Final Results - Part 2 of 4

Aviva PLC 01 March 2007 Part 2 of 4: Page 16 EEV basis Summarised consolidated income statement - EEV basis For the year ended 31 December 2006 Page 2006 2006 2005 â‚¬m Â£m Â£m Operating profit before tax attributable to shareholders' profits 23 2,990 Life EEV operating return 2,033 1,814 50 141 Fund management* 96 83 51 2,471 General insurance and health 1,680 1,551 Other: 52 (35) Other operations** (23) 28 53 (235) Corporate costs (160) (136) 53 (560) Unallocated interest charges (381) (436) ----------------------------------------------------------------------------------------------------------------------- 4,772 Operating profit before tax attributable to shareholders' profits 3,245 2,904 Adjusted for the following: 61 (138) Impairment of goodwill (94) (43) (68) Amortisation and impairment of intangibles (46) (21) 9 Financial Services Compensation Scheme and other levies 6 - 688 Variation from longer-term investment return 468 2,805 987 Effect of economic assumption changes 671 (406) 48 237 Profit on the disposal of subsidiaries and associates 161 153 49 (362) Integration and restructuring costs (246) (109) ----------------------------------------------------------------------------------------------------------------------- 6,125 Profit before tax 4,165 5,283 (1,512) Tax on operating profit (1,028) (927) (379) Tax on other activities (258) (674) ----------------------------------------------------------------------------------------------------------------------- 4,234 Profit for the year 2,879 3,682 ======================================================================================================================= Attributable to: 3,894 Equity shareholders of Aviva plc 2,648 3,470 340 Minority interests 231 212 ----------------------------------------------------------------------------------------------------------------------- 4,234 2,879 3,682 ======================================================================================================================= All profit is from continuing operations. * Excludes the proportion of the results of Morley's fund management businesses, of our French asset management operation Aviva Gestion d'Actifs (AGA) and other fund management operations within the Group that arises from the provision of fund management services to our Life businesses. These results are included within the Life EEV operating return. ** Excludes the proportion of the results of Norwich Union Life Services relating to the services provided to the UK life business. These results are included within the Life EEV operating return. Other subsidiaries providing services to our life businesses do not materially impact the Group results. Earnings per share - EEV basis For the year ended 31 December 2006 2006 Earnings per share 2006 2005 Operating profit on an EEV basis after tax, attributable to ordinary shareholders in respect of Aviva plc 116.5c Basic (pence per share) 79.2p 74.5p 115.1c Diluted (pence per share) 78.3p 73.9p Profit after tax for the year on an EEV basis, attributable to ordinary shareholders of Aviva plc 154.6c Basic (pence per share) 105.1p 146.3p 152.8c Diluted (pence per share) 103.9p 145.1p ----------------------------------------------------------------------------------------------------------------------- Page 17 Consolidated statement of recognised income and expense - EEV basis For the year ended 31 December 2006 2006 2006 2005 â‚¬m Â£m Â£m 62 Fair value gains on AFS securities, owner-occupied properties and hedging instruments 42 92 (26) Fair value (gains)/losses transferred to profit (18) 14 (3) Impairment losses on revalued assets (2) (45) (168) Actuarial losses on pension schemes (114) (547) (590) Foreign exchange rate movements (401) (44) 40 Aggregate tax effect - shareholder tax 27 224 ----------------------------------------------------------------------------------------------------------------------- (685) Net expense recognised directly in equity (466) (306) 4,234 Profit for the year 2,879 3,682 ----------------------------------------------------------------------------------------------------------------------- 3,549 Total recognised income and expense for the year 2,413 3,376 ======================================================================================================================= Attributable to: 3,247 Equity shareholders of Aviva plc 2,208 3,184 302 Minority interests 205 192 ----------------------------------------------------------------------------------------------------------------------- 3,549 2,413 3,376 ======================================================================================================================= Summarised reconciliation of movements in consolidated shareholders' funds - EEV basis For the year ended 31 December 2006 2006 2006 2005 â‚¬m Â£m Â£m 26,188 Balance at 1 January 17,546 14,011 3,601 Total recognised income and expense for the year 2,413 3,376 (1,137) Dividends and appropriations (note 15) (762) (657) Issue of share capital for the acquisition of AmerUs Group Co.(2005: RAC plc), 1,331 net of transaction costs 892 530 64 Other issues of share capital, net of transaction costs 43 59 303 Shares issued in lieu of dividends 203 100 593 Capital contribution from minority shareholders 397 212 (112) Minority share of dividends declared in the year (75) (70) 228 Minority interest in acquired/(disposed) subsidiaries 153 (36) 72 Reserves credit for equity compensation plans 48 22 - Other movements - (1) ----------------------------------------------------------------------------------------------------------------------- 31,131 Total equity 20,858 17,546 (3,189) Minority interests (2,137) (1,457) ----------------------------------------------------------------------------------------------------------------------- 27,942 Balance at 31 December 18,721 16,089 ======================================================================================================================= ------------------------------------------------------------------------------------------------------------------------ Page 18 Summarised consolidated balance sheet - EEV basis As at 31 December 2006 2006 2006 2005 â‚¬m Â£m Â£m Assets 4,343 Goodwill 2,910 2,274 4,072 Acquired value of in-force business and intangible assets 2,728 803 10,140 Additional value of in-force long-term business 6,794 6,454 4,172 Investments in joint ventures 2,795 2,129 1,336 Investments in associates 895 885 1,349 Property and equipment 904 885 22,572 Investment property 15,123 13,275 39,470 Loans 26,445 24,544 Financial investments 168,718 Debt securities 113,041 103,917 84,719 Equity securities 56,762 52,044 49,328 Other investments 33,050 26,427 11,679 Reinsurance assets 7,825 7,130 1,790 Deferred tax assets 1,199 1,018 513 Current tax assets 344 87 12,088 Receivables and other financial assets 8,098 7,706 5,188 Deferred acquisition costs and other assets 3,476 3,766 3,858 Prepayments and accrued income 2,585 2,363 21,704 Cash and cash equivalents 14,542 13,732 - Assets of operations classified as held for sale - 462 ---------------------------------------------------------------------------------------------------------------------- 447,039 Total assets 299,516 269,901 ====================================================================================================================== Equity 957 Ordinary share capital 641 599 6,657 Capital reserves 4,460 4,438 793 Other reserves 531 834 7,585 Retained earnings 5,082 2,597 10,174 Additional retained profit on an EEV basis 6,817 6,431 ---------------------------------------------------------------------------------------------------------------------- 26,166 Equity attributable to ordinary shareholders of Aviva plc 17,531 14,899 1,776 Preference share capital and direct capital instrument 1,190 1,190 3,189 Minority interests 2,137 1,457 ---------------------------------------------------------------------------------------------------------------------- 31,131 Total equity 20,858 17,546 ======================================================================================================================= Liabilities 215,269 Gross insurance liabilities 144,230 132,602 131,878 Gross liabilities for investment contracts 88,358 77,309 14,127 Unallocated divisible surplus 9,465 8,978 5,687 Net asset value attributable to unitholders 3,810 3,137 4,254 Provisions 2,850 2,875 4,593 Deferred tax liabilities 3,077 2,458 1,884 Current tax liabilities 1,262 1,033 18,115 Borrowings 12,137 11,013 13,784 Payables and other financial liabilities 9,235 9,485 6,317 Other liabilities 4,234 3,320 - Liabilities of operations classified as held for sale - 145 ---------------------------------------------------------------------------------------------------------------------- 415,908 Total liabilities 278,658 252,355 ====================================================================================================================== ---------------------------------------------------------------------------------------------------------------------- 447,039 Total equity and liabilities 299,516 269,901 ====================================================================================================================== ---------------------------------------------------------------------------------------------------------------------- Page 19 Segmentation of summarised consolidated balance sheet - EEV basis As at 31 December 2006 Life and General Life and General related business related business businesses and other Group businesses and other Group 2006 2006 2006 2005 2005 2005 Â£m Â£m Â£m Â£m Â£m Â£m Total assets before acquired additional value of in-force long-term business 252,955 37,961 290,916 224,453 38,679 263,132 Acquired additional value of in-force long-term business 1,806 - 1,806 315 - 315 ---------------------------------------------------------------------------------------------------------------------- Total assets included in the statutory IFRS balance sheet 254,761 37,961 292,722 224,768 38,679 263,447 ====================================================================================================================== Liabilities of the long-term business (241,892) - (241,892) (215,624) - (215,624) Liabilities of the general insurance and other businesses - (36,766) (36,766) - (36,731) (36,731) ----------------------------------------------------------------------------------------------------------------------- Net assets on a statutory IFRS basis 12,869 1,195 14,064 9,144 1,948 11,092 Additional value of in-force long-term business* 6,794 - 6,794 6,454 - 6,454 ----------------------------------------------------------------------------------------------------------------------- Net assets on an EEV basis** 19,663 1,195 20,858 15,598 1,948 17,546 ======================================================================================================================= Equity capital, capital reserves, shares held by employee trusts and other reserves 5,632 5,871 IFRS basis retained earnings 5,082 2,597 Additional EEV basis retained profit 6,817 6,431 ----------------------------------------------------------------------------------------------------------------------- Equity attributable to ordinary shareholders of Aviva plc on an EEV basis 17,531 14,899 Preference share capital and direct capital instrument 1,190 1,190 Minority interests 2,137 1,457 ----------------------------------------------------------------------------------------------------------------------- EEV basis total equity 20,858 17,546 ======================================================================================================================= * The analysis between the Group's and the minority interest's share of the additional value of in-force long-term business is as follows: Movement in 2006 2005 the year Â£m Â£m Â£m Group's share included in shareholders' funds 6,817 6,431 386 Minority interest share 439 329 110 Movement in AFS securities (462) (306) (156) ----------------------------------------------------------------------------------------------------------------------- Balance at 31 December 6,794 6,454 340 ======================================================================================================================= ** Analysis of net assets on an EEV basis is made up as follows: 2006 2005 Â£m Â£m Long-term business net assets on an EEV basis 19,663 15,598 ----------------------------------------------------------------------------------------------------------------------- Comprises: Embedded value 18,098 15,113 RBSG goodwill 217 217 Goodwill and intangible assets allocated to long-term business 1,527 631 Notional allocation of IAS 19 pension fund deficit to long-term business***,^ (179) (363) ----------------------------------------------------------------------------------------------------------------------- Long-term business net assets on an EEV basis 19,663 15,598 ======================================================================================================================= *** Effective from 31 December 2005, the value of the Aviva Staff Pension Scheme deficit has been notionally allocated between segments, based on current funding and the life proportion has been included within the long-term business net assets on an EEV basis. ^ Effective from 31 December 2006, the pension fund deficit notionally allocated to long-term business is net of the proportion of funding borne by the UK with-profits funds. ------------------------------------------------------------------------------------------------------------------------ Page 20 Basis of preparation - EEV basis The summarised consolidated income statement and balance sheet on pages 16 to 19 present the Group's results and financial position for the life and related businesses on the European Embedded Value (EEV) basis and for its non-life businesses on the International Financial Reporting Standards (IFRS) basis. The EEV methodology adopted is in accordance with the EEV Principles introduced by the CFO Forum in May 2004 and the Additional Guidance on EEV Disclosures published by the CFO Forum in October 2005 applicable for financial reporting for the year ending 31 December 2006. In the Directors' opinion, the EEV basis provides a more relevant reflection of the performance of the Group's life and related operations year on year than results presented under the IFRS basis. The Directors consider that the EEV methodology represents a more meaningful basis of reporting the underlying value of the Group's life and related businesses and the underlying drivers of performance. This basis allows for the impact of uncertainty in the future investment returns more explicitly and is consistent with the way the business is priced and managed. The Group's approach to establishing economic assumptions (specifically investment returns, required capital and discount rates) was reviewed by Tillinghast, a firm of actuarial consultants, at the time of adopting the EEV principles in 2004. The approach is based on the well established capital asset pricing model theory and is in line with the EEV Principles and Guidance. The results for 2006 and 2005 have been audited by our auditors, Ernst & Young LLP. Their report in respect of 2006 is included in the Report and Accounts on page 219 of that document. The preliminary announcement for the year ended 31 December 2006 does not constitute statutory accounts as defined in section 240 of the Companies Act 1985. Covered business The EEV calculations cover the following lines of business: life insurance, long-term health and accident insurance, savings, pensions and annuity business written by our life insurance subsidiaries, including managed pension fund business and our share of the other life and related business written in our associated undertakings and joint ventures, as well as the equity release business written in the UK. The Group's definition of new business under EEV includes contracts that meet the definition of 'non-participating investment' contracts under IFRS. Covered business includes the Group's share of our joint venture operations including our arrangement with The Royal Bank of Scotland Group (RBSG) and our operations in India and China. In addition, the results of Group companies providing significant administration, investment management and other services and of Group holding companies have been included to the extent that they relate to covered business. Together these businesses are referred to as 'Life and related businesses'. New business premiums New business premiums include: â€¢premiums arising from the sales of new contracts during the year; â€¢non-contractual additional premiums, including future Department of Work and Pensions (DWP) rebate premiums; and â€¢expected renewals on new contracts and expected future contractual alterations to new contracts. For products sold to individuals, premiums are generally considered to represent new business in certain circumstances, including where a new contract has been signed, or where underwriting has been performed. Renewal premiums include contractual renewals, non-contractual variations that are reasonably predictable and recurrent single premiums that are pre-defined and reasonably predictable. For group products, new business includes new contracts and increases to aggregate premiums under existing contracts. Renewal premiums are based on the level of premium received during the reporting period and allow for premiums expected to be received beyond the expiry of any guaranteed premium rates. Foreign exchange adjustments Embedded value and other balance sheet items denominated in foreign currencies have been translated to sterling using the appropriate closing exchange rate. New business contribution and other income statement items have been translated using an average exchange rate for the relevant period. The exchange rates adopted in this announcement are shown on page 44. ------------------------------------------------------------------------------------------------------------------------ Page 21 EEV methodology Overview Under the EEV methodology, profit is recognised as it is earned over the life of products defined within covered business. The total profit recognised over the lifetime of a policy is the same as under the IFRS basis of reporting, but the timing of recognition is different. Calculation of the embedded value The shareholders' interest in the life and related businesses is represented by the embedded value. The embedded value is the total of the net worth of the life and related businesses and the value of in-force covered business. Calculations are performed separately for each business and are based on the cash flows of that business, after allowing for both external and intra-group reinsurance. Where one life business has an interest in another life business, the net worth of that business excludes the interest in the dependent company. The embedded value is calculated on an after-tax basis applying current legislation and practice together with future known changes. Profits are then grossed up for tax at the full rate of corporation tax for the UK and at an appropriate rate for each of the other countries based on opening year tax rates. Net worth The net worth is the market value of the shareholders' funds and the shareholders' interest in the surplus held in the non-profit component of the long-term business funds, determined on a statutory solvency basis and adjusted to add back any non-admissible assets, and consists of the required capital and free surplus. Required capital is reported net of implicit items permitted on a local regulatory basis to cover minimum solvency margins which are assessed at a local entity basis. The level of required capital for each business, which ranges between 100% and 150% of the EU minimum solvency requirement for our main European businesses and 250% of the EU minimum equivalent solvency requirements in the US, reflects the level of capital considered by the Directors to be appropriate to manage the business, allowing for our internal assessment of the level of market, insurance and operating risk inherent in the underlying products. The same definition of required capital is used for both existing and new business. The free surplus comprises the market value of shareholder assets in excess of local statutory reserves and required capital. Value of in-force covered business The value of in-force covered business is the present value at the appropriate risk discount rate (which incorporates a risk margin) of the distributable profits to shareholders arising from the in-force covered business projected on a best estimate basis, less a deduction for the cost of holding the required level of capital. In the UK, shareholders' distributable profits arise when they are released following actuarial valuations. These valuations are carried out in accordance with statutory requirements designed to ensure and demonstrate solvency in long-term business funds. Future distributable profits will depend on experience in a number of areas such as investment return, discontinuance rates, mortality, administration costs, as well as management and policyholder actions. Releases to shareholders arising in future years from the in-force covered business and associated required capital can be projected using best estimate assumptions of future experience. In overseas businesses generally, there are similar requirements restricting payments to shareholders from life businesses. The value of in-force covered business includes an allowance for