Loans at fair value Fair values have been calculated by discounting the future cash flows using appropriate current interest rates for each portfolio of mortgages. Further details of the fair value methodology are given in note 22. The change in fair value of these loans during the year, attributable to a change in credit risk, was a loss of £239 million (2010: £85 million loss). The cumulative change attributable to changes in credit risk to 31 December 2011 was a loss of £689 million (2010: £400 million loss). Non-securitised mortgage loans include £501 million (2010: £215 million) relating to UK primary healthcare and PFI businesses which are secured against General Practitioner premises, other primary health-related premises or schools leased to government bodies. For all such loans, government support is provided through reimbursement of rental payments to the tenants to meet income service and provide for the debt to be reduced substantially over the term of the loan. Although the loan principal is not Governmentguaranteed, the nature of these businesses and premises provides considerable comfort of an ongoing business model and low risk of default.
Loans and advances to bank customers — — — 2,064 (41) 2,023 Loans to brokers and other intermediaries 96 — 96 100 — 100
Notes to the consolidated financial statements continued 24 – Securitised mortgages and related assets The Group, in our UK Life and (prior to its deconsolidation) Dutch businesses, has loans receivable, secured by mortgages, which have then been securitised through non-recourse borrowings. This note gives details of the relevant transactions.
(a) Description of current arrangements In a UK long-term business subsidiary, Aviva Equity Release UK Limited (AER), the beneficial interest in certain portfolios of lifetime mortgages has been transferred to five special purpose securitisation companies (the ERF companies), in return for initial consideration and, at later dates, deferred consideration. The deferred consideration represents receipts accrued within the ERF companies after meeting all their obligations to the note holders, loan providers and other third parties in the priority of payments. The purchases of the mortgages were funded by the issue of fixed and floating rate notes by the ERF companies. All the shares in the ERF companies are held by independent companies, whose shares are held on trust. Although AER does not own, directly or indirectly, any of the share capital of the ERF companies or their parent companies, it retains control of the majority of the residual or ownership risks and rewards related to the assets of the securitisation companies, and they have therefore been treated as subsidiaries in the consolidated financial statements. AER has no right to repurchase the benefit of any of the securitised mortgage loans, other than in certain circumstances where AER is in breach of warranty or loans are substituted in order to effect a further advance. AER has purchased subordinated notes and granted subordinated loans to some of the ERF companies. These have been eliminated on consolidation through offset against the borrowings of the ERF companies in the consolidated statement of financial position. In all of the above transactions, the Company and its subsidiaries are not obliged to support any losses that may be suffered by the note holders and do not intend to provide such support. Additionally, the notes were issued on the basis that note holders are only entitled to obtain payment, of both principal and interest, to the extent that the available resources of the respective special purpose securitisation companies, including funds due from customers in respect of the securitised loans, are sufficient and that note holders have no recourse whatsoever to other companies in the Aviva Group.
UK Securitised mortgage loans At fair value (note 23) 2,154 (1,486) 1,912 (1,464) Other securitisation assets/(liabilities) 191 (859) 130 (578)
Delta Lloyd Securitised mortgage loans At fair value (note 23) — — 5,249 (4,216) At amortised cost (note 23) — — 1,155 (1,924)
Notes to the consolidated financial statements continued 25 – Financial investments This note analyses our financial investments by type and shows their cost and fair value. These will change from one period to the next as a result of new business written, claims paid and market movements.
Fixed maturity securities Debt securities UK government 115 18,129 — 18,244 — 17,447 — 17,447
Other investments Unit trusts and other investment vehicles — 26,775 485 27,260 12 32,202 306 32,520 Derivative financial instruments (note 57b) 1,498 — — 1,498 2,274 — — 2,274
Minority holdings in property management undertakings — 617 — 617 — 664 — 664
Less assets classified as held for sale Fixed maturity securities — (93) — (93) — — — — Equity securities — (37) — (37) — — — — Other investments — (217) — (217) — — — —
Of the above total, £154,116 million (2010: £153,470 million) is expected to be recovered more than one year after the statement of financial position date. Other debt securities of £7,539 million (2010: £8,556 million) primarily include residential and commercial mortgage-backed securities, as well as other structured credit securities.
Other investments Unit trusts and specialised investment vehicles 30,455 2,478 (413) 32,520
All unrealised gains and losses and impairments on financial investments classified as fair value through profit or loss have been recognised in the income statement. Unrealised gains and losses on financial investments classified as at fair value through profit or loss recognised in the income statement in the year were a net loss of £5,527 million (2010: £7,024 million net gain). Of this, £68 million net gain (2010: £67 million net gain) related to financial investments designated as trading and £5,595 million net loss (2010: £6,957 million net gain) related to investments designated as other than trading. The movement in the unrealised gain/loss position reported in the statement of financial position during the year, shown in the table above, includes foreign exchange movements on the translation of unrealised gains and losses on financial investments held by foreign subsidiaries, which are recognised in other comprehensive income, as well as transfers due to the realisation of gains and losses on disposal and the recognition of impairment losses. Total impairments of financial investments classified as AFS in the income statement in the year, disclosed in note 6, were £21 million (2010: £76 million). The total accumulated impairment provision for financial investments classified as available-for-sale included in the table above within unrealised losses and impairments was £138 million (2010: £983 million). Movements in this AFS provision are shown in section (c) below.
(ii) Stock repurchase arrangements Included within financial investments are £nil (2010: £853 million) of debt securities and other fixed income securities which have been sold under stock repurchase arrangements. The obligations arising under these arrangements are shown in note 49.
(iii) Other arrangements In carrying on its bulk purchase annuity business, the Group’s UK Life operation is required to place certain investments in trust on behalf of the policyholders. Amounts become payable from the trust funds to the trustees if the Group were to be in breach of its payment obligations in respect of policyholder benefits. At 31 December 2011 £1,044 million (2010: £909 million) of financial investments were restricted in this way. Certain financial investments are also required to be deposited under local laws in various overseas countries as security for the holders of policies issued in those countries. Other investments are pledged as security collateral for bank letters of credit.
Notes to the consolidated financial statements continued 25 – Financial investments continued Non-UK government debt securities (gross of non-controlling interests)
Net of non-controlling interests, our direct shareholder assets exposure to worldwide bank debt securities and equities is £6.5 billion. The majority of our holding (57%) is in senior debt (covered, secured and senior unsecured). The primary exposures are to United States (32%) and United Kingdom (17%) banks. Our holdings include strategic holdings in Unicredit and other Italian banks of £288 million.
Notes to the consolidated financial statements continued 25 – Financial investments continued (f) Exposure to worldwide banks – debt and equity securities continued Participating funds assets exposure to worldwide banks – debt and equity securities (net of non-controlling interests, excluding policyholder assets)
Net of non-controlling interests, the participating fund exposures to worldwide banks debts securities and equities is £15.1 billion. The majority of the exposure (70%) is in senior debt (covered, secured and senior unsecured). Participating funds are the most exposed to France (28%) and United Kingdom (16%) banks. The significant majority of these holdings are within our participating funds where the risk to our shareholders is governed by the nature and extent of our participation within those funds.
Gross of non-controlling interests, our direct shareholder assets exposure to worldwide banks debts securities and equities is £7.4 billion. The majority of our holding (58%) is in senior debt (covered, secured and senior unsecured). The primary exposures are to United States (28%), Spain (16%) and United Kingdom (15%) banks. Our holdings include strategic holdings in Unicredit and other Italian banks of £439 million.
Greece — — — — — — — — — — — — Ireland — — — — — — — — — — — —
Amounts owed by contract holders 1,838 1,965 Amounts owed by intermediaries 1,139 1,414 Deposits with ceding undertakings 1,426 1,459 Amounts due from reinsurers 339 500 Amounts due from brokers for investment sales 270 269 Amounts receivable for cash collateral pledged (note 57c) 26 15 Amounts due from government, social security and taxes 467 388 Corporate owned life insurance 156 153 Dividends receivable 109 86 Finance lease receivables 200 175 Other banking assets — 248 Other receivables 1,978 1,623
Total deferred acquisition costs 4,778 5,416 Surpluses in the staff pension schemes (note 47(e)(vii)) 1,670 524 Other assets 19 132
Impact of assumption changes (48) — — (48) Effect of portfolio transfers, acquisitions and disposals — (18) — (18) Foreign exchange rate movements (3) (5) — (8) Shadow adjustment (593) — — (593) Deconsolidation of Delta Lloyd (116) (79) — (195)
Impact of assumption changes 58 — — 58 Effect of portfolio transfers, acquisitions and disposals 80 — — 80 Foreign exchange rate movements 39 13 — 52 Shadow adjustment (570) — — (570)
Notes to the consolidated financial statements continued 27 – Deferred acquisition costs and other assets continued The shadow adjustments relate to deferred acquisition costs on business in the US backed by investments classified as AFS. As explained in accounting policy K, unrealised gains and losses on the AFS investments and the shadow adjustments above are both recognised directly in other comprehensive income.
(c) Other assets Other assets include £6 million (2010: £1 million) that is expected to be recovered more than one year after the statement of financial position date.
(d) Prepayments and accrued income Prepayments and accrued income of £3,235 million (2010: £3,691 million), includes £90 million (2010: £172 million) that is expected to be recovered more than one year after the statement of financial position date.
28 – Assets held to cover linked liabilities Certain unit-linked products have been classified as investment contracts, while some are included within the definition of an insurance contract. The assets backing these unit-linked liabilities are included within the relevant balances in the consolidated statement of financial position, while the liabilities are included within insurance and investment contract provisions. This note analyses the carrying values of assets backing these liabilities. The carrying values of assets backing unit-linked liabilities are as follows: £m 2010 £m
Debt securities 15,295 16,150 Equity securities 20,602 31,441 Other investments 28,119 31,846 Reinsurance assets 1,454 1,215 Cash and cash equivalents 3,980 4,772 *Amount in 2011 relates to cash collateral received as part of stock lending, see note 25d (i) for details.
(b) During 2011, a total of 85,564,296 ordinary shares of 25 pence each were allotted and issued by the Company as follows: Number of shares
Shares issued under the Group’s employee and executive share option schemes 1,574,706 — — Shares issued in lieu of dividends 83,989,590 21 (21)
(ii) Executive share options These are options granted on various dates until 2004 under the Aviva Executive Share Option Plan and in 2010, under the Aviva Executive Share Option Plan 2005. Options granted between 2001 and 2004 were subject to the satisfaction of conditions relating to both the Company’s Return on Capital Employed (ROCE) and its relative Total Shareholder Return (TSR). The performance was measured over a three-year performance period and the options are normally exercisable between the third and tenth anniversary of their grant. The options granted in 2010 are described in the Directors’ Remuneration Report.
(viii) Conditional share award granted to Trevor Matthews, chief executive, Aviva UK A conditional share award was awarded to Trevor Matthews as compensation for the loss of share awards granted by his previous employer. The awards are described in section (b) on page 247 and in the Directors’ Remuneration Report.
The following table summarises information about options outstanding at 31 December 2011: Range of exercise prices
The comparative figures as at 31 December 2010 were: Range of exercise prices
One Aviva, twice the value bonus plan Number of shares Vesting period Number of shares Vesting period
(c) Movements in the year A summary of the status of the option plans as at 31 December 2010 and 2011, and changes during the years ended on those dates, is shown below.
(i) Share options The fair value of the options was estimated on the date of grant, based on the following weighted average assumptions: Weighted average assumption 2011 2010
Share price 312p 402p Exercise price 268p 310p Expected volatility 58% 56% Expected life 3.64 years 5.00 years Expected dividend yield 6.40% 6.09% Risk-free interest rate 0.89% 1.57%
The expected volatility used was based on the historical volatility of the share price over a period equivalent to the expected life of the option prior to its date of grant. The risk-free interest rate was based on the yields available on UK government bonds as at the date of grant. The bonds chosen were those with a similar remaining term to the expected life of the options. 182,907 options granted after 7 November 2002 were exercised during the year (2010: 64,903).
(ii) Share awards The fair value of the awards was estimated on the date of grant based on the following weighted average assumptions: Weighted average assumption 2011 2010
31 – Shares held by employee trusts We satisfy awards and options granted under the Group’s share plans primarily through shares purchased in the market and held by employee share trusts. This note gives details of the shares held in these trusts. Movements in the carrying value of shares held by employee trusts comprise: Number £m Number £m
Cost debited to shareholders’ funds At 1 January 8,415,487 32 17,979,232 68 Acquired in the year 9,396,602 29 3,500,000 14 Distributed in the year (4,527,613) (18) (13,063,745) (50)
Notional amount 2011 £m £m 5.9021% £500 million direct capital instrument 500 500 4.7291% €700 million direct capital instrument 490 490
The euro and sterling direct capital instruments (DCIs) were issued on 25 November 2004 and qualify as Innovative Tier 1 capital, as defined by the Financial Services Authority in GENPRU Annex 1 ‘Capital Resources’. They have no fixed redemption date but the Company may, at its sole option, redeem all (but not part) of the euro and sterling DCIs at their principal amounts on 28 November 2014 and 27 July 2020 respectively, at which dates the interest rates change to variable rates, or on any respective coupon payment date thereafter. In addition, under certain circumstances defined in the terms and conditions of the issue, the Company may at its sole option:  substitute at any time not less than all of the DCIs for, or vary the terms of the DCIs so that they become Qualifying Tier 1
The Company has the option to defer coupon payments on the DCIs on any relevant payment date. Deferred coupons shall be satisfied only in the following circumstances, all of which occur at the sole option of the Company:  Redemption; or  Substitution by, or variation so they become, alternative Qualifying Tier 1 Securities or Qualifying Upper Tier 2 Securities; or  Substitution by preference shares.
