Annual bonus As summarised in table 3, the maximum bonus opportunity for all EDs will remain unchanged for the 2013 financial year at 150% of base salary, with two-thirds of any bonus earned subject to compulsory deferral for three years. Unvested awards are subject to clawback and risk of forfeiture during this period. Annual performance is measured against a range of key financial, employee and customer performance indicators, which account for 70% of the maximum, and against personal objectives, which account for 30% of the maximum. To align with the business priorities for 2013, the financial measures at Group level will be: net capital returns’ profit before tax; MCEV value of new business (for the Life business); combined operating ratio (for the General Insurance business); and total expenses. Personal objectives will include common objectives for effective leadership and risk management. As highlighted previously, bonus outcomes will also be subject to consideration of our performance against our underpin metrics (Economic Value Added, Economic Capital and TSR).
ROE targets ROE targets determine the vesting of 50% of any LTIP award and are set annually within the context of the Company’s three-year business plan. Vesting depends upon performance over the three-year period against a target return. The 2012 LTIP award ROE targets are set out in table 9.
The definition of ROE was refined in early 2013. ROE will now be calculated as IFRS profit after tax and non-controlling interest, excluding the impact of investment variances and economic assumption changes, over average IFRS equity (excluding pension scheme net surplus/deficit) attributable to ordinary shareholders of the Company.
All employee share plans EDs are eligible to participate in a number of HMRC-approved all employee share plans on the same basis as other eligible employees. These plans included a free share element under the AESOP. Under this element of the AESOP, eligible employees can receive up to a maximum of £3,000 per annum in shares based upon the profits of the Company’s UK businesses. The shares are free of tax subject to a retention period. Free shares were awarded in 2012. However, this element of the AESOP has since been discontinued and no awards will be made in 2013. The partnership share element of the AESOP, which the Company also operates, allows participants to invest up to £125 per month out of their gross salary in the Company’s shares. There is currently no matching element to this investment by the Company. However a matching element is due to be introduced in April 2013 through which the Company will match every purchased share with two matching shares for the first £40 of a participant’s monthly contribution. For as long as the employee remains employed by the Company, matching shares will be subject to forfeiture if purchased shares are withdrawn from the AESOP within three years of purchase. From May 2013 participants will also be eligible to receive Dividend Shares through the AESOP. Shares awarded to, or investments made by, EDs through the AESOP are included in table 20 of this Report. The Aviva Savings Related Share Option Scheme and Aviva Savings Related Share Option Scheme 2007 allow eligible employees to acquire options over the Company’s shares at a discount of up to 20% of their market value at the date of grant. In order to exercise these options, participants must have saved through a three, five, or seven year HMRC-approved savings contract, subject to a maximum savings limit of £250 per month. In 2012, only three and five year contracts were offered. Details of options granted to EDs under these schemes are included in table 19.
Share ownership requirements The Company has an internal shareholding requirement such that the Group CEO is required to build a shareholding in the Company equivalent to 200% of base salary and each ED is required to build a shareholding in the Company equivalent to 150% of base salary. The EDs, including the Group CEO, are required to retain 50% of the net shares released from deferred annual bonuses and LTIPs until the shareholding requirement is met. There is no target date for meeting the share ownership requirement. Unvested share awards including shares held in connection with compulsory bonus deferrals are not taken into account in applying this test. Table 11 below shows the position at 31 December 2012, based on that day’s closing middle market price of an ordinary share of the Company of 373.00 pence.
Table 11: EDs’ share ownership requirements as at 31 December 20121
As Group CEO, he will be required to build a shareholding in the Company equivalent to 200% of his base salary. He did not hold any Aviva shares as at 31 December 2012. 2 Based on the closing middle market price of an ordinary share of the Company on 31 December 2012.
Pension EDs participate in a defined contribution plan under which they can elect to receive 31% of base salary from the Company minus a contribution of 8% of base salary up to the Scheme Specific Earnings cap (£138,000 in 2012/2013). Above the annual or life-time allowance, a cash alternative in lieu of pension is offered subject to a limit of 31% of base salary minus the 8% contribution.
Performance graph Table 12 below compares the TSR performance of the Company over the past five years with the TSR of the FTSE 100 Return Index. This index has been chosen because it is a recognised equity market index of which Aviva is a member. The companies which comprise the current LTIP comparator group for TSR purposes are listed in the ‘TSR targets’ section above. The TSR graph for the comparator group has been plotted using the 15 companies (including Aviva) in the comparator group for the 2007 grant, the 16 companies (including Aviva) in the comparator group for the 2008 grant, the 15 companies (including Aviva) in the comparator group for the 2009 and 2010 grants, and the 14 companies (excluding Aviva) in the comparator group for the 2011 and 2012 grants.
EDs’ employment contracts The key employment terms and conditions of each of the current EDs, as stipulated in their employment contracts, are set out in table 13 below.
Remuneration and benefits As described in this Report the operation of the ABP and LTIP is at the Company’s discretion and, in the case of the ACAP and ACDT, at the trustees’ discretion.
Car allowance Car allowance is received in accordance with the terms of the relevant scheme in operation for the Company as varied from time to time.
Private medical insurance Private medical insurance is provided for the ED and the ED’s family or the ED can choose to opt out of this benefit or take a lower level of cover and receive 75% of the difference in the cash value of this benefit which will be paid through salary on a monthly basis.
Contract dates Director: Mark Wilson Patrick Regan Trevor Matthews Igal Mayer Andrew Moss
Termination By the director or the Company at their discretion without compensation upon giving one month’s written notice for NEDs and three months’ written notice for the chairman of the Company.
Glyn Barker 3 May 2012 AGM 2013 Mary Francis1 3 May 2012 AGM 2013
Richard Karl Goeltz2 3 May 2012 AGM 2013 Euleen Goh3 3 May 2012 AGM 2013 Michael Hawker 3 May 2012 AGM 2013 Gay Huey Evans 3 May 2012 AGM 2013 John McFarlane 3 May 2012 AGM 2013 Lord Sharman4 3 May 2012 AGM 2013 Leslie Van de Walle5 4 May 2011 AGM 2012
Russell Walls6 3 May 2012 AGM 2013 Scott Wheway 3 May 2012 AGM 2013 Notes 1 Mary Francis resigned from the Board on 3 October 2012. 4 Lord Sharman retired from the Board on 30 June 2012. 2 Richard Karl Goeltz will retire from the Board prior to the 2013 AGM. 5 Leslie Van de Walle resigned from the Board on 2 May 2012. 3 Euleen Goh resigned from the Board on 31 December 2012. 6 Russell Walls will retire from the Board prior to the 2013 AGM.
It is the Company’s policy to set the fees paid to the chairman of the Company and NEDs taking account of the median market payments in international companies of similar size and complexity. NEDs receive a basic annual fee in respect of their Board duties. A further fee is paid to NEDs in respect of membership and, where appropriate, chairmanship of Board committees. Fees are reviewed annually and are set by the Board to attract individuals with the required range of skills and experience. In determining the level of fees paid to the NEDs, the Board receives recommendations from the EDs, who consider the NEDs’ duties and responsibilities, together with the time commitment required in preparing for and attending meetings, and the amounts paid by competitors and similar-sized companies. The Chairman of the Company and NEDs do not participate in any incentive or performance plans or pension arrangements and they also do not receive an expense allowance. The Company’s articles of association provide that the total aggregate remuneration paid to the Chairman of the Company and NEDs will be determined by the Board within the limits set by shareholders. The current aggregate limit of £2 million was approved by shareholders at the Company’s 2012 AGM. EDs are remunerated under their employment contracts and receive no additional fee for serving as Board directors.
Additional fees are paid as follows: Senior independent director £25,000 £35,000
Committee chairman (inclusive of committee membership fee) – Audit £35,000 £45,000 – Corporate Responsibility £10,000 £20,000
Notes 1 Inclusive of Board membership fee and any committee membership fees. 2 The fee for the chairman designate was effective from the commencement of the role on 1 January 2012 until 30 June 2012.
Table 16: Directors’ remuneration in 20129, 10 Base salary/fees Bonus1 In-Lieu Pension Benefits2 Total
Chairman/executive chairman John McFarlane3 413 24 — — — — 145 11 558 35
Former executive directors11 Igal Mayer7 193 606 — 632 — — 408 455 601 1,693
Notes 1 As disclosed elsewhere in this Report, following careful consideration the Committee decided that EDs would not receive a bonus for 2012. 2 The benefits disclosure includes the cost, where appropriate, of PMI, life assurance, accommodation, travel and car benefits. All the numbers disclosed include the tax charged on the benefits, where applicable. No directors received an expense allowance during the year. 3 The chairman received travel related benefits, and medical insurance during his period as executive chairman. In accordance with the terms of his appointment, as disclosed in the 2011 Directors’ Remuneration Report, he received reimbursement for such costs reasonably incurred in connection with his relocation to the UK during the 12 month period from the date of his appointment up to a maximum of £125,000, plus reimbursement of the costs incurred in respect of advice sought on the legal and tax implications of his appointment, together with any VAT or equivalent tax payable thereon.
5 Patrick Regan received contributions in lieu of pension above the pension annual allowance limit, paid as cash. The figure shown represents contributions paid or payable for 2012. 6 NEDs are reimbursed for expenses, and any tax arising on those expenses is settled directly by Aviva. 7 Figures shown for Igal Mayer have been converted from Canadian dollars to pounds sterling at the average exchange rate for 2012 of CAD $1.58: £1.00. As disclosed in the 2011 Directors’ Remuneration Report, Mr Mayer was entitled to first class return flights between Toronto and London, and a travel allowance of up to £40,000 per annum for his spouse and dependent children for travel to and from Toronto and London. Aviva also met the cost of rental accommodation in London and utility costs, as well as assistance in preparing his tax returns in line with standard policy. Aviva met the cost of any taxes due on these benefits. Mr Mayer is entitled to receive a further £594,451 in termination payments. This is made up of a payment in lieu of notice (paid in instalments) and legal fees as set out on page 110.
8 Andrew Moss received no bonus for 2012, although details of a £300,000 payment in full and final settlement of all claims that he might have a bonus are set out elsewhere in this Report. Mr Moss received a contribution in lieu of pension of £503,000 into the ACAP in April 2012, although only £209,000 of this payment was allowed to vest as part of his departure terms. The remaining £294,000 lapsed. He also received a cash supplement in lieu of pension of £6,769. Mr Moss is entitled to receive a further £923,462 in termination payments. This is made up of a payment in lieu of notice (paid in instalments) and legal fees as set out on page 110.
EDs’ pension arrangements (audited information) The position of the EDs with respect to accumulated pension benefits under the defined benefits section of the Aviva Staff Pension Scheme (ASPS) is set out in table 17 below.
Notes 1 Accrued pensions shown are the amounts that would be paid annually on retirement based on service to the end of the year (or date of leaving if earlier). 2 The defined contribution employer contributions during the year for Patrick Regan and Trevor Matthews include salary exchange contributions of £9,534 and £8,280 respectively. 3 The change in transfer value allows for fluctuations in the transfer value due to factors beyond the control of the Company and directors, such as changes in market conditions. 4 The transfer values have been calculated in line with the relevant legislation and using actuarial assumptions agreed by the trustee. The transfer value at 31 December 2011 previously provided for Igal Mayer included the value of the early retirement subsidies for which Mr Mayer did not qualify following his resignation during 2012. 5 No former directors received any increase in retirement benefits in excess of the amount to which they were entitled, on the later of the date when the benefits first became payable, or 31 March 1997. 6 The transfer value of net increase (decrease) in accrued pension shows the value of the increase (decrease) in accrued pension net of the inflation, over the year, net of contributions. This is zero for UK based employees as there is no further accrual of benefits and accrued benefits are increased up to retirement in line with inflation. 7 Igal Mayer is a member of the Aviva Canada Pension Plan, and the figures shown for him have been converted from Canadian dollars to pounds sterling at the average exchange rate for 2012 of CAD $1.58 : £1.00. Igal Mayer received contributions into the defined contribution section of the Aviva Canada pension plan. The value of his defined benefit pension plan, whilst no longer subject to future service accrual, remained subject to revaluation by reference to salary during 2012.
Share awards (audited information) Table 18 below sets out the current position (or the position as at the date of resignation of the director from the Board) of those share-based awards made to the EDs who served during 2012 under current remuneration arrangements.
CFO Recruitment Share Awards Plan7 2010 (RRSA)5 170,393 13,4146 98,610 — 85,197 394.20 356.80 Feb-12,138
Aviva Annual Bonus Plan 2012 — 8,928 — — 8,928 331.50 Mar-15
Table 18: LTIP, ABP, OATTV Plan, CFO Recruitment Share Awards Plan and Conditional Share Award (continued)
Aviva Annual Bonus Plan 2010 51,155 — — — 51,155 387.70 Dec-12
Notes 1 The actual price used to calculate the ABP and LTIP awards is based on a three day average closing middle market price of an ordinary share of the Company. These were in 2009: 256 pence, 2010: 386 pence, 2011: 434 pence and 2012: 336 pence. The three day average closing middle market price of an ordinary share of the Company used to grant the 2009 OATTV Plan awards were in 2009: 256 pence and 2010: 386 pence. The five day average closing middle market price of an ordinary share of the Company used to grant the Replacement Restricted Share Award (RRSA) in 2010 was 380.22 pence. The three day average closing middle market price of an ordinary share of the Company used to grant the Bonus Replacement Deferred Share Award (BRDSA) in 2010 was 386 pence. The three day average closing middle market price of an ordinary share of the Company used to grant the Conditional Share Award in 2011 was 309 pence.
2 The performance periods for these awards begin at the commencement of the financial year in which the award is granted. 3 The performance conditions for awards which were granted or which vested during 2012 are explained elsewhere in this Report. The performance periods for these awards begin at the commencement of the financial year in which the award is granted. 4 The award date for the awards granted in 2009 which vested in 2012 was 26 March 2009, the award date for the award granted in 2010 which vested in 2012 was 11 March 2010 and the award date for the award granted in 2011 which vested in 2012 was 2 December 2011. The awards which vested in 2012 were released with the net amount being settled in shares and the balance settled in cash and used to pay the resulting tax liability. The monetary value of awards will be calculated by multiplying the relevant number of shares by the closing middle market price of an ordinary share of the Company at the date of vesting.
5 The shares comprising these awards are restricted shares which are beneficially owned by Patrick Regan and held in trust on his behalf under the terms of a restricted share award agreement. As outlined in the 2010 Directors’ Remuneration Report, income tax and National Insurance Contributions liabilities were paid on the RRSA on 11 March 2010 and on the BRDSA on 30 March 2010.
6 These figures relate to shares issued in lieu of dividends accrued during the deferral period. 7 The awards under the CFO Recruitment Share Awards Plan were granted to Patrick Regan following his recruitment in 2010. As disclosed in the 2010 Directors’ Remuneration Report, the RRSA will vest in tranches subject to Mr Regan meeting his personal performance targets, the OATTV is subject to the same performance conditions as the OATTV Plan awards granted to other EDs in 2010 and the BRDSA is not subject to performance conditions and will vest on the third anniversary of the date of grant subject to Mr Regan remaining in employment with the Company.
Trevor Matthews remaining in employment with the Company. Trevor Matthews will cease to be a director of the Company prior to the 2013 AGM. The treatment of his awards will be determined on his ceasing to be an employee of the Company.
10 These shares were awarded as Phantom Units which will be cash settled on vesting and no shares will be transferred or allotted. 11 The information shown in this column for Andrew Moss is as at his resignation from the Board on 8 May 2012 and for Igal Mayer is as at his resignation from the Board on 19 April 2012. 12 25% of Andrew Moss’ 2010 ABP award and 100% of his 2011 and 2012 ABP awards, 2010, 2011 and 2012 LTIP awards and 2010 OATTV award lapsed on his leaving the Company on 31 May 2012. The remaining 75% of his 2010 ABP
award will vest on the normal vesting date. 13 Igal Mayer’s ABP awards vested on 1 June 2012, the first business day after leaving the Company on 31 May 2012. Mr Mayer’s 2010, 2011 and 2012 LTIP awards and 2010 OATTV award lapsed on his leaving the Company on 31 May 2012. 14 The aggregate net value of share awards granted to the directors in the period was £8.9 million (2011: £12.1 million). The net value has been calculated by reference to the closing middle market price of an ordinary share of the Company at the date of grant. This excludes shares issued in lieu of dividends.
Notes 1 The information shown for Andrew Moss is as at the date of his resignation from the Board on 8 May 2012. Mr Moss’ executive share options lapsed on leaving the Company on 31 May 2012. 2 The information shown for Igal Mayer is as at his resignation from the Board on 19 April 2012. Mr Mayer’s savings-related options lapsed on leaving the Company on 31 May 2012. 3 Any unexercised options will lapse at the end of the exercise period.
Dilution Awards granted under the Aviva employee share plans are met by the funding of two employee trusts administered by external trustees that acquire shares in the market. The current practice is that new issue shares will generally only be issued where it is not practicable or permissable to use the trust. However, the funding policy is kept under review by the Committee and the Board. Details of the shares currently held in the employee trusts are set out in note 31.
Directors’ interests in Aviva shares The interests held by each person who was a director during the 2012 financial year and their connected persons in the ordinary shares of the Company are shown in table 20 below. All the disclosed interests are beneficial. The table also summarises the interests in shares held through the Company’s various share incentive plans.
Table 20: Directors’ interests in Aviva shares9 Shares1 ABP2 LTIP3 OATTV Plan4 Options5 1 January 31 December 1 January 31 December
Glyn Barker7 — — — — — — — — — — Mary Francis 4,700 4,700 Richard Karl Goeltz6 17,500 17,500 — — — — — — — — Euleen Goh — — — — — — — — — — Michael Hawker 5,000 5,000 — — — — — — — — Gay Huey Evans — — — — — — — — — —
Notes 1 ‘Shares’ are the directors’ beneficial holdings in the ordinary shares of the Company and in respect of the EDs include any shares held in trust under the AESOP, being shares purchased by them under the partnership element of the AESOP and any shares granted under the free share element of the AESOP. In respect of Patrick Regan, it also includes the remaining restricted shares held in trust from his RRSA and BRDSA awarded under the rules of the CFO Recruitment Share Awards Plan. In respect of Andrew Moss, it also includes the remaining restricted shares held in trust from his 2009 and 2010 ABP awards (220,067 shares held at 1 January 2012 and 104,702 shares held at 8 May 2012 the date he ceased to be a director).
18 25% of Andrew Moss’ 2010 ABP award, and 100% of his 2011 and 2012 ABP awards and 2010 OATTV award lapsed on his leaving the Company on 31 May 2012. The remaining 75% of his 2010 ABP award will vest on the normal vesting date.
