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Operating and financial review

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Group operating profit before tax

The first six months of 2004 saw a continuation of the strong operational performance achieved in the second half of 2003, across all of our major businesses. This has been achieved by our continued focus on pricing and costs, our philosophy of writing for profit not volume and our disciplined approach to underwriting and efficient claims handling. The Group achieved an operating profit before tax, including life achieved operating profit, of £1,130 million (2003: £828 million), an increase of 37%. On a modified statutory basis, the equivalent operating profit was £878 million (2003: £638 million).

	6 months 2004 £m	6 months 2003 £m
Achieved operating profit before tax	1,130	828
Amortisation of goodwill	(49)	(52)
Financial Services Compensation Scheme levy	(25)	-
Change in claims equalisation provision	(11)	(28)
Exceptional costs for termination of operations	(50)	(19)
Profit/(loss) on disposal of subsidiary and associated undertakings	6	(7)
Effect of economic assumption changes	205	(217)
Short-term fluctuations in investment return – general insurance and   shareholder business	(285)	137
Variation from longer-term investment return – life business	(214)	208
Profit on ordinary activities before tax – achieved profit basis	707	850
Profit on ordinary activities before tax – modified statutory basis	414	742

Profit before tax on an achieved profit basis was lower at £707 million (2003: £850 million), reflecting the combination of lower actual returns on equities compared to our longer-term investment return assumptions and increases to short and medium-term bond yields which have adversely impacted the value of fixed interest securities, particularly in the UK and the Netherlands. The first half of 2003 was characterised by reductions in short and medium-term bond yields across our major European businesses, increasing our profit before tax.

The effect of the investment market movements is also reflected in the reduction in the modified statutory basis profit before tax to £414 million (2003: £742 million).

The taxation charge for the period was £247 million (2003: £278 million) on an achieved operating profit basis and includes a charge of £338 million (2003: £260 million) in respect of the operating profit, which is equivalent to an effective rate of 29.9% (2003: 31.4%). On a modified statutory basis the effective rate on operating profit was 29.0% (2003: 30.4%).

Long-term savings

Our worldwide long-term new business sales showed steady progress in the first half of 2004 with growth in total long-term business sales (including investments sales) of 7% to £7.9 billion (2003: £7.5 billion).

	6 months 2004			Local currency growth
	Life and pensions £m	Retail investments £m	Total £m	Life and pensions %	Retail investments %	Total %
Long-term savings sales
United Kingdom	3,014	451	3,465	2%	41%	6%
Europe (excluding UK)	3,824	260	4,084	11%	59%	14%
International	276	64	340	(43%)	75%	(35%)
	7,114	775	7,889	3%	49%	7%
Navigator		323			3%

Worldwide life and pension sales increased by 3% to £7.1 billion (2003: £6.9 billion), with worldwide life and pension sales on an APE basis increasing by 2% to £1.2 billion (2003: £1.2 billion).

In the UK, Norwich Union, our market leading business, delivered an increase in total sales of 6% to £3.5 billion. This reflects a good performance in a relatively flat market, with good growth in sales of bonds and savings and protection products. Investment sales increased largely as a result of more stable equity markets. We welcome the Government’s recent announcement on stakeholder pricing made in June this year and the clarity that it provides for the marketplace in the future. We have undertaken a review of our pensions propositions and we will be repositioning our products during the third quarter this year.

In Continental Europe, our businesses delivered 14% growth to £4.1 billion, reflecting strong sales of unit-linked savings products in France and the Netherlands, particularly those sold through our ABN AMRO bancassurance channel. Sales through our bancassurance partnerships in Spain and Italy were lower compared to the first half of 2003, which benefited from the impact of marketing efforts and one-off sales. In our International business, total sales fell by 35% to £340 million due to the slowing of fixed annuity sales in our US life operations, offset in part by improving sales in Australia, where investor confidence is returning.

