E – Product classification Insurance contracts are defined as those containing significant insurance risk if, and only if, an insured event could cause an insurer to pay significant additional benefits in any scenario, excluding scenarios that lack commercial substance, at the inception of the contract. Such contracts remain insurance contracts until all rights and obligations are extinguished or expire. Contracts can be reclassified as insurance contracts after inception if insurance risk becomes significant. Any contracts not considered to be insurance contracts under IFRS are classified as investment or service contracts. Some insurance and investment contracts contain a discretionary participating feature, which is a contractual right to receive additional benefits as a supplement to guaranteed benefits. These are referred to as participating contracts.
G – Other investment contract fee revenue Investment contract policyholders are charged fees for mortality, policy administration, investment management, surrenders or other contract services. These fees are recognised as revenue in the period in which they are assessed unless they relate to services to be provided in future periods. Amounts are considered to be assessed when the policyholder’s balance has been adjusted for those fees. If the fees are for services to be provided in future periods, then they are deferred and recognised as the service is provided.
Initiation and other “front-end” fees (fees that are assessed against the policyholder balance as consideration for origination of the contract) are charged on some non-participating investment and investment fund management contracts. Where the investment contract is recorded at amortised cost, these fees are deferred and recognised over the term of the policy. Where the investment contract is measured at fair value, the front end fees that relate to the provision of investment management services are deferred and recognised as the services are provided.
J – Insurance and participating investment contract liabilities Long-term business provisions Under current IFRS requirements, insurance and participating investment contract liabilities are measured using accounting policies consistent with those adopted previously under existing accounting practices. Accounting for insurance contracts is determined in accordance with the Statement of Recommended Practice issued by the Association of British Insurers in November 2003. As stated in the basis of preparation on page 114, no changes are required to the accounting policies adopted for the restated preliminary IFRS opening balance sheet for FRS27.
Other assessments and levies The Group is subject to various periodic insurance-related assessments or guarantee fund levies. Related provisions are established where there is a present obligation (legal or constructive) as a result of a past event. Such amounts are not included within insurance liabilities but are included under “Pension obligations and other provisions” within the balance sheet.
K – Non-participating investment contract liabilities Liabilities for non-participating investment contracts are measured at amortised cost unless previous company regulations permitted a fair valuation of liabilities to be used, such as in the case of unit-linked liabilities. The majority of the Group’s contracts classified as non-participating investment contracts are unit-linked contracts and are measured at fair value.
Amortised cost is calculated as the fair value of consideration received at the date of initial recognition, less the net effect of principal payments such as transaction costs and front end fees, plus or minus the cumulative amortisation (using the effective interest rate method) of any difference between that initial amount and the maturity value, and less any write-down for surrender payments. The effective interest rate is the one that equates the discounted cash payments to the initial amount. At each reporting date, the amortised cost liability is determined as the value of future best estimate cash flows discounted at the effective interest rate.
M – Intangible assets Goodwill Goodwill represents the excess of the cost of an acquisition over the fair value of the Group’s share of the net assets of the acquired subsidiary, associate or joint venture at the date of acquisition. Goodwill on acquisitions prior to 1 January 2004 (the date of transition to IFRS) is carried at book value (original cost less amortisation) on that date, less any impairment subsequently incurred. Goodwill arising before 1 January 1998 was eliminated against reserves and has not been reinstated. Goodwill arising on the Group’s investments in associates and joint ventures since that date is included within the carrying value of these investments.
N – Property and equipment Owner-occupied properties are carried at their revalued amounts, which are supported by market evidence, and movements are taken to a separate reserve within equity. When such properties are sold, the accumulated revaluation surpluses are transferred from this reserve to retained earnings. All other items classed as property and equipment in the balance sheet are carried at historical cost less accumulated depreciation.
• The company has transferred its rights to receive cash flows from the asset and either (a) has transferred substantially all the risks and rewards of the asset, or (b) has neither transferred nor retained substantially all the risks and rewards of the asset, but has transferred control of the asset.
