Diluted earnings per share on operating profit attributable to ordinary shareholders is 60.0p (2004: 53.7p).
Ordinary dividends declared and charged to equity in the year Final 2003 – 15.15 pence per share, paid on 17 May 2004 – 342 Interim 2004 – 9.36 pence per share, paid on 17 November 2004 – 211 Final 2004 –16.00 pence per share, paid on 17 May 2005 364 – Interim 2005 – 9.83 pence per share, paid on 17 November 2005 234 –
Preference dividends declared and charged to equity in the year 17 17 Coupon payments on direct capital instrument 42 –
Subsequent to 31 December 2005, the directors proposed a final dividend for 2005 of 17.44 pence per ordinary share, £418 million in total, making a total dividend for the year of 27.27 pence (2004: 25.36 pence). Subject to approval by shareholders at the AGM, the dividend will be paid on 17 May 2006 and will be accounted for as an appropriation of retained earnings in the year ending 31 December 2006.
Accumulated impairment At 1 January (41) – Impairment losses (43) (41) Disposals – – Foreign exchange rate movements (1) –
A summary of the goodwill allocated to cash-generating units is presented below. Spain United Kingdom RAC
(Long-term business) (General insurance and health) (non–insurance operations) Other Total £m £m £m £m £m £m £m £m £m £m
Goodwill and intangibles with indefinite useful lives have been tested for impairment in these businesses as follows: A viva plc 2005
15 – Goodwill continued Spain (long-term business) The recoverable amount of the Spanish unit has been determined based on a fair value less costs to sell calculation. This calculation is an actuarially-determined appraisal value and is based on the embedded value of the business together with the present value of expected profits from future new business. The recoverable amount significantly exceeds the carrying value of the cash generating unit including goodwill and a reasonably possible change in a key assumption will not cause the carrying value of the cash generating unit to exceed its recoverable amount.
Key assumptions used for the calculation were: – Embedded value represents the shareholder interest in the life business and is calculated in accordance with the European Embedded Value (EEV) principles. The embedded value is the total of the net worth of the life business and the value of the in-force business. The underlying methodology and assumptions have been reviewed by a firm of actuarial consultants and by the Group’s auditors; – New business contribution represents the present value of projected future distributable profits generated from business written in a period. This is based on 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 best estimate of future growth. The rate is in line with industry expectations; and
– Growth rate represents the rate used to extrapolate future cash flows beyond the business plan period and has been based upon latest information available regarding future and past growth rates. The growth rate is considered to be consistent with both past experience and external sources of data (ABI Annual Market Statistics).
RAC (non–insurance operations) The recoverable amount of the RAC (non-insurance operations) has also been determined based on a value in use calculation. The calculation uses cash flow projections based on business plans approved by management covering a three year period and a risk adjusted discount rate of 10.45%. Cash flows beyond that three year period have been extrapolated using a steady 2% growth rate. The recoverable amount significantly exceeds the carrying value of the cash generating unit including goodwill and intangible assets with indefinite useful lives and a reasonably possible change in a key assumption will not cause the carrying value of the cash generating unit to exceed its recoverable amount.
Other During the year, goodwill allocated to a Life cash-generating unit in Germany was tested for impairment. Following the impairment test, an impairment charge of £21 million has been recognised in the income statement. The impairment charge arose as a result of the low interest rate environment in which the cash generating unit operates in and the further decline in interest rates during the year. The recoverable amount for the cash-generating unit has been measured based on a value in use calculation. A pre-tax discount rate of 6.75% was used in the value in use calculation and cash flows beyond the plan period have been extrapolated using a steady 4.85% growth rate.
Notes to the consolidated financial statements continued 16 – Acquired value of in-force business (AVIF) and intangible assets Intangible
Acquisition of subsidiaries 30 61 91 Foreign exchange rate movements 5 1 6
Goodwill and intangibles (see notes Equity Total Total 15(a) and 16) interests Loans 2005 2004 £m £m £m £m £m
Share of results before tax – 332 – 332 234 Share of tax – (6) – (6) –
Additional loans – – 128 128 – Foreign exchange rate movements – 1 – 1 – Other movements and amounts classified as held for sale (167) (83) – (250) –
(ii) The principal joint ventures are as follows: Company GP proportion held PLP proportion held
Notes to the consolidated financial statements continued 17 – Investments in joint ventures continued (c) Other The Group also has a 50% holding in AVIVA-COFCO Life Insurance Company Limited, a life assurance company incorporated and operating in China. These shares are held by the Company, with a share of net assets of £10 million (2004: £14 million) and a fair value of £22 million (2004: £22 million).
Share of results after tax – 32 – 32 8 Amortisation of acquired value of in-force business – (18) – (18) (21)
Disposals – – – – (275) Fair value gains/(losses) taken to equity – (2) – (2) –
Foreign exchange rate movements – (4) – (4) (11) Additional loans/(loans repaid) – – – – 1 Other movements and amounts classified as held for sale – (5) – (5) (1)
(ii) In France, the Group has invested in a number of specialised investment companies. These invest mainly in equities, bonds, cash and cash equivalents, and properties, and distribute most of their income. Where the Group owns less than 50% of such companies, its interests are included in the consolidated balance sheet within financial investments or cash and cash equivalents as appropriate.
Notes to the consolidated financial statements continued 19 – Property and equipment Properties Ownerunder occupied Motor Computer Other construction properties vehicles equipment assets Total £m £m £m £m £m £m
Transfers to investment property (43) 40 – – – (3) Fair value gains (see note 32) – 42 – – – 42
Impairment losses/reversal of impairment losses recognised in the income statement and in equity were £nil (2004: £25 million) and £nil (2004: £nil) respectively.
19 – Property and equipment continued Owner-occupied properties are stated at their revalued amounts as assessed by qualified external valuers or by local qualified staff of the Group in overseas operations, all with recent relevant experience. Values are calculated on the basis of existing use, being the estimated arms-length value at which the properties could be exchanged with vacant possession and without allowing for alternatives to their current use.
If owner-occupied properties were stated on a historical cost basis, the carrying amount would be as follows: £m £m
Capitalised expenditure on existing properties 93 17 110 Fair value gains 1,056 98 1,154
Capitalised expenditure on existing properties 126 61 187 Fair value gains 1,169 402 1,571
Long leaseholds – over 50 years 3,018 1,939 Short leaseholds – under 50 years – 6
Of the above loans, £12,257 million (2004: £11,014 million) is expected to be recovered more than one year after the balance sheet date.
(b) Collateral At 31 December 2005, the fair values of collateral which the Group has accepted and is permitted to sell or repledge in the absence of default, and of collateral that the Group has sold and has an obligation to return, were £580 million and £nil, respectively (2004: £nil and £nil, respectively).
Delta Lloyd companies have purchased notes in the securitisation companies, which have been offset against the borrowings of the securitisation companies in the consolidated balance sheet.
Of the above total, £19,509 million (2004: £17,794 million) is expected to be recovered more than one year after the balance sheet date.
(b) The following is a summary of the cost/amortised cost, gross unrealised gains and losses and fair value of financial investments: Cost/ amortised Unrealised Unrealised cost gains losses Fair value £m £m £m £m
(ii) Included within financial investments are strategic investments held on a long-term basis as follows: Market value of shareholding
Impairment charges for the year 4 44 7 55 Reversal of impairment charges during the year (1) (122) (1) (124)
Impairment charges for the year – – – – Reversal of impairment charges during the year (1) (137) – (138)
Notes to the consolidated financial statements continued 23 – Financial investments continued (e) Stocklending The Group has entered into stocklending arrangements in the United Kingdom and overseas during the year in accordance with established market conventions. In the United Kingdom, investments are lent to locally-domiciled counterparties and governed by agreements written under English law. Other investments are specifically deposited under local laws in various countries overseas as security to holders of policies issued there.
24 – Receivables and other financial assets 2005 2004 £m £m
Expected to be recovered in less than one year 7,210 7,026 Expected to be recovered in more than one year 496 483
Deferred acquisition costs in respect of: Participating investment contracts 3 – 3 95 Non-participating investment contracts 752 – 752 494
25 – Deferred acquisition costs and other assets continued (b) The movements in deferred acquisition costs during the year were: £m £m
Impairment losses (4) (7) Reversal of impairment losses – 2 Other movements 66 62
(d) Prepayments and accrued income include £467 million (2004: £456 million) that is expected to be recovered more than one year after the balance sheet date.
The authorised share capital of the Company at 31 December 2005 was: 3,000,000,000 (2004: 3,000,000,000) ordinary shares of 25 pence each 750 750
(ii) Executive share options These are options granted on various dates from 1996 to 2004, under the Aviva Executive Share Option Scheme or predecessor schemes. The exercise of options granted before 1997 is not subject to performance conditions. Options granted between 1997 and 2000 were subject to the satisfaction of conditions relating to either the Company’s return on capital employed (ROCE) or its relative total shareholder return (TSR) against a chosen comparator group. In respect of options granted from 2000 the performance condition has been a mixture of both ROCE and TSR measures. In all cases, performance is measured over a three-year performance period and the options are normally exerciable between the third and tenth anniversary of their grant.
The Group has established various employee share trusts to facilitate the delivery of shares under the above schemes. Details of these trusts are given in note 29.
Range of exercise prices Outstanding options remaining contractual life exercise price Number Years p
The comparative figures as at 31 December 2004 were: Weighted average Weighted average
(c) Movements in the year A summary of the status of the option plans as at 31 December 2005 and 2004, and changes during the years ended on those dates, is shown below.
Granted during the year 7,956,344 434.64 6,830,193 493.88 Forfeited during the year (890) 719.00 – Exercised during the year (5,918,840) 419.69 (902,698) 418.16 Expired during the year (5,669,933) 581.58 (8,128,183) 696.65
(e) Fair value of options and awards granted after 7 November 2002 The weighted average fair value of options and awards granted during the year, estimated by using the Black-Scholes option-pricing model was £1.88 and £4.50 (2004: £1.56 and £4.08) respectively.