We are seeing signs of investor confidence returning, particularly in unit-linked sales as markets have stabilised. However, the level of uncertainty surrounding worldwide economic conditions continues to dampen an upturn in demand, particularly in respect of savings growth in the UK. We continue to work on retaining a strong competitive position in the UK and increasing customer penetration in our developing bancassurance arrangements around the world. We look forward to the launch of our joint venture with Crédit du Nord in France during the fourth quarter this year and the expansion of our distribution network with Banche Popolari Unite (BPU) in Italy, coming on stream during the first quarter of 2005.

Life achieved operating profit

	6 months 2004 £m	6 months 2003 £m
New business contribution (after the effect of solvency margin)	246	211
Profit from existing business
– expected return	406	376
– experience variances	(13)	(19)
– operating assumption changes	(4)	(10)
Expected return on shareholders’ net worth	165	147
Life achieved operating profit before tax	800	705

Life achieved operating profit before tax was higher at £800 million (2003: £705 million). The expected returns on existing business and shareholders’ net worth were higher at £571 million (2003: £523 million), reflecting the higher embedded values at the beginning of the year on which the expected return assumptions are applied.

New business margins were also higher at 26.5% (full year 2003: 26.1%) with margins improving in all major territories, except Ireland and Spain. New business contribution after the effect of solvency margin was higher at £246 million (2003: £211 million), reflecting the ongoing benefits of our pricing and cost control actions and an improvement in business mix towards unit-linked products.

We have continued to incur modest, albeit improving, levels of experience losses on our existing businesses despite the pressures exerted by the uncertain economic conditions on the operating environment. Underpinning this are strong mortality experience profits across our businesses of £36 million and better than assumed default experience on corporate bonds and commercial mortgages. This has been offset by exceptional project expenses of £48 million. Increases in lapse rates for some of our products sold in Ireland have caused us to change our assumptions. The combined effect of this change in lapse assumptions together with the adverse experience losses incurred in Ireland amounted to £13 million.

	Annual premium equivalent(1)		New business contribution(2)		New business margin(3)
	6 months 2004 £m	6 months 2003 £m	6 months 2004 £m	6 months 2003 £m	6 months 2004 %	6 months 2003 %	Full year %
Life and pensions business
United Kingdom	547	531	126	117	23.0	22.0	22.6
Europe (excluding UK)	603	581	181	159	30.0	27.4	29.8
International	74	100	17	21	23.1	21.1	24.6
	1,224	1,212	324	297	26.5	24.5	26.1
(1) Annual premium equivalent represents regular premiums plus 10% of single premiums. (2) Before effect of solvency margin which amounted to £78 million (2003: £86 million). (3) New business margin represents the ratio of new business contribution to annual premium equivalent, expressed as a percentage.

UK

Our market-leading business, Norwich Union, recorded an achieved operating profit of £356 million (2003: £339 million). The increase includes higher new business contribution before the effect of solvency margin of £126 million (2003: £117 million), with improved margins at 23.0% (full year 2003: 22.6%). The improvement in margin is as a result of pricing, cost actions and a change in business mix towards higher margin products. In addition, expected returns on shareholders’ net worth and the value of in-force were higher by £27 million, due to higher start of year asset values and higher economic assumptions. Adverse experience variances of £18 million reflect exceptional expenses in relation to project costs associated with regulatory change and adverse lapse experience on bond, pension and endowment products, offset by the better than assumed mortality and default experience on corporate bonds and commercial mortgages.

Europe (excluding UK)

Total life achieved operating profit from our Continental European businesses was £413 million (2003: £336 million). New business contribution increased to £181 million (2003: £159 million), with strong performances in France and the Netherlands. New business margins increased to 30.0% (full year 2003: 29.8%), with improvements in all territories except Ireland and Spain. In Ireland, increased competition in the protection market and the change in lapse assumptions on some business has adversely affected the new business margin. In Spain, the reported margin of 51.0% (full year 2003: 54.4%) includes the impact of a one-off bulk pensions contract, with new business premiums on an APE basis of £18 million written at a margin of 17%. Excluding this item, margins for our Spanish businesses were 56.3%.

