O therinform ation Aviva plc Annual Report and Accounts 2006 143 15 – Goodwill continued RAC (non-insurance operations) The recoverable amount of the RAC (non-insurance operations) has also been determined based on a value in use calculation. The calculation uses cash flow projections based on business plans approved by management covering a three year period and a risk adjusted discount rate of 10.27% (2005: 10.45%). Cash flows beyond that three year period have been extrapolated using a steady 2% growth rate. The recoverable amount significantly exceeds the carrying value of the cash generating unit including goodwill and intangible assets with indefinite useful lives and a reasonably possible change in a key assumption will not cause the carrying value of the cash generating unit to exceed its recoverable amount.
United States (long-term business) The carrying value of the Group’s cash-generating unit in the United States is principally represented by the former operations of AmerUs Group Co. (AmerUs), which was acquired by the Group on 15 November 2006. The unit’s current business plan is consistent with the assumptions made at the time of the acquisition in determining the appraisal value of AmerUs, which was in excess of its current carrying value. Since the acquisition date, the assets and liabilities making up the unit have not changed significantly, and there have been no other events which might have materially affected the recoverable amount of the unit.
Other During the year, goodwill allocated to a long-term business cash-generating unit in Germany, Berlinische, was tested for impairment. Following the impairment test, an impairment charge of £94 million has been recognised in the income statement. The impairment charge arose as a result of the fall off in contribution from new business in 2006 and current adverse experience within the in-force portfolio.
Notes to the consolidated financial statements continued 16 – Acquired value of in-force business (AVIF) and intangible assets Intangible Intangible assets with assets with indefinite finite
Gross amount At 1 January 2005 613 44 189 846 Additions 13 – 60 73 Acquisition of subsidiaries – 260 73 333 Foreign exchange rate movements (12) (2) 1 (13)
Amortisation for the year (26) – (39) (65) Impairment losses recognised (29) – (6) (35) Foreign exchange rate movements 4 – (1) 3
Carrying amount At 31 December 2005 315 302 195 812 Less: Amounts classified as held for sale – – (9) (9)
Intangible assets with indefinite useful lives comprise the RAC and BSM brands, and the value of the Union Financière de France Banque sales force, where the existing lives of the assets and their competitive position in, and the stability of, their respective markets support this classification. Impairment testing on intangibles is covered in note 15(b).
O therinform ation Aviva plc Annual Report and Accounts 2006 145 17 – Investments in joint ventures (a) Carrying amount
Goodwill and Equity intangibles interests Loans Total £m £m £m £m
Share of results before tax – 332 – 332 Share of tax – (6) – (6)
Share of profit after tax – 326 – 326 Acquisitions and additions 167 587 – 754 Disposals and reduction in Group interests – (43) – (43) Reclassification to subsidiaries – (8) – (8) Dividends received – (34) – (34) Additional loans – – 128 128 Foreign exchange rate movements – 1 – 1 Other movements and reclassifications as held for sale (167) (83) – (250)
Share of results before tax – 465 – 465 Share of tax – (3) – (3)
Share of profit after tax – 462 – 462 Acquisitions and additions – 372 – 372 Disposals and reduction in Group interests – (127) – (127) Reclassification to subsidiaries – (93) – (93) Dividends received – (59) – (59) Additional loans – – 113 113 Foreign exchange rate movements – (2) – (2)
Airport Property Partnership 50.0% 50.0% Apia Regional Office Fund 50.0% 61.3% Ashtenne Industrial Partnership 66.7% 38.8% The Junction Limited Partnership 50.0% 46.0% The Mall Limited Partnership 50.0% 33.5% Queensgate Property Partnership Limited 50.0% 50.0% Quercus Property Partnership Limited 50.0% 58.4%
All the above entities perform property ownership and management activities, and are incorporated and operate in Great Britain. All these investments are held by subsidiary entities.
Share of results after tax – 32 – 32 Amortisation of acquired value of in-force business – (18) – (18)
Share of profit after tax – 14 – 14 Acquisitions and additions 5 65 – 70 Fair value (losses) taken to equity – (2) – (2) Dividends received – (61) – (61) Foreign exchange rate movements – (4) – (4) Other movements and reclassifications as held for sale – (5) – (5)
Share of results before tax – 48 – 48 Share of tax – (11) – (11)
Share of results after tax – 37 – 37 Amortisation of acquired value of in-force business – (14) – (14)
Notes to the consolidated financial statements continued 18 – Investments in associates continued (b) The principal associates included above are: Type of Proportion Country of incorporation Company business Class of share held and operation
In July 2006, our French operation, Aviva France, sold its holding in ProCapital SA, an online brokerage company, to Credit Mutuel for £98 million. The sale resulted in a profit on disposal of £79 million (see note 3b).
(d) Impairment testing The Group’s investments in RBS Life Investments Limited and RBSG Collective Investments Limited have been tested for impairment by comparing their carrying values (which include goodwill which arose on their acquisition) with their recoverable amounts. The recoverable amounts for both the investments have been determined based on value in use calculations. The calculations use cash flow projections based on business plans approved by management covering a five year period and a risk adjusted discount rate of 6.8%. Cash flows beyond that five year period have been extrapolated using a growth rate of 4.5%.The recoverable amounts significantly exceed the carrying values of both the investments and a reasonably possible change to the key underlying assumptions will not cause the carrying values of the investments to exceed their recoverable amounts.
Reversal of impairment losses (see note 32b) – (2) – – – (2) Fair value gains (see note 32b) – 26 – – – 26 Foreign exchange rate movements (1) (8) – (10) (5) (24)
Carrying amount At 31 December 2005 54 499 68 218 131 970 Less: Assets reclassified as available for sale – – – – (85) (85)
Owner-occupied properties are stated at their revalued amounts as assessed by qualified external valuers or by local qualified staff of the Group in overseas operations, all with recent relevant experience. Values are calculated on the basis of existing use, being the estimated arm’s-length value at which the properties could be exchanged with vacant possession and without allowing for alternatives to their current use.
If owner-occupied properties were stated on a historical cost basis, the carrying amount would be £368 million (2005: £406 million).
Notes to the consolidated financial statements continued 20 – Investment property Freehold Leasehold Total £m £m £m
Carrying value At 1 January 2005 9,100 1,957 11,057 Additions 1,596 173 1,769 Capitalised expenditure on existing properties 126 61 187 Fair value gains 1,169 402 1,571 Disposals (1,171) (80) (1,251) Foreign exchange rate movements (55) (3) (58)
At 31 December 2005 10,765 2,510 13,275 Additions 1,373 342 1,715 Capitalised expenditure on existing properties 125 48 173 Acquisitions of subsidiaries 35 – 35 Fair value gains 1,227 280 1,507 Disposals (1,494) (47) (1,541) Transfers from property and equipment 6 – 6 Foreign exchange rate movements (41) (6) (47)
Freeholds 10,423 9,036 Long leaseholds – over 50 years 3,039 3,018 21 – Loans (a) Carrying amounts The carrying amounts of loans at 31 December 2006 and 2005 were as follows: £m £m
The carrying amounts of the above loans are stated at amortised cost with the exception of £4,941 million (2005: £5,084 million) of securitised mortgage loans and £11,316 million (2005: £10,000 million) of non-securitised mortgage loans which are designated as other than trading and measured at fair value.
The fair value has been calculated by discounting the future cashflows using appropriate current interest rates for each portfolio of mortgages.
The change in fair value of these loans during the year, attributable to a change in credit risk, was £nil (2005: £nil). The cumulative change attributable to changes in credit risk to 31 December 2006 was £nil (2005: £nil).
(b) Netherlands and Belgium In three subsidiaries, Delta Lloyd Levensverzekering NV (DLL), Amstelhuys NV (AMS), and Delta Lloyd Bank NV/SA (DLB), the principal benefits of certain portfolios of mortgage loans have been transferred to a number of special purpose securitisation companies, Arena 2000 – I BV, Arena 2001 – I BV, Arena 2002 – I BV, Arena 2003 – I BV, Arena 2004 – I BV, Arena 2004 – II BV, Arena 2005 – I BV, Arena 2006 – I BV, B-Arena NV/SA and DARTS Finance BV (the securitisation companies), which were funded primarily through the issue of fixed rate, floating rate and index-linked notes. No gains or losses were recognised on these transfers.
All the shares in the securitisation companies are held by independent trustee companies. Although DLL and AMS do not own, directly or indirectly, any of the share capital of the securitisation companies or their parent companies, these companies have been treated as subsidiaries in the consolidated financial statements. DLL, AMS and DLB have no right, nor any obligation, to repurchase the benefit of any of the securitised mortgage loans before the optional call date, other than in certain circumstances where they are in breach of warranty.
Debt securities UK government – 19,921 – 19,921 Non-UK government 7 19,388 434 19,829 Corporate – UK 19 12,230 80 12,329 Corporate – Non-UK 119 41,858 4,725 46,702 Other – 6,544 7,716 14,260
Other investments Unit trusts and other specialised investment vehicles 5 28,860 147 29,012 Derivative financial instruments 1,325 – – 1,325 Deposits with credit institutions – 381 – 381 Minority holdings in property management undertakings (see note 17b) – 542 – 542 Other 6 1,735 49 1,790 * The gain related to AFS investments recognised in equity was £347 million (2005: £110 million loss) and the amount recognised in the income statement on disposals was £162 million (2005: £154 million gain). (See notes 5 and 32b).
Of the above total, £115,004 million (2005: £19,509 million) is expected to be recovered more than one year after the balance sheet date.
Other Available Trading than trading for sale* Total £m £m £m £m
Debt securities UK government – 22,845 – 22,845 Non-UK government 4 22,908 438 23,350 Corporate – UK – 11,492 58 11,550 Corporate – Non-UK 81 31,345 5,237 36,663 Other – 8,834 675 9,509
Other investments Unit trusts 4 24,202 3 24,209 Derivative financial instruments 467 – – 467 Deposits with credit institutions – 165 – 165 Minority holdings in property management undertakings (see note 17b) – 499 – 499 Other (6) 1,069 24 1,087
Debt securities 111,409 2,402 (770) 113,041 Equity securities 45,045 12,330 (613) 56,762 Other investments
Unit trusts and specialised investment vehicles 26,433 2,642 (63) 29,012 Derivatives financial instruments – 1,325 – 1,325 Deposits with credit institutions 381 – – 381 Minority holdings in property management undertakings 542 – – 542 Other 1,712 86 (8) 1,790
Cost/ amortised Unrealised Unrealised cost gains losses Fair value £m £m £m £m
Debt securities 99,086 5,006 (175) 103,917 Equity securities 42,578 9,562 (96) 52,044 Other investments
Unit trusts and specialised investment vehicles 22,335 1,885 (11) 24,209 Derivative financial instruments – 467 – 467 Deposits with credit institutions 165 – – 165 Minority holdings in property management undertakings 499 – – 499 Other 1,040 49 (2) 1,087
(c) Other information on investments Included within financial investments are shareholdings held on a long-term basis as follows: Market value of shareholding
(d) Stocklending The Group has entered into stocklending arrangements in the UK and overseas during the year in accordance with established market conventions. In the UK, investments are lent to locally-domiciled counterparties and governed by agreements written under English law. Other investments are specifically deposited under local laws in various countries overseas as security to holders of policies issued there.
