(a) Intangible assets with indefinite useful lives comprise the RAC brand, and the value of the Union Financière de France Banque distribution channel, where the existing lives of the assets and their competitive position in, and the stability of, their respective markets support this classification. Impairment testing of these intangibles is covered in note 16(b).
Aviva plc Annual Report and Accounts 2010 18 – Interests in, and loans to, joint ventures In several business units, Group companies and other parties jointly control certain entities. This note analyses these interests and describes the principal joint ventures in which we are involved.
(a) Carrying amount (i) The movements in the carrying amount comprised: Goodwill and intangibles £m
Share of results before tax — 180 — 180 Share of tax — (15) — (15) Share of results after tax — 165 — 165 Impairment of goodwill (9) — — (9) Amortisation of intangibles1 (7) — — (7) Share of profit/loss after tax (16) 165 — 149 Acquisitions and additions — 225 64 289 Disposals and reduction in Group interests — (130) — (130) Fair value gains taken to other comprehensive income — 1 — 1 Loans repaid — — (5) (5) Foreign exchange rate movements 1 13 (11) 3
Property management undertakings — 1,021 327 1,348 Long-term business undertakings 202 146 — 348 General insurance undertakings — 5 — 5
Aviva plc Annual Report and Accounts 2010 18 – Interests in, and loans to, joint ventures continued (b) Property management undertakings The principal joint ventures are as follows: Company GP proportion held PLP proportion held
Airport Property Partnership 50.0% 50.0% Ashtenne Industrial Fund Limited Partnership 67.7% 37.4% The Mall Limited Partnership 50.0% 50.5% Queensgate Limited Partnership 50.0% 50.0% Quercus Healthcare Property Partnership Limited 50.0% 29.3% The Southgate Limited Partnership 50.0% 50.0% 20 Gracechurch Street Limited Partnership 50.0% 50.0%
(d) Impairment testing All interests in joint ventures have been tested for impairment but the only material items are detailed below.
CIMB Aviva Assurance Berhad and CIMB Aviva Takaful Berhad are developing businesses and the recoverability of value is reliant on future projected growth being achieved. These projections are inherently uncertain and dependent on local economic conditions.
Aviva plc Annual Report and Accounts 2010 18 – Interests in, and loans to, joint ventures continued (ii) AvivaSA Emeklilik ve Hayat A.S. The Group’s investment in AvivaSA Emeklilik ve Hayat A.S. has been tested for impairment by comparing its carrying value (which includes goodwill which arose on its acquisition) with its recoverable amount. The recoverable amount has been determined based on a value in use calculation. This calculation is an actuarially determined appraisal value and is based on the embedded value of the business together with the present value of expected profits from future new business. The recoverable amount exceeds the carrying value of the cash-generating unit including goodwill. Key assumptions used for the calculation were: Embedded value represents the shareholder interest in the life business and is calculated in accordance with the Market Consistent Embedded Value (MCEV) principles. The embedded value is the total of the net worth of the life business and the value of the in-force business.
New business contribution represents the present value of projected future distributable profits generated from business written in a period. This is initially based on the most recent three-year business plans approved by management.
Risk adjusted discount rate of 16.5% represents the rate used to discount expected profits from future new business. The discount rate reflects a risk margin to make prudent allowance for the risk that experience in future years for new business may differ from that assumed.
(e) Additional information Summarised aggregate financial information on the Group’s interests in its joint ventures is as follows: £m
Income, including unrealised gains/(losses) on investments 910 (105) Expenses (730) (293)
The joint ventures have no significant contingent liabilities to which the Group is exposed, nor has the Group any significant contingent liabilities in relation to its interests in them.
Aviva plc Annual Report and Accounts 2010 19 – Interests in, and loans to, associates This note analyses our interests in entities which we do not control but where we have significant influence.
Share of results after tax — (54) — (54) Impairment of goodwill and intangibles1 (32) — — (32) Amortisation of acquired value of in-force business (9) — — (9)
Aviva plc Annual Report and Accounts 2010 19 – Interests in, and loans to, associates continued Although the Group’s holding in one of the three Cyrte funds is less than 20%, it has significant influence through ownership of the fund manager, Cyrte Investments BV, a subsidiary of which acts as general partner to the funds, and through membership of its investment committee. The Group’s Dutch subsidiary owns 30.6% of the shares, and depositary receipts for shares, in Van Lanschot NV, a financial services company in the Netherlands. The Group is not able to appoint management representation on the board of this company and is therefore unable to exert significant influence over its affairs. Accordingly, this investment is treated as a financial investment rather than as an associate.
(d) Impairment testing All interests in associates have been tested for impairment but the only material items are detailed below.
(i) Aviva Life Insurance Company India Limited The Group’s investment in Aviva Life Insurance Company India Limited has been tested for impairment by comparing its carrying value (which includes goodwill which arose on their acquisition) with its recoverable amount. The recoverable amount has been determined based on a value in use calculation. This calculation is an actuarially determined appraisal value and is based on the embedded value of the business together with the present value of expected profits from future new business. The recoverable amount exceeds the carrying value of the investment. Key assumptions used for the calculation were: Cash flow projections based on (i) the policy portfolio existing at the valuation date; and (ii) the future sales based on plans approved by management covering the subsequent three-year period. The cash flows from the existing policy portfolio are calculated using best estimate assumptions, which have been supported by experience investigations where available and prudent estimates typical for the market where experience investigations are not available; The embedded values for existing business was derived using risk free rates; The value in use was derived as the sum of embedded value of existing business and the new business contribution in each future year discounted using a risk adjusted discount rate of 17.3%; and New sales beyond the three-year period have been extrapolated using a growth rate of 14% for seven years and 10%
(ii) Banca Network Investimenti SpA A review of strategy by the owners of Banca Network Investimenti SpA has significantly changed the future business plans and nature of the activities of this associate. As a result of this change in the prospects of the associate, management no longer believe that its carrying value is fully recoverable. This has generated an impairment of £20 million. Other impairments arise from UK long-term business intermediary associates.
Cost or valuation At 1 January 2009 61 573 14 876 605 2,129 Additions 62 11 — 40 36 149 Disposals (7) (49) (2) (82) (196) (336) Transfers to investment property (note 21) (16) (47) — — — (63) Transfers to intangibles (note 17) — — — (23) — (23) Fair value losses (see below) — (33) — — — (33) Foreign exchange rate movements (6) (35) (2) (14) (18) (75)
At 31 December 2009 94 420 10 797 427 1,748 Additions 122 19 1 25 58 225 Disposals (5) (35) (2) (27) (52) (121) Transfers (to)/from investment property (note 21) (1) 2 — — — 1 Transfers to Intangibles (note 17) — — — (69) (19) (88) Transfers (87) 87 — — — — Fair value gains/(losses) — (42) — — — (42) Foreign exchange rate movements 3 (11) — (3) (5) (16)
Depreciation and impairment At 1 January 2009 — (5) (8) (675) (375) (1,063) Charge for the year — (1) (1) (76) (37) (115) Disposals — 2 1 60 92 155 Transfers to intangibles (note 17) — — — 3 — 3 Transfers — — — (1) — (1) Impairment losses charged to restructuring costs — — — (1) (1) (2) Foreign exchange rate movements — — 1 13 15 29
Carrying amount At 31 December 2009 94 416 3 120 121 754 Less: Amounts classified as held for sale: — — — — (1) (1)
Aviva plc Annual Report and Accounts 2010 21 – Investment property This note gives details of the properties we hold for long-term rental yields or capital appreciation.
Carrying value At 1 January 2009 12,501 1,925 14,426 Additions 319 49 368 Capitalised expenditure on existing properties 64 9 73 Fair value losses (917) (167) (1,084) Disposals (785) (143) (928) Transfers from property and equipment (note 20) 28 35 63 Foreign exchange rate movements (453) (35) (488)
At 31 December 2009 10,757 1,673 12,430 Less: Amounts classified as held for sale — (8) (8)
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, and default rates). Inputs that are derived principally from, or corroborated by, observable market data by correlation or other means (marketcorroborated inputs).
Modelled with significant unobservable market inputs – (‘Level 3’) Inputs to Level 3 fair values are unobservable inputs for the asset or liability. Unobservable inputs may have been used to measure fair value to the extent that observable inputs are not available, thereby allowing for situations in which there is little, if any, market activity for the asset or liability at the measurement date (or market information for the inputs to any valuation models). As such, unobservable inputs reflect the assumptions the business unit considers that market participants would use in pricing the asset or liability. Examples are certain private equity investments and private placements. The majority of the Group’s financial assets and certain financial liabilities are valued based on quoted market information or observable market data. A small percentage (4.5%) of total financial assets recorded at fair value are based on estimates and recorded as Level 3 investments. Where estimates are used, these are based on a combination of independent third-party evidence and internally developed models, calibrated to market observable data where possible. Third-party valuations using significant unobservable inputs validated against Level 2 internally modelled valuations are classified as Level 3, where there is a significant difference between the third-party price and the internally modelled value. Where the difference is insignificant, the instrument would be classified as Level 2.
Discussion on the valuation techniques applied to value financial liabilities carried at fair value is included in the relevant footnote disclosure for the financial liability. For the year to 31 December 2010, transfers of financial assets from fair value hierarchy Level 1 to Level 2 amounted to £517 million (2009: £886 million), and from Level 2 to Level 1 amounted to £289 million (2009: £2,181 million). The transfers arose as a result of changes in the level of activity in the markets from which prices are sourced, as well as changes in the pricing sources used in France to value certain financial investments. The latter has not given rise to a change in pricing methodology. For the year to 31 December 2010, there were no transfers of financial liabilities between fair value hierarchy levels except for the transfer of £2,305 million securitised borrowings in our business in the Netherlands, which have moved from Level 2 to Level 1 as a result of increased market activity.
Aviva plc Annual Report and Accounts 2010 22 – Fair value methodology continued (c) Further information on Level 3 financial instruments (i) The tables below show movements in the Level 3 financial assets and liabilities measured at fair value.
Total funds Balance at 1 January 9,139 844 1,327 11,310 176 Total net gains or losses recognised in the income statement 64 6 177 247 — Total net gains or losses recognised in other comprehensive income 73 50 — 123 — Purchases 1,279 11 1,031 2,321 — Issuances — — — — 31 Disposals (636) (75) (140) (851) (5) Transfers into Level 3 300 165 289 754 — Transfers out of Level 3 (1,296) (3) (2) (1,301) — Foreign exchange rate movements (214) (26) (14) (254) 6
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 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.
The principal transfers out of Level 3 in 2010, are: The transfer of £0.65 billion Italian structured bonds, which were classified as Level 3 in 2009 because of significant differences between the third-party counterparty price used to value the bonds and the internal model valuation using observable market inputs, which was used to validate the counterparty price. Except for £55 million of structured bonds, which remain in Level 3, the third-party and internal-modelled valuations have not shown any significant differences on a monthly basis since January 2010. Consequently the bonds have been transferred to Level 2.
The transfers into Level 3 in 2010 are spread across our businesses in the UK, Italy, US, the Netherlands and France and across a number of asset classes, with no single business or asset class predominating. There are a variety of reasons for these transfers including insufficient market activity in valuation inputs, greater transparency of valuation inputs from third-party pricing sources and open investment funds becoming closed. Of the £247 million net gains (2009: £52 million net losses) recognised in the income statement during the year, £252 million gain (2009: £2 million gain) relates to net investment income and £5 million loss (2009: £54 million loss) relating to impairments is included in other expenses.
Aviva plc Annual Report and Accounts 2010 22 – Fair value methodology continued (ii) The principal investments classified as Level 3, and the valuation techniques applied to them, are: Structured bond-type products held by our businesses in France and Italy amounting to £6.49 billion and £0.06 billion respectively, 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. Most of 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 2010, the counterparty and broker quotes used to value these products were less than the modelled valuations.
Notes issued by loan partnerships held by our UK Life business amounting to £1.2 billion, for which there is no active market. These are valued using counterparty quotes, corroborated against the prices of selected similar securities. In 2010, there were insufficient market observable transactions in the selected securities to provide a reliable proxy price to corroborate the counterparty price. In addition, our UK Life business owns part of the residual equity interest in these loan partnerships valued at £0.2 billion according to net asset values, which are not considered market observable, resulting in a Level 3 classification.
Private equity investment funds amounting to £1.4 billion, of which £0.9 billion is held by our UK business. In valuing our interest in these funds, we rely on investment valuation reports received from the fund manager, making adjustments for items such as subsequent draw-downs and distributions between the date of the report and the balance sheet date and the fund manager’s carried interest. In addition, an indexation adjustment is made to reflect changes in appropriate equity market indices between the valuation report date and balance sheet date.
Certain direct private equity investments and private placements held by our business in the Netherlands and strategic interests in banking partners held by our Italian business amounting to £0.9 billion. Valuations are based on third-party independent appraisals, or where internally modelled, transactions in similar entities, discounted cash flow techniques and valuation multiples, using public and internal management information.
Other Level 3 investments amount to £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 £4.5 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 £367 million positive impact and £366 million adverse impact. Of the £7.9 billion Level 3 investments for which sensitivity analysis is not provided, £0.1 billion and £7.2 billion relate to investments held in unit-linked and participating funds respectively in Spain and France. For these products investment risk is predominantly borne by policyholders, and therefore shareholder profit before tax is insensitive to reasonable changes in fair value of these investments. Level 3 investments backing non-linked shareholder-backed business, for which no sensitivity analysis is provided, amounts to only £0.6 billion. A 10% change in valuation of these investments would reduce shareholder profit before tax by £64 million. For the year ended 31 December 2009, we reported that changing one or more unobservable inputs to a reasonable alternative would not have had a significant impact on the fair value of financial investments carried at fair value.
Aviva plc Annual Report and Accounts 2010 23 – Loans This note analyses the loans our Group companies have made, the majority of which are mortgage loans.
(a) Carrying amounts The carrying amounts of loans at 31 December 2009 and 2010 were as follows: At fair value through profit or loss other than trading £m
Policy loans 180 1,574 1,754 214 1,655 1,869 Loans to banks — 5,683 5,683 — 5,339 5,339 Securitised mortgage loans (see note 24) UK 1,912 — 1,912 1,840 — 1,840 Netherlands 5,249 1,155 6,404 5,544 1,770 7,314 7,161 1,155 8,316 7,384 1,770 9,154 Non-securitised mortgage loans 13,687 9,750 23,437 13,292 8,012 21,304 Loans and advances to bank customers — 2,023 2,023 — 1,943 1,943 Loans to brokers and other intermediaries — 100 100 — 92 92 Other loans — 1,761 1,761 — 1,378 1,378
Loans at fair value Fair values have been calculated by discounting the future cash flows using appropriate current interest rates for each portfolio of mortgages. Further details of the fair value methodology are given in note 22. The change in fair value of these loans during the year, attributable to a change in credit risk, was a loss of £85 million (2009: £338 million gain). The cumulative change attributable to changes in credit risk to 31 December 2010 was a loss of £400 million (2009: £315 million loss).
Loans at amortised cost The fair value of these loans at 31 December 2010 was £21,784 million (2009: £19,786 million).
Policy loans 1,574 — 1,574 1,655 — 1,655 Loans to banks 5,683 — 5,683 5,339 — 5,339 Securitised mortgage loans 1,156 (1) 1,155 1,771 (1) 1,770 Non-securitised mortgage loans 9,846 (96) 9,750 8,115 (103) 8,012 Loans and advances to bank customers 2,064 (41) 2,023 1,986 (43) 1,943 Loans to brokers and other intermediaries 100 — 100 92 — 92 Other loans 1,764 (3) 1,761 1,379 (1) 1,378
The movements in the impairment provisions on these loans for the years ended 31 December 2009 and 2010 were as follows: £m
(a) Description of arrangements (i) United Kingdom In a long-term business subsidiary, Aviva Equity Release UK Limited (AER), the beneficial interest in certain portfolios of lifetime mortgages has been transferred to five special purpose securitisation companies (the ERF companies), in return for initial consideration and, at later dates, deferred consideration. The deferred consideration represents receipts accrued within the ERF companies after meeting all their obligations to the note holders, loan providers and other third parties in the priority of payments. The purchases of the mortgages were funded by the issue of fixed and floating rate notes by the ERF companies. All the shares in the ERF companies are held by independent companies, whose shares are held on trust. Although AER does not own, directly or indirectly, any of the share capital of the ERF companies or their parent companies, it retains control of the majority of the residual or ownership risks and rewards related to the assets of the securitisation companies, and they have therefore been treated as subsidiaries in the consolidated financial statements. AER has no right to repurchase the benefit of any of the securitised mortgage loans, other than in certain circumstances where AER is in breach of warranty or loans are substituted in order to effect a further advance. AER has purchased subordinated notes and granted subordinated loans to some of the ERF companies. These have been eliminated on consolidation through offset against the borrowings of the ERF companies in the consolidated statement of financial position.
(ii) Delta Lloyd In three subsidiaries, Delta Lloyd Levensverzekering NV (DLL), Amstelhuys NV (AMS), and Delta Lloyd Bank (Belgium) NV/SA (DLB), the principal benefits of certain portfolios of mortgage loans have been transferred to a number of special purpose securitisation companies, which were funded primarily through the issue of fixed and floating rate notes. All the shares in the securitisation companies are held by independent trustee companies. Although DLL, AMS and DLB do not own, directly or indirectly, any of the share capital of the securitisation companies or their parent companies, they retain control of the majority of the residual or ownership risks and rewards related to the assets of the securitisation companies, and these companies have therefore been treated as subsidiaries in the consolidated financial statements. DLL, AMS and DLB have no right, nor any obligation, to repurchase the benefit of any of the securitised mortgage loans before the optional call date, other than in certain circumstances where they are in breach of warranty. Delta Lloyd companies have purchased notes in the securitisation companies, which have been eliminated on consolidation through offset against the borrowings of the securitisation companies in the consolidated statement of financial position.