Improvements in operational performance on existing business have helped us post experience profits of £12 million (2003: losses of £12 million). Furthermore, the higher start of year asset values have resulted in a £20 million increase in expected returns on net worth and in-force business.

International

Life achieved operating profit from our International business was £31 million (2003: £30 million), benefiting from higher new business contribution in Singapore and Australia, offset by reduced business levels in our US operations. New business margins were 23.1% (full year 2003: 24.6%).

New business contribution – after deducting the effect of solvency margin, tax and minority interest

New business margins after the effect of solvency margin, tax and minority interest improved to 13.2% (full year 2003: 12.9%). The increase arose primarily in our non-bancassurance channels, reflecting the impact of pricing and cost control actions and benefits from changes to business mix towards unit-linked products.

	Annual premium equivalent(1)		New business contribution(2)			New business margin(3)
	6 months 2004 £m	6 months 2003 £m	6 months 2004 £m	6 months 2003 £m	6 months 2004 %	6 months 2003 %	Full year 2003 %
Attributable to equity shareholders	1,082	1,063	143	119	13.2	11.2	12.9
Analysed between:
- Bancassurance channels	154	168	32	29	20.8	17.3	20.8
- Other distribution channels	928	895	111	90	12.0	10.1	11.5
(1) Stated after deducting the minority interest of sales. (2) Contribution stated after deducting effect of solvency margin, tax and minority interest. (3) New business margin represents the ratio of new business contribution after deducting the effect of solvency margin, tax and minority interest to annual premium income after deducting the minority share expressed as a percentage.

Bancassurance margins

Bancassurance new business margins before the effect of solvency margin increased to 40.4% (full year 2003: 39.7%). In the UK, new business margins from our life and pensions sales from our partnership with The Royal Bank of Scotland Group (RBSG) increased to 22.7% (full year 2003: 17.9%). New business bancassurance margins in Italy and Spain were 25.2% and 55.8% (full year 2003: 23.4% and 59.4%), respectively. Our bancassurance agreement with ABN AMRO in the Netherlands generated margins of 31.4% (full year 2003: 32.2%). New business bancassurance margins from our partnership with DBS in Singapore and Hong Kong were 49.6% (full year 2003: 43.7%) reflecting profitable growth from these developing operations.

Life operating profit on a modified statutory basis

On a modified statutory basis, our life operating profit amounted to £548 million (2003: £515 million). The operating result from the UK with-profit business has fallen to £54 million (2003: £64 million) as bonus rates were reduced in January 2004. The UK non-profit result was £235 million (2003: £229 million).

In Continental Europe, life modified statutory profit totalled £238 million (2003: £199 million) which was driven primarily by increased profits in the Netherlands. The Dutch result of £54 million (2003: £29 million) benefited from the increases in bond yields in the first six months of the year. Operating profit from our International businesses was lower at £21 million (2003: £23 million) reflecting lower investment returns.

Health

Premium income from our health business was £682 million (2003: £646 million), with total operating profit of £33 million (2003: £27 million). Our business in the Netherlands continues to be the main contributor to the results with total operating profit higher at £28 million (2003: £20 million), as a result of improved claims experience.

Fund management

The first half of 2004 saw more stability in worldwide investment markets compared to the first half of 2003. Operating profit from our worldwide businesses was £17 million (2003: £10 million). Assets under management at 30 June 2004 grew to £242 billion (31 December 2003: £240 billion), reflecting the impact of new business flows.

In the UK, our fund management businesses comprise our Morley Fund Management retail and institutional business, our retail investment business operating as Norwich Union and our collective investment joint venture business with RBSG. Total profits from these businesses in the period were £3 million (2003: £5 million). Total investment sales across these businesses were up 41% to £451 million (2003: £319 million).

