Operating and financial review

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1. Group operating profit before tax

The Group delivered a robust operating profit before tax, including life EEV operating return at £3,286 million (2006 restated: £3,251 million) with strong results in the life segment offset by lower results in the general insurance segment as a result of adverse effects from weather and an increase in competition in the current year. On an IFRS basis, worldwide operating profit before tax decreased by 15% to £2,228 million (2006 restated: £2,609 million) due to the impact of adverse weather.

  EEV basis   IFRS basis
  2007
£m		 Restated*
2006
£m		   2007
£m		 Restated*
2006
£m
* 2006 comparative restated for the change in IFRS operating profit definition (impact on EEV for FSCS levies was £6 million).
Life EEV operating return / IFRS long-term business profit 2,753 2,033   1,634 1,334
Fund management 90 96   155 155
General insurance and health 1,033 1,686   1,033 1,686
Other:          
Non-insurance operations (70) (23)   (74) (25)
Corporate Centre (157) (160)   (157) (160)
Group debt costs and other interest (363) (381)   (363) (381)
Operating profit before tax 3,286 3,251   2,228 2,609
Profit before tax attributable to shareholders’ profits 2,937 4,165   1,842 2,977
Equity shareholders’ funds 20,253 17,531   12,849 11,176

2. Long-term savings

Our worldwide long-term new business sales grew strongly in 2007, with total long-term savings new business sales up 25% to £38.6 billion (2006: £30.8 billion). The overall increase reflects growth in life and pension sales of 22% to £31.6 billion (2006: £25.9 billion), and strong investment sales, up 41% to £7.0 billion (2006: £4.9 billion).

  2007   Local currency growth
Long-term savings sales Life and pensions
£m		 Retail invest-
ments
£m		 Total
£m		   Life and pensions
%		 Retail invest-
ments
%		 Total
%
United Kingdom 11,655 2,751 14,406   5% 12% 6%
Europe 14,914 1,572 16,486   15% 74% 19%
North America 3,602 - 3,602   343% - 343%
Asia Pacific 1,429 2,660 4,089   49% 67% 60%
Total new business sales on a present value of new business premium (PVNBP) basis 31,600 6,983 38,583   22% 41% 25%

United Kingdom

Our UK business had a strong 2007 despite tougher market conditions in the second half of the year. Total long-term sales increased by 6% to £14,406 million (2006: £13,601 million) with improvements across all distribution channels. Within this total, life and pensions new business sales grew by 5% to £11,655 million (2006: £11,146 million), with strong growth in individual annuities and bond sales. Investment sales were up by 12% to £2,751 million (2006: £2,455 million) despite the decline in demand for UK commercial property funds in the second half of the year. Our share of sales through the bancassurance partnership with the Royal Bank of Scotland Group (RBSG) was up by 36% to £1,587 million (2006: £1,169 million), and double the level of sales achieved in 2005. This performance was underpinned by particularly strong sales of its bond and collective investments propositions and an increase in active sales advisers to the 2007 target of 1,000. Our 2007 market share has declined to 10.6% (2006: 10.8% following restatement of sales by competitors). We retained our top-three position for each of our four key markets of annuities, savings, protection and pensions.

Norwich Union continues to leverage its market leading brand, broad product range and strong multi-distribution capability to deliver enhanced shareholder value. We’ve focused on improving our customers’ experience, and at the same time improved our efficiency. We’ve grown sales and improved brand value through joint advertising with Norwich Union Insurance and continued to expand our distribution footprint. We’ve launched two simplified products through our distribution partnership with the Post Office and recently announced the launch of our "SIPP-lite" product to enhance our pensions product range.

We remain committed to delivering improvements in efficiency and service levels, addressing complex legacy systems and developing simpler customer propositions making us easy to do business with. In March 2007, we announced a partnership with Swiss Re to outsource the administration of almost three million policies, enabling us to reduce our 550 product systems to 220. To support this we successfully transferred 1,000 employees to Swiss Re in October. Policy migration is now underway with the first phase due for completion in March 2008, and all policies migrated by early 2009. This initiative combined with other simplification activity has already allowed us to decommission over 100 systems.

We are confident in our medium to long term outlook for market growth at between 5-10% per year, however given the uncertainty over the performance of the UK economy, market growth in 2008 may be slightly lower than in 2007. The UK is the fifth largest economy in the world, yet within this market there remain large numbers of people who either do not save or who are under-protected. In 2008, our focus will remain on completing our simplification programme, driving further operational efficiencies and building on service improvements. At the same time we will remain engaged with the Government, FSA, ABI and other stakeholders on the Retail Distribution Review and National Pension Saving Scheme in order to achieve an outcome that is satisfactory for customers, distributors and the industry as a whole.

Our scale, brand, broad product offering and strong distribution footprint position us well to succeed in an uncertain 2008. Our aim remains to improve profitability and grow our new business sales at least in line with the market, while maintaining or increasing our overall new business margin from current levels.

Europe

Total sales in Aviva Europe increased 19% to £16,486 million (2006: £13,731 million). Within this, life and pension sales grew 15% to £14,914 million (2006: £12,840 million), reflecting the success of our multi-distribution strategy, broad product offerings and our diversified portfolio. Investment sales were up 74% to £1,572 million (2006: £891 million) driven by strong inflows in the Netherlands and Poland.

In the Netherlands, Delta Lloyd’s life and pension sales were up 25%, boosted by a £540 million group pension contract. Overall life and pension sales in Ireland grew by 35% with growth in both the bancassurance and broker channels being supported by new product developments and expansion of the fund range. In France, product innovation, including the modernisation of the AFER product and successful marketing campaigns, helped sales grow by 2% in a market which declined overall in 2007 due to political and equity market uncertainty.

Life sales in Spain continued to show strong growth, up 15%, reflecting the highly successful launch of the tax efficient PIAS1 product and the efficient transfer of a portfolio of pension policies of £178 million into the new joint venture with Cajamurcia. In Italy, sales grew by 5%, contrasting with the Italian market which declined during 20072. This favourable performance was generated by additional marketing campaigns and the continued development of relationships with our bank partners.

In Poland, strong sales growth of 53% resulted from the development of our distribution platform combined with a strong equity market performance and the launch of umbrella funds at the end of 2006. Life and pension sales in our other central and eastern European businesses increased by 39%, including strong sales of savings products in Hungary and Turkey. In November the merger of Aviva Turkey’s life and pensions business with AK Emeklilik was completed, which will create a strong foundation for future growth.

North America

Sales in our US life business were up 39% on a pro forma3 basis to £3,602 million (2006: £884 million), representing growth across all product lines. On a pro forma3 basis sales of annuities increased 47%, life sales grew by 9% and funding agreement sales by 42%. Funding agreement sales, an integral part of our product portfolio, are large corporate transactions and consequently vary quarter on quarter.

We continue to be optimistic in our outlook for growth in 2008 and remain on track to double the size of our business within three years of the acquisition of the former AmerUs Group which completed in late 2006.

Asia Pacific

Total long-term savings sales for the year increased by 60% to £4,089 million (2006: £2,546 million), including growth of 49% in life and pension sales to £1,429 million (2006: £982 million). This was driven primarily by significantly higher investment sales across the region through Navigator (our wrap administration platform).

In Australia, total sales grew by 46% following strategic investment in key independent financial adviser groups and favourable changes to superannuation legislation. Within this total, life and pension sales increased 44% as a result of a £64 million one-off transfer of group pension business, growth in protection business and a strongly performing retail investment sector.

Sales for the rest of Asia Pacific continued to grow as a result of our expanding distribution and broadening geographical presence. Sales in Singapore grew through our strong relationships with key brokers and those in Hong Kong through the continued good performance of our partnership with the banking group DBS. In China we have increased our presence in the country to eight provinces and are now ranked second among foreign insurers, and in India, sales have increased through bancassurance partnerships, ongoing expansion of the direct sales force and the addition of new branches in the year.