Aviva plc Annual Report and Accounts 2010 24 – Securitised mortgages and related assets continued (b) Carrying values The following table summarises the securitisation arrangements: Securitised assets £m
UK Securitised mortgage loans At fair value (note 23) 1,912 (1,464) 1,840 (1,444) Other securitisation assets/(liabilities) 130 (578) — (396)
Delta Lloyd Securitised mortgage loans At fair value (note 23) 5,249 (4,216) 5,544 (4,441) At amortised cost (note 23) 1,155 (1,924) 1,770 (2,656)
Of the total UK commercial mortgage loans, £215 million (2009: £46 million) relates to primary healthcare and PFI businesses and is secured against General Practitioner premises, other primary health-related premises or schools leased to government bodies. For all such loans, government support is provided through reimbursement of rental payments to the tenants to meet income service and provide for the debt to be reduced substantially over the term of the loan. Although the loan principal is not government-guaranteed, the nature of these businesses and premises provides considerable comfort of an ongoing business model and low risk of default.
Fixed maturity securities Debt securities UK government — 17,447 — 17,447 — 21,423 — 21,423 UK local authorities — 16 — 16 — 16 — 16 Non-UK government 11 47,843 2,666 50,520 11 45,655 1,810 47,476 Corporate bonds Public utilities — 5,849 2,518 8,367 — 5,997 633 6,630 Other corporate 6 61,988 17,123 79,117 (28) 55,254 15,364 70,590 Convertibles and bonds with warrants attached — 583 — 583 — 586 — 586 Other 14 3,614 4,928 8,556 36 6,870 5,065 11,971 31 137,340 27,235 164,606 19 135,801 22,872 158,692 Certificates of deposit 80 2,590 24 2,694 — 2,802 8 2,810 Redeemable preference shares — 178 4 182 — 255 — 255
Equity securities Ordinary shares Public utilities — 4,108 — 4,108 — 3,665 15 3,680 Banks, trusts and insurance companies 7 6,708 907 7,622 — 6,458 831 7,289 Industrial miscellaneous and all other 31 34,102 2,566 36,699 8 31,668 2,540 34,216
Of the above total, £153,470 million (2009: £174,292 million) is expected to be recovered more than one year after the statement of financial position date. Other debt securities of £8,556 million (2009: £11,971 million) primarily include residential and commercial mortgage-backed securities, as well as other structured credit securities. Following a review of the Group’s investment classifications, comparative amounts for equity securities and other investments have been amended from amounts previously reported, reflecting the fact that equity and debt securities held indirectly through majority owned consolidated mutual funds in France managed by third parties, which in 2009 were presented as unit trusts and other investment vehicles within other investments, are now presented as debt and equity securities. The effect is to increase equity and debt securities by £2,085 million and £1,247 million and decrease unit trusts and other investment vehicles within other investments by £3,332 million.
Aviva plc Annual Report and Accounts 2010 25 – Financial investments continued (b) Cost, unrealised gains and fair value The following is a summary of the cost/amortised cost, gross unrealised gains and losses and fair value of financial investments: Cost/ amortised cost £m
Fixed maturity securities 164,266 7,507 (4,291) 167,482 Equity securities 44,878 7,186 (2,988) 49,076 Other investments Unit trusts and specialised investment vehicles 30,455 2,478 (413) 32,520 Derivative financial instruments 1,517 774 (17) 2,274 Deposits with credit institutions 558 — — 558 Minority holdings in property management undertakings 669 121 (126) 664 Other long-term investments 756 18 (62) 712 Other short-term investment 2 — — 2
All unrealised gains and losses and impairments on financial investments classified as fair value through profit or loss have been recognised in the income statement. Unrealised gains and losses on financial investments classified as at fair value through profit or loss recognised in the income statement in the year were a net gain of £7,956 million (2009: £15,165 million net gain). Of this, £397 million net gain (2009: £1,877 million net loss) related to financial investments designated as trading and £7,559 million net gain (2009: £17,042 million net gain) related to investments designated as other than trading. The movement in the unrealised gain/loss position reported in the statement of financial position during the year, shown in the table above, includes foreign exchange movements on the translation of unrealised gains and losses on financial investments held by foreign subsidiaries, which are recognised in other comprehensive income, as well as transfers due to the realisation of gains and losses on disposal and the recognition of impairment losses. Total impairments of financial investments classified as available for sale in the income statement in the year, disclosed in note 6, were £179 million (2009: £538 million). The total accumulated impairment provision for financial investments classified as availablefor -sale included in the table above within unrealised losses and impairments was £983 million (2009: £1,060 million). Movements in this provision are shown in section (c) below. At 31 December 2010, £1.0 billion of shareholder holdings in debt securities represent exposures to the governments (and local authorities and agencies) of Greece, Ireland, Portugal and Spain.
At 1 January 2009 (225) (1,036) — (1,261) Increase for the year charged to the income statement (93) (384) (5) (482) Write back following sale or reimbursement 174 401 — 575 Foreign exchange rate movements 25 85 (2) 108
Aviva plc Annual Report and Accounts 2010 26 – Receivables This note analyses our total receivables.
Total 8,295 9,652 Less: Amounts classified as held for sale — (20)
Expected to be recovered in less than one year 7,095 8,985 Expected to be recovered in more than one year 1,200 647
Deferred acquisition costs in respect of: Insurance contracts – Long-term business 3,148 2,952 Insurance contracts – General insurance and health business 1,141 1,227 Participating investment contracts – Long-term business 35 85 Non-participating investment contracts – Long-term business 1,078 1,032 Retail fund management business 14 20
Carrying amount at 1 January 4,069 1,227 20 5,316 Acquisition costs deferred during the year 1,167 2,283 6 3,456 Amortisation (582) (2,369) (12) (2,963) Impact of assumption changes 58 — — 58 Effect of portfolio transfers, acquisitions and disposals 80 — — 80 Foreign exchange rate movements 39 13 — 52 Shadow adjustment (570) — — (570) Other — (13) — (13)
(c) Other assets Other assets include £1 million (2009: £1 million) that is expected to be recovered more than one year after the statement of financial position date.
29 – Ordinary share capital This note gives details of Aviva plc’s ordinary share capital and shows the movements during the year.
(a) Details of the Company’s ordinary share capital are as follows: £m
(b) During 2010, a total of 53,537,268 ordinary shares of 25 pence each were allotted and issued by the Company as follows: Number of shares
At 1 January 2009 2,657,701,624 664 1,234 Shares issued under the Group’s Employee and Executive Share Option Schemes 951,455 1 — Shares issued in lieu of dividends 107,958,295 27 (27)
Aviva plc Annual Report and Accounts 2010 30 – Equity compensation plans This note describes the various equity compensation plans we use, and shows how we value the options and awards of shares in the Company.
(iv) Annual bonus plan awards These awards have been made under the Aviva Annual Bonus Plan 2005, and are described in section (b) below and in the Directors’ Remuneration Report.
(vi) CFO recruitment share awards plan awards The following awards were granted to Patrick Regan under the CFO Recruitment Share Awards Plan following his recruitment in 2010: the Replacement Restricted Share Award (RRSA), the Bonus Replacement Deferred Share Award (BRDSA) and the One Aviva Twice the Value Award (OATTV). The RRSA was awarded to compensate Mr Regan for the loss of share awards granted by his previous employer and the BRDSA was awarded to compensate Mr Regan for the loss of bonus from his previous employer. The awards are described in section (b) below and in the Directors’ Remuneration Report. No further awards will be made under this plan.
Normally exercisable 406 146,038 2010 563 1,113,993 2010, 2012 or 2014 428 91,945 2011 410 2,599,581 2011, 2013 or 2015 491 523,884 2010 or 2012 316 11,067,836 2012, 2014 or 2016 593 290,792 2011 or 2013 310 6,050,688 2013, 2015 or 2017
Aviva Executive Share Option Plan Option price p Number of shares Normally exercisable
The comparative figures as at 31 December 2009 were: Range of exercise prices
(ii) Share awards At 31 December 2010, awards issued under the Company’s executive incentive plans over ordinary shares of 25 pence each in the Company were outstanding as follows: Aviva Long Term Incentive Plan 2005 Number of shares Vesting period Number of shares Vesting period
Aviva Annual Bonus Plan 2005 Number of shares Vesting period Number of shares Vesting period
CFO Recruitment Share Awards Plan Award type Number of shares Vesting period
Aviva plc Annual Report and Accounts 2010 30 – Equity compensation plans continued (c) Movements in the year A summary of the status of the option plans as at 31 December 2009 and 2010, and changes during the years ended on those dates, is shown below.
Share price 402p 480p Exercise price 310p 316p Expected volatility 56% 55% Expected life 5.00 years 5.00 years Expected dividend yield 6.09% 5.06% Risk-free interest rate 1.57% 2.47%
The expected volatility used was based on the historical volatility of the share price over a period equivalent to the expected life of the options prior to its date of grant. The risk-free interest rate was based on the yields available on UK government bonds as at the date of grant. The bonds chosen were those with a similar remaining term to the expected life of the options. 64,903 options granted after 7 November 2002 were exercised during the year (2009: 144,590).
Share price 386.00p 216.25p Expected volatility* 66% 60% Expected volatility of comparator companies’ share price* 65% 61% Correlation between Aviva and competitors’ share price* 57% 55% Expected life 2.75 years 2.75 years Expected dividend yield 7.70% 8.23% Risk-free interest rate* 1.80% 1.76% * For awards with market-based performance conditions.
Cost debited to shareholders’ funds At 1 January 17,979,232 68 8,635,582 33 Acquired in the year 3,500,000 14 14,000,000 54 Distributed in the year (13,063,745) (50) (4,656,350) (19)
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 2010 was: £m
Aviva plc Annual Report and Accounts 2010 33 – Direct capital instruments This note gives details of the direct capital instruments issued in November 2004.
The euro and sterling direct capital instruments (the DCIs) were issued on 25 November 2004 and qualify as Innovative Tier 1 capital, as defined by the Financial Services Authority in GENPRU Annex 1 ‘Capital Resources’. They have no fixed redemption date but the Company may, at its sole option, redeem all (but not part) of the euro and sterling DCIs at their principal amounts on 28 November 2014 and 27 July 2020 respectively, at which dates the interest rates change to variable rates, or on any respective coupon payment date thereafter. In addition, under certain circumstances defined in the terms and conditions of the issue, the Company may at its sole option: substitute at any time not less than all of the DCIs for, or vary the terms of the DCIs so that they become, Qualifying Tier 1 Securities or Qualifying Upper Tier 2 Securities; substitute not less than all of the DCIs for fully paid non-cumulative preference shares in the Company. These preference shares could only be redeemed on 28 November 2014 in the case of the euro DCIs and on 27 July 2020 in the case of the sterling DCIs, or in each case on any dividend payment date thereafter. The Company has the right to choose whether or not to pay any dividend on the new shares, and any such dividend payment will be non-cumulative.
The Company has the option to defer coupon payments on the DCIs on any relevant payment date. Deferred coupons shall be satisfied only in the following circumstances, all of which occur at the sole option of the Company: Redemption; or Substitution by, or variation so they become, alternative Qualifying Tier 1 Securities or Qualifying Upper Tier 2 Securities; or Substitution by preference shares.
Balance at 1 January 3,271 3,271 Movement in the year — —
Balance at 31 December 2009 2,224 104 163 (771) 109 1,829 Arising in the year: Fair value gains/(losses) — (25) 579 — — 554 Fair value gains transferred to profit on disposals — — (123) — — (123) Transfer to profit on disposal of subsidiary (note 3b) (2) — — — — (2) Share of fair value changes in joint ventures and associates taken to other comprehensive income (notes 18a & 19a) — — (15) — — (15) Impairment losses on assets previously revalued directly through other comprehensive income now taken to income statement — — 136 — — 136 Reserves credit for equity compensation plans — — — — 41 41 Shares issued under equity compensation plans (note 36) — — — — (51) (51) Transfers to Minority Interests following DL IPO (3) — (1) (4) Foreign exchange rate movements (41) — — 78 — 37 Aggregate tax effect – shareholders’ tax 5 4 (166) — — (157)
Balance at 1 January 3,425 3,902 Profit for the year attributable to equity shareholders 1,463 1,085 Actuarial gains/(losses) on pension schemes (note 48e(iv)) 1,033 (1,140) Actuarial losses on pension schemes transferred to unallocated divisible surplus (note 44) (18) 24 Dividends and appropriations (note 15) (757) (853) Shares issued in lieu of dividends 209 299 Shares issued under equity compensation plans (note 35) 51 60 Shares distributed by employee trusts (note 31) (50) (18) Fair value gains realised from reserves (note 35) — 1 Transfer to minority interests following Delta Lloyd IPO (4) 3 Aggregate tax effect 59 62
37 – Non-controlling interests This note gives details of the Group’s minority interests and shows the movements during the year.
(278,733) 5,115 (273,618) (264,073) 5,557 (258,516) Outstanding claims provisions Long-term business (1,078) 104 (974) (921) 40 (881) General insurance and health (9,528) 1,113 (8,415) (9,977) 1,194 (8,783) (10,606) 1,217 (9,389) (10,898) 1,234 (9,664) Provisions for claims incurred but not reported (2,735) 445 (2,290) (2,719) 449 (2,270)
(292,074) 6,777 (285,297) (277,690) 7,240 (270,450) Provision for unearned premiums (4,855) 307 (4,548) (4,781) 332 (4,449) Provision arising from liability adequacy tests (2) — (2) (7) — (7) Other technical provisions (1) — (1) — — —
Aviva plc Annual Report and Accounts 2010 39 – Insurance liabilities This note analyses our insurance contract liabilities by type of product and describes how we calculate these liabilities and what assumptions we have used.
(a) Carrying amount Insurance liabilities at 31 December comprise: Long-term business £m
Outstanding claims provisions 1,078 9,528 10,606 921 9,977 10,898 Provision for claims incurred but not reported — 2,735 2,735 — 2,719 2,719
Provision for unearned premiums — 4,855 4,855 — 4,781 4,781 Provision arising from liability adequacy tests — 2 2 — 7 7 Other technical provisions — 1 1 — — —
Total 162,024 17,121 179,145 154,979 17,484 172,463 Less: Obligations to staff pension schemes transferred to provisions (note 47a) (1,445) — (1,445) (1,351) — (1,351) Amounts classified as held for sale — — — — (20) (20)
During 2010, the Group conducted a review of its classification of linked liabilities, following refinement of our policy which now defines unit-linked liabilities as those where all risks attached to the assets held to back those liabilities are borne by the policyholders. The review resulted in a reclassification of £1,890 million of insurance liabilities previously included as unit-linked non-participating liabilities as at 31 December 2009 to other non-participating liabilities. As a result of this reclassification, assets held to cover linked liabilities have also decreased by £1,890 million (see note 28).
In the Netherlands, the balance of profits, after providing appropriate returns for policyholders and after tax, accrues for the benefit of the shareholders. The bases for determining returns for policyholders are complex, but are consistent with methods and criteria followed generally in the Netherlands. In addition, a substantial number of policies provide benefits that are determined by investment performance, subject to certain guarantees, and shareholders’ profits are derived largely from management fees.
(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. 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. 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.
(iii) Methodology and assumptions There are two main methods of actuarial valuation of liabilities arising under long-term insurance contracts – the net premium method and the gross premium method – both of which involve the discounting of projected premiums and claims. Under the net premium method, the premium taken into account in calculating the provision is determined actuarially, based on the valuation assumptions regarding discount rates, mortality and disability. The difference between this premium and the actual premium payable provides a margin for expenses. This method does not allow for voluntary early termination of the contract by the policyholder, and so no assumption is required for persistency. Explicit provision is made for vested bonuses (including those vesting following the most recent fund valuation), but no such provision is made for future regular or terminal bonuses. However, this method makes implicit allowance for future regular or terminal bonuses already earned, by margins in the valuation discount rate used. The gross premium method uses the amount of contractual premiums payable and includes explicit assumptions for interest and discount rates, mortality and morbidity, persistency and future expenses. These assumptions can vary by contract type and reflect current and expected future experience. Explicit provision is made for vested bonuses and explicit allowance is also made for future regular bonuses, but not terminal bonuses.
Equity returns 26.1% 26.6% Property returns 15.0% 15.0% Fixed interest yields 13.2% 14.4%
Pensions business after vesting and pensions annuities in payment PCMA00/PCFA00 adjusted plus allowance for future mortality improvement
Assurances Life conventional non-profit 2.8% to 3.5% 3.0% to 3.8% Pensions conventional non-profit 3.5% to 3.7% 3.8% to 4.0% Deferred annuities Non-profit – in deferment 3.9% 4.2% Non-profit – in payment 3.5% to 3.7% 3.8% to 4.0% Annuities in payment Conventional annuity 3.9% to 5.4% 4.2% to 5.7% Non-unit reserves Life 3.1% 3.3% Pensions 3.8% 4.1%
PCMA00/PCFA00 adjusted plus allowance for future mortality improvement Annuities in payment General annuity business IML00/IFL00 adjusted plus allowance for future mortality improvement
(d) 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 2010 (2009: 2.00% to 7.50%). The weighted average interest rate for all traditional life policy reserves in 2010 was 4.50% (2009: 4.47%).
Aviva plc Annual Report and Accounts 2010 39 – Insurance liabilities continued 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 2010 (2009: 2.00% to 6.00%). 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. 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.
Carrying amount at 1 January 154,058 156,188 Provisions in respect of new business 12,502 11,105 Expected change in existing business provisions (9,259) (7,625) Variance between actual and expected experience 1,858 2,154 Impact of other operating assumption changes (520) (121) Impact of economic assumption changes 1,959 (404) Exceptional strengthening of longevity assumptions (see below) 483 — Other movements (197) 1,112 Change in liability recognised as an expense 6,826 6,221 Effect of portfolio transfers, acquisitions and disposals 1,117 (67) Foreign exchange rate movements (1,055) (8,284)
The variance between actual and expected experience of £1.9 billion in 2010 was primarily driven by favourable movements in investment markets, which had a direct or indirect impact on liability values. Equity markets increased, government bond yields fell in major markets and credit spreads on corporate bonds were broadly unchanged. For many types of long-term business, including unit-linked and participating funds, 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 insurance liabilities. A strengthening of longevity assumptions was made in the Netherlands, following the publication of new mortality tables, which is separately identified as an exceptional item. The reduction in liabilities from other operating assumption changes mainly relates to assurance mortality assumptions in the UK and Ireland, with a corresponding reduction made to reassurance assets. The £2.0 billion impact of economic assumption changes reflects reductions in valuation interest rates. For participating business, a movement in liabilities is generally offset by a corresponding adjustment to the unallocated divisible surplus and does not impact on profit. Where assumption changes do impact on 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 non-financial assets.
