Control environment The Group operates a ‘three lines of defence’ model. Primary responsibility for the application of the risk management framework – risk identification, measurement, management, monitoring and reporting – lies with business management (the first line of defence). Management is therefore responsible for implementing and monitoring the operation of the system of internal control and for providing assurance to the Group Executive Committee, the Audit Committee and the Risk Committee, as relevant, that it has done so. Support for and challenge of the completeness and accuracy of risk assessment, risk reporting and adequacy of mitigation plans are performed by the specialist risk function (the second line of defence) acting as the ‘critical friend’ to the first line of defence. The design of the risk management framework is also primarily the responsibility of the second line of defence. The risk function operates globally with teams in all major regions and business units.
Governance and oversight committee structure The Board delegates oversight in relation to risk management and internal control to the following committees: Risk Committee; and Audit Committee
Control activities The Group has a set of formal risk management policies that facilitate a consistent approach to the management of all the risks across all the businesses and locations in which the Group operates. These risk policies define our appetite for different, granular risk types and set out risk management and control standards for the Group’s worldwide operations. The risk policies also set out the roles and responsibilities of businesses, regions, risk policy owners and the risk oversight committees. As our business responds to changing market conditions and customer needs, we regularly monitor the appropriateness of our risk policies to ensure they remain up to date. This helps to provide assurance to the various risk oversight committees that there are appropriate controls in place for all our core business activities, and that the processes for managing risk are understood and followed consistently across our global businesses.
Businesses regularly review the risks identified against the tolerances specified in the risk policies, and where risks are outside of tolerance, action plans are required. Similarly, controls are regularly reviewed for effectiveness and remediation actions implemented where necessary. The Audit Committee receives regular reports from management to assist with its review and assessment of the effectiveness of internal control including financial reporting. A governance certification process is conducted throughout the Group in support of this review. The necessary actions have been or are being taken to remedy significant failings and weaknesses identified from these reviews. The chief executive and chief financial officer of each region have certified compliance with the Group’s governance, internal control and risk management requirements, supported by consideration of evidence from all three lines of defence. They have certified that all the key inherent risks within the business have been identified and assessed and that the business operates in a manner which conforms to the minimum standards outlined in Group risk policies as well as the business ethics code. The chief executives and chief financial officers in the regions have also confirmed that there is a governance structure that is appropriate to oversee risk management activities and that the business has complied with the terms of its delegated authority (cascaded by the Group) and has operated a delegated authority structure that is appropriate to oversee its activities. Any key risks not previously identified, control weaknesses or non-compliance with the Group policy framework or local delegation of authority must be highlighted as part of this process. The chief risk officers of each region have also certified their responsibility for providing effective challenge and independent oversight of the business management of all risks and of the system of internal control. The chief risk officers have certified in each region that they have reviewed, and where appropriate, challenged the completeness, appropriateness and adequacy of risk assessments (irrespective of risk appetite), risk reporting and the adequacy of risk mitigation plans, including proactively advising senior management of emerging risk issues. They have also certified that they have monitored the implementation of, and compliance with, the risk policies and standards, providing challenge and escalating all material breaches of limits, appetite or policy to the appropriate forum as necessary. The Group risk function has reviewed any matters identified by regions in their certification and also assessed the risk and control issues that arose and were reported during the year by the three lines of defence.
Risk management A Risk Management Framework (RMF), designed to identify, measure, manage, monitor and report significant risks to the achievement of business objectives is in place and embedded throughout the Group. The risk management policy set described above (under control activities) is a key element of the RMF. The Board has overall responsibility for determining the nature and extent of the significant risks it is willing to take in achieving its strategic objectives. The Group’s risk appetite statements were reviewed and approved by the Board in June 2010, with a key focus on balance sheet strength, liquidity and the protection of the franchise value. A company’s objectives, its internal organisation and the environment in which it operates are continually evolving and, as a result, the risks it faces are continually changing. Management in conjunction with the risk function regularly monitors the risk profile of business units, regions and the Group. On a quarterly basis, risk reports, setting out the risk profiles, risk exposures outside risk appetite and action plans are reported by the risk function. A consolidated Group-wide risk profile is considered by the Group Executive Committee and the Risk Committee. Regional executive committees and management receive and similarly consider local risk reporting. Where significant risks outside risk appetite are identified, an escalation process is followed. Such significant risks are reported by the chief risk officer to the Group Executive Committee, the Risk Committee and Audit Committee, along with any proposed mitigating actions. The risk management process has been in place for the year under review and up to the date of approval of the Annual Report and Accounts. Further details on procedures for the management of risk and the systems of internal control operated by the Group are given in the section on risk management set out on pages 65 to 68.
Internal audit Internal Audit provides independent assurance to management on the effectiveness of the internal control systems and, the adequacy of these systems to manage business risk and to safeguard the Group’s assets and resources. Internal Audit also provides objective independent assurance on risk and control to both the Audit Committee and the Risk Committee. Throughout 2010, Internal Audit, through the chief audit officer, provided quarterly reporting on issues arising and the status of action items to the Audit Committee and Risk Committee. Similar reporting is undertaken on a regional and business unit basis to local executive management and local audit committees. The effectiveness of Internal Audit is reviewed annually by the Audit Committee.
Share capital and control The information required to be provided by the directors pursuant to section 992 of the Companies Act 2006 can be found on page 97 of the Directors’ Report.
The Company’s Annual General Meeting provides a valuable opportunity for the Board to communicate with private shareholders. At the meeting, the Company complies with the Combined Code as it relates to voting, the separation of resolutions and the attendance of Board committee chairmen. Whenever possible, all directors attend the Annual General Meeting and shareholders are invited to ask questions related to the business of the meeting during the meeting and have an opportunity to meet with the directors following the conclusion of the meeting. In line with the Combined Code, details of proxy voting by shareholders, including votes withheld, are made available on request and are placed on the Company’s website following the meeting. The Company’s Annual Report and Accounts together with the Company’s Half-year Report, interim management statements, reports on Form 20F (for filing with the United States Securities and Exchange Commission) (SEC) and other public announcements, are designed to present a balanced and understandable view of the Group’s activities and prospects and are available on the Company’s website, ww.aviva.com/investorrelations /results-and-reports. The Chairman’s statement, group chief executive’s review and Performance review provide an assessment of the Group’s affairs and they will be supported by a presentation to be made at the Annual General Meeting, which can also be viewed by webcast on the Company’s website at www.aviva.com/agm after the meeting.
New York Stock Exchange listing requirements The Company was admitted to the New York Stock Exchange (NYSE) on 20 October 2009 and its ordinary shares are traded as American Depositary Shares. As a foreign company listed on the NYSE, the Company is required to comply with the NYSE corporate governance rules to the extent that these rules apply to foreign private issuers such as Aviva plc. As a foreign private issuer, the Company is therefore required to comply with NYSE Rule 303A.11 by making a disclosure of the differences between the Company’s corporate governance practices and the NYSE corporate governance rules applicable to US companies listed on the NYSE. These differences are summarised below:
Independence criteria for directors Under the NYSE listing rules applicable to US companies, independent directors must form the majority of the board of directors. The Combined Code requires that at least half the Board, excluding the Chairman, should comprise independent non-executive directors, as determined by the Board. The NYSE listing rules for US companies also state that a director cannot qualify as independent unless the Board affirmatively determines that the director has no material relationship with the company, and the NYSE rules prescribe a list of specific factors and tests that US companies must use for determining independence. The Combined Code sets out its own criteria that may be relevant to the independence determination, but permits the Board to conclude affirmative independence notwithstanding the existence of relationships or circumstances which may appear relevant to its determination, so long as it states its reasons.
This report provides details of the role of the Nomination Committee and the work it has undertaken during the year. The purpose of the committee is to assist the Board by keeping the composition of the Board under review and conducting a rigorous and transparent process when recommending or renewing appointments of directors to the Board. It also advises the Board on issues of directors’ conflicts of interest and independence. The full terms of reference for the committee can be found on the Company’s website, www.aviva.com/investor-relations/corporate-governance/ terms-of-reference, and are also available from the group company secretary. The following directors served on the committee during the year: Period
Andrew Moss* 12 July 2007 To date Russell Walls 23 January 2007 To date * The Nomination Committee notes that the Combined Code does not preclude the group chief executive from membership of the committee and the committee believes that his input is essential and invaluable in its discussions and therefore important that this is obtained through his membership of the committee. Any concern about this will be allayed by the predominant membership of independent non-executive directors on the committee.
• Succession planning 35 • Conflicts of interest 25 • Independence 20 • Others (including corporate governance matters) 20
Committee activities during 2010 During the year, the committee initiated a review of the succession plans for appointments to the Board to ensure that an appropriate balance of skills and experience is maintained and that there is progressive refreshing of the Board. Several nonexecutive directors, including the Company chairman are due to retire in 2012 and 2013 on the basis of their completion of nine years of service in line with the Combined Code guidance. An external search agency has been retained to identify potential candidates for future appointments and the committee has prepared a job specification, including an assessment of the time commitment expected from candidates. The search will be conducted and any appointments will be made, on merit, against the criteria identified by the committee having regard to the benefits of diversity on the Board, including gender. The senior independent director will chair the committee when it is dealing with the appointment of a successor to the chairmanship of the Company. In line with the Combined Code requirement, the Board undertook a review of the effectiveness of all its committees during the year, including the Nomination Committee. This report was reviewed and approved by the Board on 2 March 2011.
Russell Walls (Chairman) 1 July 2004 To date Mary Francis 1 January 2007 To date Richard Karl Goeltz 1 July 2004 To date Euleen Goh 1 January 2009 To date
Attendance Number of meetings held* 11 Russell Walls (Chairman) 11 Mary Francis 10 Richard Karl Goeltz 11 Euleen Goh 10 * There were nine scheduled Audit Committee meetings during 2010 and two additional meetings called at short notice.
The committee met on 11 occasions in 2010 and the members’ attendance record is set out above. In addition, the committee held separate meetings with members of senior management and the external auditors to discuss issues relevant to the committee and for the purpose of training. The group company secretary acts as the secretary to the committee. Russell Walls, a Fellow Chartered Certified Accountant, is a former group finance director of BAA plc, Wellcome plc and Coats Viyella plc. Richard Goeltz is a former chief financial officer of American Express Company and NatWest Group plc and a former member of the Accounting Standards Board. Euleen Goh, a Chartered Accountant and member of the Chartered Institute of Taxation, is a former financial controller of Pontiac Land and chief executive of Standard Chartered Bank, Singapore. The Board is satisfied that these directors have recent and relevant financial experience for the purpose of the Combined Code and are financial experts for the purposes of section 407 of the SarbanesOxley Act 2002. The group chief executive, chief financial officer, chief audit officer, chief accounting officer, chief risk officer and the external auditor normally attend, by invitation, all meetings of the committee. Other members of senior management are also invited to attend as appropriate to present reports. In performing its duties, the committee has access to the services of the chief audit officer, the group company secretary and external professional advisers. Keith Nicholson, a former partner at KPMG LLP, acts as an external adviser to the committee.
Committee activities during 2010 The committee follows an agreed annual work plan. It reviews, with members of management and the internal and external auditors, the Company’s financial announcements including the Annual Report and Accounts to shareholders and associated documentation. It places particular emphasis on their fair presentation and the reasonableness of the judgemental factors and appropriateness of significant accounting policies used in their preparation. At each meeting, the committee receives a report from the chief audit officer concerning the Company’s systems of internal control, including any significant new issues and actions taken on previously reported issues. The committee also reviews, approves and monitors the annual work plan for the Group’s internal audit function and approves the annual plan for the external audit. Twice each year, the committee receives reports on the adequacy of the Group’s life assurance and general insurance reserves. The committee reports to the Board regarding the effectiveness of the Group’s overall systems of internal control including the risk management systems in relation to the financial reporting process. The committee works closely with the Risk Committee, which assists the committee in its review of the Company’s systems of internal control and risk management. The committee receives reports from the external auditor and, at all scheduled meetings, holds discussions with both the chief audit officer and external auditors in the absence of management. The chairman of the committee reports to the subsequent meeting of the Board on the committee’s work and the Board receives a copy of the minutes of each meeting of the committee. The chart below shows how the committee allocated its time during 2010.
• Financial reporting 35 • Internal audit and controls 21 • External audit and external ! auditor’s report 9 • External auditor engagement and policy 9 • Financial reporting control framework and financial reporting developments 18
External auditor Ernst & Young LLP (Ernst & Young) was appointed external auditor of the Company in 2001 having previously been the auditor of Norwich Union plc. During the year, the committee performed its annual review of the independence, effectiveness and objectivity of the external auditor, assessing the audit firm, the audit partner and audit teams. The process was conducted by means of a questionnaire, completed Group-wide by members of senior management and members of the Group’s finance community and the committee. The questionnaire sought opinions on the importance of certain criteria and the performance of the external auditor against those criteria. Based on this review, the committee concluded that the audit service of Ernst & Young was fit for purpose and provided a robust overall examination of the Group’s business and the risks involved. Following this review, the committee recommended that a retender process should not be undertaken in 2010 but that the relationship and the effectiveness of the auditor be kept under review. Ernst & Young audits all significant subsidiaries of the Group. The Company introduced a revised external auditor policy on 1 January 2008 aimed at safeguarding and supporting the independence and objectivity of the external auditors. The policy is regularly reviewed and if necessary updated to reflect current global best practice on auditor independence, and is in full compliance with all UK, US and International Federation of Accountants (IFAC) rules. The revised external auditor policy aims to be simpler to interpret, providing greater clarity on what services may and may not be provided by the Group’s external auditors. The external auditor policy regulates the appointment of former audit employees to senior finance positions in the Group and sets out the approach to be taken by the Group when using the non-audit services of the external auditor, including requiring that all services provided by the external auditor are pre-approved by the committee. It distinguishes between those services where an independent view is required and that should be performed by the external auditor (such as statutory and non-statutory audit and assurance work), prohibited services where the independence of the external auditor could be threatened and they must not be used, and other non-audit services where the external auditor may be used. Non-audit services where the external auditor may be used include: non-recurring internal controls and risk management reviews (i.e. excluding outsourcing of internal audit work), advice on financial reporting and regulatory matters, due diligence on acquisitions and disposals, project assurance and advice, tax compliance services, and employee tax services. The committee receives a quarterly report of compliance against the external auditor policy and the policy has worked effectively during 2010. Annually, the committee reviews a formal letter provided by the external auditor confirming its independence and objectivity within the context of applicable regulatory requirements and professional standards. The Group paid £18.6 million to Ernst & Young for audit services in 2010, relating to the statutory audit of the Group and Company financial statements and the audit of Group subsidiaries and associates pursuant to legislation (2009: £17.9 million). The fees for other services, which included MCEV supplementary reporting, advice on accounting and regulatory matters, reporting on internal controls, reporting on the Group’s Individual Capital Assessment, and due diligence work, were £7.0 million (2009: £16.1 million), giving a total fee to Ernst & Young of £25.6 million (2009: £34.0 million). The Group paid £1.7 million to Ernst & Young in relation to other non-audit services. This included two significant engagements, which were both at Delta Lloyd Bank Belgium (DLBB): £0.4 million in relation to a report to DLBB’s management and strategy committee, and £0.4 million in relation to a review of DLBB’s cost base. The Audit Committee satisfied itself that for both engagements, robust controls (including appropriate levels of review and challenge by DLBB management) were in place to ensure that E&Y’s objectivity and independence was safeguarded, and concluded that it was in the interests of the Company to purchase these services from E&Y due to its specific expertise in the Belgian banking market. Further details are provided in note 12 to the consolidated financial statements IFRS. In addition, the Group engaged Ernst & Young to provide assurance on the Group’s Corporate Responsibility Report. In line with the Combined Code requirement, the Board undertook a review of the effectiveness of all its committees during the year, including the Audit Committee. This report was reviewed and approved by the Board on 2 March 2011.
The committee met on seven occasions in 2010 and the members’ attendance record is set out above. In addition the committee held separate meetings with members of senior management and the external auditor to discuss issues relevant to the committee and for the purposes of induction and training. The group company secretary acts as the secretary to the committee. The group chief executive, chief risk officer, chief financial officer, chief audit officer and the external auditor normally attended, by invitation, all meetings of the committee. Other members of senior management were also invited to attend as appropriate to present reports. It was the committee’s practice at each meeting to meet separately with the chief risk officer, the chief audit officer and the external auditor without any members of management being present. In performing its duties, the committee had access to the services of the chief audit officer, the chief risk officer and the group company secretary and external professional advisers. The chairman of the committee reported to subsequent meetings of the Board on the committee’s work and the Board received a copy of the minutes of each meeting of the committee. The chairman of the committee sits on the Audit and Remuneration committees to ensure that risk considerations are fully reflected in their decisions.
Risk monitoring: the committee received regular reports on key risk exposures, the drivers of risk in the Group, emerging and potential risks, and actions taken to mitigate any risks that were out of appetite. Working with the Audit Committee, it also monitored the adequacy of the Group control framework. The committee focused particularly on monitoring the Group’s capital and liquidity positions against risk appetite, the results of stress and scenario testing, and the drivers of financial and insurance risks – since these give rise to the majority of the Group’s capital requirements under both the current (IGD and ICA) and the future (Solvency II) regimes. The committee continued its practice of inviting business unit and regional teams, led by their chief executive, to present on how risk is managed in their businesses. During the year, presentations were received from Aviva USA, Delta Lloyd and the UK Region.
Operational risks: the committee paid particular attention to business protection and IT security risks, and how business units were embedding the Group IT and Business Protection policies.
Regulatory risks and relationships: the committee received regular reports on compliance issues and regulatory and other public policy initiatives. In particular, it monitored the actions being taken by management in response to the FSA’s Risk Mitigation Programme and management responses to proposed changes in the prudential requirements for financial services companies.
Fraud and financial crime: the committee maintained regular oversight of compliance with controls against financial malpractice including fraud, and of the arrangements for employees to report in confidence any concerns about lack of probity (whistleblowing).
Internal controls: Internal Audit provided the committee with independent and objective assurance over the appropriateness, effectiveness and sustainability of the Company’s system of internal controls. Key control issues reported by Internal Audit to management and to the committee members were monitored on a quarterly basis until the risk exposure had been properly mitigated. The chart below shows how the committee allocated its time during 2010.
• Risk management and risk appetite 32 • Group risk report and Group audit report 29 • Solvency II and capital position and targets 11 • Group internal capital assessment, IGD and economic capital 7 • Business protection and IT security 3 • Stress testing 3 • Others (Group liquidity position, 2009 Report and Accounts, Group policies, Aviva USA update, Aviva Investors update, Delta Lloyd update, UK Risk Committee update) 15
More detail on the management of risk is contained in the Risk management section of the Performance review on pages 65 to 68. During the year the committee held several joint meetings with the Audit Committee and one with the members of the business unit audit committee in Spain. In line with the Combined Code requirement, the Board undertook a review of the effectiveness of all its committees during the year, including the Risk Committee. This report was reviewed and approved by the Board on 2 March 2011.