During 2007 we added two new businesses to our portfolio. In July 2007 we entered the Malaysian market through the acquisition of a 49% stake in two of CIMB Group's subsidiaries and entered into exclusive bancassurance agreements with CIMB Bank. In December 2007 we received approval from Taiwan's regulator to set up our life insurance joint venture, First Aviva, with First Financial Holdings Company (FFHC), in which we have a 49% shareholding. First Aviva commenced operations on 2 January 2008.

More recently, in January 2008, we announced our intention to form a partnership with Woori Finance Holdings Company Ltd to enter the South Korean life insurance market by acquiring a stake in LIG Insurance Co Ltd. This is expected to take place in the first half of 2008 subject to regulatory approval.

We now have operations in nine Asia Pacific markets. Our businesses are at different stages of development, and in tandem with the economic outlook for Asia which predicts growth rates of between 4.1% in Taiwan to 8.6% in China for the next five years, our outlook is very positive. We have the opportunity to actively grow our existing businesses in the region, in particular in the high growth markets of India and China. At the same time, we are assessing the potential of other markets in the region.

1 PIAS are newly introduced savings contracts with tax benefits if they are in force for ten years and if an annuity is purchased at maturity.
2 ANIA quotes market decline of 5.5%, based on new business single premium plus regular premiums, at the end of November 2007 compared to the first 11 months of 2006.
3 Pro forma increases are based upon the combined sales for the former Aviva business based in Boston and the former AmerUs Group for the 2006 year and are stated on a local currency rate basis.

3. Life EEV operating return

  2007
£m		 2006
£m
New business contribution (after the effect of required capital) 912 683
Profit from existing business    
– expected return 1,266 1,011
– experience variances (16) (50)
– operating assumption changes 114 44
Expected return on shareholders' net worth 477 345
Life EEV operating return before tax 2,753 2,033
Analysed by:    
United Kingdom 864 744
Europe 1,543 1,171
North America 255 32
Asia Pacific 91 86

Worldwide life EEV operating return before tax was 35% higher at £2,753 million (2006: £2,033 million) due to increased contributions from both new and existing business. New business contribution after the effect of required capital was 33% higher at £912 million (2006: £683 million) with the group's new business margin after the effect of required capital improving to 2.9% (2006: 2.6%).

  2007
£m		 2006
£m
New business value post cost of capital 912 683
Persistency experience variances 5 (67)
Persistency assumption changes 3 (329)
Net flows after persistency 920 287
Other experience variances (21) 17
Other operating assumption changes 111 373
Net flows after all operating experience and variances 1,010 677

After adjusting for small favourable persistency experience and assumption changes of £8 million (2006: adverse £396 million) we have generated strong net flows into our life and pensions book. Other adverse experience variances of £21 million (2006 favourable: £17 million) were offset by positive Other operating assumption changes of £111 million (2006 favourable: £373 million).

The expected returns on existing business and shareholders' net worth increased to £1,743 million (2006: £1,356 million) reflecting the higher start of year embedded values and higher economic assumptions.

  Present value of new business premiums   New business contribution(1)   New business margin(1, 2)   New business contribution(3)   New business margin(2,3)
  2007
£m		 2006
£m		   2007
£m		 2006
£m		   2007
%		 2006
%		   2007
£m		 2006
£m		   2007
%		 2006
%
United Kingdom 11,655 11,146   360 327   3.1% 2.9%   305 263   2.6% 2.4%
France 3,662 3,552   169 153   4.6% 4.3%   117 110   3.2% 3.1%
Ireland 1,730 1,273   30 15   1.7% 1.2%   25 9   1.4% 0.7%
Italy 2,924 2,768   82 70   2.8% 2.5%   61 50   2.1% 1.8%
Netherlands (including Belgium & Germany) 2,944 2,346   93 56   3.2% 2.4%   53 25   1.8% 1.1%
Poland 844 534   35 28   4.1% 5.2%   32 25   3.8% 4.7%
Spain 2,392 2,059   189 184   7.9% 8.9%   173 168   7.2% 8.2%
Other Europe(4) 418 308   - (4)   - (1.3)%   (5) (6)   (1.2)% (1.9)%
Europe 14,914 12,840   598 502   4.0% 3.9%   456 381   3.1% 3.0%
North America 3,602 884   154 20   4.3% 2.3%   108 8   3.0% 0.9%
Asia 990 685   36 26   3.6% 3.8%   27 22   2.7% 3.2%
Australia 439 297   26 17   5.9% 5.7%   16 9   3.6% 3.0%
Asia Pacific 1,429 982   62 43   4.3% 4.4%   43 31   3.0% 3.2%
Total life and pensions business 31,600 25,852   1,174 892   3.7% 3.5%   912 683   2.9% 2.6%
  1. Before effect of required capital which amounted to £262 million (2006: £209 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. 'Other Europe' is made up of the Czech Republic, Hungary, Romania, Russia and Turkey.

United Kingdom

Norwich Union delivered record sales for the second year running, with life and pension sales up 5% to £11,655 million (2006: £11,146 million). New business contribution rose 10% to £360 million (2006: £327 million), the result of sales growth and an improvement in margin to 3.1% (2006: 2.9%). This was driven by a combination of the savings from our ongoing efficiency review and our commitment to maximising shareholder value through balancing price, volume and mix.

On a post cost of capital basis new business contribution was higher by 16% at £305 million (2006: £263 million) with a margin of 2.6% (2006: 2.4%).

Life EEV operating return increased strongly by 16% to £864 million (2006: £744 million) benefiting from higher new business profitability and operational improvements in the management of existing business resulting in lower costs and improved retention. In 2006 we committed to cutting costs at the same time as improving service. We have successfully completed the efficiency review announced in 2006 and have delivered the promised £125 million of annualised savings, £108 million of which contributed to 2007 financial performance. A further £100 million annualised savings are targeted by the end of 2009 which will eliminate our existing business expense overrun.

Improved customer retention has been driven through a wide programme of initiatives including the creation of a dedicated advice team, improved customer communications and more active management of distributor commission terms. Persistency experience has substantially improved to a loss of £5 million (2006: loss of £66 million). Our focus on retention activity will continue in 2008; key components of this include the migration of individual pension policies to a single, more modern administration platform, extending the functionality of this platform to offer additional features such as wider investment fund choice, e-trading, income drawdown, and providing a free upgrade to existing personal pension customers wishing to access these features. The three-stage special bonus distribution to qualifying with-profits policyholders announced earlier this year rewards customer loyalty and improves retention.

As announced in October, we have reviewed our annuitant mortality assumptions, in particular those relating to future rates of mortality improvements. This review and research into projection methodologies has resulted in the strengthening of our best-estimate annuitant longevity assumption by increasing the minimum mortality improvement factors, bringing these into line with CMI Working Paper 27. The effect of this change is to reduce profit by £153 million. Alongside this change, we have reduced the required capital for the UK annuity business from 150% to 100% of required minimum margin, bringing it into line with the economic capital requirement for this business. This improves new and existing business profits by £14 million and £132 million respectively. The combined impact of these changes was broadly neutral.

Over the last four years we have exploited our scale by raising approximately £1 billion of reinsurance financing, including a £320 million financial reinsurance transaction in 2007, improving the returns for shareholders through the use of leveraged capital. We recently completed a capital transaction which transferred to Swiss Re an economic interest in part of the UK Life policy book to be administered by them under the outsourcing agreement made earlier in 2007. This transaction will come into effect as this business migrates to Swiss Re over 2008 and 2009. The transaction size is predicted to be £281 million, plus future profit commission. The transfer has the effect of improving the return on embedded value of the UK Life business by between 40 and 50 basis points. With-profit policies and a small non-profit book are excluded from this capital transaction.

