02 Chairman’s statement 04 Business overview 06 Group chief executive’s review 08 Operating review 20 Employees 22 Corporate social responsibility 24 Financial review 42 Board of directors 45 Directors’ report 47 Corporate governance 50 Audit committee report 52 Nomination committee report 53 Directors’ remuneration report 63 Independent auditors’ report 64 Accounting policies 67 Consolidated profit and loss account Technical account – long-term business 68 Consolidated profit and loss account Technical account – general business 69 Consolidated profit and loss account Non-technical account 70 Pro forma reconciliation of Group operating profit to profit on ordinary activities before tax 71 Consolidated statement of total recognised gains and losses 71 Reconciliation of movements in consolidated shareholders’ funds 72 Consolidated Group balance sheet 74 Consolidated cash flow statement 75 Company balance sheet 76 Notes to the accounts 112 Five year review 114 Introduction of International
Shareholder profile The categories of ordinary shareholders and the ranges and size of shareholdings as at 31 December 2004 are set out below: Analysis of shareholders No. of shareholders % No. of shares %
Useful contact details Detailed below are various addresses that shareholders may find useful if they have a query in respect of their shareholding.
General insurance 5 Continental Europe 6% 6 Rest of world 4%
Aviva is the world’s fifth-largest insurance group~and the biggest in the UK. It is one of the leading providers of life and pensions products in Europe and has substantial businesses elsewhere around the world. Its main activities are long-term savings, fund management and general insurance. It has premium income and investment sales of £33 billion≈ and £273 billion of assets under management. The group has 49,000 employees serving 30 million customers worldwide.
The board has recommended a final dividend of 16.00 pence net per share which brings the total for the year to 25.36 pence. We have lived up to our commitment to increase dividends by around 5% a year on the condition that we have sufficient dividend cover.
Our shares did quite well last year, after a difficult period of depressed equity markets. We outperformed our peers in the insurance sector, both in the UK and in Europe at large. We measure our performance against our competitors with an ambition to continue to outperform.
On corporate social responsibility, we are participating both in the United Nations Global Compact programme and in European activities. We wish to be the best, and we are pleased to be recognised as one of the prime movers in this field.
Aviva has a new finance director, Andrew Moss, and three new non-executive board directors, Richard Goeltz, Russell Walls, and most recently, Lord Sharman of Redlynch OBE. Each of these individuals brings wide experience from the financial services industry and from working internationally.
We continue to strive for greater efficiency and excellence in our profession, and on that basis we aim to improve shareholder value.
Aviva relative to FTSE Eurotop 300 Life and FTSE Eurotop 300, for 2004
Our credentials Our strategy is to grow this business aggressively and profitably by building strong positions in our chosen markets. Aviva is one of the leading life and pensions providers in Europe. We are the largest company in the UK long-term savings market and have a leading bancassurance business in the Spanish life market. We are among the top five in the Netherlands, Ireland, Poland, Turkey and Singapore, among the top 10 in France, Italy, Belgium, Romania and Australia, and have significant operations in the United States and Germany. We have also established businesses with strong long-term potential in India and China.
Performance Operating profit before tax from continuing operations, including life European embedded value (EEV) operating return £1,611m Geographical analysis of net premium income and investment sales from continuing operations
Developments in 2004 • New bancassurance partnership with Crédit du Nord – gives greatly strengthened distribution capability in an important channel in the French long-term savings market.
• Life and pensions new business sales increased to £15.6 billion with growth of 22% in continental Europe.
• Joint venture in India expanded to six bancassurance partnerships and a 3000-strong direct sales force. Joint venture in China now operational in three cities.
• Higher profits generated on improved new business sales, with new business contribution** increased to £706 million.
We continue to develop our presence as a leading international fund manager, with worldwide assets under management of £273 billion. We are the second-largest UK-based fund manager and among the top five in Ireland. We also have significant businesses in France, the Netherlands and in Australia through our investment platform, Navigator. This in-house expertise aims to generate superior investment performance for shareholders, policyholders and third party institutional clients, and supports our long-term savings businesses by investing funds on their behalf.
Bu si ne ss o ve rv ie w £43m* £1,326m
• Sustainability of excellent results demonstrated by a further improvement in the group combined operating ratio to 97%, beating our group target of 100%.
• Further increase in operational efficiency through cost reduction and improvements across product delivery, administration and claims handling.
• Product innovations benefiting both customers and shareholders remain a key part of our strategy – Pay As You DriveTM pilot and digital flood map implementation both well underway.
• Extension of the penalty point initiative by Hibernian in Ireland – now offers even higher discounts to drivers without penalty points.
We benefit from our diversified business model, which combines substantial life and general insurance operations, supported by a broad range of products sold through a variety of distribution channels.
Worldwide long-term savings new business sales were £17.2 billion (2003: £14.9 billion) as we saw some recovery in equity markets. Long-term savings new business sales in continental Europe were £8,339 million (2003: £6,932 million), with strong performances from our bancassurance distribution agreements. Worldwide gross premiums written were £33,043 million (2003: £31,184 million). Pre-tax life operating return on a European embedded value (EEV) basis was £1,611 million (2003: £1,496 million).
On a modified statutory basis, group operating profit before tax was £1,861 million (2003: £1,490 million). Our total dividend for 2004 is 25.36 pence, an increase of 5% with a dividend cover of 2.25 times, in line with our dividend policy. The group delivered an overall profit before tax of £1,488 million (2003: £1,390 million).
The group’s capital position was further strengthened by the issue of a direct capital instrument of £1.0 billion in November 2004, which was four times oversubscribed. The transaction allowed us to lock into favourable funding rates.
Attaining operational excellence Controlling costs is an important element in our drive for profitable growth. We continue to improve our operational efficiency by taking advantage of economies of scale. We also apply strict financial targets for developments and new projects across our businesses.
We plan to create a further 950 jobs offshore in 2005 to service our Norwich Union businesses in the UK. This builds on the 3,700 jobs we have already created offshore and is a further major investment as part of our focus on excellent customer service. We expect to conclude our offshoring plans by the end of 2007, by which time we shall have up to 7,000 roles offshore.
Taking into account all our cost-efficiencies during 2004, the net pre-tax benefit to the profit and loss account for the year relative to 2003 was £52 million. This was ahead of our target.
Financial reporting In 2005, Aviva will report its statutory results in line with new International Financial Reporting Standard (IFRS). We have chosen to adopt the European embedded value (EEV) principles early for our 2004 supplementary results. These principles are a refinement of our approach and provide significantly enhanced disclosures to assist the investment markets. We have also been preparing to meet the requirements of the Prudential Sourcebook (PSB) for insurers introduced by the Financial Services Authority.
Taken together, IFRS, EEV and PSB represent a substantial change in how we report our financial position and performance. Thanks to our investment in a groupwide programme to update our financial reporting and financial management systems – and the hard work of hundreds of our staff – Aviva is well positioned to meet the technical and regulatory challenges that these changes represent.
Industry perspective In my role as chairman of the Association of British Insurers, I have continued to lead the industry’s work on improving communications with governments, regulators and consumers.
Our competitive advantage depends on employing people with different backgrounds, experiences and perspectives, and who feel valued for the positive contribution they can make to Aviva’s success. I thank all our staff worldwide for what they have achieved and continue to do so on behalf of our customers and shareholders.
There are signs that consumers are slowly regaining their appetite for saving. Our business mix, geographical spread and distribution capability mean Aviva is well placed to capture more than our fair share of an upturn. We have set ourselves ambitious and challenging growth targets for 2005. We are pushing ourselves to reach even higher levels of performance. I am confident that we shall succeed.
Business strategy Our long-term savings business is the group’s major engine for growth, accounting for 73% of total net premiums written. Our strategy is to achieve profitable growth by providing customers with a wide choice of high-quality products through a mix of distribution channels.
Hibernian consolidated its position as Ireland’s number three life and pensions company, with a market share of 11%. We are also among the top five in the Netherlands, Poland, Turkey, Lithuania and Singapore, among the top 10 in France, Italy, Belgium, Romania, Australia and India, and have significant operations in the United States and Germany. Our long-term savings operations in India and China are developing well, with large potential for growth over the longer term.
Distribution We believe that a strong multi-distribution capability is a fundamental part of offering choice and excellent service to our customers.
In the UK, independent financial advisers (IFAs) continue to be our main channel, producing around 75% of sales. In the run-up to depolarisation, we have announced multi-tie agreements with leading IFA networks Bankhall, Sesame and Millfield, the Portman Building Society, Barclays and Fidelity.
We are also building our new product development capability. Norwich Union is developing a market-leading “wrap” proposition through Lifetime, now a Norwich Union subsidiary company following an increased equity investment in October 2004. This provides an IT service platform that allows financial advisers to manage and transact a range of different client investments online. Through Lifetime we aim to secure new distribution relationships, open new revenue channels through fees charged, and further strengthen relationships with our distribution partners.
We operate a joint venture in India with Dabur Group, one of that country’s largest groups of companies. About 70% of our sales are generated through six bancassurance partnerships – with ABN AMRO, American Express, Bank of Bahrain and Kuwait, Canara Bank, Lakshmi Vilas Bank and, most recently, Punjab & Sind Bank. Through our bancassurance partners, corporate agents and brokers, Aviva products are now available in more than 130 locations around the country. Our direct sales force has also grown and now comprises more than 3,000 specialist financial planning advisers.
Our joint venture in China with COFCO to sell life and pensions products through banks, direct sales, brokers and agents continues to expand. In addition to our operation in Guangzhou, we opened branches in Beijing and Chengdu in September 2004.
Customer service We are committed to delivering excellent service to our customers. We are driving best practice throughout our business by sharing expertise, and have achieved good standards of service across our life businesses.
Pre-tax EEV operating return was £1,611 million (2003: £1,496 million), driven by improved new business contribution and increased returns on a higher value of assets at the start of the year. The higher new business contribution amounted to £706 million (2003: £646 million) and reflected growth in the UK, France and the Netherlands.
We continue in talks with the UK government about the future development of the UK long-term savings market. During the year we had confirmation of the price cap for stakeholder products. While not as much as we had hoped for, it creates potential for us to sell a greater number of products. During the final quarter of 2004 we took a number of actions to reposition our pension product offering. We reduced commission levels on individual “stakeholder” pensions and introduced a new “non-stakeholder” personal pension for the “full advice” market giving customers the opportunity to pay for their advice through fees, commission or a combination of both. We will continue to design and manage our pricing and commission structures to attract appropriate volumes and value of business.
In 2004 Norwich Union consolidated its market-leading position and starts 2005 with a greater degree of confidence in the market. Some further market growth is expected over the next 12 months with a stronger pick-up beyond then, and we are confident that our multi-distribution capability, strong brand and wide product range will enable us to capitalise on this.
Following the French government’s introduction of a new pension framework, Aviva France launched its Plan d’Epargne Retraite Populaire (PERP) in June 2004. Sales to date of the PERP product have been moderate, as higher net worth individuals, who are the target market for Aviva France, have yet to embrace annuity type products. However, the publicity surrounding the launch of the government’s pension reforms was used to stimulate investment in other existing products, in particular regular premium savings plans.
We continued our drive to achieve cost efficiencies and reduce operating expenses while preparing our back office teams to combine the in-force and future business generated by the Crédit du Nord partnership.
Pensions business is the main sector in the Irish market. Our focus on winning new pensions business resulted in an increase in single premium sales to £149 million (2003: £137 million) and regular premium sales to £48 million (2003: £46 million). Sales of personal retirement savings account (PRSA) products remained low, in line with experience across the industry. However, the publicity from these products has boosted sales of pensions business overall.
* Including share of associates’ premiums. **On a European embedded value (EEV) basis. † On an achieved profits basis.
Life regular premium sales increased to £18 million (2003: £16 million), reflecting an increase in protection business and additional new premiums on existing Special Savings Incentive Account (SSIA) policies.
In the third quarter of 2004, we launched a web-enabled new business system, Write Now. This system will deliver improvements to the quality and efficiency of our service to brokers in processing new business sales.
Italy New business sales in Italy increased to £1,574 million (2003: £1,453 million), ahead of modest market growth. This included sales through our bancassurance partnerships of £1,458 million (2003: £1,245 million). Operating return** improved to £79 million (2003: £70 million).
Spain We achieved good underlying growth in Spain, with new business sales up 16% to £1,657 million (2003: £1,464 million). This excludes one-off sales of £242 million (2003: £149 million) from a large bulk pension transfer during the year.
Total sales through our bancassurance partnerships were £1,579 million (2003: £1,407 million). We are also seeing growth in Aviva Vida y Pensiones, which sells through professional intermediaries and a direct sales force, supported by a branch network.
In line with our strategy of pursuing profit over volume, our focus during 2004 was to sell higher-margin protection products rather than traditional savings plans. Operating return** increased to £180 million (2003: £165 million).
We continue to keep our costs low in both Spain and Italy by using a “factory” company in each country to produce and administer bancassurance products. This operating model provides considerable cost and scale efficiencies.
Netherlands, including Belgium and Luxembourg Delta Lloyd achieved a 32% increase in life and pensions new business sales to £1,279 million (2003: £989 million). This included improved sales of £238 million (2003: £227 million) from our bancassurance partnership with ABN AMRO in the Netherlands, where bonds and regular premium mortgage products were particularly successful.
Sales were also higher through our intermediary and direct channels, with a strong improvement in group pensions new business. Total life sales were higher at £563 million (2003: £420 million), with improved sales of bonds and savings products. Unit-linked products became more attractive to investors as equity markets showed more stability.
Cost control remains a key focus for our Dutch business. Our shared service centre for administrative functions will be expanded to bring further economies of scale. In May 2004 we outsourced Delta Lloyd’s information and communication technology (ICT) infrastructure services, which is expected to bring further savings. Life sales in Belgium increased, reaffirming our position as a top 10 provider in the market.
International operations Total new business sales through our International operations were £1,008 million (2003: £951 million).
In Singapore and Hong Kong we enjoyed increased new business sales through our bancassurance partnership with DBS. Sales in Singapore were focused on higher-margin regular premium products supported by a successful single premium product launch during the third quarter. In Singapore we have around 50% of the regular premium bancassurance market and lead the employee benefits and healthcare business, and the developing broker market. In Hong Kong, total new business sales of primarily single premium products also increased strongly.
In India our joint venture with Dabur Group is developing well. We are ranked eighth among private providers. During 2004 we launched a series of unit-linked funds, with encouraging initial sales. Our 26% share of new business sales was £5 million (2003: £2 million).
Our joint venture life and pensions business in China, Aviva-COFCO, expanded during 2004 and now operates in three cities. Our 50% share of new business sales was £3 million (2003: £1 million).
Outlook We saw some improvement in world markets in 2004, and expect this to continue through 2005. This improvement has led to increasing customer confidence, although it has been slower to return than expected in some places, most notably in the UK. We did however see further signs of growth returning in the UK during the second half of 2004, and we anticipate that this momentum will continue into 2005.
We have focused on improving cost-efficiency over the past two years, an important factor in sustaining our profitability. This, along with our operating model, customer service improvements and geographical spread, has put us in a strong position to achieve growth and improve profitability as we benefit from further market upturns. Our established businesses in the UK and Europe offer further opportunities for growth while our operations in the developing markets of Eastern Europe and Asia provide excellent prospects for the long term.
We continue to develop our business internationally and to focus on our core strengths in fund management. Our aim is to lead in our chosen markets through our research and investment expertise.
We are the second-largest UK-based fund manager, among the top five in Ireland (through Hibernian) and a leading fund manager in the Netherlands (through Delta Lloyd). We also have significant fund management businesses in France and as an investment platform provider in Australia (through Navigator).
Performance Total retail investment sales improved 44% to £1,629 million (2003: £1,141 million), with good performances in the UK, Luxembourg and Australia.
Morley Fund Management Morley is one of the largest UK-based fund management houses, managing a wide range of asset classes, including equities, bonds and property. It provides fund management expertise to Aviva businesses, external pension funds, public sector organisations and public and private companies.
Morley is committed to providing a fund management business capable of competing against the best in our chosen markets. Our focus is on delivering consistent outperformance in our core asset classes of panEuropean equities, fixed income, property, and through strategic asset allocation. We also specialise in socially responsible investment, private equity, alternative investments and global and emerging market equities. As a leading institutional investor, we recognise our responsibilities as a major shareholder and take an active interest in the companies in which we invest.
In 2004, Morley secured £2.2 billion of new funded external mandates (2003: £3.1 billion) from our institutional and retail UK-based businesses.
In addition, we secured £1.1 billion of new funded external mandates in respect of property partnership vehicles, £0.7 billion from overseas operations, and £0.3 billion from pooled pensions business. Our expertise in asset allocation was acknowledged when we won an innovative mandate to manage the asset mix of a £200 million pension fund. The breadth and quality of our property operation was recognised when we were voted property fund manager of the year in Property Week’s Property Awards 2004.
A number of new funds were launched during 2004, including property partnership vehicles, a pan-European equity fund and a new Aviva Multimanager fund of funds that can be sold across Europe. We are launching the Central European Property Fund, which will invest in commercial property in the developing markets of Poland, Hungary and the Czech Republic. We continue to build on our hedge fund capability with the planned launch in early 2005 of the Central European Long Short Fund, aimed at European institutional investors and high-net-worth individuals. We have also been promoting specialist fixed income products to meet increasing interest from pension fund consultants.
Morley’s operating profit of £12 million (2003: £3 million) for its institutional and retail UK-based businesses was an encouraging result. Within the Aviva group results there are additional profits of £12 million (2003: £6 million) from other Morley businesses, including our pooled pensions business and overseas operations. This brings the total Morley group profit to £24 million (2003: £9 million) for the year.
Assets under management for Morley’s global operations increased to £134 billion.
The operating result from our Norwich Union business improved to a profit of £5 million (2003: loss of £3 million) as a result of lower costs. Our joint venture with RBSG reported an operating loss of £7 million (2003: loss of £6 million), due to significant upfront costs associated with the sale of regular premium investment products.
UK sales Total sales of retail investment products through Morley and Norwich Union were £789 million (2003: £577 million). Our share of sales through our collective investment joint venture with RBSG was £70 million (2003: £103 million).
We have £45 billion of assets under management, most of which are invested on behalf of our own operations. Operating profit was £17 million (2003: £13 million).
Market position Aviva is the leading general insurer in the UK, where Norwich Union has a market share of 14%, and in Ireland, where Hibernian has a market share of around 20%.
We are the second-largest insurer in Canada, with a 9% market share, are among the top five in the Netherlands, and have a significant business in France.
Norwich Union has a multi-distribution approach, which enables us to build upon the strength of our brand and maintain strong positions in the broker, corporate partner and direct markets. We are focused on growing sales through our direct operation with 22% growth in premiums in 2004. During 2004 we closed our Hill House Hammond high street broking operation and are on track to deliver around 500,000 policies into our direct operation, at a cost of £50 million.
In France, we operate through Aviva Assurances, which sells through a network of 840 tied agents; Eurofil, the second-largest direct insurance business in the French market for which our partnership with Crédit du Nord is an important source of business; and La Paix, a subsidiary of Aviva Assurances specialising in legal protection.
Distribution of our general insurance products in the Netherlands, where Delta Lloyd sells through intermediaries and OHRA serves direct customers, has been enhanced by our bancassurance partnership with ABN AMRO. Our shared service centre, which supports intermediaries and direct customers, continues to deliver efficiencies as part of our focus on cost control.
In Ireland, Hibernian’s multi-channel capacity is an important strength in a market primarily focused on sales via brokers. We continue to expand our direct capability, with 20% more direct policies in force during 2004.
Our general insurance operations continue to focus on product and distribution innovation, as well as looking to extend our product offerings to non-insurance products where clear synergies are identified. This, along with our scale and strength of our brand, means we are confident of achieving our long-term goal of delivering sustainable results.
In a survey by Professional Broking magazine, Norwich Union was voted the best insurer for service. We were the Insurance Times’ general insurer of the year for the second year running and won the category for most trusted insurance company in the Reader’s Digest 2004 trusted brands awards, underlining the success of our “Quote Me Happy” advertising campaign.
Increasing the range of services that we offer beyond insurance is an important part of our strategy to provide solutions more tailored to individual requirements. In August 2004 we purchased HPI Group, the UK’s leading independent provider of vehicle information and checking services. This acquisition strengthens our position as a service provider and grows our non-insurance income.
Our balanced personal and commercial portfolio allows us to achieve sustainable operating results through the underwriting cycle. Personal lines business is keenly priced but we are achieving small rate increases. These, allied with an increase of over £55 million in claims costs savings through our supply chain management, have enabled us to sustain profitability. Although the level of competition in commercial lines has grown, our focus on the small and medium-sized business sector, and rigorous underwriting, enable us to increase rates and retain our target business. Our retail operation achieved strong growth in premiums, while maintaining profitability.
Ireland Hibernian reported a strong operating result of £153 million (2003: £91 million) on net premiums written of £545 million (2003: £611 million). This performance reflected significantly lower than expected claims and resulted in an improved COR of 87% (2003: 97%). The Irish market remains very price competitive, with continuing pressure from politicians and lobby groups for providers to reduce rates and lower their profits. The government is taking steps to reduce motor claims costs which will be reflected in lower premiums to drivers.
Hibernian extended its “penalty points” initiative from August 2004 to offer drivers without penalty points on their licences an additional 7.5% premium discount, bringing the total discount to 17.5%. We extended our highly successful Ignition inexperienced driver scheme to selected provisional licence holders caught up in the current backlog in the driving test system. We have also begun a project to take advantage of the flood insurance expertise across the Aviva group, which will benefit Irish home and commercial property insurance customers.
Netherlands In the Netherlands operating profit was £71 million (2003: £35 million) on higher net premiums written of £719 million (2003: £563 million). Net premiums written for business sold through ABN AMRO increased strongly, primarily as a result of converting previously brokered business to our account from 1 January 2004. Delta Lloyd achieved an improved COR of 95% (2003: 101%).
We have launched Aviva Autograph, an exclusive new programme which records a policyholder’s driving habits using data-gathering equipment installed in the vehicle and calculates their insurance premium. Autograph will be piloted in Ontario from the first quarter of 2005.
Asia In September 2004, we agreed to sell our Asian general insurance operations to Mitsui Sumitomo Insurance Co Limited for £250 million, a multiple of 3.5 times book value. These operations comprise our general insurance businesses in Singapore, Malaysia, Thailand, Indonesia, Hong Kong, the Philippines, Marianas, Macau and Taiwan. The sale is expected to complete in stages, with the first stage having completed
Our people Aviva aspires to be world’s most trusted financial services provider. To fulfil this aspiration, we need customer focused, high performing, diverse and committed employees living Aviva’s values – performance, integrity, progressiveness and teamwork.
Examples of the progress we made during 2004 are Aviva India’s ranking as the best insurer to work for in the country’s ”Great Places to Work” survey, and Hibernian Life and Pensions’ recent top 50 ranking in the EU-sponsored list of “Companies to Work for in Ireland”.
Our commitment to our employees The morale of our employees is key to the success of our business. Involved and motivated employees deliver higher standards of service to their customers. To build this involvement and motivation, we are providing increased opportunities for flexible working, improving management working styles and behaviours, and enhancing communication through staff consultative forums. In 2004, the establishment of consultative employee forums in our major UK business units and the continued strengthening of our European Consultative Forum has helped further our dialogue with employees on topics ranging from new working methods to offshoring.
The majority of our employees’ views are canvassed through local monthly and annual opinion surveys. In 2004 we have been working on a groupwide opinion survey for introduction in 2005. This survey will enable us to benchmark employee responses, to draw upon good practice across the group and to focus future strategies accordingly. Employee morale will become a key performance indicator in the group’s performance management framework and a factor in management reward.
Norwich Union Life entered into an innovative partnership with IBM consulting to transform the Business Services function. Experienced IBM staff work alongside our own people with a brief to transfer skills and develop capability so that at the end of the contract we will have transformed our skill base.
Working for our customers Great customer service and operational efficiency are central to our success. We are delivering value to our customers by building the capabilities of our employees, using incentive plans to reward the achievement of customer satisfaction, and by employing people and resources in the most cost-effective way.
Pursuing its core purpose as “A service provider with insurance at its core and care at its heart,” Norwich Union Insurance has developed a Leadership and Care programme putting customers and staff firmly at the organisation’s centre.
Aviva Diversity Vision Diversity is about everyone. We believe in a working culture that respects, celebrates and harnesses difference to the benefit of customers, employees, shareholders, business partners and the wider communities.
Our new offshore operations provide the capacity for around-the-clock claims processing and enable us to meet the rigorous demands of our customers at lower cost. By the end of 2004, we had created 3,700 jobs in India, with plans to increase our offshoring capacity by a further 1,200 jobs in 2005, reaching a total of 7,000 by the end of 2007. These changes are essential to the delivery of high quality service and value-for-money to our customers. The impact of this continual change puts added demands on leadership to maintain the morale of our employees. We do as much as possible to support leavers and minimise compulsory redundancies through natural staff turnover and redeployment, relocation and retraining (further detail is available in our 2005 Corporate Social Responsibility report).
Diversity We actively seek diversity in our workforce because to understand and respond to our customers, we need to reflect their diverse origins, lifestyles and cultures. A diverse workforce provides an enriched pool of talent and ideas for us to draw upon. In 2004 we appointed a group diversity director and established the group’s diversity steering group of senior executives from around the world.
Leadership Identifying and developing tomorrow’s leaders is a key activity for management in all our businesses. Annual organisation and development reviews are used as the basis for assessing organisational and individual effectiveness and the potential and development needs of the group’s managers. The need to broaden or deepen experience, or readiness to move into a new role, is assessed and development plans built accordingly.
Complementing this process, the Aviva leadership academy is a groupwide suite of development programmes that, along with learning and development initiatives within our business units, supports the group’s future management planning. The Academy and its partners (London Business School, INSEAD/CEDEP and Wharton and Columbia business schools) have worked with over 700 high-potential and senior Aviva employees, from new managers to the senior leadership, enabling their personal development and increasing their ability to address our key business challenges.
Corporate Social Responsibility (CSR) focuses on the management of good corporate performance in respect of standards of business conduct, the environment, human rights and health and safety as well as the promotion of good and fair relations with our employees, our suppliers, our customers and the community.
The United Nations Environment Programme’s Finance Initiative (UNEP FI) continues to be a key grouping for Aviva. We are represented on its climate change and asset management working groups and are helping to establish a new group on general insurance.
Our most significant CSR investment in 2004, has been the establishment of the Aviva Chair in Leadership and Responsibility at INSEAD, a leading international business school. This has both external and internal benefits. The chair will generate learning, which will be shared within Aviva, particularly in the development of our senior managers, as well as produce research, which will seek to raise the external understanding and appreciation of the practice of CSR.
CSR in practice In January 2005, the directors of Aviva approved the revised CSR policy, which now requires a regular review of programme and progress by the chief executives in each of our businesses.
Our internal CSR programme has witnessed significant progress across our businesses worldwide over the year. Some key achievements are shown below.
By way of example, Norwich Union Life in the UK has revised its marketing processes to ensure consumer needs are at the heart of product development and customer communication. In addition, it has formed a board-level committee responsible for overseeing how it meets the needs of existing customers. The company was also one of the first Raising Standards accredited brands in the UK and fully supports the aims of the Financial Services Authority’s Treating Customers Fairly initiative.
Aviva is included in the annual Corporate Knights Global 100 Most Sustainable Corporations list.
Many employees further supported the appeal through collections of blankets, clothing and other essential supplies.
All of our businesses enthusiastically engage in community programmes. In India, for example, we have linked up with charities supporting the elderly and underprivileged children.
Climate change directly affects the whole spectrum of our business both in life and general insurance. Taking account of that fact, some of our products and services have beneficial environmental impacts. In the UK,
Health and safety Aviva’s Group Health and Safety policy commits all Aviva business units to providing a working environment that is both safe and fit for the intended business purpose. In doing so it ensures that health and safety issues are a matter of priority for all business operations. In 2004, a review was conducted of health and safety activities across the group’s operating units to ensure compliance with the policy and to begin developing a platform for good practice sharing and continuous improvement.
The preceding report on employees provides extensive coverage of our performance in that important element of CSR.
We continue to be the only UK insurer included in both the Dow Jones Sustainability World and STOXX Indexes and are a member of the FTSE4Good Index Series.
Introduction 2004 saw a return to more favourable investment market conditions although some sense of economic uncertainty continues to pervade. We managed our business through these conditions with strict performance management disciplines underpinned by strong corporate governance. Likewise the management of the group’s capital base and resources is critical to enhancing the group’s financial strength. We continue to evolve our governance structures to ensure their high quality and to meet the demands of changing external requirements. This report is structured as follows: • Section 1: outlines our strong performance in 2004 by reference to our key financial measures; • Section 2: sets out the status and impact of the International Financial Reporting Standards (IFRS) on our balance sheet at 31 December 2003; • Section 3: reports on the group’s capital strength by reference to accounting, regulatory and economic measures of capital. This section also includes the new disclosures required by Financial Reporting Standard (FRS) 27; and
• Section 4: explains our risk and capital management framework, and the governance processes that underpin this.
A number of the other changes will be implemented and become mandatory in 2005, with the most fundamental change being the requirement to report under IFRS for financial years starting 1 January 2005 onwards. During 2004 we provided an indication of the impact of implementing IFRS on our balance sheet at 31 December 2003 and have shown that there will be a reduction of £250 million to our statutory shareholders’ funds. In addition, from 1 January 2005 we are required to assess and monitor our capital position under the Prudential Sourcebook (PSB) regime as prescribed by the FSA.
These objectives were supported by robust and reliable financial management systems.
† Measured on operating earnings after tax, on a modified statutory solvency basis, expressed as a multiple of the ordinary dividend for the year.
Supplementary information using the EEV basis has been adopted for the first time for the year ended 31 December 2004. The EEV basis replaces the achieved profits basis which was used previously. The main difference between EEV and modified statutory basis method is that the EEV basis measures the economic profit on insurance contracts at the point of sale, whereas the modified statutory basis measures profits that can be distributed to shareholders.
By adopting these principles early the directors are seeking to achieve, through supplementary reporting, consistency and continuity of performance reporting at a time of significant and ongoing change to the group’s primary reporting arising from the two-phased approach to accounting for insurance business under IFRS.
Accounting policies Other than for the adoption of the EEV principles, there have been no changes to the group’s accounting policies in 2004.
Under this MoU Aviva has agreed to provide voluntarily early disclosure in accordance with the requirements in 2004 and then to adopt fully the standard from 2005 onwards within the Group’s IFRS financial statements. Accordingly we have provided appropriate disclosures on the UK with-profit funds’ realistic balance sheet, the group’s capital position statement and information relating to guarantees and options.
The increase in our operating profit from our life operations is attributable to an improvement in results across a number of our European businesses, particularly in the Netherlands, Italy and Spain largely driven by increased investment income. In the UK the non profit result increased reflecting higher new business surplus arising from changes in business mix and increased investment income. Offsetting these increases was the lower result from the UK with-profit funds due to lower annual and final bonus rates to our with-profit policyholders and the non-recurrence of a one-off benefit of £21 million in Poland in 2003 following regulatory changes in the level of required reserves on pensions business.
Profit and loss account – modified statutory basis (see figure 2) The group reported an increased profit on ordinary activities before tax on a modified statutory basis of £1,488 million (2003: £1,390 million), driven by the increase in the operational performance of the business. The short-term fluctuation in investment return for non-life businesses of £64 million (2003: £83 million) is a combination of the positive impact of decreases in short and medium term bond yields across our major European businesses year on year and higher actual returns on equities compared to our longer term investment return assumptions.
Profit/(loss) for the financial year attributable to equity shareholders Pre-tax operating profit*, including life result on an EEV basis – – 2,344 1,906 Pre-tax operating profit*, including modified statutory life operating profit 1,861 1,490 – – Amortisation of goodwill (120) (103) (120) (103) Amortisation of acquired additional value of in-force long-term business (126) (135) – – Financial Services Compensation Scheme and other levies (49) – (49) – Operating profit before tax 1,566 1,252 2,175 1,803 Short-term fluctuation in investment return 131 212 – – Variation from longer term investment return – – 565 779 Effect of economic assumption changes – – (318) (55) Change in the equalisation provision (23) (49) (23) (49) Net loss on the disposal of subsidiary and associated undertakings (136) (6) (136) (6) Exceptional costs for termination of operations (50) (19) (50) (19) Profit on ordinary activities before tax 1,488 1,390 2,213 2,453 Tax (355) (367) (647) (739) Profit on ordinary activities after tax 1,133 1,023 1,566 1,714 Minority interests, preference dividends and direct capital instrument appropriations (99) (91) (189) (138) Profit for the financial year attributable to equity shareholders 1,034 932 1,377 1,576 Ordinary dividends (575) (545) (575) (545) Retained profit 459 387 802 1,031 Earnings per share attributable to equity shareholders – EEV basis – – 61.0p 70.0p – modified statutory solvency basis 45.8p 41.4p – – * Pre-tax operating profit before amortisation of goodwill and exceptional items.
All operating profit arises from continuing operations. The modified statutory solvency operating earnings is also stated before the amortisation of acquired additional value of in-force long-term business.
Profit and loss account – on an EEV basis (see figure 2) The strong operational performance combined with the positive contribution from the long-term investment return variances of £565 million (2003: £779 million) and the impact of economic assumption changes of negative £318 million (2003: £55 million) resulted in a profit before tax of £2,213 million (2003: £2,453 million). This reflects the benefit of improved investment market conditions during the year and higher market values for fixed income securities as a result of lower bond yields. Lower long-term economic assumptions have the effect of reducing the expected value of future profits thereby reducing profits.
The tax for the year included a charge of £651 million (2003: £563 million) in respect of operating profit. The effective rate of tax on EEV operating return was 27.8% (2003: 29.5%) and is predominantly driven by lower tax suffered on the general insurance business following the utilisation of tax losses from earlier years. These losses were previously not recognised as deferred tax assets.
In 2004, we achieved a net pre-tax benefit to the profit and loss account in 2004, relative to 2003, of £52 million, which is greater than the £20 million previously announced. This benefit includes the lower than anticipated GFTP costs for 2004. Figure 3 provides an analysis of the net pre-tax benefit to the profit and loss account across each business in respect of the £52 million saved in 2004 relative to 2003.
By the end of 2004 we successfully completed the offshoring migration of 3,700 roles across our UK life and general insurance operations to India to service the group’s UK life and general insurance businesses and our general insurance operations in Canada. In 2004, total upfront costs incurred on these initiatives were around £50 million (2003: £66 million). As previously announced, we expect to have around 7,000 staff working in our offshore operations by 2007.
In addition to the cost initiatives shown above, we have also announced the restructuring of our UK life business. The one-off cost incurred in 2004 to achieve cost savings was £65 million and further one-off costs of £88 million are expected over the next three years. These are expected to deliver annualised savings of £130 million by the end of 2007.
Net pre-tax profit and loss benefit by business unit (figure 3) Benefit to the profit and loss account £m
Long-term savings new business margin* (figure 5) PVNBP basis** APE basis†
All business units with the exception of Ireland and the Netherlands experienced margin improvements. In the UK, there has been continued focus on strict pricing and cost actions and this coupled with the benefit of the securitisation of our equity release business and a change in business mix towards higher margin products has enabled us to maintain our margins. Higher new business contribution in France and the Netherlands reflect changes in business mix. The lower margin in Ireland reflects changes in lapse assumptions on unit-linked business and the competitive market for protection products.
New business contribution* 516 474 Profit from existing business Expected return 819 761 Experience variances (15) (31) Operating assumption changes (7) 19 Expected return on shareholders’ net worth 298 273 Life EEV operating result 1,611 1,496 * On a post cost of capital basis.
General Insurance Worldwide general insurance net premium income increased to £8,815 million (2003: £8,524 million) principally reflecting premium rate increases achieved during the year. The markets we operate in have become more competitive during 2004 though we have continued to maintain our focus on writing for value over volume.
Our claims reserves are calculated within a range of possible outcomes. Our actuarial analysis suggests that our claims reserves across the group are strong.
The combined UK operations reported a profit of £10 million (2003: loss of £6 million). Morley’s combined UK operations reported a profit of £12 million (2003: £3 million), while our UK retail business reported a profit of £5 million (2003: loss of £3 million). Our RBSG collective investments reported a loss of £7 million (2003: loss of £6 million) due to significant new business strain from sales of regular premium investment business. Within the group results are additional profits of £12 million (2003: £6 million) relating to other Morley businesses including the pooled pensions business and the overseas operations.
Non-insurance The non-insurance result on an MSSB basis was a loss of £108 million (2003: loss of £48 million) and includes a one-off provision of £40 million in respect of vacant properties following the completion of a UK wide owner occupied property strategy review which assessed current requirements in light of headcount reductions in the UK in recent years. In addition, £65 million for reorganisation costs in our UK life service company is also included.
We made excellent progress through 2004 in our preparations for reporting under IFRS and continued to be a leading participant in the dialogue with the IASB in helping to shape the new accounting and reporting framework for our sector.
In overview our work to date on implementing IFRS has led us to the following preliminary conclusions: • Accounting for substantially all of the general insurance business and approximately 85% of our long-term business will be unchanged. The remaining 15% of our life products will be accounted under International Accounting Standard (IAS) 39 – Financial Instruments; • IFRS is a technical accounting change to the way we report and present our consolidated MSSB results. There is no change to the underlying economics of Aviva’s business; • IFRS will not impact our dividend policy nor significantly impact the group’s solvency calculations which are the subject of separate regulation.
