Aviva is the leading insurance brand and customer franchise in the UK. Our combination of life, health and general insurance, together with motoring services from RAC, is unique in its scale and breadth in the UK market. We are the UK’s largest insurer with 19 million customers, and one in three households has a relationship with us. Customers can choose to buy our products through intermediaries, our corporate partners or from Aviva direct and we have become the partner of choice for many of the UK’s biggest organisations. We are ranked as one of the UK’s top ten most valuable brands. In 2010 we delivered a very strong result, with momentum building in profit and sales and improved customer service. We also made good progress in bringing our life and general insurance businesses closer together and were successful in significantly extending our distribution reach. We remain focused on improving efficiency and service across our UK operations as we grow, which will bring benefits to customers and shareholders.
Dividend for 2010 I am happy to report that the final dividend for 2010 will be 16 pence, bringing the total dividend to 25.50 pence, an increase of 6% over 2009. We continue to retain the dividend at a sustainable level for business growth.
We can benefit from the opportunity to transfer key skills and capabilities across the Group
We will build on our expertise as one of the leading partners to banks in order to develop new bancassurance relationships
Operational capital generation Our focus on operational capital generation enabled us to generate £1.7 billion of capital in 2010, up from £1.0 billion in 2009, as we continue to benefit from our combination of life and general insurance businesses. This excludes the impact of the Delta Lloyd longevity assumption changes of £0.2 billion.
Our continued disciplined focus on operational capital generation across our UK businesses resulted in a 85% increase to £973 million
In Spain and Ireland we have offered customers additional peace of mind through innovative product enhancements providing market-leading breast cancer cover.
Delta LloydEurope * On an MCEV basis from 2007. Prior years presented on an EEV basis.
2009 MCEV operating profit has been restated – see Financial Statements MCEV
Aviva Europe: Bridging the pensions gap In 2010 Aviva Europe completed an assessment of the pensions gap across Europe for those retiring between 2011 and 2051. The ‘Mind the Gap’ pensions study shows the difference between: The pension provision needed for an adequate standard of living; and
Strategy Our strategic priorities for the region are focused on driving profitable growth through improving our position and competitiveness in North America: focusing on our customers with compelling value propositions, enhanced service and personalised customer experience improving the profitability and capital generation of the North American region, which is a net capital contributor to the Group selectively expanding and growing our core life insurance and annuity distribution and product capabilities operating as a great underwriting company in our general insurance business building on our strong high-quality relationships with our distribution partners.
Outlook The fundamentals of the Asian markets remain attractive with the region’s economies reverting to pre-crisis levels. The longer-term outlook for our business in Asia remains positive and high growth rates are expected in the medium term, owing to the current low penetration rates of insurance products in many markets, high GDP growth, a growing middle class and ageing populations. By strengthening our multi-channel distribution capability as well as managing our product portfolio for margin and profit, we will be well positioned to continue delivering strong growth in both volumes and margins.
Our history The Group was formed by the merger of CGU plc and Norwich Union plc on 30 May 2000. CGU plc was renamed CGNU plc on completion of the merger, and subsequently renamed Aviva plc on 1 July 2002. CGU plc and Norwich Union plc were both major UK-based insurers operating in the long-term insurance business and general insurance markets. Both companies had long corporate histories. CGU plc was formed in 1998 from the merger of Commercial Union plc and General Accident plc. Hand in Hand, which was incorporated in 1696, was acquired by Commercial Union in 1905, which itself was incorporated in 1861. General Accident plc was incorporated in 1865. Norwich Union plc was founded as a mutual society in 1797 and operated as such until 1997, when it demutualised and became an English public limited company. Between 2000 and 2002 we actively withdrew from lines of business and markets that did not offer the potential for market-leading positions or superior returns, or did not otherwise meet our strategic objectives, principally through the disposal of property and casualty businesses in the UK London Market, the US, Australia, New Zealand and certain European countries. Since 2002, we have grown in part through carefully selected acquisitions, in particular the acquisitions of RAC in 2005 and AmerUs in 2006. During 2009, we disposed of our long-term and savings and wealth management in Australia and through an IPO we sold approximately 42% of our Dutch business, Delta Lloyd. In January 2010 we integrated our life, general insurance and health businesses in the UK under one CEO. We also announced the acquisition of River Road Asset Management, a US equity manager, to support the expansion of Aviva Investors business. Further details of recent acquisitions and disposals can be found in the section ‘Financial statements IFRS – Note 3 – Subsidiaries’.
Market position In the UK we have a market share of 11% based on annual premium equivalent (APE) according to the Association of British Insurers (ABI) quarter three 2010 data. APE is a recognised sales
Products We provide a range of general insurance products focused on personal and commercial customers. We held top three positions in all our major classes of business for 2009, according to Datamonitor, based on gross written premiums. Our general insurance business mix is approximately 60% personal lines and 40% commercial lines. Our general insurance products include personal motor, home, travel, payment protection, commercial motor, commercial property and commercial liability insurance. We also offer a range of breakdown products through the RAC. Our personal motor insurance product range includes cars, motorcycles and vans. For businesses we offer cover for fleets and commercial vehicles. Our home insurance products include building and contents insurance and home emergency cover. Our commercial products focus on insurance for small to medium enterprises and, from 2010, the larger UK corporate risk market. Looking forward we are aiming for controlled expansion in both the corporate risks and specialty lines.
All of these strengths support our efficient, effective, composite insurance model and allow us to pursue growth potential in the underpenetrated markets of Russia and Turkey.
France Business overview and strategy Aviva France is one of the top ten insurance businesses in France, being sixth in life insurance and eighth in general insurance as measured by gross written premiums, according to L’Argus de l’Assurance, as at 31 December 2008. Our life business has a 4.5% market share according to the Fédération Française des Sociétés d’Assurances (FFSA) as at 31 December 2010, based on gross written premiums. Our general insurance business has a 1.9% share of the market as based on 2010 premium income, according to the FFSA, measured by gross written premiums. Our health business has a 2.3% share of the market based on 2008 premium income, also according to the FFSA, measured by gross written premiums. We offer a range of long-term insurance and savings products, primarily for individuals, which focus on the unit-linked market. We have a longstanding relationship with the Association Française d’Epargne et de Retraite (AFER), which is the largest retirement savings association in France with 730,000 members as at 31 December 2010. We have a strong partnership with Crédit Du Nord, operating through 931 bank branches as at 22 September 2010. Aviva France operates through two main companies: Aviva Vie and Antarius. In our general insurance business we predominantly sell personal and small commercial lines insurance products through an agent network and our direct insurer, Eurofil. Our strategy for Aviva France is to continue the diversification and growth of our business and to maintain a high level of profitability. We seek to accomplish these goals through our distribution expertise, innovation of products and services, greater communication and brand visibility.
Products Aviva France provides a wide range of insurance solutions: life and long-term savings, general insurance and asset management through Aviva Investors France. The main products sold through our life channel are long-term savings, pensions and regular premium products and a broad range of protection products. We are the main distributor of the AFER product which is a leading savings product, benefiting from high customer confidence, a strong reputation and strong financial performance. In particular we believe we have developed a reputation for excellence in unitlinked products with on average 50% of our unit-linked funds being first quartile performers in 2009, according to Aviva Investors France.
Distribution Aviva France has developed a multi-distribution model combining retail, direct and bancassurance networks through owned distribution channels, independent networks and partnerships. Our retail networks sell through 870 tied agents, a direct sales force composed of 338 advisors and 662 UFF consultants and more than 1,000 active brokers in the life, health and construction markets. Direct distribution is sold through Eurofil for personal general insurance, Aviva Direct for health and protection and Epargne Actuelle for the AFER product. Eurofil is the second largest direct general insurer and Aviva Direct is the second largest insurer of funeral expense plans in France by number of policies according to the FFSA as at 31 December 2009. We also operate in the bancassurance market through our partnership with Crédit du Nord, a subsidiary of Société Générale selling life, savings, protection and general insurance products. This partnership gives Aviva access to 1.8 million customers, as at 31 December 2010. We also have several partnerships with car manufacturers including Volvo, Ford, Mazda, Mercedes Benz and GM.