Morley’s combined UK operations reported a profit of £6 million (2003: £6 million). The result reflects increased fee income following the improved market conditions compared to the prior year offset by the initial costs relating to a number of cost control initiatives. Property and Fixed Income bonds continue to dominate new business growth, while sales in our retail investment businesses improved. Our property expertise has been recognised by winning the Property Fund Manager of the Year award at the Property Week Property Awards 2004. In addition, within the group results are £4 million (2003: £1 million) of profits relating to other Morley businesses, including the pooled pensions business and overseas operations. This brings the contribution that Morley makes to the total group result to £10 million (2003: £7 million).

Operating profit through Norwich Union increased to £3 million (2003: loss of £1 million), whilst our new collective investment business with RBSG sustained a loss of £6 million (2003: nil) in the period due to new business strain from increasing sales of regular premium investment business.

Operating profit from Aviva Gestion d’Actifs, our fund management operations in France, increased to £8 million (2003: £6 million). New business sales through Navigator, our top-five master trust investment portfolio service in Australia, increased by 3% to £323 million (2003: £291 million), benefiting from improved equity markets. Profits rose to £3 million (2003: loss of £1 million). Although not included in our life achieved operating profit, on an achieved profit basis, Navigator’s new business contribution was a loss of £2 million (2003: loss of £2 million) and its embedded value was £41 million (2003: £41 million).

General insurance

Our worldwide general insurance operations had an excellent start to 2004, with total operating profit of £613 million (2003: £387 million) and a combined operating ratio (COR) of 97% (2003: 101%) across the Group. The results from all of our major businesses benefited from a positive rating environment, lower claims frequency and better than expected weather-related claims experience. Scale advantages, claims management and efficiencies should provide us with ongoing benefits. The longer-term investment return on general insurance business assets increased to £508 million (2003: £458 million), reflecting the higher start of year asset values and the interest earned on the proceeds of the subordinated debt issue, raised in the third quarter of 2003.

Underwriting profit for the period amounted to £105 million (2003: loss of £71 million). The improved performance was driven by our disciplined approach to underwriting and claims management and the non-recurrence of the reserve strengthening of £70 million in our Canadian business, Pilot, in the first half of 2003. Better than expected weather-related claims experience in the first six months of 2004 amounted to £30 million (2003: £40 million). The worldwide expense ratio improved to 10.8% (2003: 10.9%). The improvement reflects the benefit of ongoing cost efficiency initiatives across our business operations.

	Net written premiums		Underwriting result*		Operating profit*
	6 months 2004 £m	6 months 2003 £m	6 months 2004 £m	6 months 2003 £m	6 months 2004 £m	6 months 2003 £m
United Kingdom	2,674	2,496	67	10	408	313
Europe (excluding UK)	1,061	1,035	27	-	122	86
International	719	747	11	(81)	83	(12)
Continuing operations	4,454	4,278	105	(71)	613	387
* Excludes the change in the equalisation provision of £11 million (2003: £28 million) and the Financial Services Compensation Scheme levy of £25 million (2003: nil).

UK

Norwich Union Insurance is the leading general insurer in the UK. We are committed to providing high quality service whilst increasing access to our customers through a wider range of propositions, including NU Rescue and oneswoop.com. We have delivered sustainable, profitable growth, with a 7% increase in net written premiums to £2.7 billion and a 19% growth in net written premiums from our direct operation to £434 million. Better than expected weather experience has benefited our result by £20 million (2003: £30 million) and we have achieved an improved COR of 98% (2003: 99%).

In personal lines our COR has improved to 99%. We continue to achieve small rate increases (2% for motor and homeowners) and cost efficiencies. These, allied with over £200 million of annual savings in claims costs through our supply chain management have enabled us to sustain profitability. We have delivered an excellent commercial lines COR of 96% (2003: 99%). Although the level of competition in commercial lines has increased, we have recorded annualised rate increases (8% for commercial property and 15% for commercial liability) over the period. Our focus on the small/medium enterprise sector, allied with rigorous underwriting and cost control, enables us to retain our target business and maintain profitability.

