Aviva plc Annual Report and Accounts 2010 12 – Auditors’ remuneration This note shows the total remuneration payable by the Group to our auditors. The total remuneration payable by the Group, excluding VAT and any overseas equivalent thereof, to its principal auditors, Ernst & Young LLP, and its associates is shown below.
Fees payable to Ernst & Young LLP for the statutory audit of the Aviva Group and Company financial statements 1.8 — — — 1.8 Fees payable to Ernst & Young LLP and its associates for other services to Group companies: Audit of Group subsidiaries pursuant to legislation 13.7 — — — 13.7 Additional fees related to the prior year audit of Group subsidiaries pursuant to legislation 0.6 — — — 0.6 Other services pursuant to legislation 2.5 — — — 2.5 Audit of Group pension scheme — 0.1 — — 0.1 Supplementary reporting — 1.8 — — 1.8 Tax services — — 0.1 — 0.1 All other fees: Services relating to corporate finance transactions — — — 0.5 0.5 Other supplementary services — 3.4 — 1.1 4.5
Aviva plc Annual Report and Accounts 2010 13 – Tax This note analyses the tax charge for the year and explains the factors that affect it.
(iv) Unrecognised tax losses and temporary differences of previous years were used to reduce current tax expense and deferred tax expense by £34 million and £88 million respectively (2009: £59 million and £10 million respectively).
(v) Deferred tax charged to the income statement represents movements on the following items: £m
Long-term business technical provisions and other insurance items 235 (876) Deferred acquisition costs 199 261 Unrealised gains on investments 97 963 Pensions and other post-retirement obligations 50 (72) Unused losses and tax credits 117 (182) Subsidiaries, associates and joint ventures 2 12 Intangibles and additional value of in-force long-term business (114) (21) Provisions and other temporary differences (188) 169
Aviva plc Annual Report and Accounts 2010 13 – Tax continued (b) Tax charged/(credited) to other comprehensive income (i) The total tax charge comprises: £m
Current tax In respect of pensions and other post-retirement obligations (29) — In respect of foreign exchange movements (5) — (34) —
(ii) The tax charge attributable to policyholders’ returns included above is £nil (2009: £nil).
(c) Tax credited to equity Tax credited directly to equity in the year amounted to £17 million (2009: £17 million), and is wholly in respect of coupon payments on direct capital instruments.
Tax calculated at standard UK corporation tax rate of 28% (2009: 28%) 794 566 Different basis of tax – policyholders 272 82 Adjustment to tax charge in respect of prior years (28) (113) Non-assessable income (93) (105) Non-taxable profit on sale of subsidiaries and associates (44) (44) Disallowable expenses 142 279 Different local basis of tax on overseas profits 95 50 Reduction in future local statutory tax rates (26) — Movement in deferred tax not recognised (156) (15) Other (14) 7
A gradual reduction in the UK corporation tax rate from 28% to 24% over four years was announced in the Emergency Budget of 22 June 2010. The Finance (No. 2) Act 2010 enacted the first of the 1% rate reductions with effect from April 2011, the effect of which is shown in the table above. Subsequent reductions will be dealt with by future legislation. The benefit to the Group’s net assets from the further 3% reduction in the rate is estimated as approximately £90 million in total and will be recognised as the legislation is substantively enacted.
Profit for the year 1,925 (33) 1,892 Amount attributable to non-controlling interests (332) (97) (429) Cumulative preference dividends for the year (17) — (17) Coupon payments in respect of direct capital instruments (DCI) (net of tax) (42) — (42)
Profit for the year 1,475 (160) 1,315 Amount attributable to non-controlling interests (193) (37) (230) Cumulative preference dividends for the year (17) — (17) Coupon payments in respect of direct capital instruments (DCI) (net of tax) (44) — (44)
Profit attributable to ordinary shareholders 1,404 2,784 50.4 Dilutive effect of share awards and options — 47 (0.8)
Operating profit attributable to ordinary shareholders 1,534 2,784 55.1 Dilutive effect of share awards and options — 47 (0.9)
Operating profit attributable to ordinary shareholders 1,221 2,705 45.1 Dilutive effect of share awards and options — 25 (0.3)
Aviva plc Annual Report and Accounts 2010 15 – Dividends and appropriations This note analyses the total dividends and other appropriations we have paid during the year. The table below does not include the final dividend proposed after the year end because it is not accrued in these financial statements. The impact of shares issued in lieu of dividends is shown separately in note 36.
Subsequent to 31 December 2010, the directors proposed a final dividend for 2010 of 16.0 pence per ordinary share (2009: 15.0 pence), amounting to £451 million (2009: £415 million) in total. Subject to approval by shareholders at the AGM, the dividend will be paid on 17 May 2011 and will be accounted for as an appropriation of retained earnings in the year ending 31 December 2011. Interest on the direct capital instruments issued in November 2004 is treated as an appropriation of retained profits and, accordingly, it is accounted for when paid. Tax relief is obtained at a rate of 28.0% (2009: 28.0%).
Goodwill impairment charges of £3 million have been recognised as expenses. Together with impairment charges of £9 million recognised in respect of goodwill within interests in joint ventures (note 18) and £12 million recognised in respect of goodwill within interests in associates (note 19), the total goodwill write down for the year is £24 million. Movements in contingent consideration relate to contingent consideration paid or received in respect of acquisitions of subsidiaries prior to 1 January 2010. Goodwill arising on acquisitions completed before 1 January 1998 was charged directly to reserves. Goodwill arising on the Group’s acquisition of joint ventures and associates is included within the carrying value of those investments (see notes 18 and 19).
Aviva plc Annual Report and Accounts 2010 16 – Goodwill continued (b) Goodwill allocation and impairment testing A summary of the goodwill and intangibles with indefinite useful lives allocated to cash-generating units is presented below.
Carrying amount of intangibles with indefinite useful lives (detailed in note 17) Total £m
As explained in accounting policy N, the carrying amount of goodwill and intangible assets with indefinite useful lives is reviewed at least annually or when circumstances or events indicate there may be uncertainty over this value. The tests led to impairment of goodwill of £3 million in 2010 (2009: £nil). Goodwill and intangibles with indefinite useful lives have been tested for impairment in these businesses as follows: United Kingdom (i) Long-term business The UK long-term business goodwill balance is split across two cash-generating units, with no individual balance exceeding £20 million. As part of the annual review of goodwill, management have considered the recoverability of the goodwill balance associated with the UK Creditor Life business. As a result of a change in the nature of products sold by that business, management have concluded that the goodwill is no longer fully recoverable and an impairment of £2 million has been recognised as an expense during the year.
(iv) Ireland (long-term business) The recoverable amount of the Irish long-term business exceeds the carrying value of the cash-generating unit including goodwill. This calculation is an actuarially determined appraisal value and is based on the embedded value of the business together with the present value of expected profits from future new business. Key assumptions (in addition to MCEV principles) used for the calculation were: New business contribution represents the present value of projected future profits generated from business written in a period. This is initially based on the most recent three-year business plans approved by management; Growth rate represents the rate used to extrapolate new business contributions beyond the business plan period, and is based on management’s estimate of no future growth in annual cash flows; Discount rate of 5% represents the rate used to discount expected profits from future new business. The discount rate is a combination of a risk-free rate and a risk margin to make prudent allowance for the risk that experience in future years for new business may differ from that assumed. The MCEV principles applied to project future cash flows include allowance for many of the risks associated with these cash flows, and therefore these risks are not also reflected in the discount rate applied to calculate a present value of future cash flows.
depending on the particular circumstances of each unit; and Risk-adjusted discount rate of 9.9% to 10.7%, depending on management’s assessment of the specific risks of each unit, represents the rate used to discount expected profits from future new business.
Risk-adjusted discount rate of 5.6% represents the rate used to discount expected profits from future new business. The discount rate is a combination of a risk-free rate and a risk margin to make prudent allowance for the risk that experience in future years for new business may differ from that assumed. The MCEV principles applied to project future cash flows include allowance for many of the risks associated with these cash flows, and therefore these risks are not also reflected in the discount rate applied to reach a present value.
In addition to estimating the recoverable value of the Spain cash-generating unit, management have considered the terms of the contractual arrangements with bancassurance partners. Management have concluded that, under a range of reasonably possible scenarios, the contractual terms support the recoverability of the carrying value of the cash-generating unit.
Risk-adjusted discount rate of 10% represents the rate used to discount expected profits from future new business. The discount rate includes an additional margin to make prudent allowance for the risk that experience in future years for new business may differ from that assumed.
Cash flow projections To comply with paragraph 33(c) of IAS 36, cash flow projections for the period beyond the three-year plan period are extrapolated from the position in the final year of the three-year plan period. In all cases, we have assumed a positive or nil steady growth rate for subsequent years, not an increasing growth rate. The steady growth rate selected for each cash-generating unit reflects long-term expectations for the markets in which each cash-generating unit participates. Impairment tests for all cash-generating units have been performed using assumptions which management believe are reasonable. Given the magnitude of the excess of recoverable value over carrying amount in each case, management believe that it is not reasonably possible that there would be a change in the key assumptions such that the carrying amount would exceed the recoverable value.
At 31 December 2009 2,708 199 1,607 326 4,840 Additions — — 156 — 156 Acquisition of subsidiaries (note (b)) 88 115 31 — 234 Disposals — — (27) — (27) Liquidations (note (e)) (25) — — — (25) Movement in shadow adjustment (80) — — — (80) Transfers from property and equipment (note 20) — — 88 — 88 Foreign exchange rate movements 33 (6) (13) (3) 11
At 31 December 2010 1,254 195 1,103 254 2,806 * On insurance and participating investment contracts. ** On non-participating investment contracts.
(b) The acquisitions of AVIF relating to insurance contracts and investment contracts arise from the acquisition of the RBS Life assurance business (see note 3(a)). The other acquired intangible asset of £31 million arises from the acquisition of the River Road US asset management business and represents the value of existing customer relationships (see note 3(a)).
(c) Other intangible assets with finite useful lives consist primarily of the value of bancassurance and other distribution agreements. (d) Impairment losses arise from a management review of the recoverability of intangible computer software assets. As a result, impairment charges were recognised in North America (£9 million), Aviva Europe (£7 million) and Delta Lloyd (£5 million). (e) During 2010, the Group’s subsidiary London & Edinburgh Life Assurance Limited was dissolved. As a result, the fully amortised
Share of results before tax — (398) — (398) Share of tax — (4) — (4) Share of results after tax — (402) — (402) Amortisation and impairment of goodwill and intangibles1 (7) — — (7) Share of loss after tax (7) (402) — (409) Acquisitions and additions — 415 145 560 Disposals and reduction in Group interests — (59) — (59) Fair value losses taken to other comprehensive income — 8 — 8 Loans repaid — — (99) (99) Foreign exchange rate movements (14) (7) (16) (37) At 31 December 2009 202 1,172 327 1,701
187 1,432 375 1,994 1. Comprises amortisation of AVIF on insurance contracts of £2 million (2009: £3 million) and other intangibles of £5 million (2009: £4 million).
During the year the Group’s Taiwan joint venture, First-Aviva Life Insurance Co., Ltd., was classified as held for sale following the decision of management to seek to dispose of the business. The disposal is expected to be completed within 12 months. On classification as held for sale, the business was re-measured at fair value less costs to sell, and an impairment of £9 million was recognised within the income statement as a component of share of profit after tax of joint ventures and associates. Acquisitions, additions, disposals and reductions in Group interests relate to property management undertakings. The Group’s principal interests in property management joint ventures are listed below.
Property management undertakings — 1,195 375 1,570 Long-term business undertakings 187 246 — 433 General insurance undertakings — 5 — 5
All the above entities perform property ownership and management activities, and are incorporated and operate in the United Kingdom. All these investments are held by subsidiary entities.
Aviva-COFCO Life Insurance Co. Limited Ordinary shares of RMB1 each 50.0% China AvivaSA Emeklilik ve Hayat A.S. Ordinary shares of YTL1 each 49.8% Turkey CIMB Aviva Assurance Berhad Ordinary shares of RM1 each 49.0% Malaysia CIMB Aviva Takaful Berhad Ordinary shares of RM1 each 49.0% Malaysia First-Aviva Life Insurance Co., Ltd. Ordinary shares of NT$10 each 49.0% Taiwan Woori Aviva Life insurance Co. Ltd Ordinary shares of KRW 5000 each 47.3% Korea
All investments in the above companies are unlisted and are held by subsidiaries except for the shares in Aviva-COFCO Life Insurance Co. Limited, which are held by the Company. The Group’s share of net assets of that company is £115 million (2009: £55 million) and have a fair value of £115 million (2009: £72 million).
(i) CIMB Aviva Assurance Berhad and CIMB Aviva Takaful Berhad The Group’s investments in CIMB Aviva Assurance Berhad and CIMB Aviva Takaful Berhad have been tested for impairment by comparing their carrying values (which include goodwill which arose on their acquisition) with their recoverable amounts. The recoverable amounts for both the investments have been determined based on value in use calculations. 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 amounts exceed the carrying values of both the investments. Key assumptions used for the calculation were: Cash flow projections based on: (i) the policy portfolio expected at the valuation date; and (ii) the future sales based on plans approved by management covering the subsequent three-year period. The cash flows from the existing policy portfolio are calculated using best estimate assumptions, which have been supported by experience investigations where available and prudent estimates typical for the market where experience investigations are not available; The embedded value for existing business was derived using risk free rates; The value in use was derived as the sum of embedded value of existing business and the new business contribution in each future year discounted using a risk adjusted discount rate of 13.8%; and New sales beyond the three-year period have been extrapolated using a growth rate of 10%.
Growth rate represents the rate used to extrapolate new business contributions beyond the business plan period, and is based on management’s estimate of future growth of 3%.
(iii) Woori Aviva Life insurance Co. Ltd The Group’s investment in Woori Aviva Life Insurance Co. Ltd has been tested for impairment by comparing its carrying value (which includes goodwill which arose on its acquisition) with its recoverable amount. The recoverable amount has been determined based on a value in use calculation. This calculation is an actuarially determined appraisal value and is based on the embedded value of the business together with the present value of expected profits from future new business. The recoverable amount exceeds the carrying values of the investments. Key assumptions used for the calculation were: Cash flow projections based on: (i) the policy portfolio reported at the valuation date; and
(ii) the future sales based on plans approved by management covering the subsequent three-year period. The cash flows from the existing policy portfolio are calculated using best estimate assumptions, which have been supported by experience investigations where available and prudent estimates typical for the market where experience investigations are not available; The embedded value for existing business was derived using risk free rates; The value in use was derived as the sum of embedded value of existing business and the new business contribution in each future year discounted using a risk adjusted discount rate of 14.6%; and New sales beyond the three-year period have been extrapolated using a growth rate of 8%.
Share of results before tax — 16 — 16 Share of tax — (4) — (4) Share of results after tax — 12 — 12 Impairment of goodwill and intangibles1 (22) — — (22) Amortisation of acquired value of in-force business (8) — — (8) Share of profit/loss after tax (30) 12 — (18) Acquisitions and additions 32 91 — 123 Disposals (305) (317) (2) (624) Fair value losses taken to other comprehensive income — (27) — (27) Dividends received — (63) — (63) Reclassification to financial investments — (9) — (9) Foreign exchange rate movements (2) (17) (1) (20) Movements in carrying amount (305) (330) (3) (638)
At 31 December 2010 80 563 — 643 1. Includes impairment of £10 million in other intangibles (2009: £1 million).
Additions relate to the Group’s Netherlands and India associates. On 17 February 2010, the Group sold its 35% holding in Sogessur SA to that company’s main shareholder, Société Générale, for a consideration of £35 million, realising a profit on disposal of £24 million. On 31 December 2010, the Group sold its 49.99% holding in RBSG Collective Investments Limited to that company’s main shareholder, RBS Group plc. In addition the Group acquired RBS Group plc’s shareholding in RBS Life Investments Limited, resulting in the Group gaining control of that entity and it therefore ceasing to be an associate (see note 3(a)). Other disposals relate to the Group’s Netherlands associates.
Aviva Life Insurance Company India Limited Insurance Ordinary shares of RS1 each 26.0% India Banca Network Investimenti SpA Product distribution Ordinary shares of €1 each 49.99% Italy Cyrte Fund I CV Investment fund Partnership share 22.31% Netherlands Cyrte Fund II BV Investment fund Ordinary shares of €1 each 10.48% Netherlands Cyrte Fund III CV Investment fund Partnership share 28.82% Netherlands
Aviva Life Insurance Company India Limited is a developing business and the recoverability of value is reliant on future projected growth being achieved. In addition local regulatory changes have resulted in changes to the types of product that can be sold. The growth projections are inherently uncertain and dependent on local economic and regulatory conditions.
Aviva plc Annual Report and Accounts 2010 20 – Property and equipment This note analyses our tangible fixed assets, which are primarily properties occupied by Group companies and computer equipment.
At 31 December 2009 — (4) (7) (677) (306) (994) Charge for the year — — (1) (47) (29) (77) Disposals — 4 — 22 22 48 Transfers to intangibles (note 17) — — — 57 — 57 Impairment losses charged to restructuring costs — — — — (3) (3) Foreign exchange rate movements — — 1 5 6 12
Fair value losses of £46 million (2009: £26 million) have been charged to other comprehensive income, with the net reversal of losses previously charged to the income statement now being credited there. Owner-occupied properties are stated at their revalued amounts, as assessed by qualified external valuers or by local qualified staff of the Group in overseas operations, all with recent relevant experience. These values are assessed in accordance with the relevant parts of the current RICS Appraisal and Valuation Standards in the UK, and with current local valuation practices in other countries. This assessment, on the basis of Existing Use Value and in accordance with UK Practice Statement 1.3, is the estimated amount for which a property should exchange on the date of valuation between a willing buyer and a willing seller in an arm’s-length transaction, after proper marketing wherein the parties had acted knowledgeably, prudently and without compulsion, assuming that the buyer is granted vacant possession of all parts of the property required by the business and disregarding potential alternative uses. The valuation assessment adopts market-based evidence and is in line with guidance from the International Valuation Standards Committee and the requirements of IAS 16, Property, Plant and Equipment. If owner-occupied properties were stated on a historical cost basis, the carrying amount would be £347 million (2009:£328 million). The Group has no material finance leases for property and equipment.
At 1 January 2010 10,757 1,673 12,430 Additions 800 278 1,078 Capitalised expenditure on existing properties 35 13 48 Fair value gains 336 85 421 Disposals (610) (215) (825) Transfers (to)/from property and equipment (note 20) (2) 1 (1) Foreign exchange rate movements (75) (12) (87)
Investment properties are stated at their market values 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 using a discounted cash flow approach and are based on current rental income plus anticipated uplifts at the next rent review, assuming no future growth in rental income. This uplift and the discount rate are derived from rates implied by recent market transactions on similar properties. The fair value of investment properties leased to third parties under operating leases at 31 December 2010 was £12,924 million (2009: £11,750 million). Future contractual aggregate minimum lease rentals receivable under the non-cancellable portion of these leases are given in note 53(b)(i).
Aviva plc Annual Report and Accounts 2010 22 – Fair value methodology This note explains the methodology for valuing our financial assets and liabilities carried at fair value, and provides an analysis of these according to a ‘fair value hierarchy’, determined by the market observability of valuation inputs.
Examples of these are securities measured using discounted cash flow models based on market observable swap yields, and listed debt or equity securities in a market that is inactive. Valuations, whether sourced from internal models or third parties incorporate credit risk by adjusting the spread above the yield curve for government treasury securities for the appropriate amount of credit risk for each issuer, based on observed market transactions. To the extent observed market spreads are either not used in valuing a security, or do not fully reflect liquidity risk, our valuation methodology, whether sourced from internal models or third parties, reflects a liquidity premium. Where we use broker quotes and no information as to the observability of inputs is provided by the broker, we generally validate the price quoted by the broker by using internal models with observable inputs. When the price obtained from the broker and internal model are similar, we look to the inputs used in our internal model to understand the observability of the inputs used by the broker. In circumstances where internal models are not used to validate broker prices, and the observability of inputs used by brokers is unavailable, the investment is classified as Level 3. Broker quotes are usually non-binding.