Raise capital through the issue of senior unsecured debt. In October 2010, a European Mid-Term Note (EMTN) programme of maximum £2.1 billion (€2.5 billion) was established to increase Delta Lloyd’s financial flexibility. Under this programme £491 million (€575 million) worth of debt was issued in 2010 which will be used for working capital purposes.
The US long-term insurance and annuity market and the Canadian property and casualty insurance market are highly fragmented markets with a large number of insurers. Competitors for the products in which we specialise include global insurers such as Allianz, Royal & Sun Alliance, ING and AEGON. Local market competitors also feature in various product segments. We consider our competitive advantages in the North America region to be: Product innovation combined with a clear customer focus; Quality of distribution partnerships; Sophisticated pricing and underwriting capabilities; Financial strength and performance; and Investment management.
Selected consolidated financial data The following table sets forth our selected consolidated financial data for the periods indicated. This data is derived from our consolidated financial statements prepared in accordance with IFRS as issued by the IASB. The selected consolidated financial data for the five years ended 31 December 2010 has been derived from, and should be read in conjunction with, our audited consolidated financial statements and the related notes in these financial statements.
Financial highlights The following analysis is based on our consolidated financial statements and should be read in conjunction with those statements. In order to fully explain the performance of our business, we discuss and analyse the results of our business in terms of certain financial measures which are based on IFRS ‘non-GAAP measures’ which we use for internal monitoring and for executive remuneration purposes. We review these in addition to GAAP measures such as profit before and after tax.
Adjusted operating profit for non-long-term insurance business is based on expected investment returns on financial investments backing shareholder funds over the period. Expected investment returns are calculated for equities and properties by multiplying the opening market value of the investments, adjusted for sales and purchases during the year, by the longer-term rate of return. This rate of return is the same as that applied for the long-term business expected returns. The longer-term return for other investments is the actual income receivable for the period. Changes due to market value movement and interest rate changes, which give rise to variances between actual and expected investment returns, are disclosed as non-operating items. The impact of changes in the discount rate applied to claims provisions is also treated outside adjusted operating profit. Adjusted operating profit is not a substitute for profit before income taxes and non-controlling interests in earnings or net income as determined in accordance with IFRS. Our definition of adjusted operating profit may differ from similar measures used by other companies, and may change over time. The table below presents our consolidated adjusted operating profit for 31 December 2010, 2009 and 2008, as well as the reconciliation of adjusted operating profit to profit before tax attributable to shareholders’ profits under IFRS.
Economic assumption changes on general insurance and health business (61) 57 (94)
Sales Year ended 31 December 2010 Sales in 2010 were £47,059 million, an increase of £1,991 million, or 4% from £45,068 million in 2009. Sales in the UK increased for both long-term insurance and savings (19% increase on 2009) and general insurance and health (6% increase on 2009). Europe sales were flat at £21,810 million (2009: £21,750 million) with lower sales in Poland, Spain and Delta Lloyd offsetting growth in Italy and other Europe. North America long-term insurance and savings sales increased by 4%, or £183 million, and general insurance sales increased by 9%, or £158 million. Sales in Asia Pacific were down on the prior year by £534 million, or 20%, with the impact of the sale of the Australian life business in 2009 more than offsetting growth in other Asian markets.
Year ended 31 December 2010 Sales in Aviva North America were £6,686 million, an increase of £341 million, or 5% (2009: £6,345 million). Annuity sales in 2010 grew to £3,729 million, slightly above last year’s levels (2009: £3,674 million) reflecting focus on our key distribution partners while balancing productivity, profitability and capital efficiency. Compared to the prior year, our protection sales have increased by 15% to £999 million (2009: £871 million) and account for 21% (2009: 19%) of our total new business sales in the US reflecting our continued focus on business diversification. The US business is now the leading provider of life insurance protection products in the Aviva Group, following the second consecutive year of double digit internally generated growth in this segment. General insurance sales in Canada increased by £158 million, or 9%, to £1,958 million (2009: £1,800 million), benefitting from the impact of foreign exchange, which more than offset a 3% decline on a local currency basis reflecting our actions to eliminate poorly performing personal lines business. Aviva North America’s net written premiums increased by £267 million, or 4%, to £6,443 million (2009: £6,176 million). The increase is a result of higher protection product sales in the US and foreign exchange driven increases in Canada as noted above. Adjusted operating profit was £376 million, an increase of £163 million, or 77% (2009: £213 million). Long-term insurance and savings adjusted operating profit increased 105% to £174 million (2009: £85 million) driven by strong spread management, expense discipline and an improved economic environment. General insurance adjusted operating profit improved 54% in 2010 to £222 million (2009: £144 million) due to improved risk selection, product pricing and cost savings combined with benign weather in the early part of 2010. Aviva North America’s profit before tax attributable to shareholders’ profits was £309 million, a 27% increase (2009: £244 million). The increase is mainly as a result of improved operating results that more than offset short term investment variances in both our life and general insurance businesses.
Year ended 31 December 2010 Aviva Investors’ adjusted operating profit in 2010 was £97 million, a decrease of £18 million from 2009. The reduction in operating profit was as a result of higher than expected redemptions and ongoing investment in the business which is starting to bear fruit as we see an increase in higher margin external assets. During 2010, we re-oriented our business towards more durable, higher margin funds, which resulted in an increased average fee rate on gross external sales, excluding liquidity funds. Profit before tax attributable to shareholders was £61 million, a decrease of £30 million, or 33%, on 2009 (2009: £91 million). Amortisation expenses were higher than 2009, the acquisition of River Road Asset Management resulting in an intangible asset, and restructuring costs were higher than 2009 reflecting the phasing of our business transformation programme. Aviva Investors’ funds under management were £260 billion, an increase of £10 billion, or 4%, on 2009. The increase is a result of capital appreciation and the inclusion of River Road within the 2010 figures, partially offset by the impact of sterling’s appreciation against the euro.
Government UK government 3,497 — — — — — 3,497 UK local authorities 1 — — — — — 1 Non-UK government 1,951 534 777 162 80 11 3,515
Government UK government 2,108 — — — — — 2,108 UK local authorities — 10 — — — 5 15 Non-UK government 10,387 3,627 1,640 596 202 574 17,026 12,495 3,637 1,640 596 202 579 19,149
Sale of assets from investment portfolios, issuing commercial paper Maintain committed borrowing facilities (£2.1 billion) from highly rated banks Regular reviews by the Assets Committee and the Asset Liability Committee
Regulatory capital – Long-term businesses For our non-participating worldwide life assurance businesses, our capital requirements, expressed as a percentage of the EU minimum, are set for each business unit as the higher of: The level of capital at which the local regulator is empowered to take action.
Attracting and retaining talent As a global financial services organisation we recognise our role in finding and building new skills for the workforce, developing a workplace that employees want to join and develop their career with. Delivering on our strategic plans and commitments requires strong leadership and the energy, dedication and belief of all our employees. Over the past three years we have built a strong global HR function to lead our cultural transformation. We have a clear purpose – to bring to life our employee promise to deliver exceptional business performance. We have approached this by implementing strategies designed to: encourage talented people to join Aviva and stay match the right people to the right roles and take action where there are gaps enable people to be the best they can be build pride in Aviva.
Responsibility Index (2009); and Stonewall Workplace Equality Index – ranked 42nd in the top 100 employers in the UK.