Europe

New business contribution before the effect of required capital was £598 million (2006: £502 million). This reflected continued growth across the region, with volumes growing strongly in the Netherlands, Ireland, Spain, Poland and Italy. New business margins before and after required capital were 4.0% and 3.1% respectively (2006: 3.9% and 3.0%), reflecting increased margins in the Netherlands, where interest rate development was favourable, and improved profitability in Ireland, France and Italy.

Life EEV operating return from our continental European businesses was £1,543 million (2006: £1,171 million). New business contribution after the effect of required capital was £456 million (2006: £381 million), mainly reflecting increased contributions from the Netherlands, Italy and Ireland. Expected returns rose to £899 million (2006: £715 million) resulting from the higher start of year embedded value. Favourable experience variances added £49 million (2006: £91 million) to the Aviva Europe result, due to strong favourable variances in France and Poland while operating assumption changes from the same countries further boosted the Aviva Europe performance by £139 million (2006: £16 million negative), again reflecting the strong profitability arising from existing business in France and Poland.

France: Sales grew by 2% to £3,662 million (2006: £3,552 million) in a market which declined overall in 20074 due to political and fiscal uncertainty in the first half of the year and equity market turbulence in the second half. This strong sales performance, combined with a continued focus on profitability, resulted in a higher new business contribution of £169 million (2006: £153 million), with an increased margin of 4.6% (2006: 4.3%). The operating profit on an EEV basis of £537 million (2006: £402 million) was boosted by the increased proportion of unit-linked assets within managed funds, efficiency gains, product development and continued positive experience variances on lapses and mortality.

The Netherlands: Delta Lloyd's life and pension sales have grown by 25% to £2,944 million (2006: £2,346 million), driven by group pension scheme sales. New business contribution increased by 66% to £93 million (2006: £56 million), reflecting the sales growth and a higher margin of 3.2% (2006: 2.4%). The increase in new business profitability follows an increase in interest rates, in a market where competition and pricing remain fierce. Operating profit rose to £352 million (2006: £329 million), with the strong gains on new business profitability and increased expected returns on the in-force business being partially offset by allowances for worsening annuitant mortality.

Ireland: Overall life and pension sales increased strongly by 35% to £1,730 million (2006: £1,273 million). New business profitability has grown strongly, with new business contribution doubling to £30 million (2006: £15 million). This has been driven by strong volume growth, an increased focus on higher margin funds and product development initiatives. Over 2007, new business margin increased to 1.7% (2006: 1.2%). The operating return in 2007 increased to £77 million (2006: £40 million loss). The loss reported in 2006 reflected an exceptional level of adverse operating assumption changes.

Italy: Total sales grew by 5% to £2,924 million (2006: £2,768 million), contrasting with the Italian market which declined by more than 5% during 20075. New business profitability increased in 2007, with new business margin rising to 2.8% (2006: 2.5%). Growth in margin reflects an increased emphasis on higher margin products, including stronger sales of unit-linked contracts. The growth in volumes, together with the change in product mix, contributed to an overall new business contribution of £82 million (2006: £70 million). The operating return increased in line with the growth in new business contribution and in-force book, up 23% to £137 million (2006: £110 million).

Spain: Life sales continued to show strong growth, up 15% to £2,392 million (2006: £2,059 million) despite sales of risk products being affected by the slow down in the Spanish mortgage market. Increased sales of savings products successfully offset reduced new business contribution from mortgage related protection products and led to an overall growth in new business contribution to £189 million (2006: £184 million). This was achieved in increasingly difficult trading conditions. Overall, the growth in new business contribution, together with returns on the in-force book of business, contributed to a 7% increase in operating return to £239 million (2006: £221 million). The reduced new business margin of 7.9% (2006: 8.9%) reflects the change in business mix.

Poland: Life and pension sales have grown by 53% to £844 million (2006: £534 million). The strong growth in volumes, with increased focus on sales through our bank partners, led to an overall new business contribution of £35 million (2006: £28 million). Changes to the product and distribution mix led to a fall in the new business margin to 4.1% (2006: 5.2%). The operating return increased substantially to £206 million (2006: £162 million), with favourable lapse and mortality experience boosting the profitability of the in-force book.

Other Europe: The strong momentum in sales, increasing 39% to £418 million (2006: £308 million), helped generate a breakeven new business contribution (2006: £4 million negative). The creation of AvivaSA transformed the scale of the business in Turkey and supported the strong sales growth. Overall, the operating loss for Other Europe was lower at £5 million (2006: £13 million loss), reflecting the continued growth and development of these businesses.

North America

The life EEV operating return was £255 million (2006: £32 million) reflecting increased new business contribution and higher expected returns following the acquisition of AmerUs.

New business margins before and after the effect of required capital increased to 4.3% and 3.0% respectively (2006: 2.3% and 0.9% respectively) reflecting a favourable change in product mix towards higher margin indexed life and indexed annuity products and the discontinuance of lower margin life products as part of a product rationalisation process.

Asia Pacific

The life EEV operating return increased to £91 million (2006: £86 million), benefiting from higher new business volumes.

New business margins before and after the effect of required capital were 4.3% and 3.0% respectively (2006: 4.4% and 3.2% respectively). New business margins were influenced by the scale and timing of marketing campaigns and product launches, resulting in some volatility between quarters. Growth potential for the region remains strong and Aviva's diversified distribution model places the business in a strong position for continued future growth.

4 In GWP terms, the FFSA states that the French market for life individual products has declined 4% in 2007 compared to the 12 months of 2006.
5 ANIA quotes market decline of 5.5%, based on new business single premium plus regular premiums, at the end of November 2007 compared to the first 11 months of 2006.

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

The weighted average bancassurance new business margin for our principal bancassurance partners, before the effect of required capital, was 4.8% (2006: 4.8%). This mainly reflects increases in the UK, France and Asia being offset by a reduced margin in Spain and the Netherlands. After the effect of required capital, the bancassurance margin was 4.0% (2006: 4.0%).

Bancassurance
life and pensions		 Present value of new business premiums   New business contribution(1)   New business margin(2)
  2007
£m		 2006
£m		   2007
£m		 2006
£m		   2007
%		 2006
%
United Kingdom 1,145 991   54 38   4.7% 3.8%
France 778 838   36 36   4.6% 4.3%
Ireland 864 589   14 9   1.6% 1.5%
Italy 2,754 2,695   77 68   2.8% 2.5%
Netherlands 359 425   13 18   3.6% 4.2%
Spain 2,171 1,832   188 180   8.7% 9.8%
Europe 6,926 6,379   328 311   4.7% 4.9%
Asia Pacific 210 367   15 20   7.1% 5.4%
Principal bancassurance channels 8,281 7,737   397 369   4.8% 4.8%
  1. Before effect of required capital which amounted to £74 million (2006: £56 million).
  2. New business margin represents the ratio of new business contribution to present value of new business premiums, expressed as a percentage.

United Kingdom

New business margin from Norwich Union's bancassurance partnership with RBSG improved to 4.7% (2006: 3.8%) reflecting economies of scale from higher volumes and a more profitable product mix.

Europe

In France, the new business margin of our bancassurance joint venture was 4.6% (2006: 4.3%). In Ireland, new business margin has increased to 1.6% (2006: 1.5%) while sales through our partnership with AIB increased by 46%. The new business bancassurance margin in Italy increased to 2.8% (2006: 2.5%), reflecting a change in business mix. In Spain, our bancassurance partnerships produced a new business margin of 8.7% (2006: 9.8%), reflecting higher sales of savings products and lower sales of protection products linked to mortgages. Our bancassurance agreement with ABN AMRO in the Netherlands generated a margin of 3.6% (2006: 4.2%) again reflecting a change in business mix and tighter product margins.

Asia Pacific

The new business bancassurance margin from our partnership with DBS in Singapore and Hong Kong remained high, increasing to 7.1% (2006: 5.4%) reflecting the profitable growth of these developing operations.

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

New business contribution after required capital, tax and minority interest increased by 41% to £529 million (2006: £376 million) with a resultant new business margin of 1.9% (2006: 1.7%).