Aviva plc Annual Report and Accounts 2010 22 – Fair value methodology continued (b) Fair value hierarchy analysis An analysis of financial assets and liabilities according to fair value hierarchy is given below: Fair value hierarchy £m
Financial liabilities Non-participating investments contracts (note 40) 44,795 1,131 199 46,125 2,180 — 48,305 Borrowings (note 49) 2,305 2,385 — 4,690 10,259 — 14,949 Derivative liabilities (note 50) 147 2,226 9 2,382 — — 2,382
Financial investments and loans (notes 23 and 25) Loans — 20,890 — 20,890 20,189 — 41,079 Fixed maturity securities 116,026 36,592 9,139 161,757 — — 161,757 Equity securities 38,809 5,775 843 45,427 — — 45,427 Other investments (including derivatives) 26,240 3,950 1,328 31,518 — (23) 31,495
Following a review of the Group’s investment classifications, comparative amounts in the table above for debt and equity securities and other investments have been amended from amounts previously reported, reflecting the fact that equity and debt securities held indirectly through majority owned consolidated mutual funds in France managed by third parties, which in 2009 were presented as unit trusts and other investment vehicles within other investments, are now presented as debt and equity securities. The effect is to increase equity and debt securities by £2,085 million and £1,247 million respectively and decrease unit trusts and other investment vehicles within other investments by £3,332 million. Except for £50 million equity securities considered Level 3, which were previously treated as Level 1 when classified as other investments, there is no effect on the fair value hierarchy as a result of the change in presentation.
Total funds Balance at 1 January 1,850 981 64 2,895 182 Total net gains or losses recognised in the income statement 2 (55) 1 (52) 1 Total net gains or losses recognised in other comprehensive income 107 1 (4) 104 — Purchases 820 117 104 1,041 — Issuances — — — — 12 Disposals (247) (133) (5) (385) — Settlements — (73) — (73) — Transfers into Level 3 7,659 134 1,186 8,979 — Transfers out of Level 3 (923) (54) (19) (996) — Foreign exchange rate movements (129) (74) — (203) (19)
The transfer of £0.31 billion debt securities in our UK business, for which either new valuation models have been developed or there has been sufficient market activity in observable inputs to justify a Level 2 classification.
External hedge funds held principally by businesses in the UK, US and France amounting to £1.1 billion. Valuations received from fund managers are based on net asset values. However, insufficient information is provided on the underlying fund assets to support a classification other than Level 3.
(iii) Where possible, the Group tests the sensitivity of the fair values of Level 3 investments to changes in unobservable inputs to reasonable alternatives. 95% (2009: 91%) of valuations for Level 3 investments are sourced from independent third parties and, where appropriate, validated against internally-modelled valuations, third-party models or broker quotes. Where third-party pricing sources are unwilling to provide a sensitivity analysis for their valuations, the Group undertakes, where feasible, sensitivity analysis on the following basis: For third-party valuations validated against internally-modelled valuations using significant unobservable inputs, the sensitivity of the internally modelled valuation to changes in unobservable inputs to a reasonable alternative is determined.
For third-party valuations either not validated or validated against a third-party model or broker quote, the third-party valuation in its entirety is considered an unobservable input. Sensitivities are determined by flexing to a reasonable alternative the yield, NAV multiple, IRR or other suitable valuation multiples of the financial instrument implied by the third-party valuation. For example, for a fixed income security the implied yield would be the rate of return which discounts the security’s contractual cash flows to equal the third-party valuation.
Loans to banks include cash collateral received under stock lending arrangements (see note 25(d)). The obligation to repay this collateral is included in payables and other financial liabilities (note 50). Of the above loans, £35,581 million (2009: £33,241 million) is expected to be recovered more than one year after the statement of financial position date.
At 1 January (148) (122) Increase during the year (28) (58) Write back following sale or reimbursement 17 17 Write back following recovery in value 6 5 Other movements 11 2 Foreign exchange movements 1 8
Aviva plc Annual Report and Accounts 2010 23 – Loans continued (b) Collateral The Group holds collateral in respect of loans where it is considered appropriate, in order to reduce the risk of non-recovery. This collateral generally takes the form of liens or charges over properties and, in the case of policy loans, the underlying policy, for the majority of the loan balances above. In all other situations, the collateral must be in a readily realisable form, such as listed securities, and is held in segregated accounts. Transfer of title for the collateral received always occurs in such cases, although no market risk or benefit is taken. In the event of a default, the Group is able to sell or repledge the collateral. The amount of collateral received with respect to loans which the Group is permitted to sell or repledge in the absence of default was £4,542 million (2009: £3,685 million). No collateral was actually sold or repledged in the absence of default during the year (2009: £nil).
24 – Securitised mortgages and related assets The Group has loans receivable, secured by mortgages, which have then been securitised through non-recourse borrowings, in our UK Life and Dutch businesses. This note gives details of the relevant transactions.
Loan notes held by third parties are as follows: UK £m
Total loan notes issued, as above 1,464 6,140 1,444 7,097 Less: Loan notes held by Group companies (176) (1,095) — (1,212)
Loan notes held by third parties (note 49c) 1,288 5,045 1,444 5,885
Aviva plc Annual Report and Accounts 2010 25 – Financial investments This note analyses our financial investments by type and shows their cost and fair value. These will change from one period to the next as a result of new business written, claims paid and market movements.
Other investments Unit trusts and other investment vehicles 12 32,202 306 32,520 — 27,064 119 27,183 Derivative financial instruments (note 58b) 2,274 — — 2,274 2,078 — — 2,078 Deposits with credit institutions 73 485 — 558 88 881 — 969 Minority holdings in property management undertakings — 664 — 664 — 667 — 667 Other investments – long-term — 660 52 712 — 617 4 621 Other investments – short-term — 2 — 2 — — — —
Total financial investments Less assets classified as held for sale Fixed maturity securities — — — — — — — — Equity securities — — — — — — — — Other investments — — — — (23) — — (23) — — — — (23) — — (23)
These are further analysed as follows: At fair value through profit or loss 212,714 15,626 (6,533) 221,807 Available for sale 30,387 2,458 (1,364) 31,481
Fixed maturity securities 160,572 5,872 (4,687) 161,757 Equity securities 46,479 4,173 (5,225) 45,427 Other investments Unit trusts and specialised investment vehicles 26,653 784 (254) 27,183 Derivative financial instruments 1,519 896 (337) 2,078 Deposits with credit institutions 969 — — 969 Minority holdings in property management undertakings 635 69 (37) 667 Other long-term investments 729 191 (299) 621
Aviva plc Annual Report and Accounts 2010 25 – Financial investments continued (c) Impairment of financial investments The movements in impairment provisions on available-for-sale financial investments for the years ended 31 December 2009 and 2010 were as follows: Fixed maturity securities £m
At 31 December 2009 (119) (934) (7) (1,060) Increase for the year charged to the income statement (79) (100) — (179) Write back following sale or reimbursement 48 175 — 223 Write back following recovery in value 1 1 — 2 Foreign exchange rate movements (2) 33 — 31
(d) Financial investment arrangements (i) Stock lending arrangements The Group has entered into stock lending arrangements in the UK and overseas in accordance with established market conventions. The majority of the Group’s stock lending transactions occurs in the UK, where investments are lent to EEA-regulated, locally domiciled counterparties and governed by agreements written under English law. It is not the Group’s practice to enter into stock lending or repurchase agreements which result in the derecognition of financial assets from our balance sheet. Financial assets subject to such agreements are sold to be repurchased at a fixed price, usually market price on execution, or loaned for a fee. The Group therefore retains exposure to the market risks of the transferred securities. Because, as transferor, we have retained substantially all the risks and rewards of ownership of the transferred securities, they remain on balance sheet. The Group receives collateral in order to reduce the credit risk of these arrangements. Collateral must be in a readily realisable form, such as listed securities, and is held in segregated accounts. Transfer of title always occurs for collateral received, although no market risk or economic benefit is taken. The level of collateral held is monitored regularly, with further collateral obtained where this is considered necessary to manage the Group’s risk exposure. In certain markets, the Group or the Group’s appointed stock lending managers obtain legal ownership of the collateral received and can re-pledge it as collateral elsewhere or sell outright in the absence of default. The carrying amount of financial assets received in this manner at 31 December 2010 was £15,858 million (2009: £16,909 million). The value of collateral that was actually sold in the absence of default was £nil (2009: £nil). In addition to the above, the Group has received and pledged cash collateral under stock lending arrangements that has been recognised in the statement of financial position with a corresponding obligation or receivable for its return. These latter balances are shown in notes 50 and 26 respectively.
(ii) Stock repurchase arrangements Included within financial investments are £853 million (2009: £664 million) of debt securities and other fixed income securities which have been sold under stock repurchase arrangements. The obligations arising under these arrangements are shown in note 50.
(iii) Other arrangements In carrying on its bulk purchase annuity business, the Group’s UK Life operation is required to place certain investments in trust on behalf of the policyholders. Amounts become payable from the trust funds to the trustees if the Group were to be in breach of its payment obligations in respect of policyholder benefits. At 31 December 2010, £910 million (2009: £703 million) of financial investments were restricted in this way. Certain financial investments are also required to be deposited under local laws in various overseas countries as security for the holders of policies issued in those countries. Other investments are pledged as security collateral for bank letters of credit.
Amounts owed by contract holders 1,965 2,435 Amounts owed by intermediaries 1,414 1,216 Deposits with ceding undertakings 1,459 1,670 Amounts due from reinsurers 500 680 Amounts due from brokers for investment sales 269 232 Amounts receivable for collateral pledged (notes 25d and 58c) 15 15 Reimbursements due from government health insurance 388 141 Corporate owned life insurance 153 146 Dividends receivable 86 76 Finance lease receivables 175 162 Other banking assets 248 273 Other receivables 1,623 2,606
27 – Deferred acquisition costs and other assets This note shows the products on which we are deferring some of our acquisition costs and details the movements in the balance during the year.
Deferred acquisition costs on long-term business are generally recoverable in more than one year whereas such costs on general insurance and health business are generally recoverable within one year after the statement of financial position date. Surpluses in the staff pension schemes are recoverable more than one year after the statement of financial position date.
Aviva plc Annual Report and Accounts 2010 27 – Deferred acquisition costs and other assets continued (b) Movements in the year The movements in deferred acquisition costs during the year were: Long-term business £m
Carrying amount at 1 January 4,455 1,489 22 5,966 Acquisition costs deferred during the year 1,123 2,209 8 3,340 Amortisation (468) (2,464) (9) (2,941) Impact of assumption changes 94 — (1) 93 Effect of portfolio transfers, acquisitions and disposals (40) — — (40) Foreign exchange rate movements (338) (7) — (345) Shadow adjustment (757) — — (757)
The level of capitalised acquisition costs for new long-term business increased by £44 million in 2010, reflecting higher new business in the United States. The amortisation increased by £114 million in 2010, mainly in the United States where DAC balances, and the amortisation thereof, are increasing, driven by the growing volumes of business. Where amortisation of the DAC balance depends on projected profits, changes to economic conditions may lead to a movement in the DAC balance and a corresponding impact on profit. It is estimated that the movement in DAC balance would reduce profit by £115 million if market yields on fixed income investments were to increase by 1% and increase profit by £125 million if yields were to reduce by 1%. The shadow adjustments relate to deferred acquisition costs on business in the United States backed by investments classified as available for sale. As explained in accounting policy K, unrealised gains and losses on the AFS investments and the shadow adjustments above are both recognised directly in other comprehensive income.
(d) Prepayments and accrued income Prepayments and accrued income of £3,691 million (2009: £3,604 million), include £172 million (2009: £148 million) that is expected to be recovered more than one year after the statement of financial position date.
Aviva plc Annual Report and Accounts 2010 28 – Assets held to cover linked liabilities Certain unit-linked products have been classified as investment contracts, while some are included within the definition of an insurance contract. The assets backing these unit-linked liabilities are included within the relevant balances in the consolidated statement of financial position, while the liabilities are included within insurance and investment contract provisions. This note analyses the carrying values of assets backing these liabilities. The carrying values of assets backing unit-linked liabilities are as follows: £m
Loans 35 917 Debt securities 16,150 16,381 Equity securities 31,441 28,638 Other investments 31,846 29,659 Reinsurance assets 1,215 986 Cash and cash equivalents 4,772 4,214
As described in note 39(a), £1,890 million of index-linked liabilities, previously included within unit-linked non-participating provisions, have been reclassified as other non-participating provisions as at 31 December 2009. As a result, the carrying values of assets backing unit-linked liabilities at that date have been reduced accordingly.
The allotted, called up and fully paid share capital of the Company at 31 December 2010 was: 2,820,148,642 (2009: 2,766,611,374) ordinary shares of 25 pence each 705 692
At 31 December 2009 2,766,611,374 692 1,207 Shares issued under the Group’s Employee and Executive Share Option Schemes 722,968 — — Shares issued in lieu of dividends 52,814,300 13 (13)
(a) Description of the plans The Group maintains a number of active share option and award plans and schemes (the Group’s Share Plans). These are as follows: (i) Savings-related options These are options granted under the HM Revenue and Customs-approved Save As You Earn (SAYE) share option schemes in the UK and Irish Revenue-approved SAYE share option scheme in Ireland. Options are normally exercisable during the six-month period following either the third, fifth or seventh anniversary of the start of the relevant savings contract.
(ii) Executive share options These are options granted on various dates until 2004, under the Aviva Executive Share Option Plan or predecessor plans, and in 2010, under the Aviva Executive Share Option Plan 2005. Options granted between 2001 and 2004 were subject to the satisfaction of conditions relating to both the Company’s Return on Capital Employed (ROCE) and its relative Total Shareholder Return (TSR). The performance was measured over a three-year performance period and the options are normally exercisable between the third and tenth anniversary of their grant. The options granted in 2010 are described in the Directors’ Remuneration Report.
(iii) Long-term incentive plan awards These awards have been made under the Aviva Long Term Incentive Plan 2005 and are described in section (b) below and in the Directors’ Remuneration Report.
(b) Outstanding options and awards (i) Share options At 31 December 2010, options to subscribe for ordinary shares of 25 pence each in the Company were outstanding as follows: Aviva Savings Related Share Option Scheme
Aviva plc Annual Report and Accounts 2010 30 – Equity compensation plans continued
The following table summarises information about options outstanding at 31 December 2010: Range of exercise prices
One Aviva, twice the value Bonus Plan Number of shares Vesting period Number of shares Vesting period
The vesting of awards under the Aviva Long Term Incentive Plan 2005, the One Aviva, twice the value Bonus Plan and the OATTV award under the CFO Recruitment Share Awards Plan is subject to the attainment of performance conditions as described in the Directors’ Remuneration Report. Shares which do not vest, lapse.
Outstanding at 1 January 26,355,093 395.90 26,278,223 477.82 Granted during the year 8,020,085 326.52 14,863,272 316.00 Exercised during the year (73,755) 335.12 (146,330) 359.55 Forfeited during the year (1,461,530) 380.82 (1,149,764) 459.77 Cancelled during the year (2,788,423) 362.05 (8,604,422) 433.40 Expired during the year (2,794,830) 516.95 (4,885,886) 513.42
(e) Fair value of options and awards granted after 7 November 2002 The weighted average fair values of options and awards granted during the year, estimated by using the Black-Scholes option pricing model, were £1.32 and £2.39 (2009: £1.78 and £1.94) respectively.
(ii) Share awards The fair value of the awards was estimated on the date of grant, based on the following weighted average assumptions: Weighted average assumption 2010 2009
The expected volatility used was based on the historical volatility of the share price over a period equivalent to the expected life of the options prior to its date of grant. The risk-free interest rate was based on the yields available on UK government bonds as at the date of grant. The bonds chosen were those with a similar remaining term to the expected life of the options.
The shares are owned by an employee share trust with an undertaking to satisfy awards of shares in the Company under the Company’s share plans and schemes. Details of the features of the plans can be found in the Directors’ Remuneration Report. These shares were purchased in the market and are carried at cost less amounts charged to the income statement in prior years. At 31 December 2010, they had an aggregate nominal value of £2,103,871 (2009: £4,494,808) and a market value of £33,072,864 (2009: £71,539,364). The trustees have waived their rights to dividends on the shares held in the trusts.
The Companies Act 2006 abolished the requirement for a company to have an authorised share capital and the articles of association adopted by the Company on 28 April 2010 reflect this. Directors will still be limited as to the number of shares they can at any time allot because the allotment authority continues to be required under the act. Under the Company’s articles of association, the Company may issue and allot Sterling New Preference Shares and Euro New Preference Shares, which, if issued and allotted, would rank, as to payment of a dividend and capital, ahead of the Company’s ordinary share capital but behind the cumulative irredeemable preference shares currently in issue. The issued preference shares are non-voting except where their dividends are in arrears, on a winding up or where their rights are altered. On a winding up, they carry a preferential right of return of capital ahead of the ordinary shares. The Company does not have a contractual obligation to deliver cash or other financial assets to the preference shareholders and therefore the directors may make dividend payments at their discretion.
Notional amount 2010 £m 5.9021% £500 million direct capital instrument 500 500 4.7291% €700 million direct capital instrument 490 490
Prior to 1 January 2004, certain significant business combinations were accounted for using the ‘pooling of interests method’ (or merger accounting), which treats the merged groups as if they had been combined throughout the current and comparative accounting periods. Merger accounting principles for these combinations gave rise to a merger reserve in the consolidated statement of financial position, being the difference between the nominal value of new shares issued by the Parent Company for the acquisition of the shares of the subsidiary and the subsidiary’s own share capital and share premium account. The merger reserve is also used where more than 90% of the shares in a subsidiary are acquired and the consideration includes the issue of new shares by the Company, thereby attracting merger relief under the Companies Act 1985 and, from 1 October 2009, the Companies Act 2006. The balance on the reserve has arisen through the mergers of Commercial Union, General Accident and Norwich Union companies, forming Aviva plc in 2000, together with the acquisition of RAC plc in 2005.
Aviva plc Annual Report and Accounts 2010 35 – Other reserves This note gives details of the various reserves forming part of the Group’s consolidated equity, and shows the movements during the year. Movements in the year comprised: Currency translation reserve (see accounting policy E) £m
Balance at 1 January 2009 3,685 157 (711) (1,103) 113 2,141 Arising in the year: Fair value gains/(losses) — (26) 977 — — 951 Fair value gains transferred to profit on disposals — — (310) — — (310) Transfer to profit on disposal of subsidiary (96) — — — — (96) Fair value gains transferred to retained earnings on disposals (note 36) — (1) — — — (1) Share of fair value changes in joint ventures and associates taken to other comprehensive income (notes 18a & 19a) — — 122 — — 122 Impairment losses on assets previously revalued directly through other comprehensive income now taken to income statement — — 482 — — 482 Reserves credit for equity compensation plans — — — — 56 56 Shares issued under equity compensation plans (note 36) — — — — (60) (60) Transfer to minority interests following Delta Lloyd IPO (351) (26) (156) — — (533) Foreign exchange rate movements (1,014) — — 332 — (682) Aggregate tax effect – shareholders’ tax — — (241) — — (241)
Aviva plc Annual Report and Accounts 2010 36 – Retained earnings This note analyses the movements in the consolidated retained earnings during the year.
Equity shares in subsidiaries 2,055 2,098 Share of earnings 1,057 795 Share of other reserves 377 395 3,489 3,288 Preference shares in General Accident plc 250 250 Preference shares in other subsidiaries 2 2
Balance at 1 January 3,540 2,204 Profit for the year attributable to non-controlling interests 429 230 Minority share of movements in other reserves 57 35 Foreign exchange rate movements (113) (173) Total comprehensive income attributable to non-controlling interests 373 92 Capital contributions from non-controlling interests 42 6 Increase in non-controlling interests following Delta Lloyd IPO 8 1,460 Minority share of dividends declared in the year (187) (109) Non-controlling interest in acquired subsidiaries 3 (2) Changes in non-controlling interest in existing subsidiaries (38) 11 Reclassification to financial liabilities (see below) — (122)
At the start of 2009, the minority shareholders in two subsidiaries in France and Italy held options requiring the Group to purchase their shares. During that year, both sets of minority shareholders indicated that they intended to exercise these options in 2010. We therefore reclassified their interests as at 31 December 2009 to financial liabilities in the consolidated statement of financial position. These transactions were completed during 2010 with the exercise of both sets of options.
