Aviva 2014 Annual Report Download - page 175

Aviva plc Annual report and accounts 2014
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23 – Fair value methodology continued
Total net gains recognised in the income statement in the year ended 31 December 2014 in respect of Level 3 assets measured at
fair value amounted to £1,837 million (restated 2013: £234 million), with net losses in respect of liabilities of £227 million (restated
2013: gains £22 million). Included in this balance are net gains of £1,733 million (restated 2013: £199 million) attributable to those
assets and net losses of £227 million (restated 2013: gains £22 million) attributable to those liabilities still held at the end of the
year.
The principal assets classified as Level 3, and the valuation techniques applied to them, are:
• Commercial mortgage loans held by our UK Life business amounting to £10.4 billion (2013: £9.9 billion), valued using a Portfolio
Credit Risk Model (PCRM). This model calculates a Credit Risk Adjusted Value (CRAV) for each mortgage. The risk adjusted cash
flows are discounted using a yield curve, taking into account the term dependent gilt yield curve, and global assumption for the
liquidity premium. The mortgage loans have been classified as Level 3 as the liquidity premium is deemed to be non-market
observable. The illiquidity premium used in the discount rate ranges between 140 bps to 180 bps.
• Equity release and securitised mortgage loans held by our UK life business amounting to £5.9 billion (2013: £4.7 billion)
comprise:
– £3.6 billion (2013: £2.6 billion) of equity release mortgages held by our UK Life annuity business valued using an internal model
which has been refined during 2014 (see note 41(b)(iii) for further details). Inputs to the model include property growth rates,
mortality and morbidity assumptions, cost of capital and liquidity premium. These mortgage loans continue to be classified as
Level 3 as these inputs are not deemed to be market observable. The assumed property growth ranges between 1.4% to 1.7%
per annum.
– £2.3 billion (2013: £2.1 billion) of securitised and equity release mortgages are valued using a DCF model. The inputs include
liquidity risk and property risk premium which are deemed unobservable. The liquidity risk premium used ranges between 140
bps to 180 bps.
• Investment property amounting to £8.9 billion (2013: £9.5 billion). In the UK, investment property is valued at least annually by
external chartered surveyors in accordance with guidance issued by The Royal Institution of Chartered Surveyors, and using
estimates during the intervening period. Outside the UK, valuations are produced by local qualified staff of the Group or external
qualified professional appraisers in the countries concerned. Investment properties are valued on an income approach that is
based on current rental income plus anticipated uplifts at the next rent review, lease expiry, or break option taking into
consideration lease incentives and assuming no further growth in the estimated rental value of the property. This uplift and the
discount rate are derived from rates implied by recent market transactions on similar property. These inputs are deemed
unobservable.
• Structured bond-type and non-standard debt products held by our business in France amounting to £7.4 billion (2013:
£7.1 billion) and bonds held by our UK business of £1.0 billion (2013: £0.5 billion), for which there is no active market. These
bonds are valued either using counterparty or broker quotes. These bonds are validated against internal or third-party models.
These bonds have been classified as Level 3 because either (i) the third-party models included a significant unobservable liquidity
adjustment, or (ii) differences between the valuation provided by the counterparty and broker quotes and the validation model
were sufficiently significant to result in a Level 3 classification. At 31 December 2014, the values reported in respect of these
products were the lower of counterparty and broker quotes and internally modelled valuations.
• Privately placed notes held by our UK Life business of £1.8 billion transferred in during 2014 have been valued by an internal DCF
model using discount factors comprising the yield on a sovereign gilt of similar maturity, plus spreads for credit and liquidity risk.
The DCF model used was refined during the year to incorporate asset specific counterparty credit ratings. Where credit spreads
have been derived internally these inputs have been deemed to be unobservable and notes have been classified as Level 3.
• Private equity investment funds amounting to £1.0 billion (2013: £1.1 billion), together with external hedge funds held principally
by businesses in the UK and France amounting to £1.4 billion (2013: £1.1 billion), and property funds amounting to £0.3 billion
(2013: £0.5 billion) are valued based on external reports received from the fund manager. Where these valuations are at a date
other than balance sheet date, as in the case of some private equity funds, we make adjustments for items such as subsequent
draw-downs and distributions and the fund manager’s carried interest.
• Level 3 investments including a collateralised loan obligation of £0.4 billion (2013: £0.4 billion) and UK non-recourse loans of
£0.5 billion (2013: £0.8 billion) have been valued using internally developed discounted cash flow models.
• Investments including debt securities held by our French business of £0.3 billion (2013: £0.7 billion) have been valued using third
party or counterparty valuations.
• Other Level 3 investments amount to £1.2 billion (restated 2013: £1.0 billion) and relate to a diverse range of different types of
securities held by a number of businesses throughout the Group.
Aviva plc Annual report and accounts 2014 |171
IFRS Financial statements