Approval by the Board This Directors’ Remuneration Report was reviewed and approved by the Board on 6 March 2013.
 Euro New Preference Shares of €1 each, which have such rights and terms (including, terms related to the redemption of such shares, ranking and entitlement to dividend and capital) as the Board determines.
Issued share capital The Company had an aggregate issued and outstanding ordinary share capital of £736 million as of 31 December 2012. The following table sets out information about the issued and outstanding classes of equity as of 31 December 2012.
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 are still limited as to the number of shares they can allot, as the allotment authority continues to be required under the Act, save in respect of employee share schemes. Ordinary shares in issue in the Company rank pari passu. All the ordinary shares in issue carry the same right to receive all dividends and other distributions declared, made or paid by the Company. The Company is not permitted under English law to hold its own ordinary shares. Whilst the Company is presently authorised to repurchase up to 290 million ordinary shares, any shares that are repurchased must be cancelled. Details of the Company’s dividends are set out below under ‘Dividend data’. The Company’s preference shares rank, as to the payment of dividends and capital, as set out in note 32.
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 are still limited as to the number of shares they can at any time, allot as the allotment authority continues to be required in the Act save in respect of employee share schemes. There were no changes to the voting rights of any class of shares during 2010, 2011 or 2012, other than issuances in connection with our various employee option schemes and under the Company’s scrip dividend scheme. The Company did not issue shares for consideration other than cash during 2010, 2011 or 2012. In addition, at the Company’s general meetings in 2010, 2011 and 2012, shareholders authorised the limited dis-application of Section 561 of the Companies Act 2006 to permit the Company to issue new equity securities for cash without applying shareholders’ statutory pre-emptive rights.
Key management compensation The total compensation to those employees classified as key management, being those having authority and responsibility for planning, directing and controlling the activities of the Group, including the executive and non-executive directors is as follows: £m 2011 £m £m
In addition to the amounts disclosed for associates and joint ventures above, at 31 December 2012 amounts payable at yearend were £nil, and expenses incurred during the period were £5 million. Transactions with joint ventures in the UK relate to the property management undertakings, the most material of which are listed in note 18(b). Our interest in these joint ventures comprises a mix of equity and loans, together with the provision of administration services and financial management to many of them. Our UK life insurance companies earn interest on loans advanced to these entities, movements in which may be found in note 18(a). Our fund management companies also charge fees to these joint ventures for administration services and for arranging external finance. Our UK fund management companies manage most of the assets held by the Group’s main UK staff pension scheme, for which they charge fees based on the level of funds under management. The main UK scheme holds investments in Groupmanaged funds and insurance policies with other Group companies, as explained in note 47(e)(iii). The related parties’ receivables are not secured and no guarantees were received in respect thereof. The receivables will be settled in accordance with normal credit terms. Details of guarantees, indemnities and warranties provided on behalf of related parties are given in note 51(g).
Loans to joint ventures We make loans to our property management joint ventures to fund property developments which we undertake with our joint venture partners. Movements in these loans may be found in ‘Financial Statements IFRS – Note 18 – Interests in, and loans to, joint ventures’. Total loans at 31 December 2012 and at the end of each of the last three financial years are shown in the table below: £m £m
Dividend data The Company has a policy to pay a progressive dividend with reference to growth in cash flows and earnings. Under UK company law, we may only pay dividends if the company has ‘distributable profits’ available. ‘Distributable profits’ are accumulated, realised profits not previously distributed or capitalised, less accumulated, unrealised losses not previously written off based on IFRS. Even if distributable profits are available, we pay dividends only if the amount of our net assets is not less than the aggregate of our called-up share capital and undistributable reserves and the payment of the dividend does not reduce the amount of our net assets to less than that aggregate. As a holding company, the Company is dependent upon dividends and interest from our subsidiaries to pay cash dividends. Many of the Company’s subsidiaries are subject to insurance regulations that restrict the amount of dividends that they can pay to us. Historically, the Company has declared an interim and a final dividend for each year (with the final dividend being paid in the year following the year to which it relates). Subject to the restrictions set out above, the payment of interim dividends on ordinary shares is made at the discretion of our Board, whilst payment of any final dividend requires the approval of the Company’s shareholders at a general meeting. Preference shares are irredeemable and dividends on preference shares are made at the discretion of our Board. The Company pays cash dividends in pounds sterling, although the articles of association permit payment of dividends on ordinary shares in other currencies and in forms other than cash, such as ordinary shares. If dividends on ordinary shares held by the American Depositary Shares (ADS) depositary are paid in pounds sterling, the ADS depositary will convert the pounds sterling that it receives on behalf of the ADS holders into US dollars according to the prevailing market rate on the date that the ADS depositary actually receives the dividends. For the 2007 final dividend and previous final and interim dividends, shareholders on record were provided with the opportunity to elect to receive dividends in the form of newly issued ordinary shares through the Aviva Scrip Dividend Scheme. For the 2008 interim dividend, the Aviva Scrip Dividend Scheme was replaced by a dividend reinvestment plan (DRIP). For those shareholders participating in the DRIP, the Company paid a cash dividend, which was then used to buy existing shares on the open market. For the 2008 final dividend, Aviva withdrew the DRIP and
Guarantees, securitised assets and off-balance sheet arrangements As a normal part of our operating activities, various Group companies have given financial guarantees and options, including interest rate guarantees, in respect of certain long-term assurance and fund management products, as set out in Note 41. These are accounted for on-balance sheet as either part of the host insurance contract or as financial instruments under IFRS. Information on operating lease commitments can be found in Note 52(b). It is standard business practice for our Group companies to give guarantees, indemnities and warranties in connection with disposals of subsidiaries and associates to third parties. As of 31 December 2012, we believe no material loss will arise in respect of these guarantees, indemnities and warranties. Principal warranties include the accuracy and completeness of the statement of financial position at an agreed specified date, details of outstanding litigation, regulatory matters, material contractual commitments, the position on tax filings and other customary matters together with any specific items identified during due diligence. In addition, specific clauses cover such items as regulatory approvals and licences, the basis of calculation regarding actuarial insurance liabilities, reinsurance contracts and the status of employee pension plans. Their exact terms are tailored to each disposal and are set out in the respective sale and purchase agreement. Similarly, the open warranty periods, within which the purchaser could claim, and limits on the maximum amount potentially recoverable will vary for each item covered in each disposal. There are a number of outstanding claims on recent disposals, none of which are material. There are also open claim periods on other recent disposals on which we have neither received, nor expect to receive, any such claims. We believe that there is no material exposure in this respect. We have loans receivable, secured by mortgages, which have then been securitised through non-recourse borrowings by special purpose entities in our UK Life business, as set out in Note 24. These special purpose entities have been consolidated and included in the statement of financial position, as we retain the residual interest in them.
Accounting for the PUTs and PLPs as subsidiaries, joint ventures or other financial investments depends on the shareholdings in the GPs and the terms of each partnership agreement. If a partnership is managed by a contractual agreement where the parties have joint control but no individual party exerts overall control, notwithstanding that the Group’s partnership share or economic interest in the PLP (including its indirect stake via the relevant PUT and GP) may be greater than 50%, such PUTs and PLPs have been classified as joint ventures. Of the PLPs accounted for as joint ventures at 31 December 2012, the Group’s economic interest exceeded 50% in respect of one partnership, The Mall Limited Partnership, in which the Group had a 50.52% economic interest. Note 18 provides a list of the principal PLPs accounted for as joint ventures, as well as summarised information on the income, expenses, assets and liabilities of the Group’s interests in its joint ventures in aggregate. In respect of these PLPs, there are no significant contingent liabilities to which we are exposed, nor do we have any significant contingent liabilities in relation to our interests in them. External debt raised by the PLPs is secured on their respective property portfolios, and the lenders are only entitled to obtain payment of both interest and principal to the extent there are sufficient resources in the respective PLPs. The lenders have no recourse whatsoever to the policyholder and shareholders’ funds of any companies in the Aviva Group. At 31 December 2012, we had £157 million capital commitments to these PLP joint ventures.
At 31 December 2012, total consolidated cash and cash equivalents net of bank overdrafts amounted to £23,248 million, an increase of £847 million over £22,401 million in 2011. Processes for monitoring and managing liquidity risk, including liquidity stress models, have been enhanced to take into account the extraordinary market conditions, including the impact on policyholder and counterparty behaviour, the ability to sell various investment assets and the ability to raise incremental funding from various sources. Management has taken steps to strengthen liquidity in light of its assessment of the impact of market conditions, such as issuing $650 million Fixed Rate Tier 1 notes in May 2012, and intends to continue to monitor liquidity closely.
We are subject to a number of regulatory capital tests and employ realistic scenario tests to allocate capital and manage risk. The impact of these regulatory capital tests on our ability to transfer capital around the Group through dividends and capital injections is discussed later in this section under the headings ‘Sources of liquidity’ and ‘Capital injections’. At 31 December 2012, the Group had £21.4 billion (31 December 2011: £20.8 billion) of total capital employed on an MCEV basis in our trading operations which is financed by a combination of equity shareholders’ funds, preference capital, direct capital instruments, subordinated debt and internal and external borrowings. In 2012, the total capital employed increased by £0.6 billion. The increase is primarily driven by the Group’s post tax profits, offset by actuarial losses on staff pension schemes and the payment of the dividend. In addition to external funding sources, we have a number of internal debt arrangements in place. These have allowed the assets supporting technical liabilities to be invested into the pool of central assets for use across the Group. They have also enabled us to deploy cash from some parts of the business to others in order to fund growth. Although intra-Group loans in nature, they are counted as part of the capital base for the purpose of capital management. All internal loans satisfy arm’s length criteria and all interest payments have been made when due.
Management of debt Aviva plc is the principal financing vehicle in our centralised funding strategy. Our senior debt obligations are supported by guarantees from our principal UK non-life trading subsidiaries. We also manage our external debt in line with rating agency limits applicable for entities with a rating in the AA range. We aim to maintain a balance of fixed and floating rate debt, and manage the maturity of our borrowings and our undrawn committed facilities to avoid bunching of maturities. We aim to maintain access to a range of funding sources, including the banking market, the commercial paper market and the long-term debt capital markets. We issue debt in a variety of currencies, predominantly sterling, euros and US dollars, based on investor demand at the time of issuance and management of the Group’s foreign exchange translation exposures in the statement of financial position. In May 2012, we issued $650 million of Fixed Rate Tier 1 notes callable in 2017. In June 2012, we repaid a $300 million subordinated debt instrument at its first call date.
At 31 December 2012, our total external borrowings, including subordinated debt and securitised mortgage loans, amounted to £8.3 billion (2011: £8.5 billion). Of the total borrowings, £5.1 billion (2011: £5.3 billion) are considered to be core borrowings and are included within the Group’s capital employed. The balance of £3.2 billion (2011: £3.2 billion) represents operational debt issued by operating subsidiaries. We also have substantial committed credit facilities available for our use. At 31 December 2012, we had undrawn committed credit facilities expiring within one year of £0.4 billion (2011: £1.0 billion) and £1.7 billion in credit facilities expiring after more than one year (2011: £1.1 billion). Of these facilities, £750 million was allocated in 2012 (2011: £750 million) to support our commercial paper programme. Further information on the maturity profile, currency and interest rate structure of our borrowings is presented in ‘Financial statements IFRS – Note 48 – Borrowings’. Commercial paper is issued for terms up to 12 months and is generally reissued at maturity. The earliest repayment date for other debt instruments is a €650 million subordinated debt instrument with a first call date of 2 October 2013 at the option of the company. At this time Aviva will have the option of repaying the debt or accepting a step-up in the coupon and deferring repayment until future coupon dates or 2023 at the latest. The table below presents our debt position for the periods indicated: £m £m
Operating borrowings Operational borrowings at amortised cost 1,868 1,889 Operational borrowings at fair value 1,332 1,306
Undrawn borrowings At 31 December 2012, we had £2.1 billion (2011: £2.1 billion) undrawn committed central borrowing facilities available to us, provided by a range of leading international banks, all of which have investment grade credit ratings. We have allocated £750 million to support the credit rating of Aviva’s commercial paper programme. Undrawn borrowings are analysed below: £m £m
Our committed central borrowing facilities have two financial covenants:  Borrowings (excluding non-recourse indebtedness) may not exceed total shareholders’ funds. At 31 December 2012, borrowings were 62% of total shareholders funds.
Year ended 31 December 2012 Net cash from operating activities Total net cash from operating activities increased by £2,636 million to a £2,294 million inflow in 2012 (2011: £342 million outflow). The increase is primarily due to an increase in flows from the net purchase/sale of operating assets.
Net cash from investing activities Net cash from investing activities decreased by £93 million to £15 million outflow (2011: £78 million inflow). The decrease is mainly a result of a decrease in cash inflows from disposal of subsidiaries, joint ventures and associates, partly offset by lower cash used in discontinued operations.
Net cash out flow on financing activities Net cash used in financing activities was £420 million higher at £1,773 million (2010: £1,353 million). The increase is due to a higher repayment of borrowings during the year.
Net cash and cash equivalents At 31 December 2011, total consolidated net cash and cash equivalents amounted to £22,401 million, an decrease of £2,294 million over £24,695 million in 2010.
Regulatory capital position Individual regulated subsidiaries measure and report solvency based on applicable local regulations, including in the UK the regulations established by the FSA. These measures are also consolidated under the European Insurance Groups Directive (IGD) to calculate regulatory capital adequacy at an aggregate group level, where we have a regulatory obligation to have a positive position at all times. This measure represents the excess of the aggregate value of regulatory capital employed in our business over the aggregate minimum solvency requirements imposed by local regulators, excluding the surplus held in the UK and Ireland with-profit life funds. The minimum solvency requirement for our European businesses is based on the Solvency 1 Directive. In broad terms, for EU operations, this is set at 4% and 1% of non-linked and unit-linked life reserves respectively and for our general insurance portfolio of business is the higher of 18% of gross premiums or 26% of gross claims, in both cases adjusted to reflect the level of reinsurance recoveries. For our major non-European businesses (the US and Canada) a risk charge on assets and liabilities approach is used.
(2011: £258 million, 2010: £45 million) and to other investment vehicles of £nil (2011: £nil, 2010: £nil). These commitments are expected to be funded through operational cash flow without recourse to core structural borrowings.
Overview of regulation as it affects our business Our principal insurance and fund management operations are in the UK, Europe, North America and the Asia Pacific region. We are therefore subject to financial services regulation and local regulatory supervision in all these areas, as individually covered below. As the Group’s parent company is based in the UK, both EU legislation and the rules of the FSA can impact Aviva’s business practices worldwide. Regulators supervising the Group co-ordinate on a cross-border basis through a ‘college’.
 The introduction of new solo supervision requirements, including rules as to internal control within the insurance undertaking regarding the production of information relevant to supplementary supervision, the exchange of information within the group and the supervision of intragroup transactions.
 for certain products and services, giving a cooling-off period in which a consumer may cancel a contract without penalty.
 impose requirements on insurance intermediaries to provide specified minimum information to potential customers.
Solvency II The agreed Solvency II Level 1 Directive was published in November 2009. Solvency II represents a fundamental change in European regulation and will result in a more sophisticated economic risk-based capital approach. Its objectives are to establish a solvency system that is better aligned to the true risks of insurers, and aims to enable supervisors to protect policyholder
Shareholder information continued interests as effectively as possible in accordance with common principles across the EU. Since approval, the focus has been on developing the technical standards and requirements necessary to determine how the directive will be applied in practice, and expected amendments to the Solvency II Directive (Omnibus II Directive) following the creation of the new European Supervisory Authorities (ESAs) in September 2010. It is still not clear when these developments, including the implementation requirements will become legislation. The European Insurance and Occupational Pensions Authority (EIOPA), replaced CEIOPS on 1 January 2011. A proposed amending directive was published in January 2011 (‘Omnibus II Directive’) to update Solvency II. Omnibus II set out powers for EIOPA to issue binding guidance/standards, changes to specific aspects of Solvency II and delays to the implementation of Solvency II. The details of Omnibus II are still being negotiated and it is not clear when Omnibus II will become legislation. Solvency II is currently set to apply to insurers from 1 January 2014. This date is expected to be changed in 2013. EIOPA proposes to issue guidelines for supervisors in 2013 as interim measures to address the uncertainty caused by the ongoing delays to Solvency II and encourage harmonisation of supervisory approach across jurisdictions while Solvency I remains in force. These guidelines are expected to cover systems of governance, ORSA, internal model application procedures and reporting to supervisors. The FSA has proposed changes to its ICAS regime following the continuing delay. These changes will allow companies to use the work done in preparation for Solvency II for ICA. This highlights the need for continued and engaged industry participation. Aviva continues to actively participate, through the key European industry working groups, who provide the voice of the industry, in ongoing discussions in Brussels.
Future EU developments During 2013 the European Commission will be undertaking a review of the European System of Financial Supervision (ESFS). The ESFS includes the three sector specific European Supervisory Authorities (ESAs) that have powers to make binding rules and drive supervisory consistency and convergence through a single rule book. There are a number of European dossiers that are expected to progress during 2013, including Packaged Retail Investment Products (PRIPs) that will introduce common product disclosure standards and sales conduct rules, the review of the Insurance Mediation Directive (IMD) and the MiFID, the European Market Infrastructure Regulation (EMIR) that will introduce central clearing for standard Over the Counter (OTC) derivatives, the Directive for Institutions of Occupational Retirement Provisions (IORP) that sets rules for occupational pension schemes, and the Alternative Investment Fund Managers Directive (AIFMD) that will introduce a regime governing the marketing of alternative investments to EU investors.
United Kingdom The Financial Services Authority In the UK, the FSA is currently the single regulator for those individuals and firms conducting defined regulated activities in the financial services sector. The FSA has the authority to make rules and issue guidance, taking into account relevant EU directives, in relation to a wide sphere of activity encompassing the governance of the conduct of business by, and the prudential supervision of, individuals and firms authorised by the FSA to conduct such business (‘Authorised Persons’ or ‘Authorised Firms’). Under the Financial Services and Markets Act 2000 (FSMA) no person may carry on, or purport to carry on, a regulated activity by way of business in the UK unless he is an Authorised Person or an exempt person. A firm granted permission by the FSA to carry on regulated activities becomes an Authorised Person for the purposes of FSMA. ‘Regulated activities’ are prescribed in the FSMA (Regulated Activities) Order 2001 and include banking, insurance and investment business, stakeholder pension schemes, insurance mediation and certain mortgage mediation and lending activities. Authorised Firms must at all times meet specified threshold conditions, including possession of adequate resources for the carrying on of their business, and being fit and proper to conduct that business, having regard to all the circumstances. Authorised Firms must also operate in accordance with the FSA’s Principles for Business. These are 11 high level principles for conducting financial services business in the UK, including maintenance of adequate systems and controls, treating customers fairly, and communicating with customers in a manner that is clear, fair and not misleading. The FSA regime is based on the principle that firms should have effective systems and controls, including robust risk management, which are appropriate to the size, complexity and diversity of their business. It should be noted that during 2013 the FSA will be replaced by two separate regulatory bodies, the Prudential Regulation Authority (PRA) and the Financial Conduct Authority (FCA).
