Proposed Insurance Business Transfer from Aviva Annuity UK ... · 5.4 Risk profile of UKA’s...

[5.16.4.9] [Aviva UKA Part VII - IE report final.pdf] [Page 1 of 70]

Proposed Insurance Business Transfer from Aviva Annuity UK Limited to Aviva Life & Pensions UK Limited

Report of the Independent Expert under Section 109 of the Financial Services and Markets Act 2000

Prepared by: Gordon Wood

Date: 1 July 2016


Contents

1. Executive summary ......................................................................................................... 4

1.1 Overview .................................................................................................................... 4

1.2 Basis for opinions ....................................................................................................... 4

1.3 Conclusions................................................................................................................ 4

1.4 Supplementary Report ............................................................................................... 6

2. Introduction ...................................................................................................................... 7

2.1 Independent Expert .................................................................................................... 7

2.2 Purpose of this Report ............................................................................................... 7

2.3 Scope of this Report................................................................................................... 7

2.4 Independence ............................................................................................................ 8

2.5 Terms of reference ..................................................................................................... 8

2.6 Statements of reliance and limitations........................................................................ 9

2.7 Legal jurisdiction ...................................................................................................... 11

2.8 Duty to the Court ...................................................................................................... 11

2.9 Statement of truth .................................................................................................... 11

2.10 Technical Actuarial Standards .................................................................................. 11

2.11 Actuarial Profession Standards ................................................................................ 11

3. General considerations ................................................................................................. 12

3.1 Approach to review the level of security of policyholders’ benefits ........................... 12

3.2 Approach to review the rights and expectations of policyholders ............................. 12

3.3 The old regulatory regime (Solvency I) .................................................................... 13

3.4 Solvency II ............................................................................................................... 13

3.5 Future regulatory changesSolvency II ...................................................................... 14

3.6 Capital policy ............................................................................................................ 14

4. Outline of changes ........................................................................................................ 16

4.1 Background to the changes ..................................................................................... 16

4.2 Details of the changes.............................................................................................. 16

4.3 Additional considerations ......................................................................................... 17

4.4 Further requirements under Solvency II ................................................................... 20

5. Aviva Annuity UK Limited (UKA) .................................................................................. 22

5.1 Background .............................................................................................................. 22

5.2 Recent history and future development ................................................................... 22

5.3 Nature of business written........................................................................................ 22

5.4 Risk profile of UKA’s business ................................................................................. 25

5.5 Solvency position ..................................................................................................... 26

5.6 Own Risk Solvency Assessment (“ORSA”) .............................................................. 27

6. Aviva UK Life & Pensions UK Limited (UKLAP) .......................................................... 28

6.1 Background .............................................................................................................. 28

6.2 Recent history and future development ................................................................... 28

6.3 Nature of business written........................................................................................ 29

6.4 Risk profile of UKLAP’s business ............................................................................. 33

6.5 Solvency position ..................................................................................................... 34

7. Effect of proposed changes on security of policyholder guarantees .......................36

7.1 Introduction .............................................................................................................. 36

7.2 Security of policyholders’ guaranteed benefits ......................................................... 36

7.3 Security of policyholders’ benefits ............................................................................ 38

7.4 Investment management administration .................................................................. 41

7.5 Other considerations ................................................................................................ 42

7.6 Conclusions of security of benefits ........................................................................... 47

8. Effect of proposed changes on rights and expectations of policyholders .............. 48

8.1 Rights and expectations ........................................................................................... 48

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8.2 Ongoing administration and governance ................................................................. 49

8.3 Policyholder communications ................................................................................... 50

8.4 Customers’ interests ................................................................................................ 51

8.5 Other considerations ................................................................................................ 51

8.6 Conclusion of rights and expectations ..................................................................... 53

9. Conclusions ................................................................................................................... 55

Appendix A:Glossary ............................................................................................................ 57

Appendix B:Company abbreviations referred to in this Reports ...................................... 62

Appendix C:PS7/15 cross reference .................................................................................... 63

Appendix D:Information considered .................................................................................... 66

Appendix E:UK Life company structure .............................................................................. 68

Appendix F:External reinsurance treaties ........................................................................... 69

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1. Executive summary

1.1 Overview

Aviva Life Holdings UK Limited (‘‘UKLH’’) has identified opportunities to simplify the fund structure of

its business (“UKL” or ‘‘UK Life’’) which includes the transfer of the existing business (Non-Profit

Annuities) from Aviva Annuity UK Limited (“UKA”) to Aviva Life & Pensions UK Limited (“UKLAP”) (the

‘‘Part VII Transfer” or the “Scheme”).

I have been appointed as the Independent Expert in connection with the Part VII Transfer of the

business from UKA to UKLAP. My role is to prepare a report (“Scheme Report” or this ‘‘Report’’) which

considers the security of the benefits and the benefit expectations of the policyholders of both UKA

and UKLAP. In addition to the Scheme, separate parallel schemes are required in Guernsey, Jersey

and the Isle of Man for the transfer from UKA to UKLAP. My considerations and conclusions in this

Report apply equally to the Guernsey scheme, the Jersey scheme and the Isle of Man scheme as to

the Scheme.

I have compiled this Report in accordance with paragraphs 2.27 to 2.37 of the Prudential Regulation

Authority (‘‘PRA’’) Policy Statement and Section 2 of SUP 18 issued by Financial Conduct Authority

(‘‘FCA’’), which give guidance on the form of the Scheme Report.

1.2 Basis for opinions

To reach my conclusions, I have applied the principles set out in the Technical Actuarial Standards (‘‘TAS’’) and Actuarial Profession Standards (‘‘APSs’’) and I have sought to:

► Exercise my judgement in a reasoned and justifiable manner

► Describe the impact on all classes of beneficiaries

► Indicate how the Scheme might lead to any changes in the material risks to the benefits of different classes of beneficiaries

► Indicate (in broad terms) the impact on the actuarial information of adopting alternative plausible assumptions

► Assess the impact of all classes of beneficiaries

► Indicate the rationale for the proposal for the Scheme to proceed

► Include (in summary) the most material information on which my opinion is based

► Describe the rationale for my opinion

1.3 Conclusions

I am aware of a number of areas where work is still in progress which I will continue to keep under review in the period leading up to the final hearing (‘‘Sanctions Hearing’’) at the High Court of Justice of England and Wales (the ‘‘Court’’), the Royal Court of Guernsey, the Royal Court of Jersey and the Isle of Man Courts of Justice. These include:

► The financial position discussed in section 2.6.1

► The internal reinsurance agreements discussed in section 4.3.3

► The Internal Model Approval discussed in section 4.4

► The PRA approval of the Matching Adjustment, Volatility Adjustment and Transitional Measures - Technical Provision applications of UKLAP post Part VII Transfer, as discussed in section 7.5.1 and section 7.5.3.

► The unsigned external reinsurance treaties as discussed in section 5.3.3

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► The consent from external reinsurers as required in the external reinsurance treaties, as discussed in section 7.5.4.2

► The internal agreement procedures to transfer the intra-group fund management and administration service agreements between UKLAP / UKA and other services companies in Aviva Group, as discussed in section 7.4.4 and section 8.2.1

► The pending non-discretionary asset management agreement, as discussed in section 7.4.3

► The consent from counterparties of Custodian Agreements, as discussed in section 7.4.5

► The consent from counterparties of the commercial mortgages agreement, Bulk Purchase Annuity agreements and equity release arrangements, as discussed in section 7.5.7.1, section 7.5.7.2 and section 7.5.7.4

► The tax consideration discussed in section 8.5.4

Of the items set out above, the following could have a material effect on the Scheme:

► The financial position of the Companies. Should the financial positions of the Companies

adversely change prior to the Effective Data to the extent that the metrics fall outside of the stated risk appetite, then the Scheme will not proceed

► The PRA approval of the Matching Adjustment, Volatility Adjustment and Transitional Measures. If these are not approved, the Scheme will not proceed

Noting the above basis for opinions and subject to the conditions set out above and given that:

► The contractual benefits under the transferring policies will not be changed after the

implementation of the Scheme

► There will be no material change to the administration and service standards applicable to the policyholders of the transferring policies after the implementation of the Scheme

► The implementation of the Scheme will not materially change the management and governance of the transferring policies

► Additional safeguards will not need to be contained within the Scheme to protect the interests of either the UKA or UKLAP policyholders, either to ensure that the Scheme operates as set out, or for any other reasons

► There are no material concerns in the tax position as the result of the Part VII Transfer

I am satisfied that there will be no material adverse effect on the security of the guaranteed benefits for either the UKA or UKLAP policyholders following the implementation of the Scheme on the Effective Date.

I am satisfied that there will be no material adverse effect on the reasonable benefit expectations of either the UKA or UKLAP policyholders, nor on their being treated fairly in accordance with Principle 6 of the FCA’s Principles for Business (Customers’ interests) nor on other FCA conduct requirements following the implementation of the Scheme on the Effective Date.

I am satisfied that there will be no material adverse effect on the service levels experienced by either the UKA or UKLAP policyholders following the implementation of the Scheme on the Effective Date.

I am satisfied that there would be no material change to the security provided to policyholders who are resident in Guernsey, Jersey and Isle of Man or were sold their policy whilst resident in Guernsey, Jersey and Isle of Man, and that this group of policyholders would not be adversely affected to a material extent by the Scheme, and that therefore there is no reason that the Scheme should not go ahead.

I am satisfied that there will be no additional conduct risk to either the UKA or UKLAP policyholders following the implementation of the Scheme on the Effective Date.

I see no reason for additional safeguards beyond those contained in the Scheme to protect the interests of either the UKA or UKLAP policyholders.

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1.4 Supplementary Report

Paragraph 2.39 of the PRA Policy Statement requires a further report (the ‘‘Supplementary Report’’, together with the Scheme Report as ‘‘these Reports”) to be prepared prior to the Sanctions Hearing. This will provide an update for the Court on my conclusions in the light of any significant events subsequent to the date of the finalisation of this Report.

This report is based on information made available to me up to 26 May 2016 and takes no account of developments after this date. An updated financial view will be provided within the Supplementary Report which includes an allowance of the effects of the referendum on the EU membership.

Gordon Wood, FIA

1 July 2016

Associate Partner Ernst & Young LLP 10 George Street Edinburgh EH2 2DZ

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2. Introduction

2.1 Independent Expert

When an application is made to the Court for an order to sanction the transfer of long-term insurance

business from one insurance company to another, the application is subject to Part VII of the Financial

Services and Markets Act 2000 (“FSMA”) and must be approved by the Court under Section 111.

FSMA requires the application to be accompanied by a report on the terms of the Scheme by an

Independent Expert under Section 109 and the report must be made in a form approved by the PRA

having consulted the FCA (together with PRA, the ‘‘Regulators’’) under Section 5.

I have been appointed by UKLAP pursuant to Section 109 of FSMA as the Independent Expert in

connection with the Scheme involving the transfer of the entire long-term insurance business (the

‘‘Transferred Business’’) of UKA to UKLAP (together the “Companies”). The shareholders of UKLAP

will be responsible for payment of fees incurred by me in my capacity as the Independent Expert for

the Scheme.

The Scheme is expected to become operative and take effect from 1 January 2017.

I am a Fellow of the Institute and Faculty of Actuaries (‘‘IFoA’’), having qualified in 1988, and am an

Associate Partner in the EMEIA Insurance - Risk and Actuarial Services practice of Ernst & Young

LLP (“EY”), 10 George St, Edinburgh EH2 2DZ. I lead the consulting actuarial team for EY in

Scotland, undertaking a wide variety of advisory and audit engagements working for life assurance

clients in the actuarial and risk areas. Prior to joining EY in 2007, I was the Chief Actuary for Abbey

National Insurance Division, holding the regulatory Actuarial Function Holder (‘‘AFH’’) positions for

Scottish Mutual, Scottish Provident and other regulated companies.

My appointment as the Independent Expert has been approved by the PRA in a letter dated 18

February 2016 after consultation with the FCA.

2.2 Purpose of this Report

The purpose of this Report is to review the consequence of the Scheme for all policyholders affected

(UKA as well as UKLAP policyholders). I am concerned particularly to assess whether the Scheme

provides sufficient protection for policyholders’ interests in the changed circumstances which will

apply following the implementation of the Scheme.

To the best of my knowledge, I have taken account of all material facts in assessing the impact of the

Scheme and in preparing this Report. I am only required to consider the Scheme put to me and hence

this Report does not consider possible alternative schemes. However, I have also considered the

position of UKLAP and UKA should the Part VII Transfer not take place. This is shown in the relevant

sections below.

2.3 Scope of this Report

As the Independent Expert for the Scheme, I must have regard to the provisions of Part VII of the

FSMA 2000, and also take account of guidance issued by the PRA and FCA. This means that this

Report must consider the consequences of the Scheme for all policyholders affected (UKA as well as

UKLAP policyholders), including whether the Scheme provides sufficient protection for policyholders’

interests in the changed circumstances which will apply following implementation.

The Scheme will be submitted to the Court for sanction under Section 111 of Part VII of the FSMA.

This Report will be presented to the Court at an initial hearing (the “Directions Hearing”). In order to

reflect any updated financial information or circumstances nearer to the date of the Sanctions

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Hearing, I expect to provide a Supplementary Report setting out my updated opinions in respect of

the Scheme. It is likely that the Court will consider the contents of these Reports in deciding whether

to sanction the Scheme.

Readers of my Report may find it helpful to read some of the other related Scheme documents on the

Companies’ website. I have considered each of these in coming to my opinions, but have not relied on

any opinions therein.

In addition to the Scheme, separate parallel schemes are required in Guernsey, Jersey and Isle of

Man to transfer to UKLAP:

► The long-term insurance business carried on by UKA in or from within Jersey

► Any policy of long-term insurance issued by UKA under Guernsey law or to a person resident in the Bailiwick of Guernsey

► Any policy of long-term insurance issued by UKA under the Isle of Man law or to a person resident in the Isle of Man

My considerations and conclusions in this Report apply equally to the Guernsey scheme, Jersey scheme and Isle of Man scheme as to the Scheme. In this Report, references to “the Scheme” should be taken to include the schemes in Guernsey, Jersey and Isle of Man.

This Report is also intended to be presented to the Royal Court of Guernsey, the Royal Court of Jersey and the Isle of Man Courts of Justice to satisfy the requirement for a report by an independent actuary on the terms of the Guernsey scheme, Jersey scheme and Isle of Man scheme respectively.

I recognise that this report will be used by the Royal Court of Guernsey, the Royal Court of Jersey and the Isle of Man Courts of Justice in connection with their consideration of the respective schemes.

2.4 Independence

I have a term assurance policy taken out originally with Royal Scottish Assurance, which was

subsequently transferred to Aviva Life & Pensions UK Limited. This was purchased on commercial

terms, there are no discretionary benefits and I am confident that this does not impact my

independence.

With the exception of this policy, I, my immediate family, my team (including the peer reviewer) and

their immediate families do not hold any policies, investments, shareholdings nor have any other

financial interests with any of the Companies. I and my team have not been materially involved in

advising the Companies on any significant projects in the past.

EY has carried out and continues to carry out a number of different projects for Aviva plc (“Aviva”).

Partner and staff of EY have not acted for the Companies in projects relating to valuation or capital

modelling work or on any projects related to this Scheme.

I do not believe that any of these financial interests or engagements compromise my independence,

create a conflict of interest, or compromise my ability to report on the Scheme. The financial interests

and engagements were disclosed to the PRA prior to their approval of me as the Independent Expert.

I consider myself and my team to be appropriately independent of both parties for the purposes of the

Scheme.

2.5 Terms of reference

The PRA has issued guidance on the form of the Scheme Report which is set out in paragraphs 2.27

to 2.37 of Appendix 2.4 of its Policy Statement 7/15 which will form part of the PRA Rulebook and are

set out in Appendix C of this Report.

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The terms of reference for my review of the Scheme have been agreed with UKA and UKLAP, and

reviewed by the PRA.

This Report will consider the implications of the Scheme based on the financial position of the

Companies as at 1 January 2016, the date that Solvency II came into effect.

I have been assisted by other employees of EY working under my supervision in the preparation of

this Report. However, I take sole responsibility for the conclusions reached and the opinions

expressed.

In preparing this Report I have taken into account the followings:

► The Code of Practice for Experts and those instructing them, issued by the Academy of Experts

► Guidance for the Instruction of Experts in Civil Claims

► Guidance set out in paragraphs 2.27 to 2.37 of Appendix 2.4 of the PRA’s Policy Statement 7/15 which will form part of the PRA Rulebook

► Section 2 of SUP 18 issued by the FCA

► Discussions about the contents of this Report with the PRA and the FCA

This Report should be read in conjunction with the full terms of the Scheme.

2.6 Statements of reliance and limitations

2.6.1 Reliance

In preparing this Report, I have relied on the accuracy and completeness of written and verbal data

and information provided to me by the Companies, the key elements of which are listed in Appendix

D. I have reviewed the information for consistency and reasonableness, using my knowledge of the

UK life insurance industry but have not otherwise verified it.

Furthermore, I have had access to, and discussions with, senior management of both UKA and

UKLAP.

I have used the audited financial information and solvency statements under the old regulatory regime

Solvency I, as at 31 December 2015, which are set out in their 2015 regulatory returns to the PRA. I

have relied on them in carrying out my analysis. I believe this is reasonable since the results,

processes and assumptions used to produce them have been externally audited.

My analysis of the solvency position of the Companies under the new regulatory regime, Solvency II,

which commenced on 1 January 2016, is based the actual financial position as at 1 January 2016.

The Solvency II position as at 1 January 2016 has been audited.

The 30 June 2015 figures are not currently available on the same basis as the 1 January 2016

results, and as such have not been included here.

I have reviewed the information for consistency and reasonableness using my knowledge of the UK

life insurance industry, the Solvency II requirements and the Companies’ business.

