(c) Methodology The expected investment returns and corresponding expected movements in long-term business liabilities are calculated separately for each principal long-term business unit. The expected return on investments for both policyholders’ and shareholders’ funds is based on opening economic assumptions applied to the expected funds under management over the reporting period. Expected investment return assumptions are derived actively, based on market yields on risk-free fixed interest assets at the end of each financial year. The same margins are applied on a consistent basis across the Group to gross risk-free yields, to obtain investment return assumptions for equities and properties. Expected funds under management are equal to the opening value of funds under management, adjusted for sales and purchases during the period arising from expected operating experience. The actual investment return is affected by differences between the actual and expected funds under management and changes in asset mix, as well as movements in interest rates. To the extent that these differences arise from the operating experience of the long-term business, or management decisions to change asset mix, the effect is included in the operating profit. The residual difference between actual and expected investment return is included in investment variances, outside operating profit but included in profit before tax. The movement in liabilities included in operating profit reflects both the change in liabilities due to the expected return on investments and the impact of experience variances and assumption changes for non-economic items. The effect of differences between actual and expected economic experience on liabilities, and changes to economic assumptions used to value liabilities, are taken outside operating profit. For many types of long-term business, including unit-linked and with-profits funds, movements in asset values are offset by corresponding changes in liabilities, limiting the net impact on profit. For other longterm business the profit impact of economic volatility depends on the degree of matching of assets and liabilities, and exposure to financial options and guarantees.
Notes to the consolidated financial statements continued 8 – Long-term business economic volatility continued (d) Assumptions The expected rate of investment return is determined using consistent assumptions between operations, having regard to local economic and market forecasts of investment return and asset classification under IFRS. The principal assumptions underlying the calculation of the expected investment return for equities and properties are: Equities Properties
The expected return on equities and properties is calculated by reference to the ten-year swap rate in the relevant currency plus an appropriate risk margin. These are the same assumptions as are used under MCEV principles to calculate the longer-term investment return for the Group’s long-term business. For fixed interest securities classified as FV, the expected investment returns are based on average prospective yields for the actual assets held. Where such securities are classified as AFS, such as in the US, the expected investment return comprises the expected interest or dividend payments and amortisation of the premium or discount at purchase.
Analysed between: Longer-term investment return, reported within operating profit 769 749 Short-term fluctuation in investment return, reported outside operating profit General insurance and health (124) (199) Other operations* (142) —
*Mainly represents assets backing non-long-term business held by the France holding company.
Notes to the consolidated financial statements continued 9 – Longer-term investment return and economic assumption changes for non-long-term business continued (d) The total assets supporting the general insurance and health business, which contribute towards the longer-term return, are: £m £m
Actual return attributable to shareholders 3,175 3,831 Longer-term return credited to operating results (4,114) (4,329)
Movement in investment return for By Change in £m 2010 £m
Equities 1% higher/lower Group operating profit before tax 4 6 Properties 1% higher/lower Group operating profit before tax 1 2
(a) Employee numbers The number of persons employed by the Group was: At 31 December Average for the year
Employees in continuing operations 36,562 39,420 38,924 39,332 Employees in discontinued operations — 5,722 1,916 6,009
Wages and salaries 1,541 1,531 Social security costs 225 212 Post-retirement obligations Defined benefit schemes (note 47d)* 58 (219) Defined contribution schemes (note 47d) 95 70 Profit sharing and incentive plans 156 140 Equity compensation plans (note 30d) 58 50 Termination benefits 22 14
Acquisition costs 644 620 Claims handling expenses 221 234 Central costs and sharesave schemes 10 (6) Other operating expenses 1,280 1,236 Exceptional items* — (286)
Total staff costs 2,332 2,239 *The credit disclosed in exceptional items in 2010 arose from the £286 million gain on the closure of the UK schemes to future accrual, described in note 47(c).
Notes to the consolidated financial statements continued 11 – Directors Information concerning individual directors’ emoluments, interests and transactions is given in the Directors’ Remuneration Report on pages 114 to 136 in the ‘Corporate governance’ section of this report. For the purposes of the disclosure required by Schedule 5 to the Companies Act 2006, the total aggregate emoluments of the directors in respect of 2011 was £6.3 million (2010: £6.8 million). Employer contributions to pensions for executive directors for qualifying periods were £71,900 (2010: £136,400). The aggregate net value of share awards granted to the directors in the period was £12.1 million (2010: £9.5 million). The net value has been calculated by reference to the closing middle market price of an ordinary share at the date of grant. During the year, no share options were exercised by directors (2010: nil).
12 – Auditors’ remuneration This note shows the total remuneration payable by the Group to our auditors. The total remuneration payable by the Group, excluding VAT and any overseas equivalent thereof, to its principal auditors, Ernst & Young LLP, and its associates is shown below.
Fees payable to Ernst & Young LLP (E&Y LLP) for the statutory audit of the Aviva Group and Company financial statements 2.5 — — — 2.5 Fees payable to E&Y LLP and its associates for other services to Group companies: Audit of Group subsidiaries pursuant to legislation 12.8 — — — 12.8 Additional fees related to the prior year audit of Group subsidiaries pursuant to legislation 0.9 — — — 0.9 Other services pursuant to legislation 2.7 — — — 2.7 Supplementary reporting — 1.8 — — 1.8 Tax services — — 0.2 — 0.2 All other fees: Services relating to corporate finance transactions — 0.9 — — 0.9 Services relating to information technology — — — 0.3 0.3 Other supplementary services — 3.1 — 1.9 5.0
Fees payable to E&Y LLP for the statutory audit of the Aviva Group and Company financial statements 1.8 — — — 1.8 Fees payable to E&Y LLP and its associates for other services to Group companies: Audit of Group subsidiaries pursuant to legislation 11.2 — — — 11.2 Additional fees related to the prior year audit of Group subsidiaries pursuant to legislation 0.6 — — — 0.6 Other services pursuant to legislation 2.5 — — — 2.5 Audit of Group pension scheme — 0.1 — — 0.1 Supplementary reporting — 1.8 — — 1.8 Tax services — — 0.1 — 0.1 All other fees: Services relating to corporate finance transactions — — — 0.5 0.5 Other supplementary services — 2.5 — 0.2 2.7
Fees payable to E&Y LLP and its associates for services to Group companies classified as continuing operations 16.1 4.4 0.1 0.7 21.3
Fees payable to E&Y LLP and its associates for services to Group companies classified as discontinued operations 2.5 0.9 — 0.9 4.3
Fees payable for the audit of the Group’s subsidiaries pursuant to legislation include fees for the statutory audit of the subsidiaries, both inside and outside the UK, and for the work performed by Ernst & Young LLP in respect of the subsidiaries for the purpose of the consolidated financial statements of the Group. Other services pursuant to legislation comprise services in relation to statutory and regulatory filings. These include audit services for the audit of FSA returns in the UK and review of interim financial information under the Listing Rules of the UK Listing Authority. Fees for Supplementary reporting are in respect of the audit of the Group’s MCEV reporting. Although embedded value is a primary management reporting basis and our disclosures require a full audit, the relevant fees are not classified as being for statutory audit.
Fees for corporate finance transactions in 2011 relates to work performed on the partial disposal of Delta Lloyd and the US subordinated debt issue. The 2011 fees for Other supplementary services for continuing operations includes £0.5 million (2010: £0.4 million) for assurance services in connection with the Group’s Financial Reporting Control Framework; £1.6 million (2010: £1.1 million) for examination of the Group’s Individual Capital Assessment (ICA) and Economic Capital and £2.9 million (2010: £1.2 million) for other services, which includes £0.9 million relating to two risk management effectiveness reviews.
Deferred tax Origination and reversal of temporary differences (514) 280 Changes in tax rates or tax laws (28) (35) Write-down/(back) of deferred tax assets 70 (67)
(v) Deferred tax (credited)/charged to the income statement represents movements on the following items: Continuing operations 2011 £m £m
Current tax from continuing operations In respect of pensions and other post-retirement obligations (88) (29) In respect of foreign exchange movements (8) (5)
Tax charged to other comprehensive income arising from continuing operations 261 116 Tax credited to other comprehensive income arising from discontinued operations (3) (4)
(ii) The tax charge attributable to policyholders’ returns included above is £nil (2010: £nil).
(c) Tax credited to equity Tax credited directly to equity in the year amounted to £16 million (2010: £17 million), and is wholly in respect of coupon payments on direct capital instruments.
(d) Tax reconciliation The tax on the Group’s (loss)/profit before tax differs from the theoretical amount that would arise using the tax rate of the home country of the Company as follows: Shareholder £m
Tax calculated at standard UK corporation tax rate of 26.5% 23 (47) (24) Reconciling items Different basis of tax – policyholders — (129) (129) Adjustment to tax charge in respect of prior years (25) — (25) Non-assessable income (60) — (60) Non-taxable profit on sale of subsidiaries and associates (135) — (135) Disallowable expenses 215 — 215 Different local basis of tax on overseas profits 84 (2) 82 Change in future local statutory tax rates (32) — (32) Movement in deferred tax not recognised (5) — (5) Tax effect of profit from associates and joint ventures (41) — (41)
Different basis of tax – policyholders per tax reconciliation (129) 272
14 – Earnings per share This note shows how we calculate earnings per share, based both on the present shares in issue (the basic earnings per share) and the potential future shares in issue, including conversion of share options granted to employees (the diluted earnings per share). We have also shown the same calculations based on our operating profit as we believe this gives a better indication of operating performance.
Profit before tax attributable to shareholders’ profits 2,312 (1,465) 847 Share of Delta Lloyd’s tax expense as an associate (39) 5 (34)
Profit before tax 2,273 (1,460) 813 Tax attributable to shareholders’ profits (625) 396 (229)
Profit for the year 1,648 (1,064) 584 Amount attributable to non-controlling interests (150) 109 (41) Cumulative preference dividends for the year (17) — (17) Coupon payments in respect of direct capital instruments (DCI) (net of tax) (43) — (43)
Profit attributable to ordinary shareholders from continuing operations 1,438 (955) 483 Loss attributable to ordinary shareholders from discontinued operations 93 (411) (318)
Notes to the consolidated financial statements continued 14 – Earnings per share continued
(iii) The calculation of basic earnings per share uses a weighted average of 2,845 million (2010: 2,784 million) ordinary shares in issue, after deducting shares owned by the employee share trusts. The actual number of shares in issue at 31 December 2011 was 2,906 million (2010: 2,820 million) and 2,892 million (2010: 2,812 million) excluding shares owned by the employee share trusts.
Loss attributable to ordinary shareholders (318) 2,845 (11.2) Dilutive effect of share awards and options — 50 —
Diluted earnings per share 165 2,895 5.7 *The effect of future share awards and options in the loss from discontinued operations is anti-dilutive, therefore the diluted earnings per share has been maintained at (11.2) pence.
Profit attributable to ordinary shareholders 358 2,784 12.8 Dilutive effect of share awards and options — 47 (0.2)
Operating profit attributable to ordinary shareholders 93 2,845 3.3 Dilutive effect of share awards and options — 50 (0.1)
Diluted operating profit per share from discontinued operations 93 2,895 3.2
Diluted operating profit per share from continuing operations 1,315 2,831 46.5
Diluted operating profit per share from discontinued operations 219 2,831 7.7
Notes to the consolidated financial statements continued 15 – Dividends and appropriations This note analyses the total dividends and other appropriations we paid during the year. The table below does not include the final dividend proposed after the year end because it is not accrued in these financial statements. The impact of shares issued in lieu of dividends is shown separately in note 36.
Ordinary dividends declared and charged to equity in the period Final 2010 – 16.00 pence per share, paid on 17 May 2011 451 — Final 2009 – 15.00 pence per share, paid on 17 May 2010 — 415 Interim 2011 – 10.00 pence per share, paid on 17 November 2011 287 — Interim 2010 – 9.50 pence per share, paid on 17 November 2010 — 266
Subsequent to 31 December 2011, the directors proposed a final dividend for 2011 of 16.0 pence per ordinary share (2010: 16.0 pence), amounting to £465 million (2010: £451 million) in total. Subject to approval by shareholders at the AGM, the dividend will be paid on 17 May 2012 and will be accounted for as an appropriation of retained earnings in the year ending 31 December 2012. Interest on the direct capital instruments issued in November 2004 is treated as an appropriation of retained profits and, accordingly, it is accounted for when paid. Tax relief is obtained at a rate of 26.5% (2010: 28.0%).
Gross amount At 1 January 3,671 3,667 Acquisitions and additions (note 3a) 13 29 Fair value adjustments and movements in contingent consideration — (4)
Accumulated impairment At 1 January (280) (286) Impairment losses charged to expenses (160) (3) Deconsolidation of Delta Lloyd 226 — Foreign exchange rate movements 4 9
Goodwill impairment charges of £160 million have been recognised as expenses. Together with impairment charges of £15 million recognised in respect of goodwill within interests in joint ventures (note 18), the goodwill write down for the year was £175 million. Goodwill disposed of during the year relates to the sale of the RAC business (see note 3(b)). As described in note 3(b), the Group’s interest in Delta Lloyd was deconsolidated during the year, resulting in the derecognition of goodwill balances associated with this entity.
Carrying amount of intangibles with indefinite useful lives (detailed in note 17) Total £m £m £m £m
As explained in accounting policy N, the carrying amount of goodwill and intangible assets with indefinite useful lives is reviewed at least annually or when circumstances or events indicate there may be uncertainty over this value. The tests led to impairment of goodwill of £160 million in 2011 (2010: £3 million). Goodwill and intangibles with indefinite useful lives have been tested for impairment in these businesses as follows: United Kingdom (i) Long-term business As part of the annual review of goodwill, management have considered the recoverability of the goodwill balance associated with the two cash generating units representing the UK Creditor Life business and the UK Occupational Health business. As a result of deteriorating prospects for these businesses, management have concluded that the goodwill in these businesses is no longer recoverable and an impairment of £29 million has been recognised as an expense in the consolidated income statement during the year.
 Growth rates represent the rates used to extrapolate future cash flows beyond the business plan period and have been based upon latest information available regarding future and past growth rates, including external sources of data such as ABI Annual Market Statistics.
Notes to the consolidated financial statements continued 16 – Goodwill continued Europe (i) Long-term business The recoverable amount of long-term business cash-generating units in the Europe region, with the exception of France, was determined based on a value in use calculation. The first step of the test was to compare the carrying value of each cash-generating unit, including goodwill, to the MCEV of that cash-generating unit. If the MCEV is less than the carrying value of a cash generating unit, the present value of profits from expected new business for that cash-generating unit is considered. If the value of profits from expected new business for a cash-generating unit is expected to grow beyond the period of the initial plan, this growth rate is set with regard to past experience in each market and market expectations of future growth in each country. For European long-term business cash-generating units, with the exception of France, a key assumption used for the calculation was the embedded value which represents the shareholder interest in the life business and is calculated in accordance with the MCEV principles. The embedded value is the total of the net worth and the value of the in-force life business.
(iv) Ireland (long-term business) Following the announcement of the termination of Aviva Ireland’s bancassurance distribution contract (see note 3(d)), management have concluded that the goodwill associated with the Irish long-term business is not recoverable as a result of the reduction in expected volumes of future new business. A goodwill impairment loss of £120 million has therefore been recognised, reducing the carrying value of goodwill relating to this business to £nil.
(v) Ireland (general insurance and health) The recoverable amount of the Irish general insurance and health business exceeds the carrying value of the cash-generating unit, including goodwill. Key assumptions used for the calculation were:  Budgeted operating profit for an initial three-year period which represents the operating profit in the business plans, approved by management and reflecting the best estimate of future profits based on both historical experience and expected growth rates for the Irish economy. The assumptions that underline the budgeted operating profit include market share, premium rate changes, claims inflation and commission rates;  Future cash flows are extrapolated beyond the three-year business plan period assuming 2% (2010: nil) growth for general insurance business and a nil growth rate for the health business; and
The recoverable amount for the cash-generating unit exceeds its carrying value by £6 million. An increase in the risk adjusted discount rate by 27 basis points would result in the recoverable amount being equal to the carrying value.
(vi) Italy (long-term business) The recoverable amount 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. Key assumptions (in addition to MCEV principles) used for the calculation were:  New business contribution represents the present value of projected future profits generated from business written in a period.
This is initially based on the most recent three-year business plans approved by management;  Growth rate represents the rate used to extrapolate new business contributions beyond the business plan period, and is based on management’s estimate of future growth of 3% (2010: 3%); and  Risk-adjusted discount rate of 5.3% (2010: 5.6%) represents the rate used to discount expected profits from future new business. The discount rate is a combination of a risk-free rate and a risk margin to make prudent allowance for the risk that experience in future years for new business may differ from that assumed. The MCEV principles applied to project future cash flows include allowance for many of the risks associated with these cash flows, and therefore these risks are not also reflected in the discount rate applied to reach a present value.