Number of employee hours spent volunteering — 67,700 79,900 57,250 Increase the % of employee participation in volunteering
The cost of offsetting the 2010 emissions has, for the first time, been recharged to the areas of business that have created the emissions on a ‘polluter pays’ principle. This is as a result of UK HMRC’s reversal of the VAT applicable to offsets from the voluntary market. This will provide a stronger internal financial driver to reduce emissions within the business. Due to the size and nature of the business operations, Aviva UK will fund the majority of the offsetting process at 54%. In July 2010, the main UK electricity contract for zero emission electricity ended. As the UK government advised in 2008 that the benefit of the related zero emissions are not granted to the purchasing company, we sought the best value grid average electricity contract, taking into account the Climate Change Levy and will, going forwards, purchase carbon offsets to account for the emissions from this. As part of the LEED accreditation process for Aviva US’s new head office, and as renewable electricity was not able to be sourced, Aviva committed to purchasing 4.4 gigawatt hours of Renewable Energy Certificates to compensate for 70% of electricity emissions over the first two years of their building occupancy. With the modification of the UK Carbon Reduction Commitment Energy Efficiency Scheme in which Aviva is included, the climate change levy and the cost of purchasing carbon offsets, we have calculated an internal cost of carbon as set out in the table below: Aviva’s CO2 emissions 000 tonnes CO2 tonnes CO2 offset CO2 tonnes per employee 5, 7, 5, 7, 2, 2, 4, 4, 7, 7,
Simon Machell Chief executive, Aviva Asia Pacific (Age 47) Joined the Group in 1994. Formerly chief executive of Norwich Union Insurance and managing director of RAC plc. Previously held positions with Ernst & Young LLP and Legal & General Group plc. Holds a BA Honours in Economics from the University of Durham and is a Fellow of the Institute of Chartered Accountants of England and Wales.
Share capital and control The issued ordinary share capital of the Company was increased by 53,537,268 ordinary shares during the year. 722,968 shares were allotted under the Group’s employee share and incentive plans and 52,814,300 shares were allotted under the Aviva Scrip Dividend Scheme for the May 2010 and November 2010 dividends. At 31 December 2010 the issued ordinary share capital totalled 2,820,148,642 shares of 25 pence each and the issued preference share capital totalled 200 million shares of £1 each. Accordingly, the issued ordinary share capital constituted 78% of the Company’s total issued share capital and the issued preference share capital constituted 22% of the Company’s total issued share capital at 31 December 2010. All the Company’s shares in issue are fully paid up and the ordinary and preference shares have a premium and standard listing respectively on the London Stock Exchange. The Company is listed on the New York Stock Exchange (NYSE) in the form of American Depositary Shares, referenced to ordinary shares, under a depositary agreement with Citibank. Details of the Company’s share capital and shares under option at 31 December 2010 and shares issued during the year are given in notes 29 to 32 to the consolidated financial statements.
Corporate responsibility The Group has a well-established corporate responsibility programme and continues to use its position to influence other companies to engage in sustainable business practices and to be open and transparent in the information they publicly report. At the 2010 Annual General Meeting, the Company, for the first time, put its Corporate Responsibility Report included in the annual report and accounts, to an advisory vote of shareholders as a means of obtaining feedback on the report and the Company’s performance in this area. This resolution is now put to the Annual General Meeting annually. The report is set out on pages 75 to 92 and details of the resolution are set out in the Notice of AGM.
Michael Hawker AM Mr Hawker has a wealth of industry knowledge with over 24 years of experience in the banking and insurance industry in both executive and non-executive roles in Europe, Asia and Australia. He also has valuable experience of risk committees.
Lord Sharman of Redlynch OBE Lord Sharman has wide ranging international experience in the financial services industry and a wealth of non-executive experience which includes numerous non-executive directorships and the chairmanship of various listed companies. He has an excellent track record of working with and leading diverse international businesses and has applied these skills to his chairmanship of the Company’s Board.
Russell Walls Mr Walls has a strong financial background and a wealth of international business experience in addition to valuable experience of audit committees. With his financial acumen and thorough, common sense approach, he has contributed significantly to the discussions of the Board.
The Board evaluation process assessed the executive directors in their capacities as directors of the Company. They were evaluated in respect of their executive duties through a separate process whereby the chairman and the non-executive directors assessed the group chief executive and the group chief executive assessed the other executive directors. Following this comprehensive review, the directors have concluded that the Board and its committees operate effectively and agreed that the actions in respect of certain processes identified for improvement in previous reviews had been implemented. The Board also agreed to increase focus on the external environment and peer group analysis. Additionally, the chairman has concluded that each director contributes effectively and demonstrates full commitment to his/her duties.
Aviva Investors Aviva Investors, the Group’s core asset management company, considers good governance to play an important role in protecting and enhancing shareholder value. In keeping with the Group’s values, Aviva Investors looks to act as a responsible investor, monitors the governance of the companies in which it invests and seeks to maintain an effective dialogue and engagement with companies on matters which may affect shareholder interests and the future performance of those companies. Aviva Investors applies and complies with the UK Stewardship Code maintained by the Financial Reporting Council and has published detailed Stewardship and Corporate Governance and Voting Policies as part of its investment strategy, which underpin its approach to engaging and voting at company general meetings. These policies encompass social, environmental and ethical issues and are applied pragmatically after careful consideration of all relevant information. In addition, Aviva Investors makes detailed voting reports available to clients, as well as providing some summary reporting on its website, www.avivainvestors.com
Mary Francis (Chairman) 14 January 2006 To date Michael Hawker Leslie Van de Walle
The committee approved the executive directors’ (EDs’) request to freeze their basic salaries for 2010, for the second year in a row.
Comment upon and noting of the EDs’ personal objectives for 2011
Bonus Replacement Deferred Share Award (BRDSA) with a grant value of £283,333, two-thirds of the compensation for the loss of bonus which would have been paid to Mr Regan by Willis Group Holdings Limited for the 2009 financial year.
Other Benefits £1,127 cash car allowance during the year PMI £2,875 in legal fees
Bonus is a function of the degree of achievement of 2010 targets as follows: Financial 40.8% (maximum 50%) Employee 0.9% (maximum 10%) Customer 5.9% (maximum 10%) Personal 26.7% (maximum 30%)
Ordinary Shares, nominal value 25p 2,820 2,766 2,657 27 26 26 8.375% Cumulative Irredeemable Preferred Shares, nominal value £1 100 100 100 — — — 8.75% Cumulative Irredeemable Preferred Shares, nominal value £1 100 100 100 — — — Preferred Shares, nominal value £1 — — — — — — Preferred Shares, nominal value €1 — — — — — —
Related party disclosures Related party transactions For more information relating to related party transactions, including more information about the transactions described below, please see ‘Financial Statements IFRS – Note 60 – Related party transactions’.
Extraordinary market conditions Starting in mid-September 2008, the global financial markets experienced unprecedented disruption, adversely affecting the business environment in general, as well as financial services companies in particular. Markets have improved but continue to be fragile. A return to adverse financial market conditions could significantly affect our ability to meet liquidity needs and obtain capital, although management believes that we have liquidity and capital resources to meet business requirements under current market conditions. At 31 December 2010, total consolidated net cash and cash equivalents amounted to £24,698 million, an increase of £447 million over £24,251 million in 2009. Processes for monitoring and managing liquidity risk, including liquidity stress models, have been enhanced to take into account the extraordinary market conditions, including the impact on policyholder and counterparty behaviour, the ability to sell various investment assets and the ability to raise incremental funding from various sources. Management has taken steps to strengthen liquidity in light of its assessment of the impact of market conditions, such as issuing £200 million long-term subordinated debt in March 2009, and will continue to monitor the situation closely.
Sources of liquidity In managing our cash flow position, we have a number of sources of liquidity, including: dividends from operating subsidiaries; external debt issuance; internal debt and central assets; and funds generated by the sale of businesses.
