Based in Foxton in Cambridgeshire, Burlington are a privately owned business employing over 100 local people, as a rural employer they play a significant part in supporting the community.
Not content with one extraordinary record, she now plans to become the first woman to sail solo, non-stop around the world in both directions by competing in the gruelling 2008-09 Vendée Globe.
The inspiration and willpower that Dee embodied in completing the Aviva Challenge in May 2006 – an epic, 178-day journey the “wrong way” around the world – was a masterclass in skill, guts and determination.
She said: “When I was sailing against the winds deep in the Southern Ocean, when the storms seemed endless and the horrific conditions forced me into survival mode, I moved my goalposts closer and focused on getting to the next step, so I constantly felt I was making progress towards the finish line.
“Aviva’s support helped me to discover and define my own future in life, and helped me do my own forward thinking. Aviva is a company that helps you take control of your own destiny.”
Aviva is proud of its continuing partnership with Dee. She is determined to push back the boundaries of her sport and inspires others to do the same in their own lives. Her sustained focus on the future and looking ahead to fresh challenges epitomises our “Forward thinking” campaign.
U You can find out more about Dee Caffari’s challenges at www.avivaoceanracing.com
Singapore Hong Kong India China Russia Australia USA Canada Sri Lanka
France Ireland Italy Netherlands Poland Spain Lithuania Turkey Hungary Czech Republic Romania
Main operationsMain operations p42-49 Read more about our performance and future direction on pages 42 to 49 of this report p24-31 Read more about our performance and future direction on pages 24 to 31 of this report
Net written premiums £1,475m £4,905m * Typically includes motor, household, creditor, health, commercial motor, commercial property and commercial liability insurance.
p32-41 Read more about our performance and future direction on pages 32 to 41 of this report
We have commenced significant new bancassurance partnerships in Ireland (with Allied Irish Banks) and in India (with Centurion Bank of Punjab)
We outlined plans to deliver £250 million of annualised cost savings by the end of 2007 across our UK businesses, at a one-off cost of £250 million
The integration of RAC was completed on time and we met our 2006 cost saving targets £2,977m (2005: £2,528m)
‡ New business contribution after required capital, tax and minority interest.
≠ From continuing operations, including long-term savings result on a European Embedded Value (EEV) basis before adjusting items.
# Return based on opening equity shareholders’ funds on an EEV basis. ~ From continuing operations, including share of associates’ premiums. ≈ On an EEV basis.
As I come to the end of my first year as chairman of Aviva, I am delighted to be able to report on a thriving business. We have made progress towards our stated aim of providing prosperity and peace of mind for our customers. Our record financial results are proof that we are in the right markets, at the right time, and are providing the products and services that our customers want.
Across the world, the need for individuals to provide adequately for their retirement is being recognised as an increasingly important issue. The situation is particularly severe in Western countries where an ageing population is placing a greater strain on national purses and we are shortly to see the retirement of the “baby boomer” generation. Additionally, people in rapidly developing countries such as China and India are starting to pick up the savings habit. These conditions present a sizeable opportunity for us, and we are fully committed to working with customers, governments, the insurance industry and regulatory bodies to provide innovative and practical solutions.
In January 2007, Richard Harvey announced his intention to retire as our group chief executive and to move on to other charitable and business challenges. Richard is a class act by anyone’s standards. He has led the Group through numerous challenges and merger activity with professionalism, skill, and foresight. He has made a lasting impression on Aviva and on the wider international insurance industry. I wish him an enjoyable and relaxing break when he leaves us in July, and great success with whatever he chooses to do next. Furthermore, I am delighted that Andrew Moss, our group finance director has agreed to succeed Richard. Andrew has an extensive knowledge of the insurance industry and a strong track record in international financial services. I am looking forward to working with him as he leads Aviva through its next phase of growth.
O therinform ation Aviva plc Annual Report and Accounts 2006 7
AmerUs represents a significant move for us, creating a dynamic and thriving business with greater access to the largest savings market in the world. I’m delighted to welcome Tom Godlasky and his team to Aviva. Our priority is to integrate AmerUs quickly with our existing US business, achieving our projected cost savings and enhancing the profile of Aviva in the US.
Our international businesses continue to grow and develop. To recognise the increasingly diverse and complex nature of these businesses, I asked Tidjane Thiam to take responsibility for continental Europe. This allowed Philip Scott to focus on our rapidly developing businesses across North America and the Asia-Pacific region during 2006.
We continue to make progress as a “forward thinking” company. It is vital that we don’t see this as simply a slogan, it has to be fundamental to the way we operate. It means positioning ourselves for tomorrow’s opportunities, anticipating our customer’s aspirations and finding ways that lead to exceptional performance and customer service from our people.
“Forward thinking” also means helping our customers to think about and plan for their future. Two developments that take us a step further down that road are websites devoted to financial planning. We created and are supporting a website called www.six-steps.org, which focuses on retirement planning. In the UK, Norwich Union has launched a “make sense of it” website to help people understand investments and to highlight the benefits of taking professional advice.
O therinform ation Aviva plc Annual Report and Accounts 2006 9
The rapidly developing markets in the Asia-Pacific region represent a substantial longer term area of growth for us. We will be looking to accelerate our growth in India and China, while continuing to explore the potential of other markets. Across the region, we will be working to expand distribution through bancassurance, independent financial advisers and the direct sales force.
In North America, the AmerUs acquisition provides us with a scalable platform for growth in what is the largest single market in the world. Our focus is on successfully integrating AmerUs and achieving our projected costs savings.
Richard Harvey Group chief executive * Growth ambitions are annual averages after minority interests, before acquisitions, and assuming no major changes in economic conditions.
This business review complies with the recommendations of the European Union (EU) Modernisation Directive, the Companies Act 1985 (Operating and Financial Review and Directors’ Report) Regulations 2005 (the Companies Act) and is in line with current best practice. It is addressed to, and written for, the members of Aviva plc with the aim of providing a fair review of our business development, performance and position at the current time. In producing this review, we aim to present a view that is balanced and comprehensive and that is consistent with the size and complexity of our business. The review is written in the context of the risks and uncertainties facing our business. We anticipate that the format and content of the review will evolve over time, along with developments in our business and the external environment.
The Companies Act requires that a fair review of the business contains financial and, where applicable, non-financial key performance indicators (KPIs). We consider that our financial KPIs are those that communicate to the members the financial performance and strength of the group as a whole. These KPIs comprise: – Return on equity shareholders’ funds
Management also use a variety of Other Performance Indicators (OPIs) in both running and assessing the performance of individual business segments and units, rather than the group as a whole. OPIs include measures such as present value of new business premiums, new business margins, combined operating ratio and underwriting profit.
This is the first time that we have sought to report externally on either of these measures and we expect that our reporting on both will evolve. In particular, reporting on customer satisfaction is complicated by the differing needs of customers in the countries in which we operate and the relative maturities of those businesses.
By their nature, all forward-looking statements involve risk and uncertainty because they relate to future events that are beyond our control. For example, certain insurance risk disclosures are dependent on our choices about assumptions and models, which by their nature are only estimates. As such, actual future gains and losses could differ materially from those that we have estimated. Other factors that could cause actual results to differ materially from those estimated by the forward-looking statements include, but are not limited to: – UK domestic and global economic business conditions
In addition to presenting our results and financial position on an International Financial Reporting Standards basis, we also use European Embedded Value (EEV) as an alternative performance measure and reporting basis. Details of the accounting basis of preparation are set out in the “financial reporting” section of this business review on pages 60 and 61.
Our core purpose, the reason we exist, is to provide prosperity and peace of mind for our customers. Our ambition is to be the world’s most trusted savings, investment and insurance provider. To achieve this ambition, we need to be a clear leader in helping our customers grow their wealth and protect their assets and their health.
Providing a broad range of competitive motor, property, health and related insurance services to individuals and small- to medium-sized enterprises in chosen markets
To achieve the above goal, we have identified our key strategic priorities. These are set out below: Understanding and meeting the evolving needs of our customers
Building profitable businesses in selected areas where we have, or can, achieve market leading positions
Delivering growth organically and through carefully selected acquisitions designed to increase shareholder value
The table overleaf provides greater detail on how we are implementing these strategic priorities. We have set out the measures and targets that we use to assess our success in achieving our strategic priorities, some of our achievements in 2006 and what we plan to do next year.
Attracting, motivating and retaining talented people who are committed to Aviva’s values and ambitions
Meeting or exceeding customer advocacy and satisfaction targets, at group and individual business level
Meeting or exceeding sales and service targets jointly agreed with each business partner
Surveyed over 23,000 consumers across 21 countries in our third annual survey of consumer attitudes to savings, providing valuable insights on consumer trends
Expanded our bancassurance partnerships, eg, in Ireland with AIB and in India with a further 11 bank partnerships, bringing the total to over 30
Linked senior management remuneration to the measures of employee and customer measures
Maintained staff morale while undertaking significant change and restructurings, particularly in the UK
Put 300 employees through the Aviva Leadership Academy, run in partnership with leading international business schools
Progressed our diversity agenda, being recognised by inclusion in The Times’ “Top 50 places where women want to work,” and gained an Opportunity Now gold award 2007 priorities Implementing specific local initiatives to improve service to attract and retain customers
Conducting our fourth consumer attitudes to savings survey, covering 24 countries
Continuing to roll out our successful bancassurance distribution model, tailored to the specific needs of developing and mature markets
Making the most of our international presence when deploying and developing people
Building a strong employment brand to attract and retain high quality staff
Building profitable businesses in selected areas where we have, or can achieve, market-leading positions
Delivering annualised savings of £250 million from the UK cost and efficiency programme by the end of 2007
Growing our overall EEV and IFRS operating profit steadily and sustainably
Meeting or beating the group’s 12.5% return on equity shareholders’ funds target
Meeting or beating our group-wide 98% general insurance combined operating ratio target for the foreseeable future
Growing UK long-term sales at least as quickly as the market in 2007
Invested in the Aviva brand, significantly increasing awareness and favourability in the financial and business community
Initiated a major cost and efficiency programme in the UK that will reduce costs by £250 million per annum by the end of 2007
Increased general insurance only operating profits by £156 million despite modest growth in net written premiums
Maintained a balance between profitability and sales volumes in a challenging Dutch market
Won the “Best of European Business” award for introducing new products and acquiring and integrating new businesses
Maximising the benefit we obtain from our portfolio of strong global and local brands
Leveraging our low-cost flexible operating model to maximise the benefits of scale
Monitoring closely opportunities that may arise to gain scale or expand distribution
Growing faster than the market in Western Europe where low growth is expected in 2007
† Group EEV operating profit is calculated using long-term savings operating profit on an EEV basis before adjusting items. Group IFRS operating profit is calculated using long-term savings operating profit on an IFRS basis before adjusting items.
