Acquisition costs 592 597 Claims handling expenses 318 253 Central costs and sharesave schemes 109 76 Other operating expenses 1,523 1,599 11 – Directors Information concerning individual directors’ emoluments, interests and transactions is given in the Directors’ remuneration report.
The total remuneration payable by the Group, excluding VAT and any overseas equivalent thereof, to its principal auditors, Ernst & Young LLP, and its associates in respect of the audit of these financial statements is shown below, together with fees payable in respect of other work.
Fees payable to Ernst & Young LLP for the statutory audit of the Aviva Group and Company financial statements 1,364 1,452
– Other supplementary services 4,749 1,660 Fees payable to Ernst & Young LLP for services to Group pension schemes
Fees for supplementary reporting are in respect of the audit of the Group’s EEV figures. Although EEV is the Group’s primary management reporting basis and our disclosures require a full audit, the relevant fees are not classified as being for statutory audit.
Financial statements 13 – Tax This note analyses the tax charge for the year and explains the factors that affect it.
(iii) The tax charge can be analysed as follows: £m £m
Long-term business technical provisions and other insurance items 315 364 Deferred acquisition costs 34 (47) Unrealised gains on investments (793) (144) Pensions and other post-retirement obligations 40 166 Unused losses and tax credits (272) (247) Subsidiaries, associates and joint ventures (33) 135 Intangibles and additional value of in-force long-term business (75) (73) Provisions and other temporary differences 342 45
In respect of pensions and other post-retirement obligations 269 (29) In respect of unrealised (gains)/losses on investments (71) 43
Tax calculated at standard UK corporation tax rate of 30% (2006: 30%) 557 997 Different basis of tax for UK life insurance 5 209 Adjustment to tax charge in respect of prior years (49) (287) Non-assessable dividends (124) (55) Non-taxable profit on sale of subsidiaries and associates (18) (80) Disallowable expenses 7 46 Different local basis of tax on overseas profits 56 201 Reduction in future UK tax rate (net of movements in unallocated divisible surplus) (64) – Deferred tax valuation difference 1 (60)
Coupon payments in respect of direct capital instruments (net of tax) (37) – (37) (37) – (37)
(ii) Basic earnings per share is calculated as follows: Net of tax, Net of tax, minorities, minorities, preference preference dividends dividends Restated
(i) Diluted earnings per share is calculated as follows: Weighted Weighted average average number number
Operating profit attributable to ordinary shareholders 1,376 2,588 53.2 1,731 2,469 70.1 Dilutive effect of share awards and options – 24 (0.5) – 27 (0.7)
Ordinary dividends declared and charged to equity in the year Final 2006 – 19.18 pence per share, paid on 18 May 2007 (Final 2005 – 17.44 pence per share,
Subsequent to 31 December 2007, the directors proposed a final dividend for 2007 of 21.10 pence per ordinary share (2006:19.18 pence), amounting to £553 million (2006: £492 million) in total. Subject to approval by shareholders at the AGM, the dividend will be paid on 16 May 2008 and will be accounted for as an appropriation of retained earnings in the year ending 31 December 2008.
Irish shareholders who are due to be paid a dividend denominated in euros will receive a payment at the exchange rate prevailing on 27 February 2008.
Movements in contingent consideration relate to contingent consideration paid/received in respect of past acquisitions of subsidiaries. Goodwill arising on acquisitions completed before 1 January 1998 was charged directly to reserves. Goodwill arising on the Group’s acquisition of joint ventures and associates is included within the carrying value of those investments (see notes 18 and 19).
(b) Goodwill allocation and impairment testing A summary of the goodwill and intangibles with indefinite useful lives allocated to cash-generating units is presented below.
Carrying amount of goodwill (detailed in note 17) Total £m £m £m £m £m £m
General insurance and health (see (i) below) 316 314 185 185 501 499 RAC non-insurance operations (see (ii) below) 892 892 36 36 928 928
Europe France (long-term business) (see (iii) below) – – 45 42 45 42 Ireland
Italy Long-term business (see (vi) below) 46 11 254 – 300 11 General insurance and health (see (vi) below) 42 22 132 – 174 22
North America United States (long-term business) (see (ix) below) 624 635 – – 624 635
Goodwill and intangibles with indefinite useful lives have been tested for impairment in these businesses as follows:
– Some of the assumptions that underline the budgeted operating profit include market share, premium rate changes, claims inflation and commission rates.
The EEV of the French long term business was significantly greater than its carrying value, including indefinite life intangible assets. A reasonably possible change in a key assumption will not cause the carrying value of the cash generating unit to exceed its recoverable amount. Key assumptions used for the calculation were: – Embedded value represents the shareholder interest in the life business and is calculated in accordance with the European Embedded Value (EEV) principles. The embedded value is the total of the net worth of the life business and the value of the in-force business. The underlying methodology and assumptions have been reviewed by the Group’s auditors.
Notes to the consolidated financial statements continued 16 – Goodwill continued Key assumptions used for the calculation were: – Budgeted operating profit represents the operating profit in the business plans, approved by management and as such reflects the best estimate of future profits based on both historical experience and expected growth rates for the Irish economy. Some of the assumptions that underline the budgeted operating profit include market share, premium rate changes, claims inflation and commission rates.
(vi) Italy (long-term, general insurance and health) The majority of the goodwill and the intangible asset with an indefinite useful life allocated to the Italian business arises from the acquisitions described in note 3(a), which occurred in the second half of 2007. Since the acquisition dates, the assets and liabilities of the acquired companies have not changed significantly, and there have been no other events that might have materially affected the recoverable amount of the unit.
Key assumptions used for the calculation were: – Growth rate represents the rate applied to extrapolate new business contributions beyond the business plan period, and is based on management's best estimate of future growth. The rate is in line with industry expectations of 2.5%.
– Risk-adjusted discount rate represents the rate used to discount expected profits from future new business. The discount rate is a combination of a risk-free rate and a risk margin to make prudent allowance for the risk that experiences in future years may differ from those assumed. The rate is fixed at 6.7%.
(viii) Spain (long-term business) The recoverable amount of the Spanish unit has been determined based on a fair value less costs to sell calculation. This calculation is an actuarially-determined appraisal value and is based on the embedded value of the business together with the present value of expected profits from future new business. The recoverable amount significantly exceeds the carrying value of the cash generating unit including goodwill and a reasonably possible change in a key assumption will not cause the carrying value of the cash generating unit to exceed its recoverable amount.
– Risk adjusted discount rate represents the rate used to discount expected profits from future new business. The discount rate is a combination of a risk-free rate and a risk margin to make prudent allowance for the risk that experience in future years may differ from that assumed.
(ix) United States (long-term business) The recoverable amount of the United States unit has been determined based on a fair value less costs to sell calculation. This calculation is an actuarially-determined appraisal value and is based on the embedded value of the business together with the present value of expected profits from future new business. The recoverable amount significantly exceeds the carrying value of the cash generating unit including goodwill and a reasonably possible change in a key assumption will not cause the carrying value of the cash generating unit to exceed its recoverable amount.
Impairment losses recognised (28) – 2 – (26) Foreign exchange rate movements 6 – 3 – 9
(ii) the bancassurance distribution agreement with Banco Popolare, signed during the year, described in note 3(a)(iii)(c).
(i) The movements in the carrying amount comprised: Goodwill and Equity intangibles interests Loans Total £m £m £m £m
Share of results before tax – (337) – (337) Share of tax – (2) – (2)
Property management undertakings – 2,124 167 2,291 Long-term business undertakings 197 88 – 285
Goodwill and Equity 2006 intangibles interests Loans Total 2006 £m £m £m £m
The loans are not secured and no guarantees were received in respect thereof. They are interest-bearing and are repayable on termination of the relevant partnership.
(b) Property management undertakings The principal joint ventures are as follows: GP proportion PLP proportion Company held held
(c) Long-term business undertakings The principal joint ventures are as follows: Country of Proportion incorporation
All investments in the above companies are unlisted. The shares in the Chinese company are held by the Company but all the other investments are held by subsidiaries.
Details of these investments are as follows: (i) China The Group has a 50% holding in AVIVA-COFCO Life Insurance Company Limited, a life assurance company incorporated and operating in China. These shares are held by the Company, with a share of net assets of £44 million (2006: £18 million) and a fair value of £52 million (2006: £35 million).
(ii) Turkey On 31 October 2007, the Group entered into a joint venture agreement with Aksigorta AS, (“Aksigorta”), the insurance company of the Sabanci Holding Group, to form a new Turkish life and pensions joint venture. Under the terms of the agreement, the Group’s Turkish life and pensions business, Aviva Hayat ve Emeklilik A.S,. (“Aviva HE”) merged with Ak Emeklilik A.S,. (“Ak E”), Aksigorta’s life and pensions business. The joint venture entered into an exclusive long-term bancassurance agreement with Akbank TAS,, Turkey’s second-largest privately-owned bank.
The Group and Sabanci jointly control the joint venture through equal shareholdings of 49.7%, with the remaining 0.6% being held by individual shareholders. The new company, AvivaSA Emeklilik ve Hayat A.S, began trading on 1 November 2007.
Fair value of 49.7% of Ak E’s identifiable net assets 91
Included in the fair value of Ak E's net assets were acquired value of in-force business of £34 million and a distribution contract intangible asset, valued by an independent third party at £49 million, using post-tax cash flows and discount rates. The intangible asset has been assessed as having a life of 15 years and is being amortised over that period. The residual goodwill represents the value of the direct sales force and expected synergies.
Carrying value of 49.7% of Aviva HE’s net assets* 8 Fair value of 49.7% of Ak E’s net assets 91 Goodwill 45
Total carrying value 144 * Calculated as 49.7% of the total net assets of £17 million given in the table below.
(b) Disposal of shareholding in subsidiary The profit on disposal of 50.3% of Aviva HE was £74 million, calculated as follows: Carrying value of the assets and liabilities at the date of disposal: £m
Net assets disposed of (50.3%) 9 Consideration Fair value of 50.3% of Aviva HE 85 Less transaction costs (2)
(iii) Malaysia On 2 July 2007, the Group entered the Malaysian long-term savings market through a joint venture with the CIMB Group, listed on Malaysia’s stock exchange as Bumiputra-Commerce Holdings Berhad. Under an agreement signed on that date and completed the same day, the Group acquired a 49% interest in two of CIMB Group’s subsidiaries, Commerce Life Assurance Berhad (Commerce Life) and Commerce Takaful Berhad (Commerce Takaful), for a total cash consideration of £72 million, representing the value of our share of net assets and expected contribution from new business. In addition, Commerce Life and Commerce Takaful will enter into exclusive bancassurance agreements with CIMB Group’s subsidiary, CIMB Bank, for the distribution of life and takaful insurance products through the bank’s branches.
(iv) Taiwan On 27 April 2007, the Group signed an agreement with First Financial Holding Co., Ltd (FFHC) to form a joint venture, First-Aviva Life Assurance Co., Ltd (First-Aviva). This gives Aviva access to one of Asia’s most attractive markets and enables us to participate in the island’s pension reform. The Group holds 49% of First-Aviva, whose total capital is £34 million. Regulatory approval of an insurance licence was received on 31 December 2007 and operations commenced on 2 January 2008. First-Aviva will manufacture long-term savings and pension products in Taiwan, and distribute them through an exclusive bancassurance agreement with First Commercial Bank, a subsidiary of FFHC.
Share of profit after tax – 23 – 23 Acquisitions and additions 28 10 – 38
Dividends received – (12) – (12) Foreign exchange rate movements – (4) – (4) Other movements and reclassifications as held for sale – – (9) (9)
Share of results after tax – 47 – 47 Amortisation of acquired value of in-force business – (12) – (12)
Acquisitions in 2007 comprise 49.75% of Banca Network Investimenti SpA (see note 3(a)(iii)) and interests in three investment funds managed by Cyrte Investments BV (see note 3(a)(iv)).
(b) Principal associates The principal associates included above are: Country of Type of Proportion incorporation
(c) Additional information Summarised aggregate financial information on the Group’s interests in its associates is as follows: £m £m
(d) Impairment testing The Group’s investments in RBS Life Investments Limited and RBSG Collective Investments Limited have been tested for impairment by comparing their carrying values (which include goodwill which arose on their acquisition) with their recoverable amounts. The recoverable amounts for both the investments have been determined based on value in use calculations. The calculations use cash flow projections based on business plans approved by management covering a five year period and a risk adjusted discount rate of 81%. Cash flows beyond that five year period have been extrapolated using a growth rate of 4.5%. The recoverable amounts significantly exceed the carrying values of both the investments and a reasonably possible change to the key underlying assumptions will not cause the carrying values of the investments to exceed their recoverable amounts.
Properties Ownerunder occupied Motor Computer Other construction properties vehicles equipment assets Total £m £m £m £m £m £m
Fair value gains (see note 34) – 23 – – – 23 Impairment losses – (2) – – – (2)
Owner-occupied properties are stated at their revalued amounts, as assessed by qualified external valuers or by local qualified staff of the Group in overseas operations, all with recent relevant experience. These values are assessed in accordance with the relevant parts of the current RICS Appraisal and Valuation Standards in the UK, and with current local valuation practices in other countries. This assessment, on the basis of Existing Use Value and in accordance with UK Practice Statement 1.3, is the estimated amount for which a property should exchange on the date of valuation between a willing buyer and a willing seller in an arm’s-length transaction, after proper marketing wherein the parties had acted knowledgeably, prudently and without compulsion, assuming that the buyer is granted vacant possession of all parts of the property required by the business and disregarding potential alternative uses. The valuation assessment adopts market-based evidence and is in line with guidance from the International Valuation Standards Committee and the requirements of IAS 16, Property, Plant and Equipment, for all but specialised-use properties which are valued on a depreciated replacement cost (DRC) basis as permitted by paragraph 33 of IAS 16.
Capitalised expenditure on existing properties 125 48 173 Acquisitions of subsidiaries 35 – 35 Fair value gains 1,227 280 1,507
(a) Carrying amounts The carrying amounts of loans at 31 December 2007 and 2006 were as follows: £m £m
Non-securitised mortgage loans 17,596 15,185 Loans and advances to bank customers 1,307 1,085 Loans to brokers and other intermediaries 80 – Other loans 931 1,083
Of the above loans, £25,666 million (2006: £23,243 million) is expected to be recovered more than one year after the balance sheet date.