  Present value of new business premiums(1)   New business contribution(2)   New business margin(3)
  2007
£m		 2006
£m		   2007
£m		 2006
£m		   2007
%		 2006
%
Principal bancassurance channels 4,730 4,465   133 121   2.8% 2.7%
Other distribution channels 22,674 17,607   396 255   1.7% 1.4%
Total life and pensions business 27,404 22,072   529 376   1.9% 1.7%
Analysed by:                
United Kingdom 11,655 11,146   214 185   1.8% 1.7%
Europe 10,726 9,067   213 162   2.0% 1.8%
North America 3,602 884 70 5   1.9% 0.6%
Asia Pacific 1,421 975   32 24   2.3% 2.5%
  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 £1,634 million (2006 restated: £1,334 million), an increase of 21%.

United Kingdom

On an IFRS basis, life operating profit increased by 15% to £723 million (2006 restated: £629 million), due to lower expenses, higher income from unit-linked business and lower new business strain. The result included £167 million (2006: £149 million) benefit arriving from phased adoption of reserving changes introduced by PS06/14. The review of UK annuitant mortality assumptions has had a broadly neutral effect on the IFRS reported figures.

Europe

In Europe, life IFRS operating profit increased to £777 million (2006 restated: £648 million), driven primarily by increased profits in France, the Netherlands and Ireland. In France, the operating profit was higher at £243 million (2006 restated: £224 million) reflecting increased expected returns due to higher interest rates and a larger investment portfolio. In the Netherlands, operating profit on an IFRS basis was £181 million (2006 restated: £102 million) reflecting increased expected returns due to higher interest rates and more favourable mortality and other technical reserve movements. In Ireland, operating profit increased to £73 million (2006 restated: £49 million) reflecting strong business growth and improved operating performance.

North America

Life operating profit was £103 million (2006 restated: £13 million) driven primarily by the inclusion of the AmerUs business.

Asia Pacific

Life operating profit reduced in 2007 to £31 million (2006 restated: £44 million), reflecting the impact of new business strain in the developing Asian businesses.

7. Fund management operating profit

Our worldwide fund management operating profit remained stable at £155 million (2006: £155 million) on an IFRS basis. Funds under management by Aviva at 31 December 2007 grew to £316 billion (31 December 2006: £287 billion) reflecting the impact of new business and the performance of global investment markets.

  2007
£m		 2006
£m
Morley 87 76
Other UK (10) (6)
United Kingdom 77 70
France 33 33
Netherlands 23 37
Other Europe 4 3
Europe 60 73
North America 3 3
Asia Pacific 15 9
Fund management operating profit – IFRS basis 155 155

On an EEV basis, the total operating profit from our fund management businesses was £90 million (2006: £96 million) and represents the profit from those funds managed on behalf of third parties and the group's non-life businesses.

United Kingdom

Our UK fund management businesses comprise our institutional business, 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 £77 million (2006: £70 million) in the period.

Morley

IFRS fund management operating profit grew significantly to £87 million (2006: £76 million) reflecting increased investment management fee revenue resulting from business wins and investment market performance, continued cost control and focused investment in the business. In total the Morley group contributed operating profit of £91 million (2006: £79 million) to the group's results, including a £4 million contribution (2006: £3 million) from the pooled pensions business which is reported within long-term business segment.

Closing funds under management declined slightly to £165 billion (2006: £166 billion), impacted by the fall in UK property capital values.

Global equity markets returned 9.5% in sterling terms in 2007, a year that was divided into two distinct periods. Against a backdrop of solid corporate performance, share buy-backs and significant M&A activity, several indices approached or exceeded all time highs during the first half of the year. However, during the second half, problems in the US sub-prime mortgage market and subsequent global impacts (lack of credit availability and increased cost of credit, banking sector write-downs and mounting concerns of a US recession) drove investors to restructure their portfolios away from equities and resulted in market falls. Commercial property was similarly affected and posted market returns of (5.5)% for the year, the first negative year since 1992. Property company shares were also significantly impacted, falling by 35% during the year.

In common with the industry in general, the subsequent change in consumer sentiment resulted in negative cash flows in the second half of the year in respect of UK retail property funds.

Gross sales through Morley distribution channels remained strong and were achieved across a variety of asset classes and products. Average margins achieved on new business increased, in line with our strategy of targeting higher margin alternatives and specialist multi-asset mandates.

Operating losses from Norwich Union's retail investment business amounted to £10 million (2006: £6 million loss) where increased sales through the company's collectives investment business resulted in higher upfront costs.

Europe

In France, operating profit from Aviva Gestion d'Actifs (AGA) was stable at £33 million (2006: £33 million). AGA continued to demonstrate its expertise with 89% of managed funds ranked in the top half for returns over five years and for the fourth consecutive year Aviva's multi-fund life policies received a Gold Award at the 2007 Life Insurance Trophies held by the leading financial weekly Le Revenu.

Operating profit from our fund management business in the Netherlands was £23 million (2006: £37 million), reflecting lower performance related fees following the exceptional level earned in 2006. The current year result includes £2 million in respect of Cyrte Investments since its acquisition at the end of September 2007.

Asia Pacific

In Asia Pacific, our fund management and administration business consists of the successful Navigator platforms in Australia and Singapore. Operating profits improved to £15 million (2006: £9 million), reflecting the strong distribution relationships with key brokers and favourable changes to superannuation legislation in Australia.

8. General insurance and health operating profit

The Group's net written premiums from its worldwide general insurance and health businesses decreased by 1% to £10.6 billion (2006: £10.7 billion), reflecting increasing price competition across most regions.

Group operating profit from general insurance and health businesses decreased by 39% to £1,033 million (2006: £1,686 million). The worldwide general insurance combined operating ratio (COR) worsened to 100% (2006: 94%) mainly as a result of adverse weather in the UK and increased competitive pressures in this business segment across most regions. Excluding the impact of this exceptional adverse weather in the UK the group COR would have been 95%.

The general insurance and health underwriting profit decreased to £4 million (2006: £613 million) following worse than expected weather claims experience in the UK of £475 million (2006: £75 million benefit). The worldwide GI expense ratio was 13.9% (2006: 13.7%), reflecting reduced premiums and ongoing investment made to secure the future profitability of the business.

The longer-term investment return (LTIR) on general insurance and health business assets was £1,029 million (2006: £1,073 million) as the impact of the higher start-of-year asset base and higher LTIR rates in 2007 were offset by the effect of the actions taken during the second half of 2007 to reduce the level of investments held in equities. The proceeds of the equity sales were reinvested in lower risk assets which generate a lower level of longer term return.

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 favourable. As a result of the conservatism applied in setting the reserves, there are releases of £832 million (net of reinsurance) for our general insurance business and £137 million for our health operations in 2007 which reflect releases from the 2006 accident year and prior. We continue to apply our reserving policy consistently and our reserves remain at strong levels. Further description of loss development is given within Appendix B - Movements in long-term liabilities.

  Net written premiums   Underwriting result   Operating profit
  2007
£m		 2006
£m		   2007
£m		 Restated 2006
£m		   2007
£m		 Restated
2006
£m
United Kingdom 5,896 6,000   (214) 394   433 1,118
Europe 3,233 3,287   197 189   442 417
North America 1,412 1,389   18 27   154 148
Asia Pacific 28 26   3 3   4 3
Continuing operations 10,569 10,702   4 613   1,033 1,686

United Kingdom

Total operating profit of £433 million (2006: £1,118 million) includes a contribution of £53 million (2006: £37 million) from our captive reinsurance operations and health business. NU Healthcare is a leading UK health insurer providing medical insurance (PMI) and income protection to over 800,000 customers. The remaining commentary relates to Norwich Union Insurance, our UK GI business only.

