Preliminary results - 12 months ended 31 December 2006 01 March 2007

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Operating and financial review

1. Group operating profit before tax

The Group’s operating profit before tax, including life EEV operating return, grew 12% to £3,245 million (2005: £2,904 million) reflecting strong operational performance. On an IFRS basis, operating profit before tax amounted to £3,110 million (2005: £2,128 million), an increase of 46%. This robust set of results has been achieved by our continued focus on profitable growth, by growing and strengthening our distribution channels, exploiting our scale advantages in pricing and costs, in addition to our disciplined approach to underwriting and efficient claims management.

  EEV basis IFRS basis
  2006 £m 2005 £m 2006 £m 2005 £m
Life EEV operating return / IFRS long-term business profit 2,033 1,814 1,896 1,065
Fund management 96 83 155 124
General insurance and health 1,680 1,551 1,680 1,551
Other:
Other operations (23) 28 (80) (40)
Corporate costs (160) (136) (160) (136)
Unallocated interest charges (381) (436) (381) (436)
Operating profit before tax 3,245 2,904 3,110 2,128
Profit before tax attributable to shareholders 4,165 5,283 2,977 2,528
Equity shareholders' funds 17,531 14,899 11,176 8,774

2. Long-term savings

We achieved continued strong growth in 2006, with worldwide long-term savings sales 21% higher at £30.8 billion (2005: £25.6 billion) benefiting from both excellent sales growth in the UK of 31% to £13.6 billion and our strong, well diversified international portfolio where sales grew by 13% to £17.1 billion and comprised 56% of total sales. Worldwide life and pension sales increased by 17% to £25.9 billion (2005: £22.2 billion) and we achieved excellent investment sales growth of 48% to £4.9 billion (2005: £3.3 billion).

  2006 Local currency growth
Long-term savings sales Life and pensions £m Retail investments £m Total £m Life and pensions % Retail investments % Total %
Continental Europe 12,840 891 13,731 9% (13)% 8%
Rest of the World 1,866 1,564 3,430 49% 38% 44%
International 14,706 2,455 17,161 13% 14% 13%
United Kingdom 11,146 2,455 13,601 21% 112% 31%
Total new business sales on a present value of new business premium (PVNBP) basis 25,852 4,910 30,762 17% 48% 21%

United Kingdom

Our UK life business had an excellent year. Total long-term sales increased by 31% to £13,601 million (2005: £10,345 million) reflecting broad based growth underpinned by the effective implementation of the company’s A-day strategy, product developments throughout the year, an increase in customer confidence, increased pensions business within the market following A-day and buoyant equity markets. Within this total, life and pensions new business sales grew by 21% to £11,146 million (2005: £9,185 million), with particularly strong growth in pension and bond sales. Investment sales were exceptionally strong, up 112% to £2,455 million (2005: £1,160 million), driven by new fund offerings and strong investment markets. Our share of sales through the bancassurance partnership with the Royal Bank of Scotland Group was up by 58% to £1,169 million (2005: pound;742 million), reflecting an increased focus from both partners, a rise in the number of sales advisers and introduction of new product propositions. Total sales momentum continued throughout the year, with sales in the second half of the year ahead of those in the first half. The company increased its full year 2006 life and pensions market share position to 10.9% (full year 2005: 10.5%).

Norwich Union has a well-known brand, broad product range and strong multi-distribution capability. During 2006 the company invested in service improvements resulting in a measurable improvement in service standards during the year. The company remains committed to delivering improvements in efficiency and service levels, addressing its complex legacy systems and developing simpler customer propositions while being easy to do business with. We anticipate market growth of between 5 and 10% in 2007 and aim to grow at least in line with the market.

Aviva International

In Aviva International, our long-term savings new business sales increased by 13% to £17,161 million (2005: £15,238 million) reflecting strong growth in a number of our main markets and the benefit from businesses acquired during the year in Ireland and the United States. Growth in Asia was 91% and this region now accounts for 6% of total international sales. Our life and pension new business sales were 13% higher at £14,706 million (2005: £13,061 million), while investment sales grew by 14% to £2,455 million (2005: £2,177 million), primarily reflecting increased sales through the Navigator platform in Australia and Singapore.

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.

Continental Europe

Life and pension sales in continental Europe grew 9% to £12,840 million (2005: £11,801 million), accounting for 50% of the group’s total life and pension sales and reflecting the success of our multi-distribution strategy, broad product offerings, expertise in equity-backed products and diversified, balanced portfolio. Investment sales were £891 million (2005: £1,026 million) reflecting increased competition in the Netherlands.

In France, where our focus has been on successfully encouraging Fourgous transfers, life and pension sales grew by 1% to £3,552 million while our bancassurance partnership with Crédit du Nord contributed strong growth. Unit-linked savings sales in France were 10% higher in 2006. Long-term savings sales were lower in the Netherlands, affected by a challenging market experiencing aggressive pricing, competition for investment funds and regulatory and fiscal changes, and also lower in Germany where a flattening yield curve reduced sales volumes.

In Ireland, life and pension sales were 93% higher at £1,273 million following the commencement of business through our bancassurance partnership with Allied Irish Banks (AIB), Ireland’s largest retail bank, in January 2006, and reflecting increased sales through the broker channel. In Spain, we continued to focus on higher margin protection and pension business while maintaining our market position. Sales grew strongly in Italy by 22% to £2,768 million benefiting from access to additional branches in the UniCredit Group network and outperformed the local market, which contracted by 9%.

In Poland and Lithuania, favourable market conditions together with product and distribution enhancements resulted in stronger long-term savings sales. Our businesses in Turkey, the Czech Republic, Hungary and Romania continue to seek to achieve strong organic growth while developing further relationships with banks and brokers.

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.

Rest of the World

In the Rest of the World, our total sales grew by 44% to £3,430 million (2005: £2,411 million) representing strong growth in Asia and the inclusion of sales of £324 million from the AmerUs business we acquired on 15 November 2006 in the United States.

Sales in Asia continued to grow as a result of our expanding distribution and broadening geographical presence. Sales in Singapore and Hong Kong grew through our strong partnership with the banking group DBS and through the broker distribution channels. We continue to make excellent progress in developing our Indian and Chinese operations. In January 2007, Aviva India announced a significant bancassurance agreement with IndusInd Bank, one of India’s fastest-growing private sector banks. Aviva India now has over 30 bancassurance distribution agreements in place. In China we are licensed to operate in 15 cities across six provinces and were ranked fifth amongst foreign joint ventures as at the end of November 2006.

We have also further strengthened our position in the Indian sub-continent through the acquisition of a 51% stake in Eagle Insurance Company Limited (Eagle), the third largest insurer in Sri Lanka in February 2006. Eagle has since entered into two bancassurance agreements.