As anticipated, the impact of implementing IFRS on our balance sheet at 31 December 2003 is a reduction of £250 million on our reported statutory basis equity shareholders’ funds. Life EEV is unaffected by the impact of IFRS and so those adjustments relating to the life segment do not change life shareholders’ funds on an EEV basis. The reduction of £250 million includes a £106 million decrease to the life segment’s equity shareholders’ funds. This is stated after a notional allocation of £211 million of the IAS19 pension deficit relating to UK life covered business. A reconciliation between UK GAAP and IFRS basis shareholders’ funds is also included on pages 114 to 126. We will report our first set of results under IFRS as part of the interim announcement in August 2005.
An important aspect of the group’s overall capital management process is the setting of target risk-adjusted rates of return for individual business units, which are aligned to performance objectives and ensure that the group is focused on the creation of value for shareholders.
Different measures of capital The group measures its capital on a number of different bases. These include measures which comply with the regulatory regime within which the group operates and those which the directors consider appropriate for the management of the business. The measures which the group uses are: (i) Accounting bases Although the group is required to report its results on the modified statutory solvency basis, the directors consider that the European Embedded Value methodology provides a more accurate and meaningful reflection of the group’s life operations and accordingly we analyse and measure the net asset value and total capital employed for the group on this basis.
(ii) Regulatory bases In reporting the financial strength of our insurance subsidiaries the group measures the capital and solvency using the regulations prescribed by the Financial Services Authority (FSA). These regulatory capital tests are based upon required levels of solvency capital and a series of prudent assumptions in respect of the type of business written by the group’s insurance subsidiaries.
Equities securities investments assets Total Total £m £m £m £m £m £m
At 31 December 2004 the group had £19.3 billion (31 December 2003: £17.8 billion) of total capital employed in its trading operations which is efficiently financed by a combination of equity shareholders’ funds, preference capital, subordinated debt and internal and external borrowings.
The group has a number of internal debt arrangements in place. These have allowed assets supporting technical liabilities to be invested into the pool of central assets for use across the group. They have also enabled the shareholders to deploy cash from some parts of the business to others in order to fund growth.
In 2004 we have revised the presentation of internal debt to show a net debt position which represents the upstream of internal loans from business operations to corporate and holding entities net of tangible assets held by these entities as this better reflects the underlying level of internal leverage. The reduction in the net internal debt reflects, in part, the repayment by the corporate and holding entities of upstream loans and an increase in the tangible assets held by corporate entities arising from a combination of capital raising activity and dividends received from business operations.
External debt has fallen during the year as £300 million of the direct capital instrument proceeds have been used to repay commercial paper. As indicated at the time of issuing the direct capital instrument, a further £650 million of senior debt will be repaid in 2005, thereby reducing the level of external borrowings further. This repayment will be made from tangible assets held by corporate entities and, accordingly, the net internal debt will increase by a corresponding amount. This leaves the overall external and net internal leverage position unchanged.
Shareholders’ funds – EEV £14.1bn £11.7bn Total capital employed £19.3bn £17.8bn Net asset value per share 532 pence 484 pence
The improvement in shareholders’ funds reflects strong operational performance and the issuance of a direct capital instrument which raised £990 million. Net asset value per ordinary share, based on equity shareholders’ funds, was higher at 532 pence per share after adding back the equalisation provision of £388 million (31 December 2003: £364 million).
Insurance Group’s Directive (IGD) excess solvency £bn 3.6 2.4 Cover (times) over EU minimum 1.9 1.7
Aviva group had estimated excess regulatory capital, as measured under the EU Groups Directive, of £3.6 billion at 31 December 2004 (31 December 2003: £2.4 billion). 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 group’s UK life funds. The minimum solvency requirement for the group’s 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 reserves respectively and for Aviva’s general insurance portfolio of businesses 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 the group’s major non-European businesses, eg USA, Australia and Canada, a risk charge on asset and liabilities approach is used.
In November 2004 the group enhanced its strong regulatory position through issuing £990 million of a direct capital instrument. Completion of the Asia general insurance sale in 2005 will improve the IGD excess solvency by £0.2 billion.
Furthermore, from 1 January 2006, the group will be required to have a positive IGD basis solvency level at all times. The FSA has introduced further changes to the valuation rules which will apply during 2005.
These include changes to the valuation of non-insurance subsidiaries which will be restated from market value to net asset value (estimated to reduce IGD by £0.6 billion) and an allowance for pension scheme deficits (estimated to reduce IGD by £0.4 billion). The former change will be applied from 1 January 2005 while the latter will apply from 1 July 2005.
Regulated asset value £bn 0.9 6.5 7.4 Required minimum margin £bn 0.3 3.1 3.4 Excess solvency margin £bn 0.6 3.4 4.0
Economic bases – Risk based capital The group uses risk based capital as one of several measures to assess its capital requirements for its general insurance businesses. Financial modelling techniques enhance our practice of active capital management, ensuring sufficient capital is available to protect against unforeseen events and adverse scenarios, and risk management. Our aim continues to be the optimal usage of capital through appropriate allocation to our businesses.
Life operations Economic bases For the group’s non-participating worldwide life assurance business the group has set its capital requirements as the higher of: • Target levels set by reference to own internal risk assessment and internal objectives; • Minimum capital level (ie level of solvency capital at which local regulator empowered to take action).
UK with-profit funds Under the MoU entered into with the ASB relating to FRS27, we are required to disclose information on the realistic balance sheets for the group’s UK life with-profit funds, the group’s capital position statement and financial options and guarantees. These are set out in the following paragraphs.
Regulatory basis The FSA published the Prudential Sourcebook (PSB) for insurers which in 2004, is applicable for 31 December 2004 year ends. The PSB formally introduces the FSA’s realistic reporting regime setting out a realistic basis of measurement for assets and liabilities and also the realistic capital requirements.
In 2004 realistic results have been prepared in accordance with the PSB. The results make appropriate allowance for all the liabilities of the with-profit funds, including provision for future bonuses, the fair value of guarantees, options and promises on a market consistent basis and, the cost of shareholder transfers and tax associated with future bonuses.
The available capital of the with-profit funds is represented by the realistic orphan estate. The estate represents the assets of the long-term with-profit funds less the realistic liabilities for non-profit policies, less asset shares aggregated across the with-profit policies and any additional amounts expected at the valuation date to be paid to in-force policyholders in the future in respect of smoothing costs and guarantees.
The aggregate investment mix of the realistic assets at the year end was: 31 December 31 December
Risk free rates at 31 December 2004 have been determined as the annualised spot yields for the gilt market, sourced from the Bank of England, increased by 10 b.p. The increase reflects the result that gilt yield is a little less than true risk free because of the highly liquid nature. Assumptions for volatility have been sourced from various investment banks based on the market price of traded options.
Management assumptions – Management may exercise discretion in the operation of the with-profit business, through for example, smoothing of payouts, the level of annual bonuses and investment policy. How management exercises this discretion is described in the Principles and Practices of Financial Management (PPFM). The assumptions made about how management will exercise discretion in the calculation of the realistic liability are consistent with the PPFM, with the objective of achieving a realistic best estimate.
UK Other UK Overseas with-profit life life Total life Other funds operations† operations operations operations‡ Total £bn £bn £bn £bn £bn £bn
Other sources of capital* – – 0.2 0.2 2.8 3.0 * Other sources of capital represents: Subordinated debt of £2,823 million issued by
The UK with-profit funds’ available capital of £4.5 billion can only be used to provide support for UK with-profits business and is not available to cover other shareholder risks. At £4.5 billion, it is comfortably in excess of the required capital margin and, therefore, the shareholders are not required to provide further capital support to this business.
As the total available capital of £12.8 billion is arrived at on the basis of local regulatory guidance, which evaluates assets and liabilities prudently, it understates the economic capital of the business which is considerably higher. This is a limitation of the group capital statement which, to be more meaningful, needs to evaluate available capital on an economic basis and compare it with the risk capital required for each individual operation, after allowing for the considerable diversification benefits that exist in our group.
The available capital resources in each regulated entity are generally subject to restrictions as to their availability to meet requirements that may arise elsewhere in the group. The principal restrictions are: (i) UK with-profit funds (CGNU Life, CULAC & NULAP) – any available surplus held in each fund can only be used to meet the requirements of the fund itself or be distributed to policyholders and shareholders.
(ii) UK non-participating funds – any available surplus held in these is attributable to shareholders. Capital within the non profit funds may be made available to meet requirements elsewhere in the group subject to meeting the regulatory requirements of the fund. Any transfer of the surplus may give rise to a tax charge subject to availability of tax relief elsewhere in the group.
In addition to its external funding sources, the group has a number of internal loan arrangements in place. These have allowed assets supporting technical liabilities to be invested into the pool of central assets for use across the group. They have also enabled shareholders to deploy cash from some parts of the business to others in order to fund growth. In addition to these internal loan arrangements, the group has in place a number of internal reinsurance contracts which are structured to manage the capital position between certain life funds. All these internal contracts satisfy arm’s length criteria, and all payments have been made when due.
Sensitivity of insurance liabilities Insurance liabilities are sensitive to changes in market conditions and other assumptions which have been factored into their calculation, such as mortality or persistency rates. In some cases allowance is also made when calculating liabilities for the effect of management and/or policyholder actions in different economic conditions on future assumptions such as asset mix, bonus rates and surrender values.
Market conditions – assumptions are made about investment returns and interest rates. Any adverse change in either variable will increase liabilities with the effect of reducing available capital. However such changes will also impact corresponding asset valuation, changes in which may result in further decreases in available capital, or in certain cases may offset the impact of liability movements.
UK with-profit funds – available capital The amount of available capital, that is the excess of the value of assets over the realistic value of the liabilities, is sensitive to both the current level of investment markets, and the assumptions made. In addition the capital requirement for with-profit funds which is based on the FSA’s risk capital margin (RCM), takes into account the sensitivity to certain changes in conditions. The level of the RCM is set such that sufficient capital is required to meet a series of prescribed adverse shocks, consisting of falls in equity and property values, changes in fixed interest yields, rises in defaults on corporate bonds and similar instruments and adverse persistency experience. Within these shocks, allowance is made for how management would respond, consistent with PPFM, for example through changes to bonus rates and investment profiles.
Financial guarantees and options As a normal part of operating activities, various group companies have given guarantees and options, including interest rate guarantees, in respect of certain long-term insurance and fund management products.
Valuation of guarantees and options under EEV The reported cost to shareholders of the options and guarantees provided under life contracts is represented by the valuation of options and guarantees under the EEV methodology. This includes two components: the intrinsic value and the time value. The intrinsic value is the cost to shareholders arising under the best estimate assumptions and is allowed for in the calculation of the present value of in-force business. The time value, which is calculated separately, is the additional cost to shareholders arising from variability of future investment returns, and reflects the fact that in some adverse economic scenarios shareholders will incur additional costs associated with the guarantees under the EEV methodology. The time value is calculated on a stochastic basis, using “real world” assumptions to evaluate the mean cost, which is deducted from the embedded value. At 31 December 2004 this amounted to £274 million (2003: £232 million).
Except for “UK life with-profits” business the liabilities for guarantee and option costs described below relate to the statutory provision currently held within the groups MSSB liabilities. These liabilities are
different to the shareholder cost of guarantees and options under EEV as discussed above. The main reasons for the difference are as follows: • In many cases, the shareholder cost of guarantees and options is lower than the full amount of the liability. For example, for UK with-profit business, the shareholder cost is lower because some of the cost can be absorbed by the excess assets in the with-profit fund; • The shareholder cost of guarantees and options is calculated using “real world” stochastic economic scenarios, whereas the guarantee and option liabilities are calculated using a combination of market consistent stochastic scenarios in the UK and deterministic regulatory assumptions elsewhere.
In providing these guarantees and options, the group’s capital position is sensitive to market risk, such as adverse fluctuations in financial variables including foreign currency exchange rates, interest rates, real estate prices and equity prices. Interest rate guaranteed returns, such as those available on guaranteed annuity options (GAOs), are sensitive to interest rates falling below the guaranteed level, other guarantees such as maturity value guarantees and guarantees in relation to minimum rates of return, are sensitive to fluctuations in the investment return below the level assumed when the guarantee was made.
The group carefully manages its exposure to market risk. These processes are described in the “Risk management policies” section of this report.
UK Life with-profits business In the UK, from 31 December 2004, life insurers are required to comply with the FSA’s realistic reporting regime for their with-profit funds for the calculation of FSA liabilities. Provision is made for guarantees and options within the FSA realistic liabilities of the UK life with-profit funds. Under the FSA’s rules these must be measured at fair value using market consistent stochastic models. A stochastic approach includes measuring the time value of guarantees and options, which represents the additional cost arising from uncertainty surrounding future economic conditions. The time value is evaluated by projecting a large number of possible future outcomes under a wide range of economic scenarios, for example possible outcomes for interest rates and equity returns.
These realistic liabilities have not been included within the MSSB balance sheet for 2004 but will be incorporated in the statutory balance sheet from 1 January 2005 in accordance with FRS27.
Guaranteed annuity options – The group’s UK with-profit funds have written individual and group pensions which contain guaranteed annuity rate options (GAOs), where the policyholder has the option to take the benefits from a policy in the form of annuity based on guaranteed conversion rates. The group also has exposure to GAOs and similar options on deferred annuities.
Guaranteed minimum pension (Transfer Plan (section 32)) – The group’s UK with-profit funds also have certain section 32 policies which contain a guaranteed minimum level of pensions as part of the condition of the original transfer from state benefits to the policy.
In addition, while these do not constitute guarantees, the group has made promises to certain policyholders in relation to mortgage endowments that payments on these policies will meet the mortgage value, provided investment returns exceed 6% per annum net of tax between 1 January 2000 and maturity and the investment returns on the free reserves are sufficient to meet the top up costs.
Overseas life business In addition to guarantees written within the group’s UK life businesses, the group’s overseas businesses have also written contracts containing guarantees and options. Details of the significant guarantees and options provided by overseas life businesses are set out below.
France Guaranteed surrender value and guaranteed minimum bonuses Aviva France has written a number of contracts with such guarantees. The guaranteed surrender value is the accumulated value of the contract including accrued bonuses. Bonuses are based on accounting income from amortised bond portfolios, where the duration of bond portfolios is set in relation to the expected duration of the policies, plus income and releases from realised gains on equity type investments. Policy reserves equal guaranteed surrender values. Local statutory accounting envisages the establishment of a reserve, “Provision pour Aléas Financiers” (PAF), when accounting income is less than 125% of guaranteed minimum credited returns. No such PAF was established at the end of 2004.
Under Dutch regulation, liability testing is carried out to determine if additional liabilities are required for portfolio guarantees. No such reserves were required at the end of 2004.
The total liabilities for traditional business at end 2004 are £8 billion analysed as follows: Liabilities Liabilities 3% guarantee 4% guarantee £m £m
Derivatives are used only to a limited extent, based on policy guidelines agreed by the board of directors. Derivatives are used for investment or debt-hedging purposes or to structure specific retail-savings products. Speculative activity is generally prohibited unless approved by the group Derivatives committee. Derivative transactions are fully covered by either cash or corresponding assets and liabilities. Derivative contracts are entered into only with approved counterparties, in accordance with our group policies, thereby reducing the risk of credit loss.
Foreign currency exchange risk The group operates internationally and is exposed to foreign currency exchange risk arising from fluctuations in exchange rates of various currencies. The financial results and competitiveness are also affected indirectly by the domestic currencies of our main competitors, principally in sterling and euros. Approximately half of our premium income arises in currencies other than sterling, and our net assets are denominated in a variety of currencies, of which the largest are the euro and sterling. In managing our foreign currency exposures, the group does not hedge revenues as these are substantially retained locally to support the growth of our business and meet local regulatory and market requirements.
The group foreign exchange policy requires that each of our subsidiaries maintain sufficient assets in their local currencies to meet local currency liabilities. Therefore, capital held by our business units should be able to support local insurance activities despite foreign currency movements. However, such movements may impact the value of our consolidated shareholders’ equity, which is expressed in sterling. This aspect of foreign exchange risk is monitored and managed centrally, against predetermined limits. As at 31 December 2004, the group had entered into forward foreign exchange contracts to mitigate the effects of potential adverse foreign currency exchange movements. Net assets by principal currency were 41% in sterling and 47% in euros.
As of 31 December 2004, the group had entered into futures and option agreements to mitigate the effects of potential adverse equity price movements.
Each business unit is required to identify sources of liquidity risk, implement systems to measure and monitor liquidity exposures and install controls to manage its liquidity requirements in line with its liquidity profile.
At group level, liquidity is maintained at a prudent level and consistent with the expectations of the FSA and the investment community. The group also ensures there is an adequate liquidity buffer to cover contingencies including the provision of temporary liquidity to business units which experience short-term liquidity shortfalls.
As with other risk categories, line management of business areas have primary responsibility for the effective identification, management, monitoring and reporting of risks to the business unit executive and group, in accordance with group policies. Business unit risk management and governance functions are responsible for implementing the group risk management methodologies and frameworks to assist line management in this work. They also provide support and independent challenge on the completeness, accuracy and consistency of risk assessments, and the adequacy of mitigating action plans. In this way the business unit executive satisfies itself that material risks are being mitigated and managed to an acceptable level.
Operational risks are assessed according to the potential impact and probability of the event concerned. These impact assessments are made against financial, operational and reputational criteria. Operational risks are reported, as with other risks, on a quarterly basis to group. Risks assessed by business units to be at the two highest impact assessments are escalated to group intra quarter. A holistic view of the group’s financial and non financial risks, including operational risks, is monitored by the group risk committee on a quarterly basis.
1. Pehr Gyllenhammar (69) Chairman Appointed to the board in 1997, becoming chairman in 1998. Currently vice-chairman Europe at Rothschild (banking), chairman of Reuters Founders Share Company Limited, AB Kinnevik (media) and Swedish Ships Mortgage Bank (banking) and a member of the supervisory board of Lagardère SCA (media and technology). Chairman of the European Financial Services Roundtable and of the Rothschild pension funds. Former executive chairman of AB Volvo (automotive). Chairman of the nomination committee.
3. George Paul DL (65) Deputy chairman and senior independent non-executive director Appointed to the board in May 2000 as deputy chairman. Joined the Norwich Union board as a non-executive director in 1990, becoming chairman in 1994. Currently non-executive chairman of Agricola Group Limited (agricultural) and JPMorgan Fleming Overseas Investment Trust plc (asset management) and a non-executive director of Notcutts Limited (horticulture). A former chairman and chief executive officer of Harrisons & Crosfield plc (manufacturing). It is the intention that Mr Paul will retire from the board on or before 31 December 2005. Chairman of the remuneration committee.
