Preliminary results - 12 months ended 31 December 2006 01 March 2007
Appendix B
FRS 27 disclosures
The following additional disclosures have been extracted from the Group's 2006 Report and Accounts.
Movements in insurance liabilities
(i) Movements in long-term business provisions
The long-term business provision is calculated separately for each of the Group’s life operations. The provisions for overseas subsidiaries have generally been included on the basis of local regulatory requirements, mainly using the net premium method, modified where necessary to reflect the requirements of the Companies Acts.
Material judgement is required in calculating the provisions and is exercised particularly through the choice of assumptions where there is discretion over these. In turn, the assumptions used depend on the circumstances prevailing in each of the life operations. Provisions are most sensitive to assumptions regarding discount rates and mortality/morbidity rates.
Bonuses paid during the year are reflected in claims paid, whilst those allocated as part of the bonus declaration are included in the movements in the long-term business provision, as detailed below.
The following movements have occurred in the long-term business provisions during the year:
| 2006 £m | 2005 £m | |
|---|---|---|
| Carrying amount at 1 January | 114,430 | 106,491 |
| Provisions in respect of new business | 8,750 | 6,589 |
| Expected change in existing business provisions | (5,678) | (2,703) |
| Variance between actual and expected experience | 1,209 | 3,784 |
| Effect of adjusting to PS06/14 realistic basis | (800) | – |
| Impact of other operating assumption changes | (333) | (1,034) |
| Impact of economic assumption changes | (1,727) | 2,411 |
| Other movements | 314 | 340 |
| Change in liability recognised as an expense | 1,735 | 9,387 |
| Effect of portfolio transfers, acquisitions and disposals | 12,454 | (360) |
| Foreign exchange rate movements | (2,005) | (684) |
| Other movements | – | (404) |
| Carrying amount at 31 December | 126,614 | 114,430 |
The impact on existing business of implementing FSA Policy Statement 06/14, Prudential Changes for Insurers, in 2006 is £132 million, arising mainly on expenses and persistency rates in both insurance and investment contracts. This is reflected in reductions in insurance contract liabilities of £800 million, investment contract liabilities of £105 million, reinsurance recoveries of £ 502 million and deferred acquisition costs of £271 million. The impact on new business in 2006 is £17 million, giving a total increase in pre-tax profit for the year of £149 million.
(ii) Movements in general insurance and health claims provisions
Delays occur in the notification and settlement of claims and a substantial measure of experience and judgement is involved in assessing outstanding liabilities, the ultimate cost of which cannot be known with certainty at the balance sheet date. The reserves for general insurance and health are based on information currently available; however, it is inherent in the nature of the business written that the ultimate liabilities may vary as a result of subsequent developments.
The following changes have occurred in the general insurance and health claims provisions during the year:
| 2006£m | 2005£m | |
|---|---|---|
| Carrying amount at 1 January | 12,965 | 12,750 |
| Impact of changes in assumptions | 2 | (6) |
| Claim losses and expenses incurred in the current year | 7,639 | 7,124 |
| Decrease in estimated claim losses and expenses incurred in prior years | (550) | (372) |
| Incurred claims losses and expenses | 7,091 | 6,746 |
| Less: | ||
| Payments made on claims incurred in the current year | (3,765) | (3,379) |
| Payments made on claims incurred in prior years | (3,771) | (3,407) |
| Recoveries on claim payments | 304 | 263 |
| Claims payments made in the year, net of recoveries | (7,232) | (6,523) |
| Other movements in the claims provisions | (7) | (9) |
| Changes in claims reserve recognised as an expense | (148) | 214 |
| Gross portfolio transfers, acquisitions and disposals | 207 | (153) |
| Foreign exchange rate movements | (306) | 146 |
| Other gross movements | – | 8 |
| Carrying amount at 31 December | 12,718 | 12,965 |
Long-term business investment liabilities
Investment contracts are those that do not transfer significant insurance risk from the contract holder to the issuer, and are therefore treated as financial instruments under IFRS.
Many investment contracts contain a discretionary participation feature in which the contract holder has a contractual right to receive additional benefits as a supplement to guaranteed benefits and are referred to as participating contracts. They are not measured at fair value as there is currently no agreed definition of fair valuation for discretionary features under IFRS. In the absence of such a definition, it is not possible to provide a range of estimates within which a fair value is likely to fall. The IASB has deferred consideration of participating contracts to Phase ll of its insurance contracts project.
