Aviva 2006 Annual Report Download - page 168

Aviva plc
Annual Report and Accounts 2006 164
Notes to the consolidated financial statements continued
35 – Insurance liabilities continued
(ii) Group practice
The long-term business provision is calculated separately for each of the Group’s life operations. The provisions for overseas subsidiaries
have generally been included on the basis of local regulatory requirements, mainly using the net premium method, modified where
necessary to reflect the requirements of the Companies Act.
Material judgement is required in calculating the provisions and is exercised particularly through the choice of assumptions where there is
discretion over these. In turn, the assumptions used depend on the circumstances prevailing in each of the life operations. Provisions are
most sensitive to assumptions regarding discount rates and mortality/morbidity rates.
Bonuses paid during the year are reflected in claims paid, whereas those allocated as part of the bonus declaration are included in the
movements in the long-term business provision.
(iii) Methodology and assumptions
There are two main methods of actuarial valuation of liabilities arising under long-term insurance contracts – the net premium method
and the gross premium method – both of which involve the discounting of projected premiums and claims.
Under the net premium method, the premium taken into account in calculating the provision is determined actuarially, based on the
valuation assumptions regarding discount rates, mortality and disability. The difference between this premium and the actual premium
payable provides a margin for expenses. This method does not allow for voluntary early termination of the contract by the policyholder,
and so no assumption is required for persistency. Explicit provision is made for vested bonuses (including those vesting following the
most recent fund valuation), but no such provision is made for future regular or terminal bonuses. However, this method makes implicit
allowance for future regular or terminal bonuses already earned, by margins in the valuation discount rate used.
The gross premium method uses the amount of contractual premiums payable and includes explicit assumptions for interest and discount
rates, mortality and morbidity,persistency and futureexpenses. These assumptions can vary by contract type and reflect current and
expected futureexperience. Explicit provision is made for vested bonuses and explicit allowance is also made for future regular bonuses,
but not terminal bonuses.
The principal assumptions in the UK, France, the Netherlands and the United States are:
(a) UK
With-profit business The valuation of with-profit business uses the methodology developed for the Realistic Balance Sheet, adjusted to
remove the shareholders’ share of future bonuses. The key elements of the Realistic Balance Sheet methodology are the with-profit
benefit reserve (WPBR) and the present value of the expected cost of any payments in excess of the WPBR (referred to as the cost of
future policy-related liabilities). The realistic liability for any contract is equal to the sum of the WPBR and the cost of future policy-related
liabilities. The WPBR for an individual contract is generally calculated on a retrospective basis, and represents the accumulation of the
premiums paid on the contract, allowing for investment return, taxation, expenses and any other charges levied on the contract.
For a small proportion of business, the retrospective approach is not available or is inappropriate, so a prospective valuation approach is
used instead, including allowance for anticipated future regular and final bonuses.
The items included in the cost of future policy-related liabilities include:
–Maturity Guarantees;
–Smoothing (which can be negative);
–Guaranteed Annuity Options;
–GMP underpin on Section 32 transfers; and
–Expected payments under Mortgage Endowment Promise.
In the Provident Mutual and with-profit funds in NUL&P, this is offset by the expected cost of charges to WPBR to be made in respect
of guarantees.
The cost of futurepolicy-related liabilities is determined using a market-consistent approach and, in the main, this is based on a stochastic
model calibrated to market conditions at the end of the reporting period. Non-market-related assumptions (for example, persistency,
mortality and expenses) arebased on experience, adjusted to take into account futuretrends. Wherepolicyholders have valuable
guarantees, options or promises, then futurepersistency is assumed to improve, and future take-up rates of guaranteed annuity options
are assumed to increase.
Financial statements continued