Our intention is to increase the total dividend on a basis judged prudent using a dividend cover in the 1.5 to 2.0 times range as a guide, while retaining capital to support future business growth.
Our board has recommended a final dividend of 19.18 pence (2005: 17.44 pence), bringing the total dividend for the year to 30.00 pence (2005: 27.27 pence). This is a 10% (2005: 7.5%) increase. Dividend cover is 2.80 times (2005: 2.17 times).
We aim to achieve steady sustainable growth in our operating profit, both on an EEV and IFRS basis. In seeking to achieve this growth, we continue to adopt strict financial management disciplines underpinned by strong corporate governance.
Long-term business* 2,033 1,814 Fund management*† 96 83 General insurance and health 1,680 1,551 Other: Other operations*† (23) 28 Corporate costs (160) (136) Net unallocated interest charges (381) (436)
Our operating profit before tax, including long-term operating return on an EEV basis, grew by 12% to £3,245 million (2005: £2,904 million) reflecting strong operational performance. On an IFRS basis, operating profit before tax amounted to £3,110 million (2005: £2,128 million), an increase of 46%. This robust set of results has been achieved by our continued focus on profitable growth, by expanding and strengthening our distribution channels, leveraging our scale advantages in pricing and costs and our disciplined approach to underwriting and efficient claims management.
The loss from other non-insurance businesses of £46 million (2005: £10 million profit) reflects the impact in the Netherlands of increased holding company costs, a fall in the banking result reflecting pricing competition on mortgage business in an environment of rising interest rates and the inclusion of a £19 million one-off cost relating to systems migration.
Our corporate costs were higher at £160 million (2005: £136 million) despite the non-recurrence of global finance transformation costs (2005: £28 million). Within this, central costs relating to staff profit share and incentive plans rose to £17 million (2005: £7 million) while other corporate costs increased to £143 million (2005: £101 million) reflecting higher brand spend, pension funding and staff costs.
Interest on the £990 million direct capital instrument issued in 2004 of £52 million (2005: £42 million) is not included within unallocated interest, it is treated as an appropriation of profits retained in the year. The appropriation was charged upon declaration and settlement in the second half of the year. As the coupon payment attracts tax relief at 30%, the net impact on profit attributable to ordinary shareholders was £37 million (2005: £29 million).
Reconciliation of group operating profit to profit before tax – IFRS basis £m £m
Operating profit before tax – EEV basis 3,245 2,904 Adjusted for the following: Impairment of goodwill (94) (43) Amortisation and impairment of other intangibles (46) (21) Financial Services Compensation Scheme and other levies 6 – Variation from longer term investment return 468 2,805 Effect of economic assumption changes 671 (406) Profit on the disposal of subsidiaries and associates 161 153 Integration costs and restructuring (246) (109)
Integration costs totalled £41 million following the successful integration of RAC in the UK, continuing integration of Ark Life in Ireland and activity relating to the integration of AmerUs. As previously announced in September 2006, our UK businesses plan to reduce duplication and improve efficiency to deliver annual cost savings of £250 million in 2008 at a cost of £250 million by the end of 2007. The project is on track and, by the end of 2006, £205 million of reorganisation costs have been recorded.
Our taxation charge on an EEV basis was £1,286 million (2005: £1,601 million). This includes a charge of £1,028 million (2005: £927 million) in respect of operating profit, which is equivalent to an effective rate of 31.7% (2005: 31.9%). On an IFRS basis the effective tax rate on operating profit was 23.3% (2005: 25.2%), reflecting the use of tax losses in the life businesses and the release of prior year provisions following agreements reached with tax authorities on a number of issues.
The Board has recommended a final dividend increase of 10% to 19.18 pence net per share (2005: 17.44 pence) payable on 17 May 2007 to shareholders on the register on 9 March 2007. This provides growth of 10% in the total dividend for the year of 30.00 pence (2005: 27.27 pence). Our IFRS post-tax operating profits cover this dividend 2.80 times (2005: 2.17 times).
Our long-term savings new business sales were up 21% to £30,762 million (2005: £25,583 million). The overall increase reflects growth in life and pension sales of 17% to £25,852 million (2005: £22,246 million), and exceptional growth in investment sales of 48% to £4,910 million (2005: £3,337 million). Net written premiums increased to £10,702 million (2005: £10,311 million).
Our UK total long-term sales increased by 31% to £13,601 million (2005: £10,345 million). Within this total, life and pension new business sales grew by 21% to £11,146 million (2005: £9,185 million), benefiting from strong growth in pension and bond sales. Investment sales were exceptionally strong, up 112% to £2,455 million (2005: £1,160 million), benefiting from new fund offerings and strong investment markets. Our share of sales through the joint venture with The Royal Bank of Scotland Group were up by 58% to £1,169 million (2005: £742 million), reflecting an increased focus from both partners and a rise in the number of sales advisers.
In the UK, our net written premium reduced to £5,940 million (2005: £6,127 million), reflecting our continuing commitment to create value by writing profitable business and a degree of softening in commercial premium rates.
After the effect of required capital, our new business contribution increased by 12% to £683 million (2005: £612 million), producing a new business margin of 2.6% (2005: 2.8%). The movement in the margin reflects the factors affecting our European and International businesses noted above, and the strong growth in sales in the United States, where the margin is lower than the group average.
Our general insurance combined operating ratio (COR) improved to 94% (2005: 95%), and is ahead of our stated target to meet or beat a worldwide COR of 98% for the foreseeable future. The improvement in the COR reflects our continued focus on disciplined underwriting and efficient claims handling.
Our reserves are set conservatively with the aim to protect against adverse future claims experience and development. Our business is predominantly short tail in nature and loss development experience is generally stable. As a result of the prudence applied in setting the reserves, there are some releases in 2006 that reflect releases from the 2005 accident year and prior. The releases mainly arise in the UK and this favourable development benefits the UK underwriting result by £435 million with the remainder of releases arising mainly in our European businesses. We have increased our confidence levels in our reserves over the past few years and continue to maintain our reserves at very strong levels.
Our post-tax operating return on equity shareholders’ funds was 13.1% (2005: 15.0%), ahead of our 12.5% target despite opening shareholders’ funds being £3.2 billion higher and therefore impacting the return. The return is based on the post-tax operating profit from continuing operations, including the EEV operating return, expressed as a percentage of the opening equity shareholders’ funds.
O therinform ation Aviva plc Annual Report and Accounts 2006 21
As at 31 December 2006 IFRS basis EEV basis £m £m £m £m
Additional retained profit on an EEV basis – – 6,817 6,431 Equity attributable to ordinary shareholders of Aviva plc 11,176 8,774 17,531 14,899 Preference shares and direct capital instrument 1,190 1,190 1,190 1,190
During 2006, the equity attributable to our ordinary shareholders on an IFRS basis increased by 27% to £11,176 million (2005: £8,774 million). This increase primarily reflects the growth in retained earnings, which in turn reflects our strong operational performance during the year. On an EEV basis, the equity attributable to ordinary shareholders was £17,531 million (2005: At 31 December 2006, our total assets were £293 billion (2005: £263 billion) on an IFRS basis. Under EEV principles, our total assets are £6,794 million (2005: £6,454 million) higher. The difference relates to the recognition as an asset under EEV of internally generated additional value of in-force (AVIF) long-term business. The growth in total assets was substantially driven by an increase of £20 billion in financial investments, reflecting strong new business sales and investment market performance.
At 31 December 2006 our total pension fund deficit at a group level had decreased by £498 million to £973 million (gross of tax) benefiting from deficit funding contributions during 2006. Following the finalisation of previously announced negotiations, agreement was reached that 12% of the future deficit funding payments were to be borne by UK with-profit funds from 2006. Following a further funding contribution in 2006 we have now paid £339 million of the £700 million additional funding announced in March 2006.
The following section details the specific performance of our business units, split by region. This marks a change from the previous year, where we reported the business unit results by segment. The change was made to align our reporting with our management structure. Each business unit is now reported under the executive director who is responsible for the overall management of that region. Our main reporting regions are: UK – headed by Patrick Snowball
Each of the directors has written a letter to shareholders at the start of their regional section setting out their views on the businesses for which they are responsible. Additionally, the letters cover the key developments affecting the region during the year and the key priorities for the future.
Morley and UK Europe International Total Total £m £m £m £m £m
Other operations (23) 28 Corporate costs (160) (136) Net unallocated interest charges (381) (436) EEV operating profit before adjusting items 3,245 2,904
O therinform ation Aviva plc Annual Report and Accounts 2006 23
We completed the integration of RAC, meeting our 2006 cost saving commitments
We successfully implemented our pension simplification strategy, increasing long-term sales by 31% while maintaining margins
Rationalising the cost base and legacy systems of the UK businesses
We gained increased access to additional UniCredit branches in Italy, generating a significant increase in sales volumes
We balanced profitability against sales volumes in a challenging Dutch market
We focused on fund transfers in France that benefit ongoing profitability
Norwich Union (NU) is a leader in the UK. Every week we collect £360 million customer premiums, pay out £94 million in insurance claims, pay £100 million to pensioners and attend over 50,000 breakdowns.
Our financial performance this year once again shows our strength as a well-managed, disciplined composite insurance business. Now that Norwich Union’s business units operate more closely together, we are poised to deliver additional benefits that were not available before.
Our UK life business has taken advantage of both improving market sentiment and pensions “A-Day” in the UK. Our focus has been on capturing our share of market growth, thanks to our unique combination of product range and broad distribution. Our combined businesses delivered an exceptional performance, with operating profits of £1,813 million (2005: £1,571 million), and our general insurance business produced a combined operating ratio of 95% (2005: 96%).
This is already occurring following the launch of our “make sense of it” website in NU life, which gives customers sound and simple financial advice. Our newly launched web-enabled fund centre offers comprehensive information for IFAs. Our simplified life cover product, also launched in 2006 and sold over the web, makes it easier to take out life cover and so helps tackle underprovision in the UK.
The actions we have taken in 2006 to extract value from the combined UK business will help us meet the challenge of intense competition in our markets, change and improve the ways we distribute our products to customers, and meet head on the threats and opportunities offered by new technology.
We still have plenty to do to reach our customer objectives, but through process improvement, investment in technology and sharing our expertise across the UK businesses, we will deliver further substantial improvements during 2007.
