Preliminary results - 12 months ended 31 December 2005
Operating and financial review
Group operating profit before tax
The European Union requires all European listed groups to prepare their consolidated financial statements using standards issued by the International Accounting Standards Board (IASB) with effect from 1 January 2005. Aviva's statutory results have therefore been reported on an International Financial Reporting Standard (IFRS) basis rather than the previous modified statutory solvency basis and prior period comparatives have been restated accordingly. Aviva continues to believe that embedded value provides the best way to value, measure and report life businesses and European Embedded Value (EEV) is therefore a more accurate reflection of the performance of the Group's life businesses.
2005 saw the continuation of strong operational performance across our major businesses. The Group achieved an operating profit before tax, including life EEV operating return, of £2,904 million (2004: £2,224 million), an increase of 29%. On an IFRS basis, worldwide operating profit before tax increased by 25% to £2,128 million (2004: £1,669 million). This strong set of results has been achieved by our continued focus on profitable growth by growing our distribution channels, leveraging our scale advantages in pricing and costs, our disciplined approach to underwriting and efficient claims management. This, combined with our confidence on the improving capital position of the Group, has allowed us to grow our final dividend by 9% to 17.44 pence per share.
| EEV basis | IFRS basis | |||||
|---|---|---|---|---|---|---|
| 2005 £m |
2004 £m |
2005 £m |
2004 £m |
|||
| Life EEV operating return / IFRS long-term business profit | 1,814 | 1,611 | 1,065 | 1,116 | ||
| Fund management | 51 | 20 | 92 | 40 | ||
| General insurance and health | 1,551 | 1,259 | 1,551 | 1,259 | ||
| Other: | ||||||
| Other operations | 60 | (41) | (8) | (121) | ||
| Corporate costs | (136) | (188) | (136) | (188) | ||
| Unallocated interest charges | (436) | (437) | (436) | (437) | ||
| Operating profit before tax | 2,904 | 2,224 | 2,128 | 1,669 | ||
| Profit before tax / Profit before tax attributable to shareholders | 5,283 | 2,469 | 2,528 | 1,642 | ||
| Equity shareholders' funds | 14,899 | 11,661 | 8,774 | 6,893 | ||
Long-term savings
Our worldwide long-term new business sales grew strongly by 10% to £24.6 billion (2004: £22.3 billion) benefiting from our strong and well diversified international portfolio where sales grew by 16% to £14.4 billion and accounted for 59% of total sales. Worldwide life and pension sales increased by 7% to £22.2 billion (2004: £20.7 billion) and we achieved record investment sales rising by 45% to £2.4 billion (2004: £1.6 billion).
Total new business sales on a present value of new business premium (PVNBP) basis
| 2005 | Local currency growth | ||||||
|---|---|---|---|---|---|---|---|
| Long-term savings sales | Life and pensions £m |
Retail investments £m |
Total £m |
Life and pensions % |
Retail investments % |
Total % |
|
| United Kingdom | 9,053 | 1,160 | 10,213 | (1%) | 35% | 2% | |
| Continental Europe | 11,933 | 1,026 | 12,959 | 13% | 89% | 17% | |
| Rest of the World | 1,260 | 213 | 1,473 | 21% | (16%) | 14% | |
| International | 13,193 | 1,239 | 14,432 | 14% | 56% | 16% | |
| 22,246 | 2,399 | 24,645 | 7% | 45% | 10% | ||
| Navigator | 938 | 938 | 37% | 37% | |||
In the UK, Norwich Union had a strong finish to the year delivering a third consecutive quarterly sales growth, with the fourth quarter sales the highest of 2005. Sales performance improved during the year due to the focus on growing volume in key markets while continuing to manage the business for value. Total sales, including investment sales, increased by 2% to £10,213 million (2004: £10,031 million). The sales momentum reflects our focus on offering a broad range of products, the development of propositions ahead of Pensions Simplification (A-day) and the focus on collective investments. We expect further market growth in 2006 as A-day approaches. Coupled with the launch of a new with-profits bond and an increased focus on collective investments, we are well placed to take advantage of this change and anticipate that the sales momentum built in the second half of 2005 both through independent financial advisors and The Royal Bank of Scotland Group (RBSG) distribution channel will continue into 2006.
Sales in continental Europe grew 17% to £12,959 million, accounting for over 50% of total new business sales and reflecting the success of our multi-distribution strategy, broad product offerings and expertise in equity-backed products. Investment sales nearly doubled to £1,026 million and reflected an excellent fourth quarter performance as distribution capability and products were developed further and investor sentiment improved. Our bancassurance partnerships with Crédit du Nord and ABN AMRO contributed to strong sales growth in France and the Netherlands respectively, while sales grew strongly in Italy as a result the expansion of our distribution network with Banche Popolari Unite (BPU) from the start of 2005. As a result of the strong relationship with UniCredit Group, Aviva Italy expects to increase its access to the UniCredit Group branch network during 2006. In Ireland, growth in our single premium sales reflected the continued success of our five-year capital guaranteed fund and an attractive choice of fund managers. In Spain, we continued to focus on higher margin protection and pension business. Our other businesses in Poland, Turkey, Germany, the Czech Republic, Hungary, Romania and Lithuania are seeking to achieve strong organic growth while developing further relationships with banks and brokers.
Sales in Asia continued to grow as a result of our expanding distribution, the strong partnerships with the banking group DBS and increased sales from broker distribution channels. We continue to make excellent progress in developing our Indian and Chinese operations through the combination of our attractive savings products and in India, an expanding bancassurance strategy. In January 2006, Aviva India announced a major bancassurance partnership with Centurion Bank of Punjab (CBOP), a leading private bank with 2.2 million customers and 240 branches, taking the number of bancassurance agreements in the country to 18. This deal significantly increases our distribution network in India with a presence in 378 locations.
We have also further strengthened our position in the Indian sub-continent through the acquisition of a 51% stake in Eagle Insurance Limited (Eagle), the third largest insurer in Sri Lanka in February 2006. Eagle has entered a bancassurance agreement with National Development Bank Limited, Sri Lanka's biggest development bank, giving access to 25,000 customers through 28 branches. In China we are now licensed to operate in four major cities, with sales offices in a further five cities. Aviva has recently been granted permission to apply to set up a branch in Jinan, the capital city of Shandong province, and will continue to increase its presence during 2006. In Australia, sales of protection products more than doubled during 2005, and strong growth was achieved in the United States where our niche business continues to enhance its distribution and product range.
We continue to benefit from our strong platform in continental Europe and our product expertise, allied with our extensive multi distribution network, will enable us to benefit further from the significant opportunities these markets provide. In Asia, we are actively pursuing growth in markets with significant longer-term potential and further developing our relationships with local partners. In line with our strategy for growth in the international long-term savings market, we continue to review value-driven inorganic growth opportunities in the major global long-term savings markets.
Life EEV operating return
| 2005 £m |
2004 £m |
||
|---|---|---|---|
| New business contribution (after the effect of required capital) | 612 | 516 | |
| Profit from existing business | – expected return | 895 | 819 |
| – experience variances | (39) | (15) | |
| – operating assumption changes | 17 | (7) | |
| Expected return on shareholders' net worth | 329 | 298 | |
| Life EEV operating return before tax | 1,814 | 1,611 | |
The Group's life EEV operating return before tax was 11% higher at £1,814 million (2004: £1,611 million) due to increased contributions from both new and existing business. New business contribution after the effect of required capital was 18% higher at £612 million (2004: £516 million). This includes a resilient position in the UK and an improved margin in our international businesses reflecting the benefits of pricing action, cost control and an improvement in business mix towards higher margin products. New business margins before the effect of required capital increased to 3.6% (2004: 3.4%), driven primarily by improved business mix in France and Spain. The Group's new business margin after the effect of required capital was also higher at 2.8% (2004: 2.5%), reflecting improved business mix and our value focus.