The carrying amounts of the above loans are stated at amortised cost with the exception of £5,476 million (2006: £4,941 million) of securitised mortgage loans and £12,849 million (2006: £11,316 million) of non-securitised mortgage loans which are designated as other than trading and measured at fair value. The fair value has been calculated by discounting the future cash flows using appropriate current interest rates for each portfolio of mortgages.
Delta Lloyd companies have purchased notes in the securitisation companies, which have been eliminated on consolidation through offset against the borrowings of the securitisation companies in the consolidated balance sheet.
(iii) General In all of the above transactions, the Company and its subsidiaries are not obliged to support any losses that may be suffered by the noteholders and do not intend to provide such support. Additionally, the notes were issued on the basis that noteholders are only entitled to obtain payment, of both principal and interest, to the extent that the available resources of the respective special purpose securitisation companies, including funds due from customers in respect of the securitised loans, are sufficient and that noteholders have no recourse whatsoever to other companies in the Aviva Group.
Loan notes held by third-parties are as follows: UK Netherlands UK Netherlands £m £m £m £m
24 – Financial investments This note analyses our financial investments by type and shows their cost and fair value. These will change from one period to the next as a result of new business written, claims paid and market movements.
Less assets classified as held for sale – (236) – (236)
Of the above total, £154,732 million (2006: £115,004 million) is expected to be recovered more than one year after the balance sheet date.
Cost/ amortised Unrealised Unrealised cost gains losses Fair value Restated Restated £m £m £m £m
Unit trusts and investment vehicles 26,433 2,642 (63) 29,012 Derivative financial instruments – 1,325 – 1,325 Deposits with credit institutions 381 – – 381 Minority holdings in property management undertakings 542 – – 542
(ii) Stock repurchase arrangements Included within financial investments are £358 million (2006: £722 million) of debt securities and other fixed income securities which have been sold under stock repurchase arrangements. The obligations arising under these arrangements are shown in note 48.
(iii) Other arrangements Certain financial investments are specifically deposited under local laws in various overseas countries as security for the holders of policies issued in those countries.
25 – Receivables and other financial assets This note analyses our total receivables.
Expected to be recovered in less than one year 8,271 7,757 Expected to be recovered in more than one year 358 430
Deferred acquisition costs in respect of: Insurance contracts – Long-term business 1,473 848 Insurance contracts – General insurance and health business 1,583 1,422 Participating investment contracts 112 364 Non-participating investment contracts 1,126 566 Retail fund management business 27 22
Carrying amount at 1 January 3,222 3,175 Acquisition costs deferred during the year 3,780 3,248
(c) Other assets Other assets include £66 million (2006: £2 million) that is expected to be recovered more than one year after the balance sheet date.
(d) Prepayments and accrued income Prepayments and accrued income include £111 million (2006: £62 million) that is expected to be recovered more than one year after the balance sheet date.
27 – Assets held to cover linked liabilities Certain unit-linked products have been classified as investment contracts, while some are included within the definition of an insurance contract. The assets backing these unit-linked liabilities are included within the relevant balances in the consolidated balance sheet, while the liabilities are included within insurance and investment contract provisions. This note analyses the carrying values of assets backing these liabilities.
Debt securities 15,065 15,308 Equity securities 27,743 25,839 Other investments 33,171 26,712 Reinsurance assets 1,905 1,136 Cash and cash equivalents 3,939 3,648
28 – Ordinary share capital This note gives details of Aviva plc’s ordinary share capital and shows the movements during the year.
Shares in lieu of the 2006 final and 2007 interim dividends were issued on 17 May and 16 November 2007 respectively. The issue of shares in lieu of cash dividends is considered a bonus issue under the terms of the Companies Act 1985 and the nominal value of the shares is charged to the share premium account.
29 – Equity compensation plans This note describes the various equity compensation plans we use, and shows how we value the options and awards of shares in the Company.
(ii) Executive share options These are options granted on various dates from 1998 to 2004, under the Aviva Executive Share Option Scheme or predecessor schemes. Options granted between 1998 and 2000 were subject to the satisfaction of conditions relating to either the Company’s return on equity shareholders’ funds (ROE) or its relative total shareholder return (TSR) against a chosen comparator group. In respect of options granted from 2000 the performance condition has been a mixture of both ROE and TSR measures. In all cases, performance is measured over a three year performance period and the options are normally exercisable between the third and tenth anniversary of their grant.
(i) Share options At 31 December 2007, options to subscribe for ordinary shares of 25 pence each in the Company were outstanding as follows: Aviva Savings Related Option price Number Option price Number Share Option Scheme p of shares Normally exercisable p of shares Normally exercisable
Hibernian Savings Related Option price Number Option price Number Share Option Scheme (in euros) c of shares Normally exercisable c of shares Normally exercisable
RAC Savings Related Option price Number Option price Number Share Option Scheme p of shares Normally exercisable p of shares Normally exercisable
Aviva Executive Share Option Scheme Option price Number (Delta Lloyd) p of shares Normally exercisable
The comparative figures as at 31 December 2006 were: Weighted average Weighted remaining average
The vesting of awards under the Aviva Long-Term Incentive Plan 2005 is subject to the attainment of performance conditions as described in the Directors’ remuneration report. Shares which do not vest, lapse.
Since March 2003, it has generally been the Company’s practice to satisfy the awards granted after that date by the issue of new shares at the time of vesting, and no shares were purchased by the trusts. However, during 2007, shares have been purchased by the trustee to allow awards to be satsified from trust where necessary to comply with local regulations. Further details are given in note 30.
(i) Share options The fair value of the options was estimated on the date of grant, based on the following weighted average assumptions: Weighted average assumption 2007 2006
The expected volatility used was based on the historical volatility of the share price over a period equivalent to the expected life of the options prior to its date of grant.
1,496,069 options granted after 7 November 2002 were exercised during the year (2006: nil).
Share price 778.5p 814p Expected volatility* 18.35% 23% Expected volatility of comparator companies’ share price* 19% 22% Correlation between Aviva and competitors’ share price* 53% 50% Expected life 2.20 years 3.0 years Expected dividend yield 3.83% 3.60% Risk-free interest rate* 5.36% 4.50% * For awards with market-based performance conditions.
These shares were purchased in the market and are carried at cost less amounts changed to the income statement in prior years. At 31 December 2007, they had an aggregrate nominal value of £380,266 (2006: £170,550) and a market value of £10 million (2006: £6 million). The trustees have waived their rights to dividends on the shares held in the trusts.
32 – Direct capital instrument This note gives details of the direct capital instrument issued in November 2004.
Balance at 31 December 3,271 3,271 34 – Other reserves This note gives details of the various reserves forming part of the Group’s consolidated equity, and shows the movements during the year.
Arising in the year: Fair value gains – 26 347 – – 373 Fair value gains transferred to profit on disposals – – (162) – – (162) Fair value gains transferred to retained earnings on disposals (note 35) – (9) – – – (9) Impairment losses on revalued assets – (2) – – – (2) Reserves credit for equity compensation plans
Foreign exchange rate movements (386) – – 59 – (327) Aggregate tax effect – shareholders’ tax – – (50) – – (50)
Arising in the year: Fair value gains – 23 149 – – 172 Fair value gains transferred to profit on disposals – – (391) – – (391) Transfer to profit on disposal of subsidiary
Fair value gains transferred to retained earnings on disposals (note 35) – (25) – – – (25) Share of fair value changes in joint ventures and associates taken to equity (note 18a) – – 9 – – 9 Reserves credit for equity compensation plans
35 – Retained earnings This note analyses the movements in the consolidated retained earnings during the year.
Balance at 1 January 5,082 2,597 Profit for the year attributable to equity shareholders 1,327 2,215 Actuarial gains/(losses) on pension schemes (note 46e (iv) 648 (117) Actuarial (gains)/losses on pension schemes transferred to unallocated divisible surplus and other movements (61) 3 Dividends and appropriations (note 15) (871) (762) Shares issued in lieu of dividends 301 203 Shares issued under equity compensation plans (note 34) 34 18 Transfer from merger reserve on realisation (note 33) – 871 Fair value gains realised from reserves (note 34) 25 9 Aggregate tax effect (252) 45
The shares issued in lieu of dividends are in respect of the transfer to retained earnings from the ordinary dividend account, arising from the treatment of shares issued in lieu of the 2006 final and 2007 interim dividends, as explained in note 28(b).
37 – Contract liabilities and associated reinsurance The following notes explain how we calculate our liabilities to our policyholders for insurance and investment products we have sold to them. Notes 38 and 39 cover these liabilities and note 40 details the financial guarantees and options given for some of these products. Note 41 details the reinsurance recoverables on these liabilities whilst note 42 shows the effects of the assumptions we have changed during the year.
Provisions for claims incurred but not reported (2,300) 84 (2,216) (2,553) 79 (2,474)
Provision for unearned premiums – 5,484 5,484 – 5,182 5,182 Provision arising from liability adequacy tests – 24 24 – 49 49
Less: Obligations to staff pension schemes transferred to provisions (note 45a) (1,025) – (1,025) (1,086) – (1,086)
Less amounts classified as held for sale – (627) (627) – – –
– In the United States, there are two main business segments – protection products and accumulation products. Protection products include interest-sensitive whole life, term life, universal life and indexed life insurance policies. The accumulation product segment includes traditional fixed and indexed deferred annuities for individuals and funding agreements for business customers. In addition, there are two closed blocks of participating contracts arising from demutualisations of subsidiary companies. All products are classified as insurance contracts except for the funding agreements and term certain immediate annuities, which are classified as nonparticipating investment contracts.
The gross premium method uses the amount of contractual premiums payable and includes explicit assumptions for interest and discount rates, mortality and morbidity, persistency and future expenses. These assumptions can vary by contract type and reflect current and expected future experience. Explicit provision is made for vested bonuses and explicit allowance is also made for future regular bonuses, but not terminal bonuses.
(a) UK With-profit business the valuation of with-profit business uses the methodology developed for the Realistic Balance Sheet, adjusted to remove the shareholders’ share of future bonuses. The key elements of the Realistic Balance Sheet methodology are the with-profit benefit reserve (WPBR) and the present value of the expected cost of any payments in excess of the WPBR (referred to as the cost of future policy-related liabilities). The realistic liability for any contract is equal to the sum of the WPBR and the cost of future policy-related liabilities. The WPBR for an individual contract is generally calculated on a retrospective basis, and represents the accumulation of the premiums paid on the contract, allowing for investment return, taxation, expenses and any other charges levied on the contract.
Volatility of investment return Volatility assumptions are set with reference to implied volatility data on traded market instrument, where available. Specimen values based on the average term of the liabilities are as follows: Volatility
At the end of 2006 changes were made to the assumptions for certain non-profit business, resulting from a decision taken by management to adopt changes permitted by the FSA Policy Statement 06/14, Prudential Changes for Insurers, issued in December 2006. In 2007 these changes were applied to healthcare business in addition to the business affected at the end of 2006.
Assurances Life conventional non-profit 3.1% to 3.9% 3.1% to 3.9% Pensions conventional non-profit 3.9% to 4.1% 3.9% to 4.1%
Mortality assumptions are set with regard to recent company experience and general industry trends. Since 2006, the assurance mortality basis has been reviewed with the aim of harmonising assumptions wherever possible across similar lines of business in order to simplify the basis. The base mortality tables used in the valuation remain unchanged however, as summarised below: Mortality tables used
General annuity business after vesting ML00/IFL00 adjusted IML00/IFL00 adjusted plus allowance for future plus allowance for future mortality improvement mortality improvement
Pensions business after vesting PCMA00/PCFA00 adjusted PCMA00/PCFA00 adjusted plus allowance for future plus allowance for future mortality improvement mortality improvement
Annuities in payment General annuity business ML00/IFL00 adjusted IML00/IFL00 adjusted plus allowance for future plus allowance for future mortality improvement mortality improvement
(b) France The majority of provisions arise from a single premium savings product and are based on the accumulated fund value, adjusted to maintain consistency with the value of the assets backing the policyholder liabilities. The net premium method is used for prospective valuations, in accordance with local regulation, where the valuation assumptions depend on the date of issue of the contract. The valuation discount rate also depends on the original duration of the contract and mortality rates are based on industry tables.
(c) Netherlands On transition to IFRS, the valuation of most long-term insurance and participating investment contracts was changed from existing methods that generally used historic assumptions to an active basis using current market interest rates. A liability adequacy test is performed in line with IFRS requirements. Where liabilities are based on current market interest rates and assets are valued at market value, the margin in the liability adequacy test is determined by comparison of the liabilities with the present value of best estimate cash flows.
Coll 1993/2003 and DIL 98, plus further allowance for future mortality improvement
The liability for future policy benefits for traditional life insurance is computed using the net level method, based on guaranteed interest and mortality rates as used in calculating cash surrender values. Reserve interest assumptions ranged from 2.00% to 7.50% in 2007 (2006: 2.00% to 7.50%). The weighted average interest rate for all traditional life policy reserves in 2007 was 4.46% (2006: 4.48%).
Future policy benefit reserves for universal life insurance, indexed life, deferred annuity products and funding agreements are computed under a retrospective deposit method and represent policy account balances before applicable surrender charges. The weighted average interest crediting rates for universal life products were 5.45% in 2007 (2006: 4.37%). The range of interest crediting rates for deferred annuity products, excluding sales inducement payouts, was 2.50% to 7.00% in 2007 (2006: 2.75% to 7.00%). An additional liability is established for universal life contracts with death or other insurance benefit features, which is determined using an equally-weighted range of scenarios with respect to investment returns, policyholder lapses, benefit election rates, premium payout patterns and mortality. The additional liability represents the present value of future expected benefits based on current product assumptions.
The indexed life and annuity products guarantee the return of principal to the customer, and credit interest based on certain indices. A portion of the premium from each customer is invested in fixed income securities and is intended to cover the minimum guaranteed value. A further portion of the premium is used to purchase call options to hedge the growth in interest credited to the customer as a direct result of increases in the related indices. Both the call options and the options embedded in the policy are valued at their fair value.
(e) Other countries In all other countries, local generally-accepted interest rates and published standard mortality tables are used for different categories of business as appropriate. The tables are based on relevant experience and show mortality rates, by age, for specific groupings of people.
UK Reinsured London Market business 5.00% 5.00% 8 years 8 years
Movements The following changes have occurred in the general insurance and health claims provisions during the year: Carrying amount at 1 January 12,718 12,965 Impact of changes in assumptions 1 2 Claim losses and expenses incurred in the current year 8,273 7,639 Decrease in estimated claim losses and expenses incurred in prior years (937) (550)
Incurred claims losses and expenses 7,337 7,091 Less: Payments made on claims incurred in the current year (4,408) (3,765) Payments made on claims incurred in prior years (3,686) (3,771) Recoveries on claim payments 315 304
Changes in claims reserve recognised as an expense (406) (148) Effect of portfolio transfers, acquisitions and disposals 175 207 Foreign exchange rate movements 655 (306)
(i) Description of tables The tables that follow present the development of claim payments and the estimated ultimate cost of claims for the accident years 2001 to 2007. The upper half of the tables shows the cumulative amounts paid during successive years related to each accident year. For example, with respect to the accident year 2002, by the end of 2007 £5,618 million had actually been paid in settlement of claims. In addition, as reflected in the lower section of the table, the original estimated ultimate cost of claims of £6,250 million was re-estimated to be £6,122 million at 31 December 2007. This decrease from the original estimate is due to the combination of a number of factors. The original estimates will be increased or decreased, as more information becomes known about the individual claims and overall claim frequency and severity.
In 2005, the year of adoption of IFRS, only five years were required to be disclosed. This is being increased in each succeeding additional year, until ten years of information is included.
The Group aims to maintain strong reserves in respect of its non-life and health business in order to protect against adverse future claims experience and development. As claims develop and the ultimate cost of claims become more certain, the absence of adverse claims experience will then result in a release of reserves from earlier accident years, as shown in the loss development tables. However, in order to maintain reserve adequacy, the Group transfers releases to current accident year (2007) reserves where the development of claims is less mature and there is much greater uncertainty attaching to the ultimate cost of claims. The release from prior accident year reserves during 2007 is also due to an improvement in the estimated ultimate cost of claims.
(ii) Gross figures Before the effect of reinsurance, the loss development table is: Accident year £m £m £m £m £m £m £m £m £m
Four years later 6,754 6,205 5,932 Five years later 6,679 6,122 Six years later 6,630
Estimate of gross ultimate claims 6,630 6,122 5,932 6,178 6,813 7,318 8,530
Four years later (5,648) (5,297) (5,180) Five years later (5,763) (5,424) Six years later (5,841)
Four years later 6,286 5,912 5,851 Five years later 6,219 5,855 Six years later 6,173
Present value recognised in the balance sheet 1,603 344 450 744 955 1,397 1,875 4,056 11,424
Carrying amount at 1 January 5,182 5,381 Premiums written during the year 11,369 11,427 Less: Premiums earned during the year (11,345) (11,516)
(a) Carrying amount The liability for investment contracts at 31 December comprised: £m £m
Most non-participating investment contracts measured at fair value are unit-linked in structure and the fair value liability is equal to the unit reserve plus additional non-unit reserves if required on a fair value basis. For this business, a deferred acquisition cost asset and deferred income reserve liability are recognised in respect of transaction costs and front-end fees respectively, that relate to the provision of investment management services, and which are amortised on a systematic basis over the contract term. The amount of the related deferred acquisition cost asset is shown in note 26 and the deferred income liability is shown in note 49.
(c) Movements in the year The following movements have occurred in the year: (i) Participating investment contracts £m £m
The effect of changes in main assumptions is given in note 42.
40 – Financial guarantees and options continued The material guarantees and options to which this provision relates are: (i) Maturity value guarantees Substantially all of the conventional with-profit business and a significant proportion of unitised with-profit business have minimum maturity values reflecting the sums assured plus declared annual bonus. In addition, the guarantee fund has offered maturity value guarantees on certain unit-linked products.
(b) UK Life non-profit business The Group’s UK non-profit funds are evaluated by reference to statutory reserving rules, including changes introduced in 2006 under FSA Policy Statement 06/14 Prudential Changes for Insurers, as outlined in note 38b(iii)(a).
(i) Guaranteed annuity options Similar options to those written in the with-profit fund have been written in relation to non-profit products. Provision for these guarantees does not materially differ from a provision based on a market-consistent stochastic model, and amounts to £36 million at 31 December 2007 (2006: £39 million).
(i) France Guaranteed surrender value and guaranteed minimum bonuses Aviva France has written a number of contracts with such guarantees. The guaranteed surrender value is the accumulated value of the contract including accrued bonuses. Bonuses are based on accounting income from amortised bond portfolios, where the duration of bond portfolios is set in relation to the expected duration of the policies, plus income and releases from realised gains on equity-type investments. Policy reserves are equal to guaranteed surrender values. Local statutory accounting envisages the establishment of a reserve, “Provision pour Aléas Financiers” (PAF), when accounting income is less than 125% of guaranteed minimum credited returns. No PAF was established at the end of 2007.
The most significant of these contracts is the AFER Eurofund which has total liabilities of £24 billion at 31 December 2007 (2006: £21 billion). The guaranteed bonus on this contract equals 75% of the average of the last two years’ declared bonus rates and was 3.64% for 2007 (2006: 3.30%) compared with an accounting income from the fund of 4.92% (2006: 4.81%).
Guaranteed death and maturity benefits In France, the Group has also sold unit-linked policies where the death and/or maturity benefit is guaranteed to be at least equal to the premiums paid. The reserve held in the Group’s consolidated balance sheet at the end of 2007 for this guarantee is £30 million (2006: £8 million). The reserve is calculated on a prudent basis and is in excess of the economic liability. At the end of 2007, total sums at risk for these contracts were £63 million (2006: £38 million) out of total unitlinked funds of £15 billion (2006: £13 billion). The average age of policyholders was approximately 53. It is estimated that this liability would increase by £17 million (2006: £3 million) if yields were to decrease by 1% per annum and by £7 million (2006: £2 million) if equity markets were to decline by 10% from year end 2007 levels. These figures do not reflect our ability to review the tariff for this option.
Provisions consist of unit values plus an additional reserve for the guarantee. The additional provision for the guarantee was £70 million (2006: £76 million). An additional provision of £19 million (2006: £43 million) in respect of investment return guarantees on group segregated fund business is held. It is estimated that the provision would increase by £211 million (2006: £163 million) if yields were to reduce by 1% pa and by £21 million (2006: £25 million) if equity markets were to decline by 10% from year end 2007 levels.
“No MVR” guarantees Certain unitised with-profit policies containing “no MVR” guarantees, similar to those in the UK, have been sold in Ireland.
These guarantees are currently “out-of-the-money” by £53 million (2006: £69 million). This has been calculated on a deterministic basis as the excess of the current policy surrender value over the discounted value (excluding terminal bonus) of the guarantees. The value of these guarantees is sensitive to the performance of investments held in the with-profit fund.
Amounts payable under these guarantees are determined by the bonuses declared on these policies. It is estimated that the guarantees would be out-of-the-money by £46 million (2006: £74 million) if yields were to increase by 1% per annum and by £29 million (2006: £31 million) if equity markets were to decline by 10% from year end 2007 levels.
(iv) Spain and Italy Guaranteed investment returns and guaranteed surrender values The Group has also written contracts containing guaranteed investment returns and guaranteed surrender values in both Spain and Italy. Traditional profit-sharing products receive an appropriate share of the investment return, assessed on a book value basis, subject to a guaranteed minimum annual return of up to 6% in Spain and 4% in Italy on existing business, while on new business the maximum guaranteed rate is lower. Liabilities are generally taken as the face value of the contract plus, if required, an explicit provision for guarantees calculated in accordance with local regulations. At 31 December 2007, total liabilities for the Spanish business were £4 billion (2006: £3 billion) with a further reserve of £16 million (2006: £18 million) for guarantees. Total liabilities for the Italian business were £4 billion (2006: £5 billion), with a further provision of £48 million (2006: £46 million) for guarantees. Liabilities are most sensitive to changes in the level of interest rates. It is estimated that provisions for guarantees would need to increase by £66 million (2006: £66 million) in Spain and £14 million (2006: £9 million) in Italy if interest rates fell by 1% from end 2007 values.
Under this sensitivity test, the guarantee provision in Spain is calculated conservatively, assuming a long-term market interest rate of 1.42% and no lapses or premium discontinuances.
(v) United States Indexed and total return strategy products In the United States, the Group writes indexed life and deferred annuity products. These products guarantee the return of principal to the policyholder and credit interest based on certain indices, primarily the Standard & Poor’s 500 Composite Stock Price Index. A portion of each premium is used to purchase call options to hedge the growth in interest credited to the policyholder. The call options held by the Group and the options embedded in the policy are both carried at fair value. At 31 December 2007, the total liabilities for indexed products were £8.4 billion (2006: £5.4 billion). If interest rates were to increase by 1%, the provision for embedded options would decrease by £89 million (2006: £51 million) and, if interest rates were to decrease by 1%, the provision would increase by £86 million (2006: £56 million).
The Group offers an optional lifetime guaranteed income benefit focused on the retirement income segment of the deferred annuity marketplace to help customers manage income during both the accumulation stage and the distribution stage of their financial life. At 31 December 2007, a total of £0.7 billion in indexed deferred annuities have elected this benefit taking steps to guarantee retirement income.
Long-term business Insurance contracts 4,298 4,139 Participating investment contracts 22 – Non-participating investment contracts 1,461 1,395 Outstanding claims provisions 94 67
Of the above total, £2,927 million (2006: £3,848 million) is expected to be recovered more than one year after the balance sheet date.
Reinsurers’ share of incurred claim losses and expenses 201 180 Less: Reinsurance recoveries received on claims
Incurred in current year (75) (30) Incurred in prior years (223) (307)
Carrying amount at 1 January 484 482 Premiums ceded to reinsurers in the year 800 726 Less: Reinsurers’ share of premiums earned during the year (797) (722)
This disclosure only allows for the impact on liabilities and related assets, such as reinsurance, deferred acquisition costs and AVIF, and does not allow for offsetting movements in the value of backing financial assets.
43 – Unallocated divisible surplus An unallocated divisible surplus is established where the nature of policy benefits is such that the division between shareholder reserves and policyholder liabilities is uncertain. This note shows the movements in this surplus during the year.
This note analyses the tax assets and liabilities that appear in the balance sheet, and explains the movements in these balances in the year.
(a) General Current tax assets and liabilities recoverable or payable in more than one year are £223 million and £769 million (2006: £81 million and £842 million) respectively.
Long-term business technical provisions and other insurance items 905 1,247 Deferred acquisition costs (170) (126) Unrealised gains on investments (1,577) (2,379) Pensions and other post-retirement obligations 79 344 Unused losses and tax credits 465 250 Subsidiaries, associates and joint ventures (194) (227) Intangibles and additional value of in-force long-term business (811) (738) Provisions and other temporary differences (636) (249)
The Group has unrecognised tax losses of £1,066 million (2006: £1,746 million) to carry forward against future taxable income of the necessary category in the companies concerned. None of these tax losses will expire in the next 20 years (2006: £26 million within ten years and £26 million within 15-20 years). The remaining losses have no expiry date.
Deficits in the staff pension schemes (note 46(e)(vii)) 205 1,029 Other obligations to staff pension schemes – insurance policies issued by Group companies (note 38a) 1,025 1,086
Charge to income statement 198 168 366 Utilised during the year (300) (101) (401) Acquisition of subsidiaries – 1 1
(i) Defined benefit section of the ASPS The Company works closely with the trustees who are required to consult it on the funding of the scheme and its investment strategy. Following each actuarial valuation, the Company and the trustees agree the level of contributions needed. At 31 March 2006, the date of the last actuarial valuation, this section of the scheme had an excess of obligations over available assets, on a funding basis, of £1,019 million (31 March 2005: excess obligations of £888 million). The Company has agreed with the trustees a funding plan through to March 2014, over which it will aim to eliminate the funding deficit. Funding levels are monitored on an annual basis.
For funding purposes, the scheme’s valuation as at 1 April 2007 is currently being completed, with the obligations calculated using the Projected Unit Method (which is described below).
In 2006, the Group’s UK life business carried out an investigation into the allocation of costs in respect of funding the ASPS, to identify the deficit that arose in respect of accruals prior to the introduction of the current management services agreements (MSAs) and to propose a split between individual product companies based on an allocation of the deficit into pre- and post-MSA amounts. The results of this review were updated during 2006 and agreed by the relevant company boards and accepted by the UK regulator. Consequently, with effect from 1 January 2006, the Company’s UK with-profit product companies are liable for a share, currently 12%, of the additional payments for deficit funding referred to above. This resulted in a transfer of £130 million from the unallocated divisible surplus (UDS) to the income statement in 2006, to reflect the position at the start of that year, and a movement of £61 million in 2007 (2006: £30 million) back to the UDS via the statement of recognised income and expense to reflect actuarial movements in the deficit during the year and therefore a change in the amount recoverable from the with-profit product companies.
(d) Charges to the income statement The total pension costs of the Group’s defined benefit and defined contribution schemes were: £m £m
(e) IAS 19 disclosures Disclosures under IAS 19 for the material defined benefit schemes in the UK, the Netherlands, Canada and Ireland are given below. Where schemes provide both defined benefit and defined contribution pensions, the assets and liabilities shown exclude those relating to defined contribution pensions.
Basis of discount rate AA-rated AA-rated Eurozone AA-rated AA-rated Eurozone corporate bonds corporate bonds corporate bonds corporate bonds * Age-related scale increases plus 3% (2006: 2.4%).