O therinform ation Aviva plc Annual Report and Accounts 2006 25 pNorwich Union links up with eBay to launch online insurance hub Norwich Union joined eBay.co.uk to launch a unique online insurance centre exclusive to eBay users.
eBay’s 15 million customers can use the central “insurance hub” to access information on Norwich Union’s motor, home and travel insurance offerings, obtain quotes and buy insurance via a click-through to Norwich Union Direct. Plus, they can benefit from Driveaway’s seven days’ free car insurance available on eBay Motors.
IFRS IFRS EEV New New profit operating operating business business before tax profit profit PVNBP* contribution** margin** £m £m £m £m £m %
* Excludes investment sales. Investment sales totalled £2,455 million (2005: £1,160 million) giving overall new business sales of £13,601 million (2005: £10,345 million).
Our UK operation, Norwich Union, is a leader in the life and pensions market with a scale unparalleled in the UK sector. We are based in York, with significant operations in Norwich, Stevenage and Sheffield in the UK and overseas operations in India and Sri Lanka. We are regulated by the Financial Services Authority.
Our goal is to be a clear leader in our market. We will achieve this by offering a superior range of products to help our customers grow their wealth and protect their families. In the long term, we aim to grow the overall UK market by improving financial literacy and engaging with current and potential customers who are either underprovided or underprotected.
Our brand, product range, distribution breadth and financial strength mean that we are uniquely placed to deliver growth and returns for customers and shareholders.
We are a leading provider in the financial adviser market with representation on 21 of 28 multi-tie panels. We are the largest provider to Sesame, Bankhall, Tenet and Simplybiz, the four largest financial adviser networks in the UK, providing access to over 20,000 advisers. We have a joint venture with The Royal Bank of Scotland Group (RBSG), tied relationships with 16 building societies and a strategic alliance with the Co-operative Insurance Society.
We offer a comprehensive range of investment and insurance products. We hold top-three positions in each of our key markets and are a major provider in each of our chosen product lines and channels. Our portfolio of products is diversified and is close to the overall market mix. Our scale and breadth means we have the flexibility to manage our portfolio for long-term value creation, sacrificing market share, where necessary, to secure profitability.
Our scale provides us with a sound financial base from which to operate. Our in-force book provides a significant, reliable and predictable source of profit, from which we can fund new business growth, business development and dividend payments.
2006 has seen an increase in the proportion of gross domestic product invested in savings and improving market sentiment, coupled with advisers’ focus on their customers’ pension arrangements. Our focus has been on capturing our share of this increased market as we create value for customers and shareholders by driving out efficiencies, improving customer service and continuing to develop our product range.
In September 2006, we announced an efficiency programme that will deliver £125 million of cost savings from 2008 at a one-off cost of £125 million by the end of 2007. Through initiatives such as simpler, faster and more customer-focused processes, stronger supplier management and further sharing of support services across our other UK businesses; we remain on track to deliver those savings. By the end of 2006 we had decommissioned 27 systems, reduced the number of roles by 194 and had already realised savings of £12 million.
Adverse exceptional expenses of £149 million (2005: £151 million adverse) are due to our ongoing investment in projects to deliver simpler products to the customer, and the continuing simplification of systems and processes used to administer the existing book. It is anticipated that the operational changes announced in September 2006 will serve to reduce, but not completely eliminate, this cost in 2007.
The site features a retirement planner to help people understand their financial position better. Users can fill it in and save it online, or they can print it out and take it to a financial adviser.
As a result of further analysis of recent customer behaviours, we have changed the basis on certain persistency assumptions. This has included consideration of factors such as the increasing portability of pension products after A-Day, customer outlooks being based on shorter time horizons and advisers more actively managing their customers. This has resulted in a strengthening of persistency assumptions by £224 million. Offsetting this, the company has clarified the financial obligations of its with-profit funds in relation to our pension deficit, resulting in a £126 million benefit.
We continue to review the possibility of a reattribution of the inherited estate of two of our with-profit funds, CGNU Life and Commercial Union Life Assurance Company. We have formally announced the appointment of Clare Spottiswoode as an independent policyholder advocate, and written directly to potentially eligible customers. At this stage, no decision has been taken to proceed with a reattribution, which will only take place if there is agreement on a fair outcome for both customers and shareholders.
We recognise that we still have more to do to deliver the level of customer service to which we aspire. In 2007, we will develop new ways for customers to interact with us, grow our direct to consumer channel, launch simpler products and introduce a self-service capability, enhancing the overall experience for our customers. We will pay particular attention to those customers who are traditionally underprovided or underinsured.
O therinform ation Aviva plc Annual Report and Accounts 2006 29
We focus on those markets where we can create long-term shareholder value, providing a wide range of insurance products for personal and small commercial customers, plus a range of motoring solutions through RAC and associated brands. We have a multidistribution strategy, selling our full range of products through brokers, partners such as banks and building societies, and direct to our customers. Our headquarters are in Norwich and we operate from over 40 UK locations, with overseas operations in India and Sri Lanka.
1 Personal motor 2 Homeowner 3 Personal other 4 Commercial motor 5 Commercial property 6 Commercial other i Team RAC goes green Team RAC created history while taking part in the 2006 British Touring Car Championship by becoming the first motor sport team to achieve a podium finish using bio-fuels. The UK’s premier motor sport series accepts the use of the road fuel E85 (85% renewable fuel bio-ethanol with 15% petrol), but no bio-ethanol cars had previously won a podium finish in the championship. We recognise that alternative fuel issues are high on the social and corporate agenda both in terms of environmental protection and fossil fuel sustainability. By demonstrating its use on the track we hope that other teams will recognise that the use of renewable fuel is viable in competition. Our wish is to see more teams and other motor sport championships switching to bio-fuels soon.
The project has begun with Ashfield School in Nottinghamshire, where we are building a state-of-the-art workshop equipped with the latest vehicle technology.
The aim of the initiative, which includes finding work placements with local businesses, is to provide students with a gateway into a range of automotive engineering qualifications and roles, not only as vehicle technicians but also in the manufacture and product design of vehicle systems, electronic controls and robotics, which are critical jobs for the future of manufacturing in the UK.
O therinform ation Aviva plc Annual Report and Accounts 2006 31
RAC has continued to deliver excellent customer service and has been rated number one for motorists in the 2006 JD Power Roadside Assistance survey. In addition, RAC has agreed a threeyear deal to provide breakdown assistance to all VW Group brands (including Audi, Lamborghini, Bentley, Seat and Skoda), commencing in the first quarter of 2007. This follows a new sixyear deal with Lex Vehicle Leasing to provide roadside assistance and glass replacement, and a two-year UK roadside contract with AssetCo that were signed in the first half of the year. RAC also successfully renewed its contracts with Porsche and Volvo and, since the end of the year, its contract with Motability.
Our commitment to corporate social responsibility is reflected in the business decisions we take and the recognition we receive. In October, we announced the full launch of our “Pay As You Drive”TM product. This raises awareness of road safety (especially the increased dangers of driving at night to young drivers) and gives drivers greater control over their motor insurance, by enabling an informed choice about when, where and how often they use their car. RAC was named Breakdown/Recovery Company of the Year in the Greenfleet Awards, for its environmentally friendly roadside patrols.
iNorwich Union Healthcare offers dedicated support for cancer patients During the year, we have improved further Norwich Union Healthcare’s dedicated and comprehensive cancer claims service.
U For more information on Norwich Union health services please go to www.norwichunion.com/health
Operating profit Operating profit IFRS basis EEV basis £m £m £m £m
The Royal Bank of Scotland (7) (1) (7) (1) Norwich Union investment funds 1 9 1 9
Europe is, and will continue to be, one of the world’s main savings markets. We have secured a unique operating platform on the continent and are in a prime position to capture the opportunities that changing demographics, increasing private wealth and stretched public finances will create to provide customers with our products and services.
I strongly believe that Europe will continue to make a major contribution to the success of Aviva, and that we will build further on our current strong position to become the leading insurance company in Europe.
O therinform ation Aviva plc Annual Report and Accounts 2006 33 p Romania: Aviva staff build better tomorrows We volunteered to partner international aid agency Habitat for Humanity to raise funds and build four new homes for families in Romania in one week. A hundred volunteers from across Aviva – Romania, UK, Turkey, Hong Kong and USA – travelled to Cluj to erect the new homes. Our contribution exceeded any previously achieved by Habitat for Humanity in Romania, both in terms of the number of volunteers from one company, and in the total size of the project. We are very proud of the employees involved and what they achieved.
IFRS IFRS EEV New New profit operating operating business business before tax profit profit PVNBP† contribution‡ margin‡
† Excludes investment sales. Investment sales totalled £891 million (2005: £1,026 million) giving overall new business sales of £13,731 million (2005: £12,827 million).
transfers, an area in which we have been very successful and which is based on our market position as a unit-linked specialist. To date, we have achieved over 80,000 policy conversions amounting to £4.2 billion of transferred funds, of which 33% have been transferred to unit-linked funds. The majority of transfers have been generated through AFER in 2006 and together we have generated approximately 30%# of all Fourgous transfers in the market.
We generated sales growth of 1% to £3,552 million (2005: £3,530 million). Unit-linked sales increased by 10% to £1,556 million (2005: £1,423 million), with AFER unit-linked sales growing strongly by 32%, while sales through our bancassurance partnership with Crédit du Nord have increased to £838 million (2005: £728 million). These increases were offset by reduced euro fund sales in the non-bank channels. Our continued strategic focus on more profitable unit-linked sales resulted in a 14% increase in new business contribution to £153 million (2005: £135 million) giving a higher full year new business margin of 4.3% (2005: 3.8%).
We have built a strong base from which to grow while seeking to retain our focus on the higher-margin unit-linked market and on maintaining a competitive suite of products.
Following the acquisition and merger with Ark Life in January, and the start of the associated bancassurance partnership with Allied Irish Banks (AIB), Hibernian is now the third-largest life and pension provider in Ireland with a 17% market share. This transformational deal provides exclusive access to Ireland’s largest retail bank with over 280 branches and 1.6 million customers, adding to our existing channels, most notably our strong broker distribution capability. This development is a major step towards us achieving our longer term objective of growing our market-share in long-term savings and protection products.
Our life EEV operating return was a loss of £40 million (2005: £20 million profit) including £21 million of profit through the bancassurance partnership with AIB. The EEV operating loss reflects adverse persistency in the year and the impact of consequential changes in operating assumptions. Following the removal of market value adjustments at the beginning of 2006, Hibernian has experienced high rates of withdrawals from its with-profits Celebration bond. Lapse assumptions have also been strengthened for unit-linked pension business and for some other single premium life products. Other assumption changes include the strengthening of annuitant mortality following a detailed review of experience and industry trends, and a one-off change in expense assumptions.
