Aviva plc: Adoption of Aviva Market Consistent Embedded Value (MCEV) methodology and impact on results
B – Impact of MCEV adoption
In June 2008 the CFO Forum, a group representing the Chief Financial Officers of major European insurers, launched the Market Consistent Embedded Value Principles, with the intention of improving transparency and comparability in embedded value reporting across Europe. The CFO Forum members agreed that all participants will implement the principles in the form of supplementary reporting from the 2009 year end, with optional early implementation.
The Aviva plc Board has decided to adopt a market consistent embedded value methodology for supplementary reporting in respect of the financial year ended 31 December 2008 and to restate comparative financial information for the full year ended 31 December 2007 and the six months to 30 June 2008. Aviva's market consistent methodology is described in the basis of preparation note. In summary, Aviva's methodology adopts the CFO Forum Principles and Guidance published in June 2008 with the exception of the use of an adjusted risk-free yield due to current market conditions for immediate annuities in the UK and Netherlands and for immediate annuities, deferred annuities and all other US contracts. Further detail can be found in the basis of preparation note.
Aviva's MCEV methodology will therefore replace the European Embedded Value (EEV) basis of reporting as the alternative method of reporting long-term business profits, with effect from the 2008 preliminary results announcement. The directors regard the adoption of MCEV as a refinement to the EEV basis of reporting, which previously complied with some of the CFO Forum MCEV Principles, and believe that value based reporting provides information that is fundamental to understanding the financial performance of the group's life and related businesses. Accordingly the move from the EEV basis to MCEV represents an evolution of the previously adopted approach and is not a wholesale change to Aviva's embedded value reporting basis. Embedded value is also consistent with the way pricing is assessed and the business is managed. In adopting these principles early the directors are seeking to achieve consistency and continuity of performance reporting through supplementary reporting. This is particularly important at a time when phase two of the approach to accounting for insurance business under International Financial Reporting Standards (IFRS) has not yet been implemented.
MCEV is the next step in embedded value reporting bringing improved transparency and comparability. In summary, MCEV provides:
- a perspective on value, being the present value of future cash flows available to the shareholder, adjusted for the risks of those cash flows;
- improved consistency of the basic framework for risk valuation through a market consistent approach to financial risk;
- improved comparability of, and increase in, embedded value disclosures, including a greater focus on disclosure of cash emerging from the business and explicit disclosure of the allowance for non-hedgeable risks; and,
- mandatory external review.
There is no change to the underlying fundamentals or economics of our business as a result of adopting the MCEV methodology. Financial information on an MCEV basis provides a further perspective on the business, particularly for internal capital allocation purposes. Profits over the life of contracts remain unchanged; however, the timing of profit recognition changes.
While MCEV is key in assessing our life businesses in respect of value generation and the impact of the cost of capital and capital allocation, it is not the only measure we use to assess our business. We continue to also use statutory IFRS and regulatory capital measures, which are unchanged by the adoption of MCEV. The Group's dividend policy, which is set in relation to operating earnings after tax on an IFRS basis, is also unchanged by MCEV. Additionally, the internal rate of return (IRR) gives a further perspective on the value of all the cashflows associated with new business, including the investment return generated.
With effect from the 2008 preliminary results, the group intends to use the same economic assumptions for equities and properties as those used under the MCEV methodology to calculate the longer-term investment return used in IFRS reporting for its life, general insurance and health business and pension schemes. This will improve the 2008 operating result on the MCEV basis by approximately £80 million.