2007 was a tough year for our general insurance business in the UK as we experienced a combination of higher weather claims and competitive conditions in most lines of business. We took action to deal with this as early as 2006 by increasing motor rates and we have taken further rating action in homeowners and across all commercial lines. In addition we have embarked on a transformational programme for our UK GI business which will see our expense ratio drop from 13.9% to 12.4% in 2008. In light of this, we are confident that the outlook is positive and that we will continue to 'meet or beat' our 98% COR target while maintaining our strong balance sheet to back this business.

We have reviewed our reinsurance programme protecting our UK GI business and put in place additional protection via an aggregate cover to protect us against multiple weather events like those experienced in 2007. If this additional cover had been in place in 2007 our weather related losses would have been reduced by £100 million. In addition, as part of the renewal of our main catastrophe programme, we anticipate reducing our net retention. This programme renews on 1 April.

The tough market conditions are reflected in net written premiums for Norwich Union Insurance which have fallen by 3% to £5,440 million (2006: £5,583 million) and have also contributed to the decrease in operating profit from its record level of £1,081 million in 2006 to £380 million in 2007. However, the weather had the most significant impact on 2007 results, with the summer flooding and storms in January 2007 adversely affecting profit by £475 million (2006: £75 million benefit). We continue to prudently manage our reserves to avoid future adverse claims experience. Our 2007 operating profit benefited from £430 million (2006: £385 million) in respect of prior years. Of this total, £215 million is non-recurring in nature (2006: £220 million). Our combined operating ratio rose to 106% (2006: 95%) – excluding the adverse weather, the ratio would have been 97%.

The cost and efficiency programme announced in September 2006 will deliver its anticipated benefits of £125 million from 2008. Despite the benefits accruing from this programme in 2007, our expense ratio of 13.9% is in line with the 2006 ratio, reflecting the pressure on business volumes and that overall rating has been behind cost inflation. We are committed to operational efficiency and in October we announced a programme to leverage the investments we have made in the business to deliver further cost savings. The programme will be introduced in three phases. Phase one is already in progress and is set to deliver £200 million of annualised savings by the end of 2008. The remaining phases will concentrate on simplifying our structure (a process that is already well underway) and re-engineering service and processing centres designed to deliver additional benefits in 2009 and beyond.

In our core insurance markets, we have continued to use our leading position to provide rating leadership in the currently very competitive marketplace. In personal motor, following the correction in the second half of 2006, rating has been broadly in line with claims inflation at 6% (2006: average increase of 5%), which has helped contribute to an improved combined operating ratio in this business line of 102% (2006 104%). In August we announced average rating increases of 10% on household buildings and contents policies following almost a decade of flat rates in the market. This has contributed to an overall homeowner rate increase of 7% in the year (2006: 3%).

In commercial lines, during the last quarter of 2007 we targeted increases for smaller risks and underperforming segments, after experiencing four years of market rate reductions across the board. These increases averaged 3.5% and commenced in November 2007, although rates still decreased by 2% across all commercial lines in 2007 (2006: 3% reduction). The combined operating ratio for commercial property business was 124% (2006: 79%) reflecting the adverse weather, higher than usual large claims experience and a number of environmental factors that have contributed to the deterioration in performance.

Generally, the market is showing some sign of hardening. In private motor there is now a clear upward trend particularly within the broker channel and we expect this to continue in 2008. There are signs that household is beginning to move too, as insurers react to several years of flat rates and the summer floods. In commercial lines, most large insurers are applying modest rate increases and this too is expected to continue in 2008. In both the personal and commercial markets there are still elements of severe price competition but the overall direction is upwards.

Supporting our customers when they need us most and to provide them with peace of mind is vital and the action we took during the summer floods is a clear example of the importance we place on providing excellent customer service. In response to these events we ensured a network of loss adjusters, contractors and claims teams were on site at the time (including our mobile advice centre manned by claims and repair specialists) and call centre staff numbers were doubled to deal with the extra calls we received.

Our commitment to customer service has also been recognised by a number of achievements in 2007. NUI has been voted General Insurer of the Year at the Insurance Times Awards for the fifth successive year, demonstrating the confidence and trust that independent brokers have in NUI. We were also voted General Insurer of the Year at the Personal Finance & Savings Readership Awards. NU Direct's Retention team won Customer Service Team of the Year at the National Customer Service Awards. RAC has been rated as number one for motorists in the annual JD Power survey for the second consecutive year and was also named as Breakdown and Recovery Company 2007 by the Institute of Transport Management recognising the efficient and reliable service offered.

Europe

In Europe, our general insurance and health businesses recorded an operating profit of £442 million (2006: £417 million).

In France, our general insurance and health business reported an operating profit of £70 million (2006: £63 million) with an underwriting profit of £11 million (2006: £6 million). The underwriting result benefited from our strong control of costs and favourable claims experience, with the general insurance COR stable at 99% (2006: 99%). Net written premiums were stable at £733 million (2006: £735 million), reflecting moderate general insurance premium rate increases offset by the loss of a group health contract.

In Ireland, our market leading general insurance business reported operating profit of £162 million (2006: £172 million). The underwriting profit decreased to £101 million (2006: £121 million) and the COR deteriorated to 80% (2006: 77%) reflecting intensifying competition and higher claims costs. While policy count increased, falling premium rates meant that net written premiums reduced to £474 million (2006: £519 million). The business has continued to focus on growing sales through the emerging internet channel and has successfully grown sales through both the Hibernian and AIB websites. A number of new initiatives were launched in 2007, building on the life and pensions partnership and consolidating Hibernian's position as distribution leaders.

In the Netherlands, operating profit from general insurance and health was £169 million (2006: £139 million). The general insurance COR improved to 85% (2006: 89%), following favourable development of prior year claims and the maintenance of premium rates in key areas. General insurance premiums increased to £788 million (2006: £733 million) following the inclusion of Erasmus since its acquisition in March 2007. The health underwriting result deteriorated to a loss of £45 million (2006: £33 million loss) as a result of higher claims costs, net of recoveries from the central health fund and reorganisation costs. Health premiums were 10% lower at £929 million (2006: £1,022 million) reflecting differences in the timing and size of receipts from the central risk equalisation fund.

Other general insurance operations are based in Italy, Poland and Turkey and achieved net written premium of £309 million (2006: £278 million) and an operating profit of £41 million (2006: £43 million). In Italy, following the merger of the Banca Popolare Italiana Group network with Banco Popolare di Verona e Novara SCRL (BPVN), our business has agreed an exclusive long-term distribution agreement with the newly formed bank, Banco Popolare, to sell Aviva's credit protection and non-life products through its network of circa 2,200 branches. Distribution through the new agreement has already commenced in 2008 and will create a strong basis for future growth. Towards the end of 2007, our business in Poland launched a direct motor product. We are excited about the potential of the direct insurance market in Poland and hope for further success in the development of other direct business across Europe.

North America

In Canada, operating profit was £154 million (2006: £148 million), an underlying increase of 7% in local currency terms. This result reflects an increase in investment return from higher fixed income yields and higher average asset balances partly offset by a reduction in the underwriting result to £18 million (2006: £27 million). COR remained stable at 98% (2006: 98%).

Net written premiums were £1,412 million (2006: £1,389 million). This represents an underlying 4% increase in local currency driven by growth in both personal and commercial lines volumes, particularly in property through increased warranty business. This growth was partly offset by reductions in motor premiums resulting from increased competition. In the face of this, Aviva Canada continues to take an industry leading stance, achieving growth without compromising on profitability.

Asia Pacific

The operating profit from our health insurance business in Singapore and general insurance business in Sri Lanka amounted to £4 million (2006: £3 million).

9. Other operations and regional costs

The Group's other operations recorded an operating loss of £74 million (2006 restated: loss of £25 million) on an IFRS basis. This reflected lower results in the United Kingdom and costs relating to the establishment of new regional offices.