Q – Financial investments The Group classifies its investments as either financial assets at fair value through profit or loss (FV), available for sale financial assets (AFS), or loans and receivables. The classification depends on the purpose for which the investments were acquired, and is determined by local management at initial recognition. In general, the FV category is used, but the AFS category is used where the relevant life liability (including shareholders’ funds) is passively managed and carried at amortised cost.
The FV category has two sub-categories – those that meet the definition as being held for trading and those the Group chooses to designate as at fair value through profit or loss (referred to in this accounting policy as “other than trading”). Fixed maturities, purchased loans and equity securities, which the Group buys with the intention to resell in the near term (typically between three and six months), are classified as trading. All other securities in the FV category are classified as other than trading.
Purchases and sales of investments are recognised on the trade date, which is the date that the Group commits to purchase or sell the assets, at their fair values less transaction costs. Debt securities are initially recorded at their fair value which is taken to be amortised cost, with amortisation credited or charged to the income statement. Investments classified as trading, other than trading and AFS are subsequently carried at fair value. Changes in the fair value of trading and other than trading investments are included in the income statement in the period in which they arise. Changes in the fair value of securities classified as AFS, except for impairment losses and relevant foreign exchange gains and losses, are recorded in a separate reserve within equity.
R – Derivative financial instruments and hedging Derivative financial instruments include foreign exchange contracts, interest rate futures, currency and interest rate swaps, currency and interest rate options (both written and purchased) and other financial instruments that derive their value mainly from underlying interest rates, foreign exchange rates, commodity values or equity instruments. All derivatives are initially recognised in the balance sheet at their fair value, which usually represents their cost. They are subsequently re-measured at their fair value, with the method of recognising movements in this value depending on whether they are designated as hedging instruments and, if so, the nature of the item being hedged. Fair values are obtained from quoted market prices or, if these are not available, by using valuation techniques such as discounted cash flow models or option pricing models. All derivatives are carried as assets when the fair values are positive and as liabilities when the fair values are negative. Premiums paid for derivatives are recorded as an asset on the balance sheet at the date of purchase, representing their fair value at that date.
The Group does not currently have any material fair value or cash flow hedges.
Hedge accounting is used for derivatives designated in this way, provided certain criteria are met. At the inception of the transaction, the Group documents the relationship between the hedging instrument and the hedged item, as well as the risk management objective and the strategy for undertaking the hedge transaction. The Group also documents its assessment, both on inception and on an ongoing basis, of whether the hedge is expected to be, and has been, highly effective in offsetting the risk in the hedged item.
To the extent that a loan is uncollectable, it is written off as impaired. Subsequent recoveries are credited to the income statement.
W – Provisions and contingent liabilities Provisions are recognised when the Group has a present legal or constructive obligation as a result of past events, it is probable that an outflow of resources embodying economic benefits will be required to settle the obligation, and a reliable estimate of the amount of the obligation can be made. Where the Group expects a provision to be reimbursed, for example under an insurance contract, the reimbursement is recognised as a separate asset but only when the reimbursement is more probable than not.
For defined benefit plans, the pension costs are assessed using the projected unit credit method. Under this method, the cost of providing pensions is charged to the income statement so as to spread the regular cost over the service lives of employees, in accordance with the advice of qualified actuaries. The pension obligation is measured as the present value of the estimated future cash outflows using a discount rate based on market yields for high quality corporate bonds. The resulting pension scheme surplus or deficit appears as an asset or obligation in the consolidated balance sheet. The Group intends to early adopt the December 2004 amendment to IAS19, Employee Benefits, with the result that all actuarial gains and losses will be recognised immediately in equity through the Statement of recognised income and expense.
The Group accounts for share equity compensation plans, using the fair value based method of accounting (the “fair value method”). Under the fair value method, the cost of providing equity compensation plans is based on the fair value of the share awards or option plans at date of grant, which is recognised in the income statement over the expected service period of the related employees and credited to the equity compensation reserve, part of shareholders’ funds.