Aviva plc Annual Report and Accounts 2010 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. We only establish loss reserves for losses that have already occurred. We therefore do 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, we take 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.
Netherlands Permanent health and injury 3.75% 3.48% 7 years 8 years Reinsured London Market business 3.30% 4.00% 12 years 10 years Latent claims 0.88% to years 8 to 15 years Structured settlements 3.20% 3.30% 35 years 35 years
The gross outstanding claims provision before discounting was £13,179 million (2009: £13,576 million). The period of time which will elapse before the liabilities are settled has been estimated by modelling the settlement patterns of the underlying claims. The discount rate that has been applied to latent claims reserves is based on the relevant swap curve in the relevant currency having regard to the expected settlement dates of the claims. The range of discount rates used depends on the duration of the claims and is given in the table above. The duration of the claims span over 35 years, with the average duration being between 7 and 15 years depending on the geographical region. Any change in discount rates between the start and the end of the accounting period is reflected below operating profit as an economic assumption change. During 2010, we have continued to experience an increase in the number of bodily injury claims settled by periodic payment orders (PPOs) or structured settlements, especially in the UK, which are reserved for on a discounted basis.
Interest rates used to discount latent claim liabilities The discount rates used in determining our latent claim liabilities are based on the relevant swap curve in the relevant currency at the reporting date, having regard to the duration of the expected settlement of latent claims. The range of discount rates used is shown in section (ii) above and depends on the duration of the claim and the reporting date. At 31 December 2010, it is estimated that a 1% fall in the discount rates used would increase net claim reserves by approximately £70 million, excluding the offsetting effect on asset values as assets are not hypothecated across classes of business. The impact of a 1% fall in interest rates across all assets and liabilities of our general insurance and health businesses is shown in note 57(i).
Carrying amount at 1 January 12,696 14,360 Impact of changes in assumptions 26 (106) Claim losses and expenses incurred in the current year 6,908 7,328 Decrease in estimated claim losses and expenses incurred in prior years (358) (541) Exceptional strengthening of general insurance latent claims provisions 10 60
£167 million from Europe mainly due to favourable development of personal and commercial property. £44 million from Canada mainly due to favourable experience on motor and commercial liability.
At end of accident year (3,029) (2,952) (2,819) (2,971) (3,345) (3,653) (4,393) (4,915) (3,780) (3,502) One year later (4,766) (4,486) (4,190) (4,561) (5,011) (5,525) (6,676) (7,350) (5,464) Two years later (5,303) (4,921) (4,613) (4,981) (5,449) (5,971) (7,191) (7,828) Three years later (5,701) (5,233) (4,972) (5,263) (5,784) (6,272) (7,513) Four years later (5,966) (5,466) (5,258) (5,448) (6,001) (6,531) Five years later (6,121) (5,618) (5,409) (5,617) (6,156) Six years later (6,223) (5,715) (5,527) (5,725) Seven years later (6,294) (5,767) (5,594) Eight years later (6,350) (5,814) Nine years later (6,389) Estimate of gross ultimate claims
(e) Provision for unearned premiums Movements The following changes have occurred in the provision for unearned premiums (UPR) during the year: £m
Net cumulative claim payments At end of accident year (2,970) (2,913) (2,819) (2,870) (3,281) (3,612) (4,317) (4,808) (3,650) (3,386) One year later (4,624) (4,369) (4,158) (4,378) (4,925) (5,442) (6,542) (7,165) (5,286) Two years later (5,088) (4,779) (4,565) (4,712) (5,344) (5,881) (7,052) (7,638) Three years later (5,436) (5,064) (4,924) (4,986) (5,671) (6,181) (7,356) Four years later (5,648) (5,297) (5,180) (5,163) (5,892) (6,434) Five years later (5,763) (5,424) (5,325) (5,327) (6,039) Six years later (5,841) (5,508) (5,442) (5,430) Seven years later (5,896) (5,552) (5,502) Eight years later (5,954) (5,598) Nine years later (5,979) Estimate of net ultimate claims At end of accident year 6,186 6,037 6,218 6,602 6,982 7,430 8,363 9,262 7,115 6,650 One year later 6,333 6,038 6,093 6,266 6,818 7,197 8,302 9,104 7,067 Two years later 6,321 5,997 6,037 6,082 6,688 7,104 8,244 9,028 Three years later 6,329 5,973 5,942 5,882 6,544 6,996 8,249 Four years later 6,286 5,912 5,851 5,709 6,476 6,980 Five years later 6,219 5,855 5,772 5,699 6,448 Six years later 6,173 5,786 5,683 5,639 Seven years later 6,109 5,754 5,663 Eight years later 6,130 5,742 Nine years later 6,090 Estimate of net ultimate claims 6,090 5,742 5,663 5,639 6,448 6,980 8,249 9,028 7,067 6,650 Cumulative payments (5,979) (5,598) (5,502) (5,430) (6,039) (6,434) (7,356) (7,638) (5,286) (3,386)
Aviva plc Annual Report and Accounts 2010 40 – Liability for investment contracts This note analyses our investment contract liabilities by type of product and describes how we calculate these liabilities and what assumptions we have used.
(a) Carrying amount The liability for investment contracts at 31 December comprised: £m
Aviva plc Annual Report and Accounts 2010 40 – Liability for investment contracts continued (c) Movements in the year The following movements have occurred in the year: (i) Participating investment contracts £m
The variance between actual and expected experience of £0.8 billion was primarily driven by favourable movements in investment markets in 2010, which had a direct or indirect impact on liability values. Equity markets increased, government bond yields fell in major markets and credit spreads on corporate bonds were broadly unchanged. For many types of long-term business, including unitlinked and participating funds, 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 participating investment contract liabilities. The £0.8 billion variance between actual and expected experience is not a change in assumptions. For participating business, a movement in liabilities is generally offset by a corresponding adjustment to the unallocated divisible surplus and does not impact on profit. Where assumption changes do impact on 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 non-financial assets.
(iii) Guaranteed annuity options The Group’s UK with-profit funds have written individual and group pension contracts which contain guaranteed annuity rate options (GAOs), where the policyholder has the option to take the benefits from a policy in the form of an annuity based on guaranteed conversion rates. The Group also has exposure to GAOs and similar options on deferred annuities. Realistic liabilities for GAOs in the UK with-profit funds were £823 million at 31 December 2010 (2009: £760 million). With the exception of the New With-Profits Sub Fund (NWPSF), movements in the realistic liabilities in the with-profit funds are offset by a corresponding movement in the unallocated divisible surplus, with no net impact on IFRS profit. Realistic liabilities for GAOs in the NWPSF were £131 million at 31 December 2010 (2009: £109 million).
(iv) Guaranteed minimum pension The Group’s UK with-profit funds also have certain policies that contain a guaranteed minimum level of pensions as part of the condition of the original transfer from state benefits to the policy. In addition, the with-profit fund companies have made promises to certain policyholders in relation to their with-profit mortgage endowments. Top-up payments will be made on these policies at maturity to meet the mortgage value up to a maximum of the 31 December 1999 illustrated shortfall. For UKLAP WP policyholders, these payments are subject to certain conditions.
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 2010 for this guarantee is £85 million (2009: £97 million). The reserve is calculated on a prudent basis and is in excess of the economic liability. At the end of 2010, total sums at risk for these contracts were £242 million (2009: £372 million) out of total unit-linked funds of £14 billion (2009: £14 billion). The average age of policyholders was approximately 54. It is estimated that this liability would increase by £93 million (2009: £71 million) if yields were to decrease by 1% per annum and by £22 million (2009: £25 million) if equity markets were to decline by 10% from year end 2010 levels. These figures do not reflect our ability to review the tariff for this option.
(ii) Delta Lloyd Guaranteed minimum return at maturity In the Netherlands, it is market practice to guarantee a minimum return at maturity on traditional savings and pension contracts. Guarantees on older lines of business are 4% per annum, while for business written since 1 September 1999, the guarantee is 3% per annum. On Group pensions business, it is often possible to recapture guarantee costs through adjustments to surrender values or to premium rates. On transition to IFRS, Delta Lloyd changed the reserving basis for most traditional contracts to reflect current market interest rates, for consistency with the reporting of assets at market value. The cost of meeting interest rate guarantees is allowed for directly in the liabilities. Although most traditional contracts are valued at market interest rate, the split by level of guarantee shown below is according to the original underlying guarantee. The total liabilities for traditional business at 31 December 2010 are £13 billion (2009: £13 billion) analysed as follows: Liabilities 3% guarantee £m
Delta Lloyd has certain unit-linked contracts which provide a guaranteed minimum return at maturity from 4% pa to 2% pa. Provisions consist of unit values plus an additional reserve for the guarantee. The additional provision for the guarantee was £88 million (2009: £148 million). An additional provision of £15 million (2009: £33 million) in respect of investment return guarantees on group segregated fund business is held. It is estimated that the provision would increase by £106 million (2009: £180 million) if yields were to reduce by 1% pa and by £37 million (2009: £42 million) if equity markets were to decline by 10% from year end 2010 levels.
Return of premium guarantee Until 2005, Aviva Life and Pensions Ireland wrote two tranches of linked bonds with a return of premium guarantee, or a price floor guarantee, after five or six years. The first tranche has now expired. The provision for the second tranche over and above unit and sterling reserves, at the end of 2010 is £9 million (2009: £11 million). It is estimated that the provision would increase by £3 million (2009: £4 million) if equity markets were to decline by 10% from the year end 2010 levels. However, the provision increase would be broadly off-set by an increase in the value of the hedging assets that were set up on sale of these policies. We would not expect any significant impact on this provision as a result of interest rate movements. It is estimated that the provision would increase by £0.5 million (2009: £2 million) if property values were to decline by 10% from year end 2010 levels. This would be offset by an increase in the value of the hedging assets by £0.5 million (2009: £0.4 million), the difference reflecting the fact that only the second tranche was hedged for property exposure.
(v) United States Indexed and total return strategy products In the United States, the Group writes indexed life and deferred annuity products. These products guarantee the return of principal to the policyholder and credit interest based on certain indices, primarily the Standard & Poor’s 500 Composite Stock Price Index. A portion of each premium is used to purchase derivatives to hedge the growth in interest credited to the policyholder. The derivatives held by the Group and the options embedded in the policy are both carried at fair value. The US Treasury swap curve plus a risk adjustment of 1.47% (2009: 1.87%) for indexed life and 1.48% (2009: 1.65%) for indexed deferred annuities is used as the discount rate to calculate the fair value of the embedded options. The risk adjustment calculation is based on market spreads on senior long-term unsecured Aviva plc debt with a reduction to reflect policyholder priority over other creditors in case of default. The amount of change in the fair value of these embedded options resulting from the risk adjustment in 2010 is an increase of £216 million (2009: £313 million), and is principally attributable to market factors rather than instrument specific credit risk. At 31 December 2010, the total liabilities for indexed products were £20 billion (2009: £17 billion), including liabilities for the embedded option of £2.5 billion (2009: £1.7 billion). If interest rates were to increase by 1%, the provision for embedded options would decrease by £151 million (2009: £59 million) and, if interest rates were to decrease by 1%, the provision would increase by £167 million (2009: £86 million). The Group has certain products that credit interest based on a total return strategy, whereby policyholders are allowed to allocate their premium payments to different asset classes within the general account. The Group guarantees a minimum return of premium plus approximately 3% interest over the term of the contracts. The linked general account assets are fixed maturity securities, and both the securities and the contract liabilities are carried at fair value. At 31 December 2010, the liabilities for total return strategy products were £1.0 billion (2009: £1.2 billion). The Group offers an optional lifetime guaranteed income benefit focused on the retirement income segment of the deferred annuity marketplace to help customers manage income during both the accumulation stage and the distribution stage of their financial life. At 31 December 2010, a total of £8.9 billion (2009: £4.9 billion) in indexed deferred annuities have elected this benefit, taking steps to guarantee retirement income.
42 – Reinsurance assets This note details the reinsurance recoverables on our insurance and investment contract liabilities.
(a) Carrying amounts The reinsurance assets at 31 December comprised: £m
Change in reinsurance asset recognised as income (148) (128) Effect of portfolio transfers, acquisitions and disposals 34 57 Foreign exchange rate movements 28 (50) Other movements 1 (2)
Aviva plc Annual Report and Accounts 2010 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. This note shows the movements in this surplus during the year. The following movements have occurred in the year: £m
Carrying amount at 1 January 3,866 2,325 Change in participating contract assets (444) (1,314) Change in participating contract liabilities 169 3,836 Effect of special bonus to with-profit policyholders (see note 45a) (58) (69) Effect of reattribution of inherited estate (see note 45b) — (881) Other movements 4 (25) Change in liability recognised as an expense (329) 1,547 Effect of portfolio transfers, acquisitions and disposals (3) (4) Movement in respect of change in pension scheme deficit (note 48c(i)) 18 (24) Foreign exchange rate movements (61) 43 Other movements (63) (21)
(a) Special bonus declared by UK Life business On 5 February 2008, the Group’s UK long-term business operation, Norwich Union Life, announced a one-off, special bonus worth an estimated £2.3 billion, benefiting around 1.1 million with-profit policyholders in its CGNU Life and CULAC with-profit funds. The bonus has been used to enhance policy values by around 10% in total, in three instalments, with the qualifying dates being 1 January 2008, 1 January 2009 and 1 January 2010. In accordance with the way the funds are managed, the bonus distribution has been split on a 90/10 basis between policyholders and shareholders. £2,127 million was set aside for policyholders on 1 January 2008 and has been allocated over the three years. Similarly, shareholders were expected to receive £236 million over the three-year period. As explained in accounting policies F and K, the Group’s insurance and participating investment contract liabilities are measured in accordance with IFRS 4, Insurance Contracts, and FRS 27, Life Assurance. The latter requires liabilities for with-profit funds falling within the scope of the UK’s Financial Services Authority’s capital regime to be determined in accordance with this regime, adjusted to remove the shareholders’ share of future bonuses. This required us to recognise planned discretionary bonuses within policyholder liabilities at 31 December 2007, even if there was no constructive obligation at the time. As a result of the announcement made above, a transfer of £2,127 million was made in 2007 from the UDS in order to increase insurance liabilities by £1,728 million and participating investment contract liabilities by £399 million. Of the original £236 million due to shareholders, £58 million has been transferred from the UDS in 2010 (2009: £69 million).
(b) Impact of the reattribution of the inherited estate On 1 October 2009, a reorganisation of the with-profit funds of CGNU Life Assurance Limited (CGNU) and Commercial Union Life Assurance Company Limited (CULAC) was approved by the Board and became effective. The reorganisation was achieved through a reattribution to shareholders of the inherited estates of these funds. As part of the reorganisation the two funds were merged and transferred to Aviva Life & Pensions UK Limited (UKLAP). Within UKLAP, two new with-profit sub-funds were created. Policies of non-electing policyholders were transferred to the Old With-Profit Sub-Fund (OWPSF). The inherited estate has not been reattributed and remains in the OWPSF. Where policyholders elected to accept the reattribution, their policies were transferred to the New With-Profit Sub-Fund (NWPSF). The inherited estate, totalling £1,105 million at 1 October 2009, was reattributed to a separate long-term fund called the Non-Profit Sub-Fund 1(NPSF1), in which 100% of the surplus is attributable to shareholders. On the effective date of 1 October 2009, the unallocated divisible surplus of NWPSF was released as it has been allocated to shareholders. The reorganisation scheme has imposed certain restrictions around release of the assets allocated to shareholders as a result of this transaction, to ensure that sufficient protection for with-profit policyholder benefits is maintained. The initial impact of the reorganisation on profit before tax in 2009 was £202 million, of which a loss of £5 million was recognised in operating profit, reflecting the value derived from the reorganisation. The remaining £207 million was recognised outside operating profit, offsetting the shareholder tax attributable to the transaction. The ongoing impact of the reattribution is that profit recognised in the NWPSF, which prior to the reattribution would have been transferred to the unallocated distributable surplus, is now recognised in profit attributable to shareholders.
(ii) The net deferred tax liability arises on the following items: £m
Long-term business technical provisions and other insurance items 1,051 1,290 Deferred acquisition costs (678) (662) Unrealised gains on investments (1,465) (915) Pensions and other post-retirement obligations 91 100 Unused losses and tax credits 713 824 Subsidiaries, associates and joint ventures (9) (7) Intangibles and additional value of in-force long-term business (656) (766) Provisions and other temporary differences (517) (684)
(iii) The movement in the net deferred tax liability was as follows: £m
Deferred tax assets are recognised to the extent that it is probable that future taxable profits will be available against which the temporary differences can be utilised. In countries where there is a history of tax losses, deferred tax assets are only recognised in excess of deferred tax liabilities if there is convincing evidence that future profits will be available. Where this is the case, the directors have relied on business plans supporting future profits. The Group has unrecognised tax losses and other temporary differences of £2,150million (2009: £2,975 million) to carry forward against future taxable income of the necessary category in the companies concerned. Of these, trading losses of £185 million will expire within the next 15 years. The remaining losses have no expiry date. In addition, the Group has unrecognised capital losses of £384 million (2009: £462 million). Of these, £35 million will expire within the next 15 years. The remaining capital losses have no expiry date. Deferred tax liabilities have not been established for temporary differences in respect of unremitted overseas retained earnings of £140 million (2009: £144 million) associated with investments in subsidiaries and interests in joint ventures and associates because the Group can control the timing of the reversal of these differences and it is probable that they will not reverse in the foreseeable future. The temporary differences represent the unremitted earnings of those overseas subsidiaries in respect of which a tax liability may still arise on remittance of those earnings to the UK, principally as a result of overseas withholding taxes on dividends.
