12. Principal economic assumptions
(a) Deterministic calculations
Economic assumptions are derived actively, based on market yields on risk-free fixed interest assets at the end of each reporting year. The same margins are applied on a consistent basis across the Group to gross risk-free yields to obtain investment return assumptions for ordinary shares and property and to produce risk discount rates. Additional country-specific risk margins are applied to smaller businesses to reflect additional economic, political and business-specific risk, which result in the application of risk margins ranging from 3.7% to 8.7% in our eastern European and Asian business operations. Expense inflation is derived as a fixed margin above a local measure of long-term price inflation. Risk free rates and price inflation have been harmonised across territories within the Euro currency zone, except for expense inflation in Ireland where significant differences remain. Required capital is shown as a multiple of the EU statutory minimum solvency margin or equivalent.
Investment return assumptions are generally derived by major product class, based on hypothecating the assets at the valuation date. Future assumed reinvestment rates are consistent with implied market returns at 31 December 2007. Rates have been derived using rates from the current yield curve at a duration based on the term of the liabilities, or directly from forward yield curves where considered appropriate. Assumptions about future investment mix are consistent with long-term plans. In most cases, the investment mix is assumed to continue unchanged throughout the projection period. The changes in assumptions between reporting dates reflect the actual movements in risk free yields in the United Kingdom, the Eurozone and other territories. The principal economic assumptions used are as follows:
| United Kingdom | France | ||||||
|---|---|---|---|---|---|---|---|
| 2007 | 2006 | 2005 | 2007 | 2006 | 2005 | ||
| Risk discount rate | 7.3% | 7.3% | 6.8% | 7.1% | 6.7% | 6.0% | |
| Pre-tax investment returns: | |||||||
| Base government fixed interest | 4.6% | 4.6% | 4.1% | 4.4% | 4.0% | 3.3% | |
| Ordinary shares | 7.6% | 7.6% | 7.1% | 7.4% | 7.0% | 6.3% | |
| Property | 6.6% | 6.6% | 6.1% | 6.4% | 6.0% | 5.3% | |
| Future expense inflation | 3.5% | 3.4% | 3.2% | 2.5% | 2.5% | 2.5% | |
| Tax rate | 28.0% | 30.0% | 30.0% | 34.4% | 34.4% | 34.4% | |
| Required Capital (% EU minimum) | 100% | 150% / 100% | 150% / 100% | 115% | 115% | 115% | |
| Ireland | Italy | ||||||
|---|---|---|---|---|---|---|---|
| 2007 | 2006 | 2005 | 2007 | 2006 | 2005 | ||
| Risk discount rate | 7.1% | 6.7% | 6.0% | 7.1% | 6.7% | 6.0% | |
| Pre-tax investment returns: | |||||||
| Base government fixed interest | 4.4% | 4.0% | 3.3% | 4.4% | 4.0% | 3.3% | |
| Ordinary shares | 7.4% | 7.0% | 6.3% | 7.4% | 7.0% | 6.3% | |
| Property | 6.4% | 6.0% | 5.3% | 6.4% | 6.0% | 5.3% | |
| Future expense inflation | 4.0% | 4.0% | 4.0% | 2.5% | 2.5% | 2.5% | |
| Tax rate | 12.5% | 12.5% | 12.5% | 32.4% | 38.3% | 38.3% | |
| Required Capital (% EU minimum) | 150% | 150% | 150% | 115% | 115% | 115% | |
| Netherlands | Poland | ||||||
|---|---|---|---|---|---|---|---|
| 2007 | 2006 | 2005 | 2007 | 2006 | 2005 | ||
| Risk discount rate | 7.1% | 6.7% | 6.0% | 9.4% | 8.7% | 8.6% | |
| Pre-tax investment returns: | |||||||
| Base government fixed interest | 4.4% | 4.0% | 3.3% | 5.7% | 5.0% | 4.9% | |
| Ordinary shares | 7.4% | 7.0% | 6.3% | 8.7% | 8.0% | 7.9% | |
| Property | 6.4% | 6.0% | 5.3% | n/a | n/a | n/a | |
| Future expense inflation | 2.5% | 2.5% | 2.5% | 4.1% | 3.4% | 3.3% | |
| Tax rate | 25.5% | 25.5% | 29.1% | 19.0% | 19.0% | 19.0% | |
| Required Capital (% EU minimum) | 150% | 150% | 150% | 150% | 150% | 150% | |
| Spain | United States | ||||||
|---|---|---|---|---|---|---|---|
| 2007 | 2006 | 2005 | 2007 | 2006* | 2005 | ||
| Risk discount rate | 7.1% | 6.7% | 6.0% | 6.7% | 7.4% | 7.2% | |
| Pre-tax investment returns: | |||||||
| Base government fixed interest | 4.4% | 4.0% | 3.3% | 4.0% | 4.7% | 4.5% | |
| Ordinary shares | 7.4% | 7.0% | 6.3% | 7.0% | 7.7% | n/a | |
| Property | 6.4% | 6.0% | 5.3% | n/a | n/a | n/a | |
| Future expense inflation | 2.5% | 2.5% | 2.5% | 3.0% | 3.0% | 3.0% | |
| Tax rate | 30.0% | 30.0% | 35.0% | 35.0% | 35.0% | 35.0% | |
| Required Capital (% EU minimum, or equivalent) | 125% / 110% | 125% / 110% | 125% / 110% | 250% | 250% | 200% | |
* The principal economic assumptions used for AmerUs Group Co. at the date of acquisition were as follows: risk discount rate of 7.2%, pre-tax investment returns of 4.6% for base government fixed interest and required capital of 250%.
For service companies, expense inflation relates to the underlying expenses rather than the fees charged to the life company. Future returns on corporate fixed interest investments are calculated from prospective yields less an adjustment for credit risk. Following the change made to the required capital in Norwich Union Annuity Limited (NUA), required capital in the United Kingdom is now 100% Required capital in Spain is 125% EU minimum for Aviva Vida y Pensiones and 110% for bancassurance companies. The level of required capital for the US business is 250% of the risk-based capital, at the company action level, set by the National Association of Insurance Commissioners. The required capital is equivalent to 5% of the insurance liabilities on a local regulatory basis which is broadly equivalent to the required capital we hold for our main European businesses.
Other economic assumptions
Required capital relating to with-profit business is assumed to be covered by the surplus within the with-profit funds and no effect has been attributed to shareholders. Bonus rates on participating business have been set at levels consistent with the economic assumptions and Aviva's medium-term bonus plans. The distribution of profit between policyholders and shareholders within the with-profit funds assumes that the shareholder interest in conventional with-profit business in the United Kingdom and Ireland continues at the current rate of one ninth of the cost of bonus.
