 was as follows: Contract/ Contract/ notional Fair value Fair value notional Fair value Fair value amount asset liability amount asset liability £m £m £m £m £m £m
Financial liabilities owed by the Company as at the balance sheet date are largely in respect of borrowings (details of which are provided in notes E and 47) and loans owed to subsidiaries. Loans owed to subsidiaries were within agreed credit terms as at the balance sheet date.
Services provided by related parties Expense Expense incurred Payable at incurred Payable at in year year end in year year end £m £m £m £m
Our responsibilities, as independent auditors, in relation to the alternative method of reporting long-term business are established in the UK by the Auditing Practices Board and our profession’s ethical guidance. We report to you our opinion as to whether the alternative method of reporting long-term business has been properly prepared in accordance with the European Embedded Value basis. We also report to you if we have not received all the information and explanations we require for our audit of the alternative method of reporting long-term business.
Operating profit before tax attributable to shareholders’ profits 4,049 Life EEV operating return 2,753 2,033 1,519 General insurance and health2 1,033 1,686
Short-term fluctuation in return of investments backing (270) general insurance and health business (184) 149 (15) Impairment of goodwill (10) (94)
(131) Amortisation and impairment of intangibles (89) (46) 29 Profit on the disposal of subsidiaries and associates 20 161
All profit is from continuing operations. 1. Excludes the proportion of the results of Morley’s fund management businesses, of our French asset management operation Aviva Gestion d’Actifs
(AGA) and other fund management operations within the Group that arises from the provision of fund management services to our Life businesses. These results are included within the Life EEV operating return.
3. Excludes the proportion of the results of Norwich Union Life Services relating to the services provided to the UK life business. These results are included within the Life EEV operating return. Other subsidiaries providing services to our life businesses do not materially impact the Group results.
Profit after tax for the year on an EEV basis, attributable to ordinary shareholders of Aviva plc 103.1c Basic (pence per share) 70.1p 105.1p 102.2c Diluted (pence per share) 69.5p 103.9p
Fair value gains on AFS securities, owner-occupied properties 66 and hedging instruments 45 42
953 Actuarial gains/(losses) on pension schemes (IFRS section: note 17c) 648 (117) Actuarial gains/(losses) on pension schemes transferred to
(90) unallocated divisible surplus and other movements (61) 3 1,650 Foreign exchange rate movements 1,122 (401) (361) Aggregate tax effect – shareholder tax (246) 27 2,200 Net income/(expense) recognised directly in equity 1,496 (466) 3,138 Profit for the year 2,134 2,879 5,338 Total recognised income and expense for the year 3,630 2,413
(1,193) Dividends and appropriations (IFRS section: note 15) (871) (762) Issue of share capital for the acquisition of AmerUs in 2006,
– net of transaction costs – 892 66 Other issues of share capital, net of transaction costs 48 43 412 Shares issued in lieu of dividends 301 203 421 Capital contribution from minority shareholders 307 397 (90) Minority share of dividends declared in the year (66) (75) 434 Minority interest in acquired/disposed subsidiaries 317 153 68 Reserves credit for equity compensation plans 50 48
Summarised consolidated balance sheet – EEV basis As at 31 December 2007
Liabilities 209,644 Gross insurance liabilities 153,040 144,230 134,581 Gross liabilities for investment contracts 98,244 88,358 9,295 Unallocated divisible surplus 6,785 9,465 5,452 Net asset value attributable to unitholders 3,980 3,810 3,464 Deferred tax liabilities 2,529 3,077 1,629 Current tax liabilities 1,189 1,262 24,740 Payables and other financial liabilities 18,060 11,364 1,290 Liabilities of operations classified as held for sale 942 –
Segmentation of summarised consolidated balance sheet – EEV basis As at 31 December 2007
Life and General Life and General related business related business businesses and other Group businesses and other Group £m £m £m £m £m £m
Total assets before acquired additional value of in-force long-term business 278,021 40,001 318,022 255,084 37,961 293,045
Acquired additional value of in-force long-term business 1,698 – 1,698 1,806 – 1,806
Net assets on an EEV basis2 23,272 1,302 24,574 20,094 764 20,858
Equity capital, capital reserves, shares held by employee trusts and other reserves 6,326 5,632
IFRS basis retained earnings 6,233 5,082 Additional EEV basis retained profit 7,694 6,817
Preference share capital and direct capital instrument 1,190 1,190 Minority interests 3,131 2,137
Per balance at 31 December 7,982 6,794 1,188 2. Analysis of long-term business net assets on an EEV basis is made up as follows: £m £m
Long-term business net assets on an EEV basis5 23,272 20,094 3. The value of the Aviva Staff Pension Scheme deficit has been notionally allocated between segments, based on current funding and the life proportion has been included within the long-term business net assets on an EEV basis.
