Interim results for 6 months ended 30 June 2006
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”) with a negative outlook from Moody’s. These ratings were reaffirmed at the time of the AmerUs acquisition announcement in July and reflect the Group’s strong liquidity, competitive position, capital base, increasing underlying earnings and positive strategic management. As a result of the AmerUs acquisition, Aviva’s rating from Moody’s is on review for downgrade due to AmerUs’ lower credit rating.
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 equity shareholders’ funds
The Group’s annualised post-tax operating return on equity shareholders’ funds was 14.0% (2005: 14.6%) ahead of our target of 12.5%. Opening shareholders’ funds were £3.2 billion higher impacting the return as previously indicated. 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 shareholders’ funds.
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 30 June 2006 the Group had £23.5 billion (31 December 2005: £23.0 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.
| 30 June 2006 |
31 December 2005 |
|
|---|---|---|
| Total shareholders’ funds – EEV basis (including minority interests) | £18.5 billion | £17.5 billion |
| Total capital employed by business operations | £23.5 billion | £23.0 billion |
| Net asset value per share | 643 pence | 622 pence |
The significant increase in shareholders’ funds reflects the strong operational performance in the period. Net asset value per ordinary share, based on equity shareholders’ funds, was higher at 643 pence per share.
Regulatory bases
EU Groups directive
| 30 June 2006 |
31 December 2005 |
|
|---|---|---|
| Insurance Groups Directive (IGD) excess solvency | £4.2 billion | £3.6 billion |
| Cover (times) over EU minimum | 1.9 times | 1.8 times |
Aviva Group had an estimated excess regulatory capital, as measured under the EU Groups Directive, of £4.2 billion at 30 June 2006 (31 December 2005: £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 increase in IGD excess solvency was driven by the Group’s strong solvency capital generation of £0.6 billion reflecting operational performance in the period. 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 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 £6.8 billion (31 December 2005: £5.7 billion) after covering the minimum capital base of £4.5 billion (31 December 2005: £4.4 billion).
The table below sets out the regulatory basis of these general insurance groups at 30 June 2006 and 31 December 2005.
| 30 June 2006 | 31 December 2005 | |||||
|---|---|---|---|---|---|---|
| NUI plc | CGUII Group |
NUI and CGUII Group pro forma |
NUI plc | CGUII Group |
NUI and CGUII Group pro forma |
|
| Regulated asset value £bn | £1.1 bn | £10.2 bn | £11.3 bn | £1.3 bn | £8.8 bn | £10.1 bn |
| Required minimum margin £bn | £0.4 bn | £4.1 bn | £4.5 bn | £0.4 bn | £4.0 bn | £4.4 bn |
| Excess solvency margin £bn | £0.7 bn | £6.1 bn | £6.8 bn | £0.9 bn | £4.8 bn | £5.7 bn |
| Cover (times) | 3.0 times |
2.5 times |
2.6 times |
3.4 times |
2.2 times |
2.3 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 £3.7 billion (31 December 2005: £3.5 billion) of capital. This compares with a total of £5.6 billion (31 December 2005: £5.6 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% (2005: 135%) reflecting the change in annuity required capital in the second half of 2005. 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 30 June 2006 the aggregate regulatory requirements based on the EU minimum test amounted to £4.1 billion (31 December 2005: £3.9 billion). At this date, the actual net worth held in the Group’s long-term business was £7.3 billion (31 December 2005: £7.2 billion) which represents 178% (31 December 2005: 183%) of these minimum requirements.
UK Life operations
Available capital
The available capital of the with-profit funds is represented by the realistic inherited 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 30 June 2006 and 31 December 2005.
| 30 June 2006 | 31 December 2005 |
|||||
|---|---|---|---|---|---|---|
| Estimated Realistic assets £bn |
Realistic liabilities*1 £bn |
Estimated Realistic inherited estate2 £bn |
Estimated required capital margin3 £bn |
Estimated excess £bn |
Estimated excess £bn |
|
| CGNU Life | 13.9 | (11.7) | 2.2 | 0.6 | 1.6 | 1.6 |
| CULAC | 13.6 | (11.6) | 2.0 | 0.6 | 1.4 | 1.3 |
| NUL&P | 25.4 | (23.8) | 1.6 | 1.0 | 0.6 | 0.4 |
| Provident Mutual | 2.3 | (2.3) | - | - | - | - |
| Aggregate | 55.2 | (49.4) | 5.8 | 2.2 | 3.6 | 3.3 |
* These realistic liabilities include the shareholders’ share
of future bonuses of £0.7 billion (31 December 2005: £0.7 billion).
Realistic liabilities adjusted to eliminate the shareholders’ share
of future bonuses are £48.7 billion (31 December 2005: £50.5
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 £2.8 billion for CGNU Life, CULAC and NUL&P respectively
(31 December 2005: £0.7 billion, £0.9 billion and £3.4
billion for CGNU Life, CULAC and NUL&P respectively).
2 - Estimated realistic inherited estate at 31 December 2005
was £2.1 billion, £1.9 billion and £1.2 billion for CGNU
Life, CULAC and NUL&P respectively.
3 - The required capital margin (RCM) is 2.6 times covered
by the inherited estate (31 December 2005: 2.7 times).
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 30 June 2006, the estimated inherited estates of the CGNU Life and CULAC with-profits funds were £2.2 billion and £2.0 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.
As announced in February, Aviva has nominated Clare Spottiswoode as the Policyholder Advocate, as required under the new FSA rules for the reattribution of an inherited estate. The actual appointment of the Policyholder Advocate would happen when 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. Any 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 30 June 2006 was:
| 30 June 2006 % |
31 December 2005 % |
|
|---|---|---|
| Equity | 45% | 42% |
| Property | 15% | 15% |
| Fixed interest | 36% | 37% |
| Other | 4% | 6% |
| 100% | 100% |
The equity backing ratio, including property, supporting with-profit asset shares is 76% in CGNU Life and CULAC and 63% in NUL&P. New with-profit business is mainly written through CGNU Life.
Group capital statement
The purpose of the capital statement is to set out the financial strength of the Group and to provide an analysis of the disposition and constraints over the availability of capital to meet risks and regulatory requirements. The capital statement also provides a reconciliation of shareholders’ funds to regulatory capital.
| 30 June 2006 | 31 December 2005 |
||||||
|---|---|---|---|---|---|---|---|
| UK with- profit funds3 £bn |
Other UK life operations £bn |
Overseas life operations £bn |
Total life £bn |
Other operations4 £bn |
Total £bn |
Total £bn |
|
| Total shareholders’ funds | - | 2.6 | 6.8 | 9.4 | 2.7 | 12.1 | 11.1 |
| Other sources of capital1 | - | - | 0.2 | 0.2 | 2.8 | 3.0 | 2.9 |
| Unallocated divisible surplus | 5.8 | - | 2.4 | 8.2 | - | 8.2 | 9.0 |
| Adjustments onto a regulatory basis2 | - | (1.6) | (3.5) | (5.1) | (3.1) | (8.2) | (9.4) |
| Total available capital | 5.8 | 1.0 | 5.9 | 12.7 | 2.4 | 15.1 | 13.6 |
1 - Other sources of capital represents: subordinated debt
of £2,811 million (31 December 2005: £2,808 million) issued
by Aviva plc and £119 million (31 December 2005: £119 million)
subordinated perpetual loan notes issued by a Dutch subsidiary undertaking.
2 - Including an adjustment for minorities
3 - Includes the PM with-profit fund
4 - Other operations include general insurance and fund management
businesses.