the impact of financial options and guarantees arising from best estimate assumptions (the intrinsic value) and from additional costs related to the variability of investment returns (the time value). The intrinsic value is included in the underlying value of the in-force covered business using deterministic assumptions. The time value of financial options and guarantees has been determined using stochastic modelling techniques. Stochastic modelling typically involves projecting the future cash flows of the business under thousands of economic scenarios that are representative of the possible future outcomes for market variables such as interest rates and equity returns. Allowance is made, where appropriate, for the effect of management and/or policyholder actions in different economic conditions on future assumptions such as asset mix, bonus rates and surrender rates. The time value is determined by deducting the average value of shareholder cash flows under these economic scenarios from the deterministic shareholder value under best estimate assumptions. The cost of holding required capital is the difference between the required capital and the present value at the appropriate risk discount rate of the projected release of the required capital and investment earnings on the assets deemed to back the required capital. Where the required capital is covered by policyholder assets, for example in the UK with-profit funds, there is no impact of cost of capital on shareholder value. The assets regarded as covering the required capital are those that the operation deems appropriate. The value of in-force covered business includes the capitalised value of profits and losses arising from subsidiary companies providing administration, investment management and other services to the extent that they relate to covered business. This is referred to as the 'look through' into service company expenses. In addition, expenses arising in holding companies that relate directly to acquiring or maintaining covered business have been allowed for. Where external companies provide services to the life and related businesses, their charges have been allowed for in the underlying projected cost base. Risk discount rates Under the EEV methodology, a risk discount rate (RDR) is required to express a stream of expected future distributable profits as a single value at a particular date (the present value). It is the interest rate that an investment equal to the present value would have to earn in order to be able to replicate exactly the stream of future profits. The RDR is a combination of a risk free rate to reflect the time value of money plus a risk margin to make prudent allowance for the risk that experience in future years may differ from that assumed. In particular, a risk margin is added to allow for the risk that expected additional returns on certain asset classes (e.g. equities) are not achieved. ------------------------------------------------------------------------------------------------------------------------ Page 22 Risk discount rates for our life businesses have been calculated using a risk margin based upon a Group Weighted Average Cost of Capital (WACC). The Group WACC is calculated using a gross risk free interest rate, an equity risk margin, a market assessed risk factor (beta), and an allowance for the gearing impact of debt financing (including subordinated debt) on a market value basis. The market assessed risk factor captures the market's view of the effect of all types of risk on our business, including operational and other non-economic risk. The RDR is only one component of the overall allowance for risk in EEV calculations. Risk is also allowed for in the cost of holding statutory reserving margins, additional required capital and in the time value of options and guarantees. Hence to derive the RDR the Group WACC is adjusted to reflect the average level of required capital assumed to be held, and to reflect the explicit valuation of the time value of options and guarantees. In order to derive risk discount rates for each of our life businesses, the adjusted Group WACC is expressed as a risk margin in excess of the gross risk free interest rate used in the WACC calculation as described above. This risk margin is used for all our main businesses including the US. Business-specific discount rates are then calculated as the sum of this risk margin and the appropriate local gross risk free rate at the valuation date, based on returns on government bonds. A common risk free rate, and hence a common RDR, is used for all of our businesses within the Eurozone. Additional country-specific risk margins are applied to smaller businesses to reflect additional economic, political and business-specific risk. For example, risk margins ranging from 3.7% to 8.7% are applied to the Group's eastern European and Asian operations. Within each business, a constant RDR has been applied in all future time periods and in each of the economic scenarios underlying the calculation of the time value of options and guarantees. At each valuation date, the risk margin is reassessed based on current economic factors and is updated only if a significant change has occurred. In particular, changes in risk profile arising from movements in asset mix are allowed for via the updated risk margin calculation. Following the review of the risk margin at 31 December 2006, the Directors have decided to leave the life embedded value risk margin unchanged at 2.7%. The market assessed risk factor (beta) has reduced in recent periods, implying a reduction of the risk in the life business. Management will keep the risk margin under review and will make adjustments as necessary to reflect past trends and future expected trends in the riskiness of the life business, based on the beta. The sensitivity disclosures on page 36 indicate the impact to the embedded value that would arise for a change in the risk discount rate. Participating business Future regular bonuses on participating business are projected in a manner consistent with current bonus rates and expected future returns on assets deemed to back the policies. For with-profit funds in the UK and Ireland, for the purpose of recognising the value of the estate, it is assumed that terminal bonuses are increased to exhaust all of the assets in the fund over the future lifetime of the in-force with-profit policies. However, under stochastic modelling there may be some extreme economic scenarios when the total assets in the Group's with-profit funds are not sufficient to pay all policyholder claims. The average additional shareholder cost arising from this shortfall has been included in the time value of options and guarantees. For profit sharing business in continental Europe, where policy benefits and shareholder value depend on the timing of realising gains, apportionment of unrealised gains between policyholders' benefits and shareholders reflect contractual requirements as well as existing practice. Where under certain economic scenarios additional shareholder injections are required to meet policyholder payments, the average additional cost has been included in the time value of options and guarantees. Consolidation adjustments The effect of transactions between our life companies such as loans and reinsurance arrangements has been included in results split by territory in a consistent manner. No elimination is required on consolidation. As the EEV methodology incorporates the impact of profits and losses arising from subsidiary companies providing administration, investment management and other services to the Group's life companies, the equivalent profits and losses have been removed from the relevant segment (non insurance or fund management) and are instead included within the results of life and related businesses. In addition, the underlying basis of calculation for these profits has changed from the IFRS basis to the EEV basis. The capitalised value of the future profits and losses from such service companies are included in the embedded value and new business contribution calculations for the relevant territory, but the net assets (representing historical profits and other amounts) remain under non insurance or fund management. In order to reconcile the profits arising in the financial period within each segment with the assets on the opening and closing balance sheets, a transfer of IFRS profits from life and related business to the appropriate segment is deemed to occur. An equivalent approach has been adopted for expenses within our holding companies. ----------------------------------------------------------------------------------------------------------------------- Page 23 Components of life EEV return The life EEV return comprises the following components: â€¢ new business contribution written during the period including value added between the point of sale and end of the period â€¢ the profit from existing business equal to: - the expected return on the value of the in-force covered business at the beginning of the period, - experience variances caused by the differences between the actual experience during the period and expected experience based on the operating assumptions used to calculate the start of year value, - the impact of changes in operating assumptions including risk margins; â€¢ the expected investment return on the shareholders' net worth, based upon assumptions applying at the start of the year; â€¢ investment return variances caused by differences between the actual return in the period and the expected return based on economic assumptions used to calculate the start of year value; and â€¢ the impact of changes in economic assumptions in the period. The life EEV operating return comprises the first three of these components and is calculated using economic assumptions as at the start of the year and operating (demographic, expenses and tax) assumptions as at the end of the year. Life EEV return 2006 2005 Â£m Â£m New business contribution (after the effect of required capital) 683 612 Profit from existing business - expected return 1,011 895 - experience variances (50) (39) - operating assumption changes 44 17 Expected return on shareholders' net worth 345 329 ----------------------------------------------------------------------------------------------------------------------- Life EEV operating return before tax 2,033 1,814 Investment return variances 319 2,288 Effect of economic assumption changes 671 (406) ----------------------------------------------------------------------------------------------------------------------- Life EEV return before tax 3,023 3,696 Tax on operating profit (630) (566) Tax charge on other ordinary activities (295) (579) ----------------------------------------------------------------------------------------------------------------------- Life