Aviva plc Annual Report and Accounts 2010 Corporate responsibility committee report
This report provides details of the role of the Corporate Responsibility Committee and the work it has undertaken during the year. The purpose of the committee is to set guidance and direction for the Group’s corporate responsibility (CR) programme, review the Group’s key CR risks and opportunities and to monitor progress against the Group’s key performance indicators. The committee also reviews the Group’s strategy for CR together with the Group’s overall CR targets. The full terms of reference for the committee can be found on the Company’s website, www.aviva.com/investor-relations/corporate-governance/termsof -reference, and are also available from the group company secretary. The following directors served on the committee during the year: Period
The committee met on five occasions in 2010 and the members’ attendance record is set out above. The group company secretary acts as the secretary to the committee. During the year, the committee reviewed and approved the content and scope of the Company’s 2010 CR Report included in this annual report and accounts. It also continued to monitor the management of the CR risks affecting the Group and again reviewed each region’s performance and progress during the year against the Group’s key performance indicators together with the performance of Group functions such as Procurement and IT, which contribute to the Group’s CR programme activities. Internal Audit reported to the committee on the results of their reviews which were relevant to the CR activities of the Group and will continue to do so. In addition, going forward, external assurance to the committee will be provided by Ernst & Young LLP. The regional CR plans have been incorporated into the overall regional and functional strategies to facilitate the embedding of the CR strategy through formal accountabilities. There was continued focus on strengthening CR performance through employee engagement, by influencing key stakeholders and on embedding balanced leadership throughout the organisation. The committee received updates on the Group’s key CR programme activities such as the Street to School programme, on which there was an increased focus during the year; business ethics, particularly in preparation for the implementation of the UK Bribery Act; stakeholder recognition and the progress of the Group’s carbon offset projects as part of management’s commitment to be carbon neutral on a global basis. More recently, in line with the Board’s commitment to energy efficiency and reduction of waste in natural resources, the committee has supported the move towards paperless meetings. The chart opposite shows how the committee allocated its time during 2010.
• Balanced leadership debate 5 • Region review 26 • Stakeholder recognition and business ethics 16 • Street to School programme 16 • Function review 21 • Climate change response and carbon offsetting 5 • CR reporting and assurance 11
The financial and non-financial targets set for the 2010 annual bonus were met in part during the year. The combination of financial outcomes, along with those targets relating to employees, customers, and personal objectives mean the group chief executive received a 2010 bonus of 74.3% of his maximum opportunity (2009: 74.2%).
On 19 January 2011, Igal Mayer was appointed as chief executive, Aviva Europe and joined the Board. A summary of his annual remuneration is included in this report.
1. Introduction This report sets out the details of the remuneration policy for the Company’s directors, describes its implementation and discloses the amounts paid in 2010. In addition to meeting statutory requirements, particularly the regulations on directors’ remuneration reports made under the Companies Act 2006, the committee has complied with best practice guidelines, including guidance issued by the Association of British Insurers and the National Association of Pension Funds, in producing this report. Relevant sections of this report have been audited in accordance with the legislation.
The review was led by the committee with input from the Human Resources function and senior management. In addition to the internal resources, market benchmarking and external commentary was provided by Hewitt New Bridge Street (HNBS) (primarily to the committee) and PricewaterhouseCoopers (PwC) (primarily to management). During the review, the committee and management agreed a set of Remuneration Principles and Remuneration Framework to be applied throughout the Company. These were then used to help guide the conclusions and remuneration structures which will be rolled out in 2011.
Simplified annual bonus structure: In 2010, and in prior years, the financial component of the annual bonus (which comprises 50% of the total annual bonus opportunity) had multiple (typically seven) Key Performance Indicators (KPIs). In order to help drive a reward and performance culture, the number of KPIs will be ideally kept to a maximum of four. These will be disclosed in the Annual Report and Accounts following the relevant year end and will endeavour to reflect all relevant outcomes, behaviors and risk management actions sought by the Board.
New share ownership requirements: The share ownership requirement of the group chief executive will be increasing from 175% to 200% of basic salary. In addition, members of the Executive Committee (EC) who are not EDs will also see the introduction of a 50% of basic salary share ownership requirement. In line with common market practice, no time limit will now be set in order for any member of the EC to meet these requirements. Instead 50% and 25% of the EDs’ and EC members’ respective share plan releases will be required to be held until such time as their requirement is met.
Annual Bonus Target 75% of basic salary Maximum 150% basic salary Multiple financial measures Two-thirds deferred into shares for three years
Plan expired in 2010, as originally approved by shareholders in 2008
Long Term Incentive CEO: 175% standard award EDs: 150% standard award Performance measures: 50% Total Return MCEV ROCE, 50% Relative TSR 30% vests for threshold performance
Share Ownership Requirement CEO: 175% of basic salary EDs: 150% of basic salary To be fulfilled five years from date of appointment
Work with the Risk Committee to ensure that risk is properly considered in setting the overall remuneration policy for the Group and the remuneration of EDs and members of senior management.
4. Committee membership Table 2 below shows the directors who served as members of the committee during the year, all of whom are independent NEDs, and individuals who attended committee meetings: Table 2: Members and attendees of the committee during 2010 Member Position Comments
Scott Wheway Chairman of the committee Member since 5 December 2007, chairman since 1 January 2009 Mary Francis Member Member since 25 January 2006 Carole Piwnica Member Member since 25 January 2006 Leslie Van de Walle Member Member since 24 September 2009 Attendee Position Comments
Lord Sharman Chairman of the Company Attended by invitation Andrew Moss Group chief executive Attended by invitation John Ainley Group HR director Attended as an executive responsible for advising on the remuneration policy Graham Jones Group company secretary Attended as secretary to the committee Kirsty Cooper Deputy group company secretary Attended by invitation Tracey O’Rourke Group reward and HR policy director Attended as an executive responsible for advising on the remuneration policy Martyn Fisher Group reward director Attended as an executive responsible for advising on the remuneration policy David Rogers Chief accounting officer Attended to advise on matters relating to the performance measures and targets for the Group’s share incentive plans Robin Spencer Chief risk officer Attended to advise on the management of risk within the remuneration framework Representatives of Hewitt New Bridge Street (HNBS)
Attended by invitation as the committee’s independent adviser HNBS is part of AON, who provided insurance broking services to the Company in 2010
The committee has a standing calendar of agenda items within its remit. In addition to these items, the committee discusses matters relating to the operation of the Group’s remuneration policy and emerging market practices. The chart below summarises the time allocated to various agenda items during 2010 and Table 4 below sets out the matters discussed by the committee: Remuneration Committee – Allocation of agenda time %
• Strategic reward review 20 • EDs’ salaries and bonuses 15 • EDs’ objectives and Group targets 15 • Share Plan amendments, awards p and performance conditions 15 • Discussions regarding Group
January None Final approval of the Group’s stretch target for the 2010 financial year
March A review of EDs’ basic salaries and benefits in kind Assurance of non-financial bonus outcomes for 2009 Consideration and approval of EDs’ bonus awards for 2009 and approval of share awards under the Annual Bonus Plan (ABP)
Approval of the HM Revenue and Customs Approved Options Schedule to the rules of the Aviva Executive Share Option Plan 2005
Approval of the Restricted Share Awards Schedule to the rules the ABP
August A review of dilution limits Approval of an invitation to UK and Irish employees to participate in the Aviva Savings Related Share Option Scheme or the Aviva Ireland Save As You Earn Scheme (SAYE Schemes)
A review of the proposed approach to the 2010 Directors’ Remuneration Report
The committee members also participated in five workshops throughout the year to discuss the Strategic Reward Review’s progress and to review critical stages of its development.
7. Future actions and changes The Company does not anticipate any significant changes to the structure of EDs’ compensation packages in 2011, other than those outlined in section 2 and as detailed below: Changes to UK pension taxation Following announcements by the UK government during 2010, the Company is reviewing its approach to pension provisions for those employees whose pension contributions will exceed the newly reduced annual allowance (and from April 2012, the newly reduced Lifetime Allowance). The Company fully supports, where possible, the continued tax-efficient provision of retirement benefits. In addition, the manner in which contributions to the Aviva Capital Accumulation Plan (ACAP) will be taxed is also changing. In reviewing the ongoing retirement benefit plan changes, no arrangements will be entered into which materially increase the costs to the Company. Any impact of these proposals that is experienced by the EDs will be disclosed in the 2011 Annual Report and Accounts.
The Group’s strategic priorities and targets are set out elsewhere in this report. Those priorities are reflected closely in the remuneration package.
The committee also considers how, given changing economic circumstances, the Group’s priorities, and consequently the targets underpinning its bonus structures, need to change. Financial targets sit alongside targets on customer advocacy and employee engagement that the committee believes are critical to long-term organisational health. The personal objectives of EC members are reviewed by the committee to ensure they adequately reflect the strategic aims of the Group, good governance and best practice.
Basic Salary: Internal and external equity in basic salary positioning is an important contributor to a motivational remuneration package. A range of market data is used to inform decision making taking into account the Company’s benchmarking policy with regard to the relevant FTSE market during 2010 and the new group of 25 FTSE companies either side of Aviva’s position for 2011 and beyond.
Annual Bonus Plan: Bonus structures are effective only if they drive, through the targets, the maintenance of the Company on a sound financial footing and sustained profitable growth. In addition, the targets must not provide an incentive to promote behaviours which could be detrimental to the Company’s long-term interests. Management must justify the targets it recommends. The committee is satisfied that the targets provide appropriate incentives, are sufficiently challenging, are aligned to shareholders’ interests and are within the Group’s risk appetite.
LTIP: The LTIP encourages a longer-term management focus on Return on Capital Employed (ROCE) and relative TSR. These metrics measure how the Company is performing in both absolute and relative terms.
The committee considers all these elements, plus pension and other benefits, as a whole. It looks to ensure that an appropriate balance is maintained between them so that the need for both short-term success and long-term sustainable growth is recognised. The committee also ensures that the non-financial business measures and individual objectives reflect adequately the Company’s environmental, social and governance responsibilities.
Tables 5b: Breakdown of remuneration for group chief executive in 2011
2010 ‘Target’ performance means a target ABP outcome (75% of basic salary), a 50% vesting of the LTIP (87.5% of basic salary) and a 1:1 match from the OATTV Plan (50% of basic salary).
2010 ‘Stretch’ performance means a stretch ABP outcome (150% of basic salary), 100% vesting of the LTIP (175% of basic salary) and a 2:1 match from the OATTV Plan (200% of basic salary).
2011 ‘Target’ performance means a target ABP outcome (75% of basic salary) and a 50% vesting of the LTIP (137.5% of basic salary).
2011 ‘Stretch’ performance means a stretch ABP outcome (150% of basic salary) and 100% vesting of the LTIP (275% of basic salary).
Total remuneration Total remuneration package levels are informed by relevant pay data, in particular for 2010 the lower quartile to median range of the FTSE 30 and the median to upper quartile range of the FTSE 50. These reference points are chosen to reflect Aviva’s market capitalisation and comparability to other large, sophisticated multi-national companies and the positioning that is appropriate to Aviva in those different comparator groups. As outlined above, from 2011, this pay data will be based on the median of 25 FTSE companies, either side of Aviva’s market capitalisation.
Annually, one-third is paid in cash and two-thirds in deferred shares.
OATTV Plan The OATTV Plan rewards executives for growth in EPS over a three-year period. As previously approved by shareholders, the 2010 award was the final award under this plan. The plan matches 100% of the deferred ABP shares for the group chief executive (75% for other EDs). For the 2010 awards, the vesting of these matched shares is dependent on the achievement of an EPS of 49.2 pence per share and then compounded annual growth targets as follows: Less than 14.9% growth pa Nil 14.9% growth pa 0.1 for 1 57.5% growth pa 1 for 1
Matching is on a straight-line basis for performance from 14.9% to 57.5% and beyond, up to a maximum award of 2 for 1. No additional shares are awarded for the dividends paid during the three-year performance period on those shares that vest. The methodology for establishing the targets of each OATTV award was not adjusted following the financial crisis of 2008. Therefore, the outcome of each award is likely to be well below anticipated value.
LTIP The LTIP is intended to motivate the achievement of the Company’s longer-term objectives, to aid the retention of key personnel and to align executive interests to those of shareholders. In 2010 the group chief executive was eligible to receive an annual award of shares equal to 175% of basic salary. Other EDs were eligible to receive an annual award of shares equal to 150% of basic salary. From 2011 onwards, the standard awards will be 275% and 225% respectively. The Company operates a phantom scheme in the US for its US-based employees. Levels of awards reflect US market practice. For awards made prior to 2011, no additional shares are awarded for the dividends paid during the three-year performance period on those shares that vest. From 2011 onwards, dividend equivalent awards will be paid, in line with the current market practice.
Annual awards in shares that vest, subject to ROCE and relative TSR performance conditions being met at the end of a three-year performance period.
CFO Recruitment Share Awards Plan The CFO Recruitment Share Awards Plan was approved by the committee in 2010 for the granting of one-off share awards to Patrick Regan as part of the recruitment offer made to him. The following awards were granted to Mr Regan under the rules of this plan and are subject to clawback provisions: Replacement Restricted Share Award (RRSA) with a grant value of £1.65 million to compensate for the loss of unvested Willis Group Holdings Limited restricted shares and share options.
BRDSA will vest under the same terms as outlined above for the ABP and is therefore not subject to performance conditions.
OATTV will vest under the same terms as outlined above for the OATTV Plan.
Table 7: Overview of current EDs’ remuneration Andrew Moss, group chief executive
£1,031,144 (111.5% of basic salary) (£343,715 delivered in cash and £687,429 deferred into shares for three years)
LTIP – Face Value of grant £1,618,750 The face value of the grant represented 175% of basic salary on 28 February 2010.
Mr Moss receives 2% of basic salary as a non-pensionable cash supplement provided in consideration of his surrendering his Unapproved Unfunded Retirement Benefit (UURB) promise at the point when accrual in the ASPS ceased.
Legal fees were paid directly to Mr Scott’s solicitor for advising Mr Scott on his departure terms.
* Philip Scott retired from the Board on 26 January 2010 and the information shown is for the period served as an ED in 2010. ** Percentages do not necessarily add up due to rounding.
LTIP – Face Value of grant £900,000 The face value of the grant represented 150% of Mr Regan’s basic salary on 28 February 2010.
Mr Regan received £425,000 compensation for loss of bonus from previous employer. This payment was paid one-third in cash (£141,667) with the remaining £283,333 deferred into restricted shares for three years (BRDSA as detailed above).
* Patrick Regan joined the Company and Board on 22 February 2010 ** Percentages do not necessarily add up due to rounding.
Aviva plc Annual Report and Accounts 2010 Directors’ remuneration report continued
£695,490 (115.9%% of basic salary) (£231,830 delivered in cash and £463,660 deferred into shares for three years)
Basic Salary €780,000 during the year (£668,925) Mr Moneta requested not to receive an increase to his basic salary in 2010.
LTIP – Face Value of grant €1,170,000 The face value of the grant represented 150% of Mr Moneta’s basic salary on 28 February 2010.
The Trustee of the Plan accepted Aviva’s recommendation and made an award into the plan equivalent to 27% of Mr Moneta’s basic salary as at 1 April 2010.
*Andrea Moneta resigned from the Board on 19 January 2011. **Percentages do not necessarily add up due to rounding. ***These exceptional other benefits were provided to replicate pre-existing obligations and are time-limited.
The committee remains sensitive to the external environment in relation to executive pay, and particularly relating to the payment of bonuses in circumstances where financial targets have not been met and share prices have fallen. However, the combination of financial and non-financial measures is central to the structure of the ABP. The committee wants to ensure a balanced focus on both short-term financial performance and on the objective non-financial measures that are leading indicators of future financial success. This balance is, in the committee’s view, reflective of good practice in incentive design and is consistent with the FSA’s guidance on creating incentive schemes that have a focus on long-term sustainable performance and considerate of the risk environment. Aviva appropriately incentivises and rewards employees for achieving stated business goals in a manner that is consistent with our approach to sound and effective risk management. As described above, the committee took the view that it was important to maintain the integrity of the financial targets for the EDs, and so these were not adjusted during the year. In the same way, the committee believes that it is appropriate to pay bonuses based on pre-agreed rigorous targets when these have been met. To align with the business priorities for 2011, the financial measures at Group level for 2011 are IFRS Operating Profit, Net Operating Capital Generation, Internal Rate of Return and Total Sales (which are not set a stretch target in line with relevant risk considerations).
ROCE targets ROCE targets determine the vesting of 50% of any LTIP award and are set annually within the context of the Company’s three-year business plan. Vesting depends upon performance over the three-year period against a target return. The Company’s external auditor provides a formal opinion on the ROCE vesting calculation. The 2010 LTIP award ROCE targets are set out in Table 9 below: Table 9: 2010 LTIP ROCE Targets ROCE over the three-year performance period Percentage of shares in award that vests based on achievement of ROCE targets
Less than 31.5% 0% 31.5% 15% Between 31.5% and 37.5% Pro rata between 15% and 50% on a straight line basis 37.5% and above 50%
Table 11: Projections of vesting of subsisting LTIP awards LTIP award 31 December 2010 vesting projection (% of award)
Aviva LTIP 2010 50% Aviva LTIP 2009 79.6% Aviva LTIP 2008 72.3%
Details of the assumptions used in valuing the LTIP for accounting purposes can be found on page 242 of this report. The vesting assumption made in respect of the 2011 award for accounting purposes is 50%. Since the LTIP has performance conditions attached to it, one potential outcome is that neither performance condition is met and the whole of the LTIP lapses. Table 12 below has been drawn up to assist in understanding the potential value of the LTIP awards made to EDs in 2010 should the performance conditions be met in part or in whole.
At the end of the performance period for the 2007 LTIP grant, which vested in 2010, the Company was ranked ninth out of the 16 companies in the TSR comparator group (0% vesting) and ROCE was 39.0% (50% vesting of the whole award). The total vesting was therefore 50%. The 50% of the award which did not vest lapsed. The LTIP vesting history is set out in Table 13 below. Prior to the 2005 award, vesting history is based on an earlier LTIP plan, and the last award made under this plan was in 2004.
Aviva does not historically award additional shares for the dividends that were paid during the three-year performance period on those shares that vest. As outlined earlier in this report, the awards that will vest from the 2011 LTIP grants onwards will attract dividends, which is aligned to current market practice.
