Capital management

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Capital employed by segment

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

¹ The “corporate” net liabilities represent the element of the pension scheme deficit held centrally.

² 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. Net internal debt represents the balance of the amounts due from corporate and holding entities, less the tangible net assets held by these entities. 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:

• Certain subsidiaries, subject to continuing to satisfy stand alone capital and liquidity requirements, loan funds to corporate and holding entities, these loans satisfy arms length criteria and all interest payments are made when due.
• Aviva International Insurance (AII) Ltd acts as both a UK general insurer and as the primary holding company for our foreign subsidiaries. Internal capital management mechanisms in place allocate a portion of the total capital of the company to the UK general insurance operations. These mechanisms also allow for some of the assets backing technical liabilities to be made available for use across the group. Balances in respect of these arrangements are also treated as internal debt for capital management purposes.

Total capital employed is financed by a combination of equity shareholders’ funds, preference capital, subordinated debt and borrowings (including internal borrowings as described in footnote 2 above).

At 30 June 2009 we had £23.4 billion (31 December 2008: £25.3 billion) of total capital employed in our trading operations, measured on an MCEV basis. The decrease over the period is driven by the impact of foreign exchange rate losses and actuarial losses on the staff pension schemes, which have more than offset the benefit of operating earnings and market gains.

In April 2009 we issued a private placement of £245 million equivalent of Lower Tier 2 hybrid in a dual tranche transaction (£200 million on 1 April 2009 and a further €50 million on 30 April 2009). These transactions had a positive impact on group IGD solvency and economic capital measures.

Financial leverage, the ratio of external senior and subordinated debt to MCEV capital and reserves, was 41.3% (31 December 2008: 33.6%). Fixed charge cover, which measures the extent to which external interest costs, including subordinated debt interest and preference dividends, are covered by MCEV operating profit was 9.6 times (31 December 2008: 9.2 times).

At 30 June 2009 the market value of our external debt, subordinated debt, preference shares (including both Aviva plc preference shares and General Accident plc preference shares of £250 million, within minority interest), and direct capital instrument was £5,422 million (31 December 2008: £4,911 million), with a weighted average cost of 8.2% (31 December 2008: 8.8%). The group Weighted Average Cost of Capital (WACC) is 8.9% (31 December 2008: 8.3%) and has been calculated by reference to the cost of equity and the cost of debt at the relevant date. The cost of equity at 30 June 2009 was 9.3% based on a risk free rate of 3.7%, an equity risk premium of 4.0% and a market beta of 1.4.

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