We have delivered an expense ratio of 10.0% (2003: 10.5%), whilst making substantial investment in operational efficiency. We are one of the lowest cost providers in the market, with a combined expense and commission ratio, excluding creditor business, of 27%. We deliver leading standards of service with customer satisfaction scores well above industry benchmarks and continue to improve. We have successfully developed our offshore operations with over 2,200 jobs relocated to date. Service levels in our Indian centres have matched the improvements seen in the UK. We continue to invest in market-leading initiatives, including digital flood mapping, and Pay As You Drive insurance which will provide the competitive advantage required to maintain our COR through the underwriting cycle.

We have a multi-distribution strategy, with leading positions in broker, corporate partner and direct markets. We have secured a five-year contract to provide household insurance products to HSBC customers. In February we announced the closure of our UK national broker subsidiary Hill House Hammond (HHH), at an exceptional cost of £50 million and we are on course to convert over 550,000 customers into our direct operation. We have sold the HHH commercial business and realised a gain on sale of £4 million. Profit before tax also includes our full year cost of £25 million in respect of the Financial Services Compensation Scheme levy.

Europe (excluding UK)

In Europe, our general insurance businesses produced total operating profits of £122 million (2003: £86 million) with improvements in performance in all of our main markets.

In France, our general insurance business recorded operating profit of £13 million (2003: £15 million) with an underwriting loss of £6 million (2003: loss of £7 million) and a COR of 100%. The longer-term investment return was lower at £19 million (2003: £22 million).

Hibernian, our market-leading general insurance business in Ireland, reported a substantial improvement in its operating profit to £68 million (2003: £43 million). The strong underwriting profit of £36 million (2003: £14 million) reflects our disciplined underwriting, the positive rating environment in the previous year and reduced claims frequency and costs. The result for the first half of the year includes better than expected weather-related claims of £3 million (2003: £7 million). As a result of the improvement in profitability, the market dynamics are changing and we expect an increase in competition. We continue to participate in a number of market initiatives to control claims costs in order to absorb to some extent the adverse impact of the current rating environment.

In the Netherlands, operating profit increased to £23 million (2003: £12 million) representing a COR of 94% (2003: 98%). The result has benefited from the continued excellent profitability of the business written through our joint venture with ABN AMRO. Elsewhere, profits have increased as a result of prior period rate increases and improved claims experience.

International

Our International businesses recorded an operating profit of £83 million (2003: £12 million loss). This improvement is predominantly as a result of the non-recurrence of £70 million claims reserve strengthening in Pilot in the first half of 2003.

Our Canadian business reported an underwriting profit of £4 million (2003: loss of £85 million) which includes £5 million better than expected weather-related claims and also the benefit of lower claims frequency. The rating environment has begun to soften, with annualised rate increases in the first half year being minimal for personal lines and around 9% for commercial lines. Personal auto rate reductions imposed by local regulators are expected in the second half of the year and these are anticipated to be matched by legal reforms which should deliver a corresponding benefit to claims costs. The longer-term investment return was higher at £55 million (2003: £52 million), primarily reflecting the higher asset base at the start of the year.

Non-insurance operations

The result of the Group’s non-insurance operations amounted to a loss of £15 million (2003: loss of £47 million) and includes an improvement in the result from Norwich Union Life Services to a loss of £15 million (2003: loss of £27 million). The improvement is due to the ongoing benefits of the cost reduction programme.

In July 2004, we announced the sale of Your Move estate agency and e.surv surveying businesses for £42 million.

Corporate costs

Corporate costs include £45 million (2003: £12 million) in respect of the global finance transformation programme. This increase is in line with the level of finance related change activity across the Group, which has gained momentum over 2004. Our considerable investment in this project is in response to the significant changes we face arising from the Financial Services Authority and European Union regulation, and the introduction of International Financial Reporting Standards in 2005. Total costs of the programme in 2004 are anticipated to peak at £55 million in the second half of 2004, reducing substantially in 2005. Other corporate costs amounted to £49 million (2003: £44 million).