Table 14: Aviva plc five-year TSR performance against the FTSE 100 Index and the median of the comparator group
Table 15: LTIP, ABP, OATTV Plan and CFO Recruitment Share Awards Plan awards
Andrew Moss Aviva Long Term Incentive Plan 2007 136,540 — 68,2706 68,270 0 778.50 401.60 Mar-10 2008 253,289 — — — 253,289 617.50 Mar-11 2009 632,324 — — — 632,324 245.00 Mar-12 2010 — 419,365 — — 419,365 387.70 Mar-13 Aviva Annual Bonus Plan 2007 64,273 14,2587 78,5316 — 0 778.50 401.60 Mar-10 20089 93,567 — 38,459 — 55,108 617.50 386.87 Mar-11 20099 195,876 — 80,511 — 115,365 245.00 386.87 Mar-12 201010 — 177,770 73,068 — 104,702 387.70 386.87 Mar-13 One Aviva Twice the Value Bonus Plan 2008 93,567 — — — 93,567 598.00 Mar-11 2009 195,876 — — — 195,876 245.00 Mar-12 2010 — 177,770 — — 177,770 387.70 Mar-13 Philip Scott Aviva Long Term Incentive Plan 2007 107,282 — — — 107,282 778.50 Mar-10 2008 140,625 — — — 140,625 617.50 Mar-11 2009 351,562 — — — 351,562 245.00 Mar-12 Aviva Annual Bonus Plan 2007 58,647 — — — 58,647 778.50 Mar-10 2008 70,312 — — — 70,312 617.50 Mar-11 2009 127,054 — — 127,054 245.00 Mar-12 One Aviva Twice the Value Bonus Plan 2008 52,734 — — — 52,734 598.00 Mar-11 2009 95,291 — — — 95,291 245.00 Mar-12 Patrick Regan11 Aviva Long Term Incentive Plan 2010 — 233,160 — — 233,160 387.70 Mar-13 CFO Recruitment Share Awards Plan
2. The performance period for all awards begins at the commencement of the financial year in which the award is granted. 3. The performance conditions for awards granted and vested during 2010 are explained elsewhere in this report. 4. The monetary value of awards will be calculated by multiplying the relevant number of shares by the closing middle market price of an ordinary share of the Company at the date of vesting. 5. The award date for the awards granted in 2007 which vested in 2010 was 23 March 2007. 6. The awards granted in 2007 that vested in 2010 were released with the net amount being settled in shares and the balance settled in cash and used to pay the resulting tax liability. 7. These figures relate to shares issued in lieu of dividends accrued during the deferral period. 8. The information shown for Philip Scott is as at his retirement from the Board on 26 January 2010. 9. Andrew Moss and Mark Hodges elected for their ABP conditional share awards granted in 2008 and 2009 to be exchanged on 30 March 2010 for equivalent awards in respect of restricted shares. The awards vesting during the year in respect of these awards were released and sold on 30 March 2010 to cover the tax liability due on the exchange. The remaining restricted shares continue to be subject to the terms of the original awards. 10. Andrew Moss and Mark Hodges elected for their 2010 ABP awards to be granted as restricted shares. The awards vesting during the year in respect of these awards were released and sold on 30 March 2010 to cover the tax liability due at grant. The remaining restricted shares are subjected to forfeiture conditions until 30 March 2013. 11. Patrick Regan joined the Board on 22 February 2010 and held no share awards on appointment. 12 Patrick Regan elected for his RRSA award and BRDSA award to be granted as restricted shares. The awards vesting during the year in respect of the RRSA and BRDSA were released and sold on 11 March 2010 and 30 March 2010 respectively to cover the tax liabilities due at grant. The remaining restricted shares are subjected to forfeiture conditions until 30 March 2013, in respect of the BRDSA, and 22 February 2011 (one-third), 22 February 2012 (one-third) and 22 February 2013 (one-third) in respect of the RRSA.
13. The first tranche of the RRSA will vest on the first dealing day when there are no dealing restrictions in place. 14. The aggregate net value of share awards granted to the directors in the period was £9.510 million (2009: £5.256 million). The net value has been calculated by reference to the closing middle market price of an ordinary share of the Company at the date of grant.
Aviva plc Annual Report and Accounts 2010 Directors’ remuneration report continued 14.Share options Details of the EDs who were in office for any part of the financial year, and hold or held options over ordinary shares of the Company, pursuant to the Company’s share based incentive plans, are set out in Table 16 below. Savings-related share options in Table 16 refer to options granted under the HMRC approved Aviva Savings Related Share Option Scheme. Options are normally exercisable during the six-month period following the end of the relevant (three-, five- or seven-year) savings contract. Executive share options (approved) in Table 16 refer to options granted under the HMRC approved schedule to the Aviva Executive Share Option Plan 2005. Options will be exercisable on 30 March 2013 to the extent that the LTIP awards granted in 2010 have vested. Any gain made on exercise of these options will be used to reduce the number of shares vesting under the LTIP. Therefore, the vesting of the options will not increase the overall number of shares received by the EDs from their LTIP awards.
Mark Hodges Savings-related options 2007 1,705 — — — 1,705 563.0 December 2010 –
May 2011 Executive share options (approved) 2010 — 7,772 — — 7,772 386.0 March 2013
Savings-related options 2010 — 2,903 — — 2,903 310.0 December 2013 – May 2014
Philip Scott2 Savings-related options 2008 2,341 — — — 2,341 410.00 December 2011 –
Notes 1 Patrick Regan joined the Board on 22 February 2010 and held no share options on appointment. 2. The information shown for Philip Scott is as at his retirement from the Board on 26 January 2010
15. EDs’ service contracts Service contracts agreed with each ED incorporate their terms and conditions of employment. The key terms are set out in Table 17 below.
Sickness In line with senior management terms, i.e. 100% basic salary for 52 weeks, and 75% thereafter.
Contract dates Director Andrew Moss Mark Hodges Andrea Moneta Patrick Regan
Andrew Moss1 £925,000 326,460 £1,282,988 139% 175% Patrick Regan2 £600,000 — — 0% 150% Mark Hodges2 £600,000 183,155 £719,799 120% 150% Andrea Moneta3 €780,000 394 £1,548 0% N/A
19. Dilution Awards granted under the Aviva employee shares plans are met by the funding of an employee trust administered by an external trustee that acquires shares in the market. The current practice is that new issue shares will generally only be issued where it is not practicable to use the trust and the funding policy is kept under review by the committee and the Board. Details of the shares currently held in the employee trust are set out in note 30 to the accounts. During 2010 loans totalling £13.9 million were made to RBC Trustees (CI) Limited to ensure sufficient shares were available to meet its ongoing liabilities.
Aviva plc Annual Report and Accounts 2010 Directors’ remuneration report continued 20. NEDs The NEDs, including the chairman, have letters of appointment which set out their duties and responsibilities. The key terms of the appointments are set out in Table 19 below.
Termination By the director or the Company at their discretion without compensation.
It is the Company’s policy to set the fees paid to its chairman and NEDs taking account of the median market payments in international companies of similar size and complexity. NEDs receive a basic annual fee in respect of their Board duties. A further fee is paid to NEDs (other than the chairman) in respect of membership and, where appropriate, chairmanship of Board committees. Fees are reviewed annually and are set by the Board to attract individuals with the required range of skills and experience. In determining the level of fees paid to the NEDs the Board receives recommendations from the EDs, who consider the NEDs’ duties and responsibilities, together with the time commitment required in preparing for and attending meetings, and the amounts paid by competitors and similar-sized companies. There were no increases to fees during 2010. However, following a review in December 2010 of Aviva’s fees against market benchmarks and consideration of the expected changes in the workloads and responsibilities of certain committee members in light of regulatory requirements, the following changes in NEDs’ emoluments were made with effect from 1 January 2011: The fee for Board membership was increased from £63,000 pa to £65,000 pa The fee for the senior independent director (in addition to Board membership fee) was increased from £20,000 pa to £25,000 pa The fee for chairing the Risk Committee (inclusive of membership fee) was increased from £20,000 pa to £35,000 pa The fee for chairing the Remuneration Committee (inclusive of membership fee) was increased from £20,000 pa to £30,000 pa The membership fee for the Risk Committee increased from £5,000 pa to £10,000 pa The membership fee for the Nomination Committee and Corporate Responsibility Committee increased from £5,000 pa to £7,500 pa
Committee chairman – Audit – Corporate Responsibility – Remuneration – Risk £35,000 (inclusive of committee membership fee) £10,000 (inclusive of committee membership fee) £30,000 (inclusive of committee membership fee) £35,000 (inclusive of committee membership fee)
Directors’ service contracts and letters of appointment are available for inspection at the Company’s registered office during normal hours of business, and at the place of the Company’s Annual General Meeting from 10.45am on Wednesday 4 May 2011 until the close of the meeting.
Non-executive directors Mary Francis 108 103 — — — — — — 108 103 Richard Karl Goeltz 98 98 — — — — — — 98 98 Euleen Goh 78 78 — — — — — — 78 78 Michael Hawker 68 — — — — — — — 68 — Carole Piwnica 83 83 — — — — — — 83 83 Leslie Van de Walle 78 45 — — — — — — 78 45 Russell Walls 108 108 — — — — — — 108 108 Scott Wheway 88 88 — — — — — — 88 88
Accrued annual pension at 31 December 2009 22.1 84.8 — Accrued annual pension at 31 December 2010 21.8 83.6 — Gross increase in accrued pension over the year (0.3) (1.2) — Increase (decrease) in accrued pension net of inflation over the year — — — Employee contributions during the year — — — Defined contribution employer contributions during the year — — 136.4
Accounts, Mr Scott was entitled to receive a non-discounted pension with effect from January 2012, aged 58. Consequently, his early retirement pension payable from 1 August 2010 amounted to £384,900 p.a. rather than £342,535 p.a. To provide this additional £42,365 p.a. a cost was incurred to the Company of £1,227,539. Mr Scott then surrendered £25,338 p.a. of his pension for a cash sum, reducing his pension payable from 1 August 2010 to £359,562 p.a.
Table 24: Directors’ interests in Aviva Shares9 Shares1 ABP2 LTIP3 OATTV Plan4 Options5
Notes 1. ‘Shares’ are the directors’ beneficial holdings in the ordinary shares of the Company and in respect of the EDs include shares held in trust under the Company’s AESOP being shares purchased by them under the partnership element and shares granted under the free share element. In respect of Mark Hodges and Andrew Moss, it also includes the remaining restricted shares held in trust from their ABP awards, and for Patrick Regan it includes the remaining restricted shares held in trust from his RRSA and BRDSA awarded under the rules of the CFO Recruitment Share Awards Plan.
2. ABP relates to entitlements to shares arising through the Aviva Annual Bonus Plan. Under these plans some of the earned bonuses are paid in the form of restricted shares or conditional shares and deferred for three years. The transfer of the shares to the director at the end of the period is not subject to the attainment of performance conditions but a proportion of the shares can be forfeited if the executive leaves service before the end of the period. In respect of Mark Hodges and Andrew Moss, these shares are restricted shares. In respect of Patrick Regan, these shares represent the RRSA and BRDSA awarded under the rules of the CFO Recruitment Share Awards Plan and are restricted shares.
3. Awards granted under the LTIP which vest only if the performance conditions are achieved. 4. OATTV Plan awards are granted as a match to the bonus plan awards under the ABP and vest only if the performance conditions are achieved. 5. ‘Options’ are options over shares granted under the SAYE and the Aviva Executive Share Option Plan 2005. 6. Patrick Regan was appointed as a director on 22 February 2010. On this date he held no shares, awards or options. 7 These shares represent the RRSA and BRDSA awarded under the rules of the CFO Recruitment Share Awards Plan and are restricted shares. 8. These shares represent the OATTV awarded under the rules of the CFO Recruitment Share Awards Plan. 9. The interests of connected persons to the directors are included in the directors’ interests above
26. Developments in 2011 Andrea Moneta Mr Moneta resigned from the Board on 19 January 2011 and left the Company on 28 February 2011. Any deferred shares earned during his period of employment will be available for release to him on the first dealing day following his departure date. Any longterm incentives granted will vest on their due date and in accordance with the performance condition outcomes. As per Mr Moneta’s contract, a basic salary will be paid for the duration of 12 months which will be phased and mitigated as appropriate, pending any new employment. Other contractual entitlements will be paid up to 28 February 2011.
Share capital The Company has four share classes: Ordinary Shares of £0.25 each which constitute our equity security and hold voting rights; Cumulative irredeemable preference shares of £1 each, which entitle holders to attend and vote at general meetings only when dividends on such shares are in arrears. Cumulative irredeemable preference shareholders may also attend general meetings and vote on particular proposals when such proposals relate to an alteration of the rights attaching to such shares, a reduction of capital (other than through a redemption or repurchase of shares) or a winding up of business; Sterling New Preference Shares of £1 each, which have such rights and terms (including terms related to the redemption of shares, ranking and entitlement to dividend and capital) as the Board determines; and
The Companies Act 2006 abolished the requirement for a company to have an authorised share capital and the articles of association adopted by the Company on 28 April 2010 reflect this. Directors will still be limited as to the number of shares they can at any time, allot, as the allotment authority continues to be required under the Act, save in respect of employee share schemes. Ordinary shares in issue in the Company rank pari passu. All the ordinary shares in issue carry the same right to receive all dividends and other distributions declared, made or paid by the Company. The company is not permitted under English law to hold its own ordinary shares. While the company is presently authorised to repurchase up to 276 million ordinary shares, any shares that are repurchase must be cancelled. Details of the company’s dividends, including the paying agents, are set out below under ‘Articles of Association’.
Shares to satisfy options and awards Prior to March 2003, it was the practice to satisfy options and awards granted under the Group’s share plans through shares purchased in the market and held by employee share trusts which were established for the purpose of satisfying awards under the various Group share plans and funded by the Company. From March 2003 to July 2008, it was generally the Company’s practice to satisfy the awards granted after March 2003 by the issue of new shares at the time of vesting. However, since July 2008, it has been the Company’s practice to satisfy all awards and options using shares purchased in the market and held by employee trusts except where local regulations make it necessary to issue new shares. At 31 December 2010, 8,415,487 shares were held by the employee share trusts as compared to 17,979,232 at 31 December 2009, in both instances following the share purchases and distributions to individual employees throughout the year. These shares have an aggregate nominal value of £2,103,871.75 and market value £33,072,864 as of 31 December 2010, compared to £4,494,808 and £71,539,364 at 31 December 2009, respectively. Shares held by separate employee share trusts on behalf of specific individuals have not been included in these amounts. Further details are given in ‘Financial statements IFRS – Note 31 – Shares held by employee trusts.’
Shares issued under the Group’s Employee and Executive Share Option Schemes1 35,908,796 Shares issued in lieu of dividends2 —
The Company issued shares pursuant to special resolutions passed on 10 May 2006, increasing the authorised share capital from £1.45 billion and €700 million to £1.95 billion and €700 million by the creation of 500 million new preference shares of £1 each, and allowing the directors, subject to certain conditions, to issue equity securities up to the aggregate nominal value of £150 million. This authority expired at the conclusion of the AGM in 2007. A further ordinary resolution was passed on 26 April 2007 allowing the directors, subject to certain conditions, to allot equity securities up to the aggregate nominal value of £108 million. This authority expired at the conclusion of the AGM in 2008. An ordinary resolution was passed on 1 May 2008 allowing the directors, subject to certain conditions, to issue equity securities up to the aggregate nominal value of £94 million. This authority expired at the conclusion of the AGM in 2009. Ordinary resolutions were passed on 29 April 2009, increasing the authorised share capital from £1.95 billion and €700 million to £2.5 billion and €700 million by the creation of 2.2 billion ordinary shares of 25 pence each, and allowing the directors, subject to certain conditions, to issue equity securities up to the aggregate nominal value of £221 million and up to £443 million in connection with an offer by way of a rights issue. This authority expired at the conclusion of the AGM on 28 April 2010. The Companies Act 2006 abolished the requirement for a company to have an authorised share capital and the articles of association adopted by the Company on 28 April 2010 reflect this. Directors will still be limited as to the number of shares they can at any time, allot as the allotment authority continues to be required in the Act save in respect of employee share schemes. There were no changes to the voting rights of any class of shares during 2008, 2009 or 2010, other than issuances in connection with our various employee option schemes and under the Company’s scrip dividend scheme. The Company did not issue shares for consideration other than cash during 2008, 2009 or 2010. In addition, at the Company’s general meetings in 2008, 2009 and 2010, shareholders authorised the limited dis-application of Section 561 of the Companies Act 2006 to permit the Company to issue new equity securities for cash without applying shareholders’ statutory pre-emptive rights.
Income from associates predominantly relates to our investments in the Royal Bank of Scotland (RBS) life and collective investment companies prior to their restructuring described in ‘Financial Statements IFRS – Note 3 – Subsidiaries’. Under management service agreements with these associates, our UK life insurance companies provided administration services, the cost of which was recharged to the RBS companies. In addition, our fund management companies provided fund management services to these associates, for which they charged fees based on the level of funds under management. Movements in loans made to our associates may be found in ‘Financial Statements IFRS – Note 19 – Interests in, and loans to, joint ventures’. Transactions with joint ventures relate to the property management undertakings. At 31 December 2010, there were 16 such joint ventures, the most material of which are listed in note 18(b). Our interest in these joint ventures comprises a mix of equity and loans, together with the provision of administration services and financial management to many of them. Our UK life insurance companies earn interest on loans advanced to these entities and our fund management companies also charge fees to these joint ventures for administration services and for arranging external finance. Our UK fund management companies manage most of the assets held by the Group’s main UK staff pension scheme, for which they charge fees based on the level of funds under management. The main UK scheme and the Dutch scheme hold investments in Group-managed funds and insurance policies with other Group companies, as explained in note 48(e)(iii). The related parties’ receivables are not secured and no guarantees were received in respect thereof. The receivables will be settled in accordance with normal credit terms. Details of guarantees, indemnities and warranties provided on behalf of related parties are given in ‘Financial Statements IFRS – Note 52 – contingent liability and risk factors’.
Dividend data The Company’s dividend policy is to sustain a target dividend cover of between one and a half and two times our IFRS adjusted operating profit after tax before amortisation of goodwill and adjusting items. Under UK company law, we may only pay dividends if the company has ‘distributable profits’ available. ‘Distributable profits’ are accumulated, realised profits not previously distributed or capitalised, less accumulated, unrealised losses not previously written off based on IFRS. Even if distributable profits are available, we pay dividends only if the amount of our net assets is not less than the aggregate of our called-up share capital and undistributable reserves and the payment of the dividend does not reduce the amount of our net assets to less than that aggregate. As a holding company, the Company is dependent upon dividends and interest from our subsidiaries to pay cash dividends. Many of the Company’s subsidiaries are subject to insurance regulations that restrict the amount of dividends that they can pay to us. Historically, the Company has declared an interim and a final dividend for each year (with the final dividend being paid in the year following the year to which it relates). Subject to the restrictions set out above, the payment of interim dividends on ordinary shares is made at the discretion of our Board of directors, while payment of any final dividend requires the approval of the Company’s shareholders at a general meeting. Preference shares are irredeemable and dividends on preference shares are made at the discretion of our Board of directors. The Company pays cash dividends in pounds sterling, although the articles of association permit payment of dividends on ordinary shares in other currencies and in forms other than cash, such as ordinary shares. If dividends on ordinary shares held by the American Depositary Shares (ADS) depositary are paid in pounds sterling, the ADS depositary will convert the pounds that it receives on behalf of the ADS holders into US dollars according to the prevailing market rate on the date that the ADS depositary actually receives the dividends. For the 2007 final dividend and previous final and interim dividends, shareholders on record were provided with the opportunity to elect to receive dividends in the form of newly issued ordinary shares through our scrip dividend scheme. For the 2008 interim dividend the scrip dividend scheme was replaced by a dividend reinvestment plan (DRIP). For those shareholders participating in the DRIP, we paid a cash dividend, which was then used to buy existing shares on the open market. For the 2008 final dividend we withdrew the DRIP and reintroduced the scrip dividend scheme. An interim dividend is generally paid in November of each year. A final dividend is proposed by the Company’s Board of directors after the end of the relevant year and generally paid in May. The following table shows certain information regarding the dividends that we paid on ordinary shares for the periods indicated in pounds sterling and converted into US dollars at the noon buying rate in effect on each payment date.