(ix) United States (long-term business) The recoverable amount of the US long-term business exceeds the carrying value of the cash-generating unit including goodwill. The recoverable amount of the US long-term cash-generating unit has been determined based on a value in use calculation. This calculation is an actuarially determined appraisal value and is based on an embedded value of the business (the total of the net worth of the life business and the value of the in-force business) together with the present value of expected profits from future new business. Key assumptions used for the calculation were:  Embedded value represents the shareholder interest in the life business and is based on projected cash flows of the business including expected investment returns;  Risk-adjusted discount rate of 8% (2010: 8%) is used to calculate the embedded value;  New business contribution represents the present value of projected future profits generated from business written in a period.
This is initially based on the most recent three-year business plans approved by management;  Growth rate represents the rate used to extrapolate new business contributions beyond the business plan period, and is based on management’s estimate of future growth of 5% (2010: 3%) for life business and 3% (2010: 3%) for annuity business, which is set with regard to past experience in these markets; and
Cash flow projections To comply with paragraph 33(c) of IAS 36, cash flow projections for the period beyond the three-year plan period are extrapolated from the position in the final year of the three-year plan period. In all cases, we have assumed a positive or nil steady growth rate for subsequent years, not an increasing growth rate. The steady growth rate selected for each cash-generating unit reflects long-term expectations for the markets in which each cash-generating unit participates. Impairment tests for all cash-generating units have been performed using assumptions which management believe are reasonable. Except where specifically noted in the discussion of impairment testing above, given the magnitude of the excess of recoverable value over carrying amount in each case, management believe that it is not reasonably possible that there would be a change in the key assumptions such that the carrying amount would exceed the recoverable value.
Movement in shadow adjustment (123) — — — (123) Deconsolidation of Delta Lloyd (126) — (158) — (284)
Deconsolidation of Delta Lloyd — — 10 — 10 Foreign exchange rate movements (1) — — 1 —
Share of results after tax — 165 — 165 Impairment of goodwill (9) — — (9) Amortisation of intangibles* (7) — — (7)
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
Share of results before tax — (14) — (14) Share of tax — (3) — (3)
Reclassification to subsidiary — — (282) (282) Reduction in Group interest — (1) — (1)
Share of gains taken to other comprehensive income — 7 — 7 Loans repaid — — (17) (17) Foreign exchange rate movements (19) (4) 6 (17)
Less: Amounts classified as held for sale — (12) — (12)
During 2010, the Group’s Taiwan joint venture, First-Aviva Life Insurance Co., Ltd., was classified as held for sale following the decision of management to seek to dispose of the business. A sale of this business was not completed in 2011 and management have reviewed its classification as held for sale and determined that the classification remains appropriate. The disposal is expected to be completed within 12 months of the balance sheet date. On 11 November 2010, the Group entered into a joint venture agreement with Vietnam Joint-stock Commercial Bank for Industry and Trade (‘Vietinbank’) to set up a green-field life insurance company, Vietinbank Aviva Life Insurance Limited. Regulatory approval was received in September 2011 and the company was capitalised on 4 October 2011. Aviva has a 49.99% shareholding in this joint venture, with an initial cost of £12 million. Other additions relate to Aviva-COFCO Life Insurance Co. Limited and property management undertakings. Disposals and reductions in Group interests relate to property management undertakings.
Property management undertakings — 1,145 100 1,245 Long-term business undertakings 147 315 — 462 General insurance undertakings — 5 — 5
Airport Property Partnership 50.00% 50.00% Ashtenne Industrial Fund Limited Partnership 67.70% 37.43% The Mall Limited Partnership 50.00% 50.52% Queensgate Limited Partnership 50.00% 50.00% Quercus Healthcare Property Partnership Limited 50.00% 28.34% The Southgate Limited Partnership 50.00% 50.00% 20 Gracechurch Street Limited Partnership 50.00% 50.00%
(c) Long-term business undertakings The principal joint ventures are as follows: Company Proportion held
(i) Aviva-COFCO Life Insurance Co. Limited The Group’s investment in Aviva-COFCO Life Insurance Co. Limited has been tested for impairment by comparing its carrying value with its recoverable amount. The recoverable amount has been determined based on value in use calculations. This calculation is an actuarially determined appraisal value and is based on the MCEV embedded value of the business. The key assumptions used in the test were the MCEV principles. The MCEV of Aviva-COFCO Life Insurance Co. Limited exceeds its carrying value. Aviva-COFCO Life Insurance Co. Limited is a developing business and the recoverability of value is reliant on future projected growth being achieved. These projections are inherently uncertain and dependent on local economic conditions.
Notes to the consolidated financial statements continued 18 – Interests in, and loans to, joint ventures continued (iv) Woori Aviva Life insurance Co. Ltd The Group’s investment in Woori Aviva Life Insurance Co. Ltd 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. Key assumptions used for the calculation were:  Cash flow projections based on: (i) the policy portfolio reported 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 value 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 13.6% (2010: 14.6%); and  New sales beyond the three-year period have been extrapolated using a growth rate of 4% (2010: 8%). As a result of this test, an impairment of £15 million has been recognised in the income statement. Increases in the carrying value of the associate were not matched by increases in the recoverable amount calculated. Woori Aviva Life Insurance Co. Ltd is a developing business and the recoverability of value is reliant on the achievement of future projected growth. These projections are inherently uncertain and dependent on local economic conditions.
Notes to the consolidated financial statements continued 19 – Interests in, and loans to, associates This note analyses our interests in entities which we do not control but where we have significant influence.
Share of results before tax — 16 — 16 Share of tax — (4) — (4)
Movements in carrying amount 35 440 — 475 *2010 includes impairment of £10 million.
(ii) Additions Additions in 2011 relate to the Group’s Indian associate.
Share of net assets 776 227 1,003 563 *As Delta Lloyd only became an associate in May 2011, the 2010 comparatives relate to other companies.
The Group’s share of associated companies’ contingent liabilities amounted to £173 million at 31 December 2011. There were no significant contingent liabilities to which the Group was exposed in 2010.
(d) Impairment testing All interests in associates have been tested for impairment but only the material items are detailed below.
Aviva Life Insurance Company India Limited is a developing business and the recoverability of value is reliant on the achievement of future projected growth. In addition, local regulatory changes have resulted in changes to the types of product that can be sold. The growth projections are inherently uncertain and dependent on local economic and regulatory conditions.
Notes to the consolidated financial statements continued 20 – Property and equipment This note analyses our tangible fixed assets, which are primarily properties occupied by Group companies and computer equipment.
Fair value losses (see below) — (42) — — — (42)
Fair value gains of £2 million (2010: £46 million loss) have been charged to other comprehensive income, with the net reversal of losses previously charged to the income statement now being credited there. Owner-occupied properties are stated at their revalued amounts, as assessed by qualified external valuers. These values are assessed in accordance with the relevant parts of the current RICS Appraisal and Valuation Standards in the UK, and with current local valuation practices in other countries. This assessment, on the basis of existing use value and in accordance with UK Practice Statement 1.3, is the estimated amount for which a property should exchange on the date of valuation between a willing buyer and a willing seller in an arm’s-length transaction, after proper marketing wherein the parties had acted knowledgeably, prudently and without compulsion, assuming that the buyer is granted vacant possession of all parts of the property required by the business and disregarding potential alternative uses. The valuation assessment adopts market-based evidence and is in line with guidance from the International Valuation Standards Committee and the requirements of IAS 16, Property, Plant and Equipment. Similar considerations apply to properties under construction, where an estimate is made of valuation when complete, adjusted for anticipated costs to completion, profit and risk, reflecting market conditions at the valuation date. Our West Des Moines office in the United States was only completed and occupied in 2010, so it is held at its construction cost of £87 million until the next valuation in 2013. If owner-occupied properties were stated on a historical cost basis, the carrying amount would be £189 million (2010: £347 million). The Group has no material finance leases for property and equipment.
Notes to the consolidated financial statements continued 21 – Investment property This note gives details of the properties we hold for long-term rental yields or capital appreciation.
Capitalised expenditure on existing properties 35 13 48 Fair value gains 336 85 421
Capitalised expenditure on existing properties 52 9 61 Fair value gains 92 6 98
Financial liabilities Non-participating investments contracts (note 40) 42,523 1,219 248 43,990 1,669 — 45,659
Total funds Balance at 1 January 9,139 844 1,327 11,310 176 Total net gains recognised in the income statement 64 6 177 247 — Total net gains recognised in other comprehensive income 73 50 — 123 —
The Group assesses the fair value hierarchy of its financial investments biannually at 30 June and 31 December. Transfers between fair value hierarchy levels are deemed to have occurred at the assessment date. Transfers into and out of Level 3 for the year arose for the following reasons:  Changes in the market observability of valuation inputs.  Changes in the market observability of inputs used to validate valuations.  Significant differences between third-party prices used for valuations and validation prices either sourced from third parties or internal models.
These bonds are valued either using third-party counterparty or broker quotes. These bonds are validated against internal or third-party models. These bonds have been classified as Level 3 because either (i) the third-party models included a significant unobservable liquidity adjustment or (ii) differences between the valuation provided by the counterparty and broker quotes and the validation model were sufficiently significant to result in a Level 3 classification. At 31 December 2011, the values reported in respect of these products were the lower of counterparty and broker quotes and modelled valuations.
 Private equity investment funds amounting to £1.5 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.
 External hedge funds held principally by businesses in the UK, the US and France amounting to £1.3 billion. Valuations received from fund managers are based on net asset values. However, insufficient information is provided on the underlying fund assets to support a classification other than Level 3.
(iii) Where possible, the Group tests the sensitivity of the fair values of Level 3 investments to changes in unobservable inputs to reasonable alternatives. 99% (2010: 95%) of valuations for Level 3 investments are sourced from independent third parties and, where appropriate, validated against internally modelled valuations, third-party models or broker quotes. Where third-party pricing sources are unwilling to provide a sensitivity analysis for their valuations, the Group undertakes, where feasible, sensitivity analysis on the following basis:  For third-party valuations validated against internally modelled valuations using significant unobservable inputs, the sensitivity of the internally modelled valuation to changes in unobservable inputs to a reasonable alternative is determined.  For third-party valuations either not validated or validated against a third-party model or broker quote, the third-party valuation in its entirety is considered an unobservable input. Sensitivities are determined by flexing to a reasonable alternative the yield, NAV multiple, IRR or other suitable valuation multiples of the financial instrument implied by the third-party valuation. For example, for a fixed income security the implied yield would be the rate of return which discounts the security’s contractual cash flows to equal the third-party valuation.
On the basis of the methodology outlined above, the Group is able to perform sensitivity analysis for £3.8 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 £114 million positive impact and £114 million adverse impact. Of the £7.6 billion Level 3 investments for which sensitivity analysis is not provided, £0.3 billion and £6.4 billion relate to investments held in unit-linked and participating funds respectively in Italy 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, amount to only £0.7 billion. A 10% change in valuation of these investments would reduce shareholder profit before tax by £74 million.
Loans at amortised cost The fair value of these loans at 31 December 2011 was £9,532 million (2010: £21,784 million).
Notes to the consolidated financial statements continued 23 – Loans continued (b) Analysis of loans carried at amortised cost
The movements in the impairment provisions on these loans for the years ended 31 December 2010 and 2011 were as follows: £m £m
Increase during the year (66) (28) Write back following sale or reimbursement 2 17 Write back following recovery in value 39 6 Deconsolidation of Delta Lloyd 72 — Foreign exchange movements — 1 Other movements — 11
Total loan notes issued, as above 1,486 — 1,464 6,140 Less: Loan notes held by Group companies (180) — (176) (1,095)
Loan notes held by third parties (note 48c) 1,306 — 1,288 5,045
Equity securities Ordinary shares Public utilities — 4,133 — 4,133 — 4,108 — 4,108 Banks, trusts and insurance companies — 6,184 81 6,265 7 6,708 907 7,622 Industrial miscellaneous and all other — 21,857 1 21,858 31 34,102 2,566 36,699
Other investments – short-term — — — — — 2 — 2
Other investments Unit trusts and specialised investment vehicles 27,416 74 (230) 27,260
Deposits with credit institutions 427 — — 427 Minority holdings in property management undertakings 639 124 (146) 617 Other long-term investments 652 19 (96) 575 Other short-term investments — — — —
These are further analysed as follows: At fair value through profit or loss 183,959 13,555 (10,757) 186,757
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 investments 2 — — 2
Charge for the year taken to the income statement (19) (2) — (21) Write back following sale or reimbursement 28 — — 28 Write back following recovery in value — — — — Deconsolidation of Delta Lloyd 16 822 — 838 Foreign exchange rate movements — — — —
Non-cash collateral received The Group receives collateral in order to reduce the credit risk of these arrangements. Collateral must be in a readily realisable form, such as listed securities, and is held in segregated accounts. Transfer of title always occurs for collateral received, although no market risk or economic benefit is taken. The level of collateral held is monitored regularly, with further collateral obtained where this is considered necessary to manage the Group’s risk exposure. In certain markets, the Group or the Group’s appointed stock lending managers obtain legal ownership of the collateral received and can re-pledge it as collateral elsewhere or sell outright in the absence of default. The carrying amount of financial assets received in this manner at 31 December 2011 was £15,778 million (2010: £15,858 million). The value of collateral that was actually sold in the absence of default was £150 million (2010: £nil).
At 31 December 2011, the Group’s total government (non-UK) debt securities stood at £41.6 billion (FY10: £38.7 billion, excluding Delta Lloyd), an increase of £2.9 billion. The significant majority of these holdings are within our participating funds where our risk to our shareholders is governed by the nature and extent of our participation within those funds. Our direct shareholder asset exposure to government (non-UK) debt securities amounts to £10.5 billion (FY10: £10.2 billion). The primary exposures, relative to total shareholder (non-UK) government debt exposure, are to French (15.5%) and Italian (10.0%) (non-UK) government debt securities. Our combined exposure to Greek, Portuguese and Irish debt is £0.2 billion (FY10: £0.5 billion), a decrease of £0.3 billion. The participating funds exposure to (non-UK) government debt amounts to £28.8 billion (FY10: £26.2 billion), an increase of £2.6 billion. The primary exposures, relative to total (non-UK) government debt exposures included within our participating funds, are to the (non-UK) government debt securities of France (26.2%), Italy (33.6%), Belgium (3.6%), Spain (3.6%), Germany (6.1%) and Netherlands (4.5%).
(f) Exposure to worldwide banks – debt and equity securities Direct shareholder exposures to worldwide banks – debt and equity securities (net of non-controlling interests, excluding policyholder assets)
Austria — — — — — — — — — — — — Belgium — — — — — — — — — — — — Finland — — — — — — — — — — — —
Ireland — — — — — — — — — — — —
Direct shareholder exposures to worldwide banks – debt and equity securities (gross of non-controlling interests, excluding policyholder assets)
1 The 2010 comparative figures are not provided as it was not practical to be obtained.
Notes to the consolidated financial statements continued 25 – Financial investments continued (f) Exposure to worldwide banks – debt and equity securities continued Participating funds assets exposure to worldwide banks - debt and equity securities (gross of non-controlling interests, excluding policyholder assets)
Gross of non-controlling interests, the participating fund exposures to worldwide banks debts securities and equities is £16.9 billion. The majority of the exposure (71%) is in senior debt (covered, secured and senior unsecured). Participating funds are the most exposed to France (27%) and United Kingdom (15%) banks. The significant majority of these holdings are within our participating funds where the risk to our shareholders is governed by the nature and extent of our participation within those funds.
Expected to be recovered in less than one year 7,713 7,095 Expected to be recovered in more than one year 224 1,200
Notes to the consolidated financial statements continued 27 – Deferred acquisition costs and other assets This note shows the products on which we are deferring some of our acquisition costs and details the movements in the balance during the year.
Deferred acquisition costs in respect of: Insurance contracts – Long-term business 2,733 3,148 Insurance contracts – General insurance and health business 986 1,141 Participating investment contracts – Long-term business 21 35 Non-participating investment contracts – Long-term business 1,024 1,078 Retail fund management business 14 14
(b) Movements in the year The movements in deferred acquisition costs (DAC) during the year were: Long-term business £m
The allotted, called up and fully paid share capital of the Company at 31 December 2011 was: 2,905,712,938 (2010: 2,820,148,642) ordinary shares of 25 pence each 726 705
Shares issued under the Group’s employee and executive share option schemes 722,968 — — Shares issued in lieu of dividends 52,814,300 13 (13)
Ordinary shares in issue in the Company rank pari passu with any new ordinary shares issued in the Company. All the ordinary shares in issue carry the same right to receive all dividends and other distributions declared, made or paid by the Company. The issue of shares in lieu of cash dividends is considered a bonus issue under the terms of the Companies Act 2006 and the nominal value of the shares is charged to the share premium account.