  2007
£m		 Restated 2006
£m
United Kingdom (8) 36
Europe (49) (55)
North America (4) -
Asia Pacific (13) (6)
Total (74) (25)

United Kingdom

UK non-insurance operations reported an operating loss of £8 million (2006: £36 million profit) due to lower results from RAC non-insurance which included a contribution of £17 million in 2006 from disposed operations (Manufacturing Support Services and Lex Vehicle Leasing), and investment in the businesses of AutoWindscreens, BSM and HPI. Having completed the investment in transforming these businesses, we are looking to leverage maximum benefit from these operations. Continuing investment in the Lifetime business was £31 million (2006: £29 million).

Following the restatement of IFRS operating profit, NU Life Services covered business is now reported within the life result and comparatives have been adjusted.

Europe

The improvement in the loss to £49 million (2006: £55 million) reflects lower pension and interest charges, partially offset by the inclusion of new regional costs. In the Netherlands one-off items offset lower banking profits.

North America

The loss of £4 million (2006: nil) reflects the inclusion of new regional costs and the results of our other non-insurance businesses.

Asia Pacific

The loss of £13 million (2006: £6 million) reflects corporate brand expenditure and new regional costs.

On an EEV basis, our other operations reported a loss of £70 million (2006: £23 million loss) due to the reallocation of certain European costs to the Life EEV operating return.

10. Corporate centre

Corporate costs for the year were £157 million (2006: £160 million). Within this, costs relating to staff profit share and incentive plans were £17 million (2006: £17 million). Central spend decreased to £114 million (2006: £126 million), reflecting the drive towards a leaner activist centre. Project costs increased to £26 million (2006: £17 million) as we continue to invest in our brand and global finance strategy.

11. Group debt costs and other interest

Group debt costs and other interest of £363 million (2006: £381 million) comprise internal and external interest on borrowings, subordinated debt and intra-group loans not allocated to local business operations. Net pension income is also included, being the expected return on pension scheme assets less the interest charge on pension scheme liabilities. Net income from the staff pension scheme fell to £75 million (2006: £77 million).

Interest costs in the period were lower at £438 million (2006: £458 million) reflecting a reduction in internal interest following the restructuring of internal loan agreements. This was offset by an increase in the interest on subordinated debt due to amounts raised in December 2006 to repay locally held AmerUs debt and on commercial paper raised to help fund the AmerUs acquisition.

Interest on the £990 million direct capital instrument issued in 2004 is not included within group debt costs as it is instead treated as an appropriation of profits retained in the period.

12. Profit on ordinary activities before tax

  EEV basis   IFRS basis
  2007
£m		 2006
£m		   2007
£m		 2006
£m
Operating profit before tax 3,286 3,251   2,228 2,609
Investment return variances and economic assumption changes on long-term business 67 990   15 401
Short-term fluctuation in return on investments backing general insurance and health business (184) 149   (184) 149
Impairment of goodwill (10) (94)   (10) (94)
Amortisation and impairment of intangibles (89) (46)   (103) (64)
Profit on the disposal of subsidiaries and associates 20 161   49 222
Integration and restructuring costs (153) (246)   (153) (246)
Profit before tax / Profit before tax attributable to shareholders' profits 2,937 4,165   1,842 2,977

Profit before tax on an EEV basis was lower at £2,937 million (2006: £4,165 million), and includes investment variance and economic assumption changes of £67 million (2006: £990 million) which reflects the positive impact of £175 million due to the reduction in the UK corporate tax rate to 28% partly offset by the adverse impacts of worse than assumed equity returns and interest rate movements in the year.

The IFRS long-term business favourable investment variance (reflecting our new IFRS operating profit definition) of £15 million (2006: £401 million) comprises favourable investment variances in Europe offset by negative effects in the USA and UK. In Europe, the positive variances relate mainly to the realisation of capital gains on securities in the Netherlands and France. In the USA, realised and unrealised losses on investments were driven by the widening of credit spreads on debt securities, while in the UK there was a negative investment variance on surplus assets backing annuity business due to interest rate changes.

The negative short-term fluctuation in return on investments backing general insurance and health business of £184 million (2006: £149 million positive) is due to lower market returns compared to our longer term investment return assumptions. The Group reduced their exposure to equities through an active sell off of their equity book in the second half of the year. The effect of the non-life investment market movements and integration costs are included in the IFRS profit before tax attributable to shareholders' profits of £1,842 million (2006: £2,977 million).

Profit on disposal of subsidiaries and associates includes the sale of 50.3% of the Turkish life business as part of the joint venture agreement with Aksigorta A.S. This produced a profit of £74 million on an IFRS basis (£45 million on an EEV basis due to the additional value of long-term inforce business). This was partly offset by losses on a number of small disposals.

£153 million of integration and restructuring costs have been included in the results to 31 December 2007 (2006: £246 million). These include £45 million relating to the UK cost and efficiency programme announced back in 2006. This initiative has now been completed at a total cost of £250 million. The costs also include £82 million relating to the new savings targets announced in October 2007; further costs of this programme are expected to be £248 million spread over the next two years. The balance of £26 million relates to the completion of integration activity on Ark Life in Ireland and the former AmerUs business in the United States, which were both acquired in 2006.

13. Taxation

The taxation charge for the year was £803 million (2006: £1,286 million) on an EEV basis and includes a charge of £992 million (2006: £1,028 million) in respect of operating profit, which is equivalent to an effective rate of 30.2% (2006: 31.6%) mainly reflecting the impact of one-off tax credits due to changes in future UK tax rates and the release of provisions. The effective tax rate on IFRS operating profit is 27.2% (2006: 24.7%).

14. Earnings per share

Our IFRS earnings per share for 2007 was 49.2 pence (2006: 87.5 pence). This reflects the reduction in operating profit, mainly due to lower results in the general insurance segment as a result of adverse weather and increased competition, and net adverse short-term fluctuations and economic assumption changes.

15. Dividends

Ordinary dividends

The Board has recommended a final dividend increase of 10% to 21.10 pence net per share (2006: 19.18 pence) payable on 16 May 2008 to shareholders on the register on 28 March 2008. This provides growth of 10% in the total dividend for the year of 33.00 pence (2006: 30.00 pence). Our IFRS post-tax operating profits cover this dividend 1.60 times (2006 restated: 2.26 times), in line with our dividend cover target of 1.5–2.0 times.

Preference dividends

8 3/8% cumulative irredeemable preference shares of £1 each
On 18 January 2008 a dividend of 4 3/16% per share for the six month period ending 31 March 2008 was announced. This dividend is payable on 31 March 2008 to preference shareholders that were on the register on 8 February 2008.

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 2008 payable on 30 June 2008 to preference shareholders on the register on 9 May 2008.

16. Pension fund deficit

At 31 December 2007, the Group's overall pension fund deficit less surpluses had reduced by £795 million to £178 million (gross of tax). This was mainly due to the favourable impact on the valuation of liabilities of a 40 basis point increase in the UK real discount rate (the difference between the discount and inflation rate) during the year. In March 2006 we announced additional funding of £700 million. The final payment of £320 million will be made in March 2008.

17. Return on equity shareholders' funds

The Group's post-tax operating return on equity shareholders' funds was 11.3% (2006: 13.1%). This was lower than last year due to opening shareholders' funds being £2.6 billion higher. The return is below our target of 12.5% due to the impact of the adverse weather in the UK which has suppressed the return in the general insurance operations.

18. Capital

Capital management objectives

Aviva's capital management philosophy is focused on capital efficiency and effective risk management to support a progressive dividend policy and EPS growth. Rigorous capital allocation is one of the Group's primary strategic priorities and is ultimately governed by the Group Executive Committee.

The Group's overall capital risk appetite is set and managed with reference to the requirements of a range of different stakeholders including shareholders, policyholders, regulators and rating agencies. In managing capital we seek to:

Capital resources

The primary sources of capital used by the Group are equity shareholders' funds, preference shares, subordinated debt and borrowings. We also consider and, where efficient to do so, utilise alternative sources of capital such as reinsurance and securitisation in addition to the more traditional sources of funding. Targets are established in relation to regulatory solvency, ratings, liquidity and dividend capacity and are a key tool in managing capital in accordance with our risk appetite and the requirements of our various stakeholders.