The expected returns on existing business and shareholders' net worth were higher at £1,224 million (2004: £1,117 million) and reflect the higher start of year embedded values. Adverse experience variances of £39 million (2004: £15 million adverse) were offset by positive operating assumption changes of £17 million (2004: £7 million loss).
| Present value of new business premiums | New business contribution (1) | New business margin (1,2) | New business contribution (3) | New business margin (2,3) | ||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| 2005 £m |
2004 £m |
2005 £m |
2004 £m |
2005 % |
2004 % |
2005 £m |
2004 £m |
2005 % |
2004 % |
|||||
| (1) Before effect of required capital which amounted to £196 million (2004: £190 million). (2) New business margin represents the ratio of new business contribution to present value of new business premiums, expressed as a percentage. (3) After deducting the effect of required capital. |
||||||||||||||
| United Kingdom | 9,053 | 9,172 | 265 | 269 | 2.9% | 2.9% | 213 | 215 | 2.4% | 2.3% | ||||
| France | 3,530 | 2,782 | 135 | 95 | 3.8% | 3.4% | 91 | 54 | 2.6% | 1.9% | ||||
| Ireland | 665 | 561 | 16 | 19 | 2.4% | 3.4% | 13 | 16 | 2.0% | 2.9% | ||||
| Italy | 2,294 | 1,799 | 59 | 48 | 2.6% | 2.7% | 36 | 34 | 1.5% | 1.9% | ||||
| Netherlands (including Belgium and Luxembourg) | 2,407 | 2,168 | 88 | 80 | 3.7% | 3.7% | 57 | 43 | 2.4% | 2.0% | ||||
| Poland | 285 | 241 | 14 | 11 | 4.9% | 4.6% | 13 | 9 | 4.6% | 3.7% | ||||
| Spain | 2,013 | 2,110 | 175 | 143 | 8.7% | 6.8% | 155 | 121 | 7.7% | 5.7% | ||||
| Other Europe | 739 | 804 | 7 | 5 | 0.9% | 0.6% | 2 | – | 0.3% | – | ||||
| Continental Europe | 11,933 | 10,465 | 494 | 401 | 4.1% | 3.9% | 367 | 277 | 3.1% | 2.6% | ||||
| Rest of the World | 1,260 | 1,024 | 49 | 36 | 3.9% | 3.4% | 32 | 24 | 2.5% | 2.3% | ||||
| International | 13,193 | 11,489 | 543 | 437 | 4.1% | 3.8% | 399 | 301 | 3.0% | 2.6% | ||||
| Total life and pensions business | 22,246 | 20,661 | 808 | 706 | 3.6% | 3.4% | 612 | 516 | 2.8% | 2.5% | ||||
New business contribution before and after the effect of required capital increased 14% to £808 million (2004: £706 million) and 18% to £612 million (2004: £516 million), respectively, compared to 7% growth in life and pensions new business sales. This was primarily driven by growth in continental Europe, particularly as a result of a beneficial change in product mix in France and Spain. Continental Europe now accounts for around 60% of the Group's new business contribution.
UK
Norwich Union delivered a strong performance in 2005 with total sales, including investment sales, up by 2% to £10,213 million. Fourth quarter sales were the highest of the year and reflected the actions taken in the second half to improve performance and grow volume in its key markets. Strong and appropriate pricing actions have been taken to generate medium and long-term profitable growth. Norwich Union has a broad “waterfront” product range and strong multi-distribution capability and by the end of the third quarter had regained a market leading position with a market share of 11.6%.
New business contribution was £265 million (2004: £269 million) with a new business margin of 2.9% (2004: 2.9%). The withdrawal from certain less profitable personal pension business in the first half of 2005 reduced volumes, but increased margins to 3.2% at the mid point of the year. Strategic pricing action on key products and the re-entry into the more profitable section of the personal pension market at the start of the second half of 2005 resulted in a rebound in Norwich Union's market share and a reduction in new business margin to 2.7% during this period. We do not anticipate further pricing action and any future changes in the overall margin will be driven by business mix.
On a post cost of capital basis new business contribution was £213 million (2004: £215 million) with a margin of 2.4% (2004: 2.3%). This includes the impact of the change in the level of required capital held for annuity business from 200% to 150%, which benefited the result by £13 million.
Life EEV operating return was higher at £585 million (2004: £551 million) primarily driven by increased expected returns from in-force business and shareholders' net worth. The net impact of experience variances and operating assumption changes amounted to a loss of £150 million (2004: loss of £139 million). The adverse persistency and expense variances have been offset by mortality profits of £105 million (2004: £51 million profits) arising principally on protection contracts, better than expected default experience on corporate bonds and commercial mortgages of £19 million (2004: £29 million); and £110 million arising from the change in the level of required capital for annuity business from 200% to 150%.
Adverse exceptional expenses of £148 million (2004: £153 million adverse) included £47 million in respect of ongoing restructuring of the UK Life business and a further £101 million of other exceptional and project costs associated with regulatory change and strategic initiatives.
Persistency experience on unitised with-profit and unit-linked bonds as well as pensions products continues to be adverse, generating a loss of £78 million (2004: £50 million loss). This loss principally arises in relation to bond contracts on surrenders occurring at set anniversary dates where market value adjustments do not apply. Actual lapse experience has continued to be higher than assumed, notwithstanding the change in lapse assumptions made in 2004. While action is ongoing to improve our current persistency experience, this coupled with an increase in the expected number of lapses on pensions business has resulted in a provision for lapses with a consequential adverse impact on profits of £130 million (2004: £110 million adverse).
Continental Europe
New business contribution before the effect of required capital was 22% higher at £494 million (2004: £401 million), following continued strong performances in Spain, Italy and France including the contribution of £33 million from our partnership with Crédit du Nord. New business margins before and after required capital increased to 4.1% and 3.1% respectively (2004: 3.9% and 2.6%), reflecting the strategic business mix shift towards higher margin, less capital intensive products, notably in France and Spain.
Life EEV operating return from our continental European businesses grew by 14% to £1,130 million (2004: £977 million) primarily driven by new business contribution after the effect of required capital which was £90 million higher at £367 million. Expected returns rose to £646 million (2004: £591 million). Favourable experience variances were lower at £45 million (2004: £57 million favourable), reflecting favourable mortality experience of £67 million (2004: £56 million) offset by adverse persistency and expense experience of £14 million and £16 million (2004: nil and £20 million adverse), respectively. Operating assumption changes were more positive at £72 million (2004: £52 million).
France: Aviva France generated strong sales growth of 26% to £3,530 million (£2,782 million). Within this, unit-linked sales increased by 73% to £1,423 million (2004: £818 million) and Aviva France is well-positioned for continued growth. Our bancassurance partnership with Crédit du Nord recorded sales of £728 million in its first full year (2004: £127 million) and AFER unit-linked sales grew substantially by 78% to £367 million (2004: £205 million). Our strategic focus on more profitable unit-linked sales resulted in a 41% increase in new business contribution to £135 million (2004: £95 million) giving a higher full year new business margin of 3.8% (2004: 3.4%). Life EEV operating return increased to £321 million (2004: £286 million) including £33 million (2004: £4 million) from our bancassurance partnership. This performance primarily reflects the increased contribution from new business, higher expected returns and experience variances partially offset by lower operating assumption changes. The favourable experience variance of £32 million (2004: £22 million) includes higher mortality profits of £29 million (2004: £21 million).