Aviva plc Annual Report and Accounts 2010 47 – Provisions This note details the non-insurance provisions that the Group holds, and shows the movements in these during the year.
Total IAS 19 obligations to staff pension schemes 2,101 3,183 Restructuring provisions 152 198 Other provisions 690 599
At 1 January 198 599 797 Additional provisions 129 281 410 Unused amounts reversed (6) (74) (80) Change in the discounted amount arising from passage of time — 6 6
Charge to income statement 123 213 336 Utilised during the year (160) (119) (279) Acquisition of subsidiaries — 2 2 Foreign exchange rate movements (9) (5) (14)
At 1 January 253 591 844 Additional provisions 348 336 684 Unused amounts reversed (13) (23) (36) Change in the discounted amount arising from passage of time (7) (23) (30)
Aviva plc Annual Report and Accounts 2010 48 – Pension obligations This note describes the Group’s pension arrangements for its employees and explains how our obligations to these schemes are calculated.
(b) Membership The number of scheme members at 31 December 2010 was as follows: United Kingdom Netherlands
(c) UK schemes In the UK, the Group operates two main pension schemes, the Aviva Staff Pension Scheme (ASPS) and the smaller RAC (2003) Pension Scheme. New entrants join the defined contribution section of the ASPS, as the defined benefit section is closed. 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 below as the trustees). On 20 October 2010, following formal consultation, the Group confirmed its decision to close the final salary sections of both UK schemes with effect from 1 April 2011, with entry into the defined contribution sections being offered to the staff members affected. The consequential reduction in the liabilities of both schemes, arising from projecting forward salaries using estimates of inflation rather than salary inflation, is £320 million. Additional contributions to affected members’ defined contribution accounts and implementation costs have resulted in an overall gain on closure of £286 million, which is considered a profit arising in 2010. Closure of the schemes removes the volatility associated with adding future accrual for active members and will also lead to lower service costs and their expected cash funding from 2011 onwards.
(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 1% 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 2011.
(d) Credit/charges to the income statement The total pension (credit)/costs of all the Group’s defined benefit and defined contribution schemes were: £m
UK defined benefit schemes (227) 84 Overseas defined benefit schemes 52 103
(e) IAS 19 disclosures Disclosures under IAS 19 for the material defined benefit schemes in the UK, the Netherlands, Canada and Ireland are given below. Where schemes provide both defined benefit and defined contribution pensions, the assets and liabilities shown exclude those relating to defined contribution pensions. Total employer contributions for these schemes in 2011, including the ASPS deficit funding, are expected to be £285 million.
Aviva plc Annual Report and Accounts 2010 48 – Pension obligations continued Alternative measurement methods There are alternative methods of measuring liabilities, for example by calculating an accumulated benefit obligation (the present value of benefits for service already rendered but with no allowance for future salary increases) or on a solvency basis, using the cost of securing the benefits at a particular date with an insurance company or one of the growing market of alternative buy-out providers. This could take the form of a buy-out, in which the entire liability will be settled in one payment with all obligations transferred to an insurance company or buy-out provider, or a buy-in, in which annuities or other insurance products are purchased to cover a part or all of the liability. A valuation of the liabilities in either of these cases will almost always result in a higher estimate of the pension deficit than under an ongoing approach, as they assume that the sponsor immediately transfers the majority, if not all, of the risk to another provider who would be seeking to make a profit on the transaction. However, there are only a limited number of organisations that would be able to offer these options for schemes of the size of those in our Group. The full buy-out cost would only be known if quotes were obtained from such organisations but, to illustrate the cost of a buy-out valuation, an estimate for the main UK scheme is that the year-end liabilities of £7.9 billion could be valued some £4.1 billion higher, at £12.0 billion. There is a small buy-out market in Ireland, largely restricted to pensions currently in payment and it is not clear whether current capacity would enable an immediate buy-out of our Irish pension liabilities at present. The Canadian defined benefit plan’s liabilities represent the likely limit on what the Canadian group annuity market could absorb at normal competitive group annuity prices if the entire plan were subject to a buy-out valuation. There is in fact a reasonably high chance that only a portion of the plan’s liabilities could be absorbed in one tranche. IAS 19 requires us to use the projected unit credit method to measure our pension scheme liabilities. Neither of the alternative methods is considered appropriate in presenting fairly the Group’s obligations to the members of its pension schemes on an ongoing basis, so they are not considered further.
Valuations and assumptions The valuations used for accounting under IAS 19 have been based on the most recent full actuarial valuations, updated to take account of that standard’s requirements in order to assess the liabilities of the material schemes at 31 December 2010. Scheme assets are stated at their fair values at 31 December 2010. The main actuarial assumptions used to calculate scheme liabilities under IAS 19 are: UK Netherlands
Inflation rate 3.5% 3.6% 1.9% 2.1% General salary increases 5.3% 5.4% 2.9%* 3.1%* Pension increases 3.5% 3.6% 1.9** 2.1%/1.9%** Deferred pension increases 3.5% 3.6% 1.9%** 2.1%/1.9%** Discount rate 5.5% 5.7% 5.1% 5.2% Basis of discount rate AA-rated corporate bonds AA-rated corporate bonds * Age-related scale increases plus 2.9% (2009: 3.1%). ** 2.1% until 2011 and expected return less 3% thereafter (2009: 2.1% until 2011 and 1.9% thereafter) .
Inflation rate 2.5% 2.5% 2.0% 2.0% General salary increases 3.75% 3.75% 3.5% 3.5% Pension increases 1.25% 1.25% 2.0% 2.0% Deferred pension increases — — 2.0% 2.0% Discount rate 5.0% 5.5% 5.6% 5.5% Basis of discount rate AA-rated corporate bonds AA-rated corporate bonds
Netherlands CBS 2010, adjusted for experience and allowance for future improvements 65
(iv) Pension expense As noted above, plan assets in the UK and Dutch schemes include insurance policies with other Group companies. To avoid doublecounting of investment income on scheme assets and the assets backing the underlying policies, adjustments have been made to the former as shown in the tables below. The total pension expense for these schemes comprises: Recognised in the income statement £m
Total pension credit/(cost) charged to net operating expenses 177 (107) Expected return on scheme assets 522 466 Less: Income on insurance policy assets accounted for elsewhere (see (iii) above) (65) (58)
The gains on curtailments principally arise from closure of the UK schemes to future accrual, described in section (c) above.
Recognised in the statement of comprehensive income £m Expected return on scheme assets (522) (466) Actual return on these assets 1,145 1,009
Difference between the expected and actual return on scheme assets Amount of gains/(losses) 547 561 (1,893) (138) 251 Percentage of the scheme assets at the end of the year 5.5% 6.4% 23.8% 1.6% 3.1% Experience gains/(losses) on scheme liabilities (excluding changes in assumptions) Amount of gains/(losses) 450 77 105 (80) 63 Percentage of the present value of scheme liabilities 3.9% 0.7% 1.1% 0.8% 0.6%
Total fair value of assets 9,361 1,452 216 387 11,416 Present value of scheme liabilities (9,044) (1,462) (362) (551) (11,419)
Total fair value of assets 9,361 7 216 387 9,971 Present value of scheme liabilities (9,044) (1,462) (362) (551) (11,419)
The present value of unfunded post-retirement benefit obligations included in the totals in both sets of tables above is £130 million (2009: £118 million).
Deficits in the schemes at 1 January 10,105 (11,812) (1,707) (1,351) (3,058) Employer contributions 579 — 579 (34) 545 Employee contributions 15 (15) — (9) (9) Benefits paid (385) 385 — 47 47 Current and past service cost (see (iv) above) — (170) (170) — (170) Gains on curtailments and settlements (see (iv) above) (1) 348 347 — 347 Credit/(charge) to finance costs (see (iv) above) 522 (652) (130) (65) (195) Actuarial gains/(losses) (see (iv) above) 623 456 1,079 (80) 999 Transfers 1 2 3 (1) 2 Exchange rate movements on foreign plans (43) 39 (4) 48 44
Deficits in the schemes at 31 December 10,105 (11,812) (1,707) (1,351) (3,058)
The fall in the pension schemes’ net deficits during 2010 is mainly attributable to additional employer contributions and curtailment gains in the UK schemes, increases in investment values and experience gains on scheme liabilities.
Subordinated debt 6.125% £700 million subordinated notes 2036 — 690 — 690 — 690 — 690 5.750% €800 million subordinated notes 2021 — 685 — 685 — 710 — 710 5.250% €650 million subordinated notes 2023 — 521 — 521 — 539 — 539 5.700% €500 million undated subordinated notes 426 — — 426 441 — — 441 6.125% £800 million undated subordinated notes 791 — — 791 791 — — 791 Floating rate US$300 million subordinated notes 2017 — 192 — 192 — 186 — 186 6.875% £400 million subordinated notes 2058 — 398 — 398 — 395 — 395 6.875% £200 million subordinated notes 2058 — 199 — 199 — 199 — 199 6.875% €500 million subordinated notes 2038 — 427 — 427 — 442 — 442 10.6726% £200 million subordinated notes 2019 — 200 — 200 — 200 — 200 10.464% €50 million subordinated notes 2019 — 43 — 43 — 44 — 44
Within 1 year 655 512 1,167 483 344 827 1 to 5 years — 1,783 1,783 13 1,455 1,468 5 to 10 years 1,128 2,090 3,218 1,074 1,736 2,810 10 to 15 years 1,243 1,788 3,031 1,289 1,440 2,729 Over 15 years 3,382 6,244 9,626 2,985 2,340 5,325
Total contractual undiscounted cash flows 6,408 12,417 18,825 5,844 7,315 13,159
Securitised mortgage loan notes UK lifetime mortgage business 1,288 1,444 Dutch domestic mortgage business 5,045 5,885
All the above borrowings are stated at amortised cost, except for the loan notes issued in connection with the UK lifetime mortgage business of £1,288 million (2009: £1,444 million) and £3,402 million (2009: £3,664 million) of the loan notes issued in connection with the Dutch domestic mortgage business, which are carried at fair value. There is an active market for some of the Dutch securitised mortgage loan notes, amounting to £2,305 million (2009: £nil), and therefore fair values for these notes are based on market quoted prices, warranting a fair value hierarchy classification of ‘Level 1’. For the remaining loan notes carried at fair value, fair values are modelled on risk-adjusted cash flows for defaults discounted at a risk-free rate plus a market-determined liquidity premium, and are therefore classified as ‘Level 2’ in the fair value hierarchy. These have been designated at fair value through profit and loss in order to present the relevant mortgages, borrowings and derivative financial instruments at fair value, since they are managed as a portfolio on a fair value basis. This presentation provides more relevant information and eliminates any accounting mismatch. The securitised mortgage loan notes are at various fixed, floating and index-linked rates. Further details about these notes are given in note 24.
The subordinated notes were issued by the Company. They rank below its senior obligations and ahead of its preference shares and ordinary share capital. The dated subordinated notes rank ahead of the undated subordinated notes. The fair value of these notes at 31 December 2010 was £4,370 million (2009: £4,372 million), calculated with reference to quoted prices.
(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 Aviva Group. Loans of £1,098 million (2009: £790 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. The amount of these loans can be varied without any penalty being charged, subject to a maximum of 50% Loan to Value and a maximum facility of €40 million.
Aviva plc Annual Report and Accounts 2010 49 – Borrowings continued (v) Securitised mortgage loan notes Loan notes have been issued by special purpose securitisation companies in the UK and the Netherlands. Details of these securitisations are given in note 24. For the Dutch securitised mortgage loan notes carried at amortised cost of £1,642 million (2009: £2,221 million), their fair value is £1,628 million (2009: £2,170 million), calculated based on the future cash flows discounted back at the market rate of interest.
(f) Undrawn borrowings The Group and Company have the following undrawn committed central borrowing facilities available to it, of which £750 million (2009: £1,000 million) is used to support the commercial paper programme: £m
Aviva plc Annual Report and Accounts 2010 50 – Payables and other financial liabilities This note analyses our financial liabilities at the end of the year.
Deferred income 789 423 Reinsurers’ share of deferred acquisition costs 79 127 Accruals 1,896 1,623 Other liabilities 1,415 1,493 4,179 3,666 Less: Amounts classified as held for sale — (13)
Expected to be settled within one year 3,734 3,214 Expected to be settled in more than one year 445 439
Aviva plc Annual Report and Accounts 2010 52 – Contingent liabilities and other risk factors This note sets out the main areas of uncertainty over the calculation of our liabilities.
(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 guaranteed annuity options (GAOs), are sensitive to interest rates falling below the guaranteed level. Other guarantees, such as maturity value guarantees and guarantees in relation to minimum rates of return, are sensitive to fluctuations in the investment return below the level assumed when the guarantee was made. The directors continue to believe that the existing provisions for such guarantees and options are sufficient.
(d) 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 and in addition monitors 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 operate a system of ‘prior product approval’ and hence place less emphasis than the FSA on regulating sales and marketing practices. 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.
(g) Structured settlements In Canada, annuities have been purchased from licensed Canadian life insurers to provide for fixed and recurring payments to claimants. As a result of these arrangements, the Group is exposed to credit risk to the extent that any of the life insurers fail to fulfil their obligations. The Group’s maximum exposure to credit risk for these arrangements is approximately £683 million as at 31 December 2010 (2009: £984 million) based on estimated replacement cost for the underlying annuities. The 2010 structured settlement exposure valuation used revised shorter life expectancy tables, resulting in a large reduction over the prior year. The credit risk is managed by acquiring annuities from a diverse portfolio of life insurers with proven financial stability. The risk is reduced to the extent of coverage provided by Assuris, the Canadian life insurance industry compensation plan. No information has come to the Group’s attention that would suggest any weakness or failure in the Canadian life insurers from which it has purchased annuities.
Aviva plc Annual Report and Accounts 2010 52 – Contingent liabilities and other risk factors continued (h) Other In the course of conducting insurance and investment business, various Group companies receive liability claims, and become involved in actual or threatened related litigation. In the opinion of the directors, adequate provisions have been established for such claims and no material loss will arise in this respect. The Company and several of its subsidiaries have guaranteed the overdrafts and borrowings of certain other Group companies. At 31 December 2010, the total exposure of the Group and Company is £nil (2009: £nil) and £343 million (2009: £77 million) respectively and, in the opinion of the directors, no material loss will arise in respect of these guarantees and indemnities. In addition, in line with standard business practice, various Group companies have been given guarantees, indemnities and warranties in connection with disposals in recent years of subsidiaries and associates to parties outside the Aviva Group. In the opinion of the directors, no material loss will arise in respect of these guarantees, indemnities and warranties. The Group’s insurance subsidiaries pay contributions to levy schemes in several countries in which we operate. Given the economic environment, there is a heightened risk that the levy contributions will need to be increased to protect policyholders if an insurance company falls into financial difficulties. The directors continue to monitor the situation but are not aware of any need to increase provisions at the statement of financial position date.
Within 1 year 374 551 Later than 1 year and not later than 5 years 1,206 1,505 Later than 5 years 2,270 2,456
Within 1 year 136 145 Later than 1 year and not later than 5 years 423 463 Later than 5 years 737 834
Profit before tax 2,834 2,022 Adjustments for: Share of (profits)/losses of joint ventures and associates (131) 504 Dividends received from joint ventures and associates 63 22 (Profit)/loss on sale of: Investment property (45) (339) Property and equipment 5 (9) Subsidiaries, joint ventures and associates (159) (153) Investments (2,097) 1,534 (2,296) 1,033 Fair value (gains)/losses on: Investment property (421) 1,084 Investments (8,015) (15,352) Borrowings 67 196 (8,369) (14,072) Depreciation of property and equipment 77 115 Equity compensation plans, equity settled expense 50 56 Impairment and expensing of: Goodwill on subsidiaries 3 30 Financial investments, loans and other assets 202 592 Acquired value of in-force business and intangibles 21 25 Non-financial assets 5 (1) 231 646 Amortisation of: Premium or discount on debt securities 72 303 Premium or discount on loans 26 (19) Premium or discount on borrowings 1 3 Premium or discount on participating investment contracts 17 15 Financial instruments 70 (77) Acquired value of in-force business and intangibles 354 376 540 601 Change in unallocated divisible surplus (329) 1,547 Interest expense on borrowings 1,232 1,327 Net finance charge on pension schemes 195 183 Foreign currency exchange gains (34) (155) Changes in working capital Decrease in reinsurance assets 685 (124) (Increase)/decrease in deferred acquisition costs (602) (567) Increase/(decrease) in insurance liabilities and investment contracts 14,076 15,134 Increase/(decrease) in other assets and liabilities 3,892 2,301 18,051 16,744 Net purchases of operating assets Purchases of investment property (1,126) (441) Proceeds on sale of investment property 870 1,267 Net purchases of financial investments (9,645) (8,113) (9,901) (7,287) Cash generated from operations 2,213 3,286
Cash consideration for subsidiaries, joint ventures and associates acquired 304 601 Less: Cash and cash equivalents acquired with subsidiaries (781) (5)
Cash proceeds from disposal of subsidiaries, joint ventures and associates 271 808 Net cash and cash equivalents divested with subsidiaries (20) (607) Cash flows on disposals 251 201
(d) Cash and cash equivalents in the statement of cash flows at 31 December comprised: £m
Cash at bank and in hand 9,740 10,681 Cash equivalents 15,715 14,495 55 – Group capital structure The Group maintains an efficient capital structure from a combination of equity shareholders’ funds, preference capital, subordinated debt and borrowings, consistent with our overall risk profile and the regulatory and market requirements of our business. This note shows where this capital is employed.
— Certain subsidiaries, subject to continuing to satisfy stand alone capital and liquidity requirements, loan funds to corporate and holding entities. These loans satisfy arm’s length criteria and all interest payments are made when due.
Total capital employed is financed by a combination of equity shareholders’ funds, preference capital, subordinated debt and borrowings. At 31 December 2010 we had £26.5 billion (2009: £24.1 billion) of total capital employed in our trading operations, measured on an MCEV basis. Financial leverage, the ratio of external senior and subordinated debt to MCEV capital and reserves, was 31.5% (2009: 31.6%). Fixed charge cover, which measures the extent to which external interest costs, including subordinated debt interest and preference dividends, are covered by MCEV operating profit was 9.4 times (2009: 8.7 times).
