Interim results - 6 months ended 30 June 2007
Operating and financial review
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:
- 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 business unit 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.
One of our key strategic aims is to ensure that we continue to optimise our capital base. We consider a variety of techniques to achieve this aim, such as reviewing the potential to securitise parts of the insurance portfolios and initiatives to further enhance our management of financial risk. In undertaking this work we recognise the requirements of a range of stakeholders including shareholders, regulators and rating agencies. The overall capital risk appetite is managed by reference to capital constraints imposed by targets in relation to solvency (including IGD and ICA), ratings, borrowing and liquidity and dividend capacity.
Return on equity shareholders' funds
The Group's annualised post-tax operating return on equity shareholders' funds was 11.6% (2006: 14.0%) reflecting the impact of a higher opening capital base following organic growth in long-term operations, operational results including the effect of adverse weather within general insurance and movement in equity markets. 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 on an EEV basis.
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:-
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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.
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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.
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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 2007 the Group had £26.7 billion (31 December 2006: £25.9 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 2007 | 31 December 2006 | |
|---|---|---|
| Equity shareholders' funds - EEV basis | £19.1 billion | £17.5 billion |
| Total shareholders' funds - EEV basis (including minority interests) | £22.7 billion | £20.9 billion |
| Total capital employed by business operations | £26.7 billion | £25.9 billion |
| Net asset value per share | 737 pence | 683 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 737 pence per share.
Regulatory bases
EU Groups directive
| 30 June 2007 | 31 December 2006 | |
|---|---|---|
| Insurance Groups Directive (IGD) excess solvency | £4.0 billion | £3.5 billion |
| Cover (times) over EU minimum | 1.8 times | 1.8 times |
Aviva Group had an estimated excess regulatory capital, as measured under the EU Groups Directive, of £4.0 billion at 30 June 2007 (31 December 2006: £3.5 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.
Our excess solvency of £4.0 billion reflects a net increase of £0.5 billion since 31 December 2006, driven by strong operational performance, the benefit of movements in interest rates and offset by payment of the dividend. From 31 December 2006, the Group has a regulatory obligation to have a positive solvency on an IGD basis at all times. The Group's risk management processes ensure adequate review of this measure.
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 Aviva International Insurance group (AII) and Norwich Union Insurance (NUI). The combined businesses of the AII 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 £4.2 billion (31 December 2006: £3.8 billion) after covering the minimum capital base of £4.8 billion (31 December 2006: £4.5 billion).
The table below sets out the regulatory basis of these general insurance groups at 30 June 2007 and 31 December 2006.
| 30 June 2007 | 31 December 2006 | |||||
|---|---|---|---|---|---|---|
| NUI | AII Group | NUI and AII Group pro forma | NUI | AII Group | NUI and AII Group pro forma | |
| Capital resources | £1.0 bn | £8.0 bn | £9.0 bn | £1.0 bn | £7.3 bn | £8.3 bn |
| Capital resources requirement | £0.3 bn | £4.5 bn | £4.8 bn | £0.3 bn | £4.2 bn | £4.5 bn |
| Solvency surplus | £0.7 bn | £3.5 bn | £4.2 bn | £0.7 bn | £3.1 bn | £3.8 bn |
| Cover | 3.2 times | 1.8 times | 1.9 times | 2.9 times | 1.7 times | 1.8 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.
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 (or equivalent) solvency margin remains unchanged at 134% (31 December 2006: 134%). 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 2007 the aggregate regulatory requirements based on the EU minimum test amounted to £4.5 billion (31 December 2006: £4.3 billion). At this date, the actual net worth held in the Group's long-term business was £9.6 billion (31 December 2006: £8.9 billion) which represents 214% (31 December 2006: 206%) 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-profit 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-profit 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 2007 and 31 December 2006.
| 30 June 2007 | 31 December 2006 | |||||
|---|---|---|---|---|---|---|
| Estimated Realistic assets £bn | Realistic liabilities*1 £bn | Estimated Realistic inherited estate2 £bn | Estimated risk capital margin3 £bn | Estimated excess £bn | Estimated excess £bn | |
| CGNU Life | 15.9 | (13.2) | 2.7 | (0.3) | 2.4 | 2.0 |
| CULAC | 15.1 | (12.4) | 2.7 | (0.4) | 2.3 | 2.0 |
| NUL&P4 | 28.0 | (26.0) | 2.0 | (0.4) | 1.6 | 1.2 |
| Aggregate | 59.0 | (51.6) | 7.4 | (1.1) | 6.3 | 5.2 |
- * These realistic liabilities include the shareholders' share of future bonuses of £0.7 billion (31 December 2006: £0.7 billion). Realistic liabilities adjusted to eliminate the shareholders' share of future bonuses are £50.9 billion (31 December 2006: £48.6 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, £0.6 billion and £2.5 billion for CGNU Life, CULAC and NUL&P respectively (31 December 2006: £0.5 billion, £0.7 billion and £3.0 billion for CGNU Life, CULAC and NUL&P respectively).
- 2 Estimated realistic inherited estate at 31 December 2006 was £2.5 billion, £2.5 billion and £1.8 billion for CGNU Life, CULAC and NUL&P respectively.
- 3 The risk capital margin (RCM) is 6.7 times covered by the inherited estate (31 December 2006: 4.2 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.
Potential reattribution of inherited estate
Aviva continues to pursue the potential reattribution of the inherited estates of the CGNU and CULAC with-profit funds and is currently engaged in complex and lengthy negotiations with the independent Policyholder Advocate, Clare Spottiswoode. This is the first time a reattribution on this scale has been proposed under the new regulatory process. Aviva is committed to working towards a deal but will only go ahead with a reattribution if the negotiated outcome is fair to policyholders and shareholders. Aviva expects to provide an update on the negotiations later in the year.
Investment mix
The aggregate investment mix of the assets in the three main with-profit funds at 30 June 2007 was:
| 30 June 2007 % | 31 December 2006 % | |
|---|---|---|
| Equity | 42% | 42% |
| Property | 14% | 16% |
| Fixed interest | 36% | 36% |
| Other | 8% | 6% |
| 100% | 100% |
The equity backing ratio, including property, supporting with-profit asset shares is 63% in CGNU Life and CULAC and 49% 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.
The analysis below sets out the Group's available capital resources:
| 30 June 2007 | 31 December 2006 | ||||||
|---|---|---|---|---|---|---|---|
| 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 | resources | resources | resources | resources | resources | resources | resources |
| Other sources of capital1 | resources | resources | resources | resources | resources | resources | resources |
| Unallocated divisible surplus | 0.1 | 3.1 | 10.1 | 13.3 | 2.2 | 15.5 | 14.1 |
| Adjustments onto a regulatory basis2 | - | 0.2 | 0.2 | 0.4 | 2.7 | 3.1 | 3.1 |
| Total available capital | 7.4 | 1.9 | 8.7 | 18.0 | 2.5 | 20.5 | 19.5 |
- Other sources of capital represents: subordinated debt of £2,949 million (31 December 2006: £2,937 million) issued by Aviva plc and £152 million (31 December 2006: £153 million) other qualifying capital issued by Dutch, Italian and US subsidiary undertakings.
- Including an adjustment for minorities.
- Includes the Provident Mutual with-profit fund.
- Other operations include general insurance and fund management businesses.