Aviva plc Annual Report and Accounts 2010 38 – Contract liabilities and associated reinsurance The following notes explain how we calculate our liabilities to our policyholders for insurance and investment products we have sold to them. Notes 39 and 40 cover these liabilities, and note 41 details the financial guarantees and options given for some of these products. Note 42 details the reinsurance recoverables on these liabilities while note 43 shows the effects of the assumptions we have changed during the year. The following is a summary of the contract provisions and related reinsurance assets as at 31 December.
Totals (296,932) 7,084 (289,848) (282,478) 7,572 (274,906) Less: Amounts classified as held for sale — — — 20 — 20
(b) Long-term business liabilities (i) Business description The Group underwrites long-term business in a number of countries as follows: In the UK mainly in: – New With-Profits sub-fund (NWPSF) of Aviva Life & Pensions UK (UKLAP), where the with-profit policyholders are entitled to at least 90% of the distributed profits, the shareholders receiving the balance. Any surplus or deficit emerging in NWPSF that is not distributed as bonus will be transferred from this sub-fund to the Reattributed Inherited Estate External Support Account (RIEESA) (see below).
In France, where the majority of policyholders’ benefits are determined by investment performance, subject to certain guarantees, and shareholders’ profits are derived largely from management fees. In addition, a substantial number of policies participate in investment returns, with the balance being attributable to shareholders.
Aviva plc Annual Report and Accounts 2010 39 – Insurance liabilities continued In the United States, there are two main types of business – protection products and accumulation products. Protection products include interest-sensitive whole life, term life, universal life and indexed life insurance policies. The accumulation product segment includes traditional fixed and indexed deferred annuities for individuals and funding agreements for business customers. In addition, there are two closed blocks of participating contracts arising from demutualisations of subsidiary companies. All products are classified as insurance contracts except for the funding agreements and term certain immediate annuities, which are classified as non-participating investment contracts.
Future regular bonuses Annual bonus assumptions for 2011 have been set consistently with the year-end 2010 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. The mortality tables used in the valuation are summarised below: Mortality table used
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. For unit-linked and some unitised with-profit business, the provisions are valued by adding a prospective non-unit reserve to the bid value of units. The prospective non-unit reserve is calculated by projecting the future non-unit cash flows on the assumption that future premiums cease, unless it is more onerous to assume that they continue. Where appropriate, allowance for persistency is based on actual experience. Valuation discount rate assumptions are set with regard to yields on the supporting assets and the general level of 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. The provisions held in respect of guaranteed annuity options are a prudent assessment of the additional liability incurred under the option on a basis and method consistent with that used to value basic policy liabilities, and includes a prudent assessment of the proportion of policyholders who will choose to exercise the option. Valuation discount rates for business in the non-profit funds are as follows: Valuation discount rates
Aviva plc Annual Report and Accounts 2010 39 – Insurance liabilities continued Mortality assumptions are set with regard to recent Company experience and general industry trends. The mortality tables used in the valuation are summarised below: Mortality tables used
Pensions business after vesting PCMA00/PCFA00 adjusted plus allowance for future mortality improvement
TD73-77, TD88-90, TH00-02, TGF05/TGH05; H_AVDBS, F_AVDBS, H_SSDBS and F_SSDBS (in 2010)
(c) Netherlands On transition to IFRS, the valuation of most long-term insurance and participating investment contracts was changed from existing methods that used historic assumptions to an active basis using current market interest rates. A liability adequacy test is performed in line with IFRS requirements. Where liabilities are based on current market interest rates and assets are valued at market value, the margin in the liability adequacy test is determined by comparison of the liabilities with the present value of best estimate cash flows. The yield curve is constructed from yields on collateralised AAA bonds. Annuitant mortality assumptions were revised in 2010.
Life assurances Market risk-free yield curves, based on iBoxx index for collateralised
AAA bonds and GBM/V 90-95 Annuities in deferment and in payment Market risk-free yield curves, based on iBoxx index for collateralised AAA bonds
GBM/V 76-80, GBM/V 85-90, GBM/V 95-00, Coll 1993/2003 and DIL 98, plus further allowance for future mortality improvement; CBS2010 (in 2010)
(e) Other countries In all other countries, local generally accepted interest rates and published standard mortality tables are used for different categories of business as appropriate. The tables are based on relevant experience and show mortality rates, by age, for specific groupings of people.
(iv) Movements The following movements have occurred in the long-term business provisions during the year: £m
Motor 4,419 924 5,343 4,411 753 5,164 Property 1,669 188 1,857 1,697 196 1,893 Liability 2,388 1,303 3,691 2,707 1,379 4,086 Creditor 77 24 101 170 17 187 Other 975 296 1,271 992 374 1,366
Aviva plc Annual Report and Accounts 2010 39 – Insurance liabilities continued No adjustments are made to the claims technicians’ case estimates included in booked claim provisions, except for rare occasions when the estimated ultimate cost of a large or unusual claim may be adjusted, subject to internal reserve committee approval, to allow for uncertainty regarding, for example, the outcome of a court case. The ultimate cost of outstanding claims is then estimated by using a range of standard actuarial claims projection techniques, such as the Chain Ladder and Bornhuetter-Ferguson methods. The main assumption underlying these techniques is that a company’s past claims development experience can be used to project future claims development and hence ultimate claims costs. As such, these methods extrapolate the development of paid and incurred losses, average costs per claim and claim numbers based on the observed development of earlier years and expected loss ratios. Historical claims development is mainly analysed by accident period, although underwriting or notification period is also used where this is considered appropriate. Claim development is separately analysed for each geographic area, as well as by each line of business. Certain lines of business are also further analysed by claim type or type of coverage. In addition, large claims are usually separately addressed, either by being reserved at the face value of loss adjuster estimates or separately projected in order to reflect their future development. The assumptions used in most non-life actuarial projection techniques, including future rates of claims inflation or loss ratio assumptions, are implicit in the historical claims development data on which the projections are based. Additional qualitative judgement is used to assess the extent to which past trends may not apply in the future, for example, to reflect one-off occurrences, changes in external or market factors such as public attitudes to claiming, economic conditions, levels of claims inflation, judicial decisions and legislation, as well as internal factors such as portfolio mix, policy conditions and claims handling procedures in order to arrive at a point estimate for the ultimate cost of claims that represents the likely outcome, from a range of possible outcomes, taking account of all the uncertainties involved. The range of possible outcomes does not, however, result in the quantification of a reserve range. However, the following explicit assumptions are made which could materially impact the level of booked net reserves: UK mesothelioma claims The level of uncertainty associated with latent claims is considerable due to the relatively small number of claims and the long-tail nature of the liabilities. UK mesothelioma claims account for a large proportion of the Group’s latent claims. The key assumptions underlying the estimation of these claims include claim numbers, the base average cost per claim, future inflation in the average cost of claims, legal fees and the life expectancy of potential sufferers. The best estimate of the liabilities reflects the latest available market information and studies. Many different scenarios can be derived by flexing these key assumptions and applying different combinations of the different assumptions. An upper and lower scenario can be derived by making reasonably likely changes to these assumptions, resulting in an estimate £195 million greater than the best estimate, or £85 million lower than the best estimate. These scenarios do not, however, constitute an upper or lower bound on these liabilities.
Allowance for risk and uncertainty The uncertainties involved in estimating loss reserves are allowed for in the reserving process and by the estimation of explicit reserve uncertainty distributions. The reserve estimation basis for non-life claims adopted by the Group at 31 December 2010 requires all non-life businesses to calculate booked claim provisions as the best estimate of the cost of future claim payments, plus an explicit allowance for risk and uncertainty. The allowance for risk and uncertainty is calculated by each business unit in accordance with the requirements of the Group non-life reserving policy, taking into account the risks and uncertainties specific to each line of business and type of claim in that territory. The requirements of the Group non-life reserving policy also seek to ensure that the allowance for risk and uncertainty is set consistently across both business units and reporting periods. Changes to claims development patterns can materially impact the results of actuarial projection techniques. However, allowance for the inherent uncertainty in the assumptions underlying reserving projections is automatically allowed for in the explicit allowance for risk and uncertainty included when setting booked reserves. Lump sum payments in settlement of bodily injury claims decided by the UK courts are calculated in accordance with the Ogden Tables. The Ogden Tables contain a discount rate that is set by the Lord Chancellor and that is applied when calculating the present value of loss of earnings for claims settlement purposes. The Ogden discount rate is currently under review by the Lord Chancellor. The outcome of this review is expected to be announced in 2011 but it is still not clear whether or by how much the rate will change. A reduction in the Ogden discount rates will increase lump sum payments to UK bodily injury claimants.
Aviva plc Annual Report and Accounts 2010 39 – Insurance liabilities continued (iv) Movements The following changes have occurred in the general insurance and health claims provisions during the year: £m
Incurred claims losses and expenses 6,586 6,741 Less: Payments made on claims incurred in the current year (3,641) (3,922) Payments made on claims incurred in prior years (3,803) (3,814) Recoveries on claim payments 271 298
Claims payments made in the year, net of recoveries (7,173) (7,438) Unwind of discounting 64 41 Other movements in the claims provisions (18) —
Change in claims reserve recognised as an expense (541) (656) Effect of portfolio transfers, acquisitions and disposals 4 (649) Foreign exchange rate movements 102 (359) Other movements 2 — Carrying amount at 31 December 12,263 12,696
The exceptional strengthening of reserves is in respect of several specific discontinued commercial liability risks written in Canada a significant number of years ago. The effect of changes in the main assumptions is given in note 43 and the economic assumption changes are explained in note 9.
(d) Loss development tables (i) Description of tables The tables that follow present the development of claim payments and the estimated ultimate cost of claims for the accident years 2001 to 2010. 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 2002, by the end of 2010 £5,814 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 £6,250 million was re-estimated to be £6,035 million at 31 December 2010. The original estimates will be increased or decreased, as more information becomes known about the individual claims and overall claim frequency and severity. The Group aims to maintain strong reserves in respect of its general insurance and health business in order to protect against adverse future claims experience and development. As claims develop and the ultimate cost of claims become more certain, the absence of adverse claims experience will result in a release of reserves from earlier accident years, as shown in the loss development tables and movements table (c)(iv) above. However, in order to maintain overall reserve adequacy, the Group establishes strong reserves in respect of the current accident year (2010) where the development of claims is less mature and there is much greater uncertainty attaching to the ultimate cost of claims. Releases from prior accident year reserves are also due to an improvement in the estimated cost of claims. Key elements of the release from prior accident year general insurance and health net provisions during 2009 were: £230 million from the UK, including group reinsurance business, mainly due to an improved view of group reinsurance liabilities, and favourable development on personal and commercial motor claims, and commercial property and commercial liability large claims.
£237 million from Europe mainly due to favourable development of personal motor and commercial property, especially in respect of large claims.
£79 million from Canada mainly due to favourable experience on motor and personal property.
Aviva plc Annual Report and Accounts 2010 39 – Insurance liabilities continued (ii) Gross figures Before the effect of reinsurance, the loss development table is: Accident year All prior years £m £m Total £m
At end of accident year 6,590 6,250 6,385 6,891 7,106 7,533 8,530 9,508 7,364 6,911 One year later 6,770 6,372 6,172 6,557 6,938 7,318 8,468 9,322 7,297 Two years later 6,775 6,287 6,124 6,371 6,813 7,243 8,430 9,277 Three years later 6,798 6,257 6,036 6,178 6,679 7,130 8,438 Four years later 6,754 6,205 5,932 6,008 6,603 7,149 Five years later 6,679 6,122 5,853 6,003 6,605 Six years later 6,630 6,056 5,813 5,953 Seven years later 6,576 6,044 5,792 Eight years later 6,600 6,035 Nine years later 6,577 Estimate of gross ultimate claims
Present value recognised in the statement of financial position 2,293 218 249 266 283 524 728 1,054 1,430 1,826 3,392 12,263
Aviva plc Annual Report and Accounts 2010 39 – Insurance liabilities continued (iii) Net of reinsurance After the effect of reinsurance, the loss development table is: In the loss development tables shown above, the cumulative claim payments and estimates of cumulative claims for each accident year are translated into sterling at the exchange rates that applied at the end of that accident year. The impact of using varying exchange rates is shown at the bottom of each table. Disposals are dealt with by treating all outstanding and IBNR claims of the disposed entity as ‘paid’ at the date of disposal. The loss development tables above include information on asbestos and environmental pollution claims provisions from business written before 2001. The undiscounted claim provisions, net of reinsurance, in respect of this business at 31 December 2010 were £939 million (2009: £968 million). The movement in the year reflects exceptional strengthening of provisions by £10 million (2009: £60 million) in respect of several specific discontinued commercial liability risks written in Canada a significant number of years ago, other strengthening of £66 million (2009: £62 million release), claim payments, reinsurance recoveries and foreign exchange rate movements.
Carrying amount at 1 January 4,781 5,493 Premiums written during the year 10,469 9,968 Less: Premiums earned during the year (10,424) (10,613)
Change in UPR recognised as income 45 (645) Gross portfolio transfers and acquisitions (14) — Foreign exchange rate movements 43 (67)
Present value 1,336 108 139 153 206 406 541 884 1,379 1,757 3,248 10,157 Cumulative effect of foreign exchange movements — 15 27 42 48 80 116 106 (14) 17 — 437 Effect of acquisitions — 6 7 36 8 13 13 20 8 — — 111
Present value recognised in the statement of financial position 1,336 129 173 231 262 499 670 1,010 1,373 1,774 3,248 10,705
Long-term business Participating contracts 69,482 66,559 Non-participating contracts at fair value 46,124 41,289 Non-participating contracts at amortised cost 2,181 2,167 48,305 43,456
(b) Long-term business investment liabilities Investment contracts are those that do not transfer significant insurance risk from the contract holder to the issuer, and are therefore treated as financial instruments under IFRS. Many investment contracts contain a discretionary participation feature in which the contract holder has a contractual right to receive additional benefits as a supplement to guaranteed benefits. These are referred to as participating contracts and are measured according to the methodology and Group practice for long-term business liabilities as described in note 39. They are not measured at fair value as there is currently no agreed definition of fair valuation for discretionary participation features under IFRS. In the absence of such a definition, it is not possible to provide a range of estimates within which a fair value is likely to fall. The IASB has deferred consideration of participating contracts to Phase II of its insurance contracts project. For participating business, the discretionary participation feature is recognised separately from the guaranteed element and is classified as a liability, referred to as unallocated distributable surplus. Guarantees on long-term investment products are discussed in note 41. Investment contracts that do not contain a discretionary participation feature are referred to as non-participating contracts and the liability is measured at either fair value or amortised cost. Of the non-participating investment contracts measured at fair value, £44,631 million are unit linked in structure and the fair value liability is equal to the unit reserve plus additional non-unit reserves if required on a fair value basis. These contracts are classified as ‘Level 1’ in the fair value hierarchy, as the unit reserve is calculated as the publicly quoted unit price multiplied by the number units in issue, and any non-unit reserve is insignificant. For unit-linked business, a deferred acquisition cost asset and deferred income reserve liability are recognised in respect of transaction costs and front-end fees respectively, that relate to the provision of investment management services, and which are amortised on a systematic basis over the contract term. The amount of the related deferred acquisition cost asset is shown in note 27 and the deferred income liability is shown in note 51. In the United States, funding agreements consist of one to ten year fixed rate contracts. These contracts may not be cancelled by the holders unless there is a default under the agreement, but may, subject to a call premium, be terminated by Aviva at any time. Aviva issued no new funding agreements in 2010. The weighted average interest rates for fixed-rate and floating-rate funding agreements as at 31 December 2010 were 4.758% and 0.434% respectively. Funding agreements issued before 2008 are measured at fair value equal to the present value of contractual cash flows and, for business issued since 2008, are measured at amortised cost. Most funding agreements are fully collateralised and therefore their fair values are not adjusted for own credit risk. Funding agreements carried at fair value total £1.0 billion and are classified as ‘Level 2’ in the fair value hierarchy. There is a small volume of annuity certain business for which the liability is measured at amortised cost using the effective interest method. The fair value of contract liabilities measured at amortised cost is not materially different from the amortised cost liability.
Carrying amount at 1 January 66,559 65,278 Provisions in respect of new business 6,169 5,973 Expected change in existing business provisions (2,400) (1,256) Variance between actual and expected experience 845 2,469 Impact of operating assumption changes 36 (49) Impact of economic assumption changes 240 (57) Other movements (65) (1,316) Change in liability recognised as an expense 4,825 5,764 Effect of portfolio transfers, acquisitions and disposals — (246) Foreign exchange rate movements (1,918) (4,256) Other movements 16 19
Carrying amount at 1 January 43,456 42,281 Provisions in respect of new business 4,096 3,045 Expected change in existing business provisions (2,145) (1,847) Variance between actual and expected experience 1,276 2,495 Impact of operating assumption changes 20 107 Impact of economic assumption changes 3 4 Other movements 53 370 Change in liability 3,303 4,174 Effect of portfolio transfers, acquisitions and disposals 1,903 (1,596) Foreign exchange rate movements (357) (1,403)
The variance between actual and expected experience of £1.3 billion was primarily driven by favourable movements in investment markets in 2010, which had a direct or indirect impact on liability values. Equity markets increased, government bond yields fell in major markets and credit spreads on corporate bonds were broadly unchanged. For unit-linked investment contracts, movements in asset values are offset by corresponding changes in liabilities, limiting the net impact on profit. Minor variances arise from differences between actual and expected experience for persistency, mortality and other demographic factors. The impact of assumption changes in the above analysis shows the resulting movement in the carrying value of non-participating investment contract liabilities. The £1.3 billion variance between actual and expected experience is not a change in assumptions. The impact of assumption changes on profit are included in the effect of changes in assumptions and estimates during the year shown in note 43, which combines participating and non-participating investment contracts together with the impact of movements in related non-financial assets.
Aviva plc Annual Report and Accounts 2010 41 – Financial guarantees and options This note details the financial guarantees and options we have given for some of our insurance and investment products. As a normal part of their operating activities, various Group companies have given guarantees and options, including investment return guarantees, in respect of certain long-term insurance and fund management products. Further information on assumptions is given in notes 39 and 40.
(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 £31 million at 31 December 2010 (2009: £28 million).
(i) France Guaranteed surrender value and guaranteed minimum bonuses Aviva France has written a number of contracts with such guarantees. The guaranteed surrender value is the accumulated value of the contract including accrued bonuses. Bonuses are based on accounting income from amortised bond portfolios, where the duration of bond portfolios is set in relation to the expected duration of the policies, plus income and releases from realised gains on equity-type investments. Policy reserves are equal to guaranteed surrender values. Local statutory accounting envisages the establishment of a reserve, ‘Provision pour Aléas Financiers’ (PAF), when accounting income is less than 125% of guaranteed minimum credited returns. No PAF was established at the end of 2010.
(iii) Ireland Guaranteed annuity options Products with similar GAOs to those offered in the UK have been issued in Ireland. The current net of reinsurance provision for such options is £236 million (2009: £214 million). This has been calculated on a deterministic basis, making conservative assumptions for the factors which influence the cost of the guarantee, principally annuitant mortality option take-up and long-term interest rates. These GAOs are ‘in the money’ at current interest rates but the exposure to interest rates under these contracts has been hedged through the use of reinsurance, using derivatives (swaptions). The swaptions effectively guarantee that an interest rate of 5% will be available at the vesting date of these benefits so there is reduced exposure to a further decrease in interest rates.
Aviva plc Annual Report and Accounts 2010 41 – Financial guarantees and options continued ‘No MVR’ guarantees Certain unitised with-profit policies containing ‘no MVR’ guarantees, similar to those in the UK, have been sold in Ireland. These guarantees are currently ‘in-the-money’ by £13 million (2009: £10 million). This has been calculated on a deterministic basis as the excess of the current policy surrender value over the discounted value (excluding terminal bonus) of the guarantees. The value of these guarantees is usually sensitive to the performance of investments held in the with-profit fund. Amounts payable under these guarantees are determined by the bonuses declared on these policies. There is no sensitivity to either interest rates or equity markets since there is no longer any exposure to equity in these funds and a matching strategy has been implemented for bonds.