Including sales through the bancassurance partnership with AIB, new business sales increased by 93% to £1,273 million (2005: £665 million). Sales through AIB, which commenced at the end of January 2006, amounted to £589 million. Sales through the Hibernian broker channel were 4% higher at £684 million (2005: £665 million). This was mainly driven by strong sales of single premium unit-linked business reflecting buoyant market conditions and the continued success of the limited-offer guaranteed fund prior to its closure in June. New business contribution of £15 million (2005: £16 million) included £8 million through the bancassurance partnership with AIB. The year-on-year movement in new business contribution and the lower new business margin of 1.2% (2005: 2.4%) mainly reflects continuing competitive pressures and the adverse impact of lapse assumption changes noted above.
One of our key strengths is the three strong brand names of Aviva, Hibernian and AIB. This market presence gives us a significant opportunity to increase sales. A significant proportion of SSIAs will mature in April 2007 and, while we anticipate some customer inertia, we are well positioned to benefit from this opportunity.
Our main goal is to develop the business through profitable growth. To achieve our goal, we continue to work with our bancassurance partners to increase customer penetration and improve value for customers through product innovation. At the same time, we continue to focus on maintaining a cost-efficient operation. In all, we introduced or improved 32 products during the year and through access to additional branches in the UniCredit Group we have achieved strong sales growth in 2006. During the year, our bancassurance partners BPI and BPU both announced corporate mergers; our existing partnership agreements remain in force until 31 December 2009 and 31 December 2010, respectively. We continue to work on expanding our distribution and we expect approval in 2007 for the transaction involving BPI’s financial adviser network, bipielle.net.
Our life EEV operating return increased to £110 million (2005: £96 million) due to a higher new business contribution. We achieved strong sales growth in 2006 up 22% to £2,768 million (2005: £2,294 million) benefiting from the launch of new and improved products and access to additional branches in the UniCredit Group. New business contribution increased to £70 million (2005: £59 million) due to significantly higher sales, representing a new business margin of 2.5% (2005: 2.6%).
The Italian long-term savings market has significant medium-term growth potential and Aviva’s prospects for continued growth in 2007 are good.
During 2006, changing pension laws in the Netherlands, fiscal changes on life products in the Netherlands and Belgium and the impact of a reduction in the difference between short-term and long-term interest rates across the euro zone have adversely affected our results. Sales of our new “lifecycle” product in the Netherlands have not reached the levels of our previous pre-retirement products and, at the same time, increasing interest rates across the euro zone have reduced the demand for mortgages while making competing bank deposit-type products more attractive.
U For more information on Hibernian’s pension products please visit www.hibernian.ie
O therinform ation Aviva plc Annual Report and Accounts 2006 37
New products were launched via the direct sales force channel in 2006 with additional developments planned for next year. In 2006, we have developed innovative methods of capturing new business, particularly in the pensions market, with the introduction of SMS and internet technology. Additionally, we were acknowledged as having the best pension fund in central and eastern Europe by the prestigious industry monthly magazine Investment & Pensions Europe.
We expect to grow and develop our business further next year following product developments, expanded distribution and tactical initiatives implemented in 2006, combined with the favourable development of the investment markets that will benefit the entire market.
Aviva Spain operates in the long-term saving, pension and protection markets through a multi-distribution platform. We are the second-largest life insurer with an 8% market share at December 2006. Our distribution is dominated by five bancassurance partnerships with Bancaja, Caja España, Caixa Galicia, Unicaja and Caja de Granada. The majority of our products are marketed through the brands of our bancassurance partners. We use the Aviva brand in relation to our Aviva Vida y Pensiones (AVP) business, which distributes products through an agency-based network.
Our other European operations consist of our top-five businesses in Turkey, Hungary and Romania and our operation, ranked 13th, in the Czech Republic.
In the Czech Republic, Hungary and Romania, we are seeking to achieve growth with unit-linked and other saving products focused on high net worth individuals. Programmes are underway to grow the direct sales force and to improve further performance. We aim to enhance our product range while developing further our alternative distribution channels particularly bancassurance and brokers. In Romania, we see the launch of new voluntary pension scheme products in 2007 as a growth opportunity for the business.
**The “Loi Chatel” introduced in August 2005 requires that an insurer must now inform their client in the annual review notice that the client has the right to cancel the policy.
During 2006, we have increased activity in our commercial operations, predominantly in our health business, and for selfemployed customers in order to maintain the product spread of our portfolio. We also launched a credit insurance product on new car sales and plan to launch a new household product in 2007.
Following the release of a single IT system for agents and head office, all agents will soon be using a common portal and sharing claims functionality in addition to online sales information with head office.
Our performance reflects a highly competitive market place where competition is fierce and the cycle is following a downward trend. Our net written premiums increased by 2% to £735 million (2005: £726 million) reflecting limited rating increases. However, policy retention rates remain high, despite a change in the regulations regarding annually renewable policies**.
Hibernian is the largest general insurer in Ireland, with a market share of 20% The majority of our business is sourced through brokers with an increasing proportion sourced from direct and corporate partners. We expect further growth in the proportion of business written through our direct channel, particularly in the motor market, while broker distribution will continue to dominate the commercial market. Our strong brand name and expertise in the management of underwriting and claims has allowed us to maintain our leading position.
In 2006, health provision has been reformed with the amalgamation of public healthcare provision into the private sector. These changes have resulted in lower profitability within the industry and Delta Lloyd has been active in exploring strategic options. One such option was the proposed merger with Agis Health Insurance and Menzis Health and Income that was rejected by Menzis’ member council at a late stage in November. Nevertheless, Delta Lloyd remains confident in the future of its healthcare businesses, underlined by its success in writing 45,000 new policies in 2006.
Our general insurance and health operating profit was £139 million (2005: £137 million). Our general insurance COR improved to 89% (2005: 93%), reflecting a strong premium rating environment and favourable claims experience, including a low incidence of large claims. Conditions in the health market were less favourable as noted earlier, resulting in an operating profit of £11 million (2005: £40 million).
Our other European general insurance operations are based in Italy, Poland and Turkey. They sell predominantly personal and small commercial insurance through networks of agents and brokers. Our aim for these businesses is to achieve profitable growth and to contribute cash generation in support of our life businesses.
The operating profit from our other European general insurance businesses was £43 million (2005: £47 million), reflecting broadly stable market conditions.
Europe – Fund management Operating profit IFRS basis Operating profit EEV basis £m £m £m £m
Operating profit has increased to £33 million (2005: £26 million), reflecting our well-established fund management expertise, an inflow of funds from unit-linked sales in our life business and strongly performing equity markets in the early and latter quarters of 2006. We have £50 billion (2005: £46 billion) of funds under management, mostly on behalf of group companies, including the non-linked funds of Antarius, our bancassurance partnership with Crédit du Nord.
Delta Lloyd Asset Management manages investments both for Delta Lloyd’s own insurance operations and for third-parties including individual and institutional customers. As well as managing equity and fixed interest funds, our operations also include management of a property portfolio comprising residential premises, offices, shops, and participating interests in unlisted Dutch property funds.
Operating profit from our fund management business in the Netherlands was £37 million (2005: £32 million previously reported within non-insurance business). This improvement reflected an increase in funds under management of 9% during 2006, which included an increase in net inflows into institutional funds of £913 million (2005: £573 million). Inflows from individual customers have been lower in 2006 following the exceptional success of Delta Lloyd’s select dividend fund in 2005.
i France: Aviva Gestion d’Actifs wins top investment awards In France, we won the prestigious Corbeille Long Terme de Mieux Vivre Award for our leading investment position over five years. The Corbeilles, awarded annually by the newspaper Mieux Vivre Votre Argent, are a leading benchmark in French asset management. This accolade, repeating our success of 2003, along with the La Tribune/S&P Golden Trophy award that we won in 2004 and 2005, has reinforced Aviva’s reputation. This was in addition to the five gold investment awards our investment team had already won during 2006.
U For more information on Aviva Gestion d’Actifs please visit www.vam.cgu.fr
We have made great progress during the past year with our rapidly expanding businesses across the Asia-Pacific region and in North America. The strong growth of profits and sales across the majority of our businesses demonstrates the effectiveness of our highly diversified distribution network and our ability to deliver results from new opportunities.
Our general insurance business in Canada has broadened its distribution and has introduced innovative products during 2006.
Through the acquisition of AmerUs we have created a dynamic and thriving business in the US. The developing markets of the Asia-Pacific region and Russia represent a substantial longer-term area of opportunity for us. We shall be looking to accelerate growth through our strong market positions and key capabilities, notably diversified distribution and product innovation, while continuing to explore the potential of other markets.
O therinform ation Aviva plc Annual Report and Accounts 2006 43 s Canada: 10% discount for environmentally friendly drivers In Canada, we reward policyholders in Quebec who drive hybrid vehicles with an automatic 10% discount on their Aviva auto policy premium.
Aviva Singapore and Hong Kong employ a multi-channel distribution strategy including a strong partnership with Development Bank of Singapore (DBS), South East Asia’s largest banking group. In 2006, we are ranked fourth in Singapore and 14th in Hong Kong.
In Hong Kong, our business has progressed significantly over the last year with a strong increase in sales both through the development of our IFA channel, which now represents more than half of our sales, and through DBS. The overall insurance market is expected to continue to grow strongly, mainly by the bancassurance and IFA segments.
On 1 February 2006, we acquired a 51% interest in Eagle Insurance Company Limited (Eagle), the third-largest insurer in Sri Lanka, for a cash sum of £15 million. At the same time, Eagle entered into a bancassurance agreement with National Development Bank Limited, Sri Lanka’s biggest development bank and Eagle’s other major shareholder. Eagle has now entered its second bancassurance agreement, with Standard Chartered Bank, and sales commenced in September 2006.
i Aviva-COFCO wins consumers’ award Aviva-COFCO received an award for the “most reliable foreign life insurance company” in a poll co-ordinated by Hexun.com, China’s leading financial website among Chinese consumers in middle to higher income groups. The poll had approximately 700,000 respondents, who voted for sectors such as insurance, banking, futures and fund management. The key measurements used for the insurance sector were product design and innovation, sales force quality and customer service.
Continued economic growth in both China and India offers high potential returns in the longer term and, in both countries, we are actively pursuing growth in cities and provinces with significant long-term potential.