4. Effective from 31 December 2006, the pension fund deficit notionally allocated to long-term business is net of the proportion of funding borne by the UK with-profit funds.
5. The long term business net assets on an EEV basis have been restated to include the minority interest on property investment vehicles held in the UK. This change recognises that the embedded value reflects these investments post minority interest, whereas IFRS reports these investments gross. Prior year comparatives have been restated accordingly.
The results for 2007 and 2006 have been audited by our auditors, Ernst & Young LLP. Their report in respect of 2007 is included in the Report and Accounts on page 246 of this document.
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 income statement items have been translated using an average exchange rate for the relevant period. The exchange rates adopted in this announcement are shown on page 132.
Net worth The net worth is the market value of the shareholders’ funds and the shareholders’ interest in the surplus held in the non-profit component of the long-term business funds, determined on a statutory solvency basis and adjusted to add back any non-admissible assets, and consists of the required capital and free surplus. Required capital is reported net of implicit items permitted on a local regulatory basis to cover minimum solvency margins which are assessed at a local entity basis.
The level of required capital for each business, which ranges between 100% and 150% of the EU minimum solvency requirement for our main European businesses and 250% of the EU minimum equivalent solvency requirements in the US, reflects the level of capital considered by the Directors to be appropriate to manage the business, allowing for our internal assessment of the level of market, insurance and operating risk inherent in the underlying products. The same definition of required capital is used for both existing and new business. The free surplus comprises the market value of shareholder assets in excess of local statutory reserves and required capital.
The value of in-force covered business includes an allowance for the impact of financial options and guarantees arising from best estimate assumptions (the intrinsic value) and from additional costs related to the variability of investment returns (the time value). The intrinsic value is included in the underlying value of the in-force covered business using deterministic assumptions. The time value of financial options and guarantees has been determined using stochastic modelling techniques.
Risk discount rates Under the EEV methodology, a risk discount rate (RDR) is required to express a stream of expected future distributable profits as a single value at a particular date (the present value). It is the interest rate that an investment equal to the present value would have to earn in order to be able to replicate exactly the stream of future profits. The RDR is a combination of a risk free rate to reflect the time value of money plus a risk margin to make prudent allowance for the risk that experience in future years may differ from that assumed. In particular, a risk margin is added to allow for the risk that expected additional returns on certain asset classes (e.g. equities) are not achieved.
In order to derive risk discount rates for each of our life businesses, the adjusted Group WACC is expressed as a risk margin in excess of the gross risk free interest rate used in the WACC calculation as described above. This risk margin is used for all our main businesses including the US. Business-specific discount rates are then calculated as the sum of this risk margin and the appropriate local gross risk free rate at the valuation date, based on returns on government bonds. A common risk free rate, and hence a common RDR, is used for all of our businesses within the Eurozone. Additional country-specific risk margins are applied to smaller businesses to reflect additional economic, political and business-specific risk. For example, risk margins ranging from 3.7% to 8.7% are applied to the Group’s eastern European and Asian operations. Within each business, a constant RDR has been applied in all future time periods and in each of the economic scenarios underlying the calculation of the time value of options and guarantees.
Following the review of the risk margin at 31 December 2006, the Directors decided to leave the life embedded value risk margin unchanged at 2.7%. The market assessed risk factor (beta) had reduced since the initial risk margin was originally set, implying a reduction of the risk in the life business. Following the review at 31 December 2007, the Directors have decided to maintain the life embedded value risk margin at 2.7%. Management will keep the risk margin under review and will make adjustments as necessary to reflect past trends and future expected trends in the riskiness of the life business, based on the beta.