Total 8,098 7,774 Less: Amounts classified as held for sale – (68)
Total 3,476 3,806 Less: Amounts classified as held for sale – (40)
(b) The movements in deferred acquisition costs during the year were: £m £m
Amortisation of deferred acquisition costs includes £271 million (2005:nil) for the effect of adjusting to PS06/14 realistic basis.
(c) Other assets include £2 million (2005: £472 million) that is expected to be recovered more than one year after the balance sheet date.
(d) Prepayments and accrued income include £62 million (2005: £467 million) that is expected to be recovered more than one year after the balance sheet date.
O therinform ation Aviva plc Annual Report and Accounts 2006 155 26 – 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 balance sheet, while the liabilities are included within insurance and investment contract provisions disclosed in notes 35 and 37.
The authorised share capital of the Company at 31 December 2006 was: 3,000,000,000 (2005: 3,000,000,000) ordinary shares of 25 pence each 750 750
The allotted, called up and fully paid share capital of the Company at 31 December 2006 was: 2,565,753,431 (2005: 2,395,693,688) ordinary shares of 25 pence each 641 599
(b) During 2006, a total of 170,059,743 ordinary shares of 25 pence each were allotted and issued by the Company as follows: Share Share
At 1 January 2,395,693,688 599 1,167 Shares issued under the Group’s Employee and Executive Share Option Schemes 14,204,808 3 40 Shares issued in connection with acquisitions, net of transaction costs 129,000,000 32 (11) Shares issued in lieu of dividends 26,854,935 7 (7)
Shares in lieu of the 2005 final and 2006 interim dividends were issued on 17 May and 17 November 2006 respectively. The issue of shares in lieu of cash dividends is considered a bonus issue under the terms of the Companies Act 1985 and the nominal value of the shares is charged to the share premium account.
28 – Equity compensation plans (a) Description of the plans The Group maintains a number of active stock option and award schemes. These are as follows: (i) Savings-related options These are options granted under the Inland Revenue-approved Save As You Earn (SAYE) share option schemes in the UK and in Ireland. Options are normally exercisable during the six month period following either the third, fifth or seventh anniversary of the start of the relevant savings contract.
Notes to the consolidated financial statements continued 28 – Equity compensation plans continued (iv) Long-term incentive plan awards These awards have been made to senior Group executives since 2001 and are described in section (b) below and in the Directors’ remuneration report.
(v) Deferred bonus plan awards These awards have been made under the Aviva Deferred Bonus Plan, and are described in section (b) below and in the Directors’ remuneration report. The Group has established various employee share trusts to facilitate the delivery of shares under the above schemes. Details of these trusts are given in note 29.
Option price Number Option price Number Hibernian Savings Related Share Option Scheme (in euros) c of shares Normally exercisable c of shares Normally exercisable
Option price Number General Accident Executive Share Option Scheme p of shares Normally exercisable
Option price Number Option price Number Aviva Executive Share Option Scheme (Delta Lloyd) p of shares Normally exercisable p of shares Normally exercisable
Option price Number Option price Number CGU plc Deferred Bonus Plan p of shares Normally exercisable p of shares Normally exercisable
The comparative figures as at 31 December 2005 were: Weighted average Weighted average
Number Number Aviva Long-Term Incentive Plan 2005 of shares Vesting period of shares Vesting period
The vesting of awards under the Aviva Long-Term Incentive Plan is subject to the attainment of performance conditions as described in the Directors’ remuneration report. Shares which do not vest, lapse.
(iii) Shares to satisfy awards and options Prior to March 2003, it was the practice to satisfy awards and options granted under the executive incentive plans through shares purchased in the market and held by employee share trusts which were established for the purpose of satisfying awards under the various executive incentive plans and funded by the Company. Since March 2003, no shares have been purchased by the trusts, it being the Company’s current practice to satisfy the awards granted after that date by the issue of new shares at the time of vesting. At 31 December 2006, 682,202 shares were held by the employee share trusts with an aggregate nominal value of £170,550 and market value of £6 million. The trustees have waived their right to dividends on the shares held in the trusts. Further details are given in note 29.
Notes to the consolidated financial statements continued 28 – Equity compensation plans continued (c) Movements in the year A summary of the status of the option plans as at 31 December 2006 and 2005, and changes during the years ended on those dates, is shown below.
Number exercise price Number exercise price of options p of options p
Granted during the year 3,912,011 593.00 7,956,344 434.64 Forfeited during the year – – (890) 719 Exercised during the year (5,665,668) 394.93 (5,918,840) 419.69 Expired during the year (6,693,883) 569.15 (5,669,933) 581.58
(e) Fair value of options and awards granted after 7 November 2002 The weighted average fair value of options and awards granted during the year, estimated by using the Black-Scholes option-pricing model, was £2.35 and £6.70 (2005: £1.88 and £4.50) respectively.
Share price 781p 618p Exercise price 593p 491p Expected volatility 26% 35% Expected life 3.82 years 3.81 years Expected dividend yield 3.70% 4.10% Risk-free interest rate 4.80% 4.20%
These shares are owned by employee share trusts in the Company and a subsidiary undertaking to satisfy awards under the Group’s Long Term Incentive Plan and Deferred Bonus Plans. The shares were purchased in the market and are carried at cost less amounts charged to the income statement in prior years. Further details of the shares held can be found in note 28b. Details of the features of the plans can be found in the Directors’ remuneration report.
30 – Preference share capital The preference share capital of the Company at 31 December 2006 was: £m £m
The issue of new shares to fund the acquisition of AmerUs was effected by a share placing. As part of the share placing, the Company issued 129,000,000 ordinary shares for consideration of £903 million through a special purpose entity. £32 million was taken to share capital and the balance of £871 million was taken to a merger reserve, since the placing structure utilised attracted merger relief under s.131 of the Companies Act 1985. £871 million was then transferred to retained earnings following the redemption of shares in the special purpose entity.
Arising in the year: Fair value gains/(losses) – 32 (65) (19) – (52) Fair value losses transferred to profit – – 411 – – 411 Share of fair value changes in joint ventures and associates taken to equity – 2 – – – 2 Impairment losses on revalued assets – – (45) – – (45) Reserves credit for equity compensation plans (note 28d) – – – – 22 22 Foreign exchange rate movements (2) – – 19 – 17 Aggregate tax effect – policyholders’ tax – 3 – – – 3 Aggregate tax effect – shareholders’ tax – (4) 45 5 – 46
Balance at 1 January 2,597 1,709 Profit for the year attributable to equity shareholders 2,215 1,767 Actuarial losses on pension schemes (note 42d (iii)) (114) (547) Dividends and appropriations (note 14) (762) (657) Shares issued in lieu of dividends 203 100 Shares issued under equity compensation plans (note 32b) 18 – Transfer from merger reserve on realisation (note 32a) 871 – Fair value gains realised from reserves (note 32b) 9 – Aggregate tax effect 45 226 Other movements – (1)
The shares issued in lieu of dividends are in respect of the transfer to retained earnings from the ordinary dividend account, arising from the treatment of shares issued in lieu of the 2005 final and 2006 interim dividends, as explained in note 27(b).
34 – Minority interests (a) Minority interests at 31 December comprised: £m £m
Profit for the year attributable to minority interests 174 131 Minority share of movements in other reserves 1 1 Foreign exchange rate movements (19) (19)
Recognised income and expense attributable to minority interests 156 113 Capital contributions from minority shareholders 397 212 Minority share of dividends declared in the year (75) (70) Minority interest in acquired/(disposed) subsidiaries 92 (36) Other movements – (1)
O therinform ation Aviva plc Annual Report and Accounts 2006 163 35 – Insurance liabilities (a) Carrying amount Insurance liabilities at 31 December comprise: General General Long-term insurance Long-term insurance business and health Total business and health Total £m £m £m £m £m £m
Provision for unearned premiums – 5,182 5,182 – 5,381 5,381 Provision arising from liability adequacy tests – 49 49 – 48 48
• “with-profit” funds of CGNU Life Assurance (CGNU Life), Commercial Union Life Assurance (CULAC) and the with-profit and Provident Mutual funds of Norwich Union Life & Pensions (NUL&P), where the with-profit policyholders are entitled to at least 90% of the distributed profits, the shareholders receiving the balance; • “non-profit” funds of Norwich Union Annuity and NUL&P, where shareholders are entitled to 100% of the distributed profits. Shareholder profits on unitised with-profit business written by Norwich Union Life & Pensions and on stakeholder unitised with-profit business are derived from management fees and policy charges, and emerge in the non-profit funds.
– In the Netherlands, the balance of profits, after providing appropriate returns for policyholders and after tax, accrues for the benefit of the shareholders. The bases for determining returns for policyholders are complex, but are consistent with methods and criteria followed generally in the Netherlands. In addition, a substantial number of policies provide benefits that are determined by investment performance, subject to certain guarantees, and shareholders’ profits are derived largely from management fees.
Material judgement is required in calculating the provisions and is exercised particularly through the choice of assumptions where there is discretion over these. In turn, the assumptions used depend on the circumstances prevailing in each of the life operations. Provisions are most sensitive to assumptions regarding discount rates and mortality/morbidity rates.
In the Provident Mutual and with-profit funds in NUL&P, this is offset by the expected cost of charges to WPBR to be made in respect of guarantees.
The cost of future policy-related liabilities is determined using a market-consistent approach and, in the main, this is based on a stochastic model calibrated to market conditions at the end of the reporting period. Non-market-related assumptions (for example, persistency, mortality and expenses) are based on experience, adjusted to take into account future trends. Where policyholders have valuable guarantees, options or promises, then future persistency is assumed to improve, and future take-up rates of guaranteed annuity options are assumed to increase.
Volatility of investment return The volatility of returns is assumed to be distributed as follows: Financial investment Volatility
Future regular bonuses Annual bonus assumptions for 2007 have been set consistently with the year end 2006 declaration. Future annual bonus rates reflect the principles and practices of the fund. In particular, the level is set with regard to the projected margin for final bonus and the change from one year to the next is limited to a level consistent with past practice.
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.
Assurances Life conventional non-profit 3.1% to 3.9% 2.9% to 3.6% Pensions conventional non-profit 3.9% to 4.1% 3.6% to 4.0%
Deferred annuities Non-profit – in deferment 3.9% to 4.1% 3.6% to 4.6% Non-profit – in payment 4.3% 3.6%
Annuities in payment Convention annuity 4.3% to 4.9% 4.0% to 4.6%
Mortality assumptions are set with regard to recent company experience and general industry trends. Since 2005, there have been changes to both assurance and annuity mortality bases, although the same standard mortality tables are still used. The assurance mortality basis is unchanged from 2005 for most blocks of business, though has been weakened for certain blocks of business where experience reviews have indicated that this is appropriate.