In Taiwan, we have established a branch operation and have signed a memorandum of understanding with First Financial, the owner of First Commercial Bank, to explore a possible alliance.
We are working to finalise our new opportunity in Malaysia with Bumiputra-Commerce Holdings Berhad, which was announced in January 2007 and remains subject to regulatory approval.
In Singapore and Hong Kong, sales increased to £319 million (2005: £227 million) and to £216 million (2005: £103 million) respectively, reflecting strong sales through our partnership with DBS together with an increase in sales through other distribution channels, notably in the developing IFA channel in Hong Kong. In India and China, sales continue to grow rapidly with our share of sales amounting to £84 million (2005: £32 million) and £50 million (2005: £35 million), respectively. In Sri Lanka, sales have amounted to £16 million since the acquisition of Eagle.
The life EEV operating return was £49 million (2005: £44 million) due to favourable experience variances. New business contribution was £17 million (2005: £16 million), while new business margin increased to 5.7% (2005: 4.7%) benefiting from improved business mix, in particular a higher proportion of protection business.
Total new business amounted to £884 million (2005: £527 million) of which £324 million was generated by AmerUs in the six weeks following acquisition. Sales in our operations based in Boston increased by 7% as a result of strong growth of structured settlement products following the A.M. Best rating upgrade to A+ in November 2005. Full year sales by the AmerUs business were £2,261 million (2005: £1,882 million) including £330 million of funding agreement sales (2005: £38 million). Excluding the impact of funding agreements, which are irregular by nature, sales of the underlying life and annuity products showed strong quarter on quarter growth throughout 2006, with the final quarter recording the best ever sales performance.
The medium-term outlook for this market is strong. The US is expected to be the main source of world savings growth in the next 15 years as the “baby boomer” generation of over 70 million people approach and enter retirement. The products of AmerUs, in particular, are tailored to appeal to this market. In the short term there is some disruption to the market, caused by high short-term bond yields and uncertainty regarding the future regulation of fixedindexed annuities. We do not expect that these factors will diminish the medium- and long-term growth potential.
Aviva Russia was granted its licence in March 2006 and trading has commenced in corporate sales on a limited scale. Our strategy is to position the business to take advantage of the rapid growth expected to occur as the life insurance industry develops. We aim to achieve at least a top-five market position and a 10% share of the life insurance market within five years.
As a leading Australian retirement solutions provider and the UK’s top insurer, we have many customers who will benefit from this new development, including many of the Australians who have worked in the UK, either before migrating or when visiting.
We are one of the first businesses in the world to offer this flexibility to our customers.
IFRS IFRS Combined Net profit operating operating written Underwriting before tax profit ratio** premium result £m £m % £m £m **General insurance business only.
Our multi-channel, multi-distribution strategy is underpinned by relationships with independent brokers, combined with a commitment to developing corporate partnerships as well as new schemes offered to groups and affinity partners. We continue to develop our e-commerce portal capability, with online quotation and automated workflow tools, and are focused on making it easier for customers and brokers to do business with us.
Our other international operations are a health insurance business in Asia, a captive reinsurer in Bermuda and a market-leading general insurer in Sri Lanka, which was acquired in February 2006. The operating profit from our other general insurance and health businesses was £40 million (2005: £40 million).
Morley and rest of the world – Fund management Operating profit IFRS basis Operating profit EEV basis 12 months 12 months 12 months 12 months £m £m £m £m
Overleaf, we discuss the results of our largest fund management business, Morley, and our international operations. We have other significant fund management businesses that are reported in the UK and Europe business reviews on pages 31 and 41 respectively.
We are recognised as a provider of a broad range of specialist fund management solutions to our clients, which include Aviva group companies, many of the UK’s largest financial services companies, external pension funds, public sector organisations and public and private companies.
Our strategy is primarily one of organic growth; however, we actively consider acquisitions where synergies and strategic alignment are compelling. We aim to deliver sustainable and profitable growth through a focus on increasing our revenue by offering higher-margin products in our areas of strength while carefully managing our cost base.
During the year, Morley and our UK long-term savings business, Norwich Union Life, agreed to establish a single team, operating within a joint venture approach, responsible for the sale of collective investment products to consolidate and strengthen our participation in both the retail and wholesale UK sales channels over the long term*.
In June, we completed the purchase of a 56% stake in hedge fund management company ORN Capital as part of our strategy to accelerate our alternatives business, adding one multi-strategy and a number of single-strategy hedge funds to our range of absolute return products.
We continue to position our business to work with our clients to develop tailored investment solutions and capitalise on the growing demand for specialist investment products.
Business review continued * Collective investment sales are reported in our UK long-term savings segment.
O therinform ation Aviva plc Annual Report and Accounts 2006 49
Our International fund management businesses consist primarily of Navigator, operating in Australia and Singapore, and a small fund management operation in Canada.
Navigator had an excellent year with overall new business growing by 34% in 2006 to £1,110 million (2005: £848 million), benefiting from ongoing improvements in the product offering and a strong focus on customer service. In the 2006 S&P (Assirt) adviser survey, we improved our overall ranking for the third consecutive year and are now above the industry average for overall service levels.
i Morley – Awards: Morley has enjoyed a year of award-winning progress, with expansion into Europe, innovative product launches and strong performance for our investors.
Our property team continues to be recognised by the industry, winning property fund manager of the year at Property Week Awards 2006 and Property Investment Manager of the Year at Pensions Management 2006, and winning two European awards – Outstanding Company of the Year and Investor of the Year at the Central and Eastern European Real Estate Quality Awards.
Capital strength is important to us since it gives us flexibility to take advantage of opportunities to create value for our shareholders and customers. We have further strengthened our capital position during the year. Equity shareholders’ funds have increased by 18% to £17.5 billion and our excess solvency margin, as measured under the insurance group’s directive, was £3.6 billion (2005: £3.6 billion), reflecting the acquisition of AmerUs having reduced the margin by £0.7 billion and the impact of funding the pension scheme deficit. The underlying strong operational performance demonstrates the capital generative nature of our businesses. The ability to generate capital is a key strength of the group and enables us to fund both organic growth and bolt-on acquisitions from our internal capital resources.
Additionally, rating agencies have recognised this strength by reaffirming the ratings of our main operating subsidiaries, AA/AA- (very strong) from Standard & Poor’s and Aa3 (excellent) from Moody’s, both with a stable outlook.
We have built a reputation for professionalism and prudence, but we also have a forward thinking outlook. We remain committed to efficiently managing risk and capital, while continuing to seek out innovative ways to improve our processes, controls and risk and capital management.
O therinform ation Aviva plc Annual Report and Accounts 2006 51 s Finance strategy To cope with the ever-developing demands of the financial and regulatory landscape, we have refreshed and revised our finance strategy. The new strategy incorporates the four Cs: – Capital – Increasingly integrating our management of risk and capital
– Consistency – Generating trusted data from efficient processes and systems
– Allocate capital efficiently to support growth and repatriate excess capital where appropriate
We have a number of sources of capital available to us and seek to optimise our debt to equity structure so we can maximise returns to our shareholders. We consider alternative sources of capital such as reinsurance and securitisation in addition to more traditional sources of funding. We select capital funding that is appropriate to its deployment and usage.
In addition to our external funding sources, we have internal debt arrangements in place. These arrangements have allowed the assets that support technical liabilities to be invested in a pool of central assets for use across the group. They have also allowed the redeployment of cash between parts of the business to fund growth. Although these arrangements are intra-group loans, they are included as part of the capital base for the purpose of capital management. Our intra-group loans satisfy arms length criteria and all interest payments have been made when due.
We are subject to a number of regulatory capital tests and employ realistic scenario tests to allocate capital and manage risk. Overall, the group and its subsidiaries satisfy all existing requirements and, as reported below, has significant resources and capital strength.
O therinform ation Aviva plc Annual Report and Accounts 2006 53
We measure our capital using different bases that include measures that comply with the regulatory regime in which we operate and measures that the directors consider appropriate for effective management of the business. The measures that we use are: Accounting basis
Relevant capital and solvency regulations are used to measure and report the financial strength of our insurance subsidiaries. These measures are based on local regulatory requirements and are consolidated under the European Insurance Groups Directive (IGD). The regulatory capital tests verify that we retain an excess of solvency capital above the required minimum level calculated using a series of prudent assumptions about the type of business written by our insurance subsidiaries.
In addition to the FSA realistic reporting regime, the UK Accounting Standards Board requires certain capital disclosures to be made in accordance with Financial Reporting Standard 27, Life Assurance (FRS 27). The purpose of the capital statement is to set out the financial strength of the entity and to provide an analysis of the disposition and constraints over the availability of capital to meet risks and regulatory requirements. The disclosures required by FRS 27 are set out in note 49.
We believe that economic capital provides a clear measurement of the risks facing our business. Additionally, it informs the amount of capital that we need to hold to mitigate the risk of insolvency. We provide full details of our economic measures of capital in the “Risk and capital management” section on page 57.
Our capital funding is allocated so that the capital employed by trading operations is greater than the capital provided to those operations by the shareholders and subordinated debt holders. As a result, we are able to enhance the returns earned on our equity capital.
Shareholders’ funds – EEV basis £20.9bn £17.5bn Total capital employed – EEV basis £26.4bn £23.0bn Net asset value per share – EEV basis 683p 622p
Shareholders’ funds have increased by £3.4 billion to £20.9 billion (2005: £17.5 billion), reflecting our strong operational performance in 2006.
Having assessed the level of operational, demographic, market and currency risk of each of our life businesses, the required level of capital for each business is quantified and expressed as a percentage of the EU minimum. The required capital across our business varies between 100% and 250% of the EU minimum or equivalent. The weighted average level of required capital for the whole of our non-participating life businesses, expressed as a percentage of the EU minimum solvency margin or equivalent is 134% (2005: 128%). This is a blended rate and is expected to change over time with changes in the product mix.
Estimated Estimated Estimated realistic risk realistic Realistic inherited capital Estimated Estimated assets Liabilities*† estate‡ margin≠ excess excess £bn £bn £bn £bn £bn £bn * Realistic liabilities include shareholders’ proportion of future bonuses of £0.7 billion (31 December 2005: £0.7 billion). Realistic liabilities adjusted to eliminate shareholders’ proportion of future bonuses are £48.6 billion (31 December 2005: £50.5 billion).
‡ The estimated realistic estate at 31 December 2005 was £2.1 billion, £1.9 billion and £1.2 billion for CGNU Life, CULAC and NUL&P respectively.
