Aviva 2007 Annual Report Download - page 256
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Please find page 256 of the 2007 Aviva annual report below. You can navigate through the pages in the report by either clicking on the pages listed below, or by using the keyword search tool below to find specific information within the annual report.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 future years 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 are similar 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. Where the 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.
Risk discount rates
Under the EEV methodology, a risk discount rate (RDR) is required to express a stream of expected future distributable
profits as a single value at a particular date (the present value). It is the interest rate that an investment equal to the
present value would have to earn in order to be able to replicate exactly the stream of future profits. The RDR is a
combination of a risk free rate to reflect the time value of money plus a risk margin to make prudent allowance for the
risk that experience in future years may differ from that assumed. In particular, a risk margin is added to allow for the risk
that expected additional returns on certain asset classes (e.g. equities) are not achieved.
Risk discount rates for our life businesses have been calculated using a risk margin based upon a Group Weighted
Average Cost of Capital (WACC). The Group WACC is calculated using a gross risk free interest rate, an equity risk margin,
a market assessed risk factor (beta), and an allowance for the gearing impact of debt financing (including subordinated
debt) on a market value basis. The market assessed risk factor captures the market’s view of the effect of all types of risk
on our business, including operational and other non-economic risk.
Aviva plc
Annual Report and
Accounts 2007
252
Financial
statements
Alternative method of reporting long-term business profits continued