(i) Share options The fair value of the options was estimated on the date of grant, based on the following weighted average assumptions: Weighted average assumption 2005 2004
Share price 618p 538p Exercise price 491p 492p Expected volatility 35% 42% Expected life 3.81 years 4.69 years Expected dividend yield 4.1% 4.6% Risk free interest rate 4.2% 4.9%
The risk-free interest rate was based on the yields available of UK government bonds as at the date of grant. The bonds chosen were those with a similar remaining term to the expected life of the options.
28 – Equity compensation plans continued (ii) Share awards The fair value of the awards was estimated on the date of grant, based on the following weighted average assumptions: Weighted average assumption 2005 2004
Cost of options granted to employees in prior years – (40)
These shares are owned by employee share trusts in the Company and a subsidiary undertaking to satisfy awards under the Group’s Long Term Incentive Plan and Deferred Bonus Plans. The shares are purchased in the market and carried at cost. Further details of the shares held can be found in note 28. Details of the features of the plans can be found in the Directors’ remuneration report on pages 65 and 74.
Issued and paid up 100,000,000 83⁄8% cumulative irredeemable preference shares of £1 each 100 100 100,000,000 83⁄4% cumulative irredeemable preference shares of £1 each 100 100
Notes to the consolidated financial statements continued 30 – Preference share capital continued At the Annual General Meeting on 26 April 2005, the Company’s authorised preference share capital was increased to £700 million and a700 million by the creation of the new shares in the above table, in connection with the November 2004 issue of direct capital instruments (DCIs) of the same value. Note 31 below gives the conditions under which the Company has the right (but not the obligation) to substitute the sterling DCIs with Sterling New Preference Shares and the euro DCIs with Euro New Preference Shares. Although the directors have no present intention to allot these new shares, and consider the likelihood of such an issue and allotment to be remote, the Company is obliged to create and maintain a sufficient number of authorised new shares to effect a substitution.
Notional amount £m £m 5.9021% £500 million direct capital instrument 500 500 4.7291% a700 million direct capital instrument 490 490
Currency occupied Investment Hedging Equity translation properties valuation instruments compensation reserve (see reserve (see reserve (see reserve (see reserve (see accounting accounting accounting accounting accounting policy D) policy N) policy R) policy S) policy Y) Total £m £m £m £m £m £m
Arising in the year: Fair value gains/(losses) – 32 (65) (19) – (52) Fair value (gains)/losses transferred to profit – – 411 – – 411 Share of fair value changes in joint ventures and associates taken to equity – 2 – – – 2 Impairment losses on revalued assets – – (45) – – (45) Reserves credit for equity compensation plans (note 28d) – – – – 22 22 Foreign exchange rate movements (2) – – 19 – 17 Aggregate tax effect – policyholder tax – 3 – – – 3 Aggregate tax effect – shareholder tax – (4) 45 5 – 46
Notes to the consolidated financial statements continued 34 – Minority interests Minority interests at 31 December comprised: £m £m
Provision for claims incurred but not reported – 2,324 2,324 – 2,023 2,023
AVIF recognised in realistic liabilities – – – (81) – (81)
– In the Netherlands, the balance of profits, after providing appropriate returns for policyholders and after tax, accrues for the benefit of the shareholders. The bases for determining returns for policyholders are complex, but are consistent with methods and criteria followed generally in the Netherlands. In addition, a substantial number of policies provide benefits which are determined by investment performance, subject to certain guarantees, and shareholders’ profits are derived largely from management fees.
Bonuses paid during the year are reflected in claims paid, whilst those allocated as part of the bonus declaration are included in the movements in the long-term business provision.
In the Provident Mutual and With-Profit funds in NUL&P, this is offset by the expected cost of charges to WPBR to be made in respect of guarantees.
Future regular bonuses Annual bonus assumptions for 2006 have been set consistently with the year end 2005 declaration. Future annual bonus rates reflect the principles and practices of the fund. In particular, the level is set with regard to the projected margin for final bonus and the change from one year to the next is limited to a level consistent with past practice.
Mortality Mortality assumptions are set with regard to recent company experience and general industry trends. Since 2004, there have been some changes to the adjustments to the base tables for annuities in payment in order to reflect more closely the actual experience of this business.
Assurances, pure endowments and deferred annuities before vesting Nil or AM92/AF92 or Nil or AM92/AF92 or AM80/ AM80/AF80 adjusted AF80 or A67/70 adjusted
Pensions business after vesting and pensions annuities in payment PCMA00/PCFA00 or PMA80/PFA80 or PMA92/PFA92 PMA92/PFA92 adjusted plus adjusted plus allowance for future allowance for future mortality mortality improvement improvement
Non-profit business Conventional non-profit contracts, including those written in the with-profit funds, are valued using gross premium methods which discount projected future cash flows. The cash flows are calculated using the amount of contractual premiums payable, together with explicit assumptions for investment returns, inflation, discount rates, mortality, morbidity, persistency and future expenses. These assumptions vary by contract type and reflect current and expected future experience. All contracts are assumed to continue for the contractual term.
For all non-profit business, including annuities, valuation discount rate assumptions are set with regard to yields on the supporting assets and the general level of long-term interest rates as measured by gilt yields. An explicit allowance for risk is included by restricting the yields for equities and properties with reference to a margin over long-term interest rates or by making an explicit deduction from the yields on corporate bonds, mortgages and deposits, based on historical default experience of each asset class. A further margin for risk is then deducted for all asset classes.
Assurances Life conventional non-profit 2.9% to 3.6% 3.2% to 4.0% Pensions conventional non-profit 3.6% to 4.0% 4.0% to 4.5%
Notes to the consolidated financial statements continued 35 – Insurance liabilities continued Mortality tables used
Pure endowments and deferred annuities before vesting Nil or AM80/AF80 or Nil or AM80/AF80 or AM92/AF92 adjusted AM92/AF92 adjusted
Annuities in payment General annuity business IML00/IFL00 adjusted IMA80/IFA80 adjusted plus allowance for future plus allowance for future mortality improvement mortality improvement
35 – Insurance liabilities continued (d) In all 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.
Carrying amount at 1 January 106,491 96,228 Provisions in respect of new business 6,589 5,839 Expected change in existing business provisions (2,703) (3,164) Variance between actual and expected experience 3,784 1,680 Impact of operating assumption changes (1,034) 377 Impact of economic assumption changes 2,411 1,004 Other movements 340 227
Change in liability recognised as an expense 9,387 5,963 Portfolio transfers, acquisitions and disposals (360) 924 Foreign exchange rate movements (684) 289 Effect of adjusting to FRS 27 realistic basis – 3,087 Other movements (404) –
Netherlands Permanent health and injury 3.21% 3.27% 7 years 10 years
The net outstanding claims provisions before discounting were £13,014 million (2004: £12,816 million). The period of time which will elapse before the liabilities are settled has been estimated by modelling the settlement patterns of the underlying claims.
Assumptions Outstanding claims provisions are estimated based on known facts at the date of estimation. Case estimates are generally set by skilled claims technicians, applying their experience and knowledge to the circumstances of individual claims. 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.
Notes to the consolidated financial statements continued 35 – Insurance liabilities continued In most cases, no explicit assumptions are made regarding future rates of claims inflation or loss ratios. Instead, the assumptions used are those implicit in the historic claims development data on which the projections are based. Additional qualitative judgement is used to assess the extent to which past trends may not apply in the future, for example, to reflect one-off occurrences, changes in external or market factors such as public attitudes to claiming, economic conditions, levels of claims inflation, judicial decisions and legislation, as well as internal factors such as portfolio mix, policy conditions and claims handling procedures in order to arrive at the estimated ultimate cost of claims that represents the likely outcome, from the range of possible outcomes, taking account of all the uncertainties involved.
Carrying amount at 1 January 12,750 12,378 Impact of changes in assumptions (6) (30) Claim losses and expenses incurred in the current year 7,124 6,770 Increase/(decrease) in estimated claim losses and expenses incurred in prior years (372) (234)
Incurred claims losses and expenses 6,746 6,506 Less: Payments made on claims incurred in the current year (3,379) (3,120) Payments made on claims incurred in prior years (3,407) (3,244) Recoveries on claim payments 263 233
The effect of changes in the main assumptions is given in Note 39.
(d) Loss development tables The tables that follow present the development of claim payments and the estimated ultimate cost of claims for the accident years 2001 to 2005. The upper half of the tables shows the cumulative amounts paid during successive years related to each accident year. For example, with respect to the accident year 2001, by the end of 2005 £5,966 million had actually been paid in settlement of claims. In addition, as reflected in the lower section of the table, the original estimated ultimate cost of claims of £6,590 million was re-estimated to be £6,754 million at 31 December 2005. This increase from the original estimate is due to the combination of a number of factors, including claims being settled for larger amounts than originally estimated. The original estimates will also be increased or decreased, as more information becomes known about the individual claims and overall claim frequency and severity.
In the year of adoption of IFRS, only five years are required to be disclosed. This will be increased in each succeeding additional year, until ten years of information is included.
Gross cumulative claim payments At end of accident year (3,029) (2,952) (2,819) (2,971) (3,345)
Estimate of gross ultimate claims At end of accident year 6,590 6,250 6,385 6,891 7,106
Net cumulative claim payments At end of accident year (2,970) (2,913) (2,819) (2,870) (3,281)
Two years later 6,321 5,997 6,037 Three years later 6,329 5,973 Four years later 6,286
Present value recognised in the balance sheet 2,401 634 921 1,489 1,912 3,694 11,051
In the loss development tables shown above, the cumulative claim payments and estimates of cumulative claims for each accident year are translated into sterling at the exchange rates that applied at the end of that accident year. The impact of using varying exchange rates is shown at the bottom of each table. Disposals are dealt with by treating all outstanding and IBNR claims of the disposed of entity as “paid” at the date of disposal.