The sensitivity disclosures on page 265 indicate the impact to the embedded value that would arise for a change in the risk discount rate.
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 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.
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; – the profit from existing business equal to: – the expected return on the value of the in-force covered business at the beginning of the period,
– experience variances caused by the differences between the actual experience during the period and expected experience based on the operating assumptions used to calculate the start of year value; – the impact of changes in operating assumptions including risk margins; – the expected investment return on the shareholders' net worth, based upon assumptions applying at the start of the year; – investment return variances caused by differences between the actual return in the period and the expected return based on economic assumptions used to calculate the start of year value; and
– the impact of changes in economic assumptions in 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 and tax) assumptions as at the end of the year.
New business contribution (after the effect of required capital) 912 683 Profit from existing business
Life EEV return before tax 2,820 3,023 Tax on operating profit (819) (630) Tax charge on other ordinary activities (1) (295)
Total long-term savings (including share of associates and joint ventures)2 4,697 3,792 38,583 30,762 1. New business margin represents the ratio of new business contribution to PVNBP, expressed as a percentage.
2. Total long-term savings includes investment sales. Investment sales are calculated as new single premiums plus annualised value of new regular premiums.
Before the effect of required capital, tax and minority interest Annual Present value of new premium equivalent business premiums New business contribution New business margin
After the effect of required capital, tax and minority interest Annual Present value of new premium equivalent business premiums New business contribution New business margin
Geographical analysis of the components of life EEV operating return Nether- Other North Aus- Asia
UK France Ireland Italy lands Poland Spain Europe Europe America Asia tralia Pacific Total 2007 £m £m £m £m £m £m £m £m £m £m £m £m £m £m
New business contribution (after the effect of required capital) 305 117 25 61 53 32 173 (5) 456 108 27 16 43 912
Life EEV operating 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 businesses. In the USA, expenses reflect a number of one-off expenses including management incentive rewards, brand awareness and investment in strategic systems.
3. Lapse experience in Poland continues to be better than the long-term assumptions set for both Life and Pension products.
4. In the UK, other experience profits include better than assumed default experience on corporate bonds and commercial mortgages.
6. In the UK, the allowance for annuitant mortality improvement has been strengthened, by increasing the minimum rates of improvement.
UK France Ireland Italy lands Poland Spain Europe Europe America Asia Australia Pacific Total 2006 £m £m £m £m £m £m £m £m £m £m £m £m £m £m
2. Mortality experience continues to be better than the assumptions set across many of our businesses.
3. Lapse experience in the UK has been worse than assumed and primarily relates to bonds and pensions. In Poland, lapses for both life and pension products have been lower than assumed resulting in the favourable experience variance.
4. In the UK, other experience profits include better than assumed default experience on corporate bonds and mortgages, and the benefit of higher than expected performance fees in Morley.
5. Maintenance expenses in the UK relate to Morley’s change in profit margin. The change in Delta Lloyd is also driven by improved asset management profitability. The adverse movement in North America is due to a reassessment of expenses in our Boston-based operations.
New business contribution (after the effect of required capital) (649) 1,285 636 Expected return on existing business – return on VIF – 892 892 Expected return on existing business – transfer to net worth 1,216 (1,216) – Experience variances and operating assumption changes 342 (270) 72 Expected return on shareholders’ net worth 334 – 334 Investment return variances and economic assumption changes 539 (473) 66
Embedded value at the end of the year – Free surplus 4,127 – Required capital1 6,331 1. Required capital is shown net of implicit items permitted by local regulators to cover minimum solvency margins.
Netherlands (including Belgium and Germany) 1,456 1,557 1,605 (442) 4,176 1. Required capital is shown net of implicit items permitted by local regulators to cover minimum solvency margins. 2. AmerUs holding company debt amounting to £349 million at 31 December 2007 (2006: £362 million) has been included within other operations.
Present Cost of Required Free value of required Embedded capital1 surplus in-force capital value 2006 £m £m £m £m £m
The shareholders’ 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. Required capital, net of implicit items, is included within the net worth.