EEV return after tax 2,098 2,551 ======================================================================================================================= There were no separate development costs reported in these periods. ----------------------------------------------------------------------------------------------------------------------- Page 24 New business contribution The following tables set out the premium volumes and contribution from new business written by the life and related businesses, consistent with the definition of new business set out on page 20. The contribution generated by new business written during the period is the present value of the projected stream of after tax distributable profit from that business. New business contribution before tax is calculated by grossing up the contribution after tax at the full corporation tax rate for UK business and at appropriate rates of tax for other countries. New business contribution has been calculated using the same economic assumptions as those used to determine the embedded value as at the start of the year and operating assumptions used to determine the embedded value as at the end of the year, and is rolled forward to the end of the financial period. New business contribution is shown before and after the effect of required capital, calculated on the same basis as for in-force covered business. New business sales are expressed on two bases: annual premium equivalent (APE) and the present value of new business premiums (PVNBP). The PVNBP calculation is equal to total single premium sales received in the year plus the discounted value of regular premiums expected to be received over the term of the new contracts, and is expressed at the point of sale. The premium volumes and projection assumptions used to calculate the present value of regular premiums for each product are the same as those used to calculate new business contribution, so the components of the new business margin are on a consistent basis. New business contribution New business margin Annual premium Present value of before the effect of before the effect of equivalent new business premiums required capital required capital* ----------------- --------------------- ------------------- ------------------- 2006 2005 2006 2005 2006 2005 2006 2005 Â£m Â£m Â£m Â£m Â£m Â£m % % Life and pensions France 391 384 3,552 3,530 153 135 4.3% 3.8% Ireland 190 100 1,273 665 15 16 1.2% 2.4% Italy 323 252 2,768 2,294 70 59 2.5% 2.6% Netherlands (including Belgium, Germany and Luxembourg) 270 323 2,346 2,739 56 90 2.4% 3.3% Poland 72 47 534 320 28 16 5.2% 5.0% Spain 248 240 2,059 2,013 184 175 8.9% 8.7% Other Europe 63 51 308 240 (4) (1) (1.3)% (0.4)% Continental Europe 1,557 1,397 12,840 11,801 502 490 3.9% 4.2% Asia 107 63 685 396 26 20 3.8% 5.1% Australia 58 64 297 337 17 16 5.7% 4.7% United States 97 66 884 527 20 13 2.3% 2.5% Rest of the World 262 193 1,866 1,260 63 49 3.4% 3.9% International 1,819 1,590 14,706 13,061 565 539 3.8% 4.1% United Kingdom 1,439 1,155 11,146 9,185 327 269 2.9% 2.9% ----------------------------------------------------------------------------------------------------------------------- Total (before the effect of required capital) 3,258 2,745 25,852 22,246 892 808 3.5% 3.6% ======================================================================================================================= Germany has been reclassified from Other Europe to the Netherlands, Lithuania has been reclassified from Other Europe to Poland and Norwich Union's Dublin-based offshore life and savings business has been reclassified from Other Europe to the United Kingdom. * New business margin represents the ratio of new business contribution before the effect of required capital to PVNBP, expressed as a percentage. New business contribution before the effect of required capital includes minority interests in 2006 of Â£175 million (2005: Â£156 million). This comprises minority interests in France of Â£24 million (2005: Â£19 million), Ireland Â£3 million (2005: nil), Italy Â£41 million (2005: Â£35 million), Netherlands Â£9 million (2005: Â£10 million), Poland Â£4 million (2005: Â£2 million), Spain Â£93 million (2005: Â£89 million), Other Europe nil (2005: Â£1 million) and Asia Â£1 million (2005: nil). ------------------------------------------------------------------------------------------------------------------------ Page 25 New business contribution New business margin Present value of after the effect of after the effect of new business premiums required capital required capital* Life and pensions ---------------------- -------------------------- ------------------- 2006 2005 2006 2005 2006 2005 Â£m Â£m Â£m Â£m % % France 3,552 3,530 110 91 3.1% 2.6% Ireland 1,273 665 9 13 0.7% 2.0% Italy 2,768 2,294 50 36 1.8% 1.6% Netherlands (including Belgium, Germany and Luxembourg) 2,346 2,739 25 58 1.1% 2.1% Poland 534 320 25 14 4.7% 4.4% Spain 2,059 2,013 168 155 8.2% 7.7% Other Europe 308 240 (6) (4) (1.9)% (1.7)% Continental Europe 12,840 11,801 381 363 3.0% 3.1% Asia 685 396 22 16 3.2% 4.0% Australia 297 337 9 9 3.0% 2.7% United States 884 527 8 7 0.9% 1.3% Rest of the World 1,866 1,260 39 32 2.1% 2.5% International 14,706 13,061 420 395 2.9% 3.0% United Kingdom 11,146 9,185 263 217 2.4% 2.4% ----------------------------------------------------------------------------------------------------------------------- Total (after the effect of required capital) 25,852 22,246 683 612 2.6% 2.8% ======================================================================================================================= Germany has been reclassified from Other Europe to the Netherlands, Lithuania has been reclassified from Other Europe to Poland and Norwich Union's Dublin-based offshore life and savings business has been reclassified from Other Europe to the United Kingdom. * New business margin represents the ratio of new business contribution after deducting the effect of required capital to PVNBP, expressed as a percentage. New business contribution after the effect of required capital includes minority interests in 2006 of Â£142 million (2005: Â£120 million). This comprises minority interests in France of Â£15 million (2005: Â£10 million), Ireland Â£1 million (2005: nil), Italy Â£29 million (2005: Â£21 million), Netherlands Â£7 million (2005: Â£7 million), Poland Â£3 million (2005: Â£2 million), Spain Â£86 million (2005: Â£79 million), Other Europe nil (2005: Â£1 million) and Asia Â£1 million (2005: nil). EEV basis - new business contribution before the effect of required capital, tax and minority interest Annual premium Present value of new New business New business equivalent business premiums contribution* margin** ----------------- -------------------- -------------- -------------- 2006 2005 2006 2005 2006 2005 2006 2005 Â£m Â£m Â£m Â£m Â£m Â£m % % Analysed between: - Bancassurance channels 942 710 7,737 6,075 369 311 4.8% 5.1% - Other distribution channels 2,316 2,035 18,115 16,171 523 497 2.9% 3.1% ---------------------------------------------------------------------------------------------------------------------- Total 3,258 2,745 25,852 22,246 892 808 3.5% 3.6% ====================================================================================================================== * Stated before the effect of required capital. ** New business margin represents the ratio of new business contribution before the effect of required capital to PVNBP, expressed as a percentage. EEV basis - new business contribution after the effect of required capital, tax and minority interest Annual premium Present value of new New business New business equivalent business premiums* contribution** margin*** ----------------- -------------------- -------------- -------------- 2006 2005 2006 2005 2006 2005 2006 2005 Â£m Â£m Â£m Â£m Â£m Â£m % % Analysed between: - Bancassurance channels 553 387 4,465 3,238 121 93 2.7% 2.9% - Other distribution channels 2,252 1,997 17,607 15,815 255 248 1.4% 1.6% ---------------------------------------------------------------------------------------------------------------------- Total 2,805 2,384 22,072 19,053 376 341 1.7% 1.8% ======================================================================================================================= * Stated after deducting minority interests. ** Contribution stated after deducting the effect of required capital, tax and minority interests. *** New business margin represents the ratio of new business contribution after deducting the effect of required capital,tax and minority interests to PVNBP after deducting the minority interests, expressed as a percentage. ----------------------------------------------------------------------------------------------------------------------- Page 26 Post-tax internal rate of return on life and pensions new business The internal rate of return (IRR) on life and pensions new business for the Group was 12.6% for 2006 (2005: 12.5%). The internal rate of return is equivalent to the discount rate at which the present value of the post-tax cash flows expected to be earned over the life time of the business written, including allowance for the time value of options and guarantees, is equal to the total invested capital to support the writing of the business. The capital included in the calculation of the IRR is the initial capital required to pay acquisition costs and set up statutory reserves in excess of premiums received ('initial capital'), plus required capital at the same level as for the calculation of new business contribution post cost of capital. 2006 ----------------------------------- Internal rate of Total invested return Initial capital Required capital capital % Â£m Â£m Â£m France 13% 20 93 113 Ireland 7% 54 33 87 Italy 12% 17 59 76 Netherlands (including Belgium, Germany and Luxembourg) 7% 42 88 130 Poland 23% 15 6 21 Spain 30% 19 63 82 Other Europe 7% 37 3 40 Continental Europe 13% 204 345 549 United States 9% 41 37 78 Other 25% 28 22 50 Rest of the World 15% 69 59 128 International 13% 273 404 677 United Kingdom 12% 360 149 509 ---------------------------------------------------------------------------------------------------------------------- Total 13% 633 553 1,186 ====================================================================================================================== The total initial capital for life and pensions new business for 2006 of Â£633 million (2005: Â£544 million) shown above is expressed at the point of sale. Hence it is higher than the impact of writing that new business on net worth of Â£602 million (2005: Â£536 million) shown on page 29, because the latter amount includes expected profits from the point of sale to the end of the reporting period, partly offset by the expected return on the initial capital. ----------------------------------------------------------------------------------------------------------------------- Page 27 Experience variances Experience variances include the impact of the difference between expense, demographic and persistency assumptions, and actual experience incurred in the year. Also included are variances arising from tax, where such variances are due to management action. 