Overall, the Group 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, Aa3 ("excellent") with a stable outlook from Moody's and A+ ("superior") with a stable outlook from AM Best. These ratings reflect the Group's strong liquidity, competitive position, capital base, increasing underlying earnings and strategic and operational management. The Group is subject to a number of regulatory capital tests and also employs economic capital measures to manage capital and risk.

Capital allocation

Capital allocation is undertaken based on a rigorous analysis of a range of financial, strategic, risk and capital factors to ensure that capital is allocated efficiently to value adding business opportunities. A clear management decision making framework, incorporating ongoing operational and strategic performance review, periodic longer term strategic and financial planning and robust due diligence over capital allocation is in place, governed by the Group Executive Committee and Group Capital Management Committee. These processes incorporate various capital profitability metrics, including an assessment of return on capital employed and internal rates of return in relation to hurdle rates to ensure capital is allocated efficiently and that excess business unit capital is repatriated where appropriate.

Different measures of capital

In recognition of the requirements of different stakeholders, the Group measures its capital on a number of different bases, all of which are taken into account when managing and allocating capital across the Group. These include measures which comply with the regulatory regimes within which the Group operates and those which the directors consider appropriate for the management of the business. The primary measures which the Group uses are:-

  1. Accounting bases
    The Group reports its results on both an IFRS and a European Embedded Value basis. The directors consider that the European Embedded Value principles provide a more meaningful measure of the long term underlying value of the capital employed in the Group's life and related businesses. This basis allows for the impact of uncertainty in the future investment returns more explicitly and is consistent with the way the life business is priced and managed. Accordingly, in addition to IFRS, we analyse and measure the net asset value and total capital employed for the Group on this basis. This is the basis on which Group Return on Equity is measured and against which the corresponding Group target is expressed.
  2. Regulatory bases
    Individual regulated subsidiaries measure and report solvency based on applicable local regulations, including in the UK the regulations established by the Financial Services Authority (FSA). These measures are also consolidated under the European Insurance Groups Directive (IGD) to calculate regulatory capital adequacy at an aggregate Group level. The Group has fully complied with these regulatory requirements during the year.
  3. Rating agency bases
    The Group's ratings are an important indicator of financial strength and maintenance of these ratings is one of the key drivers of capital risk appetite. Certain rating agencies have proprietary capital models which they use to assess available capital resources against capital requirements, as a component of their overall criteria for assigning ratings. In addition, rating agency measures and targets in respect of gearing and fixed charge cover are important in evaluating the level of borrowings utilised by the Group. While not mandatory external requirements, in practice rating agency capital measures tend to act as one of the primary drivers of capital requirements, reflecting the capital strength required in relation to our target ratings.
  4. Economic bases
    The Group also measures its capital using an economic capital model that takes into account a more realistic set of financial and non-financial assumptions. This model has been developed considerably over the past few years and is increasingly relevant in the internal management and external assessment of the Group's capital resources. The economic capital model is used to assess the Group's capital strength in accordance with the Individual Capital Assessment (ICA) requirements established by the FSA. Further developments are planned to meet the emerging requirements of the Solvency II framework.

Accounting basis and capital employed by segment

The table below shows how our capital, on an EEV basis, is deployed by segment and how that capital is funded.

  2007
£m		 2006
£m
Long-term savings 23,272 20,094
General insurance and health 5,487 5,176
Other business including fund management 1,056 1,059
Corporate(1) (31) (19)
Total capital employed 29,784 26,310
Financed by:    
Equity shareholders' funds 20,253 17,531
Minority interests(2) 3,131 2,137
Direct capital instrument 990 990
Preference shares 200 200
Subordinated debt 3,054 2,937
External debt 1,257 1,258
Net internal debt 899 1,257
  29,784 26,310
Net asset value per share - EEV basis 772p 683p
  1. The “Corporate” net liabilities represent the element of the pension scheme deficit held centrally.
  2. Minority interests have increased to £3,131 million (2006: £2,137 million) due to foreign exchange movement, capital contributions from property investment vehicles and acquired subsidiaries, primarily Cajamurcia and Avipop.

At 31 December 2007 the Group had £29.8 billion (restated 31 December 2006: £26.3 billion) of total capital employed in its trading operations, measured on an EEV basis. The significant increase in shareholders' funds reflects the strong operational performance in the period and foreign exchange impacts. Net asset value per ordinary share, based on equity shareholders' funds, has grown to 772 pence per share (2006: 683 pence per share).

Total capital employed is financed by a combination of equity shareholders' funds, preference capital, subordinated debt and borrowings. In addition to our external funding sources, we have certain internal borrowing arrangements in place which allow some of the assets that support technical liabilities to be invested in a pool of central assets for use across the Group. These internal debt balances allow for the capital allocated to business operations to exceed the externally sourced capital resources of the Group. Although intra-group in nature, they are included as part of the capital base for the purpose of capital management. These arrangements arise in relation to the following:

Net internal debt represents the balance of the above amounts due from corporate and holding entities, less the tangible net assets held by these entities.

Financial leverage, the ratio of the Group's external senior and subordinated debt to EEV capital and reserves was 17% (2006: 20%). Fixed charge cover, which measures the extent to which external interest costs, including subordinated debt interest and preference dividends, are covered by EEV operating profit was 9.8 times (2006: 10.3 times).

Regulatory bases

Regulatory basis – Group: European Insurance Groups Directive

  31 December
2007		 31 December
2006
Insurance Groups Directive (IGD) excess solvency £3.1 billion £3.5 billion
Cover (times) over EU minimum 1.6 times 1.8 times

The Group has a regulatory obligation to have positive solvency on a regulatory IGD basis at all times. The Group's risk management processes ensure adequate review of this measure. At 31 December 2007, the estimated excess regulatory capital was £3.1 billion (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 I 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 £3.1 billion reflects a net decrease of £0.4 billion since 31 December 2006, driven by increased capital resource requirements due to changes in regulatory rules and a strengthening of the Group's approach to the calculation of the resource requirement. These additional requirements offset the growth in resources due to strong operational performance.

Regulatory basis – General insurance and International

Our principal UK general insurance regulated subsidiaries are Aviva International Insurance Group (AII) and Norwich Union Insurance (NUI). During 2007, NUI was transferred to become a subsidiary of the AII Group, bringing all of the UK general insurance operations under AII. The combined businesses of the AII Group have a strong solvency position as set out in the table below. On an aggregate basis the estimated excess solvency margin (representing the regulatory value of excess available assets over the required minimum margin) amounted to £3.7 billion (31 December 2006: £3.8 billion) after covering the minimum capital base of £5.5 billion (31 December 2006: £4.5 billion).

  31 December
2007		   31 December
2006
  AII Group   AII Group –
pro forma including NUI
Capital resources £9.2bn   £8.3bn
Capital resources requirement £5.5bn   £4.5bn
Solvency surplus £3.7bn   £3.8bn
Cover 1.7 times   1.8 times

Regulatory basis – Long-term businesses

For the Group's non-participating worldwide life assurance businesses, our capital requirements, expressed as a percentage of the EU minimum, are set for internal management and embedded value reporting purposes as the higher of:

The required capital across the Group's life businesses varies between 100% and 250% of EU minimum or equivalent. During the year, we reduced the required capital for the UK annuity business from 150% to 100% of required minimum margin, bringing it into line with the remainder of the non-profit portfolio. 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 has decreased to 130% (31 December 2006: 134%) reflecting the reduction in the level of required capital for the UK annuities business.

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 2007 the aggregate regulatory requirements based on the EU minimum test amounted to £5.1 billion (31 December 2006: £4.3 billion). At this date, the actual net worth held in the Group's long-term business was £10.5 billion (31 December 2006: £8.9 billion) which represents 205% (31 December 2006: 206%) of these minimum requirements.