Notes to the consolidated financial statements continued 30 – Group’s share plans This note describes the Group’s various equity compensation plans, and shows how the Group values the options and awards of shares in the Company.
(a) Description of the plans The Group maintains a number of active share option and award plans and schemes (the Group’s share plans). These are as follows: (i) Savings-related options These are options granted under the HMRC-approved Save As You Earn (SAYE) share option schemes in the UK and Irish Revenueapproved SAYE share option scheme in Ireland. Options are normally exercisable during the six-month period following either the third, fifth or seventh anniversary of the start of the relevant savings contract.
(iii) Long-term incentive plan awards These awards have been made under the Aviva Long Term Incentive Plan 2005 and Aviva Long Term Incentive Plan 2011, and are described in section (b) below and in the Directors’ Remuneration Report.
(vi) Recruitment and retention share award plan awards These are conditional awards granted under the Aviva Recruitment and Retention Share Award Plan in relation to the recruitment or retention of senior managers excluding executive directors. The awards vest in tranches on various dates and vesting is conditional upon the participant being employed by the Group on the vesting date and not having served notice of resignation. If a participant’s employment is terminated due to resignation or dismissal, any tranche of the award which has vested within the 12 months prior to the termination date will be subject to clawback and any unvested tranches of the award will lapse in full. No new Aviva plc ordinary shares will be issued or transferred from treasury to satisfy vested awards under this plan.
(vii) 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 (OATTV) Award. 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.
Notes to the consolidated financial statements continued 30 – Group’s share plans continued
Conditional Share Award granted to Trevor Matthews Number of shares Vesting period
The vesting of awards under the Aviva Long Term Incentive Plan 2005, the One Aviva, Twice the Value bonus plan and the OATTV Award under the CFO Recruitment Share Awards Plan is subject to the attainment of performance conditions as described in the Directors’ Remuneration Report. Shares which do not vest will lapse.
(iii) Shares to satisfy awards and options Prior to March 2003, it was the practice to satisfy awards and options granted under the Group’s share plans through shares purchased in the market and held by employee share trusts which were established for the purpose of satisfying awards under the Group’s share plans and funded by the Company. From March 2003 to July 2008, it was generally the Company’s practice to satisfy the awards granted after March 2003 by the issue of new shares at the time of vesting. However, since July 2008, it has been the Company’s practice to satisfy all awards and options using shares purchased in the market and held by employee trusts except where local regulations make it necessary to issue new shares. Further details are given in note 31.
Granted during the year 13,486,990 268.00 8,020,085 326.52 Exercised during the year (182,907) 353.26 (73,755) 335.12 Forfeited during the year (1,089,738) 347.58 (1,461,530) 380.82 Cancelled during the year (7,142,132) 320.36 (2,788,423) 362.05 Expired during the year (2,254,869) 539.48 (2,794,830) 516.95
Notes to the consolidated financial statements continued 30 – Group’s share plans continued (e) Fair value of options and awards granted after 7 November 2002 The weighted average fair values of options and awards granted during the year, estimated by using the Black-Scholes option pricing model, were £0.99 and £4.20 (2010: £1.32 and £2.39) respectively.
Share price 435.70p 386.00p Expected volatility* 66% 66% Expected volatility of comparator companies’ share price* 65% 65% Correlation between Aviva and competitors’ share price* 57% 57% Expected life 3.00 years 2.75 years Expected dividend yield** n/a 7.70% Risk-free interest rate* 1.79% 1.80% * For awards with market-based performance conditions. ** The Long-Term Incentive Plan awards granted in 2011 include additional shares being provided to employees equal to dividend rights before vesting. As a result, no dividend yield assumption is required for these awards.
The shares are owned by an employee share trust with an undertaking to satisfy awards of shares in the Company under the Company’s share plans and schemes. Details of the features of the plans can be found in the Directors’ Remuneration Report and in note 30(a). These shares were purchased in the market and are carried at cost. At 31 December 2011, they had an aggregate nominal value of £3,321,119 (2010: £2,103,871) and a market value of £39,959,704 (2010: £33,072,864). The trustees have waived their rights to dividends on the shares held in the trusts.
Notes to the consolidated financial statements continued 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 2011 was: £m £m
Under its articles of association, the Company may issue and allot Sterling New Preference Shares and Euro New Preference Shares, which, if issued and allotted, would rank, as to payment of a dividend and capital, ahead of the Company’s ordinary share capital but behind the cumulative irredeemable preference shares currently in issue. The issued preference shares are non-voting except where their dividends are in arrears, on a winding up or where their rights are altered. On a winding up, they carry a preferential right of return of capital ahead of the ordinary shares. The Company does not have a contractual obligation to deliver cash or other financial assets to the preference shareholders and therefore the directors may make dividend payments at their discretion.
33 – Direct capital instruments This note gives details of the direct capital instruments issued in November 2004.
Securities or Qualifying Upper Tier 2 Securities; or  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.
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 (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) Transfer to non-controlling interests following Delta Lloyd IPO (3) — (1) — — (4) Foreign exchange rate movements (41) — — 78 — 37 Aggregate tax effect – shareholders’ tax 5 4 (166) — — (157)
Arising in the year: Fair value gains — 2 424 — — 426 Fair value gains transferred to profit on disposals — — (189) — — (189) Transfer to profit on disposal of subsidiary (note 3b) (3) — — — — (3) Fair value gains transferred to retained earnings on disposals (note 36) — (6) — — — (6) Share of fair value changes in joint ventures and associates taken to other comprehensive income (notes 18a & 19a) — 1 (86) — — (85) Impairment losses on assets previously revalued directly through other comprehensive income now taken to income statement — — 21 — — 21 Reserves credit for equity compensation plans — — — — 48 48 Shares issued under equity compensation plans (note 36) — — — — (61) (61) Transfer to profit on deconsolidation of Delta Lloyd (485) — (115) — — (600) Transfer to retained earnings on deconsolidation of Delta Lloyd — (2) — — — (2) Foreign exchange rate movements (174) — — 30 — (144) Aggregate tax effect – shareholders’ tax 9 1 (98) — — (88)
Balance at 1 January 5,411 3,425 Profit for the year attributable to equity shareholders 225 1,463 Actuarial gains on pension schemes (note 47e(iv)) 1,002 1,033 Actuarial gains on pension schemes transferred to unallocated divisible surplus (note 44) (22) (18) Dividends and appropriations (note 15) (813) (757) Shares issued in lieu of dividends 307 209 Shares issued under equity compensation plans (note 35) 61 51 Shares distributed by employee trusts (note 31) (18) (50) Fair value gains realised from reserves (note 35) 6 — Effect of deconsolidation of Delta Lloyd 2 — Transfer to minority interests following Delta Lloyd IPO — (4) Share of other comprehensive income of joint ventures and associates (51) — Aggregate tax effect (156) 59
Equity shares in subsidiaries 480 2,055 Share of earnings 501 1,057 Share of other reserves 299 377
Preference shares in General Accident plc 250 250 Preference shares in other subsidiaries — 2
Balance at 1 January 3,741 3,540 Profit for the year attributable to non-controlling interests (165) 429 Minority share of movements in other reserves (16) 57 Foreign exchange rate movements 14 (113) Total comprehensive income attributable to non-controlling interests (167) 373 Capital contributions from non-controlling interests 68 42 Increase in non-controlling interests following Delta Lloyd IPO — 8 Minority share of dividends declared in the year (126) (187) Non-controlling interest in acquired subsidiaries — 3 Changes in non-controlling interest in existing subsidiaries (11) (38) Reclassification to financial liabilities (see below) (205) — Effect of deconsolidation of Delta Lloyd (1,770) —
As explained in note 3(d), the minority shareholder in an Irish subsidiary has an option requiring the Group to purchase its shares. As a result of this obligation, we have reclassified this non-controlling interest to financial liabilities in the consolidated statement of financial position. This option was exercised on 17 January 2012, with completion expected later in 2012.
Provision arising from liability adequacy tests (13) — (13) (2) — (2) Other technical provisions — — — (1) — (1)
39 – Insurance liabilities This note analyses our insurance contract liabilities by type of product and describes how we calculate these liabilities and the assumptions we used.
Notes to the consolidated financial statements continued 39 – Insurance liabilities continued (b) Long-term business liabilities (i) Business description The Group underwrites long-term business in a number of countries as follows:  In the UK mainly in: – New With-Profits sub-fund (NWPSF) of Aviva Life & Pensions UK (UKLAP), where the with-profit policyholders are entitled to at least 90% of the distributed profits, the shareholders receiving the balance. Any surplus or deficit emerging in NWPSF that is not distributed as bonus will be transferred from this sub-fund to the Reattributed Inherited Estate External Support Account (RIEESA) (see below).
 In the US, there are two main types of business – protection products and accumulation products. Protection products include interest-sensitive whole life, term life, universal life and indexed life insurance policies. The accumulation product segment includes traditional fixed and indexed deferred annuities for individuals and funding agreements for business customers. In addition, there are two closed blocks of participating contracts arising from demutualisations of subsidiary companies. All products are classified as insurance contracts except for the funding agreements and term certain immediate annuities, which are classified as non-participating investment contracts.
(ii) Group practice The long-term business provision is calculated separately for each of the Group’s life operations. The provisions for overseas subsidiaries have generally been included on the basis of local regulatory requirements, modified where necessary to reflect the requirements of the Companies Act 2006. Material judgement is required in calculating the provisions and is exercised particularly through the choice of assumptions where discretion is permitted. In turn, the assumptions used depend on the circumstances prevailing in each of the life operations. Provisions are most sensitive to assumptions regarding discount rates and mortality/morbidity rates. Where discount rate assumptions are based on current market yields on fixed interest securities, allowance is made for default risk implicit in the yields on the underlying assets. In Ireland, the allowance for Irish government bonds was made in proportion to the spread over the yields for equivalent AAA-rated government bonds. In 2010, a test case was taken to the European Court of Justice to rule on the current law and practice whereby insurers may take into account a person’s gender in the assessment of risk and consequently the pricing of insurance products. The ruling was issued on 1 March 2011 and requires gender equality for pricing from 21 December 2012. At 31 December 2011, the impact of the ruling on existing long-term business provisions in our UK and European businesses was not considered to be material (2010: not applicable). 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.
Notes to the consolidated financial statements continued 39 – Insurance liabilities continued (a) UK With-profit business The valuation of with-profit business uses the methodology developed for the Realistic Balance Sheet, adjusted to remove the shareholders’ share of future bonuses. The key elements of the Realistic Balance Sheet methodology are the with-profit benefit reserve (WPBR) and the present value of the expected cost of any payments in excess of the WPBR (referred to as the cost of future policyrelated liabilities). The realistic liability for any contract is equal to the sum of the WPBR and the cost of future policy-related liabilities. The WPBR for an individual contract is generally calculated on a retrospective basis, and represents the accumulation of the premiums paid on the contract, allowing for investment return, taxation, expenses and any other charges levied on the contract. For a small proportion of business, a prospective valuation approach is used, including allowance for anticipated future regular and final bonuses. The items included in the cost of future policy-related liabilities include:  Maturity Guarantees;  Guaranteed Annuity Options;  GMP underpin on Section 32 transfers; and  expected payments under Mortgage Endowment Promise.
In the Provident Mutual and With-Profits sub-funds in UKLAP, this is offset by the expected cost of charges to WPBR to be made in respect of guarantees. The cost of future policy-related liabilities is determined using a market-consistent approach and, in the main, this is based on a stochastic model calibrated to market conditions at the end of the reporting period. Non-market-related assumptions (for example, persistency, mortality and expenses) are based on experience, adjusted to take into account future trends. The principal assumptions underlying the cost of future policy-related liabilities are as follows: Future investment return A ‘risk-free’ rate equal to the spot yield on UK government securities, plus a margin of 0.1% is used. The rates vary according to the outstanding term of the policy, with a typical rate as at 31 December 2011 of 2.20% (2010: 3.78%) for a policy with ten years outstanding.
Volatility of investment return Volatility assumptions are set with reference to implied volatility data on traded market instruments, where available, or on a best estimate basis where not.
The equity volatility used depends on term, money-ness and region. The figure shown is for a sample UK equity, at the money, with a ten-year term. Fixed interest yield volatility is also dependent on term and money-ness. The figure shown is for a ten-year swap option, currently at the money.
Mortality Mortality assumptions for with-profit business are set with regard to recent Company experience and general industry trends. The mortality tables used in the valuation are summarised below: Mortality table used
Assurances, pure endowments and deferred annuities before vesting Nil or Axx00 adjusted Nil or Axx00 adjusted
Income Protection Active lives 2.4% 3.5% Claims in payment – level 3.6% 4.5% Claims in payment – index linked (1.0)% (0.7)%
(c) United States For the major part of our US business, insurance liabilities are measured in accordance with US GAAP as at the date of acquisition. The liability for future policy benefits for traditional life insurance is computed using the net level method, based on guaranteed interest and mortality rates as used in calculating cash surrender values. Reserve interest assumptions ranged from 2.00% to 7.50% in 2011 (2010: 2.00% to 7.50%). The weighted average interest rate for all traditional life policy reserves in 2011 was 4.50% (2010: 4.50%). Future policy benefit reserves for universal life insurance, deferred annuity products and funding agreements are computed under a retrospective deposit method and represent policy account balances before applicable surrender charges. For the indexed products, the liability held is calculated based on the option budget method and is equal to the host contract and the calculated value of the derivative. The value of the derivative is based on the present value of the difference between the projected fund value and the underlying fund guarantee. The range of interest crediting rates for deferred annuity products, the largest component of the US business, excluding sales inducement payouts, was 1.00% to 5.20% in 2011 (2010: 1.00% to 5.20%). An additional liability is established for universal life contracts with death or other insurance benefit features, which is determined using an equally weighted range of scenarios with respect to investment returns, policyholder lapses, benefit election rates, premium payout patterns and mortality. The additional liability represents the present value of future expected benefits based on current product assumptions. The indexed life and annuity products guarantee the return of principal to the customer, and credit interest based on certain indices. A portion of the premium from each customer is invested in fixed income securities and is intended to cover the minimum guaranteed value. A further portion of the premium is used to purchase derivatives to hedge the growth in interest credited to the customer as a direct result of increases in the related indices. Both the derivatives and the options embedded in the policy are valued at their fair value. Deferred income reserves are established for fees charged for insurance benefit features which are assessed in a manner that is expected to result in higher profits in earlier years, followed by lower profits or losses in subsequent years. The excess charges are deferred and amortised using the same assumptions and factors used to amortise deferred acquisition costs. 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.
(d) Other countries In all other countries, local generally accepted interest rates and published standard mortality tables are used for different categories of business as appropriate. The tables are based on relevant experience and show mortality rates, by age, for specific groupings of people.
Notes to the consolidated financial statements continued 39 – Insurance liabilities continued (iv) Movements The following movements have occurred in the long-term business provisions during the year: £m £m
Notes to the consolidated financial statements continued 39 – Insurance liabilities continued (ii) Discounting Outstanding claims provisions are based on undiscounted estimates of future claim payments, except for the following classes of business for which discounted provisions are held: Rate Mean term of liabilities
Reinsured London Market business 2.20% 3.30% 13 years 12 years Latent claims 0.75% to 3.25% 0.88% to 4.18% 7 to 16 years 7 to 15 years Structured settlements 2.70% 3.20% 31 years 35 years Netherlands Permanent health and injury n/a* 3.75% n/a* 7 years *Delta Lloyd no longer consolidated following the partial disposal on 6 May 2011.
