For defined benefit plans, the pension costs are assessed using the projected unit credit method. Under this method, the cost of providing pensions is charged to the income statement so as to spread the regular cost over the service lives of employees, in accordance with the advice of qualified actuaries. The pension obligation is measured as the present value of the estimated future cash outflows, using a discount rate based on market yields for high quality corporate bonds that are denominated in the currency in which the benefits will be paid and that have terms to maturity approximating to the terms of the related pension liability. The resulting pension scheme surplus or deficit appears as an asset or liability in the consolidated balance sheet.
Costs charged to the income statement comprise the current service cost (the increase in pension obligation resulting from employees’ service in the current period, together with the schemes’ administration expenses), past service cost (resulting from changes to benefits with respect to previous years’ service), and gains or losses on curtailment (when the employer materially reduces the number of employees covered by the scheme) or on settlements (when a scheme’s obligations are transferred outside the Group). In addition, the difference between the expected return on scheme assets, less investment expenses, and the interest cost of unwinding the discount on the scheme liabilities (to reflect the benefits being one period closer to being paid out) is credited to investment income. All actuarial gains and losses, being the difference between the actual and expected returns on scheme assets, changes in assumptions underlying the liability calculations and experience gains or losses on the assumptions
Equity compensation plans The Group offers share award and option plans over the Company’s ordinary shares for certain employees, including a Save As You Earn plan (SAYE plan), details of which are given in the Directors’ remuneration report and in note 29.
The Group accounts for options and awards under equity compensation plans, which were granted after 7 November 2002, until such time as they are fully vested, using the fair value based method of accounting (the “fair value method”). Under this method, the cost of providing equity compensation plans is based on the fair value of the share awards or option plans at date of grant, which is recognised in the income statement over the expected vesting period of the related employees and credited to the equity compensation reserve, part of shareholders’ funds.
(AB) Income taxes The current tax expense is based on the taxable profits for the year, after any adjustments in respect of prior years. Tax, including tax relief for losses if applicable, is allocated over profits before taxation and amounts charged or credited to reserves as appropriate.
Group pays on its profits. In the pro forma reconciliations, operating profit has been calculated after charging policyholder tax.
(AD) Share capital and treasury shares Equity instruments An equity instrument is a contract that evidences a residual interest in the assets of an entity after deducting all its liabilities. Accordingly, a financial instrument is treated as equity if: (i) there is no contractual obligation to deliver cash or other financial assets or to exchange financial assets or liabilities on terms that may be unfavourable; and
(5,514) Fee and commission expense (4,411) (4,244) (6,770) Other expenses (5,416) (3,473) (1,934) Finance costs 7 (1,547) (1,217)
Other (248) Other operations and regional costs (198) (74) (176) Corporate centre (141) (157) (474) Group debt costs and other interest (379) (363)
Adjusted for the following: (2,038) Investment return variances and economic assumption changes on long-term business 8 (1,631) 15
(146) Amortisation and impairment of intangibles 17 (117) (103) 9 Profit on the disposal of subsidiaries and associates 3b 7 49
(408) Integration and restructuring costs 6 (326) (153) (689) Exceptional items 6 (551) –
(1,625) (Loss)/profit before tax attributable to shareholders’ profits (1,300) 1,832 Tax attributable to shareholders’ profits
Operating profit can be further analysed into the following segments: Year ended 31 December 2008
UK 751 (18) 656 (12) 1,377 Europe 881 14 397 (151) 1,141 North America 16 – 145 (12) 149 Asia Pacific 46 13 – (23) 36 Aviva Investors – 114 – – 114
UK 723 (10) 421 (8) 1,126 Europe 777 27 442 (49) 1,197 North America 79 – 154 (4) 229 Asia Pacific 31 15 4 (13) 37 Aviva Investors – 147 – – 147
(116) Share of fair value changes in joint ventures and associates taken to equity 34 (93) 9 (1,161) Actuarial (losses)/gains on pension schemes 46e(iv) (929) 648 98 Actuarial losses/(gains) on pension schemes transferred to unallocated divisible surplus 46c(i) 78 (61) 3,316 Foreign exchange rate movements 34 & 36b 2,653 723 294 Aggregate tax effect – shareholder tax 13b 235 (179)
333 Net income recognised directly in equity 267 921 (1,106) (Loss)/profit for the year (885) 1,498
Reconciliation of movements in consolidated shareholders’ equity For the year ended 31 December 2008 £m 16,424 Balance at 1 January as published 15,931 14,064 – Prior year adjustment 2b – (319)
(1,005) Dividends and appropriations 15 (975) (871) 21 Issues of share capital 28 20 48 175 Shares issued in lieu of dividends 35 170 301 37 Capital contributions from minority shareholders 36b 36 –
(109) Minority share of dividends declared in the year 36b (106) (66) 44 Minority interest in acquired subsidiaries 36b 43 315
(34) Shares held by employee trusts 30 (33) (10) 2,175 Other reserves 34 2,110 1,469 3,924 Retained earnings 35 3,806 6,338 11,600 Equity attributable to shareholders of Aviva plc 11,252 13,146 1,021 Direct capital instrument 32 990 990 2,272 Minority interests 36 2,204 1,795
Liabilities 180,258 Gross insurance liabilities K & 38 174,850 152,839 110,886 Gross liabilities for investment contracts L & 39 107,559 98,244 2,397 Unallocated divisible surplus K & 43 2,325 6,785 7,132 Net asset value attributable to unitholders D 6,918 6,409 3,076 Provisions Z, AA & 45 2,984 1,937 3,113 Deferred tax liabilities AB & 44b 3,020 2,532 662 Current tax liabilities 44a 642 1,225 15,671 Borrowings AC & 47 15,201 12,657 21,485 Payables and other financial liabilities R & 48 20,840 18,060 4,696 Other liabilities 49 4,556 3,765 1,259 Liabilities of operations classified as held for sale AG & 3c 1,221 942 365,528 Total equity and liabilities 354,562 321,326
Consolidated cash flow statement For the year ended 31 December 2008
Cash flows from investing activities Acquisitions of subsidiaries, joint ventures and associates, net of cash acquired 52b (93) (243) (336) (769) Disposals of subsidiaries, joint ventures and associates, net of cash transferred 52c 180 173 353 283 Purchase of minority interest in subsidiary (65) – (65) – New loans to joint ventures and associates (182) – (182) (126) Repayment of loans to joint ventures and associates 52 – 52 159 Net repayment loans to joint ventures and associates 18a & 19a (130) – (130) 33 Purchases of property and equipment 20 (57) (159) (216) (227) Proceeds on sale of property and equipment 35 24 59 93 Purchases of intangible assets 17 (34) (26) (60) (48)
( )Net cash used in investing activities (164) (231) (395) (635)
Net increase in cash and cash equivalents 6,484 (863) 5,621 2,324 Cash and cash equivalents at 1 January 11,132 4,432 15,564 12,635 Effect of exchange rate changes on cash and
Of the total cash and cash equivalents, £493 million (2007: £96 million) was classified as held for sale (see note 3c).
Notes to the consolidated financial statements 1 – Exchange rates The Group’s principal overseas operations during the year were located within the Eurozone and the United States. The results and cash flows of these operations have been translated into sterling at an average rate for the year of €1 = £0.80 (2007: €1 = £0.68) and £1 = US$1.85 (2007: £1= US$2.00). Assets and liabilities have been translated at the year end rate of €1 = £0.97 (2007: €1 = £0.73) and £1 = US$1.44 (2007: £1= US$1.99).
Total foreign currency movements during 2008 resulted in a gain recognised in the income statement of £327 million (2007: £45 million gain).
The Group has determined its operating segments along regional lines and the results for the year are presented on this basis, using UK Life and UK General Insurance within the United Kingdom, Europe, North America, Asia Pacific and Aviva Investors as the main segments.
(i) The UK general insurance business covers the Group’s UK general insurance business and includes the results of Aviva Re, the Group’s captive reinsurance business and agencies in run off.
(ii) The UK Life segment includes the result of the UK health business which it manages.
(i) Restatement for the change in accounting policy for latent reserves As part of the Company’s aim to continuously improve the relevance and reliability of its external financial reporting, Aviva undertook a review of the Group’s General Insurance Reserving Policy in 2008.
The discount rate that has been applied is based on the relevant swap curve in the relevant currency at the reporting date, having regard to the duration of the expected settlement of the claims. The discount rate is set at the start of the accounting period with any change in rates between the start and end of the accounting period being reflected below operating profit as an economic assumption change. The range of discount rates used is shown in note 38c and depends on the duration of the claim and the reporting date. We estimate that latent claims will be payable for around the next 35 to 40 years with an average duration of 15 years.
The application of discounting to our latent claims reserves represents a change in accounting policy and has therefore been applied retrospectively. The cumulative impact of discounting on our opening reserves as at 1 January 2007 is to reduce insurance liabilities by £214 million and reinsurance assets by £61 million, and to increase retained earnings by £153 million. These have been treated as prior year adjustments in these financial statements.
As a result, certain balance sheet categories have been restated for the gross up. This resulted in increases to cash and cash equivalents (£315 million), investment property (£314 million), debt securities (£2,375 million), equity securities (£2,811 million), and net asset value attributable to unitholders (£1,671 million), and a decrease to other investments (£4,144 million) as at 31 December 2007. The impact on the 2007 income statement has been to restate net investment income and fee and commission expense by reducing both by £139 million and, in the 2007 cash flow statement, to increase cash flows from operating activities by £101 million.
(i) VIVAS Health On 15 May 2008, the Group’s Irish subsidiary, Hibernian Group plc, acquired a 70% holding in VIVAS Group Ltd. (VIVAS Health), an Irish health insurance company, for £26 million. Allied Irish Banks plc (AIB) will continue to hold the remaining 30% equity, further strengthening AIB and Hibernian’s existing relationship. The company has been re-branded as Hibernian Aviva Health. Its health insurance products will be distributed through Hibernian and AIB’s distribution channels, including Hibernian Aviva Health’s existing direct and non-direct channels.
The acquisition of this shareholding has given rise to goodwill on acquisition of £22 million, calculated as follows: Purchase cost: £m
The assets and liabilities as at the acquisition date in the table above are stated at their provisional fair values and may be amended in 2009 in accordance with paragraph 62 of IFRS 3, Business Combinations. The residual goodwill represents future cost and revenue synergies from integration with the Hibernian Group.
The results of VIVAS Health have been included in the consolidated financial statements of the Group with effect from 15 May 2008, and have contributed £5 million profit to the consolidated loss before tax.
3 – Subsidiaries continued The acquisition of this shareholding has given rise to goodwill on acquisition of £10 million, calculated as follows: Purchase cost: £m
Assets Intangible assets – 41 41 Reinsurance assets 130 – 130 Prepayments and accrued income 20 – 20 Cash and cash equivalents 8 – 8 Debt securities 1,803 (74) 1,729 Other investments 407 – 407 Property and equipment 17 1 18 Receivables and other financial assets 45 – 45 Other assets 2 2 4
The assets and liabilities as at the acquisition date in the table above are stated at their provisional fair values and may be amended in 2009 in accordance with paragraph 62 of IFRS 3, Business Combinations. The residual goodwill represents expected future revenue and cost synergies.
Notes to the consolidated financial statements continued 3 – Subsidiaries continued The estimated book and fair values of the assets and liabilities at the date of acquisition were: Book value £m
Assets Acquired value of in-force business on insurance contracts – 17 17 Reinsurance assets 28 – 28 Prepayments and accrued income 33 – 33 Cash and cash equivalents 60 – 60 Equity securities 464 – 464 Debt securities 1,735 – 1,735 Property and equipment 19 – 19 Investment property 80 – 80 Loans 21 – 21 Receivables and other financial assets 46 – 46 Other assets 19 – 19
Liabilities Insurance liabilities (1,635) 92 (1,543) Liabilities for investment contracts (818) 52 (766) Borrowings (49) – (49) Payables and other financial liabilities (41) – (41) Other liabilities (59) – (59)
The assets and liabilities as at the acquisition date in the table above are stated at their provisional fair values and may be amended in 2009 in accordance with paragraph 62 of IFRS 3, Business Combinations. The residual goodwill represents cost and revenue synergies from integrating the business with our existing Belgian operations.
Total net assets of subsidiaries described above 155 Less: Minority interests (45)
Goodwill arising on material acquisitions above 80 Other goodwill arising (see (v) below)
£32 million of the above pre-tax loss has arisen since acquisition.
(b) Disposal of subsidiaries, joint ventures and associates The profit on the disposal of subsidiaries, joint ventures and associates comprises: £m
(i) UK non-core operations As part of its strategy to exit certain UK non-core operations, the Group completed the disposals of HPI Limited to Solera Holdings Inc. and RAC Autowindscreens Limited to Arques Management GmbH in December 2008. The loss on disposal of these wholly-owned subsidiaries was £38 million, calculated as follows: £m
Liabilities Liability for investment contracts (372) Borrowings (3) Other liabilities (10)
(iii) Offshore operations On 11 July 2008, the Group sold its offshore operations, administered through Aviva Global Services Singapore Pte Ltd (AGS), to WNS (Holdings) Limited (WNS). As part of this agreement, we have entered into a master services agreement with WNS, who will provide business process services to the Group’s UK, Irish and Canadian businesses through to 2016. The consideration for the shares in AGS was £35 million and the relevant net assets at the disposal date were £21 million, giving rise to a profit on disposal of £14 million.
(i) Property and equipment held for sale As part of its restructuring, the UK data centres, presently owned and managed by Norwich Union Central Services Limited, have been classified as held for sale at 31 December 2008 at their fair value of £102 million. In remeasuring the data centres at fair value, an impairment charge of £44 million has been recognised in the income statement within integration and restructuring costs. The data centres were sold on 25 February 2009 at their fair value above.
Goodwill and intangible assets 14 – Investments and property and equipment 396 316 Receivables and other financial assets 386 554 Deferred acquisition costs and other assets 1 – Prepayments and accrued income 158 145 Tax assets – 17 Cash and cash equivalents 493 96
Gross insurance liabilities (709) (627) Borrowings – (12) Payables and financial liabilities (22) (72) Other liabilities (478) (220) Tax liabilities and other provisions (12) (11)
The relevant assets and liabilities of the DL health insurance business have been classified as held for sale, at their carrying values, in the consolidated balance sheet as at 31 December 2008.
(d) Other information Principal subsidiaries at 31 December 2008 are listed on pages 328 to 329.
One of the Group’s subsidiaries, Delta Lloyd NV, is subject to the provisions of Dutch corporate law and particularly the Dutch “structure company” regime. Under this regime, Delta Lloyd operates under a Supervisory Board which has a duty to have regard to the interests of a wide variety of stakeholders. The Supervisory Board includes two Aviva Group representatives and is responsible for advising and supervising Delta Lloyd’s Executive Board. The shareholder is one of the most important stakeholders to whom the Supervisory Board has a duty.
The Group’s results can be segmented, either by activity or by geography. Our primary reporting format is on regional reporting lines, with supplementary information being given by business activity. This note provides segmental information on the consolidated income statement and balance sheet.
Asia Pacific Our activities in Asia Pacific principally comprise our long-term business operations in Australia, China, India, Singapore, Hong Kong, Sri Lanka, Taiwan, Malaysia, and South Korea.
Aviva Investors Aviva Investors operates in most of the regions in which the Group operates, in particular the UK, France, the United States and Canada and other international businesses, managing policyholders’ and shareholders’ invested funds, providing investment management services for institutional pension fund mandates and managing a range of retail investment products, including investment funds, unit trusts, OEICs and ISAs. Fund management activities of Delta Lloyd are included in the Europe operating segment.
Measurement basis The accounting policies of the segments are the same as those for the Group as a whole. Any transactions between the business segments are on normal commercial terms and market conditions. The Group evaluates performance of operating segments on the basis of: (i) profit or loss from operations before tax attributable to shareholders.
Net earned premiums 7,502 5,368 15,045 6,218 509 – – 34,642 Fee and commission income 310 362 711 40 168 294 – 1,885 7,812 5,730 15,756 6,258 677 294 – 36,527 Net investment income (8,844) 326 (6,168) 444 (626) (407) (768) (16,043) Inter-segment revenue – – – – – 203 – 203 Share of loss of joint ventures and associates (1,058) – (38) – (32) – – (1,128) Profit on the disposal of subsidiaries
Change in investment contract provisions 7,240 – 2,765 (126) 401 349 – 10,629
Other operating expenses (1,787) (2,599) (2,970) (633) (296) (362) 552 (8,095) Impairment losses** – (26) (814) (200) – – – (1,040) Inter-segment expenses (137) (2) (18) (42) (3) – (1) (203) Finance costs (541) (10) (703) (17) – – (276) (1,547)
(Loss)/profit before tax attributable to shareholders (149) (391) 48 (338) (68) 72 (474) (1,300)
* Total reported income, excluding inter-segment revenue, is split United Kingdom £3,928 million, France £1,005 million, Netherlands £6,759 million, USA £4,954 million and Rest of the World £2,717 million. Income is attributed on the basis of geographical origin which does not materially differ from revenue by geographical destination, as most risks are located in the countries where the contracts were written.