(iv) Spain and Italy Guaranteed investment returns and guaranteed surrender values The Group has also written contracts containing guaranteed investment returns and guaranteed surrender values in both Spain and Italy. Traditional profit-sharing products receive an appropriate share of the investment return, assessed on a book value basis, subject to a guaranteed minimum annual return of up to 6% in Spain and 4% in Italy on existing business, while on new business the maximum guaranteed rate is lower. Liabilities are generally taken as the face value of the contract plus, if required, an explicit provision for guarantees calculated in accordance with local regulations. At 31 December 2010, total liabilities for the Spanish business were £4 billion (2009: £3 billion) with a further reserve of £12 million (2009: £11 million) for guarantees. Total liabilities for the Italian business were £11 billion (2009: £9 billion), with a further provision of £46 million (2009: £69 million) for guarantees. Liabilities are most sensitive to changes in the level of interest rates. It is estimated that provisions for guarantees would need to increase by £43 million (2009: £46 million) in Spain and £7 million (2009: £21 million) in Italy if interest rates fell by 1% from end 2010 values. Under this sensitivity test, the guarantee provision in Spain is calculated conservatively, assuming a long-term market interest rate of 1.6% and no lapses or premium discontinuances.
Aviva plc Annual Report and Accounts 2010 41 – Financial guarantees and options continued (d) Sensitivity 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 business Insurance contracts 3,650 4,299 Participating investment contracts 2 — Non-participating investment contracts 1,463 1,258 Outstanding claims provisions 104 40
General insurance and health Outstanding claims provisions 1,113 1,194 Provisions for claims incurred but not reported 445 449
Of the above total, £4,675 million (2009: £4,493 million) is expected to be recovered more than one year after the statement of financial position date.
(c) Movements The following movements have occurred in the reinsurance asset during the year: (i) In respect of long-term business provisions £m
Carrying amount at 1 January 5,557 5,565 Asset in respect of new business 358 412 Expected change in existing business asset (208) (57) Variance between actual and expected experience 81 (35) Impact of other operating assumption changes (443) (189) Impact of economic assumption changes (25) (250) Other movements (318) 486
Change in asset (555) 367 Effect of portfolio transfers, acquisitions and disposals 174 (41) Foreign exchange rate movements (61) (334) Carrying amount at 31 December 5,115 5,557
The impact of assumption changes in the above analysis shows the resulting movement in the carrying value of reinsurance assets. The reduction in the reinsurance asset from assumption changes mainly relates to assurance mortality assumptions in the UK and Ireland, with a corresponding reduction made to gross insurance contract liabilities. For participating businesses, a movement in reinsurance assets is generally offset by a corresponding adjustment to the unallocated divisible surplus and does not impact on profit. Where assumption changes do impact profit, these are included in the effect of changes in assumptions and estimates during the year shown in note 43, together with the impact of movements in related liabilities and other non-financial assets.
Aviva plc Annual Report and Accounts 2010 42 – Reinsurance assets continued (ii) In respect of general insurance and health outstanding claims provisions and IBNR
Carrying amount at 1 January 332 418 Premiums ceded to reinsurers in the year 770 775 Less: Reinsurers’ share of premiums earned during the year (800) (861) Change in reinsurance asset recognised as income (30) (86) Reinsurers’ share of portfolio transfers and acquisitions 4 5 Foreign exchange rate movements (2) (5) Other movements 3 —
Carrying amount at 31 December 307 332 43 – Effect of changes in assumptions and estimates during the year Certain estimates and assumptions used in determining our liabilities for insurance and investment contract business were changed from 2009 to 2010, affecting the profit recognised for the year with an equivalent effect on liabilities. This note analyses the effect of the changes. This disclosure only allows for the impact on liabilities and related assets, such as reinsurance, deferred acquisition costs and AVIF, and does not allow for offsetting movements in the value of backing financial assets.
Assumptions Long-term insurance business Interest rates (796) (363) Expenses (1) 69 Persistency rates 2 — Mortality for assurance contracts 71 11 Mortality for annuity contracts (637) 6 Tax and other assumptions 167 (49) Investment contracts Interest rates 1 20 Expenses 1 40 Persistency rates (21) — Tax and other assumptions (3) (89) General insurance and health business Change in loss ratio assumptions (4) (2) Change in discount rate assumptions (61) 57 Change in expense ratio and other assumptions 38 (21)
In Italy and Spain, the UDS balances were £435 million negative in total at 31 December 2010 (2009: Italy £92 million negative) because of an accounting mismatch between participating assets carried at market value and participating liabilities measured using local practice. The negative balance is considered to be recoverable from margins in the existing participating business liabilities.
45 – Special bonus and reattribution of the inherited estate This note describes the special distribution and reattribution of the inherited estate in our UK Life business.
(a) Current tax Current tax assets recoverable and liabilities payable in more than one year are £76 million and £246 million (2009: £254 million and £49 million). The taxation of foreign profits and worldwide debt cap rules were enacted in the Finance Act 2009. Under the foreign profits rules, a dividend exemption was introduced which largely exempts dividends received on or after 1 July 2009 from UK corporation tax. The Group has applied this legislation in arriving at its UK tax results for 2009 and 2010. The worldwide debt cap rules do not apply to Aviva plc in the period ended 31 December 2010 because the Group is a qualifying financial services group in the period.
Net liability at 1 January (820) (421) Acquisition and disposal of subsidiaries (44) (22) Amounts charged to profit (note 13a) (398) (254) Amounts charged to other comprehensive income (note 13b) (146) (196) Exchange differences 7 37 Other movements (69) 36
Deficits in the main staff pension schemes (note 48e(vii)) 527 1,707 Other obligations to main staff pension schemes – insurance policies issued by Group companies (note 48e(vii)) 1,445 1,351
Total IAS 19 obligations to main staff pension schemes 1,972 3,058 Deficits in other staff pension schemes 129 125
Other provisions comprise many small provisions throughout the Group for obligations such as costs of compensation, litigation, staff entitlements and reorganisation. Of the total, £2,245 million (2009: £3,375 million) is expected to be settled more than one year after the statement of financial position date.
Charge to income statement 328 290 618 Utilised during the year (370) (239) (609) Acquisition of subsidiaries — (32) (32) Foreign exchange rate movements (13) (11) (24)
(a) Introduction The Group operates a large number of defined benefit and defined contribution pension schemes around the world. The only material defined benefit schemes are in the UK, the Netherlands, Canada and Ireland and, of these, the main UK scheme is by far the largest. This note gives full IAS 19 disclosures for these schemes whilst the smaller ones, while still measured under IAS 19, are included as one total within Provisions (see note 47). Similarly, while the charges to the income statement for the main schemes are shown in section (e)(iv) below, the total charges for all pension schemes are disclosed in section (d) below. The assets of the main UK, Irish and Canadian schemes are held in separate trustee-administered funds to meet long-term pension liabilities to past and present employees. In the Netherlands, the main scheme is held in a separate foundation which invests in the life funds of the Group. In all schemes, the appointment of trustees of the funds is determined by their trust documentation, and they are required to act in the best interests of the schemes’ beneficiaries. The long-term investment objectives of the trustees and the employers are to limit the risk of the assets failing to meet the liabilities of the schemes over the long term, and to maximise returns consistent with an acceptable level of risk so as to control the long-term costs of these schemes. A full actuarial valuation of each of the defined benefit schemes is carried out at least every three years for the benefit of scheme trustees and members. Actuarial reports have been submitted for each scheme within this period, using appropriate methods for the respective countries on local funding bases.
Active members 7,261 8,164 4,453 4,637 Deferred members 52,833 53,221 6,090 6,155 Pensioners 29,754 28,878 3,152 3,119
Active members 732 816 1,082 1,143 Deferred members 578 558 933 877 Pensioners 1,288 1,291 683 684
Aviva plc Annual Report and Accounts 2010 48 – Pension obligations continued (i) Defined benefit section of the ASPS The Company works closely with the trustees who are required to consult it on the funding of the scheme and its investment strategy. Following each actuarial valuation, the Company and the trustees agree the level of contributions needed and funding levels are then monitored on an annual basis. At 31 March 2009, the date of the last actuarial valuation, this section of the scheme had an excess of obligations over available assets, on a funding basis, which uses more prudent assumptions than are required for reporting under IAS 19, of £3.0 billion. As a result of that valuation, the Company and the trustees have agreed a long-term funding plan where contributions, together with anticipated growth in scheme investments, are expected to eliminate the funding deficit over time. Under this agreement, deficit funding payments of £378 million were made in 2010, and are expected to be £136 million in 2011. Partly as a result of the higher funding payments and the impact on scheme liabilities of the scheme closures described above, the funding deficit is estimated to have fallen to £1.3 billion at 31 December 2010. The employing companies’ contributions to the defined benefit section of the ASPS throughout 2010 were 48% of employees’ pensionable salaries, together with the cost of redundancies during the year and the additional deficit funding described above, together totalling £501 million. Until 31 March 2011, the employers’ contribution rate for 2011 has been maintained as 48% of pensionable salaries, with expected service funding contributions for that period falling to £25 million. Active members of this section of the ASPS contributed between 5% and 7.5% of their pensionable salaries during 2010. In 2006, the Group’s UK life business carried out an investigation into the allocation of costs in respect of funding the ASPS, to identify the deficit that arose in respect of accruals prior to the introduction of the current management services agreements (MSAs) and to propose a split between individual product companies based on an allocation of the deficit into pre- and post-MSA amounts. The results of this review were agreed by the relevant company boards and accepted by the UK regulator. Consequently, with effect from 1 January 2006, the Company’s UK with-profit product companies have been liable for a share of the additional payments for deficit funding referred to above up to a total of £130 million. This has resulted in movements between the unallocated divisible surplus (UDS) and retained earnings via the statement of comprehensive income of (£18) million in 2010 (2009: £24 million) to reflect changes in the amount recoverable from the with-profit product companies.
Total defined benefit schemes (note 10b) (175) 187 UK defined contribution schemes 53 53 Overseas defined contribution schemes 17 20
The credit for the defined benefit schemes arises from the £286 million gain on the closure of the UK scheme to future accrual, described in section (c) above. There were no significant contributions outstanding or prepaid as at either 31 December 2009 or 2010.
Mortality assumptions Mortality assumptions are significant in measuring the Group’s obligations under its defined benefit schemes, particularly given the maturity of these obligations in the material schemes. The assumptions used are summarised in the table below and have been selected to reflect the characteristics and experience of the membership of these schemes.
Aviva plc Annual Report and Accounts 2010 48 – Pension obligations continued The mortality tables, average life expectancy and pension duration used at 31 December 2010 for scheme members are as follows: Life expectancy/(pension duration) at NRA of a male Life expectancy/(pension duration) at NRA of a female
UK – ASPS Club Vita pooled experience, including an allowance for future improvements 60
Actuarial gains on scheme assets 623 543 Less: (gains)/losses on insurance policy assets accounted for elsewhere (see (iii) above) (80) 18
Actuarial gains on admissible assets 543 561 Experience gains arising on scheme liabilities 450 77 Changes in assumptions underlying the present value of the scheme liabilities 6 (1,778)
Attributable to equity shareholders of Aviva plc 1,033 (1,140) Attributable to non-controlling interests (34) —
The gain arising from changes in assumptions in 2010 reflects the impact of lower discount rates for liabilities across all but the Irish schemes, together with the impact of changes in mortality assumptions in the UK and Dutch schemes, and changes in the revaluation rate for certain benefits in deferment in the UK schemes as a result of recent government legislation. The cumulative amount of actuarial gains and losses on the pension schemes recognised in other comprehensive income since 1 January 2004 (the date of transition to IFRS) is a loss of £1,231 million at 31 December 2010 (2009: cumulative loss of £2,230 million).
Fair value of scheme assets at the end of the year 9,971 8,754 7,936 8,814 8,137 Present value of scheme liabilities at the end of the year (11,419) (11,812) (9,951) (10,017) (10,196)
Main UK scheme Both the Group and the trustees regularly review the asset/liability management of the main UK scheme. It is fully understood that, whilst the current asset mix is designed to produce appropriate long-term returns, this introduces a material risk of volatility in the scheme’s surplus or deficit of assets compared with its liabilities. The principal asset risks to which the scheme is exposed are: Equity market risk – the effect of equity market falls on the value of plan assets.
There is also an exposure to currency risk where assets are not denominated in the same currency as the liabilities. The majority of this exposure has been removed by the use of hedging instruments. In 2010, there has been a reduction in the proportion of assets invested in equities, thereby mitigating the equity risk above. In addition, the trustees have taken further measures to partially mitigate inflation and interest rate risks.
Aviva plc Annual Report and Accounts 2010 48 – Pension obligations continued (vii) Recognition in the statement of financial position The assets and liabilities of the schemes, attributable to defined benefit members, including investments in Group insurance policies (see footnote below), at 31 December 2010 were: UK Netherlands Canada Ireland Total £m £m £m
Surplus included in other assets (note 27) 524 — — — 524 Deficits included in provisions (note 47) (207) (10) (146) (164) (527)
Total fair value of assets 8,142 1,358 198 407 10,105 Present value of scheme liabilities (9,554) (1,372) (308) (578) (11,812)
Deficits in the schemes included in provisions (note 47) (1,412) (14) (110) (171) (1,707)
Other assets comprise cash at bank, derivative financial instruments, receivables and payables. Plan assets in the table above include investments in Group-managed funds and insurance policies, as described in section (iii) above. Where the investment and insurance policies are in segregated funds with specific asset allocations, they are included in the appropriate line in the table above, otherwise they appear in ‘Other’. The Dutch insurance policies of £1,445 million (2009: £1,351 million) are considered non-transferable under the terms of IAS 19 and so have been treated as other obligations to staff pension schemes within provisions (see note 47). The total IAS 19 obligations and strict IAS 19 assets (i.e. excluding the non-transferable insurance policies) of the schemes give a net deficit of £1,448 million (2009: £3,058 million), as shown in the following tables.
Surplus included in other assets (note 27) 524 — — — 524 Deficits included in provisions (note 47) (207) (1,455) (146) (164) (1,972)
Total fair value of assets 8,142 7 198 407 8,754 Present value of scheme liabilities (9,554) (1,372) (308) (578) (11,812)
Deficits in the schemes included in provisions (note 47) (1,412) (1,365) (110) (171) (3,058)
Net deficits in the schemes at 31 December 11,416 (11,419) (3) (1,445) (1,448)
Aviva plc Annual Report and Accounts 2010 49 – Borrowings Our borrowings are either core structural borrowings or operational borrowings. This note shows the carrying values and contractual maturity amounts of each type, and explains their main features and movements during the year.
Debenture loans 9.5% guaranteed bonds 2016 — — 199 199 — — 199 199 4.25% senior bonds 2017 issued by Delta Lloyd N.V. — — 489 489 — — — — 2.5% subordinated perpetual loan notes — 151 — 151 — 157 — 157 Other loans — — 12 12 — — 13 13
The classifications between Upper Tier 2, Lower Tier 2 and Senior debt shown above are as defined by the Financial Services Authority in GENPRU Annex 1 ‘Capital Resources’. Subordinated debt is stated net of notes held by Group companies of £34 million (2009: £35 million). All the above borrowings are stated at amortised cost.
Borrowings are considered current if the contractual maturity dates are within a year. Where subordinated debt is undated or loan notes are perpetual, the interest payments have not been included beyond 15 years. Annual interest payments for these borrowings are £84 million (2009: £86 million). Contractual undiscounted interest payments are calculated based on underlying fixed interest rates or prevailing market floating rates as applicable. Year-end exchange rates have been used for interest projections on loans in foreign currencies.
Aviva plc Annual Report and Accounts 2010 49 – Borrowings continued (c) Operational borrowings (i) The carrying amounts of these borrowings are: Amounts owed to credit institutions Bank loans 2,550 2,182
Less than 1 year 1,560 220 1,780 324 185 509 1 to 5 years 1,157 899 2,056 769 755 1,524 5 to 10 years 266 1,084 1,350 936 825 1,761 10 to 15 years 317 956 1,273 669 754 1,423 Over 15 years 5,198 4,077 9,275 7,230 2,335 9,565
(d) Description and features (i) Subordinated debt A description of each of the subordinated notes is set out in the table below: Notional amount Issue date Redemption date Callable at par at option of the Company from In the event the Company does not call the notes, the coupon will reset at each applicable reset date to £700 million 14 Nov 2001 14 Nov 2036 16 Nov 2026 5 year Benchmark Gilt + 2.85% €800 million 14 Nov 2001 14 Nov 2021 14 Nov 2011 3 month Euribor + 2.12% €650 million 29 Sep 2003 02 Oct 2023 02 Oct 2013 3 month Euribor + 2.08% €500 million 29 Sep 2003 Undated 29 Sep 2015 3 month Euribor + 2.35% £800 million 29 Sep 2003 Undated 29 Sep 2022 5 year Benchmark Gilt + 2.40% US$300 million 19 Dec 2006 19 Jun 2017 19 Jun 2012 3 month US LIBOR + 0.84% £400 million 20 May 2008 20 May 2058 20 May 2038 3 month LIBOR + 3.26% £200 million 8 Aug 2008 20 May 2058 20 May 2038 3 month LIBOR + 3.26% €500 million 20 May 2008 22 May 2038 22 May 2018 3 month Euribor + 3.35% £200 million 1 Apr 2009 1 Apr 2019 1 Apr 2014 3 month LIBOR + 8.10% €50 million 30 Apr 2009 30 Apr 2019 30 Apr 2014 3 month Euribor + 8.25%
Aviva plc Annual Report and Accounts 2010 49 – Borrowings continued (ii) Debenture loans The 9.5% guaranteed bonds were issued by the Company at a discount of £1.1 million. This discount and the issue expenses are 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. The 4.25% senior loan notes were issued by Delta Lloyd at a discount of £2 million in November 2010. The bonds mature in November 2017. The 2.5% perpetual subordinated loan notes were issued by Delta Lloyd to finance the acquisition of NUTS OHRA Beheer BV in 1999. As part of the public offering of Delta Lloyd in 2009, their nominal value was increased to €497 million. However, because they are considered to be perpetual, their carrying value is lower at €177 million (2009: €177 million), calculated in 1999 and based on the future cash flows in perpetuity discounted back at a market rate of interest. The rate of interest paid on the notes has been gradually increased to a maximum of 2.76% in 2009. Other loans totalling £12 million (2009: £13 million) comprise borrowings in the United States. All these borrowings are at fixed rates and their fair value at 31 December 2010 was £860 million (2009: £552 million), calculated with reference to quoted prices or discounted future cash flows as appropriate.
(iii) Commercial paper The commercial paper consists of £504 million in the Company (2009: £483 million) and £139 million in Delta Lloyd N.V. (2009: £nil) and is considered core structural funding. All commercial paper is repayable within one year and is issued in a number of different currencies, primarily sterling, euros and US dollars. Its fair value is considered to be the same as its carrying value.
Non-recourse Loans to property partnerships (see (a) below) 1,098 790 Loans to Irish investment funds (see (b) below) 34 36 UK Life reassurance (see (c) below) 217 114 US 149 150 Other non-recourse loans 193 169
(c) The UK long-term business entered into a financial reassurance agreement with Swiss Re in 2008, under which up-front payments are received from Swiss Re in return for 90% of future surplus arising. The loan will be repaid as profits emerge on the business.
(e) Movements during the year Movements in borrowings during the year were: Core structural £m Operational £m £m
New borrowings drawn down, net of expenses 2,921 726 3,647 Repayment of borrowings (2,274) (613) (2,887) Net cash inflow 647 113 760 Foreign exchange rate movements (77) (801) (878) Borrowings acquired/(loans repaid) for non-cash consideration — (4) (4) Fair value movements — 59 59 Amortisation of discounts and other non-cash items 1 — 1 Other movements 6 5 11
Movements in the year 577 (628) (51) Balance at 1 January 5,489 9,511 15,000
All movements in fair value in 2009 and 2010 on securitised mortgage loan notes designated as fair value through profit or loss were attributable to changes in market conditions. These loan notes have external credit ratings which have not changed since the inception of the loans.