Determination of the ECR involves the comparison of two separate measurements of the Authorised Firm’s financial resources requirements, which the FSA refers to as the ‘twin peaks’ approach. The two separate peaks are: the requirement comprised by the mathematical reserves plus the ‘long term insurance capital requirement’ (the LTICR), together known as the ‘regulatory peak’; and a calculation of the ‘realistic’ present value of the insurer’s expected future contractual liabilities together with projected ‘fair’ discretionary bonuses to policyholders, plus a risk capital margin, together known as the ‘realistic peak’.
Given our size, and our share of the UK retail market, a major issue within our business which causes concern for the FSA may have a significant impact on these objectives. The FSA therefore aspires to have a ‘close and continuous’ relationship with us, with day-to-day supervision of Aviva conducted by a dedicated team within its Major Retail Groups Division. In practice, this means that a wide range of Group, Regional and UK Business Unit senior managers have regular scheduled ‘close and continuous’ meetings with the FSA, and other meetings and discussions on specific issues take place as the need occurs. This adds up to weekly or even daily FSA interaction at UK Region, Business Unit and Group level. The FSA also periodically conducts a formal Advanced RiskResponsive Operating framework (ARROW) review of Aviva, to assess the level of risk that the Group poses to each of the FSA objectives. The last full risk assessment was conducted in 2009 and the next full risk assessment is due to take place in quarter 3, 2011. Areas of potential risk or weakness, where the FSA particularly requires Aviva to focus attention, are formally set out in a Risk Mitigation Plan (RMP), with both risk assessment and RMP issues up-dated on an ongoing basis between each ARROW review. The FSA has highlighted in its 2010 Business Plan that its key focus areas for 2010/2011 would be: ensuring firms are soundly run, with effective risk management in place, through close scrutiny of corporate governance, financial reporting, remuneration arrangements, recovery and resolution plans, and firms’ ability to identify and mitigate risk.
UK winding up rules The general insolvency laws and regulations applicable to UK companies are modified in certain respects in relation to UK insurance companies, where direct insurance claims will have priority over the claims of other unsecured creditors (with the exception of preferred creditors), including reinsurance creditors, on a winding up by the court or a creditors’ voluntary winding up of the insurance company. Furthermore, instead of making a winding-up order when an insurance company has been proved unable to pay its debts, a UK court may reduce the amount of one or more of the insurance company’s contracts on terms and subject to conditions (if any) which the court considers fit. Where an insurance company is in financial difficulties but not in liquidation, the Financial Services Compensation Scheme may take measures to secure the transfer of all or part of the business to another insurance company. FSMA provides further protection to policyholders of insurance companies effecting or carrying out contracts of longterm insurance. Unless the court orders otherwise, a liquidator and/or administrator must carry on the insurer’s business so far as it consists of carrying out the insurer’s contracts of long-term insurance with a view to it being transferred as a going concern to a person who may lawfully carry out those contracts. In carrying on the business, the liquidator/administrator may agree to the variation of any contracts of insurance in existence when the winding-up order is made, but must not effect any new contracts of insurance.
Difficult conditions in the global capital markets and the economy generally may materially adversely affect our business and results of operations and we do not expect these conditions to improve in the near future. Our results of operations are materially affected by conditions in the global capital markets and the economy generally, in the UK, Europe, the US and elsewhere around the world. The world-wide economic environment remains uncertain. Even though some indicators are beginning to show positive trend there is a risk that the pace of recovery is not sustained, or in a worse case reverses. The path to sustained economic growth remains fragile and uneven and we continue to see levels of market volatility in global capital markets, in both debt and equity. Governments and their central banks are attempting to manage a difficult economic situation. Withdrawal of fiscal stimulus may simply push the world’s economies back into recession, while continued stimulus may lead to unsustainable asset price inflation and higher longterm inflation. The ongoing economic and sovereign concerns still pose several threats that may lead to higher volatility going forward. We cannot predict the level of growth in the global economy, but as with most businesses, we believe a period of weak market growth would have an adverse effect on our business and results of operations. In addition, the fixed-income markets have experienced a period of volatility which has negatively impacted market liquidity conditions. Financial markets remain vigilant to concerns about rising government deficits and debt levels across the globe together with the problems facing the current account deficit (CAD) countries which are also in the Eurozone. Fiscal policy tightening of CAD countries could prolong their recessions. Domestic and international equity markets have also experienced volatility and uncertainty. The type of events and continuing market volatility may have an adverse effect on us, in part because we have a large investment portfolio and are also dependent upon customer behaviour. Our sales are likely to decline in such circumstances and our profit margins could erode. Even in the absence of a market downturn, we are exposed to substantial risk of loss due to market volatility. Although the financial situation has significantly improved since the middle of 2009, markets remain fragile. ‘Financial statements IFRS – Note 5 – Details of income’ and ‘– Note 25 – Financial investments’ include analyses of unrealised and realised investment losses. Factors such as consumer spending, business investment, government spending, the volatility and strength of both debt and equity markets, and inflation all affect the business and economic environment and ultimately, the amount and profitability of our business. In an economic downturn characterised by higher unemployment, lower household income, lower corporate earnings, lower business investment and lower consumer spending, the demand for our financial and insurance products could be adversely affected. In addition, we may experience an elevated incidence of claims or surrenders of policies that could affect the current and future profitability of our business. Although our sales figures have been reasonably consistent with prior years, a prolonged economic crisis could result in lower sales figures in the future. Our policyholders may choose to defer paying insurance premiums or stop paying insurance premiums altogether. These adverse changes in the economy could affect earnings negatively and could have a material adverse effect on our business, results of operations and financial condition.
Falls in property prices could have an adverse impact on our investment portfolio and impact our results of operations and shareholders’ equity. We are subject to property price risk due to holdings of investment properties in a variety of locations worldwide. We are also subject to liquidity, valuation and counterparty risks in relation to property investments. These investments may be adversely affected by weakness in real estate markets in the UK, US and much of the rest of the world and increased mortgage delinquencies. We are also subject to property risk indirectly in our investments in residential mortgage-backed securities (RMBS) and commercial mortgage-backed securities (CMBS). There is the risk that the underlying collateral within our investments in mortgagebacked securities may default on principal and interest payments causing an adverse change in cash flows paid to our investments. In many cases, the markets for these property investments and instruments have become highly illiquid, and issues relating to counterparty credit ratings and other factors have exacerbated pricing and valuation uncertainties.
Interest rate volatility may adversely affect our profitability. Some of our products, principally traditional whole life insurance, term life insurance, universal life insurance and annuities, including fixed and equity indexed annuities, expose us to the risk that changes in interest rates will reduce our ‘spread’, or the difference between the amounts that we are required to pay under the contracts and the rate of return we are able to earn on investments intended to support obligations under the contracts. Our spread is a key component of our net income. As interest rates decrease or remain at low levels, we may be forced to reinvest proceeds from investments that have matured or have been prepaid or sold at lower yields, reducing our investment margin. Moreover, borrowers may prepay or redeem the fixed-income securities, commercial mortgages and mortgage-backed securities in our investment portfolio with greater frequency in order to borrow at lower market rates, which exacerbates this risk. Lowering interest crediting rates can help offset decreases in investment margins on some products. However, our ability to lower these rates could be limited by competition or contractually guaranteed minimum rates and may not match the timing or magnitude of changes in asset yields. As a result, our spread could decrease or potentially become negative. Our expectation for future spreads is an important component in the amortisation of policy acquisition costs and significantly lower spreads may cause us to accelerate amortisation, thereby reducing net income in the affected reporting period. In addition, during periods of declining interest rates, life insurance and annuity products may be relatively more attractive to consumers, resulting in increased premium payments on products with flexible premium features, and a higher percentage of insurance policies remaining in force from year to year, during a period when our new investments carry lower returns. Accordingly, during periods of declining interest rates, our profitability may suffer as the result of a decrease in the spread between interest rates charged to policyholders and returns on our investment portfolio. Increases in market interest rates could also negatively affect our profitability. In periods of rapidly increasing interest rates, we may not be able to replace, in a timely manner, our investments intended to support contracts with higher yielding assets needed to fund the higher crediting rates necessary to keep interest sensitive products competitive. We, therefore, may have to accept a lower spread and, thus, lower profitability or face a decline in sales and greater loss of existing contracts and related assets. In addition, in periods of increasing interest rates, surrenders of life insurance policies and fixed annuity contracts may increase as policyholders choose to forego insurance protection and seek higher investment returns. Obtaining cash to satisfy these obligations may require us to liquidate fixed maturity investments at a time when market prices for those assets are depressed because of increases in interest rates. This may result in realised investment losses. Regardless of whether we realise an investment loss, these cash payments would result in a decrease in total invested assets, and may decrease our net income. Premature withdrawals may also cause us to accelerate amortisation of policy acquisition costs, which would also reduce our net income.