Notes to the consolidated financial statements continued 34 – Merger reserve This note describes the use of the merger reserve. Prior to 1 January 2004, certain significant business combinations were accounted for using the ‘pooling of interests method’ (or merger accounting), which treats the merged groups as if they had been combined throughout the current and comparative accounting periods. Merger accounting principles for these combinations gave rise to a merger reserve in the consolidated statement of financial position, being the difference between the nominal value of new shares issued by the Parent Company for the acquisition of the shares of the subsidiary and the subsidiary’s own share capital and share premium account. The merger reserve is also used where more than 90% of the shares in a subsidiary are acquired and the consideration includes the issue of new shares by the Company, thereby attracting merger relief under the Companies Act 1985 and, from 1 October 2009, the Companies Act 2006. The balance on the reserve of £3,271 million (2010: £3,271 million) has arisen through the mergers of Commercial Union, General Accident and Norwich Union companies, forming Aviva plc in 2000, together with the acquisition of RAC plc (RAC) in 2005. Because RAC ownership was immediately transferred from Aviva plc to a subsidiary company, this reserve is unaffected by the disposal of RAC in 2011.
35 – Other reserves This note gives details of the various reserves forming part of the Group’s consolidated equity and shows the movements during the year. Movements in the year comprised: Currency translation reserve (see accounting policy E) £m
37 – Non-controlling interests This note gives details of the Group’s non-controlling interests and shows the movements during the year.
Notes to the consolidated financial statements continued 38 – Contract liabilities and associated reinsurance The following notes explain how we calculate our liabilities to our policyholders for insurance and investment products we have sold to them. Notes 39 and 40 cover these liabilities, and note 41 details the financial guarantees and options given for some of these products. Note 42 details the reinsurance recoverables on these liabilities while note 43 shows the effects of the assumptions we have changed during the year. The following is a summary of the contract provisions and related reinsurance assets as at 31 December.
Outstanding claims provisions Long-term business (1,311) 125 (1,186) (1,078) 104 (974)
Provisions for claims incurred but not reported (2,646) 395 (2,251) (2,735) 445 (2,290)
Less: Amounts classified as held for sale 344 — 344 — — —
Provision for claims incurred but not reported — 2,646 2,646 — 2,735 2,735
Provision for unearned premiums — 4,483 4,483 — 4,855 4,855 Provision arising from liability adequacy tests — 13 13 — 2 2 Other technical provisions — — — — 1 1
Less: Obligations to staff pension schemes transferred to provisions (note 46a) — — — (1,445) — (1,445) Amounts classified as held for sale (344) — (344) — — —
 In France, where the majority of policyholders’ benefits are determined by investment performance, subject to certain guarantees, and shareholders’ profits are derived largely from management fees. In addition, a substantial number of policies participate in investment returns, with the balance being attributable to shareholders.
Equity returns 26.4% 26.1% Property returns 15.0% 15.0% Fixed interest yields 18.0% 13.2%
Notes to the consolidated financial statements continued 39 – Insurance liabilities continued Non-profit business Conventional non-profit contracts, including those written in the with-profit funds, are valued using gross premium methods which discount projected future cash flows. The cash flows are calculated using the amount of contractual premiums payable, together with explicit assumptions for investment returns, inflation, discount rates, mortality, morbidity, persistency and future expenses. These assumptions vary by contract type and reflect current and expected future experience. For unit-linked and some unitised with-profit business, the provisions are valued by adding a prospective non-unit reserve to the bid value of units. The prospective non-unit reserve is calculated by projecting the future non-unit cash flows on the assumption that future premiums cease, unless it is more onerous to assume that they continue. Where appropriate, allowance for persistency is based on actual experience. Valuation discount rate assumptions are set with regard to yields on the supporting assets and the general level of long-term interest rates as measured by gilt yields. An explicit allowance for risk is included by restricting the yields for equities and properties with reference to a margin over long-term interest rates or by making an explicit deduction from the yields on corporate bonds, mortgages and deposits, based on historical default experience of each asset class. A further margin for risk is then deducted for all asset classes. The provisions held in respect of guaranteed annuity options are a prudent assessment of the additional liability incurred under the option on a basis and method consistent with that used to value basic policy liabilities, and includes a prudent assessment of the proportion of policyholders who will choose to exercise the option. Valuation discount rates for business in the non-profit funds are as follows: Valuation discount rates
Assurances Life conventional non-profit 1.8% to 1.9% 2.8% Pensions conventional non-profit 2.6% 3.5% to 3.7% Annuities Conventional immediate and deferred annuities 2.2% to 4.3% 3.7% to 5.3% Non-unit reserves on Unit Linked business Life 1.8% to 2.2% 3.1%
Notes to the consolidated financial statements continued 39 – Insurance liabilities continued (b) France The majority of reserves arise from a single premium savings product and is 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.
Carrying amount at 1 January 160,946 154,058 Provisions in respect of new business 11,149 12,502 Expected change in existing business provisions (8,964) (9,259) Variance between actual and expected experience (2,279) 1,858 Impact of other operating assumption changes (61) (520) Impact of economic assumption changes 5,663 1,959 Exceptional strengthening of longevity assumptions (see below) — 483 Other movements (623) (197) Change in liability recognised as an expense 4,885 6,826 Effect of portfolio transfers, acquisitions and disposals (6) 1,117 Deconsolidation of Delta Lloyd (32,159) — Foreign exchange rate movements 227 (1,055)
The variance between actual and expected experience of £2.3 billion in 2011 was primarily due to the impact of falling equity markets on liabilities for unit-linked insurance contracts. For many types of long-term business, including unit-linked and participating funds, movements in asset values are offset by corresponding changes in liabilities, limiting the net impact on profit. Minor variances arise from differences between actual and expected experience for persistency, mortality and other demographic factors. The impact of assumption changes in the above analysis shows the resulting movement in the carrying value of insurance liabilities. The £5.7 billion impact of economic assumption changes reflects reductions in valuation interest rates, primarily in respect of immediate annuity and participating insurance contracts in the UK. For participating business, a movement in liabilities is generally offset by a corresponding adjustment to the unallocated divisible surplus and does not impact on profit. Where assumption changes do impact on profit, these are included in the effect of changes in assumptions and estimates during the year shown in note 43, together with the impact of movements in related non-financial assets.
(c) General insurance and health liabilities (i) Provisions for outstanding claims Delays occur in the notification and settlement of claims and a substantial measure of experience and judgement is involved in assessing outstanding liabilities, the ultimate cost of which cannot be known with certainty at the statement of financial position date. The reserves for general insurance and health business are based on information currently available. However, it is inherent in the nature of the business written that the ultimate liabilities may vary as a result of subsequent developments. Provisions for outstanding claims are established to cover the outstanding expected ultimate liability for losses and loss adjustment expenses (LAE) in respect of all claims that have already occurred. The provisions established cover reported claims and associated LAE, as well as claims incurred but not yet reported and associated LAE. We only establish loss reserves for losses that have already occurred. We therefore do not establish catastrophe equalisation reserves that defer a share of income in respect of certain lines of business from years in which a catastrophe does not occur to future periods in which catastrophes may occur. When calculating reserves, we take into account estimated future recoveries from salvage and subrogation, and a separate asset is recorded for expected future recoveries from reinsurers after considering their collectability. The table below shows the split of total general insurance and health outstanding claim provisions and IBNR provisions, gross of reinsurance, by major line of business.
Notes to the consolidated financial statements continued 39 – Insurance liabilities continued Interest rates used to discount latent claim liabilities The discount rates used in determining our latent claim liabilities are based on the relevant swap curve in the relevant currency at the reporting date, having regard to the duration of the expected settlement of latent claims. The range of discount rates used is shown in section (ii) above and depends on the duration of the claim and the reporting date. At 31 December 2011, it is estimated that a 1% fall in the discount rates used would increase net claim reserves by approximately £85 million, excluding the offsetting effect on asset values as assets are not hypothecated across classes of business. The impact of a 1% fall in interest rates across all assets and liabilities of our general insurance and health businesses is shown in note 56(h).
Allowance for risk and uncertainty The uncertainties involved in estimating loss reserves are allowed for in the reserving process and by the estimation of explicit reserve uncertainty distributions. The reserve estimation basis for non-life claims requires all non-life businesses to calculate booked claim provisions as the best estimate of the cost of future claim payments, plus an explicit allowance for risk and uncertainty. The allowance for risk and uncertainty is calculated by each business unit in accordance with the requirements of the Group non-life reserving policy, taking into account the risks and uncertainties specific to each line of business and type of claim in that territory. The requirements of the Group non-life reserving policy also seek to ensure that the allowance for risk and uncertainty is set consistently across both business units and reporting periods. Changes to claims development patterns can materially impact the results of actuarial projection techniques. However, allowance for the inherent uncertainty in the assumptions underlying reserving projections is automatically allowed for in the explicit allowance for risk and uncertainty included when setting booked reserves. Lump sum payments in settlement of bodily injury claims decided by the UK courts are calculated in accordance with the Ogden Tables. The Ogden Tables contain a discount rate that is set by the Lord Chancellor and that is applied when calculating the present value of loss of earnings for claims settlement purposes. The Ogden discount rate is currently under review by the Lord Chancellor. The timing of the conclusion of this review is unclear and it is still uncertain whether or by how much the rate will change. However an allowance has been included in provisions for a reduction in the Ogden discount rates. A reduction in the Ogden discount rates will increase lump sum payments to UK bodily injury claimants.
Change in claims reserve recognised as an expense 15 (541) Effect of portfolio transfers, acquisitions and disposals — 4 Deconsolidation of Delta Lloyd (1,445) — Foreign exchange rate movements (87) 102 Other movements (1) 2
(d) Loss development tables (i) Description of tables The tables that follow present the development of claim payments and the estimated ultimate cost of claims for the accident years 2002 to 2011. The upper half of the tables shows the cumulative amounts paid during successive years related to each accident year. For example, with respect to the accident year 2002, by the end of 2011 £5,871 million had actually been paid in settlement of claims. In addition, as reflected in the lower section of the table, the original estimated ultimate cost of claims of £6,250 million was reestimated to be £6,016 million at 31 December 2011. The original estimates will be increased or decreased, as more information becomes known about the individual claims and overall claim frequency and severity.
Notes to the consolidated financial statements continued 39 – Insurance liabilities continued The Group aims to maintain strong reserves in respect of its general insurance and health business in order to protect against adverse future claims experience and development. As claims develop and the ultimate cost of claims become more certain, the absence of adverse claims experience will result in a release of reserves from earlier accident years, as shown in the loss development tables and movements table (c)(iv) above. However, in order to maintain overall reserve adequacy, the Group establishes strong reserves in respect of the current accident year (2011) where the development of claims is less mature and there is much greater uncertainty attaching to the ultimate cost of claims. Releases from prior accident year reserves are also due to an improvement in the estimated cost of claims. Key elements of the movement in prior accident year general insurance and health net provisions during 2011 were:  £78 million strengthening from the UK, including Group reinsurance business, mainly due to unfavourable development on commercial motor, commercial liability and December 2010 freeze claims.  £42 million release from Europe mainly due to favourable development of personal and commercial motor claims in Ireland and France.  £92 million release from Canada mainly due to favourable experience on motor, following the legislative changes in Ontario, and commercial liability.
Cumulative effect of foreign exchange rate movements — 17 19 27 39 70 58 (11) — (24) — 195
Accident year All prior years £m £m 2003 £m £m £m £m £m £m £m 2011 £m Total £m
Net cumulative claim payments At end of accident year (2,913) (2,819) (2,870) (3,281) (3,612) (4,317) (4,808) (3,650) (3,386) (3,300) One year later (4,369) (4,158) (4,378) (4,925) (5,442) (6,542) (7,165) (5,286) (5,242) Two years later (4,779) (4,565) (4,712) (5,344) (5,881) (7,052) (7,638) (5,885) Three years later (5,064) (4,924) (4,986) (5,671) (6,181) (7,356) (8,094) Four years later (5,297) (5,180) (5,163) (5,892) (6,434) (7,664) Five years later (5,424) (5,325) (5,327) (6,039) (6,625) Six years later (5,508) (5,442) (5,430) (6,188) Seven years later (5,552) (5,502) (5,491) Eight years later (5,598) (5,567) Nine years later (5,648) Estimate of net ultimate claims At end of accident year 6,037 6,218 6,602 6,982 7,430 8,363 9,262 7,115 6,650 6,202 One year later 6,038 6,093 6,266 6,818 7,197 8,302 9,104 7,067 6,751 Two years later 5,997 6,037 6,082 6,688 7,104 8,244 9,028 7,036 Three years later 5,973 5,942 5,882 6,544 6,996 8,249 9,007 Four years later 5,912 5,851 5,709 6,476 6,980 8,210 Five years later 5,855 5,772 5,699 6,448 6,992 Six years later 5,786 5,683 5,639 6,397 Seven years later 5,754 5,663 5,624 Eight years later 5,742 5,667 Nine years later 5,737 Estimate of net ultimate claims 5,737 5,667 5,624 6,397 6,992 8,210 9,007 7,036 6,751 6,202
Cumulative effect of foreign exchange rate movements — 15 18 26 37 68 56 (11) 2 (22) — 189
Notes to the consolidated financial statements continued 40 – Liability for investment contracts This note analyses our investment contract liabilities by type of product and describes how we calculate these liabilities and the assumptions we used.
The variance between actual and expected experience of £2.8 billion was primarily driven by unfavourable movements in investment markets in 2011, which had a direct or indirect impact on liability values. Falling equity markets reduced the value of unit linked investment contracts, which comprise the vast majority of the non-participating investment contract liabilities. For unit-linked investment contracts, movements in asset values are offset by corresponding changes in liabilities, limiting the net impact on profit. Minor variances arise from differences between actual and expected experience for persistency, mortality and other demographic factors. The impact of assumption changes in the above analysis shows the resulting movement in the carrying value of non-participating investment contract liabilities. The impact of assumption changes on profit are included in the effect of changes in assumptions and estimates during the year shown in note 43, which combines participating and non-participating investment contracts together with the impact of movements in related non-financial assets.