When the options are exercised and new shares are issued, the proceeds received, net of any transaction costs, are credited to share capital (par value) and the balance to share premium. Where the shares are already held by employee trusts, the net proceeds are credited to this account, with the difference between cost and proceeds being taken to retained earnings. In both cases, the relevant amount in the equity compensation reserve is then credited to retained earnings.
Deferred tax related to fair value re-measurement of available-for-sale investments, owner-occupied property and other amounts taken directly to equity is credited or charged to equity and is recognised in the balance sheet as a deferred tax asset or liability.
Z – Borrowings Borrowings are recognised initially at their issue proceeds less transaction costs incurred. Subsequently, borrowings are stated at amortised cost, and any difference between net proceeds and the redemption value is recognised in the income statement over the period of the borrowings using the effective interest rate method.
Equity instruments A financial instrument is treated as equity if: (i) there is no contractual obligation to deliver cash or other financial assets or to exchange financial assets or liabilities on terms that may be unfavourable; and
This report is made solely to Aviva plc “the Company” in accordance with our engagement letter dated 23 November 2004. Our audit work has been undertaken so that we might state to the Company 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 or liability to anyone other than the Company for our audit work, for this report, or for the opinions we have formed.
Opinion In our opinion, the preliminary IFRS consolidated financial statements as at 1 January 2004 have been prepared, in all material respects, in accordance with the basis set out in the accounting policies note, which describes how IFRS have been applied under IFRS1, including the assumptions management has made about the standards and interpretations expected to be effective, and the policies expected to be adopted, when management prepares its first complete set of IFRS consolidated financial statements as at 31 December 2005.
Operating profit – before tax, 3,447 amortisation of goodwill and exceptional items** 2,344 1,906 (177) Amortisation of goodwill (120) (103) (72) Financial Services Compensation Scheme and other levies (49) –
(468) Effect of economic assumption changes (318) (55) (34) Change in the equalisation provision (23) (49)
(200) Loss on the disposal of subsidiary and associated undertakings (136) (6) (73) Exceptional costs for termination of operations (50) (19)
6 Tax credit/(charge) on (loss)/profit on other ordinary activities 4 (176)
1. Excludes the proportion of the results of Morley’s fund management businesses and of our French asset management operation Aviva Gestion d’Actifs (AGA) that arise from the provision of fund management services to our life businesses. These results are included within the life EEV operating return.
2. Excludes the results of Norwich Union Equity Release (NUER). Also excludes the proportion of the results of Norwich Union Life Services relating to the services provided to the UK life business. These results are included within the life EEV operating return. Other subsidiaries providing services to our life businesses do not significantly impact the Group results.
Operating profit on an EEV basis before amortisation of goodwill and 98.8c exceptional items, after tax, attributable to equity shareholders** 67.2p 53.0p 89.7c Profit attributable to equity shareholders 61.0p 70.0p 88.8c Profit attributable to equity shareholders – diluted 60.4p 69.8p * Restated for the effect of implementing European Embedded Value principles.
Consolidated statement of total recognised gains and losses – EEV basis For the year ended 31 December 2004
1m £m £m 2,059 Profit for the financial year** 1,400 1,593 (199) Foreign exchange gains 104 415 1,860 Total recognised gains arising in the year 1,504 2,008 * Restated for the effect of implementing European Embedded Value principles.