Expiring within one year 975 600 Expiring beyond one year 1,135 1,510
Expected to be settled within one year 19,155 19,982 Expected to be settled in more than one year 1,137 560
Bank overdrafts arise substantially from unpresented cheques and amount to £319 million (2009: £422 million) in long-term business operations and £441 million (2009: £504 million) in general business and other operations. All payables and other financial liabilities are carried at cost, which approximates to fair value, except for derivative liabilities, which are carried at their fair values.
51 – Other liabilities This note analyses our other liabilities at the end of the year.
(b) Asbestos, pollution and social environmental hazards In the course of conducting insurance business, various companies within the Group receive general insurance liability claims, and become involved in actual or threatened related litigation arising therefrom, including claims in respect of pollution and other environmental hazards. Amongst these are claims in respect of asbestos production and handling in various jurisdictions, including Europe, Canada and Australia. Given the significant delays that are experienced in the notification of these claims, the potential number of incidents which they cover and the uncertainties associated with establishing liability and the availability of reinsurance, the ultimate cost cannot be determined with certainty. However, on the basis of current information having regard to the level of provisions made for general insurance claims, the directors consider that any additional costs arising are not likely to have a material impact on the financial position of the Group.
(e) European legislative change In 2010, a test case was taken to the European Court of Justice to rule on the current law and practice whereby insurers may take into account a person’s gender in the assessment of risk and consequently the pricing of insurance products, the ruling for which was issued on 1 March 2011. We are currently unable to quantify the impact on our existing insurance provisions.
(f) Payment protection insurance (PPI) mis-selling In September 2009, the FSA launched an investigation into sales practices for payment protection insurance. On 10 August 2010, the FSA announced that mis-selling of PPI policies had been widespread and that consumers who could prove mis-selling would be entitled to financial redress from distributors of the policies. However, in October 2010, on behalf of distributors, the British Bankers Association elected to seek a judicial review of this ruling and no conclusion of this legal process has yet been reached. The directors do not consider that the Group is liable for mis-selling in its role as underwriter and so no provision is currently necessary.
53 – Commitments This note gives details of our commitments to capital expenditure and under operating leases.
(a) Capital commitments Contractual commitments for acquisitions or capital expenditures of investment property, property and equipment and intangible assets, which have not been recognised in the financial statements, are as follows: £m
Investment property 63 66 Property and equipment 160 255 Intangible assets — 4
(ii) Future contractual aggregate minimum lease payments under non-cancellable operating leases are as follows: £m
Total future minimum sub-lease payments expected to be received under non-cancellable sub-leases 63 83
Aviva plc Annual Report and Accounts 2010 54 – Statement of cash flows This note gives further detail behind the figures in the statement of cash flows.
(b) Cash flows in respect of the acquisition of subsidiaries, joint ventures and associates: £m
Aviva plc Annual Report and Accounts 2010 54 – Statement of cash flows continued (c) Cash flows in respect of the disposal of subsidiaries, joint ventures and associates: £m
The above figures form part of cash flows from investing activities. As described in note 2(b), a further £930 million, being the net cash proceeds from the partial disposal of Delta Lloyd in 2009, is included in cash flows from financing activities for that year.
Financed by Equity shareholders’ funds 15,295 13,092 Non-controlling interests 3,977 4,279 Direct capital instrument 990 990 Preference shares 200 200 Subordinated debt 4,572 4,637 External debt 1,494 852
Total capital employed 26,528 24,050 1. ‘Corporate’ includes centrally held tangible net assets, the element of the staff pension scheme deficit or surplus allocated centrally and also reflects internal lending arrangements. These internal lending arrangements, which net out on consolidation, arise in relation to the following: — Aviva International Insurance Limited (AII) acts as both a UK general insurer and as the primary holding company for our foreign subsidiaries. Internal capital management mechanisms in place allocate a portion of the total capital of the company to the UK general insurance operations, giving rise to notional lending between the general insurance and holding company activities. These mechanisms also allow for some of the assets of the general insurance business to be made available for use across the Group.
Analysis of liabilities: Participating insurance liabilities 2,181 17,133 13,013 32,327 — 32,327 31,716 64,043 — 64,043 64,702 Unit-linked liabilities — — — — 3,947 3,947 17,503 21,450 — 21,450 21,268 Other non-participating life insurance 344 2,558 374 3,276 25,783 29,059 46,027 75,086 — 75,086 67,658
Available capital resources at 31 December 235 1,296 1,833 3,364 2,765 6,129 8,394 14,523
Aviva plc Annual Report and Accounts 2010 56 – Capital statement continued The available capital of the Group’s with-profit funds is determined in accordance with the ‘Realistic balance sheet’ regime prescribed by the FSA’s regulations, under which liabilities to policyholders include both declared bonuses and the constructive obligation for future bonuses not yet declared. The available capital resources include an estimate of the value of their respective estates, included as part of the unallocated divisible surplus. The estate represents the surplus in the fund that is in excess of any constructive obligation to policyholders. It represents capital resources of the individual with-profit fund to which it relates and is available to meet regulatory and other solvency requirements of the fund and, in certain circumstances, additional liabilities may arise. The liabilities included in the balance sheet for the with-profit funds do not include the amount representing the shareholders’ portion of future bonuses. However, the shareholders’ portion is treated as a deduction from capital that is available to meet regulatory requirements and is therefore shown as a separate adjustment in the capital statement. In accordance with the FSA’s regulatory rules under its realistic capital regime, the Group is required to hold sufficient capital in its UK life with-profit funds to meet the FSA capital requirements, based on the risk capital margin (RCM). The determination of the RCM depends on various actuarial and other assumptions about potential changes in market prices, and the actions management would take in the event of particular adverse changes in market conditions.
Aggregate 44.3 (42.2) 2.1 1.2 (0.9) 2.4 2.1 * These realistic liabilities include the shareholders’ share of future bonuses of £0.7 billion (31 December 2009: £0.6 billion). Realistic liabilities adjusted to eliminate the shareholders’ share of future bonuses are £41.5 billion (31 December 2009: £42.1 billion). 1. These realistic liabilities make provision for guarantees, options and promises on a market consistent stochastic basis. The value of the provision included within realistic liabilities is £1.9 billion, £0.3 billion and £3.1 billion for NWPSF, OWPSF and
Under the FSA regulatory regime, UK life with-profits business is required to hold capital equivalent to the greater of their regulatory requirement based on EU directives (regulatory peak) and the FSA realistic bases (realistic peak) described above. For UK non-participating business, the relevant capital requirement is the minimum solvency requirement determined in accordance with FSA regulations. The available capital reflects the excess of regulatory basis assets over liabilities before deduction of capital resources requirement. For UK general insurance businesses, the relevant capital requirement is the minimum solvency requirement determined in accordance with the FSA requirements. For overseas businesses in the EEA, US, Canada, Australia, Hong Kong and Singapore, the available capital and the minimum requirement are calculated under the locally applicable regulatory regimes. The businesses outside these territories are subject to the FSA rules for the purposes of calculation of available capital and capital resource requirement. For fund management and other businesses, the relevant capital requirement is the minimum solvency requirement determined in accordance with the local regulator’s requirements for the specific class of business. The available capital resources in each regulated entity are generally subject to restrictions as to their availability to meet requirements that may arise elsewhere in the Group. The principal restrictions are: (i) UK with-profit funds – (NWPSF, OWPSF and WPSF) – any available surplus held in each fund can be used to meet the requirements of the fund itself, be distributed to policyholders and shareholders or in the case of NWPSF and OWPSF, transferred via the capital support arrangement explained above (for OWPSF only to the extent support has been provided in the past). In most cases, with-profit policyholders are entitled to at least 90% of the distributed profits while the shareholders receive the balance. The latter distribution would be subject to a tax charge, which is met by the fund.
(b) Market risk Market risk is the risk of adverse financial impact due to changes in fair values or future cash flows of financial instruments from fluctuations in interest rates, equity prices, property prices and foreign currency exchange rates. Market risk arises in business units due to fluctuations in both the value of liabilities and the value of investments held. At Group level, it also arises in relation to the overall portfolio of international businesses and in the value of investment assets owned directly by the shareholders. The Group has established a policy on market risk which sets out the principles that businesses are expected to adopt in respect of management of the key market risks to which the Group is exposed. The Group monitors adherence to this market risk policy and regularly reviews how business units are managing these risks locally, through the Assets Committee and ultimately the Asset Liability Committee (ALCO). For each of the major components of market risk, described in more detail below, the Group has put in place additional processes and procedures to set out how each risk should be managed and monitored, and the approach to setting an appropriate risk appetite. The management of market risk is undertaken in businesses, regions and at Group level. Businesses manage market risks locally using the Group market risk framework and within local regulatory constraints. Businesses may also be constrained by the requirement to meet policyholders’ reasonable expectations and to minimise or avoid market risk in a number of areas. The ALM function is responsible for managing market risk at Group level, and a number of investment-related risks, in particular those faced by shareholder funds throughout the Group. The Group market risk policy sets out the minimum principles and framework for matching liabilities with appropriate assets, the approaches to be taken when liabilities cannot be matched and the monitoring processes that are required. The Group has criteria for matching assets and liabilities for all classes of business to minimise the impact of mismatches between the value of assets and the liabilities due to market movements. The local regulatory environment for each business will also set the conditions under which assets and liabilities are to be matched. In addition, where the Group’s long-term savings businesses have written insurance and investment products where the majority of investment risks are borne by its policyholders, these risks are managed in line with local regulations and marketing literature, in order to satisfy the policyholders’ risk and reward objectives.
At a business unit level, equity price risk is actively managed in order to mitigate anticipated unfavourable market movements where this lies outside the risk appetite of either the company in respect of shareholder assets or the fund in respect of policyholder assets concerned. In addition investment limits and local asset admissibility regulations require that business units hold diversified portfolios of assets thereby reducing exposure to individual equities. The Group does not have material holdings of unquoted equity securities. Equity risk is also managed using a variety of derivative instruments, including futures and options. Businesses actively model the performance of equities through the use of risk models, in particular to understand the impact of equity performance on guarantees, options and bonus rates. The Assets Committee actively monitors equity assets owned directly by the Group, which may include some material shareholdings in the Group’s strategic business partners. Sensitivity to changes in equity prices is given in section (h) below.
Interest rate risk Interest rate risk arises primarily from the Group’s investments in long-term debt and fixed income securities, which are exposed to fluctuations in interest rates. The Group manages this risk by adopting close asset liability matching criteria, to minimise the impact of mismatches between the value of assets and liabilities from interest rate movements. A number of policyholder participation features have an influence on the Group’s interest rate risk. The major features include guaranteed surrender values, guaranteed annuity options, and minimum surrender and maturity values. Details of material guarantees and options are given in note 41. In short-term business such as general insurance business, the Group requires a close matching of assets and liabilities to minimise this risk. Interest rate risk is managed by the ALM function and monitored and managed by the Assets Committee, and the Asset Liability Committee. Exposure to interest rate risk is monitored through several measures that include value-at-risk analysis, position limits, risk modelling, asset and liability matching using measures such as duration. The impact of exposure to sustained low interest rates is regularly monitored. Interest rate risk is also managed using a variety of derivative instruments, including futures, options, swaps, caps and floors, in order to provide a degree of hedging against unfavourable market movements in interest rates inherent in the assets backing technical liabilities. The Group has entered into a number of initiatives, including interest rate swap agreements and changes in asset mix, to mitigate the effects of potential adverse interest rate movements, and to enable closer matching of assets and liabilities. Sensitivity to changes in interest rates is given in section (h) below. Further information on borrowings is included in note 49.
Currency risk The Group has minimal exposure to currency risk from financial instruments held by business units in currencies other than their functional currencies, as nearly all such holdings are backing either unit-linked or with-profit contract liabilities or are hedged. For this reason, no sensitivity analysis is given for these holdings. The Group operates internationally and as a result is exposed to foreign currency exchange risk arising from fluctuations in exchange rates of various currencies. Approximately half of the Group’s premium income arises in currencies other than sterling and the Group’s net assets are denominated in a variety of currencies, of which the largest are euro, sterling and US dollars. The Group does not hedge foreign currency revenues as these are substantially retained locally to support the growth of the Group’s business and meet local regulatory and market requirements.
Aviva plc Annual Report and Accounts 2010 57 – Risk management continued The Group’s foreign exchange policy requires that each of our subsidiaries maintains sufficient assets in its local currency to meet local currency liabilities. Therefore, capital held by the Group’s business units should be able to support local business activities regardless of foreign currency movements. However, such movements may impact the value of the Group’s consolidated shareholders’ equity which is expressed in sterling. This aspect of foreign exchange risk is monitored and managed centrally, against pre-determined limits. The Group’s foreign exchange policy is to manage these exposures by aligning the deployment of regulatory capital by currency with the Group’s regulatory capital requirements by currency. Limits are set to control the extent to which the deployment of capital is not aligned fully with the Group’s regulatory capital requirement for each major currency. Currency borrowings and derivatives are used to manage exposures within the limits that have been set. At 31 December 2010, the Group’s total equity deployment by currency was: Sterling £m Euro £m
in sterling/ euro rate £m in sterling/ euro rate £m in sterling/ US$ rate £m in sterling/ US$ rate £m
Correlation risk The Group recognises that lapse behaviour and potential increases in consumer expectations are sensitive to and interdependent with market movements and interest rates. These interdependencies are taken into consideration in the ICA in the aggregation of the financial stress tests with the operational risk assessment and in scenario analysis.
The accurate and timely reporting of detailed exposure information, and their aggregation by counterparty, exposure types, sectors, geography and ratings.
The employment of risk mitigation techniques where and when deemed appropriate. These are utilised where possible to remove residual unwanted risks, as well as bring or keep exposure limits within appetite, and include methods such as collateralisation, purchase of credit protection and diversification strategies.
At 31 December 2009 AAA AA A BBB Speculative grade Not rated
Debt securities 38.6% 17.3% 24.0% 12.8% 2.5% 4.8% 161,757 Reinsurance assets 10.5% 52.1% 26.7% 0.4% 0.2% 10.1% 7,572 Other investments 0.2% 3.4% 2.0% 1.2% — 93.2% 31,518 Loans 6.2% 7.7% 0.9% 0.5% 1.0% 83.7% 41,079
The Group loan portfolio principally comprises: Policy loans which are generally collateralised by a lien or charge over the underlying policy; Loans and advances to banks which primarily relate to loans of cash collateral received in stock lending transactions.
These loans are fully collateralised by other securities; and Mortgage loans collateralised by property assets.
Aviva plc Annual Report and Accounts 2010 57 – Risk management continued Unit trusts and other investment vehicles The credit quality of the underlying debt securities within these vehicles is managed by the safeguards built into the investment mandates for these funds. We rely on our understanding that the trusts and their asset managers are only approved if they satisfy certain selection criteria (including due diligence in the form of a questionnaire and/or research by dedicated teams). In addition, the asset managers are mandated to make investments in line with the funds’ risk profiles as marketed to prospective customers and policyholders. Accordingly, as part of reviewing the asset quality of unit trusts and other investment vehicles, we monitor the assets within the funds and their performance to ensure they remain in line with the respective investment mandates for these funds. For certain of the unit trusts in our other investments, we apply minimum requirements affecting both the underlying counterparties and the investments issued by those counterparties such as a minimum size for the counterparty’s programme, a limit on the size of the overall exposure to the underlying counterparty and, where appropriate, explicit approval of the counterparty by internal credit risk management teams is required. These criteria are indicators of the asset quality for these investments, as they represent minimum criteria for liquidity and diversification. A proportion of the assets underlying these investments are represented by equities and so credit ratings are not generally applicable. Equity exposures are managed against agreed benchmarks that are set with reference to overall market risk appetite.
Policy loans are loans and advances made to policyholders, and are collateralised by the underlying policies. As such, we believe such collateralisation minimises our risk.
Aviva plc Annual Report and Accounts 2010 57 – Risk management continued Derivative credit exposures The Group is exposed to counterparty credit risk through derivative trades. This risk is mitigated through collateralising almost all trades (the exception being certain FX trades where it has historically been the market norm not to collateralise). The Group operates strict standards around collateral management and controls including the requirement that all ‘Over the Counter’ derivatives are supported by credit support annexes and ISDAs.
Neither past due nor impaired £m 0–3 months £m 3–6 months £m £m
Debt securities 161,647 — — — — 110 161,757 Reinsurance assets 7,572 — — — — — 7,572 Other investments 31,503 — — — — 15 31,518 Loans 40,039 355 35 17 6 627 41,079 Receivables and other financial assets 8,832 649 61 32 71 7 9,652
Asset liability matching The Group market risk policy sets out the minimum principles and framework for matching liabilities with appropriate assets, the approaches to be taken when liabilities cannot be matched and the monitoring processes that are required. The Group has criteria for matching assets and liabilities for all classes of business to minimise the impact of mismatches between the value of assets and the liabilities due to market movements. The local regulatory environment for each business will also set the conditions under which assets and liabilities are to be matched. The Asset Liability matching (ALM) methodology develops optimal asset portfolio maturity structures for our businesses which seek to ensure that the cash flows are sufficient to meet the liabilities as they are expected to arise.
Maturity analyses The following tables show the maturities of our insurance and investment contract liabilities, and of the financial and reinsurance assets to meet them. A maturity analysis of the contractual amounts payable for borrowings and derivatives is given in notes 49 and 58 respectively. Contractual obligations under operating leases and capital commitments are given in note 53.
On demand or within 1 year £m 1–5 years £m 5–15 years £m
Debt securities 161,757 17,309 45,298 98,792 358 Equity securities 45,428 — — — 45,428 Other investments 31,517 29,091 414 493 1,519 Loans 41,079 6,867 4,146 30,066 — Cash and cash equivalents 25,176 25,176 — — —
As described in note 25, £1,247 million debt securities and £2,085 million equity securities held by consolidated French mutual funds, previously included within other investments, have been reclassified as debt and equity securities as at 31 December 2009. The maturity analysis at 31 December 2009 has been amended accordingly. The assets above are analysed in accordance with the earliest possible redemption date of the instrument at the initiation of the Group. Where an instrument is transferable back to the issuer on demand, such as most unit trusts or similar types of investment vehicle, it is included in the ‘On demand or within 1 year’ column. Debt securities with no fixed contractual maturity date are generally callable at the option of the issuer at the date the coupon rate is reset under the contractual terms of the instrument. The terms for resetting the coupon are such that we expect the securities to be redeemed at this date, as it would be uneconomic for the issuer not to do so, and for liquidity management purposes we manage these securities on this basis. The first repricing and call date is normally ten years or more after the date of issuance. Most of the Group’s investments in equity securities and fixed maturity securities are market traded and therefore, if required, can be liquidated for cash at short notice.
(e) Insurance risk (i) Life insurance risk Types of risk Life insurance risk in the Group arises through its exposure to mortality and morbidity insurance and exposure to worse than anticipated operating experience on factors such as persistency levels and management and administration expenses.
Risk management framework The Group has developed a life insurance risk policy and guidelines on the practical application of this policy. Individual life insurance risks are managed at a business unit level but are also monitored at Group level. The impact of life insurance risks is monitored by the business units as part of the control cycle of business management. Exposure is monitored through the assessment of liabilities, the asset liability management framework, profit reporting (under both IFRS and MCEV), and the ICA process. Significant insurance risks will be reported through the risk management framework and overseen by the Life Insurance Committee. At Group level the overall exposure to life insurance risk is measured through the ICA and other management reporting. The Life Insurance Committee monitors the application of the risk policy in each business, and receives management information on life insurance risks. The committee considers all areas of life insurance risk, but in particular has a remit to monitor mortality, longevity, morbidity, persistency, product development and pricing, unit pricing and expenses. The committee also considers the reinsurance coverage across the life businesses. It confirms that guidance and procedures are in place for each of the major components of life insurance risk, and that the businesses mitigate against any life insurance risk outside local appetite, within the parameters for the overall Group risk appetite. The committee has also developed guidance for business units on management of a number of areas of life insurance risk to ensure best practice is shared throughout the Group and common standards are adopted.
Product design and pricing risk arises from poorly designed or inadequately priced products and can lead to both financial loss for and reputation damage to the Group. Guidelines have been developed to support the businesses through the complete cycle of the product development process, financial analysis and pricing.