Notes to the consolidated financial statements continued 41 – Financial guarantees and options continued (i) France Guaranteed surrender value and guaranteed minimum bonuses Aviva France has written a number of contracts with such guarantees. The guaranteed surrender value is the accumulated value of the contract including accrued bonuses. Bonuses are based on accounting income from amortised bond portfolios, where the duration of bond portfolios is set in relation to the expected duration of the policies, plus income and releases from realised gains on equity-type investments. Policy reserves are equal to guaranteed surrender values. Local statutory accounting envisages the establishment of a reserve, ‘Provision pour Aléas Financiers’ (PAF), when accounting income is less than 125% of guaranteed minimum credited returns. No PAF was established at the end of 2011. The most significant of these contracts is the AFER Eurofund which has total liabilities of £33 billion at 31 December 2011 (2010: £34 billion). Up to 2010, the guaranteed bonus on this contract equalled 75% of the average of the last two years’ declared bonus rates. Starting from year end 2010, Aviva France and the AFER association will agree the guaranteed bonus on this contract at every year end for the following year. This bonus was 3.43% for 2011 (2010: 3.55%) compared with an accounting income from the fund of 3.92% (2010: 4.01%). Non-AFER contracts with guaranteed surrender values had liabilities of £14 billion at 31 December 2011 (2010: £13 billion) and all guaranteed annual bonus rates are between 0% and 4.5%.
(ii) Ireland Guaranteed annuity options Products with similar GAOs to those offered in the UK have been issued in Ireland. The current net of reinsurance provision for such options is £271 million (2010: £236 million). This has been calculated on a deterministic basis, making conservative assumptions for the factors which influence the cost of the guarantee, principally annuitant mortality option take-up and long-term interest rates. These GAOs are ‘in the money’ at current interest rates but the exposure to interest rates under these contracts has been hedged through the use of reinsurance, using derivatives (swaptions). The swaptions effectively guarantee that an interest rate of 5% will be available at the vesting date of these benefits so there is reduced exposure to a further decrease in interest rates.
General insurance and health Outstanding claims provisions 974 1,113 Provisions for claims incurred but not reported 395 445
Change in asset 648 (555) Effect of portfolio transfers, acquisitions and disposals (2) 174 Deconsolidation of Delta Lloyd (375) — Foreign exchange rate movements (13) (61)
Change in reinsurance asset recognised as income (56) (148) Effect of portfolio transfers, acquisitions and disposals 28 34 Deconsolidation of Delta Lloyd (153) — Foreign exchange rate movements (2) 28 Other movements (6) 1
Carrying amount at 1 January 307 332 Premiums ceded to reinsurers in the year 650 770 Less: Reinsurers’ share of premiums earned during the year (678) (800) Change in reinsurance asset recognised as income (28) (30) Reinsurers’ share of portfolio transfers and acquisitions — 4 Deconsolidation of Delta Lloyd (30) — Foreign exchange rate movements (4) (2) Other movements — 3
Carrying amount at 31 December 245 307 43 – Effect of changes in assumptions and estimates during the year Certain estimates and assumptions used in determining our liabilities for insurance and investment contract business were changed from 2010 to 2011, affecting the profit recognised for the year with an equivalent effect on liabilities. This note analyses the effect of the changes. This disclosure only allows for the impact on liabilities and related assets, such as reinsurance, deferred acquisition costs and AVIF, and does not allow for offsetting movements in the value of backing financial assets.
Notes to the consolidated financial statements continued 43 – Effect of changes in assumptions and estimates during the year continued The impact of interest rates for long-term business relates primarily to the UK and Netherlands driven by the reduction in valuation interest rates. This had the effect of increasing liabilities and hence a negative impact on profit. The overall impact on profit also depends on movements in the value of assets backing the liabilities, which is not included in this disclosure.
44 – Unallocated divisible surplus An unallocated divisible surplus (UDS) is established where the nature of policy benefits is such that the division between shareholder reserves and policyholder liabilities is uncertain. This note shows the movements in this surplus during the year. The following movements have occurred in the year: £m £m
(a) Current tax Current tax assets recoverable and liabilities payable in more than one year are £29 million and £48 million (2010: £76 million and £246 million), respectively.
Net liability at 1 January (1,470) (820) Acquisition and disposal of subsidiaries 53 (44) Amounts credited/(charged) to income statement (note 13a) 513 (398) Amounts charged to other comprehensive income (note 13b) (354) (146) Deconsolidation of Delta Lloyd 326 — Foreign exchange rate movements (6) 7 Other movements 5 (69)
Total IAS 19 obligations to main staff pension schemes 406 1,972 Deficits in other staff pension schemes 86 129
Total IAS 19 obligations to staff pension schemes 492 2,101 Restructuring provisions 106 152 Other provisions 398 690
* The 2010 comparatives include insurance policies in respect of Delta Lloyd which were non-transferable under the requirements of IAS 19 and so were treated as other obligations to staff pension schemes within provisions above. Delta Lloyd ceased to be a subsidiary on 6 May 2011. Further details are given in note 47(e)(vii).
Other provisions comprise many small provisions throughout the Group for obligations such as costs of compensation, litigation, staff entitlements and reorganisation. Of the total, £605 million (2010: £2,245 million) is expected to be settled more than one year after the statement of financial position date.
Unused amounts reversed (5) (40) (45) Change in the discounted amount arising from passage of time — 3 3
Charge to income statement 77 32 109 Utilised during the year (50) (124) (174) Disposal of subsidiaries — (6) (6) Effect of deconsolidation of Delta Lloyd (55) (177) (232) Foreign exchange rate movements (18) (17) (35)
Unused amounts reversed (6) (74) (80) Change in the discounted amount arising from passage of time — 6 6
Notes to the consolidated financial statements continued 47 – Pension obligations This note describes the Group’s pension arrangements for its employees and explains how our obligations to these schemes are calculated.
(a) Introduction The Group operates a large number of defined benefit and defined contribution pension schemes around the world. The only material defined benefit schemes are in the UK, Canada and Ireland and, prior to its deconsolidation, the Netherlands. Of these, the main UK scheme is by far the largest. This note gives full IAS 19 disclosures for these schemes while the smaller ones, while still measured under IAS 19, are included as one total within Provisions (see note 46). Similarly, while the charges to the income statement for the main schemes are shown in section (e)(iv) below, the total charges for all pension schemes are disclosed in section (d) below. The assets of the UK, Irish and Canadian schemes are held in separate trustee-administered funds to meet long-term pension liabilities to past and present employees. In all schemes, the appointment of trustees of the funds is determined by their trust documentation, and they are required to act in the best interests of the schemes’ beneficiaries. The long-term investment objectives of the trustees and the employers are to limit the risk of the assets failing to meet the liabilities of the schemes over the long term, and to maximise returns consistent with an acceptable level of risk so as to control the long-term costs of these schemes. A full actuarial valuation of each of the defined benefit schemes is carried out at least every three years for the benefit of scheme trustees and members. Actuarial reports have been submitted for each scheme within this period, using appropriate methods for the respective countries on local funding bases.
(c) UK schemes In the UK, the Group operates two main pension schemes, the Aviva Staff Pension Scheme (ASPS) and the smaller RAC (2003) Pension Scheme, the obligation to which was retained after the sale of RAC Limited in September 2011. New entrants join the defined contribution section of the ASPS, as the defined benefit section is closed. This scheme is operated by a trustee company, with 11 trustee directors, comprising representatives of the employers, staff, pensioners and an independent trustee (referred to below as the trustees). On 20 October 2010, following formal consultation, the Group confirmed its decision to close the final salary sections of both UK schemes with effect from 1 April 2011, with entry into the defined contribution sections being offered to the staff members affected. The consequential reduction in the liabilities of both schemes, arising from projecting forward salaries using estimates of inflation rather than salary inflation, together with additional contributions to affected members’ defined contribution accounts and implementation costs, resulted in an overall gain on closure of £286 million, which was accounted for in 2010. Closure of the schemes has removed the volatility associated with adding future accrual for active members, and has also led to lower service costs and their cash funding since April 2011.
Notes to the consolidated financial statements continued 47 – Pension obligations continued (ii) Defined contribution (money purchase) section of the ASPS The trustees have responsibility for selecting a range of suitable funds in which the members can choose to invest and for monitoring the performance of the available investment funds. Members are responsible for reviewing the level of contributions they pay and the choice of investment fund to ensure these are appropriate to their attitude to risk and their retirement plans. Members of this section contribute at least 2% of their pensionable salaries and, depending on the percentage chosen, the Company contributes up to a maximum 14%, together with the cost of the death-in-service benefits. These contribution rates are unchanged for 2012.
Continuing operations UK defined benefit schemes 36 (227) Overseas defined benefit schemes 22 8
Total charge/(credit) from continuing operations 153 (149) Total charge from discontinued operations 7 44
The credit for the defined benefit schemes in 2010 arose from the £286 million gain on the closure of the UK scheme to future accrual, described in section (c) above. There were no significant contributions outstanding or prepaid as at either 31 December 2010 or 2011.
Mortality assumptions Mortality assumptions are significant in measuring the Group’s obligations under its defined benefit schemes, particularly given the maturity of these obligations in the material schemes. The assumptions used are summarised in the table below and have been selected to reflect the characteristics and experience of the membership of these schemes. The mortality tables, average life expectancy and pension duration used at 31 December 2011 for scheme members are as follows: Life expectancy/(pension duration) at NRA of a male Life expectancy/(pension duration) at NRA of a female
Ireland 94% PNA00 with allowance for future improvements 61 86.5 89.5 89.3 92.3
Canada UP1994, with Projection Scale AA applied on a generational basis 65 84.6 86.1 87.0 87.9
(ii) Assumptions on scheme assets The expected rates of return on the schemes’ assets are: UK Ireland Canada Netherlands
Continuing operations Current service cost (51) (126) Past service cost — (10) Gains on curtailments — 347
Charge to finance costs from continuing operations (87) (127) Charge to finance costs from discontinued operations (26) (68)
Total (charge)/credit to income arising from continuing operations (138) 84 Total charge to income arising from discontinued operations (33) (102)
Continuing operations Expected return on scheme assets (452) (457) Actual return on these assets 1,815 1,001
Actuarial gains from continuing operations 996 1,078 Actuarial gains/(losses) from discontinued operations 11 (79)
Attributable to equity shareholders of Aviva plc 1,002 1,033 Attributable to non-controlling interests 5 (34)
Difference between the expected and actual return on scheme assets Amount of gains/(losses) 1,363 547* 561* (1,893)* (138)* Percentage of the scheme assets at the end of the year 11.6% 5.5% 6.4% 23.8% 1.6% Experience gains/(losses) on scheme liabilities (excluding changes in assumptions) Amount of gains/(losses) (46) 450* 77* 105* (80)* Percentage of the present value of scheme liabilities 0.4% 3.9% 0.7% 1.1% 0.8% * Including gains and losses from discontinued operations.
Main UK scheme Both the Group and the trustees regularly review the asset/liability management of the main UK scheme. It is fully understood that, while the current asset mix is designed to produce appropriate long-term returns, this introduces a material risk of volatility in the scheme’s surplus or deficit of assets compared with its liabilities. The principal asset risks to which the scheme is exposed are:  Equity market risk – the effect of equity market falls on the value of plan assets.  Inflation risk – the effect of inflation rising faster than expected on the value of the plan liabilities.  Interest rate risk – falling interest rates leading to an increase in liabilities significantly exceeding the increase in the value of assets.
There is also an exposure to currency risk where assets are not denominated in the same currency as the liabilities. The majority of this exposure has been removed by the use of hedging instruments. In 2011, there has been a further reduction in the proportion of assets invested in equities, thereby mitigating the equity risk above. In addition, the trustees have taken further measures to partially mitigate inflation and interest rate risks.
Surplus included in other assets (note 27) 1,670 — — 1,670 Deficits included in provisions (note 46) (86) (157) (163) (406)
Surplus included in other assets (note 27) 524 — — — 524 Deficits included in provisions (note 46) (207) (164) (146) (10) (527)
Other assets comprise cash at bank, derivative financial instruments, receivables and payables. Plan assets in the table above include investments in Group-managed funds and insurance policies, as described in section (iii) above. Where the investment and insurance policies are in segregated funds with specific asset allocations, they are included in the appropriate line in the table above, otherwise they appear in ‘Other’. Prior to the deconsolidation of Delta Lloyd, the Dutch insurance policies (£1,445 million at 31 December 2010) were considered non-transferable under the terms of IAS 19 and so were treated as other obligations to staff pension schemes within the 2010 comparatives for provisions (see note 46). The total IAS 19 obligations and strict IAS 19 assets (i.e. excluding the non-transferable insurance policies) of the schemes at 31 December 2010 gave a net deficit of £1,448 million, as shown in the following table.
Total fair value of assets 9,361 387 216 7 9,971 Present value of scheme liabilities (9,044) (551) (362) (1,462) (11,419)
The present value of unfunded post-retirement benefit obligations included in the totals in both sets of tables above is £116 million (2010: £130 million).
Notes to the consolidated financial statements continued 47 – Pension obligations continued (viii) Movements in the scheme deficits and surpluses Movements in the pension schemes’ surpluses and deficits comprise: Scheme assets £m
Deficits in the schemes at 31 December 11,416 (11,419) (3) (1,445) (1,448)
The fall in the pension schemes’ net deficits during 2011 is mainly attributable to increases in investment values and additional employer contributions, partly offset by changes in actuarial assumptions.