Aviva plc Annual Report and Accounts 2010 56 – Capital statement This statement sets out the financial strength of our Group entities and provides an analysis of the disposition and constraints over the availability of capital to meet risks and regulatory requirements. The capital statement also provides a reconciliation of shareholders’ funds to regulatory capital. The analysis below sets out the Group’s available capital resources.
Total shareholders’ funds 10 (10) 22 22 4,628 4,650 14,143 18,793 (1,068) 17,725 15,086 Other sources of capital1 — — — — 200 200 189 389 4,572 4,961 5,088 Unallocated divisible surplus 201 — 1,846 2,047 9 2,056 1,372 3,428 — 3,428 3,866 Adjustments onto a regulatory basis: Shareholders’ share of accrued bonus (45) (281) (347) (673) — (673) — (673) — (673) (576) Goodwill and other intangibles5 — — — — (296) (296) (3,729) (4,025) (2,430) (6,455) (6,828) Regulatory valuation and admissibility restrictions2 69 1,587 312 1,968 (1,776) 192 (3,581) (3,389) 984 (2,405) 476
Participating investment liabilities 659 3,464 6,023 10,146 2,628 12,774 56,708 69,482 — 69,482 66,559 Non-participating investment liabilities (4) (31) — (35) 30,645 30,610 17,695 48,305 — 48,305 43,456
Aviva plc Annual Report and Accounts 2010 56 – Capital statement continued Analysis of movements in capital of long-term businesses For the year ended 31 December 2010
Available capital resources at 1 January 199 1,128 1,590 2,917 2,861 5,778 8,967 14,745 Effect of new business (2) (19) 12 (9) 95 86 (733) (647) Expected change in available capital resources 17 216 103 336 305 641 635 1,276 Variance between actual and expected experience (11) (119) 17 (113) — (113) (204) (317) Effect of operating assumption changes 2 35 (46) (9) (87) (96) (322) (418) Effect of economic assumption changes 18 107 162 287 — 287 (314) (27) Effect of changes in management policy — (22) — (22) — (22) 31 9 Effect of changes in regulatory requirements — — — — — — 642 642 Transfers, acquisitions and disposals — — — — 211 211 4 215 Foreign exchange movements — — — — (170) (170) Other movements 12 (30) (5) (23) (620) (643) (142) (785)
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 £1,218 million (this is known as RIEESA), at 31 December 2010 (31 December 2009: £1,177 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. For the WPSF/RIEESA, equity market performance has had little impact, as the funds mitigate materially all of the equity risk of the estate/RIEESA through internal hedging. In aggregate, the Group has at its disposal total available capital of £16.6 billion (2009: £17.1 billion), representing the aggregation of the solvency capital of all of our businesses. This capital is available to meet risks and regulatory requirements set by reference to local guidance and EU directives. After effecting the year-end transfers to shareholders, the UK with-profit funds have available capital of £3.4 billion (2009: £2.9 billion) (including amounts held in RIEESA). Subject to certain conditions, the RIEESA capital can be used to write new non-profit business, but the primary purpose of this capital is to provide support for the UK with-profit business. The capital is comfortably in excess of the required capital margin, and therefore the shareholders are not required to provide further support. For the remaining life and general insurance operations, the total available capital amounting to £13.2 billion (2009: £14.2 billion) is significantly higher than the minimum requirements established by regulators and, in principle, the excess is available to shareholders. In practice, management will hold higher levels of capital within each business operation to provide appropriate cover for risk. As the total available capital of £16.6 billion is arrived at on the basis of local regulatory guidance, which evaluates assets and liabilities prudently, it understates the economic capital of the business which is considerably higher. This is a limitation of the Group Capital Statement which, to be more meaningful, needs to evaluate available capital on an economic basis and compare it with the risk capital required for each individual operation, after allowing for the considerable diversification benefits that exist in our Group. Within the Aviva Group there exist intra-group arrangements to provide capital to particular business units. Included in these arrangements is a subordinated loan of £200 million from Aviva Life Holdings UK Limited to Aviva Annuity Limited to provide capital to support the writing of new business.
WPSF respectively (31 December 2009: £2.2 billion, £0.3 billion and £3.1 billion for NWPSF, OWPSF and WPSF respectively). 2. Estimated realistic inherited estate at 31 December 2009 was £nil, £0.2 billion and £1.6 billion for NWPSF, OWPSF and WPSF respectively. 3. This represents the reattributed estate of £1.2 billion at 31 December 2010 (31 December 2009: £1.1 billion) held within the non-profit fund with WPSF included within other UK life operations. 4. The WPSF fund includes the Provident Mutual (PM) fund, which has realistic assets and liabilities of £1.7 billion and therefore does not impact the realistic inherited estate. 5. The risk capital margin (RCM) is 3.7 times covered by the inherited estate and support arrangement (31 December 2009: 3.6 times).
(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.
(a) Risk management framework The risk management framework (RMF) in Aviva is the collection of processes and tools that have been put in place to ensure that the risks to which we are exposed are identified, measured, managed, monitored and reported on a continuous basis. The RMF is designed to facilitate a common approach to, and language regarding, the management of risk across the Group. The key instruments of the RMF include the risk management policies, risk reports, risk models, the governance and oversight infrastructure and the risk appetite framework. Risks are usually grouped by risk type: market, credit, liquidity, general insurance, life insurance and operational risk. Risk falling within these types may affect a number of key metrics including those relating to balance sheet strength, liquidity and profit. They may also affect the performance of the products that we deliver to our customers and the service to our customers and distributors, which can be categorised as risks to our brand and reputation. Additional information on the Group’s risk is included in the risk section of the Performance review. The Group has a set of formal risk policies that facilitate a consistent approach to the management of all our risks across all businesses and locations in which we operate. These risk policies define our appetite for different, granular risk types and set out risk management and control standards for the Group’s worldwide operations. A top-down key risk identification and assessment process is carried out monthly in the risk function at Group level based on group and regional chief risk officer and functional risk director input. This includes the consideration of emerging risks and is supported by deeper thematic reviews. The risk assessment processes are used to generate risk reports which are shared with the relevant risk committees. Risk models are an important tool in our measurement of risk and are used to support the monitoring and reporting of the risk profile and in the evaluation of alternative risk management actions. We carry out a range of stress (where one risk factor, such as equity returns, is assumed to vary) and scenario (where combinations of risk factors are assumed to vary) tests to evaluate their impact on the business and the management actions available to respond to the conditions envisaged. Monthly assessments are made of the economic capital available within the business and the economic capital required to cover the current risk profile of the business and these assessments are included in the regular reporting to the risk committees. Board oversight of risk and risk management across the Group is maintained on a regular basis through its Risk Committee. The Board has overall responsibility for determining risk appetite, which is an expression of the risk it is willing to take. The Group’s position against risk appetite is monitored and reported to the Board on a monthly basis. The risk governance framework allocates responsibility for the oversight of risk management to a number of committees at Group centre, with the Asset Liability Committee (ALCO) and the Operational Risk Committee (ORC) providing a key focus on financial and operational risk. The Group centre committees are in turn supported by similar governance structures in the regions.
Equity price risk The Group is subject to equity price risk due to daily changes in the market values of its equity securities portfolio. The Group’s shareholders are exposed to the following sources of equity risk: Direct equity shareholdings in shareholder funds and the Group defined benefit pension funds. The indirect impact from changes in the value of equities held in policyholders’ funds from which management charges or a share of performance are taken; and Its interest in the free estate of long-term with profits funds.
Property price risk The Group is subject to property price risk due to holdings of investment properties in a variety of locations worldwide and through investments in mortgages and mortgage backed securities. Investment in property is managed at regional and business level, and will be subject to local regulations on asset admissibility, liquidity requirements and the expectations of policyholders as well as overall risk appetite. The Assets Committee also monitors property assets owned directly by the Group. As at 31 December 2010, 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 (h) below.
Net assets at 31 December 2010 (899) 833 (271) 271 Net assets at 31 December 2009 (802) 802 (228) 228
Derivatives risk Derivatives are used by a number of the businesses, within policy guidelines agreed by the Board of directors, as set out in the Group policy on derivatives use. Activity is overseen by the Derivatives Approvals Committee, which monitors implementation of the policy, exposure levels and approves large or complex transactions proposed by businesses. Derivatives are primarily used for efficient investment management, risk hedging purposes or to structure specific retail savings products. Derivative transactions are covered by either cash or corresponding assets and liabilities. Speculative activity is prohibited, unless prior approval has been obtained from the Derivatives Approvals Committee. Over-the-counter derivative contracts are entered into only with approved counterparties and using ISDA documentation and credit support annexes (or equivalent) in accordance with the Group derivatives policy. Adherence to the collateral requirements as set out in the Group derivatives and Group credit policies thereby reduces the risk of credit loss. 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.
(c) Credit risk Credit risk is the risk of financial loss as a result of the default or failure of third parties to pay on their obligations to Aviva. Our credit risks arise through exposures to debt investments, structured asset investments, derivative counterparties, mortgage lending and reinsurance placement counterparties. We hold these investments for the benefit of both our policyholders and shareholders. The Group manages its credit risk at business unit, regional and Group levels. All business units and regions are required to implement local credit risk management processes (including limits frameworks), operate specific risk management committees, and ensure detailed reporting and monitoring of their exposures against pre-established risk criteria. At Group level, we manage and monitor all exposures across our business units on a consolidated basis, and operate a group limit framework that must be adhered to by all. The risk management framework also includes the market related aspect of credit risk. This is the risk of a fall in the value of fixed interest securities from changes in the perceived worthiness of the issuer and is manifested through changes in the fixed interest securities’ credit spreads. Management of credit risk is effected by five core functions: The maintenance and adherence of an effective governance structure. This includes clear guidance, scope and frameworks for all aspects of the credit risk function to ensure accountability and clarity. This also includes delegated authority to the Credit Approvals Committee which is authorised to make key decisions within certain risk appetite levels.
Aviva plc Annual Report and Accounts 2010 57 – Risk management continued The implementation of a sophisticated capital charge-based credit limit framework that considers and quantifies the key specific attributes of each exposure (e.g. seniority, maturity, etc) and provides a counterparty level aggregation methodology covering all exposures to a counterparty. This is then managed against centrally set limits. Upper limits are also set to ensure that any unexpected jump to default risks are kept within appetite. Additional limit and controls are applied for structured assets and reinsurance counterparty exposures. The limits framework also considers more systemic risk factors such as sector and geographic concentrations, and these are continually assessed throughout our global portfolio.
Additional committee and credit risk function oversight is provided on all credit risk related matters. This includes regular consideration and review of our key counterparties, monitoring and addressing key credit themes and news that emerge in the markets. The Credit Approvals Committee provides an effective forum to ensure that all key recommendations are considered, and decisions implemented throughout the Group. The regional and Group credit divisions ensure that qualitative aspects of risk management are considered and evaluated to provide further oversight and balance to the quantitative aspects.
Financial exposures by credit ratings Financial assets are graded according to current external credit ratings issued. AAA is the highest possible rating. Investment grade financial assets are classified within the range of AAA to BBB ratings. Financial assets which fall outside this range are classified as speculative grade. The following table provides information regarding the aggregated credit risk exposure, for financial assets with external credit ratings, of the Group. Not rated assets capture assets not rated by external ratings agencies.
At 31 December 2010 AAA AA A BBB Speculative grade Not rated
Debt securities 36.3% 18.1% 22.7% 15.8% 2.5% 4.6% 167,482 Reinsurance assets 0.2% 58.8% 25.3% 1.5% 0.1% 14.1% 7,084 Other investments 0.2% 1.1% 1.4% 0.4% 0.1% 96.8% 36,730 Loans 3.8% 5.8% 2.2% 0.4% 0.7% 87.1% 43,074
The carrying amount of assets included in the statement of financial position represents the maximum credit exposure. As described in note 25, £1,247 million debt securities held by consolidated French mutual funds, previously included within other investments, have been reclassified as debt securities as at 31 December 2009. In addition, certain non-rated debt securities totalling £1,917 million, which at the 31 December 2009 had been classified according to their internal credit ratings, are now presented as non-rated. Carrying values and percentages at 31 December 2009 have been amended accordingly.
Derivatives Derivative transactions must comply with Group guidance on the quality of counterparties used and the extent of collateralisation required. The counterparty must have a minimum credit rating from rating agencies (S&P, Moody’s and Fitch) and the collateral process must meet certain minimum standards as set out by Group guidelines. The largest shareholder notional positions are exchange traded, rather than over the counter (OTC), with the added protection that provides (i.e. the credit risk is mitigated significantly through regular margining and protection offered by the exchange, and is controlled by the Group’s local asset management operations).
Loans The majority of the Group loans portfolio is unrated. However, we use the following metrics to internally monitor our exposure: Property collateralization; Interest service cost; Diversity of the tenant base; and Existence of government guarantees for some residential mortgages.
Credit concentration risk The long-term businesses and general insurance businesses are generally not individually exposed to significant concentrations of credit risk due to the regulations, applicable in most markets, limiting investments in individual assets and asset classes supplemented by the Group credit policy and limits framework. In cases where the business is particularly exposed to credit risk (e.g. in respect of defaults on mortgages matching annuity liabilities) this risk is translated into a more conservative discount rate used to value the liabilities, creating a greater capital requirement, and this credit risk is actively managed. The impact of aggregation of credit risk is monitored as described above. With the exception of government bonds the largest aggregated counterparty exposure is approximately 0.9% of the Group’s total shareholder assets.
Securities finance The Group has significant securities financing operations within the UK. The risks within this business are mitigated by over- collateralisation which is designed to result in minimal residual risk. The Group operates strict standards around collateral management and controls.
Debt securities 167,334 — 3 3 28 114 167,482 Reinsurance assets 7,084 — — — — — 7,084 Other investments 36,671 19 6 15 8 11 36,730 Loans 42,045 326 26 11 7 659 43,074 Receivables and other financial assets 7,983 209 36 39 10 18 8,295
As described in note 25, £1,247 million debt securities held by consolidated French mutual funds, previously included within other investments, have been reclassified as debt securities as at 31 December 2009. The analysis of financial assets past due at 31 December 2009 has been amended accordingly. Credit terms are set locally within overall credit limits prescribed by the Group Credit Approvals Committee and within the framework of the Group Credit Policy. The credit quality of financial assets is managed at the local business unit level. Where assets have been classed as ‘past due and impaired’, an analysis is made of the risk of default and a decision is made whether to seek collateral from the counterparty. There were no material financial assets that would have been past due or impaired had the terms not been renegotiated.
(d) Liquidity risk At Group level, we maintain a prudent level of liquidity which meets the expectations of the Financial Services Authority (FSA) and the wider investment community. We maintain a buffer of liquid assets, determined by liquidity stress tests, which is designed to cover unforeseen circumstances in any of our businesses. The Group and Company have a strong liquidity position (£1.5 billion of financial assets held at Group) and through the application of a Group Liquidity policy seek to maintain sufficient financial resources to meet its obligations as they fall due. In addition to this strong liquidity position, the Group and Company maintain significant undrawn committed borrowing facilities (£2.1 billion) from a range of highly rated banks to further mitigate this risk.
Aviva plc Annual Report and Accounts 2010 57 – 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.
Debt securities 167,482 20,996 46,182 100,133 171 Equity securities 49,076 — — — 49,076 Other investments 36,730 32,625 1,713 956 1,436 Loans 43,074 7,492 5,339 30,240 3 Cash and cash equivalents 25,455 25,455 — — —
Longevity risk is carefully 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 the capital implications to manage the impact on the Group-wide exposure and the capital funding that businesses may require as a consequence. The Group has used reinsurance solutions to reduce the risks from longevity where possible and desirable and continually monitors and evaluates emerging market solutions to mitigate this risk further.
Persistency risk is managed at a business unit level through frequent monitoring of company experience, benchmarked against local market information. Generally, persistency risk arises from customers lapsing their policies earlier than has been assumed. Where possible the financial impact of lapses is reduced through appropriate product design. Businesses also implement specific initiatives to improve retention of policies which may otherwise lapse. The Group Life Insurance Committee has developed guidelines on persistency management.
Expense risk is primarily managed by the business units through the assessment of business unit profitability and frequent monitoring of expense levels.
Apart from the ICA, sensitivity testing is widely used to measure the capital required and volatility in earnings due to exposure to life insurance risks, typically through MCEV reporting (examples of which are contained elsewhere in this report). This assessment is taken at both business unit level and at Group level where the impact of aggregation of similar risks can be measured. This enables the Group to determine whether action is required to reduce risk, or whether that risk is within the overall risk appetite.
Concentration risk The Group writes a diverse mix of business in worldwide markets that are all subject to similar risks (mortality, persistency, etc). The Group assesses the relative exposures to and concentrations of each type of risk through the ICA capital requirements and material issues are escalated to and addressed at the Life Insurance Committee. This analysis enables the Group to assess whether accumulations of risk exceed risk appetite. One key concentration of life insurance risk for the Group is improving longevity risk from pensions in payment and deferred annuities in the UK and the Netherlands where the Group has material portfolios. The Group continually monitors this risk and the opportunities for mitigating actions through reinsurance, improved asset liability matching, or innovative solutions that emerge in the market. When looking at concentrations of risk, for example market risk, the risk within Aviva staff pension schemes is also considered. ICA analysis and MCEV sensitivity testing help identify both concentrations of risk types and the benefits of diversification of risk.
(ii) General insurance risk Types of risk General insurance risk in the Group arises from: Fluctuations in the timing, frequency and severity of claims and claim settlements relative to expectations; Unexpected claims arising from a single source; Inaccurate pricing of risks or inappropriate underwriting of risks when underwritten; Inadequate reinsurance protection or other risk transfer techniques; and Inadequate reserves.