2006 2005 Â£m Â£m France 71 32 Netherlands (including Belgium, Germany and Luxembourg) (9) 2 Rest of Europe 29 13 Continental Europe 91 47 United States (11) 3 Other 10 6 Rest of the World (1) 9 International 90 56 United Kingdom (140) (95) ----------------------------------------------------------------------------------------------------------------------- Total (50) (39) ======================================================================================================================= Germany has been reclassified from Other Europe to the Netherlands, Lithuania has been reclassified from Other Europe to Poland and Norwich Union's Dublin-based offshore life and savings business has been reclassified from Other Europe to the United Kingdom. Operating assumption changes Changes in operating assumptions are made when the assumed future levels of expenses, mortality or other operating assumptions are expected to change permanently. 2006 2005 Â£m Â£m France 11 14 Netherlands (including Belgium, Germany and Luxembourg) 56 55 Rest of Europe (83) 2 Continental Europe (16) 71 United States (9) (10) Other 9 12 Rest of the World - 2 International (16) 73 United Kingdom 60 (56) ----------------------------------------------------------------------------------------------------------------------- Total 44 17 ======================================================================================================================= Germany has been reclassified from Other Europe to the Netherlands, Lithuania has been reclassified from Other Europe to Poland and Norwich Union's Dublin-based offshore life and savings business has been reclassified from Other Europe to the United Kingdom. Further disclosures on experience variances and operating assumption changes on an EEV basis are provided on pages 66 and 67. ----------------------------------------------------------------------------------------------------------------------- Page 28 Geographical analysis of life EEV operating return 2006 2005 Â£m Â£m France 402 321 Ireland (40) 20 Italy 110 96 Netherlands (including Belgium, Germany and Luxembourg) 329 349 Poland 162 132 Spain 221 214 Other Europe (13) (6) Continental Europe 1,171 1,126 Asia 37 30 Australia 49 44 United States 32 25 Rest of the World 118 99 International 1,289 1,225 United Kingdom 744 589 ----------------------------------------------------------------------------------------------------------------------- Total 2,033 1,814 ======================================================================================================================= Germany has been reclassified from Other Europe to the Netherlands, Lithuania has been reclassified from Other Europe to Poland and Norwich Union's Dublin-based offshore life and savings business has been reclassified from Other Europe to the United Kingdom. Life EEV operating return includes minority interests in 2006 of Â£247 million (2005: Â£216 million). This comprises minority interests in France of Â£33 million (2005: Â£24 million), Ireland Â£(11) million (2005: nil), Italy Â£60 million (2005: Â£52 million), Netherlands Â£30 million (2005: Â£17 million), Poland Â£25 million (2005: Â£18 million), Spain Â£108 million (2005: Â£103 million), Other Europe nil (2005: Â£2 million) and Asia Â£2 million (2005: nil). ----------------------------------------------------------------------------------------------------------------------- Page 29 Analysis of movement in life and related businesses embedded value The following tables provide an analysis of the movement in embedded value for the life and related businesses for 2006 and 2005. The analysis is shown separately for net worth and the value of in-force covered business, and includes amounts transferred between these categories. The transfer to life and related businesses from other segments consists of service company profits and losses during the reported period that have emerged from the value of in-force. Since the 'look through' into service companies includes only future profits and losses, these amounts must be eliminated from the closing embedded value. All figures are shown net of tax. 2006 ----------------------------------------- Net worth Value of in-force Total Â£m Â£m Â£m Embedded value at the beginning of the year - Free surplus 2,772 - Required capital* 4,448 Total 7,220 7,893 15,113 ----------------------------------------------------------------------------------------------------------------------- New business contribution (after the effect of required capital) (602) 1,071 469 Expected return on existing business - return on VIF - 710 710 Expected return on existing business - transfer to net worth 1,023 (1,023) - Experience variances and operating assumption changes 400 (415) (15) Expected return on shareholders' net worth 239 - 239 Investment return variances and economic assumption changes 355 340 695 ----------------------------------------------------------------------------------------------------------------------- Life EEV return after tax 1,415 683 2,098 Exchange rate movements (189) (120) (309) Embedded value from business acquired 675 759 1,434 Amounts injected into life and related businesses 393 - 393 Amounts released from life and related businesses (646) - (646) Transfer to life and related businesses from other segments 113 - 113 UK pension fund deficit borne by UK with-profit funds transferred to analysis of net assets on an EEV basis** (98) - (98) ----------------------------------------------------------------------------------------------------------------------- Embedded value at the end of the year - Free surplus 3,569 - Required capital* 5,314 Total 8,883 9,215 18,098 =======================================================================================================================- * Required capital is shown net of implicit items permitted by local regulators to cover minimum solvency margins. ** The impact of the operating assumption change reflecting the UK with-profits funds contribution to the UK pension scheme deficit funding has been removed from the Life EEV analysis as the pension fund deficit notionally allocated to long-term business net assets on an EEV basis is net of the proportion of funding borne by the UK with-profits funds. The embedded value of business acquired in 2006 of Â£1,434 million represents the embedded value of Ark Life Assurance Company Limited, Eagle Insurance Company Limited and AmerUs Group Co. Required capital has increased in the year by Â£866 million. The movement comprises an increase of Â£553 million in relation to new business written, a reduction of Â£188 million in relation to in-force business, Â£607 million additional in-force required capital relating to acquisitions during the year and a reduction of Â£106 million in relation to movements in foreign exchange rates. The decrease in the in-force required capital includes the impact of PS06/14 on the amount of shareholder capital required to support the business and the effect of the increase in long-term interest rates which has decreased statutory reserves and, therefore, capital requirements. 2005 --------------------------------------------- Net worth Value of in-force Total Â£m Â£m Â£m Embedded value at the beginning of the year - Free surplus 1,894 - Required capital* 4,362 Total 6,256 6,758 13,014 ----------------------------------------------------------------------------------------------------------------------- New business contribution (after the effect of required capital) (536) 955 419 Expected return on existing business - return on VIF - 624 624 Expected return on existing business - transfer to net worth 929 (929) - Experience variances and operating assumption changes 96 (115) (19) Expected return on shareholders' net worth 225 - 225 Investment return variances and economic assumption changes 785 517 1,302 ----------------------------------------------------------------------------------------------------------------------- Life EEV return after tax 1,499 1,052 2,551 Exchange rate movements (54) (45) (99) Embedded value from business disposed of (19) (19) (38) Amounts injected into life and related businesses 266 - 266 Amounts released from life and related businesses (751) - (751) Transfer to life and related businesses from other segments 23 - 23 UK Life pension fund deficit transferred to analysis of net assets on an EEV basis** - 147 147 ----------------------------------------------------------------------------------------------------------------------- Embedded value at the end of the year - Free surplus 2,772 - Required capital* 4,448 Total 7,220 7,893 15,113 ======================================================================================================================= * Required capital is shown net of implicit items permitted by local regulators to cover minimum solvency margins. ** Reflecting CFO Forum guidance the pension scheme deficit is now being accounted for on an IAS 19 basis. Consequently, the element that had previously been included in the Life EEV analysis, being the present value of agreed deficit funding payments, has been removed from the Life EEV analysis. ------------------------------------------------------------------------------------------------------------------------ Page 30 Segmental analysis of life and related businesses embedded value Value of in-force Net worth covered business Total -------------------- -------------------------- --------------- Cost of Required Free Present value required capital* surplus of in-force capital Embedded value 31 December 2006 Â£m Â£m Â£m Â£m Â£m France 1,143 250 1,142 (244) 2,291 Ireland 254 143 535 (40) 892 Italy 320 329 206 (63) 792 Netherlands (including Belgium, Germany and Luxembourg) 1,067 1,701 1,461 (362) 3,867 Poland 105 107 540 (33) 719 Spain 273 37 606 (59) 857 Other Europe 18 25 75 (12) 106 Continental Europe 3,180 2,592 4,565 (813) 9,524 United States** 618 211 794 (145) 1,478 Other 182 125 204 (51) 460 Rest of the World 800 336 998 (196) 1,938 International 3,980 2,928 5,563 (1,009) 11,462 United Kingdom 1,334 641 5,103 (442) 6,636 ---------------------------------------------------------------------------------------------------------------------- Total 5,314 3,569 10,666 (1,451) 18,098 ======================================================================================================================= Germany has been reclassified from Other Europe to the Netherlands, Lithuania