The time value of options and guarantees (TVOG) is most significant in the United Kingdom, France, the Netherlands and the United States. In the United Kingdom, 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 traditional business including the AFER fund. 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. In the United States, this relates to crediting rate, death benefit and surrender guarantees on life business.
Royal Bank of Scotland (9) (7) Norwich Union investment funds (1) 1
Analysis of other operations’ operating result The summarised consolidated income statement – EEV basis, includes the results of the Group’s other operations as analysed below. Where subsidiaries provide services to our life businesses, that proportion has been excluded. These results are included within the Life EEV operating return. Other subsidiaries providing services to our life businesses do not materially impact the Group results.
France Ireland Italy lands Poland Spain Europe Pacific Total interest Group 2007 £m £m £m £m £m £m £m £m £m £m £m
New business contribution after effect of required capital 14 5 35 3 4 94 155 1 156 756 912
Life EEV return after tax 23 15 76 8 23 75 220 2 222 1,778 2,000
Closing life and related businesses’ embedded value 214 243 532 127 119 473 1,708 11 1,719 18,600 20,319
France Ireland Italy lands Poland Spain Europe Pacific Total interest Group 2006 £m £m £m £m £m £m £m £m £m £m £m
Life EEV operating return before tax 33 (11) 60 30 25 108 245 2 247 1,786 2,033
Life EEV return after tax 16 (7) 46 22 24 79 180 4 184 1,914 2,098
Pre-tax investment returns: Required Capital (% EU minimum, or equivalent) 125%/ 125%/ 125%/ 250% 250% 200%
Stochastic calculations The time value of options and guarantees calculation allows for expected management and policyholder actions in response to varying future investment conditions. The management actions modelled include changes to asset mix and bonus rates. Modelled policyholder actions are described under “Other assumptions”.
United Kingdom 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 evolving asset mix of the fund and assumptions over the mean and standard deviation of each asset class, together with the correlations between them.
International Model Government nominal interest rates are generated by a model that projects a full yield curve at annual intervals. The model assumes that the logarithm of the short rate follows a mean reverting process subject to two normally distributed random shocks. This ensures that nominal interest rates are always positive, the distribution of future interest rates remains credible, and the model can be calibrated to give a good fit to the initial yield curve.
Summary statistics The following table sets out the means and standard deviations of future euro and US dollar returns at 31 December 2007 for the three most significant asset classes: equities (in the case of euro), short-term bonds (defined to be of one year duration) and long-term bonds (defined to be ten year zero coupon bonds). In the accumulation of ten year bonds, it is assumed that these are held for one year, sold as nine year bonds then the proceeds are reinvested in ten year bonds, although in practice businesses follow more complex asset strategies or tend to adopt a buy and hold strategy. Correlations between asset classes have been set using the same approach as described for the United Kingdom.
Demographic assumptions Assumed future mortality, morbidity and lapse rates have been derived from an analysis of Aviva’s recent operating experience. Where appropriate, surrender and option take up rate assumptions that vary according to the investment scenario under consideration have been used in the calculation of the time value of options and guarantees, based on our assessment of likely policyholder behaviour in different investment scenarios.
Borrowings excluding non-recourse funding – EEV basis 5,374 5,069 Less: Operational financing by businesses (1,063) (874)
External debt, subordinated debt, preference shares and direct capital instrument – EEV basis 5,751 5,635 Effect of marking these instruments to market 23 356
Market value of external debt, subordinated debt, preference shares and direct capital instrument 5,774 5,991
Sensitivity analysis Economic assumptions The following tables show the sensitivity of the embedded value as at 31 December 2007 and the new business contribution before the effect of required capital for 2007 to: – one percentage point increase and decrease in the discount rates; – one percentage point increase and decrease in interest rates, including all consequential changes (including assumed investment returns for all asset classes, market values of fixed interest assets, risk discount rates); – one percentage point increase and decrease in the assumed investment returns for equity and property investments, excluding any consequential changes to the risk discount rate; – 10% rise and fall in market value of equity and property assets (not applicable for new business contribution); and
1% 10% rise in 10% fall increase in 1% decrease equity/ in equity/ EU minimum equity/ in equity/ property property capital As reported property property market market (or
Embedded value (net of tax) on page 259 returns returns values values equivalent)
Sensitivity analysis continued Sensitivities will also vary according to the current economic assumptions, mainly due to the impact of changes to both the intrinsic cost and time value of options and guarantees. Options and guarantees are the main reason for the asymmetry of the sensitivities where the guarantee impacts to different extents under the different scenarios. This can be seen in the sensitivity of a 1% movement in the interest rate for the Netherlands, where there is a significant amount of business with investment return guarantees.