Impairment of goodwill – – 66 – – – – 66 Amortisation and impairment of intangibles 3 33 34 44 – 3 – 117 (Profit)/loss on the disposal of subsidiaries and associates – 38 (24) – – – (21) (7) Exceptional items 108 312 133 42 – 6 (50) 551 Integration and restructuring costs 60 195 38 – – 33 – 326
Gross written premiums 6,128 6,039 13,538 4,628 658 – – 30,991 Premiums ceded to reinsurers (444) (577) (388) (195) (54) – – (1,658) Internal reinsurance revenue – 28 (19) (7) (2) – – –
Net written premiums 5,684 5,490 13,131 4,426 602 – – 29,333 Net change in provision for
Claims and benefits paid, net of recoveries from reinsurers (9,000) (4,064) (11,192) (2,486) (377) – (2) (27,121)
Amortisation of deferred acquisition costs and acquired value of in-force business – – (35) (122) (3) – – (160)
Profit/(loss) before tax attributable to shareholders 564 142 1,322 (38) 35 129 (322) 1,832 * Total reported income, excluding inter-segment revenue, is split United Kingdom £17,424 million, France £5,731 million, Netherlands £5,922 million, USA £3,777 million and Rest of the World £7,853 million. Income is attributed on the basis of geographical origin which does not materially differ from revenue by geographical destination, as most risks are located in the countries where the contracts were written.
Profit/(loss) before tax attributable to shareholders 564 142 1,322 (38) 35 129 (322) 1,832
Economic assumption changes on general insurance and health business – (1) – (1) – – – (2)
Goodwill 52 1,208 1,357 903 55 3 – 3,578 Acquired value of in-force business and intangible assets 65 265 1,470 2,196 28 14 – 4,038 Interests in, and loans to, joint ventures and associates 2,080 – 604 2 296 – 1 2,983 Property and equipment 123 173 519 106 32 10 1 964 Investment property 8,872 148 3,920 7 21 655 803 14,426 Loans 20,156 833 19,061 2,130 56 1 – 42,237 Financial investments 69,052 2,482 125,329 24,621 3,865 1,454 2,919 229,722 Deferred acquisition costs 1,221 998 1,254 2,627 43 3 1 6,147 Other assets 13,933 4,971 23,867 5,537 627 661 871 50,467
External borrowings by holding companies within the Group which are not allocated to operating companies are included in “Other Group activities”.
Unearned premiums 179 3,468 973 815 15 – – 5,450 Other insurance liabilities – 92 113 78 – – – 283 Liability for investment contracts 41,845 – 49,551 1,756 1,952 3,140 – 98,244 Unallocated divisible surplus 4,944 – 1,838 – 3 – – 6,785 Net asset value attributable to unitholders 758 – 2,680 – 189 – 2,782 6,409 External borrowings 2,184 12 6,153 133 – 6 4,169 12,657 Other liabilities, including inter-
(b) Further analysis by products and services The Group’s results can be further analysed by products and services which comprise long-term business, fund management, general insurance and health, and non-insurance activities.
Long-term business Our long-term business comprises life insurance, long-term health and accident insurance, savings, pensions and annuity business written by our life insurance subsidiaries, including managed pension fund business and our share of the other life and related business written in our associates and joint ventures, as well as the Lifetime mortgage business written in the UK.
Gross written premiums* 24,272 – 11,934 – 36,206 Premiums ceded to reinsurers (1,044) – (797) – (1,841)
Net written premiums 23,228 – 11,137 – 34,365 Net change in provision for unearned premiums – – 277 – 277
Segmental income 6,221 743 11,994 590 19,548 Segmental expenses (7,532) (662) (12,100) (1,622) (21,916) Tax attributable to policyholder returns 1,068 – – – 1,068
Operating profit before tax attributable to shareholders’ profits 1,694 123 1,198 (718) 2,297 * Gross written premiums includes inward reinsurance premiums assumed from other companies amounting to £255 million, of which £89 million relates to property and liability insurance, £131 million to long-term business and the remainder health business.
(ii) Segmental income statement – products and services for the year ended 31 December 2007
Net earned premiums 18,764 – 10,548 – 29,312 Fee and commission income 692 494 179 395 1,760 19,456 494 10,727 395 31,072 Net investment income 8,529 45 827 288 9,689 Inter-segment revenue – 152 – – 152 Share of (loss)/profit of joint ventures and associates (297) (9) 3 (1) (304) Profit/(loss) on the disposal of subsidiaries and associates – – (7) 56 49
Operating profit before tax attributable to shareholders’ profits 1,610 179 1,021 (594) 2,216
(iii) Segmental balance sheet – products and services as at 31 December 2008
(iv) Segmental balance sheet – products and services as at 31 December 2007
Notes to the consolidated financial statements continued 5 – Details of income
This note gives further detail on the items appearing in the first section of the consolidated income statement.
Gross written premiums (note 4a & 4b) Long-term: Insurance contracts 19,388 15,589 Participating investment contracts 4,884 4,033 General insurance and health 11,934 11,369 36,206 30,991 Less: premiums ceded to reinsurers (note 4a & 4b) (1,841) (1,658) Gross change in provision for unearned premiums (note 38e) 388 (24) Reinsurers’ share of change in provision for unearned premiums (note 41c(iii)) (111) 3 Net change in provision for unearned premiums 277 (21)
Net investment income (16,043) 9,689 Share of (loss) after tax of joint ventures (note 18a) (1,038) (339) Share of (loss)/profit after tax of associates (note 19a) (90) 35 Share of (loss) after tax of joint ventures and associates (1,128) (304) Profit on disposal of subsidiaries and associates (note 3b) 7 49
Other net foreign exchange (gains) (68) (34) Finance costs (note 7) 1,547 1,217
This note analyses the interest costs on our borrowings (which are described in note 47) and similar charges.
Interest expense on core structural borrowings Subordinated debt 229 179 Debenture loans 21 25 Commercial paper 36 55
Notes to the consolidated financial statements continued 8 – Long-term business economic volatility continued Major items included in the economic items for 2008 are as follows: – additional credit default provisions of £550 million for corporate bonds and commercial mortgages backing UK annuity business; – the impact of market movements on guarantees and options in France and the Netherlands of £260 million; – widening credit spreads on assets backing participating business in Spain, with a charge to net income of £220 million; and
(c) Methodology The expected investment returns and corresponding expected movements in long-term business liabilities are calculated separately for each principal long-term business unit.
The expected return on investments for both policyholder and shareholders funds is based on opening economic assumptions applied to the expected funds under management over the reporting period. Expected investment return assumptions are derived actively, based on market yields on risk-free fixed interest assets at the end of each financial year. The same margins are applied on a consistent basis across the Group to gross risk-free yields, to obtain investment return assumptions for equities and properties. Expected funds under management are equal to the opening value of funds under management, adjusted for sales and purchases during the period arising from expected operating experience.
Where assets are classified as fair value through profit or loss, the Group has applied the same “real-world” economic assumptions for fixed interest securities, equities and properties as are used under MCEV principles in 2008, and under EEV principles in 2007. The principal assumptions underlying the calculation of the expected investment return are: Fixed interest Equities Properties
For 2008 the fixed interest reference rate is the one-year spot rate for risk free swaps in the relevant currency at the start of the year. This is adjusted for different classes of fixed interest securities to reflect current market yields. The expected returns for equities and property assets include risk margins above the reference rate of 3.5% and 2% respectively.
9 – Longer term investment return and economic assumption changes for non-long-term business
For non-long-term business, the total investment income, including realised and unrealised gains, is split between a calculated longer term return and short-term fluctuations from this. This note gives details of the longer term return calculation and the relevant assumptions, as well as the economic assumption changes on our general insurance and health business.
(a) The short-term fluctuations in investment return and economic assumption changes attributable to the non-long-term business result and reported outside operating profit were as follows: Non-long-term business
(c) The longer term investment return is calculated separately for each principal non-long-term business unit. In respect of equities and properties, the return is calculated by multiplying the opening market value of the investments, adjusted for sales and purchases during the year, by the longer term rate of investment return.
The longer term rate of investment return is determined using consistent assumptions between operations, having regard to local economic and market forecasts of investment return. The allocated longer term return for other investments is the actual income receivable for the year.
(d) The total assets supporting the general insurance and health business, which contribute towards the longer term return were £19,576 million (2007: £18,291 million). For other operations the longer term return reflects interest income earned in the Netherlands bank and retail mortgage divisions.
United Kingdom 9.2 7.6 7.7 6.6 France 8.3 7.0 6.8 6.0 Ireland 8.3 7.0 6.8 6.0 Netherlands 8.3 7.0 6.8 6.0 Canada 7.7 7.1 6.2 6.1
The Group has applied the same economic assumptions for equities and properties as are used under MCEV principles to calculate the longer term investment return for its non-long-term business in 2008. In 2007 rates were based on EEV.
Actual return attributable to shareholders 4,985 Longer-term return credited to operating results (5,161)
Equities 1% higher/lower Group operating profit before tax 17 27 Properties 1% higher/lower Group operating profit before tax 3 4
Acquisition costs 584 592 Claims handling expenses 291 318 Central costs and sharesave schemes 83 109 Other operating expenses 1,915 1,523 11 – Directors Information concerning individual directors’ emoluments, interests and transactions is given in the Directors’ remuneration report.
Notes to the consolidated financial statements continued 12 – Auditors’ remuneration
Fees payable to Ernst & Young LLP for the statutory audit of the Aviva Group and Company financial statements 1,548 1,364
Fees payable to Ernst & Young LLP and its associates for other services to Group companies: Audit of Group subsidiaries pursuant to legislation 9,981 8,388 Additional fees related to the prior year audit of Group subsidiaries pursuant to legislation 519 372 Other services pursuant to legislation 2,439 2,124 Tax services 185 201 Services relating to information technology 112 173 Services relating to corporate finance transactions 487 736 All other services – Supplementary reporting (see below) 3,468 931
Fees for Other supplementary services include £3.5 million (2007: £0.9 million) for assurance services in connection with the Group’s Financial Reporting Control Framework, £1.2 million (2007: £1.4 million) for examination of the Group’s ICA capital, and £1.5 million (2007: £2.5 million) for other services.
In addition to the above amounts payable to the principal auditors, fees for audit services of £2.6 million (2007: £3.8 million) were payable to other firms. The total fees payable for audit services were therefore £14.6 million (2007: £14.0 million).
Current tax For this year 527 885 Prior year adjustments (284) (94)
Deferred tax Origination and reversal of temporary differences (1,814) (348) Changes in tax rates or tax laws (7) (88) Write-down of deferred tax assets 95 (6)
(ii) The Group, as a proxy for policyholders in the UK, Ireland, Singapore and Australia, is required to record taxes on investment income and gains each year. Accordingly, the tax benefit or expense attributable to UK, Irish, Singapore and Australian life insurance policyholder returns is included in the tax charge. The tax credit attributable to policyholders’ returns included in the credit above is £1,068 million (2007: £15 million charge).
(v) Deferred tax credited to the income statement represents movements on the following items: £m
Long-term business technical provisions and other insurance items 591 315 Deferred acquisition costs 224 34 Unrealised losses on investments (1,706) (793) Pensions and other post-retirement obligations 16 40 Unused losses and tax credits (413) (272) Subsidiaries, associates and joint ventures (199) (33) Intangibles and additional value of in-force long-term business 30 (75) Provisions and other temporary differences (269) 342
Notes to the consolidated financial statements continued 13 – Tax continued
Tax calculated at standard UK corporation tax rate of 28.5% (2007: 30%) (675) 554 Different basis of tax – policyholders (767) 5 Adjustment to tax charge in respect of prior years (283) (49) Non-assessable income (94) (124) Non-taxable profit on sale of subsidiaries and associates (2) (18) Disallowable expenses 95 7 Different local basis of tax on overseas profits (61) 56 Reduction in future UK tax rate (net of movements in unallocated divisible surplus) – (64) Deferred tax not recognised 292 1 Other 12 (19)
(i) The profit attributable to ordinary shareholders is: Operating profit £m
Tax attributable to shareholders’ (loss)/profits (487) 902 415 (604) 270 (334)
Profit/(loss) attributable to ordinary shareholders 1,662 (2,634) (972) 1,367 (101) 1,266
Non-operating items: Investment return variances and economic assumption changes on long-term business (note 8) (1,631) (1,280) (48.4) 15 92 3.6
Short-term fluctuation in return on investments backing non-long-term business (note 9b) (819) (553) (20.9) (184) (51) (2.0)
Economic assumption changes on general insurance and health business (94) (67) (2.5) 2 2 0.1
(Loss)/profit attributable to ordinary shareholders (1,300) (972) (36.8) 1,832 1,266 48.9
(iii) The calculation of basic earnings per share uses a weighted average of 2,643 million (2007: 2,588 million) ordinary shares in issue, after deducting shares owned by the employee share trusts. The actual number of shares in issue at 31 December 2008 was 2,658 million (2007: 2,622 million).
(Loss)/profit attributable to ordinary shareholders (972) 2,643 (36.8) 1,266 2,588 48.9
Dilutive effect of share awards and options – 24 – – 24 (0.4)
Dilutive effect of share awards and options – 24 (0.6) – 24 (0.5)
Notes to the consolidated financial statements continued 15 – Dividends and appropriations
This note analyses the total dividends and other appropriations we have paid during the year. The table below does not include the final dividend proposed after the year end because it is not accrued in these financial statements. The impact of scrip dividends is shown separately in note 35.
Ordinary dividends declared and charged to equity in the year Final 2007 – 21.10 pence per share, paid on 16 May 2008 554 – (Final 2006 – 19.18 pence per share, paid on 18 May 2007) – 492 Interim 2008 – 13.09 pence per share, paid on 17 November 2008 348 – (Interim 2007 – 11.90 pence per share, paid on 16 November 2007) – 309 902 801 Preference dividends declared and charged to equity in the year 17 17 Coupon payments on direct capital instrument 56 53
Subsequent to 31 December 2008, the directors proposed a final dividend for 2008 of 19.91 pence per ordinary share (2007: 21.10 pence), amounting to £529 million (2007: £554 million) in total. Subject to approval by shareholders at the AGM, the dividend will be paid on 15 May 2009 and will be accounted for as an appropriation of retained earnings in the year ending 31 December 2009.
Interest on the direct capital instrument issued in November 2004 is treated as an appropriation of retained profits and, accordingly, it is accounted for when paid. Tax relief is obtained at a rate of 28.5% (2007: 30%).
Accumulated impairment At 1 January (191) (176) Impairment losses charged to exceptional items (20) – Other impairment losses charged to expenses (48) (10) Write back of impairment related to disposals 9 9 Foreign exchange rate movements (65) (14)
(detailed in note 17) Total £m 2007 £m 2008 £m 2007 £m
(see (ii) below) 1,208 1,276 201 221 1,409 1,497 Europe France (long-term business)
(see (iii) below) – – 60 45 60 45 Ireland Long-term business (see (iv) below) 133 101 – – 133 101 General insurance and health
(see (v) below) 134 81 – – 134 81 Italy Long-term business (see (vi) below) 74 46 334 254 408 300 General insurance and health
(see (vii) below) 64 42 137 132 201 174 Netherlands (see (viii) below) 279 212 – – 279 212 Spain (long-term business)
(see (x) below) 865 624 – – 865 624 Canada 43 17 – – 43 17 Asia Pacific Various 55 41 – – 55 41
Goodwill and intangibles with indefinite useful lives have been tested for impairment in these businesses as follows: United Kingdom
(ii) General insurance, RAC and health Following the reorganisation of the reporting structure for the UK’s general insurance business during 2007 and 2008, further integrating the operations, management and reporting of businesses acquired with the RAC, the composition of cash-generating units to which goodwill has been allocated has been reassessed. It has been determined that goodwill should be allocated to a single ‘general insurance, RAC and health’ cash-generating unit. The analysis above reflects the revised allocation of goodwill. No impairment of goodwill has arisen or been released as a result of the reallocation.
– Growth rates represent the rates used to extrapolate future cash flows beyond the business plan period and have been based upon latest information available regarding future and past growth rates, including external sources of data such as ABI Annual Market Statistics.
As a result of an Italian off-shore long-term business entering run off, the goodwill relating to this business of £2 million has been fully impaired and recognised as an impairment charge in the income statement. For the rest of the Italian long-term business the recoverable amount exceeds the carrying value of the cash generating unit including goodwill.
(vii) Italy (non-life) The recoverable amount exceeds the carrying value of the cash generating unit including goodwill.
Key assumptions used for the calculation were: – Budgeted operating profit for an initial three year period represents the operating profit in the most recent business plans, approved by management and as such reflects the best estimate of future profits based on both historical experience and expected growth rates for the Italian economy; – Growth rate of 2.5% represents the rate used to extrapolate future cash flows beyond the business plan period; and
Notes to the consolidated financial statements continued 16 – Goodwill continued During the year, goodwill allocated to a non-insurance cash-generating unit in Belgium, was tested for impairment. Following the impairment test, an impairment charge of £46 million has been recognised in the income statement.
After recognition of this impairment charge, the recoverable amount of the Dutch cash generating units exceeds their carrying value. An increase in the risk adjusted discount rate of 1% would result in the recoverable amount of the ABN Amro cash generating unit being equal to its carrying value.
This calculation is an actuarially-determined appraisal value and is based on an embedded value of the business (the total of the net worth of the life business and the value of the in-force business) together with the present value of expected profits from future new business. The value in use exceeds the carrying value of the cash generating unit including goodwill.
17 – Acquired value of in-force business (AVIF) and intangible assets
This note shows the movements in cost and amortisation of the in-force business and intangible assets acquired when we have purchased subsidiaries.