4. Guillermo de la Dehesa (63) Independent non-executive director Appointed to the board in May 2000. Joined the board of Norwich Union as a non-executive director in 1999. Currently non-executive chairman of Aviva’s operations in Spain, non-executive vice-chairman of Goldman Sachs Europe (banking) and a director of Campofrio (consumer), Unión Eléctrica Fenosa (utility), Bank Santander Central Hispano (banking) and Telepizza (consumer). Chairman for the Centre of Economic Policy Research. Former chief executive and director of Banco Pastor (banking). A former deputy governor of the International Monetary Fund and the World Bank, a former deputy general manager of the Bank of Spain and former Secretary of State of Finance in Spain. Member of the nomination committee.
6. Richard Karl Goeltz (62) Independent non-executive director Appointed to the board in May 2004. Currently non-executive director of the Warnaco Group Inc, Federal Home Loan Mortgage Corporation (Freddie Mac), New Germany Fund (Investment trust) and a director of The London School of Economics and Political Science. A former chief financial officer of American Express Company, NatWest Group plc and The Seagram Company Ltd and a former member of the Accounting Standards Board (UK). Member of the audit and remuneration committees.
8. Carole Piwnica (47) Independent non-executive director Appointed to the board in May 2003. Currently non-executive vice-chairman-governmental affairs for Tate & Lyle plc (agriculture/industrial) and a former chairman of Amylum Group (agriculture/industrial). A member of the New York and Paris bars, practising law in Europe and the United States specialising in mergers and acquisitions, and EU regulatory matters. Member of the audit committee.
9. Philip Scott FIA (51) Executive director Appointed to the board in May 2000. Joined Norwich Union in 1973, held a number of senior positions and was appointed to the board of Norwich Union in 1993. Currently responsible for the group’s continental European and international life assurance and long-term savings business and fund management operations. Former chief executive and executive chairman of Norwich Union Life (Aviva’s life assurance and long-term savings business in the UK).
11. Patrick Snowball (54) Executive director Appointed to the board in March 2001 as chief executive of Norwich Union Insurance (Aviva’s general insurance operation in the UK). Currently responsible for the group’s worldwide general insurance operations and the provision of shared services across the UK. Previously a director of Norwich Union, appointed in October 1999, having joined that company in 1994.
12. Derek Stevens (66) Independent non-executive director Appointed to the board in 1995. Currently non-executive chairman of The Airline Group Limited (transport), non-executive director of NATS Holdings Limited (transport), a member of the financial sector committee of the Accounting Standards Board, chairman of The Royal Academy of Arts Pension Scheme board and a trustee of the Rothschild pension funds, a member of the Council of the Institute of Education at the University of London, a member of the fundraising advisory board of VSO (charity) and chairman of The Travel Foundation (charity). A former director and chief financial officer of British Airways Plc (transport), a former finance director of TSB Group plc (banking) and a former chairman of the trustees of British Airways pension schemes. Chairman of the audit committee and of Aviva Staff Pension Trustee Limited.
Contents 45 Directors’ report 47 Corporate governance 50 Audit committee report 52 Nomination committee report 53 Directors’ remuneration report 63 Independent auditors’ report 64 Accounting policies 67 Consolidated profit and loss account Technical account – long-term business 68 Consolidated profit and loss account Technical account – general business 69 Consolidated profit and loss account Non-technical account 70 Pro forma reconciliation of Group operating profit to profit on ordinary activities before tax 71 Consolidated statement of total recognised gains and losses 71 Reconciliation of movements in consolidated shareholders’ funds 72 Consolidated Group balance sheet 74 Consolidated cash flow statement 75 Company balance sheet 76 Notes to the accounts 112 Five year review 114 Introduction to International
Dividend The directors are recommending a final dividend of 16.00 pence (2003: 15.15 pence) per share which, together with the interim dividend of 9.36 pence (2003: 9.00 pence) per share, produces a total dividend for the year of 25.36 pence (2003: 24.15 pence) per share. The total cost of dividends for 2004, including preference dividends and direct capital instrument appropriation will amount to £598 million (2003: £562 million), leaving £459 million to be transferred to reserves (2003: £387 million transferred to reserves).
At the forthcoming Annual General Meeting shareholders’ approval will be sought to increase the Company’s authorised share capital from £950 million to £1.45 billion and 1700 million by the creation of 500 million new preference shares of £1 each and 700 million new preference shares of 11 each. Under the terms and conditions of the direct capital instruments issued by the Company on 25 November 2004 the Company will have the option to issue these new classes of preference share should certain events occur. Further details are set out in the notice of the Annual General Meeting.
Philip Twyman retired from the Board on 31 March 2004 upon reaching his normal retirement date and Anna Catalano resigned from the close of the Annual General Meeting on 27 April 2004.
The directors retiring by rotation in accordance with the articles of association at the Annual General Meeting and, being eligible, offering themselves for re-election are Guillermo de la Dehesa, Wim Dik, Derek Stevens and André Villeneuve. None of these directors have a service contract with a Group company.
George Paul and Elizabeth Vallance, independent non-executive directors, were re-elected by shareholders at last year’s Annual General Meeting. As they have both served in excess of nine years with the Company, or one of the legacy companies, they will retire and seek re-election again at this year’s meeting. However, in line with the Board’s plans to renew and refresh its composition, it is the intention that, if re-elected, these directors will retire on or before 31 December 2005.
Directors’ interests Other than a deed of indemnity between each director and the Company and service contracts between the executive directors and a Group company, no director had a material interest at any time during the year in any contract of significance with the Company or any of its subsidiary undertakings.
Substantial shareholdings As at 8 March 2005, the Company’s register of substantial shareholdings maintained in accordance with the provisions of Section 211 of the Companies Act 1985 showed that the holdings exceeding the 3% disclosure threshold were those of Barclays Plc which held 98,669,290 ordinary shares, representing an interest of 4.32%, and Legal & General Group Plc which held 84,829,941 ordinary shares, representing an interest of 3.72% of the issued ordinary share capital of the Company.
Group employees The Group’s statement on its employees is set out on pages 20 and 21.
In summary, the Group’s commitment to communication and dialogue with employees continues. A strong emphasis is placed on the provision of news through a variety of media, including intranets (both a Group-wide intranet, Arena, and local business unit intranets), Aviva radio, which can be accessed via mobile phone or computer, and poster campaigns. Employees have opportunities to voice their opinions and ask questions through intranet sites and climate surveys.
Face to face briefings and team meetings are actively encouraged and are held in all business units across the Group.
Trust and integrity are integral to the wellbeing of a financial services company and therefore the Group sees CSR as presenting a vital business opportunity. The CSR section of the annual report which gives further details of the programme and how the Group is exploring opportunities in this area can be found on pages 22 and 23. Aviva also prepares a separate CSR report each year which includes full details of the Group’s CSR programme and the progress achieved during the year. A copy of the printed summary of the CSR report is available from the Group Company Secretary and the full report may be viewed on www.aviva.com/csr.
In terms of managing CSR risks, the Group has an established system of business risk management which is embedded into its business planning and performance monitoring processes. This system includes the management of risks relating to social, environmental and ethical (SEE) matters. Further details of this process are contained within the Audit Committee Report on pages 50 and 51. During the year this process did not identify any purely SEE risks which were considered to be critical to the Group’s operations.
The Group reports annually on progress in accordance with the Forge management and reporting guidelines for banks and insurers and duly respects the disclosure guidelines issued by the Association of British Insurers. Governance of the programme is subject to both a regular schedule and continual review. The Board observes plans and progress annually, whilst the annual meeting of Aviva’s CSR Review Group brings together representatives from the Aviva head office, the businesses, partner non-governmental organisations and auditors to review the Group’s performance. Quarterly reviews are also carried out by a CSR Steering Group, which includes senior management from the principal businesses.
Information on health and safety matters is communicated to staff through the normal communication channels. Under the Group’s Health and Safety Policy the Group Chief Executive is accountable for health and safety.
Standards of Business Conduct The Group operates a Standards of Business Conduct Policy which provides guidance for every employee, Group-wide, to act with integrity in all business relationships.
At the 2004 Annual General Meeting, shareholders passed a resolution authorising the Board to incur expenditure, up to an aggregate limit of £100,000 per annum for the following four years, on activities which fall under the Political Parties, Elections and Referendums Act (PPER). This piece of legislation introduced a very broad definition of political expenditure, such that some of the activities undertaken throughout the Group’s businesses could now fall within that definition. The Board sought shareholders’ authority so as to avoid any inadvertent breaches of the PPER. The Board does not believe that the Group has incurred any such political expenditure in the past year.
The Board of Directors The Board currently comprises the Chairman, 10 independent non-executive directors and four executive directors. Each non-executive director serves for a fixed term not exceeding three years which may be renewed by mutual agreement. Subject to the Board being satisfied as to the director’s performance, independence and commitment, there is no specified limit regarding the number of terms a director may serve. The Company’s articles of association require that following appointment by the Board, directors submit themselves for election by shareholders at the next Annual General Meeting. The articles also provide that one-third of directors shall retire by rotation each year but are eligible to submit themselves for re-election by shareholders, and that directors shall not serve longer than the third Annual General Meeting following their election without being re-elected by shareholders. Non-executive directors who serve on the Board of the Company for nine years or more submit themselves for re-election annually.
Against the above background the Board has appointed three new independent non-executive directors. Richard Goeltz and Russell Walls in May 2004 and Lord Sharman of Redlynch in January 2005. The biographical details of these directors are set out on pages 42 and 43. All these directors have had distinguished careers in finance. Richard Goeltz and Russell Walls are both former group finance directors of major companies and Lord Sharman spent his career with KPMG becoming its international chairman. At a time of major accounting changes these new directors with their strong financial skills and international management experience make very strong additions to the Board and Richard Goeltz and Russell Walls have been appointed to the Board’s Audit Committee. Another new director is Andrew Moss who was appointed Group Finance Director in May 2004. Andrew Moss joined the Company from Lloyd’s of London where he was Director of Finance, Risk Management and Operations. In accordance with the Company’s articles of association these new directors will stand for election by shareholders at the forthcoming Annual General Meeting.
All the directors being proposed for re-election have been subject to a formal performance evaluation during 2004 including a peer review. Full biographical details of all the directors, including those proposed for election/re-election, are set out on pages 42 and 43.
To satisfy the Board that the non-executive directors are able to exercise an independence of judgement, the Nomination Committee undertakes an annual review of directors’ interests in which all potential or perceived conflicts, including time commitments, length of service and other issues relevant to their independence, are considered. Based on the outcome of the December 2004 review, the Board is of the opinion that all of the current non-executive directors are independent of management and free from any relationship or circumstances that could affect, or appear to affect, the exercise of their independent judgement. Notwithstanding that George Paul, Derek Stevens and Elizabeth Vallance have each served on the Board, or the board of a legacy company, for more than nine years the Board does not believe that this fact alone affects their independence.
The Board is also satisfied that all the directors are able to devote sufficient time to their duties to the Company. The Board had eight scheduled meetings in 2004. The attendance record of the directors at the Board and Board committee meetings which they were entitled to attend during 2004 is set out below.
Carole Piwnica 88 100 – – Andrew Moss 100 – – – Philip Scott 100 – – – Derek Stevens 100 100 – – Patrick Snowball 100 – – –
Board process The duties of the Board and its committees are set out clearly in formal terms of reference which are reviewed annually by the Board. These terms of reference address a wide range of corporate governance issues and set out those items which are specifically reserved for decision by the Board. These include the approval of the Group’s strategy and business plans, acquisitions and disposals and other transactions outside delegated limits, material changes to accounting policies or practices, significant financial decisions, dividend policy, shareholder documentation, the constitution of Board committees and the approval of key business policies including the remuneration policy. Matters which are not specifically reserved to the Board and its committees under the terms of reference, or to shareholders in General Meeting, are delegated to the Group Chief Executive. The document also sets out those matters which must be reported to the Board such as significant litigation or material breaches of compliance and covers how those matters requiring consideration by the Board outside scheduled Board meetings, are dealt with.
The Board has established a number of standing committees, including Remuneration, Audit, and Nomination Committees. Each committee operates within defined terms of reference and the minutes of their meetings are circulated to the Board. Details of the work of the respective committees, including their membership and duties, are set out in the reports of the committees on pages 50 to 53.
Performance reviews and directors’ development The Company has for a number of years undertaken annual performance reviews to assess how well the Board, its committees or its directors are performing. Directors complete a questionnaire in which they assess the Board’s and Committees’ processes and effectiveness and consider areas where such may be improved. In 2004 for the first time the process included a peer group review where the directors assessed their own and their fellow directors’ performance against set criteria, including the skills they bring and the contribution they make. This process was complemented with separate meetings between each director and the Chairman. The Board discussed the feedback from the process when it met in September and a number of actions were agreed. The review was conducted by the Chairman with the assistance of the Group Company Secretary.
The directors consider it is important to understand the views of shareholders and in particular any issues which concern them. At each Board meeting they receive a note of the issues which have been raised with management at the regular meetings held with the large investors. During the year, the Chairman met with a number of major shareholders and the senior independent non-executive director spent two separate days accompanying management at their regular meetings held with major shareholders in order to note any issues of particular relevance to the non-executive directors. Both the Chairman and the senior independent non-executive director subsequently reported to the Board the issues which were raised. Arrangements for major shareholders to meet with the non-executive directors can be made through the Company Secretary.
Details of the proxy voting by shareholders are made available on request and are placed on the Company’s website. Whenever possible all directors attend the Annual General Meeting and shareholders are invited to ask questions during the meeting and have an opportunity to meet with the directors after the conclusion of the formal part of the meeting.
Institutional investor Morley Fund Management Limited, the Group’s asset management company believes that good governance contributes to better performance and practices. Therefore, as a major investor, the Group monitors the governance of the companies in which it invests. To this end Morley holds regular meetings with the senior management of companies where it will raise matters which may affect the future performance of those companies.
Morley maintains a detailed Corporate Governance and Voting Policy as part of its investment strategy, which underpins its approach to engaging and voting at company general meetings. The policy also extends to cover social, environmental and ethical issues. Its policy is applied pragmatically, after careful consideration of all relevant information. In addition, Morley makes detailed voting reports available to clients and publishes summary statistics on its website.
Compliance with the Combined Code It is the Board’s view that the Company has complied fully throughout the accounting period with the provisions set down in Section 1 of the Combined Code. The auditors’ report on page 63 covers its review of the Company’s compliance with the relevant provisions of the Combined Code as applicable to the Company during the year under review.
With the implementation of International Financial Reporting Standards (IFRS) for the 2005 financial year the Committee has reviewed the progress of the Group’s preparation for reporting under the new standards and the processes that have been embedded throughout the Group. The Committee has also reviewed the impact of adopting IFRS on the opening balance sheet at 1 January 2004 and was satisfied that suitable policies were being applied and were appropriate.
In addition, the Committee has reviewed the Group’s capital and risk frameworks to reflect the regulatory reforms incorporated in the Financial Services Authority’s Prudential Sourcebook (PSB) and the approach to the Internal Capital Assessment (ICA) methodology assumptions and initial results. The Committee considered the assumptions and methodology used, the process followed and the adequacy of the resources.
Each of the Group’s major business units has formally constituted audit committees which provide an oversight role for their business. All such committees include some members who are independent of the relevant business. The Group Audit Director reviews the papers and minutes from these committees and all significant matters are brought to the Committee’s attention.
The Company has a formal policy aimed at safeguarding and supporting the independence of the auditor by avoiding conflicts of interests. In line with the best practice recommendations contained in the Combined Code, the Committee reviews each quarter, compliance with the policy concerning the use of the external auditor in non-audit work. The policy regulates the appointment of former audit employees into senior finance positions within the Group and sets out the approach to be taken by the Group when using the services of the auditor, distinguishing between those matters where the Company requires an independent view, such as audit and assurance work, from other advisory services. In addition to statutory audits, audit and assurance work includes reviewing statutory returns, actuarial assurance, regulatory advice which requires auditor reporting, due diligence associated with acquisitions and disposals, fraud investigations and control and audit reviews. The auditor cannot be engaged for any other purpose, although the policy recognises that there may be a small number of areas where, for pragmatic reasons, it may be in the Group’s interests to use the external auditor for this work. During the year the Committee also reviewed independence issues in relation to PwC which audit Delta Lloyd.
The Committee reviews annually a formal letter provided by the external auditor confirming its independence and objectivity within the context of applicable regulatory requirements and professional standards.
During the year the Committee instigated an annual review procedure to assess the independence, effectiveness and objectivity of the external auditor through an evaluation of both the audit firm and audit teams.
The process was conducted by means of a questionnaire completed by members of senior management and members of the Group’s finance community which sought opinions against certain criteria and the perceived importance of such. The questionnaires were collated by the Group Company Secretary. Based on this review the Committee concluded that the audit service of Ernst & Young LLP provided a good examination of the Group’s business and the risks involved.
Internal controls The Board has the ultimate responsibility for the systems of internal control maintained by the Group and for reviewing their effectiveness. The systems are intended to provide reasonable assurance, but not an absolute guarantee, against material financial misstatement or loss, and include the safeguarding of assets, the maintenance of proper accounting records, the reliability of financial information, compliance with appropriate legislation, regulation and best practice, and the identification and containment of business risks.
The Committee, acting on behalf of the Board, undertakes an annual review of the effectiveness of the internal audit function and the framework for the Group’s systems of internal control. During the year the Committee has received regular reports on the status of major finance systems development projects. In the Board’s view, the information received was sufficient to enable it to review the effectiveness of the Group’s systems of internal controls in accordance with the Guidance on Internal Control (the Turnbull Guidance). The principal features of the control framework are as follows: Control environment The Group has an established governance framework. The key features of the control environment within the framework include: the terms of reference for the Board and each of its committees; a clear organisational structure, with documented delegation of authority from the Board to executive management; a Group policy framework, which sets out risk management and control standards for the Group’s operations worldwide; and defined procedures for the approval of major transactions and capital allocation. The Group is also preparing for future changes to the regulatory regime impacting on governance. In addition during 2003 and 2004, the Group has adapted its risk and governance frameworks to implement the PSB – the Financial Services Authority’s new risk-based framework for integrating and embedding risk and capital management. Further details on financial and capital risk management are given in the financial review on pages 39 to 41.
A ud it c om m it te e re po rt
The Committee currently comprises the following directors, appointed by the Board: Pehr Gyllenhammar (Chairman) Guillermo de la Dehesa Richard Harvey Wim Dik André Villeneuve
Members of the Committee take no part in any discussions concerning their own circumstances.
In terms of the work undertaken during the year, the Committee identified a number of potential non-executive directors as part of planning for the succession of some of the current non-executive directors who have provided long service to the Board and as a consequence acquired valuable knowledge of the Company and the industry. In particular the Committee was seeking directors with strong financial backgrounds who could help with the work of the Audit Committee and the growing demands being made upon it. Following recommendations from the Committee, which were unanimously approved by the Board, Richard Goeltz and Russell Walls were appointed directors in May 2004 and subsequently joined the Audit Committee, and Lord Sharman of Redlynch was appointed to the Board in January 2005. In each case executive search consultants were used to identify suitable candidates and to assist with the preparation of the interview lists. In terms of succession planning the appointments of the new directors allowed George Paul to stand down as a member of the Audit Committee.