The discount rate and inflation rate are the two assumptions that have the largest impact on the value of the liabilities, with the difference between them being known as the net discount rate. For each country, the discount rate is based on current average yields of high quality debt instruments taking account of the maturities of the defined benefit obligations. A 1% increase in this rate (and therefore the net discount rate) would reduce the liabilities by £1.5 billion.
The mortality tables, average life expectancy and pension duration used at 31 December 2007 for scheme members are as follows: Life expectancy/(pension Life expectancy/(pension duration) at NRA of a male duration) at NRA of a female
Netherlands Coll 2003 Group Annuity Mortality with different age corrections and an 82.8 82.8 87.1 87.1
Recognised in the income statement The total pension expense for these schemes comprises: £m £m
Charged to net operating expenses 188 196 Included in profit on disposal of subsidiaries and associates – (36)
Recognised in the statement of recognised income and expense £m £m
Expected return on scheme assets 614 530 Actual return on these assets (404) (800)
Actuarial losses/(gains) on scheme assets 210 (270) Less: (gains)/losses accounted for elsewhere (see (iii) above) (72) 19
Experience losses/(gains) arising on scheme liabilities 80 (63) Changes in assumptions underlying the present value of the scheme liabilities (902) 430 Loss on acquisitions and scheme transfers 36 1
Actuarial (gains)/losses recognised in the statement of recognised income and expense (648) 117
(v) Experience gains and losses The following disclosures of experience gains and losses will be built up over time to give a five year history. Scheme assets exclude insurance policies with Group companies and income on the assets underlying them.
Difference between the expected and actual return on scheme assets Amount of (gains)/losses 138 (251) (798) (184) Percentage of the scheme assets at the end of the year 1.6% 3.1% 10.9% 3.4%
Experience (gains)/losses on scheme liabilities (excluding changes in assumptions) Amount of (gains)/losses 80 (63) 86 (12) Percentage of the present value of scheme liabilities 0.8% 0.6% 0.9% 0.2%
(vi) Risk management and asset allocation strategy As noted above, the long-term investment objectives of the trustees and the employers are to limit the risk of the assets failing to meet the liabilities of the schemes over the long term, and to maximise returns consistent with an acceptable level of risk so as to control the long-term costs of these schemes. To meet these objectives, each scheme’s assets are invested in a diversified portfolio, consisting primarily of equity and debt securities. These reflect the current long-term asset allocation ranges chosen, having regard to the structure of liabilities within the schemes.
Main UK scheme Both the Group and the trustees regularly review the asset/liability management of the main UK scheme. It is fully understood that, whilst the current asset mix is designed to produce appropriate long-term returns, this introduces a material risk of volatility in the scheme’s surplus or deficit of assets compared with its liabilities.
Interest rate risk – falling interest rates leading to an increase in liabilities significantly exceeding the increase in the value of assets.
(vii) Balance sheet recognition The assets and liabilities of the schemes, attributable to defined benefit members, including investments in Group insurance policies (see footnote below), at 31 December 2007 were: UK Netherlands Canada Ireland Total £m £m £m £m £m £m £m £m £m £m
Total fair value of assets 8,103 7,627 1,028 934 231 206 477 456 9,839 9,223
The surplus in the Irish schemes of £27 million (2006: £56 million) is included in Other assets (note 26), whilst the deficits in the other schemes of £205 million (2006: £1,029 million) are included in provisions (note 45).
Plan assets in the table above include investments in Group-managed funds in the consolidated balance sheet of £150 million (2006: £336 million) in the UK scheme, and insurance policies of £143 million and £1,025 million (2006: £152 million and £934 million) in the UK and Dutch schemes respectively. Where the investment and insurance policies are in segregated funds with specific asset allocations, they are included in the appropriate line in the table above, otherwise they appear in “Other”. Since 1 January 2007, the UK insurance policies have been considered transferable under the terms of IAS 19. However, the Dutch insurance policies are considered non-transferable under the terms of IAS 19 and so have been treated as other obligations to staff pension schemes within provisions (see note 45).
Present value of scheme liabilities (8,229) (8,601) (1,049) (944) (289) (251) (450) (400) (10,017) (10,196)
Included in other assets (note 26) – – – – – – 27 56 27 56
The present value of unfunded post-retirement benefit obligations included in the totals in both of the tables above is
Current and past service cost (see (iv) above) (4) (169) (173) – (173) Losses on curtailments (see (iv) above) – (15) (15) – (15) Credit/(charge) to investment income (see (iv) above) 614 (515) 99 (49) 50
Deficits in the schemes at 31 December 9,839 (10,017) (178) (1,025) (1,203)
Scheme Scheme scheme insurance pensions assets liabilities deficit policies deficit £m £m £m £m £m
Other actuarial gains/(losses) (see (iv) above) 270 (267) 3 (119) (116) Buy-outs and other transfers 2 16 18 (2) 16 Exchange rate movements on foreign plans (53) 60 7 17 24
Net deficits in the schemes at 31 December 9,223 (10,196) (973) (1,086) (2,059)
The change in the pension schemes’ net deficits during 2007 is mainly attributable to favourable changes in assumptions underlying the present value of the schemes’ liabilities, and further deficit contribution payments to the main UK scheme made by the employing companies.
Core structural borrowings, at amortised cost 4,311 4,195 Operational borrowings, at amortised cost 3,347 2,842 Operational borrowings, at fair value 5,011 5,100
Total contractual undiscounted cash flows for core structural borrowings 1,154 842 1,220 1,580 3,326 8,122
Where subordinated debt is undated or loan notes are perpetual, the interest payments have not been included beyond 15 years. Annual interest payments for these borrowings are £79 million (2006: £91 million).
Total contractual undiscounted cash flows for operational borrowings 624 1,422 1,727 1,717 16,474 21,964
(i) Subordinated debt A description of each of the subordinated notes is set out in the table below: In the event the Company does not call the notes,
Callable at par at the coupon will reset at Notional amount Issue date Redemption date option of the Company from each applicable reset date to £700 million 14 November 2001 14 November 2036 16 November 2026 5 year Benchmark Gilt + 2.85% 1800 million 14 November 2001 14 November 2021 14 November 2011 3 month Euribor + 2.12% 1650 million 29 September 2003 2 October 2023 2 October 2013 3 month Euribor + 2.08% 1500 million 29 September 2003 Undated 29 September 2015 3 month Euribor + 2.35% £800 million 29 September 2003 Undated 29 September 2022 5 year Benchmark Gilt + 2.40% US$300 million 19 December 2006 19 June 2017 19 June 2012 3 month US LIBOR + 0.84%
Mortgages sold to building societies (see (d) below) – 257 Banking loans 103 109 Other loans 386 171
47 – Borrowings continued (a) As explained in accounting policy C, the UK long-term business policyholder funds have invested in a number of property limited partnerships (PLPs). The PLPs have raised external debt, secured on their respective property portfolios, and the lenders are only entitled to obtain payment of both interest and principal to the extent there are sufficient resources in the respective PLPs. The lenders have no recourse whatsoever to the policyholder or shareholders’ funds of any companies in the Aviva Group. Loans of £485 million (2006: £123 million) included in the table relate to those PLPs which have been consolidated as subsidiaries.
(c) In September 2004, one of the Group’s UK long-term business subsidiaries, Norwich Union Life & Pensions Limited (NULAP), entered into a securitisation arrangement with The Royal Bank of Scotland Group plc (RBSG), to provide funding to cover initial new business acquisition and administration costs. Under the arrangement, an RBSG company provided a loan facility of £200 million to NULAP in respect of selected term assurance policies, secured on future premiums and repayment of commissions due from brokers where a policy has lapsed. The funding was repayable over four years from the date of advance, and interest was charged at a floating rate. RBSG had no recourse to the policyholder or shareholders’ funds of any companies in the Aviva Group. On 12 January 2007, under a Deed of Release and Termination, this arrangement was cancelled.
(e) Movements during the year Movements in borrowings during the year were: Total Core structural Operational 2007 £m £m £m
Borrowings reclassified to other liabilities – (174) (174) Fair value movements – (268) (268) Amortisation of discounts and other non-cash items 2 – 2
All movements in fair value in 2007 and 2006 on securitised mortgage loan notes designated as fair value through profit or loss were attributable to changes in market conditions. These loan notes have external credit ratings which have not changed since the inception of the loans.
(f) Undrawn borrowings The Group has the following undrawn committed central borrowing facilities available to it, of which £1,000 million (2006: £1,000 million) is used to support the commercial paper programme: £m £m
Expiring within one year 500 1,180 Expiring beyond one year 1,575 980 48 – Payables and other financial liabilities This note analyses our financial liabilities at the end of the year.
Payables arising out of direct insurance 1,731 1,389 Payables arising out of reinsurance operations 410 408 Deposits received from reinsurers 1,294 1,244 Bank overdrafts 621 696 Derivative liabilities 606 355 Bank customer accounts 2,460 2,008 Bank deposits received from other banks 1,288 1,013 Amounts due to brokers for investment purchases 901 342 Obligations for repayment of collateral received (notes 24c(i) & 56e) 6,545 2,129 Obligations under stock repurchase arrangements (note 24c(ii)) 358 722 Other financial liabilities 1,918 1,058
Expected to be settled in more than one year 1,963 1,035
Bank overdrafts arise substantially from unpresented cheques and amount to £183 million (2006: £266 million) in long-term business operations and £438 million (2006: £430 million) in general business and other operations.
49 – Other liabilities This note analyses our other liabilities at the end of the year.
Deferred income 339 265 Reinsurers’ share of deferred acquisition costs 233 221 Accruals 1,274 1,138 Other liabilities 2,139 2,610
Expected to be settled within one year 2,914 3,468 Expected to be settled in more than one year 851 766 50 – Contingent liabilities and other risk factors This note sets out the main areas of uncertainty over the calculation of our liabilities.
(d) Pensions mis-selling The pensions review of past sales of personal pension policies which involved transfers, opt outs and non-joiners from occupational schemes, as required by the Financial Services Authority (FSA), has largely been completed. A provision of some £23 million at 31 December 2007 (2006: £31 million) remains to meet the outstanding costs of the very few remaining cases, the anticipated cost of any guarantees provided, and potential levies payable to the Financial Services Compensation Scheme. It continues to be the directors’ view that there will be no material effect either on the Group’s ability to meet the expectations of policyholders or on shareholders.
(e) Endowment reviews In December 1999, the FSA announced the findings of its review of mortgage endowments and expressed concern as to whether, given decreases in expected future investment returns, such policies could be expected to cover full repayment of mortgages. A key conclusion was that, on average, holders of mortgage endowments had enjoyed returns such that they had fared at least as well as they would have done without an endowment. Nevertheless, following the FSA review, all of the Group’s UK mortgage endowment policyholders received policy-specific letters advising them whether their investment was on track to cover their mortgage.
In August 2004, the Group confirmed its intention to introduce time barring on mortgage endowment complaints, under FSA rules. The Group now includes details of its endowment policyholders’ time bar position within the annual re-projection mailings. Customers will be given at least 12 months individual notice before a time bar becomes applicable – double the six months’ notice required by the FSA.
(f) Regulatory compliance The Group’s insurance and investment business is subject to local regulation in each of the countries in which it operates. The FSA regulates the Group’s UK business and in addition monitors the financial resources and organisation of the Group as a whole. The FSA has broad powers including the authority to grant, vary the terms of, or cancel a regulated firm’s authorisation, to investigate marketing and sales practices and to require the maintenance of adequate financial resources. The Group’s regulators outside the UK typically have similar powers but in some cases they operate a system of “prior product approval” and hence place less emphasis than the FSA on regulating sales and marketing practices.
The impact of any such finding (whether in the UK or overseas) could have a negative impact on the Group’s reported results or on its 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 the business of the Group, its results of operations and/or financial condition and divert management’s attention from the dayto -day management of the business.
51 – Commitments This note gives details of our commitments to capital expenditure and under operating leases.
(a) Capital commitments Contractual commitments for acquisitions or capital expenditures of investment property, property and equipment and intangible assets, which have not been recognised in the financial statements, are as follows: £m £m
(i) Future contractual aggregate minimum lease rentals receivable under non-cancellable operating leases are as follows: £m £m
Within 1 year 82 108 Later than 1 year and not later than 5 years 254 386 Later than 5 years 853 873
The total of future minimum sub-lease payments expected to be received under non-cancellable sub-leases 159 200
52 – Cash flow statement This note gives further detail behind the figures in the cash flow statement.
Profit before tax 1,857 3,323 Adjustments for: Share of losses/(profits) of joint ventures and associates 304 (485) Dividends received from joint ventures and associates 32 71 Profit on sales of: Investment property (105) (46) Property and equipment (4) (2) Subsidiaries, joint ventures and associates (49) (222) Investments (5,464) (5,334)
Change in unallocated divisible surplus (2,922) 558 Interest expense on borrowings 1,208 825 Net finance income on pension schemes (99) (77) Foreign currency exchange (gains) (45) (99) Changes in working capital Decrease in reinsurance assets 75 966 (Increase)/decrease in deferred acquisition costs (906) 51 Decrease in insurance liabilities and investment contracts 8,739 9,974 Decrease/ (Increase)in other assets and liabilities 7,395 (4,301)
Net purchases of operating assets Purchases of investment property (1,671) (1,888) Proceeds on sale of investment property 1,368 1,587 Net purchases of financial investments (12,072) (2,361)
Cash consideration for subsidiaries, joint ventures and associates acquired 857 2,321 Less: Cash and cash equivalents acquired with subsidiaries (88) (432)
Cash proceeds from disposal of subsidiaries, joint ventures and associates 295 616 Net cash and cash equivalents divested with subsidiaries (12) –
Cash at bank and in hand 4,004 4,087 Cash equivalents 11,866 9,030
Of the total cash and cash equivalents shown above, £96 million has been classified as held for sale (2006: £nil) (see note 3d).
(a) Capital management objectives Aviva’s capital management philosophy is focused on capital efficiency and effective risk management to support a progressive dividend policy and EPS growth. Rigorous capital allocation is one of the Group’s primary strategic priorities and is ultimately overseen by the Group Executive Committee.