Guarantees, securitised assets and off-balance sheet arrangements As a normal part of our operating activities, various Group companies have given financial guarantees and options, including interest rate guarantees, in respect of certain long-term assurance and fund management products, as set out in ‘Financial statements IFRS – Note 41 – Financial guarantees and options’. These are accounted for on-balance sheet as either part of the host insurance contract or as financial instruments under IFRS. Information on operating lease commitments can be found in ‘Financial statements IFRS – Note 53 – Commitments’. It is standard business practice for our Group companies to give guarantees, indemnities and warranties in connection with disposals of subsidiaries and associates to third parties. As of 31 December 2010, we believe no material loss will arise in respect of these guarantees, indemnities and warranties. Standard financial warranties include the accuracy and completeness of the statement of financial position at the completion date, details of outstanding litigation, the position on tax filings and any outstanding clearance items. In addition, specific clauses cover such matters as regulatory approvals and licences, the adequacy of actuarial insurance liabilities, reinsurance contracts and the status of employee pension plans. Their exact terms are tailored to each disposal and are set out in the respective sale and purchase agreement. Similarly, the open warranty periods, within which the purchaser could claim, and limits on the maximum amount potentially recoverable will vary for each item covered in each disposal. There are a number of outstanding claims on recent disposals, none of which are material. There are also open claim periods on other recent disposals on which we have neither received, nor expect to receive, any such claims. We believe that there is no material exposure in this respect and therefore we do not have any liabilities in our statement of financial position in respect of claims under guarantees, indemnities and warranties in connection with disposals. We have loans receivable, secured by mortgages, which have then been securitised through non-recourse borrowings by special purpose entities, in our UK Life and Dutch businesses, as set out in ‘Financial statements IFRS – Note 24 – Securitised mortgages and related assets’. These special purpose entities have been consolidated and included in the statement of financial position, as we retain the residual interest in them.
Limited liability partnerships classified as joint ventures As part of their investment strategy, the UK and certain European long-term business policyholder funds have invested in a number of property limited partnerships (PLP), either directly or via property unit trusts (PUT), through a mix of capital and loans. The PLPs are managed by general partners (GP), in which the long-term business shareholder companies hold equity stakes and which themselves hold nominal stakes in the PLPs. The PUTs are managed by a Group subsidiary. Accounting for the PUTs and PLPs as subsidiaries, joint ventures or other financial investments depends on the shareholdings in the GPs and the terms of each partnership agreement. If a partnership is managed by a contractual arrangement agreement such that no party exerts control, notwithstanding that the Group’s partnership share or economic interest in the PLP (including its indirect stake via the relevant PUT and GP) may be greater than 50%, such PUTs and PLPs have been classified as joint ventures. Of the PLPs accounted for as joint ventures at 31 December 2010, the Group’s economic interest exceeded 50% in respect of one partnership, The Mall Limited Partnership, in which the Group had a 50.5% economic interest. ‘Financial statements IFRS – Note 18 – Interests in, and loans to, joint ventures’ provides a list of PLPs accounted for as joint ventures, as well as summarised information on the revenue, expenses, assets and liabilities of the Group’s interests in its joint ventures in aggregate. In respect of these PLPs, there are no significant contingent liabilities to which we are exposed, nor do we have any significant contingent liabilities in relation to our interests in them. External debt raised by the PLPs is secured on their respective property portfolios, and the lenders are only entitled to obtain payment of both interest and principal to the extent there are sufficient resources in the respective PLPs. The lenders have no recourse whatsoever to the policyholder and shareholders’ funds of any companies in the Aviva Group. At 31 December 2010, we had £nil capital commitments to these PLP joint ventures.
Liquidity and capital resources Treasury function The treasury function of our business is managed by our centralised treasury team, headed by the group treasurer. The group treasurer acts as owner of Group policies for liquidity, derivatives and foreign exchange risk management within the Group risk governance and oversight framework. Changes in policy require the agreement of the chief risk officer. Significant changes in policy require, in addition, the approval of the Assets and Liabilities Committee, the Executive Committee and then the Risk and Regulatory Committee of the Board. These policies are independently implemented and monitored by each of our businesses. Our central treasury team is split into distinct functions: a Group team, which develops our overall treasury strategy and our treasury team at Aviva Investors, which manages and monitors our treasury and cash flow positions for our holding companies. Each business unit is responsible for monitoring its own cash and liquidity positions, as well as its ongoing funding requirements. It is our policy to make the majority of our financing arrangements at the parent company level for our business units, primarily through external borrowings and equity offerings. This enables us to achieve the efficiencies afforded by our collective size. A number of our business units also raise debt on their own behalf.
Management of capital resources We seek to maintain an efficient capital structure using a combination of equity shareholders’ funds, preference capital, subordinated debt and borrowings. This structure is consistent with our risk profile and the regulatory and market requirements of our business. In managing our capital, we seek to: Match the profile of our assets and liabilities, taking into account the risks inherent in each business; Maintain financial strength to support new business growth while still satisfying the requirements of policyholders, regulators and rating agencies; Retain financial flexibility by maintaining strong liquidity, access to a range of capital markets and significant unutilised committed credit lines; Allocate capital efficiently to support growth and repatriate excess capital where appropriate; and
Manage exposures to movements in exchange rates by aligning the deployment of capital by currency with our capital requirements by currency.
We are subject to a number of regulatory capital tests and employ realistic scenario tests to allocate capital and manage risk. The impact of these regulatory capital tests on our ability to transfer capital around the Group through dividends and capital injections is discussed later in this section under the headings ‘Sources of Liquidity’ and ‘Capital injections’. Overall, the Group and its subsidiaries satisfy all existing requirements and, as reported below, have significant resources and capital strength.
Operating borrowings Amounts owed to credit institutions 2,550 2,182 Securitised mortgage loans 6,333 7,329
In both the UK and the Netherlands, we have raised non-recourse funding secured against books of mortgages. This funding has been raised through the use of special purpose entities. The beneficial interest in the books of mortgages has been passed to these special purpose entities. These entities, which are owned by independent trustees, have funded this transfer through the issue of loan notes. The value of the secured assets and the corresponding nonrecourse funding was £1,288 million in the UK and £5,045 million in the Netherlands. In both cases, we continue to receive fees from these special purpose entities in respect of loan administration services. In the Netherlands, we also receive payments under the terms of interest rate swaps which we have entered into with the special purpose entities. These special purpose entities have been consolidated as we retain the residual interest in them. The transactions and reasons for consolidation are discussed further within ‘Financial statements IFRS – Note 24 – Securitised mortgages and related assets’.
In addition to our external funding sources, we have a number of internal debt arrangements in place. These allow the assets supporting technical liabilities to be invested into a pool of central capital for use across the Group. They also enable us to deploy cash from some parts of the business to others in order to fund growth. Although these are intra-Group loans, we count them as part of our capital base for the purpose of capital management. We believe that all internal loans have been negotiated at market rates and are appropriately serviced.
Our committed central borrowing facilities have two financial covenants: Borrowings (excluding non-recourse indebtedness) may not exceed total shareholders’ funds. At 31 December 2010 borrowings were 55% of total shareholders funds.
Under UK company law, dividends can only be paid if a company has distributable reserves sufficient to cover the dividend. At 31 December 2010, Aviva plc itself had distributable reserves of £3,327 million, sufficient to pay dividends to our shareholders for three years based on historic dividend payments. In UK Life, our largest operating subsidiary, distributable reserves, which could be paid to Aviva plc via its intermediate holding company, are created mainly by the statutory long-term business profit transfer to shareholders that occurs upon the declaration of bonuses to policyholders of with-profit products. While the UK insurance regulatory laws applicable to UK Life and our other UK subsidiaries impose no statutory restrictions on an insurer’s ability to declare a dividend, the FSA’s rules require maintenance of each insurance company’s solvency margin, which might impact their ability to pay dividends to the parent company. Our other life and general insurance, and fund management subsidiaries’ ability to pay dividends and make loans to the parent company is similarly restricted by local corporate or insurance laws and regulations. For example, the ability of our US insurance subsidiaries to provide inter-company loans is subject to state regulations which restrict the making of loans or require explicit regulatory approval. In all jurisdictions, when paying dividends, the relevant subsidiary must take into account its capital position and must set the level of dividend to maintain sufficient capital to meet minimum solvency requirements and any additional target capital expected by local regulators. These minimum solvency requirements, which are consolidated under the European Insurance Group Directive, are discussed later in this section under the heading ‘Regulatory capital position’. Our US subsidiaries are also subject to state laws that limit the dividends payable to the parent company and dividends in excess of these limitations generally require the approval of the state insurance commissioner. We do not believe that the legal and regulatory restrictions constitute a material limitation on the ability of our businesses to meet their obligations or to pay dividends to the parent company, Aviva plc. We have also received funds from the sale of parts of our businesses. For the year ended 31 December 2010 cash proceeds from the disposal of subsidiaries, joint ventures and associates net of cash transferred amounted to £54 million compared to £1,131 million for the year ended 31 December 2009. Principal disposals in 2010 and cash consideration received are disclosed in ‘Financial statements IFRS – Note 3 – Subsidiaries’. We have established two main programmes for the issuance of external debt. For short-term senior debt issuance we have a £2 billion commercial paper programme which allows debt to be issued in a range of currencies. At 31 December 2010 the outstanding debt issued under this programme was £504 million. For longer term debt we have established a Euro Medium Term Note (EMTN) programme. This programme has documentation readily available to allow quick issuance of longterm debt with a variety of terms of conditions. Debt issued under this programme may be senior guaranteed debt or regulatory qualifying debt and may have a fixed or floating interest rate. At 31 December 2010 the outstanding debt issued under this programme was £1,458 million.
Application of funds We use funds to pay dividends to our shareholders, to service our debt and to pay our central Group cash flows. In 2010, total cash paid by the Company as ordinary and preference dividends and coupon payments on direct capital instrument amounted to £575 million, compared to £574 million in 2009.
In 2010, our total debt costs on central borrowings were £324 million. This compared to £334 million of interest paid on central borrowings in 2009. Total corporate centre expenses in 2010 were £178 million compared to £159 million in 2009. An additional application of our funds is the acquisition of businesses. In 2010, cash paid for the acquisition of subsidiaries, joint ventures and associates net of cash acquired amounted to £7 million, compared to £596 million in 2009. Principal acquisitions in 2010 and cash consideration paid are disclosed in ‘Financial statements IFRS – Note 3 – Subsidiaries’.
Net cash out flow on financing activities Net cash used in financing activities was £797 million higher at £1,368 million (2009: £571 million). The increase is a result of a £930 million reclassification within the statement of cash flows described further in note 2(b). The underlying decrease of £133 million reflects higher interest payments partially offset by a lower net drawdown of borrowings.
Net cash and cash equivalents At 31 December 2010, total consolidated net cash and cash equivalents amounted to £24,695 million, an increase of £444 million over £24,251 million in 2009.
Net cash and cash equivalents At 31 December 2009, total consolidated net cash and cash equivalents amounted to £24,251 million, an increase of £720 million over £23,531 million in 2008.
Currency Our exposures to movements in exchange rates and the management of these exposures is detailed in ‘Performance review – Financial and operating performance – Exchange rate fluctuations’.
Regulatory capital position Individual regulated subsidiaries measure and report solvency based on applicable local regulations, including in the UK the regulations established by the Financial Services Authority (FSA). These measures are also consolidated under the European Insurance Groups Directive (IGD) to calculate regulatory capital adequacy at an aggregate group level, where we have a regulatory obligation to have a positive position at all times. This measure represents the excess of the aggregate value of regulatory capital employed in our business over the aggregate minimum solvency requirements imposed by local regulators, excluding the surplus held in the UK and Ireland with-profit life funds. The minimum solvency requirement for our European businesses is based on the Solvency 1 Directive. In broad terms, for EU operations, this is set at 4% and 1% of non-linked and unit-linked life reserves respectively and for our general insurance portfolio of business is the higher of 18% of gross premiums or 26% of gross claims, in both cases adjusted to reflect the level of reinsurance recoveries. For our major non-European businesses (the US, and Canada) a risk charge on assets and liabilities approach is used.
The EU Insurance Groups Directive (IGD) regulatory capital solvency surplus has decreased by £0.7 billion since 31 December 2010 to £3.8 billion. The key movements over the period are set out in the following table: £bn
Investment property 63 66 7 Property and equipment 160 255 108 Intangible assets — 4 23
Audit Committee financial expert The Board has determined that Russell Walls, Richard Goeltz and Euleen Goh all qualify as Audit Committee financial experts within the meaning of Item 16A of Form 20-F, and that Russell Walls, Richard Goeltz and Euleen Goh are all independent as defined by the Securities and Exchange Commission rules and the New York Stock Exchange Corporate Governance Standards.
Code of ethics The Company has adopted a code of ethics for its group chief executive, chief financial officer, general auditor and group chief accounting officer as required by the provisions of Section 406 of the Sarbanes-Oxley Act of 2002 and the rules issued by the SEC. There have been no amendments to, or waivers from, the code of ethics relating to any of those officers. The code of ethics was filed on 7 October 2009 as an exhibit to our Form 20-F registration document.
Regulation Compliance In both our insurance and fund management businesses matters may arise as a result of industry-wide issues, inspection visits or other regulatory activity, requiring discussion and resolution with insurance industry regulators. The Aviva Group needs to ensure that procedures are in place to address any regulatory concerns, and that such procedures are properly planned, managed and resourced. Corrective action is undertaken, when necessary, with progress reported to relevant regulatory bodies in a timely manner.
Overview of regulation as it affects our business Our principal insurance and fund management operations are in the United Kingdom (UK), Europe, North America and the Asia Pacific region. We are therefore subject to financial services regulation in these areas, as individually covered below. However, as the Group’s parent company is based in the UK, both European Union (EU) legislation and the rules of the Financial Services Authority (FSA), the UK’s financial services regulator, can impact on Aviva’s business practices worldwide.
The European Union In addition to its UK businesses Aviva is also active in other EU member states through wholly owned subsidiary and joint venture companies. These companies are subject to the laws and regulations of the EU member state in which they are based, but are also affected by higher level EU legislation, which will continue to have a significant influence on the legislative environment, both in the UK and other EU markets. The EU operates by promulgating directives that must be implemented into local national legislation within each EU member country. These directives set the minimum standards for national legislatures to meet, with each legislature able to decide how they should be implemented. National governments may not pass laws which fail to meet the minimum standards set out in a directive, but are generally free to impose legal requirements which go beyond those required. Directives are written at a fairly high level, with more detail being provided at national level through legislation developed in accordance with the local legal system. Even greater detail may be imposed through the rules and regulations of national regulators, and for financial services businesses these rules can be extensive. EU financial services regulation is based on the principle of ‘home country control’, which makes the home country regulator responsible for monitoring compliance with all applicable regulation.
an additional parent undertaking solvency margin calculation analogous to the adjusted margin test referred to above, to be applied at the level of the parent undertaking.
further provisions aimed at ensuring co-operation between competent regulatory authorities of member states.
Aviva plc Annual Report and Accounts 2010 Shareholder information continued impose on insurance intermediaries requirements to provide specified minimum information to potential customers.
Markets in Financial Instruments Directive (MiFID) MiFID, which superseded the earlier Investment Services Directive, builds on the home country control principle, extending the range of ‘core’ investment services and activities that may be passported from one member state to another, clarifying the allocation of responsibilities between home and host country jurisdictions, and introducing greater harmonisation governing the organisation and conduct of business of investment firms.
Solvency II The agreed Solvency II Level 1 Directive was published in November 2009. Solvency II represents a fundamental change in European regulation and will result in a more sophisticated economic risk-based capital approach. It establishes a solvency system that is better aligned to the true risks of insurers, and aims to enable supervisors to protect policyholder interests as effectively as possible in accordance with common principles across the EU. Since approval, focus has been on the Level 2 implementing measures that determine how the directive will be applied in practice, and expected amendments to the Solvency II Directive (Omnibus II Directive) following the creation of the new European Supervisory Authorities (ESAs) in September 2010. Uncertainty remains around the implementing measures, which are not expected to be finalised before June 2011. One of the new ESAs, the European Insurance and Occupational Pensions Authority (EIOPA), replaced CEIOPS on 1 January 2011. Proposed focused amendments to the Solvency II Directive were published in January 2011, giving power to EIOPA to issue binding guidance/standards, and delay implementation of Solvency II to 1 January 2013. This highlights the need for continued engaged industry participation, and Aviva has been actively participating, through the key European industry working groups who provide the voice of industry, in on-going discussions in Brussels.
Future EU developments In Europe agreement has been reached on the roles and powers of the new ESAs which came into force in January 2011. The new ESAs have powers to make binding rules and drive supervisory consistency and convergence through a single rule book. Their involvement in the colleges of supervisors for cross-border financial institutions, together with broader changes being progressed within Europe relating to financial conglomerates, signals a move towards more focused and intrusive group supervision. The European Parliament has now approved the Alternative Investment Fund Managers Directive, and each EU nation has two years to implement the directive. Once the directive is in force the regime governing the marketing of alternative investments to EU investors will be determined by the location of the fund manager and the fund. Managers established in the EU, and managing a fund established in the EU, will be able to apply for a passport to market that EU fund to ‘professional investors’ across the EU. If the manager, or the fund, is not established in the EU the current private placement regimes will apply, to enable the marketing of the fund within the EU. Two years after implementation a decision will be made regarding the possible extension of the passport regime to non-EU countries.