The FSA’s regulation of the Group A number of the Group’s UK subsidiaries are directly authorised and regulated by the FSA, including our insurance companies (e.g. the UK Life and UK General Insurance companies), asset managers (Aviva Investors) and intermediaries (UK Healthcare). Aviva plc, although not directly authorised by the FSA, does itself come within the scope of some regulation as the ultimate insurance holding company in the Group. As Aviva is a UK-based group, the FSA has the responsibility of acting as lead regulator (i.e. the cross-sector supervisory co-ordinator) for the Group within the EU.
Approved persons and controllers The FSA places great emphasis on the principle of senior management responsibility. The directors of, and senior managers carrying out FSA defined controlled function roles in, any of the Group’s regulated entities are individually registered with the FSA under the ‘Approved Person’ regime, and can be held directly accountable to the FSA for control failings in those entities. A number of senior managers at Group level have also been registered as Approved Persons for the regulated subsidiaries, even though they are neither directors nor senior managers of these firms. This recognises that these managers exert significant influence over the regulated subsidiaries, because they are responsible for key parts of the Group’s control framework on which the regulated subsidiaries place reliance. The FSA regulates from a legal entity perspective, even though Aviva tends to operate by business unit. However, the FSA also expects that Aviva’s regulated subsidiaries operate within an overall framework of Group governance and controls. Its rules expressly provide that any systems and controls which operate on a Group basis will be taken into account in determining the adequacy of a regulated subsidiary’s systems and controls. The robustness of these Group controls is therefore subject to scrutiny and challenge by the FSA. The FSA regulates the acquisition and increase of control over Authorised Firms. Under FSMA, any person proposing to acquire control of, or increase control over certain thresholds of, an Authorised Firm must first obtain the consent of the FSA. The Authorised Firm must also inform the FSA of any such proposed acquisition or increase. In considering whether to grant or withhold its approval of the acquisition or increase of control, the FSA must be satisfied both that the acquirer is a fit and proper person and that the interests of consumers would not be threatened by this acquisition or increase of control. Control over a UK Authorised Firm is acquired if the acquirer:
 holds 10% (or 20% if the Authorised Firm is an insurance intermediary) or more of the shares, or voting power, in that firm, or a parent undertaking of the firm; or
 is able to exercise significant influence over the management of the firm by virtue of the acquirer’s shares or voting power in that company or a parent undertaking of the firm.
Increases in control require the consent of the FSA when they reach thresholds of 20%, 30% and 50% of the shares or voting power of the firm (or its parent). In order to determine whether a person or a group of persons is a ‘controller’ for the purposes of FSMA, the holdings (shares or voting rights) of the person and any other person ‘acting in concert’, if any, are aggregated.
All insurers must also carry out an Individual Capital Assessment (ICA) to calculate the amount of capital needed to back their business. If the FSA decides that the final ICA amount is insufficient, it may draw up its own Individual Capital Guidance (ICG) for the firm, which can be imposed as a requirement on the scope of the Authorised Firm’s permission.
Day-to-day supervision The FSA takes a risk-based approach to its regulatory activity, concentrating its resources on those firms and activities which it assesses pose the greatest potential threats to its four statutory objectives of:  maintaining confidence in the UK financial system;  contributing to the protection and enhancement of stability of the UK financial system;  securing the appropriate degree of protection forconsumers; and  reducing the extent to which it is possible for a regulated business to be used for a purpose connected with financial crime.
Restrictions on business FSA rules restrict an insurance company from carrying on any commercial business other than insurance business and activities directly arising from that business. Therefore, the FSA authorised insurance companies in the Group are bound by this restriction.
 following the sixth annual investigation after 1 October 2009 or later investigation and provided that investigation and investigations made in the previous 2 years determined that the Reattributed Inherited Estate exceeded the Permitted Release Threshold.
Reporting requirements FSA rules require insurance companies to file their audited annual accounts, statements of financial position and life insurers’ annual reports from the actuary performing the actuarial function with the regulator. There is also a requirement to report the annual solvency position of the insurance company’s ultimate parent. The FSA uses the annual return to monitor the solvency (i.e. the ability to meet current and future obligations such as claims payments to policyholders) of the insurance company. For general insurance business, the return is also used to assess retrospectively the adequacy of the company’s claims provisions. The directors of an insurance company are required to sign a certificate, which includes a statement as to whether the company has maintained the required minimum margin of solvency throughout the year. The directors must also certify that the company has completed its return to the FSA properly in accordance with the FSA’s instructions, and that the directors are satisfied that the company has complied in all material respects with the requirements set out in the FSA rules.
Canada We write property and casualty business in Canada via a number of wholly owned companies. Insurance business in Canada is regulated federally by the Office of the Superintendent of Financial Institutions (OSFI) for prudential supervision (i.e. capital adequacy, solvency, etc). OSFI derives its powers from the federal Insurance Companies Act (Canada) which governs the structure and operation of federally incorporated insurance companies. The capital adequacy of insurance companies is monitored under the Minimum Capital Test (‘MCT’), a risk-based framework allowing for capital to be assessed on the basis of an individual company’s risk profile taking account of the investments held and insurance business being written. Companies have their own internal MCT target that is communicated to OSFI, which is set to ensure that they maintain capital in excess of 150% of the OSFI minimum requirement. There are also ten individual provincial regulators each regulating predominantly conduct of business issues such as policy terms and conditions, and rates and underwriting of companies they have licensed to write business in the province.
Market risks relating to Aviva’s business Changes in interest rates may cause policyholders to surrender their contracts, reduce the value of our investment portfolio and impact our asset and liability matching, which could adversely affect our results of operation and financial condition. Our exposure to interest rate risk relates primarily to the market price and cash flow variability of assets and liabilities associated with changes in interest rates. Some of our products, principally traditional participating products, universal life insurance and annuities, including fixed and equity indexed annuities, expose us to the risk that changes in interest rates will reduce our ‘spread’, or the difference between the amounts that we are required to pay under the contracts and the rate of return we are able to earn on investments intended to support obligations under the contracts. Our spread is a key component of our net income. As interest rates decrease or remain at low levels, we may be forced to reinvest proceeds from investments that have matured or have been prepaid or sold at lower yields, reducing our investment return. Moreover, borrowers may prepay or redeem the fixed-income securities, commercial mortgages and mortgage-backed securities in our investment portfolio with greater frequency in order to borrow at lower market rates, which increases this risk. Lowering interest crediting or policyholder bonus rates can help offset decreases in investment margins on some products. However, our ability to lower these rates could be limited by competition or contractually guaranteed minimum rates and may not match the timing or magnitude of changes in asset yields. As a result, our spread could decrease or potentially become negative. Our expectation for future spreads is an important component in the amortisation of policy acquisition costs and significantly lower spreads may cause us to accelerate amortisation, thereby reducing net income in the affected reporting period. In addition, during periods of declining interest rates, the guarantees within existing life insurance and annuity products may be more attractive to consumers, resulting in increased premium payments on products with flexible premium features, and a higher percentage of insurance policies remaining in force from year to year, during a period when our new investments carry lower returns. Accordingly, during periods of declining interest rates, our profitability may suffer as the result of a decrease in the spread between interest rates credited to policyholders and returns on our investment portfolio. Increases in market interest rates could also negatively affect our profitability. Surrenders of life insurance policies and fixed annuity contracts may increase as policyholders seek higher returns and higher guaranteed minimum returns. Obtaining cash to satisfy these surrenders may require us to liquidate fixed maturity investments at a time when market prices for those assets are depressed which may result in realised investment losses. Regardless of whether we realise an investment loss, these cash payments would result in a decrease in total invested assets, and may decrease our net income. Premature withdrawals may also cause us to accelerate amortisation of policy acquisition costs, which would also reduce our net income. Our mitigation efforts with respect to interest rate risk are primarily focused on maintaining an investment portfolio with diversified maturities that has a weighted average duration approximately equal to the duration of our estimated liability cash flow profile. However, it may not be possible to hold assets that will provide cash flows to exactly match those relating to policyholder liabilities, in particular in jurisdictions with less developed bond markets and in certain markets where regulated surrender value or maturity values are set with reference to the interest rate environment prevailing at the time of policy issue. This is due to the duration and uncertainty of the liability cash flows and the lack of sufficient assets of suitable duration. This results in a residual asset/liability mismatch risk that can be managed but not eliminated. In addition, our estimate of the liability cash flow profile may be inaccurate for other reasons, such as varying mortality or general insurance claims, and we may be forced to liquidate investments prior to maturity at a loss in order to cover the liability. Such a loss could have a material adverse affect on our results of operations and financial condition. See ‘Financial statements IFRS – Note 56 – Risk management’.
In our US business in particular, market downturns and volatility may discourage purchases of accumulation products, such as equity-indexed annuities and equity-indexed life insurance, that have returns linked to the performance of the equity markets and may cause some of our existing customers to withdraw cash values or reduce investments in those products. A sustained weakness in the markets will decrease revenues and earnings in these types of products. For property investment, we are subject to counterparty, valuation and liquidity risks. These investments may be adversely affected by weakness in property markets and increased mortgage delinquencies. We are also subject to property risk indirectly in our investments in residential mortgage-backed securities (RMBS) and commercial mortgage-backed securities (CMBS). There is the risk that the underlying collateral may fall in value causing the investment in securities to fall in value. The markets for these property investments and instruments can become illiquid, and issues relating to counterparty credit ratings and other factors may increase pricing and valuation uncertainties.
Market fluctuations may cause the value of options and guarantees embedded in some of our life insurance products to exceed the value of the assets backing their reserves, which could adversely affect our results of operations or financial condition.
As a normal part of their operating activities, various Group companies have given guarantees and options, including interest rate and investment return guarantees, in respect of certain longterm insurance and fund management products. In providing these guarantees and options, our capital position is sensitive to fluctuations in financial variables, including foreign currency exchange rates, interest rates, property values and equity prices. Interest rate guaranteed returns, such as those available on guaranteed annuity options (GAOs), are sensitive to interest rates falling below the guaranteed level. Other guarantees, such as maturity value guarantees and guarantees in relation to minimum rates of return, are sensitive to fluctuations in the investment return below the level assumed when the guarantee was made. Periods of significant and sustained downturns in equity markets, increased equity or interest rate volatility or reduced interest rates could result in an increase in the valuation of the future policy benefit or policyholder account balance liabilities associated with such products, resulting in a reduction to net income. We use reinsurance in combination with derivative instruments to mitigate some of the liability exposure and the volatility of net income associated with these liabilities, and while we believe that these and other actions mitigate the risks related to these benefits, we remain liable for the guaranteed benefits in the event that reinsurers or derivative counterparties are unable or unwilling to pay, although this may be partially mitigated by the posting of collateral by our counterparties. We are also subject to the risk that the cost of hedging these guaranteed minimum benefits increases, resulting in a reduction to net income. In addition, we are subject to the risk that unanticipated policyholder behaviour or mortality, combined with adverse market events, produces economic losses beyond the scope of the risk management techniques employed. These, individually or collectively, may have a material adverse effect on our results of operations, financial condition or liquidity.
The determination of the amount of allowances and impairments taken on our investments is highly subjective. If our business does not perform well, we may be required to recognise an impairment of our goodwill or intangibles with indefinite and finite useful lives, which could adversely affect our results of operations or financial condition. The determination of the amount of allowances and impairments vary by investment type and is based upon our periodic evaluation and assessment of known risks associated with the respective asset class. Such evaluations and assessments are revised as conditions change and new information becomes available and additional impairments may need to be taken or allowances provided for in the future. If the carrying value of an investment is greater than the recoverable amount, the carrying value is reduced through a charge to the income statement in the period of impairment. There can be no assurance that management has
Shareholder information continued accurately assessed the level of impairments taken and allowances reflected in our financial statements. Goodwill represents the excess of the amounts we paid to acquire subsidiaries and other businesses over the fair value of their net assets at the date of acquisition. We test goodwill and intangible assets with indefinite useful lives at least annually for impairment or when circumstances or events indicate there may be uncertainty over this value. We test intangibles with finite lives when circumstances or events indicate there may be uncertainty over this value. For impairment testing, goodwill and intangibles have been allocated to cash-generating units by geographical reporting unit and business segment. The fair value of the reporting unit is impacted by the performance of the business. Goodwill, negative unallocated divisible surplus and indefinite life intangibles are written down for impairment where the recoverable amount is insufficient to support its carrying value. Such write downs could have a material adverse effect on our results of operations or financial condition.
The use of inaccurate assumptions in pricing and reserving for insurance business may have an adverse effect on our business profitability. The Group’s life insurance companies are required to make a number of assumptions in relation to the business written, including the mortality and morbidity rates of our customers, the development of interest rates, lapse rates (the rates at which customers terminate existing policies prior to their maturity dates) and future levels of expenses. These assumptions may turn out to be incorrect. When establishing their liabilities, our life insurance companies allow for changes in the assumptions made, monitor their experience against the actuarial assumptions used and assess the information gathered to refine their long-term assumptions, together with taking actual claims experience into account. However, it is not possible to determine precisely the total amounts that will ultimately be paid under the policies written by the business as amounts may vary from estimates. Changes in assumptions may also lead to changes in the level of capital required to be maintained, meaning that we may need to increase the amount of our reserves. This could have a material adverse impact on the Group’s value, the results of our operations and financial condition. Additionally, our management of the general insurance business requires the general insurance companies to make a number of assumptions in relation to the business written. These assumptions include the costs of writing the business and settling claims, and the frequency and severity of claims. The assumptions may turn out to be incorrect, thereby adversely impacting our profit. Additionally, man-made disasters, including accidents and intentional events, are particularly difficult to predict with a high
Shareholder information continued degree of accuracy. These would also have an adverse impact on our profit due to higher than expected claims. Furthermore, outstanding claims provisions for the general insurance business are based on the best-estimate of the cost of future claim payments, plus an explicit allowance for risk and uncertainty. together with related claims handling costs. Any provisions for re-opened claims are also included. A range of methods, including stochastic projections, may be used to determine these provisions. Underlying these methods are a number of explicit or implicit assumptions relating to the expected settlement amount and settlement pattern of claims. If the assumptions underlying the reserving basis were to prove incorrect, we might have to increase the amount of the general insurance provisions, which would adversely impact our financial condition or results of operations.
If our business does not perform well or if actual experience versus estimates used in valuing and amortising Deferred Acquisition Costs (DAC) and Acquired value of in-force business (AVIF) vary significantly, we may be required to accelerate the amortisation and/or impair the DAC and AVIF which could adversely affect our results of operations or financial condition. We incur significant costs in connection with acquiring new and renewal business. Those costs that vary with and are driven by the production of new and renewal business are deferred and referred to as DAC. The recovery of DAC is dependent upon the future profitability of the related business. The amount of future profit or margin is dependent principally on investment returns in excess of the amounts credited to policyholders, mortality, morbidity, persistency and expenses to administer the business. Of these factors, investment margins and general insurance underwriting profit are most likely to impact the rate of amortisation of such costs. The aforementioned factors enter into management’s estimates of gross profits or margins, which generally are used to amortise such costs. If the estimates of gross profits or margins were overstated, then the amortisation of such costs would be accelerated in the period the actual amount is known and would result in a charge to income. Significant or sustained equity market declines could result in an acceleration of amortisation of the DAC related to unit-linked business, resulting in a charge to income. Such adjustments could have a material adverse effect on our results of operations or financial condition. AVIF reflects the estimated present value of future profits that will emerge over the remaining life of certain in-force contracts in a life insurance company, acquired either directly or through the purchase of a subsidiary, and represents the portion of the purchase price that is allocated to the value of the right to receive future cash flows from the insurance and investment contracts in-force at the acquisition date. AVIF is based on actuarially determined projections. Actual experience may vary from the projections. Revisions to estimates result in changes to the amounts expensed in the reporting period in which the revisions are made and could result in impairment and a charge to income. Where AVIF is amortised, an acceleration of the amortisation of AVIF would occur if the estimates of gross profits or margins were overstated in the period in which the actual experience is known and would result in a charge to net income. Such adjustments could have an adverse effect on our results of operations or financial condition.
Shareholder information continued have taken steps to upgrade systems and processes to reduce these operational risks, we cannot anticipate the details or timing of all possible operational and systems failures which may adversely impact our business.
We operate in several markets through arrangements with third parties. These arrangements involve certain risks that we do not face with our subsidiaries. Our ability to exercise management control over our partnership operations, our joint ventures and our investment in them depends on the terms of the legal agreements. In particular, the relationships depend on the allocation of control among, and continued co-operation between, the participants. We may also face financial or other exposure in the event that any of our partners fail to meet their obligations under the agreement or encounter financial difficulty. For example, a significant proportion of our product distribution, such as bancassurance, is carried out through arrangements with third parties not controlled by us and is dependent upon the continuation of these relationships. A temporary or permanent disruption to these distribution arrangements could affect our financial condition. Some of these arrangements require our third-party partners to participate in and provide capital to our joint venture, associate and subsidiary undertakings. Our partners may change their strategic priorities or encounter financial difficulties preventing them from providing the necessary capital to promote future growth. In addition, we outsource certain customer service, technology and legacy policy administration functions to third parties and may do so increasingly in the future. If we do not effectively develop and implement our outsourcing strategy, thirdparty providers do not perform as anticipated or we experience technological or other problems with a transition to or between such providers, we may not realise the full extent of productivity improvements or cost efficiencies and may experience operational difficulties, increased costs and a loss of business.
The failure to attract or retain the necessary personnel could have a material adverse effect on our results and/or financial condition. As a global financial services organisation, we rely to an extent on the quality of local management in the countries in which we operate. The success of our operations is dependent, among other things, on our ability to attract and retain highly qualified professional employees. Competition for such key employees is intense. Our ability to attract and retain key employees is dependent on a number of factors, including prevailing market conditions and compensation packages offered by companies competing for the same talent.