Embedded derivatives The Group has exposure to a variety of embedded derivatives in its long-term savings business due to product features offering varying degrees of guaranteed benefits at maturity or on early surrender, along with options to convert their benefits into different products on pre-agreed terms. The extent of the impact of these embedded derivatives differs considerably between business units. Examples of each type of embedded derivative affecting the Group are: Options: call, put, surrender and maturity options, guaranteed annuity options, options to cease premium payment, options for withdrawals free of market value adjustment, annuity options, and guaranteed insurability options.
The majority of the general insurance business underwritten by the Group is of a short tail nature such as motor, household and commercial property insurances. The Group’s underwriting strategy and appetite is agreed by the Executive Committee and communicated via specific policy statements and guidelines. Like life insurance risk, general insurance risk is managed primarily at business unit level with oversight at a Group level, through the General Insurance Committee.
General insurance claims 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 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 include peer reviews of the business unit’s own conclusions as well as independent analysis to confirm the reasonableness of the local reviews. The adequacy of the Group’s general insurance claims provisions is ultimately overseen by the General Insurance Committee. A number of business units also have periodic external reviews by local consultant actuaries (often as part of the local regulatory requirement).
Reinsurance strategy Significant reinsurance purchases are reviewed annually at both business unit and Group level, to verify that the levels of protection being bought reflect any developments in exposure and the risk appetite of the Group. Reinsurance purchases must be in line with the strategy set out in our General Insurance Reinsurance policy. The basis of these purchases is underpinned by extensive financial and capital modelling and actuarial analysis to optimise the cost and capital efficiency benefits from our reinsurance programme. For the larger business units, this involves utilising externally sourced probabilistic models to verify the accumulations and loss probabilities based on the Group’s specific portfolios of business. Where external models are not available, scenarios are developed and tested using the Group’s data to determine potential losses and appropriate levels of reinsurance protection. The reinsurance is placed with providers who meet the Group’s counterparty security requirements, and large reinsurance placements may also require approval from the Asset Liability Committee.
Concentration risk Processes are in place to manage catastrophe risk in individual business units and at a Group level. The Group cedes much of its worldwide catastrophe risk to third-party reinsurers but retains a pooled element for its own account gaining diversification benefit. The total Group potential loss from its most concentrated catastrophe exposure zone (Northern Europe) is approximately £300 million, for a one in ten year annual loss scenario, compared to approximately £550 million when measured on a one in a hundred year annual loss scenario. For the 2010 underwriting year the Group participated in a share of a reinsurer’s US property catastrophe reinsurance portfolio. As this exposure does not correlate with the Group’s other general insurance exposures this provided a strategic opportunity to diversify the general insurance portfolio with a risk that had a high expected profit margin but also a high potential for loss. The modelled loss from a one in ten year annual loss scenario was £55 million compared to approximately £160 million when measured on a one in a hundred year annual loss scenario. As a result of better than normal experience the arrangement delivered above average underwriting returns in 2010. Notwithstanding the good return in 2010, we have renewed the arrangement in 2011 on a reduced scale reflecting expected market conditions. The total expected loss from a one in ten year annual loss scenario is £40 million compared to approximately £100 million when measured on a one in hundred year annual loss scenario.
Operational risk management We process a large number of complex transactions across numerous and diverse products, and are highly dependent on the proper functioning of information technology and communications systems. We are partially reliant on the operational processing performance of our outsourced partners including certain servicing and IT functions. The long-term nature of our business means that accurate records have to be maintained for significant periods. Significant resources are devoted to maintaining efficient and effective operations within our framework of corporate responsibility, policies and business ethics code.
(g) Brand and reputation risk We are dependent on the strength of our brands, the brands of our partners and our reputation with customers and agents in the sale of our products and services. Our success and results are, to a certain extent, dependent on the strength of our global Aviva brand and reputation. While we as a group are well recognised, we are vulnerable to adverse market and customer perception. We operate in an industry where integrity, customer trust and confidence are paramount. We are exposed to the risk that litigation, employee misconduct, operational failures, the outcome of regulatory investigations, media speculation and negative publicity, disclosure of confidential client information, inadequate services, amongst others, whether or not founded, could impact our brands or reputation. Any of our brands or our reputation could also be affected if products or services recommended by us (or any of our intermediaries) do not perform as expected (whether or not the expectations are founded) or the customer’s expectations for the product change. One of the FSA’s strategic objectives is to help customers get a fair deal through its ‘treating customers fairly’ principle. Examples of ‘treating customers fairly’ include: products and services targeted to meet customers’ needs and which perform in line with what customers have been led to expect; clear information (and advice where relevant); good service; and making sure there are no unfair barriers that prevent customers from getting access to their money, changing products or making a successful insurance claim. The FSA regularly checks that we are meeting the requirement to treat our customers fairly and we make use of various metrics to assess our own performance, including customer advocacy, retention and complaints. Failure to meet these requirements could also impact our brands or reputation. If we do not manage successfully the perception of our brands and reputation, it could cause existing customers or agents to withdraw from our business and potential customers or agents to be reluctant or elect not to do business with us. This would adversely impact our business and results of operations.
Life insurance and investment contracts The nature of long-term business is such that a number of assumptions are made in compiling these financial statements. Assumptions are made about investment returns, expenses, mortality rates and persistency in connection with the in-force policies for each business unit. Assumptions are best estimates based on historic and expected experience of the business. A number of the key assumptions for the Group’s central scenario are disclosed elsewhere in these statements for both IFRS reporting and reporting under MCEV methodology.
General insurance and health business General insurance and health claim liabilities are estimated by using standard actuarial claims projection techniques. These methods extrapolate the claims development for each accident year based on the observed development of earlier years. In most cases, no explicit assumptions are made as projections are based on assumptions implicit in the historic claims.
Long-term business Sensitivities as at 31 December 2010 Impact on profit before tax (£m)
Insurance participating (55) (235) 65 (125) (45) (10) (45) Insurance non-participating (220) 265 55 (55) (20) (45) (310) Investment participating (15) 15 35 (70) (15) — — Investment non-participating (30) 35 15 (15) (5) — — Assets backing life shareholders’ funds 15 (15) 160 (155) — — —
Insurance participating (85) (190) 65 (125) (45) (10) (45) Insurance non-participating (590) 680 240 (240) (20) (45) (310) Investment participating (15) 15 35 (70) (15) — — Investment non-participating (110) 125 15 (15) (5) — — Assets backing life shareholders’ funds (90) 90 280 (275) — — —
Sensitivities as at 31 December 2009 Impact on profit before tax (£m)
Total (315) 35 225 (260) (60) (45) (320) 1. The comparative 2008 economic sensitivities for insurance non-participating business have been restated to reflect modelling enhancements in Delta Lloyd.
Gross of reinsurance (310) 295 105 (110) (135) (345) Net of reinsurance (365) 365 105 (110) (135) (330)
Sensitivities as at 31 December 2009 Impact before profit before tax (£m)
Limitations of sensitivity analysis The above tables demonstrate the effect of a change in a key assumption while other assumptions remain unchanged. In reality, there is a correlation 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. The sensitivity analyses do not take into consideration that the Group’s assets and liabilities are actively managed. Additionally, the financial position of the Group may vary at the time that any actual market movement occurs. For example, the Group’s financial risk management strategy aims to manage the exposure to market fluctuations. As investment markets move past various trigger levels, management actions could include selling investments, changing investment portfolio allocation, adjusting bonuses credited to policyholders, and taking other protective action. A number of the business units use passive assumptions to calculate their long-term business liabilities. Consequently, a change in the underlying assumptions may not have any impact on the liabilities, whereas assets held at market value in the statement of financial position will be affected. In these circumstances, the different measurement bases for liabilities and assets may lead to volatility in shareholder equity. Similarly, for general insurance liabilities, the interest rate sensitivities only affect profit and equity where explicit assumptions are made regarding interest (discount) rates or future inflation. Other limitations in the above sensitivity analyses include the use of hypothetical market movements to demonstrate potential risk that only represent the Group’s view of possible near-term market changes that cannot be predicted with any certainty; and the assumption that all interest rates move in an identical fashion.
(ii) Fair value hedges The Group has entered into a number of interest rate swaps in order to hedge fluctuations in the fair value part of its portfolio of mortgage loans and debt securities in the Netherlands and the United States. The notional value of these interest rate swaps was £2,170 million at 31 December 2010 (2009: £3,060 million) and their fair value was £74 million liability (2009: £184 million liability). These hedges were fully effective during the year.
The foreign exchange gain of £53 million (2009: gain of £255 million) on translation of the debt to sterling at the statement of financial position date has been recognised in the hedging instruments reserve in shareholders’ equity. This hedge was fully effective throughout the current and prior years.
The Group’s sterling/euro cross currency swap derivative, which was designated as a hedge of the net investment in its European subsidiaries, matured in November 2010. Therefore, the notional value of the derivative at 31 December 2010 was £nil (2009: £500 million) and its fair value at that date was £nil (2009: £120 million liability). The fair value gain on maturity was £22 million. This hedge was fully effective up to its maturity.
Aviva plc Annual Report and Accounts 2010 58 – Derivative financial instruments continued (b) Non-hedge derivatives Non-hedge derivatives either do not qualify for hedge accounting under IAS 39 or the option to hedge account has not been taken.
Foreign exchange contracts OTC Forwards 12,211 69 (102) 6,091 17 (53) Interest and currency swaps 830 164 (125) 1,408 41 (53) Options 2,000 16 (26)
Interest rate contracts OTC Forwards 1,868 1 — 1,043 5 — Swaps 31,391 522 (1,155) 26,718 297 (839) Options 8,883 271 (71) 10,637 432 (4) Exchange traded Futures 4,748 12 (111) 5,542 404 (38) Options 471 17 — 1,066 28 —
Equity/Index contracts OTC Forwards — — — 863 71 — Swaps 2,008 31 (147) — — — Options 3,849 813 (32) 14,571 663 (243) Exchange traded Futures 4,734 247 (386) 7,417 63 (534) Options 2,284 31 (87) 2,688 19 (2)
Fair value assets are recognised as ‘Derivative financial instruments’ in note 25(a), whilst fair value liabilities are recognised as ‘other financial liabilities’ in note 50. The Group’s derivative risk management policies are outlined in note 57(b).
Income from associates predominantly relates to our investments in the Royal Bank of Scotland (RBS) life and collective investment companies prior to their restructuring described in note 3(a)). Under management service agreements with these associates, our UK life insurance companies provided administration services, the cost of which was recharged to the RBS companies. In addition, our fund management companies provided fund management services to these associates, for which they charged fees based on the level of funds under management. Movements in loans made to our associates may be found in note 19. Transactions with joint ventures relate to the property management undertakings. At 31 December 2010, there were 16 such joint ventures, the most material of which are listed in note 18(b). Our interest in these joint ventures comprises a mix of equity and loans, together with the provision of administration services and financial management to many of them. Our UK life insurance companies earn interest on loans advanced to these entities to fund property developments, including shopping, business and distribution centres, and properties in Europe, as well as a film studio development in the UK, movements in which may be found in note 18(a). Our fund management companies also charge fees to these joint ventures for administration services and for arranging external finance. Our UK fund management companies manage most of the assets held by the Group’s main UK staff pension scheme, for which they charge fees based on the level of funds under management. The main UK scheme and the Dutch scheme hold investments in Group-managed funds and insurance policies with other Group companies, as explained in note 48(e)(iii). The related parties’ receivables are not secured and no guarantees were received in respect thereof. The receivables will be settled in accordance with normal credit terms. Details of guarantees, indemnities and warranties provided on behalf of related parties are given in note 52(h).
Salary and other short-term benefits 48 39 Post-employment benefits 8 5 Equity compensation plans 21 16 Termination benefits 4 1
Statement of comprehensive income For the year ended 31 December 2010 £m £m
Profit for the year 500 571 Other comprehensive income Fair value gains on investments in subsidiaries and joint ventures A 408 883 Actuarial gains/ (losses) on pension provision 1 (3)
Statement of changes in equity For the year ended 31 December 2010
Assets Non-current assets Investments in subsidiaries A 17,623 17,236 Investment in joint venture 18c 115 72 Loans owed by subsidiaries H 2,411 3,161 Current tax assets 388 526 20,537 20,995 Current assets Loans owed by subsidiaries H 691 — Other amounts owed by subsidiaries H 2,334 2,546 Other assets 74 110 Cash and cash equivalents 1 4
Equity Ordinary share capital 29 705 692 Preference share capital 32 200 200 Called up capital 905 892 Share premium account 29b 1,194 1,207 Merger reserve D 735 735 Investment valuation reserve D 7,061 6,653 Equity compensation reserve D 99 109 Retained earnings D 3,331 3,360 Direct capital instrument 33 990 990
Liabilities Non-current liabilities Borrowings E 4,805 4,871 Loans owed to subsidiaries H 2,867 3,598 Provisions 46 47 7,718 8,516 Current liabilities Borrowings E 504 483 Loans owed to subsidiaries H 514 155 Other amounts owed to subsidiaries H 465 442 Other creditors 121 113
Where applicable, the accounting policies of the Company are the same as those of the Group on pages 170 to 182. The notes identified alphabetically on pages 310 to 314 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 alphabetically) on pages 191 to 305.
Statement of cash flows For the year ended 31 December 2010
Cash flows from financing activities Funding provided by subsidiaries 509 477 New borrowings drawdown, net of expenses 2,251 2,490 Repayment of borrowings (2,272) (2,541) Net drawdown of borrowings (21) (51) Preference dividends paid (17) (17) Ordinary dividends paid (472) (476) Interest paid on borrowings (2) (7)
A – Investments in subsidiaries (i) Movements in the Company’s investments in its subsidiaries are as follows: £m
Wages and salaries 109 85 Social security costs 10 9 Post-retirement obligations Defined benefit schemes (see (iii) below) 8 6 Defined contribution schemes 5 6 Profit sharing and incentive plans 10 9 Equity compensation plans (see (iv) below) 15 12 Termination benefits 2 3
(ii) Tax charged to other comprehensive income No tax was charged or credited to other comprehensive income in 2009 or 2010.
Tax calculated at standard UK corporation tax rate of 28% (2009: 28%) (76) (116) Adjustment to tax charge in respect of prior years (1) 7 Non-assessable dividends 311 375 Disallowable expenses (5) (3) Unpaid group relief — (102) Other (1) (3)
Balance at 1 January 2009 735 5,770 113 3,287 Arising in the year: Profit for the year — — — 571 Fair value gains on investments in subsidiaries and joint ventures — 883 — — Actuarial losses on pension provisions — — — (3) Dividends and appropriations — — — (853) Reserves credit for equity compensation plans — — 56 — Shares issued in lieu of dividends — — — 299 Trust shares distributed in the year — — — (18) Issue of share capital under equity compensation scheme — — (60) 60 Aggregate tax effect — — — 17
Subordinated debt 4,606 4,672 9.5% guaranteed bonds 2016 199 199 Commercial paper 504 483
F – Contingent liabilities Details of the Company’s contingent liabilities are given in the Group consolidated financial statements, note 52(h).
Interest rate risk Loans to and from subsidiaries are at either fixed or floating rates of interest, with the latter being exposed to fluctuations in these rates. The choice of rates is designed to match the characteristics of financial investments (which are also exposed to interest rate fluctuations) held in both the Company and the relevant subsidiary, to mitigate as far as possible each company’s net exposure. The majority of the Company’s external borrowings are at fixed rates of interest and are therefore not exposed to changes in these rates. However, for those borrowings that are at floating rates, the Company is affected by changes in these rates. Further details of the Company’s borrowings are provided in note E and the Group consolidated financial statements, note 49.
Within 1 year 691 — 1 to 5 years 1,769 2,050 Over 5 years 642 1,111
Maturity analysis of contractual undiscounted cash flows Principal £m Interest £m Total £m Principal £m Interest £m Total £m
Within 1 year 514 424 938 155 143 298 1 to 5 years 1,125 362 1,487 1,840 431 2,271 Over 5 years 1,742 180 1,922 1,758 217 1,975
Other related party balances comprise dividends and interest receivable and payable, as well as inter-company balances for fees and other transactions in the normal course of business.
E11 – Post tax internal rate of return and payback period on life and pensions new business
Operating profit before tax attributable to shareholders’ profits 1,276 United Kingdom 1,085 787 2,466 Europe 2,096 2,344 4,210 Long-term business 3,579 3,498 1,235 General insurance and health 1,050 960 147 Fund management1 125 51 (229) Other operations and regional costs2 (195) (173)
(367) Integration and restructuring costs (312) (286) (504) Exceptional items (428) (248)
These results are included within the life MCEV operating earnings consistent with the MCEV methodology. 2. Excludes the proportion of the results of subsidiaries providing services to the Life business. These results are included within the life MCEV operating earnings consistent with the MCEV methodology.
Operating earnings per share on an MCEV basis after tax, attributable to ordinary shareholders of Aviva plc 90.9c Basic (pence per share) 77.3p 83.0p 89.4c Diluted (pence per share) 76.0p 82.2p
Earnings after tax on an MCEV basis, attributable to ordinary shareholders of Aviva plc 69.6c Basic (pence per share) 59.2p 95.8p 67.6c Diluted (pence per share) 58.2p 94.9p
Total MCEV operating profit before shareholder tax was £3,760 million (2009: £3,592 million), an increase of 5%. Within this total the long-term business operating profit before shareholder tax was £3,579 million (2009: £3,498 million), an increase of 2%. For 2010, the expected profit has been adjusted to reflect an even emergence of risk, calculated by using the Implied Discount Rates to ‘unwind’ the opening balances. The basis for setting the underlying normalised investment returns has not been changed. This change has no impact on total profit.
Condensed consolidated statement of comprehensive income – MCEV basis For the year ended 31 December 2010 £m 2,054 Profit for the year 1,746 2,722
72 Aggregate tax effect – shareholder tax 61 48 987 Other comprehensive income, net of tax 839 (2,113)
Attributable to: 3,193 Equity shareholders of Aviva plc 2,714 777 (152) Non-controlling interests (129) (168)
Condensed consolidated statement of changes in equity – MCEV basis For the year ended 31 December 2010 21,581 Balance at 1 January 18,561 17,771 3,006 Total comprehensive (expense)/income for the year 2,585 609 (880) Dividends and appropriations (757) (853)
(44) Changes in non-controlling interest in existing subsidiaries (38) (111) (16) Shares acquired by employee trusts (14) (53) 48 Reserves credit for equity compensation plans 41 56 20 Aggregate tax effect – shareholder tax 17 17 23,793 Total equity 20,462 18,561 (4,624) Non-controlling interests (3,977) (4,279)
Liabilities 206,628 Gross insurance liabilities 177,700 171,092 136,962 Gross liabilities for investment contracts 117,787 110,015 3,986 Unallocated divisible surplus 3,428 3,866 10,502 Net asset value attributable to unitholders 9,032 9,894 365 Current tax liabilities 314 192 17,383 Borrowings 14,949 15,000 23,595 Payables and other financial liabilities 20,292 20,542 4,860 Other liabilities 4,179 3,653 — Liabilities of operations classified as held for sale — 33 433,539 Total equity and liabilities 372,844 357,866 The summarised consolidated statement of financial position presented above is unaltered from the corresponding IFRS summarised consolidated statement of financial position with the exception of the following: 1. Adding the excess of the Life MCEV, including non-controlling interests, over the corresponding Life IFRS net assets represented as the additional value of in-force long-term business; corresponding item within equity represented by the additional retained profit on an MCEV basis; and, corresponding adjustments to non-controlling interests.