The Group’s overall capital risk appetite is set and managed with reference to the requirements of a range of different stakeholders including shareholders, policyholders, regulators and rating agencies. In managing capital we seek to: – maintain sufficient, but not excessive, financial strength to support new business growth and satisfy the requirements of our stakeholders
– optimise our overall debt to equity structure to enhance our returns to shareholders, subject to our capital risk appetite and balancing the requirements of the range of stakeholders
– retain financial flexibility by maintaining strong liquidity, including significant unutilised committed credit lines and access to a range of capital markets
– allocate capital rigorously across the Group, to drive value adding growth in accordance with risk appetite.
Further detail over the management and allocation of capital resources is set out in the following sections and in note 55 on risk management.
(c) Capital allocation Capital allocation is undertaken based on a rigorous analysis of a range of financial, strategic, risk and capital factors to ensure that capital is allocated efficiently to value adding business opportunities. A clear management decision making framework, incorporating ongoing operational and strategic performance review, periodic longer term strategic and financial planning and robust due diligence over capital allocation is in place, including formal oversight from the Group Executive Committee and Group Capital Management Committee. These processes incorporate various capital profitability metrics, including an assessment of return on capital employed and internal rates of return in relation to hurdle rates to ensure capital is allocated efficiently and that excess business unit capital is repatriated where appropriate.
(d) Different measures of capital In recognition of the requirements of different stakeholders, the Group measures its capital on a number of different bases, all of which are taken into account when managing and allocating capital across the Group. These include measures which comply with the regulatory regimes within which the Group operates and those which the directors consider appropriate for the management of the business. The primary measures which the Group uses are:-
(i) Accounting bases The Group reports its results on both an IFRS and a European Embedded Value basis. The directors consider that the European Embedded Value principles provide a more meaningful measure of the long term underlying value of the capital employed in the Group’s life and related businesses. This basis allows for the impact of uncertainty in the future investment returns more explicitly and is consistent with the way the life business is priced and managed. Accordingly, in addition to IFRS, we analyse and measure the net asset value and total capital employed for the Group on this basis. This is the basis on which Group Return on Equity is measured and against which the corresponding Group target is expressed.
(iv) Economic bases The Group also measures its capital using an economic capital model that takes into account a more realistic set of financial and non-financial assumptions. This model has been developed considerably over the past few years and is increasingly relevant in the internal management and external assessment of the Group’s capital resources. The economic capital model is used to assess the Group’s capital strength in accordance with the Individual Capital Assessment (ICA) requirements established by the FSA. Further developments are planned to meet the emerging requirements of the Solvency II framework and other external agencies. Further details regarding the use of economic capital in risk management are set out in note 55 on “Risk Management”.
(e) Group capital structure The table below sets out the capital that is managed by the Group on an IFRS and EEV basis which, as described above, is considered as a more meaningful measure of the value of capital employed in the life and related businesses. Internally generated AVIF represents the additional value of in-force long term business recognised under the EEV basis. Further detail on the EEV basis is set out in the “Alternative method of reporting long-term business profits” section starting on page 247.
Financed by Equity shareholders’ funds and minority interests 15,402 7,982 23,384 12,874 6,794 19,668
At 31 December 2007 the Group had £29.8 billion (31 December 2006: £26.3 billion) of total capital employed, measured on an EEV basis, in its trading operations which is efficiently financed by a combination of equity shareholders’ funds, preference capital, subordinated debt and borrowings.
In 2007, the total capital employed increased by £3.5 billion reflecting strong operational performance and foreign exchange impacts.
Net internal debt represents the balance of the above amounts due from corporate and holding entities, less the tangible net assets held by these entities.
54 – Capital statement FRS 27 requires us to produce a capital statement which sets out the financial strength of our Group entities and provides an analysis of the disposition and constraints over the availability of capital to meet risks and regulatory requirements. The capital statement also provides a reconciliation of shareholders’ funds to regulatory capital.
Adjustments onto a regulatory basis: Shareholders’ share of accrued bonus (331) (333) (528) (1,192) – (1,192) – (1,192) – (1,192) (730)
Non-participating 1. Other sources of capital include Subordinated debt of £3,054 million issued by Aviva and £176 million of other qualifying capital issued by Dutch, Italian, Spanish and US subsidiary undertakings.
5. Goodwill and other intangibles includes goodwill of £535 million and JVs and associates 6. On 5 February 2008 Norwich Union Life announced a one-off special bonus worth an estimated £2.3 billion. In accordance with FRS 27, a transfer of £2.1 billion has been made from the unallocated divisible surplus to increase insurance and participating investment contract liabilities. £0.2 billion of shareholder’s share of the special bonus is included within the shareholders’ share of the accrued bonus line.
Analysis of movements in capital of long-term businesses For the year ended 31 December 2007
CGNU CULAC NUL&P Total UK life Other Total with-profit with-profit with-profit with-profit UK life UK life Overseas life Total life fund fund fund funds operations operations operations operations £m £m £m £m £m £m £m £m
Available capital resources at 1 January 2,548 2,479 1,823 6,850 1,913 8,763 9,290 18,053
Foreign exchange movements – – – – – – 682 682
The analysis of movements in capital provides an explanation of the movement in available capital of the Group’s life business for the year. This analysis is intended to give an understanding of the underlying causes of the changes in the available capital of the Group’s life business, and provides a distinction between some of the key factors affecting the available capital.
For the UK with-profit funds, the decrease in available capital is driven by a special bonus of £2.3 billion announced on 5 February 2008, which is treated as a transfer from unallocated divisible surplus to policy liabilities. This is shown in the changes in management policy line. Equity performance was moderate, which had a direct effect on the equity content of the estate assets. In addition, the implied market volatility for equities has increased, which raises the assumed asset share volatility and consequently guarantee costs have increased. The positive other movements relate mainly to methodology and modelling changes.
For the Overseas life operations, the negative variance between actual and expected experience is driven mainly by the increase in market interest rates, which has led to capital depreciation of fixed interest assets and consequential reduction of the unallocated divisible surplus in France and other European businesses.
After effecting the year end transfer to shareholders, the UK with-profit funds’ available capital of £4.5 billion (2006: £6.9 billion) can only be used to provide support for UK with-profits business and is not available to cover other shareholder risks. This is comfortably in excess of the required capital margin and, therefore, the shareholders are not required to provide further capital support to this business.
As the total available capital of £16.8 billion is arrived at on the basis of local regulatory guidance, which evaluates assets and liabilities prudently, it understates the economic capital of the business which is considerably higher. This is a limitation of the Group Capital Statement which, to be more meaningful, needs to evaluate available capital on an economic basis and compare it with the risk capital required for each individual operation, after allowing for the considerable diversification benefits that exist in our Group.
The available capital of the Group’s with-profit funds is determined in accordance with the “Realistic balance sheet” regime prescribed by the FSA’s regulations, under which liabilities to policyholders include both declared bonuses and the constructive obligation for future bonuses not yet declared. The available capital resources include an estimate of the value of their respective estates, included as part of the unallocated divisible surplus. The estate represents the surplus in the fund that is in excess of any constructive obligation to policyholders. It represents capital resources of the individual withprofit fund to which it relates and is available to meet regulatory and other solvency requirements of the fund and, in certain circumstances, additional liabilities may arise.
The liabilities included in the balance sheet for the with-profit funds do not include the amount representing the shareholders’ portion of future bonuses. However, the shareholders’ portion is treated as a deduction from capital that is available to meet regulatory requirements and is therefore shown as a separate adjustment in the capital statement.
Estimated Estimated Estimated Estimated realistic risk realistic realistic inherited capital Estimated assets liabilities estate margin excess Excess £bn £bn1 £bn2 £bn3 £bn £bn 1. These realistic liabilities make provision for guarantees, options and promises on a market consistent stochastic basis. The value of the provision included within realistic liabilities is £0.7 billion, £0.8 billion and £3.0 billion for CGNU Life, CULAC and NUL&P, respectively (31 December 2006: £0.5 billion, £0.7 billion and £3.0 billion for CGNU Life, CULAC and NUL&P respectively).
Under the FSA regulatory regime, UK with-profit funds is required to hold capital equivalent to the greater of their regulatory requirement based on EU Directive (“regulatory peak”) and the FSA realistic basis (“realistic peak”) described above.
For UK general insurance businesses, the relevant capital requirement is the minimum solvency requirement determined in accordance with the FSA requirements.
For overseas business in the EEA, US, Canada, Australia, Hong Kong and Singapore, the available capital and the minimum capital requirement are calculated under the locally applicable regulatory regimes. The businesses outside these territories are subject to the FSA rules for the purposes of calculation of available capital and capital resource requirement.
The available capital resources in each regulated entity are generally subject to restrictions as to their availability to meet requirements that may arise elsewhere in the Group. The principal restrictions are: (i) UK with-profit funds (CGNU Life, CULAC and NUL&P) – any available surplus held in each fund can only be used to meet the requirements of the fund itself or be distributed to policyholders and shareholders. With-profit policyholders are entitled to at least 90% of the distributed profits while the shareholders receive the balance. The latter distribution would be subject to a tax charge, which is met by the fund in the case of CGNU Life, CULAC and NUL&P.
(ii) UK non-participating funds – any available surplus held in these is attributable to shareholders. Capital within the non-profit funds may be made available to meet requirements elsewhere in the Group subject to meeting the regulatory requirements of the fund. Any transfer of the surplus may give rise to a tax charge subject to availability of tax relief elsewhere in the Group.
(iii) Overseas life operations – the capital requirements and corresponding regulatory capital held by overseas businesses are calculated using the locally applicable regulatory regime. The available capital resources in all these businesses are subject to local regulatory restrictions which may constrain management’s ability to utilise these in other parts of the Group. Any transfer of available capital may give rise to a tax charge subject to availability of tax relief elsewhere in the Group.
55 – Risk management This note sets out the major risks our businesses face and describes our approach to managing these. It also gives sensitivity analyses around the major economic and non-economic assumptions that can cause volatility in our earnings and capital requirements. .
The Group recognises the critical importance of having efficient and effective risk management systems in place. To this end, the Group has an established governance framework, which has four key elements: – Defined terms of reference for the Board, its committees, and the associated executive management committees; – A clear organisational structure with documented delegated authorities and responsibilities from the Board to Board committees, executive management committees and senior management; – A Group policy framework that sets out risk appetite, risk management, control and business conduct standards for the Group’s worldwide operations. Each policy has a member of senior management who is charged with overseeing compliance with the policy throughout the Group, and sets out the risks being managed, our risk appetite, and the control standards that we would expect a business to implement; and
The Group also monitors a set of specific risks on a regular basis through the Group risk monitoring framework. Business units are required to disclose to the Group risk function all material risks, along with information on likelihood and severity of risks, and the mitigating actions taken or planned. This enables the Group to assess its overall risk exposure against local and global risk appetites, and to develop a group-wide risk map, identifying any concentrations of risk that may exist, and to identify where risks lie outside risk appetite and mitigating action is required or risk appetite requires revision in light of changing market conditions. The risk map is refreshed quarterly, and business units are required to escalate material changes intra-quarter.
The Group has established a policy on market risk which sets out the principles that businesses are expected to adopt in respect of management of the key market risks to which the Group is exposed. The Group monitors adherence to this market risk policy and regularly reviews how business units are managing these risks locally, through the Group Investment Committee and ultimately to the Asset Liability Management committee. For each of the major components of market risk, described in more detail below, the Group has put in place additional policies and procedures to set out how each risk should be managed and monitored, and the approach to setting an appropriate risk appetite.
The financial impact from changes in market risk (such as interest rates, equity prices and property values) is examined through stress tests adopted in the Individual Capital Assessments (ICA) and Financial Condition Reports (FCR), which both consider the impact on capital from variations in financial circumstances on either a remote scenario, or to changes from the central operating scenario. Both consider the management actions that may be taken in mitigation of the change in circumstances.
The sensitivity of Group earnings to changes in economic markets is regularly monitored through sensitivities to investment returns and asset values in EEV reporting.
The Group market risk policy sets out the minimum principles and framework for matching liabilities with appropriate assets, the approaches to be taken when liabilities cannot be matched and the monitoring processes that are required. The Group has criteria for matching assets and liabilities for all classes of business to minimize the impact of mismatches between the value of assets and the liabilities due to market movements. The local regulatory environment for each business will also set the conditions under which assets and liabilities are to be matched.
Equity price risk The Group is subject to equity price risk due to daily changes in the market values of its equity securities portfolio. The Group’s shareholders are exposed to the following sources of equity risk: – direct equity shareholdings in shareholder funds and the Group defined benefit pension funds; – the indirect impact from changes in the value of equities held in policyholders’ funds from which management charges or a share of performance are taken; – its interest in the free estate of long-term funds.
The Investment Committee actively monitors equity assets owned directly by the Group, which may include some material shareholdings in the Group’s strategic business partners. Concentrations of specific equity holdings (eg the strategic holdings) are also monitored monthly by the Capital Management Committee.
On short-term business such as general insurance business the Group requires a close matching of assets and liabilities to minimise this risk.
Exposure to interest rate risk is monitored through several measures that include Value-at-Risk analysis, position limits, scenario testing, stress testing and asset and liability matching using measures such as duration. The impact of exposure to sustained low interest rates is regularly monitored.
Interest rate risk is also managed using a variety of derivative instruments, including futures, options, swaps, caps and floors, in order to provide a degree of hedging against unfavourable market movements in interest rates inherent in the assets backing technical liabilities.
Currency risk The Group has minimal exposure to currency risk from financial instruments held by Business Units in currencies other than their functional currencies, as nearly all such holdings are backing either unit-linked or with-profit contract liabilities. For this reason, no sensitivity analysis is given for these holdings.
At 31 December 2007, the Group’s total equity deployment by currency was: Sterling Euro US$ Other Total £m £m £m £m £m
A 10% change in sterling to euro/US$ foreign exchange rates would have had the following impact on net assets. Apart from the impact on financial instruments covered below, the changes arise from retranslation of Business Unit balance sheets from their functional currencies into sterling, with movements being taken through the currency translation reserve. These movements in exchange rates therefore have no impact on profit.
The Group applies strict requirements to the administration and valuation processes it uses, and has a control framework that is consistent with market and industry practice for the activity that is undertaken.