Notes to the consolidated financial statements continued 35 – Insurance liabilities continued (e) Provision for unearned premiums Movements The following changes have occurred in the provision for unearned premiums (“UPR”) during the year: £m £m
Of the above total, £3,717 million (2004: £4,433 million) is expected to be recovered more than one year after the balance sheet date.
(ii) The following is a summary of the reinsurance assets and related insurance reserves as at 31 December.
Provisions for claims incurred but not reported (2,324) 82 (2,242) (2,023) 86 (1,937)
Provision arising from liability adequacy tests (48) – (48) (33) – (33)
36 – Reinsurance assets continued (c) Movements The following movements have occurred in the reinsurance asset during the year: (i) Long-term business £m £m
Change in asset recognised as income (530) 818 Portfolio transfers and acquisitions – 313 Foreign exchange rate movements (78) 32 Effect of adjusting provisions to FRS 27 realistic basis – 417 Other movements (564) 13
Carrying amount at 1 January 2,196 2,541 Impact of changes in assumptions – – Reinsurers’ share of claim losses and expenses incurred in current year 146 193 Reinsurers’ share of claim losses and expenses incurred in prior years (10) (158) Reinsurers’ share of incurred claim losses and expenses 136 35 Less: Reinsurance recoveries received on claims incurred in current year (48) (103) Reinsurance recoveries received on claims incurred in prior years (251) (244) Reinsurance recoveries received in the year (299) (347) Other movements 5 3
Change in reinsurance asset recognised as income (158) (309) Reinsurers’ share of portfolio transfers and acquisitions (93) – Foreign exchange rate movements 26 1 Other movements (57) (37)
(iii) Reinsurers’ share of the provision for unearned premiums (“UPR”) 2005 2004 £m £m
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 38.
Carrying amount at 1 January 43,974 36,974 Reserves in respect of new business 3,467 3,284 Expected change in existing business provisions (1,720) (1,340) Variance between actual and expected experience 2,034 1,400 Impact of operating assumption changes 5 (18) Impact of economic assumption changes 513 47 Other movements (153) 73
Change in liability 4,146 3,446 Portfolio transfers and acquisitions 4 2,030 Foreign exchange rate movements (856) 304 Effect of adjusting to FRS 27 realistic basis – 1,220 Other movements (10) –
(a) UK Life with-profits business In the UK, life insurers are required to comply with the FSA’s realistic reporting regime for their with-profit funds for the calculation of FSA liabilities. Under the FSA’s rules, provision for guarantees and options within realistic liabilities must be measured at fair value, using market-consistent stochastic models. A stochastic approach includes measuring the time value of guarantees and options, which represents the additional cost arising from uncertainty surrounding future economic conditions.
In addition, while these do not constitute guarantees, the Group has made promises to certain policyholders, in relation to their mortgage endowments, that payments on these policies will meet the mortgage value, provided investment returns exceed 6% per annum net of tax between 1 January 2000 and maturity and the investment returns on the free reserves are sufficient to meet the top-up costs.
(b) UK Life non-profit business The Group’s UK non-profit funds are not subject to the requirements of the FSA’s realistic reporting regime and, therefore, liabilities are evaluated by reference to local statutory reserving rules.
(i) Guaranteed annuity options – Similar options to those written in the with-profit fund have been written in relation to non-profit products. Provision for these guarantees does not materially differ from a provision based on a market-consistent stochastic model, and amounts to £44 million at 31 December 2005 (2004: £47 million).
(ii) Guaranteed unit price on certain products – Certain unit-linked pension products linked to long-term life insurance funds provide policyholders with guaranteed benefits at retirement or death. No additional provision is made for this guarantee as the investment management strategy for these funds is designed to ensure that the guarantee can be met from the fund, mitigating the impact of large falls in investment values and interest rates.
The most significant of these contracts is the AFER Eurofund which has total liabilities of £22 billion at 31 December 2005 (2004: £21 billion). The guaranteed bonus on this contract equals 65% of the average of the last two years’ declared bonus rates (or 60% of the TME index rates if higher) and was 3.51% for 2005 (2004: 3.69%) compared with an accounting income from the fund of 4.91%
Non-AFER contracts with guaranteed surrender values had liabilities of £7 billion (2004: £6 billion) at 31 December 2005 and guaranteed annual bonus rates are between 0% and 4.5% on 97.8% of liabilities. There are higher guarantees in force on some older policies including a small number of policies with a guarantee of 8.5%. For non-AFER business, the accounting income return exceeded guaranteed bonus rates in 2005.
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 balance sheet at the end of 2005 for this guarantee is £14 million (2004: £17 million). The reserve is calculated on a prudent basis and is in excess of the economic liability. At the end of 2005, total sums at risk for these contracts were £73 million (2004: £182 million) out of total unit-linked funds of £8 billion (2004: £6 billion). The average age of policyholders was approximately 53. It is estimated that the economic liability would increase by £1 million (2004: £2 million) if yields were to decrease by 1% per annum and by £0.1 million (2004: £1 million) if equity markets were to decline by 10% from year end 2005 levels. These figures do not reflect our ability to review the tariff for this option.
(ii) Netherlands Guaranteed minimum return at maturity In the Netherlands, it is market practice to guarantee a minimum return at maturity on traditional savings and pensions contracts. Guarantees on older lines of business are 4% per annum while, for business written since 1 September 1999, the guarantee is 3% per annum. On group pensions business, it is often possible to recapture guarantee costs through adjustments to surrender values or to premium rates.
Return of premium guarantee In 2005 Hibernian Life has written two tranches of linked bonds with a return of premium guarantee after five or six years. The provision for these at the end of 2005 is £3 million. It is expected that the provision would increase by £4 million if equity markets were to decline by 10% from year end 2005 levels. We would not expect any significant impact on this provision as a result of interest movements.
(d) 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, real estate prices and equity prices. Interest rate guaranteed returns, such as those available on guaranteed annuity options (GAOs), are sensitive to interest rates falling below the guaranteed level. Other guarantees, such as maturity value guarantees and guarantees in relation to minimum rates of return, are sensitive to fluctuations in the investment return below the level assumed when the guarantee was made.
Long-term insurance business Interest rates (1,078) Expenses (12) Persistency rates 3 Mortality for assurance contracts 25 Mortality for annuity contracts (39) Tax and other assumptions (3) Investment contracts Interest rates (11) Expenses (6) Tax and other assumptions (2) General insurance and health business Change in loss ratio assumptions 2 Change in expense ratio assumptions 4
The impact of interest rates for long-term business relates primarily to the UK and the Netherlands. This results from the use of lower valuation interest rates on annuities and other business, reflecting the fall in market interest rates over the year.
The mortality impacts relate primarily to assumption changes in the UK and Ireland.
Long-term business technical provisions and other insurance items 1,155 991 Deferred acquisition costs (245) (210) Unrealised gains/losses on investments (2,561) (1,932) Provisions and other timing differences (223) (64) Impairment of assets 1 – Pensions and other post-retirement obligations 488 275 Unused losses and tax credits 57 318 Other temporary differences (112) (13)
Deferred tax liabilities of £347 million (2004: £181 million) have not been established for temporary differences associated with investments in subsidiaries and interests in joint ventures and associates (including tax payable on remittance of overseas retained earnings) because the Group can control the timing of the reversal of these differences and it is probable that they will not reverse in the foreseeable future. Such unremitted earnings totalled £1,659 million at 31 December 2005 (2004: £1,185 million).
Deficits in the staff pension schemes (note 42) 1,471 893 Other obligations to staff pension schemes – insurance policies issued by Group companies (note 35a) 875 813
Total IAS 19 obligations to staff pension schemes 2,346 1,706 Restructuring provisions 36 41 Other provisions 493 378
Of the total, £2,370 million (2004: £1,812 million) is expected to be settled more than one year after the balance sheet date.
(b) Movements during the year on restructuring and other provisions Restructuring Other provision provisions Total £m £m £m
Charge to income statement 128 195 323 Utilised during the year (132) (106) (238) Acquisition of subsidiaries – 34 34 Disposal of subsidiaries (1) (8) (9)
42 – Pension obligations continued (c) Details of the material defined benefit schemes (i) The valuation used for accounting under IAS 19 has 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 2005. The updating was made by actuaries in each country who, other than the actuary of the Aviva Staff Pension Scheme and Dutch arrangements, were independent of the Group. Scheme assets are stated at their market values at 31 December 2005.
Date of most recent actuarial valuation 1.4.05 1.4.04 31.12.05 31.12.03 31.12.04 31.12.03 1.1.04 1.1.04
The UK schemes are by far the most material to the Group. The post-retirement mortality base table used for these schemes is PA92 (calendar year 2006) with a one-year age rating deduction schemes, which is considered appropriate based on the mortality experience of the schemes. In addition, post-retirement mortality improvements are allowed for through a reduction to the discount rate of 30 basis points which is considered a best estimate. However, the extent of future improvements in longevity is subject to considerable uncertainty and judgement is required in setting this assumption. Increasing the allowance by 10 basis points to a 40 basis point reduction to the discount rate would increase the schemes’ liabilities by £150 million.