For participating business, the discretionary participation feature is recognised separately from the guaranteed element and is classified as a liability, referred to as unallocated divisible surplus.
Investment contracts that do not contain a discretionary participation feature are referred to as non-participating contracts and the liability is measured at either fair value or amortised cost.
Most non-participating investment contracts measured at fair value are unit-linked in structure and the fair value liability is equal to the unit reserve plus additional non-unit reserves if required on a fair value basis. For this business, a deferred acquisition cost asset and deferred income reserve liability are recognised in respect of transaction costs and front-end fees respectively, that relate to the provision of investment management services, and which are amortised on a systematic basis over the contract term.
In the United States, funding agreements consist of one to ten year fixed rate contracts. These contracts may not be cancelled by the holders unless there is a default under the agreement, but may be terminated by Aviva at any time. The weighted average interest rates for fixed-rate and floating-rate funding agreements in 2006 were 5.07% and 5.55%, respectively. The funding agreements are measured at fair value equal to the present value of contractual cash flows.
There is a small volume of annuity certain business for which the liability is measured at amortised cost using the effective interest method. The fair value of contract liabilities measured at amortised cost is not materially different from the amortised cost liability.
Movements in the year
The following movements have occurred in the year:
(i) Participating investment contracts
| 2006 £m | 2005 £m | |
|---|---|---|
| Carrying amount at 1 January | 47,258 | 43,974 |
| Provisions in respect of new business | 3,001 | 3,467 |
| Expected change in existing business provisions | (2,237) | (1,720) |
| Variance between actual and expected experience | 2,131 | 2,034 |
| Effect of adjusting to PS06/14 realistic basis | (105) | – |
| Impact of other operating assumption changes | (43) | 5 |
| Impact of economic assumption changes | (125) | 513 |
| Other movements | 51 | (153) |
| Change in liability | 2,673 | 4,146 |
| Effect of portfolio transfers, acquisitions and disposals | 125 | 4 |
| Foreign exchange rate movements | (656) | (856) |
| Other movements | – | (10) |
| Carrying amount at 31 December | 49,400 | 47,258 |
(ii) Non-participating investment contracts
| 2006 £m | 2005 £m | |
|---|---|---|
| Carrying amount at 1 January | 30,051 | 25,581 |
| Provisions in respect of new business | 5,695 | 5,247 |
| Expected change in existing business provisions | (163) | 936 |
| Variance between actual and expected experience | 265 | (1,732) |
| Impact of operating assumption changes | 15 | 2 |
| Impact of economic assumption changes | (5) | – |
| Other movements | 56 | 93 |
| Change in liability | 5,863 | 4,546 |
| Effect of portfolio transfers, acquisitions and disposals | 3,396 | – |
| Foreign exchange rate movements | (352) | (76) |
| Carrying amount at 31 December | 38,958 | 30,051 |
Loss development tables
The following table presents the development of claim payments and the estimated ultimate cost of claims for the accident years 2001 to 2006. The upper half of the table shows the cumulative amounts paid during successive years related to each accident year. For example, with respect to the accident year 2002, by the end of 2006 £5,297 million had actually been paid in settlement of claims. In addition, as reflected in the lower section of the table, the original estimated ultimate cost of claims of £6,037 million was re-estimated to be £5,912 million at 31 December 2006. This decrease from the original estimate is due to the combination of a number of factors. The original estimates will be increased or decreased, as more information becomes known about the individual claims and overall claim frequency and severity.
In 2005, the year of adoption of IFRS, only five years were required to be disclosed. This will be increased in each succeeding additional year, until ten years of information is included.
The Group aims to maintain strong reserves in respect of its non-life and health business in order to protect against adverse future claim experience and development. As claims develop and the ultimate cost of claims become more certain, the absence of adverse claims experience will then result in a release of reserves from earlier accident years, as shown in the loss development table. However, in order to maintain strong reserves the Group transfers much of this release to current accident year (2006) reserves where the development of claims is less mature and there is much greater uncertainty attaching to the ultimate cost of claims. The release from prior accident year reserves during 2006 is also due to an improvement in the estimated ultimate cost of claims.
