Aviva 2006 Annual Report Download - page 65

Overview Business review Governance Financial statements Other information
Aviva plc
Annual Report and Accounts 2006 61
Where applicable, the financial statements have also been prepared
in accordance with the Statement of Recommended Practice (SORP) on
accounting for insurance business issued by the Association of British
Insurers (ABI) in December 2005, as amended in December 2006.
IFRS 7 covers disclosures for financial instruments, and replaces
earlier standards on this subject. Although the new standard
extends the disclosures in the financial statements in several places,
it does not affect the policies themselves.
The only change to the accounting policies in 2006 has been from
an amendment to the financial instruments standard (IAS 39) that
deals with accounting for financial guarantee contracts. While not
material at the consolidated group level, this does affect the
company and its subsidiaries in respect of inter-company
guarantees given and taken.
European Embedded Value (EEV) basis of reporting
We present the results and financial position of our life and related
businesses on an EEV basis, in addition to the IFRS basis. The
directors’ opinion is that the EEV basis provides a more relevant and
transparent view of the performance of the life and related
operations year-on-year than the results presented under the IFRS
basis. The EEV methodology adopted is in accordance with the EEV
Principles introduced by the CFO Forum in M ay 2004, and the
additional guidance on EEV disclosures published by the CFO Forum
in October 2005.
On an EEV basis, the value of a policy recorded in the year of sale
takes into account future cash flows relating to that policy. Various
assumptions are used to estimate the present value of a policy.
In subsequent years, the present value of the policy is adjusted only
to reflect changes in the assumptions used.
In contrast, on an IFRS basis, the value of a sale does not take into
account future cash flows. These subsequent cash flows are
recorded in the year in which they occur. The recorded value of a
sale will reflect the premium received to date, the cost of setting up
an appropriate reserve, costs incurred in acquiring that business and
an allowance to recognise some of these acquisition costs should be
deferred and earned in line with the premium. Therefore, the value
associated with writing the same business will be recorded differently
in the year of sale on EEV and IFRS bases. However, the total profit
recognised over the full lifetime of an insurance policy is the same as
under the IFRS basis of reporting. We believe that the EEV basis gives
afairer indication of the profitability of business on inception.
Additionally, shareholders’ funds on an EEV basis incorporate
internally generated additional value of in-force business (AVIF),
which is excluded for IFRS reporting. Our incentive schemes and
internal management reporting are aligned to the EEV basis.
These financial statements include supplementary information on
EEV reporting in the “ Alternative method of reporting long-term
business” section.
Longer term investment return
The long-term nature of much of our operations means that short-
term realised and unrealised gains and losses on general insurance
and health business are shown as an adjustment to operating
profit. We focus instead on operating profit incorporating a longer
term investment return (LTIR). Our rates of return that we use for
equity and property in our LTIR methodology are aligned with the
rates that we use under EEV principles. For fixed interest securities,
we include the amortisation of premiums or discounts arising on
purchase, thereby producing an LTIR that is equivalent to the gross
redemption yield.
Critical accounting policies and estimates
The preparation of our financial statements requires us to make
estimates and assumptions that affect items reported in the
consolidated income statement, balance sheet, other primary
statements and notes to the financial statements. All estimates are
based on management’s current knowledge, assumptions based on
that knowledge, and their predictions of future events and actions.
Actual results can always differ from estimates, possibly significantly.
The table below sets out those items that we consider particularly
susceptible to changes in estimates and assumptions, and the
relevant accounting policy. Full details of the accounting policies are
set out on pages 104 to 113.
Item Accounting policy
Insurance product classification E
Insurance and participating investment contract liabilities J
Goodwill, AVIF and other intangible assets M
Impairment of financial investments R
Fair value of derivative financial instruments S
Deferred acquisition costs and other assets U
Provisions and contingent liabilities X
Pension obligations Y
Deferred tax Z
Future accounting developments
We seek to take an active role in the development of new
accounting standards, via industry forums and working parties,
and reviewing and providing comment on proposals from the
International Accounting Standards Board (IASB).
Phase II of the IASB’s project on insurance contracts remains the
most significant area that we are tracking. During 2006, the
insurance industry has worked closely with the IASB in seeking to
develop a comprehensive global accounting standardfor insurance
that will reflect the economics of our business. In June 2006, the
CFO Forum representing the large European insurers, in which we
play an active role, published principles for measurement and
recognition of insurance liabilities. We now await publication of the
IASB’s preliminary views in the first quarter of 2007. This is the first
stage in the development of the IASB’sstandard and it is unlikely
to be finalised before the end of 2009 at the earliest. The range of
possible outcomes remains large; therefore, it is too early to predict
the impact this change in accounting will have. While this standard
is under development, we will continue to focus on EEV as the best
measure of value for our long-term business.
We continue to monitor other major IASB projects including
financial statement presentation, liabilities, revenue recognition and
fair value measurement. The announcement from the IASB that no
new standards or major amendments would become mandatory
before 2009 and that the level of public consultation in the
development of new standards would increase was welcomed.