Although I did not verify the figures, I have asked the management for clarification of any results that

seemed inconsistent or unclear to me, and received satisfactory explanations.

The Companies currently have Solvency II Matching Adjustment, Volatility Adjustment and

Transitional Deductions approvals from the PRA. These approvals will need to be re-applied for

following the Part VII Transfer. I have reviewed the Solvency II Matching Adjustment, Volatility

Adjustment and Transitional Deductions approval requests for the post Part VII Transfer position and

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do not believe there are any material issues with the Companies’ proposed applications. In addition, I

note that the PRA has reviewed to the proposed applications and stated that they have “no objection

in principle”.

Furthermore, the estimates are used by the Companies as an important input in practice to make

decisions such as their Own Risk and Solvency Assessments (‘‘ORSA’’). I have had access to

material such as UKLAP’s historic Individual Capital Assessment (‘‘ICA’’) Reports and the ORSA

report in assessing policyholder security. These are not audited but are reviewed and approved by the

relevant committees and the Board. In view of this, I have satisfied myself that it is reasonable for me

to rely on the information provided to me without further verification.

As part of my analysis, I have considered estimates provided by the Companies of the expected

solvency position post Part VII Transfer as at 1 January 2016. I note that the economic position post

Part VII Transfer cannot be predicted with certainty. The absolute solvency level post Part VII Transfer

will therefore differ from the estimated solvency position as shown in this Report, but I would not

expect the impact of the Scheme to vary significantly from the estimates shown. This impact is my

primary consideration, alongside the Companies continuing to satisfy regulatory solvency

requirements, as is currently the case.

I will continue to keep the 2016 financial position under review in the period leading up to the

Sanctions Hearing, and will prepare further information in my Supplementary Report.

2.6.2 Limitations

This Report, and any extract or summary thereof, has been prepared particularly for the use of the

bodies or persons listed below:

► High Court

► Directors and senior management of UKA

► Directors and senior management of UKLAP

► PRA, FCA or any other governmental departments or agencies having responsibility for the regulation of insurance companies in the UK

► Policyholders of UKA and UKLAP

► Legal or tax advisors of the Companies

► Reinsurers of UKA and UKLAP

► The Royal Court of Guernsey

► The Guernsey Financial Services Commission

► The Royal Court of Jersey

► The Jersey Financial Services Commission

► The Isle of Man Courts of Justice

► The Insurance and Pensions Authority and Financial Supervision Commission of Isle of Man

This Report must be considered in its entirety since individual sections, if considered in isolation, may

be misleading. Draft versions of this Report and any other interim working papers must not be relied

on by any person for any purpose.

I have provided a summary of this Report for inclusion in the policyholder circular and, other than this,

no summary of this Report may be made without my express consent.

This Report has been prepared by EY on an agreed basis (as set out in our engagement letter of 28

January 2016) for UKA and UKLAP in the context of the Scheme and must not be relied upon for any

10


other purpose. No liability will be accepted by EY, or me, for any application of this Report for a

purpose for which it was not intended, nor for the results of any misunderstanding by any user of any

aspect of this Report. If other persons choose to rely in any way on the contents of this Report then

they do so entirely at their own risk.

2.7 Legal jurisdiction

This Report will be governed by and construed in accordance with English law and the English courts will have exclusive jurisdiction in connection with all disputes and differences arising out of, under or in connection with this Report.

2.8 Duty to the Court

I confirm that I am aware of the requirements of Part 35 of the Civil Procedures Rules and the

relevant Practice Direction and the Guidance for the Instruction of Experts in Civil Claims.

In reporting on the Scheme as the Independent Expert, I recognise that I owe a duty to the Court, the

Royal Court of Guernsey, the Royal Court of Jersey and the Isle of Man Courts of Justice to assist it

on matters within my expertise. This duty overrides any obligation to UKLAP and / or UKA. I confirm

that I have complied with this duty.

2.9 Statement of truth

I confirm that I have made clear which facts and matters referred to in this Report are within my own knowledge and which are not. Those that are within my own knowledge, I confirm to be true. The opinions I have expressed represent my true and complete professional opinions on the matters to which they refer.

2.10 Technical Actuarial Standards

This Report has been prepared in accordance with the following TAS issued by the Financial

Reporting Council:

► TAS D: Data

► TAS M: Modelling

► TAS R: Reporting Actuarial Information

► Insurance TAS

► Transformations TAS

In compliance with these requirements, I note that a number of key documents listed in Appendix D

have been prepared or reviewed by individuals who were subject to professional standards in

undertaking their work, including, where appropriate, TAS requirements.

2.11 Actuarial Profession Standards

This Report has been prepared in accordance with APS X2: Review of Actuarial Work which sets out the responsibilities of all IFoA members in relation to the application of work review, which may include Independent Peer Review, to promote the quality of actuarial work.

The contents of this Report have been peer reviewed to check quality and completeness, by Brian

Edey. Brian is a partner at EY, a Fellow of the IFoA and has over 20 years’ experience of actuarial

work in the life insurance industry.

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3. General considerations

3.1 Approach to review the level of security of policyholders’ benefits

As part of my role as the Independent Expert for the Part VII Transfer, I must consider the security of

policyholders’ benefits, which is the effect of the implementation of the Scheme on the likelihood that

policyholders will receive their guaranteed benefits when these are due.

Security for guaranteed benefits is provided by the amount by which the long-term fund assets

exceed the long-term fund liabilities, which includes group commitments such as intra-group loans,

funding mortgages and subordinated debt and by shareholder net assets.

The principal consideration regarding security is whether UKLAP will have adequate capital following

the transfer of business, and whether this is likely to remain the case. A company’s need for capital in

future depends on the nature of its in-force business and the type and volume of new business that it

expects to write. It also depends on the extent to which the assumptions made in valuing the business

(for example, about type of assets held, future investment returns, mortality experience, persistency

and expenses) are borne out in practice.

The assessment of the security of both the transferring UKA and existing UKLAP policyholders is also

affected by the relative sizes of UKA’s and UKLAP’s businesses.

In addition to the regulatory capital requirements, insurance companies will often draw up a capital

policy that defines a target (or minimum) level of additional capital that will be held.

I note that the level of capital held by the Companies is not the only consideration for policyholder

security. I particularly consider wider elements than the capital policy in my assessment of benefits

security, such as the approaches, including management actions, to the breaches of the capital policy

and the governance around changes to it.

I have also considered the potential impact of the Scheme on the risk profile of the business that the

policyholders are exposed to.

3.2 Approach to review the rights and expectations of policyholders

As the Independent Expert for the Scheme I must also consider the effect of the Scheme on rights

and benefits expectations of policyholders, including considerations of the proposals in the context of

the FCA’s consumer protection objective, specifically Principle 6 (Customers’ Interests): a firm must

pay due regard to the interests of its customers and treat them fairly.

This involves considering the effect of the implementation of the Scheme on any areas where

discretion is involved on behalf of the relevant insurance company, for example in determining the

charges applied to a policy and the benefits granted to the policyholder, as well as consideration of

the implementation of the Scheme on the management, service and governance standards of the

company in question.

For non-profit policies, there is no management discretion on the level of policyholders’ benefits at

maturity but there may be a degree of management discretion applicable to the level of benefits

payable on early surrender for these policies. I note that under current legislation, for the great

majority of the annuity policies post vesting, there is no current ability to take an early surrender.

Hence, I consider that the risk of management discretion in the non-profit policies giving rise to

material detriment to policyholders as a result of the Scheme is low.

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3.3 The old regulatory regime (Solvency I)

Under Solvency I, the PRA required companies to value their assets at market value (albeit subject to

certain rules) and their liabilities with allowance for prudence. In addition to holding assets to cover

these liabilities, companies held capital to cover themselves against adverse deviations in future

experience. In addition, for with-profit funds exceeding a certain size, a supplementary calculation had

to be performed using a realistic valuation basis for liabilities (“Peak 2”). This was the Regulatory Pillar

1 regime.

Over time, this approach was found not to be sufficiently reflective of the risk profiles of companies

and, as a result, at year end 2004 the Financial Services Authority (“FSA”) introduced a new risk-

based capital approach under which management had to assess the capital that it deemed was

sufficient to meet the losses arising from a 1-in-200 year event happening over one year. This “Pillar

2” regime required companies to set aside an amount of capital called the ICA, which was the

company’s own assessment of its capital requirements. The ICA was intended to provide a more

realistic and complete view of the risks to which the company was exposed.

When preparing the ICA, the PRA required companies to identify the major risks they faced and to

quantify the amount of capital to mitigate those risks. The PRA reviewed the ICA and would prescribe

an additional amount of capital that must be held by the firm in addition to the ICA. This amount of

additional capital prescribed by the PRA was called Individual Capital Guidance (‘‘ICG’’). While the

overall ICA solvency position was communicated to the PRA, it was not publically disclosed and

neither was the PRA’s communication to the company of any required ICG.

3.4 Solvency II

On 1 January 2016, a new regulatory solvency reporting requirement for the European Union (‘‘EU’’)

insurance industry and reinsurance industry (‘‘Solvency II’’) came into force. The aim of Solvency II is

to introduce solvency requirements which better reflect the risks that insurers and reinsurers face.

The Solvency II framework is based on three pillars1:

► Pillar2

1 sets out quantitative requirements, including the rules to value assets and liabilities (in particular, technical provisions), to calculate capital requirements and to identify eligible own funds (essentially surplus shareholder-owned assets) to cover those capital requirements

► Pillar 2 sets out requirements for risk management and governance, as well as the details of the supervisory process with competent authorities; this ensures that the regulatory framework is combined with the Company's own risk-management system and informs business decisions

► Pillar 3 addresses transparency, reporting to supervisory authorities and disclosure to the public, thereby enhancing market discipline and increasing comparability

Solvency II requires insurers to hold an additional Risk Margin (‘‘RM’’), which is an adjustment

designed to represent the amount that another insurance or reinsurance undertaking would require to

take on the obligations of a given insurance company.

Solvency II Pillar 1 defines the Minimum Capital Requirement (‘‘MCR’’) as the minimum level of

security below which the amount of financial resources should not fall, which is the point of intensive

regulatory intervention and the Solvency Capital Requirement (‘‘SCR’’) as the capital requirement

intended to reflect a 1 in 200 year level of loss.

1 http://europa.eu/rapid/press-release_MEMO-15-3120_en.htm

2 The same terminology as Solvency I is used in Solvency II but has a different meaning.

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http://europa.eu/rapid/press-release_MEMO-15-3120_en.htm


Every company is required, as a minimum, to hold assets to cover the technical provisions and the

SCR. Regulators will require action from management if the level of eligible own funds falls below the

SCR.

3.5 Future regulatory changes

3.5.1 Uncertainties of Solvency II

Although Solvency II and the accompanying regulations were implemented with an effective date of 1

January 2016, there remain uncertainties which are expected to have impacts on the solvency

position in the next few years, as market practice and regulatory interpretation in areas such as

matching adjustment and risk calibrations continues to evolve. Aviva management continues to

engage with the PRA to address any remaining uncertainties in their Solvency II implementation. In

addition, Solvency II itself does not change the liabilities or the risks related to the policies but aims to

lead the insurers to better reflect risks in their business in the capital they are required to hold.

I do not consider it is likely that any potential change to Solvency II regulation or interpretation of

regulation will have any material bearing on my conclusions on the impact of the Scheme.

3.6 Capital policy

In order to mitigate the risk of failing to meet regulatory capital requirements, most insurance

companies, including UKA and UKLAP, hold capital in addition to the level required by the Regulators.

The minimum capital that UKA and UKLAP aim to hold is set out in the Aviva risk appetite framework

which is implemented Aviva Group-wide.

The Aviva risk appetite framework comprises:

► Overarching risk appetites - which are aggregated quantitative statements that assist in

determining how much risk can be taken and level of capital required to support it

► Risk preferences - which are qualitative statements that express the individual risks that Aviva believes it can manage well and therefore seeks to take on, the risks Aviva can support but which need to be controlled, and the risks that Aviva seeks to avoid or minimise

► Risk tolerances and limits - which are quantitative boundaries that constrain specific risk-taking activities at an operational level

UK Life sets the solvency risk appetite for UKLAP and UKA as a point in time breach level which is used to monitor on-going solvency and calibrate the dividend risk appetite monitoring corridor. This solvency risk appetite is recalculated each year. Note that the approach and methodology used is identical for both Companies, but gives rise to different risk appetites, due to the different mix of risks in each Company.

To assess the solvency position in line with the solvency risk appetite, I consider the use of solvency

ratios, such as the ratio of eligible own funds to the SCR as defined in the solvency risk appetite

framework, to be a useful indicator of the immediate impact of security of policyholders’ benefits after

the implementation of the Scheme. In particular, the pre and post Part VII Transfer solvency ratios are

calculated using consistent methods and assumptions. These are calculated based on the Solvency II

results for each Company, and I have considered the Solvency II position as at 1 January 2016.

There is also a potential concern that the Companies’ solvency position would be weakened in future

due to subsequent actions such as the payment of excessive dividends to shareholders. Such actions

are constrained by the target solvency that is held at a higher level than the Solvency II Pillar 1 capital

requirement. Aviva management has confirmed that relevant management actions will be taken

should the solvency ratio fall below the pre-defined thresholds set in the solvency risk appetite.

14


In addition, the dividend risk appetite is used to ensure an appropriate level of solvency is maintained

when determining the amount of dividends that can be paid. An acceptable range and preferred range

are derived from the solvency risk appetite. Dividends can be paid out as long as solvency remains

above the acceptable range. Therefore, in considering the level of benefit security of the

policyholders, I have placed emphasis on the strength of the target solvency as well as the dividend

risk appetite in the Companies.

Therefore, even if the Companies currently have different estimated solvency ratios, I would generally

not consider this to have a materially adverse effect on the benefit security of the UKA and UKLAP’s

policyholders post Part VII Transfer, given the equivalence of the approach and methodology.

15


4. Outline of changes

4.1 Background to the changes

UK Life has identified opportunities to simplify the structure of its business, including the transfer of

the existing business (Non-Profit Annuities) of UKA to UKLAP.

The purpose of the Scheme is to transfer the entire long-term insurance business of UKA to UKLAP,

without affecting the contractual policy benefits or substantially changing how the business is

managed, under Section 111 of the Act.

UKLAP has a ring fenced fund, called the Reattributed Inherited Estate External Support Account

(“RIEESA”), which is used to support the security and reasonable benefit expectations of

policyholders previously transferred under the Reattribution Scheme (see table 4.3 below).

4.2 Details of the changes

The diagrams in Figure 4.1 and Figure 4.2 below show the fund structure pre and post Part VII

Transfer.

Figure 4.1: Fund structure – Pre transfer

Figure 4.2: Fund structure – Post Part VII Transfer

► The Scheme will transfer the existing policies in UKA to the UKLAP Non-profit Sub-fund (“NPSF”)

16


► The transferred policies will not be included in the Reattributed Inherited Estate External Support Account (“RIEESA”) as this is a ring fenced fund specifically set up to support policies transferred under the previous Reattribution Scheme

► Any new annuity business will be written into the NPSF

► The UKA shareholder fund will move to the UKLAP shareholder fund (‘‘SHF’’)

On the Effective Date, all the assets and liabilities of UKA shall be transferred to UKLAP SHF and

NPSF depending on where the relevant transferred asset are from or in respect of which such

liabilities arise has been allocated, with no impact on the RIEESA, other than the Residual Assets and

Liabilities3. No other LTBF funds will be affected. I note that there are unlikely to be any Residual

Assets and Liabilities, and that Due Diligence work to confirm this is currently being undertaken.

Any applications for policies (other than excluded policies4) or increases to policies received by UKA

before the Effective Date, which have not been accepted before the Effective Date, shall be treated as

if they were applications for policies or increases to policies made to UKLAP after the Effective Date

and, if duly accepted by UKLAP, shall be allocated to the NPSF, but not the RIEESA, as if they were

applications for policies or increases to policies made to UKLAP after the Effective Date.

At and with effect from the Effective Date and subject to the terms of the Scheme, UKLAP shall

become entitled to all the rights, benefits and powers of UKA whatsoever subsisting at the Effective

Date under the transferred policies. Following the Part VII Transfer, UKA will be deregulated.

All premiums attributable or referable to the transferred policies shall, from the Effective Date, be

payable to UKLAP. As the majority of business in UKA is immediate annuity, it is unlikely that

premiums will be received after the Effective Date. However, there is a possibility that for any Bulk

Purchase Annuity (“BPA”) business written near the Effective Date, not all premiums will be received

at the point of sale, and as such, premiums may be received after the Effective Date.

Part of the long-term business of UKLAP is the reinsurance accepted from UKA. All reinsurance

arrangements between UKA and the NPSF of UKLAP shall terminate as a consequence of the Part

VII Transfer of the Transferred Business to UKLAP under the Scheme.

However, where there are other reinsurance arrangements between UKA and funds of UKLAP other

than the NPSF, equivalent ‘‘internal arrangements’’ will be established to ensure that the effect of

such reinsurance impacts the NPSF rather than the originating fund in UKA.

There are previous Part VII transfer schemes together with the Irish Scheme5

which continue to affect

the operation of UK Life, which are set out in table 4.3 below.

The Scheme will be designed to preserve any with-profit funds policyholders’ and / or shareholders’

rights and obligations whilst transferring the obligations and rights from UKA to the UKLAP NPSF. The

financial effect of current safeguards will be preserved.

The costs and expenses incurred by both UKA and UKLAP in preparing and implementing the

Scheme will be paid by the shareholders of UKLAP and allocated either to UKLAP SHF or to the

UKLAP NPSF (but not to the RIEESA, a sub-account of the NPSF).