There are inherent funding risks associated with our participation in defined benefit staff pension schemes. We operate both defined benefit and defined contribution staff pension schemes. The defined benefit section of the UK staff pension scheme was closed to new members from 1 April 2011, with entry into the defined contribution sections being offered to the staff members affected. Closure of the defined benefit scheme has removed the volatility associated with adding future accrual for active members. There are inherent funding risks associated with the defined benefit schemes. Events could result in a material reduction in the funding position of such schemes and, in some cases, may result in a deficit between the pension scheme’s assets and liabilities. The factors that affect the scheme’s position include: poor investment performance of pension fund investments; greater life expectancy than assumed; adverse changes in interest rates or inflation; and other events occurring that increase the costs of past service benefits over the amounts predicted in the actuarial assumptions. In the short term, the funding position is inherently volatile due to movements in the market value of assets. Where a funding deficit or surplus arises, the position will be discussed with the scheme trustees to agree appropriate actions. This may include a plan to fund the deficit over a period of years. Any surplus or deficit in the defined benefit pension scheme will affect our shareholders’ equity, although the IFRS position may diverge from the scheme funding position. The UK pension schemes are subject to statutory requirements with regards to funding and other matters relating to the administration of the schemes. Compliance with these requirements is subject to regular review. A determination that we have failed to comply with applicable regulations could have a negative impact on our results of operations or our relationship with current and potential contributors and employees and adverse publicity.
Our process for valuing investments may include methodologies, estimations and assumptions which require judgement and could result in changes to investment valuations. We value our available for sale (AFS) and fair value ( FV) securities using designated methodologies, estimation and assumptions. These securities, which are reported at fair value on the consolidated statement of financial position, represent the majority of invested assets. We have categorised the measurement basis for assets carried at fair value into a ‘fair value hierarchy’ in accordance with the valuation inputs and consistent with IFRS 7 Financial Instruments: Disclosures. The fair value hierarchy gives the highest priority to quoted prices in active markets for identical assets or liabilities (Level 1); the middle priority to fair values other than quoted prices based on observable market information (Level 2); and the lowest priority to unobservable inputs that reflect the assumptions that we consider market participants would normally use (Level 3). The majority of our financial assets are valued based on quoted market information (Level 1) or observable market data (Level 2). The majority of investment property and commercial mortgages are classified as Level 2. At 31 December 2012, 5.1% of total financial investments, loans and investment properties at fair value were classified as Level 3, amounting to £13,434 million (5.8% and £12,918 million excluding assets held for sale). Where estimates were used for inputs to Level 3 fair values, these were based on a combination of independent third-party evidence and internally developed models, intended to be calibrated to market observable data where possible. An asset or liability’s classification within the fair value hierarchy is based on the lowest level of significant input to its valuation. See ‘IFRS critical accounting policies – Investments’. Any change to investment valuations may affect our results of operations and reported financial condition.
Systems errors or regulatory changes may affect the calculation of unit prices or deduction of charges for our unitlinked products which may require us to compensate customers retrospectively. A significant proportion of our product sales are unit-linked contracts, where product benefits are linked to the prices of underlying unit funds. While comprehensive controls are in place, there is a risk of error in the calculation of the prices of these funds due to human error in data entry, IT-related issues or other causes. Additionally, it is possible that policy charges which are deducted from these contracts are taken incorrectly, or the methodology is subsequently challenged by policyholders or regulators and changed retrospectively. Any of these can give rise to compensation payments to customers. Controls are in place to mitigate these risks, but errors could give rise to future liabilities. Payments due to errors or compensation may negatively impact our profits.
Brand and reputation risks relating to Aviva’s business We are rated by several rating agencies, and a decline in any of these ratings could affect our standing among customers, broker-dealers, agents, wholesalers and other distributors of our products and services and cause our sales and earnings to decrease. A rating downgrade, or the perceived potential for such a downgrade, of Aviva plc or any of our rated insurance subsidiaries may, among other things, materially increase the number of policy surrenders and withdrawals by policyholders of cash values from their policies. The outcome of such activities may be cash payments requiring the sale of invested assets, including illiquid assets, at a price that may result in realised investment losses. These cash payments to policyholders would result in a decrease in total invested assets and a decrease in net income. Among other things, early withdrawals may also cause us to accelerate amortisation of policy acquisition costs, which would reduce net income. A rating downgrade may also impact sales volumes, particularly in the US where there is more focus on ratings when evaluating similar products. The ratings provided by A.M. Best are widely considered to be the most important for distribution in the US, and although we have agreed to sell such operations, a downgrade could lead to a significant loss of sales. Similarly, a rating downgrade may increase our cost of borrowing or limit our access to some forms of financing.
Our businesses are conducted in highly competitive environments. There are many factors which affect our ability to sell our products, including fiscal incentives, price and yields offered, financial strength and ratings, range of product lines and product quality, brand strength and name recognition, investment management performance and historical bonus levels. In some of our markets, the Group faces competitors that are larger, have greater financial resources or greater market share, offer a broader range of products, benefit from more advantageous tax treatments, or have higher bonus rates or claims-paying ratios. Further, heightened competition for talented and skilled employees with local experience, particularly in the emerging, high-growth markets, may limit our potential to grow our business as quickly as planned. Our principal competitors in the life market include many of the major financial services businesses including, in particular, Axa, Allianz, Generali, Prudential and Standard Life. Our principal competitors in the general insurance market include Royal Bank of Scotland Insurance, RSA, Zurich, Axa and Allianz. We also face competitors who specialise in many of the niche markets in which we operate. We believe that competition will intensify across all businesses in response to consumer demand, technological advances, the impact of consolidation, regulatory actions and other factors. Our ability to generate an appropriate return depends significantly upon our capacity to anticipate and respond appropriately to these competitive pressures.
Our regulated business is subject to extensive regulatory supervision both in the UK and internationally. We are subject to extensive laws and regulations that are administered and enforced by a number of different governmental authorities and non-governmental self-regulatory agencies, including the FSA and other regulators. In light of wider financial and economic conditions, some of these authorities are considering, or may in the future consider, enhanced or new regulatory requirements intended to prevent future crises or otherwise assure the stability of institutions under their supervision. These authorities may also seek to exercise their supervisory or enforcement authority in new or more robust ways. All of these possibilities, if they occurred, could affect the way we conduct our business and manage our capital, and may require us to satisfy increased capital requirements.
Risks related to ownership of the ADSs and ordinary shares The trading price of our ADRs and dividends paid on our ADSs may be materially adversely affected by fluctuations in the exchange rate for converting sterling into US dollars. An ADS is a negotiable US security representing ownership in one share. An ADR is denominated in US dollars and represents ownership of any number of ADSs. ADRs are publicly traded shares in a non-US corporation, quoted and traded in US dollars in the US securities market. Any dividends are paid to investors in US dollars. ADRs are specifically designed to facilitate the purchase, holding and sale of non-US securities by US investors. The term ADR is often used to mean both the certificates and the securities themselves. Fluctuations in the exchange rate for converting pound sterling into US dollars may affect the value of our ADRs. Specifically, as the relative value of the pound sterling against the US dollar declines, each of the following values will also decline:  the US dollar equivalent of the pound sterling trading price of our ordinary shares on the London Stock Exchange which may consequently cause the trading price of our ADRs in the US to also decline;  the US dollar equivalent of the proceeds that a holder of our ADSs would receive upon the sale in the UK of any our ordinary shares withdrawn from the depositary; and
 conjecture about the Group’s business in the press, media or investment communities.
Shareholder rights under English law differ from the US. Individual shareholders of an English company (including US persons) have the right under English law to bring lawsuits on behalf of the company in which they are a shareholder, and on their own behalf against the company, in certain limited circumstances. English law does not permit class action lawsuits by shareholders, except in limited circumstances.
In this section Independent auditors’ report 146 Accounting policies 148 Consolidated financial statements 160 Consolidated income statement 160 Consolidated statement of comprehensive income 161 Reconciliation of Group operating profit to (loss)/profit for the year 162 Consolidated statement of changes in equity 164 Consolidated statement of financial position 166 Consolidated statement of cash flows 167
Opinion on financial statements In our opinion:  The financial statements give a true and fair view of the state of the Group’s and of the Parent Company’s affairs as at 31 December 2012 and of the Group’s loss and Group’s and Parent Company’s cash flows for the year then ended;  The Group financial statements have been properly prepared in accordance with IFRSs as adopted by the European Union;  The Parent Company financial statements have been properly prepared in accordance with IFRSs as adopted by the European
Union and as applied in accordance with the provisions of the Companies Act 2006; and  The financial statements have been prepared in accordance with the requirements of the Companies Act 2006 and, as regards the Group financial statements, Article 4 of the lAS Regulation.
Matters on which we are required to report by exception We have nothing to report in respect of the following: Under the Companies Act 2006 we are required to report to you if, in our opinion:  adequate accounting records have not been kept by the Parent Company, or returns adequate for our audit have not been received from branches not visited by us; or  the Parent Company financial statements and the part of the Directors’ remuneration report to be audited are not in agreement with the accounting records and returns; or  certain disclosures of directors’ remuneration specified by law are not made; or  we have not received all the information and explanations we require for our audit.
Under the Listing Rules we are required to review:  the directors’ statement, set out on page 87, in relation to going concern;  the parts of the Corporate Governance Statement relating to the Company’s compliance with the nine provisions of the UK
Corporate Governance Code specified for our review; and  certain elements of the report to shareholders by the Board on directors’ remuneration.
Aviva plc (the ‘Company’), a public limited company incorporated and domiciled in the United Kingdom (UK), together with its subsidiaries (collectively, the ‘Group’ or ‘Aviva’) transacts life assurance and long-term savings business, fund management and most classes of general insurance and health business through its subsidiaries, associates and branches in the UK, Ireland, continental Europe, United States (US), Canada, Asia and other countries throughout the world. Following the announcement in April 2012 relating to the restructuring of the Group, the Group’s operating segments were changed to align them with the new organisational reporting structure. The Group has determined its operating segments along market reporting lines, reflecting the management structure whereby a member of the Executive Management team is accountable to the group chief executive for the operating segment for which he is responsible. Further details of the reportable segments are given in note 4. The principal accounting policies adopted in the preparation of these financial statements are set out below. These policies have been consistently applied to all years presented, unless otherwise stated.
(vii) IAS 28, Investment in Associates and Joint Ventures (2011) IAS 28 has been revised to include joint ventures as well as associates. Joint ventures are required to be equity accounted following the issue of IFRS 11. There are no implications for the Group financial statements. The standard has been endorsed by the EU.
(viii) IFRS 13, Fair Value Measurement IFRS 13 replaces the guidance on fair value measurement in existing IFRSs with a single standard. The standard does not include requirements regarding which items should be measured at fair value but provides guidance on how to determine fair value. The standard also includes enhanced disclosures about fair value measurement. The adoption of IFRS 13 is not expected to have a significant impact on the financial statements. The standard has been endorsed by the EU
Effective for annual periods beginning on or after 1 January 2015 IFRS 9, Financial Instruments IFRS 9 will replace IAS 39, Financial Instruments –
(C) Critical accounting policies and the use of estimates The preparation of financial statements requires the Group to select accounting policies and make estimates and assumptions that affect items reported in the consolidated income statement,
Accounting policies continued consolidated statement of financial position, other primary statements and notes to the consolidated financial statements.
Critical accounting policies and the use of estimates These major areas of judgement on policy application are summarised below: Item Critical accounting judgement estimate or assumption
Insurance and participating investment contract liabilities F&K Goodwill, AVIF and intangible assets N Fair values of financial investments S Impairment of financial investments S Fair value of derivative financial instruments T Deferred acquisition costs and other assets W Provisions and contingent liabilities Z Pension obligations AA Deferred income taxes AB Operations held for sale AG
(D) Consolidation principles Subsidiaries Subsidiaries are those entities (including special purpose entities) in which the Group, directly or indirectly, has power to exercise control over financial and operating policies in order to gain economic benefits. Subsidiaries are consolidated from the date on which effective control is transferred to the Group and are excluded from consolidation from the date the Group no longer has effective control. All inter-company transactions, balances and unrealised surpluses and deficits on transactions between Group companies have been eliminated. Accounting policies of subsidiaries are aligned on acquisition to ensure consistency with the Group policies. The Group is required to use the acquisition method of accounting for business combinations. Under this method, the cost of an acquisition is measured as the aggregate of the consideration transferred, measured at acquisition date fair value, and the amount of any non-controlling interest in the acquiree. For each business combination, the Group has the option to measure the non-controlling interest in the acquiree either at fair value or at the proportionate share of the acquiree’s identifiable net assets. The excess of the consideration transferred over the fair value of the net assets of the subsidiary acquired is recorded as goodwill (see accounting policy N below). Acquisition-related costs are expensed as incurred. Transactions that do not result in a loss of control are treated as equity transactions with noncontrolling interests.
Merger accounting and the merger reserve Prior to 1 January 2004, the date of first time adoption of IFRS, 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. These transactions have not been restated, as permitted by the IFRS 1 transitional arrangements. 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.
(E) Foreign currency translation Income statements and cash flows of foreign entities are translated into the Group’s presentation currency at average exchange rates for the year while their statements of financial position are translated at the year-end exchange rates. Exchange differences arising from the translation of the net investment in foreign subsidiaries, associates and joint ventures, and of borrowings and other currency instruments designated as hedges of such investments, are recognised in other comprehensive income and taken to the currency translation reserve within equity. On disposal of a foreign entity, such exchange differences are transferred out of this reserve and are recognised in the income statement as part of the gain or loss on sale. The cumulative translation differences were deemed to be zero at the transition date to IFRS. Foreign currency transactions are accounted for at the exchange rates prevailing at the date of the transactions. Gains and losses resulting from the settlement of such transactions, and from the translation of monetary assets and liabilities denominated in foreign currencies, are recognised in the income statement. Translation differences on debt securities and other monetary financial assets measured at fair value and designated as held at fair value through profit or loss (FV) (see accounting policy S) are included in foreign exchange gains and losses in the income statement. For monetary financial assets designated as AFS, translation differences are calculated as if they were carried at amortised cost and so are recognised in the income statement, whilst foreign exchange differences arising from fair value gains and losses are recognised in other comprehensive income and included in the investment valuation reserve within equity. Translation differences on non-monetary items, such as equities which are designated as FV, are reported as part of the fair value gain or loss, whereas such differences on AFS equities are included in the investment valuation reserve.
(G) Premiums earned Premiums on long-term insurance contracts and participating investment contracts are recognised as income when receivable, except for investment-linked premiums which are accounted for when the corresponding liabilities are recognised. For single premium business, this is the date from which the policy is effective. For regular premium contracts, receivables are recognised at the date when payments are due. Premiums are shown before deduction of commission and before any salesbased taxes or duties. Where policies lapse due to non-receipt of premiums, then all the related premium income accrued but not received from the date they are deemed to have lapsed is offset against premiums. General insurance and health premiums written reflect business incepted during the year, and exclude any sales-based taxes or duties. Unearned premiums are those proportions of the premiums written in a year that relate to periods of risk after the statement of financial position date. Unearned premiums are calculated on either a daily or monthly pro rata basis. Premiums collected by intermediaries, but not yet received, are assessed based on estimates from underwriting or past experience, and are included in premiums written. Deposits collected under investment contracts without a discretionary participating feature (non-participating contracts) are not accounted for through the income statement, except for the fee income (covered in accounting policy H) and the investment income attributable to those contracts, but are accounted for directly through the statement of financial position as an adjustment to the investment contract liability.
(I) Other fee and commission income Other fee and commission income consists primarily of fund management fees, distribution fees from mutual funds, commissions on reinsurance ceded, commission revenue from the sale of mutual fund shares and transfer agent fees for shareholder record keeping. Reinsurance commissions receivable are deferred in the same way as acquisition costs, as described in accounting policy W. All other fee and commission income is recognised as the services are provided.
Accounting policies continued deficiency is recognised in the income statement by setting up an additional provision in the statement of financial position.
(M) Reinsurance The Group assumes and cedes reinsurance in the normal course of business, with retention limits varying by line of business. Premiums on reinsurance assumed are recognised as revenue in the same manner as they would be if the reinsurance were considered direct business, taking into account the product classification of the reinsured business. The cost of reinsurance related to long-duration contracts is accounted for over the life of the underlying reinsured policies, using assumptions consistent with those used to account for these policies. Where general insurance liabilities are discounted, any corresponding reinsurance assets are also discounted using consistent assumptions. Gains or losses on buying retroactive reinsurance are recognised in the income statement immediately at the date of purchase and are not amortised. Premiums ceded and claims reimbursed are presented on a gross basis in the consolidated income statement and statement of financial position as appropriate. Reinsurance assets primarily include balances due from both insurance and reinsurance companies for ceded insurance and investment contract liabilities. This includes balances in respect of investment contracts which are legally reinsurance contracts but do not meet the definition of a reinsurance contract under IFRS. Amounts recoverable from reinsurers are estimated in a manner consistent with the underlying contract liabilities, outstanding claims provisions or settled claims associated with the reinsured policies and in accordance with the relevant reinsurance contract. Reinsurance of non-participating investment contracts and reinsurance contracts that principally transfer financial risk are accounted for directly through the statement of financial position. A deposit asset or liability is recognised, based on the consideration paid or received less any explicitly identified premiums or fees to be retained by the reinsured. These deposit assets or liabilities are shown within reinsurance assets in the consolidated statement of financial position. If a reinsurance asset is impaired, the Group reduces the carrying amount accordingly and recognises that impairment loss in the income statement. A reinsurance asset is impaired if there is objective evidence, as a result of an event that occurred after initial recognition of the reinsurance asset, that the Group may not receive all amounts due to it under the terms of the contract,
Accounting policies continued and the event has a reliably measurable impact on the amounts that the Group will receive from the reinsurer.
 Computer equipment Three to five years  Other assets Three to five years
(Q) Impairment of non-financial assets Property and equipment and other non-financial assets are reviewed for impairment losses whenever events or changes in circumstances indicate that the carrying amount may not be recoverable. An impairment loss is recognised for the amount by which the carrying amount of the asset exceeds its recoverable amount, which is the higher of an asset’s net selling price and value in use. For the purposes of assessing impairment, assets are grouped at the lowest level for which there are separately identifiable cash flows. Non-financial assets except goodwill which have suffered an impairment are reviewed for possible reversal of the impairment at each reporting date.
 The Group has transferred its rights to receive cash flows from the asset and has either transferred substantially all the risks and rewards of the asset, or has neither transferred nor retained substantially all the risks and rewards of the asset, but has transferred control of the asset.