In Australia, sales grew strongly driven by higher investment sales through Navigator, the master trust fund administration business. In the United States, the inclusion of six weeks’ of sales following the acquisition of AmerUs has boosted sales by £324 million to £884 million (2005: £527 million). Our operations based in Boston grew sales by 7% as a result of strong growth of structured settlement products following their A.M. Best rating upgrade in November 2005. Sales for the full year from AmerUs were £2,261 million.

Our acquisition of AmerUs in the United States provides us with a platform for growth in that market. In Asia, we are actively pursuing growth in markets with significant longer-term potential and further developing our relationships with local partners. We are working to finalise our new opportunity in Malaysia with Bumiputra-Commerce Holdings Berhad which was announced in January 2007 and is subject to regulatory approval.

3. Life EEV operating return

    2006 £m 2005 £m
New business contribution (after the effect of required capital) 683 612
Profit from existing business – expected return 1,011 895
  – experience variances (50) (39)
  – operating assumption changes 44 17
Expected return on shareholders' net worth 345 329
Life EEV operating return before tax 2,033 1,814
Analysed as:
Continental Europe   1,171 1,126
Rest of the World   118 99
International   1,289 1,225
United Kingdom   744 589

The Group’s life EEV operating return before tax was 12% higher at £2,033 million (2005: £1,814 million) reflecting increased contributions from both new and existing business. New business contribution after the effect of required capital also grew 12% to £683 million (2005: £612 million). New business margins before the effect of required capital of 3.5% (2005: 3.6%) have been maintained from the first half of the year while the Group’s new business margin after the effect of required capital was 2.6% (2005: 2.8%). In the UK the strong life and pension sales growth was achieved while maintaining the new business margin before and after required capital at 2.9% and 2.4%, respectively demonstrating Aviva UK’s continued focus on managing margin and volume.

  Present value of new business premiums New business contribution(1) New business margin(1,2) New business contribution(3) New business margin(2,3)
  2006 £m 2005 £m 2006 £m 2005 £m 2006 % 2005 % 2006 £m 2005 £m 2006 % 2005 %
France 3,552 3,530 153 135 4.3% 3.8% 110 91 3.1% 2.6%
Ireland 1,273 665 15 16 1.2% 2.4% 9 13 0.7% 2.0%
Italy 2,768 2,294 70 59 2.5% 2.6% 50 36 1.8% 1.6%
Netherlands (including Belgium, Germany and Luxembourg) 2,346 2,739 56 90 2.4% 3.3% 25 58 1.1% 2.1%
Poland 534 320 28 16 5.2% 5.0% 25 14 4.7% 4.4%
Spain 2,059 2,013 184 175 8.9% 8.7% 168 155 8.2% 7.7%
Other Europe 308 240 (4) (1) (1.3)% (0.4)% (6) (4) (1.9)% (1.7)%
Continental Europe 12,840 11,801 502 490 3.9% 4.2% 381 363 3.0% 3.1%
Asia 685 396 26 20 3.8% 5.1% 22 16 3.2% 4.0%
Australia 297 337 17 16 5.7% 4.7% 9 9 3.0% 2.7%
United States 884 527 20 13 2.3% 2.5% 8 7 0.9% 1.3%
Rest of the World 1,866 1,260 63 49 3.4% 3.9% 39 32 2.1% 2.5%
International 14,706 13,061 565 539 3.8% 4.1% 420 395 2.9% 3.0%
United Kingdom 4 11,146 9,185 327 269 2.9% 2.9% 263 217 2.4% 2.4%
Total life and pensions business 4 25,852 22,246 892 808 3.5% 3.6% 683 612 2.6% 2.8%

(1) Before effect of required capital which amounted to £209 million (2005: £196 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.
(4) After the effect of lapse assumption charges.

The expected returns on existing business and shareholders’ net worth were higher at £1,356 million (2005: £1,224 million) reflecting the higher start of year embedded values. Adverse experience variances of £50 million (2005: £39 million adverse) were offset by positive operating assumption changes of £44 million (2005: £17 million positive).

United Kingdom

Norwich Union delivered a record performance in 2006, with total sales, including investment sales, up 31% to £13,601 million (2005: £10,345 million). New business contribution rose 22% to £327 million (2005: £269 million) largely driven by higher volumes. Margin remained level for the full year at 2.9% (2005: 2.9%)demonstrating the company’s focus on value and volume.

On a post cost of capital basis new business contribution was £263 million (2005: £217 million) with a margin of 2.4% (2005: 2.4%).

Life EEV operating return was 26% higher at £744 million (2005: £589 million) reflecting higher levels of new business contribution and improved performance from our in-force book. Total experience variances in the year were £140 million adverse (2005: £95 million adverse) driven by exceptional expenses and lower than expected persistency experience. Positive experience variances in areas such as credit and morbidity have continued, but at a lower level than in 2005.

Adverse exceptional expenses of £149 million (2005: £151 million adverse) are due to the company’s ongoing investment in projects to deliver simpler products to the customer, and the continuing simplification of systems and processes used to administer the existing book. It is anticipated that the operational changes announced in September 2006 will serve to reduce, but not completely eliminate, this cost in 2007.

Persistency experience has continued to be adverse at £66 million (2005: £78 million adverse) particularly in relation to bonds and the re-broking of regular premium pensions business following A-day. This is after a £75 million release from A-day specific provisions made in 2005, in line with expectations.

As a result of further analysis of recent customer behaviours, the company has changed certain persistency assumptions. This has included consideration of factors such as the increasing portability of pensions products post A-day, customer outlooks being based on shorter time horizons and advisers more actively managing their customers’ changing needs. This has resulted in a strengthening of persistency assumptions by £224 million. Offsetting this, the company has clarified the financial obligations of its with-profits funds in relation to pensions deficit, resulting in a £126 million benefit, and partially adopted PS06/14 (non-profit reserving changes) resulting in a £50 million benefit. Other assumptions have also been reviewed, and whilst none are of individual significance in aggregate they produce a further benefit of £108 million. In parallel with these assumption changes the company has begun to execute a wide-ranging customer retention strategy, and is confident that this, along with an updated assumptions set, will reduce future experience variances and place the business on a sustainable basis going forward.

Continental Europe

New business contribution before the effect of required capital was £502 million (2005: £490 million). This reflected continued good performances in France, Poland, Italy and Spain partially offset by the impact of lower business volumes and margins in the Netherlands. New business margins before and after required capital were 3.9% and 3.0% respectively (2005: 4.2% and 3.1%), reflecting a reduction in margins in the Netherlands and Ireland caused by economic and operating assumption changes, offset by strong margin growth in France, Spain and Poland where the business mix moved towards more profitable and less capital-intensive products.

Life EEV operating return from our continental European businesses was £1,171 million (2005: £1,126 million). New business contribution after the effect of required capital was £18 million higher at £381 million reflecting increased contributions from France, Italy, Spain and Poland. Expected returns rose to £715 million (2005: £645 million) reflecting the higher start of year embedded value. Favourable experience variances increased to £91 million (2005: £47 million), mainly reflecting strong favourable variances in France. Operating assumption changes were negative at £16 million (2005: £71 million positive) mainly reflecting adverse assumption changes in Ireland.

