Share of loss after tax (147) (92) (239) — (57) (57)
Additions – see note (iii) below 32 — 32 35 — 35 Reduction in Group interest — (601) (601) — (3) (3) Share of losses taken to other comprehensive income — (7) (7) — (143) (143)
Deconsolidation of Delta Lloyd — — — — (359) (359) Foreign exchange rate movements — (45) (45) — (43) (43)
The Group had no loans to associates as at 31 December 2012 (2011: £nil).
(i) Disposal of Delta Lloyd On 5 July 2012, the Group sold 37.2 million shares in Delta Lloyd for £313 million (net of costs), reducing the Group’s holding to 19.8% of Delta Lloyd’s ordinary share capital, representing 18.6% of shareholder voting rights. As the Group no longer has significant influence over Delta Lloyd, the Group ceased to account for that company as an associate from 5 July 2012. From that date, our holding was classified as a financial investment, held at fair value through profit and loss. Prior to sale, the Group’s share of Delta Lloyd’s net asset value declined to a value below its quoted market value and therefore the impairment recognised in 2011 to reduce the carrying value of the associate to the quoted market value was redundant and no longer required. The amount previously recognised as an impairment of £205 million has therefore been reversed during the current period, through the Group’s share of loss after tax of associates, after exchange movements on the opening balance of £12 million.
(ii) Impairment testing Following the business review, management have determined that the goodwill in Aviva Life Insurance Company India Limited is fully impaired. An impairment of £147 million has been recognised in respect of this associate, reducing its goodwill to nil. The recoverable amount of property management undertakings is the fair value less costs to sell of the joint venture, measured in accordance with the Groups accounting policy for Investment Property (See: Accounting Policy P).
Aviva Life Insurance Company India Limited Insurance 26.00% India SCPI Logipierre 1 Property management 44.46% France SCPI Selectipierre 2 Property management 22.16% France SCPI Ufifrance Immobilier Property management 20.40% France
Cost or valuation At 1 January 2011 126 440 9 723 409 1,707
Transfers from/(to) investment property (note 21) — (1) — — — (1) Fair value gains 32 — — — — 32
Deconsolidation of Delta Lloyd — — — 54 108 162 Impairment losses charged to restructuring costs — — — — — — Foreign exchange rate movements — — 1 3 (1) 3
Less: Assets classified as held for sale — (2) — — — (2)
Fair value losses of £3 million (2011: £2 million gains) have been charged to other comprehensive income, with the net reversal of losses previously charged to the income statement now being credited there. Owner-occupied properties are stated at their revalued amounts, as assessed by qualified external valuers. These values are assessed in accordance with the relevant parts of the current RICS Appraisal and Valuation Standards in the UK, and with current local valuation practices in other countries. This assessment, on the basis of Existing Use Value and in accordance with UK Valuations Standards (“Red book”), is the estimated amount for which a property should exchange on the date of valuation between a willing buyer and a willing seller in an arm’s-length transaction, after proper marketing wherein the parties had acted knowledgeably, prudently and without compulsion, assuming that the buyer is granted vacant possession of all parts of the property required by the business and disregarding potential alternative uses. The valuation assessment adopts market-based evidence and is in line with guidance from the International Valuation Standards Committee and the requirements of IAS 16, Property, Plant and Equipment. Similar considerations apply to properties under construction, where an estimate is made of valuation when complete, adjusted for anticipated costs to completion, profit and risk, reflecting market conditions at the valuation date. The £106 million impairment loss charged to the income statement mainly relates to Aviva USA’s property and equipment, the carrying value of which has been reduced to nil as set out in note 3c(i). If owner-occupied properties were stated on a historical cost basis, the carrying amount would be £275 million (2011: £189 million). The Group has no material finance leases for property and equipment.
Transfers (to)/from property and equipment (note 20) 89 54 143 1 — 1 Deconsolidation of Delta Lloyd — — — (2,015) (116) (2,131)
Investment property in the UK is valued at least annually by external chartered surveyors at open market values in accordance with the guidance issued by The Royal Institution of Chartered Surveyors or using internal valuations and estimates during the intervening period. Outside the UK, valuations are produced by local qualified staff of the Group or external qualified professional valuers in the countries concerned. In the event of a material change in market conditions between the valuation date and balance sheet date, adjustments are made to reflect any material changes in fair value. Values are calculated using a discounted cash flow approach and are based on current rental income plus anticipated uplifts at the next rent review, lease expiry, or break option taking into consideration lease incentives and assuming no future growth in the estimated rental value of the property. This uplift and the discount rate are derived from rates implied by recent market transactions on similar properties. The fair value of investment properties leased to third parties under operating leases at 31 December 2012 was £10,822 million (2011: £11,552 million). Future contractual aggregate minimum lease rentals receivable under the non-cancellable portion of these leases are given in note 52(b)(i).
22 – Fair value methodology This note explains the methodology for valuing our financial assets and liabilities carried at fair value, and provides an analysis of these according to a ‘fair value hierarchy’, determined by the market observability of valuation inputs.
Modelled with significant observable market inputs – (‘Level 2’) Inputs to Level 2 fair values are inputs other than quoted prices included within Level 1 that are observable for the asset or liability, either directly or indirectly. If the asset or liability has a specified (contractual) term, a Level 2 input must be observable for substantially the full term of the instrument. Level 2 inputs include the following:  Quoted prices for similar (i.e. not identical) assets and liabilities in active markets.  Quoted prices for identical or similar assets and liabilities in markets that are not active, the prices are not current, or price quotations vary substantially either over time or among market makers, or in which little information is released publicly.  Inputs other than quoted prices that are observable for the asset or liability (for example, interest rates and yield curves observable at commonly quoted intervals, volatilities, prepayment spreads, loss severities, credit risks, current property values and default rates).
 Inputs that are derived principally from, or corroborated by, observable market data by correlation or other means (marketcorroborated inputs).
Financial investments and loans (notes 23 & 25) Loans — 18,973 — 18,973 8,961 (3,397) 24,537
Financial Liabilities Non-participating investment contracts 45,032 825 442 46,299 1,400 (3,958) 43,741
Financial Liabilities Non-participating investment contracts (note 40) 42,523 1,219 248 43,990 1,669 — 45,659
Notes to the consolidated financial statements continued 22 – Fair value methodology continued (c) Further information on Level 3 financial instruments (i) The table below shows movements in the Level 3 financial assets and liabilities measured at fair value.
Less: Amounts classified as held for sale (120) — (396) (516) — — — — — —
Total net gains recognised in the income statement in the year in respect of Level 3 financial investments amounted to £959 million (2011: £387 million net losses). Included in this balance are £1,030 million net gains (2011: £354 million net losses) attributable to assets still held at the end of the year. The Group assesses the fair value hierarchy of its financial investments biannually at 30 June and 31 December. Transfers between fair value hierarchy levels are deemed to have occurred at the assessment date. Transfers into and out of Level 3 for the year arose for the following reasons:  Changes in the market observability of valuation inputs.  Changes in the market observability of inputs used to validate valuations.  Significant differences between third-party prices used for valuations and validation prices either sourced from third parties or internal models.
(ii) The principal investments classified as Level 3, and the valuation techniques applied to them, are:  Structured bond-type products held by our business in France amounting to £8.6 billion (2011: £6.1 billion), for which there is no active market. These bonds are valued either using third-party counterparty or broker quotes. These bonds are validated against internal or third-party models. These bonds have been classified as Level 3 because either (i) the third-party models included a significant unobservable liquidity adjustment or (ii) differences between the valuation provided by the counterparty and broker quotes and the validation model were sufficiently significant to result in a Level 3 classification. At 31 December 2012, the values reported in respect of these products were the lower of counterparty and broker quotes and modelled valuations.
 External hedge funds held principally by businesses in the UK, the US and France amounting to £1.3 billion (2011: £1.3 billion). Valuations received from fund managers are based on net asset values. However, insufficient information is provided on the underlying fund assets to support a classification other than Level 3.
 Other Level 3 investments amount to £0.9 billion (2011: £1.0 billion) and relate to a diverse range of different types of securities held by a number of businesses throughout the Group.
On the basis of the methodology outlined above, the Group is able to perform sensitivity analysis for £12.3 billion of the Group’s Level 3 investments. For these Level 3 investments, changing unobservable valuation inputs to a reasonable alternative would result in a change in fair value in the range of £558 million positive impact and £623 million adverse impact. Of the £1.1 billion Level 3 investments for which sensitivity analysis is not provided, £0.8 billion relates to investments held in unitlinked and participating funds mainly in France where investment risk is predominantly borne by policyholders and therefore shareholder profit before tax is insensitive to reasonable changes in fair value of these investments. The remaining £0.3 billion of Level 3 investments are held to back non-linked shareholder business and it is estimated that a 10% change in valuation of these investments would reduce shareholder profit before tax by £30 million.
Loans to brokers and other intermediaries — 89 89 — 96 96
Less: Amounts classified as held for sale (56) (3,341) (3,397) — — —
Loans to brokers and other intermediaries 89 — 89 96 — 96
The movements in the impairment provisions on these loans for the years ended 31 December 2011 and 2012 were as follows: £m £m
Increase during the year (45) (66) Write back following sale or reimbursement 2 2 Write back following recovery in value 9 39 Deconsolidation of Delta Lloyd — 72 Foreign exchange rate movements — —
(c) Collateral The Group holds collateral in respect of loans where it is considered appropriate in order to reduce the risk of non-recovery. This collateral generally takes the form of liens or charges over properties and, in the case of policy loans, the underlying policy for the majority of the loan balances above. In all other situations, the collateral must be in a readily realisable form, such as listed securities, and is held in segregated accounts. Transfer of title for the collateral received always occurs in such cases, although no market risk or benefit is taken. 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 £4,560 million (2011: £4,601 million). No collateral was actually sold or repledged in the absence of default during the year (2011: £nil).
Loan notes held by third parties are as follows: £m £m
Total loan notes issued, as above 1,515 1,486 Less: Loan notes held by Group companies (183) (180)
(a) Carrying amount Financial investments comprise: At fair value through profit or loss At fair value through profit or loss
Convertibles and bonds with warrants attached — 465 6 471 — 418 17 435
Redeemable preference shares — — — — — — 5 5
Other investments – short-term — — — — — — — —
Of the above total, £129,448 million (2011: £154,116 million) is due to be recovered in more than one year after the statement of financial position date. Other debt securities of £8,829 million (2011: £7,539 million) primarily include residential and commercial mortgage-backed securities, as well as other structured credit securities.
Unit trusts and specialised investment vehicles 25,966 1,647 (857) 26,756 27,416 74 (230) 27,260
Deposits with credit institutions 739 — — 739 427 — — 427 Minority holdings in property management undertakings 599 123 (138) 584 639 124 (146) 617
These are further analysed as follows: At fair value through profit or loss 180,006 20,202 (5,171) 195,037 183,959 13,555 (10,757) 186,757
Charge for the year taken to the income statement (12) — (2) (14) (19) (2) — (21) Write back following sale or reimbursement 49 — — 49 28 — — 28 Write back following recovery in value — 1 — 1 — — — — Deconsolidation of Delta Lloyd — — — — 16 822 — 838 Foreign exchange rate movements 5 — — 5 — — — —
Non-cash collateral received The Group receives collateral in order to reduce the credit risk of these arrangements. Collateral must be in a readily realisable form, such as listed securities, and is held in segregated accounts. Transfer of title always occurs for collateral received, although no market risk or economic benefit is taken. The level of collateral held is monitored regularly, with further collateral obtained where this is considered necessary to manage the Group’s risk exposure. In 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 amount of financial assets received
Notes to the consolidated financial statements continued 25 – Financial investments continued in this manner at 31 December 2012 was £16,043 million (2011: £20,053 million). The value of collateral that was actually sold in the absence of default was £nil (2011: £150 million).
