Aviva 2006 Annual Report Download - page 229

Overview Business review Governance Financial statements Other information
Aviva plc
Annual Report and Accounts 2006 225
EEV methodology continued
Net worth
The net worth is the market value of the shareholders’ funds and the shareholders’ interest in the surplus held in the non-profit
component of the long-term business funds, determined on a statutory solvency basis and adjusted to add back any non-admissible
assets, and consists of the required capital and free surplus. Required capital is reported net of implicit items permitted on a local
regulatory basis to cover minimum solvency margins which are assessed at a local entity basis. The level of required capital for each
business, which ranges between 100% and 150% of the EU minimum solvency requirement for our main European businesses and
250% of the EU minimum equivalent solvency requirements in the US, reflects the level of capital considered by the Directors to be
appropriate to manage the business, allowing for our internal assessment of the level of market, insurance and operating risk inherent in
the underlying products. The same definition of required capital is used for both existing and new business. The free surplus comprises
the market value of shareholder assets in excess of local statutory reserves and required capital.
Value of in-force covered business
The value of in-force covered business is the present value at the appropriate risk discount rate (which incorporates a risk margin) of the
distributable profits to shareholders arising from the in-force covered business projected on a best estimate basis, less a deduction for the
cost of holding the required level of capital.
In the UK, shareholders’ distributable profits arise when they are released following actuarial valuations. These valuations are carried out
in accordance with statutory requirements designed to ensure and demonstrate solvency in long-term business funds. Future distributable
profits will depend on experience in a number of areas such as investment return, discontinuance rates, mortality, administration costs,
as well as management and policyholder actions. Releases to shareholders arising in futureyears from the in-force covered business and
associated required capital can be projected using best estimate assumptions of future experience. In overseas businesses generally, there
aresimilar requirements restricting payments to shareholders from life businesses.
The value of in-force covered business includes an allowance for the impact of financial options and guarantees arising from best estimate
assumptions (the intrinsic value) and from additional costs related to the variability of investment returns (the time value). The intrinsic
value is included in the underlying value of the in-force covered business using deterministic assumptions. The time value of financial
options and guarantees has been determined using stochastic modelling techniques.
Stochastic modelling typically involves projecting the future cash flows of the business under thousands of economic scenarios that are
representative of the possible future outcomes for market variables such as interest rates and equity returns. Allowance is made, where
appropriate, for the effect of management and/or policyholder actions in different economic conditions on future assumptions such as
asset mix, bonus rates and surrender rates. The time value is determined by deducting the average value of shareholder cash flows under
these economic scenarios from the deterministic shareholder value under best estimate assumptions.
The cost of holding required capital is the difference between the required capital and the present value at the appropriate risk
discount rate of the projected release of the required capital and investment earnings on the assets deemed to back the required capital.
Wherethe required capital is covered by policyholder assets, for example in the UK with-profit funds, there is no impact of cost of capital
on shareholder value. The assets regarded as covering the required capital are those that the operation deems appropriate.
The value of in-force covered business includes the capitalised value of profits and losses arising from subsidiary companies providing
administration, investment management and other services to the extent that they relate to covered business. This is referred to as the
“ look through” into service company expenses. In addition, expenses arising in holding companies that relate directly to acquiring or
maintaining covered business have been allowed for. Where external companies provide services to the life and related businesses, their
charges have been allowed for in the underlying projected cost base.