Preliminary results - 12 months ended 31 December 2005

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Appendix A1

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 European Embedded Value basis provides a more accurate reflection of the performance of the Group’s life operations year on year than results under IFRS. Accordingly, the Group’s capital structure is analysed on this basis.

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.

Capital employed by segment

  2005
£m		 2004
£m
     
Long-term savings 15,598 13,826
General insurance and health 5,581 5,005
Other business 1,876 838
Corporate (36) (372)
Total capital employed 23,019 19,297
     
Financed by    
Equity shareholders’ funds and minority interests 16,356 12,821
Direct capital instrument 990 990
Preference shares 200 200
     
Subordinated debt 2,808 2,847
     
External debt 1,002 1,452
Net internal debt 1,663 987
  23,019 19,297

At 31 December 2005 the Group had £23.0 billion (31 December 2004: £19.3 billion) of total capital employed in our trading operations which is efficiently financed by a combination of equity shareholders’ funds, preference capital, direct capital instruments, subordinated debt and internal and external borrowings.

In 2005, the total capital employed in our long-term savings operations increased by £1.8 billion driven by the operational results and the strong movement in equity markets in the year. The capital employed in our general insurance businesses increased by £0.6 billion reflecting the profits in the year; the capital employed in our non-insurance and corporate businesses rose by £1.3 billion from £0.5 billion to £1.8 billion reflecting the RAC acquisition.

In addition to its external funding sources, the Group has a number of internal debt arrangements in place. These have allowed the assets supporting technical liabilities to be invested into the pool of central assets for use across the Group. They have also enabled the shareholders to deploy cash from some parts of the business to others in order to fund growth. Although intra-group loans in nature, they are counted as part of the capital base for the purpose of capital management. All internal loans satisfy arms length criteria and all interest payments have been made when due.

In order to better reflect the underlying level of internal leverage the presentation of internal debt was revised at the 2004 year end. The revised presentation depicts a net debt position which represents the upstream of internal loans from business operations to corporate and holding entities net of tangible assets held by these entities. The corporate net liabilities represent the element of the pension scheme deficit held centrally.

The ratio of the Group’s external debt plus subordinated debt to shareholders’ funds was 22% (31 December 2004: 31%). Fixed charged cover on an EEV basis, which measures the extent to which external interest costs are covered by EEV operating profit, was 9.6 times (31 December 2004: 8.7 times).

At 31 December 2005 the market value of the Group’s external debt, subordinated debt, preference shares, including both the Aviva plc preference shares and the General Accident plc preference shares of £250 million, within minority interests, and direct capital instrument was £5,868 million (31 December 2004: £5,953 million), with a weighted average cost of 3.8% (31 December 2004: 3.9%). The Group WACC is 6.6% and has been calculated by reference to the cost of equity and cost of debt at the relevant date. The cost of equity at 31 December 2005 was 7.6%, based on a risk free rate of 4.1%, an equity market premium of 3% and a market beta of 1.17.

Deployment of equity shareholders' funds

  2005   2004
               
  Equities
£m		 Fixed
income
securities
£m		 Other
investments
£m		 Other net
assets
£m		 Total
£m		   Total
£m
               
Assets              
Long-term savings 824 4,611 873 1,566 7,874   7,503
General insurance, health, and other business 3,679 1,519 1,274 (1,075) 5,397   4,859
  4,503 6,130 2,147 491 13,271   12,362
Goodwill         2,491   1,401
Additional and acquired value of in-force long-term business and intangible assets         7,257   5,534
Assets backing total capital employed in continuing operations         23,019   19,297
External debt         (1,002)   (1,452)
Net Internal debt         (1,663)   (987)
Subordinated debt         (2,808)   (2,847)
          17,546   14,011
               
Minority interests         (1,457)   (1,160)
Direct capital instrument         (990)   (990)
Preference capital         (200)   (200)
Equity shareholders' funds         14,899   11,661

Return on capital employed

  2005   2004
           
  Normalised
after-tax
return
£m		 Opening
equity capital
£m		 Return
on capital
%		   Return
on capital
%
           