Cash collateral received In addition to the above, the Group has received cash collateral under stock lending arrangements that has been recognised in the statement of financial position with a corresponding obligation for its return. The latter balance is included in note 49.
(ii) Other arrangements In carrying on its bulk purchase annuity business, the Group’s UK Life operation is required to place certain investments in trust on behalf of the policyholders. Amounts become payable from the trust funds to the trustees if the Group were to be in breach of its payment obligations in respect of policyholder benefits. At 31 December 2012 £1,208 million (2011: £1,044 million) of financial investments were restricted in this way. Certain financial investments are also required to be deposited under local laws in various overseas countries as security for the holders of policies issued in those countries. Other investments are pledged as security collateral for bank letters of credit.
(e) Non UK Government Debt Securities (gross of non-controlling interests) The following is a summary of non UK government debt by issuer as at 31 December 2012 analysed by policyholder, participating and shareholder funds.
Total (excluding assets held for sale) 2,471 2,208 31,044 28,780 9,834 10,524 43,349 41,512
At 31 December 2012, the Group’s total government (non-UK) debt securities stood at £46.4 billion (2011: £41.6 billion), an increase of £4.8 billion. The significant majority of these holdings are within our participating funds where the risk to our shareholders is governed by the nature and extent of our participation within those funds. Our direct shareholder asset exposure to government (non-UK) debt securities amounts to £12.1 billion (2011: £10.5 billion). The primary exposures, relative to total shareholder (non-UK) government debt exposure, are to French (16%), German (8%), Spanish (7%) and Italian (5%) (non-UK) government debt securities. The participating funds exposure to (non-UK) government debt amounts to £31.6 billion (2011: £28.8 billion), an increase of £2.8 billion. The primary exposures, relative to total (non-UK) government debt exposures included within our participating funds, are to the (non-UK) government debt securities of France (29%), Italy (27%), Germany (8%), Belgium (4%), Spain (4%), Netherlands (4%) and Poland (3%).
Less: assets of operations classified as held for sale 1.3 1.0 2.3 0.1 0.1 0.2
Total (excluding assets held for sale) 2.9 1.3 4.2 11.6 3.8 15.4
Total (excluding assets held for sale) 3.5 1.3 4.8 13.1 4.3 17.4
Gross of non-controlling interests, our direct shareholder assets exposure to worldwide bank debt securities is £7.3 billion. The majority of our holding (67%) is in senior debt. The primary exposures are to US (30%) and UK (19%) banks. Gross of non-controlling interests, our direct shareholder asset exposure to worldwide bank equity securities is £0.4 billion. Our holdings include strategic holdings in Italian banks of £289 million. Gross of non-controlling interests, the participating fund exposures to worldwide bank debt securities, where the risk to our shareholders is governed by the nature and extent of our participation within those funds, is £17.7 billion. The majority of the exposure (75%) is in senior debt. Participating funds are the most exposed to French (28%), UK (14%) and Dutch (13%) banks.
Notes to the consolidated financial statements continued 26 – Receivables This note analyses our total receivables.
Amounts owed by contract holders 1,693 1,838 Amounts owed by intermediaries 1,398 1,139 Deposits with ceding undertakings 1,395 1,426 Amounts due from reinsurers 367 339 Amounts due from brokers for investment sales 444 270 Amounts receivable for cash collateral pledged 241 26 Amounts due from government, social security and taxes 521 467 Corporate owned life insurance 162 156 Dividends receivable 6 109 Finance lease receivables 141 200 Other receivables 1,662 1,978
Expected to be recovered in less than one year 7,525 7,713 Expected to be recovered in more than one year 92 224
27 – Deferred acquisition costs, other assets, prepayments and accrued income (a) Deferred acquisition costs and other assets – carrying amount The carrying amount comprises: £m £m
Deferred acquisition costs in respect of: Insurance contracts – Long-term business 2,122 2,733 Insurance contracts – General insurance and health business 939 986 Participating investment contracts – Long-term business 30 21 Non-participating investment contracts – Long-term business 936 1,024 Retail fund management business 14 14
Total deferred acquisition costs 4,041 4,778 Surpluses in the staff pension schemes (note 47 (e) (vii)) 1,257 1,670 Other assets 56 19
Notes to the consolidated financial statements continued 27 – Deferred acquisition costs, other assets, prepayments and accrued income continued (b) Deferred acquisition costs – movements in the year The movements in deferred acquisition costs (DAC) during the year were: Long-term business £m
Impact of assumption changes (201) — — (201) (48) — — (48) Effect of portfolio transfers, acquisitions and disposals (15) (1) — (16) — (18) — (18)
Less: Amounts classified as held for sale (1,538) — — (1,538) (23) — — (23)
(c) Other assets Other assets include £3 million (2011: £6 million) that is expected to be recovered more than one year after the statement of financial position date.
28 – Assets held to cover linked liabilities Certain unit-linked products have been classified as investment contracts, while some are included within the definition of an insurance contract. The assets backing these unit-linked liabilities are included within the relevant balances in the consolidated statement of financial position, while the liabilities are included within insurance and investment contract provisions. This note analyses the carrying values of assets backing these liabilities.
Notes to the consolidated financial statements continued 29 – Ordinary share capital This note gives details of Aviva plc’s ordinary share capital and shows the movements during the year.
The allotted, called up and fully paid share capital of the Company at 31 December 2012 was: 2,945,972,261 (2011: 2,905,712,938) ordinary shares of 25 pence each 736 726
Shares issued in lieu of dividends 36,923,757 9 (9) 83,989,590 21 (21)
(a) Description of the plans The Group maintains a number of active share option and award plans and schemes (the Group’s Share Plans). These are as follows: (i) Savings-related options These are options granted under the HMRC-approved Save As You Earn (SAYE) share option schemes in the UK and Irish Revenueapproved SAYE share option scheme in Ireland. Options are normally exercisable during the six-month period following either the third, fifth or seventh anniversary of the start of the relevant savings contract. Options granted in 2012 are normally exercisable following the third or fifth anniversary.
(b) Outstanding options and awards (i) Share options At 31 December 2012, options to subscribe for ordinary shares of 25 pence each in the Company were outstanding as follows: Aviva Savings Related Share Option Scheme
The comparative figures as at 31 December 2011 were: Range of exercise prices
Aviva Long Term Incentive Plan 2011 Number of shares Vesting period
One Aviva, twice the value bonus plan Number of shares Vesting period
Granted during the year 6,236,944 269.02 13,486,990 268.00 Exercised during the year (2,862,952) 315.24 (182,907) 353.26 Forfeited during the year (2,187,371) 337.96 (1,089,738) 347.58 Cancelled during the year (3,282,095) 300.34 (7,142,132) 320.36 Expired during the year (2,766,300) 432.85 (2,254,869) 539.48
(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 Binomial option pricing model, were £0.70 and £2.61 (2011: £0.99 and £4.20) respectively.
Share price 326p 312p Exercise price 266p 268p Expected volatility 41% 58% Expected life 3.71 years 3.64 years Expected dividend yield 7.98% 6.40% Risk-free interest rate 0.37% 0.89%
Share price 331.54p 435.70p Expected volatility1 37% 66% Expected volatility of comparator companies’ share price1 38% 65% Correlation between Aviva and competitors’ share price1 63% 57% Expected life 3.00 years 3.00 years Expected dividend yield2 n/a n/a Risk-free interest rate1 0.42% 1.79% 1 For awards with market-based performance conditions. 2 The long term incentive plan awards granted in 2011 and 2012 include additional shares being provided to employees equal to dividend rights before vesting. As a result, no dividend yield assumption is required for these awards.
32 – Preference share capital This note gives details of Aviva plc’s preference share capital. The preference share capital of the Company at 31 December 2012 was: £m £m
Notional amount 2012 £m £m 5.9021% £500 million direct capital instrument 500 500 4.7291% €700 million direct capital instrument 490 490
Issued May 2012 8.25% US $650 million fixed rate tier 1 notes 392 —
No interest will accrue on any deferred coupon. Deferred coupons will be satisfied by the issue and sale of ordinary shares in the Company at their prevailing market value, to a sum as near as practicable to (and at least equal to) the relevant deferred coupons. In the event of any coupon deferral, the Company will not declare or pay any dividend on its ordinary or preference share capital. These instruments have been treated as equity. Please refer to accounting policy AD.
34 – Merger reserve This note describes the use of the merger reserve. Prior to 1 January 2004, certain significant business combinations were accounted for using the ‘pooling of interests method’ (or merger accounting), which treats the merged groups as if they had been combined throughout the current and comparative accounting periods. Merger accounting principles for these combinations gave rise to a merger reserve in the consolidated statement of financial position, being the difference between the nominal value of new shares issued by the Parent Company for the acquisition of the shares of the subsidiary and the subsidiary’s own share capital and share premium account. The merger reserve is also used where more than 90% of the shares in a subsidiary are acquired and the consideration includes the issue of new shares by the Company, thereby attracting merger relief under the Companies Act 1985 and, from 1 October 2009, the Companies Act 2006. The balance on the reserve of £3,271 million (2011: £3,271 million) has arisen through the mergers of Commercial Union, General Accident and Norwich Union companies, forming Aviva plc in 2000, together with the acquisition of RAC plc (“RAC”) in 2005. Because RAC ownership was immediately transferred from Aviva plc to a subsidiary company, this reserve is unaffected by the disposal of RAC in 2011.
Arising in the year: Fair value gains — 2 424 — — 426 Fair value gains transferred to profit on disposals — — (189) — — (189) Transfer to profit on disposal of subsidiary (3) — — — — (3) Fair value gains transferred to retained earnings on disposals (note 36) — (6) — — — (6) Share of fair value changes in joint ventures and associates taken to other comprehensive income (note 18a & 19a) — 1 (86) — — (85) Impairment losses on assets previously revalued directly through other comprehensive income now taken to income statement — — 21 — — 21 Reserves credit for equity compensation plans — — — — 48 48 Shares issued under equity compensation plans (note 36) — — — — (61) (61) Transfer to profit on deconsolidation of Delta Lloyd (485) — (115) — — (600) Transfer to retained earnings on deconsolidation of Delta Lloyd — (2) — — — (2) Foreign exchange rate movements (174) — — 30 — (144) Aggregate tax effect – shareholders’ tax 9 1 (98) — — (88)
Included in the above are £1.0 billion of currency translation and investment valuation reserves at 31 December 2012 relating to discontinued operations.
Balance at 1 January 5,954 5,411 (Loss)/profit for the year attributable to equity shareholders (3,218) 225 Actuarial (losses)/gains on pension schemes (note 47 (e) (iv)) (830) 1,002 Other pension scheme movements — (22) Dividends and appropriations (note 15) (847) (813) Shares issued in lieu of dividends 127 307 Shares issued under equity compensation plans (note 35) 67 61 Shares distributed by employee trusts (note 31) (36) (18) Fair value gains realised from reserves (note 35) — 6 Effect of deconsolidation of Delta Lloyd — 2 Share of other comprehensive income of joint ventures and associates — (51) Aggregate tax effect 172 (156)
Equity shares in subsidiaries 424 480 Share of earnings 643 501 Share of other reserves 257 299
Balance at 1 January 1,530 3,741 (Loss)/profit for the year attributable to non-controlling interests 168 (165) Non-controlling interests share of movements in other reserves 1 (16) Foreign exchange rate movements (37) 14 Total comprehensive income attributable to non-controlling interests 132 (167) Capital contributions from non-controlling interests 20 68 Non-controlling interests share of dividends declared in the year (102) (126) Changes in non-controlling interests in existing subsidiaries (6) (11) Reclassification to financial liabilities (see below) — (205) Effect of deconsolidation of Delta Lloyd — (1,770)
As explained in note 3, the minority shareholder in an Irish subsidiary has an option requiring the Group to purchase its shares. As a result of this obligation, the Group has reclassified this non-controlling interest to financial liabilities in the consolidated statement of financial position. This option was exercised on 17 January 2012, with completion expected in 2013.