15,360 Shareholders’ funds at the beginning of the year, as restated 10,752 9,304 1,860 Total recognised gains arising in the year 1,504 2,008 (879) Dividends and appropriations (598) (562)
Summarised consolidated balance sheet – EEV basis As at 31 December 2004
Investments Land and buildings 637 637 Investments in associated undertakings and participating interests 178 279 Variable yield securities 3,149 2,967 Fixed interest securities 10,750 10,098 Mortgages and loans, net of non-recourse funding 1,387 929
Reinsurers’ share of technical provisions 2,589 2,926 Reinsurers’ share of provision for linked liabilities 852 579 Assets of the long-term business 148,209 136,709 Assets held to cover linked liabilities 51,144 40,665 Other assets 9,889 10,829 Acquired value of in-force long-term business 451 488 Additional value of in-force long-term business 4,875 4,340
Liabilities Liabilities of the long-term business 131,099 121,125 Fund for future appropriations 9,218 8,443 Technical provision for linked liabilities 51,996 41,244 General insurance liabilities 18,155 17,515
Restated* Life and General Life and Restated* related business related General business Restated*
businesses and other Group businesses and other Group £m £m £m £m £m £m
Total assets included in the modified statutory balance sheet 200,656 31,614 232,270 178,441 30,239 208,680
Net assets on an EEV basis2 13,218 3,724 16,942 11,969 2,550 14,519
Shareholders’ capital, share premium, shares held by employee trusts and merger reserves 5,638 4,622
Modified statutory basis retained profit 2,682 1,932 Additional EEV basis retained profit 4,617 4,198
Group’s share included in shareholders’ funds 4,617 4,198 419 Minority interest share 258 142 116 2. Analysis of net assets on an EEV basis is as follows: £m £m
Basis of preparation – EEV basis The consolidated profit and loss account and balance sheet statements on pages 128 to 131 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 modified statutory solvency basis. The EEV methodology adopted is in accordance with the EEV Principles introduced by the CFO Forum in May 2004.
The Group’s revised approach to establishing economic assumptions (specifically investment returns, required capital and discount rates) has been reviewed by Tillinghast, a firm of actuarial consultants, as part of the restatement of 31 December 2003 and 30 June 2004 comparative figures. The approach is based on the well established capital asset pricing model theory and is in line with the EEV Principles and Guidance.
In addition, the results of our equity release business have been reclassified from non-insurance operations to life insurance operations. This has resulted in assets, liabilities and operating profits being reclassified out of non-insurance segments and into life segments. Comparatives for 2003 have been restated accordingly and the impact of the reclassification on consolidated shareholders’ funds and consolidated profit for the 2003 financial year end is nil.
In the directors’ opinion, the EEV basis provides a more accurate reflection of the performance of the Group’s life and related operations year on year than results presented under the modified statutory basis. The directors consider that the EEV methodology is a refinement to the Achieved Profits basis previously adopted by the Group and represents the most meaningful basis of reporting the underlying value in our life business and the underlying drivers of performance. 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.
The results for 2004 and 2003 have been audited by the auditors, Ernst & Young LLP. Their report in respect of 2004 is shown on page 146.
Methodology 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 modified statutory 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.
Net worth The net worth is the market value of the shareholders’ funds and the shareholders’ interest in the surplus held in the non-profit component of the long-term business funds, determined on a statutory solvency basis and adjusted to add back any non-admissible assets, and consists of the required capital and free surplus. The level of required capital for each business, which ranges between 100% and 200% of the EU minimum solvency requirement for our main European businesses, reflects the level of capital considered by the directors to be appropriate to manage the business, allowing for our internal assessment of the level of market, insurance and operating risk inherent in the underlying products. The same definition of required capital is used for both existing and new business. The free surplus comprises the market value of shareholder assets in excess of local statutory reserves and required capital.
Risk discount rates Under the EEV methodology, a risk discount rate (RDR) is required to express a stream of expected future distributable profits as a single value at a particular date (the present value). It is the interest rate that an investment equal to the present value would have to earn in order to replicate exactly the stream of future profits. The RDR is a combination of a risk-free rate to reflect the time value of money plus a risk margin to make prudent allowance for the risk that experience in future years may differ from that assumed. In particular, a risk margin is added to allow for the risk that expected additional returns on certain asset classes (eg equities) are not achieved.
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 an 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.
In order to derive risk discount rates for each of our life businesses, the adjusted Group WACC is expressed as a risk margin in excess of the gross risk-free interest rate used in the WACC calculation as described above. Business-specific discount rates are then calculated as the sum of this risk margin and the appropriate local gross risk-free rate at the valuation date, based on returns on government bonds. A common risk-free rate, and hence a common RDR, is used for all of our businesses within the Eurozone. Additional country-specific risk margins are applied to smaller businesses to reflect additional economic, political and business-specific risk. Within each business, a constant RDR has been applied in all future time periods and in each of the economic scenarios underlying the calculation of the time value of options and guarantees.