At 31 December 2007 2,273 110 1,005 709 4,097 Additions (note (a)) 331 – 60 – 391 Acquisition of subsidiaries 59 – 24 – 83 Disposals (4) (5) (79) – (88) Transfers (4) 67 (63) – – Transfers to goodwill and other assets (note (c)) – – – (31) (31) Foreign exchange rate movements 869 44 277 149 1,339
Accumulated amortisation and impairment At 1 January 2007 (379) (9) (185) – (573) Amortisation for the year (160) (7) (99) – (266) Transfers – – 54 (54) – Impairment losses charged to expenses _ _ (4) – (4) Foreign exchange rate movements (36) (2) (16) (3) (57)
At 31 December 2007 (575) (18) (250) (57) (900) Amortisation for the year (333) (13) (100) – (446) Disposals – – 39 – 39 Transfers (1) (43) 44 – – Impairment losses charged to exceptional item (note (d)) – – (32) (20) (52) Other impairment losses charged to expenses (note (e)) (2) – (13) – (15) Foreign exchange rate movements (247) (18) (87) (18) (370)
Less: Amounts classified as held for sale – gross amount – – (9) (20) (29) – accumulated amortisation and impairment – – – 20 20 – – (9) – (9)
Notes to the consolidated financial statements continued 17 – Acquired value of in-force business (AVIF) and intangible assets continued
(c) During the year the Italian business unit finalised the valuation of Avipop Assicurazioni SpA which was acquired during 2007, and its bancassurance agreement with Banco Popolare. This has resulted in a reallocation of £31 million from intangible assets with indefinite useful lives to goodwill and other assets.
Other intangible assets with finite useful lives consist primarily of the value of bancassurance and other distribution agreements.
Share of results after tax – (1,032) – (1,032) Amortisation and impairment of goodwill and intangibles (6) – – (6)
Notes to the consolidated financial statements continued 18 – Interests in, and loans to, joint ventures continued
(c) Long-term business undertakings The principal joint ventures are as follows: Company Class of share Proportion held
Aviva-COFCO Life Insurance Co. Limited Ordinary shares of RMB1 each 50.0% China AvivaSA Emeklilik ve Hayat A.S. Ordinary shares of YTL1 each 49.7% Turkey CIMB Aviva Assurance Berhad Ordinary shares of RM1 each 49.0% Malaysia CIMB Aviva Takaful Berhad Ordinary shares of RM1 each 49.0% Malaysia First-Aviva Life Insurance Co., Ltd. Ordinary shares of NT$10 each 49.0% Taiwan Woori Aviva Life insurance Co. Ltd Ordinary shares of KRW 5000 each 46.8% Korea
CIMB Aviva Assurance Berhad and CIMB Aviva Takaful Berhad The Group’s investments in CIMB Aviva Assurance Berhad and CIMB Aviva Takaful Berhad have been tested for impairment by comparing their carrying values (which include goodwill which arose on their acquisition) with their recoverable amounts. The recoverable amounts for both the investments have been determined based on value in use calculations. This calculation is an actuarially-determined appraisal value and is based on the embedded value of the business together with the present value of expected profits from future new business. The recoverable amounts exceeds the carrying values of both the investments.
Key assumptions used for the calculation were: – Embedded value represents the shareholder interest in the life business and is calculated in accordance with the Market Consistent Embedded Value (MCEV) principles. The embedded value is the total of the net worth of the life business and the value of the in-force business. The underlying methodology and assumptions have been reviewed by a firm of actuarial consultants; – New business contribution represents the present value of projected future distributable profits generated from business written in a period. This is initially based on the most recent three year business plans approved by management; – Growth rate represents the rate used to extrapolate new business contributions beyond the business plan period, and is based on management’s estimate of future growth of 5%; and
– Risk adjusted discount rate of 21% represents the rate used to discount expected profits from future new business. The discount rate reflects a risk margin to make prudent allowance for the risk that experience in future years for new business may differ from that assumed.
Share of results after tax – 47 – 47 Amortisation of acquired value of in-force business (12) – – (12)
Share of results after tax – (63) – (63) Impairment of goodwill and intangibles (16) – – (16) Amortisation of acquired value of in-force business (11) – – (11)
Share of loss after tax (27) (63) – (90) Additions (see below) 14 56 – 70 Disposals – (12) – (12) Fair value losses taken to equity – (81) – (81) Dividends received – (87) – (87) Reclassification from investment in subsidiaries – 55 – 55 Reclassification from financial investments – 62 – 62 Foreign exchange rate movements 13 109 1 123
Cyrte Fund I CV Investment fund Partnership share 13.04% Netherlands Cyrte Fund II BV Investment fund Ordinary shares of €1 each 16.00% Netherlands Cyrte Fund III CV Investment fund Partnership share 17.91% Netherlands RBSG Collective Investments
The Group’s Dutch subsidiary owns 30.1% of the shares, and depositary receipts for shares, in Van Lanschot NV, a financial services company in the Netherlands. The Group is not able to appoint management representation on the board of this company and is therefore unable to exert significant influence over its affairs. Accordingly, this investment is treated as a financial investment rather than as an associate.
Share of revenues 460 385 Share of results before tax (54) 51 Share of assets 3,812 3,123 Share of liabilities (2,974) (2,324)
Key assumptions used for the calculation were: – A cash flow project based on a three year plan period. Cash flows beyond that three year period have been extrapolated using a steady 2% growth rate; – Risk adjusted discount rate of 8.5% based on the weighted average cost of capital of similar Italian listed companies; and
As a result of the testing, an impairment of £12 million has been recognised.
Less: Amounts classified as held for sale: Gross amount – – – (25) (130) (155) Accumulated depreciation and impairment – – – 9 44 53
Fair value losses of £37 million have been charged (2007: £23 million gains credited) to equity (note 34), with the remainder being charged to the income statement.
If owner-occupied properties were stated on a historical cost basis, the carrying amount would be £414 million (2007: £301 million).
This note gives details of the properties we hold for long-term rental yields or capital appreciation.
Carrying value At 1 January 2007 11,996 3,127 15,123 Additions 1,769 109 1,878 Capitalised expenditure on existing properties 138 11 149 Acquisitions of subsidiaries 4 – 4 Disposals of subsidiaries (3) – (3) Fair value losses (660) (97) (757) Disposals (861) (432) (1,293) Transfers from property and equipment 10 31 41 Foreign exchange rate movements 210 39 249
At 31 December 2007 12,603 2,788 15,391 Additions 1,744 2 1,746 Capitalised expenditure on existing properties 92 8 100 Acquisitions of subsidiaries 81 – 81 Fair value losses (2,441) (696) (3,137) Disposals (852) (297) (1,149) Transfers (2) 2 – Foreign exchange rate movements 1,276 118 1,394
Loans to banks include cash collateral received under stock lending arrangements (see note 24(d)). The obligation to repay this collateral is included in payables and other financial liabilities (note 48).
Of the above loans, £30,673 million (2007: £25,666 million) is expected to be recovered more than one year after the balance sheet date.
The change in fair value of these loans during the year, attributable to a change in credit risk, was a loss of £644 million (2007: £210 million). The cumulative change attributable to changes in credit risk to 31 December 2008 was a loss of £854 million (2007: £210 million).
Loans at amortised cost The fair value of these loans at 31 December 2008 was £20,218 million (2007: £17,588 million).
The amount of collateral received with respect to loans which the Group is permitted to sell or repledge in the absence of default was £3,880 million (2007: £6,282 million). No collateral was actually sold or repledged in the absence of default during the year (2007: £nil).
All the shares in the ERF companies are held by independent companies, whose shares are held on trust. Although NUER does not own, directly or indirectly, any of the share capital of the ERF companies or their parent companies, it retains control of the residual or ownership risks related to them, and they have therefore been treated as subsidiaries in the consolidated financial statements. NUER has no right to repurchase the benefit of any of the securitised mortgage loans, other than in certain circumstances where NUER is in breach of warranty or loans are substituted in order to effect a further advance.
(iii) General In all of the above transactions, the Company and its subsidiaries are not obliged to support any losses that may be suffered by the noteholders and do not intend to provide such support. Additionally, the notes were issued on the basis that noteholders are only entitled to obtain payment, of both principle and interest, to the extent that the available resources of the respective special purpose securitisation companies, including funds due from customers in respect of the securitised loans, are sufficient and that noteholders have no recourse whatsoever to other companies in the Aviva Group.
Notes to the consolidated financial statements continued 23 – Securitised mortgages and related assets continued
Netherlands Securitised mortgage loans – At fair value (note 22) 4,936 (4,820) 3,699 (3,706) – At amortised cost (note 22) 2,262 (2,353) 1,911 (2,283)
Total loan notes issued, as above 1,614 7,173 1,691 5,989 Less: Loan notes held by Group companies (24) (978) (17) (369)
Loan notes held by third parties (note 47(c)) 1,590 6,195 1,674 5,620
Fixed maturity securities Debt securities UK government – 18,854 – 18,854 UK local authorities – 17 – 17 Non-UK government 9 40,015 756 40,780 Public utilities – 4,308 1,226 5,534 Convertibles and bonds with warrants attached – 855 – 855 Other 47 64,379 18,368 82,794 56 128,428 20,350 148,834 Certificates of deposit – 1,288 10 1,298 Redeemable preference shares – 349 110 459
Other investments Unit trusts and other investment vehicles – 28,850 139 28,989 Derivative financial instruments (note 56d) 2,910 – – 2,910 Deposits with credit institutions 115 436 – 551 Minority holdings in property management undertakings – 969 – 969 Other investments – long-term – 2,686 4 2,690 Other investments – short-term – 3 4 7
Total financial investments 3,090 200,994 26,034 230,118 Less assets classified as held for sale Fixed maturity securities – (336) – (336) Equity securities – (60) – (60) – (396) – (396)
Notes to the consolidated financial statements continued 24 – Financial investments continued
Other investments Unit trusts and other investment vehicles 4 31,221 181 31,406 Derivative financial instruments (note 56d) 1,609 – – 1,609 Deposits with credit institutions 114 502 – 616 Minority holdings in property management undertakings – 977 – 977 Other long-term investments – 1,640 17 1,657 Other short-term investments – 4 – 4
(b) Fair value methodology (i) For investments carried at fair value, we have categorised the measurement basis into a “fair value hierarchy” as follows: Quoted market prices in active markets – (“Level 1”) Inputs to Level 1 fair values are quoted prices (unadjusted) in active markets for identical assets. An active market is one in which transactions for the asset occur with sufficient frequency and volume to provide pricing information on an ongoing basis. Examples are listed equities in active markets, listed debt securities in active markets and quoted unit trusts in active markets.
Examples of these are securities measured using discounted cash flow models based on market observable swap yields, investment property measured using market observable information, and listed debt or equity securities in a market that is inactive.
Internal models with significant unobservable market parameters – (“Level 3”) Inputs to Level 3 fair values are unobservable inputs for the asset. Unobservable inputs may have been used to measure fair value to the extent that observable inputs are not available, thereby allowing for situations in which there is little, if any, market activity for the asset at the measurement date (or market information for the inputs to any valuation models). As such, unobservable inputs reflect the assumptions the business unit considers that market participants would use in pricing the asset. Examples are certain private equity investments and private placements.
The majority of the Group’s investments are valued based on quoted market information or observable market data. A small percentage (1%) of total assets recorded at fair value, are based on estimates and recorded as Level 3 investments. Where estimates are used, these are based on a combination of independent third-party evidence and internally developed models, calibrated to market observable data where possible. Whilst such valuations are sensitive to estimates, it is believed that changing one or more of the assumptions to reasonably possible alternative assumptions would not change the fair value significantly.
Notes to the consolidated financial statements continued 24 – Financial investments continued (ii) An analysis of investments according to fair value hierarchy is given below: Fair value hierarchy £m Level 3 £m
Investment property – 15,391 – 15,391 – – 15,391 Loans – 18,540 – 18,540 17,653 – 36,193 Fixed maturity securities 101,422 18,710 1,260 121,392 – (80) 121,312 Equity securities 54,124 4,309 632 59,065 – (236) 58,829 Other investments (including
Total funds Balance at 1 January 2008 2,211 Total net gains or losses recognised in the income statement (97) Purchases, issues, disposals and settlements (net) 270 Net transfers out of Level 3 (209) Foreign exchange rate movements 672
Policyholder funds Balance at 1 January 2008 28 Total gains or losses recognised in the income statement – Purchases, issues, disposals and settlements (net) 13 Transfers into/(out of) Level 3 (8) Foreign exchange rate movements 6
Participating funds Balance at 1 January 2008 1,498 Total gains or losses recognised in the income statement (18) Purchases, issues, disposals and settlements (net) 166 Transfers into/(out of) Level 3 (858) Foreign exchange rate movements 240
Shareholder funds Balance at 1 January 2008 685 Total gains or losses recognised in the income statement (79) Purchases, issues, disposals and settlements (net) 91 Transfers into/(out of) Level 3 657 Foreign exchange rate movements 426
(c) Cost, unrealised gains and fair value The following is a summary of the cost/amortised cost, gross unrealised gains and losses and fair value of financial investments: Cost/ amortised cost £m
Fixed maturity securities 121,973 1,970 (2,551) 121,392 Equity securities 50,635 9,052 (622) 59,065 Other investments Unit trusts and investment vehicles 28,684 3,106 (384) 31,406 Derivative financial instruments – 1,609 – 1,609 Deposits with credit institutions 616 – – 616 Minority holdings in property management undertakings 977 – – 977 Other long-term investments 1,465 249 (57) 1,657 Other short-term investments 4 – – 4
(i) Stock lending arrangements The Group has entered into stock lending arrangements in the UK and overseas during the year in accordance with established market conventions. The majority of the Group’s stock lending transactions occurs in the UK, where investments are lent to EEA-regulated, locally-domiciled counterparties and governed by agreements written under English law.
In certain markets, the Group or the Group’s appointed stock lending managers obtain legal ownership of the collateral received and can re-pledge it as collateral elsewhere or sell outright in the absence of default. The carrying amounts of financial assets received and pledged in this manner at 31 December 2008 were £18,486 million and £322million respectively (2007: £23,779 million and £4 million respectively). The value of collateral that was actually sold or re-pledged in the absence of default was £nil million (2007: £nil).
(iii) Other arrangements In carrying on its bulk purchase annuity business, the Group’s UK Life operation is required to place certain investments in trust on behalf of the policyholders. Amounts become payable from the trust funds to the trustees if the Group were to be in breach of its payment obligations in respect of policyholder benefits. At 31 December 2008, £474 million (2007:£nil) of financial investments were restricted in this way.
Notes to the consolidated financial statements continued 25 – Receivables and other financial assets
Expected to be recovered in less than one year 9,116 8,261 Expected to be recovered in more than one year 700 358
(b) Movements in the year The movements in deferred acquisition costs during the year were: Long-term business £m
Carrying amount at 1 January 1,778 1,422 22 3,222 Acquisition costs deferred during the year 1,018 2,778 10 3,806 Amortisation (196) (2,693) (5) (2,894) Impact of assumption changes 32 – – 32 Effect of portfolio transfers, acquisitions and disposals 2 34 – 36 Foreign exchange rate movements 55 42 – 97 Shadow adjustment 22 – – 22
(d) Prepayments and accrued income Prepayments and accrued income of £3,762 million (2007:£2,986 million), include £259 million (2007: £111 million) that is expected to be recovered more than one year after the balance sheet date.
The carrying values of assets backing unit-linked liabilities are as follows: £m
Loans 1,799 347 Debt securities 19,588 15,065 Equity securities 23,840 27,743 Other investments 28,799 33,171 Reinsurance assets 1,704 1,905 Cash and cash equivalents 4,125 3,939 28 – Ordinary share capital
The authorised share capital of the Company at 31 December 2008 was: 3,000,000,000 (2007: 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 2008 was: 2,657,701,624 (2007: 2,621,792,828) ordinary shares of 25 pence each 664 655
(b) During 2008, a total of 35,908,796 ordinary shares of 25 pence each were allotted and issued by the Company as follows: Number of shares Share capital £m
At 1 January 2,621,792,828 655 1,223 Shares issued under the Group’s Employee and Executive Share Option
Shares in lieu of the 2007 final dividend were issued on 16 May 2008. 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.
This note describes the various equity compensation plans we use, and shows how we value the options and awards of shares in the Company.
(ii) Executive share options These are options granted on various dates from 1998 to 2004, under the Aviva Executive Share Option Scheme or predecessor schemes. Options granted between 1998 and 2000 were subject to the satisfaction of conditions relating to either the Company’s return on equity shareholders’ funds (ROE) or its relative total shareholder return (TSR) against a chosen comparator group. In respect of options granted from 2000 the performance condition has been a mixture of both ROE and TSR measures. In all cases, performance is measured over a three-year performance period and the options are normally exercisable between the third and tenth anniversary of their grant.
(iv) Long-term incentive plan awards These awards have been made under the Aviva Long-Term Incentive Plan 2005 and are described in Section (b) below and in the Directors’ remuneration report.
(i) Share options At 31 December 2008, options to subscribe for ordinary shares of 25 pence each in the Company were outstanding as follows: Aviva Savings Related Share Option Scheme
Notes to the consolidated financial statements continued 29 – Equity compensation plans continued RAC Savings Related Share Option Scheme
The comparative figures as at 31 December 2007 were: Range of exercise prices
(c) Movements in the year A summary of the status of the option plans as at 31 December 2008 and 2007, and changes during the years ended on those dates, is shown below.
