Aviva 2013 Annual Report Download - page 170

Aviva plc
Annual report and accounts 2013
168
Notes to the consolidated financial statements continued
23 – Fair value methodology continued
Total net gains recognised in the income statement in the year ended 31 December 2013 in respect of Level 3 assets measured
at fair value amounted to £108 million (2012: £959 million), with net losses in respect of liabilities of £13 million (2012: gains
£4 million). Included in this balance are £73 million (2012: £1,030 million) of net gains attributable to those assets and £13 million
(2012: £3 million) of losses attributable to those liabilities still held at the end of the year.
The principal investments classified as Level 3, and the valuation techniques applied to them, are:
 Commercial mortgage loans held by our UK Life business amounting to £9.9 billion, valued using a Portfolio Credit Risk Model
(PCRM). This model calculates a Credit Risk Adjusted Value (CRAV) for each mortgage. The risk adjusted cash flows are
discounted using a yield curve, taking into account the term dependent gilt yield curve, and global assumption for the liquidity
premium. The mortgage loans have been classified as Level 3 as the liquidity premium is not deemed to be market observable.
 Equity release and UK securitised mortgage loans held by our UK Life business amounting to £4.7 billion, valued using
Discounted Cash Flow models (DCF). Cash flows are adjusted for credit risk and discounted using a yield curve and global
assumptions for the liquidity premium. The mortgage loans have been classified as Level 3 as assumptions used to derive the
credit risk and property risk are not deemed to be market observable.
 Investment property amounting to £9.5 billion. In the UK, the majority of investment property is valued at least annually by
external chartered surveyors in accordance with guidance issued by The Royal Institution of Chartered Surveyors, and using
estimates during the intervening period. For other investment property, valuations are produced by local qualified staff of the
Group or external qualified professional valuers in the countries concerned. Fair values are determined using an income
method, by which own lease agreement cash-flows are adjusted for anticipated uplifts, and discounted by rates implied by
recent market transactions for similar properties where available. These inputs are deemed unobservable.
 Structured bond-type and non-standard debt products held by our business in France amounting to £7.1 billion (2012: £8.6
billion), for which there is no active market. These bonds are valued either using counterparty or broker quotes. These bonds
are validated against internal or third-party models. These bonds have been classified as Level 3 because either (i) the third-
party models included a significant unobservable liquidity adjustment or (ii) differences between the valuation provided by
the counterparty and broker quotes and the validation model were sufficiently significant to result in a Level 3 classification.
At 31 December 2013, the values reported in respect of these products were the lower of counterparty and broker quotes and
internally modelled valuations.
 Private equity investment funds amounting to £1.1 billion (2012: £1.3 billion), together with external hedge funds held
principally by businesses in the UK and France amounting to £1.1 billion (2012: £1.3 billion), and property funds amounting to
£0.5 billion are valued based on external reports received from the fund manager. Where these valuations are at a date other
than balance sheet date, as in the case of some private equity funds, we make adjustments for items such as subsequent
draw-downs and distributions and the fund manager’s carried interest.
 Level 3 investments including a collateralised loan obligation of £0.4 billion (2012: £nil) and UK non-recourse loans of
£0.8 billion (2012: £nil) have been valued using internally developed discounted cash flow models.
 Investments including debt securities held by our French business of £0.7 billion (2012: £nil) and notes issued by loan
partnerships held by our UK Life business amounting to £0.3 billion (2012: £1.0 billion), have been valued using third party
or counterparty valuations.
 Other Level 3 investments amount to £1.1 billion (2012: £0.9 billion) and relate to a diverse range of different types of
securities held by a number of businesses throughout the Group.
 Level 3 liabilities include £0.5 billion (2012: £nil) of securitised mortgage loan notes which are valued using a similar technique
to the related Level 3 securitised mortgage assets.
Where possible, the Group tests the sensitivity of the fair values of Level 3 investments to changes in unobservable inputs to
reasonable alternatives. Where possible of valuations for Level 3 investments are sourced from independent third parties and,
where appropriate, validated against internally-modelled valuations, third-party models or broker quotes. Where third-party pricing
sources are unwilling to provide a sensitivity analysis for their valuations, the Group undertakes, where feasible, sensitivity analysis
on the following basis:
 For third-party valuations validated against internally-modelled valuations using significant unobservable inputs, the sensitivity
of the internally modelled valuation to changes in unobservable inputs to a reasonable alternative is determined.
 For third-party valuations either not validated or validated against a third-party model or broker quote, the third-party valuation
in its entirety is considered an unobservable input. Sensitivities are determined by flexing inputs of internal models to a
reasonable alternative, including the yield, NAV multiple, IRR or other suitable valuation multiples of the financial instrument
implied by the third-party valuation. For example, for a fixed income security the implied yield would be the rate of return
which discounts the security’s contractual cash flows to equal the third-party valuation.
On the basis of the methodology outlined above, the Group is able to perform sensitivity analysis for £35.7 billion of the Group’s
Level 3 investments. For these Level 3 investments, changing unobservable valuation inputs to a reasonable alternative would result
in a change in fair value by ± £1.8 billion. Of the £1.5 billion Level 3 investments for which sensitivity analysis is not provided, £0.6
billion relates to investments held in unit-linked and participating funds in France where investment risk is predominantly borne by
policyholders and therefore shareholder profit before tax is insensitive to reasonable change in fair value of these investments. The
remaining £0.9 billion of Level 3 investments are held predominantly to back non-linked shareholder business and it is estimated
that a 10% change in valuation of these investments would increase or reduce shareholder profit before tax by £90 million.