# The NUL&P fund includes the Provident Mutual (PM) fund, which has realistic assets and liabilities of £2.3 billion and therefore does not impact the realistic inherited estate.
We continue to investigate the possibility of a reattribution of the inherited estate of two of our with-profit funds: CGNU Life and CULAC. In February 2006, we announced the nomination of Clare Spottiswoode as policyholder advocate, a consumer led role created to represent policyholders, under new Financial Services Authority (FSA) rule governing reattribution.
In November, we agreed terms of reference with Clare Spottiswoode, and she has agreed to accept the role of independent policyholder advocate. The appointment has been approved by the FSA. We are confident that Clare Spottiswoode’s experience as both a regulator, and as a company director, makes her qualified to represent independently the with-profit policyholders’ interests and negotiate on their behalf. During her nomination period, Clare Spottiswoode has: – Established an independent office
– Set up a technical team, including actuarial and legal support
The 2005 figures for AII group, and consequently the NUI and All group pro forma, have been restated to reflect admissibility and counterparty restrictions relating to intercompany balances following a revised application of the technical rules. There is no economic impact on the All group or on our capital adequacy (IGD) calculation.
Our governance structure and policies are regularly reviewed to reflect the changing commercial and regulatory environment, and our own organisational structure.
O therinform ation Aviva plc Annual Report and Accounts 2006 57
We believe that the measurement of economic capital provides a clear and consistent way to monitor and compare the risks in our businesses.
We have developed a capital management framework using Individual Capital Assessment (ICA) principles for identifying the risks that business units, and the group as a whole are exposed to, quantifying their impact on economic capital.
Our ICA estimates how much capital is needed to mitigate the risk of insolvency to a selected remote level, based on a number of stress tests applied to the capital position of the business. These tests, covering both investment and insurance scenarios, are specified centrally to provide consistency between business units to achieve a minimum standard. Additionally, business units can supplement the tests with others applicable to their own situation.
An ICA has been developed for all material parts of the group, and the results of financial and operating experience tests are linked to our risk reporting model. We also produce projections of the ICA requirement over a number of years to show how the economic capital position is likely to evolve.
ICAs have now been produced for a number of years and the results are used as a basis for discussion with the FSA. ICA analysis is now used in our key decision making processes.
We monitor specific risks on a regular basis through our risk-monitoring framework. Our businesses are required to disclose all material risks along with information on the likelihood and severity of these risks and the mitigating actions taken or planned.
We also continually monitor the financial impact of changes to market values through a number of measurements of economic capital or sensitivities to key performance indicators.
Our largest market risk exposure is to changes in equity prices. We believe in the long-term benefits of holding equities and are prepared to accept the consequential shorter term fluctuations in our shareholder funds. For example a 10% decrease in equity prices* causes a £768 million pre-tax decrease in the level of shareholders’ funds on an IFRS basis and on an EEV basis would reduce embedded value by £1,065 million, net of tax.
Interest rate risk is the risk that arises from both the products we sell and the value of our investments due to changes in the level of interest rates. For example, long-term debt and fixed income securities are both exposed to fluctuations in interest rates. We are exposed to reductions in interest rates on business carrying investment return guarantees, and to interest rate increases on business carrying surrender value guarantees. A 1% decrease in interest rates would increase shareholders’ funds on an IFRS basis by £806 million pre-tax and on an EEV basis would increase embedded value by £310 million, net of tax. Sensitivities to increases in interest rates are shown in note 50 and the section on EEV reporting.
We manage our interest rate risk in a number of ways. In some categories of our long-term business, we reduce interest rate risk through the close matching of assets and liabilities. On short-term business such as general insurance business, we require a close matching of assets and liabilities by duration to minimise this risk.
We invest in property assets, in a variety of locations worldwide that are exposed to fluctuation in values. We believe investing in these assets provides long-term benefits for our businesses and clients. Investment in property is managed locally by our business units, subject to the risk appetite of that business unit, and within any local regulations on asset admissibility or liquidity.
We generally do not hedge foreign currency revenues, as we prefer to retain revenue locally in each business to support business growth, to meet local and regulatory market requirements, and to maintain sufficient assets in their local currency to match local currency liabilities. We are also exposed to some exchange risk from assets held in staff pension schemes, as a part of the investment strategy agreed with the scheme trustees.
Movements in exchange rates may affect the value of consolidated shareholders’ equity, which is expressed in sterling. This aspect of foreign exchange risk is monitored centrally against limits that we have set to control the extent to which capital deployment and capital requirements are not aligned. We use currency borrowings and derivatives when necessary to keep currency exposures within these predetermined limits, and to hedge specific foreign exchange risks when we feel it is appropriate; for example, in any acquisition or disposal activity.
O therinform ation Aviva plc Annual Report and Accounts 2006 59
We have a significant exposure to credit risk through our investments in corporate bonds, commercial mortgages, and other securities. We hold these investments for the benefit of both our policyholders and shareholders. We monitor and manage two types of credit risk. Firstly, we manage the exposure to individual counterparties, by measuring exposure against centrally set limits. The aggregate exposure we are prepared to accept takes account of credit ratings issued by rating agencies such as Standard & Poor’s. We also manage the level of risk we are prepared to take, and we are using increasingly detailed analysis to define our optimal balance between risk and reward, monitoring the types of investment available to us to achieve best our aims.
Our group credit committee (GCC) takes responsibility for monitoring credit exposures to individual counterparties and determining who we are prepared to work with. Our GIC sets the credit risk appetite as part of our overall management of market risk.
We are also exposed to credit risk through our use of reinsurance. Our reinsurance security committee, part of our GCC, verifies that reinsurance arrangements are only placed with providers who meet our counterparty credit standards.
Our life insurance businesses are exposed to the full range of life insurance risks from the products that they have written, typically mortality, morbidity risk, as well as experience on persistency and unforeseen expenses.
Our business units manage mortality and morbidity risk on protection business using reinsurance and while they can select reinsurers locally, we review reinsurance coverage across the group and our overall reinsurance program is assessed centrally to manage group-wide risk exposures. Sensitivity tests show that we are not materially affected by mortality risk. Our equity reduces by only £20 million for a 5% worsening in assurance mortality experience on an IFRS basis and decreases embedded value by £165 million on an EEV basis, net of tax.
** Not Rated includes mortgages and other debt that does not attract an external rating.
Our largest risk is claims incurred from catastrophe events. This risk is controlled through monitoring risk aggregations and using catastrophe reinsurance cover.
We actively use reinsurance to help reduce the financial impact of a catastrophe and to manage the volatility of our earnings. Reinsurance purchases are reviewed annually at both business unit and group level to verify that the protection we have purchased matches the level of exposure. Reinsurance arrangements are only placed with providers who meet our counterparty security standards. We use extensive financial modelling and actuarial analysis to optimise the cost and risk management benefits from our reinsurance program.
Maintaining sufficient available liquid assets to meet our obligations as they fall due is an important part of our financial management practice. Our business units must all operate controls to identify sources of liquidity risk, monitor potential exposures, and manage their liquidity requirements. At group level, we maintain a prudent level of liquidity consistent with the expectations of the FSA and the investment community. We also maintain a buffer of liquid assets to cover unforeseen contingencies including the provision of temporary funds to any of our business units that experience temporary liquidity shortfalls.
Our business units are primarily responsible for identifying, managing and reporting these risks as part of our quarterly risk reporting processes. Each operational risk is assessed by considering the potential impact and the probability of the event occurring. Impact assessments are made against financial, operational and reputational criteria.
Our operational risk committee (ORC) determines the risk appetite that the group can work within for these types of risk, assesses and monitors overall operational risk exposures, identifying any concentrations of operational risk across the group, and in particular verifies that mitigating action plans are implemented.
The consolidated financial statements and financial data contained in the report and accounts has been prepared using the group’s accounting policies on an IFRS basis, as set out on pages 104 to 113. These policies are in accordance with standards issued by the IASB and endorsed by the EU, including the early adoption of IFRS 7 as detailed in policy A. The date of transition from UK GAAP to IFRS was 1 January 2004.
O therinform ation Aviva plc Annual Report and Accounts 2006 61
IFRS 7 covers disclosures for financial instruments, and replaces earlier standards on this subject. Although the new standard extends the disclosures in the financial statements in several places, it does not affect the policies themselves.
The only change to the accounting policies in 2006 has been from an amendment to the financial instruments standard (IAS 39) that deals with accounting for financial guarantee contracts. While not material at the consolidated group level, this does affect the company and its subsidiaries in respect of inter-company guarantees given and taken.
We present the results and financial position of our life and related businesses on an EEV basis, in addition to the IFRS basis. The directors’ opinion is that the EEV basis provides a more relevant and transparent view of the performance of the life and related operations year-on-year than the results presented under the 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.
On an EEV basis, the value of a policy recorded in the year of sale takes into account future cash flows relating to that policy. Various assumptions are used to estimate the present value of a policy. In subsequent years, the present value of the policy is adjusted only to reflect changes in the assumptions used.
The long-term nature of much of our operations means that shortterm realised and unrealised gains and losses on general insurance and health business are shown as an adjustment to operating profit. We focus instead on operating profit incorporating a longer term investment return (LTIR). Our rates of return that we use for equity and property in our LTIR methodology are aligned with the rates that we use under EEV principles. For fixed interest securities, we include the amortisation of premiums or discounts arising on purchase, thereby producing an LTIR that is equivalent to the gross redemption yield.
The preparation of our financial statements requires us to make estimates and assumptions that affect items reported in the consolidated income statement, balance sheet, other primary statements and notes to the financial statements. All estimates are based on management’s current knowledge, assumptions based on that knowledge, and their predictions of future events and actions. Actual results can always differ from estimates, possibly significantly.
Phase II of the IASB’s project on insurance contracts remains the most significant area that we are tracking. During 2006, the insurance industry has worked closely with the IASB in seeking to develop a comprehensive global accounting standard for insurance that will reflect the economics of our business. In June 2006, the CFO Forum representing the large European insurers, in which we play an active role, published principles for measurement and recognition of insurance liabilities. We now await publication of the IASB’s preliminary views in the first quarter of 2007. This is the first stage in the development of the IASB’s standard and it is unlikely to be finalised before the end of 2009 at the earliest. The range of possible outcomes remains large; therefore, it is too early to predict the impact this change in accounting will have. While this standard is under development, we will continue to focus on EEV as the best measure of value for our long-term business.
We continue to monitor other major IASB projects including financial statement presentation, liabilities, revenue recognition and fair value measurement. The announcement from the IASB that no new standards or major amendments would become mandatory before 2009 and that the level of public consultation in the development of new standards would increase was welcomed.