Aviva plc Annual Report and Accounts 2010 57 – Risk management continued 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 through the risk management framework. Additionally, the ICA 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. Increasingly risk-based capital models are being used to support the quantification of risk under the ICA framework. All general insurance business units undertake a quarterly review of their insurance risks, the output from which is a key input into the ICA and risk-based capital assessments. The General Insurance Committee monitors and develops the management of insurance risk in the general insurance business units, and assesses the aggregate risk exposure. It is responsible for the development, implementation and review of the Group policies for underwriting, claims, reinsurance and reserving that operate within the risk management framework. 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 Group has pioneered various developments, such as the Aviva UK Digital Flood Map to effectively manage exposures arising from specific perils. Where appropriate such projects are employed throughout the business units to promote the adoption of best practice as standard.
(f) Operational risk Types of operational risk Operational risk is the risk of loss, arising from inadequate or failed internal processes, or from people and systems, or from external events. Operational risks include business protection, information technology, people, legal and regulatory compliance risks.
Aviva plc Annual Report and Accounts 2010 57 – Risk management continued Our businesses are primarily responsible for identifying and managing operational risks in line with minimum standards of control set out in our policies. Each operational risk is assessed by considering the potential impact and the probability of the event occurring. Impact assessments are considered against financial, operational and reputation criteria. Business management teams must be satisfied that all material risks falling outside our risk appetite are being mitigated, monitored and reported to an appropriate level. Any risks with a high potential impact level 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 from these occurrences. The Operational Risk Committee (ORC) oversees the Group’s aggregate operational risk exposure on behalf of the Group Executive Committee. It makes recommendations on the risk appetite that the Group can work within for operational risk, assesses and monitors overall operational risk exposures, identifying any concentrations of operational risk across the Group, and in particular verifies that mitigating action plans are implemented. The ORC operates a number of sub-committees which focus on specific areas of operational risk including customer, brand, business protection, IT, people, legal and regulatory compliance.
(h) Risk and capital management Sensitivity test analysis The Group uses a number of sensitivity test-based risk management tools to understand the volatility of earnings, the volatility of its capital requirements, and to manage its capital more efficiently. Sensitivities to economic and operating experience are regularly produced on all of the Group’s financial performance measurements to inform the Group’s decision making and planning processes, and as part of the framework for identifying and quantifying the risks to which each of its business units, and the Group as a whole, are exposed. For long-term business in particular, sensitivities of MCEV performance indicators to changes in both economic and non-economic experience are continually used to manage the business and to inform the decision making process. More information on MCEV sensitivities can be found in the presentation of results on an MCEV basis in the supplementary section of this report.
Aviva plc Annual Report and Accounts 2010 57 – Risk management continued Sensitivity test results Illustrative results of sensitivity testing for long-term business, general insurance and health business and the fund management and non-insurance business are set out below. For each sensitivity test the impact of a reasonably possible change in a single factor is shown, with other assumptions left unchanged.
Equity/property market values The impact of a change in equity/property market values by ± 10%. Expenses The impact of an increase in maintenance expenses by 10%. Assurance mortality/morbidity (life insurance only) The impact of an increase in mortality/morbidity rates for assurance contracts by 5%. Annuitant mortality (life insurance only) The impact of a reduction in mortality rates for annuity contracts by 5%. Gross loss ratios (non-life insurance only) The impact of an increase in gross loss ratios for general insurance and health business by 5%.
Insurance participating (20) (275) 15 (35) (15) (5) (40) Insurance non-participating (190) 270 35 (35) (25) (40) (280) Investment participating (65) (15) 20 (30) (15) — — Investment non-participating (30) 45 20 (20) (5) — — Assets backing life shareholders’ funds (10) 10 135 (140) — — —
Aviva plc Annual Report and Accounts 2010 57 – Risk management continued The different impacts of the economic sensitivities on profit and shareholders’ equity arise from classification of certain assets as available for sale in some business units, for which movements in unrealised gains or losses would be taken directly to shareholders’ equity. The sensitivities to economic movements relate mainly to business in the UK, US and the Netherlands. In general a fall in market interest rates has a beneficial impact on non-participating business and shareholders’ funds, due to the increase in market value of fixed interest securities and the relative durations of assets and liabilities; similarly a rise in interest rates has a negative impact. In the US most debt securities are classified as available-for-sale, which limits the overall sensitivity of IFRS profit to interest rate movements. The sensitivity to movements in equity and property market values relates mainly to holdings in the Netherlands, although the impact on IFRS profit is moderated by the classification of equities as available for sale. Changes in sensitivities between 2009 and 2010 reflect movements in market interest rates, portfolio growth, changes to asset mix and the relative durations of assets and liabilities and asset liability management actions. Investment variances of £791 million in 2010 include £1,010 million relating to Delta Lloyd. Of this, around £800 million is due to differing movements in asset and liability yield curves while the remainder primarily relates to gains on interest rate derivatives. Liabilities in Delta Lloyd are discounted using a yield curve based on a fully collateralised AAA bond portfolio. The discount rate increased in 2010 as an increase of around 80bps in credit spreads on collateralised bonds was only partly offset by lower risk-free yields. As a result, whilst lower interest rates increased the market value of assets, this has not been offset by a corresponding movement in liabilities. The AAA collateralised bond spread movement in the year reflected the perceived risk regarding the curve’s components which include bonds issued by Spanish savings banks and a range of other European organisations. If spreads were to reduce, this would increase the insurance liabilities and this increase may not be offset by a corresponding increase in asset values. Changes to the Delta Lloyd curve, which can generate gains or losses, can therefore significantly impact profit before tax and shareholders’ equity and the magnitude of this sensitivity is illustrated by the £800 million profit before tax and increase in shareholders’ equity experiences in 2010. The mortality sensitivities relate primarily to the UK. The impact on the Group’s results from sensitivity to these assumptions can also be found in the MCEV sensitivities included in the alternative method of reporting long-term business profits section.
General insurance and health business Sensitivities as at 31 December 2010 Impact on profit before tax (£m)
Gross of reinsurance (305) 300 95 (100) (135) (325) Net of reinsurance (360) 365 95 (100) (135) (310)
Gross of reinsurance (305) 300 95 (100) (35) (325) Net of reinsurance (360) 365 95 (100) (35) (310)
Gross of reinsurance (310) 295 105 (110) (35) (345) Net of reinsurance (365) 365 105 (110) (35) (330)
Aviva plc Annual Report and Accounts 2010 57 – Risk management continued Fund management and non-insurance business Sensitivities as at 31 December 2010 Impact before profit before tax (£m)
Aviva plc Annual Report and Accounts 2010 58 – Derivative financial instruments This note gives details of the various derivative 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.
(i) Cash flow hedges The Group has used forward starting interest rate swap agreements in the United States to hedge the variability in future cash flows associated with the forecasted purchase of fixed-income assets. During 2010, the cash flow hedges were discontinued, resulting in a fair value gain of £nil. The notional value of these interest rate swaps was £3 million at 31 December 2009 and their fair value was £nil.
(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 2010 was £2,791 million (2009: £2,806 million) and its fair value at that date was £2,811 million (2009: £2,709 million).
(i) The Group’s non-hedge derivative activity at 31 December 2010 was as follows: Contract/ notional amount £m
Within one year 1,037 1,238 Between one and two years 320 155 Between two and three years 320 66 Between three and four years 274 74 Between four and five years 263 51 After five years 2,923 657
(c) Collateral Certain derivative contracts, primarily interest rate and currency swaps, involve the receipt or pledging of collateral. The amounts of collateral receivable or repayable are included in notes 26 and 50 respectively.
Aviva plc Annual Report and Accounts 2010 59 – Assets under management In addition to the assets included in the consolidated statement of financial position, the Group manages many funds for third parties. This note details the total funds under management. The total Group assets under management are: £m
Total IFRS assets included in the consolidated statement of financial position 370,107 354,391 Less: Third-party funds included within consolidated IFRS assets (9,999) (9,980)
Aviva plc Annual Report and Accounts 2010 60 – Related party transactions This note gives details of the transactions between Group companies and related parties which comprise our joint ventures, associates and staff pension schemes. The Group receives income from related parties from transactions made in the normal course of business. Loans to related parties are made on normal arm’s-length commercial terms.
Associates 47 — 49 3 Joint ventures 18 375 17 327 Employee pension schemes 10 2 9 2
Services provided by related parties There were no services provided by related parties in 2009 or 2010.
Income Dividends received from subsidiaries 1,110 1,340 Interest receivable from Group companies 150 156 Net investment (expense)/income (14) 50
Expenses Operating expenses B (176) (194) Interest payable to Group companies H (458) (603) Interest payable on borrowings (340) (336)
Balance at 1 January 692 200 1,207 735 6,653 109 3,360 12,956 990 13,946 Profit for the year — — — — — — 500 500 — 500 Other comprehensive income — — — — 408 — 1 409 — 409 Total comprehensive income for the year — — — — 408 — 501 909 — 909 Dividends and appropriations 15 — — — — — — (757) (757) — (757) Shares issued in lieu of dividends 29 & 36 13 — (13) — — — 209 209 — 209 Employee trust shares distributed in the year 31 — — — — — — (50) (50) — (50) Reserves credit for equity compensation plans — — — — — 41 — 41 — 41 Shares issued under equity compensation plans — — — — — (51) 51 — — — Aggregate tax effect — — — — — — 17 17 — 17
Statement of changes in equity For the year ended 31 December 2009
Balance at 1 January 664 200 1,234 735 5,770 113 3,287 12,003 990 12,993 Profit for the year — — — — — — 571 571 — 571 Other comprehensive income — — — — 883 — (3) 880 — 880 Total comprehensive income for the year — — — — 883 — 568 1,451 — 1,451 Dividends and appropriations 15 — — — — — — (853) (853) — (853) Issues of share capital 29 1 — — — — — — 1 — 1 Shares issued in lieu of dividends 29 & 36 27 — (27) — — — 299 299 — 299 Employee trust shares distributed in the year 31 — — — — — — (18) (18) — (18) Reserves credit for equity compensation plans — — — — — 56 — 56 — 56 Shares issued under equity compensation plans — — — — — (60) 60 — — — Aggregate tax effect — — — — — — 17 17 — 17
Fair value as at 1 January 17,236 16,353 Movement in fair value 387 883
Staff costs and other employee related expenditure (see below) 159 130 Other operating costs 42 20 Net foreign exchange (gains)/losses (25) 44
C – Tax (i) Tax credited to the income statement £m
Current tax: For this year 229 151 Prior year adjustments (1) 7
A gradual reduction in the UK corporation tax rate from 28% to 24% over four years was announced in the Emergency Budget of 22 June 2010. The Finance (No. 2) Act 2010 enacted the first of the 1% rate reductions with effect from April 2011. Subsequent reductions will be dealt with by future legislation. There is no impact on the Company’s net assets from the reduction in the rate as the Company has no deferred tax assets or liabilities.
(v) Deferred tax There was no deferred tax recognised in the Company at 31 December 2010 (2009: £nil). The Company has unrecognised other temporary differences of £45 million (2009: £nil).
Balance at 31 December 2009 735 6,653 109 3,360 Arising in the year: Profit for the year — — — 500 Fair value gains on investments in subsidiaries and joint ventures — 408 — — Actuarial gains on pension provisions — — — 1 Dividends and appropriations — — — (757) Reserves credit for equity compensation plans — — 41 — Shares issued in lieu of dividends — — — 209 Trust shares distributed in the year — — — (50) Issue of share capital under equity compensation scheme — — (51) 51 Aggregate tax effect — — — 17
Tax of £17 million (2009: £17 million) is deductible in respect of coupon payments of £61 million (2009: £61 million) on the direct capital instruments.
Total contractual undiscounted cash flows 5,337 6,155 11,492 5,389 5,544 10,933
G – Risk management Risk management in the context of the Group is considered in the Group consolidated financial statements, note 57. 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 risk management policies are given in the Group consolidated financial statements, note 57. 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 a three-month rolling average of the Company’s share price. 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. Management believes the resulting estimated fair values recorded in the balance sheet and any changes in fair values recorded in the income statement are reasonable, and are the most appropriate values at the balance sheet date. 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 49) and loans owed to subsidiaries. Loans owed to subsidiaries were within agreed credit terms as at the balance sheet date.
Currency risk The Company’s direct subsidiaries are all incorporated and operating in the UK, and therefore are not exposed to currency risk. However, these subsidiaries are themselves exposed to foreign currency risk arising from fluctuations in exchange rates during the course of providing insurance and asset management services around the world. The exposure of the subsidiaries to currency risk is considered from a Group perspective in the Group consolidated financial statements, note 57. The Company faces exposure to foreign currency risk through some of its borrowings which are denominated in euros and US dollars. However, most of these borrowings have been on-lent to a subsidiary which holds financial investments in these currencies, generating the net investment hedge described in the Group consolidated financial statements, note 58(a)(iii).
H – Related party transactions continued Dividends, loans, interest Services provided to related parties
The related parties’ receivables are not secured and no guarantees were received in respect thereof. The receivables will be settled in accordance with normal credit terms. Details of guarantees, indemnities and warranties given by the Company on behalf of related parties are given in note 52(h).
The related parties’ payables are not secured and no guarantees were received in respect thereof. The payables will be settled in accordance with normal credit terms. The directors and key management of the Company are considered to be the same as for the Group. Information on both the Company and Group key management compensation can be found in note 60.
E17 – Summary of non-controlling interest in life and related businesses’ MCEV results
Independent auditor’s report to the directors of Aviva plc on the consolidated Market Consistent Embedded Value (MCEV) financial statements
Condensed consolidated income statement – MCEV basis For the year ended 31 December 2010 £m
4,423 Operating profit before tax attributable to shareholders’ profits 3,760 3,592 Adjusted for the following: (120) Economic variances on long-term business (103) 365 (286) Short-term fluctuation in return on investments on non-long-term business (243) 95
(72) Economic assumption changes on general insurance and health business (61) 57 (28) Impairment of goodwill (24) (62)
3,013 Profit before tax 2,561 3,450 (1,321) Tax on operating profit (1,123) (952)
2,054 Profit for the year 1,746 2,722 All profit is from continuing operations. 1. Excludes the proportion of the results of Aviva Investors fund management businesses and other fund management operations within the Group that arises from the provision of fund management services to our life businesses.
Earnings per share – MCEV basis 2010 Earnings per share 2010 Restated
(28) Fair value losses on AFS securities, owner-occupied properties and hedging instruments (24) (86) (18) Fair value gains transferred to profit (15) (30)
1,175 Actuarial losses on pension schemes 999 (1,140) (21) Actuarial gains on pension schemes transferred to unallocated divisible surplus and other movements (18) 24 31 Impairment losses 26 89 (224) Foreign exchange rate movements (190) (1,018)
— Issues of share capital — 1 243 Shares issued in lieu of dividends 209 299 49 Capital contributions from minority shareholders 42 6 — Net increase to total equity following Delta Lloyd IPO — 930
Reconciliation of shareholders’ equity on IFRS and MCEV bases For the year ended 31 December 2010
Equity attributable to ordinary shareholders of Aviva plc 12,794 2,501 15,295 Preference share capital 200 — 200 Direct capital instruments 990 — 990 Non-controlling interests 3,741 236 3,977
Ordinary share capital 692 — 692 Capital reserves 4,478 — 4,478 Other reserves 1,829 213 2,042 Shares held by employee trusts (68) — (68) Retained earnings 3,425 — 3,425 Additional retained earnings on an MCEV basis — 2,523 2,523
Net assets on a statutory IFRS net basis 17,725 15,086 Adjusting for general business and other net assets on a statutory IFRS net basis 1,331 2,231
Life and related businesses net assets on a statutory IFRS net basis 19,056 17,317 Goodwill and other intangibles (2,356) (2,606) Acquired value of in-force business (1,447) (1,493) Adjustment for share of joint ventures and associates (120) (377) Adjustment for assets to regulatory value net of tax (890) (19) Adjustment for DAC and DIR net of tax (2,839) (2,653) Adjustment for differences in technical provisions 1,303 1,414 Other accounting and tax differences (467) 630
Operating MCEV earnings 2,199 — 2,199 12 12 2,211 Non-operating MCEV earnings (361) (63) (424) (79) (142) (503)
Other movements in IFRS net equity — 525 525 536 1,061 1,061 Capital and dividend flows (1,020) — (1,020) 509 509 (511) Foreign exchange variances (170) 2 (168) 113 115 (55) Acquired/divested businesses 425 (180) 245 (245) (425) —
Equity attributable to ordinary shareholders of Aviva plc on an MCEV basis 15,295 1. Covered business represents the business that the MCEV calculations cover, as detailed in the Basis of preparation note. The embedded value is presented net of non-controlling interests and tax. 2. Non-covered but related to life business represents the adjustments to the MCEV, including goodwill, to calculate the long-term business net assets on an MCEV basis. An analysis of net assets on an MCEV basis gross of non-controlling interests is provided in E6. 3. Net assets for the total life businesses on an MCEV basis presented net of non-controlling interests.
Other movements in IFRS net equity — (266) (266) (839) (1,105) (1,105) Capital and dividend flows (250) — (250) (283) (283) (533) Foreign exchange variances (762) (218) (980) 224 6 (756) Acquired/divested businesses (1,641) (1) (1,642) 1,047 1,046 (595)
Equity attributable to ordinary shareholders of Aviva plc on an MCEV basis 13,092
E1 – Basis of preparation The condensed consolidated income statement and condensed consolidated statement of financial position on pages 316 to 318 present the Group’s results and financial position for the life and related businesses on the Market Consistent Embedded Value (MCEV) basis and for its non-life businesses on the International Financial Reporting Standards (IFRS) basis. The MCEV methodology adopted is in accordance with the MCEV Principles published by the CFO Forum in October 2009. The directors consider that the MCEV methodology gives useful insight into the drivers of financial performance of the Group’s life and related businesses. This basis values future cash flows from assets consistently with market prices, including more explicit allowance for the impact of uncertainty in future investment returns and other risks. Embedded value is also consistent with the way pricing is assessed and the business is managed. The results for 2010 and 2009 have been audited by our auditors, Ernst & Young. Their report in respect of 2010 can be found on page 352 in the Report and Accounts.
New business premiums New business premiums include: premiums arising from the sale of new contracts during the period; non-contractual additional premiums; and expected renewals on new contracts and expected future contractual alterations to new contracts.