After the effect of reinsurance the loss development table is:
| Accident Year | All prior years£m | 2001£m | 2002£m | 2003£m | 2004£m | 2005£m | 2006£m | Total£m |
|---|---|---|---|---|---|---|---|---|
| Net cumulative claim payments | ||||||||
| At end of accident year | (2,970) | (2,913) | (2,819) | (2,870) | (3,281) | (3,612) | ||
| One year later | (4,624) | (4,369) | (4,158) | (4,378) | (4,925) | |||
| Two years later | (5,088) | (4,779) | (4,565) | (4,712) | ||||
| Three years later | (5,436) | (5,064) | (4,924) | |||||
| Four years later | (5,648) | (5,297) | ||||||
| Five years later | (5,763) | |||||||
| Estimate of net cumulative claims | ||||||||
| At end of accident year | 6,186 | 6,037 | 6,218 | 6,602 | 6,982 | 7,430 | ||
| One year later | 6,333 | 6,038 | 6,093 | 6,266 | 6,818 | |||
| Two years later | 6,321 | 5,997 | 6,037 | 6,082 | ||||
| Three years later | 6,329 | 5,973 | 5,942 | |||||
| Four years later | 6,286 | 5,912 | ||||||
| Five years later | 6,219 | |||||||
| Estimate of cumulative claims | 6,219 | 5,912 | 5,942 | 6,082 | 6,818 | 7,430 | ||
| Cumulative payments | (5,763) | (5,297) | (4,924) | (4,712) | (4,925) | (3,612) | ||
| 1,884 | 456 | 615 | 1,018 | 1,370 | 1,893 | 3,818 | 11,054 | |
| Effect of discounting | (15) | (4) | (4) | (5) | (3) | (4) | (8) | (43) |
| Present value | 1,869 | 452 | 611 | 1,013 | 1,367 | 1,889 | 3,810 | 11,011 |
| Cumulative effect of foreign exchange movements | – | (7) | (7) | (10) | (15) | (53) | – | (92) |
| Effect of acquisitions | – | – | 1 | 4 | 7 | 34 | 15 | 61 |
| Present value recognised in the balance sheet | 1,869 | 445 | 605 | 1,007 | 1,359 | 1,870 | 3,825 | 10,980 |
In the loss development table shown above, the cumulative claim payments and estimates of cumulative claims for each accident year are translated into sterling at the exchange rates that applied at the end of that accident year. The impact of using varying exchange rates is shown at the bottom of the table. Disposals are dealt with by treating all outstanding and IBNR claims of the disposed of entity as “pai ” at the date of disposal.
The table also includes information on asbestos and environmental pollution claims provisions from business written before 2001. The claims provisions, net of reinsurance, in respect of this business were £312 million (2005: £289 million). The movement in the year reflects strengthening of the provisions by £9 million (2005: £83 million) and timing differences between claim payments and reinsurance recoveries.
Sensitivity analysis and capital management
The Group uses a number of sensitivity test-based risk management tools to understand the volatility of earnings, the volatility of its capital requirements, and to manage its capital more efficiently. Primarily EEV, Financial Condition Reporting (a medium term projection of the financial health of the business under a variety of economic and operating scenarios), and increasingly Individual Capital Assessment (ICA) are used. Sensitivities to economic and operating experience are regularly produced on all of the Group’s financial performance measurements as part of the Group’s decision making and planning process, and as part of the framework for identifying and quantifying the risks that each of its business units, and the Group as a whole are exposed to.
For long-term business in particular, sensitivities of EEV performance indicators to changes in both economic and non-economic experience are continually used to manage the business and to inform the decision making process. More information on EEV sensitivities can be found in the presentation of results in the EEV section of this announcement.
Life insurance and investment contracts The nature of long-term business is such that a number of assumptions are made in compiling the financial statements. Assumptions are made about investment returns, expenses, mortality rates, and persistency in connection with the in-force policies for each business unit. Assumptions are best estimates based on historic and expected experience of the business.
General insurance and health business General insurance and health claim liabilities are estimated by using standard actuarial claims projection techniques. These methods extrapolate the claims development for each accident year based on the observed development of earlier years. In most cases, no explicit assumptions are made as projections are based on assumptions implicit in the historic claims development on which the projections are based. As such, in the analysis below, the sensitivity of general insurance claim liabilities is primarily based on the financial impact of changes to the reported loss ratio.