Unallocated interest charges

Unallocated interest charges comprise internal and external interest on borrowings, subordinated debt and intra-group loans not allocated to local business operations. Total interest costs in the period were £224 million (2003: £198 million). External interest costs were higher at £124 million (2003: £94 million), reflecting the subordinated debt issue in the second half of 2003. Internal interest costs were comparable to 2003 at £100 million (2003: £104 million).

Cost savings

The Group continues to focus on achieving operational efficiencies and to drive costs out of the business. Over the past year, we have made progress and announced a further series of actions to reduce the cost borne across our larger business units. At the 2003 year end, we announced that we expected to achieve in 2004 estimated annualised savings of £250 million (relative to the 2002 expense base), delivering a net pre-tax benefit of £85 million in the profit and loss account, after the impact of one-off costs of £140 million. We remain on target to achieve the estimated gross annualised savings of £250 million based on the actions announced up to the end of 2003.

As at 30 June 2004, the net pre-tax benefit to the profit and loss account (relative to the first half of 2002) was £30 million. This benefit was achieved after bearing one-off costs of £75 million. These costs include £30 million for the continued investment in our off-shoring activities in India, and £45 million spend on our global finance transformation programme. Total costs of our off-shoring activities are anticipated to be in the region of £70 million for 2004, which is in line with our previous estimates.

In June 2004, we announced the restructuring of our business services division in UK life. The restructuring will result in approximately 700 job losses and a reduction of 250 contract worker positions. A significant amount of these job losses will be compulsory redundancies and hence there is a large one-off cost to be incurred to achieve cost savings. We expect these costs to be incurred over the remainder of 2004 and, combined with our other ongoing cost initiatives, to be in the order of approximately £30 million. We have ongoing initiatives to identify and drive further efficiency gains.

Dividend

The Board has declared an interim dividend of 9.36 pence net per share (2003: 9.00 pence) payable on 17 November 2004 to shareholders on the register on 13 August 2004.

Group capital and financial strength

Shareholders’ funds

Equity shareholders’ funds on an embedded value basis were £10.9 billion (31 December 2003: £11.0 billion) reflecting strong operational performance and the adverse impact of foreign exchange in the period. Net asset value per ordinary share, based on equity shareholders’ funds, was lower at 496 pence per share (31 December 2003: 502 pence per share) after adding back the equalisation provision of £375 million (31 December 2003: £364 million).

The ratings of the Group’s main operating subsidiaries are AA/AA- (“very strong”) from Standard & Poor’s and Aa2 (“excellent”) from Moody’s.

Return on capital employed

The Group’s normalised annualised 2004 post-tax operating return on equity was 13.4% (full year 2003: 12.7%), which reflects the strong operational performance delivered by our businesses in the year. The normalised annualised return is based on the post-tax operating profit, including life achieved profit, before amortisation of goodwill and exceptional items, expressed as a percentage of the opening equity capital.

Financial strength of the Group and its principal insurance operations

The Group is subject to a number of regulatory capital tests and also employs a number of realistic tests to allocate capital and manage risk. Overall, the Group comfortably meets all of these requirements and has significant resources and financial strength. We report on these below.

EU Groups directive

Aviva Group had an estimated excess regulatory capital, as measured under the EU Groups Directive, of £2.2 billion at 30 June 2004 (31 December 2003: £2.4 billion). This measure represents the excess of the aggregate value of regulatory capital employed in our business over the aggregate minimum solvency requirements imposed by local regulators, excluding the surplus held in the Group’s UK and Irish with-profit funds. The reduction since the 2003 year end is principally attributed to the effect of incorporating the impact of the FSA’s Solvency 1 regime on the required minimum capital of UK general insurance businesses. This was introduced in 2004 and amounted to £0.2 billion.