France: Aviva France’s sales increased by 1% to £3,552 million (2005: £3,530 million) and to date Fourgous transfers amounted to £4.2 billion which have not been included in the new business sales figures. Unit-linked sales increased by 10% to £1,556 million (2005: £1,423 million) with unit-linked sales through AFER increasing by 32%, while sales through our bancassurance partnership with Crédit du Nord increased to £838 million (2005: £728 million). These increases were offset by reduced Euro fund sales in the non-bank channels. Our continued strategic focus on more profitable unit-linked sales resulted in a 14% increase in new business contribution to £153 million (2005: £135 million) giving a higher full year new business margin of 4.3% (2005: 3.8%). Life EEV operating return increased to £402 million (2005: £321 million). This performance primarily reflects the increased contribution from new business, higher expected returns and positive experience variances. The underlying profitability of in-force life business has been enhanced as the proportion of AFER in-force funds invested in unit-linked products increased to 18% (2005: 11%) reflecting the positive impact of Fourgous transfers. The favourable experience variance of £71 million (2005: £32 million) includes higher mortality profits and the impact of Fourgous transfers into unit-linked funds.

Ireland: Including sales through the bancassurance partnership with AIB, Hibernian’s new business sales increased by 93% to £1,273million (2005: £665 million). Sales through AIB, which commenced at the end of January 2006, amounted to £589 million. Sales through the Hibernian broker channel were 4% higher at £684 million (2005: £665 million), mainly driven by strong sales of single premium savings products partly offset by the effect of changes to lapse assumptions. New business contribution of £15 million (2005: £16 million) included £8 million through the bancassurance partnership with AIB. The total Ireland new business margin was lower at 1.2% (2005: 2.4%), reflecting continuing competitive pressure and the adverse impact of lapse assumption changes in respect of unit-linked business. Life EEV operating return was a loss of £40 million (2005: £20 million profit) and included £21 million of profit through the bancassurance partnership with AIB. The EEV operating loss reflects adverse persistency in the year and the impact of consequential changes in operating assumptions. Following the removal of market value adjustments at the beginning of 2006, Hibernian has experienced higher rates of withdrawals from its with-profits Celebration bond. Lapse assumptions have also been strengthened for unit-linked pension business and for some other single premium life products. Other assumption changes include the strengthening of annuitant mortality assumptions following a detailed review of experience and industry trends, and a one-off change in expense assumptions.

Italy: Aviva Italy outperformed the local market with sales growth of 22% to £2,768 million (2005: £2,294 million) benefiting from the launch of new and improved products and access to additional branches in the UniCredit Group network. New business contribution increased to £70 million (2005: £59 million) due to significantly higher sales, representing a new business margin of 2.5% (2005: 2.6%). Life EEV operating return rose to £110 million (2005: £96 million) mainly reflecting the new business growth.

Netherlands (including Germany and Belgium): Life and pension sales in Delta Lloyd reduced by 14% to £2,346 million (2005: £2,739 million) reflecting the challenging conditions in the Dutch and German markets, which have been affected by aggressive pricing and competition for investment funds, and by regulatory and fiscal changes in the Netherlands. Delta Lloyd continues to seek out new sales opportunities with group pensions and distribution expansion providing prospects for improvement in 2007. New business contribution was £56 million (2005: £90 million) reflecting the lower volumes and the adverse impact of the 40 basis point decrease in the bond yield within the European embedded value assumptions at the end of 2005 which resulted in a lower margin of 2.4% (2005: 3.3%). Life EEV operating return of £329 million (2005: £349 million) reflected lower contribution from new business offset by increased expected returns due to a higher start of year embedded value. On 8 February 2007, Delta Lloyd announced its acquisition of the Erasmus Group in the Netherlands which remains subject to regulatory approval. This transaction is expected to add approximately 3% to Delta Lloyd’s existing life business volumes.

Poland: CU Polska achieved life and pension sales growth of 63% to £534 million (2005: £320 million), with both the life and pension businesses showing strong performances. New business contribution was £28 million (2005: £16 million), resulting in a margin of 5.2% (2005: 5.0%). Life EEV operating return increased to £162 million (2005: £132 million) due to the higher contribution from new business together with the benefit of favourable lapse and mortality assumption changes.

Spain: Aviva Spain generated sales in 2006 of £2,059 million (2005: £2,013 million) achieving underlying growth, excluding one-off sales, of 4%. New business contribution increased to £184 million (2005: £175 million) improving the new business margin to 8.9% (2005: 8.7%) as we continue to focus on higher margin protection and pension products. Life EEV operating return increased to £221 million (2005: £214 million) primarily reflecting the increased contribution from new business which was partially offset by adverse lapse assumption changes on protection business.

Other Europe: Aviva’s other European businesses are based in the Czech Republic, Hungary, Romania, Russia and Turkey. These businesses generated increased life and pension sales of £308 million (2005: £240 million, including £45 million from the Portuguese business which was disposed of in October 2005), due primarily to a strong increase in sales in Hungary ahead of changes in the tax regime. Strong momentum in sales over the last quarter of 2006 in Turkey also contributed to this performance. Our Russian business received its licence in March 2006 and trading has commenced in corporate sales on a limited scale. Life EEV operating return for the other European businesses was a loss of £13 million (2005: £6 million loss, including £3 million profit from Portugal), reflecting the developing nature of these operations.

Rest of the World

New business contribution before the effect of required capital was £63 million (2005: £49 million). This reflected continued strong growth in Asia and included £12 million of contribution from AmerUs in the six weeks following acquisition. New business margin was 3.4% (2005: 3.9%) mainly reflecting higher volume but lower margin sales in Singapore.

Life EEV operating return from our international businesses was £118 million (2005: £99 million) and included £22 million EEV operating return from the AmerUs business in the six weeks following acquisition. New business contribution after the effect of required capital was £39 million (2005: £32 million) including £8 million contribution from AmerUs. Expected returns rose to £80 million (2005: £56 million). Experience variances were negative £1 million (2005: £9 million positive) and operating assumption changes were neutral (2005: £2 million positive).

Asia: Our businesses across Asia achieved substantial life and pension sales growth of 70% to £685 million (2005: £396 million). In Singapore and Hong Kong, sales increased to £319 million (2005: £227 million) and to £216 million (2005: £103 million), respectively reflecting strong sales through Aviva’s partnership with banking group DBS together with an increase in sales through other distribution channels, notably in the developing IFA channel in Hong Kong. In India and China, sales continue to grow rapidly with our share of sales amounting to £84 million (2005: £32 million) and £50 million (2005: £35 million), respectively. In Sri Lanka, sales have amounted to £16 million since the acquisition of Eagle. New business contribution in Asia increased by 30% to £26 million (2005: £20 million) with a new business margin of 3.8% (2005: 5.1%) reflecting stronger sales of lower margin limited period single premium offerings in Singapore. The life EEV operating return from our businesses in Asia was £37 million (2005: £30 million), principally due to higher new business contribution.