Some results of sensitivity testing for long-term business and general insurance and health business are set out below. For each sensitivity test the impact of a change in a single factor is shown, with other assumptions left unchanged.
| Sensitivity Factor | Description of sensitivity factor applied |
|---|---|
| Interest rate & investment return | The impact of a change in market interest rates by ± 1% (e.g. if a current interest rate is 5%, the impact of an immediate change to 4% and 6%). The test allows consistently for similar changes to investment returns and movements in the market value of backing fixed interest securities. |
| Equity / property market values | The impact of a change in equity/property market values by ± 10% |
| Expenses | The impact of an increase in maintenance expenses by 10% |
| Assurance mortality/morbidity (life insurance only) | The impact of an increase in mortality/morbidity rates for assurance contracts by 5% |
| Annuitant mortality (life insurance only) | The impact of a reduction in mortality rates for annuity contracts by 5% |
| Gross loss ratios (non-life insurance only) | The impact of an increase in gross loss ratios for general insurance and health business by 5% |
The above sensitivity factors are applied using actuarial and statistical models, with the following pre-tax impacts on profit and shareholders’ equity at 31 December 2006:
Long-term business
Impact on profit before tax (£m)
| Interest rates +1% | Interest rates-1% | Equity / property +10% | Equity / property -10% | Expenses+10% | Assurance mortality+5% | Annuitant mortality-5% | |
|---|---|---|---|---|---|---|---|
| Insurance participating | (5) | - | 35 | (35) | (5) | - | (5) |
| Insurance non-participating | 25 | (210) | 110 | (130) | - | (20) | (295) |
| Investment participating | (30) | (35) | 10 | (10) | (5) | - | - |
| Investment non-participating | (15) | 15 | 40 | (40) | - | - | - |
| Assets backing life shareholders' funds | (280) | 305 | 60 | (60) | - | - | - |
| Total | (305) | 75 | 255 | (275) | (10) | (20) | (300) |
Impact before tax on shareholders’ equity (£m)
| Interest rates +1% | Interest rates-1% | Equity / property +10% | Equity / property -10% | Expenses+10% | Assurance mortality+5% | Annuitant mortality-5% | |
|---|---|---|---|---|---|---|---|
| Insurance participating | (25) | 25 | 35 | (35) | (5) | - | (5) |
| Insurance non-participating | (240) | 60 | 125 | (140) | - | (20) | (295) |
| Investment participating | (30) | (35) | 10 | (10) | (5) | - | - |
| Investment non-participating | (70) | 70 | 40 | (40) | - | - | - |
| Assets backing life shareholders' funds | (320) | 345 | 95 | (95) | - | - | - |
| Total | (685) | 465 | 305 | (320) | (10) | (20) | (300) |
Sensitivities as at 31 December 2005
Impact on profit before tax (£m)
| Interest rates +1% | Interest rates-1% | Equity / property +10% | Equity / property -10% | Expenses +10% | Assurance mortality +5% | Annuitant mortality-5% | |
|---|---|---|---|---|---|---|---|
| Insurance participating | 5 | (35) | 35 | (35) | (5) | - | - |
| Insurance non-participating | 60 | (350) | 105 | (120) | (5) | (30) | (295) |
| Investment participating | 10 | (50) | 10 | (10) | - | - | - |
| Investment non-participating | - | - | 35 | (35) | - | - | - |
| Assets backing life shareholders' funds | (225) | 240 | 65 | (65) | - | - | - |
| Total | (150) | (195) | 250 | (265) | (10) | (30) | (295) |
Impact before tax on shareholders’ equity (£m)
| Interest rates +1% | Interest rates-1% | Equity / property +10% | Equity / property -10% | Expenses+10% | Assurance mortality+5% | Annuitant mortality-5% | |
|---|---|---|---|---|---|---|---|
| Insurance participating | (10) | (20) | 35 | (35) | (5) | - | - |
| Insurance non-participating | 20 | (305) | 120 | (135) | (5) | (30) | (295) |
| Investment participating | (10) | (25) | 10 | (10) | - | - | - |
| Investment non-participating | (5) | - | 35 | (35) | - | - | - |
| Assets backing life shareholders' funds | (240) | 255 | 90 | (90) | – | – | – |
| Total | (245) | (95) | 290 | (305) | (10) | (30) | (295) |
Changes in sensitivities between 2005 and 2006 arise primarily from the acquisitions of Ark Life and AmerUs, and the effect of increases in market interest rates. The different impacts of the economic sensitivities on profit and shareholders' equity arise from classification of certain assets as available for sale in some business units, for which movements in unrealised gains or losses would be taken directly to shareholders' equity. The economic impacts on profit before tax for insurance contracts relate mainly to the effect of minimum return guarantees in the Netherlands. However in the case of the interest rate sensitivities, the impacts on shareholders' equity are more than offset by the effect of changes in the market value of fixed interest securities in the United States that are classified as available for sale.