Notes to the consolidated financial statements continued 29 – Equity compensation plans continued
(e) Fair value of options and awards granted after 7 November 2002 The weighted average fair values of options and awards granted during the year, estimated by using the Black-Scholes option-pricing model, were £1.99 and £4.44 (2007: £2.13 and £6.17) respectively.
1,112,282 options granted after 7 November 2002 were exercised during the year (2007: 1,496,069).
(ii) Share awards The fair value of the awards was estimated on the date of grant, based on the following weighted average assumptions: Weighted average assumption 2008 2007
Cost debited to shareholders’ funds At 1 January 1,521,064 10 682,202 – Acquired in the year 8,500,000 29 1,556,583 10 Distributed in the year (1,385,482) (6) (717,721) –
The preference share capital of the Company at 31 December 2008 was: £m
The Sterling preference shares, if issued and allotted, would rank, as to payment of a dividend and capital, ahead of the Company’s ordinary share capital but behind the cumulative irredeemable preference shares currently in issue. The issued preference shares are non-voting except where their dividends are in arrears, on a winding up or where their rights are altered. On a winding up, they carry a preferential right of return of capital ahead of the ordinary shares. The Company does not have a contractual obligation to deliver cash or other financial assets to the preference shareholders and therefore the directors may make dividend payments at their discretion.
Notes to the consolidated financial statements continued 32 – Direct capital instrument
This note gives details of the direct capital instrument issued in November 2004.
Notional amount 2008 £m 5.9021% £500 million direct capital instrument 500 500 4.7291% €700 million direct capital instrument 490 490
Prior to 1 January 2004, certain significant business combinations were accounted for using the “pooling of interests method” (or merger accounting), which treats the merged groups as if they had been combined throughout the current and comparative accounting periods. Merger accounting principles for these combinations gave rise to a merger reserve in the consolidated balance sheet, being the difference between the nominal value of new shares issued by the Parent Company for the acquisition of the shares of the subsidiary and the subsidiary’s own share capital and share premium account.
Balance at 31 December 2007 432 192 819 (63) 89 1,469 Arising in the year: Fair value losses – (37) (2,344) – – (2,381) Fair value gains transferred to profit on disposals – – (126) – – (126) Fair value losses transferred to retained earnings on disposals (note 35) – 1 – – – 1 Share of fair value changes in joint ventures and associates taken to equity (notes 18a & 19a) – – (93) – – (93)
Reserves credit for equity compensation plans (note 29d) – – – – 39 39
Foreign exchange rate movements 3,222 – – (1,040) – 2,182 Aggregate tax effect – shareholders’ tax – 1 203 – – 204
Balance at 1 January as reported 6,338 5,082 Prior year adjustment – impact of discounting on latent claims (note 2b(i)) – 112
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 2007 final dividend, as explained in note 28(b).
Notes to the consolidated financial statements continued 37 – Contract liabilities and associated reinsurance
The following is a summary of the contract provisions and related reinsurance assets as at 31 December.
(263,747) 5,565 (258,182) (233,556) 5,781 (227,775) Outstanding claims provisions Long-term business (907) 145 (762) (727) 94 (633) General insurance and health (11,842) 1,737 (10,105) (10,842) 1,634 (9,208)
(12,749) 1,882 (10,867) (11,569) 1,728 (9,841) Provisions for claims incurred but
(279,014) 7,476 (271,538) (247,224) 7,538 (239,686) Provision for unearned premiums (5,493) 418 (5,075) (5,484) 511 (4,973) Provision arising from liability adequacy tests (13) – (13) (24) – (24) Other technical provisions – – – (3) 5 2
Long-term business provisions Participating 66,863 – 66,863 66,093 – 66,093 Unit-linked non-participating 22,060 – 22,060 20,601 – 20,601 Other non-participating 67,265 – 67,265 48,618 – 48,618
Provision for unearned premiums – 5,493 5,493 – 5,484 5,484 Provision arising from liability adequacy tests – 13 13 – 24 24 Other technical provisions – – – – 3 3
(ii) Group practice The long-term business provision is calculated separately for each of the Group’s life operations. The provisions for overseas subsidiaries have generally been included on the basis of local regulatory requirements, mainly using the net premium method, modified where necessary to reflect the requirements of the Companies Act.
Material judgement is required in calculating the provisions and is exercised particularly through the choice of assumptions where discretion is permitted. 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.
38 – Insurance liabilities continued The principal assumptions underlying the cost of future policy related liabilities are as follows: Future investment return A “risk-free” rate equal to the spot yield on gilts, plus a margin of 0.1% is used. The rates vary, according to the outstanding term of the policy, with a typical rate as at 31 December 2008 being 3.58% (2007: 4.72%) for a policy with ten years outstanding.
Future regular bonuses Annual bonus assumptions for 2009 have been set consistently with the year end 2008 declaration. Future annual bonus rates reflect the principles and practices of the fund. In particular, the level is set with regard to the projected margin for final bonus and the change from one year to the next is limited to a level consistent with past practice.
Mortality Mortality assumptions are set with regard to recent company experience and general industry trends. The mortality tables used in the valuation are summarised below: Mortality table used
Notes to the consolidated financial statements continued 38 – Insurance liabilities continued Valuation discount rates for business in the non-profit funds are as follows: Valuation discount rates
Assurances Life conventional non-profit 2.7% to 3.4% 3.1% to 3.9% Pensions conventional non-profit 3.4% to 3.6% 3.9% to 4.1% Deferred annuities Non-profit – in deferment 3.8% 4.3% Non-profit – in payment 3.4% to 3.6% 3.9% to 4.1% Annuities in payment Conventional annuity 3.8% to 5.4% 4.3% to 5.2% Non-unit reserves Life 3.0% 3.4% Pensions 3.7% 4.2%
Mortality assumptions are set with regard to recent company experience and general industry trends. Since 2006, the assurance mortality basis has been reviewed with the aim of harmonising assumptions wherever possible across similar lines of business in order to simplify the basis. The mortality tables used in the valuation are summarised below: Mortality tables used
Pure endowments and deferred annuities before vesting AM00/AF00 adjusted Nil or AM80/AF80 or AM92/AF92 adjusted
Life assurances Market risk-free yield curves, based on iBoxx index for collateralised AAA bonds (2007: based on DNB swap rates)
The indexed life and annuity products guarantee the return of principal to the customer, and credit interest based on certain indices. A portion of the premium from each customer is invested in fixed income securities and is intended to cover the minimum guaranteed value. A further portion of the premium is used to purchase derivatives to hedge the growth in interest credited to the customer as a direct result of increases in the related indices. Both the derivatives and the options embedded in the policy are valued at their fair value.
Notes to the consolidated financial statements continued 38 – Insurance liabilities continued
(i) Provisions for outstanding claims Delays occur in the notification and settlement of claims and a substantial measure of experience and judgement is involved in assessing outstanding liabilities, the ultimate cost of which cannot be known with certainty at the balance sheet date. The reserves for general insurance and health are based on information currently available. However, it is inherent in the nature of the business written that the ultimate liabilities may vary as a result of subsequent developments.
The gross outstanding claims provision before discounting was £15,061 million (2007: £13,439 million). The period of time which will elapse before the liabilities are settled has been estimated by modelling the settlement patterns of the underlying claims.
(ii) Assumptions Outstanding claims provisions are estimated based on known facts at the date of estimation. Case estimates are generally set by skilled claims technicians, applying their experience and knowledge to the circumstances of individual claims. The ultimate cost of outstanding claims is then estimated by using a range of standard actuarial claims projection techniques, such as the Chain Ladder and Bornhuetter-Ferguson methods. The main assumption underlying these techniques is that a company’s past claims development experience can be used to project future claims development and hence ultimate claims costs. As such, these methods extrapolate the development of paid and incurred losses, average costs per claim and claim numbers based on the observed development of earlier years and expected loss ratios. Historical claims development is mainly analysed by accident period, although underwriting or notification period is also used where this is considered appropriate.
Incurred claims losses and expenses 8,368 7,316 Less: Payments made on claims incurred in the current year (4,682) (4,408) Payments made on claims incurred in prior years (4,307) (3,686) Recoveries on claim payments 293 315
( )Claims payments made in the year, net of recoveries (8,696) (7,779) Unwind of discounting 33 35 Other movements in the claims provisions (27) 36
The effect of changes in the main assumptions is given in note 42 and the economic assumption changes are explained in note 9.
The Institute of Actuaries’ Asbestos Working Party report in 2008 contributed to our view that experience variances, which we had previously perceived as normal short-term volatility, reflected a real worsening of expected ultimate claims experience. The market trend in mesothelioma claims has been fully reflected as a significant one-off strengthening of gross latent claims reserves in 2008 of £356 million, with a corresponding increase of £52 million in reinsurance recoverable. The net increase of £304 million comprises £668 million on an undiscounted basis and discounting of £364 million. Due to its size and the fact that this related to discontinued business, this one-off strengthening has been reported as an exceptional item below operating profit.
Whilst this is a significant step change, it should be noted that this reflects the long-term impact of the settlement of latent claims currently running at £30 million per annum, of which £25 million related to mesothelioma. The number of claims is currently predicted to rise slightly in the period to 2015 and then diminish slowly over the next 30 years to 2045.
(i) Description of tables The tables that follow present the development of claim payments and the estimated ultimate cost of claims for the accident years 2001 to 2008. The upper half of the tables shows the cumulative amounts paid during successive years related to each accident year. For example, with respect to the accident year 2002, by the end of 2008 £5,715 million had actually been paid in settlement of claims. In addition, as reflected in the lower section of the table, the original estimated ultimate cost of claims of £6,250 million was re-estimated to be £6,056 million at 31 December 2008. This decrease from the original estimate is due to the combination of a number of factors.
At end of accident year (3,029) (2,952) (2,819) (2,971) (3,345) (3,653) (4,393) (4,915) One year later (4,766) (4,486) (4,190) (4,561) (5,011) (5,525) (6,676) Two years later (5,303) (4,921) (4,613) (4,981) (5,449) (5,971) Three years later (5,701) (5,233) (4,972) (5,263) (5,784) Four years later (5,966) (5,466) (5,258) (5,448) Five years later (6,121) (5,618) (5,409) Six years later (6,223) (5,715) Seven years later (6,294) Estimate of gross ultimate claims At end of accident year 6,590 6,250 6,385 6,891 7,106 7,533 8,530 9,508 One year later 6,770 6,372 6,172 6,557 6,938 7,318 8,468 Two years later 6,775 6,287 6,124 6,371 6,813 7,243 Three years later 6,798 6,257 6,036 6,178 6,679 Four years later 6,754 6,205 5,932 6,008 Five years later 6,679 6,122 5,853 Six years later 6,630 6,056 Seven years later 6,576 Estimate of gross ultimate
Present value recognised in the balance sheet 2,939 346 419 635 709 1,088 1,543 2,076 4,605 14,360
At end of accident year (2,970) (2,913) (2,819) (2,870) (3,281) (3,612) (4,317) (4,808) One year later (4,624) (4,369) (4,158) (4,378) (4,925) (5,442) (6,542) Two years later (5,088) (4,779) (4,565) (4,712) (5,344) (5,881) Three years later (5,436) (5,064) (4,924) (4,986) (5,671) Four years later (5,648) (5,297) (5,180) (5,163) Five years later (5,763) (5,424) (5,325) Six years later (5,841) (5,508) Seven years later (5,896) Estimate of net ultimate claims At end of accident year 6,186 6,037 6,218 6,602 6,982 7,430 8,363 9,262 One year later 6,333 6,038 6,093 6,266 6,818 7,197 8,302 Two years later 6,321 5,997 6,037 6,082 6,688 7,104 Three years later 6,329 5,973 5,942 5,882 6,544 Four years later 6,286 5,912 5,851 5,709 Five years later 6,219 5,855 5,772 Six years later 6,173 5,786 Seven years later 6,109 Estimate of net ultimate
Claims previously discounted (19) (4) (4) (4) (2) (3) (4) (6) (11) (57) New discounted claims (390) – – – – – – – – (390)
Present value 1,691 209 274 443 544 870 1,219 1,754 4,443 11,447 Cumulative effect of
The effect of discounting on new discounted claims relates to the discounting of latent claims introduced for the first time in 2008.
The loss development tables above include information on asbestos and environmental pollution claims provisions from business written before 2001. The undiscounted claim provisions, net of reinsurance, in respect of this business at 31 December 2008 were £1,019 million (2007: £323 million). The movement in the year reflects exceptional strengthening of provisions by £668 million due to the increased market trend in mesothelioma claim notifications, other strengthening of £16 million (2007: £20 million), foreign exchange rate movements and timing differences between claim payments and reinsurance recoveries.
Carrying amount at 31 December 5,493 5,484 39 – Liability for investment contracts
This note analyses our investment contract liabilities by type of product and describes how we calculate these liabilities and what assumptions we have used.
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 38. 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 39 – Liability for investment contracts continued In the United States, funding agreements consist of one to ten year fixed rate contracts. These contracts may not be cancelled by the holders unless there is a default under the agreement, but may be terminated by Aviva at any time. The weighted average interest rates for fixed-rate and floating-rate funding agreements in 2008 were 4.89% and 2.58% (2007: 5.21% and 5.15%) respectively. The funding agreements issued before 2008 are measured at fair value equal to the present value of contractual cash flows, and for new business in 2008 are measured at amortised cost. Most funding agreements are fully collateralised and therefore their fair values are not adjusted for own credit risk.
(ii) No market valuation reduction (MVR) guarantees For unitised business, there are a number of circumstances where a “no MVR” guarantee is applied, for example on certain policy anniversaries, guaranteeing that no market value reduction will be applied to reflect the difference between the accumulated value of units and the market value of the underlying assets.
Notes to the consolidated financial statements continued 40 – Financial guarantees and options continued
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 2008.
The most significant of these contracts is the AFER Eurofund which has total liabilities of £33 billion at 31 December 2008 (2007: £24 billion). The guaranteed bonus on this contract equals 75% of the average of the last two years’ declared bonus rates and was 3.66% for 2008 (2007: 3.64%) compared with an accounting income from the fund of 4.85% (2007: 4.92%).
Non-AFER contracts with guaranteed surrender values had liabilities of £12 billion (2007: £8 billion) at 31 December 2008 and all guaranteed annual bonus rates are between 0% and 4.5%. For non-AFER business, the accounting income return exceeded guaranteed bonus rates in 2008.
The total liabilities for traditional business at 31 December 2008 are £14 billion (2007: £10 billion) analysed as follows: Liabilities 3% guarantee 31 December £m
Delta Lloyd has certain unit-linked contracts which provide a guaranteed minimum return at maturity from 4% pa to 2% pa. Provisions consist of unit values plus an additional reserve for the guarantee. The additional provision for the guarantee was £226 million (2007: £70 million). An additional provision of £121 million (2007: £19 million) in respect of investment return guarantees on group segregated fund business is held. It is estimated that the provision would increase by £255 million (2007: £211 million) if yields were to reduce by 1% pa and by £56 million (2007: £21 million) if equity markets were to decline by 10% from year end 2008 levels.
These guarantees are currently “in-the-money” by £16 million (2007:”out-of-the-money” by £53 million). This has been calculated on a deterministic basis as the excess of the current policy surrender value over the discounted value (excluding terminal bonus) of the guarantees. The value of these guarantees is usually sensitive to the performance of investments held in the with-profit fund. Amounts payable under these guarantees are determined by the bonuses declared on these policies. It is estimated that the guarantees would be “in-themoney ” by £16 million (2007: “out-of-the-money” by £46 million) if yields were to increase by 1% per annum and by £16 million (2007: “out-of-the-money” by £29 million) if equity markets were to decline by 10% from year end 2008 levels. There is no sensitivity to either interest rates or equity markets since there is no longer any exposure to equity in these funds and a matching strategy has been implemented for bonds.
It is estimated that the provision would increase by £4 million (2007: £1 million) if equity markets were to decline by 10% from the year end 2008 levels. However, the provision increase would be broadly off-set by an increase in the value of the hedging assets that were set up on sale of these policies. We would not expect any significant impact on this provision as a result of interest rate movements. It is estimated that the provision would increase by £2 million if property values were to decline by 10% from year end 2008 levels. This would be offset by an increase in the value of the hedging assets by £1 million, the difference reflecting the fact that only the second tranche was hedged for property exposure.
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 derivatives to hedge the growth in interest credited to the policyholder. The derivatives held by the Group and the options embedded in the policy are both carried at fair value. The US Treasury swap curve plus a risk adjustment of 5.30% (2007: 1.05%) is used as the discount rate to calculate the fair value of the embedded options.
Long-term business Insurance contracts 4,466 4,298 Participating investment contracts 52 22 Non-participating investment contracts 1,047 1,461 Outstanding claims provisions 145 94
Carrying amount at 1 January 5,781 5,534 Asset in respect of new business 235 216 Expected change in existing business asset 243 (124) Variance between actual and expected experience (1,141) 52 Impact of other operating assumption changes (761) 14 Impact of economic assumption changes 306 (122) Other movements (231) (40)
(Change in asset (1,349) (4) Effect of portfolio transfers, acquisitions and disposals 140 24 Foreign exchange rate movements 993 227
The one-off strengthening of latent claims reserves during 2008, described in note 38(c)(iii), resulted in an increase in the reinsurers’ share of claims and losses of £52 million.
