Interim results for 6 months ended 30 June 2006
Post-tax internal rate of return on life and pensions new business
The internal rate of return (IRR) on life and pensions new business for the Group was 11.8% for the six months to 30 June 2006 (full year to 31 December 2005: 12.5%).
The internal rate of return is equivalent to the discount rate at which the present value of the post-tax cash flows expected to be earned over the life time of the business written, including allowance for the time value of options and guarantees, is equal to the total invested capital to support the writing of the business. The capital included in the calculation of the IRR is the initial capital required to pay acquisition costs and set up statutory reserves in excess of premiums received (“initial capital”), plus required capital at the same level as for the calculation of new business contribution post cost of capital.
| 6 months 2006 | ||||
|---|---|---|---|---|
| Internal rate of return % |
Initial capital £m |
Required capital £m |
Total invested capital £m |
|
| Continental Europe | ||||
| France | 14% | 13 | 52 | 65 |
| Ireland | 9% | 27 | 14 | 41 |
| Italy | 11% | 17 | 33 | 50 |
| Netherlands (including Belgium, Germany and Luxembourg) | 8% | 26 | 47 | 73 |
| Poland | 18% | 5 | 3 | 8 |
| Spain | 29% | 8 | 28 | 36 |
| Other Europe | 6% | 17 | 1 | 18 |
| Rest of the World | 16% | 25 | 21 | 46 |
| International | 13% | 138 | 199 | 337 |
| UK | 10% | 219 | 76 | 295 |
| Total | 12% | 357 | 275 | 632 |
The total initial capital for life and pensions new business for the six months to 30 June 2006 of £357 million (six months to 30 June 2005: £258 million) shown above is expressed at the point of sale. Hence it is higher than the impact of writing that new business on net worth of £344 million (six months to 30 June 2005: £210 million) shown in the Analysis of movement in life and related businesses embedded value, because the latter amount includes expected profits from the point of sale to the end of the reporting period, partly offset by the expected return on the initial capital.
Aviva’s reported internal rates of return calculations are based on the total invested capital used to support the writing of the new business. However, this underestimates the returns due to the Group’s shareholders as the total invested capital includes the cash flows attributable to both the Group’s debt holders as well as the Group’s shareholders. As the cost of debt capital is significantly lower than the Group’s IRRs this underestimates the returns on new business for our shareholders measured through the reported internal rate of return calculations.
The Group could equally have defined the internal rate of return calculations based on the cash flows that are attributable to the Group’s shareholders as opposed to total cash flows.
The effect on the reported calculation of the internal rates of return on this basis is to increase the IRR for UK Life from 10.3% to 12.1%. The revised calculation assumes that the external capital composition of the Group, 30% debt and 70% equity, is used to finance the initial and required capital, and allows for the cost of debt by deducting the relevant proportion of the Group’s debt servicing costs from the future cash flows earned over the life time of the products.
The leveraged new business returns comfortably exceed the Group’s cost of equity at 30 June 2006 of 8.0% (based on a risk free rate of 4.7%, an equity risk margin of 3% and a market assessed beta of 1.1).