The FSA issued PS04/20 Financial groups in July 2004, which contains its final policy statement for the implementation of the Financial Groups Directive from 1 January 2005 onwards. Under these rules, there is no material change to our solvency position at a group level and we comfortably meet the requirement within our existing financial resources. We will continue to report our IGD solvency position to the FSA, as we have done for a number of years.

General insurance – regulatory basis

Our principal UK general insurance regulated subsidiaries are CGU International Insurance group (CGUII) and Norwich Union Insurance (NUI).

The combined businesses of the CGUII group and NUI group have strong solvency positions. On an aggregate basis the estimated excess solvency margin (representing the regulatory value of excess available assets over the required minimum margin) at 30 June 2004 was £3.9 billion (31 December 2003: £3.9 billion) after covering the required minimum margin of £3.5 billion (31 December 2003: £3.3 billion). The increase in the required minimum margin is largely attributable to the changes in the rules under Solvency 1. Solvency cover for the CGUII group has been estimated at 6.3 times (31 December 2003: 7.6 times) and for the NUI group at a cover of 2.6 times (31 December 2003: 3.2 times).

General insurance – realistic basis

Capital requirements for the Group’s worldwide general insurance businesses are assessed using risk-based capital techniques. Using this basis, capital is defined as that required to ensure that at all times the ongoing level of capital will exceed the statutory minimum solvency margin over the next 5 years with a 99% probability. Calculations reflect the increasing strength of the general insurance business balance sheets and improving stability and reductions achieved in the combined operating ratios, which produced a risk based capital requirement of 34% of net written premiums (31 December 2003: 34%).

As at 30 June 2004 the risk based capital requirement of our worldwide general insurance businesses was £3.3 billion (31 December 2003: £3.3 billion) in comparison to £4.6 billion (31 December 2003: £4.5 billion) of capital employed by these businesses after deducting goodwill and adding back the claims equalisation reserve. The combined general insurance businesses of CGUII and NUI hold total regulated available assets of £7.4 billion (31 December 2003: £7.2 billion). After deducting the risk based capital for the general insurance businesses of CGUII and NUI of £3.3 billion (31 December 2003: £3.3 billion) and, adding back the claims equalisation reserve of £0.4 billion (31 December 2003: £0.4 billion), the remaining available capital of £4.5 billion (31 December 2003: £4.3 billion) is sufficient to cover the minimum margins of the overseas life businesses by approximately 2.3 times (31 December 2003: 2.2 times).

UK Life operations

We manage the strength of our funds through a variety of different means. We have the option to use, where appropriate, financial reinsurance, securitisation, shareholder funds and policyholder funds.

In July 2004 we announced our proposals to simplify the structure of many of our non-profit funds by transferring them into Norwich Union Life and Pensions (NUL&P). The transfer of these funds will create a simpler and more efficient structure for Norwich Union. The transfer of funds is subject to a set legal procedure and we are working towards an approval of the fund transfer, to be effective from 1 January 2005. We continue our investigation for the reattribution of the orphan estate. However, with the level of regulatory change taking place in the with-profits industry, we do not envisage progressing this in the short-term.

With-profit funds – statutory and realistic basis

Statutory basis

During 2003, the FSA indicated that those companies which could demonstrate that statutory regulations for valuation of liabilities were unduly onerous relative to a realistic assessment of solvency could secure modifications to the rules by way of a waiver. Such waivers were granted to CGNU Life (CGNU) and Commercial Union Life Assurance Company (CULAC) in 2003 and the statutory valuation approach was modified at year end. We did not seek a waiver for NUL&P.

Having modified the statutory approach for CGNU and CULAC, it was no longer appropriate to continue to use an implicit item for these companies and this has been allowed to lapse. The implicit item in NUL&P is supported by the non-profit business.

The free asset ratio (FAR) is the measure of the excess of assets over liabilities, expressed as a proportion of liabilities. The ratio is based on the statutory basis (as modified) including provision for adverse movement in asset values – the resilience test, based on a fall in equity values of 13.7% and property of 20.0%.