Carrying amount at 31 December 418 511 42 – Effect of changes in assumptions and estimates during the year
Assumptions Long-term insurance business Interest rates (521) 850 Expenses 24 (13) Persistency rates 2 (2) Mortality for assurance contracts 44 16 Mortality for annuity contracts 26 11 Tax and other assumptions 93 60 Investment contracts Interest rates (75) 12 Expenses (27) 5 Persistency rates 2 – Tax and other assumptions 36 7 General insurance and health business Change in loss ratio assumptions (1) – Change in discount rate assumptions (94) 3 Change in expense ratio assumptions – (4)
An unallocated divisible surplus (UDS) is established where the nature of policy benefits is such that the division between shareholder reserves and policyholder liabilities is uncertain. This note shows the movements in this surplus during the year.
In France, Italy and Spain the UDS balances were £924 million negative in total at 31 December 2008 (2007: £116 million negative) because of an accounting mismatch between participating assets carried at market value and participating liabilities measured using local practice. In each case the negative balance is considered to be recoverable from margins in the existing participating business liabilities.
(a) Current tax Current tax assets and liabilities payable in more than one year are £230 million and £362 million (2007: £223 million and £769 million).
The taxation of foreign profits and worldwide debt cap rules has been the subject of consultation for some considerable time and HMRC are expected to announce measures in the Finance Bill 2009. It is not possible to quantify the impact of these measures at the balance sheet date.
Long-term business technical provisions and other insurance items 467 905 Deferred acquisition costs (769) (170) Unrealised gains/(losses) on investments 724 (1,577) Pensions and other post-retirement obligations 109 79 Unused losses and tax credits 702 465 Subsidiaries, associates and joint ventures 6 (194) Intangibles and additional value of in-force long-term business (1,090) (811) Provisions and other temporary differences (527) (639)
Deferred tax assets are recognised to the extent that it is probable that future taxable profits will be available against which the temporary differences can be utilised. In countries where there is a history of tax losses, deferred tax assets are only recognised in excess of deferred tax liabilities if there is convincing evidence that future profits will be available. Where this is the case the directors have relied on business plans supporting future profits.
The Group has unrecognised tax losses and other temporary differences of £2,961 million (2007: £1,805 million) to carry forward against future taxable income of the necessary category in the companies concerned. Of these, trading losses of £279 million will expire in the next 5-15 years. The remaining losses have no expiry date.
Deferred tax liabilities of £912 million (2007: £666 million) have not been established for temporary differences associated with investments in subsidiaries and interests in joint ventures and associates (including tax payable on remittance of overseas retained earnings) because the Group can control the timing of the reversal of these differences and it is probable that they will not reverse in the foreseeable future. Such unremitted earnings totalled £6,121 million at 31 December 2008 (2007: £4,258 million).
This note details the non-insurance provisions that the Group holds, and shows the movements in these during the year.
Charge to income statement 198 168 366 Utilised during the year (300) (101) (401) Acquisition of subsidiaries – 1 1 Foreign exchange rate movements 3 3 6
At 31 December 2007 135 572 707 Additional provisions 355 307 662 Unused amounts reversed (9) (73) (82) Change in the discounted amount arising from passage of time – 5 5
Charge to income statement 346 239 585 Utilised during the year (248) (193) (441) Acquisition of subsidiaries – 39 39 Foreign exchange rate movements 20 65 85
This note describes the Group’s pension arrangements for its employees and explains how our obligations to these schemes are calculated.
(c) 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).
(ii) Defined contribution (money purchase) section of the ASPS The trustees have responsibility for selecting a range of suitable funds in which the members can choose to invest and for monitoring the performance of the available investment funds. Members are responsible for reviewing the level of contributions they pay and the choice of investment fund to ensure these are appropriate to their attitude to risk and their retirement plans. The employers’ contribution rates for members of the defined contribution section throughout 2008 were 8% of pensionable salaries, together with further contributions up to 4% where members contribute, and the cost of the death-in-service benefits. These contribution rates are unchanged for 2009.
(d) Charges to the income statement The total pension costs of the Group’s defined benefit and defined contribution schemes were: UK defined benefit schemes 115 137 Overseas defined benefit schemes 60 54
Total defined benefit schemes (note 10b) 175 191 UK defined contribution schemes 39 44 Overseas defined contribution schemes 19 19
There is a small buy-out market in Ireland, largely restricted to pensions currently in payment and it is not clear whether current capacity would enable an immediate buy-out of our Irish pension liabilities at present. The Canadian defined benefit plan’s liabilities represent the likely limit on what the Canadian group annuity market could absorb at normal competitive group annuity prices if the entire plan were subject to a buy-out valuation. There is in fact a reasonably high chance that only a portion of the plan’s liabilities could be absorbed in one tranche.
Valuations and assumptions 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 2008. The updating was made by actuaries in each country who were independent of the Group. Scheme assets are stated at their fair values at 31 December 2008.
46 – Pension obligations continued The main actuarial assumptions used to calculate scheme liabilities under IAS 19 are: UK Netherlands Canada Ireland discount rate
AA-rated corporate bonds * Age-related scale increases plus 3% (2007: 3%).
**2.0% until 2011 and 1.3% thereafter (2007: 2.0% and 2.4% respectively).
The discount rate and pension increase rate are the two assumptions that have the largest impact on the value of the liabilities, with the difference between them being known as the net discount rate. For each country, the discount rate is based on current average yields of high quality debt instruments taking account of the maturities of the defined benefit obligations. A 1% increase in this rate (and therefore the net discount rate) would reduce the liabilities by £1.4 billion and the service cost for the year by £24 million.
The mortality tables, average life expectancy and pension duration used at 31 December 2008 for scheme members are as follows: Life expectancy/pension duration at NRA of a male Life expectancy/pension duration at NRA of a female
The assumptions above are based on commonly-used mortality tables. In the UK, the standard mortality tables have been adjusted to reflect recent research into mortality experience. However, the extent of future improvements in longevity is subject to considerable uncertainty and judgement is required in setting this assumption. In the UK schemes, which are by far the most material to the Group, the assumptions include an allowance for future mortality improvement, based on the actuarial profession’s medium cohort projection table and incorporating underpins to the rate of future improvement equal to 1.5% p.a. for males and 1.0% p.a. for females. The effect of assuming all members were one year younger would increase the above schemes’ liabilities by £180 million and the service cost for the year by £18 million.
Notes to the consolidated financial statements continued 46 – Pension obligations continued
Expected return on scheme assets (706) (614) Actual (negative)/positive return on these assets (1,245) 404
Actuarial losses on admissible assets (1,893) (138) Experience gains/(losses) arising on scheme liabilities 105 (80) Changes in assumptions underlying the present value of the scheme liabilities 859 902 Loss on acquisitions – (36)
The cumulative amount of actuarial gains and losses on the pension schemes recognised in the statement of recognised income and expense since 1 January 2004 (the date of transition to IFRS) is a loss of £1,090 million at 31 December 2008 (2007: loss of £161 million).
Fair value of scheme assets at the end of the year 7,936 8,814 8,137 7,334 5,473 Present value of scheme liabilities at the end of the year (9,951) (10,017) (10,196) (9,680) (7,179)
Present value of scheme liabilities (7,732) (8,229) (1,424) (1,049) (250) (289) (545) (450) (9,951) (10,017)
(Deficits)/surplus in the schemes (445) (126) (15) (21) (68) (58) (85) 27 (613) (178)
Total fair value of assets 7,287 8,103 7 3 182 231 460 477 7,936 8,814
The change in the pension schemes’ net deficits during 2008 is mainly attributable to the fall in equity and property investment values, partly offset by favourable changes in assumptions underlying the present value of the schemes’ liabilities and further deficit contribution payments to the main UK scheme made by the employing companies.
Debenture loans 9.5% guaranteed bonds 2016 198 £ – – 200 – – 200 2.5% subordinated perpetual loan notes 127 € – – – – 360 360 Other loans 10 various – 10 – – – 10
The securitised mortgage loan notes at various fixed, floating and index-linked rates. For further details about the securitised loan notes see note 23.
Notes to the consolidated financial statements continued 47 – Borrowings continued
The subordinated notes were issued by the Company. They rank below its senior obligations and ahead of its preference shares and ordinary share capital. The dated subordinated notes rank ahead of the undated subordinated notes. The fair value of these notes at 31 December 2008 was £2,979 million (2007: £3,006 million), calculated with reference to quoted prices.
All these borrowings are at fixed rates and their fair value at 31 December 2008 was £663 million (2007: £395 million), calculated with reference to quoted prices or discounted future cash flows as appropriate.
For the Dutch securitised mortgage loan notes carried at amortised cost of £2,353 million (2007: £2,283 million), their fair value is £2,224 million (2007: £2,283 million), calculated based on the future cash flows discounted back at the market rate of interest.
Net cash inflow (19) 341 322 Foreign exchange rate movements 133 499 632 Borrowings acquired for non-cash consideration – 18 18 Acquisitions – (174) (174) Fair value movements – (268) (268) Amortisation of discounts and other non-cash items 2 – 2
Movements in the year 116 416 532 Balance at 1 January 4,195 7,942 12,137
Expiring within one year 815 500 Expiring beyond one year 1,285 1,575
Expected to be settled within one year 18,468 16,097 Expected to be settled in more than one year 2,372 1,963
Bank overdrafts arise substantially from unpresented cheques and amount to £111 million (2007: £183 million) in long-term business operations and £494 million (2007: £438 million) in general business and other operations.
Deferred income 532 339 Reinsurers’ share of deferred acquisition costs 202 233 Accruals 1,643 1,274 Other liabilities 2,657 2,139 5,034 3,985 Less: Amounts classified as held for sale (478) (220)
This note sets out the main areas of uncertainty over the calculation of our liabilities.
(b) Asbestos, pollution and social environmental hazards In the course of conducting insurance business, various companies within the Group receive general insurance liability claims, and become involved in actual or threatened related litigation arising therefrom, including claims in respect of pollution and other environmental hazards. Amongst these are claims in respect of asbestos production and handling in various jurisdictions, including Europe, Canada and Australia. Given the significant delays that are experienced in the notification of these claims, the potential number of incidents which they cover and the uncertainties associated with establishing liability and the availability of reinsurance, the ultimate cost cannot be determined with certainty. However, on the basis of current information having regard to the level of provisions made for general insurance claims, and the strengthening of latent claims that took place during 2008, the directors consider that any additional costs arising are not likely to have a material impact on the financial position of the Group.
The Group has capital commitments to its joint ventures of £nil (2007: £nil) and to other investment vehicles of £48 million (2007: £157 million).
(b) Operating lease commitments (i) Future contractual aggregate minimum lease rentals receivable under non-cancellable operating leases are as follows: £m
Notes to the consolidated financial statements continued 52 – Cash flow statement continued (b) Cash flows in respect of the acquisition of subsidiaries, joint ventures and associates: £m
(c) Cash flows in respect of the disposal of subsidiaries, joint ventures and associates: £m
Cash at bank and in hand 11,249 4,004 Cash equivalents 13,425 12,181
The Group maintains an efficient capital structure from a combination of equity shareholders’ funds, preference capital, subordinated debt and borrowings, consistent with our overall risk profile and the regulatory and market requirements of our business. This note describes the way we manage our capital and shows where this is employed.
– increase the dividend on a basis judged prudent, while retaining capital to support future business growth, using dividend cover on an IFRS operating earnings after tax basis in the 1.5 to 2.0 times range as a guide.
Notes to the consolidated financial statements continued 53 – Group capital structure continued
Long-term savings 19,250 22,397 General insurance and health 5,516 5,594 Fund management 340 355 Other business (326) 831 Corporate1 (30) (31)
Financed by Equity shareholders’ funds 12,912 19,998 Minority interests2 3,013 2,501 Direct capital instrument 990 990 Preference shares 200 200 Subordinated debt 4,606 3,054 External debt 919 1,257 Net internal debt 2,110 1,146
Total capital employed 24,750 29,146 1. The “corporate” net liabilities represent the element of the pension scheme deficit held centrally.
2. Minority interests have increased to £3,013 million (2007 restated: £2,501 million) due to foreign exchange movement.
At 31 December 2008 we had £24.8 billion (2007: £29.1 billion) of total capital employed in our trading operations, measured on an MCEV basis.
Regulatory valuation and admissibility restrictions2 101 233 150 484 (405) 79 58 137 780 917 (1,135)
Other non1. Other sources of capital include Subordinated debt of £4,606 million issued by Aviva and £276 million of other qualifying capital issued by Dutch, Italian, Spanish and US subsidiary undertakings.
Analysis of movements in capital of long-term businesses For the year ended 31 December 2008
Effect of new business (92) (62) 14 (140) (172) (312) (583) (895) Expected change in
Effect of changes in regulatory requirements – – – – – – (787) (787)
Transfers, acquisitions and disposals – – – – – – 52 52
Foreign exchange movements – – – – – – 2,159 2,159
Available capital resources at 31 December 714 727 1,247 2,688 2,823 5,511 7,054 12,565
Further analysis of the movement in the liabilities of the long-term business can be found in notes 38 and 39.
For the UK funds, equity performance has been very adverse. Although hedging assets are in place against the impact of equity movement on guarantees the hedges are not perfect and until October there remained equity exposure in CGNU/CULAC through the estate investment strategy. Since October the exposure of the estate to equity in CGNU/CULAC has been very much reduced and consists largely of indirect exposure through future profit from unit-linked business, or the value of annual management charges accruing to estate from the UWP explicit charge business.
After effecting the year end transfer to shareholders, the UK with-profit funds’ available capital of £2.7 billion (2007: £4.5 billion) can only be used to provide support for UK with-profit business and is not available to cover other shareholder risks. This is comfortably in excess of the required capital margin and, therefore, the shareholders are not required to provide further capital support to this business.
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 NU Life Holdings Group to the NUL&P non-profit fund to provide capital to support the writing of new business.
1. These realistic liabilities make provision for guarantees, options and promises on a market consistent stochastic basis. The value of the provision included within realistic liabilities is £1.4 billion, £1.5 billion and £4.1 billion for CGNU Life, CULAC and NUL&P respectively (31 December 2007: £0.7 billion, £0.8 billion and £3.0 billion for CGNU Life, CULAC and NUL&P respectively).
For overseas businesses in the EEA, US, Canada, Australia, Hong Kong and Singapore, the available capital and the minimum requirement are calculated under the locally applicable regulatory regimes. The businesses outside these territories are subject to the FSA rules for the purposes of calculation of available capital and capital resource requirement.
– (ii) UK non-participating funds – any available surplus held in these is attributable to shareholders. Capital in the non-profit funds may be made available to meet requirements elsewhere in the Group subject to meeting the regulatory requirements of the fund. Any transfer of the surplus may give rise to a tax charge subject to availability of tax relief elsewhere in the Group.
– (iii) Overseas life operations – the capital requirements and corresponding regulatory capital held by overseas businesses are calculated using the locally applicable regulatory regime. The available capital resources in all these businesses are subject to local regulatory restrictions which may constrain management’s ability to utilise these in other parts of the Group. Any transfer of available capital may give rise to a tax charge subject to availability of tax relief elsewhere in the Group.
– (iv) General insurance operations – the capital requirements and corresponding regulatory capital held by overseas businesses are calculated using the locally applicable regulatory regime. The available capital resources in all these businesses are subject to local regulatory restrictions which may constrain management’s ability to utilise these in other parts of the Group. Any transfer of available capital may give rise to a tax charge, subject to availability of tax relief elsewhere in the Group.
– Strategic risks include issues such as customer, products and markets as well as any risks to our business model arising from changes in or market and risks arising from mergers and acquisitions.
– Risk oversight committees that review and monitor aggregate risk data, assess whether the risk profile is within appetite and take overall risk management decisions. The committees monitor adherence to the risk management policies and oversee mitigating actions being taken where risks are outside of appetite.
The sensitivity of Group earnings to changes in economic markets is regularly monitored through sensitivities to investment returns and asset values in MCEV reporting.
In addition, where the Group’s long-term savings businesses have written insurance and investment products where the majority of investment risks are borne by its policyholders, these risks are managed in line with local regulations and marketing literature, in order to satisfy the policyholders’ risk and reward objectives.
Equity price risk The Group is subject to equity price risk due to daily changes in the market values of its equity securities portfolio. The Group’s shareholders are exposed to the following sources of equity risk: – Direct equity shareholdings in shareholder funds and the Group defined benefit pension funds; – The indirect impact from changes in the value of equities held in policyholders’ funds from which management charges or a share of performance are taken; – Its interest in the free estate of long-term with profits funds.
At a business unit level, equity price risk is actively managed in order to mitigate anticipated unfavourable market movements where this lies outside the risk appetite of either the company in respect of shareholder assets or the fund in respect of policyholder assets concerned. In addition local asset admissibility regulations require that business units hold diversified portfolios of assets thereby reducing exposure to individual equities. The Group does not have material holdings of unquoted equity securities.
Equity risk is also managed using a variety of derivative instruments, including futures and options.
55 – Risk management continued The Group Assets Committee actively monitors equity assets owned directly by the Group, which may include some material shareholdings in the Group’s strategic business partners.
