Aviva 2009 Annual Report Download - page 211

209
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
38 – Insurance liabilities continued
(ii) Group practice
The long-term business provision is calculated separately for each of the Group’s life operations. The provisions for overseas
subsidiaries have generally been included on the basis of local regulatory requirements, mainly using the net premium method,
modified where necessary to reflect the requirements of the Companies Act.
Material judgement is required in calculating the provisions and is exercised particularly through the choice of assumptions
where discretion is permitted. In turn, the assumptions used depend on the circumstances prevailing in each of the life operations.
Provisions are most sensitive to assumptions regarding discount rates and mortality/morbidity rates.
Bonuses paid during the year are reflected in claims paid, whereas those allocated as part of the bonus declaration are
included in the movements in the long-term business provision.
(iii) Methodology and assumptions
There are two main methods of actuarial valuation of liabilities arising under long-term insurance contracts – the net premium
method and the gross premium method – both of which involve the discounting of projected premiums and claims.
Under the net premium method, the premium taken into account in calculating the provision is determined actuarially, based
on the valuation assumptions regarding discount rates, mortality and disability. The difference between this premium and the
actual premium payable provides a margin for expenses. This method does not allow for voluntary early termination of the contract
by the policyholder, and so no assumption is required for persistency. Explicit provision is made for vested bonuses (including those
vesting following the most recent fund valuation), but no such provision is made for future regular or terminal bonuses. However,
this method makes implicit allowance for future regular or terminal bonuses already earned, by margins in the valuation discount
rate used.
The gross premium method uses the amount of contractual premiums payable and includes explicit assumptions for interest
and discount rates, mortality and morbidity, persistency and future expenses. These assumptions can vary by contract type and
reflect current and expected future experience. Explicit provision is made for vested bonuses and explicit allowance is also made for
future regular bonuses, but not terminal bonuses.
(a) UK
With-profit business
The valuation of with-profit business uses the methodology developed for the Realistic Balance Sheet, adjusted to remove the
shareholders’ share of future bonuses. The key elements of the Realistic Balance Sheet methodology are the with-profit benefit
reserve (WPBR) and the present value of the expected cost of any payments in excess of the WPBR (referred to as the cost of future
policy-related liabilities). The realistic liability for any contract is equal to the sum of the WPBR and the cost of future policy-related
liabilities. The WPBR for an individual contract is generally calculated on a retrospective basis, and represents the accumulation of
the premiums paid on the contract, allowing for investment return, taxation, expenses and any other charges levied on the
contract.
For a small proportion of business, a prospective valuation approach is used, including allowance for anticipated future regular
and final bonuses.
The items included in the cost of future policy-related liabilities include:
— Maturity Guarantees
— Guaranteed Annuity Options
— GMP underpin on Section 32 transfers
— Expected payments under Mortgage Endowment Promise
In the Provident Mutual and With-Profits sub-funds in UKLAP, this is offset by the expected cost of charges to WPBR to be made
in respect of guarantees.
The cost of future policy-related liabilities is determined using a market-consistent approach and, in the main, this is based
on a stochastic model calibrated to market conditions at the end of the reporting period. Non-market-related assumptions (for
example, persistency, mortality and expenses) are based on experience, adjusted to take into account future trends.
The principal assumptions underlying the cost of future policy related liabilities are as follows:
Future investment return
A “risk-free” rate equal to the spot yield on UK Government securities, plus a margin of 0.1% is used. The rates vary, according
to the outstanding term of the policy, with a typical rate as at 31 December 2009 being 4.35%
(2008: 3.58%) for a policy with
10 years outstanding.
Volatility of investment return
Volatility assumptions are set with reference to implied volatility data on traded market instruments, where available or on a best
estimate basis where not. These are term-dependent, with specimen values for 10 year terms as follows:
Financial statements IFRS
Volatility
2009 2008
Equity returns 26.6% 34.6%
Property returns 15.0% 15.0%
Fixed interest yields 14.4% 15.9%
The table above shows the volatility of fixed interest yields, set with reference to 20 year at-the-money swaption volatilities.