Floating rate US$300 million subordinated notes 2017 — 193 — 193 — 192 — 192 4.25% senior bonds 2017 issued by Delta Lloyd N.V. — — — — — — 489 489 2.5% subordinated perpetual loan notes — — — — — 151 — 151 Other loans — — — — — — 12 12
Total contractual undiscounted cash flows 5,294 7,039 12,333 6,408 12,417 18,825
Notes to the consolidated financial statements continued 48 – Borrowings continued Borrowings are considered current if the contractual maturity dates are within a year. Where subordinated debt is undated or loan notes are perpetual, the interest payments have not been included beyond 15 years. Annual interest payments for these borrowings are £73 million (2010: £84 million). Contractual undiscounted interest payments are calculated based on underlying fixed interest rates or prevailing market floating rates as applicable. Year-end exchange rates have been used for interest projections on loans in foreign currencies.
Securitised mortgage loan notes UK lifetime mortgage business 1,306 1,288 Dutch domestic mortgage business — 5,045
All the above borrowings are stated at amortised cost, except for the loan notes issued in connection with the UK lifetime mortgage business of £1,306 million (2010: £1,288 million) and £nil (2010: £3,402 million) of the loan notes issued in connection with the Dutch domestic mortgage business, which were carried at fair value prior to the deconsolidation of Delta Lloyd. For the UK loan notes carried at fair value, their values are modelled on risk-adjusted cash flows for defaults discounted at a risk-free rate plus a marketdetermined liquidity premium, and are therefore classified as ‘Level 2’ in the fair value hierarchy. These have been designated at fair value through profit and loss in order to present the relevant mortgages, borrowings and derivative financial instruments at fair value, since they are managed as a portfolio on a fair value basis. This presentation provides more relevant information and eliminates any accounting mismatch. The securitised mortgage loan notes are at various fixed, floating and index-linked rates. Further details about these notes are given in note 24.
(d) Description and features (i) Subordinated debt A description of each of the subordinated notes is set out in the table below: Notional amount Issue date Redemption date Callable at par at option of the Company from In the event the Company does not call the notes, the coupon will reset at each applicable reset date to £700 million 14 Nov 2001 14 Nov 2036 16 Nov 2026 5 year Benchmark Gilt + 2.85% €650 million 29 Sep 2003 02 Oct 2023 02 Oct 2013 3 month Euribor + 2.08% €500 million 29 Sep 2003 Undated 29 Sep 2015 3 month Euribor + 2.35% £800 million 29 Sep 2003 Undated 29 Sep 2022 5 year Benchmark Gilt + 2.40% US$300 million 19 Dec 2006 19 Jun 2017 19 Jun 2012 3 month US LIBOR + 0.84% £400 million 20 May 2008 20 May 2058 20 May 2038 3 month LIBOR + 3.26% £200 million 8 Aug 2008 20 May 2058 20 May 2038 3 month LIBOR + 3.26% €500 million 20 May 2008 22 May 2038 22 May 2018 3 month Euribor + 3.35% £200 million 1 Apr 2009 1 Apr 2019 1 Apr 2014 3 month LIBOR + 8.10% €50 million 30 Apr 2009 30 Apr 2019 30 Apr 2014 3 month Euribor + 8.25% £450 million 26 May 2011 3 June 2041 3 June 2021 6 month LIBOR + 4.136% US$400 million 22 Nov 2011 1 Dec 2041 1 Dec 2016 8.25% (fixed)
Notes to the consolidated financial statements continued 48 – Borrowings continued Subordinated notes issued by the Company rank below its senior obligations and ahead of its preference shares and ordinary share capital. The dated subordinated notes rank ahead of the undated subordinated notes. The fair value of these notes at 31 December 2011 was £3,814 million (2010: £4,370 million), calculated with reference to quoted prices.
(ii) Debenture loans The 9.5% guaranteed bonds were issued by the Company at a discount of £1.1 million. This discount and the issue expenses are being amortised over the full term of the bonds. Although these bonds were issued in sterling, the loans have effectively been converted into euro liabilities through the use of financial instruments in a subsidiary. Other loans totalling £nil (2010: £12 million) related to borrowings in the US which were fully repaid during the year. All these borrowings are at fixed rates and their fair value at 31 December 2011 was £246 million (2010: £860 million), calculated with reference to quoted prices.
(iii) Commercial paper The commercial paper consists of £506 million issued by the Company (2010: £504 million) and is considered core structural funding. All commercial paper is repayable within one year and is issued in a number of different currencies, primarily sterling, euros and US dollars. Its fair value is considered to be the same as its carrying value.
Non-recourse Loans to property partnerships (see (a) below) 1,128 1,098 Loans to Irish investment funds (see (b) below) 33 34 UK Life reassurance (see (c) below) 254 217 Other non-recourse loans (d) 224 193
(a) As explained in accounting policy D, the UK long-term business policyholder funds have invested in a number of property limited partnerships (PLPs). The PLPs have raised external debt, secured on their respective property portfolios, and the lenders are only entitled to obtain payment of both interest and principal to the extent there are sufficient resources in the respective PLPs. The lenders have no recourse whatsoever to the policyholder or shareholders’ funds of any companies in the Group. Loans of £1,128 million (2010: £1,098 million) included in the table relate to those PLPs which have been consolidated as subsidiaries.
(b) Certain Irish policyholder investment funds and unit trusts, which have been fully consolidated in accordance with accounting policy D, have raised borrowings with external credit institutions. The borrowings are secured on the funds, with the only recourse on default being the underlying investments in these funds and unit trusts. The lenders have no recourse whatsoever to the shareholders’ funds of any companies in the Aviva Group. These loans run for a period of five years, with interest rates fixed monthly and based on a fixed margin above the euro inter-bank rate.
(e) Other loans include external debt raised by overseas long-term businesses to fund operations.
New borrowings drawn down, including commercial paper, net of expenses 3,853 1,042 4,895 Repayment of borrowings, including commercial paper (3,848) (1,283) (5,131)
Movements in borrowings during the previous year were: Core structural £m Operational £m Total £m
Net cash inflow 647 113 760 Foreign exchange rate movements (77) (801) (878) Borrowings acquired/(loans repaid) for non-cash consideration — (4) (4) Fair value movements — 59 59 Amortisation of discounts and other non-cash items 1 — 1 Movements in debt held by Group companies* 6 5 11
All movements in fair value in 2010 and 2011 on securitised mortgage loan notes designated as fair value through profit or loss were attributable to changes in market conditions.
(f) Undrawn borrowings The Group and Company have the following undrawn committed central borrowing facilities available to it, of which £750 million (2010: £750 million) is used to support the commercial paper programme: £m £m
Payables arising out of direct insurance 1,098 1,426 Payables arising out of reinsurance operations 360 571 Deposits and advances received from reinsurers 346 773 Bank overdrafts 668 760 Derivative liabilities (note 57) 1,850 2,382 Bank customer accounts — 4,780 Bank deposits received from other banks — 1,772 Amounts due to brokers for investment purchases 60 498 Obligations for repayment of cash collateral received (notes 25d(i) & 57c) 5,229 4,825 Obligations under stock repurchase arrangements (note 25d(ii)) — 853 Other financial liabilities 1,628 1,652
50 – Other liabilities This note analyses our other liabilities at the end of the year.
Deferred income 359 789 Reinsurers’ share of deferred acquisition costs 12 79
Notes to the consolidated financial statements continued 51 – Contingent liabilities and other risk factors This note sets out the main areas of uncertainty over the calculation of our liabilities.
(e) Payment protection insurance (PPI) mis-selling In September 2009, the FSA launched an investigation into sales practices for payment protection insurance (PPI). On 10 August 2010, the FSA announced that mis-selling of PPI policies had been widespread and that consumers who could prove mis-selling would be entitled to financial redress from distributors of the policies. The directors do not consider that the Group is liable for mis-selling in its role as underwriter and so no provision is currently necessary.
(g) Other In the course of conducting insurance and investment business, various Group companies receive liability claims, and become involved in actual or threatened related litigation. In the opinion of the directors, adequate provisions have been established for such claims and no material loss will arise in this respect. The Company and several of its subsidiaries have guaranteed the overdrafts and borrowings of certain other Group companies. At 31 December 2011, the total exposure of the Group and Company is £nil (2010: £nil) and £334 million (2010: £343 million) respectively and, in the opinion of the directors, no material loss will arise in respect of these guarantees and indemnities. In addition, in line with standard business practice, various Group companies have given guarantees, indemnities and warranties in connection with disposals in recent years of subsidiaries and associates to parties outside the Aviva Group. In the opinion of the directors, no material loss will arise in respect of these guarantees, indemnities and warranties. The Group’s insurance subsidiaries pay contributions to levy schemes in several countries in which we operate. Given the economic environment, there is a heightened risk that the levy contributions will need to be increased to protect policyholders if an insurance company falls into financial difficulties. The directors continue to monitor the situation but are not aware of any need to increase provisions at the statement of financial position date.
52 – Commitments This note gives details of our commitments to capital expenditure and under operating leases.
Later than 1 year and not later than 5 years 562 1,206 Later than 5 years 1,738 2,270
Total future minimum sub-lease payments expected to be received under non-cancellable sub-leases 56 63
Notes to the consolidated financial statements continued 53 – Statement of cash flows This note gives further detail behind the figures in the statement of cash flows.
Change in unallocated divisible surplus (2,721) (362) Interest expense on borrowings 711 576 Net finance charge on pension schemes 87 127 Foreign currency exchange losses/(gains) 35 (36)
Changes in working capital (Increase)/decrease in reinsurance assets (584) 658 (Increase) in deferred acquisition costs (246) (604) Increase in insurance liabilities and investment contracts 2,044 14,017 Increase in other assets and liabilities 908 1,306
Cash consideration for subsidiaries, joint ventures and associates acquired and additions 114 239 Less: Cash and cash equivalents acquired with subsidiaries — (781)
Cash proceeds from disposal of subsidiaries, joint ventures and associates 988 241 Less: Net cash and cash equivalents divested with subsidiaries (111) (19)
(d) Cash and cash equivalents in the statement of cash flows at 31 December comprised: £m £m
54 – Group capital structure The Group maintains an efficient capital structure from a combination of equity shareholders’ funds, preference capital, subordinated debt and borrowings, consistent with our overall risk profile and the regulatory and market requirements of our business. This note shows where this capital is employed.
Financed by Equity shareholders’ funds 12,829 15,038 Non-controlling interests 1,476 3,977 Direct capital instrument 990 990 Preference shares 200 200 Subordinated debt 4,550 4,572 External debt 705 1,494
55 – Capital statement This statement sets out the financial strength of our Group entities and provides an analysis of the disposition and constraints over the availability of capital to meet risks and regulatory requirements. The capital statement also provides a reconciliation of shareholders’ funds to regulatory capital. The analysis below sets out the Group’s available capital resources.
Regulatory valuation and admissibility restrictions4 70 1,492 325 1,887 (2,231) (344) (2,042) (2,386) (893) (3,279) (2,405)
Analysis of liabilities: Participating insurance liabilities 2,053 15,320 12,347 29,720 921 30,641 24,953 55,594 — 55,594 64,043
Other non-participating life insurance 362 2,710 423 3,495 30,716 34,211 34,887 69,098 — 69,098 75,086 1 Other sources of capital include subordinated debt of £4,549 million issued by Aviva and £275 million of other qualifying capital issued by Dutch, Italian and Spanish subsidiary and associate undertakings. 2 Unallocated divisible surplus for overseas life operations is included gross of minority interest. 2011 includes a negative balance of £1,449 million in Italy (2010: £420 million negative). 3 Goodwill and other intangibles includes goodwill of £262 million in joint ventures and associates. 4 Including an adjustment for minorities (except for other sources of capital that are reflected net of minority interest). 5 Includes the Provident Mutual with-profit fund. 6 Other operations include general insurance and fund management business.
Available capital resources at 1 January 235 1,296 1,833 3,364 2,765 6,129 8,394 14,523
Expected change in available capital resources 23 177 91 291 417 708 824 1,532 Variance between actual and expected experience* 1 130 95 226 — 226 (3,276) (3,050) Effect of operating assumption changes 15 56 65 136 19 155 (24) 131 Effect of economic assumption changes (31) (230) (309) (570) — (570) (135) (705) Effect of changes in management policy — — (3) (3) — (3) 8 5 Effect of changes in regulatory requirements — — — — — — (6) (6) Transfers, acquisitions and disposals — — — — — — (8) (8) Deconsolidation of Delta Lloyd — — — — — — (1,598) (1,598) Foreign exchange rate movements — — — — — — (15) (15)
Available capital resources at 31 December 240 1,159 1,629 3,028 2,779 5,807 3,745 9,552 *The negative variance between actual and expected experience is driven by reductions in the market value of assets backing participating funds in continental Europe, and consequential reductions in unallocated divisible surplus.