I am determined that we will maintain our sector-leading reputation in corporate social responsibility (CSR) and we have further important initiatives underway to keep us there.
We launched task forces on three key people-related challenges: building great leadership across Aviva; delivering talent management offerings that enable our people to achieve their potential; and leveraging the power of the Aviva brand for our current and future employees. I am confident we will be able to report significant benefit from these initiatives next year.
The formation of a board CSR committee in 2006 raised further the profile of our CSR agenda. Our decision to carbon neutralise our operations worldwide represents a significant commitment. Aviva is the first global insurer to commit to doing so. We also became a founder member of Oxfam’s 365 Alliance, ensuring that Oxfam has pre-committed, planned resource in anticipation of any disaster across the globe.
Valuing diversity and respect at work are a fundamental part of our culture. In 2006, we launched a global senior women’s network group, introduced a range of recruitment practices aimed at attracting minority groups and provided tools to encourage our employees to engage with and understand our diversity agenda.
For Aviva, the Oxfam 365 Alliance is a perfect demonstration of forward thinking in practice. We are proud to be a part of it.
In Mwamakaranga village, Tanzania, approximately 300 children benefited from Oxfam’s school feeding programme. Eight million people across East Africa faced an acute food livelihood crisis in 2006. Over the past year Oxfam has provided emergency support, helping people to deal with shortages of food and water, and more recently, with severe flooding.
We recognise there are multiple stakeholders in our CSR activities: – Our shareholders, who wish to receive a return on their investment, but also to be assured that the company is behaving responsibly in how it operates
This review seeks to set out how our CSR activities support our overall business strategy while taking account of the views of our different stakeholders.
We report our progress on CSR fully in a separate annual CSR report, which is available online at www.aviva.com/csr.
In 2006 we established a Board CSR Committee, which met three times during the year. It is chaired by Aviva’s senior independent director, Wim Dik, and consists of Aviva’s chairman, three other non-executive directors and the group chief executive. It is responsible for CSR strategy and policy, and for reviewing the progress of our CSR programme. The CSR Committee report can be found on page 86.
Employees and responsibility continued i New board CSR committee One of our chairman Lord Sharman’s first initiatives was to demonstrate our commitment to corporate social responsibility by creating a board CSR committee.
Developing a diversity strategy and programme has been an important initiative during the past two years. Supported by Aviva’s annual global employee climate survey, our diversity aims have been integrated into our performance management process.
From January 2007, the CSR and diversity functions have been combined into one CSR team with a wider remit. This team will take the lead on a more comprehensive set of activities that form our CSR agenda. The wider remit establishes clearer accountability for the delivery of our CSR programme in one place.
We are committed to conducting all aspects of our business to rigorous ethical, professional and legal standards. We regard ethical practice as critical to responsible business and have put in place measures to refresh regularly our employees’ understanding of our standards of business conduct policy.
O therinform ation Aviva plc Annual Report and Accounts 2006 65 i Aviva remains in global lists of sustainable corporations We continue to be the only UK insurer included in both the Dow Jones Sustainability World and STOXX Indexes, and we are a member of the FTSE4Good Index series. These indices track the performance of the leading sustainability-driven companies worldwide. We are particularly proud of our scores for environmental reporting (100%), social reporting (98%) and code of conduct (97%) in the Dow Jones Sustainability World Index.
These listings recognise the commitment we are making to thinking about the future in a socially responsible way. It is apparent that investors are increasingly taking account of these ratings when making investment decisions.
– Helping our customers after they have bought our products by honouring our promises, giving good service, and providing helpful information
We comment here on progress across our core business activities under our key operating regions: UK, Europe and International and Morley.
Norwich Union Life helped develop the Association of British Insurer’s Customer Impact Scheme. The scheme aims to improve performance across the life insurance industry and so improve the experiences of our customers.
This scheme helps support our obligations under the Financial Services Authority’s Treating Customers Fairly initiative. The Customer Impact Scheme includes: – formal commitments by our board that put customer interests at the heart of our business
– participation in an annual in-depth customer survey to measure how well we are doing
– a detailed annual report showing how well we have met the customer commitments (available June 2007)
Aviva France has promoted the concept of “le bon conseil” stressing the importance of proper advice and research prior to purchase. In particular, we have been fast and efficient in our adaptation of new laws in comparison to market competition.
In Delta Lloyd, our Dutch subsidiary, all employees participated in a commercial training programme to help encourage the organisation to become more customer minded. Other initiatives included employees visiting customers to obtain their views on products and services. Further, to help improve transparency of life products and provision, Delta Lloyd simplified its cost structure and lowered the costs of life products. It also promotes transparency of life products on its website.
As a forward thinking insurer we are making provision for the effects of climate change through adapting and creating new products and services to meet this challenge. We will work with others to understand better the implications of climate change and play our part in helping to develop and deliver society’s continuing response.
We are managing and reducing, where possible, our own CO2 output and encourage others to do the same, using our influence as an investor and purchaser. In 2006, our total CO2 emissions increased largely due to the inclusion of emissions data, for the first time, from the RAC and AutoWindscreen fleets and buildings, and our Asian businesses. From our existing businesses, emissions have shown a slight increase, reflecting more business travel related to operational requirements and the upgrading of our managed property portfolio in respect of air-conditioning. We will continue to focus on reducing our energy use and look to source zero emission power where we can. We will offset our remaining emissions on a retrospective basis starting with emissions generated in 2006. We will compensate for the carbon output of our consumption of nonrenewable sourced electricity and gas from buildings and business travel, including air, car and train, across all of our global operations.
Our general insurance operations have been seeking solutions to limit the effects of climate change on customers through its flood mapping and lobbying on the issue of flood defences and floodplain planning.
We regard our suppliers as our partners and work with them to help us achieve our policy aspirations in the delivery of our products and services.
In 2006, we revised our group purchasing policy. We include CSR in our supplier tendering process and in some of our businesses, require suppliers to sign up to a code of conduct.
i First insurer to go carbon neutral worldwide Aviva is committed to becoming the first insurer to carbon neutralise its operations on a worldwide basis. This is an important further step in our efforts to limit our environmental impact, following our progress with energy efficiency and use of zero emission electricity. For example, 55% of electricity used by Aviva globally is obtained from zero emission sources.
We shall offset the remaining emissions – about 125,000 tonnes a year group-wide – on a retrospective basis, starting with 2006. We will achieve this by compensating for carbon output from our use of non-renewable sourced electricity and gas in buildings and business travel by investing in projects that generate carbon credits. The credits will come from carbon mitigation methods, such as tree planting, and renewable energy generation projects that do not release carbon to the atmosphere, such as solar or wind power.
Our business units have defined local challenges and relevant issues in their market environments. Across the group, we will continue to embed CSR and to identify suitable initiatives that will help to develop and progress this agenda.
Morley’s socially responsible investment (SRI) team also supports micro-finance initiatives. It participated in the successful raising of $60 million from investors in the UK, Europe and the US to lend to micro-finance institutions (MFIs) for a period of five years. MFIs provide people with small collateral-free loans at reasonable interest rates. Specifically, Morley purchased a $1.5 million note for one of Norwich Union's sustainable future funds, which helped create the foundation for the entire structure. This initiative will finance approximately 300,000 micro-loans in Latin America, eastern Europe and southeast Asia over the five year life of the structure
– To internationalise Aviva, sharing and developing talent across our business units
– To measure our people assets, to understand our human capital and how it can be grown
In everything that we do, we are mindful of our brand values. They inform not only what we do, but the manner in which we do it. Our values are set out below: Progressiveness
Performance-driven is having clear goals and achieving them by everyone working towards them in an efficient manner.
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We are an international business, with a hugely diverse range of customers. In 2006, we employed 59,000 people in 22 countries, with 65% of these people telling us through our global climate survey that “my business unit is a great place to work.”
External surveys and monitoring organisations provide us with an opportunity to measure our progress in embracing diversity. Recognition in 2006 included the Opportunity Now “City” award, appearance in The Times’ “Top 50 places where women want to work,” an Opportunity Now Gold award (an improvement on 2004 and 2005’s bronze and silver ratings) and a silver award from Race for Opportunity.
In the UK, to maintain Norwich Union’s position as a highly efficient and effective company, and to respond to changing customer buying habits, a planned UK headcount reduction of 4,000 by 2008 was announced in 2006. Part of this reduction relates to duplication of roles in functional areas such as marketing, human resources, finance and information technology due to the bringing together of the Norwich Union Life and general insurance business. The remainder relates to increasing the number of roles (in line with plans announced in 2005) in the Indian and Sri Lankan operations that currently support Norwich Union and Aviva Canada customers. Reinforcing the importance of our brand values and of how we interact with our customers, we will be transferring more than 5,000 employees of third-party suppliers in India and Sri Lanka into our own offshore division, Aviva Global Services during the course of 2007.
i Aviva Leadership Academy We believe in the talent of our employees and we aim to create an environment where they can give their best, feel valued and develop their skills. The Aviva leadership academy is an integral part of our talent management strategy and plays a key role in building and retaining leaders. The academy programmes emphasise experiential learning, networking and the development of everyday authentic leadership skills. The programmes are progressive and reflect the changing needs of our employees as they move through the organisation.
We are a leading member company of the Centre For Executive Development (Cedep) located in Fontainbleu, France and work in conjunction with this organisation and leading international business schools including Columbia Business School, The Centre for Creative Leadership, Wharton, INSEAD and Yale to design and develop cutting-edge programmes that respond to our changing environment.
Andrew Moss (48) Group finance director Appointed to the board in May 2004 upon joining the company.
Previously director – finance, risk management and operations in Lloyd’s (insurance) and formerly held a number of senior management positions at HSBC plc (banking). Andrew Moss will succeed Richard Harvey as the group chief executive in July 2007.
Philip Scott FIA (53) Executive director Appointed to the board in May 2000. Joined Norwich Union in 1973 and held a number of senior positions before joining the Norwich Union board in 1993. Currently responsible for the group’s insurance businesses outside Europe and Morley, the group’s UK fund management operations. Philip Scott will succeed Andrew Moss as the group finance director in July 2007.
Patrick Snowball (56) Executive director Appointed to the board in March 2001. Joined the group in 1989, holding a number of senior positions before joining the board of Norwich Union in 1999. Currently responsible for the group’s United Kingdom businesses namely Norwich Union Insurance, Norwich Union Life and RAC. A member of the Financial Services Authority’s Practitioner Panel.