has been reclassified from Other Europe to Poland and Norwich Union's Dublin-based offshore life and savings business has been reclassified from Other Europe to the United Kingdom. * Required capital is shown net of implicit items permitted by local regulators to cover minimum solvency margins. ** AmerUs holding company debt amounting to Â£362 million at 31 December 2006 has been included within non-insurance. Value of in-force Net worth covered business Embedded value -------------------- ---------------------- ------------------- 2006 2005 2006 2005 2006 2005 Â£m Â£m Â£m Â£m Â£m Â£m France 1,393 1,264 898 803 2,291 2,067 Ireland 397 286 495 353 892 639 Italy 649 602 143 114 792 716 Netherlands (including Belgium, Germany and Luxembourg) 2,768 2,204 1,099 933 3,867 3,137 Poland 212 214 507 445 719 659 Spain 310 262 547 463 857 725 Other Europe 43 42 63 54 106 96 Continental Europe 5,772 4,874 3,752 3,165 9,524 8,039 United States 829 254 649 77 1,478 331 Other 307 289 153 106 460 395 Rest of the World 1,136 543 802 183 1,938 726 International 6,908 5,417 4,554 3,348 11,462 8,765 United Kingdom 1,975 1,803 4,661 4,545 6,636 6,348 ---------------------------------------------------------------------------------------------------------------------- Total 8,883 7,220 9,215 7,893 18,098 15,113 ====================================================================================================================== Germany has been reclassified from Other Europe to the Netherlands, Lithuania has been reclassified from Other Europe to Poland and Norwich Union's Dublin-based offshore life and savings business has been reclassified from Other Europe to the United Kingdom. The shareholders' net worth is the market value of the shareholders' funds and the shareholders' interest in the surplus held in the non-profit component of the long-term business funds, determined on a statutory solvency basis and adjusted to add back any non-admissible assets. Required capital, net of implicit items, of Â£5,314 million at 31 December 2006 (31 December 2005: Â£4,448 million) is included within the net worth. The value of in-force covered business includes the effect of holding shareholders' capital to support the level of required capital and allowing for projected future releases. This impact reduces the value of in-force covered business at 31 December 2006 by Â£1,451 million (31 December 2005: Â£1,187 million). ------------------------------------------------------------------------------------------------------------------------ Page 31 The embedded value at the end of 2006 includes minority interests of Â£1,387 million (2005: Â£1,000 million). This comprises minority interests in France of Â£162 million (2005: Â£148 million), Ireland Â£216 million (2005: nil), Italy Â£413 million (2005: Â£365 million), Netherlands Â£102 million (2005: Â£70 million), Poland Â£118 million (2005: Â£107 million), Spain Â£366 million (2005: Â£310 million) and Other Â£10 million (2005: nil). Time value of options and guarantees The following table sets out the time value of options and guarantees relating to covered business by territory at 31 December 2006 and 31 December 2005. 2006 2005 Â£m Â£m France 77 84 Ireland 2 3 Italy 17 19 Netherlands (including Belgium, Germany and Luxembourg) 146 118 Poland 4 5 Spain 4 8 Other Europe - 2 Continental Europe 250 239 United States 68 11 Other 4 5 Rest of the World 72 16 International 322 255 United Kingdom 50 48 ---------------------------------------------------------------------------------------------------------------------- Total 372 303 ====================================================================================================================== Germany has been reclassified from Other Europe to the Netherlands, Lithuania has been reclassified from Other Europe to Poland and Norwich Union's Dublin-based offshore life and savings business has been reclassified from Other Europe to the United Kingdom. The time value of options and guarantees (TVOG) is most significant in the United Kingdom, France, the Netherlands and the United States. In the United Kingdom, this relates mainly to non-market value adjustment (MVA) guarantees on unitised with-profit business and guaranteed annuity rates. In France, this relates mainly to guaranteed crediting rates and surrender values on traditional business including the AFER fund. In the Netherlands, this relates mainly to maturity guarantees on unit-linked products and interest rate guarantees on traditional individual and group profit sharing business. In the United States, this relates to crediting rate, death benefit and surrender on life business. The TVOG has increased to Â£372 million reflecting acquired TVOG from AmerUs of Â£56 million. ----------------------------------------------------------------------------------------------------------------------- Page 32 Minority interest in life and related businesses' EEV results 2006 2005 --------------------------------------------------------------- ------------ Shareholders' Minority interest interest Group Group Â£m Â£m Â£m Â£m New business contribution before effect of required capital 717 175 892 808 Effect of required capital (176) (33) (209) (196) ----------------------------------------------------------------------------------------------------------------------- New business contribution including effect of required capital 541 142 683 612 ======================================================================================================================= Life EEV operating return before tax 1,786 247 2,033 1,814 ======================================================================================================================= Life EEV return before tax 2,744 279 3,023 3,696 Attributed tax (830) (95) (925) (1,145) ----------------------------------------------------------------------------------------------------------------------- Life EEV return after tax 1,914 184 2,098 2,551 ======================================================================================================================= Closing life and related businesses' embedded value 16,711 1,387 18,098 15,113 ======================================================================================================================= ----------------------------------------------------------------------------------------------------------------------- Page 33 Principal economic assumptions - deterministic calculations Economic assumptions are derived actively, based on market yields on risk-free fixed interest assets at the end of each reporting period. The same margins are applied on a consistent basis across the Group to gross risk-free yields to obtain investment return assumptions for ordinary shares and property and to produce risk discount rates. Additional country-specific risk margins are applied to smaller businesses to reflect additional economic, political and business- specific risk, which result in the application of risk margins ranging from 3.7% to 8.7% in our eastern European and Asian business operations. Expense inflation is derived as a fixed margin above a local measure of long-term price inflation. Risk free rates and price inflation have been harmonised across territories within the Euro currency zone, except for expense inflation in Ireland where significant differences remain. Required capital is shown as a multiple of the EU statutory minimum solvency margin or equivalent. Investment return assumptions are generally derived by major product class, based on hypothecating the assets at the valuation date. Future assumed reinvestment rates are consistent with implied market returns at 31 December 2006. Rates have been derived using rates from the current yield curve at a duration based on the term of the liabilities, or directly from forward yield curves where considered appropriate. Assumptions about future investment mix are consistent with long-term plans. In most cases, the investment mix is assumed to continue unchanged throughout the projection period. The changes in assumptions between reporting dates reflect the actual movements in risk free yields in the United Kingdom, the Eurozone and other territories. The principal economic assumptions used are as follows: United Kingdom France ---------------------------------- -------------------------- 2006 2005 2004 2006 2005 2004 Risk discount rate 7.3% 6.8% 7.3% 6.7% 6.0% 6.4% Pre-tax investment returns: Base government fixed interest 4.6% 4.1% 4.6% 4.0% 3.3% 3.7% Ordinary shares 7.6% 7.1% 7.6% 7.0% 6.3% 6.7% Property 6.6% 6.1% 6.6% 6.0% 5.3% 5.7% Future expense inflation 3.4% 3.2% 3.3% 2.5% 2.5% 2.5% Tax rate 30.0% 30.0% 30.0% 34.4% 34.4% 34.9% Required Capital (% EU minimum) 150%/100% 150%/100% 200%/100% 115% 115% 115% Ireland Italy ------------------------------------- --------------------------- 2006 2005 2004 2006 2005 2004 Risk discount rate 6.7% 6.0% 6.4% 6.7% 6.0% 6.4% Pre-tax investment returns: Base government fixed interest 4.0% 3.3% 3.7% 4.0% 3.3% 3.7% Ordinary shares 7.0% 6.3% 6.7% 7.0% 6.3% 6.7% Property 6.0% 5.3% 5.7% 6.0% 5.3% 5.7% Future expense inflation 4.0% 4.0% 4.0% 2.5% 2.5% 2.5% Tax rate 12.5% 12.5% 12.5% 38.3% 38.3% 38.3% Required Capital (% EU minimum) 150% 150% 150% 115% 115% 115% Netherlands Poland ----------------------------- ------------------------ 2006 2005 2004 2006 2005 2004 Risk discount rate 6.7% 6.0% 6.4% 8.7% 8.6% 9.7% Pre-tax investment returns: Base government fixed interest 4.0% 3.3% 3.7% 5.0% 4.9% 6.0% Ordinary shares 7.0% 6.3% 6.7% 8.0% 7.9% 9.0% Property 6.0% 5.3% 5.7% n/a n/a n/a Future expense inflation 2.5% 2.5% 2.5% 3.4% 3.3% 3.4% Tax rate 25.5% 29.1% 31.5% 19.0% 19.0% 19.0% Required Capital (% EU minimum) 150% 150% 150% 150% 150% 150% Spain US ------------------------------- ------------------------- 2006 2005 2004 2006* 2005 2004 Risk discount rate 6.7% 6.0% 6.4% 7.4% 7.2% 7.1% Pre-tax investment returns: Base government fixed interest 4.0% 3.3% 3.7% 4.7% 4.5% 4.4% Ordinary shares 7.0% 6.3% 6.7% n/a n/a n/a Property 6.0% 5.3% 5.7% n/a n/a n/a Future expense inflation 2.5% 2.5% 2.5% 3.0% 3.0% 3.0% Tax rate 30.0% 35.0% 35.0% 35.0% 35.0% 35.0% Required Capital (% EU minimum or equivalent) 125%/110% 125%/110% 125%/110% 250% 200% 200% For service companies, expense inflation relates to the underlying expenses rather than the fees charged to the life company. Future returns on corporate fixed interest investments are calculated from prospective yields less an adjustment for credit risk. Required capital in the United Kingdom is 150% EU minimum for Norwich Union Annuity Limited and 100% for other companies. Required capital in Spain is 125% EU minimum for Aviva Vida y Pensiones and 110% for bancassurance companies. The level of required capital for the US business is 250% of the risk based capital, at