(iii) Assumptions Outstanding claims provisions are estimated based on known facts at the date of estimation. Case estimates are set by skilled claims technicians and established case-setting procedures. Claim technicians apply their experience and knowledge to the circumstances of individual claims. They take into account all available information and correspondence regarding the circumstances of the claim, such as medical reports, investigations and inspections. Claims technicians set case estimates according to documented claims department policies and specialise in setting estimates for certain lines of business or types of claim. Claims above certain limits are referred to senior claims handlers for authorisation. No adjustments are made to the claims technicians’ case estimates included in booked claim provisions, except for rare occasions when the estimated ultimate cost of individual large or unusual claim may be adjusted, subject to internal reserve committee approval, to allow for uncertainty regarding, for example, the outcome of a court case. The ultimate cost of outstanding claims is then estimated by using a range of standard actuarial claims projection techniques, such as the Chain Ladder and Bornhuetter-Ferguson methods. The main assumption underlying these techniques is that a company’s past claims development experience can be used to project future claims development and hence ultimate claims costs. As such, these methods extrapolate the development of paid and incurred losses, average costs per claim and claim numbers based on the observed development of earlier years and expected loss ratios. Historical claims development is mainly analysed by accident period, although underwriting or notification period is also used where this is considered appropriate. Claim development is separately analysed for each geographic area, as well as by each line of business. Certain lines of business are also further analysed by claim type or type of coverage. In addition, large claims are usually separately addressed, either by being reserved at the face value of loss adjuster estimates or separately projected in order to reflect their future development. The assumptions used in most non-life actuarial projection techniques, including future rates of claims inflation or loss ratio assumptions, are implicit in the historical claims development data on which the projections are based. Additional qualitative judgement is used to assess the extent to which past trends may not apply in the future, for example, to reflect one-off occurrences, changes in external or market factors such as public attitudes to claiming, economic conditions, levels of claims inflation, judicial decisions and legislation, as well as internal factors such as portfolio mix, policy conditions and claims handling procedures in order to arrive at a point estimate for the ultimate cost of claims that represents the likely outcome, from a range of possible outcomes, taking account of all the uncertainties involved. The range of possible outcomes does not, however, result in the quantification of a reserve range. As noted in section in section (b)(ii) above, an area of judgement is the impact of a European Court of Justice ruling in March 2011 on gender equality for the pricing of insurance products. At 31 December 2011, the impact of the ruling on existing general business provisions was not considered to be material (2010: not applicable). The following explicit assumptions are made which could materially impact the level of booked net reserves: UK mesothelioma claims The level of uncertainty associated with latent claims is considerable due to the relatively small number of claims and the long-tail nature of the liabilities. UK mesothelioma claims account for a large proportion of the Group’s latent claims. The key assumptions underlying the estimation of these claims include claim numbers, the base average cost per claim, future inflation in the average cost of claims, legal fees and the life expectancy of potential sufferers. The best estimate of the liabilities reflects the latest available market information and studies. Many different scenarios can be derived by flexing these key assumptions and applying different combinations of the different assumptions. An upper and lower scenario can be derived by making reasonably likely changes to these assumptions, resulting in an estimate £250 million greater than the best estimate, or £115 million lower than the best estimate. These scenarios do not, however, constitute an upper or lower bound on these liabilities.
(iv) Movements The following changes have occurred in the general insurance and health claims provisions during the year: £m £m
Carrying amount at 1 January 12,263 12,696 Impact of changes in assumptions 149 26 Claim losses and expenses incurred in the current year 6,520 6,908 Decrease in estimated claim losses and expenses incurred in prior years (140) (358) Exceptional strengthening of general insurance latent claims provisions 45 10
Incurred claims losses and expenses 6,574 6,586 Less: Payments made on claims incurred in the current year (3,393) (3,641) Payments made on claims incurred in prior years (3,514) (3,803) Recoveries on claim payments 313 271
Claims payments made in the year, net of recoveries (6,594) (7,173) Unwind of discounting 47 64 Other movements in the claims provisions (12) (18)
The effect of changes in the main assumptions is given in note 43 and the economic assumption changes are explained in note 9.
Key elements of the release from prior accident year general insurance and health net provisions during 2010 were:  £101 million from the UK, including Group reinsurance business, mainly due to an improved view of Group reinsurance liabilities, and favourable development on personal property claims, and commercial property and commercial liability large claims.
 £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.
(ii) Gross figures Before the effect of reinsurance, the loss development table is: Accident year All prior years £m £m 2003 £m £m £m £m £m £m 2011 £m Total £m
Gross cumulative claim payments At end of accident year (2,952) (2,819) (2,971) (3,345) (3,653) (4,393) (4,915) (3,780) (3,502) (3,420) One year later (4,486) (4,190) (4,561) (5,011) (5,525) (6,676) (7,350) (5,464) (5,466) Two years later (4,921) (4,613) (4,981) (5,449) (5,971) (7,191) (7,828) (6,102) Three years later (5,233) (4,972) (5,263) (5,784) (6,272) (7,513) (8,304) Four years later (5,466) (5,258) (5,448) (6,001) (6,531) (7,836) Five years later (5,618) (5,409) (5,617) (6,156) (6,736) Six years later (5,715) (5,527) (5,725) (6,311) Seven years later (5,767) (5,594) (5,792) Eight years later (5,814) (5,660) Nine years later (5,871) Estimate of gross ultimate claims At end of accident year 6,250 6,385 6,891 7,106 7,533 8,530 9,508 7,364 6,911 6,428 One year later 6,372 6,172 6,557 6,938 7,318 8,468 9,322 7,297 7,006 Two years later 6,287 6,124 6,371 6,813 7,243 8,430 9,277 7,281 Three years later 6,257 6,036 6,178 6,679 7,130 8,438 9,272 Four years later 6,205 5,932 6,008 6,603 7,149 8,409 Five years later 6,122 5,853 6,003 6,605 7,167 Six years later 6,056 5,813 5,953 6,591 Seven years later 6,044 5,792 5,933 Eight years later 6,035 5,798 Nine years later 6,016 Estimate of gross ultimate claims 6,016 5,798 5,933 6,591 7,167 8,409 9,272 7,281 7,006 6,428
Change in UPR recognised as income 265 45 Gross portfolio transfers and acquisitions (161) (14) Deconsolidation of Delta Lloyd (424) — Foreign exchange rate movements (52) 43
Present value recognised in the statement of financial position 1,246 108 115 160 258 437 606 904 1,153 1,487 2,902 9,376
Long-term business Participating contracts 64,985 69,482 Non-participating contracts at fair value 43,990 46,124 Non-participating contracts at amortised cost 1,669 2,181
(b) Long-term business investment liabilities Investment contracts are those that do not transfer significant insurance risk from the contract holder to the issuer, and are therefore treated as financial instruments under IFRS. Many investment contracts contain a discretionary participation feature in which the contract holder has a contractual right to receive additional benefits as a supplement to guaranteed benefits. These are referred to as participating contracts and are measured according to the methodology and Group practice for long-term business liabilities as described in note 39. They are not measured at fair value as there is currently no agreed definition of fair valuation for discretionary participation features under IFRS. In the absence of such a definition, it is not possible to provide a range of estimates within which a fair value is likely to fall. The IASB has deferred consideration of participating contracts to Phase II of its insurance contracts project. For participating business, the discretionary participation feature is recognised separately from the guaranteed element and is classified as a liability, referred to as unallocated distributable surplus. Guarantees on long-term investment products are discussed in note 41. Investment contracts that do not contain a discretionary participation feature are referred to as non-participating contracts and the liability is measured at either fair value or amortised cost. Of the non-participating investment contracts measured at fair value, £42,434 million in 2011 are unit linked in structure and the fair value liability is equal to the unit reserve plus additional non-unit reserves if required on a fair value basis. These contracts are classified as ‘Level 1’ in the fair value hierarchy, as the unit reserve is calculated as the publicly quoted unit price multiplied by the number units in issue, and any non-unit reserve is insignificant. For unit-linked business, a deferred acquisition cost asset and deferred income reserve liability are recognised in respect of transaction costs and front-end fees respectively, that relate to the provision of investment management services, and which are amortised on a systematic basis over the contract term. The amount of the related deferred acquisition cost asset is shown in note 27 and the deferred income liability is shown in note 50. In the US, funding agreements consist of one- to ten-year fixed rate contracts. These contracts may not be cancelled by the holders unless there is a default under the agreement, but may, subject to a call premium, be terminated by Aviva at any time. Aviva issued no new funding agreements in 2011. The weighted average interest rates for fixed-rate and floating-rate funding agreements as at 31 December 2011 were 4.766% and 0.503% respectively. Funding agreements issued before 2008 are measured at fair value equal to the present value of contractual cash flows and, for business issued since 2008, are measured at amortised cost. Most funding agreements are fully collateralised and therefore their fair values are not adjusted for own credit risk. Funding agreements carried at fair value total £0.92 billion and are classified as ‘Level 2’ in the fair value hierarchy. There is a small volume of annuity certain business for which the liability is measured at amortised cost using the effective interest method. The fair value of contract liabilities measured at amortised cost is not materially different from the amortised cost liability.
Notes to the consolidated financial statements continued 40 – Liability for investment contracts continued (c) Movements in the year The following movements have occurred in the year: (i) Participating investment contracts £m £m
Notes to the consolidated financial statements continued 41 – Financial guarantees and options This note details the financial guarantees and options we have given for some of our insurance and investment products. As a normal part of their operating activities, various Group companies have given guarantees and options, including investment return guarantees, in respect of certain long-term insurance and fund management products. Further information on assumptions is given in notes 39 and 40.
(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 £977 million at 31 December 2011 (2010: £823 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 £193 million at 31 December 2011 (2010: £131 million).
Guaranteed death and maturity benefits In France, the Group has also sold unit-linked policies where the death and/or maturity benefit is guaranteed to be at least equal to the premiums paid. The reserve held in the Group’s consolidated statement of financial position at the end of 2011 for this guarantee is £130 million (2010: £85 million). The reserve is calculated on a prudent basis and is in excess of the economic liability. At the end of 2011, total sums at risk for these contracts were £631 million (2010: £242 million) out of total unit-linked funds of £12 billion (2010: £14 billion). The average age of policyholders was approximately 54. It is estimated that this liability would increase by £96 million (2010: £93 million) if yields were to decrease by 1% per annum and by £26 million (2010: £22 million) if equity markets were to decline by 10% from year end 2011 levels. These figures do not reflect our ability to review the tariff for this option.
‘No MVR’ guarantees Certain unitised with-profit policies containing ‘no MVR’ guarantees, similar to those in the UK, have been sold in Ireland. These guarantees are currently ‘in-the-money’ by £6 million (2010: £13 million). This has been calculated on a deterministic basis as the excess of the current policy surrender value over the discounted value (excluding terminal bonus) of the guarantees. The value of these guarantees is usually sensitive to the performance of investments held in the with-profit fund. Amounts payable under these guarantees are determined by the bonuses declared on these policies. There is no sensitivity to either interest rates or equity markets since there is no longer any exposure to equity in these funds and a matching strategy has been implemented for bonds.
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 expired before the end of the previous financial reporting period. The provision for the second tranche over and above unit and sterling reserves, at the end of 2011 is £7 million (2010: £9 million). It is estimated that the provision would increase by £2 million (2010: £3 million) if equity markets were to decline by 10% from the year end 2011 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 £0.8 million (2010: £0.5 million) if property values were to decline by 10% from year end 2011 levels. This would be offset by an increase in the value of the hedging assets by £0.8 million (2010: £0.5 million).
Notes to the consolidated financial statements continued 41 – Financial guarantees and options continued (iii) Spain and Italy Guaranteed investment returns and guaranteed surrender values The Group has also written contracts containing guaranteed investment returns and guaranteed surrender values in both Spain and Italy. Traditional profit-sharing products receive an appropriate share of the investment return, assessed on a book value basis, subject to a guaranteed minimum annual return of up to 6% in Spain and 4% in Italy on existing business, while on new business the maximum guaranteed rate is lower. Liabilities are generally taken as the face value of the contract plus, if required, an explicit provision for guarantees calculated in accordance with local regulations. At 31 December 2011, total liabilities for the Spanish business were £3 billion (2010: £4 billion) with a further reserve of £5 million (2010: £12 million) for guarantees. Total liabilities for the Italian business were £11 billion (2010: £11 billion), with a further provision of £43 million (2010: £46 million) for guarantees. Liabilities are most sensitive to changes in the level of interest rates. It is estimated that provisions for guarantees would need to increase by £18 million (2010: £43 million) in Spain and £5 million (2010: £7 million) in Italy if interest rates fell by 1% from end 2011 values. Under this sensitivity test, the guarantee provision in Spain is calculated conservatively, assuming a long-term market interest rate of 1.6% and no lapses or premium discontinuances.
(iv) 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 2.48% (2010: 1.47%) for indexed life and 2.51% (2010: 1.48%) 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 2011 is an increase of £453 million (2010: £216 million), and is principally attributable to market factors rather than instrument specific credit risk. At 31 December 2011, the total liabilities for indexed products were £22 billion (2010: £20 billion), including liabilities for the embedded option of £2.6 billion (2010: £2.5 billion). If interest rates were to increase by 1%, the provision for embedded options would decrease by £152 million (2010: £151 million) and, if interest rates were to decrease by 1%, the provision would increase by £167 million (2010: £167 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 2011, the liabilities for total return strategy products were £0.9 billion (2010: £1.0 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 2011, a total of £10.1 billion (2010: £8.9 billion) in indexed deferred annuities have elected this benefit, taking steps to guarantee retirement income.
Long-term business Insurance contracts 3,747 3,650 Participating investment contracts — 2 Non-participating investment contracts 1,626 1,463 Outstanding claims provisions 125 104
Of the above total, £5,086 million (2010: £4,675 million) is expected to be recovered more than one year after the statement of financial position date.
Carrying amount at 1 January 1,558 1,643 Impact of changes in assumptions 87 17 Reinsurers’ share of claim losses and expenses Incurred in current year 247 265 Incurred in prior years (84) (46) Exceptional strengthening of general insurance latent claims provisions 10 — Reinsurers’ share of incurred claim losses and expenses 173 219 Less: Reinsurance recoveries received on claims Incurred in current year (138) (125) Incurred in prior years (196) (282) Reinsurance recoveries received in the year (334) (407) Unwind of discounting 19 23 Other movements (1) —
Carrying amount at 1 January 3,428 3,866 Change in participating contract assets (3,016) (444) Change in participating contract liabilities 244 169 Effect of special bonus to with-profit policyholders — (58) Other movements 70 4 Change in liability recognised as an expense (2,702) (329) Effect of portfolio transfers, acquisitions and disposals — (3) Deconsolidation of Delta Lloyd (144) — Foreign exchange rate movements 60 (61) Other movements 8 (45)
In Italy, the UDS balance was £1,449 million negative at 31 December 2011 (2010: £420 million negative). In France and Spain, certain participating funds had negative UDS balances at 31 December 2011, although in aggregate the UDS balances for each of these business units was positive (2010: Spain £15 million negative). Negative UDS balances result from an accounting mismatch between participating assets carried at market value and participating liabilities measured using local practice. The negative balances were tested for recoverability using embedded value methodology and in line with local accounting practice. The negative balances are considered to be recoverable from margins in the existing participating business liabilities. Losses of £17 million in Italy and £49 million in Spain were incurred for negative UDS considered irrecoverable (2010: Italy £111 million, Spain £22 million). In Italy the method for estimation of the recoverable negative UDS balance was changed in 2011, which is an alternative acceptable method under local accounting practice. The estimation basis uses a real-world embedded value method. In 2010 the recoverability test used a market-consistent embedded value method, with the reference rates based on the swap yield curve for a AA-rated bank with no liquidity premium. Using a market-consistent embedded value method in 2011 with reference rates based on swaps with no liquidity premium would reduce the negative UDS balance to £61 million. The IFRS profit before tax would reduce by £1,445 million and total comprehensive income would reduce by £425 million net of tax and non-controlling interests. It is impracticable to determine the effect of the change in estimate for future periods. Alternatively, using reference rates with allowance for a government spread premium based on the ‘ECB AAA and Other’ curve would reduce the negative UDS balance to £715 million. The IFRS profit before tax would reduce by £765 million and total comprehensive income would reduce by £225 million net of tax and non-controlling interests. In Spain no change was made to the estimation basis that uses a market-consistent embedded value method.
Long-term business technical provisions and other insurance items 455 1,051 Deferred acquisition costs (598) (678) Unrealised gains on investments (347) (1,465) Pensions and other post-retirement obligations (245) 91 Unused losses and tax credits 462 713 Subsidiaries, associates and joint ventures (10) (9) Intangibles and additional value of in-force long-term business (445) (656) Provisions and other temporary differences (205) (517)
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 £910 million (2010: £2,150 million) to carry forward against future taxable income of the necessary category in the companies concerned. Of these, trading losses of £370 million will expire within the next 20 years. The remaining losses have no expiry date. In addition, the Group has unrecognised capital losses of £418 million (2010: £384 million). These have no expiry date. There are no temporary differences in respect of unremitted overseas retained earnings for which deferred tax liabilities have not been recognised at 31 December 2011 (2010: £nil). Due to the availability of new information in the year, certain comparative amounts have been amended from amounts previously reported.
(i) Defined benefit section of the ASPS The Company works closely with the trustees who are required to consult it on the funding of the scheme and its investment strategy. Following each actuarial valuation, the Company and the trustees agree the level of contributions needed and funding levels are then monitored on an annual basis. At 31 March 2009, the date of the last actuarial valuation, this section of the scheme had an excess of obligations over available assets, on a funding basis, which uses more prudent assumptions than are required for reporting under IAS 19, of £3.0 billion. As a result of that valuation, the Company and the trustees have agreed a long-term funding plan where contributions, together with anticipated growth in scheme investments, are expected to eliminate the funding deficit over time. Under this agreement, deficit funding payments of £378 million were made in 2010, and £178 million in 2011. Further funding payments of £150 million are expected in 2012. The funding payments, the reduction in scheme liabilities arising from scheme closures described above and the benefits arising from interest rate and inflation hedging activity have been partially offset by the impact of adverse market conditions, in particular significant falls in real gilt yields. At 31 December 2011, the funding deficit is estimated to have fallen to £2.3 billion. The employing companies’ contributions to the defined benefit section of the ASPS for the first three months of 2011 were 48% of employees’ pensionable salaries, together with the cost of redundancies during the year and the additional deficit funding described above, together totalling £239 million. Active members of this section of the ASPS contributed between 5% and 7.5% of their pensionable salaries during the same period in 2011.