United Kingdom The Financial Services Authority In the UK, the Financial Services Authority (the ‘FSA) is currently the single regulator for those individuals and firms conducting defined regulated activities in the financial services sector. The FSA has the authority to make rules and issue guidance, taking into account relevant EU directives, in relation to a wide sphere of activity encompassing the governance of the conduct of business by, and the prudential supervision of, individuals and firms authorised by the FSA to conduct such business (‘Authorised Persons’ or ‘Authorised Firms’). Under the Financial Services and Markets Act 2000 (FSMA) no person may carry on, or purport to carry on, a regulated activity by way of business in the UK unless he is an Authorised Person or an exempt person. A firm granted permission by the FSA to carry on regulated activities becomes an Authorised Person for the purposes of FSMA. ‘Regulated activities’ are prescribed in the FSMA (Regulated Activities) Order 2001 and include banking, insurance and investment business, stakeholder pension schemes, insurance mediation and certain mortgage mediation and lending activities. Authorised Firms must at all times meet specified threshold conditions, including possession of adequate resources for the carrying on of its business, and being fit and proper to conduct that business, having regard to all the circumstances. Authorised Firms must also operate in accordance with the FSA’s Principles for Business. These are 11 high level principles for conducting financial services business in the UK, including maintenance of adequate systems and controls, treating customers fairly, and communicating with customers in a manner that is clear, fair and not misleading. The FSA regime is based on the principle that firms should have effective systems and controls, including robust risk management, which are appropriate to the size, complexity and diversity of their business.
Approved persons and controllers The FSA places great emphasis on the principle of senior management responsibility. The directors of, and senior managers carrying out FSA defined controlled function roles in, any of the Group’s regulated entities are individually registered with the FSA under the ‘Approved Person’ regime, and can be held directly accountable to the FSA for control failings in those firms. A number of senior managers at Group level have also been registered as Approved Persons for the regulated subsidiaries, even though they are neither directors nor senior managers of these firms. This recognises that these managers exert significant influence over the regulated subsidiaries, because they are responsible for key parts of the Group’s control framework on which the regulated subsidiaries place reliance. The FSA regulates from a legal entity perspective, even though Aviva tends to operate within Regions by Business Unit. However, the FSA also expects that Aviva’s regulated subsidiaries
Aviva plc Annual Report and Accounts 2010 Shareholder information continued operate within an overall framework of Group governance and controls. Its rules expressly provide that any systems and controls which operate on a Group basis will be taken into account in determining the adequacy of a regulated subsidiary’s systems and controls. The robustness of these Group controls is therefore subject to scrutiny and challenge by the FSA. The FSA regulates the acquisition and increase of control over Authorised Firms. Under FSMA, any person proposing to acquire control of, or increase control over certain thresholds of, an Authorised Firm must first obtain the consent of the FSA. The Authorised Firm must also inform the FSA of any such proposed acquisition or increase. In considering whether to grant or withhold its approval of the acquisition or increase of control, the FSA must be satisfied both that the acquirer is a fit and proper person and that the interests of consumers would not be threatened by this acquisition or increase of control. Control over a UK Authorised Firm (A) is acquired if the acquirer: holds 10% (or 20% if the Authorised Firm is an insurance intermediary) or more of the shares, or voting power, in that firm, or a parent undertaking of the firm; or is able to exercise significant influence over the management of the firm by virtue of the acquirer’s shares or voting power in that company or a parent undertaking of the firm.
Capital and solvency rules for insurers The FSA rules require that a UK insurer (including those within the Group) must hold capital resources equal to at least the Minimum Capital Requirement (the MCR). Insurers with with-profits liabilities of more than £500 million (which is the case with Aviva’s withprofits fund) must hold capital equal to the higher of MCR and the Enhanced Capital Requirement (the ECR). The ECR is intended to provide a more risk responsive and ‘realistic’ measure of a withprofits insurer’s capital requirements, whereas the MCR is broadly equivalent to the previous required minimum margin, and satisfies the minimum EU standards.
Day-to-day supervision The FSA takes a risk-based approach to its regulatory activity, concentrating its resources on those firms and activities which it assesses pose the greatest potential threats to its four statutory objectives of: maintaining confidence in the UK financial system contributing to the protection and enhancement of stability of the UK financial system securing the appropriate degree of protection for consumers reducing the extent to which it is possible for a regulated business to be used for a purpose connected with financial crime
Aviva plc Annual Report and Accounts 2010 Shareholder information continued playing a full role as an international leader in financial regulation.
Solvency II, which remains central to our engagement with the FSA as the industry and the regulator prepare for the application of this new regulatory regime.
Outside of the UK, each Aviva business is regulated by its own national regulator(s). However, overseas operations are also within the remit of the FSA for two main reasons: The structure of the Group means that the great majority of the overseas operations are owned, ultimately, by Aviva International Insurance Ltd (AII), a UK regulated insurance company. In its regulation of AII, the FSA has an interest in the systems and controls by which the Group manages its overseas businesses, to mitigate the risk of financial shocks arising overseas flowing through to the UK. The FSA monitors the strategy and performance of the Group’s international businesses through its programme of regular close and continuous meetings. The FSA aims to play a leading role in the development of both EU and international regulation. It is, in particular, at the vanguard of the movement towards risk-based insurance regulation. In line with this the FSA continues to place increasing weight on the ‘Treating Customers Fairly’ principle.
The Financial Services Compensation Scheme (FSCS) The FSCS is intended to compensate individuals and small businesses for claims against an Authorised Firm where the Authorised Firm is unable or unlikely to be able to meet those claims (generally, when it is insolvent or has gone out of business). Under a new funding system that started on 1 April 2008, for the purposes of funding FSCS compensation costs, the FSCS levy is split into five broad classes: Deposits Long-term insurance and pensions General insurance Investments Home finance
With the exception of the deposits class, each broad class is divided into two sub-classes based on provider/intermediation activities. Each of the ‘sub-classes’ is made up of firms which are providers or intermediaries and engage in similar styles of business with similar types of customer. The sub-classes are based on the activities a firm undertakes (and are aligned to their FSA permissions). A firm could be allocated to one or more sub-classes according to the activities that it undertakes. In the event of a failure of a market participant, the Authorised Firms in the Group could be required to make contributions to compensate investors. It should be noted that such contributions are not restricted to failures in the sub-classes to which a particular firm belongs, as there is the potential for cross-subsidy between sub-classes to be required.
Distribution of profits and with-profits business For UK authorised life insurers carrying on with-profits business, the FSA’s rules require that once an allocation of surplus in a with-profits fund has been made to policyholders, no transfer of assets representing any part of a subsequent surplus can be made, to shareholders or otherwise, unless either the ‘relevant minimum’ (as defined in the FSA Handbook) of the surplus has been allocated to policyholders or a statutory notification procedure has been followed. Calculation of the relevant minimum is based on the percentage of the relevant surplus previously allocated to eligible policyholders.
Reporting requirements FSA rules require insurance companies to file their audited annual accounts, statements of financial position and life insurers’ annual reports from the actuary performing the actuarial function with the regulator. There is also a requirement to report the annual solvency position of the insurance company’s ultimate parent. The FSA uses the annual return to monitor the solvency (i.e. the ability to meet current and future obligations such as claims payments to policyholders) of the insurance company. For general insurance business, the return is also used to assess retrospectively the adequacy of the company’s claims provisions. The directors of an insurance company are required to sign a certificate, which includes a statement as to whether the company has maintained the required minimum margin of solvency throughout the year. The directors must also certify that the company has completed its return to the FSA properly in accordance with the FSA’s instructions, and that the directors are satisfied that the company
Aviva plc Annual Report and Accounts 2010 Shareholder information continued has complied in all material respects with the requirements set out in the FSA rules.
United States We write life and annuity business in the United States through Aviva USA, a wholly owned subsidiary formed by the merger of Aviva Life Insurance Company of America with AmerUS which it acquired in July 2006. Aviva USA is domiciled in Iowa and licensed to conduct business in all 50 states. In New York it operates a wholly owned subsidiary, Aviva Life Insurance Company of New York. The US insurance industry is regulated primarily on a state- by-state basis therefore individual states have authority to pass statutes, adopt regulation or issue directives to regulate insurance activities within their jurisdiction. Consequently, life insurance companies are subject to regulation both in the state in which they are domiciled as well as in each of the individual states in which they operate. State regulation can vary in detail from state to state. All have laws and regulations covering the financial aspects of the insurance business including standards of solvency, reserves reinsurance and capital adequacy. In addition, most states have specific regulation governing licensing and the conduct of selling agents as well as the approval of products and associated product forms and literature.
Risk-based capital The NAIC has developed risk-based capital standards for life insurance companies as well as a model act for state legislatures to enact. The model act requires that life insurance companies report on a formula-based, risk-based capital standard that they calculate by applying factors to various asset, premium and reserve items. The formula takes into account the risk characteristics of a company, including asset risk, insurance risk, interest rate risk and business risk. The NAIC designed the formula as an early-warning tool to identify potentially inadequately capitalised companies for the purposes of initiating regulatory action. The model act imposes broad confidentiality requirements on those engaged in the insurance business (including insurers, agents, brokers and others) and on state insurance departments as to the use and publication of risk-based capital data. Any state adopting the model act gives the state insurance commissioner explicit regulatory authority to require various actions by, or take various actions against, insurance companies whose adjusted capital does not meet minimum risk-based capital standards. The Iowa Insurance Commissioner takes into account the NAIC’s risk-based capital standards to determine adequate compliance with Iowa insurance law. Effective 31 December 2005, the NAIC implemented new requirements, referred to as C-3 Phase II, for calculating riskbased capital in connection with variable annuity products with death and living benefit guarantees. These changes did not have a material effect on our US operations, and at 31 December 2010, the Company’s total adjusted capital under the NAIC’s definition substantially exceeded Iowa standards.
Asia Pacific We operate within the Asia Pacific region through a network of subsidiary companies either wholly owned or established as a joint venture with a local partner. Our business in the region is predominately long-term and savings business, with small general insurance and health operations. There are wholly owned businesses in Singapore and Hong Kong. Aviva operates in China, India, Malaysia, Sri Lanka, Taiwan, Korea, Indonesia and Vietnam which, depending on the nature and extent of the control we are able to exert, are either accounted for as subsidiaries, joint ventures or associates. The Asia Pacific region is made up of a number of widely differing and independent markets. The markets tend to be at different stages in their development but each has its own regulatory structures and Aviva complies with the local regulation in each of the countries in which it operates. Industry regulation across the region typically focuses on financial stability, i.e. minimum capital and the basis for calculating solvency, reserves and policyholder liability. In many of the markets across the region regulators have the power to revoke operating licences, regulate shareholder structures and the participation in and the payment of dividends. Markets within the region are moving quickly to modernise insurance regulation with an increasing focus on governance and conduct of business.
Aviva plc Annual Report and Accounts 2010 Shareholder information continued £8,489 million of cash and cash equivalents; and £5,150 million of Reinsurance Assets.
The remaining £24,959 million is comprised of various other shareholder assets such as goodwill and value of in-force business, intangible assets, property and equipment, tax assets (current and deferred), receivables and other financial assets, prepayment and accrued income, and deferred acquisition costs. These assets in normal economic conditions reasonably match our long-term insurance liabilities and benefit both policyholders and shareholders. Adverse changes to market conditions, however, could provoke an increase in credit defaults with a negative effect on shareholders’ equity and reduced investment returns. Falls in investment returns could impair our operational capability, including our ability to write significant volumes of new business. For additional information about our investments, see ‘Performance review – Analysis of investments’.
Some of our investments are relatively illiquid and are in asset classes that have been experiencing significant market valuation fluctuations. We hold certain investments that may lack liquidity, such as privately placed fixed-maturity securities, and unlisted equities, as the inputs used for their valuation are not directly observable in the market. These asset classes represented approximately 4.5% of the total assets held at fair value as of 31 December 2010. Even some of our very high-quality assets have been more illiquid as a result of the recent challenging market conditions. If we require significant amounts of cash on short notice in excess of normal cash requirements or are required to post or return collateral in connection with our investment portfolio or derivatives transactions, we may have difficulty selling these investments in a timely manner, be forced to sell them for less than we otherwise would have been able to realise, or both. The reported value of our relatively illiquid types of investments, our investments in the asset classes described in the paragraph above and, at times, our high-quality, generally liquid asset classes, do not necessarily reflect the lowest current market price for the asset. If we were forced to sell certain of our assets in the current market, there can be no assurance that we will be able to sell them for the prices at which we have recorded them and we may be forced to sell them at significantly lower prices.
Aviva plc Annual Report and Accounts 2010 Shareholder information continued securities than we prefer, or bear an unattractive cost of capital which could decrease our profitability and significantly reduce our financial flexibility. Our results of operations, financial condition, cash flows and statutory capital position could be materially adversely affected by disruptions in the financial markets.
We operate in several markets through arrangements with third parties. These arrangements involve certain risks that we do not face with our subsidiaries. Our ability to exercise management control over our partnership operations, our joint ventures and our investment in them depends on the terms of the legal agreements. In particular it depends on the allocation of control among, and continued cooperation between, the participants. We may also face financial or other exposure in the event that any of our partners fail to meet their obligations under the agreement or encounter financial difficulty. For example, a significant proportion of our product distribution, such as bancassurance, is carried out through arrangements with third parties not controlled by us and is dependent upon continuation of these relationships. A temporary or permanent disruption to these distribution arrangements could affect our financial condition. Some of these arrangements require our third-party partners to participate in and provide capital to our joint venture, associate and subsidiary undertakings. Our partners may change their strategic priorities or encounter financial difficulties preventing them from providing the necessary capital to promote future growth. In addition, we outsource certain customer service, technology and legacy policy administration functions to third parties and may do so increasingly in the future. If we do not effectively develop and implement our outsourcing strategy, thirdparty providers do not perform as anticipated or we experience technological or other problems with a transition, we may not realise productivity improvements or cost efficiencies and may experience operational difficulties, increased costs and a loss of business. In addition, our ability to receive services from thirdparty providers outside of the UK (or the jurisdictions in which our subsidiaries operate) might be impacted by cultural differences, political instability, unanticipated regulatory requirements or policies inside or outside of the UK. As a result, our ability to conduct our business might be adversely affected.
Inability of our reinsurers to meet their obligations, or the unavailability of adequate reinsurance coverage, may have an adverse impact on our profitability and shareholders’ equity. We transfer our exposure to certain risks to others through reinsurance arrangements. Under such arrangements, other insurers assume a portion of the losses and expenses associated with reported and unreported losses in exchange for a premium. The availability, amount and cost of reinsurance depend on general market conditions and may vary significantly. Any decrease in the amount of our reinsurance will increase our risk of loss. When we obtain reinsurance, we still remain primarily liable for the reinsured risks without regard to whether the reinsurer will meet its reinsurance obligations to us. Therefore, the inability or unwillingness of our reinsurers to meet their financial obligations or disputes on, and defects in reinsurance contract wording or processes, could materially affect our operations. Although we conduct periodic reviews of the financial statements and reputations of our reinsurers, our reinsurers may become financially unsound by the time they are called upon to pay amounts due, which may not occur for many years. As a result of financial market conditions and other macro-economic challenges recently affecting the global economy, our reinsurers may experience increased regulatory scrutiny, serious cash flow problems and other financial difficulties. In addition, reinsurance may prove inadequate to protect against losses. Due to the nature of the reinsurance market and the restricted range of reinsurers that have acceptable ratings, we are exposed to concentrations of risk with individual reinsurers. If a catastrophic event or the inability to meet financial obligations caused these reinsurers to default, our business profitability and shareholders’ equity could be significantly affected. Furthermore, market conditions beyond our control determine the availability and cost of the reinsurance protection we purchase. Accordingly, we may be forced to incur additional expenses for reinsurance or may not be able to obtain sufficient reinsurance on acceptable terms, which could adversely affect our ability to write future business. For the 2010 underwriting year the Group participated in a share of a reinsurer’s US property catastrophe reinsurance portfolio. Because this exposure does not correlate with the Group’s other general insurance exposure this provided a strategic opportunity to diversify the general insurance portfolio with a risk that had a high expected profit margin but also a high potential for loss. The modelled loss from a one in ten year annual loss scenario was £55 million compared to approximately £160 million when measured on a one in a hundred year annual loss scenario. As a result of better than normal experience the arrangement delivered above average underwriting returns in 2010. Notwithstanding the good return in 2010 we have renewed the arrangement in 2011 on a reduced scale reflecting expected market conditions. The total expected loss from a one in ten year
Aviva plc Annual Report and Accounts 2010 Shareholder information continued annual loss scenario is £40 million compared to approximately £100 million when measured on a one in a hundred year annual loss scenario.
We are rated by several rating agencies, and a decline in any of these ratings could affect our standing among brokers and customers and cause our sales and earnings to decrease. Claims-paying ability and financial strength ratings are factors in establishing the competitive position of insurers. A rating downgrade (or the perceived potential for such a downgrade) of Aviva plc or any of our rated insurance subsidiaries may, among other things, materially increase the number of policy surrenders and withdrawals by policyholders of cash values from their policies. The outcome of such activities may be cash payments requiring the sale of invested assets, including illiquid assets, at a price that may result in realised investment losses. These cash payments to policyholders would result in a decrease in total invested assets and a decrease in net income. Among other things, early withdrawals may also cause us to accelerate amortisation of policy acquisition costs, reducing net income. A rating downgrade may also impact sales volumes, particularly in the US where there is more focus on ratings when evaluating similar products. The ratings provided by AM Best are widely considered to be most important for distribution in the US, and a downgrade could lead to a significant loss of sales.
The use of inaccurate assumptions in pricing and reserving for insurance business may have an adverse effect on our business profitability. The management of the life insurance business within the Group requires the life insurance companies to make a number of assumptions in relation to the business written, including with regard to the mortality and morbidity rates of our customers, the development of interest rates, persistency rates (the rates at which customers terminate existing policies prior to their maturity dates) and future levels of expenses. These assumptions may turn out to be incorrect.
The cyclical nature of the insurance industry may cause fluctuations in our results. Historically, the insurance industry has been cyclical and operating results of insurers have fluctuated significantly because of volatile and sometimes unpredictable developments, many of which are beyond the direct control of any insurer. Although we have a geographically diverse group of businesses providing a diverse range of products, we expect to experience the effects of this cyclical nature, including changes in sales and premium levels, which could have a material adverse effect on our results of operations. The unpredictability and competitive nature of the general insurance business historically has contributed to significant quarter-to-quarter and year-to-year fluctuations in underwriting results and net earnings in the general insurance industry.
As a global business, we are exposed to various local political, regulatory and economic conditions, business risks and challenges which may affect the demand for our products and services, the value of our investment portfolios and the credit quality of local counterparties. We offer our products and services in Europe (including the UK), North America and the Asia Pacific region, through wholly owned and majority-owned subsidiaries, joint ventures, companies in which we hold non-controlling equity stakes, agents and independent contractors. Our international operations expose us to different local political, regulatory, business and financial risks and challenges which may affect the demand for our products and services, the value of our investment portfolio, the required levels of capital and surplus, and the credit quality of local counterparties. These risks include, for example, political, social or economic instability in countries in which we operate,
We are involved in various legal proceedings and regulatory investigations and examinations and may be involved in more in the future, any one or a combination of which could have a material adverse effect on our financial condition and results of operations. We have been named as defendants in lawsuits (both class actions and individual lawsuits). We have been subject to regulatory investigations or examinations in the various jurisdictions where we do business. These actions arise in various contexts including in connection with our activities as an insurer, securities issuer, employer, investment adviser, investor and taxpayer. Certain of these lawsuits and investigations seek significant or unspecified amounts of damages (including punitive damages), and certain of the regulatory authorities involved in these proceedings have substantial powers over the conduct and operations of our business. Due to the nature of certain of these lawsuits and investigations, we cannot make an estimate of loss or predict with any certainty the potential impact of these suits or investigations on our business, financial condition or results of operations. 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 the UK, Ireland, the Netherlands and Canada. 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. Additionally, it is possible that a regulator in one of our major markets may conduct a review of products previously sold, either as part of an industry-wide review or specific to Aviva. The result of this review may be to compensate customers for losses they have incurred as a result of the products they were sold.