Further analysis of the movement in the liabilities of the long-term business can be found in notes 39 and 40. The analysis of movements in capital provides an explanation of the movement in available capital of the Group’s life business for the year. This analysis is intended to give an understanding of the underlying causes of changes in the available capital of the Group’s life business, and provides a distinction between some of the key factors affecting the available capital. The negative shareholders’ funds balance within the UK with-profit funds arises in NWPSF as a result of regulatory valuation and admissibility differences in the reattributed estate which is valued on a realistic regulatory basis compared to the disclosure on an IFRS basis. NWPSF is fully supported by the reattributed estate of £1,113 million (this is known as RIEESA), at 31 December 2011 (31 December 2010: £1,218 million), held within NPSF1 (a non-profit fund within UKLAP included within other UK life operations), in the form of a capital support arrangement. This support arrangement will provide capital to NWPSF to ensure that the value of assets of NWPSF are at least equal to the value of liabilities calculated on a realistic regulatory basis therefore it forms part of the NWPSF available capital resources. The WPSF/RIEESA uses internal hedging to limit the impacts of equity market performance. These funds are still exposed to equity volatility which has increased significantly during the year, reducing available capital resources. In aggregate, the Group has at its disposal total available capital of £12.3 billion (2010: £16.6 billion), representing the aggregation of the solvency capital of all of our businesses. This capital is available to meet risks and regulatory requirements set by reference to local guidance and EU directives. After effecting the year-end transfers to shareholders, the UK with-profit funds have available capital of £3.0 billion (2010: £3.4 billion) (including amounts held in RIEESA). Subject to certain conditions, the RIEESA capital can be used to write new non-profit business, but the primary purpose of this capital is to provide support for the UK with-profit business. The capital is comfortably in excess of the required capital margin, and therefore the shareholders are not required to provide further support. For the remaining life and general insurance operations, the total available capital amounting to £9.3 billion (2010: £13.2 billion) is significantly higher than the minimum requirements established by regulators and, in principle, the excess is available to shareholders. In practice, management will hold higher levels of capital within each business operation to provide appropriate cover for risk. As the total available capital of £12.3 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. Within the Aviva Group there exist intra-group arrangements to provide capital to particular business units. Included in these arrangements is a subordinated loan of £200 million from Aviva Life Holdings UK Limited to Aviva Annuity Limited to provide capital to support the writing of new business. The available capital of the Group’s with-profit funds is determined in accordance with the ‘Realistic balance sheet’ regime prescribed by the FSA’s regulations, under which liabilities to policyholders include both declared bonuses and the constructive obligation for future bonuses not yet declared. The available capital resources include an estimate of the value of their respective estates, included as part of the unallocated divisible surplus. The estate represents the surplus in the fund that is in excess of any constructive obligation to policyholders. It represents capital resources of the individual with-profit fund to which it relates and is available to meet regulatory and other solvency requirements of the fund and, in certain circumstances, additional liabilities may arise. The liabilities included in the balance sheet for the with-profit funds do not include the amount representing the shareholders’ portion of future bonuses. However, the shareholders’ portion is treated as a deduction from capital that is available to meet regulatory requirements and is therefore shown as a separate adjustment in the capital statement. In accordance with the FSA’s regulatory rules under its realistic capital regime, the Group is required to hold sufficient capital in its UK life with-profit funds to meet the FSA capital requirements, based on the risk capital margin (RCM). The determination of the RCM depends on various actuarial and other assumptions about potential changes in market prices, and the actions management would take in the event of particular adverse changes in market conditions.
 Overseas life operations – the capital requirements and corresponding regulatory capital held by overseas businesses are calculated using the locally applicable regulatory regime. The available capital resources in all these businesses are subject to local regulatory restrictions which may constrain management’s ability to utilise these in other parts of the Group. Any transfer of available capital may give rise to a tax charge subject to availability of tax relief elsewhere in the Group.
 General insurance operations – the capital requirements and corresponding regulatory capital held by overseas businesses are calculated using the locally applicable regulatory regime. The available capital resources in all these businesses are subject to local regulatory restrictions which may constrain management’s ability to utilise these in other parts of the Group. Any transfer of available capital may give rise to a tax charge, subject to availability of tax relief elsewhere in the Group.
Risk management in relation to Delta Lloyd During 2011 Aviva has completed a partial disposal of its equity holding in Delta Lloyd. At 31 December 2010 Aviva held a controlling interest of 58% in Delta Lloyd’s issued equity, and as a result and in accordance with IFRS, consolidated 100% of Delta Lloyd assets and liabilities. As a result of the partial disposal of Delta Lloyd on 6 May 2011 Aviva’s share of Delta Lloyd’s voting rights has fallen below 50% and so Delta Lloyd has been deconsolidated. Aviva has retained a 42% associate interest. Aviva continues to actively monitor the quality of Delta Lloyd’s balance sheet and risk profile through:  membership of the Supervisory Board with access to Board papers and its committees;  Delta Lloyd’s submission of financial data to meet the group external reporting requirements;  Delta Lloyd’s submission of information to meet the group’s regulatory commitments; and  reviewing of the quarterly risk profile (ORSA report) as approved by the Delta Lloyd Executive Board.
To enable Aviva to satisfy its ongoing financial reporting, audit and other legal and regulatory requirements, including Aviva’s risk management and control procedures, Delta Lloyd will continue to provide to Aviva the relevant information to satisfy its legal, regulatory requirements in line with the Strategic Investment Agreement. This includes other certifications as required in connection with Aviva’s UK listing. Aviva is entitled to nominate, and propose replacements, for two Supervisory Board members.
Our credit risks arise principally through exposures to debt security investments, structured asset investments, derivative counterparties, mortgage lending and reinsurance counterparties. The group manages its credit risk at business unit, regional and group levels. All business units and regions are required to implement local credit risk management processes (including limits frameworks), operate specific risk management committees, and ensure detailed reporting and monitoring of their exposures against pre-established risk criteria. At group level, we manage and monitor all exposures across our business units on a consolidated basis, and operate a group limit framework that must be adhered to by all. Management of credit risk is effected through six core elements:  The setting up of an overall credit risk appetite by the Board Risk Committee, which controls the total credit risk to which the group is exposed.  The maintenance of and adherence to an effective governance structure. This includes clear guidance, scope and frameworks for all aspects of the management of the credit to ensure accountability and clarity including clear delegations of authority and a group wide credit risk policy and associated business standards.
 The implementation of a sophisticated capital charge-based credit limit framework that considers and quantifies the key specific attributes of each exposure (e.g. seniority, maturity, etc) and provides a counterparty level aggregation methodology covering all exposures to a counterparty. This is then managed against centrally set limits. Gross exposure limits are also set to ensure that any unexpected jump to default risks are appropriately restricted. Additional limit and controls are applied for structured assets and reinsurance counterparty exposures.
Financial exposures to peripheral European countries Included in our debt securities and other financial assets are exposures to peripheral European countries. Gross of non-controlling interests, our direct shareholder assets exposure to the governments (and local authorities and agencies) of Greece, Ireland, Portugal, Italy and Spain has reduced since 2010 and is detailed in note 25 (e) on page 240. We continue to monitor closely the situation in the eurozone and have had additional restrictions on further investment in place since late 2009 as well as taking actions to reduce exposure to higher-risk assets.
Notes to the consolidated financial statements continued 56 – Risk management continued Other investments Other investments (including assets of operations classified as held for sale £217 million) include:  £27,260 million of unit trusts and other investment vehicles. The underlying credit ratings of these assets are not reflected in this analysis.  Derivative financial instruments of £1,498 million, representing positions to mitigate the impact of adverse market movements.  Other assets of £1,619 million, including deposits with credit institutions and minority holdings in property management undertakings. The group loan portfolio principally comprises:  Policy loans which are generally collateralised by a lien or charge over the underlying policy.  Loans and advances to banks which primarily relate to loans of cash collateral received in stock lending transactions.
Loans The majority of the group loans portfolio is unrated. However, we use the following metrics to internally monitor our exposure:  property collateralisation (i.e. loan to value);  interest and debt service cover; and  diversity of the tenant base.
Securities finance The Group has significant securities financing operations within the UK and smaller operations overseas. The risks within this business are mitigated by over-collateralisation and minimum counterparty credit quality requirements which are designed to result in minimal residual risk. The Group operates strict standards around collateral management, margin calls and controls.
Unit-linked business As discussed previously, in unit-linked business the policyholder bears the market risk and credit risk, on investment assets in the unit funds, and the shareholders’ exposure to credit risk is limited to the extent that their income arises from asset management charges based on the value of assets in the fund.
Equity price risk The Group is subject to equity price risk due to daily changes in the market values of its equity securities portfolio. The Group’s shareholders are exposed to the following sources of equity risk:  Direct equity shareholdings in shareholder funds and the Group defined benefit pension funds.  The indirect impact from changes in the value of equities held in policyholders’ funds from which management charges or a share of performance are taken.  Its interest in the free estate of long-term with-profits funds.
Derivatives risk Derivatives are used by a number of the businesses, within policy guidelines agreed by the Board of directors, as set out in the Group policy on derivatives use. Activity is overseen by the Derivatives Approvals Committee, which monitors implementation of the policy, exposure levels and approves large or complex transactions proposed by businesses. Derivatives are primarily used for efficient investment management, risk hedging purposes or to structure specific retail savings products. Derivative transactions are covered by either cash or corresponding assets and liabilities. Speculative activity is prohibited, unless prior approval has been obtained from the Derivatives Approvals Committee. As noted above, over-the-counter derivative contracts are entered into only with approved counterparties and using ISDA documentation and credit support annexes (or equivalent) unless otherwise agreed by the Group ALM function. Adherence to the collateral requirements as set out in the relevant internal business standards thereby reduces the risk of credit loss. The Group applies strict requirements to the administration and valuation processes it uses, and has a control framework that is consistent with market and industry practice for the activity that is undertaken.
Correlation risk The Group recognises that lapse behaviour and potential increases in consumer expectations are sensitive to and interdependent with market movements and interest rates. These interdependencies are taken into consideration in the internal economic capital model and in scenario analysis.
(i) Analysis of maturity of insurance and investment contract liabilities For non-linked insurance business, the following table shows the gross liability at 31 December 2011 and 2010 analysed by remaining duration. The total liability is split by remaining duration in proportion to the cash-flows expected to arise during that period, as permitted under IFRS 4, Insurance Contracts. Almost all investment contracts may be surrendered or transferred on demand. For such contracts, the earliest contractual maturity date is therefore the current statement of financial position date, for a surrender amount approximately equal to the current statement of financial position liability. We expect surrenders, transfers and maturities to occur over many years, and the tables reflect the expected cash flows for non-linked investment contracts. However, contractually, the total liability for non-linked investment contracts of £59,690 million (2010: £63,197 million) would be shown in the ‘within 1 year’ column below. Unit-linked contracts are repayable or transferable on demand and are therefore shown in the ‘within 1 year’ column.
Notes to the consolidated financial statements continued 56 – Risk management continued
Long-term business Insurance contracts – non-linked 120,164 9,949 36,636 47,037 26,542
(ii) Analysis of maturity of financial assets The following table provides an analysis, by maturity date of the principal, of the carrying value of financial assets which are available to fund the repayment of liabilities as they crystallise.
Risk management framework The Group has developed a life insurance risk policy and associated business standards covering various aspects of life insurance risk management. Individual life insurance risks are managed at a business unit level but are also monitored at group level. The Group Insurance Committee monitors the application of the risk policy in each business, and receives management information on life insurance risks including experience data, analysis of change and economic capital consumption.
 Product design and pricing risk arises from poorly designed or inadequately priced products and can lead to both financial loss for and reputation damage to the Group. Business standards have been developed to support the businesses through the complete cycle of the product development process, financial analysis and pricing, and through the review of existing products.
The impact of these is reflected in the economic capital model and MCEV reporting and managed as part of the asset liability framework.
Management of general insurance risks Significant insurance risks will be reported through the risk management framework. Additionally, the economic capital model is used to assess the risks that each general insurance business unit, and the group as a whole, is exposed to, quantifying their impact and calculating appropriate capital requirements. All general insurance business units undertake a quarterly review of their insurance risks, the output from which is a key input into the economic capital assessments. The Group Insurance Committee monitors and develops the management of insurance risk in the general insurance business units, and assesses the aggregate risk exposure. It is responsible for the development and review of the group policies and business standards for underwriting, claims, reinsurance and reserving that form part of the risk management framework. Business units have developed mechanisms that identify, quantify and manage accumulated exposures to contain them within the limits of the appetite of the Group. The Group has pioneered various developments, such as the Aviva UK Digital Flood Map to effectively manage exposures arising from specific perils. Where appropriate such projects are employed throughout the business units to promote the adoption of best practice as standard.
General insurance claims reserving Actuarial claims reserving is conducted by local actuaries in the various general insurance business units according to the General Insurance Reserving policy/ business standard. The Group Insurance Committee monitors and maintains the general insurance reserving policy/ business standard, and conducts quarterly reviews of the Group’s general insurance claims provisions, and their adequacy. The reviews include peer reviews of the business unit’s own conclusions as well as independent analysis to confirm the reasonableness of the local reviews. The adequacy of the Group’s general insurance claims provisions is ultimately overseen by the Group Insurance Committee. A number of business units also have periodic external reviews by local consultant actuaries (often as part of the local regulatory requirement).
Reinsurance strategy The purchase of reinsurance is governed by the reinsurance standards for both life and general insurance recently introduced by the Group. The standards set out the Group’s minimum requirements required to achieve a consistent approach to the assessment, management, retention and placement of reinsurance across the Group. Significant reinsurance purchases are reviewed annually at both business unit and Group level, to verify that the levels of protection being bought reflect any developments in exposure and the risk appetite of the Group. Reinsurance purchases must be in line with the objectives set out in the Group reinsurance business standards. The basis of these purchases is underpinned by analysis of economic capital, economic gain, earnings volatility, liquidity, retained risk exposure profile and the Group’s franchise value. Detailed actuarial analysis is used to calculate the group’s extreme risk profile and then design cost and capital efficient reinsurance programmes to mitigate these risks to within agreed appetites. For businesses writing general insurance we will analyse the natural catastrophe exposure using external probabilistic catastrophe models widely used by the rest of the (re)insurance industry. The catastrophe accumulations and loss probabilities based on the Group’s specific portfolios of business are reviewed internally to ensure the losses from individual territories, or from our peak exposure zone Northern Europe, are within acceptable limits. Processes are in place to manage catastrophe risk in individual business units and at a group level. The Group cedes much of its worldwide catastrophe risk to third-party reinsurers but retains a pooled element for its own account gaining diversification benefit. The total Group potential loss from its most concentrated catastrophe exposure zone (Northern Europe excluding Delta Lloyd) is approximately £280 million, for a one in ten year annual loss scenario, compared to approximately £490 million when measured on a one in a hundred year annual loss scenario. In our 2009 and 2010 Report and Accounts we reported our participation in a share of a reinsurer’s US property catastrophe portfolio. Under this arrangement we assume exposure from Hiscox plc that does not correlate with the Group’s other general insurance exposures and therefore provides an opportunity to diversify the general insurance portfolio. For the 2011 underwriting year the modelled loss from a one in ten year annual loss scenario was £40 million compared to approximately £100 million when measured on a one in a hundred year annual loss scenario. The arrangement has been renewed for the 2012 underwriting year based on a similar level of participation.