Current service cost 158 148 Past service (credit)/cost (7) 1 Gain/(loss) on curtailments (21)* 8 Charge to net operating expenses 130 157 Expected return on scheme assets (439) (390) Interest charge on scheme liabilities 407 362 Credit to investment income (32) (28)
Total fair value of assets 6,727 4,991 832 755 226 168 424 372 8,209 6,286
Present value of scheme liabilities (8,098) (5,734) (876) (838) (288) (202) (418) (405) (9,680) (7,179)
(vi) Movements in the pension schemes’ deficits comprise: Scheme Scheme Pension assets liabilities deficit £m £m £m
The change in the net pension deficit during 2005 is mainly attributable to changes in assumptions underlying the present value of the schemes’ liabilities, partially offset by an increase in the market value of their assets. In the United Kingdom, the value of the liabilities has increased due to lower corporate bond yields, which are used to set the valuation discount rate, a higher assumed inflation rate and a strengthening to the post-retirement mortality future improvements allowed for in the basis. The increase in scheme assets is primarily due to an improvement in equity and bond values since the previous year end, together with deficit contribution payments made by the employing companies. The deficit has further increased by £313 million as a result of the acquisition of the RAC group in May 2005.
Notes to the consolidated financial statements continued 43 – Borrowings (a) Carrying amounts The following table provides information about the maturity periods and effective interest rates of the Group’s borrowings.
Within Over Effective Denominated 1 year 1-2 years 2-3 years 3-4 years 4-5 years 5 years Total interest rate currency £m £m £m £m £m £m £m %
Debenture loans 2.5% subordinated perpetual loan notes a – – – – – 119 119 2.5% Other loans various – – – – – 17 17 4.2%
Total commercial paper various 503 – – – – – 503 3.9%
Securitised mortgage loan notes UK lifetime mortgage business £ – – – – – 1,879 1,879 5.6% Dutch domestic
Subordinated debt 5.750% a800 million 5.700% a500 million undated subordinated notes a – – – – – 350 350 6.1
(b) Description and features (i) Subordinated debt A description of each of the subordinated notes is set out in the table below: Callable at par In the event the Company does not at option of the call the notes, the coupon will reset
The subordinated notes were issued by the Company. They rank below its senior obligations and ahead of its preference shares and ordinary share capital. The dated subordinated notes rank ahead of the undated subordinated notes. The fair value of these notes at 31 December 2005 was £4,172 million (2004: £3,107 million).
Notes to the consolidated financial statements continued 43 – Borrowings continued (ii) Debenture loans The 9.5% guaranteed bonds were issued by the Company at a discount of £1.1 million. This amount, together with the issue expenses, is being amortised over the full term of the bonds. Although these bonds were issued in sterling, the loans have effectively been converted into euro liabilities through the use of financial instruments in a subsidiary.
Other loans comprise borrowings in Canada, France, the Netherlands and Spain.
New borrowings drawn down, net of expenses 5,441 2,623 Repayment of borrowings (4,585) (1,097)
Expiring within one year 890 650 Expiring beyond one year 1,360 1,600 44 – Payables and other financial liabilities 2005 2004 £m £m
Bank overdrafts arise substantially from unpresented cheques and amount to £115 million (2004: £133 million) in long-term business operations and £369 million (2004: £518 million) in general business and other operations. Other financial liabilities include the obligation to repay £467 million (2004: £240 million) received under stock repurchase arrangements entered into in the United Kingdom and the Netherlands.
Deferred income 265 207 Reinsurers’ share of deferred acquisition costs 146 72
Other liabilities 1,862 3,389 Less: Amounts classified as held for sale (49) –
Expected to be settled within one year 2,539 3,760 Expected to be settled in more than one year 781 1,157
Notes to the consolidated financial statements continued 46 – Contingent liabilities and other risk factors (a) Uncertainty over claims provisions Note 35 gives details of the estimation techniques used in determining the general business outstanding claims provisions and of the methodology and assumptions used in determining the long-term business provisions, which are designed to allow for prudence and the appropriate cost of future policy-related liabilities. Both are estimated to give a result within the normal range of outcomes. To the extent that the ultimate cost falls outside this range, for example where experience is worse than that assumed for long-term business, or future general business claims inflation differs from that expected, there is uncertainty in respect of this liability.
(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 litigation arising therefrom, including claims in respect of pollution and other environmental hazards. Amongst these are claims in respect of asbestos production and handling in various jurisdictions, including the United Kingdom, Australia and Canada. Given the significant delays that are experienced in the notification of these claims, the potential number of incidents which they cover and the uncertainties associated with establishing liability and the availability of reinsurance, the ultimate cost cannot be determined with certainty. However, the Group’s net exposure to such liabilities is not significant and, on the basis of current information and having regard to the level of provisions made for general insurance claims, the directors consider that any costs arising are not likely to have a material impact on the financial position of the Group.
(d) Pensions mis-selling The pensions review of past sales of personal pension policies which involved transfers, opt outs and non-joiners from occupational schemes, as required by the Financial Services Authority (FSA), has largely been completed. A provision of some £42 million (2004: £52 million) remains to meet the outstanding costs of the very few remaining cases, the anticipated cost of any guarantees provided, and potential levies payable to the Financial Services Compensation Scheme. It continues to be the directors’ view that there will be no material effect either on the Group’s ability to meet the expectations of policyholders or on shareholders.
In August 2004, the Group confirmed its intention to introduce time barring on mortgage endowment complaints, under FSA rules, by the end of 2006. The Group is writing to its 1.1 million endowment policyholders as part of its ongoing review, stating that it intends to introduce a time bar on mortgage endowment complaints in the future. Customers will be given at least 12 months’ individual notice before a time bar becomes applicable – double the six months’ notice required by the FSA.
47 – Commitments (a) Capital commitments Contractual commitments for acquisitions or capital expenditures of investment property, property and equipment and intangible assets, which were not recognised in the financial statements, were as follows: £m £m
The Group has capital commitments to its joint ventures in the amount of £34 million (2004: £15 million).
(ii) Future aggregate minimum lease payments under non-cancellable operating leases are as follows: £m £m
Later than 1 year and not later than 5 years 330 356 Later than 5 years 422 381
The total of future minimum sub-lease payments expected to be received under non-cancellable subleases 143 132
Cash at bank and in hand 3,530 1,631 Cash equivalents 10,227 11,148
Available capital resources CGNU CULAC NUL&P Total UK life Other Total Overseas with- with- with- with-profit UK life UK life life Total life Other 2005 2004 profit fund profit fund profit fund3 fund operations operations operations operations operations4 Total Total £m £m £m £m £m £m £m £m £m £m £m
A further analysis of the movement in the liabilities of the long-term business can be found in notes 35 and 37.
Other movements in capital reflect cashflows for premiums received, benefits paid and the investment return on assets held. This movement also includes the change in the regulatory adjustments and regulatory rules. The only regulatory rule changes having significant impact in the year are a change in the basis for inclusion of non-insurance subsidiaries from market value to a surplus assets basis, and new rules relating to the recognition of pension deficits, requiring a charge to be made based on anticipated additional payments over the next five years instead of the inclusion of the full scheme deficit.
Within the Aviva group there exist intra-group arrangements to provide capital to particular business units. Included within these arrangements is a subordinated loan of £200 million from Aviva plc to the NUL&P non-profit fund to provide capital to support the writing of new business.
Notes to the consolidated financial statements continued 49 – Capital statement continued 31 December 31 December
For UK non-participating business, the relevant capital requirement is the minimum solvency requirement determined in accordance with FSA regulations.
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: (iii) UK with-profit funds – (CGNU Life, CULAC and NUL&P) – any available surplus held in each fund can only be used to meet the requirements of the fund itself or be distributed to policyholders and shareholders. 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 in the case of CGNU Life, CULAC and NUL&P.
(iv) UK non-participating funds – any available surplus held in these is attributable to shareholders. Capital within 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.
(v) Overseas life operations – the capital requirements and corresponding regulatory capital held by overseas businesses are calculated using the locally applicable regulatory regime. The available capital resources in all these businesses are subject to local regulatory restrictions which may constrain management’s ability to utilise these in other parts of the Group. Any transfer of available capital may give rise to a tax charge subject to availability of tax relief elsewhere in the Group.
(vi) General insurance operations – the capital requirements and corresponding regulatory capital held by overseas businesses are calculated using the locally applicable regulatory regime. The available capital resources in all these businesses are subject to local regulatory restrictions which may constrain management’s ability to utilise these in other parts of the Group. Any transfer of available capital may give rise to a tax charge, subject to availability of tax relief elsewhere in the Group.
50 – Risk management policies (a) Governance framework The Group has established a risk and financial management framework whose primary objective is to protect the Group from events that hinder the sustainable achievement of the Group’s performance objectives, including failing to exploit opportunities. The Group recognises the critical importance of having efficient and effective risk management systems in place. To this end, the Group has an established governance framework, details of which are given in the corporate governance section of this report on pages 57 to 61. This framework has three key elements: – Defined terms of reference for the Board, its committees, and the associated executive management committees; – A clear organisational structure with documented delegated authorities and responsibilities from the Board to executive management committees and senior management; and
– A Group policy framework that sets out risk appetite, risk management, control and business conduct standards for the Group’s world wide operations. Each policy has a member of senior management who is charged with overseeing compliance with the policy throughout the Group.
(b) The Group’s approach to financial risk and capital management Integration of risk and capital management The Group has developed a capital management framework using Individual Capital Assessment (ICA) principles for identifying the risks that business units, and the Group as a whole are exposed to, quantifying their impact on economic capital. The ICA estimates how much capital is needed to mitigate the risk of insolvency to a selected remote level of risk applied to a number of tests (both financial and non-financial) on the capital position of the business. The ICA works to a 99.5% confidence level of solvency over one year, in line with UK FSA regulatory requirements. An ICA has been developed for all material parts of the Group, and the results of financial and operating experience tests are linked to the Group’s risk reporting model.
The Group also uses Financial Condition Reports (FCRs) to inform decisions on capital management issues. The FCR is a medium-term forecast of the overall financial position of the business under a variety of economic and operating scenarios, allowing for new business. The FCR considers a number of financial performance measures in addition to solvency and capital requirements. FCRs are produced by business units and enable the Group to assess: – The range of risks to which the business is exposed; – Their evolution over time; and
(c) Management of financial and non-financial risks The Group has established policies on the management of financial and non-financial risks. The adoption of these policies throughout the Group enables a broadly consistent approach to the management of risk at business unit level. In addition, the Group operates a number of oversight committees that monitor aggregate risk data and take overall risk management decisions. Further details as to the operation of these policies and committees are provided by risk area below.