Aviva plc Annual Report and Accounts 2010 Shareholder information continued net assets are denominated in a variety of currencies, of which the largest are the euro, sterling and US dollar. In managing our foreign currency exposures, we do not hedge revenues as these are substantially retained locally to support the growth of the business and meet local regulatory and market requirements. Nevertheless, the effect of exchange rate fluctuations on local operating results could lead to significant fluctuations in our consolidated financial statements upon translation of the results into sterling. Although we take certain actions to address this risk, foreign currency exchange rate fluctuation could materially adversely affect our reported results due to unhedged positions or the failure of hedges to effectively offset the impact of the foreign currency exchange rate fluctuation. Our foreign exchange policy requires that each of our subsidiaries maintain sufficient assets in their local currencies to meet local currency liabilities. However, such movements may impact the value of our consolidated shareholders’ equity, which is expressed in sterling. For a discussion of the impact of changes in foreign exchange rates on our results of operations, see ‘Financial statements IFRS – Note 57 – Risk management’.
Adverse capital and credit market conditions may significantly affect our ability to meet liquidity needs, access to capital and cost of capital. The capital and credit markets have been experiencing volatility and disruption. In some cases, the markets have exerted downward pressure on availability of liquidity and credit capacity for certain issuers. We need liquidity to pay our operating expenses, interest on our debt and dividends on our capital stock, and replace certain maturing liabilities. Without sufficient liquidity, we will be forced to curtail our operations, and our business will suffer. The principal sources of our liquidity are insurance premiums, annuity considerations, deposit funds, cash flow from our investment portfolio and assets, consisting mainly of cash or assets that are readily convertible into cash. Sources of liquidity in normal markets also include a variety of short- and long-term instruments, including repurchase agreements, commercial paper, medium- and long-term debt, junior subordinated debt securities, capital securities and stockholders’ equity. In the event current resources do not satisfy our needs, we may have to seek additional financing. The availability of additional financing will depend on a variety of factors such as market conditions, the general availability of credit, the volume of trading activities, the overall availability of credit to the financial services industry, our credit ratings and credit capacity, as well as the possibility that customers or lenders could develop a negative perception of our long- or short-term financial prospects if we incur large investment losses or if the level of our business activity decreased due to a market downturn. Similarly, our access to funds may be impaired if regulatory authorities or rating agencies take negative actions against us. Our internal sources of liquidity may prove to be insufficient, and in such case, we may not be able to successfully obtain additional financing on favourable terms, or at all. Disruptions, uncertainty or volatility in the capital and credit markets may also limit our access to capital required to operate our business, most significantly our insurance operations. Such market conditions may limit our ability to replace, in a timely manner, maturing liabilities; satisfy statutory capital requirements; generate fee income and market-related revenue to meet liquidity needs; and access the capital necessary to grow our business. As such, we may be forced to delay raising capital, issue shorter-term
We have a significant exposure to annuity business and a significant life insurance risk is associated with longevity. Longevity statistics are monitored in detail, compared with emerging industry trends, and the results are used to inform both the reserving and pricing of annuities. Inevitably there remains uncertainty about the development of future longevity that cannot be mitigated. Our principal longevity risks emanate from markets with a long history of collecting population longevity data, and we study those statistics in detail. We also believe the size of our business means that we have statistically relevant data to make an assessment of the longevity characteristics of our own portfolio. In addition to evaluating current experience the key factor is our assessment of the future rate of improvement in longevity. For this, we analyse trends and study the wide range of papers written on this subject, in reaching our conclusions. A strengthening in the longevity assumption used to calculate our long-term business liabilities would result in an increase in these reserves and reduce significantly our shareholders’ equity. As disclosed in ‘Financial statements IFRS – Note 57 – Risk management’, the impact on profit before tax of a 5% change in annuitant mortality at 31 December 2010 for long-term business would be £355 million loss.
Our valuation of Available For Sale (AFS) Securities and Fair Value (FV) Securities may include methodologies, estimations and assumptions which, by their nature, require judgement. The use of reasonable alternative methodologies, estimations and assumptions could result in changes to investment valuations that may materially adversely affect our results of operations or financial condition. We value our AFS and FV securities using designated methodologies, estimation and assumptions. These securities, which are reported at fair value on the consolidated statement of financial position, represent the majority of our total cash and invested assets. We have categorised the measurement basis for assets carried at fair value into a ‘fair value hierarchy’ in accordance with the valuation inputs and consistent with IFRS7 Financial Instruments: Disclosures. The fair value hierarchy gives the highest priority to quoted prices in active markets for identical assets or liabilities (Level 1); the middle priority to fair values other than quoted prices based on observable market information (Level 2); and the lowest priority to unobservable inputs that reflect the assumptions that we consider market participants would normally use (Level 3). The majority of our financial assets are valued based on quoted market information or observable market data. At 31 December 2010, 4.3% of total financial investments, loans and investment properties at fair value were classified as Level 3, amounting to £12,349 million. Where estimates were used for inputs to Level 3 fair values, these were based on a combination of independent third-party evidence and internally developed models, calibrated to market observable data where possible. An asset or liability’s classification within the fair value hierarchy is based on the lowest level of significant input to its valuation. See ‘IFRS critical accounting policies – Investments’. During periods of market disruption including periods of significantly rising or high interest rates, rapidly widening credit spreads or illiquidity, it may be difficult to value certain of our securities, such as mortgage-backed securities, if trading becomes less frequent and/or market data becomes less observable. There may be certain asset classes that were in active markets with significant observable data that become illiquid due to the current financial environment. In such cases, more securities may fall to Level 3 and thus require more subjectivity and management judgement. As such, valuations may include inputs and assumptions that are less observable or require greater estimation as well as valuation methods which are more sophisticated or require greater estimation thereby resulting in values which may
All of our businesses are subject to operational risks, including the risk of direct or indirect loss resulting from inadequate or failed internal and external processes, systems and human error or from external events. Our business is dependent on processing a large number of complex transactions across numerous and diverse products. Furthermore, the long-term nature of the majority of our business means that accurate records have to be maintained for significant periods. We also outsource several operations, including certain servicing and IT functions and are therefore at least partially reliant upon the operational processing performance of our outsourcing partners. Our systems and processes on which we are dependent to serve our customers are designed to ensure that the operational risks associated with our activities are appropriately identified and addressed; however, they may nonetheless fail due to IT malfunctions, human error, business interruptions, nonperformance by third parties or other external events. This could disrupt business operations resulting in material reputational damage and the loss of customers, and have a consequent material adverse effect on our results. Although we have taken appropriate steps to upgrade systems and processes to reduce these operational risks, we cannot anticipate the specifics or timing of all possible operational and systems failures which may adversely impact our business. Additional detail of the types of operational risks associated with financial reporting is provided below in ‘Compliance with the Sarbanes-Oxley Act entails significant expenditure and managerial attention, and noncompliance with the Sarbanes-Oxley Act may adversely affect us.’