38 – Contract liabilities and associated reinsurance The following notes explain how the Group calculates its liabilities to policyholders for insurance and investment products it has sold to them. Notes 39 and 40 cover these liabilities, and note 41 details the financial guarantees and options given for some of these products. Note 42 details the reinsurance recoverables on these liabilities while note 43 shows the effects of changes in the assumptions. The following is a summary of the contract provisions and related reinsurance assets as at 31 December.
Provisions for claims incurred but not reported (2,843) 354 (2,489) (2,646) 395 (2,251)
Provision for claims incurred but not reported — 2,843 2,843 — 2,646 2,646
– The RIEESA of UKLAP, which is a non-profit fund where shareholders are entitled to 100% of the distributed profits, but these cannot be distributed until the ‘lock-in’ criteria set by the Reattribution Scheme have been met. RIEESA will be used to write non-profit business and also to provide capital support to NWPSF.
 In other operations in Europe and Asia, a range of long-term insurance and savings products are written.
Notes to the consolidated financial statements continued 39 – Insurance liabilities continued (ii) Group practice The long-term business provision is calculated separately for each of the Group’s life operations. The provisions for overseas subsidiaries have generally been included on the basis of local regulatory requirements, modified where necessary to reflect the requirements of the Companies Act 2006. Material judgement is required in calculating the provisions and is exercised particularly through the choice of assumptions where discretion is permitted. In turn, the assumptions used depend on the circumstances prevailing in each of the life operations. Provisions are most sensitive to assumptions regarding discount rates and mortality/morbidity rates. Where discount rate assumptions are based on current market yields on fixed interest securities, allowance is made for default risk implicit in the yields on the underlying assets. In 2010, a test case was taken to the European Court of Justice to rule on the current law and practice whereby insurers may take into account a person’s gender in the assessment of risk and consequently the pricing of insurance products. The ruling was issued on 1 March 2011 and required gender equality for pricing from 21 December 2012. The impact of the ruling on existing long-term business provisions in our UK and European businesses is not considered to be material. Bonuses paid during the year are reflected in claims paid, whereas those allocated as part of the bonus declaration are included in the movements in the long-term business provision. For UK with-profit life funds falling within the scope of the FSA realistic capital regime, and hence FRS 27, an amount may be recognised for the present value of future profits (PVFP) on non-participating business written in a with-profit fund where the determination of the realistic value of liabilities in that with-profit fund takes account, directly or indirectly, of this value. For our UK with-profit funds, no adjustment for this value is made to the participating insurance and investment contract liabilities or the unallocated divisible surplus.
(a) UK With-profit business The valuation of with-profit business uses the methodology developed for the Realistic Balance Sheet, adjusted to remove the shareholders’ share of future bonuses. The key elements of the Realistic Balance Sheet methodology are the with-profit benefit reserve (WPBR) and the present value of the expected cost of any payments in excess of the WPBR (referred to as the cost of future policyrelated liabilities). The realistic liability for any contract is equal to the sum of the WPBR and the cost of future policy-related liabilities. The WPBR for an individual contract is generally calculated on a retrospective basis, and represents the accumulation of the premiums paid on the contract, allowing for investment return, taxation, expenses and any other charges levied on the contract. For a small proportion of business, a prospective valuation approach is used, including allowance for anticipated future regular and final bonuses. The items included in the cost of future policy-related liabilities include:  Maturity Guarantees;  Guaranteed Annuity Options;  GMP underpin on Section 32 transfers; and  Expected payments under Mortgage Endowment Promise.
The equity volatility used depends on term, money-ness and region. The figure shown is for a sample UK equity, at the money, with a ten-year term. Fixed interest yield volatility is also dependent on term and money-ness. The figure shown is for a ten-year swap option with ten-year team, currently at the money.
Future regular bonuses Annual bonus assumptions for 2012 have been set consistently with the year-end 2011 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 for with-profit business are set with regard to recent Company experience and general industry trends. The mortality tables used in the valuation are summarised below: Mortality table used 2012 2011
Income Protection Active lives 2.2% 2.4% Claims in payment – level 3.1% 3.6% Claims in payment – index linked (0.7)% (1.0)%
Annuities in payment Pensions business PCMA00/PCFA00 adjusted plus allowance for future mortality improvement
For pensions annuity business in 2012, the underlying mortality assumptions for Males are 100.5% of PCMA00 with base year 2000, improvements based on CMI_2011 with a long-term improvement rate of 1.5% and an addition of 0.5% to all future annual improvements; for Females the underlying mortality assumptions are 95.5% of PCFA00 with base year 2000, improvements based on CMI_2011 with a long-term improvement rate of 1.0% and an addition of 0.5% to all future annual improvements. Year-specific adjustments are made to allow for selection effects due to the development of the Enhanced Annuity market.
Notes to the consolidated financial statements continued 39 – Insurance liabilities continued (c) United States For the major part of our US business, insurance liabilities are measured in accordance with US GAAP as at the date of acquisition. The liability for future policy benefits for traditional life insurance is computed using the net level method, based on guaranteed interest and mortality rates as used in calculating cash surrender values. Reserve interest assumptions ranged from 2.00% to 7.50% in 2012 (2011: 2.00% to 7.50%). The weighted average interest rate for all traditional life policy reserves in 2012 was 4.50% (2011: 4.50%). Future policy benefit reserves for universal life insurance, deferred annuity products and funding agreements are computed under a retrospective deposit method and represent policy account balances before applicable surrender charges. For the indexed products, the liability held is calculated based on the option budget method and is equal to the host contract and the calculated value of the derivative. The value of the derivative is based on the present value of the difference between the projected fund value and the underlying fund guarantee. The range of interest crediting rates for deferred annuity products, the largest component of the US business, excluding sales inducement payouts, was 1.00% to 5.20% in 2012 (2011: 1.00% to 5.20%). An additional liability is established for universal life contracts with death or other insurance benefit features, which is determined using an equally weighted range of scenarios with respect to investment returns, policyholder lapses, benefit election rates, premium payout patterns and mortality. The additional liability represents the present value of future expected benefits based on current product assumptions. The indexed life and annuity products guarantee the return of principal to the customer, and credit interest based on certain indices. A portion of the premium from each customer is invested in fixed income securities and is intended to cover the minimum guaranteed value. A further portion of the premium is used to purchase derivatives to hedge the growth in interest credited to the customer as a direct result of increases in the related indices. Both the derivatives and the options embedded in the policy are valued at their fair value. Deferred income reserves are established for fees charged for insurance benefit features which are assessed in a manner that is expected to result in higher profits in earlier years, followed by lower profits or losses in subsequent years. The excess charges are deferred and amortised using the same assumptions and factors used to amortise deferred acquisition costs. Deferred income reserves of £85 million in respect of insurance contracts in the United States are included under Other liabilities – Deferred income in note 50. Shadow adjustments may be made to deferred acquisition costs, acquired value of in-force business, deferred income reserves and contract liabilities. The shadow adjustments are recognised directly in other comprehensive income so that unrealised gains or losses on investments that are recognised directly in other comprehensive income affect the measurement of the liability, or related assets, in the same way as realised gains or losses.
Notes to the consolidated financial statements continued 39 – Insurance liabilities continued (c) General insurance and health liabilities (i) 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 statement of financial position date. The reserves for general insurance and health business 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. Provisions for outstanding claims are established to cover the outstanding expected ultimate liability for losses and loss adjustment expenses (LAE) in respect of all claims that have already occurred. The provisions established cover reported claims and associated LAE, as well as claims incurred but not yet reported and associated LAE. The Group only establishes loss reserves for losses that have already occurred. The Group therefore does not establish catastrophe equalisation reserves that defer a share of income in respect of certain lines of business from years in which a catastrophe does not occur to future periods in which catastrophes may occur. When calculating reserves, the Group takes into account estimated future recoveries from salvage and subrogation, and a separate asset is recorded for expected future recoveries from reinsurers after considering their collectability. The table below shows the split of total general insurance and health outstanding claim provisions and IBNR provisions, gross of reinsurance, by major line of business.
Notes to the consolidated financial statements continued 39 – Insurance liabilities continued The assumptions used in most non-life actuarial projection techniques, including future rates of claims inflation or loss ratio assumptions, are 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 a point estimate for the ultimate cost of claims that represents the likely outcome, from a range of possible outcomes, taking account of all the uncertainties involved. The range of possible outcomes does not, however, result in the quantification of a reserve range. As noted in section in section (b)(ii) – Group Practice, an area of judgement is the impact of a European Court of Justice ruling in March 2011 on gender equality for the pricing of insurance products. At 31 December 2012, the impact of the ruling on existing general business provisions was not considered to be material. The following explicit assumptions are made which could materially impact the level of booked net reserves: UK mesothelioma claims The level of uncertainty associated with latent claims is considerable due to the relatively small number of claims and the long-tail nature of the liabilities. UK mesothelioma claims account for a large proportion of the Group’s latent claims. The key assumptions underlying the estimation of these claims include claim numbers, the base average cost per claim, future inflation in the average cost of claims and legal fees. The best estimate of the liabilities reflects the latest available market information and studies. Many different scenarios can be derived by flexing these key assumptions and applying different combinations of the different assumptions. An upper and lower scenario can be derived by making reasonably likely changes to these assumptions, resulting in an estimate £240 million greater than the best estimate, or £65 million lower than the best estimate. These scenarios do not, however, constitute an upper or lower bound on these liabilities.
Allowance for risk and uncertainty The uncertainties involved in estimating loss reserves are allowed for in the reserving process and by the estimation of explicit reserve uncertainty distributions. The reserve estimation basis for non-life claims requires all non-life businesses to calculate booked claim provisions as the best estimate of the cost of future claim payments, plus an explicit allowance for risk and uncertainty. The allowance for risk and uncertainty is calculated by each business unit in accordance with the requirements of the Group non-life reserving policy, taking into account the risks and uncertainties specific to each line of business and type of claim in that territory. The requirements of the Group non-life reserving policy also seek to ensure that the allowance for risk and uncertainty is set consistently across both business units and reporting periods. Changes to claims development patterns can materially impact the results of actuarial projection techniques. However, allowance for the inherent uncertainty in the assumptions underlying reserving projections is automatically allowed for in the explicit allowance for risk and uncertainty included when setting booked reserves. Lump sum payments in settlement of bodily injury claims decided by the UK courts are calculated in accordance with the Ogden Tables. The Ogden Tables contain a discount rate that is set by the Lord Chancellor and that is applied when calculating the present value of loss of earnings for claims settlement purposes. The process for setting this discount rate is currently under review. The timing of the conclusion of this review is unclear and it is still uncertain whether or by how much the rate will change. However an allowance has been included in provisions for a reduction in the Ogden discount rates. A reduction in the Ogden discount rates will increase lump sum payments to UK bodily injury claimants.