Australia: Life and pension sales in Australia were £297 million (2005: £337 million). New business contribution was £17 million (2005: £16 million) with a new business margin of 5.7% (2005: 4.7%) benefiting from improved business mix, in particular a higher proportion of protection business. The life EEV operating return was £49 million (2005: £44 million) benefiting from favourable experience variances.

United States: Aviva’s presence in the United States market increased four-fold1 following the completion of the acquisition of AmerUs on 15 November 2006. Life and pension sales increased by 70% to £884 million (2005: £527 million) including £324 million of sales from AmerUs in the six weeks following acquisition. New business contribution increased to £20 million (2005: £13 million) while margin decreased to 2.3% (2005: 2.5%). Life EEV operating return was £32 million (2005: £25 million), including £22 million of profit from AmerUs. In our operations based in Boston, the operating profit was lower at £10 million affected by lapse variances and operating assumption changes. Full year sales by AmerUs were £2,261 million (2005: £1,882 million), including £330 million of funding agreement sales (2005: £38 million) which are irregular by nature. 2006 full year life EEV operating return for AmerUs amounted to £205 million including new business contribution of £94 million representing a new business margin of 4.2%. The margin excluding funding agreements was 3.8%.

1. Measured in terms of PVNBP

4. Bancassurance margins – before required capital, tax and minority interests

The weighted average new business margin generated through our bancassurance channels was 4.8% (2005: 5.1%) before the effect of required capital. This reflects the change in geographical mix with a lower proportion of high margin business in Spain and the impact of sales from our partnership in Ireland where margins are lower by comparison. The bancassurance margin net of required capital was 4.0% (2005: 4.2%).

Total life and pensions Present value of new business premiums New business contribution(1) New business margin(2)
  2006 £m 2005 £m 2006 £m 2005 £m 2006 % 2005 %
France 838 728 36 30 4.3% 4.1%
Ireland 589 – 9 – 1.5% n/a
Italy 2,695 2,134 68 57 2.5% 2.7%
Netherlands 425 543 18 19 4.2% 3.5%
Spain 1,832 1,793 180 169 9.8% 9.4%
Asia 367 241 20 20 5.5% 8.3%
United Kingdom 991 636 38 16 3.8% 2.5%
Total bancassurance channels 7,737 6,075 369 311 4.8% 5.1%

(1) Before effect of required capital which amounted to £56 million (2005: £58 million).
(2) New business margin represents the ratio of new business contribution to present value of new business premiums, expressed as a percentage.

Higher unit-linked sales through our French bancassurance partnership increased the new business margin to 4.3% (2005:4.1%). Our bancassurance partnership with AIB in Ireland generated a margin of 1.5% reflecting competitive pressures. In Italy, where volumes were substantially higher, the new business margin from our bancassurance partnerships reduced to 2.5% (2005: 2.7%) as a result of a change in business mix. In Spain, our bancassurance partnerships produced an increased margin of 9.8% (2005: 9.4%) due to our focus on pension and protection products. Our bancassurance partnership with ABN AMRO in the Netherlands generated a margin of 4.2% (2005: 3.5%) with the prior year affected by a special promotion on lower margin annuity business. The new business bancassurance margin from our partnership with DBS in Singapore and Hong Kong was 5.5% (2005: 8.3%), reflecting stronger sales of lower margin limited period single premium offerings in Singapore in the second half of the year. In the UK, the new business margin generated by our partnership with RBSG was higher at 3.8% (2005: 2.5%) benefiting from sales momentum, cost efficiencies and product mix.

5. New business contribution – after deducting required capital, tax and minority interest

New business contribution after required capital, tax and minority interest increased by 10% to £376 million (2005: £341 million). The new business margin was broadly maintained at 1.7% (2005: 1.8%) with bancassurance contributing over 30% of new business profits in the year.

  Present value of new business premiums(1) New business contribution(2) New business margin(3)
  2006 £m 2005 £m 2006 £m 2005 £m 2006 % 2005 %
Bancassurance channels 4,465 3,238 121 93 2.7% 2.9%
Other distribution channels 17,607 15,815 255 248 1.4% 1.6%
Total life and pensions business 22,072 19,053 376 341 1.7% 1.8%
Analysed:
Continental Europe 9,067 8,608 162 164 1.8% 1.9%
Rest of the World 1,859 1,260 29 24 1.6% 1.9%
International 10,926 9,868 191 188 1.7% 1.9%
UK 11,146 9,185 185 153 1.7% 1.7%

(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.

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 £1,896 million (2005: £1,065 million). The increase in the year is primarily driven by the beneficial impact of the with-profit fund contributing to the pension scheme deficit funding along with the early partial implementation of PS06/14 “Prudential changes for insurers” in the UK, the rise in long-term interest rates in the Netherlands and the inclusion of post-acquisition profits from AmerUs.

The operating result from the UK with-profit business of £147 million (2005: £99 million) reflects the changes in bonus rates during 2006 which saw final and certain annual bonuses rise following strong investment performance. The total non-profit operating result increased by 90%. This result has similarly benefited from the clarification of with-profit fund financial obligations in relation to the pension scheme deficit. The partial introduction of PS06/14 has had a further beneficial result, contributing £149 million representing a reduction in technical provisions offset by related deferred acquisition cost write downs.

In continental Europe, the increase in life operating profit to£1,088 million (2005: £685 million) was driven primarily by the Netherlands and Spain. In the Netherlands where long-term interest rates and the equity markets rose in 2006, operating profit was higher at £458 million (2005: £172 million) reflecting an £82 million release from the provision for guarantees on unit-linked contracts, which contrasted with a charge in 2005, and increased realised investment gains. The operating profit in Spain increased to £126 million (2005: £89 million) due to higher sales of protection products and increased investment returns benefiting from favourable equity market conditions in the year. In France, operating profit increased to £273 million (2005: £258 million) with growth reflecting the profitable development of the business and benefits following the combination of our direct operation and one of our broker businesses this year. In Ireland, operating profit increased to £60 million (2005: £28 million) including a contribution of £45 million from the bancassurance partnership with AIB.

Our life businesses in the rest of the world reported a profit of £125 million (2005: £2 million loss, including an unfavourable change in valuation basis in Singapore). Operating profit in the United States increased to £71 million (2005: £4 million loss), with a contribution of £84 million from AmerUs in the six weeks following acquisition which included a £22 million benefit from investment gains. The increased loss from our operations based in Boston reflected increased new business strain. Operating profit from our operations in Asia and Australia increased, reflecting strong investment market performance together with favourable claims and lapse experience in Australia.