(V) Collateral The Group receives and pledges collateral in the form of cash or non-cash assets in respect of stock lending transactions, as well as certain derivative contracts and loans, in order to reduce the credit risk of these transactions. Collateral is also pledged as security for bank letters of credit. The amount and type of collateral required depends on an assessment of the credit risk of the counterparty. Collateral received in the form of cash, which is not legally segregated from the Group, is recognised as an asset in the statement of financial position with a corresponding liability for the repayment in financial liabilities (note 50). However, where the Group has a currently enforceable legal right of set-off, the collateral liability and associated derivative balances are shown net, in line with market practice. Non-cash collateral received is not recognised in the statement of financial position unless the Group either sells or repledges these assets in the absence of default, at which point the obligation to return this collateral is recognised as a liability. Collateral pledged in the form of cash, which is legally segregated from the Group, is derecognised from the statement of financial position with a corresponding receivable for its return. Non-cash collateral pledged is not derecognised from the statement of financial position unless the Group defaults on its obligations under the relevant agreement, and therefore continues to be recognised in the statement of financial position within the appropriate asset classification.
(260) Other operations and regional costs (220) (214) (168) Corporate centre (143) (108) (772) Group debt costs and other interest (656) (636)
Shares acquired by employee trusts — — — — (14) — — — — — — (14) — — (14)
(b) Reclassification within the statement of cash flows As described in accounting policy A, the Group has adopted the revised versions of IFRS 3, Business Combinations, and IAS 27, Consolidated and Separate Financial Statements, and consequential amendments to several other accounting standards, in its financial reporting for the current accounting period. One such amendment to IAS 7, Statement of Cash Flows, requires cash flows arising from changes in ownership interests in a subsidiary, which do not result in a loss of control, to be classified as cash flows from financing activities, in the same way as other transactions with equity holders. The Group’s partial disposal of Delta Lloyd through its Initial Public Offering in 2009 gave rise to net cash proceeds of £930 million, which was disclosed as arising from investing activities in our consolidated statement of cash flows last year. As a result of the amendment to IAS 7 described above, we have reclassified that amount from investing activities to financing activities in the 2009 comparatives to this year’s statement. This resulted in a change in net cash from investing activities from £498 million inflow to £432 million outflow, and from financing activities from £1,501 million outflow to £571 million outflow.
Assets Acquired value of in-force business — 203 203 Financial investments 2,565 — 2,565 Other investments 161 — 161 Reinsurance assets 304 — 304 Receivables 58 — 58 Prepayments and accrued income 12 — 12 Cash and cash equivalents 767 — 767 Other assets 80 — 80
(iv) Unaudited pro forma combined revenues and profit Shown below are unaudited pro forma figures for combined revenues and profit as though the acquisition date for all business combinations effected during the year had been 1 January 2010, after giving effect to purchase accounting adjustments and the elimination of intercompany transactions. This pro forma financial information is not necessarily indicative of the combined results that would have been attained had the acquisitions taken place at 1 January 2010, nor is it necessarily indicative of future results.
Profit/(loss) before tax 2,848 729 164 (907) 2,834 Tax attributable to policyholder returns (394) — — — (394)
Change in insurance liabilities Change in insurance liabilities 6,270 5,755 Change in reinsurance asset for insurance provisions 907 (73)
Interest expense on core structural borrowings Subordinated debt 290 293 Debenture loans 32 29 Commercial paper 1 13
Aviva plc Annual Report and Accounts 2010 8 – Long-term business economic volatility continued The expected return on equities and properties has been calculated by reference to the 10-year swap rate in the relevant currency plus an appropriate risk margin. These are the same assumptions as are used under MCEV principles to calculate the longer-term investment return for the Group’s long-term business. For fixed interest securities classified as fair value through profit or loss, the expected investment returns are based on average prospective yields for the actual assets held. Where such securities are classified as available for sale, such as in the United States, the expected investment return comprises the expected interest or dividend payments and amortisation of the premium or discount at purchase.
Analysed between: Longer-term investment return, reported within operating profit 1,017 1,085 Short-term fluctuation in investment return, reported outside operating profit General insurance and health (158) 218 Other operations (85) (123) (243) 95
Deferred tax Origination and reversal of temporary differences 505 231 Changes in tax rates or tax laws (40) 2 Write-(back)/down of deferred tax assets (67) 21
(ii) The Group, as a proxy for policyholders in the UK, Ireland, Singapore and Australia (prior to its disposal in 2009), is required to record taxes on investment income and gains each year. Accordingly, the tax benefit or expense attributable to UK, Irish, Singapore and Australian life insurance policyholder returns is included in the tax charge. The tax charge attributable to policyholders’ returns included in the charge above is £394 million (2009: £217 million).
(iii) The calculation of basic earnings per share uses a weighted average of 2,784 million (2009: 2,705 million) ordinary shares in issue, after deducting shares owned by the employee share trusts. The actual number of shares in issue at 31 December 2010 was 2,820 million (2009: 2,767 million) and 2,812 million (2009: 2,749 million) excluding shares owned by the employee share trusts.
This is initially based on the most recent three-year business plans approved by management; Growth rate represents the rate used to extrapolate new business contributions beyond the business plan period, and is based on management’s estimate of future growth of 5% for life and annuity business, which is set with regard to past experience in these markets; and
Aviva plc Annual Report and Accounts 2010 17 – Acquired value of in-force business (AVIF) and intangible assets This note shows the movements in cost and amortisation of the in-force business and intangible assets acquired when we have purchased subsidiaries.
Woori Aviva Life Insurance Co. Ltd is a developing business and the recoverability of value is reliant on future projected growth being achieved. These projections are inherently uncertain and dependent on local economic conditions.
Share of loss after tax (41) (54) — (95) Acquisitions and additions — 175 — 175 Disposals (26) (7) — (33) Fair value gains taken to other comprehensive income — 114 — 114 Dividends received — (22) — (22) Reclassification from investment in subsidiaries — (68) — (68) Foreign exchange rate movements (2) (34) — (36)
(b) Principal associates The principal associates included above are: Company Type of business Class of share Proportion held
These are further analysed as follows: At fair value through profit or loss 210,635 10,506 (8,945) 212,196 Available for sale 26,921 1,479 (1,894) 26,506
Total deferred acquisition costs 5,416 5,316 Surpluses in the staff pension schemes (note 48(e)(vii)) 524 — Other assets 132 305
The Companies Act 2006 abolished the requirement for a company to have an authorised share capital and the articles of association adopted by the Company on 28 April 2010 reflect this. Directors will still be limited as to the number of shares they can at any time allot as the allotment authority continues to be required under the act, save in respect of employee share schemes. Ordinary shares in issue in the Company rank pari passu with any new ordinary shares issued in the Company. All the ordinary shares in issue carry the same right to receive all dividends and other distributions declared, made or paid by the Company. The issue of shares in lieu of cash dividends is considered a bonus issue under the terms of the Companies Act 2006 and the nominal value of the shares is charged to the share premium account.
(v) One Aviva, twice the value bonus plan awards These are conditional awards first granted under the Aviva Annual Bonus Plan 2005 in 2008, and are described in section (b) below and in the Directors’ Remuneration Report.