Impairment The Group reviews the carrying value of its AFS investments on a regular basis. If the carrying value of an AFS investment is greater than the recoverable amount, the carrying value is reduced through a charge to the income statement in the period of impairment. The following policies are used to determine the level of any impairment, some of which involve considerable judgement: AFS debt securities: An AFS debt security is impaired if there is objective evidence that a loss event has occurred which has impaired the expected cash flows, i.e. where all amounts due according to the contractual terms of the security are not considered collectible. An impairment charge, measured as the difference between the security’s fair value and amortised cost, is recognised when the issuer is known to be either in default or in financial difficulty. Determining when an issuer is in financial difficulty requires the use of judgement, and we consider a number of factors including industry risk factors, financial condition, liquidity position and near-term prospects of the issuer, credit rating declines and a breach of contract. A decline in fair value below amortised cost due to changes in risk-free interest rates does not necessarily represent objective evidence of a loss event. For securities identified as being impaired, the cumulative unrealised net loss previously recognised within the investment valuation reserve is transferred to realised losses for the year, with a corresponding movement through other comprehensive income. Any subsequent increase in fair value of these impaired securities is recognised in other comprehensive income and recorded in the investment valuation reserve unless this increase can be objectively related to an event occurring after the impairment loss was recognised in the income statement. In such an event, the reversal of the impairment loss is recognised as a gain in the income statement.
(T) Derivative financial instruments and hedging Derivative financial instruments include foreign exchange contracts, interest rate futures, currency and interest rate swaps, currency and interest rate options (both written and purchased) and other financial instruments that derive their value mainly from underlying interest rates, foreign exchange rates, credit indices, commodity values or equity instruments. All derivatives are initially recognised in the statement of financial position at their fair value, which usually represents their cost. They are subsequently remeasured at their fair value, with the method of recognising movements in this value depending on whether they are designated as hedging instruments and, if so, the nature of the item being hedged. Fair values are obtained from quoted market prices or, if these are not available, by using valuation techniques such as discounted cash flow models or option pricing models. All derivatives are carried as assets when the fair values are positive and as liabilities when the fair values are negative. Premiums paid for derivatives are recorded as an asset on the statement of financial position at the date of purchase, representing their fair value at that date. Derivative contracts may be traded on an exchange or overthe -counter (OTC). Exchange-traded derivatives are standardised and include certain futures and option contracts. OTC derivative contracts are individually negotiated between contracting parties and include forwards, swaps, caps and floors. Derivatives are subject to various risks including market, liquidity and credit risk, similar to those related to the underlying financial instruments. Many OTC transactions are contracted and documented under International Swaps and Derivatives Association (ISDA) master agreements or their equivalent, which are designed to provide legally enforceable set-off in the event of default, reducing the Group’s exposure to credit risk. The notional or contractual amounts associated with derivative financial instruments are not recorded as assets or liabilities on the statement of financial position as they do not represent the fair value of these transactions. These amounts are disclosed in note 57. The Group has collateral agreements in place between the individual Group entities and relevant counterparties. Accounting policy V below covers collateral, both received and pledged, in respect of these derivatives.
(U) Loans Loans with fixed maturities, including policyholder loans, mortgage loans on investment property, securitised mortgages and collateral loans, are recognised when cash is advanced to
(V) Collateral The Group receives and pledges collateral in the form of cash or non-cash assets in respect of stock lending transactions, certain derivative contracts and loans, in order to reduce the credit risk of these transactions. Collateral is also pledged as security for bank letters of credit. The amount and type of collateral required depends on an assessment of the credit risk of the counterparty. Collateral received in the form of cash, which is not legally segregated from the Group, is recognised as an asset in the statement of financial position with a corresponding liability for the repayment in financial liabilities (note 49). However, where the Group has a currently enforceable legal right of set-off, the collateral liability and associated derivative balances are shown net, in line with market practice. Non-cash collateral received is not recognised in the statement of financial position unless the Group either (a) sells or repledges these assets in the absence of default, at which point the obligation to return this collateral is recognised as a liability; or (b) the counterparty to the arrangement defaults, at which point the collateral is seized and recognised as an asset. Collateral pledged in the form of cash, which is legally segregated from the Group, is derecognised from the statement of financial position with a corresponding receivable recognised for its return. Non-cash collateral pledged is not derecognised from the statement of financial position unless the Group defaults on its obligations under the relevant agreement, and therefore continues to be recognised in the statement of financial position within the appropriate asset classification.
(W) Deferred acquisition costs and other assets Costs relating to the acquisition of new business for insurance and participating investment contracts are deferred in line with existing local accounting practices, to the extent that they are expected to be recovered out of future margins in revenues on these contracts. For participating contracts written in the UK, acquisition costs are generally not deferred as the liability for these contracts is calculated in accordance with the FSA’s realistic capital regime and FRS 27. For non-participating investment and investment fund management contracts, incremental acquisition costs and sales enhancements that are directly attributable to securing an investment management service are also deferred. Where such business is reinsured, an appropriate proportion of the deferred acquisition costs is attributed to the reinsurer, and is treated as a separate liability. Long-term business deferred acquisition costs are amortised systematically over a period no longer than that in which they are expected to be recoverable out of these future margins. Deferrable acquisition costs for non-participating investment and investment fund management contracts are amortised over the period in which the service is provided. General insurance and health deferred acquisition costs are amortised over the period in which the related revenues are earned. The reinsurers’ share of deferred acquisition costs is amortised in the same manner as the underlying asset. Deferred acquisition costs are reviewed by category of business at the end of each reporting period and are written-off where they are no longer considered to be recoverable. Other assets include vehicles which are subject to repurchase agreements and inventories of vehicle parts. The former are carried at the lower of their agreed repurchase price or net realisable value, whilst the latter are carried at the lower of cost and net realisable value, where cost is arrived at on the weighted average cost formula or ‘first in first out’ (FIFO) basis. Provision is made against inventories which are obsolete or surplus to requirements.
(X) Statement of cash flows Cash and cash equivalents Cash and cash equivalents consist of cash at banks and in hand, deposits held at call with banks, treasury bills and other shortterm highly liquid investments that are readily convertible to known amounts of cash and which are subject to an insignificant risk of change in value. Such investments are those with less than three months’ maturity from the date of acquisition, or which are redeemable on demand with only an insignificant change in their fair values. For the purposes of the statement of cash flows, cash and cash equivalents also include bank overdrafts, which are included in payables and other financial liabilities on the statement of financial position.
(Z) Provisions and contingent liabilities Provisions are recognised when the Group has a present legal or constructive obligation as a result of past events, it is more probable than not that an outflow of resources embodying economic benefits will be required to settle the obligation, and a reliable estimate of the amount of the obligation can be made. Restructuring provisions comprise lease termination penalties and employee termination payments. Provisions are not recognised for future operating losses. Where the Group expects a provision to be reimbursed, for example under an insurance contract, the reimbursement is recognised as a separate asset but only when the reimbursement is virtually certain. The Group recognises a provision for onerous contracts when the expected benefits to be derived from a contract are less than the unavoidable costs of meeting the obligations under the contract. Contingent liabilities are disclosed if there is a possible future obligation as a result of a past event, or if there is a present obligation as a result of a past event but either a payment is not probable or the amount cannot be reasonably estimated.
Other post-employment obligations Some Group companies provide post-employment healthcare or other benefits to their retirees. The entitlement to these benefits is usually based on the employee remaining in service up to retirement age and the completion of a minimum service period. Unlike the pension schemes, no assets are set aside in separate funds to provide for the future liability but none of these schemes is material to the Group. The costs of the Canadian scheme are included within those for the defined benefit pension schemes in that country. For such schemes in other countries, provisions are calculated in line with local regulations, with movements being charged to the income statement within staff costs.
Deferred tax assets are recognised to the extent that it is probable that future taxable profit will be available against which the temporary differences can be utilised. In countries where there is a history of tax losses, deferred tax assets are only recognised in excess of deferred tax liabilities if there is convincing evidence that future profits will be available. Deferred tax is provided on temporary differences arising from investments in subsidiaries, associates and joint ventures, except where the timing of the reversal of the temporary difference can be controlled and it is probable that the difference will not reverse in the foreseeable future. Deferred taxes are not provided in respect of temporary differences arising from the initial recognition of goodwill, or from goodwill for which amortisation is not deductible for tax purposes, or from the initial recognition of an asset or liability in a transaction which is not a business combination and affects neither accounting profit nor taxable profit or loss at the time of the transaction. Current and deferred tax relating to items recognised in other comprehensive income and directly in equity are similarly recognised in other comprehensive income and directly in equity respectively. Deferred tax related to fair value re-measurement of available for sale investments, owner-occupied properties and other amounts charged or credited directly to other comprehensive income is recognised in the statement of financial position as a deferred tax asset or liability. Current tax on interest paid on direct capital instruments and fixed rate tier 1 notes is credited directly in equity. In addition to paying tax on shareholders’ profits, the Group’s life businesses in the UK, Ireland and Singapore pay tax on policyholders’ investment returns (‘policyholder tax’) on certain products at policyholder tax rates. Policyholder tax is accounted for as an income tax and is included in the total tax expense. The Group has decided to show separately the amounts of policyholder tax to provide a more meaningful measure of the tax the Group pays on its profits. In the pro forma reconciliations, operating profit has been calculated after charging policyholder tax.
(AC) Borrowings Borrowings are classified as being for either core structural or operational purposes. They are recognised initially at their issue proceeds less transaction costs incurred. Subsequently, most borrowings are stated at amortised cost, and any difference between net proceeds and the redemption value is recognised in the income statement over the period of the borrowings using the effective interest rate method. All borrowing costs are expensed as they are incurred except where they are directly attributable to the acquisition or construction of property and equipment as described in accounting policy O above. Where loan notes have been issued in connection with certain securitised mortgage loans, the Group has taken advantage of the revised fair value option under IAS 39 to present the mortgages, associated liabilities and derivative financial instruments at fair value, since they are managed as a portfolio on a fair value basis. This presentation provides more relevant information and eliminates any accounting mismatch which would otherwise arise from using different measurement bases for these three items.
(ii) the instrument is a non-derivative that contains no contractual obligation to deliver a variable number of shares or is a derivative that will be settled only by the Group exchanging a fixed amount of cash or other assets for a fixed number of the Group’s own equity instruments.
Share of (loss)/profit after tax of joint ventures and associates (277) — (123) 28 (Loss)/profit on the disposal and remeasurement of subsidiaries and associates 3b (164) (2,359) 565 (32)
Profit/(loss) before tax attributable to shareholders’ profits 25 (2,696) 551 (464)
Less: tax attributable to policyholders’ returns 13d 221 — (178) — Tax attributable to shareholders’ profits (227) (152) (134) 107
Attributable to: Equity shareholders of Aviva plc (3,218) 225 Non-controlling interests 37 168 (165)
Continuing operations – Basic (pence per share) (15.2)p 11.1p Continuing operations – Diluted (pence per share) (15.2)p 10.9p 1 Discontinued operations in the current period represents the results of the US life and related internal asset management businesses (US Life), and in the prior period represents the results of US Life and Delta Lloyd to 6 May 2011. 2 Following a review of the classification of contracts issued by the Group’s Italian long-term business, certain portfolios have been reclassified from participating insurance to participating investment contracts for all years presented. There is no impact on the result for any year presented as a result of this reclassification.
The accounting policies (identified alphabetically) on pages 148 to 159 and notes (identified numerically) on pages 168 to 266 are an integral part of these financial statements.
(Loss)/profit for the year from continuing operations (202) 417 (Loss) for the year from discontinued operations1 (2,848) (357)
Owner-occupied properties – fair value (losses)/gains (3) 2 Share of other comprehensive income of joint ventures and associates 14 (134) Actuarial (losses)/gains on pension schemes 47e(iv) (830) 996 Other pension scheme movements — (22) Foreign exchange rate movements (200) (284) Aggregate tax effect – shareholder tax 13b 163 (160)
Other comprehensive (expense)/income, net of tax from continuing operations (828) 396 Other comprehensive income, net of tax from discontinued operations1 3c(i) 68 300
Share of operating profit (before tax) of Delta Lloyd as an associate 112 — 112 157 — 157
Operating profit before tax attributable to shareholders’ profits after integration and restructuring costs 1,427 232 1,659 1,828 407 2,235
Amortisation and impairment of intangibles (128) (129) (257) (116) (60) (176) (Loss)/profit on the disposal and remeasurement of subsidiaries
Non-operating items before tax (excluding Delta Lloyd as an associate and integration and restructuring costs) (986) (2,928) (3,914) (1,253) (871) (2,124)
Corporate centre (136) Group debt costs and other interest (659) Share of operating profit (before tax) of Delta Lloyd as an associate 112
Corporate centre (138) Group debt costs and other interest (648) Share of operating profit (before tax) of Delta Lloyd as an associate 157
Consolidated statement of changes in equity For the year ended 31 December 2012
Total comprehensive (expense)/income for the year — — — — — (349) (2) 229 74 — (3,894) (3,942) — 132 (3,810)
Shares issued in lieu of dividends 9 — (9) — — — — — — — 127 127 — — 127
Capital contributions from non-controlling interests — — — — — — — — — — — — — 20 20
Shares issued under equity compensation plans 1 — 1 — — — — — — (68) 67 1 — — 1
Aggregate tax effect – shareholder tax — — — — — — — — — — 18 18 — — 18
Issue of fixed rate tier 1 notes — — — — — — — — — — — — 392 — 392
Consolidated statement of changes in equity continued For the year ended 31 December 2011
(expense)/income for the year — — — — — (165) 4 72 30 — 982 923 — (167) 756
Non-controlling interests share of dividends declared in the year — — — — — — — — — — — — — (126) (126)
Transfer to profit on disposal of subsidiaries, joint ventures and associates — — — — — (3) — — — — — (3) — — (3)
Aggregate tax effect – shareholder tax — — — — — — — — — — 16 16 — — 16
Acquired value of in-force business and intangible assets N & 17 1,084 2,021 Interests in, and loans to, joint ventures D & 18 1,493 1,700 Interests in, and loans to, associates D & 19 215 1,118 Property and equipment O & 20 391 510
Deferred acquisition costs and other assets W & 27 3,799 6,444 Prepayments and accrued income 2,701 3,235 Cash and cash equivalents X & 54d 22,897 23,043 Assets of operations classified as held for sale AG & 3c 42,603 426
Consolidated statement of cash flows For the year ended 31 December 2012
Acquisition of, and additions to subsidiaries, joint ventures and associates, net of cash acquired 54b (129) (114) Disposals of subsidiaries, joint ventures and associates, net of cash transferred 54c 421 877 New loans to joint ventures 18a (4) (18) Repayment of loans to joint ventures 12 17 Net new loans to joint ventures 8 (1) Purchases of property and equipment 20 (220) (86) Proceeds on sale of property and equipment 43 40 Purchases of intangible assets 17 (128) (109)
Proceeds from issue of ordinary shares and fixed rate tier 1 notes, net of transaction costs 392 — Treasury shares purchased for employee trusts (33) (29) New borrowings drawn down, net of expenses 2,529 3,423 Repayment of borrowings (2,513) (3,359) Net drawdown of borrowings 16 64 Interest paid on borrowings (665) (686) Preference dividends paid 15 (17) (17) Ordinary dividends paid (630) (431) Coupon payments on direct capital instruments and fixed rate tier 1 notes 15 (73) (58) Capital contributions from non-controlling interests 37 20 68 Dividends paid to non-controlling interests of subsidiaries (102) (126)
Notes to the consolidated financial statements 168 1 – Exchange rates The Group’s principal overseas operations during the year were located within the Eurozone and the United States. The results and cash flows of these operations have been translated into sterling at the average rates for the year and the assets and liabilities have been translated at the year end rates as follows: Eurozone – Average rate (€1 equals) £0.81 £0.87 – Period end rate (€1 equals) £0.81 £0.84
United States – Average rate ($US1 equals) £0.63 £0.63 – Period end rate ($US1 equals) £0.62 £0.65
(b) Change to operating segments Following the announcement in April 2012 relating to the restructuring of the Group, the Group’s operating segments were changed to align them with the revised organisational reporting structure. The Group has determined its operating segments along market reporting lines, reflecting the management structure whereby a member of the Executive Management team is accountable to the group chief executive for the operating segment for which he is responsible. Further details of the reportable segments are given in note 4.
(c) Restatement of prior period figures Following a review of the classification of contracts issued by the Group’s Italian long-term business certain portfolios have been reclassified from participating insurance contracts to participating investment contracts. As a result there has been a reallocation from gross insurance liabilities at 31 December 2011 to gross liabilities for investment contracts of £2,722 million. The change in insurance liabilities net of reinsurance recognised in the income statement for the year to 31 December 2011 has decreased by £168 million, and the change in investment contract provisions has increased by an equal amount. There is no impact on profit for the year or equity reported for the year ended 31 December 2011.
Continuing operations United Kingdom – RAC Limited (see (i) below) (21) 532 Delta Lloyd associate (see (iii) below (129) — Australia — 23 Sri Lanka (see (iv) below) 12 — Czech Republic, Hungary and Romania (see (ii) below) 7 — Other small operations (33) 10
Notes to the consolidated financial statements continued 3 – Subsidiaries continued (i) RAC Limited The loss in respect of RAC Limited in 2012 arises from residual costs related to the sale of that company in September 2011.
(ii) Czech Republic, Hungary and Romania life business On 31 July 2012, the Group sold its operations in the Czech Republic and Hungary and its Romania life assurance business to MetLife, Inc, for £37 million. Net assets disposed of were £32 million, comprising gross assets of £379 million and liabilities of £347 million, giving a profit on disposal of £3 million after transaction costs. Recycling currency translation reserves of £4 million to the income statement resulted in an overall profit on disposal of £7 million. The sale of our Romania pensions business is still subject to regulatory approval and is expected to complete in the next 12 months, so it has been classified as held for sale (see note 3c(v)).
Interest in associate (595) Currency translation and investment valuation reserves recycled to income statement (162)
(c) Assets and liabilities of operations classified as held for sale The assets and liabilities of operations classified as held for sale as at 31 December 2012 are as follows: US Life1 £m
Assets Goodwill — 183 183 — Acquired value of in-force and intangible assets 408 83 491 1 Interests in, and loans to, joint ventures and associates — 126 126 12 Property and equipment — 2 2 1
Additional impairment to write down the disposal group to fair value less costs to sell (2,233) — (2,233) —
Liabilities Gross insurance liabilities (31,153) (3,294) (34,447) (344) Gross liabilities for investment contracts (2,197) (1,857) (4,054) — Unallocated divisible surplus — (55) (55) —
1 US Life comprises US long term business previously reported under the heading “United States” and associated internal asset management operations previously reported under “Aviva Investors” in note 4 – segmental information.