(d) Credit/charges to the income statement The total pension costs/(credit) of all the Group’s defined benefit and defined contribution schemes were: £m £m
Total defined benefit schemes (note 10b) 58 (219) UK defined contribution schemes 75 53 Overseas defined contribution schemes 20 17
(e) IAS 19 disclosures Disclosures under IAS 19 for the material defined benefit schemes in the UK, Ireland and Canada, and the Netherlands prior to the deconsolidation of Delta Lloyd, 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 2012, including the ASPS deficit funding, are expected to be £250 million.
(i) Assumptions on scheme liabilities The projected unit credit method The inherent uncertainties affecting the measurement of scheme liabilities require these to be measured on an actuarial basis. This involves discounting the best estimate of future cash flows to be paid out by the scheme using the projected unit credit method. This is an accrued benefits valuation method which calculates the past service liability to members and makes allowance for their projected future earnings. It is based on a number of actuarial assumptions, which vary according to the economic conditions of the countries in which the relevant businesses are situated, and changes in these assumptions can materially affect the measurement of the pension obligations.
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 £8.4 billion could be valued some £5.4 billion higher, at £13.8 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.
Notes to the consolidated financial statements continued 47 – Pension obligations continued 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 2011. Scheme assets are stated at their fair values at 31 December 2011. The main actuarial assumptions used to calculate scheme liabilities under IAS 19 are: UK Ireland
Basis of discount rate AA-rated corporate bonds AA-rated corporate bonds * Age-related scale increases plus 2.9%. ** 2.1% until 2011 and expected return less 3% thereafter.
The discount rate and pension increase rate are the two assumptions that have the largest impact on the value of the liabilities, with the difference between them being known as the net discount rate. For each country, the discount rate is based on current average yields of high-quality debt instruments taking account of the maturities of the defined benefit obligations. A 1% increase in this rate (and therefore the net discount rate) would reduce the liabilities by £1.7 billion and the service cost for the year by £9 million. It would also reduce the interest cost on those liabilities by £1 million.
UK – ASPS Club Vita pooled experience, including an allowance for future improvements 60 89.9 93.2 89.9 92.1
– RAC SAPS series 1, including allowances for future improvement 65 87.7 90.7 89.8 91.8
The assumptions above are based on commonly used mortality tables and, in the UK, have been changed to those used by both schemes’ trustees in the most recent full actuarial valuations. The new tables make allowance for observed variations in such factors as age, gender, pension amount, salary and postcode-based lifestyle group, and have been adjusted to reflect recent research into mortality experience. However, the extent of future improvements in longevity is subject to considerable uncertainty and judgement is required in setting this assumption. In the UK schemes, which are the most material to the Group, the assumptions include an allowance for future mortality improvement, based on the actuarial profession’s long and medium cohort projection tables (for the ASPS and RAC schemes respectively) and incorporating underpins to the rate of future improvement equal to 1.5% per annum for males and 1.0% per annum for females. The effect of assuming all members were one year younger would increase the liabilities in all the schemes by £265 million and the service cost for the year by £1 million. The discounted scheme liabilities have an average duration of 20 years in the main UK scheme, 22 years in the RAC scheme, 19 years in the Irish scheme and 13 years in the Canadian scheme. The undiscounted benefits payable from the main UK defined benefit scheme are expected to be as shown in the chart below:
Notes to the consolidated financial statements continued 47 – Pension obligations continued
The overall rates of return are based on the expected returns within each asset category and on current asset allocations. The expected returns for equities and properties are aligned with the rates used for the longer-term investment return assumptions, other than in the Netherlands, where the 2011 figures were developed in conjunction with external advisers due to the characteristics of the scheme. The figures for the total expected return on scheme assets in the following section are stated after deducting investment expenses and, in Ireland, the government levy on pension fund assets.
(iii) Investments in Group-managed funds and insurance policies Plan assets include investments in Group-managed funds in the consolidated statement of financial position of £112 million (2010: £116 million) and insurance policies with other Group companies of £163 million (2010: £160 million) in the main UK scheme. Prior to the deconsolidation of Delta Lloyd, the assets of the Dutch scheme mainly consisted of insurance policies with that company, totalling £1,445 million at 31 December 2010. The Dutch insurance policies were considered non-transferable under the terms of IAS 19 and so, in the 2010 comparatives, were treated as other obligations to staff pension schemes within provisions (see note 46). The treatment in the relevant parts of the financial statements is as follows:  Plan assets – the treatment of these funds and policies in the consolidated statement of financial position is described above.  Expected rates of return – where the relevant insurance policies are in segregated funds with specific asset allocations, their expected rates of return are included in the appropriate line in the table in section (ii) above.  Pension expense – to avoid double-counting of investment income on scheme assets and the assets backing the underlying policies, adjustments have been made to the former in the discontinued operations part of the tables in section (iv) below.
Notes to the consolidated financial statements continued 47 – Pension obligations continued (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 £m
Total pension (cost)/credit from continuing operations (51) 211 Total pension cost from discontinued operations (7) (34)
Expected return on scheme assets 452 457 Interest charge on scheme liabilities (539) (584)
The gains on curtailments in 2010 principally arose from closure of the UK schemes to future accrual, described in section (c) above.
Actuarial gains on scheme assets 1,363 544 Experience (losses)/gains arising on scheme liabilities (46) 382 Changes in assumptions underlying the present value of the scheme liabilities (321) 152
Notes to the consolidated financial statements continued 47 – Pension obligations continued The loss arising from changes in assumptions in 2011 primarily reflects the impact of lower discount rates for liabilities across all but the Irish schemes. The cumulative amount of actuarial gains and losses on the pension schemes recognised in other comprehensive income since 1 January 2004 (the date of transition to IFRS) is a loss of £224 million at 31 December 2011 (2010: cumulative loss of £1,231 million).
Notes to the consolidated financial statements continued 47 – Pension obligations continued (vii) Recognition in the statement of financial position The assets and liabilities of the schemes, attributable to defined benefit members, including investments in Group insurance policies (see footnote below), at 31 December 2011 were: UK Ireland Canada Total £m £m £m £m
Total fair value of assets 11,190 382 219 11,791 Present value of scheme liabilities (9,606) (539) (382) (10,527)
Current and past service cost (see (iv) above) — (58) (58) — (58) Credit/(charge) to finance costs (see (iv) above) 465 (565) (100) (13) (113) Actuarial gains/(losses) (see (iv) above) 1,347 (356) 991 16 1,007
Net surplus in the schemes at 31 December 11,791 (10,527) 1,264 — 1,264
Deficits in the schemes at 1 January 10,105 (11,812) (1,707) (1,351) (3,058)
Current and past service cost (see (iv) above) — (170) (170) — (170) Gains/(losses) on curtailments (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
Exchange rate movements on foreign plans (43) 39 (4) 48 44
Core structural borrowings, at amortised cost 5,255 6,066 Operational borrowings, at amortised cost 1,889 4,193 Operational borrowings, at fair value 1,306 4,690
(b) Core structural borrowings (i) The carrying amounts of these borrowings are: Upper Tier 2 £m
Subordinated debt 6.125% £700 million subordinated notes 2036 — 690 — 690 — 690 — 690
The classifications between Upper Tier 2, Lower Tier 2 and Senior debt shown above are as defined by the FSA in GENPRU Annex 1 ‘Capital Resources’. Subordinated debt is stated net of notes held by Group companies of £32 million (2010: £34 million). All the above borrowings are stated at amortised cost. As described in note 57(a), the Group has designated a portion of its euro and US dollar denominated debt as a hedge of the net investment in its European and American subsidiaries. The carrying value of the debt, included in the table above, at 31 December 2011 was £1,815 million (2010: £2,791 million).
(d) Other non-recourse loans include external debt raised by special purpose vehicles in the UK long-term business. The lenders have no recourse whatsoever to the shareholders’ funds of any companies in the Group.
Notes to the consolidated financial statements continued 48 – Borrowings continued (v) Securitised mortgage loan notes Loan notes have been issued by special purpose securitisation companies in the UK and, prior to the deconsolidation of Delta Lloyd, the Netherlands. Details of these securitisations are given in note 24.
(e) Movements during the year Movements in borrowings during the year were: Core structural £m Operational £m Total £m
Net cash inflow/(outflow) 5 (241) (236) Foreign exchange rate movements 9 193 202 Borrowings acquired/(loans repaid) for non-cash consideration — 34 34 Fair value movements — 8 8 Amortisation of discounts and other non-cash items 3 — 3 Deconsolidation of Delta Lloyd (816) (5,683) (6,499) Movements in debt held by Group companies* (12) 1 (11)
New borrowings drawn down, including commercial paper, net of expenses 2,921 726 3,647 Repayment of borrowings, including commercial paper (2,274) (613) (2,887)
* Certain subsidiary companies have purchased issued subordinates notes and securitised loan notes as part of their investment portfolios. In the consolidated statement of financial position, borrowings are shown net of these holdings but movements in such holdings over the year are reflected in the tables above.
Expected to be settled within one year 10,253 19,155 Expected to be settled in more than one year 977 1,137
Bank overdrafts arise substantially from un-presented cheques and amount to £211 million (2010: £319 million) in long-term business operations and £457 million (2010: £441 million) in general business and other operations. All payables and other financial liabilities are carried at cost, which approximates to fair value, except for derivative liabilities, which are carried at their fair values.
Expected to be settled within one year 2,195 3,734 Expected to be settled in more than one year 633 445
(b) Asbestos, pollution and social environmental hazards In the course of conducting insurance business, various companies within the Group receive general insurance liability claims, and become involved in actual or threatened related litigation arising there from, including claims in respect of pollution and other environmental hazards. Among these are claims in respect of asbestos production and handling in various jurisdictions, including Europe, Canada and Australia. Given the significant delays that are experienced in the notification of these claims, the potential number of incidents which they cover and the uncertainties associated with establishing liability and the availability of reinsurance, the ultimate cost cannot be determined with certainty. However, on the basis of current information having regard to the level of provisions made for general insurance claims, the directors consider that any additional costs arising are not likely to have a material impact on the financial position of the Group.
(c) Guarantees on long-term savings products As a normal part of their operating activities, various Group companies have given guarantees and options, including interest rate guarantees, in respect of certain long-term insurance and fund management products. Note 41 gives details of these guarantees and options. In providing these guarantees and options, the Group’s capital position is sensitive to fluctuations in financial variables including foreign currency exchange rates, interest rates, property values and equity prices. Interest rate guaranteed returns, such as those available on GAOs, are sensitive to interest rates falling below the guaranteed level. Other guarantees, such as maturity value guarantees and guarantees in relation to minimum rates of return, are sensitive to fluctuations in the investment return below the level assumed when the guarantee was made. The directors continue to believe that the existing provisions for such guarantees and options are sufficient.
(d) Regulatory compliance The Group’s insurance and investment business is subject to local regulation in each of the countries in which it operates. The FSA regulates the Group’s UK business and 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.
Notes to the consolidated financial statements continued 51 – Contingent liabilities and other risk factors continued (f) 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 £686 million as at 31 December 2011 (2010: £683 million) based on estimated replacement cost for the underlying annuities. 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.
Contractual obligations for future repairs and maintenance on investment properties are £nil (2010: £1 million). The Group has capital commitments to its joint ventures of £258 million (2010: £45 million) and to other investment vehicles of £nil (2010: £nil).
(ii) Future contractual aggregate minimum lease payments under non-cancellable operating leases are as follows: £m £m
Later than 1 year and not later than 5 years 400 423 Later than 5 years 667 737
Profit before tax from continuing operations 635 1,939 Adjustments for: Share of loss/(profits) of joint ventures and associates 123 (141) Dividends received from associates 71 16 (Profit)/loss on sale of: Investment property (10) (41) Property and equipment (4) 5 Subsidiaries, joint ventures and associates (565) (163)
Depreciation of property and equipment 57 64 Equity compensation plans, equity settled expense 48 50 Impairment and expensing of: Goodwill on subsidiaries 160 3 Financial investments, loans and other assets 118 83 Acquired value of in-force business and intangibles 56 16 Non-financial assets 1 (1)
Amortisation of: Premium or discount on debt securities 82 84 Premium or discount on borrowings 3 2 Premium or discount on non participating investment contracts 45 17 Financial instruments 3 73 Acquired value of in-force business and intangibles 390 324
Net purchases of operating assets Purchases of investment property (1,211) (1,070) Proceeds on sale of investment property 719 798 Net purchases of financial investments (4,850) (7,187)
Operating cash flows reflect the movement in both policyholder and shareholder controlled cash and cash equivalent balances. Around two thirds of the Group’s balances relate to unit-linked or participating policyholder funds. As such, the asset mix and the level of cash held by these funds are determined from a policyholder perspective and can move significantly from one year to another. Shareholder cash has remained broadly unchanged at £8.6 billion (2010: £8.5 billion). Purchases and sales of operating assets, including financial investments, are included within operating cash flows as the purchases are funded from cash flows associated with the origination of insurance and investment contracts, net of payments of related benefits and claims. During the year, the net operating cash inflow reflects a number of factors, including changes in the investment strategy of funds to hold a lower weighting of cash and higher levels of financial investments, the level of premium income and the timing of receipts of premiums and the payment of creditors, claims and surrenders. It also includes changes in the size and value of consolidated cash investment funds and changes in the Group participation in these funds.
Notes to the consolidated financial statements continued 53 – Statement of cash flows continued (b) Cash flows in respect of, and additions to, the acquisition of subsidiaries, joint ventures and associates comprised: £m £m
Cash flows on acquisitions and additions – continuing operations 114 (542) Cash flows on acquisitions and additions – discontinued operations — 65
(c) Cash flows in respect of the disposal of subsidiaries, joint ventures and associates comprised: £m £m
Cash flows on disposals – continuing operations 877 222 Cash flows on disposals – discontinued operations (502) 29
Cash at bank and in hand 8,854 9,740 Cash equivalents 14,215 15,715
Total capital employed 20,750 26,271 * ‘Corporate’ includes centrally held tangible net assets, the staff pension scheme surplus and also reflects internal lending arrangements. These internal lending arrangements, which net out on consolidation, arise in relation to the following: – Aviva Insurance Limited (AI) acts as both a UK general insurer and as the primary holding company for our foreign subsidiaries. Internal capital management mechanisms in place allocate a portion of the total capital of the company to the UK
Adjustments onto a regulatory basis: Shareholders’ share of accrued bonus (22) (99) (189) (310) — (310) (41) (351) — (351) (673)
Notes to the consolidated financial statements continued 55 – Capital statement continued Analysis of movements in capital of long-term businesses For the year ended 31 December 2011
Notes to the consolidated financial statements continued 55 – Capital statement continued
WPSF respectively (31 December 2010: £1.9 billion, £0.3 billion and £3.1 billion for NWPSF, OWPSF and WPSF respectively). 2 Estimated realistic inherited estate at 31 December 2010 was £nil, £0.3 billion and £1.8 billion for NWPSF, OWPSF and WPSF respectively. 3 This represents the reattributed estate of £1.1 billion at 31 December 2011 (31 December 2010: £1.2 billion) held within NPSF1 (a non-profit fund within UKLAP 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 2.7 times covered by the inherited estate and support arrangement (31 December 2010: 3.7 times).
Under the FSA regulatory regime, UK life with-profits business is required to hold capital equivalent to the greater of their regulatory requirement based on EU directives (regulatory peak) and the FSA realistic bases (realistic peak) described above. For UK non-participating business, the relevant capital requirement is the minimum solvency requirement determined in accordance with FSA regulations. The available capital reflects the excess of regulatory basis assets over liabilities before deduction of capital resources requirement. For UK general insurance businesses, the relevant capital requirement is the minimum solvency requirement determined in accordance with the FSA requirements. For overseas businesses in the European Economic Area (EEA), US, Canada, Hong Kong and Singapore, the available capital and the minimum requirement are calculated under the locally applicable regulatory regimes. The businesses outside these territories are subject to the FSA rules for the purposes of calculation of available capital and capital resource requirement. For fund management and other businesses, the relevant capital requirement is the minimum solvency requirement determined in accordance with the local regulator’s requirements for the specific class of business. The available capital resources in each regulated entity are generally subject to restrictions as to their availability to meet requirements that may arise elsewhere in the Group. The principal restrictions are:  UK with-profit funds – (NWPSF, OWPSF and WPSF) – any available surplus held in each fund can be used to meet the requirements of the fund itself, be distributed to policyholders and shareholders or in the case of NWPSF and OWPSF, transferred via the capital support arrangement explained above (for OWPSF only to the extent support has been provided in the past). In most cases, with-profit policyholders are entitled to at least 90% of the distributed profits while the shareholders receive the balance. The latter distribution would be subject to a tax charge, which is met by the fund.