7. Fund management operating profit

Our worldwide fund management operating profit was 25% higher at £155 million (2005: £124 million) on an IFRS basis, as the momentum from the first half of the year continued. On an EEV basis, the total operating profit from our fund management businesses was £96 million (2005: £83 million) and represents the profit on those funds managed on behalf of third parties and the Group’s non-life businesses. Assets under management at 31 December2006 increased to £364 billion (31 December 2005: £322 billion) reflecting the impact of new business flows and the strong performance of worldwide investment markets.

  2006 £m 2005 £m
UK 62 36
International 14 13
Morley 76 49
France 33 26
Netherlands 37 32
Other Europe and International 15 9
International 85 67
UK (excluding Morley) (6) 8
Fund management operating profit – IFRS basis 155 124

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 £56 million (2005: £44 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, Delta Lloyd Asset Management in the Netherlands and other businesses including our fund administration business Navigator. Our international fund management operating profit was £99 million (2005: £80 million).

Morley

The Morley group contributed an overall operating profit of £79 million (2005: £52 million) to the Group’s results, including a £3 million contribution (2005: £3 million) from the pooled pensions business which is reported within the long-term business segment. Our fund management operating profit grew significantly to £76 million (2005: £49 million), reflecting increased investment management fee revenue, continued cost control and a profit contribution of £14 million (2005: £10 million) from higher performance fees which were mainly recognised in the second half of the year.

Morley’s total funds under management increased by £12 billion in 2006 to £166 billion as we achieved strong sales to third-party life companies and discretionary fund managers and also won a number of institutional mandates across our core asset classes of fixed income, UK equities, property including specialist partnership vehicles and asset allocation. Funds under management also benefited from investment market performance, the take-on of £2.3 billion of Ark Life policyholder investments in May and the acquisition of ORN Capital in June. Our fee income benefited from these new business mandates and strongly performing investment markets that, coupled with our management of our expense base, delivered a further improvement in our cost/income ratio to 72% (2005: 77%).

We aim to deliver sustainable and profitable growth through a focus on increasing our revenue by offering higher-margin products in our areas of strength while carefully managing our cost base. We continue to position our business to work with our clients to develop tailored investment solutions and capitalise on the growing demand for specialist investment products.

International

Operating profit from Aviva Gestion d’Actifs (AGA), our market-leading fund management operation in France, increased to £33 million (2005: £26 million) reflecting new business inflows, particularly from unit-linked sales, and strongly performing equity markets. AGA continued to demonstrate its expertise with over 96% of managed funds ranked in the top half for returns over five years and was ranked best fund manager over the last five years by the weekly magazine ‘Mieux Vivre Votre Argent’ in September 2006.

Operating profit from our fund management business in the Netherlands was £37 million (2005: £32 million, previously reported within non-insurance business). This improvement reflected an increase in funds under management, which included an increase in net inflows into institutional funds of £913 million (2005: £573 million).

Our other overseas businesses reported operating profits of £15 million (2005: £9 million) reflecting stronger results in our operations in Australia and Singapore. New business sales through Navigator, our fund administration business grew 48% to £1,371 million (2005: £938 million). Within this, sales in Australia increased by 34% to £1,110 million (2005: £848 million), benefiting from continuing improvements in product offerings, sustained customer service levels and its strategic investments in key distributors. Singapore reported significantly higher sales of £ 261 million (2005: £90 million) reflecting strong distribution relationships with key brokers, an increased fund choice and an ongoing buoyant economic environment.

United Kingdom (excluding Morley)

Operating losses from Norwich Union’s retail investment business amounted to £6 million (2005: £8 million profit) where increased sales through the company’s collectives investment business with RBSG resulted in a higher new business strain.

8. General insurance and health operating profit

Net written premiums from the Group’s worldwide general insurance and health business increased 3% to £10.7 billion, driven by an increase in the Netherlands of 39% to £1.8 billion. Operating profit from our worldwide general insurance and health businesses increased by 8% to £1,680 million (2005: £1,551 million).

The Group’s general insurance combined operating ratio (COR) improved to 94% (2005: 95%), comfortably 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. The worldwide expense ratio for general insurance was 13.7% (2005: 11.4%), reflecting investment in the business and brand to gain competitive advantage.

Underwriting profit for the year totalled £607 million (2005: £505 million) including £91 million of better than expected weather-related claims experience (2005: benefit of £7 million). This continued profitability demonstrates our disciplined approach to underwriting, claims management and lower claims frequency across our major businesses.

The longer-term investment return (LTIR) on general insurance and health business assets increased to £1,073 million (2005: £1,046 million) as the higher start-of-year asset base, together with positive cash inflows, more than offset the lower LTIR rates applied in 2006.

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 2006 which reflect releases from the 2005 accident year and prior. The releases mainly arise in the UK and this favourable development benefits the UK underwriting result by £435 million, with the remainder of releases arising in our European businesses. We have increased our confidence levels in our reserves over the past few years and continue to maintain our reserves at very strong levels.

  Net written premiums Underwriting result* Operating profit*
  2006 £m 2005 £m 2006 £m 2005 £m 2006 £m 2005 £m
United Kingdom 5,940 6,127 380 303 1,075 974
Continental Europe 3,287 2,754 189 164 417 390
Rest of the World 1,474 1,430 38 38 188 187
International 4,761 4,184 227 202 605 577
General insurance and health operations 10,701 10,311 607 505 1,680 1,551

* Excludes the Financial Services Compensation Scheme credit of £6 million (2005: nil).

United Kingdom

Norwich Union Insurance (NUI) has had another excellent year, delivering record profits of £1,075 million (2005: £970 million) and a COR of 95%, despite a small reduction in general insurance net written premiums to £5,583 million (2005: £5,832 million), as we continue to focus on our commitment to write profitable business.

The result has been achieved against a backdrop of increasingly tough market conditions. It includes a benefit of £75 million from better than expected weather (2005: neutral), together with savings on prior year claims that have arisen as a result of management action to control claims costs and improve processes and our reserving approach. Of the £435 million of reserves releases, of which £50 million relates to weather, approximately half reflect exceptional releases resulting from management actions. These benefits have allowed us to re-invest in the business to secure future profitability.

In commercial lines intense competition has led to a reduction in rates of around 3% (2005: 1% decrease) in commercial property but retention rates remain very strong. In commercial motor we have seen a reduction of rates of 2% (2005: 1% decrease), although we are seeing the first indications that the sector is hardening. Again retention rates have remained strong. Our disciplined approach to risk selection and underwriting continues to maintain attractive levels of profitability across all commercial classes.