Long-term savings 1,248 13,826 9.0%   8.9%
General insurance and health 1,002 5,005 20.0%   17.1%
Other business 78 838 9.3%   (2.0)%
Corporate (114) (372) 30.6%   40.9%
  2,214 19,297 11.5%   10.4%
Borrowings (237) (5,286) 4.5%   3.9%
  1,977 14,011 14.1%   13.9%
Minority interests (187) (1,160) 16.1%   17.5%
Direct capital instrument (29) (990) 2.9%   -
Preference capital (17) (200) 8.5%   8.5%
Equity shareholders' funds 1,744 11,661 15.0%   13.7%

The return on capital is calculated as the after-tax return on opening equity capital, based on Group operating profit, including Life EEV operating return, on continuing operations.

Sensitivity analysis

The sensitivity of the Group’s shareholders’ funds on an EEV basis at 31 December 2005 to a 10% fall in global equity markets or a rise of 1% in global interest rates is as follows:

31 December
2004
£bn		   31 December
2005
£bn		 Equities
down 10%
£bn		 Interest rates
up 1%
£bn
These sensitivities assume a full tax charge/credit on market value assumptions.
  1. Assumes EEV assumptions adjusted to reflect revised bond yields.
  2. Comprising internal, external and subordinated debt, net of corporate tangible net assets.
         
13.8 Long-term savings1 15.6 14.7 15.4
5.5 General insurance and other 7.4 7.0 7.1
(5.3) Borrowings2 (5.5) (5.5) (5.5)
14.0 Shareholders’ funds 17.5 16.2 17.0

The table above incorporates the effect on the value of the pension scheme assets of a 10% decrease in equity and a 1% increase in fixed income bond yields. The latter sensitivity also assumes an equivalent movement in both inflation and discount rate (i.e. no change to real interest rates) and, therefore, incorporates the offsetting effects of these items on the pension scheme liabilities. A 1% increase in the discount rate only has the effect of reducing the pension scheme liability by £1.7 billion thereby enhancing shareholders’ funds by £1.2 billion (after deducting tax).

Shareholders’ funds, including minority interests.

    31 December 2005
Closing shareholders' funds		   31 December 2004
Closing shareholders' funds
                 
  Note IFRS net
assets
£m		 Internally
generated
AVIF
£m		 Total
Equity
£m		   IFRS net
assets
£m		 Internally
generated
AVIF
£m		 Total
Equity
£m
Notes
  1. Goodwill of £2,491 million (2004: £1,401 million) has been allocated as follows: life assurance £848 million (2004: £812 million); general insurance and health £398 million; (2004: £465 million) and other businesses £1,245 million (2004: £124 million).
  2. Intangibles of £379 million (2004: £65 million) have been allocated as follows: general insurance and health £265 million (2004: £19 million); other businesses £114 million (2004: £46 million).
  3. The external borrowings reported in the summary consolidated balance sheet of £11,013 million (2004: £10,090 million) comprise £6,303 million (2004: £5,193 million) securitised mortgage funding, £2,808 million (2004: £2,847 million) subordinated debt, £900 million (2004: £598 million) borrowings by operating businesses and £1,002 million (2004: £1,452 million) borrowings by holding companies of the Group not allocated to operating companies (shown as external debt).
  4. Total intangible assets of £9,748 million (2004: £6,935 million) comprise goodwill of £2,491 million (2004: £1,401 million); acquired value of in-force long-term business and intangibles of £803 million (2004: £516 million) and additional value of inforce long-term business of £6,454 million (2004: £5,018 million). The associated deferred tax liability on the intangibles of £123 million (2004: nil) is included within other net assets.
  5. The post-tax pension fund deficit of £989 million has been allocated as follows: life operations £363 million, general insurance and health £532 million, other business £58 million and corporate of £36 million.
                 