(i) Insurance Risk Life Insurance Business The risk management framework for life insurance business is set out as follows.
Notes to the consolidated financial statements continued 50 – Risk management policies continued The committee considers all areas of life insurance risk, but in particular has a remit to monitor mortality, longevity, persistency, 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 businesses adopt a risk management framework to mitigate against any life insurance risk outside local appetite, within the parameters for the overall Group risk appetite. The framework adopted in business units is reviewed in detail and approved twice yearly. The key points of this framework are as follows: – Mortality and morbidity – businesses must implement an underwriting procedure, and regularly monitor experience against external benchmarks; – All risks must be managed at product or portfolio level to avoid cross subsidies between product lines and between different funds; and
Mortality and morbidity risks are mitigated by use of reinsurance. The Group allows business units to select reinsurers based on local factors, but assesses the overall programme to manage group-wide risk exposures and monitor the aggregation of risk ceded to individual reinsurers is within appetite for credit risk.
4. Embedded derivatives within insurance contracts 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.
2. Risk management Significant insurance risks will be reported through the Group Risk monitoring framework. Additionally, the ICA framework is used to assess the risks that each general insurance business unit, and the Group as a whole, is exposed to, quantifying their impact and calculating appropriate capital requirements.
Actuarial Management The adequacy of the Group’s general insurance claims provisions is ultimately overseen by the Reserving Committee, which covers both life and general insurance reserving. Actuarial claims reserving is conducted by local actuaries in the various general insurance business units according to the General Insurance Reserving policy. The General Insurance Risk Committee monitors and maintains the General Insurance Reserving policy, and conducts quarterly reviews of the Group’s general insurance claims provisions, and their adequacy. The reviews are conducted under the direction of the Aviva General Insurance Actuarial Director and include peer reviews of the business unit’s own conclusions as well as independent analysis to confirm the reasonableness of the local reviews. A number of business units also have periodic external reviews by local consultant actuaries (often as part of the local regulatory requirement).
Notes to the consolidated financial statements continued 50 – Risk management policies continued (ii) Asset/liability management (ALM) The Group has established a policy on asset liability management that sets out the minimum principles that businesses are expected to adopt to manage the key ALM risks to which the Group is exposed. The Group monitors adherence to this policy and regularly reviews how business units are managing the ALM risks locally, through the Group Investment Committee and ultimately to the Asset Liability Management committee.
The Group policy sets out the 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 in order to manage the financial risk from the mismatching of assets and liabilities as investment markets change. In addition, the local regulatory environment for each business sets out how asset and liabilities are to be matched.
Maturity periods and interest rate risk Interest rate risk arises primarily from the products sold by the Group and the value of investments. For example, long-term debt and fixed income securities are exposed to fluctuations in interest rates. Exposure to interest rate risk is monitored through several measures that include Value-at-Risk analysis, position limits, scenario testing, stress testing and asset and liability matching using measures such as duration.
Interest rate risk is managed using a variety of derivative instruments, including futures, options and swaps, caps & floors, in order to provide a degree of hedging against unfavourable market movements in interest rates inherent in the assets backing technical liabilities.
On certain categories of long-term business, interest rate risk is reduced through close matching of assets and liabilities. On short-term business such as general insurance business the Group requires a close matching of assets and liabilities by duration to minimise this risk.
31.12.2005 Within Over £m Total 1 year 1-5 years 5-15 years 15 years 31.12.2004 Within Over £m Total 1 year 1-5 years 5-15 years 15 years
Long-term business 31.12.2004 Within Over £m Total 1 year 1-5 years 5-15 years 15 years
50 – Risk management policies continued (iii) Market risk Market risk is the risk of adverse financial impact due to changes in fair values of financial instruments from fluctuations in foreign currency exchange rates, interest rates, property prices and equity prices. Market risk arises in business units due to fluctuations in 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.
Currency risk 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 and sterling. 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.
At 31 December 2005 the Group’s total equity deployment by currency was: Sterling Euro Other Total £m £m £m £m
Net assets are stated after taking account of the effect of currency swaps and forward foreign exchange contracts.
Interest rate risk Interest rate risk arises primarily from the Group’s investments, long-term debt and fixed income securities.
Interest rate risk also exists in policies that carry investment guarantees on early surrender or at maturity, where claim values can become higher than the value of backing assets when interest rates rise or fall.
The impact of exposure to sustained low interest rates is regularly monitored.
At 31 December 2005, the Group had entered into a number of interest rate swap agreements to mitigate the effects of potential adverse interest rate movements, and to enable close matching of assets and liabilities.
Property price risk The Group is subject to property price risk due to holdings of investment properties in a variety of locations worldwide. The investment in property is managed at business unit level, and will be subject to local regulations on asset admissibility, liquidity requirements and the expectations of policyholders. At 31 December 2005, no material derivative contracts had been entered into to mitigate the effects of changes in property prices.
Notes to the consolidated financial statements continued 50 – Risk management policies continued Equity price risk The Group is subject to equity price risk due to daily changes in the market values of its equity securities portfolio. The Group’s shareholders are exposed to both direct equity shareholdings in its shareholder assets, from the indirect impact from changes in the value of equities held in policyholders funds from which management charges or a share of performance are taken and from its interest in the free estate of long-term funds.
At business unit level, equity price risk is actively managed through the use of derivative instruments, including futures and options, in order to mitigate anticipated unfavourable market movements where this lies outside the risk appetite of the fund concerned. The Group does not have material holdings of unquoted equity securities. In addition local asset admissibility regulations require that business units hold diversified portfolios of assets thereby reducing exposure to individual equities.
The Investment Committee actively monitors its directly owned equity assets, which may include some material shareholdings in the Group’s strategic business partners.
Derivatives risk Derivatives are used to a limited extent, within policy guidelines agreed by the Board of Directors. Derivatives are only used for efficient investment management, risk hedging purposes or to structure specific retail-savings products. Derivative transactions are fully covered by either cash or corresponding assets and liabilities. Speculative activity is prohibited, unless approval has been obtained from the Derivatives committee and Group finance director. Over the counter derivative contracts are entered into only with approved counterparties, in accordance with our Group policies, thereby reducing the risk of credit loss. The Group applies strict requirements to the administration and valuation processes it uses, and has a control framework that is consistent with market and industry practice. The Derivatives committee monitors this framework, exposure levels and approves large or complex transactions proposed by business units.
A number of policyholder participation features have an influence on the Group’s interest rate risk. The following are the major features identified: – Guaranteed surrender values; – Guaranteed annuity options; and
The Group’s management of credit risk includes monitoring exposures at a Group level and requiring business units to implement local credit risk policies. Large individual counterparty exposures exceeding £25 million are aggregated and monitored at Group level against centrally-set limits reflecting the credit ratings by companies such as Standard & Poor’s. In addition, the Group evaluates the concentration of exposures by industry sector and geographic region through the Credit committee.
50 – Risk management policies continued The carrying amount of assets included on the balance sheet represents the maximum credit exposure.
Speculative AAA AA A BBB grade Not-rated Total £m £m £m £m £m £m £m
Concentrations of credit 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. In cases where the business is particularly exposed to credit risk (e.g. in respect of defaults on mortgages or debt matching annuity liabilities) this risk is translated into a more conservative discount rate used to value the liabilities, creating a greater capital requirement, and this credit risk is actively managed. The impact of aggregation of credit risk is monitored as described above. With the exception of AAA rated Governments the largest aggregated counterparty exposure does not exceed 1.6% of the Group’s total financial assets.
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 and the impact from reinsurer default is measured regularly, in particular through the ICA tests, and is managed accordingly. Both the Credit committee and Reinsurance Security committee have a monitoring role over this risk. The Group’s largest reinsurance counterparty is National Indemnity Corporation, a member of the Berkshire Hathaway Group. At 31 December the reinsurance asset recoverable from National Indemnity Corporation was £1.3bn. This exposure is monitored on a regular basis with the forecast to completion monitored for any shortfall in the claims history to verify that the contract is progressing as expected and that no further exposure for the Group will arise.
– Verify that aggregate operational risk exposures remain within risk appetites.
50 – Risk management policies continued (vi) Sensitivity analysis and capital management 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. Primarily, FCRs are used, and increasingly ICA. However, sensitivities to economic and operating experience are regularly produced on all of the Group’s financial performance measurements as part of the Group’s decision making and planning process, and to set the framework for identifying and quantifying the risks that each of its business units, and the Group as a whole are exposed to.
For example, under ICA, an estimate of how much capital is needed to mitigate the risk of insolvency from events occurring within a selected remote level of probability is measured. This high level risk appetite parameter is then used to calibrate a series of core stress and scenario tests of both an economic and operating nature to be examined by each business unit. Business units satisfy themselves that the range and level of these tests is appropriate to their local risk profile, and supplement the core tests where necessary. Business units also perform an assessment of the operational risk; this assessment is subject to central review and challenge by Group to verify consistency across business units and to identify aggregate exposures. The businesses are then able to assess the capital requirements within this risk appetite framework. The Group uses both results at a business unit level and aggregated results to assess the benefits of diversification of risk in the Group, and to assess capital requirements of the types of risk it is exposed to. These results enable the Group to assess whether its risk appetite is appropriate and whether mitigating action is required.
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.
Annuitant mortality (life insurance only) The impact of a reduction in mortality rates for annuity contracts by 5% Gross loss ratios (non-life insurance only) The impact of an increase in gross loss ratios for general insurance and health business by 5%.
Investment participating (10) (25) – – – Investment non-participating (5) – – – –
The mortality sensitivities relate primarily to the UK and Irish business units.
