Aviva 2009 Annual Report Download - page 169

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Performance review
Aviva plc Notes to the consolidated financial statements continued
Corporate responsibility
Annual Report and Accounts 2009
Governance
Shareholder information
Financial statements IFRS
Financial statements MCEV
Other information
8 – Long-term business economic volatility
The long-term nature of much of the Group’s operations means that, for management’s decision-making and internal performance
management, the effects of short-term economic volatility are treated as non-operating items. The Group focuses instead on an
operating profit measure that incorporates an expected return on investments supporting its long-term business. This note explains
the methodology behind this.
(a) Definitions
Operating profit for long-term business is based on expected investment returns on financial investments backing shareholder and
policyholder funds over the reporting period, with consistent allowance for the corresponding expected movements in liabilities.
Operating profit includes the effect of variance in experience for non-economic items, such as mortality, persistency and expenses,
and the effect of changes in non-economic assumptions. Changes due to economic items, such as market value movements and
interest rate changes, which give rise to variances between actual and expected investment returns, and the impact of changes in
economic assumptions on liabilities, are disclosed separately outside operating profit.
(b) Economic volatility
The investment variances and economic assumption changes excluded from the long-term business operating profit are as follows:
Long-term business
2009 2008
£m £m
Investment variances and economic assumption changes (75) (1,631)
The limited economic variance in 2009 reflects the recovery in investment markets, with positive variances on fixed interest assets
in Europe and the United States driven by the narrowing of credit spreads towards the end of the year, offset by losses from equity
derivatives in the Netherlands. Investment variances include the reversal of £160 million of losses incurred in 2008 relating to assets
backing participating business in Spain. Additional credit default provisions for corporate bonds and commercial mortgages were
maintained at £550 million in the UK and increased by £97 million in Europe. This compares to a significantly negative impact in
2008 driven by the global financial crisis.
(c) Methodology
The expected investment returns and corresponding expected movements in long-term business liabilities are calculated separately
for each principal long-term business unit.
The expected return on investments for both policyholder and shareholders funds is based on opening economic assumptions
applied to the expected funds under management over the reporting period. Expected investment return assumptions are derived
actively, based on market yields on risk-free fixed interest assets at the end of each financial year. The same margins are applied on
a consistent basis across the Group to gross risk-free yields, to obtain investment return assumptions for equities and properties.
Expected funds under management are equal to the opening value of funds under management, adjusted for sales and purchases
during the period arising from expected operating experience.
The actual investment return is affected by differences between the actual and expected funds under management and
changes in asset mix, as well as movements in interest rates. To the extent that these differences arise from the operating
experience of the long-term business, or management decisions to change asset mix, the effect is included in the operating profit.
The residual difference between actual and expected investment return is included in investment variances, outside operating profit
but included in profit before tax.
The movement in liabilities included in operating profit reflects both the change in liabilities due to the expected return on
investments and the impact of experience variances and assumption changes for non-economic items.
The effect of differences between actual and expected economic experience on liabilities, and changes to economic
assumptions used to value liabilities, are taken outside operating profit. For many types of long-term business, including unit-linked
and with-profits funds, movements in asset values are offset by corresponding changes in liabilities, limiting the net impact on
profit. For other long-term business the profit impact of economic volatility depends on the degree of matching of assets and
liabilities, and exposure to financial options and guarantees.
(d) Assumptions
The expected rate of investment return is determined using consistent assumptions between operations, having regard to local
economic and market forecasts of investment return and asset classification under IFRS.
Within the 2008 results, the expected rate of investment return was calculated by reference to the one year swap rate in the
relevant currency plus an appropriate risk premium for equities and properties. For 2009, the Group considers that the return over
the typical duration of the assets held is more appropriate and is more consistent with our expectation of long-term rates of return.
The expected return on equities and properties has therefore been calculated by reference to the 10 year swap rate in the relevant
currency plus an appropriate risk premium.
If the IFRS operating profit had been calculated by reference to the one year swap rate, this profit would have been
£200 million lower. There is no impact on IFRS profit before tax.
Financial statements IFRS