4.3 Additional considerations

4.3.1 Management actions

3

The definitions of the Residual Assets and Liabilities are provided in the Appendix A. 4

The definitions of the excluded policies are provided in the Appendix A. 5

See table 4.3 in the section below

17


I am aware of a number of planned management actions which are expected to operate in respect of

UK Life. These management actions are commercially sensitive and as such have not been included

in this report. I have reviewed these, and I am comfortable that they will not have an adverse impact

on UKLAP post Part VII Transfer.

4.3.2 Prior Schemes

There are other schemes and agreements which operate in respect of the Aviva Group (see table 4.3

below) and I have considered the impacts of the relevant sections of such schemes and

arrangements on UKA and UKLAP policyholders after the implementation of the Scheme. The main

existing schemes considered are the Reattribution Scheme, NWL Transfer Scheme and Irish Scheme.

Table 4.3: Summary of UK Life previous schemes

Time Scheme

name Transferred from Transferred

To Current location

1997 NULIS Scheme

Norwich Union Life Insurance Society (‘‘NULIS’’)

UKLAP UKLAP WPSF and NPSF

1999 Northern Assurance transfer

Northern Assurance Company Limited (‘‘NAC’’)

Norwich Union Linked Life Assurance Limited (‘‘NULL’’)

UKLAP NPSF

2000 Norwich Union / CGU merger

CGU Norwich Union Aviva Group and no fund changes

2005 NULAP 2005 Scheme

NULL UKLAP UKLAP NPSF (PM sub- fund was also transferred to UKLAP)

2009 Reattribution Scheme

CGNU, CULAC and Norwich Union Life Limited (‘‘NUL RBS’’)

UKLAP UKLAP RIEESA, NWPSF and OWPSF

2009 Hamilton Life Scheme

Hamilton Life Assurance Company Limited (‘‘HLAC’’)

UKLAP UKLAP NPSF

2009 Aviva Rebrand

By 2009, most of the business was merged or transferred to Norwich Union through the schemes listed above. On 1 June 2009, Norwich Union was rebranded to Aviva.

2011 NWL Transfer Scheme

National Westminster Life Assurance Limited (‘‘NWL’’) and of Royal Scottish Assurance plc (‘‘RSA’’)

UKLAP UKLAP NPSF and With- profit Sub-Fund (5)

2015 Irish Scheme

Aviva Life and Pension Ireland (‘‘ALPI’’)

UKLAP UKLAP IWPSF were created and NP policies were transferred to NPSF

The Part VII Transfer will not affect the schemes listed above, with the exception of the NULAP

Scheme and the UKLAP Reattribution Scheme. Both of these Schemes contained provisions for co-

insurance arrangements. These arrangements will cease to apply, with updated arrangements being

allowed for in the current Part VII Scheme document, as discussed in section 4.3.4.

The policies that were transferred into the NPSF as part of these schemes are now UKLAP

policyholders, and as such are subject to the considerations set out in this report. However, I am

satisfied that there will be no material adverse impacts on the UKLAP’s policyholders as concluded in

Section 9.

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4.3.3 Internal Reinsurance Vehicle

UKA has reinsured some of its liabilities into UKLAP under quota share (“QS”) reinsurance

arrangements which will terminate on the implementation of the Scheme.

In addition, Aviva Group includes a UK regulated reinsurance entity, AII. UKA has currently reinsured

some of its business to AII on a QS basis and is intending to increase this level of reinsurance with an

expected implementation date of 1 July 2016 but with an effective date of 1 January 2016. Also, asset

and liability risks (including operational and expense) of the UKLAP NPSF business are reinsured on

a QS basis into AII at the same level as that for UKA, with an effective date of 1 January 2016 and a

proposed implementation date of 1 July 2016.

As such, the proportions of business reinsured from UKA to AII and from UKLAP NPSF to AII will be

equal at the Effective Date. Although, I note that these changes have not yet been entered into and

are subject to ongoing discussions with the PRA and PRA non-objection.

On the Effective Date, the reinsurance between UKA and AII will be transferred to an arrangement

between UKLAP and AII for those transferred policies.

The Scheme will not impact the reinsurance arrangements, except that AII has the right to terminate

the QS reinsurance agreements in the event of the Part VII Transfer which would lead to a forced

recapture. The Part VII Transfer has been discussed at length with AII management and Board, who

have raised no concerns or objections. A formal notification of the Part VII Transfer will be sent to AII

after the Directions Hearing and AII’s consent will be sought in advance of the Sanctions Hearing.

This is the same approach as the external reinsurer notification discussed in section 7.5.4.2. I will

include an update on this point in my Supplementary Report. However, there is currently no reason to

believe this consent will not be given.

4.3.4 Co-insurance

The NULAP Scheme transferred policyholders from NULL to UKLAP. However, for policyholders with

defined annuity benefits these benefits are provided for by UKA. This introduced “co-insurance”.

Co-insurance means that some customers are policyholders of both UKLAP and UKA on the same

policy. The co-insurance ensured that pension policies originally written in UKLAP WPSF, PM WPSF

or NPSF2 with defined annuity benefits have those annuity benefits provided for by UKA (rather than

UKLAP).

The pensions in question were those where the amount of pension was defined in the original

contract, typically, but not exclusively, under a guaranteed annuity option. Thus, the price at which the

annuity was transacted did not impact the particular policyholder’s pension. At the time of the transfer,

the with profits fund was required to make a payment equal to the purchase price which UKA would

have charged in the open market for such an annuity.

Transferring the business to UKA ensured that the pension annuities of the Aviva Group were

consolidated in one place. In the case of the With Profit funds it also ensured that a potentially

shrinking pool of with profits policyholders was not exposed to the risks from a growing pool of non-

profit annuity business.

There was a concern that if UKA ceased to be competitive in the annuity market, these provisions

could lead to a situation where shareholders were systematically benefiting from lucrative annuity

19


business at the expense of the With Profits Funds, and hence safeguards were put in place to ensure

the rates remained competitive.

The current Scheme preserves the UKLAP with-profit fund and shareholder rights and obligations whilst transferring the UKA obligations and rights to the UKLAP NPSF.

4.3.4.1 Safeguards

When the co-insured policies were set up, various safeguards were introduced to ensure appropriate treatment of the terms of those policies.

Safeguards are included in the Scheme document, which ensure that the financial effect of current safeguards will be preserved following the Part VII Transfer.

The key safeguards are summarised below:

► In circumstances where the Board believes that the annuity rates in respect of a co-insured

Policy will be uncompetitive, the Board may take either of the following actions, to be determined in its discretion having obtained appropriate actuarial advice:

o direct that the annuity be allocated to the Non-Profit Sub-Fund Ex-RIEESA

o direct that the annuity shall be allocated to the Allocated Sub-Fund.

With effect from the Effective Date, the current co-insurance arrangement between UKA and UKLAP

will cease to have effect. The Scheme preserves the existing UKLAP with-profit fund policyholders’ or

shareholders’ rights and obligations whilst transferring the UKA obligations and rights to the UKLAP

NPSF but with no impact on the RIEESA.

I have reviewed the relevant safeguards, and am satisfied that the current safeguards will mean there

is no material adverse effect on either the co-insured and non-co-insured policyholders.

4.4 Further requirements under Solvency II

Prior to the Scheme being proposed, both UKA and UKLAP undertook necessary work to transition

from the old regulatory regime, Solvency I, to the current regime, Solvency II. There are four particular

areas that I have considered:

► UKA and UKLAP have the same approach to calculate the Solvency II results which is consistent

with the Aviva Group methodology

► UKA applied for a matching adjustment and volatility adjustment to the PRA, which was approved. However, this will not automatically transfer to UKLAP and UKLAP will need to re- apply for a matching adjustment and volatility adjustment for the post Part VII Transfer UKLAP. The Scheme contains provisions that the Scheme will not become effective unless the PRA has approved these for the post Part VII Transfer to UKLAP. As discussed in section 7.5.1 and 7.5.2, this does not cause me a material concern

► UKLAP and UKA applied for Transitional Measures on their Technical Provisions (‘‘TMTP’’), which were approved by the PRA. Following the approval of the Scheme by the Court, which will take effect on the Effective Date; there will be a need to submit a fresh application to supersede the previously approved UKLAP and UKA solo applications for TMTP and any subsequent addenda. The Scheme also contains provisions that it will not become effective unless the PRA have approved the TMTP for the post Part VII Transfer UKLAP. As discussed in section 7.5.3, this does not give me a material concern

► Aviva Group has received approval from the PRA for the use of its internal model to calculate its Solvency II results. The Internal Model Approval (“IMAP”) letter did not contain any conditions that would affect the Part VII Transfer. Management believes that any changes to the model necessary to give effect to the Scheme will be classified as a minor change, as they involve

20


administrative changes to the modelling hierarchy, which will have no material impact on the SCR. The Companies are currently finalising their thinking on this aspect and I will include further comment in my Supplementary Report which will set out my updated opinions in respect of the Scheme

21


5. Aviva Annuity UK Limited (UKA)

5.1 Background

UKA is authorised and regulated by the FCA and the PRA. The principal activity of UKA is the transaction of annuity business. 95% of business within UKA is annuity business, split as follows:

► 58% Bulk Purchased Annuity business

► 35% Compulsory Purchase Annuity business

► 1% Purchased Life Annuity business.

The remaining 5% of business within UKA relates to Payment Protection Orders reinsured from Aviva Insurance Limited (“UKGI”).

The immediate parent undertaking is UKLAP, a company incorporated in England. UKA is held as an investment of the UKLAP Shareholder Fund. Profits arising in UKA are wholly attributable to UKLAP shareholders. The ultimate parent undertaking and controlling party is Aviva plc, a company incorporated in England.

5.2 Recent history and future development

5.2.1 Recent history

UKA is a UK-regulated insurer, incorporated in 1996. UKA was formerly known as Norwich Union Annuity Ltd (‘‘NUA’’). Prior to 2005, pension annuity business was reinsured to NUA, but under the NULAP 2005 Scheme the pensions annuity business was transferred to NUA, NUA moved to being owned by the UKLAP Shareholder Fund and was renamed Aviva Annuity UK Limited on 1 June 2009.

Since that point most of the Aviva Group’s annuity business has been written into UKA, primarily including pension annuities. It also reinsures general insurance structured settlement business.

The Government announced a number of significant changes in the March 2014 Budget, including the removal of the need for retirees to purchase an annuity. UKA has continued to provide individual annuities as a clear market remains for traditional retirement products and to compete in the BPA market.

5.2.2 Future development

The entire UKA business will be transferred to UKLAP NPSF, but not the RIEESA, under the Scheme,

with the exception of any property and liabilities that the Board determines as not being attributable to

the long-term insurance business of UKA or as required for the management of the long-term

insurance business of UKA.

The future development of the UKA business will be consistent with the UKLAP business strategies

after the implementation of the Scheme.

5.3 Nature of business written

5.3.1 Financial position of UKA before the Scheme

The majority of business written by UKA is pension annuity business which is written partly in the

external market place and partly from maturing pension policies written by Aviva companies. There is

a trend toward external business. UKA aims to price competitively at key ages in the individual annuity

market subject to achieving target levels of profitability.

The Solvency I position of UKA is shown in table 5.1 below.

22


Table 5.1 UKA Reserves as at 31 December 2015

UKA only writes non-profit business, both non-linked business and index-linked business, of which

approximately 83% is non-linked business. The largest product line within the non-linked business is

the UK pension annuity business, which accounts for approximately 79% of UKA business by

reserves (net of reinsurance).

There is a contingent loan in place between UKLAP and UKA under the BPA agreements. The

purpose of the contingent loan is to provide support to the UKA solvency position under the Solvency I

ICA in adverse scenarios. The contingent loan facility commits UKLAP to providing a loan to UKA

sufficient to bring the value of UKA assets up to a level which covers its ICA realistic liabilities plus an

additional defined margin. UKLAP could only provide this capital if it was able to meet its own

regulatory capital requirements after the loan has been drawn down. Aviva has discussed the

proposal to remove the contingent loan facility with the BPA Trustees and have received no

objections. A formal deed of waiver has been issued to remove the requirement for the contingent

loan facility from the contracts.

5.3.2 Policy features

I have reviewed the key features including type of benefit, premium and other policy features for

pension annuities, including the Enhanced Pension Annuity, which in total represent around 95% of

the UKA business. The remaining 5% of policies are life and general annuity and BPAs. The key

features document and the terms and conditions of pension annuities are relatively standard across

the UK business and as such we have only reviewed the most recent key features documents.

I am satisfied that there are no unknown, onerous guarantees for UKA that invalidate my conclusions.

There are also no terms and conditions which have caused me concern.

Discussion of the sensitivity of the guarantees is shown in section 7.2.1.

5.3.3 Reinsurance

There are 11 reinsurance treaties with external reinsurers and 3 internal reinsurance treaties, where

UKA is the ceding insurer and under which business was in-force at the valuation date of 31

December 2015.

The ceded-external and ceded-internal mathematical reserves were £148m and £11,119m

respectively as at 31 December 2015.

23


The key internal treaties are:

► £7,549m from the quota-share reinsurance of 22.5% of the net liabilities of the UKA long-term

fund to UKLAP. The premiums payable in 2015 were £327m

► £3,355m from the quota-share reinsurance of 10% of the net liabilities of the UKA long-term fund to AII. The premiums payable in 2015 were £145m

The external treaties are shown in Appendix F.

In order to mitigate reinsurance risk, a number of actions are undertaken by UKA, including:

► Risk mitigation in the form of collateral for some of the external treaties

► Terms within the treaties covering the event of reinsurer downgrade

► Overall exposure to each reinsurer is managed through Aviva’s counterparty credit risk management process

In addition, any residual exposure to counterparty risk is addressed by holding capital (as the reinsurer counterparty credit risk forms part of the SCR calculation).

For some of the small reinsurance treaties, copies of the treaties or signed copies cannot be traced by

UKA. Although the value of the treaties is very small (less than £2m as at 31 December 2015), it is

anticipated that new or signed treaties will be put in place before the implementation of the Scheme. I

will review the position of these treaties and include comment in the Supplementary Report.

5.3.4 Articles of Association

I have reviewed the Articles of Association of UKA and have not identified any issue in relation to them

that might adversely affect the rights and expectations of policyholders with respect to the Scheme.

5.3.5 Non-UK residents

Under EU legislation, if the policy was concluded in another European Economic Area (‘‘EEA’’) state,

then the insurance regulator in the relevant country must be informed of the Scheme. In the event that

the regulator in the relevant local jurisdiction was to object to the policy transferring, then that policy

would need to remain behind in the transferor company.

UKA has carried on long-term insurance business in or from Jersey, Guernsey (or has issued policies

under Guernsey law or to residents of the Bailiwick of Guernsey) and the Isle of Man. Aviva has taken

advice from local counsel in each of these jurisdictions, it appears that such business, even if also

carried on in UK, falls within the respective jurisdictions of the Royal Court of Guernsey, the Royal

Court of Jersey and the Isle of Man Courts of Justice. Accordingly, there will be separate, parallel

schemes for the transfer of such business to UKLAP on the same terms as the Scheme and my

considerations and conclusions in this Report apply equally to the Guernsey scheme, Jersey scheme

and Isle of Man as to the Scheme.

Under the Scheme, there are no foreign branches of UKA and no business is written outside the UK.

No new business is currently written with policyholders living outside the UK. However, historically,

annuity business has been written for policyholders who have annuitised UK pensions and are

currently living in 135 different foreign jurisdictions. This was partly due to the legal obligation for

insurers to automatically annuitise certain UK pension products when the pension policyholder

reaches the age of 75, before recent changes in legislation removed this restriction.

No communications are issued in foreign language to any policyholders in UKA, and it is not

envisaged that UKA will issue any foreign communications in connection with the Scheme. Please

refer to section 8.3 for further details on the policyholder communications.

24


5.4 Risk profile of UKA’s business

UKA’s main risks are:

► Market risk such as interest rate risk, property risk including commercial mortgages risk, credit

risk and liquidity risk for assets under management

► Life insurance risk such as mortality risk and longevity risk on its annuity liabilities

► Operational risk arising from inadequate or failed internal processes, personnel or systems, or from external events

I have reviewed the UKA risk profile pre-transfer and the pro-forma6

position post Part VII Transfer

calculated using Aviva’s Internal Model under Solvency II and considered the diversification benefit

achieved across the individual risks.

Table 5.2 shows the top 5 risks in UKA before and after diversification:

Table 5.2 Top 5 risks in UKA under Solvency II

Pre-diversification Post – diversification

Longevity Interest Rates Credit Commercial Mortgages Residential property

Longevity Credit Commercial Mortgages Residential Property Interest Rates

5.4.1 Longevity

Longevity risk is the biggest risk in UKA both before and after diversification. This is mitigated by the

external reinsurance treaties which provide a longevity swap in respect of varying proportions of a

defined block of in-force UK pension annuity business and of new enhanced annuities written. UKA

has developed a policy for the management of life insurance risk and guidelines for the practical

application of key areas of life insurance practice. The impact of life insurance risk is monitored by

UKA as part of the control cycle of business management. Exposure is monitored through the

assessment of liabilities and operation of a deals framework that includes economic capital

assessment of insurance risk-related deals, e.g. bulk purchase annuity deals, profit reporting, Stress

& Scenario analysis, and the Solvency II Internal Model process.

5.4.2 Market risk

UKA is exposed to significant market risk with a material exposure to interest rate risk, credit risk

commercial mortgages and residential property risk. The financial impact of market risk is examined

through stress tests adopted in the Solvency II Internal Model and Stress & Scenario analysis.

5.4.3 Diversification

Diversification reduces the capital requirements for all risks, the extent varying with correlations and

size of risk. Where risks are not positively correlated with the larger risks, the reduction is more

significant.

6 The investment terminology defines ‘‘pro-forma’’ as a method of calculating financial results in order to emphasize either

current or projected figures.