(iii) Spanish long-term business – Aseval On 18 December 2012 Aviva reached a settlement with Bankia S.A. (“Bankia”) to transfer the Group’s entire holding in Aseval Aseguradora Valenciana, Sociedad Anónima de Seguros y Reaseguros (“Aseval”), a Spanish life assurance company, to Bankia. Aseval was classified as held for sale at this date. The transfer is expected to complete on or before 30 April 2013 with proceeds of £494 million. Aseval is included within the ‘Italy, Spain and Other’ operating segment at its carrying value.
(a) Operating segments Following the announcement in April 2012 relating to the restructuring of the Group, the Group’s operating segments were changed to align them with the new management structure. The revised segments are set out below. Results for prior years have been restated to facilitate comparison with this new structure.
France The principal activities of our French operations are long-term business and general insurance. The long-term business offers a range of long-term insurance and savings products, primarily for individuals, with a focus on the unit-linked market. The general insurance business predominantly sells personal and small commercial lines insurance products through agents and a direct insurer.
Canada The principal activity of the Canadian operation is general insurance. In particular it provides personal and commercial lines insurance products through a range of distribution partners.
Higher growth markets Activities reported in the higher growth markets operating segment include our businesses in Asia, Poland, Turkey and Russia. Our activities in Asia principally comprise our long-term business operations in China, India, Singapore, Hong Kong, South Korea, Vietnam and Indonesia as well as our life operations in Taiwan and Malaysia which are held for sale as at the balance sheet date and the results of Sri Lanka up until the date of disposal in December 2012. Higher growth also includes general insurance operations in Singapore, Indonesia, Poland and Turkey and long-term business in Poland, Turkey and Russia (which is held for sale at the year-end).
Aviva Investors Aviva Investors operates in most of the markets in which the Group operates, in particular the UK, France and Canada and other international businesses, managing policyholders’ and shareholders’ invested funds, providing investment management services for institutional pension fund mandates and managing a range of retail investment products, including investment funds, unit trusts, OEICs and ISAs. The internal asset management operations of Aviva Investors North America are being sold with the Group’s US life operations and are classified as held for sale and as a discontinued operation in these financial statements.
Other Group activities Investment return on centrally held assets and head office expenses, such as Group treasury and finance functions, together with certain taxes and financing costs arising on central borrowings are included in ‘Other Group activities’, along with central core structural borrowings and certain tax balances in the segmental statement of financial position. Also included here are consolidation and elimination adjustments and the Group’s interest in Delta Lloyd, as an associate to 5 July 2012, and as a financial investment after that date.
(Loss)/profit on the disposal and remeasurement of subsidiaries and associates (2) (21) — — 7 12 — (160) (164) (2,359) (2,523)
Change in insurance liabilities, net of reinsurance 404 (22) (880) (40) 400 (292) — — (430) (1,566) (1,996)
Change in investment contract provisions (3,151) — (983) — (295) 18 (39) — (4,450) (77) (4,527)
Change in unallocated divisible surplus (347) — (4,359) — (1,491) (119) — — (6,316) — (6,316)
Amortisation of acquired value of in-force business (13) — (18) — (9) (3) — — (43) (183) (226)
Impairment of goodwill and other intangibles, depreciation and other amortisation expense (107) (59) (3) (17) (129) (7) (9) (5) (336) (916) (1,252)
Profit/(loss) before tax attributable to shareholders 98 206 482 244 340 217 2 (1,564) 25 (2,696) (2,671)
Investment return variances and economic assumption changes on long-term business 663 — (28) — — (15) — — 620 (342) 278
Amortisation and impairment of intangibles 54 40 — 11 13 4 6 — 128 129 257
Exceptional items — — — — — — — — — — — Share of Delta Lloyd's non-operating items (before tax), as an associate — — — — — — — 523 523 — 523 Share of Delta Lloyd's tax expense, as an associate — — — — — — — (107) (107) — (107)
Operating profit/(loss) before tax attributable to shareholders 910 404 422 276 414 202 42 (782) 1,888 239 2,127 1 Impairment losses, and reversal of such losses, recognised directly in other comprehensive income were £nil million and £nil million respectively. 2 Discontinued operations represent the operations of the United States Life business and related internal asset management activities. 3 Aviva Investors operating profit includes £3 million profit relating to the Aviva Investors Pooled Pension business. 4 Other group activities include Delta Lloyd as an associate up until 5 July 2012 and as a financial investment thereafter.
Notes to the consolidated financial statements continued 4 – Segmental information continued a (ii) Segmental income statement for the year ended 31 December 2011
Claims and benefits paid, net of recoveries from reinsurers (9,589) (3,217) (5,366) (1,308) (4,118) (782) — — (24,380) (4,029) (28,409)
Change in insurance liabilities, net of reinsurance (2,373) 89 62 (1) (283) 222 — — (2,284) (2,523) (4,807)
Change in investment contract provisions 949 — 583 — 37 46 (137) — 1,478 (180) 1,298
Change in unallocated divisible surplus 358 — 1,334 — 1,053 (24) — — 2,721 (19) 2,702
Profit/(loss) before tax attributable to shareholders 151 806 267 297 (48) 178 36 (1,136) 551 (464) 87
Economic assumption changes on general insurance and health business — 86 — 4 — — — — 90 — 90
Impairment of goodwill, associates and joint ventures 149 — — — 11 15 — 217 392 — 392
Amortisation and impairment of intangibles 66 9 4 11 12 5 9 — 116 60 176
(Profit)/loss on the disposal of subsidiaries and associates — (528) (37) — — — (23) 23 (565) 32 (533)
Share of Delta Lloyd's non-operating items (before tax), as an associate — — — — — — — (10) (10) — (10) Share of Delta Lloyd's tax expense, as an associate — — — — — — — 34 34 — 34
Net asset value attributable to unitholders 1,375 — 3,383 — — 205 — — 6,183 11,146
Liabilities of operations classified as held for sale 3,257 — — 35,835 — 2,188 118 13 — 41,411
Notes to the consolidated financial statements continued 4 – Segmental information continued a (iv) Segmental statement of financial position as at 31 December 2011
Other Other includes the RAC non-insurance operations (up to the disposal date of 30 September 2011), service companies, head office expenses, such as Group treasury and finance functions, and certain financing costs and taxes not allocated to business segments.
Notes to the consolidated financial statements continued 4 – Segmental information continued b (i) Segmental income statement – products and services for the year ended 31 December 2012
Net written premiums 12,279 8,894 — — 21,173 Net change in provision for unearned premiums — (16) — — (16)
Inter-segment revenue — — 127 — 127 Share of (loss)/profit of joint ventures and associates (27) 1 3 (254) (277) (Loss)/profit on the disposal and remeasurement of subsidiaries and associates (6) (21) — (137) (164)
Profit/(loss) before tax from continuing operations 1,085 635 11 (1,485) 246 Tax attributable to policyholder returns (221) — — — (221)
Profit/(loss) before tax attributable to shareholders 864 635 11 (1,485) 25 Adjusted for: Non-operating items from continuing operations (excluding Delta Lloyd as an associate) 967 258 40 182 1,447 Share of Delta Lloyd's non-operating items (before tax), as an associate — — — 523 523 Share of Delta Lloyd's tax expense, as an associate — — — (107) (107)
Operating profit/(loss) before tax attributable to shareholders’ profits from continuing operations 1,831 893 51 (887) 1,888 Operating profit/(loss) before tax attributable to shareholders’ profits from discontinued operations4 200 — 55 (16) 239
Notes to the consolidated financial statements continued 4 – Segmental information continued b (ii) Segmental income statement – products and services for the year ended 31 December 2011
Gross written premiums1 16,505 9,750 — — 26,255 Premiums ceded to reinsurers (960) (588) — — (1,548)
Claims and benefits paid, net of recoveries from reinsurers (18,435) (5,945) — — (24,380) Change in insurance liabilities, net of reinsurance (2,281) (3) — — (2,284) Change in investment contract provisions 1,478 — — — 1,478 Change in unallocated divisible surplus 2,721 — — — 2,721 Amortisation of acquired value of in-force business on insurance contracts (70) — — — (70) Impairment of goodwill and other intangibles, depreciation and other
Profit/(loss) before tax from continuing operations 527 609 45 (808) 373 Tax attributable to policyholder returns 178 — — — 178
Profit/(loss) before tax attributable to shareholders from continuing operations 705 609 45 (808) 551 Adjusted for: Non-operating items from continuing operations (excluding Delta Lloyd as an associate) 1,221 326 16 (49) 1,514 Share of Delta Lloyd's non-operating items (before tax), as an associate — — — (10) (10) Share of Delta Lloyd's tax expense, as an associate — — — 34 34
Operating profit/(loss) before tax attributable to shareholders’ profits 2,308 936 110 (851) 2,503 1 Gross written premiums includes inward reinsurance premiums assumed from other companies amounting to £226 million, of which £110 million relates to property and liability insurance and £116 million relates to long-term business. 2 General insurance and health business segment includes gross written premiums of £1,107 million relating to health business. The remaining business relates to property and liability insurance. 3 Other includes the RAC, up to the date of disposal, Delta Lloyd as an associate from 6 May 2011, head office expenses, such as group treasury and finance functions, and certain financing costs and taxes not allocated to business segments. 4 Discontinued operations represent the operations of the United States Life business and related internal asset management activities and the results of Delta Lloyd up until its deconsolidation in May 2011. 5 Following a review of the classification of contracts issued by the Group’s Italian long-term business, certain portfolios have been reclassified from participating insurance to participating investment contracts for all years presented. There is no impact on the result for any year presented as a result of this reclassification.
Acquired value of in-force business and intangible assets 799 146 56 83 1,084 Interests in, and loans to, joint ventures and associates 1,699 5 4 — 1,708
Gross insurance liabilities 98,086 15,005 — — 113,091 Gross liabilities for investment contracts 110,494 — — — 110,494 Unallocated divisible surplus 6,931 — — — 6,931 Net asset value attributable to unitholders 4,963 — — 6,183 11,146
Total equity and liabilities 315,689 b (iv) Segmental statement of financial position – products and services as at 31 December 2011
Total equity and liabilities 312,376 1 ”Other” includes Delta Lloyd as an associate. 2 Following a review of the classification of contracts issued by the Group’s Italian long-term business, certain portfolios have been reclassified from participating insurance to participating investment contracts for all years presented. There is no impact on the result for any year presented as a result of this reclassification.
Gross written premiums (note 4a and 4b) Long-term: Insurance contracts 9,683 11,671 Participating investment contracts 3,526 4,834
Less: Premiums ceded to reinsurers (note 4a and 4b) (1,571) (1,548) Gross change in provision for unearned premiums (note 39e) (21) (189) Reinsurers’ share of change in provision for unearned premiums (note 42ciii) 5 (47) Net change in provision for unearned premiums (16) (236)
Fee and commission income Fee income from investment contract business 461 519 Fund management fee income 330 368 Other fee income 304 445 Reinsurance commissions receivable 92 71 Other commission income 41 33 Net change in deferred revenue 45 29
Realised gains on disposals 1,844 1,729 Unrealised gains and losses (see policy J) Gains/(losses) arising in the year 14,239 (3,827) (Gains) recognised in prior periods and now realised (1,844) (1,729)
Gains recognised in prior periods as unrealised in equity (1) (1)
Income from continuing operations 43,095 30,719 Income from discontinued operations 3,494 7,800
Total income 46,589 38,519 1 Following a review of the classification of contracts issued by the Group’s Italian long-term business, certain portfolios have been reclassified from participating insurance to participating investment contracts for all years presented. There is no impact on the result for any year presented as a result of this reclassification.
Change in insurance liabilities Change in insurance liabilities 663 2,583 Change in reinsurance asset for insurance provisions (233) (299)
Change in investment contract provisions Investment income allocated to investment contracts 3,178 (363) Other changes in provisions
Commission expenses for insurance and participating investment contracts 2,393 2,476 Change in deferred acquisition costs for insurance and participating investment contracts 131 (2) Deferrable costs for non-participating investment contracts 126 66 Other acquisition costs 970 1,113 Change in deferred acquisition costs for non-participating investment contracts 85 46
Impairment of goodwill on subsidiaries (note 16) 109 160 Amortisation of acquired value of in-force business on insurance contracts (note 17) 43 70 Amortisation of intangible assets (note 17) 96 111 Impairment of acquired value of in-force business (note 17) 73 — Impairment of intangible assets (note 17) 49 49 Integration and restructuring costs (see below) 461 261 Exceptional items (see below) — — Other expenses 664 657
Other net foreign exchange (gains)/losses 4 23 Finance costs (note 7) 735 776
Total expenses 49,039 38,610 1 Following a review of the classification of contracts issued by the Group’s Italian long-term business, certain portfolios have been reclassified from participating insurance to participating investment contracts for all years presented. There is no impact on the result for any year presented as a result of this reclassification.
Notes to the consolidated financial statements continued 6 – Details of expenses continued Integration and restructuring costs Integration and restructuring costs from continuing operations are £461 million (2011: £261 million). This includes restructuring and transformation activity that has been taken to align our business operations with our strategy, including the Group’s Simplify programme (£165 million), Ireland transformation (£130 million) including the merger of our UK and Ireland businesses, £24 million in relation to the transformation of Aviva Investors and £25 million in respect of other restructuring activities. This also includes a cost of £117 million relating to preparing the business for the implementation of Solvency II.
Change in insurance liabilities, net of reinsurance (note 39) — (57) Other expenses (as above) — —
7 – Finance costs This note analyses the interest costs on our borrowings (which are described in note 48) and similar charges. Finance costs comprise: Continuing operations 2012 £m £m
(b) Economic volatility The investment variances and economic assumption changes excluded from the long-term business operating profit are as follows: Long-term business 2012 £m £m
(c) Methodology The expected investment returns and corresponding expected movements in long-term business liabilities are calculated separately for each principal long-term business unit. The expected return on investments for both policyholders’ and shareholders’ funds is based on opening economic assumptions applied to the expected funds under management over the reporting period. Expected investment return assumptions are derived actively, based on market yields on risk-free fixed interest assets at the end of each financial year. The same margins are applied on a consistent basis across the Group to gross risk-free yields, to obtain investment return assumptions for equities and properties. Expected funds under management are equal to the opening value of funds under management, adjusted for sales and purchases during the period arising from expected operating experience. The actual investment return is affected by differences between the actual and expected funds under management and changes in asset mix, as well as movements in interest rates. To the extent that these differences arise from the operating experience of the longterm business, or management decisions to change asset mix, the effect is included in the operating profit. The residual difference between actual and expected investment return is included in investment variances, outside operating profit but included in profit before tax. The movement in liabilities included in operating profit reflects both the change in liabilities due to the expected return on investments and the impact of experience variances and assumption changes for non-economic items. The effect of differences between actual and expected economic experience on liabilities, and changes to economic assumptions used to value liabilities, are taken outside operating profit. For many types of long-term business, including unit-linked and with-profits funds, movements in asset values are offset by corresponding changes in liabilities, limiting the net impact on profit. For other longterm business the profit impact of economic volatility depends on the degree of matching of assets and liabilities, and exposure to financial options and guarantees.
(a) The short-term fluctuations in investment return and economic assumption changes attributable to the non-long-term business result and reported outside operating profit were as follows: Non-long-term business 2012 £m £m
Short-term fluctuations in investment return (see (b) below) – continuing operations 7 (266) Economic assumption changes – continuing operations (see (g) below) (21) (90)
Net investment income 827 602 Foreign exchange on unrealised gains/losses and other charges (97) (99)
Analysed between: Longer-term investment return, reported within operating profit 723 769 Short-term fluctuation in investment return, reported outside operating profit
Notes to the consolidated financial statements continued 9 – Longer-term investment return and economic assumption changes for non-long-term business continued
Actual return attributable to shareholders 3,095 3,175 Longer-term return credited to operating results (3,902) (4,114)
(f) The table below shows the sensitivity of the Group’s non-long-term business operating profit for continuing operations before tax to changes in the longer-term rates of return: Continuing operations
Equities 1% higher/lower Group operating profit before tax 6 4 Properties 1% higher/lower Group operating profit before tax 2 1
Defined benefit schemes (note 47d) 19 58 Defined contribution schemes (note 47d) 102 86
Acquisition costs 522 597 Claims handling expenses 158 222 Central costs and sharesave schemes 48 10 Other operating expenses 1,122 1,160
Total staff costs 1,995 2,332 11 – Directors Information concerning individual directors’ emoluments, interests and transactions is given in the Directors’ Remuneration Report on pages 104 to 120 in the ‘Corporate governance’ section of this report. For the purposes of the disclosure required by Schedule 5 to the Companies Act 2006, the total aggregate emoluments of the directors in respect of 2012 was £6.3 million (2011: £7.7 million). Employer contributions to pensions for executive directors for qualifying periods were £179,200 (2011: £71,900). The aggregate net value of share awards granted to the directors in the period was £8.9 million (2011: £12.1 million). The net value has been calculated by reference to the closing middle market price of an ordinary share at the date of grant. During the year, no share options were exercised by directors (2011: nil).
Fees payable to PwC LLP and its associates for the statutory audit of the Aviva Group and Company financial statements 2.2 Fees payable to PwC LLP and its associates for other services Audit of Group subsidiaries 9.6
Tax compliance services 0.4 Tax advisory services 0.1 Services relating to corporate finance transactions 0.3 Other non-audit services not covered above 7.7
Fees payable to PwC LLP and its associates for services to Group companies classified as continuing operations 29.8
Fees payable to PwC LLP and its associates for Audit of Group subsidiaries 1.7 Fees payable to PwC LLP and its associates for other non-audit services to Group subsidiaries 0.3
Total fees payable to PwC LLP and its associates for services to Group companies 31.8
Total audit fees 13.7 Audit related assurance 2.7 Other assurance services 5.6
Tax compliance services 0.2 Other non audit services not covered above 2.0
The tables above reflect the disclosure requirements of SI2011/2198 – The Companies (Disclosure of Auditor Remuneration and Liability Limitation Agreements) (Amendment) Regulations 2011. Comparatives for 2011 have been adjusted accordingly. In addition to the fees for 2012 shown above, during 2012 the Group paid PwC £0.2 million in relation to the audit of Group occupational pension schemes and paid E&Y £1.0 million in relation to the 2011 audit of group subsidiaries. Fees payable for the audit of the Group’s subsidiaries include fees for the statutory audit of the subsidiaries, both inside and outside the UK, and for the work performed by the principal auditors in respect of the subsidiaries for the purpose of the consolidated financial statements of the Group. Audit related assurance comprises services in relation to statutory and regulatory filings. These include audit services for the audit of FSA returns in the UK and review of interim financial information under the Listing Rules of the UK Listing Authority. Fees for other assurance services comprise non statutory assurance work which is customarily performed by the external auditor, including the audit of the Group’s MCEV reporting. Although embedded value is a primary management reporting basis and our disclosures require a full audit, the relevant fees are not classified as being for statutory audit. As noted above PwC replaced E&Y as the group’s principal auditor for the 2012 year. Prior to 2012, PwC was a significant provider of consulting services to the Group. The level of 2012 fees for non-audit services therefore includes fees billed in the year relating to projects that commenced prior to PwC’s appointment as auditor. All of these services are in compliance with applicable UK, US and IFAC independence rules. We do not expect PwC’s non-audit fees to continue at this level in the future. Other assurance services in 2012 includes fees relating to the audit of the Group’s MCEV reporting of £1.3 million, £1.8 million for examination of the Group Individual Capital Assessment and Economic Capital, and £3.4 million associated with assurance services to prepare the businesses for Solvency II implementation. The 2012 fees for other non-audit services for continuing operations of £7.7 million includes advice to our European businesses in relation to the risk management aspects of Solvency II (£1.9 million), £1.9 million relating to four regulatory advice engagements, £0.7 million relating to restructuring at Aviva Investors, £0.3 million for risk training, £0.3 million supporting an industry-wide competition review, £0.3 million for an additional claims reserves review and £2.3 million for other services. The 2012 fees for tax compliance services of £0.4 million includes fees for one engagement in Higher Growth markets of £0.3 million, and fees for corporate finance transactions of £0.3 million relates to an engagement for an Aviva Investors property fund. Details of the Group’s process for safeguarding and supporting the independence and objectivity of the external auditors are given in the Audit Committee report.