Ireland: Hibernian, the third-largest life and pensions provider in Ireland, increased sales by 18% to £665 million (2004: £561 million) benefiting from strong sales of single premium business during the year. New business contribution of £16 million (2004: £19 million) with a lower new business margin of 2.4% (2004: 3.4%) reflects consumer preference for lower margin single premium business, and includes the adverse impact of further lapse assumption changes in respect of unit-linked pension business. Life EEV operating return was also lower at £20 million (2004: £40 million) driven by adverse experience. Variances were predominantly as a result of lapses on unit-linked pensions business. Our new bancassurance joint venture agreement with Allied Irish Banks (AIB), Ireland's largest retail bank, completed on 27 January 2006 to create a leading force in the Irish life and pensions market with a market share of around 16% and brings further opportunities for growth.
Italy: Aviva Italy outperformed the local market with total sales growth of 27% to £2,294 million (2004: £1,799 million) benefiting from a combination of strong market growth and the extension of our bancassurance agreement with Banche Popolari Unite (BPU) to a further 380 branches at the start of 2005. New business contribution increased to £59 million (2004: £48 million) due to significantly higher sales, reflected in a new business margin of 2.6% (2004: 2.7%). Life EEV operating return rose to £96 million (2004: £79 million) reflecting the new business growth and the return from our equity investment in the BPU Group at the start of 2005.
Netherlands (including Belgium and Luxembourg): Life and pensions sales in Delta Lloyd grew by 10% to £2,407 million (2004: £2,168 million) with a 9% increase in sales through the bancassurance joint venture with ABN AMRO to £543 million (2004: £493 million). New business contribution was £88 million (2004: £80 million) reflecting strong sales with a steady new business margin of 3.7% (2004: 3.7%). Life EEV operating return of £318 million (2004: £277 million) included favourable operating assumption changes driven by reductions in maintenance expenses, as benefits of the efficiency programmes start to come through.
Poland: CU Polska achieved new business sales growth of 4% to £285 million (2004: £241 million). New business contribution was £14 million (2004: £11 million), resulting in a margin of 4.9% (2004: 4.6%). Life EEV operating return increased to £128 million (2004: £93 million) due to increased experience profits and operating assumption changes including mortality profits of £23 million (2004: £6 million) and favourable maintenance expense experience.
Spain: Aviva Spain generated sales in 2005 of £2,013 million (2004: £2,110 million) achieving underlying growth, excluding one-off sales, of 6%. New business contribution increased significantly by 22% to £175 million (2004: £143 million) improving the new business margin to 8.7% (2004: 6.8%) as we continue to focus on higher margin protection and pension products. New business contribution after the effect of required capital increased by 27% to £155 million (2004: £121 million) resulting in an increase in the life EEV operating return to £214 million (2004: £180 million).
Other Europe: In Aviva's other European businesses, operations based in the Czech Republic, Dublin, Germany, Hungary, Lithuania, Portugal, Romania and Turkey generated life and pensions sales of £739 million (2004: £804 million) and a healthy life EEV operating return of £33 million (2004: £22 million), 50% higher than 2004. The life business in Portugal was sold on 7 October 2005.
Rest of the World
Our businesses in the rest of the world achieved overall life and pensions sales growth of 21% to £1,260 million (2004: £1,024 million) with encouraging performances from Asia and the US. Total sales in Asia were 23% higher at £396 million (2004: £316 million) as volumes in Hong Kong doubled to £103 million (2004: £52 million) and Singapore's sales of £226 million (2004: £242 million) achieved underlying growth of 35%, excluding limited offerings. Sales continue to grow rapidly in India and China with our share of sales amounting to £32 million (2004: £15 million) and £35 million (2004: £7 million), respectively. Life and pensions sales in Australia increased by 8% to £337 million (2004: £312 million) while sales in the US rose by 32% to £527 million (2004: £396 million), benefiting from a wider product offering and distribution improvements. New business contribution increased by 33% to £49 million (2004: £36 million) with a new business margin of 3.9% (2004: 3.4%) benefiting from improved business mix and higher volumes. The life EEV operating return from our businesses in the rest of the world was £99 million (2004: £83 million), principally due to higher new business contributions.
Bancassurance margins – before required capital, tax and minority interests
The weighted average bancassurance new business margin before the effect of required capital increased to 5.1% (2004: 4.9%), reflecting our strategic focus on higher margin products. The bancassurance margin net of required capital was 4.2% (2004: 4.0%).
| Total life and pensions | Present value of new business premiums | New business contribution (1) | New business margin (2) | |||||
|---|---|---|---|---|---|---|---|---|
| 2005 £m |
2004 £m |
2005 £m |
2004 £m |
2005 % |
2004 % |
|||
| (1) Before effect of required capital which amounted to £58 million (2004: £43 million). (2) New business margin represents the ratio of new business contribution to present value of new business premiums, expressed as a percentage. |
||||||||
| United Kingdom | 636 | 461 | 16 | 12 | 2.5% | 2.6% | ||
| France | 728 | 127 | 30 | 4 | 4.1% | 3.1% | ||
| Italy | 2,134 | 1,666 | 57 | 46 | 2.7% | 2.8% | ||
| Netherlands | 543 | 493 | 19 | 21 | 3.5% | 4.3% | ||
| Spain | 1,793 | 1,956 | 170 | 142 | 9.5% | 7.3% | ||
| Asia | 241 | 264 | 20 | 17 | 8.3% | 6.4% | ||
| Total bancassurance channels | 6,075 | 4,967 | 312 | 242 | 5.1% | 4.9% | ||
In the UK, the new business margin from life and pensions sales from our partnership with RBSG was largely maintained at 2.5% (2004: 2.6%). Higher unit-linked sales through our French bancassurance partnership with Crédit du Nord increased the new business margin to 4.1% (2004: 3.1%). In Italy, new business contribution rose by 24% to £57 million with a margin of 2.7% (2004: 2.8%) as a result of greater volumes. In Spain, our bancassurance partnerships produced an increased margin of 9.5% (2004: 7.3%) due to the focus on pension and protection products. Our bancassurance partnership with ABN AMRO in the Netherlands generated a margin of 3.5% (2004: 4.3%) as new business sales included an annuity business special promotion in the first quarter of 2005. The new business bancassurance margin from our partnership with DBS in Singapore and Hong Kong was 8.3% (2004: 6.4%), reflecting the profitable growth of these developing operations.