– the impact of changes in operating assumptions including risk margins; • Expected investment return on the shareholders’ net worth, based upon assumptions applying at the start of the year; • Investment return variances caused by differences between the actual return in the period and the expected return based on economic assumptions used to calculate the start of year value; and
• The impact of changes in economic assumptions in the period.
New business contribution (after the effect of required capital) 516 474 Profit from existing business – expected return 819 761
Life EEV return before tax 1,794 2,137 Tax on operating profit (490) (457) Tax change on other ordinary activities (58) (175)
Life EEV return after tax 1,246 1,505 * Restated for the effect of implementing European Embedded Value principles.
The contribution generated by new business written during the period is the present value of the projected stream of after tax distributable profit from that business. New business contribution before tax is calculated by grossing up the contribution after tax at the full corporation tax rate for UK business and at appropriate rates of tax for other countries. New business contribution has been calculated using the same economic assumptions as those used to determine the embedded value as at the start of the year and operating assumptions used to determine the embedded value as at the end of the year, and is rolled forward to the end of the financial period.
New business sales are expressed on two bases: annual premium equivalent (APE), the UK life industry’s standard measure, and the present value of future 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.
New business contribution is shown before and after the effect of required capital, calculated on the same basis as for in-force covered business. New business contribution before New business contribution after
Total (before the effect of required capital) 2,598 2,427 20,687 18,809 706 646
New business contribution after the effect of required capital includes minority interests in 2004 of £94 million (2003: £86 million). This comprises minority interests in France of £1 million (2003: £nil), Italy £19 million (2003: £15 million), Netherlands £8 million (2003: £7 million), Poland £2 million (2003: £1 million) and Spain £64 million (2003: £63 million).
EEV basis – new business contribution before the effect of required capital, tax and minority interest Annual premium equivalent** Present value of new business premiums New business contribution
EEV basis – new business contribution after the effect of required capital, tax and minority interest Annual premium equivalent** Present value of new business premiums New business contribution†
† Contribution stated after deducting the effect of required capital, tax and minority interests.
* Restated for the effect of implementing European Embedded Value principles.
Netherlands (including Belgium and Luxembourg) 21 28 * Restated for the effect of implementing European Embedded Value principles.
Further disclosures on experience variances and operating assumption changes are provided on pages 137 and 138.
Life business 1,569 1,522 Equity release 51 31 Non-insurance service and holding companies (34) (75) Fund management service companies 25 18 * Restated for the effect of implementing European Embedded Value principles.
Full year 2004 £m £m £m £m £m £m £m £m £m £m
6. Maintenance expense assumption changes in the UK reflects the benefit of cost saving initiatives coming through.
9. Other operating assumptions in the Netherlands relates to positive changes in asset mix and tax reflecting, in part, the fact that the embedded value of Delta Lloyd was previously assessed using a blended average tax rate of 25%, which is below the local corporation tax rate. The calculation has been refined to tax all future profits at the full corporation tax rate at the beginning of the year of 34.5% and to allow explicitly for the tax benefit arising from investing in the “5% holdings” (investments in Dutch companies where at least 5% of the share capital is owned), on which all investment income is tax free. This change results in a £53 million benefit.
1. Exceptional expenses in the UK reflect one-off project costs including those associated with the pace of regulatory change. In the Netherlands, they relate to project costs in Delta Lloyd Life and development costs in Belgium.
5. In France, there is a £21million charge, mainly resulting from updated expense assumptions, following the revisions to the agreement signed between Aviva and the AFER association. Expense assumptions have been changed primarily in Poland reflecting improvements in efficiency.
6. Changes in the UK reflect expected beneficial mortality experience for protection business.
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 2004 and 2003. 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 from life and related businesses to other segments consists of service company profits and losses during the reported period that have emerged from the value of in-force. Since the “look through” into service companies includes only future profits and losses, these amounts must be eliminated from the closing embedded value.