Ordinary share capital 705 — 705 Capital reserves 4,465 — 4,465 Other reserves 2,245 (176) 2,069 Shares held by employee trusts (32) — (32) Retained earnings 5,411 — 5,411 Additional retained earnings on an MCEV basis — 2,677 2,677
Equity attributable to ordinary shareholders of Aviva plc 10,356 2,736 13,092 Preference share capital 200 — 200 Direct capital instruments 990 — 990 Non-controlling interests 3,540 739 4,279
Reconciliation of IFRS total equity to MCEV net worth For the year ended 31 December 2010 £m £m
MCEV net worth 12,240 12,213 MCEV value of in-force1 7,024 6,325
MCEV2 19,264 18,538 1. Comprises PVFP of £10,180 million (31 December 2009: £9,417 million), FC of £(882) million (31 December 2009: £(820) million), CNHR of £(1,070) million (31 December 2009: £(788) million), and TVOG of £(1,204) million
Opening group MCEV 15,058 2,055 17,113 (2,831) (776) 14,282 Opening adjustments — — — — — —
Opening group MCEV 14,522 2,639 17,161 (2,499) 140 14,662 Opening adjustments — — — — — —
Operating MCEV earnings 2,247 — 2,247 15 15 2,262 Non-operating MCEV earnings 942 (99) 843 (496) (595) 347
Covered business The MCEV calculations cover the following lines of business: life insurance, long-term health and accident insurance, savings, pensions and annuity business written by our life insurance subsidiaries, including managed pension fund business and our share of the other life and related business written in our associated undertakings and joint ventures, as well as the equity release business written in the UK. Covered business includes the Group’s share of our joint ventures including our arrangement with The Royal Bank of Scotland Group (RBSG) and our associated undertakings in India, China, Turkey, Malaysia, Taiwan and South Korea. In addition, the results of group companies providing significant administration, fund management and other services and of group holding companies have been included to the extent that they relate to covered business. Together these businesses are referred to as ‘Life and related businesses’.
Calculation of the embedded value The shareholders’ interest in the life and related businesses is represented by the embedded value. The embedded value is the total of the net worth of the life and related businesses and the value of in-force covered business. Calculations are performed separately for each business and are based on the cash flows of that business, after allowing for both external and intra-group reinsurance. Where one life business has an interest in another, the net worth of that business excludes the interest in the dependent company. The embedded value is calculated on an after-tax basis applying current legislation and practice together with future known changes. Where gross results are presented, these have been calculated by grossing up post-tax results at the full rate of corporation tax for each country based on opening period tax rates, apart from the US, where a nil tax rate was used for the 2009 post-tax results, and consequently for ‘grossing up’.
Net worth The net worth is the market value of the shareholders’ funds and the shareholders’ interest in the surplus held in the non-profit component of the long-term business funds, determined on a statutory solvency basis and adjusted to add back any non-admissible assets, and consists of the required capital and free surplus. Required capital is the market value of assets attributed to the covered business over and above that required to back liabilities for covered business, for which distribution to shareholders is restricted. Required capital is reported net of implicit items permitted on a local regulatory basis to cover minimum solvency margins which are assessed at a local entity level. The level of required capital for each business unit is set equal to the higher of: The level of capital at which the local regulator is empowered to take action; The capital requirement of the business unit under the Group’s economic capital requirements; and The target capital level of the business unit.
This methodology reflects the level of capital considered by the directors to be appropriate to manage the business, and includes any additional shareholder funds not available for distribution, such as the reattributed inherited estate in the UK. The same definition of required capital is used for both existing and new business. The free surplus is the market value of any assets allocated to, but not required to support, the in-force covered business at the valuation date. The level of required capital across the business units expressed as a percentage of the EU minimum solvency margin (or equivalent) can be found in E18.
Value of in-force covered business (VIF) The value of in-force covered business consists of the following components: present value of future profits; time value of financial options and guarantees; frictional costs of required capital; and cost of residual non-hedgeable risks.
Present value of future profits (PVFP) This is the present value of the distributable profits to shareholders arising from the in-force covered business projected on a best estimate basis. Distributable profits generally arise when they are released following actuarial valuations. These valuations are carried out in accordance with any local statutory requirements designed to ensure and demonstrate solvency in long-term business funds. Future distributable profits will depend on experience in a number of areas such as investment return, discontinuance rates, mortality, administration costs, as well as management and policyholder actions. Releases to shareholders arising in future years from the in-force covered business and associated required capital can be projected using assumptions of future experience. Future profits are projected using best estimate non-economic assumptions and market consistent economic assumptions. In principle, each cash flow is discounted at a rate that appropriately reflects the riskiness of that cash flow, so higher risk cash flows are discounted at higher rates. In practice, the PVFP is calculated using the ‘certainty equivalent’ approach, under which the reference rate is used for both the investment return and the discount rate. This approach ensures that asset cash flows are valued consistently with the market prices of assets without options and guarantees. Further information on the risk-free rates is given in note E18. The PVFP includes the capitalised value of profits and losses arising from subsidiary companies providing administration, investment management and other services to the extent that they relate to covered business. This is referred to as the ‘look through’ into service company expenses. In addition, expenses arising in holding companies that relate directly to acquiring or maintaining covered business have been allowed for. Where external companies provide services to the life and related businesses, their charges have been allowed for in the underlying projected cost base.
Time value of financial options and guarantees (TVOG) The PVFP calculation is based on a single (base) economic scenario; however, a single scenario cannot appropriately allow for the effect of certain product features. If an option or guarantee affects shareholder cash flows in the base scenario, the impact is included in the PVFP and is referred to as the intrinsic value of the option guarantee; however, future investment returns are uncertain and the actual impact on shareholder profits may be higher or lower. The value of in-force business needs to be adjusted for the impact of the range of potential future outcomes. Stochastic modelling techniques can be used to assess the impact of potential future outcomes, and the difference between the intrinsic value and the total stochastic value is referred to as the time value of the option or guarantee. Stochastic modelling typically involves projecting the future cash flows of the business under thousands of economic scenarios that are representative of the possible future outcomes for market variables such as interest rates and equity returns. Under a market consistent approach, the economic scenarios generated reflect the market’s tendency towards risk aversion. Allowance is made, where appropriate, for the effect of management and/or policyholder actions in different economic conditions on future assumptions such as asset mix, bonus rates and surrender rates. Stochastic models are calibrated to market yield curves and volatility levels at the valuation date. Tests are performed to confirm that the scenarios used produce results that replicate the market price of traded instruments. Where evidence exists that persistency rates are linked to economic scenarios, dynamic lapse assumptions are set that vary depending on the individual scenarios. This cost is included in the TVOG. Dynamic lapses are modelled for parts of the UK, US and French businesses. Asymmetries in non-economic assumptions that are linked to economic scenarios, but that have insufficient evidence for credible dynamic assumptions, are allowed for within mean best estimate assumptions.
Participating business Future regular bonuses on participating business are projected in a manner consistent with current bonus rates and expected future market-consistent returns on assets deemed to back the policies. For with-profit funds in the UK and Ireland, for the purpose of recognising the value of the estate, it is assumed that terminal bonuses are increased to exhaust all of the assets in the fund over the future lifetime of the in-force with-profit policies. However, under stochastic modelling there may be some extreme economic scenarios when the total assets in the Group’s with-profit funds are not sufficient to pay all policyholder claims. The average additional shareholder cost arising from this shortfall has been included in the TVOG. For profit-sharing business in continental Europe, where policy benefits and shareholder value depend on the timing of realising gains, the apportionment of unrealised gains between policyholders and shareholders reflect contractual requirements as well as existing practice. Under certain economic scenarios where additional shareholder injections are required to meet policyholder payments, the average additional cost has been included in the TVOG.
Exchange rates The Group’s principal overseas operations during the period were located within the Eurozone and the United States. The results and cash flows of these operations have been translated at the average rates for that period and the assets and liabilities have been translated at the period end rates. Please refer to note 1 on page 191 of the IFRS financial statements.
United Kingdom MCEV operating earnings were 38% higher at £1,085 million (2009: £787 million) mainly due to increases in the value of new business and expected returns.
Total expected return increased to £773 million (2009: £653 million), reflecting the additional expected return following the reattribution of the inherited estate partly offset by the adoption of implied discount rates as the basis for determining the expected return.
Experience variances of £20 million adverse (2009: £29 million adverse) reflect favourable mortality experience offsetting adverse persistency experience in current economic conditions.
E2 – Geographical analysis of MCEV operating earnings continued Aviva Europe MCEV operating earnings increased 18% to £2,013 million (2009: £1,704 million), as positive operating assumption changes, favourable experience variances and modelling improvements more than offset lower expected returns.
Total expected return was 19% lower at £753 million (2009: £934 million) reflecting lower assumed rates of return and the adoption of implied discount rates as the basis for determining the expected return.
Other operating variances were positive at £271 million (2009: £214 million). These largely arose in France and relate to modelling refinements of £164 million as well as £107 million from actions taken to reduce the level of policyholder guarantees on profit-sharing products in France.
Delta Lloyd MCEV operating earnings decreased to £83 million (2009: £640 million) mainly due to adverse operating assumption changes compared to positive assumption changes in 2009.
Operating experience and assumption changes on existing business amounted to £336 million adverse (2009: £168 million favourable) as the impact of adopting an industry-standard longevity table was partly offset by favourable expense assumption changes related to planned expense savings following restructuring activities.
Other operating variances of £157 million (2009: £65 million) related to various modelling changes, mainly in Delta Lloyd Belgium and Delta Lloyd Life.
North America MCEV operating earnings increased to £289 million (2009: £266 million) as higher earnings from existing business were partly offset by lower value of new business. The improvement in in-force earnings was driven by management actions coupled with disciplined spread management, higher expected returns and modelling refinements.
Value of new business of negative £(194) million (2009: £16 million positive) reflected adverse economic movements, particularly in the second half of the year as risk free rates decreased. The impact of economic movements has more than offset the benefits of pricing and product management actions.
Value of new business 354 175 1 142 40 128 18 504 (92) 412 (194) 52 624 Earnings from existing business
– expected existing business contribution (reference rate) 169 98 12 13 74 34 13 244 49 293 20 20 502 – expected existing business contribution (in excess of reference rate) 425 183 30 34 25 76 9 357 181 538 401 25 1,389 Experience variances – maintenance expense1 12 (25) 6 (11) 5 (1) 5 (21) (21) (42) (16) (2) (48) – project and other related expenses1 (8) (5) (2) — — (2) (5) (14) (4) (18) (18) (3) (47) – mortality/morbidity2 23 27 3 (4) 13 2 3 44 13 57 (7) 9 82 – lapses3 (29) 27 (10) 18 (1) (11) (11) 12 5 17 (3) (27) (42) – other4 (18) 93 (4) 12 14 3 8 126 (9) 117 37 (5) 131
Expected return on shareholders’ net worth 179 47 20 50 9 18 8 152 124 276 82 12 549 Other operating variances8 (4) 271 (6) (15) 30 (9) — 271 157 428 133 15 572
– expected existing business contribution (reference rate) 113 161 22 15 67 39 22 326 43 369 55 11 15 26 563 – expected existing business contribution (in excess of reference rate) 402 282 18 5 4 119 — 428 324 752 249 15 1 16 1,419 Experience variances – maintenance expense1 37 — 6 (2) 14 (10) 5 13 (3) 10 — 6 (1) 5 52 – project and other related expenses1
In Poland, lapse experience continued to be better than the long-term assumptions for both Life and Pension products. 4 Other experience is favourable overall. Both France and Italy include one-off adjustments reflecting final commission payments from prior years. The favourable impact in Italy reflects to one-off profit sharing on a reinsurance treaty. The favourable impact in Delta Lloyd relates to the revised investment and bonus strategy in Germany following the decision to close this operation to new business. The adverse impact in the USA relates to the cost of enhancing policyholder crediting rates.
6 Favourable mortality assumption changes in France and Poland reflecting recent experience. The adverse impact in Delta Lloyd reflects the net impact of using updated mortality tables in the Netherlands, Germany and Belgium, following the issuance of revised advice from the respective actuarial associations.
7 Persistency assumptions have been strengthened across most of our businesses, in light of experience. In Poland, persistency assumptions have been weakened following sustained favourable experience. 8 Other assumption changes in the US primarily relate to the timing of management action in setting policyholder credited rates. In Delta Lloyd, the change represents tax effects resulting from a reallocation of assets. 9 Other operating variances in France, Poland and Asia have arisen as a result of more accurate modelling. In Delta Lloyd, these relate to revisions to investment and bonus strategies and expenses in Delta Lloyd Germany following the decision to close this operation to new business. In Spain, these reflect the impact of re-pricing actions on risk products.
Value of new business 254 100 1 42 29 43 15 230 (41) 189 (126) 41 358 Earnings from existing business
Operating assumption changes: – maintenance expense5 57 21 (2) (8) 97 83 — 191 89 280 (57) 8 288 – project and other related expenses (65) — — — — — — — (3) (3) — — (68) – mortality/morbidity6 1 38 5 1 4 — — 48 (198) (150) (42) 13 (178) – lapses7 (2) (8) (12) 10 10 (17) (6) (23) (21) (44) 4 (9) (51) – other (6) 3 — — 6 — 1 10 (5) 5 — — (1)
Expected return on shareholders’ net worth 129 27 14 17 6 7 6 77 50 127 53 9 318 Other operating variances8 (4) 162 (4) (2) 20 (4) — 172 64 236 87 9 328
Earnings after tax and non-controlling interests 778 596 25 76 266 143 33 1,139 12 1,151 188 82 2,199 1 Adverse expense experience occurred across a number of businesses. 2 Mortality experience continues to be better than the assumption set across a number of our businesses, most notably in France and the UK Annuity business. 3 Persistency experience remains volatile across most of our businesses, in part reflecting the wider economic circumstances. In France, persistency experience reflects a release of the short-term provision. 4 Other experience includes, in France, the benefit from policyholders switching to unit linked funds, and, in the USA favourable spread experience. 5 Favourable maintenance expense assumptions reflect the benefit of the shared service centre in Spain, together with the release of margins in Spain, related to bancassurance joint venture governance costs, and Poland. In the UK, the expense assumptions include a reallocation of provisions in the service company, better reflecting the expected future allocation of costs. In the USA, the adverse impact reflects a revised allocation of costs between ongoing and one-off. In Delta Lloyd, favourable expense assumptions relate to planned expense saving following restructuring activities.
6 Delta Lloyd have updated mortality assumptions to reflect recently published tables, which include a significantly increased allowance for mortality improvements. In France and the USA, mortality assumptions have been updated reflecting experience.
Earnings after tax and non-controlling interests 1 Maintenance expense experience in the UK relates to profits from existing business administration. Project and other related expenses in the UK reflect project costs associated with strategic initiatives, including developments designed to offer a wider range of products to customers, and the simplification of systems and processes. Project and other related expenses in Delta Lloyd relate to integration costs in Belgium.
In Poland, lapse experience continued to be better than the long-term assumptions for both Life and Pension products. 4 Other experience is favourable overall. Both France and Italy include one-off adjustments reflecting final commission payments from prior years. The favourable impact in Italy reflects one-off profit sharing on a reinsurance treaty. The favourable impact in Delta Lloyd relates to the revised investment and bonus strategy in Germany following the decision to close this operation to new business. The adverse impact in the USA relates to the cost of enhancing policyholder crediting rates. 5 Favourable expense assumption changes reflect the impact of cost reductions in Delta Lloyd and Poland, together with the impact of revisions to expense allocations in Delta Lloyd. The adverse impact in Spain relates the capitalisation of certain governance costs in respect of bancassurance joint ventures. 6 Favourable mortality assumption changes in France and Poland reflect recent experience. The adverse impact in Delta Lloyd reflects the net impact of using updated mortality tables in the Netherlands, Germany and Belgium, following the issuance of revised advice from the respective actuarial associations. 7 Persistency assumptions have been strengthened across most of our businesses, in light of experience. In Poland, persistency assumptions have been weakened following sustained favourable experience. 8 Other assumption changes in the US primarily relate to the timing of management action in setting policyholder credited rates. In Delta Lloyd, the change represents tax effects resulting from a reallocation of assets. 9 Other operating variances in France, Poland and Asia have arisen as a result of more accurate modelling. In Delta Lloyd, these relate to revisions to investment and bonus strategies and expenses in Delta Lloyd Germany following the decision to close this operation to new business. In Spain, these reflect the impact of re-pricing actions on risk products.
Total 125 51 1 Aviva Europe included the result from the fund management in Poland in 2009. This business was transferred across to Aviva Investors from 1 January 2010. 2 The Australian Life business was sold on 1 October 2009, included within the 2009 operating earnings is £7 million.
E4 – Analysis of other operations and regional costs Where subsidiaries provide services to our life business, that proportion has been excluded. These results are included within the Life MCEV operating return.
United Kingdom — (21) (21) — (28) (28) Aviva Europe (55) (43) (98) (36) (41) (77) Delta Lloyd — (24) (24) — (30) (30) Europe (55) (67) (122) (36) (71) (107) North America (26) 6 (20) (19) 3 (16) Asia Pacific (32) — (32) (20) (2) (22)
Total assets before acquired value of in-force long-term business 323,476 45,378 368,854 307,117 45,880 352,997 Acquired additional value of in-force long-term business 1,253 — 1,253 1,394 — 1,394
Total assets included in the IFRS statement of financial position 324,729 45,378 370,107 308,511 45,880 354,391
Liabilities of the long-term business (305,673) — (305,673) (291,194) — (291,194) Liabilities of the general insurance and other businesses — (46,709) (46,709) — (48,111) (48,111)
Net assets on an MCEV basis2 21,793 (1,331) 20,462 20,792 (2,231) 18,561
MCEV basis total equity 20,462 18,561 1 The analysis between the Group’s and non-controlling interests’ share of the additional value of in-force long-term business is as follows: £m £m
Group’s share included in shareholders’ funds 2,677 2,523 154 Non-controlling interests’ share 236 739 (503) Movements in AFS securities (176) 213 (389)
Long-term business net assets on an MCEV basis 21,793 20,792 3 Goodwill and intangible assets includes amounts related to associated undertakings and joint ventures. 4 The value of the Aviva Staff Pension Scheme surplus has been notionally allocated between segments, based on current funding and the Life proportion has been included within the long-term business net assets on an MCEV basis. The pension fund surplus notionally allocated to long-term business is net of the agreed funding borne by the UK with-profit funds.
Closing MCEV 1,641 8,342 6,148 16,131 1 Required capital is shown net of implicit items permitted by local regulators to cover minimum solvency margins. 2 Other non-operating variances are described under Exceptional items on page 331 . 3 Included within capital and dividend flows is the transfer to Life and related businesses from other segments consisting of service company profits and losses during the reported period that have emerged from the value of in-force. Since the ‘look through’ into service companies includes only future profits and losses, these amounts must be eliminated from the closing embedded value.
Acquisitions during the year consist of an increase in the Group’s interest in RBS Life Investments Limited, and the purchase of the interests of minority shareholders in two subsidiaries in France and Italy.
Opening MCEV 1,348 8,148 5,026 14,522 New business value (1,571) 983 998 410 Expected existing business contribution (reference rate) — — 381 381 Expected existing business contribution (in excess of reference rate) — — 986 986 Transfers from VIF and required capital to the free surplus 1,869 (738) (1,131) — Experience variances (198) 135 (38) (101) Assumption changes 48 6 19 73 Expected return on shareholders’ net worth 164 182 — 346 Other operating variances 10 (141) 283 152
Operating MCEV earnings 322 427 1,498 2,247 Economic variances 1,317 (324) (315) 678 Other non-operating variances (238) 909 (407) 264
Total MCEV earnings/(loss) 1,401 1,012 776 3,189 Capital and dividend flows2 (250) — — (250) Foreign exchange variances 6 (556) (183) (733) Acquired/divested business (301) (1,058) (311) (1,670)
Closing MCEV 2,204 7,546 5,308 15,058 1 Required capital is shown net of implicit items permitted by local regulators to cover minimum solvency margins. 2 Included within capital and dividend flows is the transfer to Life and related businesses from other segments consisting of service company profits and losses during the reported period that have emerged from the value of in-force. Since the ‘look through’ into service companies includes only future profits and losses, these amounts must be eliminated from the closing embedded value.
E8 – Life MCEV operating earnings In this table the life and pensions MCEV earnings have been broken down into constituent parts. The life and pensions MCEV operating earnings comprise: the value of new business written during the year; the earnings from existing business including other operating variances; and the expected investment return on the shareholders’ net worth. These components are calculated using economic assumptions as at the start of the year (in-force business) or start of the quarter (new business) and operating (demographic and expenses) assumptions as at the end of the year.