New business contribution – after deducting required capital, tax and minority interest
New business contribution after required capital, tax and minority interest increased by 14% to £341 million outpacing post minority sales growth of 5%. The new business margin therefore improved to 1.8% (2004: 1.6%). The increase arose primarily in our bancassurance channels, reflecting the beneficial change in business mix in France to higher margin unit-linked business and in Spain to higher margin protection business. The margin from our non-bancassurance channels improved to 1.6% (2004: 1.5%) and similarly reflects the higher unit-linked sales achieved from the Group's intermediated distribution channels.
| Present value of new business premiums (1) | New business contribution (2) | New business margin (3) | ||||||
|---|---|---|---|---|---|---|---|---|
| 2005 £m |
2004 £m |
2005 £m |
2004 £m |
2005 % |
2004 % |
|||
| (1) Stated after deducting the minority interest. (2) Stated after deducting the effect of required capital, tax and minority interest. (3) New business margin represents the ratio of new business contribution to present value of new business premiums, expressed as a percentage. |
||||||||
| Bancassurance channels | 3,238 | 2,728 | 93 | 74 | 2.9% | 2.7% | ||
| Other distribution channels | 15,815 | 15,353 | 248 | 223 | 1.6% | 1.5% | ||
| Total life and pensions business | 19,053 | 18,081 | 341 | 297 | 1.8% | 1.6% | ||
| Analysed: | ||||||||
| UK | 9,053 | 9,172 | 149 | 150 | 1.6% | 1.6% | ||
| Continental Europe | 8,740 | 7,885 | 167 | 129 | 1.9% | 1.6% | ||
| Rest of the World | 1,260 | 1,024 | 25 | 18 | 2.0% | 1.8% | ||
| International | 10,000 | 8,909 | 192 | 147 | 1.9% | 1.6% | ||
Long-term business operating profit on an International Financial Reporting Standard (IFRS) basis
On an IFRS basis, our long-term business operating profit before shareholder tax was £1,065 million (2004: £1,116 million). The decrease in the year is driven by the effect of falls in long-term interest rates in the Netherlands.
The operating result from the UK with-profit business of £99 million (2004: £97 million) reflects the changes in bonus rates during 2005 which saw terminal and certain annual bonuses rise following strong with-profits fund investment performance. The UK non-profit result increase to £285 million (2004: £256 million) and includes a strong performance from our annuity and equity release business which offset higher levels of new business strain.
In continental Europe, operating profit of £683 million (2004: £664 million) was driven primarily by France and Spain. In France, operating profit of £258 million (2004: £213 million) includes a contribution from the Crédit du Nord partnership in its first full year of £17 million, with underlying growth reflecting the profitable development of the business and tightly controlled expenses. Additionally, the result includes the benefit of higher investment gains. Operating profit in Spain increased to £89 million (2004: £72 million) due to the higher sales of protection products which delivers new business surplus in the first year. In the Netherlands, the fall in long-term interest rates in 2005 resulted in a lower operating profit of £168 million (2004: £214 million) reflecting provision for guarantees on unit-linked contracts in the first half of the year prior to the slight recovery in rates in the second half of the year.
Our life businesses in the rest of the world reported a loss of £2 million (2004: £99 million profit) reflecting lower investment gains and a change in valuation basis in Asia introduced on 1 January 2005.
Fund management operating profit
Our worldwide fund management operating profit more than doubled to £92 million (2004: £40 million) on an IFRS basis, as the momentum from the first half of the year continued. Assets under management at 31 December 2005 grew to £317 billion (31 December 2004: £280 billion) reflecting the impact of new business flows and the strong performance of worldwide investment markets.
In the UK, our fund management businesses comprise our institutional business Morley Fund Management (Morley), our retail investment business trading as Norwich Union, and our collective investment joint venture business with RBSG. These businesses reported an operating profit of £44 million (2004: £8 million) in the year. Our international operations consist of Morley's overseas businesses based in Melbourne, Dublin, Warsaw, Boston, Milan and Madrid, Aviva Gestion d'Actifs in France, and other businesses including our fund administration business Navigator. Our international fund management operating profit was £48 million (2004: £32 million).
| 2005 £m |
2004 £m |
|
|---|---|---|
| Morley | ||
| – UK | 36 | 10 |
| – International | 13 | 8 |
| UK (excluding Morley) | 8 | (2) |
| France | 26 | 15 |
| Other Europe and International | 9 | 9 |
| Fund management operating profit – IFRS basis | 92 | 40 |
The total Morley group contributed an overall operating profit of £52 million (2004: £22 million) to the Group's results, including £3 million from the pooled pensions business which is reported within the life segment (2004: £4 million).
Morley achieved strong growth in 2005 as its global fund management operating profit increased to £49 million (2004: £18 million). This growth reflected increased management fees, higher performance fees (recognised in the second half of the year) contributing £9 million to profits (2004: £4 million) and careful cost control. Operating profit from the UK business was £36 million (2004: £10 million) while overseas businesses, including Hibernian Investment Managers (HIM), accounted for £13 million (2004: £8 million). Fee income benefited from new business wins, revenue enhancing initiatives, and strongly performing investment markets. These, combined with Morley's continued management of its expense base delivered an improved cost/income ratio of 77% (2004: 88%) which is in line with the industry average. Morley's continued market-leading expertise in Property and Socially Responsible Investment (SRI) was recognised as it was named Property Manager of the Year at the UK Pension Awards 2005 and won the Global Pensions SRI Provider of the Year Award 2006.
By increasing the level of specialist, higher margin business and actively managing our cost base, we aim to continue delivering sustainable and profitable growth, while investing for the future. As announced in November 2005, the joint venture in Ireland between Aviva and AIB will result in the transfer of the investment management of Ark Life's policyholder funds (€3 billion at 30 September 2005) to HIM which is expected to complete in the second quarter of 2006. This is in line with Morley's strategic intent to develop further market leading initiatives in partnership with other Aviva businesses.
Operating profit from Norwich Union's retail investment business, amounted to £9 million (2004: £4 million), whilst our collective investment business with RBSG benefited from higher sales of investment products to report a loss of £1 million (2004: loss of £6 million).
Aviva Gestion d'Actifs, our market-leading fund management operation in France, continued to demonstrate its expertise with over 94% of managed funds ranked in the top half for returns over five years. Operating profit increased to £26 million (2004: £15 million) reflecting new business inflows, including a portion of the funds within the Crédit du Nord partnership, and strongly performing equity markets.
Our other overseas businesses reported operating profits of £9 million (2004: £9 million). New business sales through Navigator, our fund administration business grew 37% to £938 million (2004: £661 million). Within this, sales in Australia increased by 26% to £848 million (2004: £648 million), benefiting from continuing improvements in product offerings and customer service while Singapore reported significantly higher sales of £90 million (2004: £13 million) reflecting strong distribution relationships with key brokers and an increased fund choice.
On an EEV basis, the total operating profit from our fund management businesses was £52 million (2004: £20 million) due predominantly to those funds managed on behalf of third parties and the Group's non-life businesses.
General insurance and health operating profit
Net written premiums from the Group's worldwide general insurance and health business increased by 4% to £10.3 billion, driven by an increase in the UK of 7% to £6.1 billion.
Operating profit from our worldwide general insurance and health businesses increased by 22% to £1,551 million (2004: £1,259 million). The Group's general insurance combined operating ratio (COR) improved to 95% (2004: 97%), and is ahead of our stated target to meet or beat a worldwide COR of 98% for the foreseeable future. Scale advantages, focused underwriting, claims management and efficiencies continue to provide us with ongoing benefits.
Underwriting profit for the year totalled £505 million (2004: £271 million). The improved performance was driven by our disciplined approach to underwriting, claims management and lower claims frequency across all our major businesses. Better than expected weather-related claims experience in 2005 benefited the result by £7 million (2004: benefit of £50 million). The worldwide expense ratio was 11.4% (2004: 11.2%), reflecting the change in distribution mix towards the direct channel and investment in the business to gain competitive advantage, including the RAC acquisition. The expense ratio includes employee benefit costs on a more current actuarial basis than previously accounted for under UK GAAP.