Operational risk management We process a large number of complex transactions across numerous and diverse products, and are highly dependent on the proper functioning of information technology and communications systems. We are partially reliant on the operational processing performance of our outsourced partners including certain servicing and IT functions. The long-term nature of our business means that accurate records have to be maintained for significant periods. Significant resources are devoted to maintaining efficient and effective operations within our framework of corporate responsibility, policies, business standards and business ethics code.
Notes to the consolidated financial statements continued 56 – Risk management continued The different impacts of the economic sensitivities on profit and shareholders’ equity arise from classification of certain assets as AFS in some business units, for which movements in unrealised gains or losses would be taken directly to shareholders’ equity. The sensitivities to economic movements relate mainly to business in the UK and the US for continuing operations, and the Netherlands for discontinued operations. In general, a fall in market interest rates has a beneficial impact on non-participating business and shareholders’ funds, due to the increase in market value of fixed interest securities and the relative durations of assets and liabilities; similarly a rise in interest rates has a negative impact. In the US, most debt securities are classified as AFS, which limits the overall sensitivity of IFRS profit to interest rate movements. The mortality sensitivities relate primarily to the UK. Changes in sensitivities between 2010 and 2011 reflect movements in market interest rates, portfolio growth, changes to asset mix and the relative durations of assets and liabilities and asset liability management actions. The impact on the Group’s results from sensitivity to these assumptions can also be found in the MCEV sensitivities included in the alternative method of reporting long-term business profits section.
Gross of reinsurance excluding Delta Lloyd (205) 180 50 (55) (130) (300)
Fund management and non-insurance business Sensitivities as at 31 December 2011 Impact before profit before tax (£m)
Notes to the consolidated financial statements continued 56 – Risk management continued Limitations of sensitivity analysis The above tables demonstrate the effect of a change in a key assumption while other assumptions remain unchanged. In reality, there is a correlation between the assumptions and other factors. It should also be noted that these sensitivities are non-linear, and larger or smaller impacts should not be interpolated or extrapolated from these results. The sensitivity analyses do not take into consideration that the Group’s assets and liabilities are actively managed. Additionally, the financial position of the Group may vary at the time that any actual market movement occurs. For example, the Group’s financial risk management strategy aims to manage the exposure to market fluctuations. As investment markets move past various trigger levels, management actions could include selling investments, changing investment portfolio allocation, adjusting bonuses credited to policyholders, and taking other protective action. A number of the business units use passive assumptions to calculate their long-term business liabilities. Consequently, a change in the underlying assumptions may not have any impact on the liabilities, whereas assets held at market value in the statement of financial position will be affected. In these circumstances, the different measurement bases for liabilities and assets may lead to volatility in shareholder equity. Similarly, for general insurance liabilities, the interest rate sensitivities only affect profit and equity where explicit assumptions are made regarding interest (discount) rates or future inflation. Other limitations in the above sensitivity analyses include the use of hypothetical market movements to demonstrate potential risk that only represent the Group’s view of possible near-term market changes that cannot be predicted with any certainty, and the assumption that all interest rates move in an identical fashion.
57 – Derivative financial instruments and hedging This note gives details of the various instruments we use to mitigate risk. The Group uses a variety of derivative financial instruments, including both exchange traded and over-the-counter instruments, in line with our overall risk management strategy. The objectives include managing exposure to price, foreign currency and/or interest rate risk on existing assets or liabilities, as well as planned or anticipated investment purchases. In the narrative and tables below, figures are given for both the notional amounts and fair values of these instruments. The notional amounts reflect the aggregate of individual derivative positions on a gross basis and so give an indication of the overall scale of the derivative transaction. They do not reflect current market values of the open positions. The fair values represent the gross carrying values at the year end for each class of derivative contract held (or issued) by the Group. The fair values do not provide an indication of credit risk, as many over-the-counter transactions are contracted and documented under ISDA (International Swaps and Derivatives Association, Inc.) master agreements or their equivalent. Such agreements are designed to provide a legally enforceable set-off in the event of default, which reduces credit exposure. In addition, the Group has collateral agreements in place between the individual Group entities and relevant counterparties.
(ii) Fair value hedges The Group entered into a number of interest rate swaps in order to hedge fluctuations in the fair value part of its portfolio of mortgage loans and debt securities in the US. The notional value of these interest rate swaps was £844 million at 31 December 2011 (2010: £2,170 million) and their fair value was £77 million liability (2010: £74 million liability). These hedges were fully effective during the year.
(i) The Group’s non-hedge derivative activity at 31 December 2011 and 2010 was as follows: Contract/ notional amount £m
Interest rate contracts OTC Forwards — — — 1,868 1 —
58 – Assets under management In addition to the assets included in the consolidated statement of financial position, the Group manages funds for third parties. This note details the total assets under management.
Key management compensation The total compensation to those employees classified as key management, being those having authority and responsibility for planning, directing and controlling the activities of the Group, including the executive and non-executive directors, is as follows: £m £m
Salary and other short-term benefits1 36 36 Post-employment benefits1 9 7 Equity compensation plans 18 21 Termination benefits1 2 2 1 Following a review of the composition of key management, comparative amounts have been amended from amounts previously reported.
Operating expenses B (184) (176) Interest payable to Group companies H (460) (458) Interest payable on borrowings (353) (340)
Statement of changes in equity For the year ended 31 December 2011: Note
Investments in subsidiaries A 15,230 17,623 Investment in joint venture 18c 150 115 Loans owed by subsidiaries H 2,375 2,411 Current tax assets 261 388
Ordinary share capital 29 726 705 Preference share capital 32 200 200 Called up capital 926 905 Share premium account 29b 1,173 1,194 Merger reserve D 735 735 Investment valuation reserve D 4,674 7,061 Equity compensation reserve D 86 99 Retained earnings D 3,116 3,331 Direct capital instrument 33 990 990
Statement of cash flows For the years ended 31 December 2011 and 2010: All the Company’s operating and investing cash requirements are met by subsidiary companies and settled through intercompany loan accounts. As the direct method of presentation has been adopted for these activities, no further disclosure is required. In respect of financing activities, the following items pass through the Company’s own bank accounts.
Cash flows from financing activities Funding provided by subsidiaries 847 866 New borrowings drawdown, net of expenses 3,319 2,251 Repayment of borrowings (3,326) (2,272) Net repayment of borrowings (7) (21) Preference dividends paid (17) (17) Ordinary dividends paid (431) (472) Interest paid on borrowings (376) (359)
Staff costs and other employee-related expenditure (see below) 156 159 Other operating costs 6 42 Net foreign exchange losses/(gains) 22 (25)
Wages and salaries 102 109 Social security costs 11 10 Post-retirement obligations Defined benefit schemes (see (iii) below) 3 8 Defined contribution schemes 10 5 Profit sharing and incentive plans 11 10 Equity compensation plans (see (iv) below) 16 15 Termination benefits 3 2
(iv) Equity compensation plans All transactions in the Group’s equity compensation plans involve options and awards for ordinary shares of the Company. Full disclosure of these plans is given in the Group consolidated financial statements, note 30. The cost of such options and awards is borne by all participating businesses and, where relevant, the Company bears an appropriate charge. As the majority of the charge to the Company relates to directors’ options and awards, for which full disclosure is made in the Directors’ Remuneration Report, no further disclosure is given here on the grounds of immateriality.
(ii) Tax charged to other comprehensive income No tax was charged or credited to other comprehensive income in 2010 or 2011.
Total contractual undiscounted cash flows 5,327 7,061 12,388 5,337 6,155 11,492
Where subordinated debt is undated, the interest payments have not been included beyond 15 years. Annual interest payments for these borrowings are £73 million (2010: £73 million). The fair value of the subordinated debt at 31 December 2011 was £3,814 million (2010: £4,370 million). The fair value of the 9.5% guaranteed bonds 2016 at 31 December 2011 was £246 million (2010: £248 million). The fair value of the commercial paper is considered to be the same as its carrying value. Further details of these borrowings and undrawn committed facilities can be found in the Group consolidated financial statements, note 48.
G – Risk management Risk management in the context of the Group is considered in the Group consolidated financial statements, note 56. The business of the Company is managing its investments in subsidiary and joint venture operations. Its risks are considered to be the same as those in the operations themselves and full details of the major risks and the Group’s approach to managing these are given in the Group consolidated financial statements, note 56. Such investments are held by the Company at fair value in accordance with accounting policy D. The fair values of the subsidiaries and joint venture are estimated using applicable valuation models, underpinned by the Company’s market capitalisation. This uses the Company’s closing share price at year end. Given that the key input into the valuation model is based on an observable current share price, and therefore sensitive to movements in that price, the valuation process is not sensitive to non-observable market assumptions. Management believes the resulting estimated fair values recorded in the balance sheet and any changes in fair values recorded in the income statement are reasonable, and are the most appropriate values at the balance sheet date. Financial assets, other than investments in subsidiaries and the joint venture, largely consist of amounts due from subsidiaries. As at the balance sheet date, these receivable amounts were neither past due nor impaired. Financial liabilities owed by the Company as at the balance sheet date are largely in respect of borrowings (details of which are provided in note E and the Group consolidated financial statements, note 48) and loans owed to subsidiaries. Loans owed to subsidiaries were within agreed credit terms as at the balance sheet date.
Interest rate risk Loans to and from subsidiaries are at either fixed or floating rates of interest, with the latter being exposed to fluctuations in these rates. The choice of rates is designed to match the characteristics of financial investments (which are also exposed to interest rate fluctuations) held in both the Company and the relevant subsidiary, to mitigate as far as possible each company’s net exposure. The majority of the Company’s external borrowings are at fixed rates of interest and are therefore not exposed to changes in these rates. However, for those borrowings that are at floating rates, the Company is affected by changes in these rates. Further details of the Company’s borrowings are provided in note E and the Group consolidated financial statements, note 48.
Currency risk The Company’s direct subsidiaries are all incorporated and operating in the UK, and therefore are not exposed to currency risk. However, these subsidiaries are themselves exposed to foreign currency risk arising from fluctuations in exchange rates during the course of providing insurance and asset management services around the world. The exposure of the subsidiaries to currency risk is considered from a Group perspective in the Group consolidated financial statements, note 56. The Company faces exposure to foreign currency risk through some of its borrowings which are denominated in euros and US dollars. However, most of these borrowings have been on-lent to a subsidiary which holds financial investments in these currencies, generating the net investment hedge described in the Group consolidated financial statements, note 57(a)(iii).
The related parties’ payables are not secured and no guarantees were received in respect thereof. The payables will be settled in accordance with normal credit terms. The directors and key management of the Company are considered to be the same as for the Group. Information on both the Company and Group key management compensation can be found in note 59.
I – Statement of cash flows Following a review of the classification, of the cash flows, comparative amounts have been amended from amounts previously reported.
Share of operating profit (before tax) of Delta Lloyd as an associate 157 — 157 — — —
Adjusted for the following: Economic variances on long-term business (6,541) (316) (6,857) (450) (71) (521) Short-term fluctuation in return on investments on non-long term business (266) (60) (326) (199) (44) (243) Economic assumption changes on general insurance and health business (90) — (90) (61) — (61)
Amortisation and impairment of intangibles (266) (5) (271) (173) (14) (187) Profit on the disposal of subsidiaries and associates 565 159 724 163 (4) 159
(Loss)/profit for the year (2,786) 85 (2,701) 1,461 13 1,474 1 Excludes the proportion of the results of Aviva Investors fund management businesses and other fund management operations within the Group that arises from the provision of fund management services to our life businesses.
Earnings after tax on an MCEV basis, attributable to ordinary shareholders of Aviva plc Basic (pence per share) (67.3p) 4.0p (63.3p) 48.4p 1.0p 49.4p
The effect of future share awards and options in the loss from continuing operations and total is anti-dilutive, therefore the diluted earnings per share has been maintained at (67.3) pence and (63.3) pence respectively. Total MCEV operating profit before shareholder tax was £3,537 million (2010: £3,760 million), a decrease of 6%. Within this total the long-term business operating profit before shareholder tax was £3,399 million (2010: £3,579 million), a decrease of 5%.
(Loss)/profit for the year from continuing operations (2,786) 1,461 Profit for the year from discontinued operations 85 13
(Loss)/profit from the period (2,701) 1,474 Other comprehensive income from continuing operations Fair value losses on AFS securities, owner-occupied properties and hedging instruments (9) — Actuarial gains on pension schemes 996 1,078 Actuarial losses on pension schemes transferred to unallocated divisible surplus and other movements (22) (18) Share of other comprehensive income of joint ventures and associates (141) — Foreign exchange rate movements (461) (57) Aggregate tax effect – shareholder tax (160) 37
Attributable to: Equity shareholders of Aviva plc (1,419) 2,445 Non-controlling interests (948) (129)
Balance at 1 January 20,205 18,573 Total comprehensive (expense)/income for the year (2,367) 2,316 Dividends and appropriations (813) (757) Shares issued in lieu of dividends 307 209 Capital contributions from minority shareholders 68 42 Movements in ordinary shareholder equity following deconsolidation of Delta Lloyd (316) — Movements in non-controlling interests following deconsolidation of Delta Lloyd (1,484) — Minority share of dividends declared in the year (126) (187) Recycling of reserves to income statement on disposal of subsidiary (3) — Non-controlling interest in acquired subsidiaries — 3 Changes in non-controlling interest in existing subsidiaries (11) (38) Shares acquired by employee trusts (29) (14) Reserves credit for equity compensation plans 48 41 Aggregate tax effect – shareholder tax 16 17
Financial investments 216,058 253,288 Reinsurance assets 7,112 7,084 Deferred tax assets 238 288 Current tax assets 140 198
Reconciliation of shareholders’ equity on IFRS and MCEV bases For the year ended 31 December 2011: IFRS £m
Equity attributable to ordinary shareholders of Aviva plc 12,643 186 12,829 Preference share capital 200 — 200 Direct capital instruments 990 — 990 Non-controlling interests 1,530 (54) 1,476
Equity attributable to ordinary shareholders of Aviva plc 12,794 2,244 15,038 Preference share capital 200 — 200 Direct capital instruments 990 — 990 Non-controlling interests 3,741 236 3,977
Life and related businesses net assets on a statutory IFRS net basis 15,664 19,056 Goodwill and other intangibles (2,117) (2,356) Acquired value of in-force business (960) (1,447) Adjustment for share of joint ventures and associates (7) (120) Adjustment for assets to regulatory value net of tax (1,880) (890) Adjustment for DAC and DIR net of tax (2,622) (2,839) Adjustment for differences in technical provisions 2,904 1,303 Other accounting and tax differences (507) (505)
MCEV net worth 10,475 12,202 MCEV value of in-force1 2,619 6,805 1 Comprises PVFP of £5,847 million (31 December 2010: £9,952 million), FC of £642 million (31 December 2010: £884 million), CNHR of £1,046 million (31 December 2010: £1,070 million), and TVOG of £1,540 million
(31 December 2010: £1,193 million). 2 Comprises embedded value of £12,274 million (31 December 2010: £15,874 million) and non-controlling interest in long-term business assets of £820 million (31 December 2010: £3,133 million).