The mortality sensitivities relate primarily to the UK and Ireland.
The impact on the Group’s results from sensitivity to these assumptions can also be found in the EEV sensitivities included in the EEV section of this announcement.
General insurance and health business
Sensitivities as at 31 December 2006
Impact on profit before tax (£m)
| Interest rates +1% | Interest rates -1% | Equity / property +10% | Equity / property -10% | Expenses +10% | Gross loss ratios +5% | |
|---|---|---|---|---|---|---|
| Net of reinsurance | (270) | 290 | 370 | (370) | (140) | (325) |
Impact before tax on shareholders’ equity (£m)
| Interest rates +1% | Interest rates -1% | Equity / property +10% | Equity / property -10% | Expenses +10% | Gross loss ratios +5% | |
|---|---|---|---|---|---|---|
| Net of reinsurance | (270) | 290 | 370 | (370) | (35) | (325) |
Sensitivities as at 31 December 2005
Impact on profit before tax (£m)
| Interest rates +1% | Interest rates -1% | Equity / property +10% | Equity / property -10% | Expenses +10% | Gross loss ratios +5% | |
|---|---|---|---|---|---|---|
| Net of reinsurance | (275) | 285 | 330 | (330) | (115) | (305) |
Impact before tax on shareholders’ equity (£m)
| Interest rates +1% | Interest rates -1% | Equity / property +10% | Equity / property -10% | Expenses +10% | Gross loss ratios +5% | |
|---|---|---|---|---|---|---|
| Net of reinsurance | (275) | 285 | 330 | (330) | (30) | (305) |
For general insurance, the impact of the expense sensitivity on profit also includes the increase in ongoing administration expenses, in addition to the increase in the claims handling expense provision.
Fund management and non-insurance businesses
Sensitivities as at 31 December 2006
Impact on profit before tax (£m)
| Interest rates +1% | Interest rates -1% | Equity / property +10% | Equity / property -10% | |
|---|---|---|---|---|
| Total | (26) | 26 | 44 | (44) |
Impact before tax on shareholders’ equity (£m)
| Interest rates +1% | Interest rates- 1% | Equity / property +10% | Equity / property -10% | |
|---|---|---|---|---|
| Total | (52) | 51 | 78 | (78) |
Sensitivities as at 31 December 2005
Impact on profit before tax (£m)
| Interest rates +1% | Interest rates-1% | Equity / property +10% | Equity / property -10% | |
|---|---|---|---|---|
| Total | (35) | 35 | 26 | (26) |
Impact before tax on shareholders’ equity (£m)
| Interest rates +1% | Interest rates-1% | Equity / property +10% | Equity / property -10% | |
|---|---|---|---|---|
| Total | (70) | 70 | 60 | (60) |
Limitations of sensitivity analysis The above tables demonstrate the effect of a change in a key assumption while other assumptions remain unchanged. In reality, there is correlation between the assumptions and other factors. It should also be noted that these sensitivities are non-linear, and larger or smaller impacts should not be interpolated or extrapolated from these results.
The sensitivity analyses do not take into consideration that the Group’s assets and liabilities are actively managed. Additionally, the financial position of the Group may vary at the time that any actual market movement occurs. For example, the Group’s financial risk management strategy aims to manage the exposure to market fluctuations. As investment markets move past various trigger levels, management actions could include selling investments, changing investment portfolio allocation, adjusting bonuses credited to policyholders, and taking other protective action.
A number of the business units use passive assumptions to calculate their long-term business liabilities. Consequently, the actual impact of a change in the assumptions may not have any impact on the liabilities, whereas assets are held at market value on the balance sheet. In these circumstances, the different measurement bases for liabilities and assets may lead to volatility in shareholder equity. Similarly, for general insurance liabilities, the interest rate sensitivities only affect profit and equity where explicit assumptions are made regarding interest (discount) rates or future inflation.
Other limitations in the above sensitivity analyses include the use of hypothetical market movements to demonstrate potential risk that only represent the Group’s view of possible near-term market changes that cannot be predicted with any certainty; and the assumption that all interest rates move in an identical fashion.