Embedded value at the beginning of the year – Free surplus 1,721 – Required capital* 4,114
Life EEV return after tax 495 751 1,246 Exchange rate movements 51 68 119 Embedded value of businesses acquired 79 23 102 Amounts injected into life and related businesses 324 – 324 Amounts released from life and related businesses (576) – (576) Transfer to life and related businesses from other segments 48 – 48
Embedded value at the end of the year – Free surplus 1,894 – Required capital* 4,362 * Required capital is shown net of implicit items permitted by local regulators to cover minimum solvency margins.
Embedded value at the beginning of the year 4,616 5,169 9,785
New business contribution (after the effect of required capital) (581) 908 327 Expected return on existing business – return on VIF – 533 533 Expected return on existing business – transfer to net worth 774 (774) – Experience variances and operating assumption changes 147 (157) (10) Expected return on shareholders’ net worth 190 – 190 Investment return variances and economic assumption changes 395 70 465
Embedded value at the end of the year – Free surplus 1,721 – Required capital* 4,114 * Required capital is shown net of implicit items permitted by local regulators to cover minimum solvency margins.
The embedded value of businesses acquired in 2003 of £64 million represents the embedded value of Delta Lloyd ABN AMRO Verzekeringen Holding BV, the insurance company acquired as part of the bancassurance agreement entered into with ABN AMRO NV in the Netherlands.
A lt er na ti ve m et ho d of r ep or ti ng
Netherlands (including Belgium and Luxembourg) 945 509 1,355 (332) 2,477 * Required capital is shown net of implicit items permitted by local regulators to cover minimum solvency margins.
Netherlands (including Belgium and Luxembourg) 1,454 1,267 1,023 1,087 2,477 2,354 * Restated for the effect of implementing European Embedded Value prinicples.
**The movement in the net worth from that previously reported under achieved profits is £146 million at 31 December 2003 and relates to the reclassification of NUER’s VIF from net worth to the present value of future in-force.
The shareholders’ net worth is the market value of the shareholders’ funds and the shareholders’ interest in the surplus held in the non-profit component of the long-term business funds, determined on a statutory solvency basis and adjusted to add back any non-admissible assets. Required capital, net of implicit items, of £4,362 million at 31 December 2004 (31 December 2003: £4,114 million) is included within the net worth.
The increase in the time value of options and guarantees from £232 million at 31 December 2003 to £274 million at 31 December 2004 is primarily due to the 60bp fall in bond yields in continental Europe during the second half of 2004. The overall impact of the lower yields was an increase of £39 million.
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 period. 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. 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.
Investment return assumptions are generally derived by major product class, based on hypothecating the assets at the valuation date. Assumptions about future investment mix are consistent with long-term plans. In most cases, the investment mix is assumed to continue unchanged throughout the projection period. The changes in assumptions between reporting dates reflect the actual movements in risk-free yields in the UK, the Eurozone and other territories. The principal economic assumptions used are as follows: UK France
Risk discount rate 6.4% 7.0% 7.0% Pre-tax investment returns: Base government fixed interest 3.7% 4.3% 4.3%
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 the Europe and International businesses, as these models better reflect the characteristics of the businesses.
Europe and International Model (excluding UK) Government nominal interest rates are generated by a model that projects a full yield curve at annual intervals. The model assumes that the logarithm of the short rate follows a mean reverting process subject to two normally distributed random shocks. This ensures that nominal interest rates are always positive, the distribution of future interest rates remains credible, and the model can be calibrated to give a good fit to the initial yield curve.
Summary statistics The following table sets out the means and standard deviations of future euro returns at 31 December 2004 for the three most significant asset classes: equities, short-term bonds (defined to be of one-year duration) and long-term bonds (defined to be 10 year zero coupon bonds). In the accumulation of 10 year bonds, it is assumed that these are held for one year, sold as nine-year bonds then the proceeds are reinvested in 10-year bonds, although in practice businesses follow more complex asset strategies or tend to adopt a buy and hold strategy. Correlations between asset classes have been set using the same approach as described for the UK.
* 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).
**Standard deviations have been calculated by accumulating a unit investment for the required number of years in each simulation, taking the natural logarithm of the result, calculating the variance of this statistic, dividing by the projection period (n years) and taking the square root. This makes the result comparable to implied volatilities quoted in investment markets.