Pure endowments and deferred annuities Nil or AM80/AF80 or Nil or AM80/AF80 or before vesting AM92/AF92 adjusted AM92/AF92 adjusted
Pensions business after vesting PCMA00/PCFA00 adjusted PCMA00/PCFA00 adjusted plus allowance for future plus allowance for future mortality improvement mortality improvement Annuities in payment
General annuity business IML00/IFL00 adjusted IML00/IFL00 adjusted plus allowance for future plus allowance for future mortality improvement mortality improvement
Life assurances Actual swap rate GBM 61-65, GMB71-75, GBM/V 76-80, GBM 80-85,
GBMV 95-00, Coll 1993/2003 and DIL 98, plus further allowance for future mortality improvement
The liability for future policy benefits for traditional life insurance is computed using the net level method, based on guaranteed interest and mortality rates as used in calculating cash surrender values. Reserve interest assumptions range from 2.00% to 7.50%. The weighted average interest rate for all traditional life policy reserves in 2006 was 4.48%.
Future policy benefit reserves for universal life insurance, indexed life, deferred annuity products and funding agreements are computed under a retrospective deposit method and represent policy account balances before applicable surrender charges. The weighted average interest crediting rates for universal life products were 4.37% in 2006. The range of interest crediting rates for deferred annuity products, excluding sales inducement payouts, was 2.75% to 7.00% in 2006. An additional liability is established for universal life contracts with death or other insurance benefit features, which is determined using an equally-weighted range of scenarios with respect to investment returns, policyholder lapses, benefit election rates, premium payout patterns and mortality. The additional liability represents the present value of future expected benefits based on current product assumptions.
Carrying amount at 1 January 114,430 106,491 Provisions in respect of new business 8,750 6,589 Expected change in existing business provisions (5,678) (2,703) Variance between actual and expected experience 1,209 3,784 Effect of adjusting to PS06/14 realistic basis (800) – Impact of other operating assumption changes (333) (1,034) Impact of economic assumption changes (1,727) 2,411 Other movements 314 340
Change in liability recognised as an expense 1,735 9,387 Effect of portfolio transfers, acquisitions and disposals 12,454 (360) Foreign exchange rate movements (2,005) (684) Other movements – (404)
In most cases, no explicit assumptions are made regarding future rates of claims inflation or loss ratios. Instead, the assumptions used are those implicit in the historic claims development data on which the projections are based. Additional qualitative judgement is used to assess the extent to which past trends may not apply in the future, for example, to reflect one-off occurrences, changes in external or market factors such as public attitudes to claiming, economic conditions, levels of claims inflation, judicial decisions and legislation, as well as internal factors such as portfolio mix, policy conditions and claims handling procedures in order to arrive at the estimated ultimate cost of claims that represents the likely outcome, from the range of possible outcomes, taking account of all the uncertainties involved.
The Group aims to maintain strong reserves in respect of its non-life 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 then result in a release of reserves from earlier accident years, as shown in the loss development tables. However, in order to maintain strong reserves, the Group transfers much of this release to current accident year (2006) reserves where the development of claims is less mature and there is much greater uncertainty attaching to the ultimate cost of claims. The release from prior accident year reserves during 2006 is also due to an improvement in the estimated ultimate cost of claims.
Notes to the consolidated financial statements continued 35 – Insurance liabilities continued Before the effect of reinsurance, the loss development table is: Accident year £m £m £m £m £m £m £m £m
Gross cumulative claim payments At end of accident year (3,029) (2,952) (2,819) (2,971) (3,345) (3,653)
Three years later (5,701) (5,233) (4,972) Four years later (5,966) (5,466) Five years later (6,121)
Estimate of gross ultimate claims At end of accident year 6,590 6,250 6,385 6,891 7,106 7,533
Three years later 6,798 6,257 6,036 Four years later 6,754 6,205 Five years later 6,679
Estimate of gross ultimate claims 6,679 6,205 6,036 6,371 6,938 7,533
Present value recognised in the balance sheet 3,225 545 727 1,053 1,379 1,902 3,887 12,718
Estimate of gross ultimate claims At end of accident year 6,186 6,037 6,218 6,602 6,982 7,430
Three years later 6,329 5,973 5,942 Four years later 6,286 5,912 Five years later 6,219
Changes in UPR recognised as an (income)/expense (89) 216 Gross portfolio transfers and acquisitions 3 174 Foreign exchange rate movements (113) 74 Other movements – (6)
Of the above total, £3,848 million (2005: £3,717 million) is expected to be recovered more than one year after the balance sheet date.
Gross Reinsurance Gross Reinsurance provisions assets Net provisions assets Net £m £m £m £m £m £m
Provisions for claims incurred but not reported (2,553) 79 (2,474) (2,324) 82 (2,242)
Provision arising from liability adequacy tests (49) – (49) (48) – (48)
Notes to the consolidated financial statements continued 36 – Reinsurance assets continued (b) Assumptions The assumptions used for reinsurance contracts follow those used for insurance contracts.
Change in asset (713) (530) Effect of portfolio transfers, acquisitions and disposals 1,639 – Foreign exchange rate movements (99) (78) Other movements 1 (564)
Carrying amount at 1 January 1,914 2,196 Impact of changes in assumptions – – Reinsurers’ share of claim losses and expenses incurred in current year 102 146 Reinsurers’ share of claim losses and expenses incurred in prior years 78 (10) Reinsurers’ share of incurred claim losses and expenses 180 136 Less: Reinsurance recoveries received on claims incurred in current year (30) (48) Reinsurance recoveries received on claims incurred in prior years (307) (251) Reinsurance recoveries received in the year (337) (299) Other movements – 5
Carrying amount at 1 January 482 398 Premiums ceded to reinsurers in the year 726 706 Less: Reinsurers’ share of premiums earned during the year (722) (612) Other movements – (1)
Changes in reinsurance asset recognised as income 4 93 Reinsurers’ share of portfolio transfers and acquisitions 1 (6) Foreign exchange rate movements (3) 2 Other movements – (5)
Carrying amount at 31 December 484 482 37 – Liability for investment contracts (a) Carrying amount The liability for investment contracts at 31 December comprised: £m £m
Many investment contracts contain a discretionary participation feature in which the contract holder has a contractual right to receive additional benefits as a supplement to guaranteed benefits. These are referred to as participating contracts and are measured according to the methodology and group practice for long-term business liabilities as described in note 35. They are not measured at fair value as there is currently no agreed definition of fair valuation for discretionary participation features under IFRS. In the absence of such a definition, it is not possible to provide a range of estimates within which a fair value is likely to fall. The IASB has deferred consideration of participating contracts to Phase II of its insurance contracts project.
Notes to the consolidated financial statements continued 37 – Liability for investment contracts continued (c) Movements in the year The following movements have occurred in the year: (i) Participating investment contracts £m £m
Change in liability recognised as an expense 2,673 4,146 Effect of portfolio transfers, acquisitions and disposals 125 4 Foreign exchange rate movements (656) (856) Other movements – (10)
Carrying amount at 1 January 30,051 25,581 Provisions in respect of new business 5,695 5,247 Expected change in existing business provisions (163) 936 Variance between actual and expected experience 265 (1,732) Impact of operating assumption changes 15 2 Impact of economic assumption changes (5) – Other movements 56 93
Change in liability 5,863 4,546 Effect of portfolio transfers, acquisitions and disposals 3,396 – Foreign exchange rate movements (352) (76)
Included within portfolio transfers above is £165 million reclassified from insurance liabilities (see note 35) as a result of Prudential Rule No 49 issued by the Australian Prudential Regulation Authority (APRA), which requires further unbundling of certain savings products between insurance liabilities and investment contracts.
(iii) Guaranteed annuity options – The Group’s UK with-profit funds have written individual and group pension contracts which contain guaranteed annuity rate options (GAOs), where the policyholder has the option to take the benefits from a policy in the form of an annuity based on guaranteed conversion rates. The Group also has exposure to GAOs and similar options on deferred annuities.
(iv) Guaranteed minimum pension – The Group’s UK with-profit funds also have certain policies that contain a guaranteed minimum level of pensions as part of the condition of the original transfer from state benefits to the policy.
(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 2006.
The total liabilities for traditional business at 31 December 2006 are £8 billion (2005: £8 billion) analysed as follows: Liabilities 3% Liabilities 3% Liabilities 4% Liabilities 4%
O therinform ation Aviva plc Annual Report and Accounts 2006 177 38 – Financial guarantees and options continued (iii) Ireland Guaranteed annuity options Products with similar GAOs to those offered in the UK have been issued in Ireland. The current net of reinsurance provision for such options is £152 million (2005: £145 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 and long-term interest rates.
These guarantees are currently “out-of-the-money” by £69 million (2005: £84 million). This has been calculated on a deterministic basis as the excess of the current policy surrender value over the discounted value (excluding terminal bonus) of the guarantees. The value of these guarantees is sensitive to the performance of investments held in the with-profit fund. Amounts payable under these guarantees are determined by the bonuses declared on these policies. It is estimated that the guarantees would be out-of-the-money by £74 million (2005: £74 million) if yields were to increase by 1% per annum and by £31 million (2005: £39 million) if equity markets were to decline by 10% from year end 2006 levels.
(v) United States Indexed and total return strategy products In the United States, the Group writes indexed life and deferred annuity products. These products guarantee the return of principal to the policyholder and credit interest based on certain indices, primarily the Standard & Poor’s 500 Composite Stock Price Index. A portion of each premium is used to purchase call options to hedge the growth in interest credited to the policyholder. The call options held by the Group and the options embedded in the policy are both carried at fair value. At 31 December 2006, the total liabilities for indexed products were £5.4 billion. If interest rates were to increase by 1%, the provision for embedded options would decrease by £51 million and, if interest rates were to decrease by 1%, the provision would increase by £56 million.
Persistency rates 45 3 Mortality for assurance contracts 25 25 Mortality for annuity contracts 60 (39) Tax and other assumptions (17) (3) Investment contracts Interest rates 23 (11)
Persistency rates 2 – Tax and other assumptions (4) (2) General insurance and health business Change in loss ratio assumptions (2) 2 Change in expense ratio assumptions – 4
The impact of interest rates for long-term business relates primarily to the UK and the Netherlands. This results from the use of higher valuation interest rates on annuities and other business, reflecting the rise in market interest rates over the year. The mortality impacts relate primarily to assumption changes in the UK and Ireland.
The impact on existing business of implementing FSA Policy Statement 06/14, Prudential Changes for Insurers, in 2006 is £132 million, arising mainly on expenses and persistency rates in both insurance and investment contracts. This is reflected in reductions in insurance contract liabilities of £800 million (see note 35(b)), investment contract liabilities of £105 million (see note 37(c)), reinsurance recoveries of £502 million (see note 36(c)) and deferred acquisition costs of £271 million (see note 25(b)). The impact on new business in 2006 is £17 million, giving a total increase in pre-tax profit for the year of £149 million.