Sensitivities to a 1% movement in the equity/property return will only impact the value of the in-force covered business, whereas a 10% movement in equity/property values may impact both the net worth and the value of in-force, depending on the allocation of assets.
The demographic sensitivities shown above represent a standard change to the assumptions for all products. Different products will be more or less sensitive to the change and impacts may partially offset.
United Kingdom Aviva Employment Services Limited Aviva Insurance Limited Aviva International Insurance Limited CGNU Life Assurance Limited CGU Bonus Limited CGU Underwriting Limited Commercial Union Life Assurance Company Limited Gresham Insurance Company Limited Hamilton Insurance Company Limited Hamilton Life Assurance Company Limited HPI Limited Lifetime Group Limited London and Edinburgh Insurance Company Limited Morley Fund Management Limited Morley Pooled Pensions Limited Norwich Union Annuity Limited Norwich Union Central Services Limited Norwich Union Collective Investments Limited Norwich Union Consumer Products Limited Norwich Union Equity Release Limited Norwich Union Healthcare Limited Norwich Union Insurance Limited Norwich Union Insurance Services Limited Norwich Union Investment Funds Limited Norwich Union Life (RBS) Limited Norwich Union Life & Pensions Limited Norwich Union Life Services Limited Norwich Union Risk Services Limited NUI Investments Limited RAC Auto Windscreens Limited RAC Insurance Limited RAC Motoring Services RAC plc The British School of Motoring Limited
Canada Aviva Canada Inc and its principal operating subsidiaries: Aviva Insurance Company of Canada Elite Insurance Company Pilot Insurance Company Scottish & York Insurance Co Limited S&Y Insurance Company Traders General Insurance Company
Société d’Epargne Viagére SA (75.0%) Union Financière de France Banque (Banking) (76.3%)
Italy Aviva Italia Holding S.p.A and its principal subsidiaries: Aviva Assicurazioni S.p.A (50.0%) Aviva Italia S.p.A Aviva Life SpA (50.0%) Aviva Previdenza S.p.A (50.0%) Aviva Vita S.p.A (25.5%) Eurovita Assicurazioni S.p.A (40.5%)
Netherlands Delta Lloyd N.V. (92.0%) and its principal subsidiaries: Delta Lloyd ABN AMRO Verzekeringen Holding BV (51.0%) Delta Lloyd Asset Management N.V. Delta Lloyd Bankengroep N.V. (Banking) Delta Lloyd Levensverzekering N.V. Delta Lloyd Schadeverzekering N.V. Delta Lloyd Zorgverzekering N.V. Erasmus Groep BV OHRA Schadeverzekeringen N.V. OHRA Levensverzekeringen N.V.
Spain Aseguradora Valenciana S.A., de Seguros y Reaseguros (Aseval) (50.0%) Aviva Vida y Pensiones, Sociedad Anonima de Seguros y Reaseguros Caja Espana Vida, Compania de Seguros y Reaseguros
Aviva USA Corporation and its principal operating subsidiary: Aviva Life Insurance Company
Associates and joint ventures The Group has ongoing interests in the following operations that are classified as associates or joint ventures. Further details of those operations that were most significant in 2007 are set out in notes 18 and 19.
Documents concerning the company which are referred to in the report and accounts are available for inspection at St Helen’s, 1 Undershaft, London EC3P 3DQ.
The wider use of electronic communications enables fast receipt of documents, reduces the Company’s printing, paper and postage costs and has a positive impact on the environment.
