Aviva 2005 Annual Report Download - page 208

Financial statements continued
Alternative method of reporting long-term business continued
EEV methodology continued
In order to derive risk discount rates for each of our life businesses, the adjusted Group WACC is expressed as a risk margin in excess of
the gross risk free interest rate used in the WACC calculation as described above. Business-specific discount rates are then calculated as
the sum of this risk margin and the appropriate local gross risk free rate at the valuation date, based on returns on government bonds.
A common risk free rate, and hence a common RDR, is used for all of our businesses within the Eurozone. Additional country-specific risk
margins are applied to smaller businesses to reflect additional economic, political and business-specific risk for example, risk margins
ranging from 3.7% to 8.7% are applied to the Group’s eastern European and Asian operations. Within each business, a constant RDR
has been applied in all future time periods and in each of the economic scenarios underlying the calculation of the time value of options
and guarantees.
At each valuation date, the risk margin is reassessed based on current economic factors and is updated only if a significant change has
occurred. In particular, changes in risk profile arising from movements in asset mix are allowed for via the updated risk margin calculation.
Participating business
Future regular bonuses on participating business are projected in a manner consistent with current bonus rates and expected future
returns on assets deemed to back the policies.
For with-profit funds in the UK and Ireland, for the purpose of recognising the value of the estate, it is assumed that terminal bonuses are
increased to exhaust all of the assets in the fund over the future lifetime of the in-force with-profit policies. However, under stochastic
modelling there may be some extreme economic scenarios when the total assets in the Group’s with-profit funds are not sufficient to pay
all policyholder claims. The average additional shareholder cost arising from this shortfall has been included in the time value of options
and guarantees.
For profit sharing business in continental Europe, where policy benefits and shareholder value depend on the timing of realising gains,
apportionment of unrealised gains between policyholders’ benefits and shareholders reflect contractual requirements as well as existing
practice. Where under certain economic scenarios additional shareholder injections are required to meet policyholder payments, the
average additional cost has been included in the time value of options and guarantees.
Consolidation adjustments
The effect of transactions between our life companies such as loans and reinsurance arrangements has been included in results split by
territory in a consistent manner. No elimination is required on consolidation.
As the EEV methodology incorporates the impact of profits and losses arising from subsidiary companies providing administration,
investment management and other services to the Group’s life companies, the equivalent profits and losses have been removed from
the relevant segment (non insurance or fund management) and are instead included within the results of life and related businesses.
In addition, the underlying basis of calculation for these profits has changed from the IFRS basis to the EEV basis.
The capitalised value of the future profits and losses from such service companies are included in the embedded value and new business
contribution calculations for the relevant territory, but the net assets (representing historical profits and other amounts) remain under
non-insurance or fund management. In order to reconcile the profits arising in the financial period within each segment with the assets
on the opening and closing balance sheets, a transfer of IFRS profits from life and related business to the appropriate segment is deemed
to occur. An equivalent approach has been adopted for expenses within our holding companies.
Components of life EEV return
The life EEV return comprises the following components:
– new business contribution written during the period including value added between the point of sale and end of the period;
– the profit from existing business equal to:
• the expected return on the value of the in-force covered business at the beginning of the period,
• experience variances caused by the differences between the actual experience during the period and expected experience based on
the operating assumptions used to calculate the start of year value,
• the impact of changes in operating assumptions including risk-margins;
– the expected investment return on the shareholders' net worth, based upon assumptions applying at the start of the year;
– investment return variances caused by differences between the actual return in the period and the expected return based on economic
assumptions used to calculate the start of year value; and
– the impact of changes in economic assumptions in the period.
Aviva plc 2005 Financial statements
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