Aviva plc: Adoption of Aviva Market Consistent Embedded Value (MCEV) methodology and impact on results
C – Impact of turbulent market conditions
The CFO Forum MCEV Principles were designed during a period of relatively stable market conditions. As announced on 19 December 2008, the CFO Forum has agreed to conduct a review of the impact of turbulent market conditions on the MCEV Principles, the result of which may lead to changes to the published MCEV Principles or the issuance of further guidance. The particular areas under review include implied volatilities, the cost of non-hedgeable risks, the use of swap rates as a proxy for risk-free rates and the effect of liquidity premia.
Aviva's MCEV methodology adopts the CFO Forum Principles and Guidance with the exception of 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 other US contracts. In stable markets, swap curves are an appropriate risk-free rate. However, in the current turbulent market it is possible, for products where backing asset portfolios can be held to maturity, to earn risk free returns in excess of swaps by investing in corporate bonds and credit default swaps (CDS).
The risk free rate for these products has therefore been increased above the swap curve due to the additional risk-free returns available on backing asset portfolios in the current market. This is not in compliance with Principle 14 of the CFO Forum MCEV Principles, which require that the risk free rates "should, wherever possible, be the swap yield curve appropriate to the currency of the cash flows". Aviva believes that these adjustments are required to maintain consistency with current market prices. Further details can be found in the basis of preparation note. Sensitivity analysis to changes in the risk free rate. This methodology will be updated if the CFO Forum issues additional guidance.