Other assumptions Taxation Current tax legislation and rates have been assumed to continue unaltered, except where changes in future tax rates have been announced.
Expense assumptions Management expenses and operating expenses of holding companies attributed to life and related businesses have been included in the EEV calculations and split between expenses relating to the acquisition of new business, the maintenance of business in-force and project expenses. Future expense assumptions include an allowance for maintenance expenses and a proportion of recurring project expenses. Certain expenses of an exceptional nature, when they occur, are identified separately and are generally charged as incurred. No future productivity gains have been anticipated. Where subsidiary companies provide administration, investment management or other services to businesses included in the EEV calculations, the value of profits or losses arising from these services have been included in the embedded value and new business contribution.
Sensitivity analysis – economic assumptions The tables below show the sensitivity of the embedded value as at 31 December 2004 and the new business contribution before the effect of required capital for the full year 2004 to: • One percentage point increase and decrease in the discount rates; • One percentage point increase and decrease in interest rates, including all consequential changes (assumed investment returns for all asset classes, market values of fixed interest assets, risk discount rates); • One percentage point increase and decrease in the assumed investment returns for equity and property investments, excluding any consequential changes to the risk discount rate; • 10% rise and fall in market value of equity and property assets (not applicable for new business contribution); and
• Decrease in the level of required capital to 100% EU minimum (or equivalent) (not applicable for new business contribution).
In each sensitivity calculation, all other assumptions remain unchanged except where they are directly affected by the revised economic conditions. For example, future bonus rates are automatically adjusted to reflect sensitivity changes to future investment returns.
Netherlands (including Belgium and Luxembourg) 2,477 250 (230) 310 (310) 85
Sensitivities will also vary according to the current economic assumptions, mainly due to the impact of changes to both the intrinsic cost and time value of options and guarantees. Options and guarantees are the main reason for the asymmetry of the sensitivities, where the guarantee impacts to different extents under the different scenarios. This can be seen in the sensitivity of a 1% movement in the interest rate for the Netherlands, where there is a significant amount of business with investment return guarantees. The reduction of 60 basis points to the assumed pre-tax investment returns at 31 December 2004 has significantly increased the sensitivity, reflecting the level of the guarantees relative to the interest rate assumption.
New business contribution As reported returns returns 2004 £m £m £m
Italy 48 – – Netherlands (including Belgium and Luxembourg) 80 22 (18) Poland 11 – – Spain 143 – – Other 5 – – International 36 – –
Sensitivity analysis – non-economic assumptions The tables below show the sensitivity of the embedded value as at 31 December 2004 and the new business contribution before the effect of required capital for the full year 2004 to the following changes in non-economic assumptions: • 10% decrease in maintenance expenses (a 10% sensitivity on a base expense assumption of £10 pa would represent an expense assumption of £9 pa). Where there is a “look through” into service company expenses, the fee charged by the service company is unchanged while the underlying expense decreases; • 10% decrease in lapse rates (a 10% sensitivity on a base assumption of 5% pa would represent a lapse rate of 4.5% pa); and
In each sensitivity calculation, all other assumptions remain unchanged. 10% decrease in 10% decrease in maintenance 10% decrease in mortality/morbidity Embedded value (net of tax) As reported expenses lapse rates rates 2004 £m £m £m £m
New business contribution (gross of tax) As reported expenses lapse rates rates 2004 £m £m £m £m
We have audited the supplementary information on pages 128 to 145 in respect of the year ended 31 December 2004, which comprises a European Embedded Value basis Summarised profit and loss account, Consolidated statement of total recognised gains and losses, Reconciliation of movements in consolidated shareholders’ funds, Summarised consolidated balance sheet and the related notes and analyses. The supplementary information has been prepared in accordance with the CFO Forum Principles as described on, and using the methodology and assumptions set out on pages 132 to 134. The supplementary information should be read in conjunction with the accounts prepared on the modified statutory solvency basis, which are on pages 64 to 111.