The failure to attract or retain the necessary personnel could have a material adverse effect on our results and/or financial condition. As a global financial services organisation with a decentralised management structure, we rely, to a considerable extent, on the quality of local management in the regions and countries in which we operate. The success of our operations is dependent, among other things, on our ability to attract and retain highly qualified professional people. Competition for such key people in most countries in which we operate is intense. Our ability to attract and retain key people, and in particular directors, experienced investment managers, fund managers and underwriters, is dependent on a number of factors, including prevailing market conditions and compensation packages offered by companies competing for the same talent.
Aviva plc Annual Report and Accounts 2010 Shareholder information continued that require mandatory contributions from market participants in some instances in the event of a failure of another market participant. As a major participant in the majority of our chosen markets, circumstances could arise where we, along with other companies, may be required to make such contributions. Additionally there is a risk to us and other insurers that we may be obliged to meet compensation costs arising from bank failures. The financial crisis has exposed a number of weaknesses in the current regulatory framework. Whilst these weaknesses are predominantly in the banking sector, the insurance and investment management industries potentially face a number of regulatory initiatives aimed at addressing lessons learnt from the crisis. We could be impacted by global initiatives (led by the G20), European initiatives and national initiatives in the markets within which we operate. The Solvency II Directive (‘Solvency II’), an insurance industry regulation agreed by the European Parliament in 2009, will require European domiciled insurers to move to more risk-based capital requirements. However, the more detailed implementing measures still need to be agreed and there is a risk that this could lead to a significant increase in the capital required to support our annuity and other business. There is evidence of heightened supervisory action throughout the world to assess and protect the financial position of regulated insurance companies. For example, the FSA has asked all life insurers in the UK to apply further stress tests to their solvency positions from 2008 to ensure they hold sufficient capital. Other European Regulators in certain countries in which we operate have adopted new rules – or indicated that they may adopt new rules in the future – relating to distributable reserves and retention of profits, which could affect the dividends our subsidiaries may pay to us. A determination that we have failed to comply with applicable regulation could have a negative impact on our reported results or on our relations with current and potential customers. Regulatory action against a member of the Group could result in adverse publicity for, or negative perceptions regarding, the Group, or could have a material adverse effect on our business, our results of operations and/or financial condition and divert management’s attention from the day-to-day management of the business.
Regulatory changes or errors may affect the calculation of unit prices or deduction of charges for our unit-linked products which may require Aviva to compensate customers retrospectively. A significant proportion of our product sales are unit-linked contracts, where product benefits are linked to the prices of underlying unit funds. Whilst comprehensive controls are in place, there is a risk of error in the calculation of the prices of these funds, which may be due to human error in data entry, IT-related issues or other causes. Additionally, it is possible that policy charges which are deducted from these contracts are taken incorrectly, or the methodology is subsequently challenged by policyholders or regulators and changed retrospectively. Any of these can give rise to compensation payments to customers. Controls are in place to mitigate these risks, but errors could give rise to future liabilities. Payments due to errors or compensation may negatively impact our profits.
From time to time changes in the interpretation of existing tax laws, amendments to existing tax rates or the introduction of new tax legislation may adversely impact our business, results of operations and financial condition. We operate in numerous tax jurisdictions around the world. Tax risk is the risk associated with changes in tax law or in the interpretation of tax law. It also includes the risk of changes in tax rates and the risk of failure to comply with procedures required by tax authorities. Failure to manage tax risks could lead to an additional tax charge. It could also lead to a financial penalty for failure to comply with required tax procedures or other aspects of tax law. If, as a result of a particular tax risk materialising, the tax costs associated with particular transactions are greater than anticipated, it could affect the profitability of those transactions. There are also specific rules governing the taxation of policyholders. We will be unable accurately to predict the impact of future changes in tax law on the taxation of life insurance and pension policies in the hands of policyholders. Amendments to existing legislation (particularly if there is the withdrawal of any tax relief or an increase in tax rates) or the introduction of new rules may affect the future long-term business and the decisions of policyholders. The impact of such changes upon us might depend on the mix of business in force at the time of such change and could have a material adverse effect on our business, results of operations and/or financial condition. The design of life insurance products by our life insurance companies takes into account a number of factors, including risks, benefits, charges, expenses, investment returns (including bonuses) and taxation. The design of long-term insurance products is based on the tax legislation in force at that time. Changes in tax legislation or in the interpretation of tax legislation
There are inherent funding risks associated with our participations in defined benefit staff pension schemes. We operate both defined benefit and defined contribution staff pension schemes. There are inherent funding risks associated with the defined benefit schemes. Events could result in a material reduction in the funding position of such schemes and, in some cases, a deficit between the pension scheme’s assets and liabilities could increase. The factors that affect the scheme’s position include: poor investment performance of pension fund investments; greater life expectancy than assumed; adverse changes in interest rates; and other events occurring which make past service benefits more expensive than predicted in the actuarial assumptions by reference to which funding requirements have been assessed. In the short term, the funding position is inherently volatile due to movements in the market value of assets. Where a funding deficit or surplus arises the position will be discussed with the scheme trustees to agree appropriate actions. This may include a funding plan being agreed to make good the deficit over a period of years but could also include a range of other actions such as changes to member contribution rates, changes in future benefit accruals or closure of schemes to new members. Any surplus or deficit in the defined benefit pension scheme will affect our shareholders’ equity.
Our acquisitions may divert management attention and other resources and involve risks of undisclosed liabilities and integration issues. In recent years we have completed a number of acquisitions around the world. We may make further acquisitions in the future. Growth by acquisition involves risks that could adversely affect our operating results, including the substantial amount of management time that may be diverted from operations to pursue and complete acquisitions. Our acquisitions could also result in the incurrence of additional indebtedness, costs, contingent liabilities, and impairment and amortisation expenses related to goodwill and other intangible assets, all of which could materially adversely affect our businesses, financial condition and results of operations. Future acquisitions may have a dilutive effect on the ownership and voting percentages of existing shareholders. We may also finance future acquisitions with debt issuances or by entering into credit facilities, each of which could adversely affect our businesses, financial condition and results of operations. The businesses we have recently acquired include long-term insurance and savings, general insurance and health and fund management. There could be unforeseen liabilities that arise out of the businesses we have acquired and may acquire in the future which may not be covered by, or exceed the amounts of any indemnities provided to us by the sellers.
Risks related to ownership of the ADSs and Ordinary Shares As a holding company, we are dependent on our operating subsidiaries to cover operating expenses and dividend payments. Our insurance and fund management operations are generally conducted through direct and indirect subsidiaries. As a holding company, Aviva plc’s principal sources of funding are dividends from subsidiaries, shareholder-backed funds and any amounts that may be raised through the issuance of debt and commercial paper. Certain subsidiaries have regulatory restrictions that may limit the payment of dividends, which in some circumstances could limit our ability to pay dividends to shareholders. In the current economic environment, such restrictions could become more stringent.
The holders of our ADSs may not be able to exercise their voting rights due to delays in notification to and by the depositary. The depositary for our ADSs may not receive voting materials for our ordinary shares represented by our ADSs in time to ensure that holders of our ADSs can instruct the depositary to vote their shares. In addition, the depositary’s liability to holders of our ADSs for failing to carry out voting instructions or for the manner of carrying out voting instructions is limited by the Deposit Agreement governing our ADR facility. As a result, holders of our ADSs may not be able to exercise their right to vote and may have limited recourse against the depositary or us, if their shares are not voted according to their request.
Holders of our ADSs will have limited recourse if we or the depositary fail to meet our respective obligations under the Deposit Agreement. The Deposit Agreement expressly limits our obligations and liability and those of the depositary. Neither we nor the depositary will be liable if either of us: are prevented from or delayed in performing any obligation by circumstances beyond our/their control; exercise or fail to exercise discretion under the Deposit Agreement; or take any action based upon the advice of, or information from, legal counsel, accountants, any person presenting ordinary shares for deposit, any holder or owner of an Aviva Plc ADR or any other person believed by us or the depositary in good faith to be competent to give such advice or information.
In addition, the depositary has the obligation to participate in any action, suit or other proceeding with respect to our ADSs which may involve it in expense or liability only if it is indemnified. These provisions of the Deposit Agreement will limit the ability of holders of our ADSs to obtain recourse if we or the depositary fails to meet their obligations under the Deposit Agreement or if they wish to involve us or the depositary in a legal proceeding.
Our ADS and ordinary share price could be volatile and could drop unexpectedly and holders may not be able to sell their ADRs or ordinary shares at or above the price they paid. The price at which our ADSs and ordinary shares will trade may be affected by a large number of factors, some of which will be specific to us and our operations and some of which will be related to the insurance industry and equity markets generally. As a result of these factors, holders may not be able to resell their ADSs or ordinary shares at or above the price which they paid for them. In particular, the following factors, in addition to other risk factors described in this section, may have a significant impact on the market price of our ADSs or ordinary shares: investor perception of our Company, including actual or anticipated variations in our revenues, earnings or other operating results; announcement of intended acquisitions, disposals or financings or speculations of such acquisitions, disposals or financings; changes in our dividend policy, which could result from changes in our cash flow and capital position; sales of blocks of our shares by significant shareholders; hedging activities on our shares;
Aviva plc Annual Report and Accounts 2010 Shareholder information continued a downgrade of our credit or financial strength ratings, including placement on credit watch, or rumours of such downgrades; actual or potential litigation involving us or the insurance or fund management industries generally; changes in financial estimates and recommendations by securities research analysts; fluctuations in foreign exchange rates and interest rates; the performance of other companies in the financial services’ sector; regulatory developments in the principal markets in which we operate; international or local political, economic and market conditions; and unforeseen events such as natural disaster or terrorist attacks and other developments stemming from such events and the uncertainty related to these developments.
As a ‘foreign private issuer’ in the US we are exempt from certain rules under the US securities laws and are permitted to file less information with the SEC than US companies. As a ‘foreign private issuer’, we are exempt from certain rules under the US Securities Exchange Act of 1934, as amended (the ‘Exchange Act’), that impose certain disclosure obligations and procedural requirements for proxy solicitations under Section 14 of the Exchange Act. In addition, our officers, directors and principal shareholders are exempt from the reporting and ‘shortswing ’ profit recovery provisions of Section 16 of the Exchange Act and the rules under the Exchange Act with respect to their purchases and sales of our ordinary shares and ADRs. Moreover, we are not required to file periodic reports and financial statements with the SEC as frequently or as promptly as US companies whose securities are registered under the Exchange Act. In addition, we are not required to comply with Regulation FD, which restricts the selective disclosure of material information. Although we must comply with UK listing rules on insider reporting of share ownership and on protection of inside information, there may be less publicly available information concerning us than there is for US public companies.
Limitations on Enforceability of Civil Liabilities under US Federal Securities Laws. We are an English company. Any experts working on our behalf are likely to be residents of the United Kingdom and not the United States. In addition, most of our officers and directors are residents of the United Kingdom and not the United States. It may be difficult or impossible to serve legal process on persons located outside the United States and to force them to appear in a US court. It may also be difficult or impossible to enforce a judgement of a US court against persons outside the United States, or to enforce a judgement of a foreign court against such persons in the United States. We believe that there may be doubt as to the enforceability against persons in the United Kingdom, whether in original actions or in actions for the enforcement of judgements of US courts, of civil liabilities predicated solely upon the laws of the United States, including its federal securities laws. Individual shareholders of an English company (including US persons) have the right under English law to bring lawsuits on behalf of the company in which they are a shareholder, and on their own behalf against the company, in certain limited circumstances. English law does not permit class action lawsuits by shareholders, except in limited circumstances.
We have audited the Group and Parent Company financial statements (the ‘financial statements’) of Aviva plc for the year ended 31 December 2010 which comprise the Accounting Policies, the Consolidated and Parent Company Income Statements, the Pro Forma Reconciliation of Group Operating Profit to Profit before Tax, the Consolidated and Parent Company Statements of Comprehensive Income, the Consolidated and Parent Company Statements of Changes in Equity, the Consolidated and Parent Company Statements of Financial Position, the Consolidated and Parent Company Cash Flow Statements, and the related notes 1 to 60 and A to H. The financial reporting framework that has been applied in their preparation is applicable law and International Financial Reporting Standards (IFRSs) as adopted by the European Union. This report is made solely to the Company’s members, as a body, in accordance with Chapter 3 of Part 16 to the Companies Act 2006. Our audit work has been undertaken so that we might state to the Company’s members those matters we are required to state to them in an auditor’s report and for no other purpose. To the fullest extent permitted by law, we do not accept or assume responsibility to anyone other than the Company and the Company’s members as a body, for our audit work, for this report, or for the opinions we have formed.
Respective responsibilities of directors and auditors As explained more fully in the Directors’ Responsibilities Statement set out on pages 107-108, the directors are responsible for the preparation of the financial statements and for being satisfied that they give a true and fair view. Our responsibility is to audit and express an opinion on the financial statements in accordance with applicable law and International Standards on Auditing (UK and Ireland). Those standards require us to comply with the Auditing Practices Board’s (APB’s) Ethical Standards for Auditors.
Scope of the audit of the financial statements An audit involves obtaining evidence about the amounts and disclosures in the financial statements sufficient to give reasonable assurance that the financial statements are free from material misstatement, whether caused by fraud or error. This includes an assessment of: whether the accounting policies are appropriate to the Group’s and the Parent company’s circumstances and have been consistently applied and adequately disclosed; the reasonableness of significant accounting estimates made by the directors; and the overall presentation of the financial statements.
Opinion on financial statements In our opinion: the financial statements give a true and fair view of the state of the Group’s and of the Parent company’s affairs as at 31 December 2010 and of the Group’s and the Parent company’s profit for the year then ended; the financial statements have been properly prepared in accordance with IFRSs as adopted by the European Union; and the financial statements have been prepared in accordance with the requirements of the Companies Act 2006 and, as regards the Group financial statements, Article 4 of the IAS Regulation.
Opinion on other matters prescribed by the Companies Act 2006 In our opinion: the part of the Directors’ Remuneration Report to be audited has been properly prepared in accordance with the Companies Act 2006; the information given in the Directors’ Report for the financial year for which the financial statements are prepared is consistent with the financial statements; and the information given in the Corporate Governance Statement, set out on pages 104 and 105, with respect to internal control and risk management systems in relation to financial reporting processes and about share capital structures is consistent with the financial statements.
James W Dean (Senior statutory auditor) for and on behalf of Ernst & Young LLP, Statutory Auditor 1. The maintenance and integrity of Aviva plc’s website is the responsibility of the directors; the work carried out by the auditors does not involve consideration of these matters and, accordingly, the auditors accept no responsibility for any changes that may have occurred to the financial statements since they were initially presented on the website. 2. Legislation in the United Kingdom governing the preparation and dissemination of financial statements may differ from legislation in other jurisdictions.
(A) Basis of presentation Since 2005, all European Union listed companies have been required to prepare consolidated financial statements using International Financial Reporting Standards (IFRS) issued by the International Accounting Standards Board (IASB) and endorsed by the European Union (EU). The date of transition to IFRS was 1 January 2004. In addition to fulfilling their legal obligation to comply with IFRS as adopted by the European Union, the Group and Company have also complied with IFRS as issued by the International Accounting Standards Board and applicable at 31 December 2010. In 2008, the IASB issued revised versions of IFRS 3, Business Combinations, and IAS 27, Consolidated and Separate Financial Statements. The former introduced a number of changes in accounting for such transactions that impact the amount of goodwill recognised, the reported results in the period an acquisition occurs and future reported results. The latter now requires a change in the ownership interest of a subsidiary (without loss of control) to be accounted for as an equity transaction, rather than giving rise to goodwill or a gain or loss. Consequential amendments were made to IAS 7, Statement of Cash Flows, IAS 12, Income Taxes, IAS 21, The Effects of Changes in Foreign Exchange Rates, IAS 28, Investments in Associates, and IAS 31, Interests in Joint Ventures. During 2008 and 2009, the IASB also issued amendments to IFRS 1, First Time Adoption of IFRS, IFRS 2, Share-Based Payment, IAS 39, Financial Instruments: Recognition and Measurement and the results of its annual improvements project. IFRIC interpretation 17, Distributions of Non-cash Assets to Owners, issued in 2008, has also been endorsed by the EU. These are all applicable for the first time in the current accounting period and are now reflected in the Group’s financial reporting, with no material impact other than on presentation as described in note 2(b). Further amendments to IFRS 1, IAS 24, Related Party Disclosures, and IAS 32, Financial Instruments – Presentation, and the results of its next annual improvements project have been issued and endorsed by the EU, while other amendments to IFRS 1, IFRS 7, Financial Instruments – Disclosures, and IAS 12 have been issued but have not yet been so endorsed. These are applicable prospectively for accounting periods commencing 1 February 2010 or later, and are therefore not applicable for the current accounting period. On adoption, they will not have any material impact on the Group’s financial reporting. In 2009, the IASB issued IFRS 9, Financial Instruments – Classification and Measurement, followed by additional requirements on accounting for financial liabilities in 2010. These are the first two parts of a replacement standard for IAS 39. They are applicable prospectively for accounting periods commencing 1 January 2013 or later, and are therefore not applicable for the current accounting period. IFRS 9 has not yet been endorsed by the EU but, on adoption, will require us to review the classification of certain financial instruments while allowing us to retain fair value measurement as we deem necessary. We have not yet completed our assessment of its impact. IFRIC interpretation 19, Extinguishing Financial Liabilities with Equity Instruments, and an amendment to interpretation 14, IAS 19 – The Limit on a Defined Benefit Asset, Minimum Funding Requirements and their Interaction, were issued during 2008 and 2009 and have been endorsed by the EU. These are applicable prospectively for accounting periods commencing 1 July 2010 or later, and are therefore not applicable for the current accounting period. On adoption, they will not have any impact on our financial reporting. In accordance with IFRS 4, Insurance Contracts, the Group has applied existing accounting practices for insurance and participating investment contracts, modified as appropriate to comply with the IFRS framework and applicable standards. Further details are given in policy F below. Items included in the financial statements of each of the Group’s entities are measured in the currency of the primary economic environment in which that entity operates (the functional currency). The consolidated financial statements are stated in sterling, which is the Company’s functional and presentation currency. Unless otherwise noted, the amounts shown in these financial statements are in millions of pounds sterling (£m). As supplementary information, consolidated financial information is also presented in euros. The separate financial statements of the Company are on pages 306 to 314.
