Appendix A1

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Group capital structure

The Group maintains an efficient capital structure financed by 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's capital structure, analysed on an EEV basis, is set out below.

Capital employed by segment

  2007
£m		 2006
£m
  1. The “Corporate” net liabilities represent the element of the pension scheme deficit held centrally
Long-term savings 23,272 20,094
General insurance and health 5,487 5,176
Other business including fund management 1,056 1,059
Corporate1 (31) (19)
Total capital employed 29,784 26,310
Financed by    
Equity shareholders’ funds and minority interests 23,384 19,668
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

At 31 December 2007 the Group had £29.8 billion (restated 31 December 2006: £26.3 billion) of total capital employed in our trading operations which is financed by a combination of equity shareholders' funds, preference capital, direct capital instruments, subordinated debt and internal and external borrowings.

In the year to 31 December 2007, the total capital employed increased by £3.5 billion reflecting growth in long-term saving operations driven by operational results and foreign exchange impacts.

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 dividend, are covered by EEV operating profit was 9.8 times (2006: 10.3 times).

At 31 December 2007 the market value of the Group's external debt, subordinated debt, preference shares, including both the Aviva plc preference shares and the General Accident plc preference shares of £250 million, within minority interests, and direct capital instrument was £5,774 million (2006: £5,991 million), with a weighted average cost of 4.2% (31 December 2006: 3.9%). The Group WACC is 7.0% and has been calculated by reference to the cost of equity and cost of debt at the relevant date. The cost of equity at 31 December 2007 was 7.9%, based on a risk free rate of 4.6%, an equity market premium of 3% and a market beta of 1.1.

Deployment of equity shareholders' funds

In order to better reflect the risk to shareholder funds the presentation of deployment of equity shareholders' funds has been revised at 31 December 2007. To do this we have 'looked through' unitised investments which are classified as "other" within the IFRS balance sheet and made adjustments for minority holdings that are fully consolidated on the balance sheet. In addition, we have explicitly shown the market risks within the staff pension schemes.

  31
December
2007		 Restated
31 December
2006
  Equities
£m		 Property
£m		 Cash, Loans & Debt securities
£m		 Other Invest-ments
£m		 Other net assets
£m		 Total
£m		 Total
£m
Total assets included in the statutory IFRS balance sheet 56,018 16,019 170,904 40,413 36,366 319,720 294,851
Goodwill1         (3,299) (3,299) (3,127)
Acquired value of in-force business and intangible assets         (3,197) (3,197) (2,728)
Liabilities of the long-term, general & other businesses excluding pension fund deficit and debt (49,693) (13,094) (162,303) (35,184) (37,466) (297,740) (274,362)
Minorities and other investments reclassification2 259 233 320 (3,681) 2,869 - -
Shareholder funds 6,584 3,158 8,921 1,548 (4,727) 15,484 14,634
               
Pension fund 5,022 641 3,875 301 (10,017) (178) (973)
Adjusted shareholder funds 11,606 3,799 12,796 1,849 (14,744) 15,306 13,661
Goodwill1           3,299 3,127
Additional and acquired value of in-force long-term business and intangible assets3           11,179 9,522
Assets backing total capital employed in continuing operations           29, 784 26,310
  1. Includes goodwill relating to the joint venture with the Royal Bank of Scotland Group.
  2. Minority and other investments reclassification represents the reallocation of unit trusts to their constituent parts net of net asset value attributable to unitholders.
  3. Net internal debt represents the upstream of internal loans from business operations to corporate and holding entities net of tangible assets held by those entities.

Sensitivity analysis

The sensitivity of the Group's shareholders' funds on an EEV basis at
31 December 2007 to a 10% fall in global equity markets or a rise of 1%
in global interest rates is as follows:

2006
£bn		   2007
£bn		 Equities
down 10%
£bn		 Interest rates up 1%
£bn
20.1 Long-term savings1 23.3 22.3 22.4
6.2 General insurance and other 6.5 6.1 6.1
(5.4) Borrowings2 (5.2) (5.2) (5.2)
20.9 Shareholders’ funds 24.6 23.2 23.3
  1. Assumes EEV assumptions adjusted to reflect revised bond yields.
  2. Comprising internal, external and subordinated debt, net of corporate tangible net assets.

The table above incorporates the effect on the value of the pension scheme assets of a 10% decrease in equity and a 1% increase in fixed income bond yields. The latter sensitivity also assumes an equivalent movement in both inflation and discount rate (i.e. no change to real interest rates) and therefore, incorporates the offsetting effects of these items on the pension scheme liabilities. A 1% increase in the real interest rate only has the effect of reducing the pension scheme liability by £1.4 billion thereby enhancing shareholders' funds by £1 billion (after deducting tax).

Risk management – Equity hedges

The following table shows the material equity derivatives currently within the Group's shareholder funds that are used as part of a long-term strategy to manage equity risk. It excludes derivatives used for portfolio management purposes:

Derivative Notional
£bn1		 Market fall required before protection starts2 Outstanding
Duration
(a) 0.7 10% 9 months
(b) 0.4 2% 3-15 months
  1. The notional amount represents the market value as at 31 December 2007 of the equities covered by the hedge.
  2. The 'market fall before protection starts' shows the percentage the market could fall from the 31 December 2007 positions before the derivative moves into the money.
  3. We use different methods to reduce the cost of derivatives. We have limited the downside protection on derivative (a) and we have created a zero cost collar by selling some of the upside on derivative (b).

Shareholders' funds, including minority interests.

    31 December 2007
Closing shareholders' funds		   31 December 2006
Closing shareholders' funds
  Note IFRS net assets
£m		 Internally generated AVIF
£m		 Total equity
£m		   IFRS net assets
£m 		Internally generated AVIF
£m		 Total equity
£m
Life assurance 1,2              
United Kingdom   4,428 3,680 8,108   3,757 3,403 7,160
France   1,447 1,214 2,661   1,221 1,070 2,291
Ireland   943 195 1,138   971 48 1,019
Italy   1,020 204 1,224   688 115 803
Netherlands (including Belgium and Germany)   2,994 1,152 4,146   2,860 977 3,837
Poland   276 671 947   202 517 719
Spain   1,122 630 1,752   845 530 1,375
Other Europe   346 (90) 256   61 45 106
Europe   8,148 3,976 12,124   6,848 3,302 10,150
North America 5 2,202 154 2,356   2,315 (27) 2,288
Asia Pacific   512 172 684   380 116 496
    15,290 7,982 23,272   13,300 6,794 20,094
General insurance and health 1,2              
United Kingdom   2,960 - 2,960   2,887 - 2,887
France   301 - 301   333 - 333
Ireland   423 - 423   423 - 423
Netherlands   756 - 756   684 - 684
Other Europe   295 - 295   161 - 161
Europe   1,775 - 1,775   1,601 - 1,601
North America   726 - 726   666 - 666
Asia Pacific   26 - 26   22 - 22
    5,487 - 5,487   5,176 - 5,176
Other business 1,2 1,056 - 1,056   1,059 - 1,059
Corporate   (31) - (31)   (19) - (19)
External debt   (1,257) - (1,257)   (1,258) - (1,258)
Internal debt   (899) - (899)   (1,257) - (1,257)
Subordinated debt   (3,054) - (3,054)   (2,937) - (2,937)
    (4,185) - (4,185)   (4,412) - (4,412)
Shareholders' funds, including minority interests   16,592 7,982 24,574   14,064 6,794 20,858
Comprising:                
Equities   11,741 - 11,741   14,343 - 14,343
Property   4,644 - 4,644   3,263 - 3,263
Cash, loans and debt securities   11,986 - 11,986   7,102 - 7,102
Other investments   1,865 - 1,865   1,446 - 1,446
Other net assets and pension liability (14,930) - (14,930)   (12,493) - (12,493)
Intangible assets 3 6,496 7,982 14,478   5,855 6,794 12,649
Borrowings   (5,210) - (5,210)   (5,452) - (5,452)
Shareholders' funds, including minority interests   16,592 7,982 24,574   14,064 6,794 20,858

Notes

IFRS net assets shown above include the allocation of tax assets and liabilities and hence differ from segmental net assets.

  1. Goodwill of £3,299 million (31 December 2006: £3,127 million) has been allocated as follows: life assurance £1,631 million (31 December 2006: £1,533 million); general insurance and health £418 million (31 December 2006: £390 million); other businesses £1,250 million (31 December 2006: £1,204 million).
  2. Intangibles of £1,191 million (31 December 2006: £638 million) have been allocated as follows: life assurance £622 million (31 December 2006: £211 million); general insurance and health £424 million (31 December 2006: £287 million); other businesses £145 million (31 December 2006: £140 million).
  3. Total intangible assets of £14,478 million (31 December 2006: £12,649 million) comprise goodwill of £3,299 million (31 December 2006: £3,127 million); acquired value of in-force long-term business and intangibles of £3,197 million (31 December 2006: £2,728 million) and additional value of in-force long-term business of £7,982 million (31 December 2006: £6,794 million). The associated deferred tax liability on the intangibles of £811 million (31 December 2006: £738 million) is included within other net assets.
  4. The post-tax pension fund deficit of £722 million (31 December 2006: £673 million) has been allocated as follows: life operations £(2) million (31 December 2006: £179 million), general insurance and health: £(23) million (31 December 2006: £458 million), other business £747 million (31 December 2006: £17 million) and corporate of £nil (31 December 2006: £19 million).
  5. AVIF was negative for the US life business in 2006 due to the embedded value being below its balance sheet value on an IFRS basis. This is due to the cost of locked-in required capital under EEV which is not recognised under IFRS.

Analysis of return on capital employed
For the year ended 31 December 2007

    Operating return (Note 1)   Restated Opening Shareholders’ funds including minority interests Annualised
Return on
Capital
  Note Before tax
£m		 After tax
£m		   £m %
Life assurance            
United Kingdom   864 605   7,160 8.4%
France   537 351   2,291 15.3%
Ireland   77 67   1,019 6.6%
Italy   137 85   803 10.6%
Netherlands (including Belgium and Germany)   352 261   3,837 6.8%
Poland   206 167   719 23.2%
Spain   239 167   1,375 12.1%
Other Europe   (5) -   106 -
Europe   1,543 1,098   10,150 10.8%
North America   255 165   2,288 7.2%
Asia Pacific   91 68   496 13.7%
    2,753 1,936   20,094 9.6%
General insurance and health            
United Kingdom   306 214   2,887 7.4%
France   70 45   333 13.5%
Ireland   162 142   423 33.6%
Netherlands   169 123   684 18.0%
Other Europe   41 29   161 18.0%
Europe   442 339   1,601 21.2%
North America   154 100   666 15.0%
Asia Pacific   4 3   22 13.6%
    906 656   5,176 12.7%
Fund management   90 63   305 20.7%
Other business   (70) (49)   754 (6.5)%
Corporate   (82) (95)   (19) 500.0%
External debt   (79) (55)   (1,258) 4.4%
Net internal debt 2 (53) (37)   (1,257) 2.9%
Subordinated debt   (179) (125)   (2,937) 4.3%
    3,286 2,294   20,858 11.0%
Less:            
Minority interests     (259)   (2,137) 12.1%
Direct capital instrument     (37)   (990) 3.7%
Preference capital     (17)   (200) 8.5%
Return on equity shareholders’ funds     1,981   17,531 11.3%

Notes

  1. The operating return is based upon Group EEV operating profit, which is stated before impairment of goodwill, amortisation of intangibles, exceptional items and tax including policyholder tax, adjusted for the short-term fluctuation in investment return.
  2. The net internal debt return before tax of (£53) million comprises investment return of £127 million and Group internal debt costs and other interest of (£180) million.

Analysis of return on capital employed
For the year ended 31 December 2006

    Operating return (Note 1)   Opening shareholders’ funds including minority interests Return on
Capital
  Note Before tax
£m		 After tax
£m		   £m %
Life assurance            
United Kingdom   744 521   6,524 8.0%
France   402 264   2,067 12.8%
Ireland   (40) (35)   482 (7.3)%
Italy   110 68   727 9.3%
Netherlands (including Belgium and Germany)   329 235   3,055 7.7%
Poland   162 132   658 20.0%
Spain   221 143   1,228 11.6%
Other Europe   (13) (10)   95 (10.5)%
Europe   1,171 797   8,312 9.6%
North America   32 21   332 6.3%
Asia Pacific   86 64   430 14.9%
    2,033 1,403   15,598 9.0%
General insurance and health            
United Kingdom   957 670   2,907 23.0%
France   63 41   362 11.3%
Ireland   172 150   545 27.5%
Netherlands   139 98   553 17.7%
Other Europe   54 38   167 22.8%
Europe   428 327   1,627 20.1%
North America   148 96   848 11.3%
Asia Pacific   4 3   17 17.6%
    1,537 1,096   5,399 20.3%
Other business   65 45   1,876 2.4%
Corporate   (83) (112)   (36) 311.1%
External debt   (61) (43)   (1,002) 4.3%
Net internal debt 2 (77) (54)   (1,481) 3.6%
Subordinated debt   (169) (118)   (2,808) 4.2%
    3,245 2,217   17,546 12.6%
Less:            
Minority interests     (208)   (1,457) 14.3%
Direct capital instrument     (37)   (990) 3.7%
Preference capital     (17)   (200) 8.5%
Return on equity shareholders’ funds     1,955   14,899 13.1%