25


5.5 Solvency position

5.5.1 Solvency I

Solvency I was the regulatory regime in-force until 31 December 2015, following which, Solvency II

came into force. As the Solvency I position is the most recent published statutory requirement and the

results have been audited, I have included them below to demonstrate the financial position of UKA

before the Part VII Transfer.

Table 5.3 summarises the statutory Solvency I position of UKA from 2011 to 2015 as shown in the

UKA’s annual returns to the PRA.

Table 5.3 UKA Solvency I Position

At 31 December 2015 UKA had available capital resources of £2.8b to cover the Regulatory Pillar 1

capital requirement of £1.2b, a solvency cover ratio of 244%. In addition, the Capital Resources at the

end of each financial year shown were very considerably in excess of the Capital Resources

Requirement; as such they demonstrate a strong level of solvency.

5.5.2 Solvency II

Table 5.4 summarises the pre Part VII Transfer statutory Solvency II position of UKA as at 1 January 2016 as calculated by management. These results have been externally audited.

All Solvency II results presented within this Report include the benefit of transitional deductions.

Table 5.4 UKA pre Part VII Transfer Solvency II financial position at 1 January 2016

1 January 16*

Own Funds (A) 3,415

SCR (B) 1,887

Surplus/deficit (C=A-B) 1,528

Solvency II Solvency Ratio (D=A/B) 181% * The 2016 figures allow for the increase in reinsurance to AII and the benefit of the matching adjustment.

On 1 January 2016 UKA had capital resources of £3.4b to cover Solvency II SCR of £1.9b, which

represents a Solvency II cover ratio of 181%. I did not identify items which cause me concern with

respect to UKA’s solvency position or the security of the UKA policyholders’ guaranteed benefits.

26


These figures demonstrate UKA’s ability to cover its SCR under Solvency II as at 1 January 2016 and

hence its ability to pay policyholders’ benefits, with an adequate level of security. I note that a dividend

payment is expected to be paid in 2016, and that the figures represented above do not allow for that

dividend payment. I will comment in my Supplementary Report on the updated Solvency II position of

UKA at half-year 2016.

The expected Solvency II position after the Part VII Transfer is considered in section 7.2.2.

5.5.2.1 Solvency II assumptions

As part of the reporting process, UKA produces a results validation report. This report includes looking

at the effect a change in the assumptions would have on the overall results.

A range of plausible alternatives are considered, focussing on longevity, commercial mortgages,

equity release risk, lapses and expenses. The assessment indicates that should the plausible

assumption at the more extreme end of the range be chosen, the SCR would not increase by more

than 4% (c£140m) at an aggregate level.

5.6 Own Risk Solvency Assessment (“ORSA”)

5.6.1 Legal requirement

ORSA is defined as a set of processes constituting a tool for decision-making and strategic analysis

and it assesses the overall solvency needs relating to the specific risk profile of an insurance

company.

An ORSA report is required under Solvency II regulations, and shows the outcome of the combined

processes and procedures in place to manage and assess the risk and solvency position of UKA and

UKLAP.

5.6.2 ORSA outcome

I have reviewed the ORSA output and note that the Capital Plan forecasts that UK Life is sufficiently

well capitalised to be continuously compliant with all required regulatory capital levels throughout the

plan period (2016-2018).

I have reviewed the details of the Capital Plan, including the key assumptions, the solvency and

dividend affordability and the risk profile and believe the conclusion reached within the ORSA to be

reasonable.

There were no material issues in this ORSA which are likely to invalidate my conclusions.

27


6. Aviva UK Life & Pensions UK Limited (UKLAP)

6.1 Background

UKLAP is a private limited company incorporated in England and was formerly known as Norwich

Union Life & Pensions Limited. The company changed its name to Aviva Life & Pensions UK Limited

on 1 June 2009. The principal activity of the company is the transaction of long-term insurance

business.

UKLAP’s immediate parent undertaking is UKLH, a company incorporated in England. The ultimate

parent undertaking and controlling party is Aviva plc, a company incorporated in England. UKLAP is

100% owned by the Aviva Group.

6.2 Recent history and future development

6.2.1 Recent history

UKLAP is a UK-regulated insurer, incorporated in 1999. The Company was formerly known as Norwich Union Life & Pensions Limited (NULAP, as defined in section 4.3.2) and changed its name to Aviva Life & Pensions UK Limited on 1 June 2009.

The Norwich Union insurance business was founded in 1808 and sold business in the UK, Ireland and other countries worldwide. In 1997, Norwich Union demutualised under the NULIS Scheme and UKLAP (originally known as NULAP) was created as a wholly owned subsidiary of the new Norwich Union plc company to hold part of the UK long-term insurance business of Norwich Union. Other subsidiaries, such as UKA (originally known as NUA), were created to hold other parts of the Norwich Union business.

Since demutualisation, the underlying structure of UKLAP has changed as a result of a number of mergers, transfers and acquisitions.

UKLAP has both non-profit and with-profit funds and writes primarily pensions, bonds and protection business. UKLAP management considers that this will continue unchanged into the foreseeable future.

On 31 December 2014 UKLAP purchased Aviva Life & Pensions Ireland Limited (‘‘ALPI’’) and on 1 January 2015 the long-term liabilities of ALPI were transferred to UKLAP under the Irish Scheme.

6.2.2 Future development

UKLAP will continue to develop and enhance its products and services, building on existing strengths

and launching products with a focus on digital servicing for new and existing customers.

The Government's pension reform gives consumers new freedom and flexibility in how and when they

access their pension savings. Supported by fellow Aviva Group companies, UKLAP intends to provide

customers with a range of retirement solutions supported by pensions, drawdown, equity release and

long-term care products.

The protection market for both individual and group life cover continues to be a strategic priority for

UKLAP.

Following the transfer of Irish policyholders in 2014, the existing Irish branch of UKLAP has been used

to grow UKLAP’s customer base in Ireland by providing similar products and services tailored to this

specific market.

28


6.3 Nature of business written

6.3.1 Financial position of UKLAP before the Scheme

Table 6.1 summarises the mathematical reserves for UKLAP as at 31 December 2015.

Table 6.1: UKLAP Reserves as at 31 December 2015

Number of

policyholder

Amount of gross

reserves

Ceded- external

Ceded- internal

Net of

reinsurance

£'000 £'000 £'000 £'000

Non-linked Business

UK Life Business (WP *) 1,556,754 4,722,328 991,940 - 3,730,388

UK Life Business (NP * ) 1,886,464 1,884,788 1,167,869 7,953 708,966

UK Life Business (PM * ) 28,077 41,256 - - 41,256

UK Pensions Business (WP) 523,363 7,451,270 1,306 - 7,449,964

UK Pensions Business (NP) 764,265 8,028,023 821,361 - 7,206,662

Pension Business (PM) 94,130 565,947 - - 565,947

Overseas Business (WP) 20,883 180,959 8,592 - 172,367

Overseas Business (NP) 33,775 252,149 7,562 111,871 132,716

Overseas Business (Belgian) 126,036 104,171 104,171 - -

5,033,747 23,230,891 3,102,801 119,824 20,008,266

Accumulating with-profit

UK Life Business (WP) 239,106 8,156,218 3,396 - 8,152,822

UK Life Business (NP**) - 954 - - 954

UK Pensions Business (WP) 360,129 7,401,165 1,453 - 7,399,712

UK Pensions Business (NP) - 16,628 - - 16,628

Pension Business (PM) 29,122 671,338 - - 671,338

Overseas Business (WP) 12,250 356,402 - - 356,402

Overseas Business (NP**) - 457 - - 457

Stakeholder WPSF 55,445 749,004 - - 749,004

696,052 17,352,166 4,849 - 17,347,317

Property linked

UK Life Business (WP) 84,927 7,574 - - 7,574

UK Life Business (NP) 217,518 8,494,630 38,590 - 8,456,040

UK Pensions Business (WP) 1,072,502 166,118 - - 166,118

UK Pensions Business (NP) 1,231,872 42,388,087 3,292,751 - 39,095,336

Overseas Business (WP) 6,567 40,887 - - 40,887

Overseas Business (NP) 15,080 542,392 - - 542,392

2,628,466 51,639,688 3,331,341 - 48,308,347

Index lined

UK Life Business (NP) 1,807 137,306 18,859 - 118,447

UK Pensions Business (WP) 288 1,104 - - 1,104

UK Pensions Business (NP) 27,423 1,565,613 272,101 - 1,293,512

Overseas Business (NP) 145 9,138 - 6,493 2,645

Total mathematical reserves 8,387,928 93,935,906 6,729,951 126,317 87,079,638

* WP=With-profit NP=Non-Profit PM=Provident Mutual

**There are some unitised with-profit contracts with investments expressed as unit-linked benefits which are categorised as

accumulating with-profit business.

29


UKLAP writes a full range of life assurance business, but property-linked business dominates with

55% of the total business.

UKLAP consists of the LTBF and the SHF as shown in figures 4.1 and 4.2. Within the LTBF there are

eight sub-funds which contain all the assets and liabilities relating to insurance policies written by

UKLAP. Some of these have arisen as a result of previous transfers of business and restructuring in

the Aviva Group.

In principal, the SHF contains the capital attributable to shareholders which is used to support the

LTBF. These assets of the Shareholder Fund can be paid out as dividends. The assets can also be

used to support any deficits that may arise in the subsidiaries held by the UKLAP Shareholder Fund

(principally UKA).

Table 6.2 below summarises the business written by sub-fund.

Table 6.2 Summary of Business Written by Fund

Funds Conventional

With-profit Unitised With- profit

Conventional Non-Profit

Index- linked

Property- Linked

Open to new business*

UKLAP WPSF ü ü ü Y

NWPSF ü ü ü Y

OWPSF ü ü ü Y

IWPSF ü ü I

PM Sub-Fund ü ü ü I

Belgian Sub- Fund

ü ü N

WPSF5 ü N

NPSF ** ü ü ü Y

*Y= Yes N=No I=Increments Only

**NPSF includes RIEESA, UK NPSF and Irish NPSF where UK NP has the index-linked business.

The majority of the With-Profit Sub-funds (‘‘WPSF’’) are 90:10 funds and contain conventional with-

profit, with-profit annuity and unitised with-profit business. New with-profit annuities are written in the

UKLAP WPSF. Other new with-profit policies are written in the NWPSF7

and OWSPF8, split in the

proportion 88.25%:11.75% in accordance with the Reattribution Scheme.

The New With-profit Sub-Fund (“NWPSF”) was created as a result of the Reattribution Scheme in 2009 and contains:

► Policies that opted to take the Policyholder Incentive Payment (‘‘PIP’’) and gave up rights to

future distributions from the estate

► 88.25% of each policy that was ineligible for the PIP

► 88.25% of each with-profit policy written after Reattribution Scheme

The Old With-profit Sub-Fund (“OWPSF”) was created as a result of the Reattribution Scheme in 2009 and contains:

► Policies that did not take up the PIP and still have rights to future distributions from the estate

► 11.75% of each policy that was ineligible for the PIP

► 11.75% of each with-profit policy written after Reattribution Scheme

7

See the definition in the sections below. 8 See the definition in the sections below.

30


The Irish With-Profit Sub-Fund (‘‘IWPSF’’) was created on 1 January 2015 when the Irish business

written in ALPI, was transferred into UKLAP pursuant to Section 13 of the Assurance Companies Act

1909, the Insurance Act 1989 and the European Communities (Life Assurance) Framework

Regulations 1994 (as amended), being the Irish equivalent of a transfer pursuant to Part VII of the

Financial Services and Markets Act 2000. The non-profit business of ALPI was transferred into the

UKLAP NPSF.

The Provident Mutual Sub-Fund (‘‘PM Sub-Fund’’) is mainly conventional with-profit business with

shareholders entitled to 10% of the distributed surplus (after making a payment to shareholders

amounting to one ninth of any personal pension compensation payments met by the sub-fund). The

Provident Mutual sub-fund is open to new business for increments only.

The Belgian Sub-fund is not open to new business. Shareholders are entitled to the 100% of any

surplus arising in excess of that distributed to policyholders as bonus. In practice, no transfers have

been made to shareholders from this fund since the demutualisation of the NULIS business in June

1997. Belgian Sub-fund reinsures out all liability to Delta Lloyd which receives the annual premiums

(totalled £14.9m during 2015) payable by the policyholders of the Belgian Sub-Fund. The amount of

mathematical reserves ceded under the treaty is £104m in 2015.

The With-profit Sub-Fund (5) (‘‘WPSF5’’) has immaterial capital resources as the business is all reinsured externally. The liabilities are 100% reinsured to external reinsurers (Scottish Equitable, Scottish Widows Limited). Under the terms of the treaties, the amount of each premium which is to be allocated in respect of unitised with-profit units is passed to the respective reinsurer and the reinsurer accepts 100% of the liability. The with-profit policyholders have no participatory rights in the profits of WPSF5. They participate in the profits of the respective reinsurer.

The NPSF was originally two sub-funds (Non-Profit Sub-Fund 1 and 2), created as a result of the NULAP 2005 Scheme to separate life and pensions business, and now combined. Following the Section 13 transfer of the Irish business, the NPSF also now includes Irish non-profit business.

RIEESA is the UKLAP’s Reattributed Inherited Estate External Support Account maintained, due to

the terms of the UKLAP Reattribution Scheme, which is available:

► To support the security and reasonable benefit expectations of policyholders transferring under

the Reattribution Scheme

► To support business allocated to the OWPSF or the NWPSF after the effective date of the Reattribution Scheme

► To support the writing of new with-profit business in NWPSF or OWPSF

The shareholders are entitled to a share of the distributed surplus arising in the various funds as follows:

31


Table 6.3 Shareholders entitlement to distributed surplus

Fund Description

UKLAP

WPSF

A maximum of 12.5% of the cost of bonus arising from with-profit immediate annuities

written prior to 2 October 2000.

A maximum of 10% of the distributed surplus arising from other conventional with-profit

business.

Shareholders have no entitlement to a share of surplus arising in this fund from directly

written unitised with-profit business.

NWPSF A maximum of 10% of any amount which the UKLAP Board determines to be available for

distribution as bonus (after allowing for tax in respect of any such distribution).

OWPSF A maximum of 10% of any amount which the UKLAP Board determines to be available for

distribution as bonus (after allowing for tax in respect of any such distribution).

NPSF 100% of the distributed surplus (including RIEESA).

PM Sub-

Fund

10% of the distributed surplus (after making a payment to shareholders amounting to one

ninth of any personal pension compensation payments met by the sub-fund).

Belgium

Sub-Fund

Shareholders are entitled to the 100% of any surplus arising in excess of that distributed to

policyholders as bonus. In practice, no transfers have been made to shareholders from

this fund since the demutualisation of NULIS in June 1997.

WPSF5 100% of the distributed surplus.

IWPSF A maximum of 10% of any amount which the UKLAP Board determines to be available for

distribution as bonus in the IWPSF (after allowing for tax in respect of any such

distribution).

6.3.2 Policy features

I have reviewed the most recent key features documents for each of the Level and Decreasing

Insurance, Term Assurance and Mortgage Linked products. This represents over 75% of the UKLAP

business, by policy count, including type of benefit, premium and other policy features. The remaining

25% of policies are pension and general annuities, and a small portion (i.e. 1%) of miscellaneous

products. The key features documents and the terms and conditions for these types of products are

standard across the UK business.

I note that there are a number of guarantees within these policies I reviewed, such as the mortgage

endowment promise and guaranteed annuity options which are considered in section 7.3.2.1.

I am satisfied that there are no unknown, onerous guarantees in the UKLAP policies that invalidate

my conclusion. There are also no terms and conditions which have caused me concern.

I also gain comfort from the requirement for reporting guarantees in the audited regulatory returns and

the Solvency II results which include all options and guarantees.

Further analysis on the sensitivity testing of the guarantees is shown in section 7.2.1.

6.3.3 Reinsurance

The UKLAP with-profit funds do not cede any long-term business on a facultative basis to any

reinsurer who is not authorised to carry on insurance business in the United Kingdom. As shown in

Table 6.1, UKLAP ceded £6,730m reserves externally and £126m reserves internally as at 31

December 2015.

The UKLAP with-profit funds have no reinsurance treaties where they are the cedant and where the

reserves or premiums exceed £10m.

32


There is a treaty that reinsures 100% of the business in the UKLAP Belgian sub-fund to Delta Lloyd.

The amount of mathematical reserves ceded under the treaty is £104m.

In order to mitigate reinsurance risk, a number of actions are undertaken by UKLAP, including:

► Risk mitigation in the form of collateral for some of the external treaties

► Terms within the treaties covering the event of reinsurer downgrade

► Overall exposure to each reinsurer is managed through Aviva’s counterparty credit risk management process

In addition, any residual exposure to counterparty risk is addressed by holding capital (as the reinsurer counterparty credit risk forms part of the SCR calculation).

The existing reinsurance arrangements in UKLAP do not impact on the Scheme.

6.3.4 Articles of Association

I have reviewed the Articles of Association of UKLAP and have not identified any issue in relation to

them that might adversely affect the rights and expectations of policyholders with respect to the

Scheme.

6.4 Risk profile of UKLAP’s business

The risk profile of UKLAP is characterised by the fact that it writes a broad range of life insurance

business and is exposed to the usual risks, including market risk from adverse changes in the

financial situation and life insurance risks, particularly in respect of mortality, longevity, persistency

and expenses.

I have reviewed the UKLAP risk profile pre-transfer and the pro-forma position post Part VII Transfer

calculated using Aviva’s Internal Model and considered the diversification benefit achieved across the

individual risks.

The table below shows the top 5 risks in UKLAP before and after diversification:

Table 6.4: Top 5 risks in UKLAP

Pre-diversification Post-diversification

Longevity Credit Interest Rates Operational Risk Lapses

Longevity Credit Residential Property Commercial Mortgages Operational risk

The risk profile of UKLAP is already determined on a look-through basis, and therefore includes the

exposure to the risks arising in UKA, and so is not affected by the Scheme.