The appointment of four new non-executive directors over the past two years will allow for the planned retirement of George Paul and Elizabeth Vallance at the end of 2005. Derek Stevens and André Villeneuve are also long serving directors and the Committee has been reviewing the necessary skill and knowledge replacement with the intention that these directors will retire on or before 31 December 2006.
PricewaterhouseCoopers (PwC) advised the Committee on the implications of the international accounting standards on the accounting treatment of the share plans. PwC is the auditor of Delta Lloyd, the Group’s subsidiary company in the Netherlands and also advised the Company on a wide range of non-audit accounting issues during the year.
No changes were made to the remuneration policy and packages during the year other than for those executives who were members of the Aviva Staff Pension Scheme on a non-contributory basis. A requirement to contribute was introduced from 1 April 2004 at a level of 2.5% pa of gross pensionable salaries. This will rise to 5% pa from April 2005.
Chairman and non-executive directors It is the Company’s policy to set the fees paid to its Chairman and non-executive director’s at the median level for international companies of similar size and complexity. Non-executive directors receive a basic annual fee in respect of their Board and Board committee duties, with a further fee being paid to those directors (other than the Chairman and Deputy Chairman) who have the additional responsibility of chairing meetings of Board committees. Fees are reviewed regularly and are set by the Board to attract individuals with the broad range of skills and experience appropriate for a major international company. In determining the level of fees paid to the non-executive directors the Board considers a recommendation from the executive directors who take into account their duties and responsibilities, the time commitment required in preparing for and attending meetings, and the amounts paid by competitors and similar-sized companies. Other than the Chairman who receives a car allowance, the Chairman and non-executive directors receive no benefits in addition to their fees nor do they participate in any incentive or performance plans.
The Company’s articles of association provide that the total aggregate remuneration paid to directors shall be determined by the Board within the limits set by shareholders. In recognition of the growing accountabilities and time commitments required of non-executive directors of major companies, the market level of fees has increased over recent years. To be able to continue to pay competitive fees and
Remuneration package The remuneration package for the Group’s senior executives which applied during the year is set out below and it is proposed that a number of changes be made to the packages for 2005. These changes and the reason for proposing them are described on page 56 under the heading Remuneration Review.
During the year the remuneration package comprised the following elements: • A basic salary; • An annual bonus plan – to encourage executives to meet annual targets relating to business, and personal, performance; • A deferred bonus plan – linked to the annual bonus plan to encourage executives to take all of their bonus in the form of shares and to retain them for a period of three years; • A long-term incentive plan – to align executives’ longer term interests with those of shareholders; • A defined benefit pension entitlement; • Other benefits comprising a car allowance and private medical insurance.
The balance between these elements is set such that, for directors achieving “Target” performance, basic salary represents approximately 40% of the potential total remuneration package, with the annual bonus/deferred bonus plan representing 35% and the long-term incentive plan 25%. At “Stretch” performance, basic pay represents approximately 28% of the potential total remuneration package, with the annual bonus/deferred bonus plan representing 36% and the long-term incentive plan also representing about 36%. “Stretch” performance broadly represents the achievement of aggregate business results at 115% or more of the business plan targets set for the year.
The Committee considered the suggestion of certain institutional investors that the vesting of matching awards should be subject to the attainment of performance conditions. The award of matching shares can only be made in relation to bonuses actually earned, (ie the performance conditions attaching to the annual bonus plan must have been met). The plan makes it compulsory for participants to defer 50% of their bonus into shares and encourages participants to invest the whole of their bonus into shares, thereby strengthening further the alignment of their interests with those of shareholders. The Committee believed that the imposition of additional performance conditions would be detrimental to achieving such extended shareholdings. As a result of benchmarking the Company’s remuneration package, the Committee was aware that the maximum amount which a participant could earn under the Company’s annual cash bonus plan, and hence defer, (being 50% of basic salary), was at the bottom decile of the market range. Taking the above into account, the Committee was satisfied that the absence of performance conditions was reasonable. However, the continuation of this practice was given particular consideration in the remuneration review and it is proposed to amend the Plan as described in the remuneration review below.
The achievement of median TSR performance within the comparator group triggers the vesting of 20% of the shares, which rises to 70% if the Company’s performance is in the upper decile of the comparator group. The comparator group for the TSR part of the plan comprises 19 European financial services companies, namely – Abbey (prior to
15 November 2004), AEGON, Allianz, AXA, Barclays, CNP Assurances, Ergo, Fortis, HBOS, HSBC, ING, Legal & General, Lloyds TSB, Prudential, Royal Bank of Scotland, Royal & Sun Alliance, Skandia, Swiss Life and Zurich. The awards vest after three years, but only to the extent that the performance conditions are satisfied.
If the performance targets have not been met at all at the end of the performance period they will be retested at the end of five years, the ROCE performance condition being adjusted accordingly, (ie the cumulative ROCE would need to be at least 40% in excess of the rate of inflation over the extended performance period for any awards under that part of the plan to vest). The Committee is conscious that certain institutions are not in favour of performance conditions being retested. From a benchmarking exercise the Committee noted that the Company’s performance conditions ie upper decile TSR and ROCE exceeding 30% in excess of inflation over the performance period are very demanding compared with such plans generally. The Committee believes that it is important to strike a balance between setting challenging performance conditions and retaining the motivational incentive which is the fundamental purpose of the Plan. No retesting takes place if any part of the performance condition has been met at the end of the three-year performance period. However, the practice of retesting was given particular consideration in the remuneration review and it is proposed that the Plan be amended as described in the remuneration review below.
Whether or not the performance conditions have been met is determined by the Committee. The rules of the Plan require the Committee to request an independent consultant to determine the relevant TSR positions. In respect of the ROCE calculation, the Committee requests that the Group’s auditor expresses a formal opinion on the basis of the calculation used.
Major changes to accounting policies and practices including the change to international accounting standards in 2005 and the adoption of European Embedded Value principles referred to elsewhere in these Report and Accounts will impact a number of the key performance targets and performance measures used in connection with the annual bonus plan and long-term incentive plans. During the transition period, the Committee will satisfy itself that the evaluation of actual performance against the performance conditions set makes appropriate allowance for the changes to the accounting basis.
The Company operates a number of Inland Revenue approved all-employee share plans in the UK. Senior executives are entitled to participate in these plans on the same basis as other eligible employees. These include the Free Share element of the Aviva All-Employee Share Ownership Plan (AESOP). Under this plan, eligible employees can receive up to a maximum of £3,000 pa in the form of shares from the profits of the Company, free of tax, subject to a retention period. The Partnership element of the AESOP allows participants to invest up to £125 per month out of their gross salary in the Company’s shares.
The Aviva Savings Related Share Option Scheme allows eligible employees to acquire options over the Company’s shares at a discount of up to 20% to their market value at the date of grant. In order to exercise these options, participants must have saved the consideration through either a three, five or seven year approved savings contract, subject to a maximum savings limit of £250 per month.
Directors’ service contracts Compensation payable Contract Unexpired Notice upon early date term period termination
Richard Harvey 1 June 2000 Rolling 1 year None 1 year
Philip Scott 1 June 2000 Rolling 1 year None 1 year
Patrick Snowball 1 June 2000 Rolling 1 year None 1 year
Philip Twyman* 1 June 2000 Rolling 1 year None 1 year * Mr Twyman retired from service and from the Board on 31 March 2004 upon reaching his normal retirement date.
Non-executive appointments The non-executive directors, including the Chairman, have letters of appointment which set out their duties and responsibilities. Such appointments are generally for three years and may be renewed by mutual consent. These appointments can be terminated at any time by either party, without the payment of compensation, upon giving one month’s written notice.
The dates of the appointments/reappointments for the current directors are as follows.
Remuneration review Process The current remuneration policy and packages were adopted in 2000 upon the merger of CGU and Norwich Union and the share-based incentive plans were approved by shareholders at the Company’s 2001 Annual General Meeting.
During the year the Committee undertook a comprehensive review of the remuneration policy and packages described above with the purpose of ensuring that they continue to attract, motivate and retain high calibre employees by encouraging and rewarding superior performance fairly in a manner which is aligned with shareholders’ interests. The Committee has been advised by Management with the support of KPMG LLP and the Committee sought its own independent review of the proposals from New Bridge Street Consultants.
The review process involved: • Challenging the Company’s remuneration philosophy, policy and practices to ensure that the remuneration framework continued to support the overall business strategy and was aligned with shareholders’ interests and the Company’s culture and values; • Analysing competitive market practice and assessing the Company’s position relative to corporate governance best practices; • Seeking views on the Company’s remuneration objectives from senior executives (at various levels within the Company) and non-executive directors in their respective capacities as senior business leaders managing teams, individuals who would be affected by any changes and as the stewards of the Company; • Developing a revised remuneration package, which aligns the issues arising from the above with the interests of shareholders; Aviva plc 2004
• Seeking an independent opinion on the proposals; • Discussing the proposals with institutional investor bodies including the Association of British Insurers, the National Association of Pension Funds/Research Recommendations and Electronic Voting Limited and Pensions Investment Research Consultants Limited; and
Shareholders will have an opportunity to approve the proposals through the submission of this Remuneration Report and the resolutions concerning the adoption of new share-based incentive plans at the Company’s forthcoming Annual General Meeting. If approved the new remuneration structure will become effective for the 2005 financial year.
Following the remuneration review, the Committee concluded that some aspects of the current remuneration policy were no longer in line with corporate governance good practice, most notably the lack of performance conditions relating to the matching shares awarded under the Deferred Bonus Plan and the retesting of the performance conditions under the Long-Term Incentive Plan. The review also concluded that although Aviva is the largest insurer in the UK and the fifth largest in the world the competitiveness of the total remuneration package was found to be significantly behind that of other leading financial services, and FTSE50, companies of a similar size and complexity, principally due to the modest incentive potential of the current package. The Committee concluded that any further upside potential should be linked to the achievement of stretching performance targets in order to encourage superior performance.
Basic salary There are no proposed changes to the Company’s policy on basic salary levels nor indeed to any element of “fixed” remuneration. These will continue to be set around the median level against pay data for companies in the FTSE50. Basic salaries will generally be reviewed annually and when approving any increases the Committee will continue to take into account the performance of the individual and the Company, relevant market data and practice for comparable jobs and the pay rises proposed for the majority of employees. Salary progression will remain dependent upon personal performance, with progress above the general level of increases requiring superior performance. It is not anticipated that there will be any changes in basic salary levels of the executive directors as a result of introducing the new reward structure.
The key performance targets will be more selective and focused for the measurement of “Target” performance and “Stretch”. “Stretch” performance will be measured against those key performance targets which influence share price performance, and will equate to 120% (currently 115%) of “Target” level on those measures where such quantification is appropriate. The minimum level of bonus will be paid when performance reaches 90% of “Target”. Key performance targets will include financial, customer and employee measures.
Long-term incentive plan In considering the long-term incentive plan the Committee was mindful of the need for the levels of award to be competitive and motivating, and also of the intention to require directors to build up and retain a personal shareholding in the Company.
The Committee identified a need to position the directors’ long-term incentive awards at a more competitive and motivational level, hence it proposes to increase the typical award to 175% of salary for the Group Chief Executive and to 150% of salary for the other executive directors. Vesting of the awards will continue to be measured on both a comparative basis ie TSR relative to a comparator group (50% of the award) and an absolute basis being the ROCE (50% of the award). The comparator group to be used for the TSR measure will remain the major financial institutions in Europe but with a closer match to those companies which are competitors in that they trade with similar products in the same geographic markets. As a result the new comparator group will comprise, Aegon, Allianz, AXA, Fortis, Friends Provident, Generali, HBOS, ING, Legal & General, Lloyds TSB, Prudential, Royal Bank of Scotland, Royal & Sun Alliance and Zurich, making a total of 14 companies. Vesting of the awards under the TSR measure will be subject to an underpin to ensure that the financial performance of the Company over the performance period has been sufficiently robust to warrant such vesting.
Vesting against the TSR performance measures will be on the following basis: Position of Aviva in the comparator group Percentage of shares in the award that will vest
Further details of the new Annual Bonus Plan and Long-Term Incentive Plan are set out in the Notice for the Annual General Meeting.
Total remuneration The effect of the proposed refinements outlined above would be that at target performance executive directors’ total potential remuneration would be positioned at broadly median compared with the Companys’ comparators with cognisance being given to size and complexity of the Company.
Share ownership requirements At present there are no formal share ownership requirements relating to the executive directors. As part of the revised remuneration package the Group Chief Executive and the executive directors will be required to build a shareholding equivalent to 1.75 times annual salary and 1.5 times annual salary respectively, over a five-year period.
Executive pensions As a consequence of the major changes to pension scheme regulations from 1 April 2006 known as “pensions simplification” including the introduction of a “lifetime allowance”, the Committee is reviewing the provision of pensions for its senior executives in order to provide more flexibility around their personal circumstances. However, the overall cost to the Company of any alternative pension arrangements will not exceed the costs of providing pensions under the current arrangements.
Executive Share Option Plan In order to maintain maximum flexibility regarding its reward structure the Company is taking the opportunity to renew its current executive share option plan. However, under its proposed remuneration arrangements as outlined above, it has no present intention to include grants of options under this plan as part of its remuneration structure. In any event no senior executive would receive an award under the Long-Term Incentive Plan and the Executive Share Option Plan in respect of the same financial year.
1. “Bonuses” include amounts earned in respect of 2004 performance under the Annual Bonus Plan (including amounts deferred under the Aviva Deferred Bonus Plan), and where appropriate, the value of shares granted under the free share part of the Aviva All-Employee Share Ownership Plan.
3. Non-executive directors. The benefit disclosed for Pehr Gyllenhammar refers to a car allowance. The fee for George Paul reflects his duties as deputy chairman, chairman of the Remuneration Committee and acting as the senior independent non-executive director. The fee for Derek Stevens includes an additional amount for serving as the chairman of the Board’s Audit Committee and of the trustee of the Aviva Staff Pension Scheme. The fee for Guillermo de la Dehesa includes an amount for serving as the non-executive chairman of the Group’s operations in Spain. No non-executive director accrued retirement benefits during the year.
During the year shares granted to certain former executive directors under the Company’s incentive plans vested. Details of these awards were fully disclosed in the year of grant.
7. No executive director served on the Board of an external company in a personal capacity during the year for which he was remunerated.
Pension benefits During the year, each of the executive directors accumulated pension benefits under the defined benefits section of the Aviva Staff Pension Scheme, the Group’s pension scheme for its UK employees.
Pension Increase in pension column at Transfer value Transfer value Increase of Age at accumulated pension 2004 31 December of pension of pension transfer value 2004 £’000 £’000 £’000 £’000 £’000 £’000 £’000
Also disclosed is the transfer value of the accumulated pensions at 31 December 2003 and 2004. The “increase of transfer value 2004”
– Bonus Plan options * At date of ceasing to be a director – 31 March 2004.
Exercise of options On 25 February 2004 Philip Twyman exercised the executive options which were granted to him in 1996, making a gain of £8,367.
Aviva Deferred Bonus Plan * At 1 January 2004 or date of appointment, if later.
The Aviva Long-Term Incentive Plan was approved by shareholders at the 2001 Annual General Meeting and awards are made on an annual basis. Awards are subject to the attainment of performance conditions over a three-year performance period as described on page 54. The three-year performance condition relating to the awards granted in May 2001 fell due for testing during the year. For any awards to vest under the TSR condition the Company’s TSR, when compared with the TSR of a comparator group of European financial services companies (see page 54), would need to at least match median performance when 20% of the awards become exercisable. At upper decile performance 70% of the awards would vest. Between median and upper quartile the number of awards vesting is determined on a straight-line basis. For any awards to vest under the ROCE condition, the Company’s ROCE would have to exceed 24% in excess of RPI over the three-year performance period when 24% of the awards would vest, rising to 30% if the ROCE exceeded 30% over the same period. At the end of the performance period relating to the awards granted in 2001, the Company was ranked twelfth out of the 20 companies in the comparator group and the ROCE was 27.5%. Accordingly none of the awards vested based on the TSR part of the Plan but 21.7% of the awards vested under the ROCE condition. The 78.3% of the awards which did not vest lapsed.
Directors’ interests in Aviva shares The interests held by each person who was a director at the end of the financial year in the ordinary shares of 25 pence each in the Company is shown below. All the disclosed interests are beneficial. The table also summarises the interests in shares held through the Company’s various all-employee and executive share schemes. Details of the options and long-term incentive awards are shown on pages 60 and 61 and as described above.
Shares1 Deferred Bonus Plan Awards2 Long-Term Incentive Awards3 Options4 Aviva Share Plan5 1 January 31 December 1 January 31 December 1 January 31 December 1 January 31 December 1 January 31 December
Derek Stevens 2,005 2,005 – – – – – – – – Elizabeth Vallance 830 830 – – – – – – – – André Villeneuve 640 640 – – – – – – – – Russell Walls* – 1,500 – – – – – – – –
* At appointment – Richard Goeltz and Russell Walls 3 May 2004; Andrew Moss 10 May 2004.
Notes 1. “Shares” are the directors’ beneficial holdings in the ordinary shares of the Company and include shares purchased by them under the partnership element of the Company’s All Employee Share Ownership Plan (AESOP) and shares granted under the free share element of the AESOP, which are currently held in trust.
2. “Deferred Bonus Plan Awards” relates to an entitlement to shares arising through the Aviva Deferred Bonus Plan. Half of the number of the shares disclosed relate to shares which have been granted as a result of the directors deferring some, or all, of their annual cash bonuses and therefore represent a director’s investment in the Company. The remaining 50% are shares granted on a “one for one” matching basis. Upon vesting the participants receive additional shares representing the dividends paid on the shares during the deferral period.
3. “Long Term Incentive Awards” are awards granted under the Aviva Long-Term Incentive Plan which only vest if the performance conditions are achieved.
5. “Aviva Share Plan” relates to shares held under the Plan referred to above in which only Andrew Moss participates.
The following changes to directors’ interests during the period 1 January 2005 to 8 March 2005 have been reported to the Company. They relate to shares acquired each month under the partnership element of the AESOP: Number of shares
This report is made solely to the Company’s members, as a body, in accordance with section 235 of the Companies Act 1985. Our audit work has been undertaken so that we might state to the Company’s members those matters we are required to state to them in an auditors’ report and for no other purpose. To the fullest extent permitted by law, we do not accept or assume responsibility to anyone other than the Company and the Company’s members as a body, for our audit work, for this report, or for the opinions we have formed.