In personal lines, homeowner rates have increased by 3% (2005: 6%) and again retention is strong. The personal motor market has remained challenging but the rating action we have taken is already having a positive impact on profitability, with the full year COR of 104%, 1% lower than at the half year and rates have increased by 5% on average throughout the year (2005: 4%). We are satisfied with the extent of the corrective action taken and are seeing encouraging signs that others in the market are following our lead. Following the opening of a dedicated retention centre in November, personal motor retention rates are improving.

Distribution costs have risen in 2006, with our expense ratio increasing to 13.9% (2005: 10.9%), as we have invested to secure future profitability. As flagged at the half year, the investments have been in brand presence and technology to provide better service to our brokers and to enable personal lines transactions to be performed on-line and in one place. The expense ratio has also been impacted by a full year of expenses associated with RAC Rescue, whose model includes higher costs of acquiring and administering business. In September, we announced details of our UK Cost & Efficiency programme which will deliver cost savings and enhanced cost flexibility.

Following the successful completion of the integration, RAC has made an overall contribution of £160 million to Group operating profit. Of this, £115 million is recognised within general insurance and the remainder in the results of our non-insurance operations. Specifically, we have delivered cost savings of £100 million and we remain on track to meet the target profit of £220 million in 2008.

RAC has continued to deliver excellent customer service and has been rated number one for motorists in the 2006 JD Power Roadside Assistance survey. In addition, RAC has agreed a three-year deal to provide breakdown assistance to all VW Group brands (including Audi, Lamborghini, Bentley, Seat and Skoda), commencing in the first quarter of 2007. This follows a new six-year deal with Lex Vehicle Leasing to provide roadside assistance and glass replacement, and a two-year UK roadside contract with AssetCo that were signed in the first half of the year. RAC also successfully renewed its contracts with Porsche and Volvo. Since the year end we have also successfully renewed our contract with Motability until 2014.

During 2006, we signed deals with the Post Office (to provide motor, homeowner and commercial van products), and with the broker Towergate (to provide creditor insurance). We also successfully renewed our contracts with Abbey and Saga to provide homeowner insurance, and our contract with Lloyds TSB to provide creditor insurance. We won the Insurance Times ‘General Insurer of the Year’ for the fourth consecutive year, a significant achievement that reflects the consistency of our performance across the business.

NU Healthcare is a leading UK health insurer providing medical insurance (PMI) and income protection to over 800,000 customers. The PMI health business recorded a break even result (2005: £4 million) reflecting increased strategic focus and investment in the Healthcare business.

Continental Europe

In continental Europe, our general insurance and health businesses produced an operating profit of £417 million (2005: £390 million).

In France, our general insurance and health business reported an operating profit of £63 million (2005: £35 million) with an underwriting profit of £6 million (2005: loss of £21 million). The underwriting result benefited from cost savings due to our head office relocation and favourable claims experience, resulting in an improved general insurance COR of 99% (2005: 101%). Net written premiums increased by 2% to £735 million (2005: £726 million) reflecting selective rises in rates in an increasingly competitive market, notably in commercial lines. Increased activity in our commercial operations in 2006, particularly in the health and self-employed sectors of our business, ensures that we are in a strong position to continue to grow in a competitive 2007 market place.

In Ireland, operating profit was stable at £172 million (2005: £171 million) including favourable weather-related experience of £5 million (2005: £7 million). The underwriting profit increased to £121 million (2005: £116 million) driven by improved claims costs as direct settlement was more extensively used and the number of personal injury claims fell. This led to a COR of 77% (2005: 78%). We expect an adverse impact on COR in 2007 as a result of rate reductions and claims inflation. Net written premiums increased to £519 million (2005: £499 million) despite intense competition for market share. We continue to focus on developing alternative distribution channels and on enhancing our internet portal functionality to enable us to capitalise on the expected growth of the internet channel. Building on Hibernian Life & Pension’s strategic partnership with AIB, we will commence selling motor insurance through AIB’s website, and will seek to develop further opportunities with AIB in the future. Our partnership with Tesco, through which we sell motor insurance, has produced encouraging sales volumes in 2006, while we continue to invest in flood mapping technology to improve underwriting and pricing.

In the Netherlands, operating profit from general insurance and health was £139 million (2005: £137 million). The general insurance COR improved to 89% (2005: 93%) reflecting a strong premium rating environment and favourable claims experience, including a low incidence of large claims. General insurance premiums were 3% higher at £733 million (2005: £716 million). The health COR remained at 103% on a significantly higher level of premiums of £1,022 million (2005: £554 million) following the introduction of new healthcare arrangements which merged public and private healthcare at the start of 2006 and Delta Lloyd’s success in writing new policies in 2006. In November, the proposed merger with Agis Health Insurance and Menzis Health and Income was rejected by Menzi ’ member council at a late stage in the process. Nevertheless, Delta Lloyd remains confident in the future of its healthcare businesses, underlined by its success in writing 45,000 new policies in 2006. On 8 February 2007, Delta Lloyd announced its acquisition of the Erasmus Group in the Netherlands, subject to regulatory approval. This transaction has a good strategic fit and is expected to add 12 to 15% to Delta Lloyd’s existing general insurance business volumes.

Our other European general insurance businesses, including operations in Italy, Turkey and Poland, recorded an operating profit of £43 million (2005: £47 million).

Rest of the World

Our general insurance businesses in the rest of the world achieved an operating profit of £188 million (2005: £187 million).

Our Canadian business reported a stable operating profit of £148 million (2005: £147 million) and the COR was 98% (2005: 97%). The £11 million benefit from lower than average weather-related claims has been offset by lower premium rates on commercial lines and flat rates on personal lines which were driven by legislative rate changes. Additionally rising claims inflation has caused a deterioration in the claims ratio. Although the number of policies written increased in 2006, net written premiums were stable on a local currency basis at £1,389 million (2005: £1,324 million) reflecting small decreases in premium rates and customers’ lower propensity to switch insurer resulting in high retention levels. We continue to expand our distribution capability and during 2006 invested in two market-leading group brokers in Quebec.

The operating profit from our other rest of the world businesses including the Group’s captive reinsurer was £40 million (2005: £40 million).

9. Other operations

The Group’s other operations reported a loss of £80 million (2005: loss of £40 million) on an IFRS basis. This comprises £45 million of profits from RAC non-insurance operations (2005: £30 million), lower losses from NU Life Services Ltd of £50 million (2005: loss of £66 million), a loss of £29 million relating to the development of the Lifetime and SIPP platform (2005: £14 million) and a loss of £46 million (2005: £10 million profit) from other non-insurance operations including our Dutch banking division.

Operating profit from RAC non-insurance operations, which include BSM, HPI, Auto Windscreens and Solus, amounted to £45 million reflecting the results for the entire year (2005: £30 million post-acquisition). In the second half of 2006 the Group completed the sale of the Lex brand in July for a profit of £3 million. In total, this transaction and the previous disposals of the other non-core operations of the RAC group generated sale proceeds of £358 million, and a profit on disposal of £69 million in 2006 (2005: £5 million). These businesses contributed an operating profit of £17 million in the period.