The main risks within UKLAP are:

► Life insurance risk such as longevity risk and lapses

► Market risk such as interest rate risk, credit risk exposure resulting from fluctuations in credit quality of third parties and risks arising from residential property and commercial mortgages

► Operational risk as the loss arising from inadequate or failed internal processes, personnel or systems, or from external events

33


6.4.1 Longevity

Longevity risk is the single largest undiversified risk and the largest contributor to the diversified SCR

results for UKLAP. The longevity risk arises from UKLAP holding UKA as a subsidiary, and as such,

the Part VII Transfer will have little impact on the size of this risk. In addition, some of the risk is

hedged via a longevity swap in UKA.

6.4.2 Market risk

Market risk includes credit risk and interest rate risk. Credit risk contributes significantly to the

diversified SCR. Some of the credit risk in UKLAP arises from holding UKA as a subsidiary and such,

the Part VII Transfer will have little impact on the size of this risk.

Interest rate risk is the third largest undiversified risk. In more recent years, management has taken

action to hedge this risk to reduce the impact on the SCR.

6.4.3 Operational risk

Since the correlation between operational risk and other risk types is low, less capital is held as an

operational risk event is unlikely to happen at the same time as a risk event for other risk types.

6.5 Solvency position

6.5.1 Solvency I

Table 6.5 summarises the pre Part VII Transfer statutory Solvency I position of UKLAP for financial

year from 2011 to 2015 as shown in UKLAP’s annual returns to the PRA.

Table 6.5 Pre Part VII Transfer statutory Solvency I position of UKLAP

At 31 December 2015, UKLAP had available capital resources of £10.9b to cover the Regulatory Pillar

1 capital requirement of £6.2b, a solvency cover ratio of 175%. In addition, the Capital Resources as

at the end of each financial year shown were very considerably in excess of the Capital Resources

Requirement; as such they demonstrate a strong level of solvency.

6.5.2 Solvency II

Table 6.6 summarises the pre Part VII Transfer statutory Solvency II position of UKLAP as at 1

January 2016 as calculated by Aviva management. These results have been externally audited.

34


All Solvency II results presented within this Report include the benefit of transitional deductions.

Table 6.6 UKLAP pre Part VII Transfer Solvency II financial position9

as at 1 January 2016

1 January 16

Own Funds (A) 8,456

SCR (B) 5,464

Surplus/deficit (C=A-B) 2,992

Solvency II Solvency Ratio (D=A/B) 155%

I have reviewed the Solvency II figures for UKLAP as at 1 January 2016. On 1 January 2016, UKLAP

had capital resources of £8.5b to cover Solvency II SCR of £5.5b, which represents a Solvency II

cover ratio of 155%. I note that a dividend is expected to be paid in 2016, and that the figures

represented above do not allow for that dividend payment. I will comment in my Supplementary

Report on the updated Solvency II position of UKLAP at half-year 2016.

I did not identify items which cause me concern with respect to UKLAP or UKA’s solvency position or

the security of the policyholders’ guaranteed benefits.

The expected Solvency II position after the Part VII Transfer is considered in section 7.2.2.

6.5.3 Own Risk and Solvency Assessment (‘‘ORSA’’)

Aviva Life & Pensions UK Limited produces a single ORSA report to cover all its entities, which

includes details for UKA and UKLAP. See section 5.6 for further detail.

9 The figures are shown on a consolidated basis which includes UKA.

35


7. Effect of proposed changes on security of policyholder

guarantees

7.1 Introduction

There are two key areas to consider regarding the impact of the Scheme on policyholders of both

UKA and UKLAP:

► Security of policyholders’ guaranteed benefits

► Rights and benefit expectations of policyholders, including the Companies’ interpretation of Principle 6 of the FCA’s Principles for Business (Customers’ interests)

In the sections below, I consider the effect of the Scheme on security of policyholders’ guaranteed benefits. My consideration of rights and benefit expectations are documented in section 8.

As described in section 4, the transferring business from UKA comprises only non-profit annuities

which will be transferred to UKLAP NPSF, but not the RIEESA, and become part of the LTBF in

UKLAP. I note that there are with-profit policies within UKLAP, and as such, when considering the

security of policyholders, I have considered both non-profit and with-profit policies.

The security of both the transferring UKA and the existing UKLAP policyholders depends principally

on:

► The changes of risk profile of UKLAP to which the transferring and existing policies will be

exposed after implementation of the Scheme

► The amount of surplus capital in UKLAP to cover its capital resources requirements in order to provide security for the benefits of both the transferring and existing policies after the implementation of the Scheme

► The reasonable expectations such as benefit expectation, service standards, management and governance of the business after the Effective Date

7.2 Security of policyholders’ guaranteed benefits

7.2.1 Estimated effect on risk profile

After the implementation of the Scheme, the UKA policies will be direct policies of UKLAP NPSF.

These policies will be directly exposed to the risk profile of UKLAP which has a different mix of

business to UKA. In addition, differences may be present due to different distribution channels and

demographic profiles.

The UKLAP pre Part VII Transfer figures are calculated on a look-through basis and so already

include the underlying risks in UKA. We note that UKA is currently valued using the adjusted equity

method. The valuation method will not change following the Part VII Transfer.

As such, there will be little change to the risk profile of UKLAP, with the SCR remaining broadly

unchanged bar some small technical adjustments.

I have reviewed the Companies pre and post Part VII Transfer risk profiles and their Stress and

Scenario Testing (“SST”) in conjunction with the indicative financial impacts of scenarios and

sensitivities in order to understand how the values of options and guarantees move under stress.

These stress tests included:

► An SST exercise coordinated by Aviva Group

► A war gaming session to identify risks that could cause business model failure

36


► A local scenario and reverse stress testing exercise specific to UK Life entities own risk exposures

I have reviewed the results of the SST exercises, including the Board approval of the results and am

satisfied that my conclusions as to lack of material adverse effect on policyholders’ guaranteed

benefits and security of benefits remain true in the stress events outlined.

Furthermore, UKA is currently a subsidiary of UKLAP and all of its risks ultimately flow to UKLAP,

although I note that in a very extreme insolvency event, UKLAP could decide not to support UKA.

However, given capital coverage is in excess of the level required to withstand stresses equal to a 1

in 200 year event, I consider this to be an extremely unlikely event. As such, there will be minimal

change in the risks to the existing UKLAP policyholders in that post Transfer there is no option to not

support UKA. However, as discussed, it is very unlikely that this option would be taken up and

therefore, after the implementation of the Scheme, UKLAP will be in essentially the same position

having accepted UKA’s risks.

Overall, I am satisfied that the amalgamated risk profile will not have a material effect on the security

of the guaranteed benefits of transferring UKA policies nor that of the current UKLAP policyholders.

7.2.2 Financial resources available to provide security for benefits

I have reviewed the post Part VII Transfer Solvency II figures estimated as at 1 January 2016 as

shown in the table below.

Table 7.1: Post Part VII Transfer Solvency II financial position at 1 January 2016

£m

1 January 2016*

Pre Part VII

Transfer

Post Part VII

Transfer

UKA UKLAP UKLAP**

Own Funds (A) 3,415 8,456 8,505

SCR (B) 1,887 5,464 5,530

Surplus/deficit (C=A-B) 1,528 2,992 2,975

Solvency II Solvency

Ratio*** (D=A/B)

181% 155% 154%

* The 2016 figures allow for the increase reinsurance to AII and the benefit of the matching adjustment ** Note that UKA is already treated on a look-through basis in the UKLAP results pre Part VII Transfer. ***A dividend payment is expected to be paid in 2016, and that the figures represented above do not allow for that dividend

payment.

The UKA Part VII Transfer has the following high level impacts on UKLAP’s solvency position on 1 January 2016 results:

► Overall risk margin would decrease following the Part VII Transfer due to greater diversification

between the UKA and UKLAP business:

► UKA’s risk margin consists almost solely of longevity risk, whereas the non-profit UKLAP risk

margin is made up of a variety of risks, including longevity, operational, expense and lapse risks

► Following the Part VII, the combined risk margin is lower due to the incremental

diversification between these risks which is not permitted under the pre-Part VII legal entity structure.

► As the result of the Part VII Transfer, the reinsurance credit risk exposure in respect of the quota

share arrangement between UKA and UKLAP is removed

37


The total SCR has increased by £66m from £5,464m pre Part VII Transfer to £5,530m post Part VII Transfer as the net result of:

► £21m increase due to the change in risk margin included in the assumption adjustments10

, primarily driven by the non-profit business which has a shorter duration

► £22m decrease due to the reduction in reinsurance credit risk to AII

► £14m decrease due to an increase in the tax relief on UK NP

► £82m increase due to the reduction in the tax effect of transitional relief on the SCR

As at 1 January 2016, the solvency cover ratio of UKLAP post Part VII Transfer is very slightly lower than that of UKLAP pre Part VII Transfer and the UKLAP post Part VII Transfer solvency ratio is much lower than that of the UKA pre Part VII Transfer.

However, UKA is well above its solvency risk appetite and could potentially release a dividend to UKLAP in the near term, which would reduce the coverage to a level comparable with UKLAP (even after allowing for UKLAP’s dividend payment). Therefore, although UKA business solvency coverage reduces from 181% pre Part VII Transfer to 154% in UKLAP Post Part VII Transfer, I do not consider this to have a materially adverse effect on the security of the guaranteed benefits of UKA as far as UKLAP itself remains capitalised to a level that meets its solvency risk appetite.

I have reviewed the fund by fund financial position and note that, as expected, the Part VII Transfer

will not impact any UKLAP funds other than the NPSF. The NPSF SCR is expected to decrease

significantly due to the reduction in reinsurance credit risk exposure.

Overall, I am satisfied that the Scheme is not projected to have a material adverse effect on the

security of the guaranteed benefits of the transferring business and the existing business within

NPSF.

7.3 Security of policyholders’ benefits

7.3.1 Capital policy

7.3.1.1 Solvency II solvency risk appetite

The Companies have a common management structure. The UK Life Board within the Aviva Group sets the overarching risk appetites for UK Life. I have reviewed the quantitative solvency risk appetite which is set out at the consolidated entity and solo entity level. Whilst the target solvency ratio are different for UKLAP and UKA, these ratios are based on the same risk methodology and scenarios i.e. an additional capital equal to a defined level of stress.

UKA and UKLAP capital policies currently provide a buffer over and above the Solvency II capital requirements and the policyholders of UKA and UKLAP will be afforded a greater level of security than that strictly required under the Solvency II rules.

Therefore, I conclude that there should be no detriment to the UKA policyholders’ security by moving to the UKLAP risk appetite. Clearly, as UKLAP policyholders will maintain the same risk appetite as what they had previously, there is no detriment for them.

7.3.1.2 Dividend risk appetite

The UK Life Board sets the dividend risk appetites using a solvency monitoring corridor approach.

Dividends would only be paid if the payment does not result in moving below the specified risk

appetites. The dividend risk appetite applies to both UKA and UKLAP, their current risk appetite ratio

is similar and is determined using the same methodology. Therefore, I conclude that there will be no

10 This is the change in the unwind of risk margin included in the 1 year Value of Risk adjustments

38


detriment to the UKA and UKLAP policyholders’ security, as a result of a dividend payment as a

subsequent action.

7.3.1.3 Liquidity risk appetite

The overall liquidity risk appetite is made up of the shareholder liquidity risk appetite and the

policyholder liquidity risk appetite11

. UKLAP’s liquidity risk appetite covers a range of facilities and

buffers, including the requirement to be able to fund an injection to a subsidiary following a solvency

stress in that subsidiary. The largest such subsidiary stress is taken for this purpose. UKA currently

sees the largest stress of all UKLAP subsidiaries, however after the Part VII Transfer the largest

subsidiary is Aviva Equity Release UK Limited (‘‘UKER’’) whose stress is a much smaller and hence

the liquidity risk appetite requirements become less onerous as a result.

In addition, the UKA solvency stress becomes part of UKLAP’s core solvency risk appetite post Part

VII Transfer, but the liquidity element becomes less material as it would not be necessary to find cash

to transfer out of UKLAP to make an injection after a solvency stress.

UKLAP and UKA have the same policyholder liquidity risk appetites, which will remain unchanged post Part VII Transfer. Hence, I conclude that the Part VII Transfer will have no material adverse impact to the UKA and UKLAP’s policyholders’ security.

7.3.1.4 Management actions

In addition to considering the actual level of capital intended to be held under Solvency II, I have also

reviewed the planned management actions.

I noted from my assessment of the management actions that:

► Surplus generation and dividend capacity is boosted by a number of the management actions

► A number of these management actions also serve to improve the liquidity position of UKLAP and some of the management actions reduce capital requirements and technical provisions

I note that the planned management actions are intended to improve the overall solvency and / or

liquidity position and are not needed in order to meet Solvency II capital requirements. In addition,

whilst these management actions do have the potential to impact on the ultimate level of bonus for the

with-profit policyholders, it is unlikely that this impact would be different pre or post Part VII Transfer.

Therefore, I am satisfied that the management actions are appropriate for the security of

policyholders’ benefit in future years.

7.3.1.5 Risk preference

Risk preferences are set as part of the Aviva’s Enterprise Risk Management Framework. They are

qualitative statements that express the types of risk that UK Life actively seeks, limits and avoids.

As the risk preferences are the same for all UK non-profit funds, there will be no impact for the UKA

transferring policyholder security. There will be no change to the current UKLAP with-profit risk

preferences as a result of the Part VII Transfer.

7.3.1.6 Conclusions of Capital Policy

Given that:

► UKLAP and UKA have the similar risk appetites and employ the same methodology

► UKA has the same risk preferences as the UK non-profit funds within UK Life

11 This is for internal accounting and management purpose and not a technical distinction under Solvency II.

39


► The Companies have a common management structure

► The shareholders of UKLAP and UKA are in the same group

I am satisfied that the Scheme would not have a materially adverse effect on the security of

transferring UKA policyholders’ guaranteed benefits or those in UKLAP, the transferee company.

7.3.2 Contagion risk

Contagion risk is the risk that capital resources might flow from one fund to another in the event that

one of the funds has insufficient assets to meet its liabilities, where several funds exist in the same

company or group of companies. This risk could adversely impact the benefit security of policyholders

from the fund from which the resources have been moved. The two key areas where contagion risk

applies are in the Mortgage Endowment Promise and the RIEESA. I discuss each of these in turn

below. Based on the reasons set out, I do not believe that there is any material increase to contagion

risk as a result of the Part VII Transfer.

7.3.2.1 Mortgage endowment promise

UKLAP has stated that payments on with-profit mortgage endowment policies may, if necessary, be

topped up at maturity (subject to certain conditions) where there is a shortfall between the claim value

and the mortgage originally targeted. This is referred to as the ‘Promise payment’ below. Top-up

payments can be met from future investment earnings on the free reserves within the UKLAP with-

profit sub-funds which includes WPSF, NWPSF and OWPSF. If investment earnings on the free

reserves are not sufficient to meet the top-up payments then the payments may be reduced or

eliminated.

Maximum top-up amounts have been communicated to policyholders who are aware of the potential

shortfall after the Promise payment. For valuation purposes, UKLAP has assumed that the full

Promise amount would be paid at all times. Therefore, the Promise payment has been capped at the

maximum amount which is also reflected in the current reserve.

Table 7.2 shows the last four-year provisions under Solvency I Pillar I made in the WPSF, NWPSF

and OWPSF respectively to cover part of the top-up payment. The reserves are decreasing year on

year due to the Promise maturing and the improved performance of the investment earnings.

Table 7.2: Mortgage endowment promise reserves

Funds (£m) 2015 2014 2013 2012

WPSF 251 359 462 587

NWPSF 299 335 351 346

OWPSF 80 86 87 83

Under Solvency II, UKLAP allows for the total expected top-up payment, based on a full stochastic

projection which takes account of a full range of economic scenarios, which includes the full Promise

payment in the worst case scenario.

I am satisfied with the Solvency II position of UKLAP pre and post Part VII Transfer, and as such,

believe that the WPSF, NWPSF and OWPSF will have sufficient assets to meet the mortgage

endowment promise.

Given:

► The maximum top-up amounts have been communicated with the policyholders

► The full promise amounts are reflected in the Solvency I position

► The prudence of the Solvency II projections

► The overall Solvency II capital position

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I do not consider that the mortgage endowment promise will cause material contagion risk to the

benefit security of the transferring policyholders.

7.3.2.2 RIEESA

The RIEESA, as defined in section 6.3.1, is a ring-fenced fund. The surplus in that fund is used to

make strategic investments, advance loans to Aviva Group companies and write NP new business

providing that in doing so there is no unacceptable risk of failing to meet statutory capital

requirements.

In order to ensure that the capital requirements of the fund can be met in an adverse (1-in-10)

scenario, Aviva add a buffer to the SCR. The surplus, after allowance for this buffer, is then primarily

used to write new business. This level of surplus is monitored monthly. Should it fall below defined

trigger levels, the With-Profit Committee will be informed, and should it fall to zero, Aviva UK Life will

immediately cease to write new business in the RIEESA.

There is a very small possibility that in a very serious adverse event, the RIEESA would not have

sufficient assets to meet the support needed for the relevant with-profit sub-funds. However, given the

level of monitoring in place, it is likely that management actions would be taken before this became

the case.

However, in the unlikely event the RIEESA required support, assets from the NPSF may have to be

injected directly into the relevant with-profit sub-funds.

Given the low likelihood of assets being required from the NPSF, I do not believe there is a material

risk to the benefit security of the UKA policyholders transferring into the NPSF.

7.4 Investment management administration

7.4.1 ISDAs

UKA is a party to a number of International Swaps and Derivatives Association (‘‘ISDA’’) contracts and

UKLAP is a party to ISDA contracts with each of the relevant counterparties.