Net liability at 1 January (1,440) (635) Acquisition of subsidiaries (182) (36) Amounts charged to profit (note 12a) (199) (965) Amounts (charged)/credited to equity (note 12b) (14) 262 Exchange differences 16 6 Other movements (59) (72)
The Group has unrecognised tax losses of £1,746 million (2005: £1,035 million) to carry forward against future taxable income of the necessary category in the companies concerned. These tax losses will expire as follows: £26 million 0-10 years and £26 million 11-20 years (2005: £40 million within 0-10 years and £35 million within 11-20 years). The remaining losses have no expiry date. In addition, the Group has an unrecognised capital loss of £468 million (2005: £446 million). This tax loss can be offset against future capital gains and has not been recognised in these financial statements. These capital losses of £29 million will expire within 0-10 years. The remaining capital losses have no expiry date. (2005: no expiry date).
Deficits in the staff pension schemes (note 42d (v)) 1,029 1,471 Other obligations to staff pension schemes – insurance policies issued by Group companies (note 35a) 1,086 875
Total IAS 19 obligations to staff pension schemes 2,115 2,346 Restructuring provision 234 36 Other provisions 501 493
Charge to income statement 246 37 283 Utilised during the year (47) (116) (163) Acquisition of subsidiaries – 98 98 Disposal of subsidiaries – (2) (2)
The assets of the main UK, Irish and Canadian schemes are held in separate trustee-administered funds to meet long-term pension liabilities to past and present employees. In the Netherlands, the main scheme is held in a separate foundation which invests in the life funds of the Group. In all schemes, the appointment of trustees of the funds is determined by their trust documentation, and they are required to act in the best interests of the funds’ 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.
(b) Main UK scheme In the UK, the Group operates two main pension schemes, the Aviva Staff Pension Scheme (ASPS) and the smaller RAC (2003) Pension Scheme. New entrants join the defined contribution section of the ASPS, as the defined benefit section is closed to new employees. 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).
The employing companies’ contributions to the defined benefit section of the ASPS throughout 2006 were 35% of employees’ pensionable salaries, together with the cost of redundancies during the year, and additional deficit funding payments totalling £200 million. As this section of the scheme is closed to new entrants and the contribution rate is determined using the projected unit credit method, it is expected that the percentage cost of providing future service benefits will continue to increase as the membership ages, leading to higher pension costs, and the number of members falls, leading to a higher charge per member. The employers’ contribution rate for 2007 has therefore been increased to 37% of pensionable salaries (expected to be £120 million), pending finalisation of the April 2006 valuation. The Group is also expecting to make further contributions of some £400 million into the ASPS prior to March 2008. Active members of this section of the ASPS contribute 5% of their pensionable salaries.
In 2005, the Group’s UK life business carried out an investigation into the allocation of costs in respect of funding the ASPS, to identify the deficit that arose in respect of accruals prior to the introduction of the current management services agreements (MSAs) and to propose a split between individual product companies based on an allocation of the deficit into pre-and post-MSA amounts. The results of this review were updated during 2006 and agreed by the relevant company boards and accepted by the UK regulator. Consequently, with effect from 1 January 2006, the Company’s UK with-profit product companies are liable for a share, currently 12%, of the additional payments for deficit funding referred to above. This has resulted in a transfer of £130 million from the unallocated divisible surplus (UDS) to the income statement, to reflect the position at the start of the year, and a movement of £30 million back to the UDS via the statement of recognised income and expense to reflect actuarial movements in the deficit during the year and therefore a change in the amount recoverable from the with-profit product companies.
UK defined benefit schemes 150 141 UK defined contribution schemes 51 33 Overseas defined benefit schemes 63 17 Overseas defined contribution schemes 20 14
Excluding the deficit funding in the UK schemes discussed above, total employer contributions for these schemes in 2007 are expected to be £270 million.
(i) Assumptions on scheme liabilities The inherent uncertainties affecting the measurement of scheme liabilities require these to be measured on an actuarial basis. This involves discounting the best estimate of future cash flows to be paid out by the scheme using the projected unit credit method. This is an accrued benefits valuation method which calculates the past service liability to members and makes allowance for their projected future earnings. It is based on a number of actuarial assumptions, which vary according to the economic conditions of the countries in which the relevant businesses are situated, and changes in these assumptions can materially affect the measurement of the pension obligations.
The valuations used for accounting under IAS 19 have been based on the most recent full actuarial valuations, updated to take account of that standard’s requirements in order to assess the liabilities of the material schemes at 31 December 2006. The updating was made by actuaries in each country who, other than the actuary of the Aviva Staff Pension Scheme and Dutch arrangements, were independent of the Group. Scheme assets are stated at their fair values at 31 December 2006.
The main actuarial assumptions used to calculate scheme liabilities under IAS 19 are: UK Netherlands Canada Ireland
Canada UP1994 projected to 2005, using Scale AA 65 18.2 18.2 21.2 21.2 Ireland PA92c2015 (current pensioners)/2030 (future pensioners) 60 23.6 24.8 26.6 27.7
Plan assets in the UK and Dutch schemes include insurance policies with other Group companies. Where these policies are in segregated funds with specific asset allocations, their expected rates of return are included in the appropriate line in the table above.
O therinform ation Aviva plc Annual Report and Accounts 2006 183 42 – Pension obligations continued The total pension expense for these schemes comprises: £m £m
Current service cost 196 158 Past service cost/(credit) 3 (7) (Gain)/loss on curtailments (39)* (21)
Actuarial (gains) on scheme assets (270) (831) Less: Gains accounted for elsewhere (see above) 19 –
Actuarial losses on the pension schemes 117 547 Less: Recoveries from unallocated divisible surplus and other movements (3) –
Actuarial losses recognised in the statement of recognised income and expense 114 547 * The current year credit mainly arises in the UK as a result of the remeasurement of pension liabilities in the RAC plc defined benefit scheme, following the MSS and LVL disposals (see note 3(b)).
The cumulative amount of actuarial gains and losses on the pension schemes recognised in the statement of recognised income and expenses since 1 January 2004 (the date of transition to IFRS) is a loss of £809 million at 31 December 2006 (2005: loss of £692 million).
Fair value of scheme assets at the end of the year 9,223 8,209 6,286 Present value of scheme liabilities at the end of the year (10,196) (9,680) (7,179)
(v) Scheme deficits and surpluses The assets and liabilities of the schemes, attributable to defined benefit members, including investments in Group insurance policies (see footnote below), at 31 December 2006 were: UK Netherlands Canada Ireland Total £m £m £m £m £m £m £m £m £m £m
(Deficits)/surplus in the schemes (974) (1,371) (10) (44) (45) (62) 56 6 (973) (1,471)
Plan assets in the table above include investments in Group-managed funds in the consolidated balance sheet of £336 million (2005: £578 million) in the UK scheme, and insurance policies of £152 million and £934 million (2005: £143 million and £732 million) in the UK and Dutch schemes respectively. Where the investment and insurance policies are in segregated funds with specific asset allocations, they are included in the appropriate line in the table above, otherwise they appear in “Other”. The Dutch insurance policies are backed by all the assets in the relevant column above, whilst the UK policies are included in “Other”. These insurance policies, totalling £1,086 million (2005: £875 million) are considered non-transferable under the terms of IAS 19 and so have been treated as other obligations to staff pension schemes within provisions (see note 41).
Total fair value of assets 7,475 6,584 – 100 206 226 456 424 8,137 7,334
Current and past service cost (see (iii) above) (4) (195) (199) – (199) (151) Gains on curtailments (see (iii) above) – 39 39 – 39 21 Credit/(charge) to investment income (see (iii) above) 530 (453) 77 (40) 37 (3)
Other actuarial gains/(losses) (see (iii) above) 270 (267) 3 (119) (116) (580) Buy-outs and other transfers 2 16 18 (2) 16 – Exchange rate movements on foreign plans (53) 60 7 17 24 17
Borrowings are considered current if the contractual maturity dates are within a year.
Debenture loans 2.5% subordinated perpetual loan notes 116 a – – – – 330 330
Securitised mortgage loan notes UK lifetime mortgage business 1,835 £ – – – – 1,721 1,721 Dutch domestic mortgage business 5,233 a – – – – 5,233 5,233
Total contractual undiscounted cash flows 1,778 2,264 2,947 3,297 19,800 30,086
O therinform ation Aviva plc Annual Report and Accounts 2006 187 43 – Borrowings continued
Securitised mortgage loan notes UK lifetime mortgage business 1,879 £ – – – – 1,751 1,751 Dutch domestic mortgage business 4,424 a – – – – 4,424 4,424
Notes to the consolidated financial statements continued 43 – Borrowings continued (b) Description and features (i) Subordinated debt A description of each of the subordinated notes is set out in the table below: In the event the Company does not call Callable at par at option the notes, the coupon will reset at
(ii) Debenture loans The 9.5% guaranteed bonds were issued by the Company at a discount of £1.1 million. This discount and the issue expenses are being amortised over the full term of the bonds. Although these bonds were issued in sterling, the loans have effectively been converted into euro liabilities through the use of financial instruments in a subsidiary.
The 2.5% perpetual subordinated loan notes were issued by a Dutch subsidiary to finance the acquisition of NUTS OHRA Beheer BV in 1999. They are convertible into ordinary shares in Delta Lloyd NV, should there be a public offering of those shares. These loan notes have a face value of a489.9 million but, because they are considered to be perpetual, their carrying value is a172.4 million, calculated in 1999 and based on the future cash flows in perpetuity discounted back at a market rate of interest. The rate of interest paid on the notes is being gradually increased to a maximum of 2.76% in 2009.
(iii) Bank loans In September 2004, one of the Group’s UK long-term business subsidiaries, Norwich Union Life & Pensions Limited (NULAP), entered into a securitisation arrangement with The Royal Bank of Scotland Group plc (RBSG), to provide funding to cover initial new business acquisition and administration costs. Under the arrangement, an RBSG company has provided a loan facility of £200 million to NULAP in respect of selected term assurance policies, secured on future premiums and repayment of commissions due from brokers where a policy has lapsed. The funding is repayable over four years from the date of advance, and interest is charged at a floating rate. RBSG has no recourse to the policyholder or shareholders’ funds of any companies in the Aviva Group. The balance drawn on the facility at 31 December 2006 was £200 million (2005: £191 million). On 12 January 2007, under a Deed of Release and Termination, this arrangement was cancelled.
As explained in note 17b, 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 Aviva Group. Loans of £259 million (2005: £156 million) included in the tables relate to those PLPs which have been consolidated as subsidiaries.
The fair value of these loans is considered to be the same as their carrying value.
O therinform ation Aviva plc Annual Report and Accounts 2006 189 43 – Borrowings continued (v) Securitised mortgage loan notes Loan notes have been issued by special purpose securitisation companies in the UK and the Netherlands. Details of these securitisations are given in note 22.
For the Dutch securitised mortgage loan notes carried at amortised cost of £5,233 million (2005: £4,424 million) their fair value is £5,271 million (2005: £4,508 million), calculated based on the future cash flows discounted back at the market rate of interest.