Notes to the consolidated financial statements continued 39 – Insurance liabilities continued (iv) Movements The following changes have occurred in the general insurance and health claims provisions during the year: £m £m
Incurred claims losses and expenses 6,153 6,574 Less: Payments made on claims incurred in the current year (3,243) (3,393) Payments made on claims incurred in prior years (3,104) (3,514) Recoveries on claim payments 297 313
Claims payments made in the year, net of recoveries (6,050) (6,594) Unwind of discounting 35 47 Other movements in the claims provisions 2 (12)
Changes in claims reserve recognised as an expense 140 15 Effect of portfolio transfers, acquisitions and disposals (171) — Deconsolidation of Delta Lloyd — (1,445) Foreign exchange rate movements (158) (87) Other movements (2) (1)
(d) Loss development tables (i) Description of tables The tables that follow present the development of claim payments and the estimated ultimate cost of claims for the accident years 2003 to 2012. The upper half of the tables shows the cumulative amounts paid during successive years related to each accident year. For example, with respect to the accident year 2003, by the end of 2012 £5,727 million had actually been paid in settlement of claims. In addition, as reflected in the lower section of the table, the original estimated ultimate cost of claims of £6,385 million was reestimated to be £5,791 million at 31 December 2012. The original estimates will be increased or decreased, as more information becomes known about the individual claims and overall claim frequency and severity. The Group aims to maintain strong reserves in respect of its general insurance and health business in order to protect against adverse future claims experience and development. As claims develop and the ultimate cost of claims become more certain, the absence of adverse claims experience will result in a release of reserves from earlier accident years, as shown in the loss development tables and movements table (c)(iv) above. However, in order to maintain overall reserve adequacy, the Group establishes strong reserves in respect of the current accident year (2012) where the development of claims is less mature and there is much greater uncertainty attaching to the ultimate cost of claims. Releases from prior accident year reserves are also due to an improvement in the estimated cost of claims. Key elements of the movement in prior accident year general insurance and health net provisions during 2012 were:  £47 million release from UK & Ireland, including Group reinsurance business, due to favourable development in Group reinsurance, health and across a number of lines of business in Ireland.  £51 million release from Europe mainly due to favourable development of personal motor and commercial property claims in France.  £122 million release from Canada mainly due to continued favourable experience on motor, following the legislative changes in Ontario.
 £92 million release from Canada mainly due to favourable experience on motor, following the legislative changes in Ontario, and commercial liability.
Notes to the consolidated financial statements continued 39 – Insurance liabilities continued (ii) Gross figures Before the effect of reinsurance, the loss development table is: Accident year All prior years £m 2003 £m £m £m £m £m £m £m
Gross cumulative claim payments At end of accident year (2,819) (2,971) (3,345) (3,653) (4,393) (4,915) (3,780) (3,502) (3,420) (3,055) One year later (4,190) (4,561) (5,011) (5,525) (6,676) (7,350) (5,464) (5,466) (4,765) Two years later (4,613) (4,981) (5,449) (5,971) (7,191) (7,828) (6,102) (5,875) Three years later (4,972) (5,263) (5,784) (6,272) (7,513) (8,304) (6,393) Four years later (5,258) (5,448) (6,001) (6,531) (7,836) (8,607) Five years later (5,409) (5,617) (6,156) (6,736) (8,050) Six years later (5,527) (5,725) (6,311) (6,936) Seven years later (5,594) (5,792) (6,467) Eight years later (5,660) (5,826) Nine years later (5,727) Estimate of gross ultimate claims At end of accident year 6,385 6,891 7,106 7,533 8,530 9,508 7,364 6,911 6,428 6,201 One year later 6,172 6,557 6,938 7,318 8,468 9,322 7,297 7,006 6,330 Two years later 6,124 6,371 6,813 7,243 8,430 9,277 7,281 6,950 Three years later 6,036 6,178 6,679 7,130 8,438 9,272 7,215 Four years later 5,932 6,008 6,603 7,149 8,409 9,235 Five years later 5,853 6,003 6,605 7,167 8,446 Six years later 5,813 5,953 6,591 7,167 Seven years later 5,792 5,933 6,596 Eight years later 5,798 5,926 Nine years later 5,791 Estimate of gross ultimate claims 5,791 5,926 6,596 7,167 8,446 9,235 7,215 6,950 6,330 6,201
Notes to the consolidated financial statements continued 39 – Insurance liabilities continued (iii) Net of reinsurance After the effect of reinsurance, the loss development table is: In the loss development tables shown above, the cumulative claim payments and estimates of cumulative claims for each accident year are translated into sterling at the exchange rates that applied at the end of that accident year. The impact of using varying exchange rates is shown at the bottom of each table. Disposals are dealt with by treating all outstanding and IBNR claims of the disposed entity as ‘paid’ at the date of disposal. The loss development tables above include information on asbestos and environmental pollution claims provisions from business written before 2003. The undiscounted claim provisions for continuing operations, net of reinsurance, in respect of this business at 31 December 2012 were £1,003 million (2011: £929 million). The movement in the year reflects strengthening of provisions by £8 million in the UK (2011: exceptional strengthening of £35 million), other increases in undiscounted provisions of £51 million (2011: £23 million), reclassification of commercial liability provisions of £55 million, claim payments, reinsurance recoveries and foreign exchange rate movements.
The variance between actual and expected experience of £1.0 billion was primarily driven by favourable movements in investment markets in 2012. The rise in investment markets increased the value of unit linked contracts, which comprise the vast majority of the non-participating investment contract liabilities. For unit-linked investment contracts, movements in asset values are offset by corresponding changes in liabilities, limiting the net impact on profit. Minor variances arise from differences between actual and expected experience for persistency, mortality and other demographic factors. The impact of assumption changes in the above analysis shows the resulting movement in the carrying value of non-participating investment contract liabilities. The impact of assumption changes on profit are included in the effect of changes in assumptions and estimates during the year shown in note 43, which combines participating and non-participating investment contracts together with the impact of movements in related non-financial assets.
(i) Guaranteed annuity options Similar options to those written in the with-profit fund have been written in relation to non-profit products. Provision for these guarantees does not materially differ from a provision based on a market-consistent stochastic model, and amounts to £35 million at 31 December 2012 (2011: £35 million).
(ii) Guaranteed unit price on certain products Certain unit-linked pension products linked to long-term life insurance funds provide policyholders with guaranteed benefits at retirement or death. No additional provision is made for this guarantee as the investment management strategy for these funds is designed to ensure that the guarantee can be met from the fund, mitigating the impact of large falls in investment values and interest rates.
Guaranteed death and maturity benefits In France, the Group has also sold unit-linked policies where the death and/or maturity benefit is guaranteed to be at least equal to the premiums paid. The reserve held in the Group’s consolidated statement of financial position at the end of 2012 for this guarantee is £101 million (2011: £130 million). The reserve is calculated on a prudent basis and is in excess of the economic liability. At the end of 2012, total sums at risk for these contracts were £223 million (2011: £631 million) out of total unit-linked funds of £12 billion (2011: £12 billion). The average age of policyholders was approximately 54. It is estimated that this liability would increase by £88 million (2011: £96 million) if yields were to decrease by 1% per annum and by £21 million (2011: £26 million) if equity markets were to decline by 10% from year end 2012 levels. These figures do not reflect our ability to review the tariff for this option.
(ii) 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 £256 million (2011: £271 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. These GAOs are ‘in the money’ at current interest rates but the exposure to interest rates under these contracts has been hedged through the use of reinsurance, using derivatives (swaptions). The swaptions effectively guarantee that an interest rate of 5% will be available at the vesting date of these benefits so there is reduced exposure to a further decrease in interest rates.
(iii) Spain and Italy Guaranteed investment returns and guaranteed surrender values The Group has also written contracts containing guaranteed investment returns and guaranteed surrender values in both Spain and Italy. Traditional profit-sharing products receive an appropriate share of the investment return, assessed on a book value basis, subject to a guaranteed minimum annual return of up to 6% in Spain and 4% in Italy on existing business, while on new business the maximum guaranteed rate is lower. Liabilities are generally taken as the face value of the contract plus, if required, an explicit provision for guarantees calculated in accordance with local regulations. At 31 December 2012, total liabilities for the Spanish business were £3 billion (2011: £3 billion) with a further reserve of £0.1 million (2011: £5.1 million) for guarantees. Total liabilities for the Italian business were £10 billion (2011: £11 billion), with a further provision of £45 million (2011: £43 million) for guarantees. Liabilities are most sensitive to changes in the level of interest rates. It is estimated that provisions for guarantees would need to increase by £5 million (2011: £18 million) in Spain and £1 million (2011: £5 million) in Italy if interest rates fell by 1% from end 2012 values. Under this sensitivity test, the guarantee provision in Spain is calculated conservatively, assuming a long-term market interest rate of 1.89% and no lapses or premium discontinuances.
1 Balances in respect of all reinsurance treaties are included under reinsurance assets, regardless of whether they transfer significant insurance risk.
Of the above total, £5,251 million (2011: £5,086 million) is expected to be recovered more than one year after the statement of financial position date.
Change in asset 450 648 Effect of portfolio transfers, acquisitions and disposals 197 (2) Deconsolidation of Delta Lloyd — (375) Foreign exchange rate movements (48) (13)
The impact of assumption changes in the above analysis shows the resulting movement in the carrying value of reinsurance assets. The changes to the reinsurance asset from assumption changes mainly relates to business in the UK and Ireland, with corresponding movements in gross insurance contract liabilities. For participating businesses, a movement in reinsurance assets is generally offset by a corresponding adjustment to the unallocated divisible surplus and does not impact on profit. Where assumption changes do impact profit, these are included in the effect of changes in assumptions and estimates during the year shown in note 43, together with the impact of movements in related liabilities and other non-financial assets.
Notes to the consolidated financial statements continued 42 – Reinsurance assets continued (ii) In respect of general insurance and health outstanding claims provisions and IBNR
Carrying amount at 1 January 1,369 1,558 Impact of changes in assumptions 22 87 Reinsurers’ share of claim losses and expenses
Incurred in current year 286 247 Incurred in prior years 13 (84) Exceptional strengthening of general insurance latent claims provisions — 10
Reinsurers’ share of incurred claim losses and expenses 299 173 Less: Reinsurance recoveries received on claims
Reinsurance recoveries received in the year (288) (334) Unwind of discounting 13 19 Other movements — (1)
Change in reinsurance asset recognised as income 46 (56) Effect of portfolio transfers, acquisitions and disposals (136) 28 Deconsolidation of Delta Lloyd — (153) Foreign exchange rate movements (26) (2) Other movements 1 (6)
Persistency rates — (4) Mortality for assurance contracts — 35 Mortality for annuity contracts 241 (21) Tax and other assumptions (207) 99 Investment contracts Interest rates (2) (82) Expenses (1) — Persistency rates — — Tax and other assumptions — 28 General insurance and health business Change in loss ratio assumptions — 5 Change in discount rate assumptions (21) (90) Change in expense ratio and other assumptions (21) 22
Notes to the consolidated financial statements continued 44 – Unallocated divisible surplus An unallocated divisible surplus (UDS) is established where the nature of policy benefits is such that the division between shareholder reserves and policyholder liabilities is uncertain at the reporting date. Therefore the expected duration for settlement of the UDS is not defined. The following movements have occurred in the year: £m £m
Carrying amount at 1 January 650 3,428 Change in participating contract assets 6,140 (3,016) Change in participating contract liabilities 253 244 Other movements (77) 70 Change in liability recognised as an expense 6,316 (2,702) Effect of portfolio transfers, acquisitions and disposal 1 — Deconsolidation of Delta Lloyd — (144) Foreign exchange rate movements 24 60 Other movements (5) 8
In Italy, the UDS balance was £2 million negative at 31 December 2012 (2011: £1,449 million negative). In Spain, certain participating funds had negative UDS balances at 31 December 2012, although in aggregate the UDS balance was £95 million positive (2011: £13 million positive). Negative UDS balances result from an accounting mismatch between participating assets carried at market value and participating liabilities measured using local practice. The negative balances were tested for recoverability using embedded value methodology and in line with local accounting practice. Testing is conducted at a participating fund-level within each life entity. The negative balances are considered to be recoverable from margins in the existing participating business liabilities. In Italy, there was a loss of £9 million for negative UDS considered irrecoverable (2011: £17 million loss), and in Spain a reversal of £33 million of previous losses (2011: £49 million loss). In Italy the estimation of the recoverable negative UDS balance uses a real-world embedded value method, with a risk-discount rate of 6.25%. (2011: 7.05%). The embedded value method includes implicit allowance for the time value of options and guarantees. If the risk discount rate were increased by 1% it is estimated that the recoverable negative UDS balance would be unchanged. In Spain, the estimation of the recoverable negative UDS balance uses a market-consistent embedded value method.