After the implementation of the Scheme, all existing UKA ISDA relationships will continue unchanged

but between UKLAP and the relevant counterparties except for the terms of collateral governance

which will be aligned to the UKLAP terms which are slightly different between UKLAP and UKA. I

have discussed the differences in the terms of collateral governance with Aviva management and am

comfortable that they are not materially different.

The Companies will write to the relevant counterparties in advance of the implementation of the

Scheme and also ask to formally acknowledge that transactions executed after the implementation of

the Scheme will be with UKLAP rather than with UKA.

I do not believe there to be any material impact as a result of the original collateral arrangements with

UKA being aligned with the UKLAP arrangements as a result of the Part VII Transfer.

7.4.2 Securities lending

UKA and UKLAP are both party to a number of securities lending contracts. The same approach as

for the ISDAs will be taken to ensure no material detriment will arise to either set of policyholders after

the implementation of the Scheme.

The only limitation for the Part VII Transfer is the standard term governing the ‘Cessation of

Underwriting Business’’ which gives rise to an option for the counterparty to terminate the contracts in

certain circumstances. I have reviewed the contracts and I believe it is unlikely that this provision will

41


be applied. In addition, it is important to note that Aviva do not use securities lending as a funding tool,

rather as a discretionary low-risk yield enhancement strategy. As such, should the contracts be

terminated, there would be no detriment to policyholder security.

7.4.3 Non-discretionary transactions

UKA currently has non-discretionary asset management agreements with Barclays and Morgan

Stanley. There are no terms of the agreements that might constitute an impediment of the Part VII

Transfer. The Companies will notify Barclays and Morgan Stanley to the Part VII Transfer prior to

implementation of the Scheme. In addition, there is one further non-discretionary derivative

counterparty agreement with other companies but the documentation underpinning these

arrangements has not yet been located. I aim to review this arrangement and provide an update in the

Supplementary Report.

7.4.4 Internal agreements

Both UKLAP and UKA are parties to Discretionary Fund Management Agreements with Aviva

Investors Global Services Ltd (“AIGSL”), dated 22 May 2015 (the IMA).

The IMA includes a restrictive clause stating that no assignment or transfer may be made without the

prior written consent of the other Party.

In addition, UKA and UKLAP are both party to an Operational Service Level Agreement relating to the

IMA which also requires written consent for the Part VII Transfer.

The Companies plan to terminate the existing agreements between UKA and AIGSL internally before

31 December 2016 and replace with new IMA agreements between UKLAP and AIGSL which will

come into effect on the implementation of the Scheme. Thus, the requirement for such discretionary

investment management services agreement for UKA will fall away after the implementation of the

Scheme.

7.4.5 Custodian Agreements

There are Custody Agreements with Midland Bank PLC (‘‘HSBC’’) and JP Morgan Chase Bank

(‘‘JPM’’) to which UKA is a party in respect of its assets. Both agreements have the restriction that

‘‘neither party may assign this Agreement without the written consent of the other party’’. The

Companies will obtain consent from HSBC and JPM prior to implementation of the Scheme. I aim to

review the consents for these arrangements and provide an update in the Supplementary Report.

7.5 Other considerations

7.5.1 Application for UKLAP matching adjustment

UKA and UKLAP both currently have approved matching adjustment applications which allow the

discount rate of the liabilities to be increased when liabilities cannot be surrendered. The approved

application of UKA will not automatically transfer to UKLAP and as such, UKLAP will need to re-apply

for a matching adjustment for the enlarged company following the Part VII Transfer of UKA. This

application will supersede the previously approved UKLAP and UKA applications.

The Scheme document states that the Part VII Transfer will not become effective if confirmation is not

received from the PRA that UKLAP can take the benefit of the matching adjustment. The PRA

indicated in May 2016 that, based on UKLAP’s draft application, it had no objection in principle to

UKLAP’s matching adjustment application proposed to be submitted by the firms as a consequence of

the Part VII transfer. The final application will be submitted for PRA decision following the Directions

Hearing.

42


My review of the original matching adjustment application as well as the responses from PRA does

not suggest that there is a likelihood of any material issues regarding the anticipated PRA approval.

However, I intend to provide an update on the matching adjustment re-application in my

Supplementary Report.

7.5.2 Application for UKLAP volatility adjustment

The PRA has approved the volatility adjustment applications for both UKA and UKLAP, which allows the Companies to use an adjusted risk-free interest rate term structure in order to calculate the best estimate liabilities. However, the approved application of UKA will not automatically transfer to UKLAP and UKLAP will need to re-apply for a volatility adjustment for the enlarged company post Part VII Transfer.

The draft volatility adjustment application was submitted to the PRA in April 2016 to seek a “no objection in principle” response from the PRA in advance of the Directions Hearing for the use of a volatility adjustment by UKLAP, following the Part VII transfer.

The PRA indicated in May 2016 that, based on UKLAP’s draft application, it had no objection in principle to UKLAP’s volatility adjustment application proposed to be submitted as a consequence of the Part VII transfer. The final application will be submitted for PRA decision following the Directions Hearing.

I have reviewed the pro-forma application and do not note any strong evidence that PRA will not approve the volatility adjustment application in respect of the Part VII Transfer. The final application will be submitted following the result of the Directions Hearing.

7.5.3 Transitional Measures on technical provisions under Solvency II

UKA is eligible for Transitional Measures on technical provisions (“TMTP”) under Solvency II.

Following the transfer, UKLAP will, need to re-apply for these Transitional Measures, and subject to

PRA approval, extend its TMTP arrangements to cover the business transferred from UKA determined

as at 1st January 2017, and allowing for economic conditions at that date.

The Scheme document states that the Part VII Transfer will not become effective unless the PRA

provides approval that UKLAP may apply a deduction for Transitional Measures, following

implementation of the Scheme. The PRA indicated in May 2016 that, based on UKLAP’s draft

application, it had no objection in principle to UKLAP’s TMTP application proposed to be submitted as

a consequence of the Part VII transfer. The final application will be submitted for PRA decision

following the Directions Hearing.

My review of the relevant Transitional Measures applications as well as the responses from PRA also

does not suggest that there is a likelihood of any material issues regarding PRA re-approval.

I intend to provide an update on the Transitional Measures re-application in my Supplementary

Report.

7.5.4 Reinsurance

7.5.4.1 Internal reinsurance arrangements

As discussed in section 4.3.3, there are internal reinsurance arrangements in place between UKA and

AII and UKLAP and AII. The internal reinsurance in place at 1 January 2016 has been reflected in the

audited Solvency II positions discussed in this Report.

On 1 July 2016, management propose to amend the levels of internal reinsurance, with a back dated

effective date of 1 January 2016. I have been provided with, and have reviewed, the updated

Solvency II results based on these amended arrangements. The new reinsurance arrangements lead

43


to an improved solvency position for UKLAP both pre and post Part VII Transfer. Although, I note that

these changes have not yet been entered into and are subject to ongoing discussions with the PRA

and PRA non-objection.

I do not believe that the changes to the internal reinsurance arrangements will have an adverse

impact on the conclusions reached in section 7.2 in terms of the policyholders’ guaranteed benefits

security.

7.5.4.2 External reinsurance treaties

UKA has external reinsurance arrangements with Hannover Re, Maturin UK, Munich Re, Partner Re,

RGA, Swiss Re Europe S.A, and XL Re (the ‘‘External Treaties’’):

► There are no restrictions on the transfer of contractual rights/obligations by way of Part VII

Transfer in the Hannover Re, Munich Re, RGA, or Swiss Re treaties

► Consent is required for such a transfer under the Partner Re and XL Re treaties

► There are no prohibitions or restrictions in respect of the Maturin UK transaction which would prevent the UKA Part VII Transfer but any assignment must be in writing

► Notifications are required to be sent to Swiss Re and Munich Re

► The final agreement with Hannover Re has not yet been signed

► An ‘‘agreement procedures’’ exercise is required to finalise the transfer of contractual rights/obligations under RGA treaties

UKA will approach all reinsurers to provide their consent to the Part VII Transfer where appropriate. In addition, notification letters will be sent to all third parties, including reinsurers that are not required to give consent. I have reviewed the draft reinsurer letter which has also been reviewed by the FCA, and the third party letters.

I can see no reason why there would be any detriment to the UKA policyholders’ security by

transferring the external treaties from UKA to UKLAP.

I have discussed the financial impact of reinsurers not transferring, and note that it would be material.

However, from my conversations with management, I see no reason why the external reinsurers

would not agree to the transfer.

I have also noted an administration agreement fee letter with Milliman Inc under the Maturin UK

treaties. It offers a right for Milliman to request an indemnity from UKA if Milliman considered itself

suffering a loss from the Part VII Transfer. However, Aviva management believes that it is unlikely to

happen and will seek confirmation from Milliman that they do not wish to exercise such a right of

indemnity under Part VII Transfer.

I will continue to review the correspondence with Milliman as well as all other counterparties prior to

the Sanctions Hearing and I will provide an update in the Supplementary Report.

7.5.4.3 Reinsurance risk

Aviva has taken to steps to ensure that reinsurance risk has been mitigated where possible. These

include:

► Reinsuring the same level of UKLAP NPSF’s and UKA’s assets and liabilities to AII

► Re-assessing financial positions to reflect the amended levels of internal reinsurance with a

back dated effective date of 1 January 2016

► Seek consent from all reinsurers agreeing the change of counterparty as the result of the Part

VII Transfer

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7.5.5 External policyholder security

The UKA and UKLAP policyholders are eligible under the Financial Services Compensation Scheme

(‘‘FSCS’’). The FSCS compensation limit for long-term insurance business is 100% of the loss caused

by the insurer’s insolvency with no upper limit. The FSCS will pay compensation to eligible individual

policyholders of long-term insurance policies issued by UKA and UKLAP in the event of the

Companies’ default.

This means that even if a customer did have policies with both UKA and UKLAP pre Part VII Transfer,

they would have the same level of protection when those policies are both held by UKLAP, as all the

business written by both entities is long-term insurance business.

7.5.6 Intra-group loans

UKA is a party to a number of intra-group loans, as set out below:

► Loan of £87m to Aviva Group Holdings Limited maturing 22nd December 2028, to provide group

liquidity. UKA’s position with regards this intra-group loan will transfer to UKLAP under the Part VII Transfer.

► Loan of £200m from Aviva Life Holdings UK Limited to provide capital to borrower. This subordinated debt is disclosed in UKA’s 2015 yearend financial statement. UKA’s position with regards this intra-group loan will transfer to UKLAP under the Part VII Transfer.

► Three loans of £28m, £149m and £150m from UKA to UKLAP respectively. After the Part VII Transfer, the loan agreements between UKA and UKLAP will terminate as UKA will become a sub-fund of UKLAP.

The counterparty risk of other loans is low since the agreements are within Aviva Group. Therefore,

there are no material issues caused by the intra-group loans that concern me in my role as the

Independent Expert.

7.5.7 Other material third party agreements

7.5.7.1 Commercial mortgages

UKA, together with UKLAP, fund the provision by Aviva Commercial Finance Limited (‘‘ACF’’) and

Aviva Public Private Finance Limited (‘‘APPF’’) for commercial mortgage loans. Although UKA and

UKLAP entered into the same agreements with ACF and APPF, there are some restrictions against

the transfer of rights/obligations from UKA to UKLAP:

► No party may transfer their rights and/or obligations under the Agreement without the consent of

the other parties

► Variation must be by written agreement unless such variation is required to give effect to any change which is required under FSMA or the FCA Rules

Following conversations with Aviva management, I do not expect there to be material objections to the

Part VII Transfer. I will continue to review the correspondence with the counterparties prior to the

Hearing and provide an updated opinion in the Supplementary Report.

7.5.7.2 Bulk Purchase Annuity (‘‘BPA’’) agreement

UKA is a party to a number of BPA buy-in and buy-out agreements. With the exception of the one

Trustee approval noted below, none of these agreements include any restriction or prohibition in

respect of the transfer of UKA to UKLAP under the Scheme.

Some schemes contain specific provisions in relation to the provision of a contingent loan facility from

UKLAP to UKA which give the Trustees the right to surrender the schemes in the event that the

contingent loan facility is terminated and a replacement guarantee providing broadly similar protection

45


is not put in place. Management has informed me that the Companies will put in place an amendment

agreement with the relevant Trustees to secure the waiver of their right to terminate the relevant BPA

schemes in the event that the contingent loan facility is removed.

In addition, the consent of the Trustee of one of the agreements is required for the transfer of UKA to

UKLAP pursuant to the Part VII Transfer. Management has informed me that the Companies will seek

the consent of the Trustees to the transfer of UKA to UKLAP pursuant to the Part VII Transfer.

I have discussed the proposed amended agreements with Aviva management, and agree with them

that it is unlikely the Trustees would withhold their consent to an amendment to the Schemes for the

following reasons:

► The Trustees are unlikely to find a more favourable replacement BPA in the open market, which

is what they would have to do if they objected to the withdrawal of the contingent loan facility and exerted their resultant contractual sanction of terminating the BPA

► UKA is now in a much more robust capital position than it was c 2009 (when the BPAs were put in place) and therefore the imperative to have the facility in place for UKA has fallen away

I will review the amended agreements once initiated and provide my opinions in the Supplementary

Report. I do not anticipate any material issues.

7.5.7.3 Infrastructure investments

UKA entered into a number of infrastructure deals to finance infrastructure projects such school

buildings, the manufacture and supply to a rail company, offshore wind farms, hospital facilities

building and maintenance and wind and solar projects.

I have reviewed the investment agreements and did not identify any restrictions that might constitute

an impediment to the Part VII Transfer or cause adverse effects to either UKA or UKLAP’s

policyholders after the implementation of the Scheme.

7.5.7.4 Equity release

UKA has Funding and Mortgage Sale Agreements with UKER to provide funding. Although there are

no restrictions or prohibition on the transfer or assignment of rights/obligations pursuant to the

Scheme, a new arrangement is proposed in 2016 whereby UKER will act only as originator and

administrator of Equity Release Mortgages (“ERM”) and therefore that all risk will pass to UKA.

UKA also entered a number of Equity Release securitisations with UKER when it securitised its ERMs

in order to create a matching adjustment eligible asset. There are no prohibitions or restrictions within

the Equity Release securitisations against the Scheme.

UKA continues to buy ERM from UKER under the ERM restructure plan, which has been approved as

part of the Matching Adjustment application and is reflected in the Solvency II position discussed in

this Report. The terms on which UKA buys ERM from UKER and the terms of the existing ERM

arrangements will both be updated prior to the Part VII Transfer to ensure consistency. This proposal

to update the existing terms (and have them backdated to 1 January 2016) has been sent to the Life

Business’ Asset Liability Committee. I will provide an update in my Supplementary Report.

UKA is currently a subsidiary of UKLAP, and as such, for all practical purposes, the risk arising from

the UKER contracts in UKA is ultimately borne by UKLAP. In addition, the ERM restructure plan

ensures that any future ERM purchases cannot be made if they would cause UKA or UKLAPs metrics

to fall outside of the stated risk appetite.

I do not believe the acceptance of the ERM business will lead to any adverse deterioration in the

benefit security of either the UKA or UKLAP policyholders.

46


7.6 Conclusions of security of benefits

I note that there are a number of areas that are currently outstanding (for example, agreement of third

parties to the transfer). However, as discussed above, I do not believe that any of these outstanding

items will have a materially detrimental effect and as such, I am satisfied that:

► The security of policyholders’ guaranteed benefits will not be materially adversely affected by the

Scheme

► The implementation of the Scheme will not lead to material detriment to the security of policyholders’ benefits

► There are no concerns caused to the security of policyholders’ benefits by the changes to the investment management administration

► There are no concerns brought to my attention in my review of third party agreements, which is likely to have a material adverse effect to the security of policyholders’ benefits

For these reasons, I am satisfied that the Scheme will not have a material adverse effect on the

security of either UKA or UKLAP’s policyholders guarantees.

I will provide an update on the outstanding items in my Supplementary Report.

47


8. Effect of proposed changes on rights and expectations of

policyholders

8.1 Rights and expectations

8.1.1 The reasonable expectations of the policyholders

The transferring policies are all non-profit annuities comprising of level, fixed escalation and index-

linked business. Hence, both the transferring UKA and existing UKLAP policyholders have the

reasonable expectations that:

► The income remains guaranteed under the policy for level annuities or as determined in

accordance with the terms under the policies for fixed escalation or index-linked annuities

► The financial stability of the entity offering the annuities is not materially impaired

► The administration and service standards received are not compromised after the implementation of the Scheme

► The management and governance of the policies are in line with the contractual terms under the policies

► The benefit expectations of the with-profit policyholders are not materially altered following the implementation of the Scheme.

The security of policyholder benefits and the financial stability points are discussed in section 7, the

other points are considered below.

8.1.2 Non-Profit Sub-fund (‘‘NPSF’’)

In addition to the points identified in section 8.1.1, there are a number of specific considerations in

respect of the NPSF. In considering the transfer of UKA business to the UKLAP NPSF, but not the

RIEESA, the following areas were compared:

► The objectives of the fund

► The applicable charges in the fund

The main types of business written in the NPSF are conventional non-profit and unit-linked policies.

However, the fund also has some pension annuity business similar to that written by UKA. It is open

to new business, which is consistent with the UKA business.

48


Table 8.1: Summary of assets held by NPSF and UKA at 31 December 2015

£m NPSF UKA

Government Bonds 458 6,070

Corporate Bonds Rated A and above - 8,879

Corporate Bonds Below A - 3,742

Property - 198

Derivatives 83 533

Commercial Mortgages - 7,563

Healthcare Mortgages - 4,174

Equity Release Mortgages - 4,216

Current Assets 60 65

Unit Linked Fund Assets 45,219 -

Other liquidity funds* - 2,158

Other 1,197 244

Total 47,018 37,842

* Other Liquidity Funds are easily accessible collective funds provided by a range of investment managers.