New borrowings drawn down, net of expenses 6,119 5,441 Repayment of borrowings (5,218) (4,585)
Fair value movements (52) 62 Amortisation of discounts and other non-cash items 5 2
(d) Undrawn borrowings The Group has the following undrawn committed central borrowing facilities available to it, of which £1,000 million (2005: £1,000 million) is used to support the commercial paper programme: £m £m
Expiring within one year 1,180 890 Expiring beyond one year 980 1,360 44 – Payables and other financial liabilities £m £m
Expected to be settled within one year 8,200 7,384 Expected to be settled in more than one year 1,035 2,101
Deferred income 265 265 Reinsurers’ share of deferred acquisition costs 221 146
Other liabilities 2,610 1,862 Less: Amounts classified as held for sale – (49)
(d) Pensions mis-selling The pensions review of past sales of personal pension policies which involved transfers, opt outs and non-joiners from occupational schemes, as required by the Financial Services Authority (FSA), has largely been completed. A provision of some £31 million (2005: £42 million) remains to meet the outstanding costs of the very few remaining cases, the anticipated cost of any guarantees provided, and potential levies payable to the Financial Services Compensation Scheme. It continues to be the directors’ view that there will be no material effect either on the Group’s ability to meet the expectations of policyholders or on shareholders.
O therinform ation Aviva plc Annual Report and Accounts 2006 191 46 – Contingent liabilities and other risk factors continued In August 2004, the Group confirmed its intention to introduce time barring on mortgage endowment complaints, under FSA rules. The Group now includes details of its endowment policyholders’ time bar position within the annual reprojection mailings. Customers will be given at least 12 months individual notice before a time bar becomes applicable – double the six months’ notice required by the FSA.
In addition, in line with standard business practice, various Group companies have been 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.
Contractual obligations for future repairs and maintenance on investment properties are £3 million (2005: £8 million).
The Group has capital commitments to its joint ventures of £nil (2005: £34 million) and to other investment vehicles of £14 million (2005: £nil).
Later than 1 year and not later than 5 years 33 44 Later than 5 years 23 13
The total of future minimum sublease payments expected to be received under non-cancellable subleases 200 200
O therinform ation Aviva plc Annual Report and Accounts 2006 193 48 – Cash flow statement continued (b) Cash flows in respect of the acquisition of subsidiaries, joint ventures and associates £m £m
Cash consideration for subsidiaries, joint ventures and associates acquired 2,321 1,478 Less: Cash and cash equivalents acquired with subsidiaries (432) (55)
(c) Cash flows in respect of the disposal of subsidiaries, joint ventures and associates £m £m
Cash proceeds from disposal of subsidiaries, joint ventures and associates 616 464 Net cash and cash equivalents divested with subsidiaries – –
(d) Cash and cash equivalents in the Cash flow statement at 31 December comprised: £m £m
Of the total cash and cash equivalents shown above, £nil has been classified as held for sale (2005: £25 million) (see note 3d).
Notes to the consolidated financial statements continued 49 – Capital statement FRS 27 requires us to produce a capital statement which 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.
O therinform ation Aviva plc Annual Report and Accounts 2006 195 49 – Capital statement continued Analysis of movements in capital For the year ended 31 December 2006
CGNU CULAC NUL&P Total UK life Other Total with-profit with-profit with-profit with-profit UK life UK life Overseas life Total life fund fund fund funds operations operations operations operations £m £m £m £m £m £m £m £m capital resources and expected experience assumption changes Effect of economic 136 151 383 670 54 724 48 772 assumption changes Effect of changes in management (53) (83) (143) (279) – (279) (7) (286)
policy Transfers, acquisitions and disposals – – – – – – 617 617 Foreign exchange movements – – – – – – (202) (202)
Further analysis of the movement in the liabilities of the long-term business can be found in notes 35 and 37.
For the UK with-profit funds, the increase in available capital has been driven by the favourable economic environment. Equity performance was positive, which had a direct effect on the equity content of the estate assets and an indirect impact from the reduction in maturity guarantee costs. Fixed interest yields have generally increased. Although this has led to capital depreciation of fixed interest assets it also resulted in a reduction of guarantee costs, with the increase in yield having a net benefit to the estates of all the funds. Also, the implied market volatility for equities has reduced, which lowers the assumed future asset share volatility, particularly in CGNU and CULAC, and consequently guarantee costs are reduced.
The capital position of the Other UK life operations was augmented by changes to reserving for UK non-profit business permitted under the FSA Policy Statement PS06/14 Prudential Changes for Insurers, as outlined in Note 35(b), which are included in operating assumption changes.
As the total available capital of £19.5 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.
Notes to the consolidated financial statements continued 49 – Capital statement continued 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 plc to the NUL&P non-profit fund to provide capital to support the writing of new business.
Realistic Risk Realistic Realistic orphan capital assets liabilities estate margin Excess Excess £bn £bn £bn £bn £bn £bn 1. These realistic liabilities include the shareholders’ share of future bonuses of £0.7 billion (31 December 2005: £0.7 billion). Realistic liabilities adjusted to eliminate the shareholders’ share of future bonuses are £48.6 billion (31 December 2005: £50.5 billion).
Under the FSA regulatory regime, UK life with-profits business is required to hold capital equivalent to the greater of their regulatory requirement based on EU Directives (“regulatory peak”) and the FSA realistic bases (“realistic peak”) described above.
50 – Risk management (a) Risk management framework The Group has established a risk management framework whose primary objective is to protect the Group from events that hinder the sustainable achievement of the Group’s performance objectives, including failing to exploit opportunities. Risk is categorised as follows: – Market
The Group recognises the critical importance of having efficient and effective risk management systems in place. To this end, the Group has an established governance framework, which has three key elements: – Defined terms of reference for the Board, its committees, and the associated executive management committees; – A clear organisational structure with documented delegated authorities and responsibilities from the Board to executive management committees and senior management; and
– A Group policy framework that sets out risk appetite, risk management, control and business conduct standards for the Group’s worldwide operations. Each policy has a member of senior management who is charged with overseeing compliance with the policy throughout the Group.
The adoption of the Group’s policies on risk management enables a consistent approach to management of risk at business unit level. The Group operates a number of oversight committees that monitor aggregate risk data and take overall risk management decisions.
The Group also monitors a set of specific risks on a regular basis through the Group risk monitoring framework. Businesses units are required to disclose to the Group risk function all material risks, along with information on likelihood and severity of risks, and the mitigating actions taken or planned. This enables the Group to assess its overall risk exposure and to develop a group-wide risk map, identifying any concentrations of risk that may exist, and to define which risks and what level of risk the Group is prepared to accept. The risk map is refreshed quarterly, and business units are required to escalate material changes intra-quarter.
Notes to the consolidated financial statements continued 50 – Risk management continued (b) Market risk Market risk is the risk of adverse financial impact due to changes in fair values or future cash flows of financial instruments from fluctuations in interest rates, equity prices, property prices, and foreign currency exchange rates. Market risk arises in business units due to fluctuations in both the value of liabilities and the value of investments held. At Group level, it also arises in relation to the overall portfolio of international businesses and in the value of investment assets owned directly by the shareholders.
The management of market risk is undertaken in both business units and at Group level. Business units manage market risks locally using their market risk framework and within local regulatory constraints. Business units may also be constrained by the requirement to meet policyholders’ reasonable expectations and to minimise or avoid market risk in a number of areas. The Group Investment committee is responsible for managing market risk at Group level, and a number of investment related risks, in particular those faced by the shareholder funds throughout the Group.
The Group market risk policy sets out the minimum principles and framework for matching liabilities with appropriate assets, the approaches to be taken when liabilities cannot be matched and the monitoring processes that are required. The Group has criteria for matching assets and liabilities for all classes of business in order to manage the financial risk from the mismatching of assets and liabilities when investment markets change. The local regulatory environment for each business will also set the conditions under which assets and liabilities are to be matched.
Interest rate risk is also managed using a variety of derivative instruments, including futures, options and swaps, caps and floors, in order to provide a degree of hedging against unfavourable market movements in interest rates inherent in the assets backing technical liabilities.
10% 10% 10% 10% increase in decrease increase decrease sterling/ in sterling/ in sterling/ in sterling/ euro rate euro rate US$ rate US$ rate £m £m £m £m
Notes to the consolidated financial statements continued 50 – Risk management continued Derivatives risk Derivatives are used by a number of the larger businesses, within policy guidelines agreed by the Board of directors and overseen by a Group derivatives committee, which monitors implementation of the policy, exposure levels and approves large or complex transactions proposed by business units. Derivatives are primarily used for efficient investment management, risk hedging purposes or to structure specific retail-savings products. The Group also manages a number of hedge funds which use derivatives extensively within a defined derivative framework. Derivative transactions are fully covered by either cash or corresponding assets and liabilities. Speculative activity is prohibited, unless approval has been obtained from the Derivatives committee. Over the counter derivative contracts are entered into only with approved counterparties, in accordance with our Group policies, thereby reducing the risk of credit loss. The Group applies strict requirements to the administration and valuation processes it uses, and has a control framework that is consistent with market and industry practice for the activity that is undertaken.
O therinform ation Aviva plc Annual Report and Accounts 2006 201 50 – Risk management continued The long-term businesses and general insurance businesses are generally not individually exposed to significant concentrations of credit risk due to the regulations, applicable in most markets, limiting investments in individual assets and asset classes. In cases where the business is particularly exposed to credit risk (e.g. in respect of defaults on mortgages or debt matching annuity liabilities) this risk is translated into a more conservative discount rate used to value the liabilities, creating a greater capital requirement, and this credit risk is actively managed. The impact of aggregation of credit risk is monitored as described above. With the exception of AAA rated Governments the largest aggregated counterparty exposure does not exceed 1.6% of the Group’s total financial assets.
The following table provides information regarding the carrying value of financial assets that have been impaired and the ageing of financial assets that are past due but not impaired.
At 31 December 2005 Financial assets that are past due but not impaired
The credit ratings table above analyses the credit quality of the above balances where a credit rating is available. The credit quality of receivables and other financial assets is managed at the local business unit level with uncollectible amounts being impaired when necessary.
The Life Insurance Risk Committee monitors the risk framework developed and implemented in each business, and receives management information on life insurance risks. The committee considers all areas of life insurance risk, but in particular has a remit to monitor mortality, longevity, morbidity, persistency, pricing, unit pricing and expenses. The committee also considers the reinsurance coverage across the life businesses. It confirms that guidance and procedures are in place for each of the major components of life insurance risk, and that businesses adopt a risk management framework to mitigate against any life insurance risk outside local appetite, within the parameters for the overall Group risk appetite. The framework adopted in business units is reviewed in detail and approved twice yearly.
Mortality and morbidity risks are mitigated by use of reinsurance. The Group allows business units to select reinsurers, from those approved by the Group, based on local factors, but assesses the overall programme to manage group-wide risk exposures and monitor the aggregation of risk ceded to individual reinsurers is within appetite for credit risk.
Longevity risk is carefully monitored against the latest external industry data and emerging trends. Whilst individual businesses are responsible for reserving and pricing for annuity business, the Group monitors the exposure to this risk and the capital implications to manage the impact on the group-wide exposure and the capital funding that businesses may require as a consequence. The Group has used reinsurance solutions to reduce the risks from longevity where possible and desirable and continually monitors emerging market solutions to mitigate this risk further.