Notes to the consolidated financial statements continued 45 – Tax assets and liabilities This note analyses the tax assets and liabilities that appear in the statement of financial position and explains the movements in these balances in the year.
(a) Current tax Current tax assets recoverable and liabilities payable in more than one year are £37 million and £8 million (2011: £29 million and £48 million), respectively.
Long-term business technical provisions and other insurance items 2,067 455 Deferred acquisition costs (681) (598) Unrealised gains on investments (2,869) (347) Pensions and other post-retirement obligations (135) (245) Unused losses and tax credits 535 462 Subsidiaries, associates and joint ventures (10) (10) Intangibles and additional value of in-force long-term business (363) (445) Provisions and other temporary differences 449 (205)
Net liability at 1 January (933) (1,470) Acquisition and disposal of subsidiaries — 53 Amounts (charged)/credited to income statement (note 13a) (122) 513 Amounts credited/(charged) to other comprehensive income (note 13b) 24 (354) Deconsolidation of Delta Lloyd — 326 Foreign exchange rate movements 27 (6) Other movements (3) 5
Notes to the consolidated financial statements continued 46 – Provisions This note details the non-insurance provisions that the Group holds, and shows the movements in these during the year.
Effect of deconsolidation of Delta Lloyd — — — (55) (177) (232)
Notes to the consolidated financial statements continued 47 – Pension obligations (a) Introduction The Group operates a large number of defined benefit and defined contribution pension schemes. The material defined benefit schemes are in the UK, Canada and Ireland with the main UK scheme being the largest. This note gives full IAS 19 disclosures for these schemes. The smaller ones, while still measured under IAS 19, are included as one total within Provisions (see note 46). Similarly, while the charges to the income statement for the main schemes are shown in section (e)(iv) below, the total charges for all pension schemes are disclosed in section (d) below. The assets of the UK, Irish and Canadian schemes are held in separate trustee-administered funds to meet long-term pension liabilities to past and present employees. In all schemes, the appointment of trustees of the funds is determined by their trust documentation, and they are required to act in the best interests of the schemes’ beneficiaries. The long-term investment objectives of the trustees and the employers are to limit the risk of the assets failing to meet the liabilities of the schemes over the long term, and to maximise returns consistent with an acceptable level of risk so as to control the long-term costs of these schemes. A full actuarial valuation of each of the defined benefit schemes is carried out at least every three years for the benefit of scheme trustees and members. Actuarial reports have been submitted for each scheme within this period, using appropriate methods for the respective countries on local funding bases.
(b) Membership The number of scheme members was as follows: United Kingdom Ireland Canada
(i) Defined benefit section of the ASPS This scheme is operated by a trustee company, with 11 trustee directors, comprising representatives of the employers, staff, pensioners and an independent trustee (referred to as the trustees). The Company works closely with the trustees who are required to consult it on the funding of the scheme and its investment strategy. Following each actuarial valuation, the Company and the trustees agree the level of contributions needed and funding levels are then monitored on an annual basis. At 31 March 2009, the date of the last actuarial valuation, this section of the scheme had an excess of obligations over available assets, on a funding basis, which uses more prudent assumptions than are required for reporting under IAS 19, of £3.0 billion. As a result of that valuation, the Company and the trustees have agreed a long-term funding plan where contributions, together with anticipated growth in scheme investments, are expected to eliminate the funding deficit over time. Under this agreement, deficit funding payments of £378 million were made in 2010, £178 million in 2011 and £128 million in 2012. Further funding payments of £144 million are expected in 2013. Funding payments along with the rise in gilt yields and return on invested scheme assets have resulted in a reduced deficit which is estimated to have fallen by £1.3 billion to £1.0 billion at 31 December 2012.The Company is currently undergoing a triennial actuarial valuation as at 31 March 2012, which is expected to be finalised by 30 June 2013.
(ii) Defined contribution (money purchase) section of the ASPS The trustees have responsibility for selecting a range of suitable funds in which the members can choose to invest and for monitoring the performance of the available investment funds. Members are responsible for reviewing the level of contributions they pay and the choice of investment fund to ensure these are appropriate to their attitude to risk and their retirement plans. Members of this section contribute at least 2% of their pensionable salaries and, depending on the percentage chosen, the Company contributes up to a maximum 14%, together with the cost of the death-in-service benefits. These contribution rates are unchanged for 2013.
Total charge from continuing operations 121 144 Total charge from discontinued operations 5 16
(e) IAS 19 disclosures Disclosures under IAS 19 for the material defined benefit schemes in the UK, Ireland and Canada, are given below. Where schemes provide both defined benefit and defined contribution pensions, the assets and liabilities shown exclude those relating to defined contribution pensions. Total employer contributions for these schemes in 2013, including the ASPS deficit funding, are currently expected to be £230 million.
Basis of discount rate AA-rated corporate bonds AA-rated corporate bonds AA-rated corporate bonds
The discount rate and pension increase rate are the two assumptions that have the largest impact on the value of the liabilities, with the difference between them being known as the net discount rate. For each country, the discount rate is based on current average yields of high-quality debt instruments taking account of the maturities of the defined benefit obligations. A 1% increase in this rate (and therefore the net discount rate) would reduce the liabilities by £2.0 billion and the service cost for the year by £2 million. It would also increase the interest cost on the liabilities by £1 million.
UK – ASPS Club Vita pooled experience, including an allowance for future improvements 60 90.1 93.3 90.1 92.2
The assumptions above are based on commonly used mortality tables and, in the UK, are those used by both schemes’ trustees in the most recently completed full actuarial valuations. The tables make allowance for observed variations in such factors as age, gender, pension amount, salary and postcode-based lifestyle group, and 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 the most material to the Group, the assumptions include an allowance for future mortality improvement, based on the actuarial profession’s long and medium cohort projection tables (for the ASPS and RAC schemes respectively) and incorporating underpins to the rate of future improvement equal to 1.5% pa for males and 1.0% pa for females. The effect of assuming all members were one year younger would increase the liabilities in all the schemes by £293 million and would not significantly impact the service cost for the year. The discounted scheme liabilities have an average duration of 20 years in the main UK scheme, 21 years in the RAC scheme, 22 years in the Irish scheme and 13 years in the Canadian scheme. The undiscounted benefits payable from the main UK defined benefit scheme are expected to be as shown in the chart below:
The expected rates of return on the schemes’ assets presented above are as at the beginning of the year. The overall rates of return are based on the expected returns within each asset category and on current asset allocations. The expected returns for equities and properties are aligned with the rates used for the Group’s longer-term investment return assumptions. The figures for the total expected return on scheme assets in the following section are stated after deducting investment expenses and, in Ireland, the government levy on pension fund assets. The amended IAS 19, Employee Benefits, which is effective from 1 January 2013, will replace the concept of expected return on scheme assets with interest on scheme assets, which will be calculated using the same interest rate as applied for the purpose of discounting the defined benefit obligation.
(iii) Investments in Group-managed funds and insurance policies Plan assets include investments in Group-managed funds in the consolidated statement of financial position of £62 million (2011: £112 million) and insurance policies with other Group companies of £179 million (2011: £163 million) in the main UK scheme.
Continuing operations Current service cost (19) (51) Gains on curtailments 15 —
Expected return on scheme assets 427 452 Interest charge on scheme liabilities (509) (539)
Total charge to income arising from continuing operations (86) (138) Total charge to income arising from discontinued operations — (33)
Continuing operations Expected return on scheme assets (427) (452) Actual return on these assets 611 1,815
Actuarial gains on scheme assets 184 1,363 Experience losses arising on scheme liabilities (100) (46) Changes in assumptions underlying the present value of the scheme liabilities (914) (321)
Percentage of the present value of scheme liabilities 0.9% 0.4% 3.9% 0.7% 1.1% 1 Including gains and losses from discontinued operations.
Main UK scheme Both the Group and the trustees regularly review the asset/liability management of the main UK scheme. It is fully understood that, whilst the current asset mix is designed to produce appropriate long-term returns, this introduces a material risk of volatility in the scheme’s surplus or deficit of assets compared with its liabilities. The principal risks to which the scheme is exposed are interest rate, inflation and equity markets. These are actively mitigated for example, by using inflation and interest rate swaps. Additionally, the exposure to equities has been reduced over time. 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.
Notes to the consolidated financial statements continued 47 – Pension obligations continued (vii) Recognition in the statement of financial position The assets and liabilities of the schemes attributable to defined benefit members at 31 December 2012 were: UK £m
Net surplus/(deficits) in the schemes 1,146 (371) (169) 606 1,584 (157) (163) 1,264
Surplus included in other assets (note 27) 1,257 — — 1,257 1,670 — — 1,670 Deficits included in provisions (note 46) (111) (371) (169) (651) (86) (157) (163) (406)
Other assets comprise cash at bank, derivative financial instruments, receivables and payables. Plan assets in the table above include investments in Group-managed funds and insurance policies, as described in section (iii) above. Where the investment and insurance policies are in segregated funds with specific asset allocations, they are included in the appropriate line in the table above, otherwise they appear in ‘Other’. The present value of unfunded post-retirement benefit obligations included in the table above is £127 million at 31 December 2012 (2011: £116 million).
Net surplus in the schemes at 1 January 11,791 (10,527) 1,264 — 1,264
Net surplus in the schemes at 31 December 12,281 (11,675) 606 — 606
Net deficits in the schemes at 1 January 11,416 (11,419) (3) (1,445) (1,448)
Net surplus in the schemes at 31 December 11,791 (10,527) 1,264 — 1,264 2 Relates to non-transferrable insurance policies treated as other obligations to staff pension schemes in the Delta Lloyd subsidiary, which was deconsolidated in 2011.
The fall in the pension schemes’ net surplus during 2012 is mainly attributable to losses arising from changes in actuarial assumptions, which primarily reflect the impact of lower discount rates for liabilities.
Core structural borrowings, at amortised cost 5,139 5,255 Operational borrowings, at amortised cost 1,868 1,889 Operational borrowings, at fair value 1,332 1,306
Floating rate US$300 million subordinated notes 2017 — — — — — 193 — 193
The classifications between Upper Tier 2, Lower Tier 2 and Senior debt shown above are as defined by the FSA in GENPRU Annex 1 ‘Capital Resources’. Subordinated debt is stated net of notes held by Group companies which were £nil (2011: £32 million). All the above borrowings are stated at amortised cost. As described in note 57, the Group has designated a portion of its euro and US dollar denominated debt as a hedge of the net investment in its European and American subsidiaries. The carrying value of the debt, included in the table above, at 31 December 2012 was £1,741 million (2011: £1,815 million).
Total contractual undiscounted cash flows 5,179 6,648 11,827 5,294 7,039 12,333
Notes to the consolidated financial statements continued 48 – Borrowings continued Contractual undiscounted interest payments are calculated based on underlying fixed interest rates or prevailing market floating rates as applicable. Year-end exchange rates have been used for interest projections on loans in foreign currencies.