Movements in the reconciling items during the period arise mainly from the deconsolidation of Delta Lloyd on 6 May 2011and consequent removal of Delta Lloyd life business from covered business. The adjustment for assets to regulatory value and differences in technical provisions relates mainly to the US, reflecting differences between the IFRS and local solvency reserving basis. The DAC and DIR adjustment relates mainly to the UK and US.
Other movements in IFRS net equity — 412 412 270 682 682
Equity attributable to ordinary shareholders of Aviva plc on an MCEV basis 12,829 1 Covered business represents the business that the MCEV calculations cover, as detailed in the Basis of preparation note. The embedded value is presented net of non-controlling interests and tax. 2 Non-covered but related to life business represents the adjustments to the MCEV, including goodwill, to calculate the long-term business net assets on an MCEV basis. An analysis of net assets on an MCEV basis gross of non-controlling interests is provided in E6. 3 Net assets for the total life businesses on an MCEV basis presented net of non-controlling interests.
Life and pensions operating earnings For life and pensions operating earnings, Aviva uses normalised investment returns. The use of asset risk premia reflects management’s long-term expectations of asset returns in excess of the swap yield from investing in different asset classes. The normalised investment return on equities and property has been calculated by reference to the ten-year swap rate in the relevant currency plus an appropriate risk premium. The expected return on bonds has been calculated by reference to the swap rate consistent with the duration of the backing assets in the relevant currency plus an appropriate risk margin (expected return is equivalent to the gross redemption yield less an allowance for defaults). The expected existing business contribution (in excess of reference rate) is calculated using the implied discount rate (IDR), which itself is based on the normalised investment returns. The methodology applies the IDR to the value of in force (VIF) and required capital (RC) components of the MCEV and adds to this the total expected return for free surplus (FS) to derive the total expected return, in a manner consistent with that previously used under European embedded value reporting. This total is presented as the expected existing business contribution (reference rate), expected existing business contribution (in excess of reference rate) and expected return on shareholders’ net worth (grossed up for tax for pre-tax presentation), with only the excess contribution being impacted by the change. The change to expected returns has no impact on total return or on the closing balance sheet.
E1 – Basis of preparation continued MCEV methodology Overview Under the MCEV methodology, profit is recognised as it is earned over the life of products defined within covered business. The total profit recognised over the lifetime of a policy is the same as under the IFRS basis of reporting, but the timing of recognition is different.
For Aviva US, the required capital is set at 325% of the NAIC Company Action Level in line with management targets and target credit ratings. This methodology reflects the level of capital considered by the directors to be appropriate to manage the business, and includes any additional shareholder funds not available for distribution, such as the reattributed inherited estate in the UK. The same definition of required capital is used for both existing and new business. The free surplus is the market value of any assets allocated to, but not required to support, the in-force covered business at the valuation date. The level of required capital across the business units expressed as a percentage of the EU minimum solvency margin (or equivalent) can be found in E18.
US new business tax US new business has been valued on a basis with tax applied at the full corporation rate and consequential movements in the value of the Deferred Tax Asset included as a variance within existing business operating return.
Exchange rates The Group’s principal overseas operations during the period were located within the eurozone and the US. The results and cash flows of these operations have been translated at the average rates for that period and the assets and liabilities have been translated at the period end rates. Please refer to note 1 on page 191 of the IFRS financial statements.
Earnings from existing business: – expected returns at the reference rate 214 274 62 16 566 19 585 – expected returns in excess of the reference rate 340 334 515 10 1,199 109 1,308
Expected return on shareholders’ net worth 147 184 64 16 411 41 452
Value of new business grew 7% to £380 million (2010: £354 million) due to our focus on value maximisation through active management of our new business mix, robust cost control and pricing discipline.
Total expected return decreased by 9% to £701 million (2010: £773 million) as a result of a lower opening implied discount rate, albeit on a higher embedded value.
Experience variances of £116 million (2010: £20 million adverse) primarily reflect benefits from the Part VII transfer of the former RBS JV business, partly offset by £30 million adverse project expenditures due to increased level of regulatory change.
Value of new business was 27% lower at £369 million (2010: £504 million) following lower sales in Spain and management action to reduce sales of profit-sharing products in Italy and, to a lesser extent, in France.
Total expected return increased by 5% to £792 million (2010: £753 million) due to increased yields on shareholders’ net worth.
Other operating variances were positive at £237 million (2010: £271 million). These largely arose in France and relate to modelling refinements of £324 million, offset by adverse modelling refinements in Italy of £110 million.
Value of new business of negative £131 million (2010: £194 million negative) reflects the continuing adverse economic environment with low risk-free rates. The year on year improvement results from product actions, together with assumption and modelling changes, that more than offset adverse economic movements.
Total expected return increased by 27% to £641 million (2010: £503 million) reflecting a higher implied discount rate.
Operating experience and assumption changes on existing business were £213 million adverse (2010: £153 million adverse) reflecting adverse expense and mortality experience, the strengthening of future expense assumptions and revisions to policyholder behaviour and annuity spread assumptions.
Other operating variances were £56 million adverse (2010: £133 million favourable), primarily reflecting the marginal impact of new business on the value of deferred tax losses.
Asia Pacific MCEV operating earnings were 28% lower at £78 million (2010: £109 million) as the higher value of new business was more than offset by lower expected return and adverse impacts of existing business.
Operating experience variances, other operating variances and assumption changes on existing business were adverse £35 million (2010: nil), primarily reflecting adverse lapse experience and assumption strengthening.
Earnings after tax and non-controlling interests 884 681 (64) 22 295 46 8 988 156 59 2,087 106 2,193 1 Adverse expense experience occurred across a number of businesses. 2 Mortality experience continues to be better than the assumption set across a number of our businesses, most notably in France. Adverse experience reflects normal volatility in mortality and increased retention limits in the US. 3 Persistency experience continues to be somewhat volatile across our businesses. Asia reflects an accumulation of small adverse experience across businesses. 4 Other experience includes tax benefits from the transfer of former RBS joint venture business into the long-term fund in the UK. 5 Maintenance and project expense assumptions have been revised in many regions with a broadly neutral impact on continuing business and a benefit from restructuring in Delta Lloyd. 6 Mortality assumptions have been updated in France reflecting experience. 7 Persistency assumptions have been updated in a number of businesses reflecting lower expected lapses in France (AFER), increases due to the economic environment in Ireland and Spain and, in the US, revisions to dynamic policyholder lapse behaviour. 8 Other operating assumption changes in Poland relate to a change to assumed management actions in relation to product charges, and, in the US, revisions to policyholder utilisation of rider benefits offset by revisions to annuity spread assumptions. 9 Other operating variances relate to modelling changes and the release of a modelling provision in France, and modelling refinements in Italy and, in the US, the marginal impact of new business on the value of deferred tax losses, with cost of capital transactions and model refinements broadly offsetting.
Operating assumption changes: – maintenance expense5 57 21 (2) (8) 97 83 — 191 (57) 8 199 89 288 – project and other related expenses (65) — — — — — — — — — (65) (3) (68)
Expected return on shareholders’ net worth 129 27 14 17 6 7 6 77 53 9 268 50 318
E3 – Geographical analysis of fund management operating earnings The summarised consolidated income statement – MCEV basis includes earnings from the Group’s fund management operations as analysed below. This excludes the proportion of the results of Aviva Investors fund management businesses and other fund management operations within the Group that arise from the provision of fund management services to our Life businesses. These results are included within the Life MCEV operating earnings.
Total – continuing operations 32 31 Total – discontinued operations 9 94
E5 – Exceptional items and integration and restructuring costs Exceptional Items of £57 million (2010: £428 million) were mainly due to a £22 million provision for compensation scheme costs for the leveraged property fund in Ireland, as well as a £35 million expense for the discounted cost of strengthening latent claims provisions in the UK. For full year 2010, exceptional items were mainly due to a change in the cost of capital charge for the Cost of Non-Hedgeable Risk, from 2.5% to 3.3% p.a. with total impact of £365 million, the impact of reducing state contributions to Pillar II Pension funds in Poland, following the announcement to change legislation on 1 April 2011 of £280 million, and the recognition by Delta Lloyd of £59 million costs in relation to unit-linked insurance compensation scheme and compensation costs in defined contribution pension schemes, partly offset by a £286 million benefit from the closure of the final salary section of the UK staff pension scheme to future accruals. Integration and restructuring costs incurred in the year amounted to £212 million (FY10: £312 million). This includes costs associated with preparing the businesses for Solvency II implementation of £88 million expenditure relating to the Quantum Leap project in Europe of £51 million, and other restructuring exercises across the Group of £91 million partly offset by benefits of regulatory changes of £20 million.
E6 – Segmentation of condensed consolidated statement of financial position 2011 Restated
Total assets before acquired value of in-force long-term business 281,471 30,090 311,561 323,476 45,378 368,854 Acquired additional value of in-force long-term business 815 — 815 1,253 — 1,253
Liabilities of the long-term business (266,622) — (266,622) (305,673) — (305,673) Liabilities of the general insurance and other businesses — (30,391) (30,391) — (46,709) (46,709)
Group’s share included in shareholders’ funds 486 2,420 (1,934) Non-controlling interests’ share (54) 236 (289) Movements in AFS securities (300) (176) (125)
‘look through’ into service companies includes only future profits and losses, these amounts must be eliminated from the closing embedded value. 4 As a result of the January 2012 announced disposal of the Czech, Hungarian, and Romanian businesses, the VIF movement reflects the write-down of this business to the IFRS carrying value.
‘look through’ into service companies includes only future profits and losses, these amounts must be eliminated from the closing embedded value.
– expected returns 1,765 1,661 – experience variances 46 92 – operating assumption changes 41 187 Other operating variance 177 415 Expected return on shareholders’ net worth 411 425
Life and pensions operating earnings before tax 3,129 3,496 Economic variances (6,541) (450) Other non-operating variances (32) (686)
Life and pensions earnings before tax (3,444) 2,360 Tax on operating earnings (908) (1,035) Tax on other activities 2,098 296
Life and pensions earnings after tax – continuing operations (2,254) 1,621 Life and pensions earnings after tax – discontinued operations (33) (83)
Value of new business – continuing operations 432 689 399 716 Value of new business – discontinued operations — 1 (41) (92)
Life and pensions operating return – continuing operations 2,087 3,129 2,187 3,496 Life and pensions operating return – discontinued operations 106 270 12 83
E9 – Present value of life new business premiums The tables below set out the present value of new business premiums (PVNBP) written by the life and related businesses, gross of tax and non-controlling interests. The PVNBP calculation is equal to total single premium sales received in the period plus the discounted value of regular premiums expected to be received over the term of the new contracts, and is expressed at the point of sale. The premium volumes and projection assumptions used to calculate the present value of regular premiums for each product are the same as those used to calculate the value of new business, so the components of the new business margin are on a consistent basis. The weighted average capitalisation factor (WACF) is the multiple of the annualised regular premium which gives the present value at point of sale of the regular premiums.
In Poland, the decrease in the WACF reflects the lower proportion of new pension business written following legislative changes, making this business less attractive. This business had a high WACF, reflecting the long duration of the business combined with premiums increasing each year.
Total life and pensions – discontinued operations1 599 1,721 — (41) — (2.4)
E11 – Post-tax internal rate of return and payback period on life and pensions new business The new business written requires up-front capital investment due to high set-up costs and capital requirements. The internal rate of return (IRR) is a measure of the shareholder return expected on this capital investment. It is equivalent to the discount rate at which the present value of the post-tax cash flows expected to be earned over the lifetime of the business written, including allowance for the time value of options and guarantees, is equal to the total invested capital to support the writing of the business. The capital included in the calculation of the IRR is the initial capital required to pay acquisition costs and set up statutory reserves in excess of premiums received (initial capital), plus required capital at the same level as for the calculation of the value of new business. The payback period shows how quickly shareholders can expect the total capital to be repaid. The payback period has been calculated based on undiscounted cash flows and allows for the initial and required capital. The projected investment returns in both the IRR and payback period calculations assume that equities, properties and bonds earn a return in excess of risk-free consistent with the long-term rate of return assumed in operating earnings. The IRR on life and pensions new business for the Group (excluding Delta Lloyd) was 14.4% (2010: 13.3%).
Payback period Years 1 The Asia Pacific region IRR and payback period excluding Taiwan, which is held for sale, are 14% and 8 years respectively (2010: 11% and 8 years). 2 Current period represents the results of Delta Lloyd up to 6 May 2011 only.