General insurance and health business – impact before tax on shareholders’ equity (£m) Gross loss
The sensitivity to a 5% increase in gross loss ratios is the same both net and gross of reinsurance because this increase does not result in any material excess of loss reinsurance limits being reached. For general insurance, the impact of the expense sensitivity on profit also includes the increase in on-going administration expenses, in addition to the increase in the claims handling expense provision.
Limitations of sensitivity analysis The above tables demonstrate the effect of a change in a key assumption while other assumptions remain unchanged. In reality, such an occurrence is remote, due to correlations between the assumptions and other factors. It should also be noted that these sensitivities are non-linear, and larger or smaller impacts should not be interpolated or extrapolated from these results.
51 – Derivative financial instruments continued Non-hedge derivative assets have the following maturities: £m £m
Within one year 17 22 Between one and two years 33 44 Between two and three years 205 271 Between three and four years – – Between four and five years – – After five years 212 280 52 – Assets under management The total Group assets under management are: £m £m
Income earned Receivable at Income earned Receivable at in year year end in year year end £m £m £m £m
Income Dividends received from subsidiaries 1,708 336 Interest receivable from Group companies 217 227 Net investment income (10) 19
Financial statements of the Company Income statement For the year ended 31 December 2005
Current assets Loans owed by subsidiaries 869 1,061 Other assets 55 144 Cash and cash equivalents 2 31
Loans owed to subsidiaries 1,121 949 Other amounts owed to subsidiaries 701 1,294 Other creditors 94 95
Fair value gains on investments in subsidiaries B 1,521 2,494 Aggregate tax effect 12b 13 – Reserves credit for equity compensation plans 9 22 21
Reconciliation of movements in shareholders’ equity For the year ended 31 December 2005
All the Company's operating and investing cash requirements are met by subsidiary companies and settled through intercompany loan accounts. As the direct method of presentation has been adopted for these activities, no further disclosure is required. In respect of financing activities, the following items pass through the Company's own bank accounts.
Net (decrease)/increase in cash and cash equivalents (29) 23 Cash and cash equivalents at 1 January 31 8
Where applicable, the accounting policies of the Company are the same as those of the Group on pages 78 to 86. The notes (identified alphabetically on pages 194 to 198) are an integral part of these separate financial statements. Where the same items appear in the Group financial statements, reference is made to the notes (identified numerically) on pages 93 to 189.
A – First time adoption of International Financial Reporting Standards (i) The Company has adopted International Financial Reporting Standards (IFRS) for these financial statements for the year ended 31 December 2005. In order to show comparative balances, the year ended 31 December 2004 is also shown under IFRS. The date of transition to IFRS is, therefore, 1 January 2004.
(ii) Reconciliation of equity reported under UK GAAP to equity reported under IFRS As at As at 1 January 31 December £m £m
(iii) Reconciliation of profit and loss reported under UK GAAP to profit and loss reported under IFRS For the year ended £m
(iv) Adjustments between UK GAAP and IFRS The basis for the material adjustments between UK GAAP and IFRS is as follows: (1) Dividend recognition Under UK GAAP, dividends are accrued in the period to which they relate, regardless of when they are declared and approved. Under IAS 10, Events after the Balance Sheet Date, shareholders’ dividends are accrued only when declared and appropriately approved. This affects both dividends receivable from subsidiaries and those payable to shareholders, increasing shareholders’ funds by £6 million at 1 January 2004 and reducing them by £1,344 million at 31 December 2004. Profit for the year ended 31 December 2004 was similarly reduced by £1,372 million as a result.
A – First time adoption of International Financial Reporting Standards continued (3) Pensions As explained in note 1(b)(iii) of the Group accounts, the Group’s UK GAAP pension policy was to expense the cost of providing pension benefits using actuarial valuation methods which give a substantially even charge over the expected service lives of employees. This resulted in either a prepayment or an accrual to the extent that this charge did not equate to the cash contributions made into the schemes. Under IAS 19, Employee Benefits, the projected benefit obligation is matched against the fair value of the underlying assets and other unrecognised actuarial gains and losses in determining the pension expense for the year in the Group financial statements. As explained in note C(ii) below, the Company now recognises a pension expense equal to its contributions payable in the year and provides for the cost of any unfunded benefits. This has reduced shareholders’ funds by £4 million at 1 January 2004 and by £27 million at 31 December 2004. Profit for the year ended 31 December 2004 was similarly reduced by £23 million as a result.
(4) Equity compensation plans Under IFRS 2, Share-based Payment, the Company has established an equity compensation reserve for all options and awards granted over its shares. The credit to equity as at 31 December 2004 arises because the cost of such options and awards is borne by the participating businesses and the charge to the Company's own income statement is therefore less than the reserve credit. The credit to the 2004 income statement under IFRS reflects the timing difference between charging under UK GAAP and IFRS for these options and awards.
As part of the ongoing Group restructuring, the Company acquired all the shares in Norwich Union Holdings Limited and Norwich Union Limited from subsidiaries on 12 December and 20 December 2005 respectively. These transactions were carried out at their fair values and are also included in “acquisitions” above.
Staff costs and other employee-related expenditure 62 55 Other operating costs 120 84 Net foreign exchange (gains)/losses (22) 29
Full disclosure on the Group’s pension schemes is given in note 42 on pages 164 to 167.
C – Operating expenses continued (iii) Equity compensation plans All transactions in the Group’s equity compensation plans involve options and awards for ordinary shares of the Company. Full disclosure of these plans is given in note 28 on pages 142 to 145. The cost of such options and awards is borne by all participating businesses and, where relevant, the Company bears an appropriate change.
(iv) Auditors’ remuneration Other corporate costs include auditors’ remuneration in respect of the Company of £77,000 (2004: £13,000). The higher fees in 2005 reflect additional work carried out in connection with the Company’s transition to IFRS for its own financial statements. Audit fees in respect of further assurance services totalled £237,000 (2004: £747,000).
(ii) Tax reconciliation The tax on the Company’s profit before tax differs from the theoretical amount that would arise using the tax rate of the home country of the Company as follows: £m £m
Deferred income tax assets are recognised for tax loss carry forwards to the extent that the realisation of the related tax benefit through the future taxable profits is probable. The Company has unrecognised tax losses of £167 million (2004: £nil) to carry forward against future taxable profits.
Arising in the year: Profit for the year – – – 1,347 Fair value gains on investments in subsidiaries – 1,521 – – Dividends and appropriations – – – (657) Reserves credit for equity compensation plans – – 22 – Shares issued in lieu of dividends – – – 100 Shares issued on acquisition of subsidiary 508 – – – Aggregate tax effect – – – 13 Other movements – – – (1)
Repayable as follows: One year or less 499 1,070 After five years 3,006 3,045
Loans to and from subsidiaries, associates and joint ventures are made on normal arm’s length commercial terms. The maturity analysis of the related party loans is as follows: Contractual repricing or maturity dates currency 1 year years years years years years Total interest
The related parties’ payables are not secured and no guarantees were received in respect thereof. The payables will be settled in accordance with normal credit terms.
We have audited the alternative method of reporting long-term business on pages 200 to 221 in respect of the year ended 31 December 2005, which comprises a European Embedded Value basis Summarised Consolidated Income Statement, Consolidated Statement of Recognised Income and Expense, Consolidated Statement of Changes in Equity, Summarised Consolidated Balance Sheet and the related notes on pages 200 to 221. The alternative method of reporting long-term business has been prepared in accordance with the CFO Forum Principles dated May 2004 as described on, and using the methodology and assumptions set out on, pages 204 to 206.
Respective responsibilities of directors and auditors The directors are responsible for preparing the alternative method of reporting long-term business on the above European Embedded Value basis.
(160) Integration costs (109) – – Exceptional costs for termination of operations – (40)
1. Excludes the proportion of the results of Morley’s fund management businesses and of our French asset management operation Aviva Gestion d’Actifs (AGA) that arises from the provision of fund management services to our life businesses. These results are included within the life EEV operating return.
2. Excludes the proportion of the results of Norwich Union Life Services relating to the services provided to the UK life business. These results are included within the life EEV operating return. Other subsidiaries providing services to our life businesses do not materially impact the Group results.
Earnings per share – EEV basis For the year ended 31 December 2005 2005 Earnings per share 2005 2004
Operating profit on an EEV basis after tax, attributable to ordinary shareholders in respect of Aviva plc
Fair value gains, on AFS securities and owner-occupied properties, net of transfers to the income statement 61 130 Actuarial losses on pension schemes (547) (145) Foreign exchange rate movements (44) 119 Equity Compensation Reserve charge for the period 22 21 Aggregate tax effect – shareholder tax 224 (15)
Net (expense)/income recognised directly in equity (284) 110 Profit for the year* 3,682 1,819
Equity 868 Ordinary share capital 599 570 9,320 Additional retained profit on an EEV basis 6,431 4,768 21,593 Equity attributable to ordinary shareholders of Aviva plc 14,899 11,661 1,725 Preference share capital and direct capital instrument 1,190 1,190
Liabilities 192,177 Gross insurance liabilities 132,602 124,122 112,042 Gross liability for investment contracts 77,309 69,555 13,012 Unallocated divisible surplus 8,978 7,549 4,546 Net asset value attributable to unitholders 3,137 2,247 3,562 Deferred tax liabilities 2,458 1,543 1,497 Current tax liabilities 1,033 922 13,746 Payables and other financial liabilities 9,485 7,240 210 Liabilities of operations classified as held for sale 145 –
Liabilities of the long-term business (215,624) – (215,624) (197,054) – (197,054) Liabilities of the general insurance and other businesses – (36,731) (36,731) – (33,256) (33,256)
Net assets on a statutory IFRS basis 9,144 1,948 11,092 8,808 185 8,993 Additional value of in-force long-term business1 6,454 – 6,454 5,018 – 5,018
Net assets on an EEV basis2 15,598 1,948 17,546 13,826 185 14,011
Equity capital, capital reserves, shares held by employee trusts and other reserves 5,871 5,184
IFRS basis retained earnings 2,597 1,709 Additional EEV basis retained profit 6,431 4,768
EEV basis total equity 17,546 14,011 1. The analysis between the Group’s and the minority interest’s share of the additional value of in-force long-term business is as follows: Movement in 2005 2004 the year £m £m £m
2. Analysis of net assets on an EEV basis is made up as follows: £m £m
Basis of preparation – EEV basis The consolidated income statement and balance sheet on pages 200 and 202 present the Group’s results and financial position for the life and related businesses on the European Embedded Value (EEV) basis and for its non-life businesses on the International Financial Reporting Standards (IFRS) basis. The EEV methodology adopted is in accordance with the EEV Principles introduced by the CFO Forum in May 2004. In October 2005 the CFO Forum published additional guidance on EEV disclosures applicable for financial reporting for the year ending 31 December 2006 which has been reflected as far as is possible in this report, in accordance with our previous reporting.