Respective responsibilities of directors and auditors The directors are responsible for preparing the Annual Report, including the accounts which are required to be prepared in accordance with applicable United Kingdom law and accounting standards as set out in the Statement of directors’ responsibilities on page 49 in relation to the accounts.
Basis of audit opinion We conducted our audit in accordance with United Kingdom Auditing Standards issued by the Auditing Practices Board. An audit includes examination, on a test basis, of evidence relevant to the amounts and disclosures in the accounts and the part of the Directors’ remuneration report to be audited. It also includes an assessment of the significant estimates and judgements made by the directors in the preparation of the accounts, and of whether the accounting policies are appropriate to the Group’s circumstances, consistently applied and adequately disclosed.
Equalisation provision Our evaluation of the presentation of information in the accounts has had regard to the statutory requirement for insurance companies to maintain an equalisation provision. The nature of the equalisation provision, the amount set aside at 31 December 2004 and the effect of the movement in the provision during the year on the general business technical result and profit on ordinary activities before tax, are disclosed in accounting policy U and note 40 to the accounts
In December 2004, the UK Accounting Standards Board issued FRS27 “Life Assurance”, which requires certain disclosures to be made in relation to with-profit funds, capital and guarantees and options. Preparation of accounts in accordance with the standard is mandatory for accounting periods ending on or after 23 December 2005, and the Group will make these disclosures in its 2005 financial statements, produced under International Financial Reporting Standards. In accordance with the Memorandum of Understanding signed by Aviva in relation to this standard’s application to insurers’ 2004 Report and Accounts, the required disclosures are made in the Financial review on pages 24 to 41.
General business 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 balance sheet date. Unearned premiums are computed principally on either the 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.
C – Claims Long-term business claims reflect the cost of all claims arising during the year, including claims handling costs, as well as policyholder bonuses accrued in anticipation of a bonus declaration.
General business claims incurred include all losses occurring during the year, whether reported or not, related handling costs, a reduction for the value of salvage and other recoveries, and any adjustments to claims outstanding from previous years. Claims handling costs include internal and external costs incurred in connection with the negotiation and settlement of claims. Internal costs include all direct expenses of the claims department and any part of the general administrative costs directly attributable to the claims function.
E – Unexpired risks Provision is made for any overall excess of expected claims and deferred acquisition costs over unearned premiums, after taking account of the investment return expected to arise on assets relating to the relevant general business provisions.
F – 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. As the volume of reinsurance assumed is not material to the Group, no separate disclosure of this business has been made in the relevant notes to these accounts. 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. Gains or losses on buying retroactive reinsurance are recognised in the profit and loss account immediately at the date of purchase and are not amortised. Premiums ceded and claims reimbursed are presented on a gross basis in the consolidated profit and loss account and balance sheet as appropriate.
The long-term nature of much of the Group’s operations means that, for management’s decision-making and internal performance management, short-term realised and unrealised investment gains and losses are treated as non-operating items. The Group focuses instead on an operating profit measure that incorporates a longer term return on investments supporting its non-long-term business and shareholders’ funds in its long-term business. As permitted by the ABI SORP, total
Non-long-term business investment income and unrealised gains and losses are taken to the non-technical account. The longer term return on the investments owned by general business operations is then transferred from the non-technical account to the general business technical account. Profits and losses arising on investment transactions with the long-term funds are included in realised investment gains.
I – Pension costs and other post-retirement benefits The Group operates a number of defined benefit and defined contribution plans throughout the world, the assets of which are generally held in separate trustee-administered funds. The pension plans are generally funded by payments from employees and by the relevant Group companies, taking account of the recommendations of qualified actuaries.
For defined benefit plans, the pension costs are assessed using the projected unit credit method. Under this method, the cost of providing pensions is charged to the profit and loss account so as to spread the regular cost over the service lives of employees, in accordance with the advice of qualified actuaries.
In November 2000, the Accounting Standards Board issued Financial Reporting Standard (FRS) 17 “Retirement Benefits”, the accounting provisions of which are not required to be adopted by the Group until 2005. However, the FRS requires certain disclosures to be made in the notes to the accounts, as shown in note 45e.
Provision is made for deferred tax liabilities, or credit taken for deferred tax assets, using the liability method, on all material timing differences, including revaluation gains and losses on investments recognised in the profit and loss account. Deferred tax is calculated at the rates at which it is expected that the tax will arise and discounted to take into account the likely timing of payments and pattern of expected realisation of investments. The discount rates used are the post-tax yields to maturity that could be obtained at the balance sheet date on government bonds with maturity dates and in currencies similar to those of the deferred tax assets or liabilities.
L – Investments Investments are stated at their current values at the end of the year, with the exception of certain non-linked long-term business debt securities and fixed income securities which are shown at amortised cost, as this basis more closely corresponds with the valuation of the relevant long-term liabilities. Current values, for this purpose, are: stock exchange mid-market values for listed securities; average trading prices for unlisted securities where a market exists; and directors’ valuations for other unlisted securities, and for mortgages and loans.
M – Derivative instruments The Group uses derivative instruments, including forward foreign exchange contracts, interest rate swaps, futures and options for hedging purposes. Derivative instruments are accounted for as follows: • Forward foreign exchange contracts. The interest rate differential is included in investment income, while the effect of the currency movements on these contracts is treated as an exchange difference; • Cross-currency swaps related to the Group’s borrowings. These are translated at the year end rates and included as part of borrowings; • Interest rate swaps. The interest payable and receivable is included within investment expenses or investment income as appropriate; • Futures contracts and purchased options. These are included at market value and shown under the category of investments to which the contracts relate. No adjustment is made to the classification of existing investments to reflect the effect of the future settlement of these transactions.
N – Consolidation of subsidiary undertakings The results of all material subsidiary undertakings are consolidated using audited accounts prepared to 31 December. Subsidiary undertakings acquired during the year are consolidated from the date of acquisition. In the Company balance sheet, subsidiary undertakings are stated at current value which, for this purpose, is embedded value for life operations and net asset value for other entities.
The full embedded value of the long-term business and further details of the methodology and assumptions are included as supplementary information on pages 128 to 146.
Q – Long-term business provision and technical provision for linked liabilities The long-term business provision is calculated separately for each life operation, based on local regulatory requirements and actuarial principles consistent with those applied in the UK. Each calculation represents a determination within a range of possible outcomes, where the assumptions used in the calculations depend on the circumstances prevailing in each life operation. Further details of the methodology and the principal assumptions used are given in note 38.
Within the long-term business provision, explicit allowance is made for vested bonuses, including those added following the current valuation. The allowance for future bonuses depends on the methodology and is explained in note 38. The provisions held for linked business and unitised with-profits business are the unit liabilities together with certain non-unit provisions.
S – Subordinated debt and debenture loans Subordinated debt and borrowings issued at a discount are included in the balance sheets at their proceeds, net of issue costs and discount on issue to the extent not yet amortised at the balance sheet date. The difference between net proceeds and redemption value is charged to loan interest in the profit and loss account over the period of the borrowings, using the effective yield method.
T – Fund for future appropriations In certain participating long-term business, the nature of the policy benefits is such that the division between shareholder reserves and policyholder liabilities is uncertain. Amounts whose allocation either to policyholders or shareholders has not been determined by the end of the financial year are held in the fund for future appropriations. Transfers between this fund and the long-term business technical account represent changes in the unallocated amounts between balance sheet dates.
U – Equalisation provision Provision is made in the Group accounts for the equalisation provisions established, where required, in the accounts of individual insurance companies in the UK and in a limited number of countries overseas. The provision is required by law even though no actual liability exists at the balance sheet date.
X – Leases Leases, where a significant portion of the risks and rewards of ownership are retained by the lessor, are classified as operating leases. Payments made as lessees under operating leases (net of any incentives received from the lessor) are charged to the profit and loss account on a straight-line basis over the period of the lease.
1m £m £m 30,196 Gross premiums written (5a) 20,533 19,373 (933) Outward reinsurance premiums (F) (634) (595)
29,263 Written and earned premiums, net of reinsurance (B & 5a) 19,899 18,778 7,521 Unrealised gains on investments (G & 6a) 5,114 7,069
Amortisation of acquired additional value of in-force long-term business (185) (included within other technical charges and investment income) (126) (135)
1m £m £m 15,519 Gross premiums written (5a & b) 10,553 10,395 (1,094) Outward reinsurance premiums (F) (744) (805)
(34) Change in the equalisation provision (U & 40) (23) (49)
Financial Services Compensation Scheme levy (40) – Change in the equalisation provision (40) (23) (49)
Consolidated profit and loss account Non-technical account For the year ended 31 December 2004
1m £m £m 1,083 Balance on long-term business technical account 737 701 454 Tax credit attributable to balance on the long-term business technical account (J & 13a) 308 273 1,537 Profit from long-term business operations before tax 1,045 974 1,943 Balance on general business technical account 1,321 923
Investment income (G & 6a) (3) Share of result of associated undertakings, net of goodwill amortisation (2) –
424 Unrealised gains on investments (G & 6a) 288 143 98 Allocated investment return transferred from the long-term 67 129 business technical account (G & 6b)
1,520 Profit for the financial year attributable to equity shareholders 1,034 932 675 Retained profit transferred to reserves (34) 459 387
Earnings per share attributable to equity shareholders Operating profit before amortisation of goodwill, amortisation of acquired additional value of in-force long-term business and exceptional items, after tax, attributable to 84.1c equity shareholders (15a) 57.2p 44.0p 67.4c Profit attributable to equity shareholders (15a) 45.8p 41.4p 66.8c Profit attributable to equity shareholders – diluted (15b) 45.4p 41.3p
Operating profit before tax based on longer-term investment return before amortisation of goodwill, amortisation of acquired additional value of in-force long-term business and exceptional items 1,743 Modified statutory life profit (3a)*† 1,185 1,122
Pro forma reconciliation of Group operating profit to profit on ordinary activities before tax For the year ended 31 December 2004
1 Movement in shares held by employee trusts (33) 1 – 248 Goodwill written back and other movements (K & 34) 169 –
Consolidated statement of total recognised gains and losses For the year ended 31 December 2004
Reinsurers’ share of technical provisions 552 Provision for unearned premiums (B) 392 339 5,737 Long-term business provision (Q) 4,073 3,356 1,200 Technical provision for linked liabilities (Q & 24) 852 579
Prepayments and accrued income 2,293 Accrued interest and rent 1,628 1,628 1,549 Other prepayments and accrued income 1,100 943
Creditors 2,551 Creditors arising out of direct insurance operations 1,811 1,707 631 Creditors arising out of reinsurance operations 448 523 Long-term business borrowings 396 Amounts due to credit institutions (42c) 281 172
The cash flows presented in this statement relate to non-long-term business transactions only. Long-term business profits are included as net cash inflow from operating activities only to the extent that they have been remitted to shareholders by way of dividends from life operations.
Acquisitions and disposals Net disposals of subsidiary and associated undertakings† (47b) 59 600
Fixed assets Shares in subsidiary undertakings (N & 16e) 15,338 13,633 Investment in joint venture (O and 19c) 22 22
Creditors: Amounts falling due within one year Amounts owed to subsidiary undertakings (2,876) (1,949) Loans (42e) (1,071) (1,172) Proposed ordinary dividend (14) (364) (342) Other creditors (111) (63)
2 – Presentation changes (a) As explained in note 16(e), the Company’s shares in its subsidiaries are stated at current value which for the life operations is their embedded value. This is now calculated using European Embedded Value (EEV) principles, which is a change from the Achieved Profit basis used previously. As disclosed in the supplementary information on page 128 to 146, this change of basis has resulted in a £413 million reduction in value of the life subsidiaries at 31 December 2003. The Company’s balance sheet at that date, and relevant notes, have been restated for this change.
3 – Segmental information The Group’s reportable business segments are long-term business, health business, fund management and general insurance business. The main geographical segments are the UK, Europe (excluding the UK) and International.
(iii) Operating profit in respect of fund management Operating profit £m £m
UK 10 (6) Europe (excluding UK) France 17 13 Other Europe 7 3 International
Europe (excluding UK) France (8) (9) 32 35 Ireland 79 26 153 91 Netherlands 26 (5) 71 35 Other Europe 2 (6) 39 32 International
Total Group operating profit in respect of non-insurance operations (115) (56)
UK 1,240 1,133 Europe (excluding UK) 738 621 International 231 64
(c) Net assets by business and geographical segment Long-term business General insurance and health business Total £m £m £m £m £m £m
Other business 735 725 Acquired additional value of in-force long-term business (note 23) 451 488 Corporate and other holding company assets 755 666
External borrowings (note 42) (1,412) (1,709) Internal borrowings (987) (1,613) Subordinated debt (note 36) (2,823) (2,814)
In 2004 the internal leverage has been revised for the presentation of internal debt. As a result the net debt position shows the upstream of internal loans from business operations to corporate and holding entities net of tangible assets held by these entities. The reduction in the net internal debt reflects, in part, the repayment by the corporate and holding entities of upstream loans and an increase in the tangible assets held by corporate entities arising from a combination of capital raising activities and dividends received from business operations.
4 – Long-term savings new business premiums An analysis of new life and savings new business premiums is provided below.
Investment sales: Europe (excluding UK) Netherlands 196 204 – – 196 204 Poland 75 109 2 1 77 110 Other Europe 254 49 – – 254 49 International 243 98 – – 243 98
Total long-term business premiums, including share of associates 20,861 19,648 20,205 19,035 Less: share of premiums from associates
UK 5,900 5,721 5,434 5,135 Europe (excluding UK) France 564 558 524 515 Ireland 568 650 545 611 Netherlands 771 605 719 563 Other Europe 287 284 230 226 International
(ii) The longer term investment return and short-term fluctuation are as follows: Shareholders’ interest in long-term business Non-long-term business £m £m £m £m
Total investment return before tax 108 214 682 716 Less: share of result of associated undertakings, net of goodwill amortisation – – 2 – Add: unallocated interest charges – – 465 406
Longer term investment return 41 85 1,085 1,039 Short-term fluctuation in investment return 67 129 64 83
Actual return attributable to shareholders: Long-term business* 572 625 Non-long-term business 4,795 5,431
(d) The table below shows the sensitivity of Group operating profit before tax to changes in the longer term rates of return: By
Equities 1% higher/lower Group operating profit before tax 32 33 Properties 1% higher/lower Group operating profit before tax 12 11 7 – Long-term business bonuses The following amounts have been included in the long-term business technical account in respect of policyholder bonuses: £m £m
For participating business, the discretionary participation feature is recognised separately from the guaranteed element and is classified as a separate liability, referred to as the fund for future appropriations.
8 – Net operating expenses Net operating expenses in the technical accounts comprise: Long-term business General business Total £m £m £m £m £m £m
Changes in deferred acquisition costs 234 (79) (34) (70) 200 (149)
Wages and salaries 1,402 1,447 Social security costs 208 213 Pension costs (note 45d) 117 116 11 – Directors Information concerning individual directors’ emoluments, interests and transactions is given on pages 53 to 62.
Audit services Statutory audit 7.0 6.4 Audit-related regulatory and supplementary reporting 3.1 3.3 10.1 9.7 Further assurance services 3.3 2.7 Other services 1.5 0.9
13 – Tax (a) Tax on profit on ordinary activities Tax credited/(charged) in the non-technical account comprises: £m £m
Current tax UK corporation tax 11 (78) Overseas tax (110) (20) Prior year adjustments 126 20 Tax attributable to balance on long-term business technical account (308) (273)
Deferred tax Origination and reversal of timing differences (27) (19) Changes in tax rates or law 2 (11) (Decrease)/increase in discount (49) 14
Current tax UK corporation tax (243) (207) Overseas tax (133) (105) Prior year adjustments
Deferred tax Origination and reversal of timing differences (373) (129) Increase/(decrease) in discount 174 (35) Prior year adjustments 3 (7)
The total tax charged in the long-term business technical account relates to the following: Parent company and subsidiary undertakings (587) (520) Associated undertakings (19) (9)
Total tax charged in the long-term business technical account (606) (529)
13 – Tax continued (c) Factors affecting current tax charge for the year The tax assessed in the non-technical account is lower (2003: lower) than the standard UK corporation tax rate, because of the following factors: Non-long-term business £m £m
Provisions and other timing differences 11 10 88 79 99 89
Provisions and other timing differences 253 262 (70) (52) 183 210
Discounted net (provision)/asset for deferred tax (549) (334) (74) 15 (623) (319)
Net (provision)/asset at 31 December (549) (334) (74) 15 (623) (319)
13 – Tax continued (iii) The net (provision)/asset for deferred tax is disclosed in the accounts as follows: Long-term business Non-long-term business Total £m £m £m £m £m £m
Amount included in provisions for other risks and charges (note 41) (552) (438) (134) (96) (686) (534)
Amount included in other debtors (note 26) 3 104 60 111 63 215
14 – Ordinary dividends Ordinary dividends in the profit and loss account comprise: £m £m
Irish shareholders who are due to be paid a dividend denominated in euros will receive a payment at the exchange rate prevailing on 8 March 2005.
15 – Earnings per share (a) (i) Basic earnings per share
Adjusted for the following items: – Amortisation of acquired additional value of in-force long-term business (126) (89) (3.9) (135) (98) (4.4) – Financial services compensation scheme and other levies (49) (29) (1.3) – – – – Exceptional costs for termination of operations (note 16d) (50) (40) (1.8) (19) (16) (0.7) – Short-term fluctuation in investment return 131 173 7.6 212 198 8.9 – Change in the equalisation provision (note 40) (23) (16) (0.7) (49) (34) (1.5) – Net loss on the disposal of subsidiary and
Profit attributable to equity shareholders 1,291 (257) 1,034 991 (59) 932
Earnings per share has been calculated based on the operating profit before amortisation of goodwill, amortisation of acquired additional value of in-force long-term business and exceptional items, after tax attributable to equity shareholders, as well as on the profit attributable to equity shareholders. The directors believe the former two earnings per share figures provide a better indication of operating performance.
15 – Earnings per share continued (b) Diluted earnings per share
Profit attributable to equity shareholders 1,034 2,256 45.8 932 2,251 41.4 Dilutive effect of share awards and options – 22 (0.4) – 8 (0.1)
16 – Subsidiary undertakings (a) Acquisitions During the year ended 31 December 2004, the Group acquired the following companies: Country of incorporation Percentage acquired Month of acquisition
The total consideration comprised: Cash (including contingent cash amounts and costs of acquisition) 120 Loan notes 2
Accounting policy Other significant Book value alignments adjustments Fair value £m £m £m £m
Additional value of in-force long-term business – – 18 18 Other assets 2,070 – – 2,070
The total consideration comprised: Cash (including contingent cash amounts and costs of acquisition) 62
(iii) Total goodwill arising on the acquisitions of HPI Group Holdings Limited and Antarius Fair value £m
The total consideration comprised: Cash (including contingent cash amounts) 182 Loan notes 2
Financial Reporting Standard 2 “Accounting for subsidiary undertakings” requires the results of the Asian general insurance business to be consolidated with those of the Group’s ongoing operations until the completion of the transaction. Although the Group has retained no economic interest in the operations of this business beyond 31 December 2003, the post tax operating profits are incorporated in the Group’s consolidated profit and loss account from 1 January 2004 to the date of completion. This will be offset by a corresponding change to the profit on sale calculated
Pre tax profit on sale 169 304 Tax attributable to profit on sale (40) (72)
The Group has hedged its exposure to the sale proceeds of US$450 million through the purchase of foreign currency forward contracts.