Our responsibilities, as independent auditors, in relation to the supplementary information are established in the UK by the Auditing Practices Board and our profession’s ethical guidance. We report to you our opinion as to whether the supplementary information has been properly prepared in accordance with the European Embedded Value basis. We also report to you if we have not received all the information and explanations we require for our audit of the supplementary information.
Opinion In our opinion, the supplementary information for the year ended 31 December 2004 has been properly prepared in accordance with the European Embedded Value basis, using the methodology and assumptions set out on pages 132 to 134.
Italy Aviva Italia Holding SpA and its principal subsidiaries: Aviva Vita SpA (25.5%) Commercial Union Assicurazioni SpA (50.0%) Commercial Union Life SpA (50.0%) Commercial Union Previdenza Compagnia di Assicurazioni e
Associates and joint ventures The Group has ongoing interests in the following operations that are classified as associates or joint ventures. Further details of those operations that were most significant in 2004 are set out in notes 20 and 21 on pages 80 to 82.
UK RBS Life Investments Limited (49.99%) RBSG Collective Investments Limited (49.99%) The British Aviation Insurance Company Limited (38.1%) The Group also has interests in several UK property limited partnerships. Further details are provided in note 20 on page 30.
For those private shareholders who currently receive dividends paid directly into their bank or building society account, it is now the Company’s practice to issue one consolidated tax voucher each year instead of a voucher with each dividend payment. Shareholders who do not wish to receive this service and wish to continue to receive tax vouchers with each dividend may elect to do so by contacting the Company’s registrar at the address on page 149.
Share dealing facilities The Company has arranged the following services that can be used to buy or sell Aviva shares. Alternatively if shareholders hold a share certificate they can also use any bank, building society or stockbroker offering share dealing facilities. If shareholders are in any doubt about buying or selling their shares they should seek professional financial advice.
Share dealing facilities for UK shareholders/share account members: To buy and sell shares over the telephone or internet shareholders can contact Shareview Dealing, arranged through Lloyds TSB Registrars. For telephone purchases or sales call 0870 850 0852 between 8.30am and 4.30pm, Monday to Friday and for internet purchases or sales log on to www.shareview.co.uk/dealing
To buy or sell shares over the telephone, shareholders can contact Barclays Stockbrokers on 0870 549 3002 (if they hold a share certificate) or 0870 549 3001 (if they hold a share account statement).
NatWest Stockbrokers provide a Share Dealing Service at certain branches for Aviva Share Account holders only. For more information contact NatWest Stockbrokers on 0845 122 0689.
Amalgamating your shares If shareholders received more than one copy of this Annual Report, it may be because Aviva has more than one record of shareholdings in their name. To ensure that shareholders do not receive duplicate mailings in future, they can have all their shares amalgamated into one account by contacting Lloyds TSB Registrars at the address on page 149.
ShareGift The Orr Mackintosh Foundation operates a purely voluntary charity share donation scheme for shareholders who wish to dispose of small numbers of shares whose value makes it uneconomical to sell them. Details of the scheme are available from ShareGift at www.sharegift.org or can be obtained from the Company’s registrar.
Operational highlights • Strong performance in both long-term savings and general insurance businesses • Improved life result; higher new business contribution across all major business units and sustained sales growth in continental Europe • Excellent general insurance result with strong profit growth and a combined operating ratio‡ of 97%, beating our group target • Strong capital position and a significant increase in shareholder funds†
* From continuing operations, including Life European Embedded Value (EEV) operating return before amortisation of goodwill and exceptional items.
‡ Combined operating ratio (COR) broadly expresses the total of claims costs, commission and expenses as a percentage of premiums and is one of our key performance measures. ≠ Including health premium income. # With reference to net premium income from continuing operations. ~ Based on gross worldwide premiums. ≈ Based on gross worldwide premiums, including share of associates’ premiums. All growth rates in this document are quoted at constant rates of exchange.
Group financial calendar for 2005 Annual General Meeting 26 April Announcement of first quarter long-term savings new business figures 28 April Announcement of unaudited six months’ interim results 11 August Announcement of third quarter long-term savings new business figures 27 October