The longer-term investment return (LTIR) on general insurance and health business assets increased to £1,046 million (2004: £988 million). The higher start-of-year asset base, together with positive cash inflows, more than offset the decrease in LTIR rates applied in 2005. As previously announced, the Group has decided to make this discretionary change to its LTIR methodology from 2005 in addition to including the amortisation of the premium or discount arising upon the acquisition of fixed income securities as a proxy for gross redemption yield and has restated its 2004 comparatives accordingly.
The reserves in the Group are set conservatively with the aim to protect against adverse future claims experience and development. Our business is predominantly short tail in nature and loss development experience is generally stable. As a result of the prudence applied in setting the reserves, there are some releases in 2005 which reflect releases from the 2004 accident year and prior. We have increased our confidence levels in our reserves over the past few years and have maintained our reserves at very strong levels.
| Net written premiums | Underwriting result* | Operating profit* | ||||||
|---|---|---|---|---|---|---|---|---|
| 2005 £m |
2004 £m |
2005 £m |
2004 £m |
2005 £m |
2004 £m |
|||
| * Excludes the Financial Services Compensation Scheme levy of nil (2004: £40 million). | ||||||||
| United Kingdom | 6,127 | 5,715 | 303 | 146 | 974 | 797 | ||
| Continental Europe | 2,754 | 2,731 | 164 | 82 | 390 | 288 | ||
| Rest of the World | 1,430 | 1,372 | 38 | 43 | 187 | 174 | ||
| International | 4,184 | 4,103 | 202 | 125 | 577 | 462 | ||
| Continuing operations | 10,311 | 9,818 | 505 | 271 | 1,551 | 1,259 | ||
UK
2005 has been a year of great achievement for our UK general insurance business. Norwich Union Insurance (NUI) delivered another outstanding result, with an operating profit of £970 million (2004: £788 million). Our COR improved to 96% (2004: 97%), underlining our commitment to the market to ‘meet or beat' a worldwide COR of 98%. This performance has been achieved against the backdrop of the RAC acquisition in May and the subsequent integration activity during the rest of the year. Our balanced portfolio supports sustainable, profitable growth, with a 3% year on year underlying growth in net written premiums (excluding RAC) and 15% in our Direct operation, including over 200% growth in our internet-based sales, making NU Direct one of the UK's leading online insurers.
This excellent result reflects disciplined underwriting and cost control. Weather costs in the year were broadly neutral. We have delivered an additional £40 million of annualised savings in claim costs through effective supply chain management. Our focus on efficiency has enabled us to deliver a 10.5% expense ratio excluding the impact of RAC (2004: 10.6%). Including RAC, the expense ratio was 10.9%. We have achieved rate increases of 4% in personal motor (2004: 2%) and 6% in homeowner (2004: 6%), while commercial rates are holding up and profitability remains strong.
The RAC integration has largely been completed. As announced in October 2005, we now plan to achieve pre-tax savings of £100 million in 2006, at a cost of £130 million, exceeding the £80 million target announced when the RAC was acquired. We expect to deliver an annualised operating profit of £250 million on a like for like basis from the RAC acquisition, with an additional 1.4 million RAC customers by 2008. This acquisition will enable us to deliver an extensive portfolio of products and services to our customers. We have already launched motor and travel products under the RAC Direct Insurance brand and plan to launch a new homeowner product in March 2006.
RAC delivered a good performance in the year, with post acquisition profits of £59 million. The Rescue business, presented as general insurance, contributed £29 million to the insurance underwriting result.
During 2005, we signed a deal with Barclays to become its sole provider of homeowner, motor and travel insurance, and extended our long-standing agreement with Asda to be its sole provider of general insurance until the end of 2009. These deals underscore our position as partner of choice to the UK's top brands. We have achieved consistently strong customer satisfaction scores and won the Insurance Times “General Insurer of the Year” award for the third year running, underlining the consistency of our performance across the business.
We continue to invest in market-leading initiatives. Our digital flood map is being used in England and Wales, leading to a considerable decrease in the number of policyholders being declined homeowner insurance. We plan to install 100,000 Pay As You DriveTM devices by the end of 2006.
NU Healthcare is a leading UK health insurer providing private medical insurance (PMI) and income protection to over 750,000 customers. The PMI health result was £4 million (2004: £9 million) reflecting investment in the business and market conditions.
Continental Europe
In continental Europe, our general insurance and health businesses produced an operating profit of £390 million (2004: £288 million).
In France, our general insurance and health business reported an operating profit of £35 million (2004: £33 million) with an underwriting loss of £21 million (2004: loss of £16 million). Net written premiums increased by 8% to £726 million (2004: £670 million) reflecting rating increases in commercial and health lines. The longer-term investment return was also higher at £56 million (2004: £49 million). The general insurance business reported an unchanged COR of 101%.
In Ireland, the market remains highly competitive leading to a reduction in net written premiums for Hibernian, our market-leading general insurance business, to £499 million (2004: £545 million). As anticipated personal motor rates stabilised in the second half of the year. Operating profit increased to £171 million (2004: £135 million) while the COR improved to 78% (2004: 87%). The underwriting profit increased to £116 million (2004: £82 million) reflecting our focus on disciplined underwriting, lower average claims costs and frequency. Weather-related claims were better than long-term averages benefiting the result by £7 million (2004: neutral impact). Investment in Geocoding, the flood mapping project providing improved risk selection and pricing techniques continues, while our corporate partnership with Tesco was rolled out in July. We have also expanded our RAC Rescue capability and, as announced in October, we are targeting 400,000 additional Roadside customers by 2008. These actions together with our core focus on careful, targeted underwriting and cost management, will support growth of the business.
In the Netherlands, operating profit from general insurance and health increased 54% to £137 million (2004: £88 million). The general insurance COR improved to 93% (2004: 95%) reflecting strong premium rates and favourable claims experience, including the benefit of lower weather-related claims. Legislative reforms in the Dutch healthcare market, which became effective 1 January 2006, amalgamated the provision of public and private health insurance. This reform will create opportunities for our health business as more healthcare services move to private providers.
Our other European general insurance businesses, including operations in Italy, Turkey and Poland, recorded an operating profit of £47 million (2004: £32 million).
Rest of the World
Our general insurance businesses in the rest of the world recorded an operating profit of £187 million (2004: £174 million).
Our Canadian business reported an operating profit of £147 million (2004: £133 million) and the COR was unchanged at 97%. The benefit of favourable claims frequency, notably on our motor business, was mostly offset by higher weather losses impacting property class results in the second half of 2005. The longer-term investment return rose to £112 million (2004: £96 million), reflecting the higher asset base and positive cash inflows. Net written premiums increased slightly on a local currency basis to £1,324 million (2004: £1,202 million) despite legislative automobile reforms that have led to lower premium rates for motor insurance pools. These reduced rates have been matched by lower claims costs and have also benefited our renewal retention level. We have maintained our underwriting discipline as the rates in the commercial market have continued to decrease. Aviva Canada continues to expand its distribution capability, launching its strategic alliance with Loblaw Companies Ltd. in two further provinces in 2005. It has also invested in initiatives such as Premiere Healthcare which launched in October 2005 to provide the best healthcare solutions for customers, through timely, effective and high quality healthcare services.