(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 2010 2009
Aviva plc Annual Report and Accounts 2010 31 – Shares held by employee trusts We satisfy awards and options granted under the Group’s Share Plans primarily through shares purchased in the market and held by employees share trusts. This note gives details of the shares held in these trusts. Movements in the carrying value of shares held by employee trusts comprise: Number £m Number £m
34 – Merger reserve This note analyses the movements in the merger reserve during the year. Movements in the year comprised: £m
Aviva plc Annual Report and Accounts 2010 39 – Insurance liabilities continued Volatility of investment return Volatility assumptions are set with reference to implied volatility data on traded market instruments, where available, or on a best estimate basis where not. These are term-dependent, with specimen values for ten-year terms as follows: Volatility
Assurances Non-profit AM00/AF00 or TM00/TF00 adjusted for smoker status and age/sex specific factors
Carrying amount at 1 January 1,643 1,766 Impact of changes in assumptions 17 (72) Reinsurers’ share of claim losses and expenses Incurred in current year 265 255 Incurred in prior years (46) 7 Reinsurers’ share of incurred claim losses and expenses 219 262 Less: Reinsurance recoveries received on claims Incurred in current year (125) (138) Incurred in prior years (282) (202) Reinsurance recoveries received in the year (407) (340) Unwind of discounting 23 22
The impact of interest rates for long-term business relates primarily to the UK driven by the reduction in interest rates. This had the effect of increasing liabilities and hence a negative impact on profit. The overall impact on profit also depends on movements in the value of assets backing the liabilities, which is not included in this disclosure. The impact of mortality for annuity contracts relates to the exceptional strengthening in the Netherlands, following the publication of new mortality tables, and to smaller changes in the UK. Other assumptions relate mainly to the move to realistic reserving in Ireland, which reduced insurance liabilities, and changes in the UK.
Aviva plc Annual Report and Accounts 2010 46 – Tax assets and liabilities This note analyses the tax assets and liabilities that appear in the statement of financial position, and explains the movements in these balances in the year.
The assumptions above are based on commonly used mortality tables and, in the UK, have been changed to those used by both schemes’ trustees in the most recent full actuarial valuations. The new tables make allowance for observed variations in such factors as age, gender, pension amount, salary and postcode-based lifestyle group, and have been adjusted to reflect recent research into mortality experience. However, the extent of future improvements in longevity is subject to considerable uncertainty and judgement is required in setting this assumption. In the UK schemes, which are by far the most material to the Group, the assumptions include an allowance for future mortality improvement, based on the actuarial profession’s long and medium cohort projection tables (for the ASPS and RAC schemes respectively) and incorporating underpins to the rate of future improvement equal to 1.5% pa for males and 1.0% pa for females. The effect of assuming all members were one year younger would increase the above schemes’ liabilities by £240 million and the service cost for the year by £3 million. The discounted scheme liabilities have an average duration of 18 years in the UK schemes and between 12 and 19 years in the overseas schemes. The undiscounted benefits payable from the main UK defined benefit scheme are expected to be as shown in the chart below: Undiscounted benefit payments £m
The overall rates of return are based on the expected returns within each asset category and on current asset allocations. The expected returns for equities and properties are aligned with the rates used for the longer-term investment return assumptions, other than in the Netherlands, where they have been developed in conjunction with external advisers due to the characteristics of the scheme. The figures for the total expected return on scheme assets in the following section are stated after deducting investment expenses.
Aviva plc Annual Report and Accounts 2010 48 – Pension obligations continued (v) Experience gains and losses The following disclosures of experience gains and losses give a five-year history. Scheme assets exclude insurance policies with Group companies and income on the assets underlying them.
(d) Other loans include €500 million 10.44% subordinated notes due 2019, of which €400 million of the loan was issued by Delta Lloyd Levensverzekering and €100m by Delta Lloyd Schadeverzekering.
Movements in borrowings during the previous year were: Core structural £m Operational £m £m
New borrowings drawn down, net of expenses 2,739 1,521 4,260 Repayment of borrowings (2,546) (1,307) (3,853)
Contractual obligations for future repairs and maintenance on investment properties are £1 million (2009: £1 million). The Group has capital commitments to its joint ventures of £nil (2009: £nil) and to other investment vehicles of £nil (2009: £33 million).
Total liabilities 3,180 23,124 19,410 45,714 63,003 108,717 169,649 278,366 — 278,366 263,643 1. Other sources of capital include Subordinated debt of £4,572 million issued by Aviva and £389 million of other qualifying capital issued by Dutch, Italian, Spanish and US subsidiary undertakings. 2. Including an adjustment for minorities (except for other sources of capital that are reflected net of minority interest). 3. Includes the Provident Mutual with-profit fund. 4. Other operations include general insurance and fund management business. 5. Goodwill and other intangibles includes goodwill of £258 million in joint ventures and associates.
Aviva plc Annual Report and Accounts 2010 57 – Risk management This note sets out the major risks our businesses face and describes the Group’s approach to managing these. It also gives sensitivity analyses around the major economic and non-economic assumptions that can cause volatility in the Group’s earnings and capital requirements.
Aviva plc Annual Report and Accounts 2010 57 – Risk management continued The Group writes unit-linked business in a number of its operations. In unit-linked business, the policyholder bears the investment risk on the assets held in the unit-linked funds, as the policy benefits are directly linked to the value of the assets in the fund. The shareholders’ exposure to market risk on this business is limited to the extent that income arising from asset management charges is based on the value of assets in the fund.
Other investments Other investments include: £32,520 million of unit trusts and other investment vehicles. The underlying credit ratings of these assets are not reflected in this analysis.
Aviva plc Annual Report and Accounts 2010 57 – Risk management continued Where any decision to adopt a position in respect of policyholder assets and liabilities is not closely matched but is within the business unit’s investment risk appetite, the impact is monitored through our economic capital measurement process. The decision taken must be justified to the local management board and Group management by a full analysis of the impact of the level of mismatch on both risk and return. ALM strategy may be determined at a sub-fund level for a block of closely related liabilities. Alternatively, if ALM strategy is determined at a fund or company level, it will usually be appropriate (for pricing, financial reporting and risk management purposes) to develop a hypothecation of assets to notional sub-funds with different liability characteristics. It is for this reason that Group Risk provides a framework of corporate objectives within which the operating businesses develop specific and appropriate ALM methodologies, to seek to ensure that our businesses have sufficient liquidity to settle claims as they are expected to arise. ALM modelling is based on a projection of both assets and liabilities into the future. A further tenet of our risk management strategy involves investment strategies, which also take into account the accounting, regulatory, capital and tax issues. The ALM strategy also takes into account the reasonable expectations of policyholders, local best practice and meets relevant regulatory requirements. Our investment strategies are designed to seek to ensure that sufficient liquidity exists in extreme business scenarios. For example, our investment strategy must consider a scenario of high lapses accompanied by poor investment markets or a general insurance catastrophe event.
(i) Analysis of maturity of insurance and investment contract liabilities For non-linked insurance business, the following table shows the gross liability at 31 December 2010 analysed by remaining duration. The total liability is split by remaining duration in proportion to the cash-flows expected to arise during that period, as permitted under IFRS 4, Insurance Contracts. Almost all investment contracts may be surrendered or transferred on demand. For such contracts, the earliest contractual maturity date is therefore the current statement of financial position date, for a surrender amount approximately equal to the current statement of financial position liability. We expect surrenders, transfers and maturities to occur over many years, and the tables reflect the expected cash flows for non-linked investment contracts. However, contractually, the total liability for non-linked investment contracts of £63,197 million (2009: £59,504 million) would be shown in the ‘within 1 year’ column below. Unit-linked contracts are repayable or transferable on demand and are therefore shown in the ‘within 1 year’ column.
Long-term business Insurance contracts – non-linked 123,933 10,139 38,549 45,181 30,064 Investment contracts – non-linked 59,504 4,304 12,562 24,119 18,519 Linked business 80,206 80,206 — — — General insurance and health 17,484 7,215 6,936 2,865 468
Managed by: Aviva Investors 259,787 249,630 Other Aviva and external managers 142,464 129,781
(iii) Pension costs The Company is one of a number of UK companies being charged for its employees participating in the Aviva Staff Pension Scheme, and its contributions are affected by the financial position of the scheme. There is no contractual agreement or policy for charging the net defined benefit cost for this scheme across the participating Group entities but, instead, this cost is recognised in the financial statements of the main UK employing company. The Company therefore recognises a pension expense equal to its contributions payable in the year for its staff, together with the service cost of any unfunded benefits, within staff costs above. Full disclosure on the Group’s pension schemes is given in the Group consolidated financial statements, note 48.