Concentration risk The Group writes a diverse mix of business in worldwide markets that are all subject to similar risks (mortality, persistency etc). The Group assesses the relative costs and concentrations of each type of risk through the ICA capital requirements and material issues are escalated to and addressed at the Life Insurance Risk committee. This analysis enables the Group to assess whether accumulations of risk exceeds risk appetite.
One key concentration of life insurance risk for the Group is improving longevity risk from pensions in payment and deferred annuities in the UK and the Netherlands where the Group has material portfolios. The Group continually monitors this risk and the opportunities for mitigating actions through reinsurance, improved asset liability matching, or innovative solutions that emerge in the market.
Risk management Significant insurance risks will be reported through the Group Risk monitoring framework. Additionally, the ICA framework is used to assess the risks that each general insurance business unit, and the Group as a whole, is exposed to, quantifying their impact and calculating appropriate capital requirements.
Reinsurance strategy 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. The basis of these purchases is underpinned by extensive financial and capital modelling and actuarial analysis to optimise the cost and capital efficiency benefits. For the larger business units, this involves utilising externally sourced probabilistic models to verify the accumulations and loss probabilities based on the Group’s specific portfolios of business. Where external models are not available, scenarios are developed and tested using the Group’s data to determine potential losses and appropriate levels of reinsurance protection. The reinsurance is placed with providers who meet the Group’s counterparty security requirements.
Concentration risk Processes are in place to manage catastrophe risk in individual business units and at a Group level. The Group cedes much of its worldwide catastrophe risk to third party reinsurers but retains a pooled element for its own account gaining economic diversification benefit. Aviva’s total retained risk increases as catastrophe events become more remote, so that the total Group loss from its most concentrated catastrophe exposure (Northern European windstorm) is approximately £370 million, one in ten years, compared to approximately £700 million, one in 100 years.
(e) Operational risk Operational risk arises as a result of inadequately controlled internal processes or systems, human error, or from external events.
(f) Liquidity risk The Group has a strong liquidity position and through the application of a Group Liquidity Management policy seeks to maintain sufficient financial resources to meet its obligations as they fall due. In addition to its strong liquidity position, the Group maintains significant committed borrowing facilities from a range of highly rated banks to further mitigate this risk.
(g) Risk and capital management The Group uses a number of sensitivity test-based risk management tools to understand the volatility of earnings, the volatility of its capital requirements, and to manage its capital more efficiently. Primarily, EEV, FCRs, and increasingly ICA are used. Sensitivities to economic and operating experience are regularly produced on all of the Group’s financial performance measurements to inform the Group’s decision making and planning processes, and as part of the framework for identifying and quantifying the risks that each of its business units, and the Group as a whole are exposed to.
Interest rate and investment return The impact of a change in market interest rates by ± 1% (e.g. if a current interest rate is 5%, the impact of an immediate change to 4% and 6%). The test allows consistently for similar changes to investment returns and movements in the market value of backing fixed interest securities.
Expenses The impact of an increase in maintenance expenses by 10%. Equity/property market values The impact of a change in equity/property market values by ± 10% Assurance mortality/morbidity (life insurance only) The impact of an increase in mortality/morbidity rates for assurance contracts by 5%.
Interest Interest Equity/ Equity/ Assurance Annuitant rates rates property property Expenses mortality mortality +1% –1% +10% - 10% +10% +5% –5%
Investment non-participating – – 35 (35) – – – Assets backing life shareholders’ funds (225) 240 65 (65) – – –
Impact before tax on shareholders’ equity (£m) Interest Interest Equity/ Equity/ Assurance Annuitant rates rates property property Expenses mortality mortality +1% –1% +10% -10% +10% +5% –5%
O therinform ation Aviva plc Annual Report and Accounts 2006 207 50 – Risk management continued Changes in sensitivities between 2005 and 2006 arise primarily from the acquisitions of Ark Life and AmerUs, and the effect of increases in market interest rates. The different impacts of the economic sensitivities on profit and shareholders' equity arise from classification of certain assets as available for sale in some business units, for which movements in unrealised gains or losses would be taken directly to shareholders' equity. The economic impacts on profit before tax for insurance contracts relate mainly to the effect of minimum return guarantees in the Netherlands. However in the case of the interest rate sensitivities, the impacts on shareholders' equity are more than offset by the effect of changes in the market value of fixed interest securities in the United States that are classified as available for sale.
General insurance and health business Sensitivities as at 31 December 2006 Impact on profit before tax (£m)
Interest Interest Equity/ Equity/ Gross loss rates rates property property Expenses ratios +1% –1% +10% -10% +10% +5%
Notes to the consolidated financial statements continued 50 – Risk management continued Fund management and non-insurance business Sensitivities as at 31 December 2006 Impact on profit before tax (£m)
Sensitivities as at 31 December 2005 Impact on profit before tax (£m)
(a) Cash flow hedges The Group had no cash flow hedge activity at 31 December 2006 (2005: nil).
The foreign exchange gain of £59 million (2005: £19 million) on translation of the debt to sterling at the balance sheet date was recognised in the hedging instruments reserve in shareholders’ equity. This hedge was fully effective throughout the current and prior year.
The Group’s derivative risk management policies are outlined in Note 50(b).
Notes to the consolidated financial statements continued 51 – Derivative financial instruments continued The contractual undiscounted cash flows in relation to non-hedge derivative liabilities have the following maturities: £m £m
Unit trusts, OEICs, Peps and Isas 20,574 16,188 Segregated funds 43,672 35,427
Third-party funds under management now include funds administered under the Navigator platform. This change has increased the total assets under management at 31 December 2006 by £6,058 million (2005: £4,606 million).
O therinform ation Aviva plc Annual Report and Accounts 2006 211
Income Dividends received from subsidiaries 865 1,708 Interest receivable from Group companies 219 217 Profit on disposal of subsidiary B 94 – Net investment income/(expenses) 34 (10)
Statement of recognised income and expenses For the year ended 31 December 2006
Reconciliation of movements in shareholders’ equity For the year ended 31 December 2006
Financial statements of the Company continued Company balance sheet At 31 December 2006
Loans owed to subsidiaries 1,031 1,121 Other amounts owed to subsidiaries 3,157 701 Other creditors 95 94
Financial statements of the Company continued Cash flow statement For the year ended 31 December 2006
Cash flows from financing activities Funding provided by subsidiaries 299 880 Net drawdown/(repayment) of borrowings 234 (370) Preference dividends paid (17) (17) Ordinary dividends paid (490) (497) Interest paid on borrowings (23) (25)
Net increase/(decrease) in cash and cash equivalents 3 (29) Cash and cash equivalents at 1 January 2 31
A – Change in accounting policy In August 2005, the IASB issued an amendment to IAS 39, Financial Guarantee Contracts, which requires financial guarantees issued to be recognised initially at their fair value, and subsequently measured at the higher of the expected liability (or receivable) under the guarantee and the amount initially recognised less any cumulative amortisation. Whilst not material at the Company or consolidated Group level, the amendment affects the Company’s subsidiaries in respect of intercompany guarantees given and taken in the ordinary course of business, where guarantee fees had not necessarily reflected the fair value to each party of the issued instrument. This value must now be reflected in each entity’s financial statements, and will result in additional accruals (for fee income) and prepayments (for fees payable) in the balance sheets of the affected companies, with movements in these values credited or charged to profit in the relevant income statements. The amendment is effective for the year ended 31 December 2006 and the impact at a Company level was immaterial.
At 31 December 2006, the Company has three wholly-owned subsidiaries, all incorporated in Great Britain. These are General Accident plc, Norwich Union Limited and Aviva Group Holdings Limited. Aviva Group Holdings Limited is an intermediate holding company, whilst General Accident plc and Norwich Union Limited no longer carry out this function. The principal subsidiaries of the Aviva Group at 31 December 2006 are listed on pages 244 to 245.
Wages and salaries 53 43 Social security costs 6 5 Post-retirement obligations
O therinform ation Aviva plc Annual Report and Accounts 2006 215
C – Operating expenses continued (iii) Pension costs The Company is one of a number of UK companies being charged for its employees participating in the Aviva Staff Pension Scheme, and its contributions are affected by the financial position of the scheme. There is no contractual agreement or policy for charging the net defined benefit cost for this scheme across the participating Group entities but, instead, this cost is recognised in the financial statements of the main UK employing company. The Company therefore recognises a pension expense equal to its contributions payable in the year for its staff, together with the service cost of any unfunded benefits, within staff costs above.
(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 note 28. 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.
D – Tax (i) Tax credited to income statement: £m £m
Current tax: For this year 438 29 Prior year adjustments 76 30
(ii) Tax reconciliation The tax on the Company’s (loss)/profit before tax differs from the theoretical amount that would arise using the tax rate of the home country of the Company as follows: £m £m
D – Tax continued (iv) The movement in the net deferred tax asset was as follows: £m £m
The issue of new shares to fund the acquisition of AmerUs was effected by a share placing. The placing structure utilised attracted merger relief under section 131 of the Companies Act 1985, resulting in a credit to the merger reserve of £871 million. Subsequent internal transactions required to complete the placing structure have resulted in this part of the merger reserve being realised. Consequently, a transfer of £871 million has been made from the merger reserve to retained earnings.
The fair value of the subordinated debt at 31 December 2006 was £3,076 million (2005: £3,148 million). The fair value of the 9.5% guaranteed bonds 2016 at 31 December 2006 was £257 million (2005: £275 million). The fair value of the commercial paper is considered to be the same as its carrying value.
H – Contingent liabilities Details of the Company’s contingent liabilities are given in note 46(f).
Loans to and from subsidiaries, associates and joint ventures are made on normal arm’s length commercial terms. The maturity analysis of the related party loans is as follows: Loans owned by subsidiaries Maturity analysis 2006 2005 £m £m
Loans owed to subsidiaries Maturity analysis of contractual undiscounted cash flows 2006 2005
Income earned Receivable at Income earned Receivable in year year end in year at year end £m £m £m £m
The related parties’ receivables are not secured and no guarantees were received in respect thereof. The receivables will be settled in accordance with normal credit terms. Details of guarantees, indemnities and warranties given by the Company on behalf of related parties are given in note 46(f).
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 may be found in note 53.
Independent auditor’s report to the directors of Aviva plc on the alternative method of reporting long-term business profits
Basis of audit opinion We conducted our audit in accordance with International Standards on Auditing (UK and Ireland) issued by the Auditing Practices Board. An audit includes examination, on a test basis, of evidence relevant to the amounts and disclosures in the alternative method of reporting long-term business. It also includes an assessment of the significant estimates and judgements made by the directors in the preparation of the alternative method of reporting long-term business, and of whether the accounting policies are appropriate to the Group’s circumstances, consistently applied and adequately disclosed.
Opinion In our opinion the alternative method of reporting long-term business for the year ended 31 December 2006 has been properly prepared in accordance with the European Embedded Value basis, using the methodology and assumptions set out on pages 224 to 226.