Foreign exchange adjustments Embedded value and other balance sheet items denominated in foreign currencies have been translated to sterling using the appropriate closing exchange rate. New business contribution and other income statement items have been translated using an average exchange rate for the relevant period. The exchange rates adopted in this announcement are shown on page 106.
At each valuation date, the risk margin is reassessed based on current economic factors and is updated only if a significant change has occurred. In particular, changes in risk profile arising from movements in asset mix are allowed for via the updated risk margin calculation.
For profit sharing business in continental Europe, where policy benefits and shareholder value depend on the timing of realising gains, apportionment of unrealised gains between policyholders’ benefits and shareholders reflect contractual requirements as well as existing practice. Where under certain economic scenarios additional shareholder injections are required to meet policyholder payments, the average additional cost has been included in the time value of options and guarantees.
Components of life EEV return The life EEV return comprises the following components: – new business contribution written during the period including value added between the point of sale and end of the period; – the profit from existing business equal to: • the expected return on the value of the in-force covered business at the beginning of the period,
• experience variances caused by the differences between the actual experience during the period and expected experience based on the operating assumptions used to calculate the start of year value,
Components of life EEV return continued The life EEV operating return comprises the first three of these components and is calculated using economic assumptions as at the start of the year and operating (demographic, expenses and tax) assumptions as at the end of the year.
New business contribution (after the effect of required capital) 612 516 Profit from existing business
– expected return 895 819 – experience variances (39) (15) – operating assumption changes 17 (7)
Life EEV return before tax 3,696 1,794 Tax on operating profit (566) (490) Tax charge on other ordinary activities (579) (58)
New business contribution The following tables set out the premium volumes and contribution from new business written by the life and related businesses, consistent with the definition of new business set out on page 204.
The contribution generated by new business written during the period is the present value of the projected stream of after tax distributable profit from that business. New business contribution before tax is calculated by grossing up the contribution after tax at the full corporation tax rate for UK business and at appropriate rates of tax for other countries. New business contribution has been calculated using the same economic assumptions as those used to determine the embedded value as at the start of the year and operating assumptions used to determine the embedded value as at the end of the year, and is rolled forward to the end of the financial period. New business contribution is shown before and after the effect of required capital, calculated on the same basis as for in-force covered business.
New business sales are expressed on two bases: annual premium equivalent (APE) and the present value of future new business premiums (PVNBP). The PVNBP calculation is equal to total single premium sales received in the year plus the discounted value of regular premiums expected to be received over the term of the new contracts, and is expressed at the point of sale. The premium volumes and projection assumptions used to calculate the present value of regular premiums for each product are the same as those used to calculate new business contribution, so the components of the new business margin are on a consistent basis.
Annual premium equivalent1 business premiums effect of required capital effect of required capital2
Total (before the effect 1. United Kingdom APE has been restated to include NUER APE volumes of £37 million (2004: £48 million).
New business contribution continued New business contribution before the effect of required capital includes minority interests in 2005 of £156 million (2004: £121 million). This comprises minority interests in France of £19 million (2004: £7 million), Italy £35 million (2004: £27 million), Netherlands £10 million (2004: £10 million), Poland £2 million, (2004: £2 million), Spain £89 million (2004: £75 million) and Other Europe £1 million (2004: nil).
New business New business Present value of new contribution after the margin after the business premiums effect of required capital effect of required capital1
Netherlands (including Belgium and Luxembourg) 2,407 2,168 57 43 2.4% 2.0%
1. New business margin represents the ratio of new business contribution after deducting the effect of required capital to PVNBP, expressed as a percentage.
New business contribution after the effect of required capital includes minority interests in 2005 of £120 million (2004: £94 million). This comprises minority interests in France of £10 million (2004: £1 million), Italy £21 million (2004: £19 million), Netherlands £7 million (2004: £8 million), Poland £2 million (2004: £2 million), Spain £79 million (2004: £64 million) and Other Europe £1 million (2004: nil).
Annual premium equivalent business premiums1 New business contribution2 New business margin3 1. Stated after deducting minority interests.
Experience variances Experience variances include the impact of the difference between expense, demographic and persistency assumptions, and actual experience incurred in the year. Also included are variances arising from tax, where such variances are due to management action.
Netherlands (including Belgium and Luxembourg) 47 21 Rest of Europe 11 (4)
Further disclosures on experience variances and operating assumption changes on an EEV basis are provided on pages 211 and 212.
Life EEV operating return includes minority interests in 2005 of £216 million (2004: £186 million). This comprises minority interests in France of £24 million (2004: £9 million), Italy £52 million (2004: £43 million), Netherlands £17 million (2004: £26 million), Poland £18 million (2004: £16 million), Spain £103 million (2004: £90 million) and Other Europe £2 million (2004: £2 million).
Analysis of movement in life and related businesses embedded value continued All figures are shown net of tax.
The embedded value of business disposed of in 2005 of £38 million represents the embedded value of the business in Portugal and Delta Lloyd’s stake in ENNIA Caribe, a Dutch Antilles and Aruba based insurer.
Required capital has increased in the year by £86 million. The movement comprises an increase of £557 million in relation to new business written, a reduction of £415 million in relation to in-force business and a reduction of £56 million in relation to movements in foreign exchange rates. The reduction in the in-force required capital includes a release of £245 million arising from the restructure of the UK nonprofit funds and a release of £295 million arising from the reduction in the level of required capital for UK annuities. The underlying increase in the in-force required capital of £125 million which reflects the effect of the reduction in long-term interest rates, which has increased statutory reserves, and therefore capital requirements and has more than off-set the reduction in capital in respect of business run-off.
New business contribution (after the effect of required capital) (520) 875 355 Expected return on existing business – return on VIF – 576 576 Expected return on existing business – transfer to net worth 738 (738) – Experience variances and operating assumption changes (98) 79 (19) Expected return on shareholders’ net worth 208 – 208 Investment return variances and economic assumption changes 167 (41) 126
Life EEV return after tax 495 751 1,246 Exchange rate movements 51 68 119 Embedded value of businesses acquired 79 23 102 Amounts injected into life and related businesses 324 – 324 Amounts released from life and related businesses (576) – (576) Transfer from life and related businesses to other segments 48 – 48
Embedded value at the end of the year – Free surplus 1,894 – Required capital1 4,362 1. Required capital is shown net of implicit items permitted by local regulators to cover minimum solvency margins.
The embedded value of business acquired in 2004 of £102 million represents the total embedded value of Antarius, the bancassurance joint venture with Crédit du Nord in France.
Segmental analysis of the components of life EEV operating return UK France Ireland Italy Netherlands Poland Spain Other Europe International Total
3. Lapse experience in the UK has been worse than assumed and mainly relates to bonds and pension business. In Ireland, the adverse persistency has mainly arisen on unitlinked pensions business.
7. Other operating assumption changes in the UK primarily relate to the change in annuitant required capital to 150% of required minimum margins which results in a £110 million one-off benefit. In France other operating assumptions represent an allowance for further tax benefits arising from dividends from subsidiaries. In the Netherlands, they reflect a variety of changes including increased annual management fees on unit-linked contracts, favourable change in asset mix, and the reduction of future guaranteed returns on group pensions business in Belgium. In Poland it was previously assumed that the introduction of new individual pension products would lead to significant conversion of existing policies. The prudent allowance made for this is no longer required.
2. Exceptional expenses in the UK reflect costs of £65 million for the restructuring of the business services division and one-off project costs of £88 million associated with the pace of regulatory change.
5. In the UK, other experience profits include £29 million of profits arising from better than assumed default experience on corporate bonds and commercial mortgages.
6. Maintenance expense assumption changes in the UK reflect the benefit of cost saving initiatives coming through.
7. The UK and the Netherlands include capitalised additional future project expenses.
9. Other operating assumptions in the Netherlands relates to positive changes in asset mix and tax reflecting, in part, the fact that the embedded value of Delta Lloyd was previously assessed using a blended average tax rate of 25%, which is below the local corporation tax rate. The calculation has been refined to tax all future profits at the full corporation tax rate at the beginning of the year of 34.5% and to allow explicitly for the tax benefit arising from investing in the “5% holdings” (investments in Dutch companies where at least 5% of the share capital is owned), on which all investment income is tax free. This change results in a £53 million one-off benefit. France includes the benefit of tax assumption changes. France has historically recorded favourable tax operating experience as a result of better than assumed tax on dividend income.
Netherlands (including Belgium and Luxembourg) 1,024 1,068 1,253 (321) 3,024 1. Required capital is shown net of implicit items permitted by local regulators to cover minimum solvency margins.
The shareholders’ net worth is the market value of the shareholders’ funds and the shareholders’ interest in the surplus held in the non-profit component of the long-term business funds, determined on a statutory solvency basis and adjusted to add back any non-admissible assets. Required capital, net of implicit items, of £4,448 million at 31 December 2005 (31 December 2004: £4,362 million) is included within the net worth.