Regulatory basis – UK Life with-profit funds

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 within the funds, 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 31 December 2007 and 31 December 2006. Aviva recently announced a one off special bonus of £2.3 billion in respect of the CGNU Life and CULAC with-profits fund, the impact of this special bonus is reflected in the numbers presented below.

31
December
2007		 31
December
2006
  Estimated realistic
assets
£bn		 Estimated realistic liabil-
ities1, 2
£bn		 Estimated realistic inherited estate3
£bn		 Estimated risk capital margin4
£bn		 Estimated excess
£bn		 Estimated excess
£bn
CGNU Life 14.5 (13.1) 1.4 (0.3) 1.1 2.0
CULAC 13.9 (12.7) 1.2 (0.4) 0.8 2.0
NUL&P5 26.1 (24.2) 1.9 (0.6) 1.3 1.2
Aggregate 54.5 (50.0) 4.5 (1.3) 3.2 5.2
  1. These realistic liabilities include the shareholders' share of future bonuses of £1.2 billion (31 December 2006: £0.7 billion). Realistic liabilities adjusted to eliminate the shareholders' share of future bonuses are £48.8 billion (31 December 2006: £48.6 billion).
  2. These realistic liabilities make provision for guarantees, options and promises on a market consistent stochastic basis. The value of the provision included within realistic liabilities is £0.7 billion, £0.8 billion and £3.0 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).
  3. 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. The distribution has resulted in a £2.3 billion reduction in the estimated realistic inherited estate.
  4. The risk capital margin (RCM) is 3.5 times covered by the inherited estate (31 December 2006: 4.2 times). The RCM is lower as a result of de-risking the cost of guarantees.
  5. The NUL&P fund includes the Provident Mutual (PM) fund which has realistic assets and liabilities of £2.1 billion and therefore does not impact the realistic inherited estate.

Investment mix

The aggregate investment mix of the assets in the three main with-profit funds at 31 December 2007 was:

  31 December
2007
%		 31 December
2006
%
Equity 37% 42%
Property 13% 16%
Fixed interest 37% 36%
Other 13% 6%
  100% 100%

The equity backing ratios, including property, supporting with-profit asset shares are 75% in CGNU Life and CULAC and 70% in NUL&P. New with-profit business is mainly written through CGNU Life.

A de-risking strategy has been implemented in CGNU Life and CULAC to protect the estate from variations in equity and property values. While the asset mix for funds backing policyholder liabilities was unchanged by this, the de-risking involved the reduction of the equity proportion of the assets backing the cost of guarantees and the inherited estate by approximately £2 billion.

Potential reattribution of inherited estate

Aviva's negotiations with the Policyholder Advocate, Clare Spottiswoode, regarding the potential reattribution of the remainder of the inherited estates of CGNU Life and CULAC continue. We are keen to bring this to a conclusion soon so that we can put an offer to policyholders as early as possible. We will only complete this process if we are able to negotiate an arrangement that is fair to policyholders and shareholders.

Regulatory basis – Solvency II

Solvency II represents new legislation which proposes a fundamental review of the capital adequacy regime for the European insurance industry. It aims to establish a revised set of EU-wide capital requirements and risk management standards that will replace the current requirements applicable to European insurance firms and groups. Solvency II is a unique opportunity to modernise the regulation of insurance companies and groups. Aviva is fully committed to contributing to the success of Solvency II and continues to play an active role in its development through participation in the consultation and quantitative impact studies run by the European Commission and European regulators, as well as working with industry forums and working parties. Solvency II has the potential to align regulatory capital with internal risk processes and measures, provided the possible problems and pitfalls are avoided. While the proposed regime is still at an early stage, the progress has been encouraging; the European Commission published its draft proposal for the high level principles, "Level 1 Framework Directive", in July 2007 and it is envisaged that the full suite of rules will be in place by the end of 2010, with full implementation by 2012.

Rating agency bases

Ratings are important in supporting access to debt capital markets and in providing assurance to business partners and policyholders over the financial strength of the Group and its ability to service contractual obligations. In recognition of this, the Group has solicited rating relationships with a number of rating agencies. Rating agencies generally assign ratings based on an assessment of a range of financial (e.g. capital strength, gearing and fixed charge cover ratios) and non-financial (e.g. competitive position and quality of management) factors. Managing our capital and liquidity position in accordance with the Group's target rating levels is a core consideration in all material capital management and capital allocation decisions.

Economic bases

The Group uses a risk based capital model to assess its economic capital requirements and to aid in risk and capital management across the Group. This model is used to support the Group's Individual Capital Assessments (ICA) which are reported to the FSA for all UK regulated insurance businesses.

This model is based on a framework for identifying the risks that business units, and the Group as a whole, are exposed to. The FSA now uses the results of our ICA process when setting target levels of capital for the UK regulated businesses. In line with FSA requirements, the ICA estimates the capital required to mitigate the risk of insolvency to a 99.5% confidence level over a one year time horizon (equivalent to events occurring in 1 out of 200 years) against financial and non-financial tests. Our ICA uses a mixture of scenario-based approaches and stochastic economic capital models. Tests covering investment and insurance scenarios are specified centrally to provide consistency across businesses and to achieve a minimum standard. Where appropriate, businesses may also supplement these with tests specific to their own situation. In aggregating the various risk tests at business unit and Group level, we allow for correlation effects between different risks as well as diversification benefits. This means that the aggregate sum of the risks is less than the sum of all of the individual risks.

Financial modelling techniques enhance our practice of active risk and capital management, ensuring sufficient capital is available to protect against unforeseen events and adverse scenarios. Our aim continues to be the optimal usage of capital through appropriate allocation to our businesses. We continue to develop our economic capital modelling capability for all our businesses as part of our development programme to increase the focus on economic capital management.

Capital Generation and Utilisation

As part of its capital management processes, the Group regularly reviews the generation and deployment of capital. The table below demonstrates the net capital generation of the Group on a regulatory basis. The net capital generated can be considered as a measure of the change in the Group's surplus capital on a regulatory basis. A reconciliation of the movement in IGD surplus is also shown.

  2007
£bn		 2006
£bn
Operational capital generation:    
Life in-force profits 1.9 1.7
New business strain (0.6) (0.6)
Non-life profits 0.6 1.0
Operational capital generated 1.9 2.1
Increase in capital requirements (0.5) (0.5)
Free operational capital generated 1.4 1.6
Interest costs (0.2) (0.2)
External dividend (0.9) (0.8)
Scrip dividend 0.3 0.2
Capital generated after financing costs 0.6 0.8
Investment return variances and economic assumption changes 0.2 0.5
Profit on disposals 0.1 0.2
Capital raising - 1.1
Cost of acquisitions (0.6) (1.8)
Qualifying assets acquired net of capital requirements 0.1 (0.3)
Pension funding and restructuring costs (0.1) (0.3)
Foreign exchange impact on surplus capital 0.2 (0.1)
Other - (0.1)
Net capital generated 0.5 -
Reconciliation to movement in IGD surplus    
Opening IGD surplus 3.5 3.6
Net capital generated 0.5 -
Regulatory changes (0.4) (0.1)
Additional capital requirement over regulatory minimum 0.4 0.6
Non-IGD qualifying capital generated within life funds (0.6) (0.4)
Minorities (0.2) (0.1)
Other (0.1) (0.1)
Closing IGD surplus 3.1 3.5

Free operational capital generated represents the net of the following:

In arriving at net capital generated, the analysis additionally takes account of material non-operating items affecting capital over the period. Material items in 2007 include the impact of investment return variances and economic assumption changes and the impact of acquisitions in the year.

The reconciliation of the net capital generated to the movement in the Group's IGD surplus takes into account capital generated within life funds which fall outside the perimeter of the Group's IGD calculation.

During the year, we have undertaken a number of proactive actions in relation to capital management:

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