Aviva 2005 Annual Report Download - page 107

1 – First time adoption of International Financial Reporting Standards continued
The overall impact on annual profits arising from this accounting change is dependent upon levels of new business, product mixes, the
ageing profile of the existing in-force business and reserving policies. Additional new business strain under IFRS would be expected to
be mitigated by the emergence of higher IFRS basis profits of the in-force book of business. Until mid-2003, unit-linked bond business
sold by Norwich Union in the UK contained a guaranteed minimum death benefit, and hence contained significant insurance risk, and
accordingly, as permitted by IFRS Phase 1, the UK GAAP basis profit profile has been retained. After mid-2003, this benefit was removed
and business written since this time has been classified as non-participating investment business. The existing in-force business is therefore
small and profits are insufficient to offset the new business strain. A significant conversion effect on profit therefore arises.
This reduction in profit is no more than a timing adjustment. Aviva’s main value measure remains European embedded value and the
profit arising on this basis is unaffected by this technical accounting change.
(3) Employee benefits
The overall impact of adopting IAS 19, Employee benefits, and IFRS 2, Share based compensation, has been to increase costs by
£48 million in 2004. This partly reflects the fact that IAS 19 has used a more current actuarial valuation to measure the ongoing pension
service cost. The charge under UK GAAP was based on the SSAP 24 valuation which, as disclosed in the 2004 Annual Report and
Accounts, was last updated for financial reporting purposes in April 2002.
(4) Goodwill
Goodwill is no longer amortised under IFRS but is subject to annual impairment review. Impairment charges of £41 million were incurred
in 2004, relating to sundry small overseas businesses, which had been fully reflected within the UK GAAP amortisation charge of
£120 million. No additional impairment arose as a result of the transition to IFRS.
A further £169 million credit arises to profit before tax, as goodwill previously charged directly to reserves was deducted from profit
upon disposal of subsidiaries under UK GAAP. Under IFRS no such deduction is required. This change has no impact on operating profit
or shareholders’ funds.
(5) Policyholder tax
Operating profit before tax has fallen relative to the UK GAAP result by £93 million as a result of a change in the allocation of the tax
charged to the life funds between policyholders and shareholders. This presentational change has no impact on operating profit after
tax or the tax suffered by the life funds but merely represents how the tax charge is presented in the financial statements. The increase in
tax costs charged to operating profit arises principally in the UK, but has been partly offset by a change in allocation in the Netherlands,
where all tax is now deemed to be shareholder tax.
It is a feature of the UK tax regime that the tax attributable to life business operations is a single charge in respect of policyholder income
and shareholder profits. Under UK GAAP, the difficulty of allocating this charge between policyholders and shareholders is generally
acknowledged and hence, under UK GAAP, the total tax charge is deducted from life operating profit in the long-term technical account,
the net result of which is then grossed up at the effective shareholder tax rate. Traditionally, Aviva has grossed up at 30% which
represents its view of the long-term effective rate. We remain of the view that this will be the rate suffered by shareholders over the
longer term.
Under IFRS, all taxation must be reported within the taxation line. The profit before this total tax would present a misleading picture of
the Group’s profit as (i) much of the policyholder tax is in the with-profits funds where the unallocated divisible surplus is adjusted on a
net of tax basis; (ii) the cost of policyholder tax is priced into the relevant products; and (iii) the level of tax will vary on an annual basis in
line with the investment return on assets backing the long-term funds.
The UK industry has therefore agreed that it is appropriate to adopt an income statement presentation which depicts profit before
tax attributable to the shareholders. This requires an allocation of the total tax charge between policyholders and shareholders, with
the policyholder charge being offset against operating profit. There is no universal view on how this allocation should be performed.
Aviva has taken the view that the IFRS conceptual framework does not permit companies to use notional allocation or gross-up
methods. Instead, the allocation to policyholder tax should reflect the actual tax payable at policyholder rates, including deferred tax.
Aviva has therefore developed a conceptual methodology to achieve this consistently year-on-year.
In 2004, the level of tax attributed to the shareholders was reduced by the following arrangement. The £1.5 billion of capital injected into
the life funds on the demutualisation of Norwich Union in 1997 had the effect that future distributions up to that amount by Norwich
Union Life and Pensions are treated as already having suffered some shareholder tax. In 2004, a substantial proportion of the company’s
shareholders’ surplus was sheltered by this arrangement and this has the impact of lowering the actual tax paid at shareholder rates.
This is a genuine benefit to shareholders and resulted in higher profit after tax. This tax benefit has a finite capacity and will at some point
be exhausted, such that over the long-term there will be an increase in shareholder tax rates back towards 30%. The use of this capacity
is dependent on the level of distributions made by Norwich Union Life & Pensions.
The impact of this is that operating profit before tax falls relative to the UK GAAP result, as the actual shareholder rate suffered in the UK
in 2004 was lower than 30%.
It should be noted that, from an EEV perspective, an asset representing this tax benefit is already established and so 30% remains as an
appropriate shareholder tax rate for this business.
Financial statements
Aviva plc 2005
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