The Group’s definition of new business under MCEV includes contracts that meet the definition of ‘non-participating investment’ contracts under IFRS. For products sold to individuals, premiums are considered to represent new business where a new contract has been signed, or where underwriting has been performed. Renewal premiums include contractual renewals, non-contractual variations that are reasonably predictable and recurrent single premiums that are pre-defined and reasonably predictable. For Group products, new business includes new contracts and increases to aggregate premiums under existing contracts. Renewal premiums are based on the level of premium received during the reporting period and allow for premiums expected to be received beyond the expiry of any guaranteed premium rates.
Life and pensions operating earnings For life and pensions operating earnings, Aviva uses normalised investment returns. The use of asset risk premia reflects management’s long-term expectations of asset returns in excess of the swap yield from investing in different asset classes. The normalised investment return on equities and property has been calculated by reference to the ten year swap rate in the relevant currency plus an appropriate risk premium. The expected return on bonds has been calculated by reference to the swap rate consistent with the duration of the backing assets in the relevant currency plus an appropriate risk margin (equivalent to the gross redemption yield less an allowance for defaults). From 2010, Aviva has changed the approach to calculating expected returns within operating profit. The expected existing business contribution (in excess of reference rate) is now calculated using the implied discount rates (IDR), which itself is based on the normalised investment returns. The revised methodology applies the IDR to the Value of In Force (VIF) and Required Capital (RC) components of the MCEV and adds to this the total expected return for Free Surplus (FS) to derive the total expected return, in a manner consistent with that previously used under European Embedded Value reporting. This total is presented as the expected existing business contribution (reference rate), expected existing business contribution (in excess of reference rate) and expected return on shareholders’ net worth (grossed up for tax for pre-tax presentation), with only the excess contribution being impacted by the change. The change to expected returns has no impact on total return or on the closing balance sheet.
E1 – Basis of preparation continued US capital solutions Credit has been taken within the 2010 US embedded value, and value of new business, for the anticipated reduction in capital requirements based on management’s intention to enact transactions which allow recognition of additional assets that can be held against certain reserves, reducing shareholder capital requirements. Similar transactions, which are effectively based upon a parental guarantee that sufficient capital resources would be available if required, have been enacted for business written between 2006 and 2009. Previously credit has been taken for equivalent capital solution transactions only after they have been formally enacted.
Frictional costs of required capital The additional costs to a shareholder of holding the assets backing required capital within an insurance company rather than directly in the market are called frictional costs. They are explicitly deducted from the PVFP. The additional costs allowed for are the taxation costs and any additional investment expenses on the assets backing the required capital. The level of required capital has been set out above in the net worth section. Frictional costs are calculated by projecting forwards the future levels of required capital. Tax on investment return and investment expenses are payable on the assets backing required capital, up until the point that they are released to shareholders.
Cost of residual non-hedgeable risks (CNHR) The cost of residual non-hedgeable risks (CNHR) covers risks not already allowed for in the time value of options and guarantees or the PVFP. The allowance includes the impact of both non-hedgeable financial and non-financial risks. The most significant risk not included in the PVFP or TVOG is operational risk. Asymmetric risks allowed for in the TVOG or PVFP are described earlier in the basis of preparation. No allowance has been made within the cost of non-hedgeable risk for symmetrical risks as these are diversifiable by investors.
E1 – Basis of preparation continued The embedded value of the US spread-based products anticipates the application of management discretion allowed for contractually within the policies, subject to contractual guarantees. This includes the ability to change the crediting rates and indexed strategies available within the policy. Consideration is taken of the economic environment assumed in future projections and returns in excess of the reference rate are not assumed. Anticipated market and policyholder reaction to management action has been considered. The anticipated management action is consistent with current decision rules and has been approved and signed off by management and legal counsel.
Restatement During 2010, the Group’s Dutch subsidiary, Delta Lloyd, reviewed its approach to the scope of business using adjusted swap rates (also known as a ‘liquidity premium’). Delta Lloyd’s approach has been aligned with the Quantitative Impact Study (QIS) 5 methodology set out as part of Solvency II developments. The swap rate adjustment is applied in full to immediate annuity type contracts (as previously). In addition, 75% of the liquidity premium is applied to participating contracts and 50% to all other life covered business. This change aligns local Delta Lloyd and Group Aviva reporting for MCEV and Solvency II internal model calculations. This change increases the closing 2010 embedded value by £20 million net of non-controlling interests. Results for 2009 have been restated on a consistent basis leading to an increase in the opening 2009 embedded value of £310 million; an increase in 2009 new business value of £35 million; an increase in 2009 expected return of £34 million and an increase in closing 2009 embedded value of £57 million, all net of non-controlling interests.
Value of new business 354 504 (92) (194) 52 624 Earnings from existing business: – expected returns at the reference rate 169 244 49 20 20 502 – expected returns in excess of the reference rate 425 357 181 401 25 1,389 – expected returns 594 601 230 421 45 1,891 – experience variances (20) 147 (16) (7) (28) 76 – operating assumption changes (18) 338 (320) (146) 13 (133) Expected return on shareholders’ net worth 179 152 124 82 12 549 Other operating variances (4) 271 157 133 15 572
Value of new business 247 521 (48) 16 29 765 Earnings from existing business: – expected returns at the reference rate 113 326 43 55 26 563 – expected returns in excess of the reference rate 402 428 324 249 16 1,419 – expected returns 515 754 367 304 42 1,982 – experience variances (29) 43 (3) (87) (23) (99) – operating assumption changes (67) (8) 171 (38) (14) 44 Expected return on shareholders’ net worth 138 180 88 89 17 512 Other operating variances (17) 214 65 (18) 50 294
Value of new business grew 43% to £354 million (2009: £247 million), due to our focus on value maximisation through active management of our new business mix, robust cost control and pricing discipline.
Assumption changes were £18 million adverse (2009: £67 million adverse) reflecting a net increase in expense allowances, following the closure of our offshore subsidiary to new business.
Europe In Europe, operating profit decreased to £2,096 million (2009: £2,344 million). Growth in Aviva Europe operating return reflects assumption changes and more favourable operating experience partly offset by lower expected returns. The reduction in Delta Lloyd operating profit mainly reflects adverse assumption changes. 2009 benefited from favourable assumption changes.
Value of new business was 3% lower at £504 million (2009: £521 million). After allowing for movements in currency, this is in line with prior year. This reflects increased contributions from profit-sharing products in France and Italy. These contributions have been offset by the impact of reduced sales in Ireland, Spain and Poland.
Experience variances were favourable at £147 million (2009: £43 million). The 2010 result reflects positive experience on mortality, as well as the release of short-term lapse provisions and the benefit from policyholders switching to unit linked funds in France. This has been offset by the impact of adverse lapse experience in Spain and Ireland.
Assumption changes on existing business were favourable at £338 million (2009: £8 million adverse). This arises from the positive impact of a detailed review of our expense assumptions, as well as the positive impact of mortality changes in France. This is offset by further strengthening of lapse assumptions in Spain and Ireland.
Value of new business was negative at £(92) million (2009: £(48) million) reflecting the continuing impacts of adverse economic assumptions.
Total expected return was lower at £354 million (2009: £455 million) due to the adoption of implied discount rates as the basis for determining the expected return.
Total expected return increased to £503 million (2009: £393 million) reflecting the adoption of implied discount rates as the basis for determining expected return and the grossing up for tax in 2010 as a result of the reassessment of the tax paying position.
Operating experience and assumption changes on existing business were £153 million adverse (2009: £125 million adverse). Included within this are positive benefits of disciplined spread management offset by adverse operating assumption changes relating to immediate annuitant mortality strengthening and increased expense loadings.
Other operating variances were £133 million favourable (2009: £18 million adverse) reflecting management actions and modelling refinements.
Value of new business was 79% higher at £52 million (2009: £29 million, £11 million excluding the contribution from Australia), reflecting improved scale efficiencies, product mix and volumes.
Total expected return was £57 million (2009: £59 million, £37 million excluding the contribution from Australia), benefiting from the adoption of implied discount rates as the basis for determining the expected return.
Operating experience variances, other operating variances and assumption changes on existing business were nil (2009: £13 million), as favourable mortality and assumptions changes were offset by experience variances.
Earnings before tax and non-controlling interests 1,085 971 37 266 377 319 43 2,013 83 2,096 289 109 3,579 1 Adverse expense experience occurred across a number of businesses. 2 Mortality experience continues to be better than the assumption set across a number of our businesses, most notably in France and the UK Annuity business. 3 Persistency experience remains volatile across most of our businesses, in part reflecting the wider economic circumstances. In France, persistency experience reflects a release of the short-term provision. 4 Other experience includes, in France, the benefit from policyholders switching to unit-linked funds, and, in the USA favourable spread experience. 5 Favourable maintenance expense assumptions reflect the benefit of the shared service centre in Spain, together with the release of margins in Spain, related to bancassurance joint venture governance costs, and Poland. In the UK, the expense assumptions include a reallocation of provisions in the service company, better reflecting the expected future allocation of costs. In the USA, the adverse impact reflects a revised allocation of costs between ongoing and one-off. In Delta Lloyd, favourable expense assumptions relate to planned expense saving following restructuring activities.
Expected return on shareholders’ net worth 138 66 16 57 8 26 7 180 88 268 89 11 6 17 512 Other operating variances9 (17) 62 (4) — 121 37 (2) 214 65 279 (18) 50 — 50 294
Earnings before tax and non-controlling interests 787 785 64 216 499 113 27 1,704 640 2,344 266 45 56 101 3,498 1 Maintenance expense experience in the UK relates to profits from existing business administration. Project and other related expenses in the UK reflect project costs associated with strategic initiatives, including developments designed to offer a wider range of products to customers, and the simplification of systems and processes. Project and other related expenses in Delta Lloyd relate to integration costs in Belgium. 2 Mortality experience continues to be better than the assumptions set across a number of our businesses. 3 Persistency experience has been volatile across most of our businesses, in part reflecting wider economic volatility. In France, positive persistency experience including the release of a short-term provision, in line with positive underlying experience.
5 Favourable expense assumption changes reflect the impact of cost reductions in Delta Lloyd and Poland, together with the impact of revisions to expense allocations in Delta Lloyd. The adverse impact in Spain relates to the capitalisation of certain governance costs in respect of bancassurance joint ventures.
– expected existing business contribution (reference rate) 122 61 8 4 53 13 11 150 19 169 13 14 318 – expected existing business contribution (in excess of reference rate) 306 115 19 11 18 27 7 197 68 265 261 20 852 Experience variances – maintenance expense1 8 (16) 5 (6) 3 (3) 4 (13) (9) (22) (10) (1) (25) – project and other related expenses1 (6) (3) (1) — — (2) (4) (10) (1) (11) (12) (3) (32) – mortality/morbidity2 17 15 2 (2) 10 — 2 27 3 30 (5) 7 49 – lapses3 (21) 19 (7) 6 — (6) (9) 3 — 3 (2) (22) (42) – other4 (12) 62 (3) 3 10 2 6 80 (3) 77 24 (4) 85
Value of new business 177 94 8 38 39 51 8 238 (43) 195 16 9 13 22 410 Earnings from existing business
986 Experience variances – maintenance expense1 27 — 4 (1) 10 (8) 4 9 4 13 — 5 — 5 45 – project and other related expenses1
Operating assumption changes: – maintenance expense5 — (14) 3 (10) 38 (69) 7 (45) 197 152 (9) (9) 6 (3) 140 – project and other related expenses
2 Mortality experience continues to be better than the assumptions set across a number of our businesses. 3 Persistency experience has been volatile across most of our businesses, in part reflecting wider economic volatility. In France, positive persistency experience including the release of a short-term provision, in line with positive underlying experience.
United Kingdom 28 42 Europe 10 6 North America (8) (7) Asia Pacific — (1)
United Kingdom 3 (14) Aviva Europe1 — 3 Delta Lloyd 94 21
E5 – Exceptional items and integration and restructuring costs Exceptional Items of £(428) million (2009: £(248) million) were mainly due to a change in the cost of capital charge for the Cost of Non-Hedgeable Risk, from 2.5% to 3.3% pa with total impact £(365) million, the impact of reducing state contributions to Pillar II Pension funds in Poland, following the announcement to change legislation on 1 April 2011 of £(280) million, and the recognition by Delta Lloyd of £(59) million costs in relation to unit-linked insurance compensation scheme and compensation costs in defined contribution pension schemes, partly offset by a £286 million benefit from the closure of the final salary section of the UK staff pension scheme to future accruals. Exceptional costs for full year 2009 totalled £(248) million. This included £175 million in respect of the reattribution of the inherited estate in the UK, £(261) million in respect of the change in legislation in Poland restricting charges against pension funds, £(102) million brand migration costs and £(60) million in respect of latent claims reserves in Canada. Integration and restructuring costs incurred in the year amounted to £312 million (2009: £286 million). This includes expenditure relating to the Quantum Leap project in Europe of £40 million, costs associated with preparing the businesses for Solvency II implementation of £114 million and other restructuring exercises across the Group of £123 million. Costs incurred in 2009 related to expenditure on cost savings programmes in the UK life and general insurance businesses and in Europe.
Net assets on a statutory IFRS basis 19,056 (1,331) 17,725 17,317 (2,231) 15,086 Additional value of in-force long-term business1 2,737 — 2,737 3,475 — 3,475
Equity capital, capital reserves, shares held by employee trusts and other reserves 7,207 7,144 IFRS basis retained earnings 5,411 3,425 Additional MCEV basis retained earnings 2,677 2,523
Equity attributable to ordinary shareholders of Aviva plc on an MCEV basis 15,295 13,092 Preference share capital and direct capital instruments 1,190 1,190 Non-controlling interests 3,977 4,279
2 Analysis of net assets on an MCEV basis is made up as follows: £m £m
Embedded value 16,131 15,058 Non-controlling interests 3,133 3,480 19,264 18,538 Goodwill and intangible assets allocated to long-term business3 2,356 2,606 Notional allocation of IAS19 pension fund surplus/(deficit) to long-term business4 173 (352)
MCEV financial statements continued Aviva plc Annual Report and Accounts 2010
E7 – Analysis of life and pension earnings The following table provides an analysis of the movement in embedded value for covered business. The analysis is shown separately for free surplus, required capital and the value of in-force covered business, and includes amounts transferred between these categories. All figures are shown net of tax and non-controlling interests.
Total MCEV earnings 460 671 707 1,838 Capital and dividend flows3 (1,020) — — (1,020) Foreign exchange variance (26) (65) (79) (170) Acquired/divested business 23 190 212 425
Life and Pensions operating earnings before tax 3,579 3,498 Economic variances (103) 365 Other non-operating variances (811) 364
Life and Pensions earnings before tax 2,665 4,227 Tax on operating earnings (1,057) (903) Tax on other activities 202 (44)
E9 – Present value of life new business premiums The tables below set out the present value of new business premiums (PVNBP) written by the life and related businesses, the value of new business and the resulting margin, firstly gross and then net of tax and non-controlling interests. The PVNBP calculation is equal to total single premium sales received in the period plus the discounted value of regular premiums expected to be received over the term of the new contracts, and is expressed at the point of sale. The premium volumes and projection assumptions used to calculate the present value of regular premiums for each product are the same as those used to calculate the value of new business, so the components of the new business margin are on a consistent basis. The Weighted Average Capitalisation Factor (WACF) is the multiple of the annualised regular premium which gives the present value at point of sale of the regular premiums.
United Kingdom 531 5.3 2,803 6,111 8,914 France 92 6.6 608 4,283 4,891 Ireland 78 4.3 337 735 1,072 Italy 111 5.3 592 3,015 3,607 Poland 71 13.1 927 152 1,079 Spain 128 6.1 782 1,672 2,454 Other Europe 82 4.5 365 55 420 Aviva Europe 562 6.4 3,611 9,912 13,523 Delta Lloyd 207 9.3 1,935 1,730 3,665 Europe 769 7.2 5,546 11,642 17,188 North America 90 9.6 861 3,684 4,545 Asia 185 4.5 828 267 1,095 Australia 49 4.0 196 65 261 Asia Pacific 234 4.4 1,024 332 1,356
United Kingdom 10,298 8,914 254 177 2.5% 2.0% France 4,340 4,111 100 94 2.3% 2.3% Ireland 704 804 1 8 0.1% 1.0% Italy 1,965 1,614 42 38 2.1% 2.4% Poland 531 933 29 39 5.5% 4.2% Spain 1,136 1,326 43 51 3.8% 3.8% Other Europe 538 420 15 8 2.8% 1.9% Aviva Europe 9,214 9,208 230 238 2.5% 2.6% Delta Lloyd 1,721 3,235 (41) (43) (2.4)% (1.3)% Europe 10,935 12,443 189 195 1.7% 1.6% North America 4,728 4,545 (126) 16 (2.7)% 0.4% Asia Pacific 1,598 1,348 41 22 2.6% 1.6%
Total life and pensions 27,559 27,250 358 410 1.3% 1.5% 1 Value of new business of £(194) million reflects adverse economic movements, particularly in the second half of 2010, as risk free rates decreased.
United Kingdom 15% 98 198 296 7 France 9% 34 202 236 9 Ireland 5% 34 17 51 11 Italy 11% 32 183 215 6 Poland 25% 16 9 25 4 Spain 22% 25 80 105 4 Other Europe 14% 41 16 57 6 Aviva Europe 13% 182 507 689 7 Delta Lloyd 6% 106 112 218 16 Europe 11% 288 619 907 9 North America 14% 65 366 431 4 Asia Pacific 11% 62 34 96 13
United Kingdom 220 99 62 (70) 311 (53) (130) (183) 128 Aviva Europe 495 89 27 112 723 (177) (281) (458) 265 Delta Lloyd 175 57 (124) 55 163 (111) (124) (235) (72) Europe 670 146 (97) 167 886 (288) (405) (693) 193 North America 159 90 (100) 457 606 (192) (390) (582) 24 Asia Pacific 82 11 (5) 2 90 (55) (58) (113) (23)
United Kingdom 78 42 22 13 143 298 298 Aviva Europe 257 119 70 31 40 517 378 Delta Lloyd (6) 21 21 12 (10) 38 18 Europe 251 140 91 43 30 555 396 North America (26) (85) 10 22 (6) (85) (85) Asia Pacific 59 22 11 5 3 100 98
Total 1,641 8,342 6,148 16,131 1 Required capital is shown net of implicit items permitted by local regulators to cover minimum solvency margins. 2 France and Aviva USA have a positive surplus on a statutory basis. 3 Aviva USA’s holding company debt amounting to £765 million at 31 December 2010 has been included within non-covered business.