The operating profit from our other businesses was £40 million (2004: £41 million). The sale of our Asian general insurance operations completed at the end of the year, and we have recognised a pre-tax profit of £165 million on disposal in the results for the year.
Other operations
The result of the Group's other operations on an IFRS basis improved to a reduced loss of £8 million (2004: loss of £121 million). This improvement reflects the inclusion of the results of RAC non-insurance operations including RAC Services and RAC Auto Windscreens of £30 million, lower losses from NU Life Services Ltd of £66 million (2004: loss of £80 million) and the improved performance from the non-insurance operations in the Netherlands including the banking division result of £39 million (2004: loss of £5 million). The 2005 result also includes a loss of £14 million relating to the development of the Lifetime platform, while in 2004 the results were lowered by a £40 million vacant property provision which has not recurred.
Following the RAC acquisition, we sold Hyundai Cars (UK) to Hyundai Motor UK Limited and the commercial fleet division of Lex Transfleet Limited to Fraikin Limited. In October 2005 HBOS plc exercised their call option to purchase RAC's 50% shareholding in Lex Vehicle Leasing (LVL). We are currently in negotiations to agree a fair value. Accordingly, the assets and liabilities of this business have been included as held for sale on the balance sheet. Since the beginning of 2006 we have also sold Multipart Holdings Ltd and its subsidiaries and Lex Commercials Ltd to Imperial Holdings Ltd and sold our 49.99% share of Hyundai Car Finance to Lloyds TSB Asset Finance. The assets and liabilities of these businesses of £317 million were therefore also classified as held for sale.
On an EEV basis, operating profit for our other operations was £60 million (2004: £41 million loss) as this excludes the majority of NU Life Services Ltd losses which are incorporated within the life EEV operating return.
Corporate costs
Following the successful completion of the global finance transformation programme (GFTP) in the first half of the year, GFTP costs were £28 million (2004: £85 million) lowering the Group's corporate costs to £136 million (2004: £188 million). Other corporate costs have increased to £108 million (2004: £103 million) driven by increased promotional brand spend.
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 and net pension income. Total interest costs in the year were £436 million (2004: £437 million). External interest costs were £248 million (2004: £246 million) while internal interest costs were broadly unchanged at £220 million (2004: £219 million). Net pension income of £32 million (2004: £28 million) represents the expected return on pension scheme assets less the interest charge on pension scheme liabilities and is recognised as a consequence of adopting IFRS.
Interest on the direct capital instrument of £42 million (2004: nil) is not included within unallocated interest and it is instead treated as an appropriation of profits retained in the year. In accordance with IFRS, the £42 million appropriation was charged upon declaration and settlement in November 2005. As the coupon payment attracts tax relief at 30%, the net impact of the appropriation to profit attributable to ordinary shareholders was £29 million.
Profit on ordinary activities before tax
| EEV basis | IFRS basis | ||||
|---|---|---|---|---|---|
| 2005 £m |
2004 £m |
2005 £m |
2004 £m |
||
| Operating profit before tax | 2,904 | 2,224 | 2,128 | 1,669 | |
| Impairment of goodwill | (43) | (41) | (43) | (41) | |
| Amortisation of acquired additional value of in-force long-term business | – | – | (73) | (85) | |
| Amortisation and impairment of intangibles | (21) | (3) | (45) | (7) | |
| Financial Services Compensation Scheme and other levies | – | (49) | – | (49) | |
| Profit on disposal of subsidiary and associates | 153 | 34 | 153 | 34 | |
| Short-term fluctuations on return of investments backing general insurance and health business | 517 | 161 | 517 | 161 | |
| Variation from longer-term investment return – life business | 2,288 | 501 | – | – | |
| Effect of economic assumption changes | (406) | (318) | – | – | |
| Integration costs | (109) | – | (109) | – | |
| Exceptional costs for termination of operations | – | (40) | – | (40) | |
| Profit before tax/ Profit before tax attributable to shareholders' profits | 5,283 | 2,469 | 2,528 | 1,642 | |
Profit before tax on an EEV basis was substantially higher at £5,283 million (2004: £2,469 million), and includes the positive investment return variances and short-term investment fluctuations of £2,805 million (2004: £662 million) and negative economic assumption changes of £406 million (2004: £318 million negative).
In the second half of 2005 we completed the sale of our Asian general insurance businesses and recorded a profit on sale of £165 million. Other small disposals amounting to a total loss of £12 million were completed. Following the integration activities on acquisition of RAC, a total spend of £109 million has been incurred to date with a further £21 million estimated to be incurred in 2006.
2005 saw a return to strong equity market performance particularly in the second half of 2005. In the UK, the FTSE all share index rose by 18% from the end of 2004 levels, the CAC 40 by 23% and the AEX by 25%. The variance from the longer-term investment return reflects the higher than assumed overall equity returns during the year following these improvements in the equity markets and increased market values of fixed income securities following the fall of 50 basis points and 40 basis points in UK and Euro zone bond yields respectively. This has resulted in a significant increase in the Group's life embedded value. Long-term economic assumptions, which are set by reference to long-term bond yields, were revised downwards at 31 December 2005 and these lower assumptions have reduced the expected value of future profits from in-force life contracts, reducing profits by £406 million.
The non-life short-term fluctuations of £517 million (2004: £161 million) are principally due to the higher equity market returns compared to our longer-term investment return assumptions. The effect of the non-life investment market movements, profit on disposal, and integration costs are included in the IFRS profit before tax attributable to shareholders' profits of £2,528 million (2004: £1,642 million).
The taxation charge for the period was £1,601 million (2004: £650 million) on an EEV basis and includes a charge of £927 million (2004: £618 million) in respect of operating profit, which is equivalent to an effective rate of 31.9% (2004: 27.8%). On an IFRS basis the effective tax rate on operating profit was 25.2% (2004: 19.1%). The increase in the effective rate of tax in 2005 reflects the non recurrence of one-off items in 2004 which reduced the tax charge offset by the release of current tax provisions following agreements reached with tax authorities on a number of issues around the Group.
Dividends
Ordinary dividends
The Board has recommended a final dividend increase of 9% to 17.44 pence net per share (2004: 16.00 pence) payable on 17 May 2006 to shareholders on the register on 10 March 2006. This provides growth of 7.5% in the total dividend for the year of 27.27 pence (2004: 25.36 pence). Our IFRS post-tax operating profits cover this dividend 2.17 times (2004: 2.11 times).
Pension fund deficit
At 31 December 2005 the total pension fund deficit at a group level had increased by £578 million to £1,471 million (gross of tax). The increase in the deficit has been driven by a number of factors including the acquisition of the pension fund deficit of the RAC members of £313 million and the adverse impact on the valuation of liabilities of a 70 basis point reduction in real interest rates during 2005, which more than offset the positive effect of the strong rise in equity markets. The UK schemes are the largest and the total deficit is £1,371 million.
Currently substantially all of the deficit is borne by shareholders as historic contractual arrangements have, to date, meant that no deficit funding has been recharged to the Group's UK with-profit funds. We are close to finalising our negotiations on the appropriate proportion to be borne by the UK with-profit funds and are hopeful of agreeing that these funds will contribute approximately 12% of the future deficit funding payments to the Norwich Union pension fund. Should this level of deficit funding be agreed, shareholders' funds will improve by approximately £120 million (pre-tax) and this will be accounted for in 2006.