Operating profit before tax attributable to shareholders’ profits 2,990 Life EEV operating return 2,033 1,814 2,471 General insurance and health 1,680 1,551
6,125 Profit before tax 4,165 5,283 (1,512) Tax on operating profit (1,028) (927)
1. Excludes the proportion of the results of Morley’s fund management businesses, of our French asset management operation Aviva Gestion d’Actifs (AGA) and other fund management operations within the Group that arises from the provision of fund management services to our Life businesses. These results are included within the Life EEV operating return.
Operating profit on an EEV basis after tax, attributable to ordinary shareholders in respect of Aviva plc 116.5c Basic (pence per share) 79.2p 74.5p 115.1c Diluted (pence per share) 78.3p 73.9p
(685) Net (expense) recognised directly in equity (466) (306) 4,234 Profit for the year 2,879 3,682 3,549 Total recognised income and expense for the year 2,413 3,376
Summarised reconciliation of movements in consolidated shareholders’ funds – EEV basis For the year ended 31 December 2006 1m £m £m 3,601 Total recognised income and expense for the year 2,413 3,376
Summarised consolidated balance sheet – EEV basis As at 31 December 2006 1m £m £m
Assets 4,072 Acquired value of in-force business and intangible assets 2,728 803 10,140 Additional value of in-force long-term business 6,794 6,454 4,172 Investments in joint ventures 2,795 2,129 1,336 Investments in associates 895 885 1,349 Property and equipment 904 885
Financial investments 1,790 Deferred tax assets 1,199 1,018 513 Current tax assets 344 87 12,088 Receivables and other financial assets 8,098 7,706 5,188 Deferred acquisition costs and other assets 3,476 3,766 3,858 Prepayments and accrued income 2,585 2,363 21,704 Cash and cash equivalents 14,542 13,732 – Assets of operations classified as held for sale – 462
Liabilities 215,269 Gross insurance liabilities 144,230 132,602 131,878 Gross liabilities for investment contracts 88,358 77,309 14,127 Unallocated divisible surplus 9,465 8,978 5,687 Net asset value attributable to unitholders 3,810 3,137 4,593 Deferred tax liabilities 3,077 2,458 1,884 Current tax liabilities 1,262 1,033 13,784 Payables and other financial liabilities 9,235 9,485
O therinform ation Aviva plc Annual Report and Accounts 2006 223
Segmentation of summarised consolidated balance sheet – EEV basis As at 31 December 2006
Total assets before acquired additional value of in-force long-term business 252,955 37,961 290,916 224,453 38,679 263,132
Acquired additional value of in-force long-term business 1,806 – 1,806 315 – 315
Total assets included in the statutory IFRS balance sheet 254,761 37,961 292,722 224,768 38,679 263,447
Net assets on a statutory IFRS basis 12,869 1,195 14,064 9,144 1,948 11,092 Additional value of in-force long-term business1 6,794 – 6,794 6,454 – 6,454
Equity capital, capital reserves, shares held by employee trusts and other reserves 5,632 5,871
Equity attributable to ordinary shareholders of Aviva plc on an EEV basis 17,531 14,899
EEV basis total equity 20,858 17,546 1. The analysis between the Group’s and the minority interest’s share of the additional value of in-force long-term business is as follows: Movement in 2006 2005 the year £m £m £m
Group’s share included in shareholders’ funds 6,817 6,431 386 Minority interest share 439 329 110 Movement in AFS securities (462) (306) (156)
Comprises: Embedded value 18,098 15,113 RBSG goodwill 217 217 Goodwill and intangible assets allocated to long-term business 1,527 631 Notional allocation of IAS 19 pension fund deficit to long-term business3,4 (179) (363)
The Group’s approach to establishing economic assumptions (specifically investment returns, required capital and discount rates) was reviewed by Tillinghast, a firm of actuarial consultants, at the time of adopting the EEV principles in 2004. The approach is based on the well established capital asset pricing model theory and is in line with the EEV Principles and Guidance.
Covered business includes the Group’s share of our joint venture operations including our arrangement with The Royal Bank of Scotland Group (RBSG) and our operations in India and China. In addition, the results of Group companies providing significant administration, investment management and other services and of Group holding companies have been included to the extent that they relate to covered business. Together these businesses are referred to as “Life and related businesses”.
Foreign exchange adjustments Embedded value and other balance sheet items denominated in foreign currencies have been translated to sterling using the appropriate closing exchange rate. New business contribution and other income statement items have been translated using an average exchange rate for the relevant period. The exchange rates adopted in this announcement are shown on page 120.
EEV methodology continued Net worth The net worth is the market value of the shareholders’ funds and the shareholders’ interest in the surplus held in the non-profit component of the long-term business funds, determined on a statutory solvency basis and adjusted to add back any non-admissible assets, and consists of the required capital and free surplus. Required capital is reported net of implicit items permitted on a local regulatory basis to cover minimum solvency margins which are assessed at a local entity basis. The level of required capital for each business, which ranges between 100% and 150% of the EU minimum solvency requirement for our main European businesses and 250% of the EU minimum equivalent solvency requirements in the US, reflects the level of capital considered by the Directors to be appropriate to manage the business, allowing for our internal assessment of the level of market, insurance and operating risk inherent in the underlying products. The same definition of required capital is used for both existing and new business. The free surplus comprises the market value of shareholder assets in excess of local statutory reserves and required capital.
In the UK, shareholders’ distributable profits arise when they are released following actuarial valuations. These valuations are carried out in accordance with statutory requirements designed to ensure and demonstrate solvency in long-term business funds. Future distributable profits will depend on experience in a number of areas such as investment return, discontinuance rates, mortality, administration costs, as well as management and policyholder actions. Releases to shareholders arising in future years from the in-force covered business and associated required capital can be projected using best estimate assumptions of future experience. In overseas businesses generally, there are similar requirements restricting payments to shareholders from life businesses.
Stochastic modelling typically involves projecting the future cash flows of the business under thousands of economic scenarios that are representative of the possible future outcomes for market variables such as interest rates and equity returns. Allowance is made, where appropriate, for the effect of management and/or policyholder actions in different economic conditions on future assumptions such as asset mix, bonus rates and surrender rates. The time value is determined by deducting the average value of shareholder cash flows under these economic scenarios from the deterministic shareholder value under best estimate assumptions.
The value of in-force covered business includes the capitalised value of profits and losses arising from subsidiary companies providing administration, investment management and other services to the extent that they relate to covered business. This is referred to as the “look through” into service company expenses. In addition, expenses arising in holding companies that relate directly to acquiring or maintaining covered business have been allowed for. Where external companies provide services to the life and related businesses, their charges have been allowed for in the underlying projected cost base.
Future regular bonuses on participating business are projected in a manner consistent with current bonus rates and expected future returns on assets deemed to back the policies.
Consolidation adjustments The effect of transactions between our life companies such as loans and reinsurance arrangements has been included in results split by territory in a consistent manner. No elimination is required on consolidation.
O therinform ation Aviva plc Annual Report and Accounts 2006 227
• the impact of changes in operating assumptions including risk margins; – the expected investment return on the shareholders’ net worth, based upon assumptions applying at the start of the year; – investment return variances caused by differences between the actual return in the period and the expected return based on economic assumptions used to calculate the start of year value; and
– expected return 1,011 895 – experience variances (50) (39) – operating assumption changes 44 17
Life EEV return before tax 3,023 3,696 Tax on operating profit (630) (566) Tax charge on other ordinary activities (295) (579)
New business New business Present value of new contribution before the margin before the
Annual premium equivalent business premiums effect of required capital effect of required capital1
O therinform ation Aviva plc Annual Report and Accounts 2006 229
2. New business margin represents the ratio of new business contribution before the effect of required capital to PVNBP, expressed as a percentage.
Annual premium equivalent business premiums1 New business contribution2 New business margin3
Further disclosures on experience variances and operating assumption changes on an EEV basis are provided on pages 233 and 234.
Germany has been reclassified from Other Europe to the Netherlands, Lithuania has been reclassified from Other Europe to Poland and Norwich Union’s Dublin-based offshore life and savings business has been reclassified from Other Europe to the United Kingdom.
Analysis of movement in life and related businesses embedded value The following tables provide an analysis of the movement in embedded value for the life and related businesses for 2006 and 2005. The analysis is shown separately for net worth and the value of in-force covered business, and includes amounts transferred between these categories. The transfer to life and related businesses from other segments consists of service company profits and losses during the reported period that have emerged from the value of in-force. Since the “look through” into service companies includes only future profits and losses, these amounts must be eliminated from the closing embedded value. All figures are shown net of tax.
New business contribution (after the effect of required capital) (602) 1,071 469 Expected return on existing business – return on VIF – 710 710 Expected return on existing business – transfer to net worth 1,023 (1,023) – Experience variances and operating assumption changes 400 (415) (15) Expected return on shareholders’ net worth 239 – 239 Investment return variances and economic assumption changes 355 340 695
Life EEV return after tax 1,415 683 2,098 Exchange rate movements (189) (120) (309) Embedded value from business acquired 675 759 1,434 Amounts injected into life and related businesses 393 – 393 Amounts released from life and related businesses (646) – (646) Transfer to life and related businesses from other segments 113 – 113 UK pension fund deficit borne by UK with-profit funds transferred to analysis of net assets on an EEV basis2 (98) – (98)
Embedded value at the end of the year – Free surplus 2,772 – Required capital1 4,448 1. Required capital is shown net of implicit items permitted by local regulators to cover minimum solvency margins.
2. Reflecting CFO Forum guidance the pension scheme deficit is now being accounted for on an IAS 19 basis. Consequently, the element that had previously been included in the Life EEV analysis, being the present value of agreed deficit funding payments, has been removed from the Life EEV analysis.
New business contribution (after the effect of required capital) 263 110 9 50 25 25 168 (6) 8 31 683
Profit from existing business – expected return 474 142 41 26 158 52 53 9 29 27 1,011 – experience variances: Maintenance
Life EEV operating return before tax 744 402 (40) 110 329 162 221 (13) 32 86 2,033 1. Exceptional expenses in the UK reflect £32 million relating to the ongoing transformation of the life business and £117 million of other exceptional and project costs associated with strategic initiatives, including developments designed to improve the future new business volumes, and regulatory changes. In the Netherlands, exceptional expenses reflect higher project costs compared to allowances as well as the payment to ABN AMRO in respect of the joint venture operations.
3. Lapse experience in the UK has been worse than assumed and primarily relates to bonds and pensions. In Poland, lapses for both life and pension products have been lower than assumed resulting in the favourable experience variances.
4. In the UK, other experience profits include better than assumed default experience on corporate bonds and mortgages and the benefit of higher than expected performance fees in Morley.
6. In the UK, exceptional expenses relate to short-term project costs and capitalisation of reorganisation costs. Ireland reflects changes in expense assumptions regarding the future attribution of investment income and expenses between policyholders and shareholders.