Notes to the consolidated financial statements continued 13 – Tax This note analyses the tax charge/(credit) for the year and explains the factors that affect it.
Current tax For this year 516 535 Prior year adjustments (47) (10)
(ii) The Group, as a proxy for policyholders in the UK, Ireland and Singapore, is required to record taxes on investment income and gains each year. Accordingly, the tax benefit or expense attributable to UK, Irish and Singapore life insurance policyholder returns is included in the tax charge/(credit). The tax charge attributable to policyholders’ returns included in the charge above is £221 million (2011: £178 million credit).
Deferred tax credited to income statement from continuing operations (21) (569)
Deferred tax charged to income statement from discontinued operations 143 56
(b) Tax (credited)/charged to other comprehensive income (i) The total tax (credit)/charge comprises: £m £m
Tax charged to other comprehensive income arising from discontinued operations 107 98
Notes to the consolidated financial statements continued 13 – Tax continued (ii) The tax charge attributable to policyholders’ returns included above is £nil (2011: £nil).
Different local basis of tax on overseas profits (141) (3) (144) 84 (2) 82 Change in future local statutory tax rates (12) — (12) (32) — (32) Movement in deferred tax not recognised (69) — (69) (5) — (5) Tax effect of loss/(profit) from associates and joint ventures 75 — 75 (41) — (41)
The tax charge/(credit) attributable to policyholders' returns is removed from the Group’s total loss before tax in arriving at the Group’s (loss)/profit before tax attributable to shareholders' profits. As the net of tax profits attributable to with-profit and unit-linked policyholders is zero, the Group’s pre-tax profit/(loss) attributable to policyholders is an amount equal and opposite to the tax charge/(credit) attributable to policyholders included in the total tax charge/(credit). The difference between the policyholder tax charge/(credit) and the impact of this item in the tax reconciliation can be explained as follows: £m £m
Notes to the consolidated financial statements continued 14 – (Loss)/earnings per share This note shows how we calculate (loss)/earnings per share, based both on the present shares in issue (the basic (loss)/earnings per share) and the potential future shares in issue, including conversion of share options granted to employees (the diluted earnings per share). We have also shown the same calculations based on our operating profit as we believe this gives a better indication of operating performance.
(a) Basic (loss)/earnings per share (i) The (loss)/profit attributable to ordinary shareholders is: Continuing operations
Profit/(loss) attributable to ordinary shareholders from discontinued operations 161 (3,009) (2,848) 178 (329) (151)
Profit/(loss) attributable to ordinary shareholders 1,300 (4,590) (3,290) 1,531 (1,366) 165
(ii) Basic (loss)/earnings per share is calculated as follows: Continuing operations Before tax £m
Share of Delta Lloyd's non-operating items (before tax) as an associate (523) (388) (13.3) 10 15 0.5 Share of Delta Lloyd's tax expense, as an associate 107 — — (34) — —
(Loss)/profit attributable to ordinary shareholders from discontinued operations (2,696) (2,848) (97.9) (464) (151) (5.3)
(iii) The calculation of basic (loss)/earnings per share uses a weighted average of 2,910 million (2011: 2,845 million) ordinary shares in issue, after deducting shares owned by the employee share trusts. The actual number of shares in issue at 31 December 2012 was 2,946 million (2011: 2,906 million) and 2,936 million (2011: 2,892 million) excluding shares owned by the employee share trusts.
Notes to the consolidated financial statements continued 14 – (Loss)/earnings per share continued (b) Diluted earnings per share (i) Diluted earnings per share is calculated as follows: Total £m
(Loss)/profit attributable to ordinary shareholders (442) 2,910 (15.2) 316 2,845 11.1 Dilutive effect of share awards and options — 44 — — 50 (0.2)
Diluted (loss)/earnings per share from discontinued operations1 (2,848) 2,954 (97.9) (151) 2,895 (5.3)
Diluted (loss)/earnings per share1 (3,290) 2,954 (113.1) 165 2,895 5.7 1 Losses have an anti-dilutive effect. Therefore the basic and diluted earnings for 2012 and the diluted earnings for 2011, have remained the same.
Operating profit attributable to ordinary shareholders 161 2,910 5.5 178 2,845 6.3 Dilutive effect of share awards and options — 44 (0.1) — 50 (0.1)
Ordinary dividends declared and charged to equity in the year Final 2011 – 16.00 pence per share, paid on 17 May 2012 465 — Final 2010 – 16.00 pence per share, paid on 17 May 2011 — 451 Interim 2012 – 10.00 pence per share, paid on 16 November 2012 292 — Interim 2011 – 10.00 pence per share, paid on 17 November 2011 — 287
Subsequent to 31 December 2012, the directors proposed a final dividend for 2012 of 9.0 pence per ordinary share (2011: 16.0 pence), amounting to £265 million (2011: £465 million) in total. Subject to approval by shareholders at the AGM, the dividend will be paid on 17 May 2013 and will be accounted for as an appropriation of retained earnings in the year ending 31 December 2013. Interest payments on the direct capital instruments issued in November 2004 and the fixed rate tier 1 notes issued in May 2012 are treated as an appropriation of retained profits and, accordingly, are accounted for when paid. Tax relief is obtained at a rate of 24.5% (2011: 26.5%).
Deconsolidation of Delta Lloyd — (542) Foreign exchange rate movements (64) (8)
Goodwill on acquisitions and additions arose on the acquisition of a small long-term insurance business in Spain and a small general insurance business in Canada. Goodwill impairment charges of £891 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 impairment charges of £147 million recognised in respect of goodwill within interests in associates (note 19) the goodwill write down for the year was £1,047 million. After a reversal of a previously recognised impairment of the Delta Lloyd associate of £205 million (note 19) the total charge for impairment of goodwill, joint ventures and associates for the year was £842 million. Goodwill disposed of during the year relates to the Group’s Sri Lanka subsidiary (see note 3(b)). Goodwill classified as held for sale consists of £180 million relating to Aseval, a Spanish long-term business, and £3 million relating to the Russian long-term business (see note 3(c)).
Spain – long-term business 450 542 — — 450 542 United States
Long-term business Value in use is calculated as an actuarially determined appraisal value, based on the embedded value of the business calculated in accordance with market consistent embedded value (‘MCEV’) principles, together with the present value of expected profits from future new business. If the embedded value of the business tested is sufficient to demonstrate goodwill recoverability on its own, then it is not necessary to estimate the present value of expected profits from future new business. If required, the present value of expected profits arising from future new business written over a given period is calculated on an MCEV basis, using profit projections based on the most recent three year business plans approved by management. These plans reflect management’s best estimate of future profits based on both historical experience and expected growth rates for the relevant cash
Italy long-term business MCEV MCEV 2.0 3.0 10.6 10.8 Spain long-term business MCEV MCEV 0.0 3.0 7.9 5.3
France – indefinite life intangible asset The recoverable amount of the indefinite life intangible asset has been assessed based on the fair value less costs to sell of the cashgenerating unit to which it relates. The fair value less costs to sell was determined based on the quoted market value of the share of interest in the subsidiary to which it relates.
Movement in shadow adjustment 45 — — — 45 Transfers from property and equipment — — 3 — 3
Impairment losses charged to expenses (note 6) (7) — (50) — (57) Reversal of impairment losses — — 2 — 2
(a) Intangible assets with indefinite useful lives comprise the value of the Union Financière de France Banque distribution channel, where the existing lives of the assets and their competitive position in, and the stability of, their respective markets support this classification. Impairment testing of these intangibles is covered in note 16(b).
Notes to the consolidated financial statements continued 18 – Interests in, and loans to, joint ventures In several business units, Group companies and other parties jointly control certain entities. This note analyses these interests and describes the principal joint ventures in which we are involved.
1 Comprises amortisation of AVIF on insurance contracts of £3 million (2011: £3 million) and other intangibles of £3 million (2011: £3 million).
During 2010, the Group’s Taiwan joint venture, First-Aviva Life Insurance Co., Ltd., was classified as held for sale following the decision of management to seek to dispose of the business. A sale of this business was not completed in 2012 and management have reviewed its classification as held for sale and determined that the classification remains appropriate. The disposal is expected to be completed within 12 months of the balance sheet date. During 2012, the Group’s Malaysian joint ventures, CIMB Aviva Assurance Berhad and CIMB Aviva Takaful Berhad, were classified as held for sale following the decision of management to seek to dispose of the businesses. On 17 January 2013 agreement was reached to sell Aviva’s interests in these businesses to Sun Life Assurance Company of Canada. Upon receipt of regulatory approval the parties will work to close the proposed transaction during the first half of 2013. The expected proceeds of this transaction are £152 million. These businesses have been included in the statement of financial position at their carrying value. Additions and disposals relate to the increase and reduction of investments in property management undertakings. The Group’s principal interests in property management joint ventures are listed below.
Key Assumptions for the calculation of value in use for long-term business undertakings All interests in joint ventures have been tested for impairment but only the material items are detailed below.
(e) Additional information Summarised aggregate financial information on the Group’s interests in its joint ventures is as follows: £m £m
(b) Principal associates The Group’s principal associates are as follows: Company Type of business Proportion held Country of incorporation and operation
(c) Additional information Summarised aggregate financial information on the Group’s interests in its associates is as follows: Total £m
The Group’s share of associated companies’ contingent liabilities amounted to £nil million at 31 December 2012 (2011: £173 million).
Notes to the consolidated financial statements continued 20 – Property and equipment This note analyses our property and equipment, which are primarily properties occupied by Group companies, properties under construction and computer equipment.
Transfers (to) investment property (note 21) (111) (32) — — — (143) Fair value gains (6) (3) — — — (9) Transfer to intangible assets (note 17) — — — (3) — (3) Foreign exchange rate movements — (1) — — (7) (8)
Depreciation and impairment At 1 January 2011 — — (7) (640) (310) (957) Charge for the year — — (1) (36) (24) (61)
Impairment charge (see below) — (91) — (5) (10) (106) Foreign exchange rate movements — (1) — 3 6 8
Capitalised expenditure on existing properties 103 8 111 52 9 61
Less: Assets classified as held for sale (18) — (18) — — —
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 include 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.
Notes to the consolidated financial statements continued 22 – Fair value methodology continued Modelled with significant unobservable market inputs – (‘Level 3’) Inputs to Level 3 fair values are unobservable inputs for the asset or liability. Unobservable inputs may have been used to measure fair value to the extent that observable inputs are not available, thereby allowing for situations in which there is little, if any, market activity for the asset or liability at the measurement date (or market information for the inputs to any valuation models). As such, unobservable inputs reflect the assumptions the business unit considers that market participants would use in pricing the asset or liability. Examples are certain private equity investments and private placements. The majority of the Group’s financial assets and certain financial liabilities are valued based on quoted market information or observable market data. A small percentage (5.5%) of total financial assets recorded at fair value are based on estimates and recorded as Level 3 investments. Where estimates are used, these are based on a combination of independent third-party evidence and internally developed models, calibrated to market observable data where possible. Third-party valuations using significant unobservable inputs validated against Level 2 internally modelled valuations are classified as Level 3, where there is a significant difference between the third-party price and the internally modelled value. Where the difference is insignificant, the instrument would be classified as Level 2.
Discussion on the valuation techniques applied to value financial liabilities carried at fair value is included in the relevant footnote disclosure for the financial liability. For the year to 31 December 2012, transfers of financial assets from fair value hierarchy Level 1 to Level 2 amounted to £1.3 billion (2011: £2.2 billion), and £0.3 billion (2011: £9 million) from Level 2 to Level 1. The transfers from Level 1 to Level 2 arose primarily in France (£1.0 billion) and the UK (£0.3 billion) as a result of changes in the level of activity and environment in the markets from which prices are sourced. For the year to 31 December 2012, there were no transfers of financial liabilities between fair value hierarchy levels (2011: no transfers).
Financial investments and loans (notes 23 & 25) Loans — 18,486 — 18,486 9,630 — 28,116
Total funds Balance at 1 January 7,940 483 2,945 11,368 292 8,709 972 2,668 12,349 208 Total net (losses)/gains recognised in the
Deconsolidation of Delta Lloyd — — — — — (1) (518) — (519) —
The transfers into and out of Level 3 in 2012 were predominantly in our business in France and related principally to changes in the market liquidity of certain debt securities resulting in changes to the availability of observable market inputs. Of the £959 million net gains (2011: £387 million net losses) recognised in the income statement during the year, a £968 million gain (2011: £390 million losses) is recognised in net investment income and £9 million losses (2011: £3 million gains) relates to impairments and is included in other expenses.
 Notes issued by loan partnerships held by our UK Life business amounting to £1.0 billion (2011: £1.2 billion), for which there is no active market. These are valued using counterparty quotes which are corroborated against index information obtained for similar asset classes, taking into further consideration the quality of the underlying loan portfolio, leverage structure, credit rating, illiquidity margins, market spreads and duration.
 Private equity investment funds amounting to £1.3 billion (2011: £1.5 billion), of which £1.1 billion (2011: £0.9 billion) is held by our UK business. In valuing our interest in these funds, we rely on investment valuation reports received from the fund manager, making adjustments for items such as subsequent draw-downs and distributions between the date of the report and the balance sheet date and the fund manager’s carried interest. In addition, an indexation adjustment is made to reflect changes in appropriate equity market indices between the valuation report date and balance sheet date.
 Certain strategic interests in banking partners held by our Italian business amounting to £0.3 billion (2011: £0.3 billion). Valuations are based on third-party independent appraisals, or where internally modelled, transactions in similar entities, discounted cash flow techniques and valuation multiples, using public and internal management information.
Notes to the consolidated financial statements continued 22 – Fair value methodology continued (iii) Where possible, the Group tests the sensitivity of the fair values of Level 3 investments to changes in unobservable inputs to reasonable alternatives. 99% (2011: 99%) 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.
(a) Carrying amounts The carrying amounts of loans at 31 December 2012 and 2011 were as follows: At fair value through profit or loss other than trading £m
UK securitised mortgage loans (see note 24) 2,218 — 2,218 2,154 — 2,154
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 49). Of the above loans, £19,179 million (2011: £21,626 million) are due to be recovered in more than one year after the statement of financial position date.
Notes to the consolidated financial statements continued 23 – Loans continued Loans at amortised cost The fair value of these loans at 31 December 2012 was £8,735 million (2011: £9,532 million).
Notes to the consolidated financial statements continued 24 – Securitised mortgages and related assets The Group, in our UK Life business has loans receivable, secured by mortgages, which have then been securitised through nonrecourse borrowings. This note gives details of the relevant transactions.
Securitised mortgage loans At fair value (note 23) 2,218 (1,515) 2,154 (1,486) Other securitisation assets/(liabilities) 351 (1,054) 191 (859)
Fixed maturity securities Debt securities UK government — 18,348 — 18,348 115 18,129 — 18,244
Equity securities Ordinary shares Public utilities — 3,684 — 3,684 — 4,133 — 4,133 Banks, trusts and insurance companies — 7,196 62 7,258 — 6,184 81 6,265 Industrial, miscellaneous and all other — 22,397 1 22,398 — 21,857 1 21,858
Other investments Unit trusts and other investment vehicles — 26,315 441 26,756 — 26,775 485 27,260
Notes to the consolidated financial statements continued 25 – Financial investments continued (b) Cost, unrealised gains and fair value The following is a summary of the cost/amortised cost, gross unrealised gains and losses and fair value of financial investments: Cost/ amortised cost £m
(c) Impairment of financial investments The movements in impairment provisions on available-for-sale financial investments for the years ended 31 December 2011 and 2012 were as follows: Fixed maturity securities £m
Non UK Government Debt Securities 2012 £m £m £m £m £m 2012 £m £m
Less: assets of operations classified as held for sale 197 34 556 9 2,274 19 3,027 62
Notes to the consolidated financial statements continued 25 – Financial investments continued (f) Exposure to worldwide banks – debt securities Direct shareholder and participating fund assets exposures to worldwide bank debt securities (net of non-controlling interests, excluding policyholder assets)
Net of non-controlling interests, our direct shareholder assets exposure to worldwide bank debt securities is £6.5 billion. The majority of our holding (65%) is in senior debt. The primary exposures are to US (32%) and UK (20%) banks. Net of non-controlling interests, our direct shareholder asset exposure to worldwide bank equity securities is £0.2 billion. Our holdings include strategic holdings in Italian banks of £148 million. Net of non-controlling interests, the participating fund exposures to worldwide bank debt securities, where the risk to our shareholders is governed by the nature and extent of our participation within those funds, is £15.6 billion. The majority of the exposure (75%) is in senior debt. Participating funds are the most exposed to French (28%), UK (14%) and Dutch (14%) banks.
Less: assets of operations classified as held for sale 1.4 1.1 2.5 0.2 0.1 0.3
Deferrable acquisition costs (DAC) 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. Of the above total, £1,351 million (2011: £3,148 million) is expected to be recovered more than one year after the statement of financial position date; the reduction in this amount reflects that the DAC balance for the US is included in amounts classified as held for sale at 31 December 2012. For long-term business where amortisation of the DAC balance depends on projected profits, the amount expected to be recovered is estimated and actual experience will differ. Surpluses in the staff pension schemes are recoverable more than one year after the statement of financial position date.