Monitoring credit risk We have a significant exposure to credit risk through our investments in corporate bonds, commercial mortgages, and other securities. We hold these investments for the benefit of both our policyholders and shareholders.
The Group’s management of credit risk includes monitoring exposures at a Group level and requiring business units to implement local credit risk policies. The local business unit credit risk policies involve the establishment and operation of specific risk management committees and the detailed reporting and monitoring of the financial asset portfolio against pre-established risk criteria. Large individual counterparty exposures exceeding £25 million are aggregated and monitored at Group level against centrally-set limits reflecting the credit ratings by companies such as Standard & Poor’s. In addition, the Group evaluates the concentration of exposures by industry sector and geographic region through the Group Credit Committee.
Credit concentration risk The long-term businesses and general insurance businesses are generally not individually exposed to significant concentrations of credit risk due to the regulations, applicable in most markets, limiting investments in individual assets and asset classes. In cases where the business is particularly exposed to credit risk (e.g. in respect of defaults on mortgages or debt matching annuity liabilities) this risk is translated into a more conservative discount rate used to value the liabilities, creating a greater capital requirement, and this credit risk is actively managed. The impact of aggregation of credit risk is monitored as described above. With the exception of Government bonds the largest aggregated counterparty exposure is approximately 0.5% of the Group’s total assets.
In the event of a catastrophic event, the counterparty exposure to a single reinsurer is estimated not to exceed 1.1% of shareholders’ equity.
Financial Carrying Neither past assets that value due nor 6 months- Greater than have been in the impaired 0-3 months 3-6 months 1 year 1 year impaired balance sheet £m £m £m £m £m £m £m
Receivables and other financial assets 8,347 200 21 13 2 46 8,629
Financial Carrying Neither past assets that value due nor 6 months- Greater than have been in the impaired 0-3 months 3-6 months 1 year 1 year impaired balance sheet Restated Restated £m £m £m £m £m £m £m
Receivables and other financial assets 7,274 711 49 32 26 6 8,098
The fair value of collateral held against loans that are past due or impaired at 31 December 2007 was £185 million (2006: £61 million). This predominantly consists of commercial properties.
(i) Life insurance risk Types of risk Life insurance risk in the Group arises through its exposure to mortality and morbidity insurance and exposure to worse than anticipated operating experience on factors such as persistency levels and management and administration expenses.
Apart from ICA and FCR, sensitivity testing is widely used to measure the capital required and volatility in earnings due to exposure to life insurance risks, typically through EEV reporting (examples of which are contained elsewhere in this report). This assessment is taken at both business unit level and at Group level where the impact of aggregation of similar risks can be measured. This enables the Group to determine whether action is required to reduce risk, or whether that risk is within the overall risk appetite.
ICA analysis and EEV sensitivity testing help identify both concentrations of risk types and the benefits of diversification of risk.
(ii) General insurance risk Type of risk General insurance risk in the Group arises from: – Fluctuations in the timing, frequency and severity of claims and claim settlements relative to expectations; – Unexpected claims arising from a single source; – Inaccurate pricing of risks or inappropriate underwriting of risks when underwritten; – Inadequate reinsurance protection or other risk transfer techniques; and
Management of general insurance risks Significant insurance risks will be reported through the Group Risk monitoring framework. Additionally, the ICA framework is used to assess the risks that each general insurance business unit, and the Group as a whole, is exposed to, quantifying their impact and calculating appropriate capital requirements. Increasingly risk-based capital models are being used to support the quantification of risk under the ICA framework. All general insurance business units undertake a quarterly review of their insurance risks, the output from which is a key input into the ICA and risk-based capital assessments.
Business units have developed mechanisms that identify, quantify and manage accumulated exposures to contain them within the limits of the appetite of the Group. The Group has pioneered various developments, such as the Norwich Union UK Digital Flood Map to effectively manage exposures arising from specific perils. Where appropriate such projects are employed throughout the business units to promote the adoption of best practice as standard.
General Insurance claims reserving Actuarial claims reserving is conducted by local actuaries in the various general insurance business units according to the General Insurance Reserving policy. The General Insurance Risk Committee monitors and maintains the General Insurance Reserving policy, and conducts quarterly reviews of the Group’s general insurance claims provisions, and their adequacy. The reviews are conducted under the direction of the Aviva General Insurance Actuarial Director and include peer reviews of the business unit’s own conclusions as well as independent analysis to confirm the reasonableness of the local reviews.
The reinsurance is placed with providers who meet the Group’s counterparty security requirements, and large reinsurance placements may also require approval from the Group Asset Liability Management Committee.
Concentration risk Processes are in place to manage catastrophe risk in individual business units and at a Group level. The Group cedes much of its worldwide catastrophe risk to third party reinsurers but retains a pooled element for its own account gaining diversification benefit. Aviva’s total retained risk increases as catastrophe events become more remote, so that the total Group loss from its most concentrated catastrophe exposure (Northern European windstorm) is approximately £370 million, on a “one in ten years” basis, compared to approximately £700 million when measured on a “one in 100 years” basis.
Types of operational risk Operational risk arises as a result of inadequately controlled internal processes or systems, human error, or from external events.
Risk management framework In accordance with Group policies, business unit management has primary responsibility for the effective identification, management, monitoring and reporting of risks to the business unit executive management team and to Group as part of the quarterly risk reporting process. Each operational risk is assessed by considering the potential impact and the probability of the event occurring. Impact assessments are made against financial, operational and reputational criteria.
The Group Operational Risk Committee (ORC) oversees the Group’s aggregate operational risk exposure on behalf of the Group Executive Committee and reports to the Board Risk & Regulatory Committee. It makes recommendations on the risk appetite that the group can work within for operational risk, assesses and monitors overall operational risk exposures, identifying any concentrations of operational risk across the group, and in particular verifies that mitigating action plans are implemented. The ORC operates a number of sub-committees which focus on specific areas of operational risk covering business protection, IT, compliance, human resources, and business standards.
Sensitivity test analysis The Group uses a number of sensitivity test-based risk management tools to understand the volatility of earnings, the volatility of its capital requirements, and to manage its capital more efficiently. Primarily, EEV, ICA, and FCRs are used. Sensitivities to economic and operating experience are regularly produced on all of the Group’s financial performance measurements to inform the Group’s decision making and planning processes, and as part of the framework for identifying and quantifying the risks that each of its business units, and the Group as a whole are exposed to.
Life insurance and investment contracts The nature of long-term business is such that a number of assumptions are made in compiling these financial statements. Assumptions are made about investment returns, expenses, mortality rates, and persistency in connection with the in-force policies for each business unit. Assumptions are best estimates based on historic and expected experience of the business. A number of the key assumptions for the Group’s central scenario are disclosed elsewhere in these statements for both IFRS reporting and reporting under EEV methodology.
Annuitant mortality (life insurance only) The impact of a reduction in mortality rates for annuity contracts by 5%.
Interest Interest Equity/ Equity/ Assurance Annuitant rates rates property property Expenses mortality mortality +1% --1% +10% –10% +10% +5% –5%
Assets backing life shareholders’ funds (280) 305 255 (255) – – –
The sensitivities to economic movements relate mainly to business in the UK, USA and the Netherlands. In the UK and USA, a fall in market interest rates has a beneficial impact on non-participating business and shareholders’ funds, due to the increase in market value of fixed interest securities and the relative durations of assets and liabilities; similarly a rise in interest rates has a negative impact. In the USA most debt securities are classified as available-for-sale, which limits the overall sensitivity of IFRS profit to interest rate movements. In contrast, a rise in market interest rates has a positive impact for non-participating business in the Netherlands, due to the effect of minimum investment return guarantees, which acts to partly offset the impacts in the UK and USA.
Interest Interest Equity/ Equity/ Gross loss rates rates property property Expenses ratios +1% –1% +10% –10% +10% +5%
Impact before tax on shareholders’ equity (£m) Interest Interest Equity/ Equity/ Gross loss rates rates property property Expenses ratios +1% –1% +10% –10% +10% +5%
Interest Interest Equity/ Equity/ rates rates property property +1% –1% +10% –10%
A small percentage (less than 1%) of total assets recorded at fair value, are based on estimates. Where estimates are used, these are based on a combination of independent third party evidence and internally developed models, calibrated to market observable data where possible. Whilst such valuations are sensitive to estimates, it is believed that changing one or more of the assumptions to reasonably possible alternative assumptions would not change the fair value significantly.
(b) Fair value hedges The Group had no fair value hedge activity at 31 December 2007 (2006: nil).
(c) Net investment hedges To reduce the Group’s exposure to foreign currency risk, the Group has entered into the following net investment hedges: – The Group has designated a portion of its Euro and US dollar denominated debt as a hedge of the net investment in its European and American subsidiaries. The carrying value of the debt at 31 December 2007 was £1,988 million (2006: £1,875 million) and its fair value at that date was £1,972 million (2006: £1,973 million).
The foreign exchange loss of £114 million (2006: gain £59 million) on translation of the debt to sterling at the balance sheet date was recognised in the hedging instruments reserve in shareholders’ equity. This hedge was fully effective throughout the current and prior year.
– The Group has entered into a Sterling/Euro cross currency swap derivative which has been designated as a hedge of the net investment in its European subsidiaries. The notional value of the derivative at 31 December 2007 was £1,000 million (2006: nil) and its fair value at that date was £27 million (2006: nil).
– This fair value loss of £27 million (2006: nil) on revaluation of the derivative at balance sheet date was recognised in the hedging instruments reserve in shareholders’ equity. This hedge was fully effective since its inception in the current year.
(d) Non-hedge derivatives The Group’s non-hedge derivative activity at 31 December 2007 was as follows: Contract/ Contract/ notional Fair value Fair value notional Fair value Fair value amount asset liability amount asset liability £m £m £m £m £m £m
Fair value assets are recognised as “Derivative financial instruments” in note 24(a), whilst fair value liabilities are recognised as “other financial liabilities” in note 48.
The contractual undiscounted cash flows in relation to non-hedge derivative liabilities have the following maturities: £m £m
(e) Collateral Certain derivative contracts, primarily interest rate and currency swaps, involve the receipt or pledging of collateral. The amounts of collateral receivable or repayable are included in notes 25 and 48 respectively.
57 – Assets under management In addition to the assets included in the consolidated balance sheet, the Group manages many funds for third parties. This note details the total funds under management.
Total IFRS assets included in the consolidated balance sheet 319,720 294,851 Additional value of in-force long-term business 7,982 6,794
Funds under management 363,918 326,881 Funds not managed by Aviva fund managers (48,017) (39,711)
Income Income earned Receivable at earned Receivable at in year year end in year year end £m £m £m £m
Services provided by related parties There were no services provided by related parties in either 2006 or 2007.
Details of loans made to joint ventures and associates may be found in notes 18 and 19 respectively.
The bonus will be used to enhance policy values by around 10% in total, in three instalments, with the qualifying dates being 1 January 2008, 1 January 2009 and 1 January 2010. In accordance with the way the funds are managed, the bonus distribution is being split on a 90/10 basis between policyholders and shareholders. Over the three years, policyholders will receive a total currently estimated as £2,127 million and shareholders will receive a total currently estimated as £236 million.
As explained in accounting policy K and note 38(b), the Group’s insurance and participating investment contract liabilities are measured in accordance with IFRS 4, Insurance Contracts, and FRS 27, Life Assurance. The latter requires liabilities for with-profit funds falling within the scope of the UK’s Financial Services Authority’s capital regime to be determined in accordance with this regime, adjusted to remove the shareholders’ share of future bonuses. This requires us to recognise planned discretionary bonuses within policyholder liabilities at the balance sheet date, even if there was no constructive obligation at the time. As a result of the announcement made above, a transfer of £2,127 million has been made from the unallocated divisible surplus (note 43) in order to increase insurance liabilities by £1,728 million (note 38(b)) and participating investment contract liabilities by £399 million (note 39(c)). In compliance with paragraph 4(a) of FRS 27, the insurance liabilities on a realistic basis exclude any shareholders’ interest in this bonus. Furthermore, no profit arising to shareholders has been accrued in these financial statements as the payment to them was not a constructive obligation at the balance sheet date.
Statement of recognised income and expense For the year ended 31 December 2007
Fair value (losses)/gains on investments in subsidiaries A (3,420) 4,075 Fair value gains transferred to income statement – (94) Aggregate tax effect 16 15 Actuarial gains/(expenses) on pension scheme 5 (4)
Net (expenses)/income recognised directly in equity (3,399) 3,992 Profit/(loss) for the year 1,717 (24)
Reconciliation of movements in shareholders’ equity For the year ended 31 December 2007
Equity Ordinary share capital 28 655 641 Preference share capital 31 200 200
Cash flows from financing activities Funding provided by subsidiaries 399 299 New borrowings drawn down, net of expenses 4,780 3,956 Repayment of borrowings (4,606) (3,722) Net drawdown of borrowings 174 234 Preference dividends paid (17) (17) Ordinary dividends paid (500) (490) Interest paid on borrowings (47) (23)
Fair value as at 1 January 27,886 22,919 Additions – 1,562 Disposals – (670) Movement in fair value (3,420) 4,075
Staff costs and other employee related expenditure (see below) 92 87 Other operating costs 95 71 Net foreign exchange losses 6 43
Defined benefit schemes (see (iii) below) 6 6 Defined contribution schemes 2 2
Profit sharing and incentive plans 13 1 Equity compensation plans (see (iv) below) 17 17 Termination benefits 2 2
Full disclosure on the Group’s pension schemes is given in note 46.
Notes to the Company financial statements For the year ended 31 December 2007
C – Tax (i) Tax credited to income statement: £m £m
Current tax: For this year 351 438 Prior year adjustments 5 76
(ii) Tax reconciliation The tax on the Company’s profit/(loss) before tax differs from the theoretical amount that would arise using the tax rate of the home country of the Company as follows: £m £m
The Company has unrecognised tax losses of £nil (2006: £167 million) to carry forward against future taxable profits. The losses which were unrecognised in the company in 2006 remain unrecognised in other UK subsidiaries.