 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.
Notes to the consolidated financial statements continued 56 – Risk management This note sets out the major risks our businesses face and describes the Group’s approach to managing these. It also gives sensitivity analyses around the major economic and non-economic assumptions that can cause volatility in the Group’s earnings and capital requirements.
(a) Risk management framework The risk management framework (RMF) in Aviva forms an integral part of the management and Board processes and decision-making framework across the Group. The key elements of our risk management framework comprise risk appetite, risk modelling, roles and responsibilities, risk policies and procedures and risk governance and oversight. Additional information on the key elements of the RMF is included in the risk and capital management section of the performance review. The Group’s approach to risk management ensures that significant existing or emerging risks are actively identified, measured, managed, monitored and reported on a continuous basis. For the purposes of risk identification and measurement, risks are usually grouped by risk type: credit, market, 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 risks is included in the risk section of the Performance review. To promote a consistent and rigorous approach to risk management across all our businesses and locations in which we operate, we have a set of formal risk policies and business standards. These risk policies and business standards set out our appetite for different risk types and provide risk management and control requirements for the Group’s worldwide operations. A regular top-down key risk identification and assessment process is carried out 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 and is replicated at regional and business unit level. 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 consideration of the risk management actions available. 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. 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 regular 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) providing a key focus on business and financial risks and the Operational Risk Committee (ORC) providing a key focus on operational risks. The group-level committees are in turn supported by similar governance structures in the regions.
(b) Credit risk Credit risk is the risk of financial loss as a result of the default or failure of third parties to meet their payment obligations to Aviva, or variations in market values as a result of changes in expectations related to these risks. Credit risk arises as a consequence of asset investments made to achieve the returns required to satisfy policyholder liabilities and to provide enhanced long-term risk-adjusted returns to shareholders. Aviva is exposed to third party credit quality changes through a range of other activities including reinsurance. Credit risk is an area where we can provide the returns required to satisfy policyholder liabilities and to generate returns for our shareholders. In general we prefer to take credit risk over equity and property risks, due to the better expected risk adjusted return, our credit risk analysis capability and the structural investment advantages conferred to insurers with long-dated, relatively illiquid liabilities.
Notes to the consolidated financial statements continued 56 – Risk management continued Our approach to managing credit risk recognises that there is a risk of adverse financial impact resulting from fluctuations in credit quality of third parties including default, rating transition and credit spread movements. Credit risk categories include spread risk, default risk and rating migration risk:  Spread risk arises from changes in level or volatility of third party credit spreads over risk-free interest rates, that can be caused by credit concerns (improving or worsening) on the issuer, or from market factors, such as risk appetite and liquidity within the market.
 Default risk is the risk that a counterparty is unable or unwilling to meet its financial obligations when they fall due, and includes delays in repayments, restructuring of repayments/interest schedule and bankruptcy.
 Rating migration risk is the risk that a change in external credit rating of a counterparty adversely impacts Aviva.
 The accurate and timely reporting of detailed exposure information, and their aggregation by counterparty, exposure types, sectors, geography and ratings.
 Additional committee and risk function oversight is provided on all credit risk related matters. This includes regular consideration and review of our key counterparties, systemic factors such as sector and geographic concentrations, monitoring and addressing key credit themes and news that emerge in the markets. The Credit Approvals Committee provides a forum to ensure that all key recommendations are considered, and decisions implemented throughout the group. The regional and group ALM and risk functions ensure that qualitative aspects of risk management are considered and evaluated to provide further oversight and balance to the quantitative aspects.
 Risk mitigation techniques are used where and when deemed appropriate. These are utilised where possible to remove residual unwanted risks, as well as to bring or keep exposure limits within appetite, and include methods such as collateralisation and the purchase of credit protection such as credit default index swaps. Collateral held either takes the form of cash, disclosed in note 49 as a payable, or other financial assets, disclosed in note 25(d). Where a financial asset is recognised in the statement of financial position at fair value, that value reflects the credit enhancement as a result of the relevant collateral received.
Notes to the consolidated financial statements continued 56 – Risk management continued A detailed breakdown of the group’s current credit exposure by credit quality is shown below.
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 sub-investment 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 2011 AAA AA A BBB Speculative grade Not rated
These loans are fully collateralised by other securities.  Mortgage loans collateralised by property assets.
Unit trusts and other investment vehicles The credit quality of the underlying debt securities within these vehicles is managed by the safeguards built into the investment mandates for these funds. We rely on our understanding that the trusts and their asset managers are only approved if they satisfy certain selection criteria (including due diligence in the form of a questionnaire and/or research by dedicated teams). In addition, the asset managers are mandated to make investments in line with the funds’ risk profiles as marketed to prospective customers and policyholders. Accordingly, as part of reviewing the asset quality of unit trusts and other investment vehicles, we monitor the assets within the funds and their performance to ensure they remain in line with the respective investment mandates for these funds. A proportion of the assets underlying these investments are represented by equities and so credit ratings are not generally applicable. Equity exposures are managed against agreed benchmarks that are set with reference to overall market risk appetite.
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, associated business standards and the credit 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. 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 1.2% of the Group’s total shareholder assets.
Notes to the consolidated financial statements continued 56 – Risk management continued Reinsurance credit exposures The Group is exposed to concentrations of risk with individual reinsurers, due to the nature of the reinsurance market and the restricted range of reinsurers that have acceptable credit ratings. The Group operates a policy to manage its reinsurance counterparty exposures, by limiting the reinsurers that may be used and applying strict limits to each reinsurer. Reinsurance exposures are aggregated with other exposures to ensure that the overall risk is within appetite. The Credit Approvals Committee has a monitoring role over this risk. The Group’s largest reinsurance counterparty is Swiss Reinsurance Company Ltd (including subsidiaries). At 31 December 2011, the reinsurance asset recoverable, including debtor balances, from Swiss Reinsurance Company Ltd was £1,314 million.
Derivative credit exposures The Group is exposed to counterparty credit risk through derivative trades. This risk is mitigated through collateralising almost all trades (the exception being certain FX trades where it has historically been the market norm not to collateralise). The Group operates strict standards around collateral management and controls, including the requirement that all ‘Over the Counter’ derivatives are supported by credit support annexes and ISDAs or their local equivalents unless otherwise agreed with the Group ALM team. Counterparties 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. Residual exposures are captured within the Group’s credit management framework. Many of the largest shareholder notional positions are exchange traded, rather than over the counter (OTC), with the added protection that provides (i.e. mitigated significantly through the protection offered by the exchange) and is controlled by the Group’s local asset management operations.
Impairment of financial assets The following table provides information regarding the carrying value of financial assets that have been impaired and the ageing of financial assets that are past due but not impaired.
Receivables and other financial assets 7,650 134 148 2 3 — 7,937
Receivables and other financial assets 7,983 209 36 39 10 18 8,295
Credit investment criteria 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.
Notes to the consolidated financial statements continued 56 – Risk management continued (c) Market risk Market risk is the risk of adverse financial impact due to changes in fair values or future cash flows of financial instruments from fluctuations in interest rates, foreign currency exchange rates, property and commodity prices. Market risk arises in business units due to fluctuations in both the value of liabilities and the value of investments held. At Group level, it also arises in relation to the overall portfolio of international businesses and in the value of investment assets owned directly by the shareholders. The Group has established a policy on market risk which sets out the principles that businesses are expected to adopt in respect of management of the key market risks to which the Group is exposed. The Group monitors adherence to this market risk policy and regularly reviews how business units are managing these risks locally, through the Assets Committee and ultimately the Asset Liability Committee (ALCO). For each of the major components of market risk, described in more detail below, the Group has put in place additional processes and procedures, described in internal business standards, to set out how each risk should be managed and monitored, and the approach to setting an appropriate risk appetite. The management of market risk is undertaken in businesses, regions and at group level. Businesses manage market risks locally using the Group market risk framework and within local regulatory constraints. The ALM function is responsible for managing market risk at Group level. The Group market risk policy sets out the minimum principles and framework for matching liabilities with appropriate assets, the approaches to be taken when liabilities cannot be matched and the monitoring processes that are required. The Group has criteria for matching assets and liabilities for all classes of business to minimise the impact of mismatches between the value of assets and the liabilities due to market movements. The local regulatory environment for each business will also set the conditions under which assets and liabilities are to be matched. In addition, where the Group’s long-term savings businesses have written insurance and investment products where the majority of investment risks are borne by its policyholders, these risks are managed in line with local regulations and marketing literature, in order to satisfy the policyholders’ risk and reward objectives. The Group writes unit-linked business in a number of its operations. In unit-linked business, the policyholder bears the investment risk on the assets held in the unit-linked funds, as the policy benefits are directly linked to the value of the assets in the fund. The shareholders’ exposure to market risk on this business is limited to the extent that income arising from asset management charges is based on the value of assets in the fund.
We continue to limit our direct equity exposure in line with our risk preferences for equity risk. The reduction of the shareholding in Delta Lloyd has decreased the Group’s IFRS balance sheet risks and, in particular, has led to a fall in equity exposures. The sale of the RAC business has also reduced our strategic equity exposure and our extended equity hedging programme during 2011 has further reduced our equity exposures. At a business unit level, equity price risk is actively managed in order to mitigate anticipated unfavourable market movements where this lies outside the risk appetite of either the Company in respect of shareholder assets or the fund in respect of policyholder assets concerned. In addition investment limits and local asset admissibility regulations require that business units hold diversified portfolios of assets thereby reducing exposure to individual equities. The Group does not have material holdings of unquoted equity securities. Equity risk is also managed using a variety of derivative instruments, including futures and options. Businesses actively model the performance of equities through the use of risk models, in particular to understand the impact of equity performance on guarantees, options and bonus rates. At 31 December 2011 the Group’s shareholder funds held £3 billion notional of equity hedges, with up to 12 months to maturity with an average strike of 89% of the prevailing market levels on 31 December 2011. The Assets Committee actively monitors the Group’s equity exposures relative to risk appetite. Sensitivity to changes in equity prices is given in section (h) below.
Notes to the consolidated financial statements continued 56 – Risk management continued 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 the Group’s property exposure, relative to risk appetite As at 31 December 2011, 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.
Interest rate risk Interest rate risk arises primarily from the Group’s investments in long-term debt and fixed income securities and their movement relative to the value placed on the insurance liabilities. A number of policyholder participation features have an influence on the group’s interest rate risk. The major features include guaranteed surrender values, guaranteed annuity options, and minimum surrender and maturity values. Details of material guarantees and options are given in note 41. Interest rate risk is managed by the ALM function and monitored and managed at Group level by the Assets Committee, and the Asset Liability Committee. Exposure to interest rate risk is monitored through several measures that include value-at-risk analysis, position limits, risk modelling (stress and scenario tests), asset and liability matching using measures such as duration. The Group has a general preference for minimising interest rate risk where practical and has also set a quantitative group level interest rate risk appetite. The impact of exposure to sustained low interest rates is regularly monitored. The Group manages this risk by adopting close asset liability matching criteria, to minimise the impact of mismatches between the value of assets and liabilities from interest rate movements. Interest rate risk is also managed using a variety of derivative instruments, including futures, options, swaps, caps and floors, in order to provide a degree of hedging against unfavourable market movements in interest rates inherent in the assets backing technical liabilities. Sensitivity to changes in interest rates is given in section (h) below. Further information on borrowings is included in note 48.
Currency risk The Group has minimal exposure to currency risk from financial instruments held by business units in currencies other than their functional currencies, as nearly all such holdings are backing either unit-linked or with-profit contract liabilities or are hedged. For this reason, no sensitivity analysis is given for these holdings. The Group operates internationally and as a result is exposed to foreign currency exchange risk arising from fluctuations in exchange rates of various currencies. Approximately half of the group’s premium income arises in currencies other than sterling and the Group’s net assets are denominated in a variety of currencies, of which the largest are euro, sterling and US dollars. The Group does not hedge foreign currency revenues as these are substantially retained locally to support the growth of the Group’s business and meet local regulatory and market requirements. The Group’s foreign exchange standard requires that each of our subsidiaries should aim to maintain sufficient assets in its local currency to meet local currency liabilities and to report any material mismatches. Therefore, capital held by the Group’s business units should generally be able to support local business activities regardless of foreign currency movements. However, such movements may impact the value of the Group’s consolidated shareholders’ equity which is expressed in sterling. This aspect of foreign exchange risk is monitored and managed centrally, against pre-determined limits. The Group’s approach is to manage these exposures by aligning the deployment of regulatory capital by currency with the Group’s regulatory capital requirements by currency. Limits are set to control the extent to which the deployment of capital is not aligned fully with the Group’s regulatory capital requirement for each major currency. Currency borrowings and derivatives are used to manage exposures within the limits that have been set.
Notes to the consolidated financial statements continued 56 – Risk management continued At 31 December 2011 and 2010, the Group’s total equity deployment by currency was: Sterling £m Euro £m
(d) Liquidity risk At Group level, there is a liquidity risk appetite which requires that sufficient liquid resources be maintained to cover net outflows in a stress scenario. 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 risk policy and business standard seek to maintain sufficient financial resources to meet their 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 leading international banks to further mitigate this risk. The Group has also implemented a liquidity risk policy and framework to ensure that businesses within the Group also maintain sufficient liquidity to withstand adverse scenarios.
Long-term business Insurance contracts – non-linked 132,400 12,025 42,609 50,206 27,560
Notes to the consolidated financial statements continued 56 – Risk management continued The committee considers all areas of life insurance risk, but in particular has a remit to monitor mortality, longevity, morbidity, persistency, product development and pricing, unit pricing and expenses. The committee also considers the reinsurance coverage across the life businesses. It confirms that guidance and procedures are in place for each of the major components of life insurance risk, and that the businesses mitigate against any life insurance risk outside local appetite, within the parameters for the overall Group risk appetite. The committee has also developed guidance for business units on management of a number of areas of life insurance risk to ensure best practice is shared throughout the Group and common standards are adopted.
 Longevity risk and internal experience analysis are carefully monitored against the latest external industry data and emerging trends. While 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 and continually monitors and evaluates emerging market solutions to mitigate this risk further.
 Expense risk is primarily managed by the business units through the assessment of business unit profitability and frequent monitoring of expense levels.
In addition to economic capital modelling, sensitivity testing is 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 made at both business unit level and at group level where the impact of aggregation of similar risks can be measured and is supplemented by scenario analysis. This enables the group to determine whether action is required to reduce risk, or whether that risk is within the overall risk appetite.
Embedded derivatives The Group has exposure to a variety of embedded derivatives in its long-term savings business due to product features offering varying degrees of guaranteed benefits at maturity or on early surrender, along with options to convert their benefits into different products on pre-agreed terms. The extent of the impact of these embedded derivatives differs considerably between business units and exposes Aviva to changes in policyholder behaviour in the exercise of options as well as market risk. Examples of each type of embedded derivative affecting the Group are:  Options: call, put, surrender and maturity options, guaranteed annuity options, options to cease premium payment, options for withdrawals free of market value adjustment, annuity options, and guaranteed insurability options.  Guarantees: embedded floor (guaranteed return), maturity guarantee, guaranteed death benefit, and guaranteed minimum rate of annuity payment.  Other: indexed interest or principal payments, maturity value, loyalty bonus.
(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.
Notes to the consolidated financial statements continued 56 – Risk management continued The majority of the general insurance business underwritten by the Group is of a short tail nature such as motor, household and commercial property insurances. The Group’s underwriting strategy and appetite is agreed by the Executive Committee and communicated via specific policy statements and guidelines. Like life insurance risk, general insurance risk is managed primarily at business unit level with oversight at a group level, through the Group Insurance Committee. The vast majority of the Group’s general insurance business is managed and priced in the same country as the domicile of the customer.
(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.
Notes to the consolidated financial statements continued 56 – 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 and business standards. Each operational risk is assessed by considering the potential impact and the probability of the event occurring. Business management teams must be satisfied that all material risks falling outside our risk tolerances are being mitigated, monitored and reported to an appropriate level. Any risks with a high potential impact 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.