The balance of deferred acquisition costs for long-term business decreased by £0.7 billion in 2012, reflecting the impact of assumption changes and shadow adjustment in the US. 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 the DAC balance would reduce profit by £30 million (2011: £145 million) if market yields on fixed income investments were to increase by 1% and increase profit by £50 million (2011: £170 million) if yields were to reduce by 1%. The reduction in sensitivities for 2012 reflects that the US business is held for sale and carried at fair value less cost to sell. The shadow adjustments relate to deferred acquisition costs on business in the US backed by investments classified as AFS. 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 £3,104 million including assets classified as held for sale (2011: £3,235 million), includes £108 million (2011: £90 million) that is expected to be recovered more than one year after the statement of financial position date.
Debt securities 16,472 15,295 Equity securities 22,500 20,602 Reinsurance assets 1,576 1,454 Cash and cash equivalents 4,305 3,980
(a) Details of the Company’s ordinary share capital are as follows: £m £m
(b) During 2012, a total of 40,259,323 ordinary shares of 25 pence each were allotted and issued by the Company as follows: Number of shares
(ii) Executive share options These are options granted on various dates until 2004 under the Aviva Executive Share Option Plan 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 Equity (ROE) 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.
(iv) Annual bonus plan awards These awards have been made under the Aviva Annual Bonus Plan 2005 and Aviva Annual Bonus Plan 2011, and are described in section (b) below and in the Directors’ Remuneration Report.
(viii) Conditional share award granted to Trevor Matthews A conditional share award was awarded to Trevor Matthews as compensation for the loss of share awards granted by his previous employer. The awards are described in section (b) below and in the Directors’ Remuneration Report.
The following table summarises information about options outstanding at 31 December 2012: Range of exercise prices
Notes to the consolidated financial statements continued 30 – Group’s share plans continued (ii) Share awards At 31 December 2012, awards issued under the Company’s executive incentive plans over ordinary shares of 25 pence each in the Company were outstanding as follows: Aviva Long Term Incentive Plan 2005 Number of shares Vesting period
The vesting of awards under the Aviva Long Term Incentive Plan 2005, the Aviva Long Term Incentive Plan 2011, the OATTV bonus plan and the OATTV Award under the CFO Recruitment Share Awards Plan is subject to the attainment of performance conditions as described in the Directors’ Remuneration Report. Shares which do not vest will lapse.
(iii) Shares to satisfy awards and options Since July 2008, it has been the Company’s practice to satisfy all awards and options using shares purchased in the market and held by employee trusts except where local regulations make it necessary to issue new shares. Further details are given in note 31.
(c) Movements in the year A summary of the status of the option plans as at 31 December 2011 and 2012, and changes during the years ended on those dates, is shown below.
Notes to the consolidated financial statements continued 30 – Group’s share plans continued (d) Expense charged to the income statement The total expense recognised for the year arising from equity compensation plans was as follows: £m £m
(i) Share options The fair value of the options was estimated on the date of grant, based on the following weighted average assumptions: Weighted average assumption 2012 2011
The expected volatility used was based on the historical volatility of the share price over a period equivalent to the expected life of the option 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. 2,862,952 options granted after 7 November 2002 were exercised during the year (2011: 182,907).
(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 2012 2011
Notes to the consolidated financial statements continued 31 – Shares held by employee trusts We satisfy awards and options granted under the Group’s share plans primarily through shares purchased in the market and held by employee share trusts. This note gives details of the shares held in these trusts. Movements in the carrying value of shares held by employee trusts comprise: Number £m Number £m
The euro and sterling direct capital instruments (the DCIs) were issued on 25 November 2004 and qualify as Innovative Tier 1 capital, as defined by the Financial Services Authority in GENPRU Annex 1 ‘Capital Resources’. They have no fixed redemption date but the Company may, at its sole option, redeem all (but not part) of the euro and sterling DCIs at their principal amounts on 28 November 2014 and 27 July 2020 respectively, at which dates the interest rates change to variable rates, or on any respective coupon payment date thereafter. In the case of the sterling DCI this variable rate will be the six month sterling deposit rate plus margin while the euro DCI variable rate will be the three month euro deposit rate plus margin. The fixed rate tier 1 notes (the FxdRNs) were issued on 3 May 2012 and also qualify as Innovative Tier 1 capital. The FxdRNs are perpetual but are subject to a mandatory exchange into non-cumulative preference shares in the Company after 99 years. The Company may, at its sole option, redeem all (but not part) of the FxdRNs at their principal amounts on 3 November 2017, or on any respective coupon payment date thereafter. On the occurrence of a Capital Disqualification Event as defined in the terms and conditions of the issue for both the DCIs and FxdRNs, the Company may at its sole option substitute at any time not less than all of the DCIs or FxdRNs for, or vary the terms of the DCIs so that they become, Qualifying Tier 1 Securities or Qualifying Upper Tier 2 Securities. In addition, on the occurrence of a Substitution Event as defined in the terms and conditions of the issue for the DCIs, the Company may at its sole option substitute not less than all of the DCIs for fully paid non-cumulative preference shares in the Company. These preference shares can only be redeemed on 28 November 2014 in the case of the euro DCIs and on 27 July 2020 in the case of the sterling DCIs, or in each case on any dividend payment date thereafter. For the FxdRNs, having given the required notice, the Company has the right to substitute not less than all of the notes for fully paid non-cumulative preference shares at any time. These preference shares can only be redeemed on 3 November 2017, or on any dividend payment date thereafter. The Company has the right to choose whether or not to pay any dividend on the new shares, and any such dividend payment will be noncumulative. The Company has the option to defer coupon payments on the DCIs or FxdRNs on any relevant payment date. In relation to the DCIs, deferred coupons shall be satisfied only in the following circumstances, all of which occur at the sole option of the Company:  Redemption; or  Substitution by, or variation so they become, alternative Qualifying Tier 1 Securities or Qualifying Upper Tier 2 Securities; or  Substitution by preference shares.
Notes to the consolidated financial statements continued 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 net of non-controlling interests: Currency translation reserve (see accounting policy E)
Arising in the year: Fair value gains — (3) 554 — — 551 Fair value gains transferred to profit on disposals — — (234) — — (234) Transfer to profit on disposal of subsidiaries, joint ventures and associates 91 — 96 — — 187 Share of fair value changes in joint ventures and associates taken to other comprehensive income (note 18a & 19a) — — 14 — — 14 Impairment losses on assets previously revalued directly through other comprehensive income now taken to income statement — — 12 — — 12 Reserves credit for equity compensation plans — — — — 42 42 Shares issued under equity compensation plans (note 36) — — — — (68) (68) Foreign exchange rate movements (367) — — 74 — (293) Aggregate tax effect – shareholders’ tax 18 1 (117) — — (98)
36 – Retained earnings This note analyses the movements in the consolidated retained earnings during the year.
The shares issued in lieu of dividends are in respect of the transfer to retained earnings from the ordinary dividend account, arising from the treatment of these shares explained in note 29(b). The Group’s regulated subsidiaries are required to hold sufficient capital to meet acceptable solvency levels based on applicable local regulations. Their ability to transfer retained earnings to the UK parent companies is therefore restricted to the extent these earnings form part of local regulatory capital.
Notes to the consolidated financial statements continued 37 – Non-controlling interests This note gives details of the Group’s non-controlling interests and shows the movements during the year.
Provision arising from liability adequacy tests (11) — (11) (13) — (13)
Less: Amounts classified as held for sale 38,501 (883) 37,618 344 (1) 343 1 Following a review of the classification of contracts issued by the Group’s Italian long-term business, there has been a reallocation from participating insurance liabilities at 31 December 2011 to participating investment contract liabilities of £2,722 million.
Notes to the consolidated financial statements continued 39 – Insurance liabilities This note analyses the Group insurance contract liabilities by type of product and describes how the Group calculates these liabilities and the assumptions the Group used.
Long-term business provisions Participating 49,473 — 49,473 52,872 — 52,872 Unit-linked non-participating 9,936 — 9,936 10,168 — 10,168
Provision for unearned premiums — 4,441 4,441 — 4,483 4,483 Provision arising from liability adequacy tests — 11 11 — 13 13 Other technical provisions — — — — — —
1 Following a review of the classification of contracts issued by the Group’s Italian long-term business, there has been a reallocation from participating insurance liabilities at 31 December 2011 to participating investment contract liabilities of £2,722 million.
(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).
– Old With-Profits sub-fund (OWPSF), With-Profits sub-fund (WPSF) and Provident Mutual sub-fund (PMSF) of UKLAP, where the with-profit policyholders are entitled to at least 90% of the distributed profits, the shareholders receiving the balance.
(iii) Methodology and assumptions There are two main methods of actuarial valuation of liabilities arising under long-term insurance contracts – the net premium method and the gross premium method – both of which involve the discounting of projected premiums and claims. Under the net premium method, the premium taken into account in calculating the provision is determined actuarially, based on the valuation assumptions regarding discount rates, mortality and disability. The difference between this premium and the actual premium payable provides a margin for expenses. This method does not allow for voluntary early termination of the contract by the policyholder, and so no assumption is required for persistency. The gross premium method uses the amount of contractual premiums payable and includes explicit assumptions for interest and discount rates, mortality and morbidity, persistency and future expenses. These assumptions can vary by contract type and reflect current and expected future experience.
In the Provident Mutual and With-Profits sub-funds in UKLAP, this is offset by the expected cost of charges to WPBR to be made in respect of guarantees. The cost of future policy-related liabilities is determined using a market-consistent approach and, in the main, this is based on a stochastic model calibrated to market conditions at the end of the reporting period. Non-market-related assumptions (for example, persistency, mortality and expenses) are based on experience, adjusted to take into account future trends. The principal assumptions underlying the cost of future policy-related liabilities are as follows:
Notes to the consolidated financial statements continued 39 – Insurance liabilities continued Future investment return A ‘risk-free’ rate equal to the spot yield on UK swaps was used. This replaced the use of a spot yield on UK government securities plus a margin of 0.1%, which was used at 31 December 2011. The rates vary according to the outstanding term of the policy, with a typical rate as at 31 December 2012 of 1.92% (2011: 2.20%) for a policy with ten years outstanding.
Non-profit business The valuation of non-profit business is based on regulatory requirements, adjusted to remove certain regulatory reserves and margins in assumptions, notably for annuity 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.
Notes to the consolidated financial statements continued 39 – Insurance liabilities continued 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 2012 2011
Assurances Life conventional non-profit 1.8% 1.8% to 1.9% Pensions conventional non-profit 2.2% 2.6% Annuities Conventional immediate and deferred annuities 2.6% to 4.1% 2.2% to 4.3% Non-unit reserves on Unit Linked business Life 2.1% 1.8% to 2.2%
The above valuation discount rates are after reduction for investment expenses and credit risk. For conventional immediate annuity business the allowance for credit risk comprises long-term assumptions for default and downgrades, which vary by the credit ratings for bonds and mortgages, and short-term supplementary allowances for higher expected defaults during the current economic conditions. The credit risk allowance made for corporate bonds and commercial mortgages, including healthcare mortgages, held by Aviva Annuity UK Limited equated to 56 bps and 89 bps respectively at 31 December 2012 (2011: 60 bps and 69 bps respectively). For corporate bonds, the allowance represented 30% of the average credit spread for the portfolio (2011: 26%). The total valuation allowance held by Aviva Annuity UK Limited in respect of corporate bonds and mortgages, including healthcare mortgages, was £1.8 billion (2011: £1.6 billion) over the remaining term of the UK Life corporate bond and commercial mortgage portfolio. Total liabilities for annuity business were £30 billion at 31 December 2012 (2011: £27 billion). Mortality assumptions for non-profit business are set with regard to recent Company experience and general industry trends. The mortality tables used in the valuation are summarised below: Mortality tables used 2012 2011
General annuity business IML00/IFL00 adjusted plus allowance for future mortality improvement
(b) France The majority of reserves arise from single premium savings products and are based on the accumulated fund values, adjusted to maintain consistency with the value of the assets backing the policyholder liabilities. For traditional business the net premium method is used for prospective valuations, in accordance with local regulation, where the valuation assumptions depend on the date of issue of the contract. The valuation discount rate also depends on the original duration of the contract and mortality rates are based on industry tables.
Carrying amount at 1 January 131,171 157,988 Provisions in respect of new business 8,631 10,894 Expected change in existing business provisions (8,362) (8,541) Variance between actual and expected experience 943 (2,279) Impact of other operating assumption changes (718) (61) Impact of economic assumption changes 1,726 5,663 Other movements (109) (623) Change in liability recognised as an expense 2,111 5,053 Effect of portfolio transfers, acquisitions and disposals (214) (6) Deconsolidation of Delta Lloyd — (32,159) Foreign exchange rate movements (1,878) 295
Carrying amount at 31 December 131,190 131,171 1 Following a review of the classification of contracts issued by the Group’s Italian long-term business, there has been a reallocation from participating insurance liabilities at 31 December 2011 to participating investment contract liabilities of £2,722 million.
The variance between actual and expected experience of £0.9 billion in 2012 was primarily due to the impact of favourable investment returns on liabilities for unit-linked insurance contracts. For many types of long-term business, including unit-linked and participating funds, movements in asset values are offset by corresponding changes in liabilities, limiting the net impact on profit. Minor variances arise from differences between actual and expected experience for persistency, mortality and other demographic factors. The impact of assumption changes in the above analysis shows the resulting movement in the carrying value of insurance liabilities. The £1.7 billion impact of economic assumption changes reflects reductions in valuation interest rates, primarily in respect of immediate annuity and participating insurance contracts in the UK. The £0.7 billion impact of operating assumption changes mainly relates to mortality assumption in the UK, with the net impact reduced by movements in corresponding reinsurance assets. For participating business, a movement in liabilities is generally offset by a corresponding adjustment to the unallocated divisible surplus and does not impact on profit. Where assumption changes do impact on profit, these are included in the effect of changes in assumptions and estimates during the year shown in note 43, together with the impact of movements in related non-financial assets.
Reinsured London Market business 2.0% 2.20% 11 years 13 years Latent claims 0.33% to 3.35% 0.75% to 3.25% 6 to 15 years 7 to 16 years Structured settlements 2.60% 2.70% 33 years 31 years
The gross outstanding claims provision before discounting was £11,004 million (2011: £11,420 million). The period of time which will elapse before the liabilities are settled has been estimated by modelling the settlement patterns of the underlying claims. The discount rate that has been applied to latent claims reserves is based on the relevant swap curve in the relevant currency having regard to the expected settlement dates of the claims. The range of discount rates used depends on the duration of the claims and is given in the table above. The duration of the claims span over 35 years, with the average duration being between 6 and 15 years depending on the geographical region. Any change in discount rates between the start and the end of the accounting period is reflected below operating profit as an economic assumption change. During 2012, the Group has seen a levelling off in the number of new bodily injury claims settled by periodic payment orders (PPOs) or structured settlements, which are reserved for on a discounted basis.
Interest rates used to discount latent claim liabilities The discount rates used in determining our latent claim liabilities are based on the relevant swap curve in the relevant currency at the reporting date, having regard to the duration of the expected settlement of latent claims. The range of discount rates used is shown in section (ii) above and depends on the duration of the claim and the reporting date. At 31 December 2012, it is estimated that a 1% fall in the discount rates used would increase net claim reserves by approximately £95 million, excluding the offsetting effect on asset values as assets are not hypothecated across classes of business. The impact of a 1% fall in interest rates across all assets and liabilities of our general insurance and health businesses is shown in note 56.
Carrying amount at 1 January 10,745 12,263 Impact of changes in assumptions 61 149 Claim losses and expenses incurred in the current year 6,291 6,520 Decrease in estimated claim losses and expenses incurred in prior years (199) (140) Exceptional strengthening of general insurance latent claims provisions — 45
Key elements of the release from prior accident year general insurance and health net provisions during 2011 were:  £42 million strengthening from UK & Ireland, including Group reinsurance business, mainly due to unfavourable development on commercial motor, commercial liability and December 2010 freeze claims in the UK offset by favourable development of personal and commercial motor claims in Ireland.
 £6 million release from Europe mainly due to favourable development of personal and commercial motor claims in France offset by adverse development in Italy and Delta Lloyd.
Present value recognised in the statement of financial position 2,319 75 119 172 282 438 611 808 1,041 1,543 3,146 10,554
Change in UPR recognised as income 21 265 Gross portfolio transfers and acquisitions (6) (161) Deconsolidation of Delta Lloyd — (424) Foreign exchange rate movements (57) (52)
Accident year All prior years £m 2003 £m £m £m £m £m £m £m £m
Net cumulative claim payments At end of accident year (2,819) (2,870) (3,281) (3,612) (4,317) (4,808) (3,650) (3,386) (3,300) (2,925)
Two years later (4,565) (4,712) (5,344) (5,881) (7,052) (7,638) (5,885) (5,637) Three years later (4,924) (4,986) (5,671) (6,181) (7,356) (8,094) (6,177) Four years later (5,180) (5,163) (5,892) (6,434) (7,664) (8,356) Five years later (5,325) (5,327) (6,039) (6,625) (7,852) Six years later (5,442) (5,430) (6,188) (6,724) Seven years later (5,502) (5,491) (6,245) Eight years later (5,567) (5,524) Nine years later (5,592) Estimate of net ultimate claims At end of accident year 6,218 6,602 6,982 7,430 8,363 9,262 7,115 6,650 6,202 5,941
Two years later 6,037 6,082 6,688 7,104 8,244 9,028 7,036 6,685 Three years later 5,942 5,882 6,544 6,996 8,249 9,007 6,978 Four years later 5,851 5,709 6,476 6,980 8,210 8,962 Five years later 5,772 5,699 6,448 6,992 8,221 Six years later 5,683 5,639 6,397 6,939 Seven years later 5,663 5,624 6,372 Eight years later 5,667 5,613 Nine years later 5,649 Estimate of net ultimate claims 5,649 5,613 6,372 6,939 8,221 8,962 6,978 6,685 6,103 5,941
Present value recognised in the statement of financial position 1,365 71 106 168 265 409 590 789 1,016 1,505 3,016 9,300
Notes to the consolidated financial statements continued 40 – Liability for investment contracts This note analyses our investment contract liabilities by type of product and describes how the Group calculates these liabilities and the assumptions used.
(a) Carrying amount The liability for investment contracts at 31 December comprised: Long-term business 2012 £m
1 Following a review of the classification of contracts issued by the Group’s Italian long-term business, there has been a reallocation from participating insurance liabilities at 31 December 2011 to participating investment contract liabilities of