the company action level, set by the National Association of Insurance Commissioners. The required capital is equivalent to 5% of the insurance liabilities on a local regulatory basis which is broadly equivalent to the required capital we hold for our main European businesses. * The principal economic assumptions used for AmerUs Group Co. at the date of acquisition were as follows: risk discount rate of 7.2%, pre-tax investment returns of 4.6% for base government fixed interest and required capital of 250%. ----------------------------------------------------------------------------------------------------------------------- Page 34 Other economic assumptions Required capital relating to with-profit business is assumed to be covered by the surplus within the with-profit funds and no effect has been attributed to shareholders. Bonus rates on participating business have been set at levels consistent with the economic assumptions and Aviva's medium-term bonus plans. The distribution of profit between policyholders and shareholders within the with-profit funds assumes that the shareholder interest in conventional with-profit business in the United Kingdom and Ireland continues at the current rate of one ninth of the cost of bonus. Principal economic assumptions - stochastic calculations The time value of options and guarantees calculation allows for expected management and policyholder actions in response to varying future investment conditions. The management actions modelled include changes to asset mix and bonus rates. Modelled policyholder actions are described under 'Other assumptions'. This section describes the models used to generate future investment simulations, and gives some sample statistics for the simulations used. Two separate models have been used, for the UK businesses and for International businesses, as each of these models better reflect the characteristics of the businesses. United Kingdom Model Overall asset returns have been generated assuming that the portfolio total return has a lognormal distribution. The mean and standard deviation of the overall asset return have been calculated using the evolving asset mix of the fund and assumptions over the mean and standard deviation of each asset class, together with correlations between them. Asset Classes The significant asset classes for UK participating business are equities, property and long-term fixed rate bonds. The most significant assumption is the distribution of future long-term interest rates, since this is the most important factor in the cost of guaranteed annuity options. Summary Statistics The following table sets out the means and standard deviations (StDev) of future returns at 31 December 2006 for the three most significant asset classes. Interest rates are assumed to have a lognormal distribution with an annualised standard deviation of 12.5% p.a. for the natural logarithm of the interest rate. Mean* StDev** ---------------------------------------------------------------------------------------------------------------------- Equities 7.6% 20% Property 6.6% 15% Government Bonds 4.6% 3.25-4.5%*** * Means have been calculated by accumulating a unit investment for the required number of years in each simulation, averaging the accumulation across all simulations, and converting the result to an equivalent annual rate (by taking the nth root of the average accumulation minus 1). ** Standard deviations have been calculated by accumulating a unit investment for the required number of years in each simulation, taking the natural logarithm of the result, calculating the variance of this statistic, dividing by the projection period (n years) and taking the square root. This makes the result comparable to implied volatilities quoted in investment markets. *** Depending on the duration of the portfolio. For the UK, the statistics are the same over all projection horizons. Assumptions are also required for correlations between asset classes. These have been set based on an assessment of historical data. Returns for corporate fixed interest investments in each scenario are equal to the return on Government bonds plus a fixed additional amount, based on current spreads less a margin for credit risk. International Model Government nominal interest rates are generated by a model that projects a full yield curve at annual intervals. The model assumes that the logarithm of the short rate follows a mean reverting process subject to two normally distributed random shocks. This ensures that nominal interest rates are always positive, the distribution of future interest rates remains credible, and the model can be calibrated to give a good fit to the initial yield curve. The total annual return on equities is calculated as the return on 1 year bonds plus an excess return. The excess return is assumed to have a lognormal distribution. The model also generates property total returns and real yield curves, although these are not significant asset classes for Aviva outside the UK. Asset Classes The most important assets are fixed rate bonds of various durations. In some businesses equities are also an important asset class. Summary Statistics The following table sets out the means and standard deviations of future euro and US dollars returns at 31 December 2006 for the three most significant asset classes: equities (in the case of euro), short-term bonds (defined to be of 1 year duration) and long-term bonds (defined to be 10 year zero coupon bonds). In the accumulation of 10 year bonds, it is assumed that these are held for one year, sold as 9 year bonds then the proceeds are reinvested in 10 year bonds, although in practice businesses follow more complex asset strategies or tend to adopt a buy and hold strategy. Correlations between asset classes have been set using the same approach as described for the United Kingdom. ----------------------------------------------------------------------------------------------------------------------- Page 35 5- year return 10- year return 20- year return ------------------------ ------------------- ------------------ Mean* StDev** Mean* StDev** Mean* StDev** --------------------------------------------------------------------------------------------------------------------- Euro Short Government Bonds 3.7% 1.7% 3.7% 3.0% 3.8% 5.3% Long Government Bonds 4.2% 3.8% 4.1% 2.9% 4.1% 3.3% Equities 7.0% 19.5% 6.9% 19.3% 6.9% 19.0% US dollar Short Government Bonds 4.5% 2.0% 4.4% 3.5% 4.7% 6.7% Long Government Bonds 5.0% 4.5% 4.8% 3.7% 5.0% 4.4% * Means have been calculated by accumulating a unit investment for the required number of years in each simulation, averaging the accumulation across all simulations, and converting the result to an equivalent annual rate (by taking the nth root of the average accumulation minus 1). ** Standard deviations have been calculated by accumulating a unit investment for the required number of years in each simulation, taking the natural logarithm of the result, calculating the variance of this statistic, dividing by the projection period (n years) and taking the square root. This makes the result comparable to implied volatilities quoted in investment markets. Other assumptions Taxation Current tax legislation and rates have been assumed to continue unaltered, except where changes in future tax rates have been announced. Demographic assumptions Assumed future mortality, morbidity and lapse rates have been derived from an analysis of Aviva's recent operating experience. Where appropriate, surrender and option take up rate assumptions that vary according to the investment scenario under consideration have been used in the calculation of the time value of options and guarantees, based on our assessment of likely policyholder behaviour in different investment scenarios. Expense assumptions Management expenses and operating expenses of holding companies attributed to life and related businesses have been included in the EEV calculations and split between expenses relating to the acquisition of new business, the maintenance of business in-force and project expenses. Future expense assumptions include an allowance for maintenance expenses and a proportion of recurring project expenses. Certain expenses of an exceptional nature, when they occur, are identified separately and are generally charged as incurred. No future productivity gains have been anticipated. Where subsidiary companies provide administration, investment management or other services to businesses included in the European Embedded Value calculations, the value of profits or losses arising from these services have been included in the embedded value and new business contribution. Valuation of debt Borrowings in the EEV consolidated balance sheet are valued on an IFRS basis, consistent with the primary financial statements. At 31 December 2006 the market value of the Group's external debt, subordinated debt, preference shares including General Accident plc preference shares of Â£250 million (classified as minority interests) and direct capital instrument was Â£5,991 million (31 December 2005: Â£5,868 million). 2006 2005 Â£m Â£m Borrowings per summarised consolidated balance sheet - EEV basis 12,137 11,013 Less: Securitised mortgage funding (7,068) (6,303) ----------------------------------------------------------------------------------------------------------------------- Borrowings excluding non-recourse funding - EEV basis 5,069 4,710 Less: Operational financing by businesses (874) (900) ----------------------------------------------------------------------------------------------------------------------- External debt and subordinated debt - EEV basis 4,195 3,810 Add: Preference shares (including General Accident plc) and direct capital instrument 1,440 1,440 ----------------------------------------------------------------------------------------------------------------------- External debt, subordinated debt, preference shares and direct capital instrument - EEV basis 5,635 5,250 Effect of marking these instruments to market 356 618 ----------------------------------------------------------------------------------------------------------------------- Market value of external debt, subordinated debt, preference shares and direct capital instrument 5,991 5,868 ======================================================================================================================= Other It has been assumed that there will be no changes to the methods and bases used to calculate the statutory technical provisions and current surrender values, except where driven by varying future investment conditions under stochastic economic scenarios. ------------------------------------------------------------------------------------------------------------------------ Page 36 Sensitivity analysis - economic assumptions The