The 2006 loss from other non-insurance businesses of £46 million (2005: £10 million profit) reflects the impact in the Netherlands of increased holding company costs, a lower profit in the banking result following pricing competition for mortgage business in an environment of rising interest rates, and the inclusion of a £19 million one-off cost relating to systems migration.

On an EEV basis,our other operations recorded a loss of £23 million (2005: £28 million profit) as this excludes the majority of NU Life Services Ltd losses which are incorporated within the life EEV operating return.

10. Corporate costs

The Group’s corporate costs were higher at £160 million (2005: £136 million) despite the non-recurrence of global finance transformation costs (2005: £28 million). Within this, central costs relating to staff profit share and incentive plans rose to £17 million (2005: £7 million) while other corporate costs increased to £143 million (2005: £101 million) reflecting higher brand spend, pension funding and staff costs.

11. 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. Also included is net pension income being the expected return on pension scheme assets less the interest charge on pension scheme liabilities. Interest costs in the year were lower at £458 million (2005: £468 million). External interest costs were lower at £230 million (2005: £248 million) as senior debt was repaid at the end of 2005 while internal interest costs amounted to £228 million (2005: £220 million). Net pension income increased to £77 million (2005: £32 million) reflecting a larger increase in the expected return on assets than the interest cost on the liabilities due to asset gains in 2005 and accelerated deficit funding payments.

Interest on the £990 million direct capital instrument issued in 2004 of £52 million (2005: £42 million) is not included within unallocated interest as it is instead treated as an appropriation of profits retained in the year. The appropriation was charged upon declaration and settlement in the second half of the year. As the coupon payment attracts tax relief at 30%, the net impact of the appropriation to profit attributable to ordinary shareholders was £37 million (2005: £29 million).

12. Profit on ordinary activities before tax

  EEV basis IFRS basis
  2006 £m 2005 £m 2006 £m 2005 £m
Operating profit before tax 3,245 2,904 3,110 2,128
Impairment of goodwill (94) (43) (94) (43)
Amortisation of acquired additional value of in-force long-term business - - (100) (73)
Amortisation and impairment of intangibles (46) (21) (70) (45)
Financial Services Compensation Scheme and other levies 6 - 6 -
Profit on disposal of subsidiary and associates 161 153 222 153
Short-term fluctuations in return on investments backing general insurance and health business 149 517 149 517
Variation from longer-term investment return – life business 319 2,288 - -
Effect of economic assumption changes 671 (406) - -
Integration and restructuring costs (246) (109) (246) (109)
Profit before tax/ Profit before tax attributable to shareholders' profits 4,165 5,283 2,977 2,528

Profit before tax on an EEV basis was lower at £4,165 million (2005: £5,283 million), and includes favourable investment return variances and short-term investment fluctuations of £468 million (2005: £2,805 million) and positive economic assumption changes of £671 million (2005: £406 million negative).

During the year we completed the sale of our remaining RAC non-core businesses and our associate holding in a French online brokerage company generating disposal profits of £148 million. The sale of a minority stake in our Irish life business as part of the Ark Life transaction contributed a lower profit on disposal on an EEV basis of £25 million compared to £86 million on an IFRS basis as, under the latter, the additional value of long-term in-force business is excluded from the IFRS balance sheet. Other small disposals produced a loss of £12 million.

Groupwide integration costs totalled £41 million following the successful integration of RAC in the UK, continuing assimilation of Ark Life in Ireland and activity that commenced relating to the acquisition of AmerUs. As previously announced in September, our UK business plans to reduce duplication and improve efficiency to deliver annual cost savings of £250 million in 2008 at a cost of £250 million by the end of 2007. The project is on track and by the end of 2006 £205 million of restructuring costs have been recorded.

The variance from the longer-term investment return primarily reflects higher than assumed equity returns, particularly in the second half of the year. In the UK, the FTSE All Share index rose by 13%, the CAC 40 by 18% and the AEX by 13% from end of 2005 levels. This was partially offset by lower market values of fixed income securities due to the rise of 50 basis points and 70 basis points in UK and Euro zone bond yields, respectively in 2006. Long-term economic assumptions, which are set by reference to long-term bond yields, were revised upwards at 31 December 2006 and these higher assumptions have increased the expected value of future profits from in-force life contracts, increasing profits by £671 million.

The non-life short-term fluctuations amounted to a profit of £149 million (2005: £517 million positive) as equity markets outperformed our longer-term investment return assumptions in the year. The effect of the non-life investment market movements, profit on disposal together with integration and restructuring costs are included in the IFRS profit before tax attributable to shareholders’ profits of £2,977 million (2005: £2,528 million).

The Group’s taxation charge on an EEV basis was £1,286 million (2005: £1,601 million). This includes a charge of £1,028 million (2005: £927 million) in respect of operating profit, which is equivalent to an effective rate of 31.7% (2005: 31.9%). On an IFRS basis the effective tax rate on operating profit was 23.3% (2005: 25.2%) reflecting the use of tax losses in the life businesses and release of prior year provisions following agreements reached with tax authorities on a number of issues.

13. Dividends

Ordinary dividends

The Board has recommended a final dividend increase of 10% to 19.18 pence net per share (2005: 17.44 pence) payable on 17 May 2007 to shareholders on the register on 9 March 2007. This provides growth of 1 % in the total dividend for the year of 30.00 pence (2005: 27.27 pence). Our IFRS post-tax operating profits cover this dividend 2.80 times (2005: 2.17 times). Excluding the beneficial impacts of one-offs in 2006 and applying a normalised tax rate, the dividend cover was 2.0 times.

Preference dividends

8 3/8 % cumulative irredeemable preference shares of £1 each
The Board has recommended a dividend of 4 3/16 % per share for the six month period ending 31 March 2007 payable on 31 March 2007 to preference shareholders on the register on 9 March 2007.

8 3/4% cumulative irredeemable preference shares of £1 each
The Board has recommended a dividend of 4 3/8 % per share for the six month period ending 30 June 2007 payable on 30 June 2007 to preference shareholders on the register on 1 June 2007.

14. Pension fund deficit

At 31 December 2006 the total pension fund deficit at a group level was £973 million (gross of tax) (2005: £1,471 million) benefiting from deficit funding contributions during 2006. Following the finalisation of previously announced negotiations, agreement was reached that 12% of the deficit funding payments were to be borne by UK with-profit funds from 2006. Following a further funding contribution in 2006 we have now paid £339 million of the £700 million additional funding announced in March 2006.

15. 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 Aa3 (“excellent”) with a stable outlook from Moody’s. These ratings reflect the Group’s strong liquidity, competitive position, capital base, increasing underlying earnings and strategic and operational management.