(ii) In July 2004, the Group completed the disposal of its Your Move estate agency and e.surveying business. Total consideration was £42 million and the net assets disposed of £12 million. The loss on disposal was £141 million after deducting the associated cost of disposal and after writing back goodwill of £167 million, previously written off to reserves, as required by FRS10 “Goodwill and intangible assets”. The same goodwill amount is also credited directly to the profit and loss account reserve and therefore has a neutral effect on shareholders’ funds.
(e) The Company’s subsidiary undertakings Movements in the Company’s shares in subsidiary undertakings are set out below: Restated £m £m
16 – Subsidiary undertakings continued (f) Principal subsidiary undertakings Principal subsidiary undertakings at 31 December 2004 are listed on page 147.
One of the Group’s subsidiaries, Delta Lloyd NV, is subject to the provisions of Dutch corporate law and particularly the Dutch “structure company” regime. Under this regime, Delta Lloyd has appointed a Supervisory Board which has a duty to have regard to the interests of a wide variety of stakeholders. The Supervisory Board includes two Aviva Group representatives and is responsible for advising and supervising Delta Lloyd’s Executive Board. The shareholder is one of the most important stakeholders to whom the Supervisory Board has a duty. The relationship between the Supervisory Board and its shareholder reflects this and this strengthens the position of Delta Lloyd Group as a major part of the Aviva Group.
Cost: At 1 January 1,553 (53) 1,500 1,342 Additions (note 16b) 144 – 144 140 Disposals (13) – (13) (9) Foreign exchange rate movements 3 – 3 27
Amortisation: At 1 January 408 (13) 395 302 Charge in the year 107 (3) 104 88 Disposals (2) – (2) (9) Foreign exchange rate movements 2 – 2 14
Positive and negative goodwill is being amortised on a straight-line basis over its useful economic life. Useful economic lives have been determined in respect of each acquisition to match the period over which the value of the underlying businesses will exceed the value of their identifiable net assets. No useful economic lives are in excess of 20 years. As explained in accounting policy K on page 65, goodwill arising in 1997 and prior years was eliminated directly against reserves.
18 – Land and buildings (a) The carrying value of land and buildings comprises: Long-term business Non-long-term business Total £m £m £m £m £m £m
Effect of changes in ownership 28 – Reclassification to subsidiaries (89) –
(c) The principal joint ventures included above are as follows: (i) Property management undertakings GP PLP
Ashtenne Industrial Partnership 66.7% 40.2% The Global Switch Limited Partnership 25.0% 25.0% The Junction Limited Partnership 50.0% 48.8% The Mall Limited Partnership 50.0% 40.9% Paddington Central 1 Limited Partnership 50.0% 50.0% Quercus Property Partnership Limited 50.0% 74.2%
All the above undertakings perform property ownership and management activities, and are incorporated and operate in Great Britain. The Global Switch Limited Partnership has subsidiaries in several European countries which carry out property ownership and management activities locally. All these investments are held by subsidiary undertakings.
The cost of the above investments was £652 million and £37 million respectively (2003: £950 million and £72 million respectively). None of the other participating interests is listed on a recognised investment exchange.
Share of result for the year after tax 43 1 44 Foreign exchange rate movements (5) (6) (11) Unrealised investment gains after tax 8 11 19
(ii) The principal associated undertakings included above are: Country of incorporation Company Type of business Class of share Proportion held and operation
Aviva Life Insurance Company India Pvt. Limited Insurance Ordinary Rs1 shares 26.0% India ProCapital S.A. Online brokerage Ordinary e1 shares 43.5% France RBSG Collective Investments Limited Investment Ordinary £1 shares 49.99% Great Britain RBS Life Investments Limited Insurance Ordinary £1 shares 49.99% Great Britain The British Aviation Insurance Company Limited Insurance Ordinary £1 shares 38.1% Great Britain
21 – Other financial investments (a) The tables below show the carrying value and cost of these financial investments as at the dates indicated. All investments are held at current value unless otherwise indicated.
Other loans: Loans secured on policies 1,041 – 1,041 1,041 – 1,041
Long-term Non-long-term Total Long-term Non-long-term Total business business 2003 business business 2003 £m £m £m £m £m £m
Other loans: Loans secured on policies 1,065 – 1,065 1,065 – 1,065
Shares and other variable yield securities and units in unit trusts 26,782 25,623 Debt securities and other fixed income securities 80,490 76,318
21 – Other financial investments continued (d) In addition to the investments in participating interests detailed in note 20a, the Group holds investments exceeding 20% of a class of the equity capital in a number of other companies in the UK and elsewhere. These investments do not represent a material part of the assets or investment income of the Group. These include the Group’s shareholding in Delta Lloyd Investment Fund NV where 20.13% (2003: 13.0%) is held directly and a further 11.74% (2003: 20.8%) is held in segregated policyholder funds. As this company invests mainly in equities and all dividends received are passed on to the shareholders, the Group’s interest has been shown in other financial investments in these accounts.
(e) Included within other financial investments are shareholdings held on a long-term basis as follows: Market value of shareholding
(f) At 31 December 2004, the Group held equity index futures, forwards and options to buy a notional total of £915 million (2003: £2,528 million) and to sell a notional total of £2,587 million (2003: £2,397 million) for long-term business operations. These contracts have a net negative fair value of £32 million (2003: £337 million). No adjustment has been made to the classification of existing investments to reflect the effect of the future settlement of these transactions.
The ultimate effective holding company of ERF1, ERF2 and ERF3 is Equity Release Holdings Limited, whose shares are held on trust. The ultimate effective holding company of ERF4T and ERF4 is Equity Release Holdings (Jersey) Limited, whose shares are also held on trust. NUER does not own, directly or indirectly, any of the share capital of the ERF companies or their parent companies. NUER has no right to repurchase the benefit of any of the securitised mortgage loans, other than in certain circumstances where NUER is in breach of warranty or loans are substituted in order to effect a further advance.
NUER has indemnified ERF1 and ERF2 for any losses they may suffer should their customers set off any shortfall in their annuities purchased from another Aviva Group company against amounts they owe to these companies, and any shortfall due to negative equity not insured elsewhere. NUER’s liability under these indemnities, estimated as £11 million (2003: £6 million), is included in other creditors in the consolidated balance sheet, whilst the linked liabilities figure has been reduced by the same amount to show the Group’s net interest in these securitisations.
NUER has purchased £13 million of subordinated fixed rate notes in ERF1, which are repayable in 2031, and has granted a £14 million floating rate subordinated loan to ERF3. These are included in debt securities and other fixed income securities within other financial investments in the consolidated balance sheet.
NUER receives fees from the ERF companies in respect of loan administration and cash handling. Income of £5 million (2003: £3 million) has been included in investment income, relating to the securitisation of the mortgage portfolios.
22 – Securitised mortgages and allocated assets continued (b) In two Dutch subsidiaries, Delta Lloyd Levensverzekering NV (DLL), and Amstelhuys NV (AMS) the principal benefits of six portfolios of mortgage loans have been transferred to six special purpose securitisation companies, Arena 2000-1 BV, Arena 2001-1 BV, Arena 2002-1 BV, Arena 2003-1 BV, Arena 2004-1 BV, Arena 2004-ll BV and DARTS Finance BV (the securitisation companies), which were funded primarily through the issue of fixed rate notes. No gains or losses were recognised on these transfers.
All the shares in the securitisation companies are held by independent trustees, respectively Stichting Security Trustee Arena 2000-1, Stichting Security Trustee Arena 2001-1, Stichting Security Trustee Arena 2002-1, Stichting Security Trustee Arena 2003-1, Stichting Security Trustee Arena 2004-1, Stichting Security Trustee Arena 2004-ll and Stichting Trustee DARTS Finance 1. DLL and AMS do not own, directly or indirectly, any of the share capital of the securitisation companies or their parent companies. DLL and AMS have no right, nor any obligation, to repurchase the benefit of any of the securitised mortgage loans, other than in certain circumstances where they are in breach of warranty.
23 – Acquired additional value of in-force long-term business Movements in the acquired additional value of in-force long-term business comprise: £m £m
24 – Assets held to cover linked liabilities (a) A reconciliation of assets to linked liabilities is as follows: £m £m
Assets held to cover linked liabilities 51,144 40,665 Reinsurers’ share of technical provision 852 579
Investments 1,198 1,141 Loans and advances to banks 125 136 Loans and advances to customers 2,028 2,563
(b) Banking liabilities (see note 43), excluding intra-group balances, comprise: £m £m
(b) At 31 December 2004, options to subscribe for ordinary shares of 25 pence each in the Company were outstanding as follows: Aviva Savings Related Option price Number Normally Option price Number Normally Share Option Scheme p of shares exercisable p of shares exercisable
Norwich Union Savings Related Option price Number Normally Share Option Scheme p of shares exercisable
General Accident Savings Related Option price Number Normally Share Option Scheme p of shares exercisable
Aviva Executive Option price Number Normally Option price Number Normally Share Option Scheme p of shares exercisable p of shares exercisable
General Accident Executive Option price Number Normally Option price Number Normally Share Option Scheme p of shares exercisable p of shares exercisable
Aviva Executive Option price Number Normally Option price Number Normally Share Option Scheme (Delta Lloyd) p of shares exercisable p of shares exercisable
(c) From March 1998 to March 2003, it was the Company’s practice to satisfy awards and options granted under the executive incentive plans through shares purchased in the market and held by employee share trusts which were established for this purpose and funded by the Company. From March 2003, no shares have been purchased by the trusts, it being the Company’s current practice to satisfy awards granted after that date by the issue of new shares at the time of vesting. At 31 December 2004, 5,894,264 shares were held by the employee share trusts with an aggregate nominal value of £1.5 million and a market value of £37 million. The trustees of the employee share trusts have waived their rights to dividends on the shares held in these trusts. Further details are given in note 33 below.
At 31 December 2004, awards granted under the Company’s executive incentive schemes were outstanding as follows: Number Number
The vesting of awards under the Aviva Long Term Incentive Plan is subject to the attainment of performance conditions, as described on page 54 and 55. Share awards which do not vest lapse.
(d) During 2004, a total of 25,102,699 ordinary shares of 25 pence each were allocated and issued by the Company as follows: Share capital Share premium
Shares issued under the Group’s all-employee share schemes and executive incentive plans 4,986,752 1 24 Shares issued in lieu of dividends – Interim 2004 20,115,947 5 (5)
(e) 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.
(b) The preference shares are non-voting except where their dividends are in arrears, on a winding up or where their rights are being altered. On a winding up, they carry a preferential right to return of capital ahead of the ordinary shares.
The euro and sterling direct capital Instruments (the DCIs) were issued on 25 November 2004, the issue costs of £9 million have been charged to reserves. The DCIs have no fixed redemption date but the Company may, at its sole option, redeem all (but not part) of the DCIs at their principal amount on 28 November 2014 and 27 July 2020 for the Euro and Sterling DCIs respectively, or on any respective coupon payment date thereafter. In addition, under certain circumstances defined in the terms and conditions of the issue, the Company, at its sole option: (i) redeem all (but not part) of the DCIs at their principal amounts at any time prior to 28 November 2014 and 27 July 2020 for the euro and sterling DCIs respectively; (ii) substitute at any time all (but not some only) of the DCIs for, or vary the terms of the DCIs so that they become, Qualifying Tier 1 Securities or Qualifying Upper Tier 2 Securities; (iii) substitute all (but not some only) of the DCIs for fully paid non-cumulative preference shares in the Company. These preference shares could only be redeemed on the 28 November 2014 in the case of euro DCIs and on 27 July 2020 in the case of the sterling DCIs, or in the each case on any dividend payment date thereafter. The Company has the right to choose whether or not to pay any dividend on the new shares, and any such dividend payment will be non-cumulative.
33 – Shares held in employee trusts Movements in the cost of shares held in employee trusts comprise: Number £m Number £m
These shares are owned by employee share trusts in the Company and a subsidiary undertaking to satisfy awards under the Group’s Long Term Incentive Plan, Executive Share Option Plans and Deferred Bonus Plans. The shares are purchased in the market and recorded at cost. Further details of the shares held can be found in note 30c. Further details of the features of the plans can be found in the Directors’ remuneration report on pages 34 – Group reserves Merger Profit and reserve loss account Total £m £m £m
Transfer from non-technical account – 459 459 Foreign exchange rate movements – 28 28 Shares issued in lieu of dividends (see below) – 103 103 Issue costs on direct capital instrument – (9) (9) Other movements – 169 169
The cumulative amount in the profit and loss account reserve relating to net unrealised gains is £511 million (2003: £161 million).
At 1 January 2004 as previously reported 2,074 227 7,004 9,305 Prior year adjustments
– transfer between reserves (see below) 5,735 – (5,735) – – change in valuation basis for subsidiaries (note 2a) (413) – – (413)
Profit for the year attributable to equity shareholders, including dividends received or receivable from subsidiary undertakings – – 1,469 1,469
36 – Subordinated debt Group and Company £m £m 5.700% 1500 million undated subordinated notes 349 347 6.125% £800 million undated subordinated notes 785 785
The subordinated notes rank below the senior obligations of the Company and ahead of the preference shares and ordinary share capital issued by the Company. The dated subordinated notes rank ahead of the undated subordinated notes. The fair value of these notes at 31 December 2004 was £3,107 million (2003: £3,003 million).
(b) The directors have been advised by the Group’s reporting actuary that the assets of each of the long-term operations were at least sufficient to meet their respective liabilities at 31 December 2004.
The gross premium method uses the amount of contractual premiums payable and includes explicit assumptions for interest and discount rates, mortality and morbidity, persistency and future expenses. These assumptions can vary by contract type and reflect current and expected future experience. Explicit provision is made for vested bonuses and explicit allowance may also be made for future regular bonuses, but not terminal bonuses.
For unitised with-profit business, the provisions are valued initially by determining the lower of the current non-guaranteed surrender value and the bid value of units. This result is then compared with a prospective valuation and the higher result is taken. The prospective valuation projects future benefits assuming that future premiums cease and future bonuses are zero, except for policies with a guaranteed minimum bonus rate where this guaranteed rate is allowed for. Allowance for persistency is based on actual experience and takes into account the likelihood of a significantly greater lapse experience on those occasions on which the life company guarantees not to apply a Market Value Reduction charge.
For unit-linked business, the provisions are valued initially 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 cashflows on the assumption that future premiums cease. Where appropriate, allowance for persistency is based on actual experience.
38 – Long-term business provision 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.
Deferred annuities With-profit – in deferment 4.3% to 4.5% 4.2% to 4.8% Non-profit – in deferment 4.0% to 5.5% 4.2% to 5.8% With-profit – in payment 4.3% 4.2% to 4.7% Non-profit – in payment 4.0% 4.2% to 4.7%
Annuities in payment Conventional annuity 4.7% to 5.3% 5.0% to 5.5% With-profit annuity 2.0% 1.5%
* Allowance for future mortality improvements reflect the “medium cohort” projection from the CMIB working paper published in December 2002, adjusted for females and for a higher rate of improvement at very old ages.
(ii) France The majority of provisions arise from a single premium savings product and are based on the accumulated fund value, adjusted to maintain consistency with the value of the assets backing the policyholder liabilities. 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. There have been no changes in the assumptions since 2003.
39 – Provisions for outstanding claims (a) The ultimate cost of general business outstanding claims is estimated by using a range of standard actuarial claims projection techniques, such as the Chain Ladder and Bornhuetter-Ferguson methods. Such methods extrapolate the development of paid and incurred claims, average costs per claim and ultimate claim numbers for each accident year, based upon the observed development of earlier years and expected loss ratios. The main assumption underlying these techniques is that past claims development experience can be used to project future claims development and hence ultimate claims costs. As such, these methods extrapolate the development of paid and incurred losses, average costs per claim and claim numbers for each accident year based on the observed development of earlier years. In most cases, no explicit assumptions are made regarding future rates of claims inflation or loss ratios. Instead the assumptions used are those implicit in the historic claims development data on which the projections are based.
Judgement is used to assess the extent to which past trends may not apply in future, for example to reflect changes in external or market factors such as public attitudes to claiming, economic conditions, levels of claims inflation, judicial decisions and legislation, as well as internal factors such as portfolio mix, policy conditions and claims handling procedures. The approach adopted takes into account, inter alia, the nature and materiality of the business and the type of data available. Large claims are usually separately assessed, either by being measured at case estimate face value or separately projected in order to reflect their future development. Case estimates are generally set by skilled claims technicians applying their experience and knowledge to the circumstances of individual claims. Additional qualitative input, such as allowance for one-off occurrences or changes in legislation, policy conditions or portfolio mix, is also used in arriving at the estimated ultimate cost of claims, in order that it represents the most likely outcome, from a range of possible outcomes, taking account of all the uncertainties involved.
40 – Equalisation provision An equalisation provision has been established in the Group accounts as explained in accounting policy U on page 66. This had the effect of reducing Group and Company shareholders’ funds by £388 million at the year end (2003: £364 million). The change in the equalisation provision during the year comprised a reduction of £23 million (2003: £49 million) in the balance on the general business technical account and the profit on ordinary activities before tax.
Movement during the year: Additional provisions made in the year 151 Amounts utilised (121) Amounts released unutilised (13)
42 – Borrowings (a) The analysis by business segment is: Debenture loans Amounts owed to credit institutions Commercial paper Total £m £m £m £m £m £m £m £m
Long-term business 33 16 281 172 – – 314 188 General business – – 11 11 – – 11 11 Other 472 476 41 101 899 1,132 1,412 1,709 Non-long-term business 472 476 52 112 899 1,132 1,423 1,720
Repayable as follows: One year or less – – 172 1 Between one and two years – – – 172 Between two and five years – – – – After five years 33 16 300 303
The interest charge for the year on the above loans was: 1 – 39 42
The 2.5% perpetual subordinated loan notes were issued by a Dutch subsidiary undertaking to finance the acquisition of NUTS OHRA Beheer BV in 1999. They are convertible into ordinary shares in Delta Lloyd NV, should there be a public offering of those shares. These loan notes have a face value of 1489.9 million but, because they are considered to be perpetual, their carrying value is 1172.4 million, calculated in 1999 and based on the future cash flows in perpetuity discounted back at a market rate of interest. The rate of interest paid on the notes is being gradually increased to a maximum of 2.76% in 2009.