The Group commenced regular deficit funding contributions in 2004 which amounted to £51 million during 2005. In light of the Group's strong capital and cash flow position, the Board will propose to the pension scheme trustees that Aviva makes an additional deficit funding contribution to both the Norwich Union and the RAC pension schemes of £700 million over the next two years. It is expected that 12% of the payments will be made from the UK with-profits funds, and the remainder will be funded using internal resources. In anticipation that these proposals will be accepted, the shareholders contributed an additional £160 million at the end of 2005.
Group capital structure
The Group maintains an efficient capital structure from a combination of equity shareholders' funds, preference capital, subordinated debt and borrowings, consistent with the Group's risk profile and the regulatory and market requirements of its business. 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, as reported below, has significant resources and financial strength.
The ratings of the Group's main operating subsidiaries are AA/AA- (“very strong”) with a stable outlook from Standard & Poor's and Aa2 (“excellent”) negative outlook from Moody's. These ratings were reaffirmed in November 2005 and reflect the Group's very strong liquidity, competitive position, capital base, increasing underlying earnings and positive strategic management.
Capital management
In managing its capital, the Group seeks to:
- match the profile of its assets and liabilities, taking account of the risks inherent in each business. In the case of the Group's life operations, which have long-term liabilities, the majority of capital is held in fixed income securities. A significant proportion of the capital supporting the Group's general insurance and health operations is held in equities, reflecting the relatively low risk profile of these businesses;
- maintain financial strength to support new business growth and satisfy the requirements of its policyholders, regulators and rating agencies;
- retain financial flexibility by maintaining strong liquidity, including significant unutilised committed credit lines, and access to a range of capital markets;
- allocate capital efficiently to support growth and repatriate excess capital where appropriate; and
- manage exposures to movement in exchange rates by aligning the deployment of capital by currency with the Group's capital requirements by currency.
An important aspect of the Group's overall capital management process is the setting of target risk-adjusted rates of return for individual business units, which are aligned to performance objectives and ensure that the Group is focused on the creation of value for shareholders. The Group has a number of sources of capital available to it and seeks to optimise its debt to equity structure in order to ensure that it can consistently maximise returns to shareholders. The Group considers not only the traditional sources of capital funding but the alternative sources of capital including reinsurance and securitisation, as appropriate, when assessing its deployment and usage of capital.
Return on capital employed
The Group's 2005 post-tax operating return on equity was 15.0% (2004: 13.7%), which reflects the strong operational performance delivered by our businesses. This return is based on the post-tax operating profit from continuing operations, including the EEV operating return, expressed as a percentage of the opening equity capital.
Different measures of capital
The Group measures its capital on a number of different bases. These include measures which comply with the regulatory regime within which the Group operates and those which the directors consider appropriate for the management of the business. The measures which the Group uses are:-
- Accounting bases
Although the Group is required to report its results on an IFRS basis, the directors consider that the European Embedded Value principles provide a more accurate and meaningful reflection of the Group's life operations and accordingly we analyse and measure the net asset value and total capital employed for the Group on this basis. - Regulatory bases
In reporting the financial strength of our insurance subsidiaries the Group measures the capital and solvency using the regulations prescribed by the Financial Services Authority (FSA). These regulatory capital tests are based upon required levels of solvency capital and a series of prudent assumptions in respect of the type of business written by the Group's insurance subsidiaries. - Economic bases
Notwithstanding the required levels of capital laid out by the FSA, the Group also measures its capital using various risk based capital models that take into account a more realistic set of financial and non-financial assumptions. These models have been under considerable development over the past few years and have become more relevant in the internal assessment of the Group's financial strength. In addition, these models include measures used by rating agencies in measuring and assessing the financial strength of the Group.
Group
Accounting bases
The Group's capital, from all funding sources, has been allocated such that the capital employed by trading operations is greater than the capital provided by its shareholders and its subordinated debt holders. As a result, the Group is able to enhance the returns earned on its equity capital.
At 31 December 2005 the Group had £23.0 billion (31 December 2004: £19.3 billion) of total capital employed in its trading operations which is efficiently financed by a combination of equity shareholders' funds, preference capital, subordinated debt and borrowings.
| 31 December 2005 | 31 December 2004 | |
|---|---|---|
| Total shareholders' funds – EEV basis (including minority interests) | £17.5 billion | £14.0 billion |
| Total capital employed by business operations | £23.0 billion | £19.3 billion |
| Net asset value per share | 622 pence | 511 pence |
The significant increase in shareholders' funds reflects strong operational performance and the significant investment gains recorded during the year as well as the capital raised as part of the acquisition of RAC in May. Net asset value per ordinary share, based on equity shareholders' funds, was higher at 622 pence per share.
Regulatory bases
EU Groups directive
| 31 December 2005 | 31 December 2004 | |
|---|---|---|
| Insurance Groups Directive (IGD) excess solvency | £3.5 billion | £3.6 billion |
| Cover (times) over EU minimum | 1.8 times | 1.9 times |
Aviva Group had an estimated excess regulatory capital, as measured under the EU Groups Directive, of £3.5 billion at 31 December 2005 (31 December 2004: £3.6 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 life funds. The minimum solvency requirement for the Group's European businesses is based on the Solvency 1 Directive. In broad terms, for EU operations, this is set at 4% and 1% of non-linked and unit-linked life reserves, respectively and for Aviva's general insurance portfolio of business is the higher of 18% of gross premiums or 26% of gross claims, in both cases adjusted to reflect the level of reinsurance recoveries. For the Group's major non-European businesses (the US, Australia and Canada) a risk charge on assets and liabilities approach is used. The IGD is a pure aggregation test with no credit given for the considerable diversification benefits of Aviva.
The FSA introduced further changes to the valuation rules which applied during 2005 which we signposted last year. From 1 January 2005, the valuations of non-insurance subsidiaries were restated from market value to net asset value reducing IGD by £0.6 billion. Furthermore, the FSA introduced the rules for accounting for pension fund deficits under IAS with effect from April 2005. The impact of this is to reduce Aviva's excess solvency by £0.4 billion. The impact of these valuation changes has been offset by the Group's strong solvency capital generation in the period which amounted to £1.5 billion while the acquisition of RAC reduced the excess regulatory capital by a further £0.8 billion. As previously announced, completion of the Asian general insurance business sale in the period improved the IGD excess solvency by £0.2 billion. The revised FSA rules do not incorporate the full value of the Group's pension fund deficit, inclusion of which would have the effect of reducing the IGD by £0.5 billion.
From 1 January 2005, the Group is required to monitor its capital in accordance with the requirements of the Prudential Sourcebook (PSB) as set out by the FSA. We have established the Group's risk and governance frameworks to ensure compliance and finalised the parameters and assumptions that underpin the Individual Capital Assessment (ICA). From 1 January 2006, the Group is required to have a positive IGD basis solvency level at all times. The Group's risk management processes ensure adequate review of this measure at all times.
Economic bases
We have developed a framework using ICA principles for identifying the risks that business units, and the Group as a whole, are exposed to and quantifying their impact on economic capital. The ICA estimates the capital required to mitigate the risk of insolvency to a 99.5% confidence level over a one year time horizon against financial and non-financial tests.
Currently our ICA uses a mixture of scenario based approaches and risk based capital models. The FSA will use the results of our ICA process when discussing the target levels of capital it believes the UK regulated businesses should maintain. We have been discussing the Group's ICA with the FSA over the past six months and we expect to conclude these discussions shortly.
