Analysis of assets
Total assets - Valuation bases/fair value hierarchy (continued)
1.2. Financial investments
Financial investments are an integral element of an insurance business.
Aviva holds large quantities of high quality bonds, primarily to match our liability to make guaranteed payments to policyholders. Some credit risk is taken, partly to boost returns to policyholders and partly to optimise the risk/return profile for shareholders. The risks are consistent with the products we offer and the related investment mandates, and are in line with our risk appetite.
The group also holds significant quantities of equities. Many of these are held in participating funds or unit linked funds, where they form an integral part of the investment expectations of policyholders and follow well-defined investment mandates. Some equities are also held in shareholder funds and the staff pension schemes, where the holdings are designed to maximise long-term returns with an acceptable level of risk. The vast majority of equity investments are valued at quoted market prices.
The group's credit risk policy restricts the exposure to individual counterparties across all types of risk.
The fair values of investments are based on quoted bid prices or amounts derived from cash flow models. Fair values for unlisted equity securities are estimated using applicable price/earnings or price/cash flow ratios refined to reflect the specific circumstances of the issuer. Securities, for which fair values cannot be measured reliably, are recognised at cost less impairment.
Where it is determined that the market in which a price is quoted has become inactive, the quoted price is assessed against either independent valuations or internally modelled valuations which take into account other market observable information. Where the quoted price differs sufficiently from these reassessed prices, the fair value recognised on the balance sheet is based on this adjusted valuation. However, if these reassessed prices confirm that the quoted price remains appropriate, then the fair value recognised on the balance sheet continues to be the quoted price.
The group classifies its investments as either financial assets at fair value through profit or loss (FV) or financial assets available for sale (AFS). The classification depends on the purpose for which the investments were acquired, and is determined by local management at initial recognition. In general, the FV category is used as, in most cases, the group's investment or risk management strategy is to manage its financial investments on a fair value basis. The AFS category is used where the relevant long-term business liability (including shareholders funds) is passively managed.
Investments classified as FV and AFS are subsequently carried at fair value. Changes in the fair value of FV investments are included in the income statement in the period in which they arise. Changes in the fair value of securities classified as AFS, except for impairment losses, are recorded in a separate investment valuation reserve in equity. Where investments classified as AFS are sold or impaired, the accumulated fair value adjustments are transferred out of the investment valuation reserve and into the income statement.
To test for impairment, the group reviews the carrying value of its investments on a regular basis. If the carrying value of an investment is greater than the recoverable amount, the carrying value is reduced through a charge to the income statement in the period of impairment.
For listed investments classified as AFS, the group performs an objective review of the current financial position and prospects of the issuer on a regular basis, to identify whether any impairment provision is required. For unlisted investments classified as AFS, the group considers the current financial position of the issuer and the future prospects in identifying the requirement for an impairment provision. For both listed and unlisted AFS securities identified as being impaired, the cumulative unrealised net loss previously recognised within the AFS reserve is transferred to realised losses for the year.
Cost, unrealised gains and fair value
The following is a summary of the cost/amortised cost, gross unrealised gains and losses and fair value of financial investments:
| 30 June 2009 | ||||
|---|---|---|---|---|
| Cost/ amortised cost £m |
Unrealised gains £m |
Impairment and unrealised losses £m |
Fair value £m |
|
| Debt securities | 151,528 | 4,051 | (8,733) | 146,846 |
| Equity securities | 44,092 | 2,319 | (9,907) | 36,504 |
| Other investments | 29,274 | 2,092 | (1,683) | 29,683 |
| 224,894 | 8,462 | (20,323) | 213,033 |
| 31 December 2008 | ||||
|---|---|---|---|---|
| Cost/ amortised cost £m |
Unrealised gains £m |
Impairment and Unrealised losses £m |
Fair value Restated £m |
|
| Debt securities | 156,097 | 7,634 | (13,140) | 150,591 |
| Equity securities | 54,518 | 2,685 | (13,792) | 43,411 |
| Other investments | 34,692 | 4,243 | (2,819) | 36,116 |
| 245,307 | 14,562 | (29,751) | 230,118 |
1.2.1. Debt instruments
| Fair value hierarchy | ||||
|---|---|---|---|---|
| Level 1 £m | Level 2 £m |
Level 3 £m |
Total £m |
|
| Debt securities - Shareholder assets | ||||
| UK Government | 1,224 | - | - | 1,224 |
| Non-UK Government | 10,391 | 2,312 | 121 | 824 |
| Corporate bonds - Public utilities | 1,204 | 1,144 | 50 | 2,398 |
| Corporate convertible bonds | 10 | 273 | - | 283 |
| Other corporate bonds | 7,841 | 15,667 | 372 | 23,880 |
| Other | 2,470 | 5,044 | 388 | 7,902 |
| Total | 23,140 | 24,440 | 931 | 48,511 |
| Total % | 47.7% | 50.4% | 1.9% | |
| FY 2008 | 26,134 | 24,469 | 834 | 51,437 |
| FY 2008 % | 50.8% | 47.6% | 1.6% |
Only 3.3% of shareholder exposure to financial investments (2.1% of shareholder assets recorded at fair value) is fair valued using models with significant unobservable market parameters. Where estimates are used these are based on a combination of independent third party evidence and internally developed models, calibrated to market observable data where possible. Whilst such valuations are sensitive to estimates it is believed that changing one or more of the assumptions for reasonably possible alternative assumptions would not change the fair value significantly.
The majority of the debt instruments held by our North American businesses are valued by independent pricing firms in accordance with usual market practice in that region.
48% of shareholder exposure to debt securities is based on quoted prices in an active market. The continuing trend of reduced liquidity due to the ongoing uncertainty in the international financial markets contributes to the relatively high proportion of debt securities that is based on quoted prices in markets that are not active or where the prices are less current.
