Aviva 2014 Annual Report Download - page 194

Aviva plc Annual report and accounts 2014
Notes to the consolidated financial statements continued
190
41 – Insurance liabilities continued
(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.
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.
(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;
• Guarantees on surrender, including no-MVR (Market Value Reduction) Guarantees and Guarantees linked to inflation
• Guaranteed Annuity Options;
• GMP (Guaranteed Minimum Pension) underpin on Section 32 transfers; and
• Expected payments under Mortgage Endowment Promise.
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 swaps is used for the valuation of With-Profits business. The rates vary according to
the outstanding term of the policy, with a typical rate as at 31 December 2014 of 1.88% (2013: 3.11%) for a policy with ten 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.
Volatility 2014 2013
Equity returns 22.3% 22.1%
Property returns 15.0% 15.0%
Fixed interest yields 27.2% 16.3%
The equity volatility used depends on term, money-ness and region. The figure shown is for a sample UK equity, at the money,
with a ten-year term. Fixed interest yield volatility is also dependent on term and money-ness. The figure shown is for a ten-year
swap option with ten-year term, currently at the money.
Future regular bonuses
Annual bonus assumptions for 2015 have been set consistently with the year-end 2014 declaration. Future annual bonus rates
reflect the principles and practices of each fund. In particular, the level is set with regard to the projected margin for final bonus
and the change from one year to the next is limited to a level consistent with past practice.
Mortality
Mortality assumptions for with-profit business are set with regard to recent Company experience and general industry trends. The
mortality tables used in the valuation are summarised below:
Mortality table used 2014 2013
Assurances, pure endowments and deferred annuities before vesting Nil or Axx00 adjusted Nil or Axx00 adjusted
Pensions business after vesting and pensions annuities in payment
PCMA00/PCFA00 adjusted plus
allowance for future mortality
improvement
PCMA00/PCFA00 adjusted plus
allowance for future mortality
improvement
190 | Aviva plc Annual report and accounts 2014