Value of new business 624 765 Earnings from existing business – expected returns at the reference rate 502 563 – expected returns in excess of the reference rate 1,389 1,419 – expected returns 1,891 1,982 – experience variances 76 (99) – operating assumption changes (133) 44 Other operating variance 572 294 Expected return on shareholders’ net worth 549 512
There were no separate development costs reported in these years. Other non-operating variances are described under Exceptional items on page 331. The table above presents a summarised breakdown of the life and pensions MCEV earnings on a gross of non-controlling interests basis and gross of tax with tax shown separately. The Group favours the gross presentation for consistency with the IFRS results. The table below compares the key items on the different bases as the subsequent analysis is provided predominantly on a net of tax and non-controlling interests basis as preferred by the CFO Forum Principles.
Value of new business 358 624 410 765 Life and pensions operating return 2,199 3,579 2,247 3,498 Life and pensions earnings 1,838 2,665 3,189 4,227
United Kingdom 579 5.2 2,997 7,301 10,298 France 89 6.3 565 4,353 4,918 Ireland 65 4.0 263 675 938 Italy 50 5.4 270 4,186 4,456 Poland 51 9.2 468 135 603 Spain 109 5.9 648 1,436 2,084 Other Europe 89 4.6 412 126 538 Aviva Europe 453 5.8 2,626 10,911 13,537 Delta Lloyd 172 9.3 1,591 1,587 3,178 Europe 625 6.7 4,217 12,498 16,715 North America 97 10.2 993 3,735 4,728 Asia Pacific 240 4.7 1,132 485 1,617
In Poland, the WACF has significantly fallen, reflecting the lower proportion of new pension business written following legislative changes making this business less attractive. This business had a high WACF, reflecting the long duration of the business combined with premiums increasing each year.
United Kingdom 10,298 8,914 354 247 3.4% 2.8% France 4,918 4,891 175 169 3.6% 3.5% Ireland 938 1,072 1 12 0.1% 1.1% Italy 4,456 3,607 142 124 3.2% 3.4% Poland 603 1,079 40 55 6.6% 5.1% Spain 2,084 2,454 128 151 6.1% 6.2% Other Europe 538 420 18 10 3.3% 2.4% Aviva Europe 13,537 13,523 504 521 3.7% 3.9% Delta Lloyd 3,178 3,665 (92) (48) (2.9)% (1.3)% Europe 16,715 17,188 412 473 2.5% 2.8% North America1 4,728 4,545 (194) 16 (4.1)% 0.4% Asia Pacific 1,617 1,356 52 29 3.2% 2.1%
United Kingdom 14% 109 133 242 8 France 9% 53 169 222 9 Ireland 6% 56 23 79 10 Italy 10% 27 156 183 7 Poland 22% 20 9 29 5 Spain 26% 25 72 97 3 Other Europe 12% 43 7 50 8 Aviva Europe 13% 224 436 660 7 Delta Lloyd 6% 116 140 256 33 Europe 11% 340 576 916 15 North America 7% 162 376 538 14 Asia 6% 58 25 83 25 Australia 11% 2 34 36 8 Asia Pacific 8% 60 59 119 20
United Kingdom 345 129 208 (183) 499 (43) (95) (138) 361 Aviva Europe 478 77 147 126 828 (150) (342) (492) 336 Delta Lloyd 139 50 (225) 83 47 (58) (55) (113) (66) Europe 617 127 (78) 209 875 (208) (397) (605) 270 North America 210 53 (56) 292 499 (41) (375) (416) 83 Asia Pacific 52 9 (5) 15 71 (57) (34) (91) (20)
Impact of experience variances and assumption changes on net worth £m
E13 – Maturity profile of business (a) Total in-force business To show the profile of the VIF emergence, the value of VIF in the statements of financial position has been split into five-year tranches depending on the date when the profit is expected to emerge.
United Kingdom 153 766 538 287 553 2,297 2,297 Aviva Europe 1,649 980 575 342 375 3,921 3,288 Delta Lloyd 517 109 56 (176) (76) 430 196 Europe 2,166 1,089 631 166 299 4,351 3,484 North America 56 (47) 12 12 9 42 42 Asia Pacific 187 94 35 15 3 334 325
United Kingdom 289 629 490 288 369 2,065 2,065 Aviva Europe 1,613 1,149 656 350 342 4,110 3,271 Delta Lloyd 54 149 177 151 (234) 297 125 Europe 1,667 1,298 833 501 108 4,407 3,396 North America (238) (251) 28 13 54 (394) (394) Asia Pacific 102 72 29 18 26 247 241
United Kingdom 107 30 34 19 40 230 230 Aviva Europe 286 126 80 37 43 572 414 Delta Lloyd (38) 89 97 75 (138) 85 70 Europe 248 215 177 112 (95) 657 484 North America 20 6 64 52 66 208 208 Asia Pacific 46 14 8 4 5 77 76
E14 – Segmental analysis of life and related business embedded value
United Kingdom 1,139 2,934 2,297 6,370 France2 (243) 1,737 1,446 2,940 Ireland 47 336 444 827 Italy 202 313 82 597 Poland 129 114 876 1,119 Spain 81 266 207 554 Other Europe 43 45 233 321 Aviva Europe 259 2,811 3,288 6,358 Delta Lloyd 356 944 196 1,496 Europe 615 3,755 3,484 7,854 North America2,3 (248) 1,437 42 1,231 Asia Pacific 135 216 325 676
Total 2,204 7,546 5,308 15,058 1 Required capital is shown net of implicit items permitted by local regulators to cover minimum solvency margins. 2 The large increase in required capital in the UK reflects the additional capital locked in following the reattribution of the inherited estate. 3 France and Aviva USA have a positive surplus on a statutory basis. 4 Aviva USA’s holding company debt amounting to £810 million at 31 December 2009 has been included within non-covered business.
E15 – Risk allowance within present value of in-force (VIF) Within the VIF in the tables, there are additional allowances for risks not included within the basic present value of future profits calculation.
The Time Value of Options and Guarantees has reduced by £248 million to £993 million, reflecting favourable impacts from model refinements in France and US and the impact of renegotiating the guarantees on AFER in France. The allowance for Non-hedgeable risks has increased by £(260) million, reflecting the change to the charge from 2.5% to 3.3%.
United Kingdom 2,572 (285) (197) (25) 2,065 France 2,048 (144) (155) (497) 1,252 Ireland 517 (9) (21) — 487 Italy 189 (22) (11) (27) 129 Poland 1,050 (17) (74) (9) 950 Spain 326 (16) (28) (17) 265 Other Europe 198 (3) (5) (2) 188 Aviva Europe 4,328 (211) (294) (552) 3,271 Delta Lloyd 544 (129) (80) (210) 125 Europe 4,872 (340) (374) (762) 3,396 North America 80 (9) (45) (420) (394) Asia 324 (19) (30) (34) 241 Australia — — — — — Asia Pacific 324 (19) (30) (34) 241
Total 9.9% 10.1% 1 The IDRs have been restated following more detailed review resulting from the change in expected return methodology, which reflected a more appropriate allowance for the impact of the release of required capital and other refinements. 2 The US full-year 2009 IDR has been revised to reflect the expected future tax paying position of the business. This reduces the IDR from 41.2% to 35.6%. The revised IDR gives the correct expected return allowing for the impact of tax on future cash flows within the IDR calculation and the impact of the tax assumption change on the closing full-year 2009 balance sheet. 3 Asia Pacific excludes Australian life and pensions business sold in October 2009.
Value of new business after tax 16 2 47 5 56 126 9 135 — 135 410 545 Life MCEV operating earnings after tax 45 14 79 53 81 272 76 348 1 349 2,247 2,596 Life MCEV (loss)/earnings after tax 51 1 64 17 57 190 (98) 92 — 92 3,189 3,281 Closing covered businesses’ embedded value 320 290 762 162 586 2,120 1,346 3,466 14 3,480 15,058 18,538
There are no non-controlling interests in the United Kingdom or North America.
Reference rate 1 year 1.0% 1.2% 2.8% 5 years 2.7% 3.5% 3.2% 10 years 3.7% 4.3% 3.5% 15 years 4.1% 4.6% 3.8% 20 years 4.2% 4.6% 3.8% Expense inflation 3.3% 3.3% 2.4%
Reference rate 1 year 1.3% 1.3% 2.5% 5 years 2.5% 2.8% 3.3% 10 years 3.4% 3.7% 3.8% 15 years 3.8% 4.1% 3.9% 20 years 3.8% 4.2% 3.9% Expense inflation 2.1% 2.5% 2.1%
Reference rate 1 year 0.4% 0.7% 1.3% 5 years 2.2% 3.1% 2.2% 10 years 3.5% 4.2% 2.6% 15 years 4.0% 4.6% 2.9% 20 years 4.2% 4.8% 2.9% Expense inflation 3.0% 3.0% 3.0%
France n/a n/a n/a n/a n/a n/a n/a 0.36% 0.30% Spain 0.15% 0.12% 0.20% 0.15% 0.30% 0.75% 1.00% 0.36% 0.30% Delta Lloyd 0.38% 0.39% 0.34% 0.43% 0.61% 1.03% 1.83% 0.36% 0.43% US immediate annuities 0.76% 0.85% 0.65% 0.65% 1.05% 1.50% 3.00% 0.66% 0.65% US deferred annuities and all other contracts 0.64% 0.70% 0.55% 0.55% 0.90% 1.25% 2.50% 0.56% 0.55% 1 The rate provided is for immediate annuities/bulk purchase annuities.
Adjustments are made where liabilities are not fully backed by assets earning a liquidity premium and for contracts that are exposed to some lapse risk. The revised approach increases the EV by £0.3 billion due to the release of prudent margins in the previous direct Credit Default Swap-based approach. There has been no change to the types of contracts to which a liquidity premium is applied, apart from in Delta Lloyd, which has been restated for the move to the QIS 5 approach.
Equity risk premium 3.5% 3.5% 3.5% Property risk premium 2.0% 2.0% 2.0%
United Kingdom1 27.0% 28.0% 28.0% 100%/110%/200% 100%/110%/200% France 34.4% 34.4% 34.4% 107.5% 110% Ireland2 12.5% 12.5% 12.5% 175%/250% 150% Italy3 32.4% 32.4% 32.4% 111%/165% 115%/184% Poland 19.0% 19.0% 19.0% 125.5% 150% Spain4 30.0% 30.0% 30.0% 130% - 134%/175% 110%/125% Delta Lloyd5 25.0% 25.5% 25.5% 120% 139% United States6 35.0% 0.0% 0.0% 325% 325% 1 The required capital in the United Kingdom under MCEV is 100% for unit-linked and other non-participating business and 110% for annuity business with 200% for BPA business. In addition, the reattribution of the inherited estate has led to additional capital being locked in to support the with-profit business, and this has been included within required capital. 2 Required capital in Ireland under MCEV is 175% for bancassurance and 250% for retail business. 3 Required capital in Italy under MCEV is 165% of the EU minimum for Eurovita and 111% for bancassurance and 130% for retail business. 4 Required capital in Spain is 175% of the EU minimum for Aviva Vida y Pensiones and 130% – 134% for bancassurance companies. 5 This capital level is the aggregate capital required for Delta Lloyd. 6 Following a more detailed review of the implied tax position of Aviva US, 2010 results have been calculated including the impact of full corporation tax applying to the cash flows and consequently the 2010 results are ‘grossed up’ at the corporation tax rate in line with other businesses. 7 Current tax legislation and rates have been assumed to continue unaltered except where changes in future tax rates have been announced.
Other economic assumptions Required capital relating to with-profit business is generally assumed to be covered by the surplus within the with-profit funds and no effect has been attributed to shareholders. Where the fund is insufficient, and additional shareholder support is required, this is included within required capital, including the RIEESA in the UK. Bonus rates on participating business have been set at levels consistent with the economic assumptions. The distribution of profit between policyholders and shareholders within the with-profit funds assumes that the shareholder interest in conventional with-profit business in the United Kingdom and Ireland continues at the current rate of one-ninth of the cost of bonus.
(b) Economic assumptions – Stochastic calculations The calculation of time value of options and guarantees allows for expected management and policyholder actions in response to varying future investment conditions. The management actions modelled include changes to asset mix, bonus rates and rates of interest and other guarantees granted to policyholders. Modelled policyholder actions are described under ‘Other assumptions’.
UK sterling 10 years 15.3% 14.8% 14.3% 13.6% n/a n/a 14.1% n/a 15 years 14.1% 13.6% 13.1% 12.3% n/a n/a 14.6% n/a 20 years 13.1% 12.5% 12.0% 11.2% n/a n/a 14.4% n/a 25 years 12.3% 11.7% 11.2% 10.4% n/a n/a 14.0% n/a Euro 10 years 21.2% 20.9% 20.6% 20.3% 17.9% 17.8% 17.7% 17.6% 15 years 20.7% 20.1% 19.5% 18.8% 18.0% 17.6% 17.3% 16.9% 20 years 19.2% 18.5% 17.8% 16.9% 17.1% 16.7% 16.3% 15.7% 25 years 17.8% 16.9% 16.1% 15.2% 16.2% 15.6% 15.0% 14.4% Delta Lloyd 10 years 17.8% 18.1% 18.8% 19.8% 14.5% 15.3% 17.3% 18.6% 15 years 20.5% 21.0% 21.4% 21.7% 15.2% 15.8% 17.8% 18.9% 20 years 25.2% 25.3% 24.3% 23.4% 15.8% 16.7% 18.1% 18.5% 25 years 28.5% 26.4% 24.0% 22.5% 16.8% 17.5% 18.2% 18.3% US dollar 10 years 24.0% 23.6% 22.9% 22.2% 20.0% 18.9% 18.0% 17.3% 15 years 23.9% 23.1% 22.2% 21.1% 17.5% 16.4% 15.6% 15.0% 20 years 23.0% 21.9% 20.6% 19.4% 15.5% 14.5% 13.8% 13.2% 25 years 21.7% 20.4% 19.1% 17.8% 13.7% 12.9% 12.2% 11.6%
For businesses where stochastic scenarios are calibrated before the year end, the closing embedded value has been adjusted for the subsequent decrease in market volatilities up to the year end.
E18 – Principal assumptions continued (c) Other assumptions Valuation of debt Borrowings in the MCEV consolidated statement of financial position are valued on an IFRS basis, consistent with the primary financial statements. At 31 December 2010 the market value of the Group’s external debt, subordinated debt, preference shares including General Accident plc preference shares of £250 million (classified as non-controlling interests) and direct capital instrument was £7,279 million (31 December 2009: £6,634 million).
Borrowings per summarised consolidated statement of financial position – MCEV basis 14,949 15,000 Add: amount included within held for sale — — Less: Securitised mortgage funding (6,332) (7,329)
External debt and subordinated debt – MCEV basis 6,066 5,489 Add: Preference shares (including General Accident plc) and direct capital instrument 1,440 1,440
External debt, subordinated debt, preference shares and direct capital instrument – MCEV basis 7,506 6,929 Effect of marking these instruments to market (227) (295)
E19 – Sensitivity analysis (a) Economic assumptions The following tables show the sensitivity of the embedded value and the value of new business to: 10 basis point increase in the liquidity premium adjustment, where applicable; one and two percentage point increase and decrease in the risk-free rate, including all consequential changes (including assumed investment returns for all asset classes, market values of fixed interest assets, risk discount rates); 10% increase and decrease in market values of equity and property assets; 25% increase in equity and swaption volatilities; 50 basis point increase and decrease in credit spreads with no change to liquidity premium; and decrease in the level of required capital to 100% EU minimum (or equivalent).
Interest rates 2010 Embedded value (net of tax and non-controlling interest)
As reported on page 10bp increase in adjustment to risk-free rates £m £m £m £m £m
United Kingdom 6,370 150 (205) 185 (435) 385 France 2,940 5 (60) (15) (140) (245) Ireland 827 — (30) 40 (55) 60 Italy 597 — (20) 35 (40) 80 Poland 1,119 — (60) 65 (110) 135 Spain 554 10 (15) 15 (35) 30 Other Europe 321 — (5) 15 (15) 25 Aviva Europe 6,358 15 (190) 155 (395) 85 Delta Lloyd 1,496 65 350 (480) 580 (1,235) Europe 7,854 80 160 (325) 185 (1,150) North America 1,231 170 (180) 65 (460) 60 Asia Pacific 676 — 35 (75) 45 (230)
Market values 2010 Embedded value (net of tax and non-controlling interest)
United Kingdom 6,370 275 (325) (215) France 2,940 150 (165) (125) Ireland 827 20 (20) — Italy 597 — — — Poland 1,119 10 (10) — Spain 554 10 (10) (10) Other Europe 321 5 — — Aviva Europe 6,358 195 (205) (135) Delta Lloyd 1,496 255 (260) (35) Europe 7,854 450 (465) (170) North America 1,231 25 (20) — Asia Pacific 676 20 (20) (5)
Corporate bond credit spread 2010 Embedded value (net of tax and non-controlling interest)
United Kingdom 254 — — — France 100 6 (7) (3) Ireland 1 — — — Italy 42 1 (1) — Poland 29 — — — Spain 43 — — — Other Europe 15 — — — Aviva Europe 230 7 (8) (3) Delta Lloyd (41) 6 (6) — Europe 189 13 (14) (3) North America (126) — — — Asia Pacific 41 — — —
E19 – Sensitivity analysis continued (b) Non-economic assumptions The following tables below show the sensitivity of the embedded value and the value of new business 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); and 5% decrease in both mortality and morbidity rates disclosed separately for life assurance and annuity business.
New business 2010 Value of new business (net of tax and non-controlling interest)
As reported on page 329 £m 10% decrease in maintenance expenses £m 10% decrease in lapse rates £m 5% decrease in mortality/ morbidity rates – life assurance £m 5% decrease in mortality/ morbidity rates – annuity business £m
Respective responsibilities of directors and auditors As explained more fully in the Statement of directors’ responsibilities on page 351, the directors are responsible for preparing the consolidated MCEV financial statements in accordance with the MCEV Principles. Our responsibility, as independent auditor, is to audit and express an opinion on the consolidated MCEV financial statements, in accordance with the terms of our engagement letter dated 4 August 2010 and having regard to International Standards on Auditing (UK and Ireland). Those standards require us to comply with the Auditing Practices Board’s Ethical Standards for Auditors.
Product definitions Annuities A type of policy that pays out regular amounts of benefit, either immediately and for the remainder of a person’s lifetime, or deferred to commence from a future date. Immediate annuities may be purchased for an individual and his or/her dependants or on a bulk purchase basis for groups of people. Deferred annuities are accumulation contracts, which may be used to provide benefits in retirement, and may be guaranteed, unit-linked or index-linked.
ISAs Individual savings accounts – Tax-efficient plans for investing in stocks and shares, cash deposits or life insurance investment funds, subject to certain limits. Introduced in the UK in 1999.
Non profits Long-term savings and insurance products sold in the UK other than “With profits” (see definition below) products.
OEIC Open ended investment company is a collective investment fund structured as a limited company in which investors can buy and sell shares.
Product definitions cont. Single premium A single lump sum is paid by the policyholder at commencement of the contract.
Unit-linked annuities A unit-linked annuity is a type of deferred annuity which is invested in units of investment funds, whose value depends directly on the market value of assets in those funds.
With-profits A type of long-term savings and insurance product sold in the UK under with profits policies premiums are paid into a separate fund. Policyholders receive a return on their policies through bonuses, which “smooth” the investment return from the assets which premiums are invested in. Bonuses are declared on an annual and terminal basis. Shareholders have a participating interest in the with-profit funds and any declared bonuses. Generally, policyholder and shareholder participation in with-profit funds in the UK is split 90:10.
Combined Code on Corporate Governance The Combined Code on Corporate Governance sets out guidance in the form of principles and provisions on how companies should be directed and controlled to follow good governance practice. The Financial Services Authority (FSA) requires companies listed in the UK to disclose, in relation to the Combined Code, how they have applied its principles and whether they have complied with its provisions throughout the accounting year. Where the provisions have not been complied with, companies must provide an explanation for this.
FSA The UK’s Financial Services Authority – Main regulatory body appointed by the government to oversee the financial services industry in the UK. Since December 2001 it has been the single statutory regulator responsible for the savings, insurance and investment business.
General terms cont. Funds under management Represents all assets actively managed or administered by or on behalf of the Group including those funds managed by third parties.
IFRS operating profit From continuing operations on an IFRS basis, stated before tax attributable to shareholders’ profits, impairment of goodwill and exceptional items. This is also refered to as adjusted operating profit.