Merger valuation compensation Retained reserve reserve reserve earnings £m £m £m £m
Arising in the year: Loss for the year – – – (24) Fair value gains on investments in subsidiaries – 4,075 – – Fair value gains transferred to income statement – (94) – – Actuarial losses on pension schemes – – – (4) Dividends and appropriations – – – (762) Reserves credit for equity compensation plans – – 48 – Shares issued in lieu of dividends – – – 203 Issue of share capital under equity compensation scheme – – (18) 18 Merger relief on acquisition of AmerUs 871 – – – Transfer to retained earnings on realisation of merger reserve (871) – – 871 Aggregate tax effect – – – 15 Other movements – – – (2)
Total contractual undiscounted cash flows 4,215 3,105 7,320 3,900 3,055 6,955
Further details of these borrowings can be found in note 47.
G – Contingent liabilities Details of the Company’s contingent liabilities are given in note 50(h).
H – Risk management policies Risk management in the context of the Group is considered in note 55.
Interest rate risk Loans to and from subsidiaries are at either fixed or floating rates of interest, with the latter being exposed to fluctuations in these rates. The choice of rates is designed to match the characteristics of financial investments (which are also exposed to interest rate fluctuations) held in both the Company and the relevant subsidiary, to mitigate as far as possible each company's net exposure.
The majority of the Company's external borrowings are at fixed rates of interest and are therefore not exposed to changes in these rates. However, for those borrowings that are at floating rates, the Company is affected by changes in these rates. Further details of the Company's borrowings are provided in notes E and 47.
Currency risk The Company’s direct subsidiaries are all incorporated and operating in the UK, and therefore are not exposed to currency risk. However, these subsidiaries are themselves exposed to foreign currency risk arising from fluctuations in exchange rates during the course of providing insurance and asset management services around the world. The exposure of the subsidiaries to currency risk is considered from a Group perspective in note 55.
The Company faces exposure to foreign currency risk through some of its borrowings which are denominated in Euros and US dollars. However, most of these borrowings have been on-lent to a subsidiary which holds financial investments in these currencies, generating the net investment hedge described in note 56(c).
Within 1 year 132 645 1 to 5 years 1,359 1,253 Over 5 years 1,248 1,388
Principal Interest Total Principal Interest Total Maturity analysis of contractual undiscounted cash flows £m £m £m £m £m £m
Services provided to related parties Income Income earned Receivable at earned Receivable at in year year end in year year end £m £m £m £m
Financial statements – Information on the European Embedded Value Norwich Union advertising In September 2007 Norwich Union launched a new brand advertising campaign. The adverts show a number of problems in life that we can’t solve alongside the benefits Norwich Union can provide.The advertising shows how Norwich Union’s products and services reflect it’s brand promise: We make it easier to choose us, use us and stay with us.
We have audited the alternative method of reporting long-term business on pages 247 to 267 in respect of the year ended 31 December 2007, which comprises a European Embedded Value basis Summarised Consolidated Income Statement, Consolidated Statement of Recognised Income and Expense, Reconciliation of Movements in Consolidated Shareholders’ Funds, Summarised Consolidated Balance Sheet and the related notes on pages 247 to 267. The alternative method of reporting long-term business has been prepared in accordance with the European Embedded Values Principles published by the CFO Forum in May 2004 and the Additional Guidance on European Embedded Value Disclosures published by the CFO Forum in October 2005 (together “the EEV Principles”) as described on, and using the methodology and assumptions set out on, pages 251 to 253.
This report is made solely to the Company’s directors, as a body. Our audit work has been undertaken so that we might state to the Company’s directors those matters we are required to state to them in an auditors’ report and for no other purpose. To the fullest extent permitted by law, we do not accept or assume responsibility to anyone other than the company and the Company’s directors as a body, for our audit, for this report, or for the opinions we have formed.
Basis of audit opinion We conducted our audit in accordance with International Standards on Auditing (UK and Ireland) issued by the Auditing Practices Board. An audit includes examination, on a test basis, of evidence relevant to the amounts and disclosures in the alternative method of reporting long-term business. It also includes an assessment of the significant estimates and judgments made by the directors in the preparation of the alternative method of reporting long-term business, and of whether the accounting policies are appropriate to the Group’s circumstances, consistently applied and adequately disclosed.
We planned and performed our audit so as to obtain all the information and explanations which we considered necessary in order to provide us with sufficient evidence to give reasonable assurance that the alternative method of reporting longterm business stated on the European Embedded Value basis is free from material misstatement, whether caused by fraud or other irregularity or error. In forming our opinion we also evaluated the overall adequacy of the presentation of the alternative method of reporting long-term business.
4,832 Operating profit before tax attributable to shareholders’ profits 3,286 3,251 Adjusted for the following: (661) Variation from longer term investment return on long-term business (450) 319 760 Effect of economic assumption changes on long-term business 517 671
2. Restated 2006 results reflect the adjustment to general insurance and health operating profit for £6m FSCS levy credit, previously reported outside the operating profit but within profit before tax.
Earnings per share – EEV basis For the year ended 31 December 2007
Operating profit on an EEV basis after tax, attributable to ordinary shareholders of Aviva plc 112.5c Basic (pence per share) 76.5p 79.2p 111.5c Diluted (pence per share) 75.8p 78.3p
Consolidated statement of recognised income and expense – EEV basis For the year ended 31 December 2007 5m £m £m
(18) Fair value gains transferred to profit (12) (18) – Impairment losses on revalued assets – (2)
Reconciliation of movements in consolidated shareholders’ equity – EEV basis For the year ended 31 December 2007 5m £m £m 4,973 Total recognised income and expense for the year 3,630 2,413
Assets 4,379 Acquired value of in-force business and intangible assets 3,197 2,728 10,934 Additional value of in-force long-term business 7,982 6,794 3,529 Interests in, and loans to, joint ventures 2,576 2,795 1,652 Interests in, and loans to, associate 1,206 895 1,290 Property and equipment 942 904
Financial Investments 808 Deferred tax assets 590 1,199 515 Current tax assets 376 344 11,824 Receivables and other financial assets 8,629 8,098 6,147 Deferred acquisition costs and other assets 4,487 3,476 4,090 Prepayments and accrued income 2,986 2,585 21,608 Cash and cash equivalents 15,774 13,117 1,545 Assets of operations classified as held for sale 1,128 –
Equity 897 Ordinary share capital 655 641 10,541 Additional retained profit on an EEV basis 7,694 6,817 27,744 Equity attributable to ordinary shareholders of Aviva plc 20,253 17,531 1,630 Preference share capital and direct capital instrument 1,190 1,190
Total assets included in the statutory IFRS balance sheet 279,719 40,001 319,720 256,890 37,961 294,851
Net assets on a statutory IFRS basis 15,290 1,302 16,592 13,300 764 14,064 Additional value of in-force long-term business1 7,982 – 7,982 6,794 – 6,794
Equity attributable to ordinary shareholders of Aviva plc on an EEV basis 20,253 17,531
EEV basis total equity 24,574 20,858 1. The analysis between the Group’s and the minority interest’s share of the additional value of in-force long-term business is as follows: Movement in 2007 2006 the year £m £m £m
Embedded value 20,319 18,098 RBSG goodwill 217 217 Goodwill and intangible assets allocated to long-term business 2,036 1,527 Notional allocation of IAS 19 pension fund deficit to long-term business3,4 (58) (179) Minority interest in property investment vehicles 758 431
Basis of preparation – EEV basis The summarised consolidated income statement and balance sheet on pages 247 to 249 present the Group’s results and financial position for the life and related businesses on the European Embedded Value (EEV) basis and for its non-life businesses on the International Financial Reporting Standards (IFRS) basis. The EEV methodology adopted is in accordance with the EEV Principles introduced by the CFO Forum in May 2004 and the Additional Guidance on EEV Disclosures published by the CFO Forum in October 2005.
The Directors consider that the EEV methodology represents a more meaningful basis of reporting the value of the Group’s life and related businesses and the drivers of performance, than IFRS methodology. This basis allows for the impact of uncertainty in the future investment returns more explicitly and is consistent with the way the business is priced and managed.
At the time the Group adopted EEV principles in 2004, its approach to establishing economic assumptions, including investment returns, required capital and discount rates, was reviewed by Tillinghast, a firm of actuarial consultants. The approach used by the Group is based on the established ‘capital asset pricing model’ theory and remains in line with EEV principles and guidance.
Overview Under the EEV methodology, profit is recognised as it is earned over the life of products defined within covered business. The total profit recognised over the lifetime of a policy is the same as under the IFRS basis of reporting, but the timing of recognition is different.
The embedded value is calculated on an after-tax basis applying current legislation and practice together with future known changes. Profits are then grossed up for tax at the full rate of corporation tax for the UK and at an appropriate rate for each of the other countries based on opening year tax rates.
In the UK, shareholders’ distributable profits arise when they are released following actuarial valuations. These valuations are carried out in accordance with statutory requirements designed to ensure and demonstrate solvency in long-term business funds. Future distributable profits will depend on experience in a number of areas such as investment return, discontinuance rates, mortality, administration costs, as well as management and policyholder actions. Releases to shareholders arising in future years from the in-force covered business and associated required capital can be projected using best estimate assumptions of future experience. In overseas businesses generally there are similar requirements restricting payments to shareholders from life businesses.
The cost of holding required capital is the difference between the required capital and the present value at the appropriate risk discount rate of the projected release of the required capital and investment earnings on the assets deemed to back the required capital. Where the required capital is covered by policyholder assets, for example in the UK with-profit funds, there is no impact of cost of capital on shareholder value. The assets regarded as covering the required capital are those that the operation deems appropriate.
EEV methodology continued The RDR is only one component of the overall allowance for risk in EEV calculations. Risk is also allowed for in the cost of holding statutory reserving margins, additional required capital and in the time value of options and guarantees. Hence to derive the RDR the Group WACC is adjusted to reflect the average level of required capital assumed to be held, and to reflect the explicit valuation of the time value of options and guarantees.
For with-profit funds in the UK and Ireland, for the purpose of recognising the value of the estate, it is assumed that terminal bonuses are increased to exhaust all of the assets in the fund over the future lifetime of the in-force with-profit policies. However, under stochastic modelling there may be some extreme economic scenarios when the total assets in the Group’s with-profit funds are not sufficient to pay all policyholder claims. The average additional shareholder cost arising from this shortfall has been included in the time value of options and guarantees.
– expected return 1,266 1,011 – experience variances (16) (50) – operating assumption changes 114 44
Life EEV operating return before tax 2,753 2,033 Investment return variances (450) 319 Effect of economic assumption changes 517 671
New business contribution The table below sets out the premium volumes, the contribution from and the resulting margin achieved on new business written by the life and related businesses.
New business sales are expressed on two bases: annual premium equivalent (APE) and the present value of new business premiums (PVNBP). The PVNBP calculation is equal to total single premium sales received in the year plus the discounted value of regular premiums expected to be received over the term of the new contracts, and is expressed at the point of sale. The premium volumes and projection assumptions used to calculate the present value of regular premiums for each product are the same as those used to calculate new business contribution, so the components of the new business margin are on a consistent basis.
Geographical analysis of new business New business New New business New
Annual value of new Before the effect Before the effect After the effect After the effect premium equivalent business premiums of required capital of required capital of required capital of required capital £m £m £m £m £m £m £m £m £m £m £m £m
5. In the USA, expense assumptions have been strengthened following investment in the business capability.
8. In the UK, other operating assumption changes reflect the reduction in the level of required capital assumed on our annuity portfolio. In France, other operating assumption changes reflect increased profitability driven by product development and the increased proportion of unit-linked assets within managed funds. In the USA, other assumption changes relate to the implementation of an efficient financing solution to free up capital previously held to support excessive regulatory reserves.
Geographical analysis of the components of life EEV operating return continued Nether- Other North Asia
Life EEV operating 1. Project and other related expenses in the UK reflect £32 million relating to the ongoing transformation of the life business and £117 million of other exceptional and project costs associated with strategic initiatives, including developments designed to improve the future new business volumes, and regulatory changes. In the Netherlands, these expenses reflect higher project costs compared to allowances as well as the payment to ABN AMRO in respect of the joint venture operations.
7. The change in mortality assumptions in the UK includes an alignment in the basis for internal business. Mortality assumptions in France were changed following improvements in mortality experience over the last few years.
9. In the UK, the assumption changes reflect the beneficial impact of the with-profit funds sharing the pension scheme deficit funding (£126 million) and the impact of PS06/14, primarily in reducing the non-profit reserves (£50 million). In Delta Lloyd the impact is due to changes to management fee rebates.
Analysis of movement in life and related businesses embedded value The following tables provide an analysis of the movement in embedded value for the life and related businesses for 2007 and 2006. The analysis is shown separately for net worth and the value of in-force covered business, and includes amounts transferred between these categories. The transfer to life and related businesses from other segments consists of service company profits and losses during the reported year that have emerged from the value of in-force. Since the “look through” into service companies includes only future profits and losses, these amounts must be eliminated from the closing embedded value. All figures are shown net of tax.
Life EEV return after tax 1,782 218 2,000 Exchange rate movements 572 402 974 Embedded value from business acquired 84 26 110 Net amounts released from life and related businesses (795) – (795) Transfer from life and related businesses to other segments (68) – (68)
The embedded value of business acquired in the twelve months to 31 December 2007 of £110 million represents the embedded value of Hamilton Life Asssurance Company Limited, Area Life International Assurance Limited and Erasmus Groep BV, Caja de Ahorros De Murcia, Aviva SA Emeklilik ve Hayat A.S, CIMB Aviva Takaful Berhad, CIMB Aviva Assurance Berhad and First Aviva Life Assurance Co.,Ltd.
Required capital has increased in the period by £1,017 million. The movement comprises an increase of £810 million in relation to new business written, a reduction of £372 million regarding in-force business, an increase of £197 million due to a reduction in implicit items, £46 million additional in-force required capital relating to the acquisitions during the period and a £336 million increase due to foreign exchange rate movements. The decrease in the in-force business required capital includes the impact of the higher solvency margin required for certain unit linked business, following clarification by the French regulator to the industry and the reduction in the level of required capital for UK annuities.