Total contractual undiscounted cash flows 3,626 1,262 4,888 3,437 748 4,185
(d) Description and features (i) Subordinated debt A description of each of the subordinated notes is set out in the table below: Notional amount Issue date Redemption date Callable at par at option of the Company from In the event the Company does not call the notes, the coupon will reset at each applicable reset date to £700 million 14 Nov 2001 14 Nov 2036 16 Nov 2026 5 year Benchmark Gilt + 2.85% €650 million 29 Sep 2003 02 Oct 2023 02 Oct 2013 3 month Euribor + 2.08% €500 million 29 Sep 2003 Undated 29 Sep 2015 3 month Euribor + 2.35% £800 million 29 Sep 2003 Undated 29 Sep 2022 5 year Benchmark Gilt + 2.40% £400 million 20 May 2008 20 May 2058 20 May 2038 3 month LIBOR + 3.26% £200 million 8 Aug 2008 20 May 2058 20 May 2038 3 month LIBOR + 3.26% €500 million 20 May 2008 22 May 2038 22 May 2018 3 month Euribor + 3.35% £200 million 1 Apr 2009 1 Apr 2019 1 Apr 2014 3 month LIBOR + 8.10% €50 million 30 Apr 2009 30 Apr 2019 30 Apr 2014 3 month Euribor + 8.25% £450 million 26 May 2011 3 June 2041 3 June 2021 6 Month LIBOR + 4.136% $400 million 22 November 2011 1 December 2041 1 December 2016 8.25%(fixed)
Subordinated notes issued by the Company 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 2012 was £4,435 million (2011: £3,814 million), calculated with reference to quoted prices.
Notes to the consolidated financial statements continued 48 – Borrowings continued (iv) Loans Loans comprise: £m £m
Non-recourse Loans to property partnerships (see (a) below) 1,004 1,128 Loans to Irish investment funds (see (b) below) 20 33 UK Life reassurance (see (c) below) 257 254 Other non-recourse loans (d) 336 224
(a) As explained in accounting policy D, the UK long-term business policyholder funds have invested in a number of property limited partnerships (PLPs). The PLPs have raised external debt, secured on their respective property portfolios, and the lenders are only entitled to obtain payment of both interest and principal to the extent there are sufficient resources in the respective PLPs. The lenders have no recourse whatsoever to the policyholder or shareholders’ funds of any companies in the Group. Loans of £1,004 million (2011: £1,128 million) included in the table relate to those PLPs which have been consolidated as subsidiaries. (b) Certain Irish policyholder investment funds and unit trusts, which have been fully consolidated in accordance with accounting policy D, have raised borrowings with external credit institutions. The borrowings are secured on the funds, with the only recourse on default being the underlying investments in these funds and unit trusts. The lenders have no recourse whatsoever to the shareholders’ funds of any companies in the Aviva Group. These loans run for a period of five years, with interest rates fixed monthly and based on a fixed margin above the euro inter-bank rate. (c) The UK long-term business entered into a financial reassurance agreement with Swiss Re in 2008, under which up-front payments are received from Swiss Re in return for 90% of future surpluses arising. The loan will be repaid as profits emerge on the business. The UK long-term business entered into an additional financial reassurance agreement with BNP Paribas in 2012 in return for 100% of future surpluses arising. The loan will be repaid as profits emerge on the business. (d) Other non-recourse loans include external debt raised by special purpose vehicles in the UK long-term business. The lenders have no recourse whatsoever to the shareholders’ funds of any companies in the Group. It also includes an operational loan from Delta Lloyd to the UK Life Belgian branch. (e) Other loans include external debt raised by overseas long-term businesses to fund operations, which includes £145 million (2011: £158 million) of external debt held by the Group’s US business.
New borrowings drawn down, including commercial paper, net of expenses 2,200 452 2,652 3,853 1,042 4,895 Repayment of borrowings, including commercial paper (2,295) (347) (2,642) (3,848) (1,283) (5,131)
Borrowings acquired for non-cash consideration — — — — 34 34
1 Certain subsidiary companies have purchased issued subordinated notes and securitised loan notes as part of their investment portfolios. In the consolidated statement of financial position, borrowings are shown net of these holdings but movements in such holdings over the year are reflected in the tables above.
Expiring within one year 420 955 Expiring beyond one year 1,725 1,160
Deferred income 319 359 Reinsurers’ share of deferred acquisition costs 11 12
(a) Uncertainty over claims provisions Note 39 gives details of the estimation techniques used by the Group to determine the general business outstanding claims provisions and of the methodology and assumptions used in determining the long-term business provisions. These approaches are designed to allow for the appropriate cost of policy-related liabilities, with a degree of prudence, to give a result within the normal range of outcomes. To the extent that the ultimate cost falls outside this range, for example where experience is worse than that assumed, or future general business claims inflation differs from that expected, there is uncertainty in respect of these liabilities.
Notes to the consolidated financial statements continued 51 – Contingent liabilities and other risk factors continued (c) Guarantees on long-term savings products As a normal part of their operating activities, various Group companies have given guarantees and options, including interest rate guarantees, in respect of certain long-term insurance and fund management products. Note 41 gives details of these guarantees and options. In providing these guarantees and options, the Group’s capital position is sensitive to fluctuations in financial variables including foreign currency exchange rates, interest rates, property values and equity prices. Interest rate guaranteed returns, such as those available on GAOs, are sensitive to interest rates falling below the guaranteed level. Other guarantees, such as maturity value guarantees and guarantees in relation to minimum rates of return, are sensitive to fluctuations in the investment return below the level assumed when the guarantee was made. The directors continue to believe that the existing provisions for such guarantees and options are sufficient.
(d) Regulatory compliance The Group’s insurance and investment business is subject to local regulation in each of the countries in which it operates. The FSA regulates the Group’s UK business (from 1 April 2013, the FSA will split into two new regulatory bodies: the Prudential Regulation Authority (PRA), which will be a subsidiary of the Bank of England, and the Financial Conduct Authority (FCA)) and will monitor the financial resources and organisation of the Group as a whole. The FSA has broad powers including the authority to grant, vary the terms of, or cancel a regulated firm’s authorisation; to investigate marketing and sales practices; and to require the maintenance of adequate financial resources. The Group’s regulators outside the UK typically have similar powers, but in some cases they also operate a system of ‘prior product approval’. The Group’s regulated businesses have compliance resources to respond to regulatory enquiries in a constructive way, and take corrective action when warranted. However, all regulated financial services companies face the risk that their regulator could find that they have failed to comply with applicable regulations or have not undertaken corrective action as required. The impact of any such finding (whether in the UK or overseas) could have a negative impact on the Group’s reported results or on its relations with current and potential customers. Regulatory action against a member of the Group could result in adverse publicity for, or negative perceptions regarding, the Group, or could have a material adverse effect on the business of the Group, its results of operations and/or financial condition and divert management’s attention from the day-to-day management of the business.
(f) Structured settlements The Company has purchased annuities from licensed Canadian life insurers to provide for fixed and recurring payments to claimants. As a result of these arrangements, the Company is exposed to credit risk to the extent that any of the life insurers fail to fulfil their obligations. The Company’s maximum exposure to credit risk for these types of arrangements is approximately $1,145 million as at 31 December 2012 (2011: $1,085 million, 2010: $1,063 million). Credit risk is managed by acquiring annuities from a diverse portfolio of life insurers with proven financial stability. This risk is reduced to the extent of coverage provided by Assuris, the life insurance industry compensation plan. As at 31 December 2012, no information has come to the Company’s attention that would suggest any weakness or failure in life insurers from which it has purchased annuities and consequently no provision for credit risk is required.
Notes to the consolidated financial statements continued 52 – Commitments continued Contractual obligations for future repairs and maintenance on investment properties are £nil (2011: £nil). The Group has capital commitments to its joint ventures of £157 million (2011: £258 million) and to other investment vehicles of £nil (2011: £nil).
Financed by Equity shareholders' funds 12,434 12,829 Non-controlling interests 2,214 1,476 Direct capital instruments and fixed rate tier 1 notes 1,382 990 Preference shares 200 200 Subordinated debt 4,337 4,550 External debt 802 705
Notes to the consolidated financial statements continued 53 – Group capital structure continued At the end of 2012 the market value of our external debt, subordinated debt, preference shares (including both Aviva plc preference shares of £200 million and General Accident plc preference shares, within non-controlling interests, of £250 million), and direct capital instruments and fixed rate tier 1 notes was £7,260 million (2011: £5,782 million), with a weighted average cost, post tax, of 4.4% (2011: 6.6%). The Group Weighted Average Cost of Capital (WACC) is 6.3% (2011: 7.1%) and has been calculated by reference to the cost of equity and the cost of debt at the relevant date. The cost of equity at 2012 was 7.5% (2011: 7.4%) based on a risk free rate of 1.9% (2011: 2.0%), an equity risk premium of 4.0% (2011: 4.0%) and a market beta of 1.4 (2011: 1.3).
54 – Statement of cash flows This note gives further detail behind the figures in the statement of cash flows.
Profit before tax from continuing operations 246 373 Adjustments for: Share of loss of joint ventures and associates 277 123 Dividends received from joint ventures and associates 48 71 (Profit)/loss on sale of: Investment property (7) (8) Property and equipment — (4) Subsidiaries, joint ventures and associates 164 (565)
Amortisation of: Premium or discount on debt securities 105 82 Premium or discount on borrowings (12) 3 Premium or discount on non-participating investment contracts 20 45 Financial instruments 64 7 Acquired value of in-force business and intangibles 121 137
Net purchases of operating assets Purchases of investment property (839) (1,211) Proceeds on sale of investment property 1,141 717 Net purchases/(sales) of financial investments 1,231 (3,264)
Cash generated from operating activities – continuing operations 2,676 111 Cash generated from operating activities – discontinued operations 46 27
Cash consideration for subsidiaries, joint ventures and associates acquired and additions 136 114 Less: Cash and cash equivalents acquired with subsidiaries (7) —
Cash flows on acquisitions and additions – continuing operations 129 114 Cash flows on acquisitions and additions – discontinued operations — —
Cash and cash equivalents (excluding bank overdrafts) 23,814 23,069 Less: Assets classified as held for sale (917) (26)
Adjustments onto a regulatory basis: Shareholders' share of accrued bonus (23) (95) (186) (304) — (304) — (304) — (304) (351)
Other non-participating life insurance 359 2,758 483 3,600 33,889 37,489 35,634 73,123 — 73,123 69,442 Amounts classified as held for sale — — — — — — (34,446) (34,446) — (34,446) (344)
1 Other sources of capital include Subordinated debt of £4,337 million issued by Aviva and £43 million of other qualifying capital issued by Italian and Spanish subsidiary and associate undertakings. 2 Unallocated divisible surplus for overseas life operations is included gross of minority interest and amounts disclosed include balances classified as held for sale. 2012 includes a negative balance of £2 million in Italy (2011: £1,449 million negative). 3 Goodwill and other intangibles includes goodwill of £132 million in joint ventures and associates including amounts classified as held for sale. 4 Includes an adjustment for minorities (except for other sources of capital that are reflected net of minority interest). 5 Includes the Provident Mutual with-profit fund. 6 Other operations include general insurance and fund management business. 7 Following review of the classification of contracts issued by the Group’s Italian business, there has been a reallocation from participating insurance liabilities at 31 December 2011 to participating investment contract liabilities of £2,722 million.
Analysis of movements in capital of long-term businesses For the year ended 31 December 2012
Further analysis of the movement in the liabilities of the long-term business can be found in notes 39 and 40. The analysis of movements in capital provides an explanation of the movement in available capital of the Group’s life business for the year. This analysis is intended to give an understanding of the underlying causes of changes in the available capital of the Group’s life business, and provides a distinction between some of the key factors affecting the available capital. The negative shareholders’ funds balance within the UK with-profit funds arises in NWPSF as a result of regulatory valuation and admissibility differences in the reattributed estate which is valued on a realistic regulatory basis compared to the disclosure on an IFRS basis. NWPSF is fully supported by the reattributed estate of £748 million (this is known as RIEESA) at 31 December 2012 (31 December 2011: £1,113 million) held within NPSF1 (a non-profit fund within UKLAP included within other UK life operations) in the form of a capital support arrangement. This support arrangement will provide capital to NWPSF to ensure that the value of assets of NWPSF are at least equal to the value of liabilities calculated on a realistic regulatory basis, therefore it forms part of the NWPSF available capital resources.
