B1 Basis of preparation

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B1 – Basis of preparation

The condensed consolidated income statement and condensed consolidated statement of financial position on pages 88 to 90 present the group’s results and financial position for the life and related businesses on the Market Consistent Embedded Value (MCEV) basis and for its non-life businesses on the International Financial Reporting Standards (IFRS) basis. The MCEV methodology adopted is in accordance with the MCEV Principles published by the CFO Forum in October 2009.

The directors consider that the MCEV methodology gives useful insight into the drivers of financial performance of the group’s life and related businesses. This basis values future cash flows from assets consistently with market prices, including more explicit allowance for the impact of uncertainty in future investment returns and other risks.

Embedded value is also consistent with the way pricing is assessed and the business is managed.

The results for 2009 and 2008 have been audited by our auditors, Ernst & Young. Their report in respect of 2009 can be found on page 316 in the Report and Accounts.

CFO Forum principles update

The CFO Forum issued updated MCEV Principles and Guidance in October 2009, replacing the guidance issued in June 2008. The main change was to permit the use of liquidity premium on contracts with predictable cashflows. Aviva’s methodology of applying liquidity premium to contracts where backing assets can be held to maturity is unchanged. Further details are given on page 110. Aviva’s methodology is compliant with the updated CFO Forum Principles.

Covered business

The MCEV calculations cover the following lines of business: life insurance, long-term health and accident insurance, savings, pensions and annuity business written by our life insurance subsidiaries, including managed pension fund business and our share of the other life and related business written in our associated undertakings and joint ventures, as well as the equity release business written in the UK.

Covered business includes the group’s share of our joint ventures including our arrangement with The Royal Bank of Scotland Group (RBSG) and our associated undertakings in India, China, Turkey, Malaysia, Taiwan and South Korea. In addition, the results of group companies providing significant administration, fund management and other services and of group holding companies have been included to the extent that they relate to covered business. Together these businesses are referred to as “Life and related businesses”.

New business premiums

New business premiums include:

– premiums arising from the sale of new contracts during the period;

– non-contractual additional premiums, including future Department of Work and Pensions (DWP) rebate premiums; and

– expected renewals on new contracts and expected future contractual alterations to new contracts.

The group’s definition of new business under MCEV includes contracts that meet the definition of “non-participating investment” contracts under IFRS.

For products sold to individuals, premiums are considered to represent new business where a new contract has been signed, or where underwriting has been performed. Renewal premiums include contractual renewals, non-contractual variations that are reasonably predictable and recurrent single premiums that are pre-defined and reasonably predictable.

For group products, new business includes new contracts and increases to aggregate premiums under existing contracts. Renewal premiums are based on the level of premium received during the reporting period and allow for premiums expected to be received beyond the expiry of any guaranteed premium rates.

Life and pensions operating earnings

For life and pensions operating earnings, Aviva uses normalised investment returns. The use of asset risk premia reflects management’s long-term expectations of asset returns in excess of the swap yield from investing in different asset classes.

Within the 2008 results, the normalised investment returns were calculated by reference to the one year swap rate in the relevant currency plus an appropriate risk premium for bonds, equities and properties. For 2009, the group considers that the return over the typical duration of the assets held is more appropriate and is more consistent with the group’s expectation of long-term rates of return.

Therefore, the expected return on equities and properties has been calculated by reference to the 10 year swap rate in the relevant currency plus an appropriate risk premium. The expected return on bonds has been calculated by reference to the swap rate consistent to the duration of the backing assets in the relevant currency plus an appropriate risk premium.

This assumption does not impact the embedded value as asset risk premia are not recognised until earned.

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