Other loans comprise borrowings in Canada, France, the Netherlands and Spain, none of which is considered material for further disclosure.
Repayable as follows: Between one and two years 4 6 – – – 2 Between two and five years 91 – – – – 5
The interest charge for the year on the above was: 11 4 1 1 1 5
All commercial paper is repayable within one year and is issued in a number of different currencies, primarily sterling, euros and US dollars. Part of this has effectively been converted into a sterling liability through the use of financial instruments in the Company and a subsidiary undertaking.
(e) The Company’s loans comprise: £m £m 8.625% guaranteed bonds 2005 200 199 Bank loans – 75 Commercial paper 871 1,097
Repayable as follows: One year or less 1,071 1,172 Between one and two years – 199 Between two and five years – – After five years 198 198
(g) The Group has the following undrawn committed central borrowing facilities available to it, of which £1,000 million (2003: £1,100 million) is used to support the commercial paper programme: £m £m
The accounting provisions of FRS17 were not expected to be mandatory for the Group until the year ending 31 December 2003 but, in the transitional period, certain disclosures were required in the notes to the accounts. In November 2002, the Accounting Standards Board issued an amendment to FRS17 which extended the transitional period through to, in the Group’s case, the year ending 31 December 2005. The transitional disclosures, to the extent not given in section (c), are set out in section (e) below.
There were no significant contributions outstanding or prepaid as at either 31 December 2004 or 2003.
(e) FRS17 defined benefit plan disclosures (i) Disclosures under FRS17 for the material schemes in the UK, the Netherlands, Canada and Ireland are shown below. Where schemes provide both defined benefit and defined contribution pensions, the assets and liabilities shown exclude those relating to defined contribution pensions. The figures for the Dutch and Canadian schemes include arrangements to meet other post-retirement obligations to staff in those countries. The valuation used for these disclosures has been based on the most recent actuarial valuations, updated to take account of the requirements of FRS17 in order to assess the liabilities of the major schemes at 31 December 2004. The updating was made by actuaries in each country, with overall co-ordination by external consultants, Watson Wyatt. Other than the actuary of the Aviva Staff Pension Scheme and the Dutch arrangements, the actuaries making the calculation were independent of the Group. Scheme assets are stated at their market values at 31 December 2004.
Current service cost 148 149 Past service cost 1 1 Loss on curtailments 8 7 Charge to net operating expenses 157 157 Expected return on scheme assets (391) (348) Interest charge on scheme liabilities 362 322 Credit to investment income (29) (26)
Expected return on scheme assets less actual return (220) (479) Experience (gains)/losses arising on scheme liabilities (12) 106 Changes in assumptions underlying the present value of the scheme liabilities 362 587 Loss on acquisitions and scheme transfers – 5
Percentage of the present value of scheme liabilities 0.2% 1.6% 2.4%
(v) The assets and liabilities of the schemes, attributable to defined benefit members, at 31 December 2004 were: UK Netherlands Canada Ireland Total £m £m £m £m £m £m £m £m £m £m
The net pension liability in the UK defined benefit scheme of £510 million assumes a related deferred tax asset of £218 million, notwithstanding that the Group has unrecognised UK deferred tax assets. This is because the nature of the losses and other short-term timing differences which comprise the unrecognised assets are more restricted in their availability for relief against future taxable profits than are the future pension scheme contributions.
The change in the net pension deficit calculated under FRS17 is mainly attributable to changes in assumptions underlying the present value of the schemes’ liabilities, partially offset by an increase in the market value of their assets. In the UK, the value of the liabilities has increased due to lower corporate bond yields, which are used to set the valuation discount rate, and a higher assumed inflation rate. The increase in asset values is primarily due to an improvement in equity and bond values since the previous year end.
Totals excluding pension net asset 8,965 7,114 2,403 1,681 Less: pension liability on FRS17 basis (619) (583) (619) (583)
Totals including pension liability on FRS17 basis 8,346 6,531 1,784 1,098
Profit on ordinary activities before tax, excluding exceptional items 1,574 1,404 Adjustments for financing expense and items not involving movements of cash: Depreciation of tangible fixed assets 126 75 Amortisation of goodwill 120 103 Amortisation of acquired additional value of in-force long-term business 126 135 Increase in general business underwriting liabilities and provisions 951 1,010 Realised and unrealised gains and losses (211) (166) Net loss on the disposal of subsidiary undertakings 136 6 Decrease in deferred acquisition costs (34) (71) Movement in banking assets and liabilities (120) 143 Movement in other liabilities/assets 140 (669) Profits not yet transferred from long-term business funds (730) (1,014) Loan interest expense 274 241
Net cash inflow from operating activities, excluding exceptional items 2,352 1,197
(e) Non-long-term business cash included in the consolidated balance sheet comprised: 2004 2003 Changes in year £m £m £m
47 – Cash flow statement continued (f) Movements in opening and closing non-long-term portfolio investments were: £m £m
Net purchases of investments 3,905 1,672 Changes in non recourse funding (1,437) –
Balance at 31 December Total non-long-term portfolio investments 20,498 16,271 Non-recourse funding (1,437) –
(c) Guarantees on long-term savings products As a normal part of their operating activities, various Group companies have given guarantees, including interest rate guarantees, in respect of certain long-term insurance and fund management products. In the UK, in common with other pension and life policy providers, the Group wrote individual and group pension policies in the 1970s and 1980s with a guaranteed annuity rate option (GAO). Since 1993, such policies have become more valuable to policyholders, and more costly for insurers, as current annuity rates have fallen in line with interest rates. Reserving policies for the cost of GAOs varied until a ruling by the House of Lords in the Equitable Life case in 2000 which effectively required full reserving by all companies. Prior to the ruling, consistent with the Group’s ordinary reserving practice in respect of such obligations, full reserves for GAOs had already been established. No adjustment was made, or was necessary, to the Group‘s reserving practice as a result of the ruling. The directors continue to believe that the existing provisions are sufficient.
(d) Pensions mis-selling The pensions review of past sales of personal pension policies which involved transfers, opt outs and non-joiners from occupational schemes, as required by the Financial Services Authority (FSA), has largely been completed. A provision of some £50 million (2003: £65 million) remains to meet the outstanding costs of the few remaining cases, the anticipated cost of any guarantees provided, and potential levies payable to the Financial Services Compensation Scheme (FSCS). It continues to be the directors’ view that there will be no material effect either on the Group’s ability to meet the expectations of policyholders or on shareholders.
48 – Contingent liabilities and other risk factors continued (e) Endowment reviews In December 1999, the FSA announced the findings of its review of mortgage endowments and expressed concern as to whether, given decreases in expected future investment returns, such policies could be expected to cover full repayment of mortgages. A key conclusion was that, on average, holders of mortgage endowments had enjoyed returns such that they had fared at least as well as they would have done without an endowment. Nevertheless, following the FSA review, all of the Group’s UK mortgage endowment policyholders received policy-specific letters advising them whether their investment was on track to cover their mortgage.
In May 2002, in accordance with FSA requirements, the Group commenced sending out the second phase of endowment policy update letters, which provide policyholders with information about the performance of their policies and advice as to whether these show a projected shortfall at maturity. The Group will continue to send these updates annually to all mortgage endowment holders, in accordance with FSA requirements. The Group has made provisions totalling £130 million (2003: £80 million) to meet potential mis-selling costs and the associated expenses of investigating complaints. It continues to be the directors’ view that there will be no material effect either on the Group’s liability to meet the expectations of policyholders or on shareholders.
51 – Post balance sheet events After the balance sheet date, the Board of Aviva plc announced the terms of a recommended cash and share offer, to be made by Goldman Sachs and JPMorgan Cazenove on behalf of Aviva plc, for the entire issued and to be issued share capital of RAC plc, subject to regulatory approvals.
Premium income after reinsurance and investment sales Life assurance, investment sales, including share of associates 21,834 20,176 19,200 19,065 17,349
Deduct EEV profit/life achieved profit (1,611) (1,496) (1,518) (1,662) (1,566) Adjustment in respect of life service companies (d) (57) (58) – – – Add modified statutory life profit 1,185 1,138 1,016 1,191 1,187
Shareholder funds per statutory accounts 8,320 6,554 5,836 6,474 7,278 Additional value of internally-generated in-force long-term business 4,617 4,198 3,468 5,268 5,999
Pence per ordinary share Net asset value per statutory accounts (a) 329p 298p 264p 290p 324p Net asset value (on a European embedded value basis/achieved profit basis) (a) 532p 484p 417p 524p 591p Market price (London) (a) 628p 490p 443p 845p 1082p Earnings per share attributable to equity shareholders (b): MSSB operating profit before amortisation of goodwill, amortisation of acquired additional value of in-force long-term business and exceptional items, after tax, attributable to equity shareholders in respect of continuing operations 57.2p 44.0p 34.8p 40.8p 24.6p * On a European embedded value (EEV) basis.
(a) The net asset value and market price (London) are as at 31 December. The net asset value is calculated based on equity shareholders’ funds, adding back the equalisation provision.
(i) The 2000 and 2001 profit and loss account figures were restated in 2002 for the reclassification of the results of various service companies from life assurance to non-insurance operations.
(iii) The 2000 and 2001 results of the Australia and New Zealand general insurance have been reclassified from continuing operations to discontinued operations following the disposal of the business in 2002.
(v) The wealth management result has been included within fund management and non-insurance operations in all years.
Introduction From 2005 all European Union listed groups will be required to prepare their consolidated financial statements using standards issued by the International Accounting Standards Board (IASB) as adopted by the European Union. Aviva will therefore prepare consolidated accounts in 2005 in accordance with IFRS rather than with UK GAAP. The listing rules in the UK require that the 2005 interim results must also be presented on an IFRS basis. Aviva intends to publish its first IFRS results in August 2005. This will include income statement, balance sheet and cash flow statement comparatives for half year and full year 2004.
The restated IFRS preliminary opening balance sheet does not reflect any changes in respect of any amendments to IAS39 on the fair value option currently being discussed by the IASB. Proposals to restrict the fair value option are being considered by the IASB and are the subject of continuing debate between the IASB, industry and regulators, in which Aviva is actively participating. It is too early to anticipate the outcome of these discussions and therefore its eventual impact on the Group.
Financial Reporting Standard 27, Life Assurance (FRS27) was issued by the UK’s Accounting Standards Board (ASB) on 13 December 2004, in the wake of the Penrose enquiry and is mandatory for reporting periods starting on or after 23 December 2005. Aviva along with other major insurance companies and the Association of British Insurers (ABI) has signed a Memorandum of Understanding (MoU) with the ASB relating to FRS27. Under this MoU, Aviva has agreed to provide voluntarily early disclosure of the requirements for 2004 and then to fully adopt the standard from 2005, including within the Group’s IFRS financial statements.
Within FRS27 the ASB acknowledged the difficulty of applying the requirements retrospectively and indeed it is the Group’s view that it would be impractical to do so. Hence in accordance with IAS8 only the balance sheet at 31 December 2004 will be restated for the impact of FRS27. No adjustments are therefore required, nor have any been made, to the restated preliminary IFRS opening balance sheet below.
Cumulative translation differences The Group has elected that the cumulative translation differences of foreign operations were deemed to be zero at the transition date to IFRS.
Equity compensation plans The Group has elected not to apply the provisions of International Financial Reporting Standard 2, Share-based Payment, to options and awards granted on or before 7 November 2002 which had not vested by 1 January 2005.
Comparatives The Group has not taken advantage of the exemption within IFRS1 that allows comparative information presented in the first year of adoption of IFRS not to comply with International Accounting Standard 32, Financial Instruments: Disclosure and Presentation (IAS32), International Accounting Standard 39, Financial Instruments: Recognition and measurement (IAS39) and International Financial Reporting Standard 4, Insurance Contracts (IFRS4).
Estimates Where estimates had previously been made under UK GAAP, consistent estimates (after adjustments to reflect any difference in accounting policies) have been made for the same date on transition to IFRS (ie, judgements affecting the Group’s opening balance sheet have not been revisited for the benefit of hindsight).
Summarised preliminary consolidated balance sheet at date of transition to IFRS – 1 January 2004 UK GAAP (MSSB)
Provisions including pension obligations as measured under IAS 19 336 1,469 1,805 Non-transferable investment in life fund – (598) (598)
Analysis of adjustments to the balance sheet at 1 January 2004 as a result of the transition to IFRS Investment Insurance Employee Dividend Deferred Borrowings Other valuation changes benefits Goodwill recognition taxation /Cash items Total (Note 1) (Note 2) (Note 3) (Note 4) (Note 5) (Note 6) (Note 7) (Note 8) adjustments £m £m £m £m £m £m £m £m £m
Financial investments and loans 1,854 6 38,620 40,480 Assets held to cover linked liabilities (40,665) (40,665)
Equity Share capital – Capital reserves – Shares held by employee trusts – Revaluation and other reserves 568 568
Equity attributable to shareholders of Aviva plc 191 289 (834) 40 344 (351) – 71 (250)
Increase in valuation of debt securities 1,718 Change in valuation of certain mortgages 113 Other sundry adjustments 23
As a result of applying IAS39, the Group now carries all investments in debt and equity securities at fair value. The change in valuation of debt securities from amortised cost to fair value increases the valuation of investments by £1,718 million at 1 January 2004. This change in the valuation of debt securities is largely offset by corresponding movements in the unallocated divisible surplus and to a small extent technical liabilities. The net impact on shareholders’ funds at 1 January 2004 is to increase them by £191 million.
Revaluation reserve Under IFRS, changes in the fair value of securities classified as “at fair value through profit or loss” are recognised in the income statement. Changes in the fair value of securities classified as available-for-sale (AFS), except for impairment losses and relevant foreign exchange gains and losses, are recorded as a component of shareholders’ equity, net of related deferred taxes. When securities classified as AFS are sold or impaired the accumulated fair value adjustments are transferred out of this reserve to the income statement. Accounting policy Q - Financial investments on page 124 explains further how the Group has classified its investments.
Furthermore, further owner-occupied properties are carried at their revalued amounts and movements are taken to a separate reserve within equity. When such properties are sold, the accumulated revaluation surpluses are transferred from this reserve to retained earnings.
Under UK GAAP, fair value movements on all investments, including those classified as AFS securities under IFRS and owner-occupied properties, are recorded in the consolidated profit and loss account.
Note 2: Insurance change The impact on shareholders’ funds of insurance changes is as follows: £m
Change in value of non-participating investment contracts (55) Derecognition of claims equalisation provision 364 Change in valuation of reinsurance treaties (48) Other sundry items 28
The principal changes to the Group’s insurance accounting upon transition to IFRS are discussed further below.
Following a detailed review, 61% of life policy reserves on an MSSB basis at 31 December 2003 have been classified as insurance and 24% have been classified as participating investment contracts (being those investment contracts containing a discretionary participating feature as defined within IFRS4) and both classes will continue to be accounted for under the Group’s existing (UK GAAP) accounting policies. The remaining 15% have been classified as non-participating investment contracts and therefore are required to be accounted for under IAS39 and International Accounting Standard 18, Revenue (IAS18). Virtually all our general insurance products are classified as insurance.
This change in accounting has resulted in the removal of the Group’s SSAP24 balances, a net debtor of £251 million, after allowing for deferred tax, at 1 January 2004 and the recognition of a deficit of £583 million, net of deferred tax, valued in accordance with IAS19. This gives an overall impact on shareholders’ funds of £834 million at 1 January 2004.
There are a number of adjustments impacting the Group’s “pension obligations and other provisions” line. However the most significant adjustment relates to the recognition of the gross pension deficit as illustrated in the table below: £m £m
(b) Equity Compensation plans Under UK GAAP, the costs of awards to employees under equity compensation plans, other than the Save As You Earn plans, are recognised immediately if they are not conditional on performance criteria. If the award is conditional upon future performance criteria, the cost is recognised over the period to which the employee’s service relates. The minimum cost for the award is the difference between the fair value of the shares at the date of grant less any contribution required from employee or exercise price. The cost is based on a reasonable expectation of the extent that the performance criteria will be met. Any subsequent changes in that expectation are reflected in the income statement as necessary.
This change in accounting has not resulted in any material change to the balance sheet at 1 January 2004.
Note 5: Dividend recognition Under UK GAAP, dividends are accrued in the period to which they relate regardless of when they are declared and approved. Under International Accounting Standard 10, Events after the Balance Sheet Date (IAS10), shareholders’ dividends are accrued only when declared and appropriately approved. This has increased shareholders’ funds by £344 million.
The changes to deferred tax arise from the removal of discounting, changes to the valuation of the Group’s assets and liabilities under IFRS and presentational changes to disclosure of tax assets and liabilities. The main net increases in deferred tax at 1 January 2004 that reduce shareholders’ funds are: £m
Reversal of discounting (the total discounting applied to UK GAAP deferred tax liabilities was £151 million, of which £110 million relates to non-life and shareholders’ interests) 110
The IASB issued an amendment to IAS19, Employee Benefits, in December 2004. Its requirements are applicable for accounting periods beginning on or after 1 January 2006, but the Group intends to adopt them early. This has no impact on the opening balance sheet presented.
In accordance with the standard for Phase I of insurance contracts (IFRS4), the Group has applied existing accounting practices for insurance and participating investment contracts, modified, as appropriate, to comply with the IFRS framework and applicable standards.
B – Use of estimates The preparation of financial statements requires the Group to make estimates and assumptions that affect items reported in the restated IFRS opening balance sheet. Although these estimates are based on management’s best knowledge of current facts, circumstances and, to some extent, future events and actions, actual results ultimately may differ from those estimates, possibly significantly.
From 1 January 2004, the date of first time adoption of IFRS, the Group is required to use the purchase method of accounting to account for the acquisition of subsidiaries. Prior to 1 January 2004, certain significant business combinations were accounted for using the “pooling of interests method” (or merger accounting), which treats the merged groups as if they had been combined throughout the current and comparative accounting periods. Merger accounting principles for these combinations have given rise to a merger reserve in the consolidated balance sheet. These transactions have not been restated as permitted by the IFRS1 transitional arrangements.
Associates and joint ventures Associates are entities over which the Group has significant influence but which it does not control. Generally, it is presumed that the Group has significant influence where it has between 20% and 50% of voting rights. Joint ventures are entities whereby the Group and other parties undertake an economic activity which is subject to joint control arising from a contractual agreement. In a number of these, the Group’s share of the underlying assets and liabilities may be greater than 50% but the terms of the relevant agreements make it clear that control is not exercised. Such jointly-controlled entities are referred to as joint ventures in these IFRS disclosures.
D – Foreign currency translation Balance sheets of foreign entities are translated into the Group’s presentation currency 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 taken to a separate reserve within equity. At 1 January 2004 this reserve had been deemed to be zero in accordance with IFRS1. The euro exchange rate employed in the translation of the restated IFRS preliminary opening balance sheet is 11 = £0.70.