Realistic basis
We measure our realistic strength by the value of the orphan estate. The estate provides a level of capital that is available to absorb any unexpected short-term impact from adverse experience. It provides investment freedom to improve policyholders’ returns and enables the operation of the with-profit business and associated features of guarantees and smoothing.

The FSA published PS04/16 Integrated Prudential Sourcebook for insurers in July 2004, which includes final policy statements on non-life and life capital requirements. This is expected to become final in November 2004 in order to be applicable for 31 December 2004 year ends. PS04/16 includes a final policy statement on the enhanced capital requirement (ECR) and the appropriate balance sheet provisions and capital requirements for with-profit business. The results below for the realistic orphan estate have been calculated in line with the key principles of PS04/16, including the stress tests to determine the required capital margin (RCM). This is a stronger basis than the ABI basis on which our previous results were disclosed.

Appropriate allowance is made for all realistic liabilities of the with-profit funds, including provision for future bonus, the fair value of guarantees, options and promises on a market consistent basis and the cost of shareholder transfers and tax associated with future bonus. The calculations also make allowance for how the with-profit funds are expected to be run, for example investment policy, and how policyholders are expected to behave, for example persistency.

Free asset ratios for the three main companies at 30 June 2004 are set out below, with a comparison of the realistic solvency position.

	Estimated statutory FAR %	Estimated realistic orphan estate £bn	Estimated required capital margin £bn	Estimated excess £bn
CGNU Life	16.8%	1.4	0.4	1.0
CULAC	12.2%	1.5	0.4	1.1
NUL&P	14.4%	1.3	1.0	0.3
Aggregate	14.3%	4.2	1.8	2.4
* The FAR for NUL&P includes implicit items for non-profit business only. Based on PS04/16, the RCM is 2.3 times covered by the orphan estate in aggregate.

The aggregate value of assets in the three main with-profit funds amounted to £52 billion. The aggregate investment mix of these funds at the half year was:

	30 June 2004 %	31 December 2003 %
Equity	39%	38%
Property	17%	16%
Fixed interest	41%	42%
Other	3%	4%
	100%	100%

Equity backing ratios, including property, supporting with-profit asset shares is 64% in CGNU Life and CULAC and 54% in NUL&P. With-profit new business is mainly written through CGNU Life.

Other external developments

European Embedded Value (EEV)
In May 2004 the CFO Forum, a group representing the Chief Financial Officers of major European insurers, launched the European Embedded Value Principles, with the intention of improving comparability and transparency in embedded value reporting across Europe. Aviva strongly supported this initiative through the Chairmanship of the Working Party that developed the principles. We believe that embedded value remains the best measure of value added for our long-term insurance business and believe that in a time of significant accounting change, users require a consistent and meaningful basis of reporting.

The CFO Forum members agreed that all participants will implement the principles as their supplementary basis of reporting from the 2005 year end, with optional early implementation at the 2004 year end. We will seek to publish numbers on the new basis over that period. The implementation of these new principles represents a significant investment by the industry and we are currently in the process of making the enhancements required to our actuarial systems. We currently anticipate that we will present disclosures in compliance with the European Embedded Value Principles at the 2004 year end.

International Financial Reporting Standards (IFRS)
From 2005, all listed companies within the European Union must present their results in accordance with IFRS. Aviva supports the convergence of accounting standards, which over the long term should improve comparability internationally and particularly across Europe.

The standards themselves have undergone significant change over the last 12 months and there remain a number of areas of uncertainty, not least whether the standards IAS 32 and IAS 39 which cover accounting for financial instruments will be endorsed by the European Union. Despite these external factors, our conversion project, which is part of the global finance transformation programme, is progressing well and we continue to take a leading position in debating the accounting issues affecting the insurance industry.

Aviva believes that, in the interest of good governance, it is important that the process of educating its stakeholders on the transition to IFRS begins as soon as possible despite the uncertainties remaining. We therefore intend to hold an external presentation giving an indication of the impact upon Aviva of IFRS adoption (Phase 1) in the early autumn.

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