The table above shows that the key differences between the NPSF and UKA asset profiles are the

mortgages and corporate bonds held by UKA. UKA currently holds a significant number of mortgages

valued at approximately £16b, while NPSF holds none. The valuation of these mortgages is in line

with the Aviva Group Solvency II methodology, which is how they will be valued after the Part VII

Transfer.

UKA is currently a subsidiary of UKLAP, and as such, for all practical purposes, the credit risk of the

UKA assets is ultimately borne by UKLAP. In addition, the assets transferred from UKA will continue to

be managed as separate portfolios under the investment management agreement. Therefore, whilst

the asset profile of the NPSF will be different following the Transfer, I do not believe this has an

adverse impact on the security of either the UKA or UKLAP policyholder benefits.

8.2 Ongoing administration and governance

8.2.1 Administration and service standards

The policies administration services of both UKA and UKLAP are already provided by the same

service company, Aviva Life Services UK Limited (‘‘UKLS’’), and the Scheme will not impact these

arrangements as there are no restrictions for the internal transfer of rights and duties under the

Management Service Agreements. The applicable charges in the fund have been agreed with UKLS,

these charges are consistent Aviva Group-wide.

Furthermore, I have received assurances from management that the terms upon which services are

provided by the service company to UKLAP will remain unchanged as a result of the Part VII Transfer.

I have considered the service standards and I am satisfied that the Scheme should have no material

effect on the service standards experienced by policyholders of either UKA or UKLAP.

8.2.2 Governance and management

The transferring business is currently managed by UKA with certain management services (such as

financial and actuarial, legal, IT, property management and HR services) being outsourced to UKLS

and subject to the governance of the UK Life Board. This is the same arrangement as within UKLAP,

and as such, the transferring business will be subject to the same governance following the

implementation of the Scheme.

49


Therefore, I am satisfied that there will be no material effect of the standards of governance and

management applicable to the transferring business after the implementation of the Scheme.

8.3 Policyholder communications

The regulations surrounding Part VII transfers require that, unless the Court otherwise orders, all

policyholders in all affected companies should be written to in order to inform them of the Scheme.

Consideration may be given to the practicality and costs of sending notices against the likely benefits

for policyholders of receiving such communications.

8.3.1 Coverage

All of the policyholders of UKA will be transferring to the UKLAP. As such there are no UKA non-

transferring policyholders in respect of whom a notification would be required. As such, all UKA

policyholders will be contacted. We note that there are a number of policyholders for whom UKA does

not currently have a current address. However, a tracing process is underway to contact as many

policyholders as possible.

An application will be made to the Court for a waiver to omit mailing the UKLAP’s policyholders with

the exception of those with co-insured policies.

The reasons for seeking this waiver are:

► The policies are not being transferred under the proposed Scheme

► There will be no change to the terms and conditions of the selected policies

► There will be no change to the governance processes applied to the selected policies

Prior to requesting these waivers at the Directions Hearing, Aviva will need to gain both the PRA and

FCA non-objection of the waivers; they in turn will reference these within their Directions Hearing

Reports.

Additional waivers, for both UKA and UKLAP policyholders, which are also being considered include:

► Deceased policyholders whose policies are still in-force, notified deaths

► Second lives

► Policyholders who live in a blacklist country on the Jurisdiction Index

► Dispensation from mailing underlying members of Group Pension and Group Protection Schemes

► Policyholders for whom Aviva does not have a current addresses (anyone without a current address is going through a tracing process before the mailing)

I am satisfied that there will be no material change to the security of benefits or to the reasonable

benefit expectations of policyholders under any such policy.

8.3.2 Communication plan

A detailed communication plan has been produced which should ensure that policyholders are

adequately informed of the nature and effect of the Scheme.

There are some policyholders for whom Aviva does not have a current address. Aviva management

has assured me that administration teams are working to trace these policyholders. Where an

address is currently unavailable, the companies will continue to attempt to trace customers until the

mailing is complete.

50


The Scheme will also be published in media and on Aviva’s website. Policyholders will also be able to

call a helpline with any queries about the Scheme.

I have reviewed the drafts of the Companies’ proposed communication materials and in my opinion:

► The material is straightforward, provides sufficient information for the policyholders to understand

and details any required actions where relevant

► It has explained to the policyholders their right to object and the ways in which they can exercise this right

► The access to the available documentation and relevant information is made clear

► A Questions & Answers package has been attached to ensure engagement from the affected policyholders and help them to understand the impacts of the Scheme at a high level

► A foreign language translation of the Mailing Pack can be provided to the policyholders in German, Dutch, Swedish or French, free of charge, if required.

I am satisfied that the proposed communication plan described above is appropriate and consistent

with the principles pertaining to the fair treatment of policyholders.

8.4 Customers’ interests

The Scheme needs to be considered in the context of the regulatory obligation on both UKA and

UKLAP to treat their customers fairly, particularly with respect to the policyholders’ reasonable benefit

expectations and the management, service and governance standards of the fund.

As discussed in section 8.2.2, the governance of both funds is similar, with UK Life Board having

ultimate responsibility. As such no changes are required post Part VII Transfer.

The policy administration for both UKA and UKLAP policyholders is provided by UKLS using the same

management, staff and processes.

I have reviewed the Aviva Customer Experience Standard which is an Aviva Group-wide standard

setting out the controls and control objectives needed to manage customer-facing processes at Aviva

in line with its risk appetite. The controls are designed to help customers fully understand the features,

benefits, risks and costs of the financial products they buy.

For with-profit policyholders, there will be no changes to the principles or practices used to determine

policyholder benefits.

For the reasons set out above, I am satisfied that the Scheme will not adversely affect the fair

treatment of either the transferring policyholders or those of the transferee company.

8.5 Other considerations

8.5.1 Safeguards

The Scheme will result in the transferring policyholders continuing to be administered and managed in

the same way as before. Management has transferred safeguards in the Scheme for all policyholders;

however, in particular there are special clauses for protection of co-insured policies referred to in

section 4.3.4.

I have reviewed these safeguards and am satisfied that they preserve the security of the benefits of

both the transferring UKA and existing UKLAP policyholder. As such, I see no reason for additional

safeguards beyond those contained in the Scheme to protect the interests of either the UKA or

UKLAP policyholders, either to ensure that the Scheme operates as set out, or for any other reasons.

51


8.5.2 Walkaway option

As UKA is a wholly owned, limited liability subsidiary of UKLAP, UKLAP’s obligation to UKA is legally

limited to any unpaid amount due in respect of its shares in UKA. As all these shares are fully paid up,

UKLAP cannot be compelled by law to contribute any further capital to UKA. In extreme

circumstances, such as the possibility of insolvency for UKA, UKLAP could, in theory, “walk away” and

allow UKA to become insolvent and default on its liabilities. In addition, UKLAP’s current solvency

coverage ratio is lower than UKA and it might not be able to support UKA.

However, in practice there are various other operational and regulatory constraints that make it highly

unlikely that UKLAP or Aviva Group would not provide capital support for UKA in the event that such

capital support was required. These include:

► Damage to the Aviva brand

► Regulation on customers’ interests

► General regulatory objections

Therefore, whilst UKLAP may not be legally obliged to support the UKA policies in all circumstances, I

believe that it is highly unlikely that such support would not be provided if required. Aviva Group may

also step in to resolve in the extreme circumstance where UKLAP failed to support UKA. The “walk

away” option can therefore be considered to be of negligible realistic value to UKLAP.

8.5.3 Contingent liabilities

In additional to the financial risks considered in section 7.2, I have also considered the material

exposures to non-financial risks which could affect the policyholders’ benefit security and expectation

adversely. The key non-financial risks in the Companies are:

► Terms and conditions challenges

► Internal data theft

► Reserve modelling errors

► Mis-Selling

► Product Governance

► With-profit errors

I have asked the Companies’ Legal departments for disclosure of any outstanding compliance or legal

issues, which may lead to material actual or contingent liabilities to the Companies.

The key findings are:

► There are no material litigation claims or material contingent liabilities from the litigation claims

against UKA and UKLAP

► There are no current or anticipated regulatory or compliance issues that may have a materially adverse effect on UKLAP and UKA with the exception of the FCA’s recently published legacy review and the forthcoming annuity review. The Companies consider it too early to tell what the impact of the FCA’s review might be

► There are no material guarantees which will have a material adverse impact on the security of UKA and UKLAP policyholders’ benefit after the Part VII Transfer

► UKA and UKLAP are both parties to indemnity agreements with the same counterparties. Hence, the potential impacts of such existing indemnities on UKA and UKLAP’s policyholders will not be affected by the Part VII Transfer

► UKA has a reinsurance treaty with Aviva Insurance Limited (“UKGI”) whereby UKA has the obligation to provide a quote in respect of the payment protection order claim liabilities to the

52


individual claimants. This liability has been included in the Solvency II position discussed in section 7.2.2 and therefore I do not consider there to be materially adverse impact on UKLAP policyholders’ benefit as a result of the Part VII Transfer

As UKLAP is the parent undertaking of UKA, the contingent liabilities of UKA pre Part VII Transfer are

ultimately borne by UKLAP (assuming sufficient funds are available). Hence, I do not consider there to

be a materially adverse effect to the security of UKLAP policyholders’ benefits.

8.5.4 Tax considerations

I have considered the tax position of UKLAP and UKA and taken advice, where appropriate, from EY

tax specialists. The Companies have reported no material open issues or expected exposures in their

current tax position and our tax specialists concur that there are thus no material issues present to

concern me in my role as the Independent Expert.

Based on the information reviewed by my EY tax colleagues and the discussions they have held with

the Companies, they do not believe that there will be any material tax costs due to the Part VII

Transfer. In addition, due to the business profile of UKA, they do not expect any materially adverse

taxation impacts going forward in UKLAP.

My specialists have also reviewed the expected tax clearances being requested of HMRC as a result

of the Part VII Transfer. They have reported that the clearances are as expected and do not believe

there is a material likelihood of HMRC raising objections.

The Government announced changes to tax rates and also proposed changes to the utilisation of tax

losses in the Budget announcement on 16 March 2016. The proposed loss utilisation changes are

subject to a consultation process, expected to commence in May 2016, with any legislation to take

effect only from 1 April 2017. My tax specialists have discussed the potential consequences of those

proposed changes with the Companies. Given the Companies’ historical tax position, they are

satisfied that the proposed changes are not likely to have any material adverse impacts in UKA or,

going forward, in UKLAP. Similarly, they are satisfied that whilst the impact of the proposed changes

for the Solvency II balance sheet (and in particular the calculation of the SCR) will need to be

assessed as details of the proposed changes emerge, they would not expect the Part VII transfer to

result in any material adverse impacts from any such changes.

I will continue to monitor discussions between the Companies and HMRC but at present, there

appears to be no material issue arising from the tax consequences of the Part VII Transfer. I will

continue to review the taxation implications and provide an update in the Supplementary Report.

8.6 Conclusion of rights and expectations

Given that:

► The contractual benefits under the transferring policies will not be changed after the

implementation of the Scheme

► There will be no material change to the administration and service standards applicable to the policyholders of the transferring policies after the implementation of the Scheme

► The implementation of the Scheme will not materially change the management and governance of the transferring policies

► Additional safeguards will not need to be contained within the Scheme to protect the interests of either the UKA or UKLAP policyholders, either to ensure that the Scheme operates as set out, or for any other reasons

► There are no material concerns in the tax position as the result of the Part VII Transfer

► There will be no material change to benefit expectations of the with-profit policyholders following the implementation of the Scheme

53


I am satisfied that there will be no material adverse effect on policyholders being treated fairly in accordance with Principle 6 of the FCA’s Principles for Business (Customers’ interests) nor on other FCA conduct requirements.

I am satisfied that the Scheme would not have a materially adverse effect on the rights and

expectations of either the transferring policyholders of UKA or those of UKLAP.

54


9. Conclusions

I am aware of a number of areas where work is still in progress which I will continue to keep under review in the period leading up to the Sanctions Hearing at the Court, the Royal Court of Guernsey, the Royal Court of Jersey and the Isle of Man Courts of Justice. These include:

► The financial position discussed in section 2.6.1

► The internal reinsurance agreements discussed in section 4.3.3

► The Internal Model Approval discussed in section 4.4

► The PRA approval of the Matching Adjustment, Volatility Adjustment and Transitional Measures - Technical Provision applications of UKLAP post Part VII Transfer, as discussed in section 7.5.1, section 7.5.3 and section 7.5.3

► The unsigned external reinsurance treaties as discussed in section 5.3.3

► The consent from external reinsurers as required in the external reinsurance treaties, as discussed in section 7.5.4

► The internal agreement procedures to transfer the intra-group fund management and administration service agreements between UKLAP / UKA and other services companies in Aviva Group, as discussed in section 7.4.4 and section 8.2.1

► The pending non-discretionary asset management agreement, as discussed in section 7.4.3

► The consent from counterparties of Custodian Agreements, as discussed in section 7.4.5

► The consent from counterparties of the commercial mortgages agreement, Bulk Purchase Annuity agreements and equity release arrangements, as discussed in section 7.5.7.1, section 7.5.7.2 and section 7.5.7.4.

► The tax consideration discussed in section 8.5.4

Of the items set out above, the following could have a material effect on the Scheme:

► The financial position of the Companies. Should the financial positions of the Companies

adversely change prior to the Effective Date, to the extent that the metrics fall outside of the stated risk appetite, then the Scheme will not proceed

► The PRA approval of the Matching Adjustment, Volatility Adjustment and Transitional Measures. If these are not approved, the Scheme will not proceed

Noting the above basis for opinions and subject to the conditions set out above:

I am satisfied that there will be no material adverse effect on the security of the guaranteed benefits for either the UKA or UKLAP policyholders following the implementation of the Scheme on the Effective Date.

I am satisfied that there will be no material adverse effect on the reasonable benefit expectations of either the UKA or UKLAP policyholders, nor on their being treated fairly in accordance with Principle 6 of the FCA’s Principles for Business (Customers’ interests) nor on other FCA conduct requirements following the implementation of the Scheme on the Effective Date.

I am satisfied that there will be no material adverse effect on the service levels experienced by either the UKA or UKLAP policyholders following the implementation of the Scheme on the Effective Date.

I am satisfied that there would be no material change to the security provided to policyholders who are resident in Guernsey, Jersey and Isle of Man or were sold their policy whilst resident in Guernsey, Jersey and Isle of Man, and that this group of policyholders would not be adversely affected to a material extent by the Scheme, and that therefore there is no reason that the Scheme should not go ahead. I see no reason for additional safeguards beyond those contained in the Scheme to protect the interests of either the UKA or UKLAP policyholders.

55


Gordon Wood, FIA

1 July 2016

Associate Partner Ernst & Young LLP 10 George Street Edinburgh EH2 2DZ

56


Appendix A: Glossary

Terms used in this Report

AFH Actuarial Function Holder. The AFH’s main responsibility is to advise the firm’s management on the risks being run by the firm and the capital required to support the business

APSs Actuarial Profession Standards, a requirement placed by IFoA

APS X2: Review of Actuarial Work, a part of APSs to call for the exercise of

judgement in relation to the review of actuarial work

Board The board of directors of the relevant entity from time to time

BPA Bulk Purchase Annuity

Capital Resources The excess of admissible assets over liabilities

Companies UKA and UKLAP

Contingent loan The loan provided by UKLAP to support UKA in adverse scenarios of

UKA’s solvency position

Court High Court of Justice of England and Wales

Directions

Hearing

The initial hearing at the Court relating to the consideration of the

Scheme and allowing it to proceed to the Sanctions Hearing

EEA European Economic Area which includes EU countries and also Iceland,

Liechtenstein and Norway

Effective Date 1 January 2017, the date on which the Scheme is expected to be

implemented

EMEIA Europe, Middle East, India and Africa

ERM Equity Release Mortgages

EU European Union

Excluded Policies Policies written, or assumed, by the Transferor, under which

any liability remains unsatisfied or outstanding at the Effective

Time, or proposals for insurance received by, the Transferor:

(a) in the course of effecting or carrying out insurance

business in the UK or any other EEA State which:

(i) was concluded in an EEA State other than the

UK; and

(ii) the PRA has not prior to the issue of the Order

by which the Court sanctions this Scheme

delivered a certificate in the form required by

paragraph 3A of Part I of Schedule 12 to the

Act in respect of the relevant EEA State in

which the contract was concluded,

together with all rights, benefits and powers and all

liabilities of the Transferor under such policies, and for

these purposes, “EEA State” bears the meaning

57


ascribed thereto in paragraph 8 of Part I of Schedule 3

to the Act; or

(b) which are not capable of being transferred pursuant to

Part VII of the Act at the Effective Time; and

any further Policy issued by the Transferor pursuant to

the exercise of any right or option under an Excluded

Policy referred to in (a) and (b) above, as described in

paragraph 13.5 (of the Scheme document)

EY Ernst & Young LLP

FCA Financial Conduct Authority, the regulator of the financial services

industry in the UK responsible for conduct of financial services firms

including the fairness of financial services contracts

FSA Financial Services Authority, replaced by the FCA and the PRA on 1 April

2013

FSCS Financial Services Compensation Scheme

FSMA The Financial Services and Markets Act 2000

HMRC HM Revenue and Customs, the government department responsible for

collecting and administering taxes

ICG Individual Capital Guidance, the additional capital prescribed by the PRA

for the insurance company (only relevant under Solvency I)

IFoA Institute and Faculty of Actuaries

Independent

Expert

The individual appointed to report on the terms of an insurance business

transfer scheme and approved by the PRA and FCA pursuant to Section

109 of FSMA

ICA Individual Capital Assessment, an insurance company’s own

assessment of the capital that it needs for regulatory purposes. This

amount is reviewed and adjusted if necessary by the PRA (only relevant

under Solvency I)

IMA Investment Management Agreement with AIGSL

ISDA International Swaps and Derivatives Association

IWPSF Irish With-Profit Sub-Fund, a sub-fund of LTBF

LTBF Long-term Business Fund

Matching

Adjustment

Under Solvency II, provisions give insurers relief for holding certain long-

term assets which match the cash flows of a designated portfolio of life

or annuity insurance and reinsurance obligations

MCR Minimum Capital Requirement, the minimum level of security below

which the amount of financial resources should not fall.