(220) Amortisation and impairment of intangibles (187) (135) 187 Profit on the disposal of subsidiaries and associates 159 72
(217) Minority share of dividends declared in the year (187) (109) 3 Non-controlling interest in (disposed)/acquired subsidiaries 3 (2)
Condensed consolidated statement of financial position – MCEV basis As at 31 December 2010 £m
(37) Shares held by employee trusts (32) (68) 6,292 Retained earnings 5,411 3,425 3,113 Additional retained earnings on an MCEV basis1 2,677 2,523 17,784 Equity attributable to ordinary shareholders of Aviva plc 15,295 13,092 1,384 Preference share capital and direct capital instruments 1,190 1,190 4,624 Non-controlling interests1 3,977 4,279
(31 December 2009: £(1,484) million). 2. Comprises embedded value of £16,131 million (31 December 2009: £15,058 million) and non-controlling interest in long-term business assets of £3,133 million (31 December 2009: £3,480million).
Value of new business 247 169 12 124 55 151 10 521 (48) 473 16 11 18 29 765 Earnings from existing business
Operating MCEV earnings 694 568 937 2,199 Economic variances (175) 103 228 156 Other non-operating variances2 (59) — (458) (517)
E11 – Post-tax internal rate of return and payback period on life and pensions new business The new business written requires up-front capital investment, due to high set-up costs and capital requirements. The internal rate of return (IRR) is a measure of the shareholder return expected on this capital investment. It is equivalent to the discount rate at which the present value of the post-tax cash flows expected to be earned over the lifetime of the business written, including allowance for the time value of options and guarantees, is equal to the total invested capital to support the writing of the business. The capital included in the calculation of the IRR is the initial capital required to pay acquisition costs and set up statutory reserves in excess of premiums received (initial capital), plus required capital at the same level as for the calculation of the value of new business. The payback period shows how quickly shareholders can expect the total capital to be repaid. The payback period has been calculated based on undiscounted cash flows and allows for the initial and required capital. The projected investment returns in both the IRR and payback period calculations assume that equities, properties and bonds earn a return in excess of risk-free consistent with the long-term rate of return assumed in operating earnings. The IRR on life and pensions new business for the Group was 12.5% (2009: 10.0%).
United Kingdom 2,938 (291) (322) (28) 2,297 France 2,051 (123) (170) (312) 1,446 Ireland 476 (9) (23) — 444 Italy 156 (19) (11) (44) 82 Poland 1,013 (14) (118) (5) 876 Spain 281 (18) (41) (15) 207 Other Europe 247 (3) (9) (2) 233 Aviva Europe 4,224 (186) (372) (378) 3,288 Delta Lloyd 580 (107) (85) (192) 196 Europe 4,804 (293) (457) (570) 3,484 North America 607 (133) (69) (363) 42 Asia Pacific 441 (26) (58) (32) 325
Risk premium – used for operating profit, Implied Discount Rates (IDR), Internal Rates of Return (IRR) and payback period For life and pensions operating earnings, Aviva uses normalised investment returns. The normalised investment returns are expressed as a swap rate based on the typical duration of the assets held plus an asset risk premium. More detail is given in note E1 – Basis of preparation. The use of asset risk premia only impacts operating earnings as expected returns reflect management’s long-term expectations of asset returns in excess of the reference rate from investing in different asset classes. This assumption does not impact the embedded value or value of new business as asset risk premia are not recognised until earned. The asset risk premia set out in the table below are added to the ten year swap rate to calculate expected returns.
E18 – Principal assumptions continued Model – United Kingdom, Europe (excluding Delta Lloyd) and Asia Pacific Swap rates are generated by a model, the LIBOR Market Model (LMM), that projects a full swap curve at monthly intervals. Forward rates are assumed to have a log-normal distribution which guarantees non-negative interest rates. The model is calibrated to at-themoney swaptions of a variety of terms and tenors. Swaption volatilities are taken from SuperDerivatives. Tests have been performed to ensure that sufficient scenarios have been used that the result converges to the stochastic value of the business being valued. The total annual return on equities is calculated as the return on one-year swaps plus an excess return. This excess return is generally modelled using a log-normal model where volatility varies by time horizon. This allows the model to capture the term structure of implied volatilities. The model is calibrated to at-the-money options of a variety of terms. For the UK, a two-dimensional model is used to capture the term structure of implied volatilities and the projected in the money position. Option volatilities are taken from Markit. The model also generates property total returns and real yield curves, although these are not significant asset classes for Aviva outside the UK. In the absence of liquid market data, the volatilities of these asset classes are based on historic data. Assumptions for correlations between asset classes have been set based on historic data.
Statement of directors’ responsibilities in respect of the Market Consistent Embedded Value (MCEV) basis When compliance with the European Insurance CFO Forum Market Consistent Embedded Value Principles (MCEV Principles), published in October 2009, is stated, those principles require the directors to prepare supplementary information in accordance with the methodology contained in the MCEV Principles and to disclose and explain any non-compliance with the guidance included in the MCEV Principles. In preparing this supplementary information, the directors have done so in accordance with these MCEV Principles and have also fully complied with all the guidance included therein. Specifically, the directors have: determined assumptions on a realistic basis, having regard to past, current and expected future experience and to relevant external data, and then applied them consistently; made estimates that are reasonable and consistent; and, provided additional disclosures when compliance with the specific requirements of the MCEV Principles is insufficient to enable users to understand the impact of particular transactions, other events and conditions and the Group’s financial position and financial performance.
Independent auditor’s report to the directors of Aviva plc on the consolidated Market Consistent Embedded Value (MCEV) financial statements We have audited the consolidated MCEV financial statements of Aviva plc for the year ended 31 December 2010 which comprise the Condensed Consolidated Income Statement – MCEV basis, the Condensed Consolidated Statement of Comprehensive Income – MCEV basis, the Condensed Consolidated Statement of Changes in Equity – MCEV basis, the Condensed Consolidated Statement of Financial Position – MCEV basis, the Reconciliation of Shareholders’ Equity on IFRS and MCEV bases, the Reconciliation of IFRS Total Equity to MCEV Net Worth, the Group MCEV Analysis of Earnings and the related notes E1 to E19. The financial reporting framework that has been applied in the consolidated MCEV financial statements is the Market Consistent Embedded Value Principles issued in June 2008 by the CFO Forum as amended in October 2009 (the MCEV Principles) and the basis of preparation set out on pages 321 to 324. We have reported separately on the statutory Group financial statements of Aviva plc for the year ended 31 December 2010. The information contained in the consolidated MCEV financial statements should be read in conjunction with the financial statements prepared on an IFRS basis. This report is made solely to the Company in accordance with our engagement letter dated 4 August 2010. 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 to anyone other than the Company for our audit work, for this report, or for the opinions we have formed.
‘Hard’ insurance market A term used to describe the state of the general insurance market. A “hard” insurance market is characterised by high levels of underwriting profits and the ability of insurers to charge high premium rates. Hard insurance markets generally occur when capital is scarce and are the opposite of “soft” insurance markets.
1–1,000 548,877 91.66 151,469,464 5.37 1,001–5,000 47,710 7.52 89,477,091 3.17 5,001–10,000 2,933 0.41 20,374,662 0.72 10,001–250,000 1,997 0.30 90,938,140 3.23 250,001–500,000 188 0.03 68,921,413 2.45 500,001 and above 462 0.08 2,390,194,136 84.75 American Depositary Receipts (ADRs) 1 0.00 8,773,736+ 0.31
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