Property price risk The Group is subject to property price risk due to holdings of investment properties in a variety of locations worldwide. Investment in property is managed at business unit level, and will be subject to local regulations on asset admissibility, liquidity requirements and the expectations of policyholders as well as overall risk appetite. The Group Assets Committee also monitors property assets owned directly by the Group.
In short-term business such as general insurance business the Group requires a close matching of assets and liabilities to minimise this risk.
As at 31 December 2008, the Group had entered into a number of interest rate swap agreements to mitigate the effects of potential adverse interest rate movements, and to enable closer matching of assets and liabilities.
Notes to the consolidated financial statements continued 55 – Risk management continued At 31 December 2008, the Group’s total equity deployment by currency was: Sterling £m Euro £m
The changes arise from retranslation of business unit balance sheets from their functional currencies into sterling, with movements being taken through the currency translation reserve. These movements in exchange rates therefore have no impact on profit.
Credit risk is the risk of loss in the value of financial assets due to counterparties failing to meet all or part of their obligations. The Group risk management framework also includes the market related aspect of credit risk. This is the risk of a fall in the value of fixed interest securities from changes in the perceived worthiness of the issuer and is manifested through changes in the fixed interest securities’ credit spreads.
The following table provides information regarding the aggregated credit risk exposure, for financial assets with external credit ratings, of the Group. Not rated assets capture assets not rated by external ratings agencies.
– Derivative financial instruments of £2,911 million representing positions to mitigate the impact of adverse market movements, and
– Loans and advances to banks which primarily relate to loans of cash collateral received in stock lending transactions. These loans are fully collateralised by other securities, and
Credit concentration risk 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 supplemented by the Group credit policy and limits framework. In cases where the business is particularly exposed to credit risk (e.g. in respect of defaults on mortgages 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 Government bonds the largest aggregated counterparty exposure is approximately 0.4% of the Group’s total assets.
In the event of a catastrophic event, the counterparty exposure to a single reinsurer is estimated not to exceed 3.3% of shareholders’ equity.
Unit-linked business As discussed previously, in unit-linked business the policyholder bears the market risk, including credit risk, on investment assets in the unit funds, and the shareholders’ exposure to credit risk is limited to the extent that their income arises from asset management charges based on the value of assets in the fund.
Neither past due nor impaired £m 3-6 months £m 6 months1 year £m
Neither past due nor impaired £m 0-3 months £m 3-6 months £m 6 months1 year £m
The fair value of collateral held against loans that are past due or impaired at 31 December 2008 was £879 million (2007: £185 million). This predominantly consists of commercial properties.
There were no material financial assets that would have been past due or impaired had the terms not been renegotiated.
(d) Liquidity risk The Group and Company have a strong liquidity position and through the application of a Group Liquidity policy seek to maintain sufficient financial resources to meet its obligations as they fall due. In addition to this strong liquidity position, the Group and Company maintain significant committed borrowing facilities from a range of highly rated banks to further mitigate this risk.
Long-term business Insurance contracts – non-linked 126,450 10,243 34,546 48,031 33,630 Investment contracts – non-linked 60,264 3,639 13,922 24,319 18,384 General insurance and health 19,866 8,849 7,512 3,038 467
The Life Insurance Committee monitors the application of the risk policy in each business, and receives management information on life insurance risks. The committee considers all areas of life insurance risk, but in particular has a remit to monitor mortality, longevity, morbidity, persistency, product development and pricing, unit pricing and expenses.
Management of life insurance risks The individual life insurance risks are managed as follows: – 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 and evaluates emerging market solutions to mitigate this risk further.
ICA analysis and MCEV sensitivity testing help identify both concentrations of risk types and the benefits of diversification of risk
– Guarantees: embedded floor (guaranteed return), maturity guarantee, guaranteed death benefit, and guaranteed minimum rate of annuity payment.
– Other: indexed interest or principal payments, maturity value, loyalty bonus.
Management of general insurance risks Significant insurance risks will be reported through the Group risk management framework. Additionally, the ICA 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. Increasingly risk-based capital models are being used to support the quantification of risk under the ICA framework. All general insurance business units undertake a quarterly review of their insurance risks, the output from which is a key input into the ICA and risk-based capital assessments.
Notes to the consolidated financial statements continued 55 – Risk management continued Business units have developed mechanisms that identify, quantify and manage accumulated exposures to contain them within the limits of the appetite of the Group. The Group has pioneered various developments, such as the Norwich Union UK Digital Flood Map to effectively manage exposures arising from specific perils. Where appropriate such projects are employed throughout the business units to promote the adoption of best practice as standard.
General insurance claims reserving Actuarial claims reserving is conducted by local actuaries in the various general insurance business units according to the General Insurance Reserving policy. The General Insurance Committee monitors and maintains the General Insurance Reserving policy, and conducts quarterly reviews of the Group’s general insurance claims provisions, and their adequacy. The reviews include peer reviews of the business unit’s own conclusions as well as independent analysis to confirm the reasonableness of the local reviews.
Reinsurance strategy Significant reinsurance purchases are reviewed annually at both business unit and Group level, to verify that the levels of protection being bought reflect any developments in exposure and the risk appetite of the Group. Reinsurance purchases must be in line with the strategy set out in our Group General insurance reinsurance policy. The basis of these purchases is underpinned by extensive financial and capital modelling and actuarial analysis to optimise the cost and capital efficiency benefits. For the larger business units, this involves utilising externally sourced probabilistic models to verify the accumulations and loss probabilities based on the Group’s specific portfolios of business. Where external models are not available, scenarios are developed and tested using the Group’s data to determine potential losses and appropriate levels of reinsurance protection.
The reinsurance is placed with providers who meet the Group’s counterparty security requirements, and large reinsurance placements may also require approval from the Group Asset Liability Committee.
Concentration risk Processes are in place to manage catastrophe risk in individual business units and at a Group level. The Group cedes much of its worldwide catastrophe risk to third party reinsurers but retains a pooled element for its own account gaining diversification benefit. 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 £400 million, on a “one in ten years” basis, compared to approximately £850 million when measured on a “one in 100 years” basis.
Sensitivity test analysis 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, MCEV, ICA, and scenario analysis 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.
Life insurance and investment contracts The nature of long-term business is such that a number of assumptions are made in compiling these financial statements. Assumptions are made about investment returns, expenses, mortality rates, and persistency in connection with the in-force policies for each business unit. Assumptions are best estimates based on historic and expected experience of the business. A number of the key assumptions for the Group’s central scenario are disclosed elsewhere in these statements for both IFRS reporting and reporting under MCEV methodology.
General insurance and health business General insurance and health claim liabilities are estimated by using standard actuarial claims projection techniques.
Sensitivity test results Illustrative results of sensitivity testing for long-term business, general insurance and health business and the fund management and non-insurance business are set out below. For each sensitivity test the impact of a reasonably possible change in a single factor is shown, with other assumptions left unchanged.
Equity/property market values The impact of a change in equity/property market values by ± 10%. Expenses The impact of an increase in maintenance expenses by 10%. Assurance mortality/morbidity
(life insurance only) The impact of an increase in mortality/morbidity rates for assurance contracts by 5%.
Insurance participating (30) (135) 85 (90) (20) (5) (10) Insurance non-participating (185) 270 110 (105) (20) (25) (310) Investment participating (50) (40) 30 (25) – – – Investment non-participating (210) 230 20 (20) (5) – – Assets backing life shareholders’
Insurance participating (5) 20 – – (5) – – Insurance non-participating (320) 275 105 (95) (5) (20) (295) Investment participating (5) (25) – – (5) – – Investment non-participating (170) 190 65 (60) – – – Assets backing life shareholders’
Changes in sensitivities between 2007 and 2008 reflect movements in market interest rates, portfolio growth, changes to asset mix and the relative durations of assets and liabilities, and asset liability management actions.
Gross of reinsurance (205) 235 110 (110) (150) (390) Net of reinsurance (255) 290 110 (110) (150) (365)
Gross of reinsurance (205) 235 110 (110) (35) (390) Net of reinsurance (255) 290 110 (110) (35) (365)
The Group uses cash flow, fair value and net investment hedges to mitigate risk, as detailed below.
(b) Fair value hedges The Group has entered into a number of interest rate swaps in order to hedge fluctuations in the fair value of part of its mortgage loans portfolio. The notional value of these interest rate swaps was £1,088 million at 31 December 2008 (2007: £nil) and the fair value was £86 million liability (2007: £nil). These hedges were fully effective during the year.
– The foreign exchange loss of £716 million (2007: loss of £114 million) on translation of the debt to sterling at the balance sheet date has been recognised in the hedging instruments reserve in shareholders’ equity. This hedge was fully effective throughout the current and prior year.
– The Group holds a Sterling/Euro cross currency swap derivative, which has been designated as a hedge of the net investment in its European subsidiaries. During the year, the Group reduced the size of the notional amount from £1 billion to £500 million, realising a loss of £164 million in closing out this part of the contract. The notional value of the derivative at 31 December 2008 was £500 million (2007: £1,000 million) and its fair value at that date was £(185) million liability (2007: £27 million). The fair value loss of £160 million on revaluation of the derivative at the balance sheet date, as well as the £164 million loss realised on closing part of the contract, were recognised in the hedging instruments reserve in shareholders’ equity. This hedge was fully effective throughout the year.
(d) Non-hedge derivatives The Group’s non-hedge derivative activity at 31 December 2008 was as follows: Contract/ notional amount £m
Interest rate contracts OTC Forwards 3,008 17 (11) 3,305 15 (2) Swaps 20,246 482 (909) 16,172 279 (350) Options 9,309 920 – 986 251 (1) Exchange traded Futures 6,067 615 (15) 6,505 220 (37) Options – – – 15 – –
Equity/Index contracts OTC Options 11,619 470 (39) 12,278 267 (61) Exchange traded Futures 2,859 45 (68) 5,456 418 (23) Options 4,513 189 (51) 473 21 (2)
Notes to the consolidated financial statements continued 56 – Derivative financial instruments continued The contractual undiscounted cash flows in relation to non-hedge derivative liabilities have the following maturities: £m
Within one year 1,001 151 Between one and two years 285 100 Between two and three years 32 20 Between three and four years 43 20 Between four and five years 69 21 After five years 611 516
Total Aviva fund managers 356,232 335,215 External fund managers 24,874 24,214
This note gives details of the transactions between Group companies and related parties which comprise our joint ventures, associates and staff pension schemes.
The Group received income from related parties from transactions made in the normal course of business. Loans to related parties are made on normal arm’s-length commercial terms.
Associates 61 – 58 – Joint ventures 5 3 4 2 Employee pension schemes 24 6 26 6
The related parties’ receivables are not secured and no guarantees were received in respect thereof. The receivables will be settled in accordance with normal credit terms. Details of guarantees, indemnities and warranties provided on behalf of related parties are given in note 50(h).
Services provided by related parties There were no services provided by related parties in either 2007 or 2008.
Salary and other short-term benefits 38 40 Post-employment benefits 3 4 Equity compensation plans 9 14 Termination benefits 3 2
Information concerning individual directors’ emoluments, interests and transactions is given in the Directors’ remuneration report.
Financial statements of the Company Income Statement At 31 December 2008
Statement of recognised income and expense For the year ended 31 December 2008
Fair value losses on investments in subsidiaries A (8,113) (3,420) Actuarial gains on pension scheme 2 5 Aggregate tax effect 16 16
Excess of expenses over income recognised for the year (7,299) (1,682)
Reconciliation of movements in shareholders’ equity For the year ended 31 December 2008
Equity Ordinary share capital 28 664 655 Preference share capital 31 200 200
Liabilities Non-current liabilities Borrowings E 4,838 3,252 Loans owed to subsidiaries 3,108 1,842 Provisions 40 40 7,986 5,134 Current liabilities Borrowings E 535 918 Loans owed to subsidiaries 975 1,846 Other amounts owed to subsidiaries 352 191 Other creditors 101 65
Cash flows from financing activities Funding provided by subsidiaries 401 399 Net borrowings drawdown, net of expenses 3,905 4,780 Repayment of borrowings (3,463) (4,606) Net drawdown of borrowings 442 174 Preference dividends paid (17) (17) Ordinary dividends paid (732) (500) Interest paid on borrowings (30) (47) Net cash from financing activities 64 9
A – Investments in subsidiaries (i) Movements in the Company’s investments in its subsidiaries are as follows: Fair value as at 1 January 24,466 27,886 Movement in fair value (8,113) (3,420)
(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 29. 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.
Current tax: For this year 387 351 Prior year adjustments 5 5
(ii) Tax credited to equity Tax credited to equity comprises £16 million (2007: £16 million) in respect of coupon payments on the direct capital instruments.
(iv) Deferred tax asset (i) The net deferred tax asset comprises: £m
(ii) The movement in the net deferred tax asset was as follows: £m
Balance at 31 December 2007 735 13,883 89 3,207 Arising in the year: Profit for the year – – – 796 Fair value losses on investments in subsidiaries – (8,113) – – Actuarial gains on pension schemes – – – 2 Dividends and appropriations – – – (975) Reserves credit for equity compensation plans – – 39 – Shares issued in lieu of dividends – – – 170 Employee trust shares distributed in the year – – – (6) Issue of share capital under equity compensation scheme – – (15) 15 Aggregate tax effect – – – 16
Where subordinated debt is undated, the interest payments have not been included beyond 15 years. Annual interest payments for these borrowings are £77 million (2007: £70 million).
The fair value of the subordinated debt at 31 December 2008 was £2,979 million (2007: £3,006 million). The fair value of the 9.5% guaranteed bonds 2016 at 31 December 2008 was £224 million (2007: £249 million). The fair value of the commercial paper is considered to be the same as its carrying value.
Further details of these borrowings and undrawn committed facilities can be found in note 47.
F – Contingent liabilities Details of the Company’s contingent liabilities are given in note 50(h).
The business of the Company is managing its investments in subsidiary and joint venture operations. Its risks are considered to be the same as those in the operations themselves and full details of the risk management policies are given in note 55. Such investments are held by the Company at fair value in accordance with accounting policy D.
The Company faces exposure to foreign currency risk through some of its borrowings which are denominated in euros and US dollars. However, most of these borrowings have been on-lent to a subsidiary which holds financial investments in these currencies, generating the net investment hedge described in note 56(c).
Within 1 year – 132 1-5 years 1,402 1,359 Over 5 years 2,015 1,248
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 58.
We have audited the consolidated Aviva MCEV financial statements of Aviva plc for the year ended 31 December 2008 which comprise a Market Consistent Embedded Value basis Summarised consolidated income statement, the Consolidated statement of recognised income and expense, the Reconciliation of movements in shareholders’ equity, the Summarised consolidated balance sheet, the Reconciliation of shareholders’ equity, the Group MCEV analysis of earnings and the Segmentation of summarised consolidated balance sheet and the related notes M1 to M15. The consolidated Aviva MCEV financial statements have been prepared in accordance with the basis of preparation set out on, pages 295 to 299.
Respective responsibilities of directors and auditors The directors are responsible for preparing the consolidated Aviva MCEV financial statements under the basis of preparation as set out on pages 295 to 299.
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 consolidated Aviva MCEV financial statements. It also includes an assessment of the significant estimates and judgements made by the directors in the preparation of the consolidated Aviva MCEV financial statements, and of whether the accounting policies are appropriate to the Group’s circumstances, consistently applied and adequately disclosed.
Summarised consolidated income statement For the year ended 31 December 2008
Other: (204) Other operations and regional costs2 (163) (70) (176) Corporate centre (141) (157) (474) Group debt costs and other interest (379) (363)
(118) Economic assumption changes on general insurance and health business (94) 2
(83) Impairment of goodwill (66) (10) (134) Amortisation and impairment of intangibles (108) (89)
1. Excludes the proportion of the results of Aviva Investors fund management businesses and other fund management operations within the group that arises from the provision of fund management services to our life businesses. These results are included within the life MCEV operating earnings consistent with Aviva’s MCEV methodology.
2. Excludes the proportion of the results of subsidiaries providing services to the Life business. These results are included within the life MCEV operating earnings.
Earnings after tax on an MCEV basis, attributable to ordinary shareholders of Aviva plc
Consolidated statement of recognised income and expenses – MCEV basis For the year ended 31 December 2008 290 Financial statem ents IFRS 284 – 332 £m £m
(348) Fair value (losses)/gains on AFS securities, owner-occupied properties and hedging instruments (278) 45
(10) Fair value gains transferred to profit (8) (12) (1,161) Actuarial (losses)/gains on pension schemes (929) 648 98 Actuarial gains/(losses) on pension schemes transferred to unallocated divisible surplus and other movements 78 (61)
101 Impairment losses 81 – 3,741 Foreign exchange rate movements 2,993 1,159 83 Aggregate tax effect – shareholder tax 66 (246)
(109) Minority share of dividends declared in the year (106) (66) 44 Minority interest in acquired subsidiaries 43 315
(30) Shares acquired by employee trusts (29) (10) (67) Changes in minority interest in existing subsidiaries (65) – 40 Reserves credit for equity compensation plans 39 50
Overview Business review Governance Financial statements IFRS Financial statements MCEV Other information £m £m
(34) Shares held by employee trusts (33) (10) 3,924 Retained earnings 3,806 6,338 444 Additional retained earnings on an MCEV basis 431 7,342 13,311 Equity attributable to ordinary shareholders of Aviva plc 12,912 19,998 1,227 Preference share capital and direct capital instruments 1,190 1,190 3,106 Minority interests 3,013 2,501
Life and related businesses net assets on an statutory IFRS net basis 16,581 14,639 Goodwill and other intangibles (2,947) (2,359) Acquired value of in-force business (2,490) (1,790) Adjustment for share of JVs & associates (472) (380) Adjustment for assets to regulatory value net of tax 1,474 335 Adjustment for DAC & DIR net of tax (2,680) (1,740) Adjustment for differences in technical provisions 1,265 737 Other accounting and tax differences 78 938 MCEV net worth 10,809 10,380 MCEV value of in-force 5,580 9,716 1. Comprises embedded value of £14,089 million (2007: £18,248 million) and minority interest in long-term business assets of £2,300 million (2007: £1,848 million).