NPSF Non-Profit Sub-fund, a sub-fund of LTBF

ORSA Own Risk and Solvency Assessments, which assesses policyholder

security and is reported to the PRA

OWPSF Old With-profit Sub-Fund, a sub-fund of LTBF

58


Part VII Transfer A court-sanctioned legal transfer of some or all of the policies of one

company to another. It is governed by Part VII of the Financial Services

and Markets Act 2000 (FSMA) with supplementary guidance set out in

SUP 18 of the FCA handbook.

Regulatory Pillar 1

or Peak 2

Under Solvency I, calculation of its solvency position that an insurance

company regulated in the UK must carry out at regular intervals based

on a calculation of its liabilities and its capital requirements on a

regulatory basis

‘‘Pillar 2’’ regime Under Solvency I, companies are required to set aside an amount of

capital (‘‘ICA’’) to provide a more realistic and complete view of the risks

to which the companies are exposed

PIP Policyholder Incentive Payment

PM Sub-Fund Provident Mutual Sub-Fund, a sub-fund of LTBF

PRA Prudential Regulation Authority, the regulator of the financial services

industry in the UK responsible for the safety and soundness of firms and

securing an appropriate degree of protection for policyholders

Property Linked A unit-linked contract, where underlying fund price is dependent on the

value of some property, e.g. stocks and shares, rather than an index.

QS Quota Share reinsurance arrangements

Regulators Financial services regulatory bodies, namely the PRA and FCA

Reports Scheme Report and Supplementary Report

Residual Assets Any of the following elements:

(a) property in respect of which the Court has declined to order the

transfer to UKLAP under Section 112 of the Act (excluding

transferred policies)

(b) property attributable to the Transferred Business where UKA and

UKLAP agree that the transfer of such property should be delayed

(c) property which is outside the jurisdiction of the Court or in respect of

which its transfer pursuant to an order of the Court is not recognised

by the laws of the jurisdiction in which the property is situated

(excluding Excluded Policies)

(d) property which cannot be transferred or vested in UKLAP for any

other reason (excluding Excluded Policies)

(e) the Withheld Assets

(f) proceeds of sale or income or other accrual or return, whether or not

in the form of cash, earned or received from time to time after the

Effective Date in respect of any property referred to in paragraphs (a)

to (e) of this definition.

Residual

Liabilities

Any liability whatsoever of UKA:

(a) that is attributable to or connected with a Residual Asset and arises

at any time before the Subsequent Transfer Date12

applicable to that

Residual Asset

(b) in respect of which the Court has declined to order the transfer to

UKLAP under Section 112 of the Act (excluding Excluded Policies)

12

See definition in Appendix A

59


(c) any liability of UKA which cannot be transferred to or vested in

UKLAP for any other reason (excluding Excluded Policies) or

(d) that is attributable to the Transferred Business where UKA and

UKLAP agree that the transfer of such liability should be delayed or

that such liability should not be transferred.

RIEESA UKLAP’s Reattributed Inherited Estate External Support Account

Risk Margin An adjustment designed to represent the amount that an insurance or

reinsurance undertaking would require to take on the obligations of a

given insurance company

Sanctions Hearing The hearing at the Court at which the final decision whether or not to

approve the Scheme is made

Scheme The insurance business transfer scheme that is the subject of this

Report

Scheme Report,

or this Report

The Independent Expert's report on the terms of the insurance business

transfer scheme

SCR Solvency Capital Requirement, is the capital requirement under

Solvency II

SHF Shareholder Fund

Solvency II The Solvency II Directive (2009/138/EC) is an EU Directive that codifies

and harmonises EU insurance regulation

Subsequent

Transfer Date

The date after the Effective Date on which such Residual Asset or

Residual Liability is or is to be transferred to UKLAP

SUP 18 Chapter 18 of the Supervision Manual of the Regulators’ Handbooks of

Rules and Guidance. It sets out the FCA’s requirements relating to the

transfer of long-term insurance business

Supplementary

Report

A further report required by paragraph 2.39 of the PRA Policy Statement

to be prepared prior to the final Court hearing in order to provide an

update for the Court on Independent Expert’s conclusions in the light of

any significant events subsequent to the date of the finalisation of this

Report

TAS Technical Actuarial Standards, the principles created by Financial

Reporting Council against which all Required or Reserved Actuarial work

should be performed.

TMTP Transitional measures on technical provisions

Transferred

Business

Transitional

deduction

The entire long-term business of UKA being transferred to UKLAP under

the Scheme

Transitional deduction from the technical provisions, aiming to provide a

smoother transition for insurance companies from Solvency I to

Solvency II, phasing in the full impact of Solvency II over 16 years.

Unit-linked A class of policy where benefits are defined as a number of ‘units’ in one

or more specified funds, where the price of the fund can be linked to

underlying assets, see also property linked, or to an index.

Vesting Being entitled to receive a pension benefit equal to the value of the

60


pensioner’s individual defined contribution account.

WPSF With-Profit Sub-funds, a sub-fund of LTBF

WPSF5 With-profit Sub-fund (5), a sub-fund of LTBF

61


Appendix B: Company abbreviations referred to in this Reports

ACF Aviva Commercial Finance Limited

AIGSL Aviva Investors Global Services Ltd

AII Aviva International Insurance Ltd

ALPI Aviva Life & Pensions Ireland Limited

APPF Aviva Public Private Finance Limited

Aviva Aviva plc

CGNU CGNU Life Assurance Limited

CULAC Commercial Union Life Assurance Company

HLAC Hamilton Life Assurance Company

HSBC HSBC Bank (formerly Midland Bank)

JPM JP Morgan Chase Bank

NAC Northern Assurance Company Limited

NUA Norwich Union Annuity Ltd

NULAP Norwich Union Life & Pensions Limited

NULIS Norwich Union Life Insurance Society

NULL Norwich Union Linked Life Assurance Limited

NUL RBS Norwich Union Life Limited

NWL National Westminster Life Assurance Limited

RSA Royal Scottish Assurance plc

UKA Aviva Annuity UK Ltd

UKER Aviva Equity Release UK Limited

UKGI Aviva Insurance Limited

UKL / UK Life UK Life business, not a legal entity but the management entity of

UKLH

UKLAP Aviva Life & Pensions UK Limited

UKLH Aviva Life Holdings UK Limited

UKLS Aviva Life Services UK Limited

62


Appendix C: PS7/15 cross reference

Reference

Detail

IE report reference

2.30 (1)

who appointed the independent expert and who is bearing the costs of that appointment;

Section 2.1

2.30 (2)

confirmation that the independent expert has been approved or nominated by the PRA;

Section 2.1

2.30 (3)

a statement of the independent expert’s professional qualifications and (where appropriate) descriptions of the experience that makes them appropriate for the role;

Section 2.1

2.30 (4)

whether the independent expert, or his employer, has, or has had, direct or indirect interest in any of the parties which might be thought to influence his independence, and details of any such interest;

Section 2.4

2.30 (5)

the scope of the report;

Section 2.3

2.30 (6)

the purpose of the scheme;

Section 4.1

2.30 (7)

a summary of the terms of the scheme in so far as they are relevant to the report;

Section 4.2

2.30 (8) what documents, reports and other material information the independent expert has considered in preparing the report and whether any information that they requested has not been provided;

Appendix D

2.30 (9)

the extent to which the independent expert has relied on:

(a) information provided by others; and

(b) the judgment of others;

Section 2.6

2.30 (10)

the people on whom the independent expert has relied and why, in their opinion, such reliance is reasonable;

Section 2.6

2.30 (11)

their opinion of the likely effects of the scheme on policyholders (this term is defined to include persons with certain rights and contingent rights under the policies), distinguishing between:

(a) transferring policyholders;

(b) policyholders of the transferor whose contracts will not be transferred; and

(c) policyholders of the transferee;

Section 7&8

2.30 (12)

their opinion on the likely effects of the scheme on any reinsurer of a transferor, any of whose contracts of reinsurance are to be transferred by the scheme;

Section 4.3.3 and section 7.5.4

2.30 (13)

what matters (if any) that the independent expert has not taken into account or evaluated in the report that might,

Section 1.3, 2.6, 8.6

63

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in their opinion, be relevant to policyholders' consideration of the scheme; and

and 9

2.30 (14)

for each opinion that the independent expert expresses in the report, an outline of their reasons.

Section 4-8

2.32 (1)

a description of any reinsurance arrangements that it is proposed should pass to the transferee under the scheme

Section 4.3.3 and Section 7.5.4

2.32 (2)

a description of any guarantees or additional reinsurance that will cover the transferred business or the business of the transferor that will not be transferred.

Section 7

2.33 (1)

include a comparison of the likely effects if it is or is not implemented;

Section 7.2.2

2.33 (2)

state whether they considered alternative arrangements and, if so, what;

Section 2.2

2.33 (3)

where different groups of policyholders are likely to be affected differently by the scheme, include comment on those differences they consider may be material to the policyholders;

Section 7-8

2.33 (4)

include their views on:

(a) the effect of the scheme on the security of policyholders' contractual rights, including the likelihood and potential effects of the insolvency of the insurer;

(b) the likely effects of the scheme on matters such as investment management, new business strategy, administration, claims handling, expense levels and valuation bases in so far as they may affect:

(i) the security of policyholders' contractual rights;

(ii) levels of service provided to policyholders; or

(iii) for long-term insurance business, the reasonable expectations of policyholders; and

(c) the cost and tax effects of the scheme, in relation to how they may affect the security of policyholders' contractual rights, or for long-term insurance business, their reasonable expectations

Section 7-8

2.36 (1)

describe the effect of the scheme on the nature and value of any rights of policyholders to participate in profits;

Section 7-8

2.36 (2)

if any such rights will be diluted by the scheme, describe how any compensation offered to policyholders as a group (such as the injection of funds, allocation of shares, or cash payments) compares with the value of that dilution, and whether the extent and method of its proposed division is equitable as between different classes and generations of policyholders;

Section 7

64









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2.36 (3)

describe the likely effect of the scheme on the approach used to determine:

(a) the amounts of any non-guaranteed benefits such as bonuses and surrender values; and

(b) the levels of any discretionary charges;

Section 7.3, 7.4 and 7.5

2.36 (4)

describe what safeguards are provided by the scheme against a subsequent change of approach to these matters that could act to the detriment of existing policyholders of either firm;

Section 4.3.4

2.36 (5)

include the independent expert's overall assessment of the likely effects of the scheme on the reasonable expectations of long-term insurance business policyholders;

Section 8

2.36 (6)

state whether the independent expert is satisfied that for each firm the scheme is equitable to all classes and generations of its policyholders; and

Section 8

2.36 (7)

state whether, in the independent expert's opinion, for each relevant firm the scheme has sufficient safeguards (such as principles of financial management or certification by a with-profit actuary or actuarial function holder) to ensure that the scheme operates as presented.

Section 8.5.1

65

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http://fshandbook.info/FS/glossary-html/handbook/Glossary/W?definition=G1482

http://fshandbook.info/FS/glossary-html/handbook/Glossary/A?definition=G1479


Appendix D: Information considered

In writing this Report, I relied upon the accuracy of certain documents and spreadsheets provided by UKA and UKLAP.

These included, but were not limited to the following:

Documents Relevant company

2011-2015 PRA Returns Both

ERM Restructure UKA

2012-2015 Financial Reports Both

2012-2014 ICA returns Both

Assumption sets and Justifications Both

ORSA Both

Management Services Agreement Dual Diligent summary Both

Investment Management Agreement Dual Diligent summary Both

Reinsurance Mixer Board Approval Both

Transitional Deduction from Technical Provisions, Volatility Adjustment and Matching Adjustment application to PRA and correspondence

Both

Post Part VII Transfer Transitional Deduction from Technical Provisions, Volatility Adjustment and Matching Adjustment application pro-forma and PRA response

UKLAP

Corporate Plan Both

Individual Risk Appetites statement Both

Group Capital Policy Both

Group Risk Appetites Framework Both

PRA and FCA meeting minutes for mailing waivers Both

Monthly capital update Both

Un-modelled reserves and provision summary UKA

Product Governance Provision UKLAP

Operating risk fund allocation Both

Example policy documents Both

Stress and scenarios testing and results Both

RIEESA Headroom testing UKLAP

Credit risk Both

Life insurance risk policy UKLAP

Customer experience standards Both

Solvency II estimated financial position 31 December 2014 Both

Solvency II estimated financial position 1 January 2016 Both

Policyholder communication drafts Both

External reinsurance counterparties communication drafts UKA

Third party consents letter draft UKA

Whiteness statement Both

Scheme documents with terms and conditions Both

Chief Finance Actuary Report Both

With-profit Actuary UKLAP

Capital Plan Both

Board and management committee structure Both

Articles of association Both

Group structure chart Both

Company overview UKLAP

Due Diligent report Both

Funding and Mortgage Sales Agreement Due Diligent summary UKA

Loan Agreements Due Diligent summary Both

External reinsurance treaties Due Diligent summary UKA

Internal reinsurance treaties Due Diligent summary Both

Operational Service Level Agreement Due Diligent summary Both

66


Commercial mortgage agreements Due Diligent summary Both

Infrastructure investment agreements Due Diligent summary UKA

Real Estate Due Diligent summary UKA

Equity release Due Diligent summary UKA

BPA agreements Due Diligent summary UKA

Custodian agreements Due Diligent summary UKA

Contingent liabilities summary from legal department Both

Due Diligent outstanding actions summary Both

Guarantees register Both

67


Appendix E: UK Life company structure

LEGAL ENTITIES MANAGEMENT ENTITIES

UK & Ireland Life Aviva Life Holdings UK Ltd

(UKLH)

UK Life

Heritage Aviva Entities

Aviva Life &

Pensions UK Ltd (UKLAP)

Heritage FL Entities

Friends Life Ltd (FLL)

UK Like Management View

UK Life

Retirement

Aviva Annuity

UK Ltd (UKA)

Friends Provident Life &

Pensions Ltd (FLP)

UK Life Corporate &

Business Solutions

Note:

• UKLAP includes Aviva Life & Pensions Ireland (ALPI)

• FLP includes Friends Provident International Limited (FPIL)

Strategic Partners & Protection

Heritage

Ireland

68


Appendix F: External reinsurance treaties

Reinsurer Parties Nature of cover Treaty Number

Premium payable in 2015

Mathematical reserves ceded

Munich Re (Treaty 1 and 2) and Hannover Re (Treaty 3)

External 50% (Treaty 1) or 90% (Treaties 2 and 3) Quota share on UK Long Term Care(Immediate Care) business

Treaties 1-3

£0m £2.0m

Hannover Re External 75% longevity swap on UK Impaired Life Annuity business

Treaty 4 £1.6m £7.6m

XL Re External Longevity swap in respect of 7% of a defined block of in-force UK pension annuity business agreed at the treaty commencement date.

Treaty 5 £37.2m £11.1m

Partner Re External Longevity swap in respect of 3% of a defined block of in-force UK pension annuity business agreed at the treaty commencement date.

Treaty 6 £16.0m £4.8m

RGA Reinsurance UK Limited and RGA Reinsurance US Limited

External Longevity swap in respect of varying proportions of new enhanced annuities written from the treaty commencement date. The UK entity takes 10% of the total business reinsured whilst the US entity takes 90% of the total business reinsured.

Treaty 7 £28.5m £36.1m

Maturin UK 2008-01 (M/F 80-100) IC Limited

External Longevity swap in respect of a defined block of in-force UK pension business agreed at the treaty commencement date. Payments are subject to a cap and floor.

Treaty 8 £42.4m £(5.3)m

RGA Reinsurance International Company Limited and RGA Global Reinsurance Company Limited

External Longevity swap subject to a deductible. The longevity swap is` in respect of varying proportions of new enhanced annuities written from the treaty commencement date. The International entity takes 5% of the total business reinsured whilst the Global entity takes 95% of the total business reinsured.

Treaty 9 £5.7m £61.4m

RGA Reinsurance International Company Limited and RGA Global Reinsurance Company Limited

External Longevity swap subject to a deductible. The longevity swap is in respect of varying proportions of new enhanced annuities written from the treaty commencement date. The International entity takes 5% of the total business reinsured whilst the Global entity takes 95% of the total business reinsured.

RAG Treaty

£0.6m £6.0m

SWISS RE EUROPE S.A. UK Branch

External Longevity swap in respect of varying proportions of new enhanced annuities (Excluding bulk purchase annuities) written from the treaty commencement date of 10th February 2014.

Swiss Re Treaty

£1.2m £2.7m

69


UKLAP Internal 100% reinsurance of non-profit immediate pension annuities which were originally written in Aviva Life & Pensions UK Limited and were transferred to Aviva Annuity UK Limited as at 1 January 2005. The effect of the treaty is to transfer all the liabilities to Aviva Life & Pensions UK Limited as if the business had not been transferred.

Treaty 34

Nil £213.9m

UKLAP Internal Quota-Share reinsurance of 22.5% of the net Liabilities of the Aviva Annuity UK Limited long-term fund.

Internal Treaty

£326.8m £7,549.4m

AII Internal Quota-Share reinsurance of 10% of the net Liabilities of the Aviva Annuity UK Limited long-term fund.

Internal Treaty

£145.3m £3,355.3m

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