Aviva 2005 Annual Report Download - page 85

Financial statements
Aviva plc 2005
Listed AFS securities: 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. This review takes into account the likelihood of the current
market price recovering to former levels.
Unlisted AFS securities: 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.
Mortgages, investment property and securitised loans: Impairment
is measured based on the present value of expected future cash
flows discounted at the effective rate of interest of the loan,
subject to the fair value of the underlying collateral. When a loan
is considered to be impaired, the income statement is charged
with the difference between the carrying value and the estimated
recoverable amount. Interest income on impaired loans is
recognised based on the estimated recoverable amount.
Reversals of impairments are only recognised where the decrease in
the impairment can be objectively related to an event occurring
after the write down (such as an improvement in the debtor’s credit
rating), and are not recognised in respect of equity instruments.
(S) Derivative financial instruments and hedging
Derivative financial instruments include foreign exchange contracts,
interest rate futures, currency and interest rate swaps, currency
and interest rate options (both written and purchased) and other
financial instruments that derive their value mainly from underlying
interest rates, foreign exchange rates, commodity values or equity
instruments. All derivatives are initially recognised in the balance
sheet at their fair value, which usually represents their cost. They are
subsequently remeasured at their fair value, with the method of
recognising movements in this value depending on whether they
are designated as hedging instruments and, if so, the nature of the
item being hedged. Fair values are obtained from quoted market
prices or, if these are not available, by using valuation techniques
such as discounted cash flow models or option pricing models.
All derivatives are carried as assets when the fair values are positive
and as liabilities when the fair values are negative. Premiums paid
for derivatives are recorded as an asset on the balance sheet at the
date of purchase, representing their fair value at that date.
Derivative contracts may be traded on an exchange or
over-the-counter (OTC). Exchange-traded derivatives are
standardised and include certain futures and option contracts.
OTC derivative contracts are individually negotiated between
contracting parties and include forwards, swaps, caps and
floors. Derivatives are subject to various risks including market,
liquidity and credit risk, similar to those related to the underlying
financial instruments.
The notional or contractual amounts associated with derivative
financial instruments are not recorded as assets or liabilities on the
balance sheet as they do not represent the potential gain or loss
associated with such transactions. These amounts are disclosed in
note 51.
Interest rate and currency swaps
Interest rate swaps are contractual agreements between two
parties to exchange periodic payments in the same currency, each
of which is computed on a different interest rate basis, on a
specified notional amount. Most interest rate swaps involve the net
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– The Company has transferred its rights to receive cash flows
from the asset and either (a) has transferred substantially all the
risks and rewards of the asset, or (b) has neither transferred
nor retained substantially all the risks and rewards of the asset,
but has transferred control of the asset.
A financial liability is derecognised when the obligation under the
liability is discharged or cancelled or expires.
Financial assets and liabilities are offset and the net amount
reported in the balance sheet when there is a legally enforceable
right to set off the recognised amounts and there is an intention to
settle on a net basis, or realise the asset and settle the liability
simultaneously.
(R) Financial investments
The Group classifies its investments as either financial assets at fair
value through profit or loss (FV) or available for sale financial assets
(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 strategy is to manage its
financial investments on a fair value basis. In certain circumstances,
the FV category is used where this eliminates an accounting
mismatch. The AFS category is used where the relevant life liability
(including shareholders’ funds) is passively managed and carried at
amortised cost.
The FV category has two sub-categories – those that meet the
definition as being held for trading and those the Group chooses to
designate as FV (referred to in this accounting policy as “other than
trading”). Fixed maturities, purchased loans and equity securities,
which the Group buys with the intention to resell in the near term
(typically between three and six months), are classified as trading. All
other securities in the FV category are classified as other than trading.
Purchases and sales of investments are recognised on the trade
date, which is the date that the Group commits to purchase
or sell the assets, at their fair values less transaction costs.
Debt securities are initially recorded at their fair value which is
taken to be amortised cost, with amortisation credited or charged
to the income statement. Investments classified as trading, other
than trading and AFS are subsequently carried at fair value.
Changes in the fair value of trading and other than trading
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 and relevant foreign exchange
gains and losses, are recorded in a separate investment valuation
reserve within equity.
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. Equity securities for which fair values cannot be
measured reliably are recognised at cost less impairment. When
securities classified as AFS are sold or impaired, the accumulated
fair value adjustments are transferred out of the investment
valuation reserve to the income statement.
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. The following
policies are used to determine the level of any impairment: