Aviva 2009 Annual Report Download - page 224

222
Aviva plc Notes to the consolidated financial statements continued
Annual Report and Accounts 2009
40 – Financial guarantees and options continued
‘No MVR’ guarantees
Certain unitised with-profit policies containing ‘no MVR’ guarantees, similar to those in the UK, have been sold in Ireland.
These guarantees are currently ‘in-the-money’ by £10 million
(2008: ‘in-the-money’ by £16 million, 2007: ‘out-of-the-money’
by £53 million)
. This has been calculated on a deterministic basis as the excess of the current policy surrender value over the
discounted value (excluding terminal bonus) of the guarantees. The value of these guarantees is usually sensitive to the
performance of investments held in the with-profit fund. Amounts payable under these guarantees are determined by the bonuses
declared on these policies. It is estimated that the guarantees would be ‘in-the-money’ by £10 million
(2008: ‘in-the-money’
by £16 million, 2007: ‘out-of-the-money’ by £46 million)
if yields were to increase by 1% per annum and by £10 million (2008:
‘in-the-money’ by £16 million, 2007: ‘out-of-the-money’ by £29 million)
if equity markets were to decline by 10% from year end
2009 levels. There is no sensitivity to either interest rates or equity markets since there is no longer any exposure to equity in these
funds and a matching strategy has been implemented for bonds.
Return of premium guarantee
Until 2005, Hibernian Life wrote two tranches of linked bonds with a return of premium guarantee, or a price floor guarantee,
after five or six years. The provision for these over and above unit and sterling reserves, at the end of 2009 is £11 million
(2008: £18 million, 2007: £0.1 million).
It is estimated that the provision would increase by £4 million (2008: £4 million, 2007: £1 million) if equity markets were to
decline by 10% from the year end 2009 levels. However, the provision increase would be broadly off-set by an increase in the
value of the hedging assets that were set up on sale of these policies. We would not expect any significant impact on this provision
as a result of interest rate movements. It is estimated that the provision would increase by £2 million if property values were to
decline by 10% from year end 2009 levels. This would be offset by an increase in the value of the hedging assets by £0.4 million,
the difference reflecting the fact that only the second tranche was hedged for property exposure.
(iv) Spain and Italy
Guaranteed investment returns and guaranteed surrender values
The Group has also written contracts containing guaranteed investment returns and guaranteed surrender values in both Spain
and Italy. Traditional profit-sharing products receive an appropriate share of the investment return, assessed on a book value basis,
subject to a guaranteed minimum annual return of up to 6% in Spain and 4% in Italy on existing business, while on new business
the maximum guaranteed rate is lower. Liabilities are generally taken as the face value of the contract plus, if required, an
explicit provision for guarantees calculated in accordance with local regulations. At 31 December 2009, total liabilities for the
Spanish business were £3 billion
(2008: £5 billion, 2007: £4 billion) with a further reserve of £11 million (2008: £19 million,
2007: £16 million)
for guarantees. Total liabilities for the Italian business were £6 billion (2008: £5 billion, 2007: £4 billion) , with a
further provision of £52 million
(2008: £55 million, 2007: £48 million) for guarantees. Liabilities are most sensitive to changes in
the level of interest rates. It is estimated that provisions for guarantees would need to increase by £46 million
(2008: £59 million,
2007: £66 million)
in Spain and £16 million (2008: £5 million, 2007: £14 million) in Italy if interest rates fell by 1% from end 2009
values. Under this sensitivity test, the guarantee provision in Spain is calculated conservatively, assuming a long-term market
interest rate of 1.6% and no lapses or premium discontinuances.
(v) United States
Indexed and total return strategy products
In the United States, the Group writes indexed life and deferred annuity products. These products guarantee the return of principal
to the policyholder and credit interest based on certain indices, primarily the Standard & Poor’s 500 Composite Stock Price Index.
A portion of each premium is used to purchase derivatives to hedge the growth in interest credited to the policyholder.
The derivatives held by the Group and the options embedded in the policy are both carried at fair value.
The US Treasury swap curve plus a risk adjustment of 1.87%
(2008: 5.30%, 2007: 1.05%) for indexed life and 1.65%
(
2008: 5.30%, 2007: 1.05%) for indexed deferred annuities is used as the discount rate to calculate the fair value of the
embedded options.
The risk adjustment calculation is based on market spreads on senior long-term unsecured Aviva plc debt with a reduction
to reflect policyholder priority over other creditors in case of default. The amount of change in the fair value of these embedded
options resulting from the risk adjustment in 2009 is an increase of £313 million (2008: £514 million decrease), and is principally
attributable to market factors rather than instrument specific credit risk. There were no significant gains or losses attributable to
the risk adjustment or instrument specific credit risk. At 31 December 2009, the total liabilities for indexed products were
£17 billion
(2008: £15 billion, 2007: £8 billion) , including liabilities for the embedded option of £1.7 billion (2008: £1.9 billion,
2007: £1.2 billion)
. If interest rates were to increase by 1%, the provision for embedded options would decrease by £59 million
(2008: £138 million, 2007: £89 million) and, if interest rates were to decrease by 1%, the provision would increase by £86 million
(2008: £155 million, 2007: £86 million) .
The Group has certain products that credit interest based on a total return strategy, whereby policyholders are allowed to
allocate their premium payments to different asset classes within the general account. The Group guarantees a minimum return
of premium plus approximately 3% interest over the term of the contracts. The linked general account assets are fixed maturity
securities, and both the securities and the contract liabilities are carried at fair value. At 31 December 2009, the liabilities for total
return strategy products were £1.2 billion
(2008: £1.5 billion, 2007: £1.2 billion) .
The Group offers an optional lifetime guaranteed income benefit focused on the retirement income segment of the deferred
annuity marketplace to help customers manage income during both the accumulation stage and the distribution stage of their
financial life. At 31 December 2009, a total of £4.9 billion
(2008: £3.2 billion, 2007: £0.7 billion) in indexed deferred annuities
have elected this benefit taking steps to guarantee retirement income.