E13 – Maturity profile of business continued (b) New business To show the profile of the VIF emergence, the value of new business has been split into five-year tranches depending on the date when the profit is expected to emerge.
£m 1 Required capital is shown net of implicit items permitted by local regulators to cover minimum solvency margins. 2 France and Aviva USA have a positive surplus on a statutory basis. 3 Negative MCEV in Italy results from widening of spreads on sovereign debt over the year. 4 Aviva USA’s holding company debt amounting to £736 million at 31 December 2011 has been included within non-covered business.
Total – excluding Delta Lloyd 1,247 7,398 5,733 14,378 1 Required capital is shown net of implicit items permitted by local regulators to cover minimum solvency margins. 2 France and Aviva USA have a positive surplus on a statutory basis. 3 Aviva USA’s holding company debt amounting to £765 million at 31 December 2010 has been included within non-covered business.
E16 – Implied discount rates (IDR) In the valuation of a block of business, the IDR is the rate of discount such that a traditional embedded value calculation for the covered business equates to the MCEV. The cash flows projected are the expected future cash flows including expected investment cash flows from equities, bonds and properties earning a risk premium in excess of risk free, statutory reserves and required capital. The risk premiums used are consistent with those used in the expected existing business contribution within operating earnings. As the risk premiums are positive, a discount rate higher than risk-free is required to give a value equal to the market-consistent embedded value. Average derived risk discount rates are shown below for the embedded value.
Other Europe 6.7 8.0 Aviva Europe n/a 6.9 North America1 n/a 34.2 Asia Pacific 5.2 5.9
Total n/a 9.8 1 Where there is significant difference in projected real world and risk neutral profits and the value of the in force business plus required capital is negative or close to zero, the IDR is not well defined and consequently IDR is not meaningful.
Value of new business after tax 15 (1) 54 4 47 119 — (26) 93 358 451 Life MCEV operating earnings after tax 41 6 104 40 81 272 3 49 324 2,199 2,523 Life MCEV (loss)/earnings after tax 47 (11) (26) 2 (29) (17) 6 (17) (28) 1,566 1,538 Closing covered businesses’ embedded value 250 268 630 153 489 1,790 19 1,324 3,133 15,874 19,007
US deferred annuities and all other contracts 1.09% 0.51% 0.49% 0.56% 0.64% 0.70% 0.55% 0.55% 1.13% 0.56%
Adjustments are made where liabilities are not fully backed by assets earning a liquidity premium and for contracts that are exposed to some lapse risk. There has been no change to the types of contracts to which a liquidity premium is applied.
A reduction in the UK corporation tax rate from 28% to 26% was substantively enacted in March 2011 and is effective from 1 April 2011. A further reduction from 26% to 25% was substantively enacted in July 2011 and will be effective from 1 April 2012. The effect of the 25% rate has been reflected in the Group’s MCEV net assets as at 31 December 2011. In addition, the Government announced its intention to further reduce the UK corporation tax rate to 24% from 1 April 2013 and to 23% from 1 April 2014. The benefit to the Group’s MCEV net assets from the further 2% reduction in the rate from 25% to 23% is estimated at approximately £100 million in total. Considerable changes to the regime for taxing UK life insurance companies will be made with effect from 1 January 2013. Draft legislation on this was included in the draft 2012 Finance Bill published on 6 December 2011, and consultation on the changes and the draft legislation has continued since then. Based on the draft legislation published in December 2011 and the continued consultation, it is not expected that these changes will have a material impact on the Group’s MCEV net assets.
(b) Economic assumptions – stochastic calculations The calculation of time value of options and guarantees allows for expected management and policyholder actions in response to varying future investment conditions. The management actions modelled include changes to asset mix, bonus rates and rates of interest and other guarantees granted to policyholders. Modelled policyholder actions are described under ‘Other assumptions’.
Model – Delta Lloyd The interest rate model used is a short rate G2++ model. The model is calibrated to the QIS5 yield curve and the swaption implied volatilities. Swaption implied volatilities are taken from Bloomberg. The equity model is a Heston model. Assumptions for correlations between asset classes have been set based on historic data.
Option length UK France Italy Ireland Spain US UK France Italy Ireland Spain US Delta Lloyd
Property implied volatilities Best estimate levels of volatility have been used in the absence of meaningful option prices from which implied levels of volatility can be derived. For the UK, model property implied volatility is 15% for 31 December 2011 (31 December 2010: 15%).
Borrowings per summarised consolidated statement of financial position – MCEV basis 8,450 14,949 Less: Securitised mortgage funding (1,306) (6,332)
Borrowings excluding non-recourse funding – MCEV basis 7,144 8,617 Less: Operational financing by businesses (1,889) (2,551)
Market value of external debt, subordinated debt, preference shares and direct capital instrument 5,782 7,279
E19 – Sensitivity analysis (a) Economic assumptions The following tables show the sensitivity of the embedded value and the value of new business to:  10 basis point increase in the liquidity premium adjustment, where applicable;  one percentage point increase and decrease in the risk-free rate, including all consequential changes (including assumed investment returns for all asset classes, market values of fixed interest assets, risk discount rates);  10% increase and decrease in market values of equity and property assets;  25% increase in equity and swaption volatilities;  50 basis point increase and decrease in credit spreads with no change to liquidity premium; and  decrease in the level of required capital to 100% EU minimum (or equivalent).
In each sensitivity calculation, all other assumptions remain unchanged except where they are directly affected by the revised economic conditions. For example, future bonus rates are automatically adjusted to reflect sensitivity changes to future investment returns. Some of the sensitivity scenarios may have consequential effects on valuation bases, where the basis for certain blocks of business is actively updated to reflect current economic circumstances. Consequential valuation impacts on the sensitivities are allowed for where an active valuation basis is used. Where businesses have a target asset mix, the portfolio is re-balanced after a significant market movement otherwise no re-balancing is assumed. For new business, the sensitivities reflect the impact of a change immediately after inception of the policy. In general, the magnitude of the sensitivities will reflect the size of the embedded values, though this will vary as the sensitivities have different impacts on the different components of the embedded value. In addition, other factors can have a material impact, such as the nature of the options and guarantees, as well as the types of investments held. The credit spread sensitivities assume that the change relates to credit risk and not liquidity risk; in practice, credit spread movements may be partially offset due to changes in liquidity risk. Sensitivities will also vary according to the current economic assumptions, mainly due to the impact of changes to both the intrinsic cost and time value of options and guarantees. Options and guarantees are the main reason for the asymmetry of the sensitivities where the guarantee impacts to different extents under the different scenarios.
Interest rates 2011 Embedded value (net of tax and non-controlling interest)
In line with the CFO Forum press release on 9 December 2011, a sensitivity to include an allowance for the current sovereign debt market conditions has been performed. The calculated sensitivity uses the ECB AAA and other curve in place of the reference rate for liabilities in Italy and Spain and results in an increase of £0.6 billion to the embedded value of £12.3 billion.
Market values Credit spread 2011 Value of new business (net of tax and non-controlling interest)
Embedded value 2011 Embedded value (net of tax and non-controlling interest)
New business 2011 Value of new business (net of tax and non-controlling interest)
As reported on page 340 £m 10% decrease in maintenance expenses £m 10% decrease in lapse rates £m 5% decrease in mortality/
Statement of directors’ responsibilities in respect of the MCEV basis When compliance with the European Insurance CFO Forum Market Consistent Embedded Value Principles (MCEV Principles), published in October 2009, is stated, those principles require the directors to prepare supplementary information in accordance with the methodology contained in the MCEV Principles and to disclose and explain any non-compliance with the guidance included in the MCEV Principles. In preparing this supplementary information, the directors have done so in accordance with these MCEV Principles and have also fully complied with all the guidance included therein. Specifically, the directors have:  determined assumptions on a realistic basis, having regard to past, current and expected future experience and to relevant external data, and then applied them consistently;  made estimates that are reasonable and consistent; and,  provided additional disclosures when compliance with the specific requirements of the MCEV Principles is insufficient to enable users to understand the impact of particular transactions, other events and conditions and the Group’s financial position and financial performance.
Independent auditor’s report to the directors of Aviva plc on the consolidated MCEV financial statements We have audited the consolidated MCEV financial statements of Aviva plc for the year ended 31 December 2011, which comprises the Condensed consolidated income statement – MCEV basis, the Condensed consolidated statement of comprehensive income – MCEV basis, the Condensed consolidated statement of changes in equity – MCEV basis, the Condensed consolidated statement of financial position – MCEV basis, the Reconciliation of shareholders’ equity on IFRS and MCEV bases, the Reconciliation of IFRS total equity to MCEV net worth, the Group MCEV analysis of earnings and the related notes E1 to E19. The Consolidated MCEV financial statements have been prepared by the directors of Aviva plc in accordance with the MCEV Principles issued in June 2008 by the CFO Forum as amended in October 2009 (‘the CFO Forum Principles’) and the basis of preparation set out on pages 328 to 331.
Directors’ responsibilities for the Consolidated MCEV financial statements The directors are responsible for the preparation of these Consolidated MCEV financial statements in accordance with the basis of preparation set out on pages 328 to 331 and for such internal control as the directors determine is necessary to enable the preparation of the financial statements that are free from material misstatement, whether due to fraud or error.
Basis of accounting and restriction on use Without modifying our opinion, we draw attention to Note E1 to the Consolidated MCEV financial statements, which describes the basis of preparation. The Consolidated MCEV financial statements are prepared by Aviva plc in accordance with the CFO Forum Principles. As a result, the Consolidated MCEV financial statements may not be suitable for another purpose. This report, including the opinion, has been prepared for and only for the Company’s directors as a body in accordance with our letter of engagement dated 3 August 2011 and for no other purpose. We do not, in giving this opinion, accept or assume responsibility for any other purpose or to any other person to whom this report is shown or into whose hands it may come save where expressly agreed by our prior consent in writing.
Product definitions Annuities A type of policy that pays out regular amounts of benefit, either immediately and for the remainder of a person’s lifetime, or deferred to commence from a future date. Immediate annuities may be purchased for an individual and his or her dependants or on a bulk purchase basis for groups of people. Deferred annuities are accumulation contracts, which may be used to provide benefits in retirement, and may be guaranteed, unit-linked or index-linked.
Group pensions A pension plan that covers a group of people, which is typically purchased by a company and offered to their employees.
Guaranteed annuities A policy that pays out a fixed regular amount of benefit for a defined period.
Index linked annuities An index linked annuity is a type of deferred annuity whose credited interest is linked to an equity index. It guarantees a minimum interest rate and protects against a loss of principal.
OEIC An open ended investment company is a collective investment fund structured as a limited company in which investors can buy and sell shares.
With-profits A type of long-term savings and insurance product sold in the UK under with-profits policies premiums are paid into a separate fund. Policyholders receive a return on their policies through bonuses, which ‘smooth’ the investment return from the assets which premiums are invested in. Bonuses are declared on an annual and terminal basis. Shareholders have a participating interest in the with-profit funds and any declared bonuses. Generally, policyholder and shareholder participation in with-profit funds in the UK is split 90:10.
General terms Acquired value of in force (AVIF) An estimate of future profits that will emerge over the remaining term of all existing life and pensions policies for which premiums are being paid or have been paid at the statement of financial position date.
Association of British Insurers (ABI) Association of British Insurers – A major trade association for UK insurance companies, established in July 1985.
FSA The UK’s Financial Services Authority – Main regulatory body appointed by the Government to oversee the financial services industry in the UK. Since December 2001 it has been the single statutory regulator responsible for the savings, insurance and investment business.
‘Hard’ insurance market A term used to describe the state of the general insurance market. A ‘hard’ insurance market is characterised by high levels of underwriting profits and the ability of insurers to charge high premium rates. Hard insurance markets generally occur when capital is scarce and are the opposite of ‘soft’ insurance markets.
Inherited estate In the UK, the assets of the long-term with-profit funds less the realistic reserves for non-profit policies written within the with-profit funds, 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.
Present value of new business (PVNBP) Present value of new regular premiums plus 100% of single premiums, calculated using assumptions consistent with those used to determine the value of new business under MCEV principles published by the CFO Forum.
Turnbull Guidance on Internal Control The Turnbull Guidance sets out best practice on internal controls for UK listed companies, and provides additional guidance in applying certain sections of the UK Corporate Governance.
The forum was created in 2002, the Market Consistent Embedded Value Principles were launched in June 2008. The principles are a further development of the European Embedded Value Principles first launched in May 2004.
EU solvency The excess of assets over liabilities and the worldwide minimum solvency margins, excluding goodwill and the additional value of in-force long-term business, and excluding the surplus held in the Group’s life funds. The Group solvency calculation is determined according to the UK Financial Services Authority application of EU Insurance Groups Directive rules.
Frictional costs The additional taxation and investment costs incurred by shareholders through investing the required capital in the Company rather than directly.
Group MCEV A measure of the total consolidated value of the Group with covered life business included on an MCEV basis and non-covered business (including pension schemes and goodwill) included on an IFRS basis.
Market Consistent Embedded Value (MCEV) terms cont. Implicit items Amounts allowed by local regulators to be deducted from capital amounts when determining the EU required minimum margin.
Net worth The market value of the shareholders’ funds and the shareholders’ interest in the surplus held in the nonprofit component of the long-term business funds, determined on a statutory solvency basis and adjusted to add back any non-admissible assets, and consists of the required capital and free surplus.
Present value of new business premiums (PVNBP) The present value of new regular premiums plus 100% of single premiums, calculated using assumptions consistent with those used to determine the value of new business.
By size of shareholding Number of shareholders % Number of shares %
2012 financial calendar Annual General Meeting Announcement of first quarter Interim Management Statement Announcement of unaudited half-year results Announcement of third quarter Interim Management Statement 2011 final dividend dates – ordinary shares Ex-dividend date Record date Scrip dividend price setting period Scrip dividend price announcement date Last date for receipt of Scrip elections Dividend payment date*
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