New business contribution (after the effect of required capital) 217 91 13 36 58 14 155 (4) 7 25 612
2. Mortality experience continues to be better than assumed across most of our businesses, and particularly for protection business in the UK, AFER and unit-linked business in France and group business in the Netherlands.
5. Mortality assumptions have been revised in the Netherlands following the publication of new annuitant mortality tables used for group business.
6. In the UK, the adverse lapse assumption change reflects a more prudent allowance for future persistency experience in the UK following recent experience. In Ireland, the lapse assumption change mainly relates to unit-linked pension business. Lapse assumption changes in the Netherlands largely relate to group business in the intermediary division.
O therinform ation Aviva plc Annual Report and Accounts 2006 235
As at 31 December 2006 £m £m £m £m £m £m
Netherlands (including Belgium, Germany and Luxembourg) 2,768 2,204 1,099 933 3,867 3,137
The value of in-force covered business includes the effect of holding shareholders’ capital to support the level of required capital and allowing for projected future releases. This impact reduces the value of in-force covered business at 31 December 2006 by £1,451 million (31 December 2005: £1,187 million).
Time value of options and guarantees The following table sets out the time value of options and guarantees relating to covered business by territory at 31 December 2006 and 31 December 2005.
The TVOG has increased to £372 million reflecting acquired TVOG from AmerUs of £56 million.
New business contribution before effect of required capital 717 175 892 808 Effect of required capital (176) (33) (209) (196)
Pre-tax investment returns: Required Capital (% EU minimum) 150%/ 150%/ 200%/ 115% 115% 115%
Pre-tax investment returns: Base government fixed interest 4.0% 3.3% 3.7% 4.7% 4.5% 4.4% Ordinary shares 7.0% 6.3% 6.7% n/a n/a n/a
Required Capital (% EU minimum or equivalent) 125%/ 125%/ 125%/ 250% 200% 200%
* The principal economic assumptions used for AmerUs Group Co. at the date of acquisition were as follows: risk discount rate of 7.2%, pre-tax investment returns of 4.6% for base government fixed interest and required capital of 250%.
Principal economic assumptions – stochastic calculations The time value of options and guarantees calculation allows for expected management and policyholder actions in response to varying future investment conditions. The management actions modelled include changes to asset mix and bonus rates. Modelled policyholder actions are described under “Other assumptions”.
Summary Statistics The following table sets out the means and standard deviations (StDev) of future returns at 31 December 2006 for the three most significant asset classes. Interest rates are assumed to have a lognormal distribution with an annualised standard deviation of 12.5% p.a. for the natural logarithm of the interest rate.
Principal economic assumptions – deterministic calculations continued For the UK, the statistics are the same over all projection horizons. Assumptions are also required for correlations between asset classes. These have been set based on an assessment of historical data. Returns for corporate fixed interest investments in each scenario are equal to the return on Government bonds plus a fixed additional amount, based on current spreads less a margin for credit risk.
Asset Classes The most important assets are fixed rate bonds of various durations. In some businesses equities are also an important asset class.
Summary Statistics The following table sets out the means and standard deviations of future euro and US dollars returns at 31 December 2006 for the three most significant asset classes: equities (in the case of Euro), short-term bonds (defined to be of 1-year duration) and long-term bonds (defined to be 10-year zero coupon bonds). In the accumulation of 10-year bonds, it is assumed that these are held for one year, sold as 9-year bonds then the proceeds are reinvested in 10-year bonds, although in practice businesses follow more complex asset strategies or tend to adopt a buy and hold strategy. Correlations between asset classes have been set using the same approach as described for the United Kingdom.
US dollar 1. Means have been calculated by accumulating a unit investment for the required number of years in each simulation, averaging the accumulation across all simulations, and converting the result to an equivalent annual rate (by taking the nth root of the average accumulation minus 1).
Borrowings per summarised consolidated balance sheet – EEV basis 12,137 11,013 Less: Securitised mortgage funding (7,068) (6,303)
Other It has been assumed that there will be no changes to the methods and bases used to calculate the statutory technical provisions and current surrender values, except where driven by varying future investment conditions under stochastic economic scenarios.
Sensitivity analysis – economic assumptions The tables below show the sensitivity of the embedded value as at 31 December 2006 and the new business contribution before the effect of required capital for 2006 to: – one percentage point increase and decrease in the discount rates; – one percentage point increase and decrease in interest rates, including all consequential changes (including assumed investment returns for all asset classes, market values of fixed interest assets, risk discount rates); – one percentage point increase and decrease in the assumed investment returns for equity and property investments, excluding any consequential changes to the risk discount rate; – 10% rise and fall in market value of equity and property assets (not applicable for new business contribution); and
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.
Embedded value (net of tax) on page 235 rates rates rates rates
O therinform ation Aviva plc Annual Report and Accounts 2006 241
Embedded value (net of tax) on page 235 returns returns market values market values (or equivalent)
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. This can be seen in the sensitivity of a 1% movement in the interest rate for the Netherlands, where there is a significant amount of business with investment return guarantees. The increase of 70 basis points to the assumed pre-tax investment returns at 31 December 2006 has significantly decreased this sensitivity, reflecting the level of the guarantees relative to the interest rate assumption.
Sensitivity analysis – economic assumptions continued in equity/ in equity/ New business contribution before As reported property property required capital (gross of tax) on page 228 returns returns 2006 £m £m £m
O therinform ation Aviva plc Annual Report and Accounts 2006 243
5% decrease in 10% decrease in in mortality/ decrease in 10% in mortality/ morbidity rates
Embedded value As reported maintenance decrease in morbidity rates – annuity (net of tax) on page 235 expenses lapse rates – life insurance business
10% decrease in mortality/ decrease in 10% in mortality/ morbidity rates
Italy Aviva Italia Holding S.p.A and its principal subsidiaries: Aviva Assicurazioni S.p.A (50.0%) Aviva Italia S.p.A Aviva Life SpA (50.0%) Aviva Previdenza S.p.A (50.0%) Aviva Vita S.p.A (25.5%) Eurovita Assicurazioni S.p.A (41.5%)
Aviva USA Corporation and its principal operating subsidiaries: Aviva Life Insurance Company Aviva Life Insurance Company of New York
Associates and joint ventures The Group has ongoing interests in the following operations that are classified as associates or joint ventures. Further details of those operations that were most significant in 2006 are set out in notes
Managing your shareholding: The Company’s Register of members is maintained by the Company’s Registrar, Lloyds TSB Registrars. Shareholders who have any queries in respect of their shareholding should refer to them via the contact details provided below. In addition to assisting with general queries the Registrar can also help with the following: Amalgamating different share accounts If shareholders received more than one copy of this Annual Report, it could be because there is more than one record for the shareholder on the share register. To ensure that duplicate mailings are avoided the Registrar can arrange for accounts to be amalgamated.
Dividend payments direct to your bank account As an alternative to having dividends paid by cheque, shareholders can, if they wish, have them credited directly into their bank or building society account on the dividend payment date. Having the dividend paid directly into their bank account offers shareholders the benefits of avoiding the risk of cheques being lost in the post, and is more convenient as payment is credited automatically on the payment date. The tax voucher is sent to the shareholder’s registered address as usual. Shareholders wishing to set up a dividend mandate can do so on the Company’s website www.aviva.com/dividendmandate. For overseas shareholders, a TAPS (Transcontinental Automated Payment Service) is available, which allows shareholders in many countries to have dividends credited direct to their bank accounts in local currencies.
– NatWest Stockbrokers provide a Share Dealing Service either over the telephone or at certain NatWest branches for Aviva Share Account holders only. For more information contact NatWest Stockbrokers on 0845 122 0689. NatWest Stockbrokers Limited (NWS) is a member of the London Stock Exchange and PLUS. NWS is authorised and regulated by the Financial Services Authority, registered number 124395. Registered Office: Waterhouse Square, 138-142 Holborn, London EC1N 2TH. Registered Number 1959479, England. NWS is operated by a joint venture between The Royal Bank of Scotland Group plc and The Toronto-Dominion Bank.
Share dealing facilities for overseas shareholders To sell Aviva shares over the telephone, shareholders can contact Barclays Stockbrokers on +44 (0)141 352 3959. Non-UK residents will need to provide various documentation in order to use this service and details will be provided on registration. Please note that regulations prevent this service from being offered to US, Canadian and Australian residents. Settlement proceeds will be sent to either a UK sterling bank account or by sterling cheque.
ShareGift The Orr Mackintosh Foundation operates a purely voluntary charity share donation scheme for shareholders who wish to dispose of small numbers of shares when the dealing costs or minimum fee makes it uneconomical to sell them. Details of the scheme are available from ShareGift at www.sharegift.org or can be obtained from the Company’s Registrar.
Share price Shareholders can access the current share price of Aviva plc ordinary shares at www.aviva.com or alternatively can call 0906 843 2197. Calls are currently charged at 60 pence per minute at all times. The average time to access the share price is approximately one minute.
Announcement of first quarter long-term savings new business figures 24 April Annual General Meeting 26 April Announcement of unaudited six months’ interim results 9 August Announcement of third quarter long-term savings new business figures 25 October
Ex-dividend date 7 March Record date 9 March Scrip dividend price available 14 March Dividend payment date 17 May
First dividend payment for 83⁄8% cumulative irredeemable preference shares 31 March First dividend payment for 83⁄4% cumulative irredeemable preference shares 30 June Second dividend payment for 83⁄8% cumulative irredeemable preference shares 30 September Second dividend payment for 83⁄4% cumulative irredeemable preference shares 31 December
Please quote Aviva plc, as well as the name and address in which the shares are held, in all correspondence. If you have a shareholder reference, please have this available as well.
General shareholding, Lloyds TSB Registrars The Causeway 0870 600 3952 administration queries www.shareview.co.uk Worthing and Aviva share account queries e-mail: aviva@lloydstsb-registrars.co.uk West Sussex BN99 6DA
Individual Savings Accounts (ISAs) Lloyds TSB Registrars The Causeway 0870 242 4244 (ISA Manager) Worthing
Alternative versions of this publication (including braille, large print and audio-tape) are available on request from the Registrar.
At Aviva, we find new ways to deliver more fulfilling futures to our customers, and all our stakeholders. Forward thinking has been our business for 300 years. Today, it expresses our dedication to thinking beyond the immediate and the everyday, to building better tomorrows.
Forward thinking is at the heart of our business. It guides our daily actions, encourages us to look past what limits us now, and determines the steps that will carry us beyond those limits, tomorrow.
Within this report, you will find examples of forward thinking in action. Around the world, Aviva is a market leader in developing innovative new products and services as we seek to anticipate what people need and provide solutions.
Our vision of the future extends to recognising our responsibilities to society. We know that we must limit our impact on the environment in which we operate, for the benefit of future generations. Richard Harvey Group chief executive
We are committed to caring for the environment and looking for sustainable ways to minimise our impact on it.
This year our annual report and accounts has been printed by Burlington. We choose Burlington because not only do they have the important environmental certification by SGS for the FSC standards, but also they take innovative steps to minimise their impact on the environment even further. A great example of this is where they plan to use naturally cooled water from their well to supply the existing air conditioning system.