Estimated excess available capital £bn 1 These realistic liabilities include the shareholders’ share of future bonuses of £0.3 billion (31 December 2011: £0.3 billion). Realistic liabilities adjusted to eliminate the shareholders’ share of future bonuses are £36.0 billion (31 December 2011: £38.8 billion). These realistic liabilities make provision for guarantees, options and promises on a market consistent stochastic basis. The value of the provision included within realistic liabilities is £1.8 billion, £0.3 billion and £3.5 billion for NWPSF, OWPSF and WPSF respectively (31 December 2011: £1.9 billion, £0.3 billion and £3.1 billion for NWPSF, OWPSF and WPSF respectively).
Under the FSA regulatory regime, UK life with-profits business is required to hold capital equivalent to the greater of their regulatory requirement based on EU directives (regulatory peak) and the FSA realistic bases (realistic peak) described above. 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. For UK general insurance businesses, the relevant capital requirement is the minimum solvency requirement determined in accordance with the FSA requirements. For overseas businesses in the European Economic Area (EEA), US, Canada, Hong Kong and Singapore, the available capital and the minimum requirement are calculated under the locally applicable regulatory regimes. The businesses outside these territories are subject to the FSA rules for the purposes of calculation of available capital and capital resource requirement. For fund management and other businesses, the relevant capital requirement is the minimum solvency requirement determined in accordance with the local regulator’s requirements for the specific class of business.
Notes to the consolidated financial statements continued 55 – Capital statement continued The available capital resources in each regulated entity are generally subject to restrictions as to their availability to meet requirements that may arise elsewhere in the Group. The principal restrictions are:  (i) UK with-profits fund – (NWPSF, OWPSF and WPSF) – any available surplus held in each fund can be used to meet the requirements of the fund itself, be distributed to policyholders and shareholders or in the case of NWPSF and OWPSF, transferred via the capital support arrangement explained above (for OWPSF only to the extent support has been provided in the past). In most cases, with-profit policyholders are entitled to at least 90% of the distributed profits while the shareholders receive the balance. The latter distribution would be subject to a tax charge, which is met by the fund.
 (ii) UK non-participating funds – any available surplus held in these is attributable to shareholders. Capital in the non-profit funds may be made available to meet requirements elsewhere in the Group subject to meeting the regulatory requirements of the fund. Any transfer of the surplus may give rise to a tax charge subject to availability of tax relief elsewhere in the Group.
 (iii) Overseas life 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. In several business units, Group companies and other parties jointly control certain entities; these joint venture operations may constrain management’s ability to utilise the capital 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.
56 – Risk management This note sets out the major risks our businesses and its shareholders face and describes the Group’s approach to managing these. It also gives sensitivity analyses around the major economic and non-economic assumptions that can cause volatility in the Group’s earnings and capital position.
The risk management framework of a small number of our joint ventures and strategic equity holdings differs from the Aviva framework outlined in this note. We work with these entities to understand how risks are managed and to align them, where possible, with Aviva’s framework.
As at 31 December 2012 AAA AA A BBB Speculative grade Not rated
As at 31 December 2011 AAA AA A BBB Speculative grade Not rated
Less: Assets classified as held for sale (39,447) 3,958 (35,489) (311) — (311)
Following a review of the collateral reported, the total net credit exposure (excluding assets classified as held for sale) at 31 December 2011 has decreased by £1,045 million.
(vi) 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 applying strict limits to each reinsurer. Reinsurance exposures are aggregated with other exposures to ensure that the overall risk is within appetite. The Group risk function has an active monitoring role with escalation to the Chief Financial Officer (CFO), Group ALCO and the Board Risk Committee as appropriate. The Group’s largest reinsurance counterparty is Swiss Reinsurance Company Ltd (including subsidiaries). At 31 December 2012, the reinsurance asset recoverable, including debtor balances, from Swiss Reinsurance Company Ltd was £1,717 million.
(i) Equity price risk The Group is subject to equity price risk arising from changes in the market values of its equity securities portfolio. We continue to limit our direct equity exposure in line with our risk preferences. The reduction of the shareholding in Delta Lloyd has decreased the Group’s equity price risk and, in particular, has led to a fall in equity exposures. Our equity hedging programme during 2012 has further reduced our equity exposures. At a business unit level, investment limits and 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. Equity risk is also managed using a variety of derivative instruments, including futures and options. Businesses actively model the performance of equities through the use of risk models, in particular to understand the impact of equity performance on guarantees, options and bonus rates. At 31 December 2012 the Group’s shareholder funds held £3 billion notional of equity hedges, with up to 12 months to maturity with an average strike of 88% of the prevailing market levels on 31 December 2012. Sensitivity to changes in equity prices is given in section ‘(j) risk and capital management’ below.
(ii) Property price risk The Group is subject to property price risk directly due to holdings of investment properties in a variety of locations worldwide and indirectly through investments in mortgages and mortgage backed securities. Investment in property is managed at business unit level, and is subject to local regulations on asset admissibility, liquidity requirements and the expectations of policyholders. As at 31 December 2012, no material derivative contracts had been entered into to mitigate the effects of changes in property prices. Sensitivity to changes in property prices is given in section ‘(j) risk and capital management’ below.
10% increase in sterling/ euro rate £m 10% decrease in sterling/ euro rate £m 10% increase in sterling/
Notes to the consolidated financial statements continued 56 – Risk management continued (vi) Derivatives risk Derivatives are used by a number of the businesses. Activity is overseen by the Group risk function, who monitors exposure levels and approves large or complex transactions. Derivatives are primarily used for efficient investment management, risk hedging purposes, or to structure specific retail savings products. The Group applies strict requirements to the administration and valuation processes it uses, and has a control framework that is consistent with market and industry practice for the activity that is undertaken.
Maturity analyses The following tables show the maturities of our insurance and investment contract liabilities, and of the financial and reinsurance assets to meet them. A maturity analysis of the contractual amounts payable for borrowings and derivatives is given in notes 48 and 57, respectively. Contractual obligations under operating leases and capital commitments are given in note 52.
(i) Analysis of maturity of insurance and investment contract liabilities For non-linked insurance business, the following table shows the gross liability at 31 December 2012 and 2011 analysed by remaining duration. The total liability is split by remaining duration in proportion to the cash-flows expected to arise during that period, as permitted under IFRS 4, Insurance Contracts. Almost all linked business and non-linked investment contracts may be surrendered or transferred on demand. For such contracts, the earliest contractual maturity date is therefore the current statement of financial position date, for a surrender amount approximately equal to the current statement of financial position liability. We expect surrenders, transfers and maturities to occur over many years, and the tables reflect the expected cash flows for these contracts. However, contractually, the total liability for linked business and non-linked investment contracts would be shown in the ‘within 1 year’ column below, and previously the total liability for linked business was shown in the ‘within 1 year’ column. Changes in durations between 2011 and 2012 reflect evolution of the portfolio, and changes to the models for projecting cash-flows.
Notes to the consolidated financial statements continued 56 – Risk management continued (ii) Analysis of maturity of financial assets The following table provides an analysis, by maturity date of the principal, of the carrying value of financial assets which are available to fund the repayment of liabilities as they crystallise. This table excludes assets held for sale.
 Longevity risk and internal experience analysis are monitored against the latest external industry data and emerging trends. Whilst individual businesses are responsible for reserving and pricing for annuity business, the Group monitors the exposure to this risk and any associated capital implications. The Group has used reinsurance solutions to reduce the risks from longevity and continually monitors and evaluates emerging market solutions to mitigate this risk further.
Aviva has a preference for general insurance risk in measured amounts for explicit reward, in line with our core skills in underwriting and pricing. The majority of the general insurance business underwritten by the Group continues to be short tail in nature such as motor, household and commercial property insurances. The Group’s underwriting strategy and appetite is communicated via specific policy statements, related business standards and guidelines. General insurance risk is managed primarily at business unit level with oversight at the Group level. Claims reserving is undertaken by local actuaries in the various general insurance businesses and is also subject to periodic external reviews. Reserving processes are further detailed in note 39 ‘insurance liabilities’. The vast majority of the Group’s general insurance business is managed and priced in the same country as the domicile of the customer.
Management of general insurance risks Significant insurance risks will be reported under the risk management framework. Additionally, the economic capital model is used to assess the risks that each general insurance business unit, and the Group as a whole, is exposed to, quantifying their impact and calculating appropriate capital requirements. Business units have developed mechanisms that identify, quantify and manage accumulated exposures to contain them within the limits of the appetite of the Group. The business units are assisted by a Business Capability team who provide technical input for major decisions which fall outside individual delegated limits or escalations outside group risk preferences, group risk accumulation, concentration and profitability limits.
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. The basis of these purchases is underpinned by analysis of economic capital, economic gain, earnings volatility, liquidity, retained risk exposure profile and the Group’s franchise value. Detailed actuarial analysis is used to calculate the Group’s extreme risk profile and then design cost and capital efficient reinsurance programmes to mitigate these risks to within agreed appetites. For businesses writing general insurance we analyse the natural catastrophe exposure using external probabilistic catastrophe models widely used by the rest of the (re)insurance industry. The Group cedes much of its worldwide catastrophe risk to third-party reinsurers but retains a pooled element for its own account gaining diversification benefit. The total Group potential loss from its most concentrated catastrophe exposure zone (Northern Europe) is approximately £260 million, for a one in ten year annual loss scenario, compared to approximately £460 million when measured on a one in a hundred year annual loss scenario. In our 2011 Annual Report & Accounts we reported our participation in a share of Hiscox’s US property catastrophe portfolio. This arrangement expired on the 31 December 2012 and remaining exposure will run off during 2013.
(g) Asset management risk Asset Management risk arises through exposure to negative investment performance, fund liquidity, and factors that influence franchise value such as product development appropriateness and capability, and client retention. The Group’s exposure to asset management risk is informed through regular assessment of the investment management capabilities and proven track record of the investment funds. Aviva is directly exposed to the risks associated with operating an asset management business through its ownership of Aviva Investors. The underlying risk profile of our asset management risk is derived from investment performance, specialist investment professionals and leadership, product development capabilities, fund liquidity, margin, client retention, regulatory developments, fiduciary and contractual responsibilities. Investment performance has remained strong over 2012 despite some positions being impacted by the volatility of global markets.
Notes to the consolidated financial statements continued 56 – Risk management continued Action has been taken during the year to improve the operational infrastructure and enhance the quality of the customer experience including; progressing towards the implementation of the Blackrock Aladdin platform to support our investment process; review of our Business Development capability; and a continued drive to work closely with clients.
(h) Operational risk Operational risk is the risk of direct or indirect loss, arising from inadequate or failed internal processes, people and systems, or external events including changes in the regulatory environment. We have limited appetite for operational risk and aim to reduce these risks as far as is commercially sensible. Our business units are primarily responsible for identifying and managing operational risks within their businesses, within the group-wide operational risk framework including the risk and control self-assessment process. Businesses must be satisfied that all material risks falling outside our risk tolerances are being mitigated, monitored and reported to an appropriate level. Any risks with a high potential impact are monitored centrally on a regular basis. Businesses use key indicator data to help monitor the status of the risk and control environment. They also identify and capture loss events, taking appropriate action to address actual control breakdowns and promote internal learning.
(i) Brand and reputation risk We are exposed to the risk that litigation, employee misconduct, operational failures, the outcome of regulatory investigations, media speculation and negative publicity, disclosure of confidential client information, inadequate services, whether or not founded, could impact our brands or reputation. Any of our brands or our reputation could also be affected if products or services recommended by us (or any of our intermediaries) do not perform as expected (whether or not the expectations are founded) or the customer’s expectations for the product change. We seek to reduce this risk to as low a level as commercially sensible. The FSA regularly considers whether we are meeting the requirement to treat our customers fairly and we make use of various metrics to assess our own performance, including customer advocacy, retention and complaints. Failure to meet these requirements could also impact our brands or reputation. If we do not manage the perception of our brands and reputation successfully, it could cause existing customers or agents to withdraw from our business and potential customers or agents to choose not to do business with us.