Embedded value at the beginning of the year – Free surplus 2,772 – Required capital1 4,448
Life EEV return after tax 1,415 683 2,098 Exchange rate movements (189) (120) (309) Embedded value of business acquired 675 759 1,434 Net amounts released from life and related businesses (253) – (253) Transfer to life and related businesses from other segments 113 – 113 UK pension fund deficit borne by UK with-profit funds transferred to analysis of net assets on an EEV basis2 (98) – (98)
Embedded value at the end of the year – Free surplus 3,569 – Required capital1 5,314 1. Required capital is shown net of implicit items permitted by local regulators to cover minimum solvency margins.
2. The impact of the operating assumption change reflecting the UK with-profits funds contribution to the UK pension scheme deficit funding has been removed from the Life EEV analysis as the pension fund deficit notionally allocated to long-term business net assets on an EEV basis is net of the proportion of funding borne by the UK with-profits funds.
Segmental analysis of life and related businesses embedded value Value of in-force
Present Cost of Required Free value of required Embedded capital1 surplus in-force capital value 2007 £m £m £m £m £m
Netherlands (including Belgium and Germany) 1,067 1,701 1,461 (362) 3,867 1. Required capital is shown net of implicit items permitted by local regulators to cover minimum solvency margins.
Time value of options and guarantees The following table sets out the time value of options and guarantees relating to covered business by territory.
The TVOG has increased by £20 million to £392 million, reflecting the impact of adverse investment variances.
Geographical analysis of fund management operating profit The summarised consolidated income statement – EEV basis, includes profit from the Group’s fund management operations as analysed below. This excludes the proportion of the results of Morley’s fund management businesses, of our French asset management operation Aviva Gestion d’Actifs (AGA) and other fund management operations within the Group that arises from the provision of fund management services to our Life businesses. These results are included within the Life EEV operating return.
Life EEV operating return before tax 43 20 75 21 25 124 308 3 311 2,442 2,753
New business contribution after effect of required capital 15 1 29 7 3 86 141 1 142 541 683
Principal economic assumptions Deterministic calculations Economic assumptions are derived actively, based on market yields on risk-free fixed interest assets at the end of each reporting year. The same margins are applied on a consistent basis across the Group to gross risk-free yields to obtain investment return assumptions for ordinary shares and property and to produce risk discount rates. Additional countryspecific risk margins are applied to smaller businesses to reflect additional economic, political and business-specific risk, which result in the application of risk margins ranging from 3.7% to 8.7% in our eastern European and Asian business operations. Expense inflation is derived as a fixed margin above a local measure of long-term price inflation. Risk free rates and price inflation have been harmonised across territories within the Euro currency zone, except for expense inflation in Ireland where significant differences remain. Required capital is shown as a multiple of the EU statutory minimum solvency margin or equivalent.
For service companies, expense inflation relates to the underlying expenses rather than the fees charged to the life company. Future returns on corporate fixed interest investments are calculated from prospective yields less an adjustment for credit risk. Following the change made to the required capital in Norwich Union Annuity Limited, required capital in the United Kingdom is now 100% EU minimum for all life companies. Required capital in Spain is 125% EU minimum for Aviva Vida y Pensiones and 110% for bancassurance companies. The level of required capital for the US business is 250% of the risk based capital, at the company action level, set by the National Association of Insurance Commissioners. The required capital is equivalent to 5% of the insurance liabilities on a local regulatory basis which is broadly equivalent to the required capital we hold for our main European businesses.
Other economic assumptions Required capital relating to with-profit business is assumed to be covered by the surplus within the with-profit funds and no effect has been attributed to shareholders. Bonus rates on participating business have been set at levels consistent with the economic assumptions and Aviva’s medium-term bonus plans. The distribution of profit between policyholders and shareholders within the with-profit funds assumes that the shareholder interest in conventional with-profit business in the United Kingdom and Ireland continues at the current rate of one-ninth of the cost of bonus.
This section describes the models used to generate future investment simulations and gives some sample statistics for the simulations used. Two separate models have been used, for the UK businesses and for International businesses, to better reflect the characteristics of the businesses.
Summary statistics The following table sets out the mean and standard deviations (StDev) of future returns at 31 December 2007 for the three most significant asset classes. Interest rates are assumed to have a lognormal distribution with an annualised standard deviation of 11.5% p.a. for the natural logarithm of the interest rate.
Government Bonds 4.6% 3.25-4.5%3 1. Means have been calculated by accumulating a unit investment for the required number of years in each simulation, averaging the accumulation across all simulations, and converting the result to an equivalent annual rate (by taking the nth root of the average accumulation minus one).
For the UK, the statistics are the same over all projection horizons. Assumptions are also required for correlations between asset classes. These have been set based on an assessment of historical data. Returns for corporate fixed interest investments in each scenario are equal to the return on Government bonds plus a fixed additional amount, based on current spreads less a margin for credit risk.
The total annual return on equities is calculated as the return on one year bonds plus an excess return. The excess return is assumed to have a lognormal distribution. The model also generates property total returns and real yield curves, although these are not significant asset classes for Aviva outside the UK.
US dollar 1. Means have been calculated by accumulating a unit investment for the required number of years in each simulation, averaging the accumulation across all simulations, and converting the result to an equivalent annual rate (by taking the nth root of the average accumulation minus one).
Taxation Current tax legislation and rates have been assumed to continue unaltered, except where changes in future tax rates have been announced.
Valuation of debt Borrowings in the EEV consolidated balance sheet are valued on an IFRS basis, consistent with the primary financial statements. At 31 December 2007 the market value of the Group’s external debt, subordinated debt, preference shares including General Accident plc preference shares of £250 million (classified as minority interests) and direct capital instrument was £5,774 million (2006: £5,991 million).
Borrowings per summarised consolidated balance sheet – EEV basis 12,657 12,137 Add: amount included within held for sale 12 – Less: Securitised mortgage funding (7,295) (7,068)
External debt and subordinated debt – EEV basis 4,311 4,195 Add: Preference shares (including General Accident plc) and direct capital instrument 1,440 1,440
– decrease in the level of required capital to 100% EU minimum (or equivalent) (not applicable for new business contribution).
Embedded value (net of tax) on page 259 rates rates rates rates
1% increase 1% decrease 1% increase 1% decrease New business contribution As reported discount in discount in interest in interest before required capital (gross of tax) on page 255 rates rates rates rates
New business contribution As reported property property before required capital (gross of tax) on page 255 returns returns 31 December 2007 £m £m £m
New business contribution As reported maintenance in lapse rates – life – annuity before required capital (gross of tax) on page 255 expenses rates assurance business Year to 31 December 2007 £m £m £m £m £m
France Aviva Participations SA and its principal subsidiaries: Antarius S.A. (50.0%) Aviva Assurances S.A. Aviva Courtage S.A. Aviva France SA Aviva Gestion d’Actifs S.A. Aviva Vie SA Eurofil S.A.
Ireland Hibernian Group plc and its principal subsidiaries: Ark Life Assurance Company Limited Hibernian General Insurance Limited Hibernian Life & Pensions Limited Hibernian Investment Managers Limited
Poland Commercial Union Polska – Towarzystwo Ubezpieczen Na Zycie SA (90.0%) Commercial Union Polska – Towarzystwo Ubezpieczen Ogolnych SA (90.0%) Commercial Union Powszechne Towarzystwo Emerytalne Emerytalne BPH CU WBK S.A. (88.8%)
Caja Murcia Vida y Pensiones, de Seguros y Reaseguros S.A. (5.0%) Caja Granada Vida, de Seguros y Reaseguros, S.A. (25.0%) CxG Aviva Corporacion CaixaGalicia de Seguros y Reaseguros, S.A. (50.0%) Unicorp Vida, Compania de Seguros y Reaseguros (50.0%)
United States AmerUs Group Co and its principal subsidiaries: American Investors Life Insurance Company, Inc. AmerUs Annuity Group Co. (AAG) AmerUs Life Insurance Company AmerUs Life and Annuity Company Aviva Capital Management ILICO Holdings, Inc.
Electronic communications Aviva has taken full advantage of changes brought about by the Companies Act 2006 which recognises the growing importance of electronic communications and allows companies to provide documentation and communications to shareholders via their websites (except to those who have specifically elected to receive a hard (ie paper) copy).
Dividend payments directly to your bank or building society account As an alternative to having dividends paid by cheque, shareholders can, if they wish, have them credited directly into their bank or building society account on the dividend payment date. Having the dividend paid directly into their bank or building society account avoids the risk of cheques being lost or intercepted in the post and is more convenient as payment is credited automatically on the payment date. Shareholders wishing to set up a dividend mandate can do so by completing the dividend mandate form attached to the dividend cheque, via the Company’s website at www.aviva.com/dividendmandate or by contacting the Registrar.
Scrip Dividend The Company currently operates the Aviva Scrip Dividend Scheme (the “Scheme”) which provides shareholders with the opportunity to receive their dividends in the form of new ordinary shares in the Company instead of cash.
Shareholders who have not joined the Scheme but wish to do so should contact the Registrar, Equiniti, and request a mandate form. The completed mandate form will need to be received by Equiniti by no later than 17 April 2008 in order to be effective for the 2007 final dividend (payable on 16 May 2008). Further details are included on the Company’s website at www.aviva.com/scripdividend.
It is the Company’s intention that following the payment of the 2007 final dividend on 16 May 2008 the Aviva Scrip Dividend Scheme will be withdrawn and shareholders will be offered the opportunity to participate in a Dividend Reinvestment Plan. Full details of the new plan will be communicated to shareholders at this time.
ID fraud/unsolicited mail Aviva has been working with Equiniti to review its procedures and where possible restrict the opportunities for fraud. All shareholders must continue to be vigilant and if any unsolicited mail offering advice is received, shareholders should inform the Registrar immediately.
Corporate Nominee The Company operates a corporate nominee service, the Aviva Share Account. Shareholders who choose to join the nominee account will not have any personal details entered on the Company’s public share register. Members of the Aviva Share Account may retain the same rights as registered shareholders and are able to elect to receive the same shareholder communications. To join the Aviva Share Account or view the terms and conditions please contact the Registrar using the contact details provided on page 272.
Also for a comprehensive shareholder guide including practical help on many shareholder related topics including transferring shares and updating personal details online, shareholders may visit the shareholder centre at www.aviva.com/shareholders
Share dealing Shareholders who hold their shares in the Aviva Share Account will need to use one of the services detailed below to buy or sell Aviva shares. Those who hold a share certificate can use the services below or any bank, building society or stockbroker offering share dealing facilities. Shareholders in any doubt about buying or selling Aviva shares should seek professional financial advice.
– You can buy or sell shares via the internet or by telephone through Shareview Dealing, a share dealing service provided by Equiniti Financial Services Limited. For internet purchases and sales log on to www.shareview.co.uk/dealing and for telephone purchases and sales call 08456 037 037 between 8am and 4.30pm, Monday to Friday.
– Equiniti Financial Services Limited also offers a postal share dealing service. For further information and a postal share dealing form telephone 0871 384 2953*.
To check instructions and maintain high quality service standards, Barclays Stockbrokers may record and monitor calls. New Business Development hours are between 8am and 6pm, Monday to Friday, excluding Bank Holidays.
Barclays Stockbrokers is authorised and regulated by the Financial Services Authority, registered number 124247.
– NatWest Stockbrokers provide a share dealing service either over the telephone or at certain NatWest branches for Aviva Share Account holders only. For more information contact NatWest Stockbrokers on 0845 122 0689. NatWest Stockbrokers Limited (“NWS”) is a member of the London Stock Exchange and PLUS.
NWS is authorised and regulated by the Financial Services Authority, registered number 124395. Registered Office: Waterhouse Square, 138-142 Holborn, London EC1N 2TH. Registered in England and Wales, registered number 1959479, England. NWS is operated by a joint venture between The Royal Bank of Scotland Group plc and The Toronto-Dominion Bank.
Share price Shareholders can access the current share price of Aviva plc ordinary shares at www.aviva.com/shareprice or alternatively can call FT Cityline on 0906 843 2197. Calls are currently charged at 60 pence per minute on a per second basis from a BT landline. Charges from other networks and mobile networks may vary. The average time to access the share price is approximately one minute. The current share price of Aviva’s preference shares can be found on the London Stock Exchange website at www.londonstockexchange.com/en-gb/pricesnews * Calls to these numbers are charged at 8 pence per minute from a BT landline. Charges from other telephone providers may vary.
Alternative format If you would like to request a copy of our Annual Report and Accounts or Annual Review in an alternative format, for example, large print, braille or audio cassette, please contact the Registrar using the details above.
Group financial calendar for 2008 Announcement of quarterly trading update 25 April Annual General Meeting 1 May Announcement of unaudited six months’ interim results 30 July Announcement of quarterly trading update 22 October
Useful contact details Detailed below are the contact details and various addresses that shareholders may find useful. Please quote Aviva plc, as well as the name and address in which the shares are held, in all correspondence. If you have your shareholder reference, please have this available as well.
Individual Savings Accounts (ISAs): Equiniti (ISA) Manager Aspect House, Spencer Road Lancing, West Sussex BN99 6DA
Barclays Stockbrokers (ISA) Manager Tay House, 300 Bath Street Glasgow G2 4JR
Annual General Meeting The Company’s Annual General Meeting will be held at the Barbican Centre, Silk Street, London EC2Y 8DS on 1 May 2008 at 11am. The Notice of Meeting, together with details of the business to be conducted at the Meeting, is available on the Company’s website at www.aviva.com/agm
Shareholders unable to attend the Meeting still have an opportunity to submit a question to the Board of Directors. Answers to the most frequently asked questions will be circulated at the Meeting and published on the Company’s website shortly after the Meeting. Any shareholders wishing to submit a question may do this by completing and returning the form included in the Notice of Meeting or online via the Aviva website at www.aviva.com/agm
‘One Aviva, twice the value’. Realising the full potential of Aviva’s businesses by acting as one group.
FSC – Forest Stewardship Council. This ensures there is an audited chain of custody from the tree in the well managed forest through to the finished document in the printing factory.