We continue to develop our risk based capital modelling capability for all our businesses as part of our longer-term development programme for more complex risk modelling techniques, and increasingly operate our business by reference to economic and risk based capital requirements.
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) amounted to £5.4 billion (31 December 2004: £5.7 billion) after covering the minimum capital base of £4.3 billion (31 December 2004: £4.1 billion).
The table below sets out the regulatory basis of these general insurance groups at 31 December 2005 and 31 December 2004.
| 31 December 2005 | 31 December 2004 | ||||||
|---|---|---|---|---|---|---|---|
| NUI plc | CGUII Group | NUI and CGUII Group pro forma | NUI plc | CGUII Group | NUI and CGUII Group pro forma | ||
| Regulated asset value £bn | £1.0bn | £8.7bn | £9.7bn | £1.0bn | £8.8bn | £9.8bn | |
| Required minimum margin £bn | £0.4bn | £3.9bn | £4.3bn | £0.4bn | £3.7bn | £4.1bn | |
| Excess solvency margin £bn | £0.6bn | £4.8 bn | £5.4bn | £0.6bn | £5.1bn | £5.7bn | |
| Cover (times) | 2.8 times | 2.2 times | 2.3 times |
2.6 times | 2.4 times | 2.4 times |
|
Economic bases – Risk based capital
The Group uses a number of measures of risk based capital to assess its capital requirements for its general insurance businesses. Financial modelling techniques enhance our practice of active capital management, ensuring sufficient capital is available to protect against unforeseen events and adverse scenarios, and risk management. Our aim continues to be the optimal usage of capital through appropriate allocation to our businesses.
Our traditional risk based capital measure for general insurance business assesses insurance market and credit risks and makes prudent allowance for diversification benefits. The underlying model looks at the level of capital necessary to enable the general insurance business to meet the statutory minimum solvency margin over a five year period with 99% probability of not requiring further capital. We consider risks over a five year period allowing for planned levels of business growth. Based on this model, our risk based capital requirement may be expressed at 34% of net written premiums which is equivalent to £3.5 billion (31 December 2004: £3.3 billion) of capital. This compares with a total of £5.6 billion (31 December 2004: £5.0 billion) of shareholders' capital employed in our general insurance businesses.
Life operations
Economic bases
For the Group's non-participating worldwide life assurance business the Group has set its capital requirements as the higher of:
- Target levels set by reference to own internal risk assessment and internal objectives
- Minimum capital level (i.e. level of solvency capital at which local regulator is empowered to take action)
Having undertaken an assessment of the level of operational, demographic, market and currency risk of each of our life businesses, we have quantified the levels of capital required for each business. We have expressed these as a percentage of EU minimum.
The required capital across all the Group's businesses varies depending on the level of operational, market and currency risk, between 100% and 200% of EU minimum or equivalent. In the UK we have assessed the required capital for our annuity book at 150% of the EU minimum and the remainder of the non-profit portfolio has been set at 100% of the EU minimum. The weighted average level of required capital for the Group's non-participating life business, expressed as a percentage of the EU minimum solvency margin is 128% (2004: 135%). This is a blended rate and we would expect this to change over time with product mix.
These levels of required capital are used in the calculation of the Group's embedded value to evaluate the cost of locked in capital. At 31 December 2005 the aggregate regulatory requirements based on the EU minimum test amounted to £3.9 billion (31 December 2004: £3.7 billion). At this date, the actual net worth held in the Group's long-term business was £7.2 billion (31 December 2004: £6.3 billion) which represents 183% (31 December 2004: 168%) of these minimum requirements.
UK Life operations
Available capital
The available capital of the with-profit funds is represented by the realistic orphan estate. The estate represents the assets of the long-term with-profits funds less the realistic liabilities for non-profit policies, less asset shares aggregated across the with-profit policies and any additional amounts expected at the valuation date to be paid to in-force policyholders in the future in respect of smoothing costs, guarantees and promises. Realistic balance sheet information is shown below for the three main UK with-profits funds; CGNU Life, Commercial Union Life Assurance Company (CULAC) and Norwich Union Life & Pensions (NUL&P). These realistic liabilities have been included within the long-term business provision and the liability for insurance and investment contracts on the Group's IFRS balance sheet at 31 December 2005 and 31 December 2004.
| 31 December 2005 | |||||
|---|---|---|---|---|---|
| Estimated Realistic assets £bn |
Realistic liabilities*1 £bn |
Estimated Realistic orphan estate2 £bn |
Estimated required capital margin3 £bn |
Estimated excess £bn |
|
| * These realistic liabilities include the shareholders' share of future bonuses of £0.7 billion (31 December 2004: £0.5 billion). Realistic liabilities adjusted to eliminate the shareholders' share of future bonuses are £50.5 billion (31 December 2004: £47 billion). 1 These realistic liabilities make provision for guarantees, options and promises on a market consistent stochastic basis. The value of the provision included within realistic liabilities is £0.7 billion, £0.9 billion and £3.4 billion for CGNU Life, CULAC and NUL&P respectively (31 December 2004: £0.6 billion, £0.9 billion and £3.3 billion for CGNU Life, CULAC and NUL&P respectively). 2 Estimated realistic orphan estate at 31 December 2004 was £1.7 billion, £1.6 billion and £1.2 billion for CGNU Life, CULAC and NUL&P respectively. 3 The required capital margin (RCM) is 2.7 times covered by the orphan estate (31 December 2004: 2.6 times). |
|||||
| CGNU Life | 14.0 | 11.9 | 2.1 | 0.5 | 1.6 |
| CULAC | 14.0 | 12.1 | 1.9 | 0.6 | 1.3 |
| NUL&P | 25.9 | 24.7 | 1.2 | 0.8 | 0.4 |
| Provident Mutual | 2.5 | 2.5 | – | – | – |
| Aggregate | 56.4 | 51.2 | 5.2 | 1.9 | 3.3 |
Possible reattribution of inherited estate
As previously announced, Aviva is reviewing the possibility of a reattribution of the inherited estate, or orphan assets, of two of our with-profit funds: CGNU Life and CULAC. At 31 December 2005, the estimated inherited estates of the CGNU Life and CULAC with-profits funds were £2.1 billion and £1.9 billion, respectively. At this stage, no decision has been taken to proceed with a reattribution. This will only be undertaken if there are clear benefits for both policyholders and shareholders.
Under FSA rules, one condition of the new regulations (introduced in 2005) for the reattribution of an inherited estate, is the appointment of an independent policyholder advocate to represent policyholders during the procedure, a development that Aviva welcomes. In early February 2005, Aviva was delighted to announce that Clare Spottiswoode has been nominated as the policyholder advocate and that the Financial Services Authority (FSA) has approved this nomination.
The actual appointment of the policyholder advocate would occur once terms of reference are agreed, the FSA has fully considered the outline of any reattribution scheme and if Aviva is fully satisfied that a reattribution is in the clear interests of policyholders and shareholders. The appointment is not expected to happen before the autumn of 2006.
Investment mix
The aggregate investment mix of the assets in the three main with-profit funds at 31 December 2005 was:
| 31 December 2005 % |
31 December 2004 % |
|
|---|---|---|
| Equity | 42% | 36% |
| Property | 15% | 15% |
| Fixed interest | 37% | 43% |
| Other | 6% | 6% |
| 100% | 100% | |
The equity backing ratio, including property, supporting with-profit asset shares is 72% in CGNU Life and CULAC and 60% in NUL&P. With-profit new business is mainly written through CGNU Life.