Life assurance 1              
United Kingdom   2,929 3,496 6,425   3,162 2,703 5,865
France   1,177 890 2,067   1,175 644 1,819
Ireland   410 72 482   403 248 651
Italy   639 88 727   478 72 550
Netherlands (including Belgium and Luxembourg)   2,229 826 3,055   1,758 727 2,485
Poland   191 456 647   176 381 557
Spain   790 438 1,228   761 279 1,040
Other Europe   77 128 205   160 53 213
International   702 60 762   735 (89) 646
    9,144 6,454 15,598   8,808 5,018 13,826
                 
General insurance and health 1,2              
United Kingdom   2,725   2,725   2,504   2,504
France   362   362   416   416
Ireland   545   545   498   498
Netherlands   553   553   461   461
Other Europe   302   302   162   162
Canada   848   848   687   687
Other   246   246   277   277
    5,581 - 5,581   5,005 - 5,005
                 
Other business 1,2 1,876   1,876   838   838
Corporate   (36)   (36)   (372)   (372)
External debt 3 (1,002)   (1,002)   (1,452)   (1,452)
Internal debt   (1,663)   (1,663)   (987)   (987)
Subordinated debt   (2,808)   (2,808)   (2,847)   (2,847)
    (3,633) - (3,633)   (4,820) - (4,820)
Shareholders' funds, including minority interests   11,092 6,454 17,546   8,993 5,018 14,011
                 
Comprising                
Equities   4,503   4,503   3,881   3,881
Debt and fixed income securities   6,130   6,130   4,802   4,802
Property   957   957   1,292   1,292
Deposits and other investments   1,190   1,190   1,480   1,480
Intangible assets 4 3,294 6,454 9,748   1,917 5,018 6,935
Other net assets   491   491   907   907
Borrowings   (5,473)   (5,473)   (5,286)   (5,286)
    11,092 6,454 17,546   8,993 5,018 14,011

Geographical analysis of return on capital employed
For the year ended 31 December 2005

    Operating return (Note 1)   Opening
Shareholders’ funds
including minority
interests		   Return on
Capital
               
  Note Before tax
£m		 After tax
£m		   £m   %
               
Life assurance              
United Kingdom   585 409   5,865   7.0%
France   321 209   1,819   11.5%
Ireland   20 17   651   2.6%
Italy   96 60   550   10.9%
Netherlands (including Belgium and Luxembourg)   318 217   2,485   8.7%
Poland   128 104   557   18.7%
Spain   214 139   1,040   13.4%
Other Europe   33 22   213   10.3%
International   99 71   646   11.0%
               
    1,814 1,248   13,826   9.0%
               
General insurance and health              
United Kingdom   827 580   2,504   23.2%
France   35 23   416   5.5%
Ireland   171 150   498   30.1%
Netherlands   137 94   461   20.4%
Other Europe   47 32   162   19.8%
Canada   147 95   687   13.8%
Other   40 28   277   10.1%
               
    1,404 1,002   5,005   20.0%
               
Other business   111 78   838   9.3%
Corporate   (104) (114)   (372)   30.6%
External debt   (79) (67)   (1,452)   4.6%
Net internal debt 2 (73) (52)   (987)   5.3%
Subordinated debt   (169) (118)   (2,847)   4.1%
    2,904 1,977   14,011   14.1%

Notes
  1. The operating return is based upon Group operating profit, which is stated before impairment of goodwill, amortisation of additional value of in-force business, exceptional items and tax including policyholder tax, adjusted for the short-term fluctuation in investment return.
  2. The return before tax of £(73) million comprises investment return of £147 million and unallocated interest of £(220) million.

Year ended 31 December 2004

    Operating return
(Note 1)		   Opening
shareholders’ funds
including minority
interests		   Return on
Capital
               
  Note Before tax
£m		 After tax
£m		   £m   %
Notes
  1. The operating return is based upon Group operating profit, which is stated before impairment of goodwill, amortisation of additional value of in-force business, exceptional items and tax including policyholder tax, adjusted for the short-term fluctuation in investment return.
  2. The return before tax of £(84) million comprises investment return of £135 million and unallocated interest of £(219) million.
               