(ii) Life insurance and investment contracts The nature of long-term business is such that a number of assumptions are made in compiling these financial statements. Assumptions are made about investment returns, expenses, mortality rates and persistency in connection with the in-force policies for each business unit. Assumptions are best estimates based on historic and expected experience of the business. A number of the key assumptions for the Group’s central scenario are disclosed elsewhere in these statements for both IFRS reporting and reporting under MCEV methodology.
Assets backing life shareholders' funds 10 (15) (40) 45 (45) — — —
Total excluding Delta Lloyd and United States (290) 180 (585) 120 (165) (130) (50) (520)
Assets backing life shareholders' funds 135 (15) (10) 10 (10) — — —
Gross of reinsurance excluding Delta Lloyd (260) 235 (125) 50 (50) (25) (300)
Gross of reinsurance excluding Delta Lloyd (205) 180 (125) 50 (55) (30) (300)
Fund management and non-insurance business sensitivities as at 31 December 2012 2012 Impact on profit before tax £m
Total excluding Delta Lloyd (5) — 30 (90) 10 2012 Impact on shareholders' equity before tax £m
Notes to the consolidated financial statements continued 56 – Risk management continued Sensitivities as at 31 December 2011 2011 Impact on profit before tax £m
57 – Derivative financial instruments and hedging This note gives details of the various instruments we use to mitigate risk. The Group uses a variety of derivative financial instruments, including both exchange traded and over-the-counter instruments, in line with our overall risk management strategy. The objectives include managing exposure to price, foreign currency and / or interest rate risk on existing assets or liabilities, as well as planned or anticipated investment purchases. In the narrative and tables below, figures are given for both the notional amounts and fair values of these instruments. The notional amounts 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 fair values represent the gross carrying values at the year end for each class of derivative contract held (or issued) by the Group. The fair values do not provide an indication of credit risk, as many over-the-counter transactions are contracted and documented under ISDA (International Swaps and Derivatives Association, Inc.) master agreements or their equivalent. Such agreements are designed to provide a legally enforceable set-off in the event of default, which reduces credit exposure. In addition, the Group has collateral agreements in place between the individual Group entities and relevant counterparties.
(a) Instruments qualifying for hedge accounting The Group has formally assessed and documented the effectiveness of its instruments qualifying for hedge accounting in accordance with IAS 39, Financial Instruments: Recognition and Measurement. To aid discussion and analysis, these instruments are analysed into cash flow, fair value and net investment hedges, as detailed below.
(i) Cash flow hedges At the end of 2012 the Group entered into two cash flow hedges, using foreign exchange forward and option contracts, to hedge the currency exposure on expected proceeds in 2013 of businesses held for sale as at 31 December 2012. The fair value of the cash flow hedges as of 31 December 2012 was a £5 million derivative asset. No amounts in respect of the cash flow hedges have been recognised in the income statement for the year. All cash flows being hedged upon transaction completion are expected to occur and movements in the fair value will be recycled to the income statement in 2013. These hedges were fully effective in the year.
(ii) Fair value hedges The Group entered into a number of interest rate swaps in order to hedge fluctuations in the fair value part of its portfolio of mortgage loans and debt securities in the US. The notional value of these swaps was £765 million at 31 December 2012 (2011: £844 million) and their fair value was £54 million liability (2011: £77 million liability). During 2012, there were hedging relationships that became ineffective. The amount of ineffectiveness included in the income statement as a result was £14 million. The related hedges were re-designated and are expected to be effective in future periods.
Notes to the consolidated financial statements continued 57 – Derivative financial instruments and hedging continued (iii) Net investment hedges To reduce its exposure to foreign currency risk, the Group has entered into the following net investment hedges: The Group has designated a portion of its euro and US dollar denominated debt as a hedge of the net investment in its European and American subsidiaries. The carrying value of the debt at 31 December 2012 was £1,741 million (2011: £1,815 million) and its fair value at that date was £1,785 million (2011: £1,694 million). The foreign exchange gain of £74 million (2011: gain of £30 million) on translation of the debt to sterling at the statement of financial position date has been recognised in the hedging instruments reserve in shareholders’ equity. This hedge was fully effective throughout the current and prior years.
Interest rate and currency swaps 611 64 (21) 502 83 (3)
Less: Amounts classified as held for sale (4,403) (679) 54 — — —
Key management compensation 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
Profit for the year — — — — — — 616 616 — 616 Other comprehensive income — — — — 2,380 — — 2,380 — 2,380 Total comprehensive income
Issue of fixed rate tier 1 notes — — — — — — — — 392 392 Aggregate tax effect — — — — — — 18 18 — 18
Shares issued under equity compensation plans — — — — — (61) 61 — — — Aggregate tax effect — — — — — — 16 16 — 16
Current assets Loans owed by subsidiaries H 1,240 — 691 Other amounts owed by subsidiaries H 3,019 2,280 2,334
Liabilities Non-current liabilities Borrowings E 4,536 4,781 4,805 Loans owed to subsidiaries H 13,153 13,306 14,067
Where applicable, the accounting policies of the Company are the same as those of the Group on pages 148 to 159. The notes identified alphabetically on pages 270 to 272 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 168 to 266.
Statement of cash flows For the years ended 31 December 2012 and 2011
Fair value as at 1 January 28,889 31,284 30,897 Movement in fair value 2,134 (2,395) 387
(ii) At 31 December 2012, the Company has two wholly owned subsidiaries, both incorporated in the UK. 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 2012 are listed on pages 48 and 49.
C – Tax (i) Tax credited to equity Tax credited to equity comprises £18 million (2011: £16 million) in respect of coupon payments on the direct capital instruments and fixed rate tier 1 notes.
Arising in the year: Profit for the year — — — 616 Fair value gains on investments in subsidiaries and joint ventures — 2,126 — — Impairment losses on assets previously revalued through other comprehensive income now taken to the income statement — 254 — — Dividends and appropriations — — — (847) Reserves credit for equity compensation plans — — 42 — Shares issued in lieu of dividends — — — 127 Trust shares distributed in the year — — — (44) Issue of share capital under equity compensation scheme — — (68) 74 Aggregate tax effect — — — 18
Tax of £18 million (2011: £16 million) is deductible in respect of coupon payments of £73 million (2011: £58 million) on the direct capital instruments and fixed rate tier 1 notes.
Maturity analysis of contractual undiscounted cash flows: Principal £m Interest £m Total £m Principal £m Interest £m Total £m
F – Contingent liabilities Details of the Company’s contingent liabilities are given in the Group consolidated financial statements, note 51(g).
G – Risk management Risk management in the context of the Group is considered in the Group consolidated financial statements, note 56. The business of the Company is managing its investments in subsidiary and joint venture operations. Its risks are considered to be the same as those in the operations themselves and full details of the major risks and the Group’s approach to managing these are given in the Group consolidated financial statements, note 56. Such investments are held by the Company at fair value in accordance with accounting policy D. The fair values of the subsidiaries and joint venture are estimated using applicable valuation models, underpinned by the Company’s market capitalisation. This uses the Company’s closing share price at year end. Given that the key input into the valuation model is based on an observable current share price, and therefore sensitive to movements in that price, the valuation process is not sensitive to non-observable market assumptions. Financial assets, other than investments in subsidiaries and the joint venture, largely consist of amounts due from subsidiaries. As at the balance sheet date, these receivable amounts were neither past due nor impaired. Financial liabilities owed by the Company as at the balance sheet date are largely in respect of borrowings (details of which are provided in note E and the Group consolidated financial statements, note 48) and loans owed to subsidiaries. Loans owed to subsidiaries were within agreed credit terms as at the balance sheet date.
I – Parent company income statement The Company has not presented its own income statement as permitted by Section 408 of the Companies Act 2006. The profit for the year attributable to equity shareholders was £616 million (2011: £231 million), which included £1,585 million (2011: £1,068 million) dividend income from subsidiary companies.
J – Equity compensation plans All transactions in the Group’s equity compensation plans involve options and awards for ordinary shares of the Company. Full disclosure of these plans is given in the Group consolidated financial statements, note 30. The cost of such options and awards is borne by all participating businesses and, where relevant, the Company bears an appropriate charge. As the majority of the charge to the Company relates to directors’ options and awards, for which full disclosure is made in the Directors’ Remuneration Report, no further disclosure is given here on the grounds of materiality.
K – Subsequent event On 21 January 2013 the Company provided a guarantee to its subsidiary, Aviva Group Holdings Limited, on a short term external borrowing of £200 million which will be repaid from disposal proceeds.
Critical illness cover Pays out a lump sum if the insured person is diagnosed with a serious illness that meets the plan definition.
ISAs Individual savings accounts – Tax-efficient plans for investing in stocks and shares, cash deposits or life insurance investment funds, subject to certain limits.
Mortgage endowment An insurance contract combining savings and protection elements which is designed to repay the principal of a loan or mortgage.
Personal pensions A pension plan tailored to the individual policyholder, which includes the options to stop, start or change their payments.
SICAVs This is an open-ended investment fund, structured as a legally independent joint stock company, whose units are issued in the form of shares.
Bancassurance An arrangement whereby banks and building societies sell insurance and investment products to their customers on behalf of other financial providers.
Fair value The amount for which an asset can be exchanged, or a liability settled, between knowledgeable, willing parties in an arm’s length transaction.
Gross written premiums The total earnings or revenue generated by sales of insurance products, before any reinsurance is taken into account. Not all premiums written will necessarily be treated as income in the current financial year, because some of them could relate to insurance cover for a subsequent period.
Operating profit From continuing operations based on expected investment returns, stated before tax attributable to shareholders’ profits and before non-operating items inlcuding, impairment of goodwill, exceptional and other items. This is also referred to as adjusted operating profit.
Banks and nominee companies 15,334 2.60 2,614,092,081 88.73 Pension fund managers and insurance companies 239 0.04 2,788,904 0.09
Annual General Meeting (AGM)  The 2013 AGM will be held at The Barbican Centre, Silk
 Shareholders can vote electronically at www.investorcentre.co.uk/eproxy, in person by attending the meeting, or by completing and returning the relevant voting card(s) by post.
 11am on Friday, 3 May 2013 for members of the Aviva Share Account and participants in the Aviva All Employee Share Ownership Plan.
Dividends  Dividends on ordinary shares are normally paid in May and
November - please see the table above for the key dates in respect of the 2012 final dividend.
 Holders of ordinary and preference shares will receive any dividends payable in sterling and holders of ADRs will receive any dividends payable in US dollars.
In writing: Computershare Investor Services PLC The Pavilions, Bridgwater Road, Bristol BS99 6ZZ
American Depositary Receipts (ADRs) – Citibank For any queries regarding Aviva ADRs, please contact Citibank Shareholder Services (Citibank): By telephone: 1 877 248 4237 (1 877-CITI-ADR), or +1 781 575 4555 if you are calling from outside the US. (Lines are open from 8.30am to 6.00pm, Monday to Friday US Eastern Standard Time).
Group Company Secretary Shareholders may contact the group company secretary as follows: By email: aviva.shareholders@aviva.com
In writing: Kirstine Cooper, Group Company Secretary St Helen’s, 1 Undershaft, London EC3P 3DQ
Be on your guard – beware of fraudsters! Shareholders are advised to be very wary of any unsolicited telephone calls or correspondence offering to buy shares at a discount or offering free financial advice or company reports. Boiler rooms use increasingly sophisticated means to approach investors and often leave their victims out of pocket. The Financial Services Authority (FSA) has found most share fraud victims are experienced investors who lose an average of £20,000. The FSA has provided tips on how to protect your savings which you can find at www.fsa.gov.uk/scams.