tables below show the sensitivity of the embedded value as at 31 December 2006 and the new business contribution before the effect of required capital for 2006 to: â€¢ one percentage point increase and decrease in the discount rates; â€¢ one percentage point increase and decrease in interest rates, including all consequential changes (including assumed investment returns for all asset classes, market values of fixed interest assets, risk discount rates); â€¢ one percentage point increase and decrease in the assumed investment returns for equity and property investments, excluding any consequential changes to the risk discount rate; â€¢ 10% rise and fall in market value of equity and property assets (not applicable for new business contribution);and â€¢ decrease in the level of required capital to 100% EU minimum (or equivalent) (not applicable for new business contribution). In each sensitivity calculation, all other assumptions remain unchanged except where they are directly affected by the revised economic conditions. For example, future bonus rates are automatically adjusted to reflect sensitivity changes to future investment returns. Some of the sensitivity scenarios may have consequential effects on valuation bases, where the basis for certain blocks of business is actively updated to reflect current economic circumstances. Consequential valuation impacts on the sensitivities are allowed for where an active valuation basis is used. Where businesses have a target asset mix, the portfolio is re-balanced after a significant market movement otherwise no re-balancing is assumed. Embedded value As reported on 1% increase in 1% decrease in 1% increase in 1% decrease in (net of tax) page 30 discount rates discount rates interest rates interest rates 31 December 2006 Â£m Â£m Â£m Â£m Â£m France 2,291 (135) 155 (90) 85 Ireland 892 (40) 40 (30) 30 Italy 792 (20) 25 (5) (60) Netherlands (including Belgium,Germany and Luxembourg) 3,867 (165) 195 50 (210) Poland 719 (35) 40 (5) 5 Spain 857 (45) 50 (25) 25 Other Europe 106 (5) 5 - - Continental Europe 9,524 (445) 510 (105) (125) United States 1,478 (80) 85 (85) 85 Other 460 (15) 20 - - Rest of the World 1,938 (95) 105 (85) 85 International 11,462 (540) 615 (190) (40) United Kingdom 6,636 (470) 560 (310) 350 ----------------------------------------------------------------------------------------------------------------------- Total 18,098 (1,010) 1,175 (500) 310 ======================================================================================================================== EU 1% increase in 1% decrease in 10% rise in 10% fall in minimum Embedded value As reported on equity/property equity/property equity/property equity/property capital (net of tax) page 30 returns returns market values market values (or equivalent) 31 December 2006 Â£m Â£m Â£m Â£m Â£m Â£m France 2,291 75 (75) 115 (135) 40 Ireland 892 20 (20) 30 (30) 15 Italy 792 10 (10) 10 (10) 10 Netherlands(including Belgium, Germany and Luxembourg) 3,867 225 (225) 405 (415) 95 Poland 719 10 (10) 10 (10) 10 Spain 857 15 (15) 15 (15) 5 Other Europe 106 - - - - 5 Continental Europe 9,524 355 (355) 585 (615) 180 United States 1,478 25 (10) 5 (5) 80 Other 460 5 (5) 10 (10) 5 Rest of the World 1,938 30 (15) 15 (15) 85 International 11,462 385 (370) 600 (630) 265 United Kingdom 6,636 220 (230) 435 (435) 95 ---------------------------------------------------------------------------------------------------------------------- Total 18,098 605 (600) 1,035 (1,065) 360 ====================================================================================================================== ----------------------------------------------------------------------------------------------------------------------- Page 37 In general, the magnitude of the sensitivities will reflect the size of the embedded values, though this will vary as the sensitivities have different impacts on the different components of the embedded value. In addition, other factors can have a material impact, such as the nature of the options and guarantees, as well as the types of investments held. The interest rate sensitivity will vary significantly by territory, depending on the type of business written: for example, where non-profit business is well matched by backing assets, the favourable impact of reducing the risk discount rate is the dominant factor. Sensitivities will also vary according to the current economic assumptions, mainly due to the impact of changes to both the intrinsic cost and time value of options and guarantees. Options and guarantees are the main reason for the asymmetry of the sensitivities where the guarantee impacts to different extents under the different scenarios. This can be seen in the sensitivity of a 1% movement in the interest rate for the Netherlands, where there is a significant amount of business with investment return guarantees. The increase of 70 basis points to the assumed pre-tax investment returns at 31 December 2006 has significantly decreased this sensitivity, reflecting the level of the guarantees relative to the interest rate assumption. Sensitivities to a 1% movement in the equity/property return will only impact the value of the in-force covered business, whereas a 10% movement in equity/property values may impact both the net worth and the value of in-force, depending on the allocation of assets. New business contribution before required capital As reported on 1% increase in 1% decrease in 1% increase in 1% decrease in (gross of tax) page 24 discount rates discount rates interest rates interest rates 31 December 2006 Â£m Â£m Â£m Â£m Â£m France 153 (13) 15 (1) (2) Ireland 15 (4) 4 (2) 1 Italy 70 (4) 5 2 (12) Netherlands (including 56 (10) 11 43 (39) Belgium, Germany and Luxembourg) Poland 28 (2) 3 - 1 Spain 184 (12) 14 (5) 5 Other Europe (4) (2) 2 (1) - Continental Europe 502 (47) 54 36 (46) United States 20 (3) 3 (1) (2) Other 43 (8) 9 3 (4) Rest of the World 63 (11) 12 2 (6) International 565 (58) 66 38 (52) United Kingdom 327 (55) 65 (20) 23 ----------------------------------------------------------------------------------------------------------------------- Total 892 (113) 131 18 (29) ======================================================================================================================= New business contribution before required capital As reported on 1% increase in equity/ 1% decrease in equity/ (gross of tax) page 24 property returns property returns 31 December 2006 Â£m Â£m Â£m France 153 6 (6) Ireland 15 2 (2) Italy 70 1 (1) Netherlands (including Belgium, Germany and Luxembourg) 56 16 (21) Poland 28 1 (1) Spain 184 2 (1) Other Europe (4) 1 (1) Continental Europe 502 29 (33) United States 20 1 (1) Other 43 1 (1) Rest of the World 63 2 (2) International 565 31 (35) United Kingdom 327 31 (31) ----------------------------------------------------------------------------------------------------------------------- Total 892 62 (66) ======================================================================================================================= Page 38 Sensitivity analysis - non-economic assumptions The tables below show the sensitivity of the embedded value as at 31 December 2006 and the new business contribution before the effect of required capital for 2006 to the following changes in non-economic assumptions: â€¢ 10% decrease in maintenance expenses (a 10% sensitivity on a base expense assumption of Â£10pa would represent an expense assumption of Â£9pa). Where there is a 'look through' into service company expenses, the fee charged by the service company is unchanged while the underlying expense decreases; â€¢ 10% decrease in lapse rates (a 10% sensitivity on a base assumption of 5% pa would represent a lapse rate of 4.5% pa); â€¢ 5% decrease in both mortality and morbidity rates disclosed separately for life assurance and annuity business. No future management actions are modelled in reaction to the changing non-economic assumptions. In each sensitivity calculation, all other assumptions remain unchanged. No changes to valuation bases have been included. 5% decrease in 5% decrease in 10% decrease in mortality/ mortality/ Embedded value As reported on maintenance 10% decrease morbidity rates morbidity rates - (net of tax) page 30 expenses lapse rates -life assurance annuity business Year to 31 December 2006 Â£m Â£m Â£m Â£m Â£m France 2,291 35 35 20 (5) Ireland 892 20 20 5 (5) Italy 792 5 - - - Netherlands(including Belgium, Germany and Luxembourg) 3,867 75 15 15 (45) Poland 719 20 35 10 - Spain 857 10 40 15 (5) Other Europe 106 5 5 - - Continental Europe 9,524 170 150 65 (60) United States 1,478 25 15 15 (5) Other 460 10 10 10 - Rest of the World 1,938 35 25 25 (5) International 11,462 205 175 90 (65) United Kingdom 6,636 180 85 75 (120) ----------------------------------------------------------------------------------------------------------------------- Total 18,098 385 260 165 (185) ======================================================================================================================= 5% decrease in 5% decrease in New business contribution 10% decrease in mortality/ mortality/ before required capital As reported on maintenance 10% decrease morbidity rates morbidity rates - (gross of tax) page 24 expenses lapse rates -life assurance annuity business Year to 31 December 2006 Â£m Â£m Â£m Â£m Â£m France 153 5 7 6 - Ireland 15 2 4 1 - Italy 70 2 2 1 - Netherlands (including Belgium, Germany and Luxembourg) 56 10 9 5 (2) Poland 28 2 3 2 - Spain 184 4 19 5 - Other Europe (4) - 1 - (1) Continental Europe 502 25 45 20 (3) United States 20 1 (1) - (1) Other 43 3 4 1 - Rest of the World 63 4 3 1 (1) International 565 29 48 21 (4) United Kingdom 327 21 25 23 (4) ----------------------------------------------------------------------------------------------------------------------- Total 892 50 73 44 (8) ======================================================================================================================= The demographic sensitivities shown above represent a standard change to the assumptions for all products. Different products will be more or less sensitive to the change, and impacts may partially offset. End of part 2 of 4. ----------------------------------------------------------------------------------------------------------------------- This information is provided by RNS The company news service from the London Stock Exchange

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Aviva (AV.)

Thursday, 23rd May 2024

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HL. QQ. AJB

Another day and another round of takeover talk with Hargreaves Lansdown being eyed by private equity suitors. AJ Bell also advances on upbeat earnings news whilst QinetiQ upgrades its profit guidance, too.

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