(g) Brand and reputation risk Brand and reputation risk is the risk of loss of franchise value due to damage to our brand or our reputation with customers, distributors, investors and regulators. Our success and results are, to a certain extent, dependent on the strength of our global Aviva brand and reputation. While we as a group are well recognised, we are vulnerable to adverse market and customer perception. We operate in an industry where integrity, customer trust and confidence are paramount. We are exposed to the risk that litigation, employee misconduct, operational failures, the outcome of regulatory investigations, media speculation and negative publicity, disclosure of confidential client information, inadequate services, among others, whether or not founded, could impact our brands or reputation. Any of our brands or our reputation could also be affected if products or services recommended by us (or any of our intermediaries) do not perform as expected (whether or not the expectations are founded) or the customer’s expectations for the product change. One of the FSA’s strategic objectives is to help customers get a fair deal through its ‘treating customers fairly’ principle. Examples of ‘treating customers fairly’ include: products and services targeted to meet customers’ needs and which perform in line with what customers have been led to expect; clear information (and advice where relevant); good service; and making sure there are no unfair barriers that prevent customers from getting access to their money, changing products or making a successful insurance claim. The FSA regularly checks that we are meeting the requirement to treat our customers fairly and we make use of various metrics to assess our own performance, including customer advocacy, retention and complaints. Failure to meet these requirements could also impact our brands or reputation. If we do not manage successfully the perception of our brands and reputation, it could cause existing customers or agents to withdraw from our business and potential customers or agents to be reluctant or elect not to do business with us. This would adversely impact our business and results of operations.
(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 the Group’s key financial performance metrics 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.
Life insurance and investment contracts The nature of long-term business is such that a number of assumptions are made in compiling these financial statements. Assumptions are made about investment returns, expenses, mortality rates and persistency in connection with the in-force policies for each business unit. Assumptions are best estimates based on historic and expected experience of the business. A number of the key assumptions for the Group’s central scenario are disclosed elsewhere in these statements for both IFRS reporting and reporting under MCEV methodology. For participating funds, a negative unallocated divisible surplus (UDS) may be held, subject to recoverability from margins in the participating business liabilities, with any irrecoverable amount charged to net income. The amount of negative UDS that is recoverable is sensitive to movements in risk-free interest rates and credit spreads on the participating fixed interest assets. The increase in interest rate sensitivities for participating investment contracts between 2010 and 2011 primarily reflects the widening of credit spreads on bonds in Italy. An increase in interest rates would increase the amount of irrecoverable UDS that is charged to net income, while a reduction in interest rates would allow the reversal of losses incurred in previous periods.
Notes to the consolidated financial statements continued 56 – 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.
Long-term business Sensitivities as at 31 December 2011 Impact on profit before tax (£m)
Assets backing life shareholders’ funds 135 (15) 35 (35) — — —
Assets backing life shareholders’ funds 35 85 40 (40) — — —
Assets backing life shareholders’ funds 30 (35) 15 (10) — — —
Assets backing life shareholders’ funds (75) 70 20 (15) — — —
Notes to the consolidated financial statements continued 56 – Risk management continued General insurance and health business Sensitivities as at 31 December 2011 Impact on profit before tax (£m)
Gross of reinsurance excluding Delta Lloyd (205) 180 50 (55) (30) (300)
Net of reinsurance excluding Delta Lloyd (275) 275 50 (55) (30) (290)
Gross of reinsurance excluding Delta Lloyd (235) 220 45 (50) (110) (285)
Net of reinsurance excluding Delta Lloyd (290) 285 45 (50) (110) (280)
Gross of reinsurance excluding Delta Lloyd (235) 220 45 (50) (30) (285)
Net of reinsurance excluding Delta Lloyd (290) 285 45 (50) (30) (280)
Sensitivities as at 31 December 2010 Impact before profit before tax (£m)
Notes to the consolidated financial statements continued 57 – Derivative financial instruments and hedging continued (i) Cash flow hedges During 2010, the cash flow hedges were discontinued. The Group has therefore no cash flow hedges to report.
(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 2011 was £1,815 million (2010: £2,791 million) and its fair value at that date was £1,694 million (2010: £2,811 million). The decrease in the value of debt designated as a hedge of net investment is due to the repayment of an €800 million hybrid debt instrument in November 2011 combined with a depreciation in the euro versus sterling. The foreign exchange gain of £30 million (2010: gain of £53 million) on translation of the debt to sterling at the statement of financial position date has been recognised in the hedging instruments reserve in shareholders’ equity. This hedge was fully effective throughout the current and prior years.
Foreign exchange contracts OTC Forwards 6,727 41 (38) 12,211 69 (102) Interest rate and currency swaps 502 83 (3) 830 164 (125)
Fair value assets are recognised as ‘Derivative financial instruments’ in note 25(a), while fair value liabilities are recognised as ‘Derivative liabilities’ in note 49. The Group’s derivative risk management policies are outlined in note 56(b).
Notes to the consolidated financial statements continued 57 – Derivative financial instruments and hedging continued (ii) The contractual undiscounted cash flows in relation to non-hedge derivative liabilities have the following maturities: £m £m
Total IFRS assets included in the consolidated statement of financial position 312,376 370,107 Less: Third-party funds included within consolidated IFRS assets (11,814) (9,999)
Managed by: Aviva Investors 262,506 259,787 Other Aviva and external managers 74,055 142,464 59 – 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 undertakes transactions with related parties in the normal course of business. Loans to related parties are made on normal arm’s-length commercial terms.
Notes to the consolidated financial statements continued 59 – Related party transactions continued Transactions with joint ventures in the UK relate to the property management undertakings, the most material of which are listed in note 18(b). Our interest in these joint ventures comprises a mix of equity and loans, together with the provision of administration services and financial management to many of them. Our UK life insurance companies earn interest on loans advanced to these entities, movements in which may be found in note 18(a). Our fund management companies also charge fees to these joint ventures for administration services and for arranging external finance. Our UK fund management companies manage most of the assets held by the Group’s main UK staff pension scheme, for which they charge fees based on the level of funds under management. The main UK scheme holds investments in Group-managed funds and insurance policies with other Group companies, as explained in note 47(e)(iii). 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 provided on behalf of related parties are given in note 51(g). Transactions with joint ventures in Asia relate to life business in India, Malaysia, Korea, Taiwan, China and Vietnam.
Income statement For the years ended 31 December 2011 and 2010: Note 2011 £m £m
Dividends received from subsidiaries 1,068 1,110 Interest receivable from Group companies 143 150 Net investment expense (8) (14)
Statement of comprehensive income For the years ended 31 December 2011 and 2010
Fair value (losses)/gains on investments in subsidiaries and joint ventures A (2,387) 408 Actuarial gains on pension provision 1 1
Total comprehensive income for the year — — — — (2,387) — 232 (2,155) — (2,155)
Shares issued in lieu of dividends 29 & 36 21 — (21) — — — 307 307 — 307 Employee trust shares distributed in the year 31 — — — — — — (18) (18) — (18) Reserves credit for equity compensation plans — — — — — 48 — 48 — 48 Shares issued under equity compensation plans — — — — — (61) 61 — — — Aggregate tax effect — — — — — — 16 16 — 16
Total comprehensive income for the year — — — — 408 — 501 909 — 909
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 financial position At 31 December 2011 and 2010: Note 2011 £m £m
Loans owed by subsidiaries H — 691 Other amounts owed by subsidiaries H 2,280 2,334 Other assets 61 74 Cash and cash equivalents 17 1
Fair value as at 1 January 17,623 17,236 Movement in fair value (2,393) 387
C – Tax (i) Tax credited to the income statement £m £m
Current tax: For this year 83 229 Prior year adjustments (58) (1)
(iii) Tax credited to equity Tax credited to equity comprises £16 million (2010: £17 million) in respect of coupon payments on the direct capital instruments.
Tax calculated at standard UK corporation tax rate of 26.5% (2010: 28%) (54) (76) Adjustment to tax charge in respect of prior years (58) (1) Non-assessable dividends 283 311 Disallowable expenses (4) (5) Unpaid group relief (64) — Movement in deferred tax not recognised (78) — Other — (1)
(v) Deferred tax There was no deferred tax recognised in the Company at 31 December 2011 (2010: £nil). The Company has unrecognised tax losses of £296 million (2010: £nil) and other temporary differences of £245 million (2010: £45 million). The tax losses have no expiry date.
Arising in the year: Profit for the year — — — 231 Fair value losses on investments in subsidiaries and joint ventures — (2,387) — — Actuarial gains on pension provisions — — — 1 Dividends and appropriations — — — (813) Reserves credit for equity compensation plans — — 48 — Shares issued in lieu of dividends — — — 307 Trust shares distributed in the year — — — (18) Issue of share capital under equity compensation scheme — — (61) 61 Aggregate tax effect — — — 16
Tax of £16 million (2010: £17 million) is deductible in respect of coupon payments of £58 million (2010: £61 million) on the direct capital instruments.
Condensed consolidated income statement – MCEV basis For the year, ended 31 December 2011 and 2010: £m
Operating profit before tax attributable to shareholders’ profits United Kingdom 1,193 — 1,193 1,085 — 1,085
Other operations and regional costs2 (204) 7 (197) (171) (24) (195)
Operating profit before tax attributable to shareholders’ profits (excluding Delta Lloyd as an associate) 3,097 283 3,380 3,473 287 3,760
Non-operating items before tax (excluding Delta Lloyd as an associate) (7,259) (222) (7,481) (1,340) (277) (1,617)
Share of Delta Lloyd’s non-operating items (before tax) as an associate 10 — 10 — — —
(Loss)/profit before tax attributable to shareholders’ profits (4,029) 61 (3,968) 2,133 10 2,143
These results are included within the life MCEV operating earnings consistent with the MCEV methodology. 2 Excludes the proportion of the results of subsidiaries providing services to the Life business. These results are included within the life MCEV operating earnings consistent with the MCEV methodology.
Operating earnings per share on an MCEV basis after tax, attributable to ordinary shareholders of Aviva plc Basic (pence per share) 71.3p 3.8p 75.1p 74.5p 2.8p 77.3p
Condensed consolidated statement of comprehensive income – MCEV basis For the year ended 31 December 2011: £m
Other comprehensive income net of tax from continuing operations 203 1,040 Other comprehensive income/(expense), net of tax from discontinued operations 131 (198)
Total comprehensive (expense)/income for the year from continuing operations (2,583) 2,501 Total comprehensive income/(expense) for the year from discontinued operations 216 (185)
Condensed consolidated statement of changes in equity – MCEV basis For the year ended 31 December 2011: £m
Condensed consolidated statement of financial position – MCEV basis As at 31 December 2011: £m
Assets Goodwill 2,640 3,391 Acquired value of in-force business and intangible assets 2,021 2,806 Additional value of in-force long-term business1 132 2,480 Interests in, and loans to, joint ventures 1,700 1,994 Interests in, and loans to, associates 1,118 643 Property and equipment 510 750 Investment property 11,638 13,064
Deferred acquisition costs and other assets 6,444 6,072 Prepayments and accrued income 3,235 3,691 Cash and cash equivalents 23,043 25,455 Assets of operations classified as held for sale 426 14
Equity Ordinary share capital 726 705 Capital reserves 4,444 4,465 Other reserves 1,262 2,069 Shares held by employee trusts (43) (32) Retained earnings 5,954 5,411 Additional retained earnings on an MCEV basis1 486 2,420
Liabilities Gross insurance liabilities 150,101 177,700 Gross liabilities for investment contracts 110,644 117,787 Unallocated divisible surplus 650 3,428 Net asset value attributable to unit holders 10,352 9,032
Total equity and liabilities 312,508 372,587 1 Adding the excess of the Life MCEV, including non-controlling interests, over the corresponding Life IFRS net assets represented as the additional value of in-force long-term business; corresponding item within equity represented by the additional retained profit on an MCEV basis; and, corresponding adjustments to non-controlling interests. The summarised consolidated statement of financial position presented above is unaltered from the corresponding IFRS summarised consolidated statement of financial position with the exception of the following:
Ordinary share capital 726 — 726 Capital reserves 4,444 — 4,444
Ordinary share capital 705 — 705 Capital reserves 4,465 — 4,465
Reconciliation of IFRS total equity to MCEV net worth For the year ended 31 December 2011: £m
Net assets on a statutory IFRS net basis 15,363 17,725 Adjusting for general business and other net assets on a statutory IFRS net basis 301 1,331
E1 – Basis of preparation The condensed consolidated income statement and condensed consolidated statement of financial position on pages 322 to 325 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-covered 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 2011 and 2010 have been audited by our auditors, Ernst & Young LLP. Their report in respect of 2011 can be found on page 360 in the Report and Accounts.
Covered business The MCEV calculations cover the following lines of business: life insurance, long-term health and accident insurance, savings, pensions and annuity business written by our life insurance subsidiaries, including managed pension fund business and our share of certain life and related business written in our associated undertakings and joint ventures, as well as the equity release business written in the UK. Covered business includes the Group’s share of our joint ventures including our associated undertakings in India, China, Turkey, Malaysia, Taiwan and South Korea. In addition, the results of group companies providing significant administration, fund management and other services and of Group holding companies have been included to the extent that they relate to covered business. Together these businesses are referred to as ‘Life and related businesses’. Aviva’s associate holding of Delta Lloyd is not included within covered business as MCEV is not used to manage Delta Lloyd. For ‘Group’ MCEV reporting, which includes general insurance and other non-covered business, Delta Lloyd is included on an IFRS basis.
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.
Calculation of the embedded value The shareholders’ interest in the life and related businesses is represented by the embedded value. The embedded value is the total of the net worth of the life and related businesses and the value of in-force covered business. Calculations are performed separately for each business and are based on the cash flows of that business, after allowing for both external and intra-group reinsurance. Where one life business has an interest in another, the net worth of that business excludes the interest in the dependent company. The embedded value is calculated on an after-tax basis applying current legislation and practice together with future known changes. Where gross results are presented, these have been calculated by grossing up post-tax results at the full rate of corporation tax for each country based on opening period tax rates, apart from the UK, where a 26% tax rate was used for 2011 for grossing up.
Value of in-force covered business (VIF) The value of in-force covered business consists of the following components:  present value of future profits;  time value of financial options and guarantees;  frictional costs of required capital; and  cost of residual non-hedgeable risks.
Present value of future profits (PVFP) The PVFP is the present value of the distributable profits to shareholders arising from the in-force covered business projected on a best estimate basis. Distributable profits generally arise when they are released following actuarial valuations. These valuations are carried out in accordance with any local statutory requirements designed to ensure and demonstrate solvency in long-term business funds. Future distributable profits will depend on experience in a number of areas such as investment return, discontinuance rates, mortality, administration costs, as well as management and policyholder actions. Releases to shareholders arising in future years from the in-force covered business and associated required capital can be projected using assumptions of future experience. Future profits are projected using best estimate non-economic assumptions and market consistent economic assumptions. In principle, each cash flow is discounted at a rate that appropriately reflects the riskiness of that cash flow, so higher-risk cash flows are discounted at higher rates. In practice, the PVFP is calculated using the ‘certainty equivalent’ approach, under which the reference rate is used for both the investment return and the discount rate. This approach ensures that asset cash flows are valued consistently with the market prices of assets without options and guarantees. Further information on the risk-free rates is given in note E18. The PVFP includes the capitalised value of profits and losses arising from subsidiary companies providing administration, investment management and other services to the extent that they relate to covered business. This is referred to as the ‘look through’ into service company expenses. In addition, expenses arising in holding companies that relate directly to acquiring or maintaining covered business have been allowed for. Where external companies provide services to the life and related businesses, their charges have been allowed for in the underlying projected cost base.
E1 – Basis of preparation continued Time value of financial options and guarantees (TVOG) The PVFP calculation is based on a single (base) economic scenario; however, a single scenario cannot appropriately allow for the effect of certain product features. If an option or guarantee affects shareholder cash flows in the base scenario, the impact is included in the PVFP and is referred to as the intrinsic value of the option guarantee; however, future investment returns are uncertain and the actual impact on shareholder profits may be higher or lower. The value of in-force business needs to be adjusted for the impact of the range of potential future outcomes. Stochastic modelling techniques can be used to assess the impact of potential future outcomes, and the difference between the intrinsic value and the total stochastic value is referred to as the time value of the option or guarantee (TVOG). Stochastic modelling typically involves projecting the future cash flows of the business under thousands of economic scenarios that are representative of the possible future outcomes for market variables such as interest rates and equity returns. Under a market consistent approach, the economic scenarios generated reflect the market’s tendency towards risk aversion. Allowance is made, where appropriate, for the effect of management and/or policyholder actions in different economic conditions on future assumptions such as asset mix, bonus rates and surrender rates. Stochastic models are calibrated to market yield curves and volatility levels at the valuation date. Tests are performed to confirm that the scenarios used produce results that replicate the market price of traded instruments. Where evidence exists that persistency rates are linked to economic scenarios, dynamic lapse assumptions are set that vary depending on the individual scenarios. This cost is included in the TVOG. Dynamic lapses are modelled for parts of the UK, US and French businesses. Asymmetries in non-economic assumptions that are linked to economic scenarios, but that have insufficient evidence for credible dynamic assumptions, are allowed for within mean best estimate assumptions.
Cost of residual non-hedgeable risks (CNHR) The cost of residual non-hedgeable risks (CNHR) covers risks not already allowed for in the TVOG 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.