Shareholders may also cast their vote for the 2008 AGM online quickly and easily using the Sharevote service by visiting www.sharevote.co.uk or the Aviva website at www.aviva.com/agm
Managing your shareholding The Company’s Register of Members is maintained by the Company’s Registrar, Equiniti, and any shareholders who have any queries in respect of their shareholding should contact them directly by using the contact details provided on page 272. In addition to assisting with general queries the Registrar can also help with the following: Amalgamating your shareholding If shareholders received more than one copy of the Company’s communications, it could be because there is more than one record for them on the share register. To avoid duplicate mailings the Registrar can arrange for accounts to be amalgamated.
Consolidated tax vouchers Private shareholders who have dividends paid directly into their bank or building society account receive one consolidated tax voucher each year unless they have requested otherwise. If you would prefer to receive a tax voucher with each dividend payment please contact the Registrar.
Company website Visit www.aviva.com for up-to-date investor information including the Company’s latest results and key dates. An electronic copy of current and past Annual and Interim Reports can be viewed online or downloaded from the website. Shareholders can also find Aviva’s current and historic share prices, share dealing information, news, updates and, when available, presentations from the Group Chief Executive. Shareholders may also register to receive future shareholder communications electronically by visiting www.aviva.com/ecomms
Shareholder information Shareholder profile The categories of ordinary shareholders and the range and size of shareholdings as at 31 December 2007 are set out below: Analysis of shareholders No. of shareholders % No. of shares %
– Equiniti Financial Services Limited is authorised and regulated by the Financial Services Authority, registered number 6208699.
– To buy or sell shares over the telephone, shareholders can contact Barclays Stockbrokers on 0870 549 3002 (for shareholders with a share certificate) or 0870 549 3001 (for shareholders with an Aviva Share Account statement).
– Barclays Stockbrokers also offers a postal share dealing service. For further information and a postal share dealing form telephone 0870 514 3263.
Share dealing 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 documents in order to use this service and details will be provided on registration. Please note that regulations prevent this service from being offered to the residents of the United States, Canada and Australia. Settlement proceeds will be sent to either a UK sterling bank account or by sterling cheque.
Aviva plc Registered in England Number: 2468686 Registered Office: St Helen’s, 1 Undershaft, London EC3P 3DQ
Ordinary shares – 2007 final dividend Ex-dividend date 26 March Record date 28 March Scrip dividend price available 2 April Dividend payment date 16 May
General shareholding, administration and Aviva Share Account queries: Equiniti Aspect House, Spencer Road Lancing, West Sussex BN99 6DA
The voting results for the 2008 AGM, including the number of votes withheld, will be available on the Company’s website shortly after the AGM at www.aviva.com/agm *Calls to these numbers are charged at 8 pence per minute from a BT landline. Charges from other telephone providers may vary.
Cover image: An overview of our international marketing campaigns that bring the Aviva brands to life.
Regional overviews: 20 UK 32 Europe 40 North America 46 Asia Pacific 52 Finance 64 Employees and responsibility 76 Board of directors 78 Executive management 79 Directors’ report 82 Corporate governance report 88 Audit Committee report 90 Nomination Committee report 91 Risk and Regulatory Committee report 92 Corporate Social Responsibility
Financial Statements – International Financial Reporting Standards (IFRS) basis 114 Accounting policies 126 Consolidated income statement 127 Pro forma reconciliation of Group operating profit to profit before tax 129 Consolidated statement of recognised income and expense 129 Reconciliation of movements in consolidated shareholders’ equity 130 Consolidated balance sheet 131 Consolidated cash flow statement 132 Notes to the consolidated financial statements: 236 Financial statements of the Company
Designed and produced by Radley Yeldar using the paperless proofing system RingMaster®. Board photography by Marcus Ginns.
This year our annual report and accounts has been printed by Burlington. We choose Burlington because they have the important environmental certification by SGS for the FSC standards.
Also we take care to minimise the impact on the environment in the paper we use. The paper we have used, Greencoat 55 Silk, is made from 55% recycled post-consumer fibre using non-toxic, harmless de-inking residues. It also contains fibre sourced from responsibly managed and sustainable forests, certified in accordance with the FSC. And additionally, it is manufactured under strict environmental management systems, the international ISO 14001 standard and EMAS (Eco-Management & Audit Scheme).