(B) Operating profit The long-term nature of much of the Group’s operations means that, for management’s decision-making and internal performance management, short-term realised and unrealised investment gains and losses are treated as non-operating items. The Group focuses instead on an operating profit measure (also referred to as adjusted operating profit) that incorporates an expected return on investments supporting its long-term and non-long-term businesses. Operating profit for long-term business is based on expected investment returns on financial investments backing shareholder and policyholder funds over the reporting period, with allowance for the corresponding expected movements in liabilities. Variances between actual and expected investment returns, and the impact of changes in economic assumptions on liabilities, are disclosed separately outside operating profit. For non-long-term business, the total investment income, including realised and unrealised gains, is analysed between that calculated using a longer-term return and shortterm fluctuations from that level. Further details of this analysis and the assumptions used are given in notes 8 and 9.
Item Accounting policy Insurance and participating investment contract liabilities F&K Goodwill, AVIF and intangible assets N Fair values of financial investments S Impairment of financial investments S Fair value of derivative financial instruments T Deferred acquisition costs and other assets W Provisions and contingent liabilities Z Pension obligations AA Deferred income taxes AB
Merger accounting and the merger reserve Prior to 1 January 2004, certain significant business combinations were accounted for using the ‘pooling of interests method’ (or merger accounting), which treats the merged groups as if they had been combined throughout the current and comparative accounting periods. Merger accounting principles for these combinations gave rise to a merger reserve in the consolidated statement of financial position, being the difference between the nominal value of new shares issued by the Parent Company for the acquisition of the shares of the subsidiary and the subsidiary’s own share capital and share premium account. These transactions have not been restated, as permitted by the IFRS 1 transitional arrangements. The merger reserve is also used where more than 90% of the shares in a subsidiary are acquired and the consideration includes the issue of new shares by the Company, thereby attracting merger relief under the Companies Act 1985 and, from 1 October 2009, the Companies Act 2006.
Associates and joint ventures Associates are entities over which the Group has significant influence, but which it does not control. Generally, it is presumed that the Group has significant influence if it has between 20% and 50% of voting rights. Joint ventures are entities whereby the Group and other parties undertake an economic activity which is subject to joint control arising from a contractual agreement. In a number of these, the Group’s share of the underlying assets and liabilities may be greater than 50% but the terms of the relevant agreements make it clear that control is not exercised. Such jointly controlled entities are referred to as joint ventures in these financial statements. Gains on transactions between the Group and its associates and joint ventures are eliminated to the extent of the Group’s interest in the associates and joint ventures. Losses are also eliminated, unless the transaction provides evidence of an impairment of the asset transferred between entities. Investments in associates and joint ventures are accounted for using the equity method of accounting. Under this method, the cost of the investment in a given associate or joint venture, together with the Group’s share of that entity’s post-acquisition changes to shareholders’ funds, is included as an asset in the consolidated statement of financial position. As explained in policy N, the cost includes goodwill identified on acquisition. The Group’s share of their post-acquisition profits or losses is recognised in the income statement and its share of post-acquisition movements in reserves is recognised in reserves. Equity accounting is discontinued when the Group no longer has significant influence or joint control over the investment. If the Group’s share of losses in an associate or joint venture equals or exceeds its interest in the undertaking, the Group does not recognise further losses unless it has incurred obligations or made payments on behalf of the entity.
(E) Foreign currency translation Income statements and cash flows of foreign entities are translated into the Group’s presentation currency at average exchange rates for the year while their statements of financial position are translated at the year-end exchange rates. Exchange differences arising from the translation of the net investment in foreign subsidiaries, associates and joint ventures, and of borrowings and other currency instruments designated as hedges of such investments, are recognised in other comprehensive income and taken to the currency translation reserve within equity. On disposal of a foreign entity, such exchange differences are transferred out of this reserve and are recognised in the income statement as part of the gain or loss on sale. The cumulative translation differences were deemed to be zero at the transition date to IFRS. Foreign currency transactions are accounted for at the exchange rates prevailing at the date of the transactions. Gains and losses resulting from the settlement of such transactions, and from the translation of monetary assets and liabilities denominated in foreign currencies, are recognised in the income statement. Translation differences on debt securities and other monetary financial assets measured at fair value and designated as held at fair value through profit or loss (FV) (see policy S) are included in foreign exchange gains and losses in the income statement. For monetary financial assets designated as AFS, translation differences are calculated as if they were carried at amortised cost and so are recognised in the income statement, whilst foreign exchange differences arising from fair value gains and losses are recognised in other comprehensive income and included in the investment valuation reserve within equity. Translation differences on non-monetary items, such as equities which are designated as FV, are reported as part of the fair value gain or loss, whereas such differences on AFS equities are included in the investment valuation reserve.
(K) Insurance and participating investment contract liabilities Claims Long-term business claims reflect the cost of all claims arising during the year, including claims handling costs, as well as policyholder bonuses accrued in anticipation of bonus declarations. General insurance and health claims incurred include all losses occurring during the year, whether reported or not, related handling costs, a reduction for the value of salvage and other recoveries, and any adjustments to claims outstanding from previous years. Claims handling costs include internal and external costs incurred in connection with the negotiation and settlement of claims. Internal costs include all direct expenses of the claims department and any part of the general administrative costs directly attributable to the claims function.
Long-term business provisions Under current IFRS requirements, insurance and participating investment contract liabilities are measured using accounting policies consistent with those adopted previously under existing accounting practices, with the exception of liabilities remeasured to reflect current market interest rates and those relating to UK with-profit and non-profit contracts, to be consistent with the value of the backing assets. For liabilities relating to UK with-profit contracts, the Group has adopted FRS 27, Life Assurance, as described in policy F above, in addition to the requirements of IFRS. In the United States, shadow adjustments are made to the liabilities or related deferred acquisition costs and are recognised directly in other comprehensive income. This means that the measurement of these items is adjusted for unrealised gains or losses on the backing assets such as AFS financial investments (see policy S), that are recognised directly in other comprehensive income, in the same way as if those gains or losses had been realised. The long-term business provisions are calculated separately for each life operation, based either on local regulatory requirements or existing local GAAP at the later of the date of transition to IFRS or the date of the acquisition of the entity, and actuarial principles consistent with those applied in the UK. Each calculation represents a determination within a range of possible outcomes, where the assumptions used in the calculations depend on the circumstances prevailing in each life operation. The principal assumptions are disclosed in note 39(b). For liabilities of the UK with-profit funds, FRS 27 requires liabilities to be calculated as the realistic basis liabilities as set out by the UK’s Financial Services Authority, adjusted to remove the shareholders’ share of future bonuses. For UK non-profit insurance contracts, the Group applies the realistic regulatory basis as set out in the FSA Policy Statement 06/14, Prudential Changes for Insurers, where applicable.
(ii) Provision for unearned premiums The proportion of written premiums, gross of commission payable to intermediaries, attributable to subsequent periods is deferred as a provision for unearned premiums. The change in this provision is taken to the income statement as recognition of revenue over the period of risk.
Impairment The Group reviews the carrying value of its loans and receivables and AFS investments on a regular basis. If the carrying value of a loan, receivable or AFS investment is greater than the recoverable amount, the carrying value is reduced through a charge to the income statement in the period of impairment. The following policies are used to determine the level of any impairment, some of which involve considerable judgement: AFS debt securities: An AFS debt security is impaired if there is objective evidence that a loss event has occurred which has impaired the expected cash flows, i.e. where all amounts due according to the contractual terms of the security are not considered collectible. An impairment charge, measured as the difference between the security’s fair value and amortised cost, is recognised when the issuer is known to be either in default or in financial difficulty. Determining when an issuer is in financial difficulty requires the use of judgement, and we consider a number of factors including industry risk factors, financial condition, liquidity position and near-term prospects of the issuer, credit rating declines and a breach of contract. A decline in fair value below amortised cost due to changes in risk-free interest rates does not necessarily represent objective evidence of a loss event.
(T) Derivative financial instruments and hedging Derivative financial instruments include foreign exchange contracts, interest rate futures, currency and interest rate swaps, currency and interest rate options (both written and purchased) and other financial instruments that derive their value mainly from underlying interest rates, foreign exchange rates, commodity values or equity instruments. All derivatives are initially recognised in the statement of financial position at their fair value, which usually represents their cost. They are subsequently remeasured at their fair value, with the method of recognising movements in this value depending on whether they are designated as hedging instruments and, if so, the nature of the item being hedged. Fair values are obtained from quoted market prices or, if these are not available, by using valuation techniques such as discounted cash flow models or option pricing models. All derivatives are carried as assets when the fair values are positive and as liabilities when the fair values are negative. Premiums paid for derivatives are recorded as an asset on the statement of financial position at the date of purchase, representing their fair value at that date. Derivative contracts may be traded on an exchange or over-the-counter (OTC). Exchange-traded derivatives are standardised and include certain futures and option contracts. OTC derivative contracts are individually negotiated between contracting parties and include forwards, swaps, caps and floors. Derivatives are subject to various risks including market, liquidity and credit risk, similar to those related to the underlying financial instruments. The notional or contractual amounts associated with derivative financial instruments are not recorded as assets or liabilities on the statement of financial position as they do not represent the fair value of these transactions. These amounts are disclosed in note 58.
(U) Loans Loans with fixed maturities, including policyholder loans, mortgage loans on investment property, securitised mortgages and collateral loans, are recognised when cash is advanced to borrowers. The majority of these loans are carried at their unpaid principal balances and adjusted for amortisation of premium or discount, non-refundable loan fees and related direct costs. These amounts are deferred and amortised over the life of the loan as an adjustment to loan yield using the effective interest rate method. Loans with indefinite future lives are carried at unpaid principal balances or cost. For certain mortgage loans, the Group has taken advantage of the revised fair value option under IAS 39 to present the mortgages, associated borrowings and derivative financial instruments at fair value, since they are managed as a portfolio on a fair value basis. This presentation provides more relevant information and eliminates any accounting mismatch that would otherwise arise from using different measurement bases for these three items. The fair values of mortgages classified as FV are estimated using discounted cash flow forecasts, based on a risk-adjusted discount rate which reflects the risks associated with these products, calibrated using the margins available on new lending or with reference to the rates offered by competitors. They are revalued at each period end, with movements in their fair values being taken to the income statement. At each reporting date, we review loans carried at amortised cost for objective evidence that they are impaired and uncollectable, either at the level of an individual security or collectively within a group of loans with similar credit risk characteristics. To the extent that a loan is uncollectable, it is written down as impaired to its recoverable amount, measured as the present value of expected future cash flows discounted at the original effective interest rate of the loan, including any collateral receivable. Subsequent recoveries in excess of the loan’s written-down carrying value are credited to the income statement.
Where such business is reinsured, an appropriate proportion of the deferred acquisition costs is attributed to the reinsurer, and is treated as a separate liability. Long-term business deferred acquisition costs are amortised systematically over a period no longer than that in which they are expected to be recoverable out of these future margins. Deferrable acquisition costs for non-participating investment and investment fund management contracts are amortised over the period in which the service is provided. General insurance and health deferred acquisition costs are amortised over the period in which the related revenues are earned. The reinsurers’ share of deferred acquisition costs is amortised in the same manner as the underlying asset. Deferred acquisition costs are reviewed by category of business at the end of each reporting period and are written-off where they are no longer considered to be recoverable. Other assets include vehicles which are subject to repurchase agreements and inventories of vehicle parts. The former are carried at the lower of their agreed repurchase price or net realisable value, whilst the latter are carried at the lower of cost and net realisable value, where cost is arrived at on the weighted average cost formula or ‘first in first out’ (FIFO) basis. Provision is made against inventories which are obsolete or surplus to requirements.
(X) Statement of cash flows Cash and cash equivalents Cash and cash equivalents consist of cash at banks and in hand, deposits held at call with banks, treasury bills and other short-term highly liquid investments that are readily convertible to known amounts of cash and which are subject to an insignificant risk of change in value. Such investments are those with less than three months’ maturity from the date of acquisition, or which are redeemable on demand with only an insignificant change in their fair values. For the purposes of the statement of cash flows, cash and cash equivalents also include bank overdrafts, which are included in payables and other financial liabilities on the statement of financial position.
(Z) Provisions and contingent liabilities Provisions are recognised when the Group has a present legal or constructive obligation as a result of past events, it is more probable than not that an outflow of resources embodying economic benefits will be required to settle the obligation, and a reliable estimate of the amount of the obligation can be made. Where the Group expects a provision to be reimbursed, for example under an insurance contract, the reimbursement is recognised as a separate asset but only when the reimbursement is virtually certain. The Group recognises a provision for onerous contracts when the expected benefits to be derived from a contract are less than the unavoidable costs of meeting the obligations under the contract. Contingent liabilities are disclosed if there is a possible future obligation as a result of a past event, or if there is a present obligation as a result of a past event but either a payment is not probable or the amount cannot be reasonably estimated.
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 made at the beginning of the period, are recognised immediately in other comprehensive income. For defined contribution plans, the Group pays contributions to publicly or privately administered pension plans. Once the contributions have been paid, the Group, as employer, has no further payment obligations. The Group’s contributions are charged to the income statement in the year to which they relate and are included in staff costs.
(AC) Borrowings Borrowings are recognised initially at their issue proceeds less transaction costs incurred. Subsequently, most borrowings are stated at amortised cost, and any difference between net proceeds and the redemption value is recognised in the income statement over the period of the borrowings using the effective interest rate method. All borrowing costs are expensed as they are incurred except where they are directly attributable to the acquisition or construction of property and equipment as described in policy O above. Where loan notes have been issued in connection with certain securitised mortgage loans, the Group has taken advantage of the revised fair value option under IAS 39 to present the mortgages, associated liabilities and derivative financial instruments at fair value, since they are managed as a portfolio on a fair value basis. This presentation provides more relevant information and eliminates any accounting mismatch which would otherwise arise from using different measurement bases for these three items.
Income 5 42,675 Gross written premiums 36,274 34,690 (2,191) Premiums ceded to reinsurers (1,863) (2,576)
40,484 Premiums written net of reinsurance 34,411 32,114 (89) Net change in provision for unearned premiums (75) 559 40,395 Net earned premiums G 34,336 32,673 2,096 Fee and commission income H & I 1,782 1,789 25,874 Net investment income j 21,993 25,155 155 Share of profit/(loss) after tax of joint ventures and associates 131 (504) 187 Profit on the disposal and re-measurement of subsidiaries and associates 3b 159 153
(1,108) Tax expense AB & 13 (942) (707) 463 Less: tax attributable to policyholders’ returns 13 394 217
Earnings per share AF & 14 59.3c Basic (pence per share) 50.4p 37.8p 58.3c Diluted (pence per share) 49.6p 37.5p
Pro forma reconciliation of Group operating profit to profit before tax For the year ended 31 December 2010
Operating profit before tax attributable to shareholders’ profits 2,727 Long-term business 2,318 1,887 1,236 General insurance and health 1,050 960
Adjusted for the following: 931 Investment return variances and economic assumption changes on long-term business 8 791 (75)
(286) Short-term fluctuation in return on investments on non-long-term business 9a (243) 95 (72) Economic assumption changes on general insurance and health business 9a (61) 57 (28) Impairment of goodwill and other amounts expensed 16 (24) (62)
(286) Integration and restructuring costs 6 (243) (286) (321) Exceptional items 6 (273) 45 2,871 Profit before tax attributable to shareholders’ profits 2,440 1,805 Tax attributable to shareholders’ profits 2,226 Profit for the year 1,892 1,315 £m
211 Impairment losses on assets previously revalued through other comprehensive income now taken to the income statement 179 482
Non-controlling interests in acquired/(disposed) subsidiaries — — — — — — — — — — — — — 3 3
Changes in non-controlling interests in existing subsidiaries — — — — — — — — — — — — — (38) (38)
At 1 January 2009 664 200 1,234 3,271 (33) 3,685 157 (711) (1,103) 113 3,902 11,379 990 2,204 14,573 Profit for the year — — — — — — — — — — 1,085 1,085 — 230 1,315 Other comprehensive income — — — — — (1,110) (26) 1,030 332 — (1,071) (845) — (138) (983) Total comprehensive income for the year — — — — — (1,110) (26) 1,030 332 — 14 240 — 92 332 Owner-occupied properties – Fair value losses transferred to retained earnings on disposals — — — — — — (1) — — — 1 — — — —
Non-controlling interests in acquired/(disposed) subsidiaries — — — — — — — — — — — — — (2) (2)
820 Ordinary share capital 29 705 692 233 Preference share capital 32 200 200
Liabilities 206,628 Gross insurance liabilities K & 39 177,700 171,092 136,962 Gross liabilities for investment contracts L & 40 117,787 110,015 3,986 Unallocated divisible surplus K & 44 3,428 3,866 10,502 Net asset value attributable to unitholders D 9,032 9,894 3,422 Provisions Z, AA & 47 2,943 3,980 2,044 Deferred tax liabilities AB & 46b 1,758 1,038 365 Current tax liabilities 46a 314 192 17,383 Borrowings AC & 49 14,949 15,000 23,595 Payables and other financial liabilities R & 50 20,292 20,542 4,860 Other liabilities 51 4,179 3,653 — Liabilities of operations classified as held for sale AG & 3c — 33 430,357 Total equity and liabilities 370,107 354,391
Cash flows from financing activities Proceeds from issue of ordinary shares, net of transaction costs — 1 Treasury shares purchased for employee trusts (14) (53) New borrowings drawn down, net expenses 3,647 4,260 Repayment of borrowings (2,887) (3,853) Net drawdown of borrowings 49e 760 407 Interest paid on borrowings (1,421) (1,199) Preference dividends paid (17) (17) Ordinary dividends paid (472) (476) Coupon payments on direct capital instruments (59) (61) Capital contributions from non-controlling interests 42 6 Dividends paid to non-controlling interests of subsidiaries (187) (109) Partial disposal of subsidiary 2b & 54c — 930
Net increase in cash and cash equivalents 803 1,682 Cash and cash equivalents at 1 January 24,251 23,531 Effect of exchange rate changes on cash and cash equivalents (359) (962)
2 – Presentation changes (a) Pension scheme net finance costs In financial years prior to and including 2008, the net finance income on the Group’s defined benefit pension schemes, representing the surplus of expected income on scheme assets over the unwind of the discount on their liabilities, was classified as investment income in the consolidated income statement. Since adoption of IFRS in 2004, this figure had always been in a net finance income position but movements in scheme deficits and interest rates resulted in a net finance charge in 2009. For consistency with prior years, this net charge was included within investment income in the Group’s 2009 financial statements. In 2010, there is again a net finance charge which we believe should more appropriately be included within finance costs in the consolidated income statement. For consistency and comparability, we have therefore reclassified the 2009 comparative (£183 million) from net investment income to finance costs.
Aviva plc Annual Report and Accounts 2010 3 – Subsidiaries This note provides details of the acquisitions and disposals of subsidiaries that the Group has made during the year, together with details of businesses held for sale at the year end. The principal Group subsidiaries are listed on pages 40 to 41.