Consolidation adjustments The effect of transactions between Group life companies such as loans and reinsurance arrangements have been included in the results split by territory in a consistent manner. No elimination is required on consolidation. As the MCEV methodology incorporates the impact of profits and losses arising from subsidiary companies providing administration, investment management and other services to the Group’s life companies, the equivalent profits and losses have been removed from the relevant segment (non-insurance or fund management) and are instead included within the results of life and related businesses. In addition, the underlying basis of calculation for these profits has changed from the IFRS basis to the MCEV basis. The capitalised value of the future profits and losses from such service companies are included in the embedded value and value of new business calculations for the relevant business, but the net assets (representing historical profits and other amounts) remain under non-insurance or fund management. In order to reconcile the profits arising in the financial period within each segment with the assets on the opening and closing statement of financial positions, a transfer of IFRS profits from life and related business to the appropriate segment is deemed to occur. An equivalent approach has been adopted for expenses within our holding companies. The assessments of goodwill, intangibles and pension schemes relating to life insurance business utilise the IFRS measurement basis.
Restatement The 2010 opening and closing embedded values have been restated for the US, primarily reflecting modelling corrections to the valuation of certain life contracts and an overstatement of asset income identified in 2011. The resulting impact of the restatement was that the opening 2010 embedded value increased by £12 million and the closing 2010 embedded value reduced by £257 million, with no impact on operating profit.
Impact of Delta Lloyd disposal On 6 May 2011, the Group sold 25 million shares in Delta Lloyd N.V. (“Delta Lloyd”) (the Group’s Dutch long-term insurance, general insurance and fund management subsidiary), reducing our holding to approximately 43% of Delta Lloyd’s ordinary share capital. In line with IFRS, up to the date of partial disposal, Delta Lloyd has been presented as a discontinued operation. Following the partial disposal, when Delta Lloyd became an associate of Aviva, Delta Lloyd has been removed from covered business as it is not managed by either Aviva or Delta Lloyd on an MCEV basis. The impact on MCEV as at 6 May 2011 is a reduction of £1,519 million.
Earnings from existing business: – expected returns at the reference rate 169 244 20 20 453 49 502 – expected returns in excess of the reference rate 425 357 401 25 1,208 181 1,389
Expected return on shareholders’ net worth 179 152 82 12 425 124 549
United Kingdom MCEV operating earnings were 10% higher at £1,193 million (2010: £1,085 million) mainly due to increases in the value of new business and experience variances, partly offset by lower expected return.
Assumption changes were £11 million adverse (2010: £18 million adverse) reflecting the strengthening of mortality and morbidity rates.
E2 – Geographical analysis of life MCEV operating earnings continued North America MCEV operating earnings decreased by 17% to £241 million (2010: £289 million) as higher expected return and improved value of new business were more than offset by adverse experience, operating assumption changes and other operating variances.
Value of new business was 37% higher at £71 million (2010: £52 million), reflecting improved scale efficiencies, product mix and volumes.
Total expected return decreased by 26% to £42 million (2010: £57 million), as a result of lower implied discount rates.
– expected existing business contribution (in excess of reference rate) 340 140 26 72 20 72 4 334 515 10 1,199 109 1,308
– project and other related expenses1 (30) (15) (1) — — (1) (1) (18) (16) (4) (68) 4 (64)
Operating assumption changes: – maintenance expense5 63 11 (65) (28) 51 (4) (2) (37) (54) 19 (9) 100 91 – project and other related expenses5 (65) (4) — — — — — (4) — — (69) — (69)
Expected return on shareholders’ net worth 147 60 30 47 10 32 5 184 64 16 411 41 452
Earnings before tax and non-controlling interests 1,193 1,077 (91) 74 410 137 10 1,617 241 78 3,129 270 3,399 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. Adverse experience reflects normal volatility in mortality and increased retention limits in the US. 3 Persistency experience continues to be somewhat volatile across our businesses. Asia reflects an accumulation of small adverse experience across businesses. 4 Other experience includes tax benefits from the transfer of former RBS joint venture business into the long-term fund in the UK. 5 Maintenance and project expense assumptions have been revised in many regions with a broadly neutral impact on continuing business and a benefit from restructuring in Delta Lloyd. 6 Mortality assumptions have been updated in France reflecting experience. 7 Persistency assumptions have been updated in a number of businesses reflecting lower expected lapses in France (AFER), increases due to the economic environment in Ireland and Spain and, in the US, revisions to dynamic policyholder lapse behaviour. 8 Other operating assumption changes in Poland relate to a change to assumed management actions in relation to product charges, and, in the US, revisions to policyholder utilisation of rider benefits offset by revisions to annuity spread assumptions. 9 Other operating variances relate to modelling changes and the release of a modelling provision in France, and modelling refinements in Italy, and in the US, the marginal impact of new business on the value of deferred tax losses, with cost of capital transactions and model refinements broadly offsetting.
– project and other related expenses1 (8) (5) (2) — — (2) (5) (14) (18) (3) (43) (4) (47)
Operating assumption changes: – maintenance expense5 83 31 (3) (11) 140 132 — 289 (88) 8 292 220 512 – project and other\related expenses5 (92) — — — — — — — — — (92) (6) (98)
Expected return on shareholders’ net worth 179 47 20 50 9 18 8 152 82 12 425 124 549
Earnings before tax and non-controlling interests 1,085 971 37 266 377 319 43 2,013 289 109 3,496 83 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.
7 Persistency assumptions have been updated in a number of businesses. 8 Other operating variances for France relate to modelling changes, particularly relating to the time value of options and guarantees, and the benefit of reducing minimum guarantee rates. In Delta Lloyd, modelling changes include impacts related to commercial mortgages partly offset by changes to group pensions business. In the US, other operating variances related to the benefit of an AXXX capital solution together with modelling refinements on our asset portfolio.
Earnings from existing business – expected existing business contribution (reference rate) 158 71 9 7 51 13 16 167 40 12 377 7 384 – expected existing business contribution (in excess of reference rate) 252 84 17 22 15 26 4 168 334 7 761 41 802
Operating assumption changes: – maintenance expense5 47 7 (45) (10) 36 (2) (2) (16) (35) 14 10 43 53 – project and other related expenses5 (49) (2) — — — — — (2) — — (51) — (51)
Expected return on shareholders’ net worth 109 36 20 16 7 13 3 95 42 12 258 17 275
Earnings from existing business – expected existing business contribution (reference rate) 122 61 8 4 53 13 11 150 13 14 299 19 318 – expected existing business contribution (in excess of reference rate) 306 115 19 11 18 27 7 197 261 20 784 68 852
Earnings after tax and non-controlling interests 778 596 25 76 266 143 33 1,139 188 82 2,187 12 2,199 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.
6 Delta Lloyd has updated mortality assumptions to reflect recently published tables, which include a significantly increased allowance for mortality improvements. In France and the USA, mortality assumptions have been updated reflecting experience.
United Kingdom 11 3 Aviva Europe — — Asia Pacific — (2)
Total assets included in the IFRS statement of financial position 282,286 30,090 312,376 324,729 45,378 370,107
Net assets on a statutory IFRS basis 15,664 (301) 15,363 19,056 (1,331) 17,725 Additional value of in-force long-term business1 132 — 132 2,480 — 2,480
Net assets on an MCEV basis2 15,796 (301) 15,495 21,536 (1,331) 20,205 Equity capital, capital reserves, shares held by employee trusts and other reserves 6,389 7,207 IFRS basis retained earnings 5,954 5,411 Additional MCEV basis retained earnings 486 2,420
Equity attributable to ordinary shareholders of Aviva plc on an MCEV basis 12,829 15,038 Preference share capital and direct capital instruments 1,190 1,190 Non-controlling interests 1,476 3,977
MCEV basis total equity 15,495 20,205 1 The analysis between the Group’s and non-controlling interests’ share of the additional value of in-force long-term business is as follows: £m
2 Analysis of net assets on an MCEV basis is made up as follows: £m
Goodwill and intangible assets allocated to long-term business3 2,117 2,356 Notional allocation of IAS19 pension fund surplus/(deficit) to long-term business4 585 173
Long-term business net assets on an MCEV basis 15,796 21,536 3 Goodwill and intangible assets include amounts related to associated undertakings and joint ventures. 4 The value of the Aviva Staff Pension Scheme surplus has been notionally allocated between segments, based on current funding and the Life proportion has been included within the long-term business net assets on an MCEV basis. The pension fund surplus notionally allocated to long-term business is net of the agreed funding borne by the UK with-profit funds.
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 (VIF) covered business, and includes amounts transferred between these categories. All figures are shown net of tax and non-controlling interests.
Expected existing business contribution (reference rate) — — 377 377 — — 7 7 384 Expected existing business contribution (in excess of reference rate) — — 761 761 — — 41 41 802 Transfers from VIF and required capital to the free surplus 1,822 (583) (1,239) — 85 (25) (60) — —
Divested business is the removal of Delta Lloyd from covered business subsequent to the reduction of our holding to 42%.
Expected existing business contribution (reference rate) — — 299 299 — — 19 19 318 Expected existing business contribution (in excess of reference rate) — — 784 784 — — 68 68 852 Transfers from VIF and required capital to the free surplus 1,594 (509) (1,085) — 217 (78) (139) — —
Expected return on shareholders’ net worth 111 157 — 268 15 35 — 50 318 1 Required capital is shown net of implicit items permitted by local regulators to cover minimum solvency margins. 2 Other non-operating variances relate to increase in CNHR charge from 2.5% to 3.3% p.a., legislation changes to Poland Pensions, costs for Solvency II implementation and other restructuring and unit-linked insurance compensation scheme and compensation costs in Delta Lloyd. 3 Included within capital and dividend flows is the transfer to Life and related businesses from other segments consisting of service company profits and losses during the reported period that have emerged from the value of in-force. Since the
E8 – Life MCEV operating earnings The table below presents the life and pensions MCEV earnings broken down into constituent parts. The life and pensions MCEV operating earnings comprise: the value of new business written during the year; the earnings from existing business including other operating variances; and the expected investment return on the shareholders’ net worth. These components are calculated using economic assumptions as at the start of the year (in-force business) or start of the quarter (new business) and operating (demographic and expenses) assumptions as at the end of the year.
Value of new business 689 716 Earnings from existing business – expected returns at the reference rate 566 453 – expected returns in excess of the reference rate 1,199 1,208
There were no separate development costs reported in these years. Other non-operating variances are described under Exceptional items in note E5. The table above presents a summarised breakdown of the life and pensions MCEV earnings on a gross of non-controlling interests basis and gross of tax with tax shown separately. The Group favours the gross presentation for consistency with the IFRS results. The table below compares the key items on the different bases as the subsequent analysis is provided predominantly on a net of tax and non-controlling interests basis as preferred by the CFO Forum Principles.
Life and pensions earnings – continuing operations (1,317) (3,444) 1,633 2,360 Life and pensions earnings – discontinued operations (20) (46) (67) (113)
Total life and pensions – continuing operations 1,591 5.4 8,651 19,269 27,920 Total life and pensions – discontinued operations1 73 9.1 663 422 1,085 1 Current period discontinued represent the results of Delta Lloyd up to 6 May 2011 only.
Total life and pensions – continuing operations 1,369 5.7 7,748 22,432 30,180 Total life and pensions – discontinued operations 172 9.3 1,591 1,587 3,178
E10 – Geographical analysis of value of new business The tables below set out the present value of new business premiums (PVNBP) written by the life and related businesses, the value of the new business and the resulting margin, firstly gross and then net of tax and non-controlling interests. The value generated by new business written during the period is the present value of the projected stream of after-tax distributable profit from that business, including expected profit between point of sale and the valuation date. The value of new business has been calculated using economic assumptions at the point of sale which has been implemented with the assumptions being taken as those appropriate to the start of each quarter. For contracts that are re-priced more frequently, weekly or monthly economic assumptions have been used. The operating assumptions are consistent with those used to determine the embedded value. The value of new business is shown after the effect of the frictional costs of holding required capital, and after the effect of the costs of residual non-hedgeable risks on the same basis as for the in-force covered business.
Total life and pensions – continued operations 27,920 30,180 689 716 2.5 2.4 Total life and pensions – discontinued operations1 1,085 3,178 1 (92) 0.1 (2.9)
Total life and pensions – continued operations 24,418 25,838 432 399 1.8 1.5
1 Current period discontinued operations represent the results of Delta Lloyd up to 6 May 2011 only.
Net of non-controlling interest 2011 £m 0–5 6–10 11–15 16–20 20+ Total
Restated Net of non-controlling interest 2010 £m 0–5 6–10 11–15 16–20 20+ Total
Net of non-controlling interests 2011 £m 0–5 6–10 11–15 16–20 20+ Total
Net of non-controlling interests 2010 £m 0–5 6–10 11–15 16–20 20+ Total 1 Current period discontinued operations represent the results of Delta Lloyd up to 6 May 2011 only.
E14– Segmental analysis of life and related business embedded value continued The required capital across our life businesses varies between 100% and 325% of EU minimum or equivalent. The weighted average level of required capital for our life business, excluding Delta Lloyd, expressed as a percentage of the EU minimum (or equivalent) solvency margin has increased to 135% (2010: 130%). These levels of required capital are used in the calculation of the Group’s embedded value to evaluate the cost of locked in capital. At 31 December 2011 the aggregate regulatory requirements based on the EU minimum test amounted to £5.9 billion (2010: £6.0 billion). At this date, the actual net worth held in our long-term business, excluding Delta Lloyd, was £9.3 billion (2010: £8.6 billion) which represents 158% (2010: 144%) of these minimum requirements.
The time value of options and guarantees (excluding Delta Lloyd) has increased by £621 million to £1,410 million, reflecting adverse impacts from economic movements over the year; in particular, significant increases in swaption volatility and decreases in risk-free rates. The allowance for non-hedgeable risks (excluding Delta Lloyd) increased by £124 million to £945 million, primarily due to lower reference rates. The charge for CNHR remains unchanged at 3.3%.
There are no non-controlling interests in the UK or North America.
E18 – Principal assumptions (a) Economic assumptions – deterministic calculations Economic assumptions are derived actively, based on market yields on risk-free fixed interest assets at the end of each reporting period. In setting the risk-free rate we have, wherever possible, used the mid-price swap yield curve for an AA-rated bank. The curve is extrapolated if necessary to get rates suitable to the liabilities. For markets in which there is no reliable swap yield curve the relevant government bond yields are used. For certain business, swap rates are adjusted for a ‘liquidity premium’ in deriving the risk-free rates, and these adjustments are shown below the reference rate table. Required capital is shown as a multiple of the EU statutory minimum solvency margin or equivalent. The principal economic assumptions used are as follows: Reference rate (spot, swap rates) and expense inflation
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. The risk-free rate is taken as the swap yield curve for the currency of the liability, adjusted as follows: 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. The approach to estimating the market level of liquidity premium in corporate bond assets is consistent with the formula structure proposed by the CFO/CRO Forum working party.
The formula is: UK/Europe: 50% of (iBoxx Corporate bond spread – 40bp) USA: 60% of (iBoxx Corporate bond spread – 40bp)
Risk premium – used for operating profit, implied discount rates (IDR), internal rates of return (IRR) and payback period For life and pensions operating earnings, Aviva uses normalised investment returns. The normalised investment returns are expressed as a swap rate based on the typical duration of the assets held plus an asset risk premium. More detail is given in note E1 – Basis of preparation. The use of asset risk premia only impacts operating earnings as expected returns reflect management’s long-term expectations of asset returns in excess of the reference rate from investing in different asset classes. This assumption does not impact the embedded value or value of new business as asset risk premia are not recognised until earned. The asset risk premia set out in the table below are added to the ten-year swap rate to calculate expected returns.
Future returns on fixed interest investments are calculated from prospective yields less an adjustment for credit risk.
1 The required capital in the United Kingdom under MCEV is 100% for unit-linked and other non-participating business and annuity business with 200% for BPA business. In addition, the reattribution of the inherited estate has led to additional capital being locked in to support the with-profit business, and this has been included within required capital. 2 Required capital in Ireland under MCEV is 174% for bancassurance and 180% for retail business. 3 This is the aggregate required capital level in Italy. The required capital as a percentage of EU minimum has increased due to the current economic environment. 4 Required capital in Spain is 156% of the EU minimum for Aviva Vida y Pensiones and 122%–130% for bancassurance companies. 5 Current tax legislation and rates have been assumed to continue unaltered except where changes in future tax rates have been substantively enacted as at the valuation date.
Other economic assumptions Required capital relating to with-profit business is generally assumed to be covered by the surplus within the with-profit funds and no effect has been attributed to shareholders. Where the fund is insufficient and additional shareholder support is required, this is included within required capital, including the RIEESA in the UK. Bonus rates on participating business have been set at levels consistent with the economic assumptions. The distribution of profit between policyholders and shareholders within the with-profit funds assumes that the shareholder interest in conventional with-profit business in the UK and Ireland continues at the current rate of one-ninth of the cost of bonus.