Life assurance              
United Kingdom   551 385   5,439   7.1%
France   286 185   1,559   11.9%
Ireland   40 35   613   5.7%
Italy   79 49   436   11.2%
Netherlands (including Belgium and Luxembourg)   277 201   2,461   8.2%
Poland   93 75   458   16.4%
Spain   180 117   916   12.8%
Other Europe   22 14   78   17.9%
International   83 60   598   10.0%
               
    1,611 1,121   12,558   8.9%
               
General insurance and health              
United Kingdom   662 484   2,711   17.9%
France   33 21   435   4.8%
Ireland   135 118   391   30.2%
Netherlands   90 67   311   21.5%
Other Europe   32 20   109   18.3%
Canada   133 86   618   13.9%
Other   41 29   246   11.8%
               
    1,126 825   4,821   17.1%
               
Other business   (21) (14)   683   (2.0)%
Corporate   (162) (81)   (198)   40.9%
External debt   (77) (65)   (1,879)   3.5%
Net internal debt 2 (84) (61)   (1,613)   3.8%
Subordinated debt   (169) (118)   (2,838)   4.2%
    2,224 1,607   11,534   13.9%

Strategic Investments

The Group has certain equity investments which are classified as strategic. The market value of these holdings and the percentage of the issued share capital of these companies held by the Group are as follows:

  Long-term business   General & Other   Market value   Proportion held
                       
  2005
£m		 2004
£m		   2005
£m		 2004
£m		   2005
£m		 2004
£m		   2005
%		 2004
%
                       
Münchener Rückversicherungs Gesellschaft 150 205   - 179   150 384   0.8% 2.5%
Unicredit Group 383 283   501 255   884 538   2.1% 2.8%
Société Générale - 242   - 2   - 244   - 1.1%
                       
  533 730   501 436   1,034 1,166      

Group Capital Resources

During 2004, the FSA published Policy Statement PS04-24 which requires the Group to disclose the Group Capital Resources (GCR), the Capital Resources Requirement (CRR) and the resulting surplus or deficit. The statement for 2005 is given in the table below. This information has been published by the Group in prior years and represents the surplus calculated in accordance with the Insurance Groups’ Directive (IGD).

In 2005, the FSA issued further guidance in the Consultation Paper CP05-09. The FRS 27 Group Capital Statement shows the Group’s capital resources on a regulatory basis; following publication of CP05-09, the Group is required to reconcile this to the Group’s capital resources on a statutory reporting basis. This reconciliation is given in the second table below.

  31 December 2005
  UK Life
Funds
£bn		 IGD solvency
£bn		 Group
Total
£bn
Group Capital Resources (PS04-24) 3.1 7.8 10.9
Less: Capital Resources Requirement (3.1) (4.3) (7.4)
Group surplus - 3.5 3.5

Under the FSA rules the Group capital resource amount relating to UK life funds is set at the lower of the regulatory capital requirement and the actual regulatory capital. The UK Life funds are excluded from the IGD solvency calculation.

The FRS 27 Group capital statement shows the Group’s capital resources on a regulatory basis; the FSA, following publication of the Consultation Paper CP05-09, requires the Group to reconcile this to the Group’s resources on a statutory reporting basis. The Group Capital Adequacy Report is prepared in accordance with the FSA’s valuation rules and brings in capital in respect of the with-profit funds equal to the UK Life Capital Resources Requirement; the FRS 27 disclosure brings in the totality of the with-profit capital resources.

  31 December 2005
  £bn
Total capital and reserves (IFRS basis) 11.1
Plus: Other qualifying capital 2.9
Plus: UK Life Funds (restricted at amount of regulatory capital requirements) 3.1
Less: Goodwill, acquired AVIF and intangible assets (3.1)
Less: Other adjustments to restate from IFRS to regulatory basis (3.1)
Group Capital Resources (PS04–24) 10.9

The Group Capital Resources can be analysed as follows:

  31 December 2005
  £bn
Core Tier 1 Capital 6.5
Innovative Tier 1 Capital 1.0
Total Tier 1 Capital 7.5
Upper Tier 2 Capital 1.7
Lower Tier 2 Capital 1.7
Group Capital Resources Tier 1 & Tier 2 Capital (PS04–24) 10.9
   
Less: UK Life Funds (restricted at amount of regulatory capital requirements) (3.1)
Plus: Actual UK life fund capital resources 6.5
Less: Assets treated as inadmissible at local level (0.7)
Total per FRS 27 capital position statement 13.6

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