The estimated book and fair values of the assets and liabilities at the acquisition date were: Book value £m
The fair value adjustment for intangible assets relates to customer relationships acquired. Goodwill of £29 million arising from this acquisition consists largely of the expected benefits from new business and new product introductions. The results of River Road have been included in the consolidated financial statements of the Group with effect from 24 February 2010, and have contributed £10 million revenues and £4 million loss to the consolidated profit before tax. Had it been consolidated from 1 January 2010, River Road would have contributed £12 million revenues and £5 million loss to the consolidated profit before tax.
Total profit on disposal and remeasurement arising from transaction (see (b) below) 128
No goodwill arises from this transaction. There is no potential deferred tax on the acquired value of in-force business. As the acquisition occurred on 31 December 2010, no revenue or profit or loss has been recognised in the consolidated income statement since the acquisition date. If the acquisition had occurred on 1 January 2010, RBS Life would have contributed £188 million revenues and £56 million profit to the consolidated profit before tax.
(iii) Other goodwill arising Goodwill arising on all acquisitions, as shown in note 16(a), was £29 million, which arises on the River Road acquisition described above. There has also been a £4 million reduction in goodwill for changes in contingent consideration payable on previous acquisitions.
Aviva plc Annual Report and Accounts 2010 3 – Subsidiaries continued (b) Disposal and remeasurement of subsidiaries, joint ventures and associates The profit on the disposal and remeasurement of subsidiaries, joint ventures and associates comprises: United Kingdom RBS Life and RBS Collective (see (a)(ii) above) 128 — Non-core operations (see below) 4 — France (including £24 million described in note 19a) 26 — Netherlands (4) 31 Australia — 122 Other small operations 5 —
Other Group activities Investment return on centrally held assets and head office expenses, such as Group treasury and finance functions, together with certain taxes and financing costs arising on central borrowings are included in ‘Other Group activities’. Similarly, central core structural borrowings and certain tax balances are included in ‘Other Group activities’ in the segmental statement of financial position. Also included here are consolidation and elimination adjustments.
Aviva plc Annual Report and Accounts 2010 4 – Segmental information continued (i) Segmental income statement for the year ended 31 December 2010
Gross written premiums 6,572 4,405 13,507 4,469 6,680 641 — — 36,274 Premiums ceded to reinsurers (673) (333) (452) (124) (221) (60) — — (1,863) Internal reinsurance revenue — 37 (14) (5) (16) (2) — — —
Net written premiums 5,899 4,109 13,041 4,340 6,443 579 — — 34,411 Net change in provision for unearned premiums (12) (16) (68) (2) 29 (6) — — (75)
Claims and benefits paid, net of recoveries from reinsurers (8,144) (2,829) (9,413) (4,234) (4,069) (463) — — (29,152) Change in insurance liabilities, net of reinsurance (2,923) 237 (687) (569) (3,020) (215) — — (7,177) Change in investment contract provisions (3,300) — (5,034) (48) (129) — (230) — (8,741) Change in unallocated divisible surplus (166) — 478 (33) — 50 — — 329 Amortisation of acquired value of in-force business — — (43) (12) (115) (4) — — (174) Depreciation and other amortisation expense (71) (42) (54) (37) (82) (5) (10) — (301) Other operating expenses (1,300) (1,636) (2,060) (1,226) (834) (140) (425) (1,101) (8,722) Impairment losses** — (3) — (123) (81) — — — (207) Inter-segment expenses (125) (2) (16) — (71) — — — (214) Finance costs (193) (38) (18) (723) (27) — (3) (420) (1,422)
Profit/(loss) before tax attributable to shareholders 784 457 608 895 309 39 61 (713) 2,440
Adjusted for non-operating items: Reclassification of corporate costs and unallocated interest 99 148 7 12 5 — 12 (283) — Investment return variances and economic assumption changes on long-term business 87 — 154 (1,010) (10) (12) — — (791) Short-term fluctuation in return on investments backing non-long-term business — (31) 47 44 (44) — — 227 243 Economic assumption changes on general insurance and health business — 60 1 — — — — — 61 Impairment of goodwill 4 — 9 1 — 1 — 9 24 Amortisation and impairment of intangibles 68 7 37 23 75 1 5 — 216 (Profit)/loss on the disposal of subsidiaries and associates (128) (5) (26) 4 (1) — — (3) (159) Integration and restructuring costs 41 35 61 18 32 2 30 24 243 Exceptional items (99) (157) — 549 10 — (11) (19) 273
Operating profit/(loss) before tax attributable to shareholders 856 514 898 536 376 31 97 (758) 2,550 * Total reported income, excluding inter-segment revenue, is split United Kingdom £22,160 million, France £8,748 million, Netherlands £7,782 million, USA £6,497 million and Rest of the World £13,214 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 losses, and reversal of such losses, recognised directly in other comprehensive income were £179 million and £nil million respectively. # United Kingdom General Insurance includes the Group Reinsurance business, agency run-off business and the non-insurance business for the RAC.
Aviva plc Annual Report and Accounts 2010 4 – Segmental information continued (ii) Segmental income statement for the year ended 31 December 2009
Gross written premiums 6,086 4,239 12,936 4,482 6,413 534 — — 34,690 Premiums ceded to reinsurers (1,311) (355) (468) (134) (231) (77) — — (2,576) Internal reinsurance revenue — 28 (13) (7) (6) (2) — — —
Net written premiums 4,775 3,912 12,455 4,341 6,176 455 — — 32,114 Net change in provision for unearned premiums 2 607 (16) 6 (35) (5) — — 559
Claims and benefits paid,net of recoveries from reinsurers (7,313) (3,409) (8,871) (3,567) (4,110) (279) — — (27,549) Change in insurance liabilities, net of reinsurance 663 531 (2,321) (1,448) (2,895) (212) — — (5,682) Change in investment contract provisions (4,008) — (6,451) (239) (128) (148) (211) — (11,185) Change in unallocated divisible surplus 872 — (2,280) (68) — (71) — — (1,547) Amortisation of acquired value of in-force business (46) — (47) (3) (149) (4) — — (249) Depreciation and other amortisation expense (45) (72) (60) (35) (77) (6) (5) — (300) Other operating expenses (1,804) (1,893) (2,107) (1,248) (653) (246) (348) (306) (8,605) Impairment losses** — (42) (17) (445) (104) — — — (608) Inter-segment expenses (119) (6) (15) — (60) (1) — (1) (202) Finance costs (254) (34) (25) (745) (25) — — (436) (1,519)
Impairment of goodwill 35 — 26 1 — — — — 62 Amortisation and impairment of intangibles 3 18 31 19 69 2 2 — 144 Profit on the disposal of subsidiaries and associates — — — (31) — (122) — — (153) Integration and restructuring costs 89 114 64 — — — 21 (2) 286 Exceptional items (163) 42 16 — 60 — — — (45)
Operating profit/(loss) before tax attributable to shareholders 659 481 797 399 213 77 115 (719) 2,022 * Total reported income, excluding inter-segment revenue, is split United Kingdom £18,256 million, France £12,890 million, Netherlands £7,808 million, USA £6,350 million and Rest of the World £13,962 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 losses, and reversal of such losses, recognised directly in other comprehensive income were £482 million and £nil respectively. # United Kingdom General Insurance includes the Group Reinsurance business, agency run-off business and the non-insurance business for the RAC.
Aviva plc Annual Report and Accounts 2010 4 – Segmental information continued (iii) Segmental statement of financial position as at 31 December 2010
Goodwill 29 1,208 927 307 838 54 28 — 3,391 Acquired value of in-force business and intangible assets 277 241 1,072 58 1,102 16 40 — 2,806 Interests in, and loans to, joint ventures and associates 1,603 — 315 323 1 381 14 — 2,637 Property and equipment 152 90 99 236 149 7 17 — 750 Investment property 8,121 37 1,382 2,043 6 — 1,060 415 13,064 Loans 19,781 502 977 19,120 2,529 40 — 125 43,074 Financial investments 83,099 2,525 95,940 33,627 31,829 2,639 1,062 2,567 253,288 Deferred acquisition costs 1,445 628 632 188 2,518 5 — — 5,416 Other assets 14,409 3,724 17,748 3,361 2,939 446 1,164 1,890 45,681
Insurance liabilities Long-term business and outstanding claims provisions 66,261 5,136 37,165 30,240 31,218 2,482 — — 172,502 Unearned premiums 185 2,171 1,023 336 1,098 42 — — 4,855 Other insurance liabilities — 69 111 61 100 2 — — 343 Liability for investment contracts 44,350 — 65,020 3,220 2,929 — 2,268 — 117,787 Unallocated divisible surplus 2,010 — 1,243 138 — 37 — — 3,428 Net asset value attributable to unitholders 991 — 4,231 678 — — — 3,132 9,032 External borrowings 2,796 — 127 6,574 178 — — 5,274 14,949 Other liabilities, including inter-segment liabilities 7,316 (1,823) 3,760 13,706 2,541 193 901 2,892 29,486
(iv) Segmental statement of financial position as at 31 December 2009
(i) Segmental income statement – products and services for the year ended 31 December 2010
Net written premiums 24,712 9,699 — — 34,411 Net change in provision for unearned premiums — (75) — — (75)
Net earned premiums 24,712 9,624 — — 34,336 Fee and commission income 644 115 561 462 1,782 25,356 9,739 561 462 36,118 Net investment income 19,673 633 16 1,671 21,993 Inter-segment revenue — — 231 — 231 Share of profit/(loss) of joint ventures and associates 172 — (5) (36) 131 Profit on the disposal of subsidiaries and associates 130 1 — 28 159
Claims and benefits paid, net of recoveries from reinsurers (22,366) (6,786) — — (29,152) Change in insurance liabilities, net of reinsurance (7,611) 434 — — (7,177) Change in investment contract provisions (8,741) — — — (8,741) Change in unallocated divisible surplus 329 — — — 329 Amortisation of acquired value of in-force business (174) — — — (174) Depreciation and other amortisation expense (189) (35) (13) (64) (301) Other operating expenses (3,084) (3,182) (583) (1,873) (8,722) Impairment losses (164) (3) — (40) (207) Inter-segment expenses (221) (8) — (2) (231) Finance costs (262) (64) (43) (1,053) (1,422)
Net written premiums 22,921 9,193 — — 32,114 Net change in provision for unearned premiums — 559 — — 559
Profit/(loss) before tax 2,421 959 108 (1,466) 2,022 Tax attributable to policyholder returns (217) — — — (217)
Goodwill 1,615 459 28 1,289 3,391 Acquired value of in-force business and intangible assets 2,328 356 59 63 2,806 Interests in, and loans to, joint ventures and associates 2,630 6 — 1 2,637 Property and equipment 472 47 18 213 750 Investment property 12,490 146 — 428 13,064 Loans 28,596 664 — 13,814 43,074 Financial investments 237,659 11,481 82 4,066 253,288 Deferred acquisition costs 4,261 1,141 14 — 5,416 Other assets 34,678 7,517 1,627 1,859 45,681
Goodwill 1,616 462 2 1,301 3,381 Acquired value of in-force business and intangible assets 2,396 382 12 70 2,860 Interests in, and loans to, joint ventures and associates 2,851 5 44 82 2,982 Property and equipment 397 48 12 296 753 Investment property 11,138 191 — 1,093 12,422 Loans 26,915 769 5 13,390 41,079 Financial investments 220,660 11,548 65 6,406 238,679 Deferred acquisition costs 4,069 1,227 20 — 5,316 Other assets 38,469 7,014 523 913 46,919
Fee and commission income Fee income from investment contract business 441 456 Fund management fee income 567 536 Other fee income 498 473 Reinsurance commissions receivable 127 180 Other commission income 147 138 Net change in deferred revenue 2 6
Aviva plc Annual Report and Accounts 2010 6 – Details of expenses This note gives further detail on the items appearing in the second section of the consolidated income statement.
Claims and benefits paid, net of recoveries from reinsurers 29,152 27,549
Change in investment contract provisions Investment income allocated to investment contracts 3,907 5,136 Other changes in provisions Participating investment contracts (note 40) 4,825 5,764 Non-participating investment contracts 2 (5,425) Change in reinsurance asset for investment contract provisions 7 5,710
Fee and commission expense Acquisition costs Commission expenses for insurance and participating investment contracts 3,010 2,953 Change in deferred acquisition costs for insurance and participating investment contracts (573) (536) Deferrable costs for non-participating investment contracts 141 112 Other acquisition costs 1,276 1,137 Change in deferred acquisition costs for non-participating investment contracts (29) (31) Investment income attributable to unitholders 1,586 331 Reinsurance commissions and other fee and commission expense 456 430
Other expenses Other operating expenses Staff costs (note 10) 1,677 1,845 Central costs and sharesave schemes 144 108 Depreciation (note 20) 77 115 Impairment losses on property and equipment (note 20) 3 2 Impairment of goodwill on subsidiaries and other amounts expensed (note 16a) 3 30 Amortisation of acquired value of in-force business on insurance contracts (note 17) 174 249 Amortisation of intangible assets (note 17) 197 142 Impairment of acquired value of in-force business (note 17) — 13 Impairment of intangible assets (note 17) 21 12 Integration and restructuring costs (see below) 243 286 Exceptional items (see below) (220) 776 Other expenses 1,102 1,113
Impairments Net impairment on loans 22 53 Net impairment on financial investments 179 538 Net impairment on receivables and other financial assets 1 2 Net impairment on non-financial assets 2 (1)
Certain prior year disclosures in note 6 have been amended to conform to current year presentation
Aviva plc Annual Report and Accounts 2010 6 – Details of expenses continued Integration and restructuring costs Integration and restructuring costs were £243 million (2009: £286 million). This includes expenditure relating to restructuring exercises across the group of £123 million, including UK restructuring costs of £53 million, £18 million in Delta Lloyd, £20 million in North America and £30 million in Aviva Investors. Expenditure relating to the Quantum Leap project in Europe amounted to £40 million and costs associated with preparing the businesses for Solvency II implementation amounted to £59 million. Costs incurred in 2009 mainly related to expenditure on cost saving programmes in the UK and Europe.
Exceptional items Exceptional items totalled £273 million net expense (2009: £45 million net income) in the year.
For the year ended 31 December 2009, this comprised: A net exceptional profit before tax of £207 million as a result of the reattribution of the inherited estate (see note 45), of which £674 million was included in ‘other expenses’ and £881 million credit was included in changes in ‘unallocated divisible surplus’; A £60 million expense for the strengthening of reserves in respect of several specific discontinued commercial liability risks written in Canada a significant number of years ago, which was included in ‘change in insurance liabilities’; and
The table below sets out the lines of the income statement in which the exceptional items have been included: £m
Change in unallocated divisible surplus (note 44) — 881 Change in insurance liabilities, net of reinsurance (note 39) (493) (60) Other expenses (as in the table above) 220 (776)
Interest expense on operational borrowings Amounts owed to credit institutions 123 113 Securitised mortgage loan notes At amortised cost 67 77 At fair value 140 185 207 262
Interest on banking customer deposits 394 390 Interest on reinsurance deposits 8 12 Interest on collateral received 20 47 Net finance charge on pension schemes (notes 2a & 48e(iv)) 195 183 Other similar charges 152 177
Aviva plc Annual Report and Accounts 2010 8 – Long-term business economic volatility The long-term nature of much of the Group’s operations means that, for management’s decision-making and internal performance management, the effects of short-term economic volatility are treated as non-operating items. The Group focuses instead on an operating profit measure that incorporates an expected return on investments supporting its long-term business. This note explains the methodology behind this.
(a) Definitions Operating profit for long-term business is based on expected investment returns on financial investments backing shareholder and policyholder funds over the reporting period, with consistent allowance for the corresponding expected movements in liabilities. Operating profit includes the effect of variance in experience for non-economic items, such as mortality, persistency and expenses, and the effect of changes in non-economic assumptions, where not treated as exceptional. In 2010, the strengthening of annuitant longevity assumptions in the Netherlands is treated as an exceptional item outside operating profit. Changes due to economic items, such as market value movements and interest rate changes, which give rise to variances between actual and expected investment returns, and the impact of changes in economic assumptions on liabilities, are disclosed separately outside operating profit.
Investment variances of £791 million include £1,010 million relating to Delta Lloyd. Of this, around £800 million is due to differing movements in asset and liability yield curves while the remainder primarily relates to gains on interest rate derivatives. Liabilities in Delta Lloyd are discounted using a yield curve based on a fully collateralised AAA bond portfolio. The discount rate increased in 2010 as an increase of around 80bps in credit spreads on collateralised bonds was only partly offset by lower risk-free yields. As a result, whilst lower interest rates increased the market value of assets, this has not been offset by a corresponding movement in liabilities. The AAA collateralised bond spread movement in the year reflected the perceived risk regarding the curve’s components which include bonds issued by Spanish savings banks and a range of other European organisations. If spreads were to reduce, this would increase the insurance liabilities which may not be offset by a corresponding increase in asset values. This was partly offset by negative economic variances of £154 million in Aviva Europe, primarily from the impact of increased bond yields and credit spreads on assets in Ireland, Italy and Spain. The additional provisions for credit defaults on corporate bonds and commercial mortgages in the UK that were established in 2008 remain at consistent levels.
(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 £m
Short-term fluctuation in investment return (see (b) below) (243) 95 Economic assumption changes (see (g) below) (61) 57
(b) The longer-term investment return and short-term fluctuation are as follows: Non-long-term business £m
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 2009 and 2010.
Actual return attributable to shareholders 4,758 5,547 Longer-term return credited to operating results (5,760) (5,789)
(g) The economic assumption changes mainly arise from movements in the rate used to discount latent claims. As explained in accounting policy K, provisions for latent claims are discounted, using rates 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 disclosed in note 39(c).
United Kingdom operations 20,762 21,663 21,166 24,068 Aviva Europe 9,797 9,741 9,506 9,755 Delta Lloyd 5,722 6,297 6,009 6,486 North America 5,212 5,247 5,296 5,498 Asia Pacific 1,738 1,599 1,593 1,595 Aviva Investors 1,386 1,311 1,267 1,313 Corporate centre 525 469 504 467
Acquisition costs 620 491 Claims handling expenses 234 270 Central costs and sharesave schemes (6) 53 Other operating expenses 1,677 1,845 Exceptional items (286) —
11 – Directors Information concerning individual directors’ emoluments, interests and transactions is given in the Directors’ Remuneration Report on pages 115 to 136 in the ‘Corporate governance’ section of this report. For the purposes of the disclosure required by Schedule 5 to the Companies Act 2006, the total aggregate emoluments of the directors in respect of 2010 was £6.8 million (2009: £6.7 million). Employer contributions to pensions for executive directors for qualifying periods were £136,400 (2009: £123,000). This is only for one ED as the others in the qualifying periods were not receiving any pension contributions by Aviva. The aggregate net value of share awards granted to the directors in the period was £9.510 million (2009: £5.256 million). The net value has been calculated by reference to the market price at the date of grant. During the year, no share options were exercised by directors (2009: nil).