Time value of options and guarantees The following table sets out the time value of options and guarantees relating to covered business by territory at 31 December 2005 and £m £m
The time value of options and guarantees (TVOG) is most significant in the UK, France and the Netherlands. In the UK, this relates mainly to non-market value adjustment (MVA) guarantees on unitised with-profit business and guaranteed annuity rates. In France, this relates mainly to guaranteed crediting rates and surrender values on traditional business including the AFER fund. In the Netherlands, this relates mainly to maturity guarantees on unit-linked products and interest rate guarantees on traditional individual and Group profit sharing business.
New business contribution before effect of required capital 652 156 808 706 Effect of required capital (160) (36) (196) (190)
New business contribution including effect of required capital 492 120 612 516
Closing life and related businesses’ embedded value 14,113 1,000 15,113 13,014
Principal 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. The same margins are applied on a consistent basis across the Group to gross risk free yields to obtain investment return assumptions for ordinary shares and property and to produce risk discount rates. Additional country-specific risk margins are applied to smaller businesses to reflect additional economic, political and business specific risks, which result in the application of risk margins ranging from 3.7% to 8.7% in our eastern European and Asian business operations. Expense inflation is derived as a fixed margin above a local measure of long-term price inflation. Risk free rates and price inflation have been harmonised across territories within the euro currency zone, except for expense inflation in Ireland where significant differences remain. Required capital is shown as a multiple of the EU statutory minimum solvency margin.
Principal economic assumptions – deterministic calculations continued Investment return assumptions are generally derived by major product class, based on hypothecating the assets at the valuation date. Future assumed reinvestment rates are consistent with implied market returns at 31 December 2006. Rates have been derived using rates from the current yield curve at a duration based on the term of the liabilities, or directly from forward yield curves where considered appropriate. Assumptions about future investment mix are consistent with long-term plans. In most cases, the investment mix is assumed to continue unchanged throughout the projection period. The changes in assumptions between reporting dates reflect the actual movements in risk free yields in the UK, the Eurozone and other territories. The principal economic assumptions used are as follows: UK France
Pre-tax investment returns: Required Capital (% EU minimum) 150%/ 200%/ 200%/ 115% 115% 115%
Principal economic assumptions – deterministic calculations continued For service companies, expense inflation relates to the underlying expenses rather than the fees charged to the life company. Future returns on corporate fixed interest investments are calculated from prospective yields less an adjustment for credit risk. Required capital in the United Kingdom is 150% EU minimum for Norwich Union Annuity Limited and 100% for other companies. Required capital in Spain is 125% EU minimum for Aviva Vida y Pensiones and 110% for bancassurance companies.
Summary Statistics The following table sets out the means and standard deviations (StDev) of future returns at 31 December 2005 for the three most significant asset classes. Interest rates are assumed to have a lognormal distribution with an annualised standard deviation of 13% p.a. for the natural logarithm of the interest rate.
Government Bonds 4.1% 3.25-4.75%3 1. Means have been calculated by accumulating a unit investment for the required number of years in each simulation, averaging the accumulation across all simulations, and converting the result to an equivalent annual rate (by taking the nth root of the average accumulation minus 1).
Principal economic assumptions – deterministic calculations continued Europe (excluding UK) and International Model Government nominal interest rates are generated by a model that projects a full yield curve at annual intervals. The model assumes that the logarithm of the short rate follows a mean reverting process subject to two normally distributed random shocks. This ensures that nominal interest rates are always positive, the distribution of future interest rates remains credible, and the model can be calibrated to give a good fit to the initial yield curve.
Borrowings per summarised consolidated balance sheet – EEV basis 11,013 10,090 Less: Securitised mortgage funding (6,303) (5,193)
External debt, subordinated debt, preference shares and direct capital instrument - EEV basis 5,250 5,739 Effect of marking these instruments to market 618 214
– Decrease in the level of required capital to 100% EU minimum (or equivalent) (not applicable for new business contribution).
Sensitivity analysis – economic assumptions continued 1% increase 1% decrease 10% rise in 10% fall in in equity/ in equity/ equity/ equity/ EU minimum As reported property property property property capital
Embedded value (net of tax) on page 213 returns returns market values market values (or equivalent)
1% increase 1% New business contribution before As reported in discount decrease in 1% increase in 1% decrease in required capital (gross of tax) on page 207 rates discount rates interest rates interest rates 2005 £m £m £m £m £m
Netherlands (including Belgium and Luxembourg) 88 16 (16) Poland 14 – –
One of the key assumptions underpinning the new business contribution is the appropriate level of required capital supporting different types of products. The effect of the assumptions relating to levels of required capital is most significant in relation to annuity business written in the UK. Following a review of the Individual Capital Assessment results in the third quarter of 2005, Aviva concluded that the appropriate level of capital required to support the risks for this business is equivalent to 150% (2004: 200%) of the EU required minimum margins (RMM), notwithstanding the prudent margins incorporated in the technical provisions. This brings the required capital used to report business performance closer in line with the economic capital required to support the business.
Sensitivity analysis – non-economic assumptions The tables below show the sensitivity of the embedded value as at 31 December 2005 and the new business contribution before the effect of required capital for 2005 to the following changes in non-economic assumptions: – 10% decrease in maintenance expenses (a 10% sensitivity on a base expense assumption of £10 pa would represent an expense assumption of £9 pa). Where there is a “look through” into service company expenses, the fee charged by the service company is unchanged while the underlying expense decreases; – 10% decrease in lapse rates (a 10% sensitivity on a base assumption of 5% pa would represent a lapse rate of 4.5% pa); – 10% decrease in both mortality and morbidity rates.
New business contribution before required As reported maintenance decrease in in mortality/ capital (gross of tax) on page 207 expenses lapse rates morbidity rates
The demographic sensitivities shown above represent a standard change to the assumptions for all products. Different products will be more or less sensitive to the change, and impacts may partially offset.
France Aviva Participations SA and its principal subsidiaries: Aviva Assurances SA Aviva Courtage SA Aviva Direct SA Aviva France SA Aviva Gestion d’Actifs S.A. Aviva Vie SA Eurofil S.A.
Ireland Hibernian Group plc and its principal subsidiaries: Hibernian General Insurance Limited Hibernian Investment Managers Limited Hibernian Life & Pensions Limited RAC School of Motoring Ltd
Italy Aviva Italia Holding SpA and its principal subsidiaries: Aviva Assicurazioni SpA (50.0%) Aviva Italia SpA Aviva Life SpA (50.0%) Aviva SpA (51.0%) Aviva Previdenza SpA (50.0%) Aviva Vita SpA (25.5%) Eurovita Assicurazioni SpA (41.5%)
Poland Commercial Union Polska Towarzystwo Ubezpieczen Ogolnych SA (90.0%) Commercial Union Polska Towarzystwo Ubezpieczen na Zycie SA (90.0%) Commercial Union Powszechne Towarzystwo Emerytalne BPH CU WBK SA (75.0%)
United Kingdom RBS Life Investments Limited (49.99%) RBSG Collective Investments Limited (49.99%) British Aviation Insurance Company Limited (38.1%) The Group also has interests in several UK property limited partnerships. Further details are provided in note 17 on page 131.
Dividend payments direct to your bank account As an alternative to having dividends paid by cheque, shareholders can, if they wish, have them credited directly into their bank or building society account on the dividend payment date. For overseas shareholders, a TAPS (Transcontinental Account Payment) service is available, which allows shareholders in many countries to have dividends credited direct to their bank accounts in local currencies.
Consolidated Tax Vouchers Private shareholders who currently receive dividends paid directly into their bank or building society account receive one consolidated tax voucher each year instead of a voucher with each dividend payment, unless they inform the Registrar otherwise.
Scrip dividend The Aviva Scrip Dividend Scheme (the “Scheme”) provides shareholders with the opportunity to receive their dividends in the form of new ordinary shares instead of cash. Shareholders who have not joined the Scheme but wish to do so should contact Lloyds TSB Registrars and request a mandate form. The mandate form will need to be received by Lloyds TSB Registrars no later than 25 April 2006 in order to be effective for the 2005 final dividend.
A range of shareholder frequently asked questions is available online at www.aviva.com/shareholders
Shareholders with disabilities Alternative versions of this publication (including braille, large print and audio-tape) are available on request.
– To buy or sell shares over the telephone, shareholders can contact Barclays Stockbrokers** on 0870 549 3002* (for shareholders with a share certificate) or 0870 549 3001* (for shareholders with a share account statement).
Banks and nominee companies 13,242 1.95 2,029,487,492 84.71 Pension fund managers and insurance companies 98 0.01 120,670 0.01
Financial statements 78 Accounting policies 87 Consolidated income statement 88 Pro forma reconciliation of Group operating profit to profit before tax 90 Consolidated balance sheet 91 Consolidated statement of recognised income and expense 91 Reconciliation of movements in consolidated shareholders’ equity 92 Consolidated cash flow statement 93 Notes to the consolidated financial statements 190 Financial statements of the Company 199 Independent auditors’ report to the directors of
Aviva is the world’s sixth-largest insurance group and the largest insurance services provider in the UK. We are one of the leading providers of life and pension products in Europe and are actively growing our long-term savings businesses in Asian markets, Australia and the USA. Our main activities are long-term savings, fund management and general insurance. We have premium income and investment sales of £35.0 billion and £317 billion of assets under management. We have more than 54,000 employees serving millions of customers.
General shareholding queries Lloyds TSB Registrars The Causeway 0870 600 3952* Worthing
Aviva Group www.aviva.com UK long-term savings and general insurance www.norwichunion.com Fund management www.morleyfm.com Aviva worldwide internet sites www.aviva.com/websites * All 0870 numbers are charged at national rates, and are only available if you are calling from the UK.