Notes

  1. The operating return is based upon Group operating profit, which is stated before impairment of goodwill and exceptional items including policyholder tax, adjusted for the short-term fluctuation in investment return.
  2. The net internal debt return before tax of £(77) million comprises investment return of £151 million and Group internal debt costs and other interest of £(228) million.

Group Capital Resources

Since 1 January 2005 insurance groups have been required to report their capital adequacy to the FSA. UK insurers are required to disclose in respect of its ultimate insurance parent undertaking the Group Capital Resources (GCR), the Capital Resources Requirement (CRR) and the resulting surplus or deficit. From 31 December 2006 the Prudential sourcebook for insurers INSPRU 6.1.15R requires UK insurers to meet this requirement at the ultimate EEA insurance parent level. The statement for 2007 is given in the table below. This information represents the group solvency surplus calculated in accordance with the INSPRU 6.1.

  31 December
2007
  UK Life Funds
£bn		 Other businesses
£bn		 Group
Total
£bn
Group Capital Resources 7.7 8.7 16.4
Less: Capital Resources Requirement (7.7) (5.6) (13.3)
IGD Group surplus - 3.1 3.1

The sensitivity of the Group's IGD surplus at 31 December 2007 to a 10% fall in global equity markets or a rise of 1% in global interest rates is as follows

 
  2007
£bn		 Equities down 10%
£bn		 Interest rates up 1%
£bn
IGD Group surplus 3.1 2.6 2.5

The sensitivity to equity market falls has been reduced during the year due to the sale of £2.6bn equities within the general insurance operations. This reduced the sensitivity by £0.2 billion after tax. This was partly offset by strengthening of the euro which increased the Group's sensitivity by £0.1 billion. Most of the IGD equity exposure is in Delta Lloyd, however, we have in place a number of hedging instruments which would protect the Group's IGD solvency position against more severe equity shock. The overall IGD sensitivity to a 10% fall in equity markets (excluding Delta Lloyd) is £0.2 billion.

In 2006, the FSA further extended the requirement to reconcile Group capital resources on regulatory basis to the Group's capital resources on a statutory reporting basis. In addition, this reconciliation provides further analysis of differences between the Group capital resources and the amounts included in the capital statement made in accordance with FRS 27 and disclosed in the Group consolidated accounts. This reconciliation is given in the second table below. We continue to monitor and actively manage our IGD equity exposure through a combination of assessing the appropriate levels of equity exposures as well as hedging transactions.

The Group Capital Adequacy Report is prepared in accordance with the FSA's valuation rules (Peak 1) and brings in capital in respect of the UK life funds equal to the UK Life Capital Resources Requirement. The FRS 27 disclosure brings in the realistic value of with-profit capital resources (Peak 2). As the two bases differ, the reconciliation below is presented by removing the restricted regulatory assets and then replacing them with the unrestricted realistic assets.

  31 December 2007
£bn
Total capital and reserves (IFRS basis) 16.6
Plus: Other qualifying capital 3.4
Plus: UK unallocated divisible surplus 5.0
Less: Goodwill, acquired AVIF and intangible assets (6.3)
Less: Adjustments onto a regulatory basis (2.3)
Group Capital Resources on regulatory basis 16.4
The Group Capital Resources can be analysed as follows:  
   
Core Tier 1 Capital 13.6
Tier 1 waiver (implicit items) 0.2
Innovative Tier 1 Capital 1.0
Total Tier 1 Capital 14.8
Upper Tier 2 Capital 1.7
Lower Tier 2 Capital 2.0
Group Capital Resources Deductions (2.1)
Group Capital Resources on regulatory basis (Tier 1 & Tier 2 Capital) 16.4
   
Less: UK life restricted regulatory assets (8.3)
Add: UK life unrestricted realistic assets 6.9
Add: Overseas UDS – restricted asset 1.8
Total FRS 27 capital 16.8

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