Opening Group MCEV 18,248 2,059 20,307 881 2,940 21,188 Opening adjustments – – – – – – Adjusted opening Group MCEV 18,248 2,059 20,307 881 2,940 21,188
Operating MCEV earnings 1,753 – 1,753 535 535 2,288 Non-operating MCEV earnings (8,638) (53) (8,691) (1,229) (1,282) (9,920)
Other movements in IFRS net equity – (28) (28) (994) (1,022) (1,022) Capital and dividend flows (63) – (63) (712) (712) (775) Foreign exchange variances 2,702 567 3,269 (926) (359) 2,343 Acquired/divested businesses 87 94 181 (181) (87) – Closing Group MCEV 14,089 2,639 16,728 (2,626) 13 14,102
Equity attributable to ordinary shareholders of Aviva plc on an MCEV basis 19,998 1. Covered business represents the business that the MCEV calculations cover, as detailed in the Basis of preparation note. The embedded value is presented net of minority interests and tax.
2. Non-covered but related to life business represents the adjustments to the MCEV, including goodwill, to calculate the long-term business net assets on an MCEV basis. An analysis of net assets on an MCEV basis gross of minority interests is provided on page 294.
Segmentation of summarised consolidated balance sheet For the year ended 31 December 2008
Total assets before acquired value of in-force long-term business 305,562 46,634 352,196 278,677 40,951 319,628
Acquired additional value of in-force long-term business 2,366 – 2,366 1,698 – 1,698
Net assets on a statutory IFRS basis 16,581 (2,135) 14,446 14,639 1,292 15,931 Additional value of in-force long-term
Net assets on an MCEV basis2 19,250 (2,135) 17,115 22,397 1,292 23,689
Equity capital, capital reserves, shares held by employee trusts and other reserves 8,675 6,318 IFRS basis retained earnings 3,806 6,338 Additional MCEV basis retained earnings 431 7,342
2. Analysis of net assets on an MCEV basis is made up as follows: Goodwill and intangible assets allocated to long-term business3 2,947 2,359
Notional allocation of IAS19 pension fund deficit to long-term business4 (86) (58)
Long-term business net assets on an MCEV basis 19,250 22,397 3. Goodwill and intangible assets includes amounts related to associated undertakings and joint ventures 4. The value of the Aviva Staff Pension Schemes deficit has been notionally allocated between segments, based on current funding and the life proportion has been included within the long-term business net assets on an MCEV basis. The pension fund deficit notionally allocated to long-term business is net of the proportion of funding borne by the UK with-profit funds.
The directors consider that Aviva’s MCEV methodology gives useful insight into the drivers of financial performance of the group’s life and related businesses. This basis values future cash flows from assets consistently with market prices, including more explicit allowance for the impact of uncertainty in future investment returns and other risks. Embedded value is also consistent with the way pricing is assessed and the business is managed.
The results for 2008 and 2007 have been audited by our auditors, Ernst & Young. Their report in respect of 2008 can be found on page 288 in the Report and Accounts.
Adjusted risk-free rate Aviva’s MCEV methodology adopts the CFO Forum Principles and Guidance with the exception of the use of an adjusted risk-free yield due to current market conditions for UK and Netherlands immediate annuities and for immediate annuities, deferred annuities and all other contracts in the US. In stable markets, swap curves are an appropriate risk-free rate. However, in the current turbulent market it is possible, for products where backing asset portfolios can be held to maturity, to earn returns in excess of swaps by investing in corporate bonds and credit default swaps (CDS).
The reference rate for these products has been increased above the swap curve to estimate the additional returns available through replicating portfolios where backing assets can be held to maturity in the current market. Due to the limited availability of CDS assets, particularly at the long durations, this is a material area of judgement and sensitivity analysis has been provided on page 320 on the additions to the swap curves.
In current markets, adjustments have been made to the swap rate for UK and Netherlands immediate annuities and all US contracts. Details of adjustments can be found in note M14.
The Group’s definition of new business under MCEV includes contracts that meet the definition of “non-participating investment” contracts under IFRS.
For products sold to individuals, premiums are considered to represent new business where a new contract has been signed, or where underwriting has been performed. Renewal premiums include contractual renewals, noncontractual variations that are reasonably predictable and recurrent single premiums that are pre-defined and reasonably predictable.
Life and pensions operating earnings For life and pensions operating earnings, Aviva uses normalised investment returns, which are generally expressed as one year swap returns plus an asset risk premium. The use of asset risk premiums reflects management’s long-term expectations of asset returns in excess of the swap yield from investing in different asset classes. This assumption does not impact the embedded value as asset risk premia are not recognised until earned.
Overview Under the MCEV methodology, profit is recognised as it is earned over the life of products defined within covered business. The total profit recognised over the lifetime of a policy is the same as under the IFRS basis of reporting, but the timing of recognition is different.
Calculation of the embedded value The shareholders’ interest in the life and related businesses is represented by the embedded value. The embedded value is the total of the net worth of the life and related businesses and the value of in-force covered business. Calculations are performed separately for each business and are based on the cash flows of that business, after allowing for both external and intra-group reinsurance. Where one life business has an interest in another, the net worth of that business excludes the interest in the dependent company.
Value of in-force covered business (VIF) The value of in-force covered business consists of the following components: − present value of future profits; − time value of financial options and guarantees; − frictional costs of required capital; and,
Distributable profits generally arise when they are released following actuarial valuations. These valuations are carried out in accordance with any local statutory requirements designed to ensure and demonstrate solvency in long-term business funds. Future distributable profits will depend on experience in a number of areas such as investment return, discontinuance rates, mortality, administration costs, as well as management and policyholder actions. Releases to shareholders arising in future years from the in-force covered business and associated required capital can be projected using assumptions of future experience.
Future profits are projected using best estimate non-economic assumptions and market consistent economic assumptions. In principle, each cash flow is discounted at a rate that appropriately reflects the riskiness of that cash flow, so higher risk cash flows are discounted at higher rates. In practice, the PVFP is calculated using the “certainty equivalent” approach, under which the reference rate is used for both the investment return and the discount rate. This approach ensures that asset cash flows are valued consistently with the market prices of assets without options and guarantees. Further information on the risk-free rates is given in note M14.
Time value of financial options and guarantees (TVOG) The PVFP calculation is based on a single (base) economic scenario. However, a single scenario cannot appropriately allow for the effect of certain product features. If an option or guarantee affects shareholder cash flows in the base scenario, the impact is included in the PVFP and is referred to as the intrinsic value of the option guarantee.
Frictional costs are calculated by projecting forwards the future levels of required capital. Tax on investment return and investment expenses are payable on the assets backing required capital up until the point that they are released to shareholders.
Cost of residual non-hedgeable risks (CNHR) The cost of residual non-hedgeable risks (CNHR) covers risks not already allowed for in the time value of options and guarantees or the PVFP. The allowance includes the impact of both non-hedgeable financial and non-financial risks. The most significant risk not included in the PVFP or TVOG is operational risk.
Aviva’s methodology includes a cost of non-hedgeable risk equivalent to a charge of 2.5% applied to groupdiversified capital. The cost has been calculated as a 1.5% charge applied to business unit-level capital, that is, allowing for diversification within a business unit, but not between business units. The charge was set so as to give an aggregate allowance that was in excess of the expected operational risk costs arising from the in-force covered business over its remaining lifetime.
For with-profit funds in the UK and Ireland, for the purpose of recognising the value of the estate, it is assumed that terminal bonuses are increased to exhaust all of the assets in the fund over the future lifetime of the in-force with-profit policies. However, under stochastic modelling there may be some extreme economic scenarios when the total assets in the Group’s with-profit funds are not sufficient to pay all policyholder claims. The average additional shareholder cost arising from this shortfall has been included in the TVOG.
As the MCEV methodology incorporates the impact of profits and losses arising from subsidiary companies providing administration, investment management and other services to the Group’s life companies, the equivalent profits and losses have been removed from the relevant segment (non-insurance or fund management) and are instead included within the results of life and related businesses. In addition, the underlying basis of calculation for these profits has changed from the IFRS basis to the MCEV basis.
Prior year comparatives The prior year comparatives have been restated to MCEV as announced on 4 February 2009.
Presentation changes Please refer to note 2 of the IFRS section of the Report and Accounts.
Exchange rates The Group’s principal overseas operations during the period were located within the Eurozone and the United States.
M2 – Analysis of life and pension earnings The following table provides an analysis of the movement in embedded value for the covered business. The analysis is shown separately for free surplus, required capital and the value of in-force covered business, and includes amounts transferred between these categories. Included within capital and dividend flows is the transfer to life and related businesses from other segments consisting of service company profits and losses during the reported period that have emerged from the value of in-force. Since the “look through” into service companies includes only future profits and losses, these amounts must be eliminated from the closing embedded value. All figures are shown net of tax and minority interests.
Expected existing business contribution (in excess of reference rate) – – 303 303 – – 284 284
Experience variances 154 3 (284) (127) 271 (13) (336) (78) Assumption changes 563 (114) (584) (135) 18 (8) (40) (30) Expected return on
These components are calculated using economic assumptions as at the start of the year (in-force business) or start of the quarter (new business) and operating (demographic and expenses) assumptions as at the end of the year.
– expected returns 1,438 1,297 – experience variances (224) (111) – operating assumption changes (165) (25) – other operating variances 271 1 Expected return on shareholders’ net worth 701 485
The tables below set out the present value of new business premiums (PVNBP), written by the life and related businesses, the value of new business and the resulting margin firstly gross and then net of tax and minority interests. The PVNBP calculation is equal to total single premium sales received in the period plus the discounted value of regular premiums expected to be received over the term of the new contracts, and is expressed at the point of sale.
M4 – New business continued (b) Geographical analysis of value of new business
M4 – New business continued The projected investment returns in both the IRR and payback period calculations assume that equities, properties and bonds earn a return in excess of risk-free consistent with the long-term rate of return assumed in operating earnings.
Total initial capital for life and pensions new business of £838 million (2007 restated: £699 million) is expressed at the point of sale. Hence, it is higher than the impact of writing that new business on net worth of £758 million (2007 restated: £624 million) shown on page 298, because the latter amount includes expected profits from the point of sale to the end of the reporting period, partly offset by the cost of holding the initial capital. The fall in IRR reflects the reduction on reference rates and the higher weighting of the Netherlands.
This note shows how our business generates free surplus. To do this the impact of the business on net worth and required capital is considered separately for existing business and new business.
United Kingdom 403 119 736 85 1,343 (147) (159) (306) 1,037 Europe 619 280 (92) 325 1,132 (438) (422) (860) 272 North America 194 39 (24) 197 406 (118) (475) (593) (187) Asia Pacific 73 14 1 (12) 76 (55) (53) (108) (32)
United Kingdom 549 66 225 57 897 (245) (149) (394) 503 Europe 537 197 42 118 894 (225) (345) (570) 324 North America 103 33 19 133 288 (107) (280) (387) (99) Asia Pacific 55 12 (4) 4 67 (47) (34) (81) (14)
United Kingdom 634 542 385 279 213 2,053 2,053 Europe 1,560 1,200 741 447 411 4,359 3,380 North America (66) (245) (238) (211) (342) (1,102) (1,102) Asia Pacific 108 71 47 28 16 270 262
– expected existing business contribution (reference rate) 338 188 39 30 107 91 60 19 534 86 9 25 34 992
– expected existing business contribution (in excess of reference rate) 210 38 8 6 95 8 22 – 177 53 4 2 6 446
M7 – Geographical analysis of MCEV operating earnings continued Gross of tax and minority interests Restated 2007
– expected existing business contribution (reference rate) 373 148 26 23 96 50 46 10 399 75 10 20 30 877
– lapses (16) 1 – 1 4 12 (16) 3 5 (4) (8) (2) (10) 125 – other7 (31) 134 – 4 (40) (4) – (14) 80 9 (4) – (4) 54 Expected return on
M7 – Geographical analysis of MCEV operating earnings continued Net of tax and minority interests 2008
– expected existing business contribution (reference rate) 244 115 26 9 74 64 23 15 326 56 10 18 28 654
– expected existing business contribution (in excess of reference rate) 151 24 5 2 68 6 9 – 114 35 2 1 3 303
Earnings after tax and minority interests 635 426 50 38 129 172 97 17 929 132 24 33 57 1,753 1. Project and other related expenses in the UK reflect project costs associated with strategic initiatives, including developments designed to offer a wider range of products to customers, and the simplification of systems and processes. Expenses in the Netherlands reflect an overrun in Belgium following the acquisition of Swiss Life Belgium, and restructuring within the intermediary division.
6. In UK, favourable mortality assumption changes are in respect of mortality and morbidity changes across a range of products. In the Netherlands, mortality assumption changes reflect the impact of using a new industry mortality basis.
7. In the UK, an additional lapse provision has been set up in anticipation of higher short-term recession related withdrawals and higher mortgage and income protection claims to reflect rising unemployment. In France, persistency assumptions have been weakened following continual favourable experience on AFER products.
9. Other operating variances in France are mainly in respect of the impact of the mutualisation of funds following the merger of two legal entities. In the Netherlands, changes are mainly in respect of aligning the profit sharing policy for existing group business in Belgium, following the acquisition of Swiss Life Belgium.
Value of new business 195 81 26 20 3 34 57 4 225 34 39 11 50 504 Earnings from existing business – expected existing
Experience variances – maintenance morbidity2 8 18 (1) – (1) 10 (3) 2 25 (2) 4 2 6 37 – lapses3 (9) 5 4 (5) 4 13 (1) 1 21 – (9) – (9) 3 – other4 (17) (14) (4) 1 12 5 5 1 6 (18) 2 1 3 (26) Operating assumption changes: – maintenance morbidity6 20 (1) – 1 (24) 11 (5) 2 (16) – (7) 3 (4) – – lapses (11) – – – 2 8 (7) 3 6 (3) (7) (1) (8) (16) – other7 (22) 85 – 2 (23) (4) – (11) 49 6 (3) – (3) 30 Expected return on
2. Mortality experience continues to be better than the assumptions set across a range of businesses.
6. Mortality assumptions in the UK reflect changes to the anti-selection loading on annuities. In the Netherlands, the mortality assumption strengthening reflected a partial implementation of a new industry mortality basis.
This note sets out further information on the operating earnings from fund management set out in the summarised consolidated income statement.
The summarised consolidated income statement – MCEV basis, includes earnings from the Group’s fund management operations as analysed below. This excludes the proportion of the results of Aviva Investors fund management businesses and other fund management operations within the Group that arise from the provision of fund management services to our Life businesses. These results are included within the Life MCEV operating earnings.
United Kingdom 34 40 Europe 9 15 North America (3) 3 Asia Pacific 1 6
United Kingdom (18) (10) Netherlands 2 17 Other Europe 4 4 Asia Pacific 13 15
United Kingdom 1,357 1,477 2,053 4,887 France2 (92) 1,567 1,044 2,519 Ireland 135 252 603 990 Italy 261 235 149 645 Netherlands (including Belgium and Germany) (333) 2,284 159 2,110 Poland 115 134 979 1,228 Spain 143 225 287 655 Other Europe 43 34 159 236 Europe 272 4,731 3,380 8,383 North America3 (362) 1,528 (1,102) 64 Asia 72 159 193 424 Australia 9 253 69 331 Asia Pacific 81 412 262 755 1. Required capital is shown net of implicit items permitted by local regulators to cover minimum solvency margins.
2. France, Netherlands and US have a positive surplus on a statutory basis.
3. Aviva USA’s holding company debt amounting to £1,128 million at 31 December 2008 has been included within non-covered business.
2. Aviva USA’s holding company debt amounting to £349 million at 31 December 2007 has been included within non-covered business.
The shareholders’ 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. This is split between required capital, net of implicit items, and free surplus.
M11 – Risk allowance with present value of in-force (PVIF) Within the VIF in the tables on page 312, there are additional allowances for risks not included within the basic present value of future profits calculation.
M12 – Implied discount rates (IDR) In the valuation of a block of business, the implied discount rate is the rate of discount such that a traditional embedded value for the business equates to the MCEV.
Average derived risk discount rates are shown below for the embedded value.
Life MCEV operating earnings after tax 29 17 50 5 24 102 227 – 227 1,753 1,980
Life MCEV (loss)/earnings after tax 18 (21) (30) (22) 20 (72) (107) – (107) (6,885) (6,992)
Life MCEV operating earnings after tax 32 19 46 19 18 88 222 1 223 1,567 1,790
There are no minority interests in the United Kingdom or North America.
The curve is extrapolated if necessary to get rates suitable to the liabilities. For markets in which there is no reliable swap yield curve the relevant government bond yields are used.
Required capital is shown as a multiple of the EU statutory minimum solvency margin or equivalent.