United Kingdom2 1,270 2,568 2,065 5,903 France3 (71) 1,592 1,252 2,773 Ireland 175 226 487 888 Italy 263 268 129 660 Poland 60 131 950 1,141 Spain 135 212 265 612 Other Europe 38 33 188 259 Aviva Europe 600 2,462 3,271 6,333 Delta Lloyd 368 1,095 125 1,588 Europe 968 3,557 3,396 7,921 North America3,4 (152) 1,240 (394) 694 Asia 118 181 241 540 Australia — — — — Asia Pacific 118 181 241 540
E16 – Implied discount rates (IDR) In the valuation of a block of business, the implied discount rate is the rate of discount such that a traditional embedded value calculation for the covered business equates to the MCEV. The cash flows projected are the expected future cash flows including expected investment cash flows from equities, bonds and properties earning a risk premium in excess of risk free, statutory reserves and required capital. The risk premiums used are consistent with those used in the expected existing business contribution within operating earnings. As the risk premiums are positive, a discount rate higher than risk-free is required to give a value equal to the market-consistent embedded value. Average derived risk discount rates are shown below for the embedded value.
United Kingdom 8.4% 10.4% France 6.7% 7.2% Ireland 4.4% 5.1% Italy 7.3% 5.3% Poland 7.3% 7.1% Spain 9.6% 8.4% Other Europe 8.0% 8.9% Aviva Europe 6.9% 6.9% Delta Lloyd 14.8% 10.5% Europe 8.7% 8.1% North America2 24.5% 35.6% Asia Pacific3 5.9% 7.2%
E17 – Summary of non-controlling interest in life and related businesses’ MCEV results £m Ireland £m Italy £m
Value of new business after tax 15 (1) 54 4 47 119 (26) 93 — 93 358 451 Life MCEV operating earnings after tax 41 6 104 40 81 272 49 321 3 324 2,199 2,523 Life MCEV (loss)/earnings after tax 47 (11) (26) 2 (29) (17) (17) (34) 6 (28) 1,838 1,810 Closing covered businesses’ embedded value 250 268 630 153 489 1,790 1,324 3,114 19 3,133 16,131 19,264
Reference rate 1 year 1.3% 1.3% 2.5% 5 years 2.6% 2.9% 3.3% 10 years 3.4% 3.7% 3.8% 15 years 3.8% 4.1% 4.0% 20 years 3.8% 4.2% 3.9% Expense inflation 2.0% 2.4% 2.5%
Reference rate 1 year 4.4% 4.5% 4.4% 5 years 5.5% 5.8% 4.3% 10 years 5.7% 5.8% 4.2% 15 years 5.4% 5.7% 4.1% 20 years 5.1% 5.5% 4.0% Expense inflation 3.0% 3.0% 2.9%
For service companies, expense inflation relates to the underlying expenses rather than the fees charged to the life company. The following adjustments are made to the swap rate for immediate annuity type contracts and for all contracts for Aviva USA and for Delta Lloyd. The risk-free rate is taken as the swap yield curve for the currency of the liability, adjusted by: New business Embedded value
For Delta Lloyd, the adjustment shown is applied to immediate annuity type contracts. For participating contracts, 75% of this value is used and for all other contracts, 50% of this value is used. This methodology is consistent with QIS 5 Solvency II requirements. For 2010, the approach to estimating the market level of liquidity premium in corporate bond assets has been simplified to use the formula structure proposed by CFO/CRO Forum working party.
A gradual reduction in the UK corporation tax rate from 28% to 24% over 4 years was announced in the Emergency Budget of 22 June 2010. The Finance (No. 2) Act 2010 enacted the first of the 1% rate reductions with effect from April 2011, with subsequent reductions to be dealt with by future legislation. The benefit to the Group‘s MCEV net assets arising from the 3% reduction of the rate from 27% to 24% is estimated as £160 million in total.
Model – North America Swap rates are generated by a model, the LIBOR Market Model Plus (LMM+), which projects a full swap curve at monthly intervals. Previously the LMM model was used to generate scenarios. Forward rates are assumed to have a distribution that lies between the lognormal and normal distributions. Although this no longer guarantees non-negative interest rates, it maintains interest rates within a more plausible range than the standard Libor Market Model, and gives a better fit to certain swaption volatility surfaces. The model is calibrated to volatilities for swaptions for ten year swaps for a range of option terms and strike rates. Swaption volatilities are taken from SuperDerivatives. Tests have been performed to ensure that sufficient scenarios have been used that the result converges to the stochastic value of the business being valued. The total annual return on equities is calculated as the return on one-year swaps plus an excess return. This excess return is modelled using a log-normal model where volatility varies by time horizon. This allows the model to capture the term structure of implied volatilities. The model is calibrated to at-the-money options of a variety of terms. Option volatilities are taken from Markit. Assumptions for correlations between asset classes have been set based on historic data.
Asset classes The significant asset classes for UK participating business are equities, property and long-term fixed rate bonds. The most significant assumptions are the distribution of future long-term interest rates (nominal and real) and swaption implied volatilities For many businesses, including US, France and Delta Lloyd, the most important assets are fixed rate bonds of various durations.
Summary statistics Swaption implied volatilities The implied volatility is that determined by Black-Scholes formula to reproduce the market price of the option. The following table sets out the model swaption implied volatilities.
E18 – Principal assumptions continued Equity implied volatilities The implied volatility is that determined by the Black-Scholes formula to reproduce the market price of the option. The following table set out the model equity implied volatilities.
Property implied volatilities Best estimate levels of volatility have been used in the absence of meaningful option prices from which implied levels of volatility can be derived. For the UK and Delta Lloyd, model property implied volatility is 15% for 31 December 2010 (31 December 2009: 15%).
Demographic assumptions Assumed future mortality, morbidity and lapse rates have been derived from an analysis of Aviva’s recent operating experience with a view to giving a best estimate of future experience. We have anticipated future changes in experience where that is appropriate, e.g. we have allowed for improvements in future policyholder longevity. We have set the assumptions based on a best estimate of shareholder outcomes. In particular, where the policyholder behaviour varies with economic experience, we have set assumptions which are dynamic, i.e. vary depending on the economic assumptions. For example, surrender and option take up rate assumptions that vary according to the investment scenario under consideration have been used in the calculation of the time value of options and guarantees, based on our assessment of likely policyholder behaviour in different investment scenarios. Additionally, where demographic experience is not driven by economic scenarios but is asymmetric on a stand-alone basis, the best estimate assumption considers the weighted-average expected experience, not simply the median or most likely outcome.
Non-hedgeable risk For the opening balance sheet and operating profit, a charge of 2.5% has been applied to the Group-diversified capital required on a 1-in-200 one-year basis over the remaining lifetime of in-force business. For the closing balance sheet, a charge of 3.3% has been applied. The charge is set so as to give an aggregate allowance that is in excess of the expected operational risk costs arising from the inforce covered business over its remaining lifetime. The capital levels used are projected to be sufficient to cover non-hedgeable risks at the 99.5% confidence level one year after the valuation date. The capital is equal to the capital from the ICA results for those risks considered. The capital has been projected as running off over the remaining life of the in-force portfolio in line with the drivers of the capital requirement. In addition to the operational risk allowance, financial non-hedgeable risks and other product level asymmetries have been allowed for. These allowances are not material as significant financial non-hedgeable risks and product level asymmetries are either modelled explicitly and included in the TVOG or are included in the PVFP through the use of appropriate best estimate assumptions.
Market value of external debt, subordinated debt, preference shares and direct capital instrument 7,279 6,634
In each sensitivity calculation, all other assumptions remain unchanged except where they are directly affected by the revised economic conditions. For example, future bonus rates are automatically adjusted to reflect sensitivity changes to future investment returns. Some of the sensitivity scenarios may have consequential effects on valuation bases, where the basis for certain blocks of business is actively updated to reflect current economic circumstances. Consequential valuation impacts on the sensitivities are allowed for where an active valuation basis is used. Where businesses have a target asset mix, the portfolio is re-balanced after a significant market movement otherwise no re-balancing is assumed. For new business, the sensitivities reflect the impact of a change immediately after inception of the policy. In general, the magnitude of the sensitivities will reflect the size of the embedded values, though this will vary as the sensitivities have different impacts on the different components of the embedded value. In addition, other factors can have a material impact, such as the nature of the options and guarantees, as well as the types of investments held. The credit spread sensitivities assume that the change relates to credit risk and not liquidity risk; in practice, credit spread movements may be partially offset due to changes in liquidity risk. Sensitivities will also vary according to the current economic assumptions, mainly due to the impact of changes to both the intrinsic cost and time value of options and guarantees. Options and guarantees are the main reason for the asymmetry of the sensitivities where the guarantee impacts to different extents under the different scenarios. This can be seen in the sensitivity of a 1%–2% movement in the interest rate for Delta Lloyd and US, where there is a significant amount of business with investment return guarantees.
United Kingdom 6,370 (15) (700) 765 15 France 2,940 (85) (125) 160 10 Ireland 827 — — — 5 Italy 597 — — — 5 Poland 1,119 — — — 5 Spain 554 (5) (60) 55 5 Other Europe 321 — — — — Aviva Europe 6,358 (90) (185) 215 30 Delta Lloyd 1,496 10 (75) 85 10 Europe 7,854 (80) (260) 300 40 North America 1,231 (160) (920) 825 90 Asia Pacific 676 (5) (15) 15 30 Total 16,131 (260) (1,895) 1,905 175
Interest rates 2010 Value of new business (net of tax and non-controlling interest)
Market values 2010 Value of new business (net of tax and non-controlling interest)
Corporate bond credit spread 2010 Value of new business (net of tax and non-controlling interest)
United Kingdom 254 — (58) 61 2 France 100 (6) (1) 3 3 Ireland 1 — — — — Italy 42 — — — 1 Poland 29 — — — — Spain 43 — (7) 6 1 Other Europe 15 — — — — Aviva Europe 230 (6) (8) 9 5 Delta Lloyd (41) — (1) 1 1 Europe 189 (6) (9) 10 6 North America (126) (17) (76) 67 15 Asia Pacific 41 — — — 5
Embedded value 2010 Embedded value (net of tax and non-controlling interest)
As reported on page 339 £m 10% decrease in maintenance expenses £m 10% decrease in lapse rates £m 5% decrease in mortality/ morbidity rates – life assurance £m 5% decrease in mortality/ morbidity rates – annuity business £m
United Kingdom 6,370 185 50 65 (310) France 2,940 45 35 30 — Ireland 827 15 25 5 (10) Italy 597 10 — 5 — Poland 1,119 25 45 15 — Spain 554 10 40 10 (5) Other Europe 321 15 25 5 — Aviva Europe 6,358 120 170 70 (15) Delta Lloyd 1,496 210 5 15 (80) Europe 7,854 330 175 85 (95) North America 1,231 75 (30) 65 (15) Asia Pacific 676 30 5 10 —
United Kingdom 254 9 12 4 (23) France 100 4 7 2 — Ireland 1 1 1 — — Italy 42 2 1 1 — Poland 29 1 4 2 — Spain 43 1 7 2 — Other Europe 15 1 5 1 — Aviva Europe 230 10 25 8 — Delta Lloyd (41) 9 2 1 (3) Europe 189 19 27 9 (3) North America (126) 8 (13) 10 — Asia Pacific 41 8 4 2 —
Opinion In our opinion the consolidated MCEV financial statements for the year ended 31 December 2010 have been properly prepared, in all material respects, in accordance with the MCEV Principles and the basis of preparation set out on pages 321 to 324.
Ernst & Young LLP London 2 March 2011 1 The maintenance and integrity of Aviva plc’s website is the responsibility of the directors; the work carried out by the auditors does not involve consideration of these matters and, accordingly, the auditors accept no responsibility for any changes that may have occurred to the financial statements since they were initially presented on the website. 2 Legislation in the United Kingdom governing the preparation and dissemination of financial statements may differ from legislation in other jurisdictions.
O ther inform ation Aviva plc Annual Report and Accounts 2010
Income drawdown The policyholder can transfer money from any pension fund to an income drawdown plan from which they receive an income. The remainder of the pension fund continues to be invested, giving it the potential for growth.
Pensions A means of providing income in retirement for an individual and possibly his/her dependants. Our pensions products include personal and group pensions, stakeholder pensions and income drawdown.
Superannuation Superannuation is a pension product sold in Australia where employers pay a proportion of an employee’s salaries and wages into a fund, which can be accessed when the employee retires.
Takaful Insurance products that observe the rules and regulations of Islamic law.
Acquired value of in force (AVIF) An estimate of future profits that will emerge over the remaining term of all existing life and pensions policies for which premiums are being paid or have been paid at the statement of financial position date.
General insurance Also known as non-life or property and casualty insurance. Casualty insurance primarily covers losses arising from accidents that cause injury to other people or damage the property of others. Property insurance covers loss or damage through fire, theft, flood, storms and other specified risks.
IFRS International Financial Reporting Standards. These are accounting regulations designed to ensure comparable statement of financial position preparation and disclosure, and are the standards that all publicly listed companies in the European Union are required to use.
‘Soft’ insurance market A term used to describe the state of the general insurance market. A “soft” insurance market is characterised by low levels of profitability and market competition driving premium rates lower. Soft insurance markets generally occur when there is excess capital and are the opposite of “hard” insurance markets.
Turnbull Guidance on Internal Control The Turnbull Guidance sets out best practice on internal controls for UK listed companies, and provides additional guidance in applying certain sections of the Combined Code.
Market Consistent Embedded Value (MCEV) terms cont. Market consistent A measurement approach where economic assumptions are such that projected asset cash flows are valued consistently with current market prices for traded assets.
Net asset value per ordinary share Net asset value divided by the number of ordinary shares in issue. Net asset value is based on equity shareholders’ funds.
Present value of new business premiums (PVNBP) Present value of new regular premiums plus 100% of single premiums, calculated using assumptions consistent with those used to determine the value of new business.
Risk-free rate (reference rate in CFO Forum terminology) In stable markets, including the period from 31 December 2006 to 30 June 2007, the riskfree rate is taken as the swap curve yield. In current markets, including the period from 1 July 2007, the risk-free rate is taken as swaps except for all contracts that contain features similar to immediate annuities and are backed by appropriate assets, including paid up group deferred annuities and all other contracts in the Netherlands, and deferred annuities and all other contracts in the US. The adjusted risk-free rate is taken as swaps plus the additional return available for products and where backing asset portfolios can be held to maturity.
Spread business Contracts where a significant source of shareholder profits is the taking of credit spread risk that is not passed on to policyholders. The most significant spread business in Aviva are immediate annuities and US deferred annuities and life business.
Stochastic techniques Techniques that incorporate the potential future variability in assumptions.
Time value and intrinsic value A financial option or guarantee has two elements of value, the time value and intrinsic value. The intrinsic value is the discounted value of the option or guarantee at expiry, assuming that future economic conditions follow best estimate assumptions. The time value is the additional value arising from uncertainty about future economic conditions.
Individual 584,732 97.11 257,030,913 9.11 Banks and nominee companies 13,810 2.29 2,508,890,999 88.97 Pension fund managers and insurance companies 84 0.01 106,844 0.00 Other corporate bodies 3,542 0.59 54,119,886 1.92
Range of shareholdings Number of shareholders % Number of shares %
Total 602,168 100 2,820,148,642 100 +The number of registered ordinary shares represented by ADRs. Please note that each Aviva ADR represents two (2) ordinary Aviva shares.
Annual General Meeting 4 May 2011 Announcement of first quarter Interim Management Statement 17 May 2011 Announcement of unaudited half-year results 4 August 2011 Announcement of third quarter Interim Management Statement 3 November 2011
Ex-dividend date 23 March 2011 Record date 25 March 2011 Scrip dividend price setting period
Ordinary shareholders – Have your dividends paid directly into your bank account Visit www.aviva.com/dividends for further details or contact Equiniti to obtain a form. If your holding is less than 1,500 shares, you can set up a mandate instruction over the telephone.
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, offering free financial advice or offers of free company reports. If you receive any unsolicited advice: Make sure you get the correct name of the person and organization; Check that they are properly authorised by the Financial Services Authority (FSA) before getting involved by visiting www.fsa.gov.uk/register/; Report the matter to the FSA by calling 0845 606 1234 or visit www.fsa.gov.uk/pages/consumerinformation; and
More detailed information on this can be found on the Consumer Financial Education Body website www.moneymadeclear.org.uk.
Email: aviva@equiniti.com Telephone: 0871 384 2953* + 44 (0) 121 415 7046 (for callers outside of the UK)
For further information about Aviva’s ADR programme, please go to www.citi.com/dr.
Internet sites Aviva owns various internet sites, most of which interlink with each other: Aviva Group www.aviva.com UK long-term savings and general insurance www.aviva.co.uk Asset management www.avivainvestors.com Aviva worldwide internet sites www.aviva.com/websites
Other useful links for shareholders: Aviva shareholder services centre www.aviva.com/shareholderservices ADR holders www.aviva.com/adr Aviva preference shareholders www.aviva.com/preferenceshares Dividend information for ordinary shares www.aviva.com/dividends Annual General Meeting information www.aviva.com/agm Electronic voting for Annual General Meeting† www.aviva.com/agm Aviva share price www.aviva.com/shareprice Register for electronic communications www.aviva.com/ecomms * Calls to 0871 numbers are charged at 8 pence per minute from a BT landline. Charges from other telephone providers may vary. Lines are open from 8.30am to 5.30pm, Monday to Friday. † This service will only be available until 11am on Thursday, 28 April 2011.