Capital management

In managing its capital, the Group seeks to:

  1. 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;
  2. maintain financial strength to support new business growth and satisfy the requirements of its policyholders, regulators and rating agencies;
  3. retain financial flexibility by maintaining strong liquidity, including significant unutilised committed credit lines, and access to a range of capital markets;
  4. allocate capital efficiently to support growth and repatriate excess capital where appropriate; and
  5. 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 post-tax operating return on equity shareholders’ funds was 13.1% (2005: 15.0%), ahead of our 12.5% target notwithstanding the impact of opening shareholders’ funds being £3.2 billion higher than the previous year. 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:-

  1. 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 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.
  2. 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.
  3. 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 2006 the Group had £26.4 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.

  31 December 2006 31 December 2005
Total shareholders' funds – EEV basis (including minority interests) £20.9 billion £17.5 billion
Total capital employed by business operations £26.4 billion £23.0 billion
     
Net asset value per share – EEV basis 683 pence 622 pence

The significant increase in shareholders’ funds reflects strong operational performance in 2006. Net asset value per ordinary share, based on equity shareholders’ funds, was higher at 683 pence per share.

Regulatory bases

EU Groups directive

  31 December 2006 31 December 2005
Insurance Groups Directive (IGD) excess solvency £3.6 billion £3.6 billion
Cover (times) over EU minimum 1.8 times 1.8 times

Aviva Group had an estimated excess regulatory capital, as measured under the Group Capital Adequacy calculation per the EU Groups Directive, of £3.6 billion at 31 December 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 % 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 Group’s excess solvency of £3.6 billion reflects operational and investment performance generating solvency capital during the year, offset by the acquisition of AmerUs which reduced the solvency surplus by £0.7 billion, and the funding of the pension deficit. The impact of the acquisition of AmerUs reflects the £2.5 billion of acquired intangibles, including acquired value of in-force business and goodwill, offset by the positive effect of the £0.9 billion share placing to finance the transaction and a further uplift of £0.9 billion to move from IFRS to the US local solvency basis. From 31 December 2006, the Group has a regulatory obligation to have a positive solvency on an IGD basis. 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.

UK general insurance and international

Regulatory basis
Our principal UK general insurance regulated subsidiaries are Aviva International Insurance group (AII) and Norwich Union Insurance (NUI). The combined businesses of the AII Group and NUI Group have strong solvency positions. 2005 figures for the AII Group, and consequently NUI and AII Group pro forma, have been restated to reflect admissibility and counterparty restrictions relating to intercompany balances. There is no economic impact on the AII Group and no impact on the Group capital adequacy (IGD) calculation for Aviva plc.

On an aggregate basis the estimated solvency surplus representing the regulatory value of Group capital resources over the capital resources requirement amounted to £4.0 billion (31 December 2005 restated: £3.5 billion) after covering the requirement of £4.5 billion (31 December 2005 restated: £4.0 billion).

The table below sets out the regulatory basis of these general insurance groups at 31 December 2006 and 2005.

  31 December 2006 31 December 2005
  NUI AII Group NUI and AII Group pro forma NUI AII Group restated* NUI and AII Group pro forma restated*
Capital resources £bn £1.1 bn £7.4 bn £8.5 bn £1.3 bn £6.2 bn £7.5 bn
Capital resources requirement £bn £0.4 bn £4.1 bn £4.5 bn £0.4 bn £3.6 bn £4.0 bn
Solvency surplus £bn £0.7 bn £3.3 bn £4.0 bn £0.9 bn £2.6 bn £3.5 bn
Cover (times) 3.1 times 1.8 times 1.9 times 3.4 times 1.7 times 1.9 times

* Figures for AII Group, and consequently NUI and AII Group pro forma, have been restated to reflect admissibility and counterparty restrictions relating to intercompany balances following a revised application of the technical rules. There is no economic impact on the AII Group and no impact on the Group capital adequacy (IGD) calculation for Aviva plc.

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.

Life operations

Regulatory basis
For the Group’s non-participating worldwide life assurance business the Group has set its capital requirements as the higher of:

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 250% of EU minimum or equivalent for businesses. 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 or equivalent is 134% (2005: 128%). This is a blended rate and we would expect this to change over time with product mix. The increase from 2005 is due to the acquisition of AmerUs reflecting the combination of required capital for our expanded US business being assessed at 25 % of the local risk based capital requirement (2005: 200%), and the higher weighting of US operations in 2006.

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 2006 the aggregate regulatory requirements based on the EU minimum test amounted to £4.3 billion (31 December 2005: £3.9 billion). At this date, the actual net worth held in the Group’s long-term business was £8.9 billion (31 December 2005: £7.2 billion) which represents 206% (31 December 2005: 183%) of these minimum requirements. The increase in this ratio reflects the impact of favourable equity market performance on the net worth and the acquisition of AmerUs.

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 31 December 2006 and 31 December 2005.

31 December 2006 31 December 2005
  Estimated Realistic assets £bn Realistic liabilities*1 £bn Estimated Realistic inherited estate2 £bn Estimated risk capital margin3 £bn Estimated excess £bn Excess £bn
CGNU Life 14.3 (11.8) 2.5 (0.5) 2.0 1.6
CULAC 14.1 (11.6) 2.5 (0.5) 2.0 1.3
NUL&P4 27.7 (25.9) 1.8 (0.6) 1.2 0.4
Aggregate 56.1 (49.3) 6.8 (1.6) 5.2 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 shareholder ’ share of future bonuses are £48.6 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 £0.5 billion, £0.7 billion and £3.0 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 risk capital margin (RCM) is 4.2 times covered by the inherited estate (31 December 2005: 2.7 times).
  4. The NUL&P fund includes the Provident Mutual (PM) fund, which has realistic assets and liabilities of £2.3 billion and therefore does not impact the realistic inherited estate.

Possible reattribution of inherited estate

As previously announced, Aviva is continuing to review the possibility of a reattribution of the inherited estate of two of its with-profit funds: CGNU Life and CULAC. At 31 December 2006, the estimated inherited estates of the CGNU Life and CULAC with-profits funds before the estimated risk capital margin amounted to £2.5 billion each, totalling £5.0 billion.

As announced in November 2006, Aviva has appointed Clare Spottiswoode as the Policyholder Advocate with the FSA’s approval following her nomination in February 2006. At this stage, no decision has been taken to proceed with a reattribution, which will only be undertaken if there is agreement on a fair outcome for both policyholders and shareholders. This will include agreement by the independent Policyholder Advocate and Aviva on any incentive payments to eligible with-profits policyholders.

Investment mix

The aggregate investment mix of the assets in the three main with-profit funds at 31 December 2006 was:

  31 December 2006 % 31 December 2005 %
Equity 42% 42%
Property 16% 15%
Fixed interest 36% 37%
Other 6% 6%
  100% 100%

The equity backing ratio, including property, supporting with-profit asset shares is 74% in CGNU Life and CULAC and 65% in NUL&P. With-profit new business is mainly written through CGNU Life.

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