The principal economic assumptions used are as follows: Reference rate and expense inflation
Reference rate – term 1 year 2.5% 4.7% 4.4% 6.2% Reference rate – term 5 years 3.3% 4.6% 4.3% 5.8% Reference rate – term 10 years 3.8% 4.7% 4.2% 5.5% Reference rate – term 15 years 4.0% 4.9% 4.1% 5.4% Reference rate – term 20 years 3.9% 5.0% 4.0% 5.4% Expense inflation 2.5% 3.0% 2.9% 4.7%
Reference rate – term 1 year 1.3% 4.2% Reference rate – term 5 years 2.2% 4.2% Reference rate – term 10 years 2.6% 4.7% Reference rate – term 15 years 2.9% 4.9% Reference rate – term 20 years 2.9% 5.0% Expense inflation 3.0% 3.5%
UK and Netherlands immediate annuities 1.45% 0.85% 0.55% 0.25% 1.50% 0.50% US immediate annuities 2.00% 0.65% 0.55% 0.25% 3.00% 0.50% US deferred annuities and other contracts 1.50% 0.65% 0.55% 0.25% 2.50% 0.50%
Risk premium – used for operating profit, Implied Discount Rates (IDR), Internal Rates of Return (IRR) and payback period For life and pensions operating earnings, Aviva uses normalised investment returns, which are generally expressed as one year swap returns plus an asset risk premium. The use of asset risk premia only impacts operating earnings as expected returns reflect management’s long-term expectations of asset returns in excess of the reference rate from investing in different asset classes. This assumption does not impact the balance sheet embedded value or value of new business as asset risk premia are not recognised until earned. The asset risk premia set out in the table below are added to the 1 year reference rate to calculate expected returns.
5. Correct tax legislation and rates have been assumed to continue unaltered except where changes in future tax rates have been announced.
Other economic assumptions Required capital relating to with-profit business is assumed to be covered by the surplus within the with-profit funds and no effect has been attributed to shareholders. Bonus rates on participating business have been set at levels consistent with the economic assumptions. The distribution of profit between policyholders and shareholders within the with-profit funds assumes that the shareholder interest in conventional with-profit business in the United Kingdom and Ireland continues at the current rate of one-ninth of the cost of bonus.
Model – United Kingdom, Europe (excluding Delta Lloyd) and North America Swap rates are generated by a model, the Libor Market Model (LMM), that projects a full swap curve at monthly intervals. Forward rates are assumed to have a log-normal distribution which guarantees non-negative interest rates. The model is calibrated to at-the-money swaptions of a variety of terms and tenors. Swaption volatilities are taken from Bloomberg. Tests have been performed to ensure that sufficient scenarios have been used that the result converges to the stochastic value of the business being valued.
The inflation model used is based on the standard Jarrow-Yildirim inflation model which connects real and nominal yields and an inflation index. This is calibrated to ZCII quotes on HICPxT-index.
Swaption implied volatilities The implied volatility is that determined by Black's formula to reproduce the market price of the option. The following table sets out the model swaption implied volatilities.
For the UK and the Netherlands, model property implied volatility is 15% for 31 December 2008 (31 December 2007:15%).
We have set the assumptions based on a best estimate of outcome of shareholder outcomes. In particular, where the policyholder behaviour varies with economic experience, we have set assumptions which are dynamic, i.e. vary depending on the economic assumptions. For example, surrender and option take up rate assumptions that vary according to the investment scenario under consideration have been used in the calculation of the time value of options and guarantees, based on our assessment of likely policyholder behaviour in different investment scenarios.
Expense assumptions Management expenses and operating expenses of holding companies attributed to life and related businesses have been included in the MCEV calculations and split between expenses relating to the acquisition of new business, the maintenance of business in-force and project expenses. Future expense assumptions include an allowance for maintenance expenses and a proportion of recurring project expenses. Certain expenses of an exceptional nature, when they occur, are identified separately and are generally charged as incurred. No future productivity gains have been anticipated.
Valuation of debt Borrowings in the MCEV consolidated balance sheet are valued on an IFRS basis, consistent with the primary financial statements. At 31 December 2008 the market value of the Group’s external debt, subordinated debt, preference shares including General Accident plc preference shares of £250 million (classified as minority interests) and direct capital instrument was £4,911 million (31 December 2007: £5,774 million).
Borrowings per summarised consolidated balance sheet – MCEV basis 15,201 12,657 Add: amount included within held for sale – 12 Less: Securitised mortgage funding (7,785) (7,295)
External debt and subordinated debt – MCEV basis 5,525 4,311 Add: Preference shares (including General Accident plc) and direct capital instrument 1,440 1,440
Market value of external debt, subordinated debt, preference shares and direct capital instrument 4,911 5,774
In this note the sensitivity of both our embedded value and value of new business is presented. There are sensitivities to the economic assumptions used and the non-economic assumptions.
− decrease in the level of required capital to 100% EU minimum (or equivalent).
In general, the magnitude of the sensitivities will reflect the size of the embedded values, though this will vary as the sensitivities have different impacts on the different components of the embedded value. In addition, other factors can have a material impact, such as the nature of the options and guarantees, as well as the types of investments held.
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%–2% movement in the interest rate for the Netherlands and US, where there is a significant amount of business with investment return guarantees.
Risk free rates 2008 Embedded value (net of tax and minority interest)
As reported on page 312 £m 10% increase £m 10% decrease £m increase £m
Swaption implied volatilities 25% increase £m 50bps increase £m 50bps decrease £m
United Kingdom 4,887 – (610) 770 10 France 2,519 (95) (120) 125 15 Ireland 990 – – – 5 Italy 645 – – – 5 Netherlands (including Belgium and Germany) 2,110 (165) (265) 285 100 Poland 1,228 – – – 5 Spain 655 – (55) 60 5 Other Europe 236 – – – – Europe 8,383 (260) (440) 470 135 North America 64 (45) (625) 660 5 Asia 424 – (25) 20 15 Australia 331 – (5) 10 5 Asia Pacific 755 – (30) 30 20
United Kingdom 147 5 (5) (2) France 79 2 (2) (3) Ireland 10 1 (1) – Italy 21 – – – Netherlands (including Belgium and Germany) (67) – – (1) Poland 46 – – – Spain 80 – – – Other Europe 24 1 (2) – Europe 193 4 (5) (4) North America 36 – – – Asia 24 – – – Australia 9 – – – Asia Pacific 33 – – –
United Kingdom 147 – (79) 85 1 France 79 (2) 2 (9) 1 Ireland 10 – – – 1 Italy 21 – – – – Netherlands (including Belgium and Germany) (67) – (11) 12 14 Poland 46 – – – – Spain 80 – (4) 5 – Other Europe 24 – (1) (1) 2 Europe 193 (2) (14) 7 18 North America 36 (12) (67) 72 10 Asia 24 – – – 2 Australia 9 – – – – Asia Pacific 33 – – – 2
(b) Non-economic assumptions The following tables below show the sensitivity of the embedded value and the value of new business to the following changes in non-economic assumptions: − 10% decrease in maintenance expenses (a 10% sensitivity on a base expense assumption of £10 pa would represent an expense assumption of £9 pa). Where there is a “look through” into service company expenses the fee charged by the service company is unchanged while the underlying expense decreases; − 10% decrease in lapse rates (a 10% sensitivity on a base assumption of 5% pa would represent a lapse rate of 4.5% pa); and
As reported on page 312 £m 10% decrease in maintenance expenses £m 10% decrease in lapse rates £m 5% decrease in mortality/
United Kingdom 4,887 165 100 70 (190) France 2,519 50 35 30 – Ireland 990 20 25 10 (5) Italy 645 5 5 5 – Netherlands (including Belgium and Germany) 2,110 195 5 30 (195) Poland 1,228 40 65 15 – Spain 655 10 45 15 (5) Other Europe 236 5 15 – – Europe 8,383 325 195 105 (205) North America 64 85 80 70 (20) Asia 424 15 5 5 – Australia 331 10 20 15 – Asia Pacific 755 25 25 20 –
Value of new business 2008 Value of new business (net of tax)
As reported on page 303 £m 10% decrease in maintenance expenses £m 10% decrease in lapse rates £m 5% decrease in mortality/
United Kingdom 147 18 23 15 (20) France 79 1 2 1 – Ireland 10 2 4 – – Italy 21 1 – – – Netherlands (including Belgium and Germany) (67) 15 4 2 (14) Poland 46 3 5 2 – Spain 80 2 12 3 – Other Europe 24 2 6 2 (2) Europe 193 26 33 10 (16) North America 36 6 4 7 (3) Asia 24 5 2 1 – Australia 9 1 5 2 – Asia Pacific 33 6 7 3 –
CFO Forum The CFO Forum www.cfoforum.nl is a high-level group formed by the Chief Financial Officers of major European listed and non-listed insurance companies. Its aim is to discuss issues relating to proposed new accounting regulations for their businesses and how they can create greater transparency for investors. The Forum was created in 2002, the Market Consistent Embedded Value principles were launched in June 2008 and CFO Forum members across Europe have agreed to adopt these for their 2009 published accounts. The principles are a further development of the European Embedded Value principles first launched in May 2004.
Inherited estate The assets of the long-term with-profit funds less the realistic reserves for non-profit policies, less asset shares aggregated across the with-profit policies
MCEV Aviva’s Market Consistent Embedded Value methodology which is in accordance with the MCEV Principles published by the CFO Forum in June 2008 with the exception of the use of an adjusted risk-free yield due to current market conditions for immediate annuities in the UK and the Netherlands and for immediate annuity, deferred annuity and other contracts in the US.
United Kingdom Aviva Employment Services Limited Aviva Insurance Limited Aviva International Insurance Limited Aviva Investors Global Services Limited Aviva Investors Pensions Limited Aviva Investors UK Fund Services Limited Aviva Investors UK Funds Limited CGNU Life Assurance Limited CGU Bonus Limited CGU Underwriting Limited Commercial Union Life Assurance Company Limited Gresham Insurance Company Limited Hamilton Insurance Company Limited Hamilton Life Assurance Company Limited Lifetime Group Limited London and Edinburgh Insurance Company Limited Norwich Union Annuity Limited Norwich Union Central Services Limited Norwich Union Consumer Products Limited Norwich Union Equity Release Limited Norwich Union Healthcare Limited Norwich Union Insurance Limited Norwich Union Insurance Services Limited Norwich Union Life (RBS) Limited Norwich Union Life & Pensions Limited Norwich Union Life Services Limited Norwich Union Risk Services Limited NUI Investments Limited RAC Financial Services Limited RAC Insurance Limited RAC Motoring Services RAC plc
Canada Aviva Canada Inc. and its principal operating subsidiaries: Aviva Insurance Company of Canada Elite Insurance Company Pilot Insurance Company Scottish & York Insurance Co. Limited S&Y Insurance Company Traders General Insurance Company
Ireland Hibernian Group plc and its principal subsidiaries: Ark Life Assurance Company Limited Hibernian Aviva General Insurance Limited Hibernian Aviva Health Group Limited (70%) Hibernian Aviva Life & Pensions Limited
Netherlands Delta Lloyd N.V. (92.0%) and its principal subsidiaries: Delta Lloyd ABN AMRO Verzekeringen Holding BV (51.0%) Delta Lloyd Asset Management N.V. Delta Lloyd Bankengroep N.V. (Banking) Delta Lloyd Levensverzekering N.V. Delta Lloyd Schadeverzekering N.V. Erasmus Groep BV OHRA Levensverzekeringen N.V. OHRA Schadeverzekeringen N.V.
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 2008 are set out in notes 18 and 19.
The Group also has interests in several property limited partnerships. Further details are provided in note 18.
Aviva plc is a public limited company incorporated on 09 February 1990 and registered in England and Wales.
Documents concerning the Company which are referred to in the report and accounts are available for inspection at St Helen’s, 1 Undershaft, London EC3P 3DQ.
Dividend payments direct to your bank account Instead of having your dividends paid by cheque, you can, if you wish, have them credited directly into your bank or building society account on the dividend payment date. This reduces the risk of cheques getting lost in the post and is also quicker and more convenient as payment is credited automatically on the payment date. Your tax voucher will be sent to your registered address as usual. If you would like to set up a dividend mandate, you can do so via our website www.aviva.com/dividendmandate or by contacting Equiniti to request a mandate form.
Electronic communications We have embraced the changes brought about by the Companies Act 2006 which recognises the growing importance of electronic communications. We therefore provide documentation and communications to you via our website unless you have specifically elected to receive a hard copy.
Using electronic communications enables fast receipt of documents, reduces our printing, paper and postage costs and has a positive impact on the environment.
A range of frequently asked shareholder questions including practical help on transferring shares and updating personal details is available online at www.aviva.com/shareholderguide
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 Equiniti.
Share dealing We have arranged the following services that can be used to buy or sell Aviva shares which you may find useful.
Available to shareholders in If you hold a share certificate If your shares are held in the Aviva Share Account
Overseas shareholders: Overseas shareholders: WH Ireland Limited# UK and overseas UK shareholders: Not available
Email: CSOS@WH-ireland.co.uk Overseas shareholders: Telephone +44 113 394 6603 Email: CSOS@WH-ireland.co.uk
Alternatively, if you hold a share certificate, you can also use any bank, building society or stockbroker offering share dealing facilities to buy or sell shares. If you are in any doubt about buying or selling shares, you should seek professional financial advice. * Equiniti Financial Services Limited is authorised and regulated by the Financial Services Authority of 25 The North Colonnade, Canary Wharf, London E14 5HS (FSA reference 468631).
** 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 in England and Wales, registered number 1959479. NWS is operated by a joint venture between The Royal Bank of Scotland Group plc and The Toronto-Dominion Bank.
† Barclays Stockbrokers is the group name for the businesses of: Barclays Stockbrokers Limited, a member of the London Stock Exchange and PLUS. Registered No. 1986161; Barclays Sharedealing, Registered No. 2092410 and Barclays Bank Trust Company Limited, Registered No. 920880. All companies are registered in England and the registered address is: 1 Churchill Place, London E14 5HP. All companies are authorised and regulated by the Financial Services Authority.
Calls made to 0870 numbers will cost no more than 8p per minute, plus 6p call set-up fee for BT residential customers. The price on non-BT phone lines may be different. You can only use these numbers if you are calling from within the UK. Calls may be recorded to monitor the quality of service, to check instructions and for security purposes.
‡ If you are not UK resident, you will need to provide various documents to Barclays Stockbrokers Limited 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.
Annual General Meeting Our Annual General Meeting will be held at the Barbican Centre, Silk Street, London EC2Y 8DS on: 29 April 2009 at 11.00am The Notice of Meeting, together with details of the business to be conducted at the Meeting is available on our website www.aviva.com/agm
If you are unable to attend but would like to ask the directors any questions, please do so via our website www.aviva.com/agm or complete and return the shareholder questions form, which can be found at the back of the Notice of Meeting. Answers to the most frequently asked questions will be circulated at the meeting and published on our website after the meeting.
Alternative format If you would like to request a copy of our Annual Report and Accounts in an alternative format, for example, braille or audio, please contact Equiniti by calling 0871 384 2953*.
Ordinary shares - 2008 final dividend Ex-dividend date 25 March Record date 27 March Dividend payment date 15 May
Useful contact details Detailed below are the contact details that shareholders may find useful. Please quote Aviva plc as well as the name and address in which the shares are held in all correspondence. Please quote your shareholder reference number as well, which you will find on your latest dividend stationery.
General shareholding, administration and Aviva Share Account queries Equiniti Aspect House Spencer Road Lancing West Sussex BN99 6DA
Aviva worldwide internet sites www.aviva.com/websites ** From 1 June 2009, this website will change to www.aviva.co.uk
Also we take care to minimise the impact on the environment in the paper we use. The paper we have used, Revive 50:50 Silk, is a recycled paper containing 50% recovered waste and 50% virgin fibre and manufactured at a mill accredited with ISO 14001 environmental management standard. The pulp used in this product is bleached using an Elemental Chlorine Free process. The laminate used on the outer cover is biodegradeable.
FSC – Forest Stewardship Council. This ensures there is an audited chain of custody from the tree in the well-managed forest through to the finished document in the printing factory.
Cert no. SGS-COC-O620 1 Chairman’s introduction 2 Group chief executive’s review 4 Group chief executive’s perspective 14 Group structure 16 Our global brand 18 Group strategy 20 Key performance indicators 22 Group performance 28 Capital management 32 Risk management 36 Regional overviews: 36 Aviva investors 42 UK 50 Europe 58 North America 64 Asia Pacific 70 People and responsibility 80 Basis of preparation 82 Board of directors 86 Executive management 87 Directors’ report 90 Corporate governance report 96 Audit Committee report 98 Nomination Committee report 99 Risk and Regulatory Committee report 100 Corporate Social Responsibility
Committee report 101 Directors’ remuneration report 122 Contents 123 Independent auditor’s report 125 Accounting policies 140 Consolidated income statement 141 Pro forma reconciliation of Group operating profit to profit before tax 143 Consolidated statement of recognised income and expense 143 Reconciliation of movements in consolidated shareholders’ equity 144 Consolidated balance sheet 145 Consolidated cash flow statement 146 Notes to the consolidated financial statements 278 Financial statements of the Company 281 Notes to the Company financial statements 325 Glossary 328 Aviva Group of Companies 330 Shareholder services
By recognising who people are and what they want, and doing something about it, we aim to set ourselves apart from other companies.