Lord Sharman of Redlynch OBE (64) Chairman Appointed to the board in January 2005 and became chairman on 1 January 2006. Currently chairman of Aegis Group plc (media services), an independent non-executive director of BG Group plc (utility) and Reed Elsevier plc (publisher) and a member of the supervisory board of ABN AMRO N.V. (banking). Former chairman of KPMG International (auditors), former deputy chairman of Group 4 Securicor plc (security services) and a former independent non-executive director of Young & Co.’s Brewery PLC (drinks) and AEA Technology plc (commercial/technology).
Guillermo de la Dehesa (65) Independent non-executive director Appointed to the board in May 2000. Joined the board of Norwich Union as a non-executive director in 1999. Currently non-executive chairman of Aviva’s operations in Spain, non-executive vicechairman of Goldman Sachs Europe (banking) and a non-executive director of Campofrio (consumer), Unión Eléctrica Fenosa (utility) and Bank Santander Central Hispano (banking). Chairman of the Centre of Economic Policy Research and a member of the Group of Thirty (consultative group on international economic and monetary affairs). A former deputy governor of the International Monetary Fund and the World Bank, a former deputy general manager of the Bank of Spain and former Secretary of State of Finance in Spain.
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Mary Francis CBE (58) Independent non-executive director Appointed to the board in October 2005. Currently senior independent non-executive director of Centrica plc (utilities), a non-executive director of St Modwen Properties plc (property development), a director of the Bank of England, Fund Distribution Limited and Almeida Theatre Company Limited. A member of the advisory board of the National Consumer Council and Governor of the Pensions Policy Institute. A former Director General of the Association of British Insurers and senior civil servant.
Carole Piwnica (49) Independent non-executive director Appointed to the board in May 2003. A member of the New York and Paris bars, practising law in Europe and the US specialising in private equity and EU regulatory matters. Currently a non-executive director of Toepfer International GmbH (trading) and a member of the biotech advisory board of Monsanto. A former non-executive vice-chairman – governmental affairs for Tate & Lyle plc (agricultural/industrial), a former non-executive director of S A Spadel N.V. (food and beverages) and former chairman of Amylum Group (agricultural/industrial).
Russell Walls (63) Independent non-executive director Appointed to the board in May 2004. Currently a non-executive director of Signet Group plc (retail) and chairman of its audit committee. A former group finance director of BAA plc (transport), Wellcome plc (pharmaceuticals) and Coats Viyella plc (textiles). Former senior independent non-executive director of Stagecoach Group plc (transport) and of Hilton Group plc (leisure) and a former non-executive director of the Mersey Docks and Harbour Company plc (transport).
The issued ordinary share capital of the Company was increased by 170 million ordinary shares during the year. 129 million new shares were allotted on 18 July 2006 in part consideration for the acquisition of AmerUs Group Co which completed on 15 November 2006. The balance of 41 million shares was allotted under the Group’s employee share and incentive plans and the Aviva Scrip Dividend Scheme. At 31 December 2006 the issued ordinary share capital totalled 2,565.8 million shares. Details of the Company’s share capital and shares under option at 31 December 2006 and shares issued during the year are given in notes 27 to 30 of the accounts.
Authority to purchase own shares At the Company’s Annual General Meeting held on 10 May 2006, shareholders renewed the Company’s authority to make market purchases of up to 239 million ordinary shares, up to 100 million 83⁄4% preference shares and up to 100 million 83⁄8% preference shares. This authority was not used during the year and, at the forthcoming Annual General Meeting, shareholders will be asked to renew these authorities for another year. Details are contained in the Notice of Meeting. The Company held no Treasury shares during the year.
Post balance sheet events There have been no material events between 31 December 2006 and the date of this report that are required to be brought to the attention of shareholders.
The Company’s Articles of Association require one-third of the directors to retire by rotation each year. At the forthcoming Annual General Meeting Guillermo de la Dehesa, Wim Dik, Richard Karl Goeltz, and Russell Walls, all independent non-executive directors will retire and, being eligible, will offer themselves for re-election. Derek Stevens and André Villeneuve who were re-elected by shareholders at last year’s Annual General Meeting had served on the Board for more than nine years and therefore retired on 31 December 2006 in line with the Board’s plans to renew and refresh its composition. None of the directors retiring at the Annual General Meeting has a service contract with the Company.
Directors’ interests and indemnity arrangements At no time during the year did any director hold a material interest in any contract of significance with the Company or any of its subsidiary undertakings other than a third-party indemnity provision between each director and the Company and service contracts between each executive director and a Group company. The Company has purchased and maintained throughout the year directors’ and officers’ liability insurance in respect of itself and its directors. The directors also have the benefit of the indemnity provision contained in the Company’s Articles of Association. The Company has executed deeds of indemnity for the benefit of each director of the Company, and each person who was a director of the Company during the year, in respect of liabilities that may attach to them in their capacity as directors of the Company or of associated companies. These provisions, which are qualifying third-party indemnity provisions as defined by Section 309B of the Companies Act 1985, were in force throughout the year and are currently in force. Details of directors’ remuneration, service contracts and interests in the shares of the Company are set out in the Directors’ remuneration report.
Health and safety The health and safety of the Group’s employees is a priority and is reviewed at regular intervals. Each business within the Group has an appointed health and safety representative, whose role is to bring to the attention of senior management any areas of concern that should be addressed within the health and safety programme. Information on health and safety matters is communicated to staff through the normal communication channels. Under the Group’s Health and Safety Policy the Group Chief Executive is accountable for health and safety.
Charitable donations Aviva has continued to support community initiatives and charitable causes worldwide and the total Group commitment during the year, as measured in accordance with Business in The Community’s PerCent Standard, was £6.3 million (2005: £5.7 million).
Political donations It is the Company’s policy not to make donations to political organisations or for political causes, and it does not intend to change this policy. Accordingly, during the year the Company has made no donations to EU political organisations or incurred any EU political expenditure as defined in the Political Parties, Elections and Referendums Act 2000 (PPER) (2005: nil). In 2004, shareholders passed a resolution authorising the Board to incur expenditure, up to an aggregate limit of £100,000 per annum, on activities that fall under the PPER. The PPER introduced a very broad definition of political expenditure, such that some of the activities undertaken throughout the Group’s businesses could arguably fall within that definition. The Board sought shareholders’ authority to incur such expenditure in order to avoid any inadvertent breaches of the PPER. The Board does not believe that the Group has incurred any such political expenditure in the past year. The Board’s authority to incur such political expenditure expires in 2008.
The Group acquired the AmerUs group of companies on 15 November 2006 and, in line with accepted practice in the United States that group made political donations totalling $2,250 in December 2006. In common with other sizeable companies in the US, AmerUs also operates a Political Action Committee (PAC). The PAC allows employees to make contributions to be used for political donations and, in December 2006 a donation of $1,000 was made by the employee PAC. These are not political donations made by the Company. Following the integration of AmerUs into the Aviva Group, no future political donations will be made by the Company although AmerUs will continue to operate its employee PAC.
In summary, the Group’s commitment to communication and dialogue with employees continues. A strong emphasis is placed on the provision of news through a variety of media, including intranets (both a Group-wide intranet, Arena, and local business unit intranets), Aviva radio, which can be accessed via mobile phone or computer, and poster campaigns. Employees have opportunities to voice their opinions and ask questions through intranet sites and climate surveys. Face-to-face briefings and team meetings are actively encouraged and are held in all business units across the Group. During 2006, the Group’s businesses in the United Kingdom established employee consultative forums.
Employee practice Aviva Group companies are committed to providing equal opportunities to all employees, irrespective of their sex, sexual orientation, marital status, creed, colour, race, nationality, ethnic origin, disability, age, religion or union membership status. Aviva is an inclusive employer and values diversity in its employees. These commitments extend to recruitment and selection, training, career development, flexible working arrangements and promotion and performance appraisal. In the event of employees becoming disabled, every effort is made to ensure that their employment with the Group continues and to provide specialised training where this is appropriate.
Creditor payment policy and practice It is the Group’s policy to pay creditors when they fall due for payment. Terms of payment are agreed with suppliers when negotiating each transaction and the policy is to abide by those terms, provided that the suppliers also comply with all relevant terms and conditions. The Company has no trade creditors. In respect of Group activities in the UK, the amounts due to trade creditors at 31 December 2006 represented approximately 13 days of average daily purchases through the year (2005: 8 days).
Auditor and the disclosure of information to the auditor Each person who was a director of the Company on the date that this report was approved, confirms that so far as the director is aware, there is no relevant audit information, being information needed by the auditor in connection with preparing its report, of which the auditor is unaware. Each director has taken all the steps that he/she ought to have taken as a director in order to make himself/herself aware of any relevant audit information and to establish that the auditor is aware of that information. This confirmation is given and should be interpreted in accordance with the provisions of Section 234ZA of the Companies Act 1985.
It is the Board’s view that the Company has been fully compliant throughout the accounting period with the provisions set down in Section 1 of the Combined Code (including the changes that became effective for financial years commencing on or after 1 November 2006). This report sets out details of how the Company has applied the principles and complied with the provisions of the Combined Code during 2006. Further information on the Code can be found on the Financial Reporting Council’s website, www.frc.org.uk.
The Board The directors are responsible to shareholders for ensuring that the Company is appropriately managed and that it achieves its objectives. It meets regularly to determine the strategic direction, to review the Company’s operating and financial performance and to oversee that the Company is adequately resourced and effectively controlled. The specific duties of the Board are clearly set out in its terms of reference that address a wide range of corporate governance issues and list those items that are specifically reserved for decision by the Board. Matters requiring Board approval include: – Group strategy and business plans; – Acquisitions, disposals and other transactions outside delegated limits; – Financial reporting and controls; – Capital structure; – Dividend policy; – Shareholder documentation; – The constitution of Board committees; – Key business policies, including the remuneration policy.
The directors The Board currently comprises the Chairman, six independent nonexecutive directors and four executive directors. Each non-executive director serves for a fixed term not exceeding three years that may be renewed by mutual agreement. Subject to the Board being satisfied with a director’s performance, independence and commitment, there is no specified limit regarding the number of terms a director may serve. All directors are required to be elected by shareholders at the Annual General Meeting following his/her appointment by the Board and be re-elected at least once every three years. Any non-executive director who has served on the Board for nine years or more is required to submit himself/herself for re-election annually. The Board’s policy is to appoint and retain non-executive directors who can apply their wider knowledge and experiences to their understanding of the Aviva Group, and to review and refresh regularly the skills and experience it requires through a programme of rotational retirement. In addition to the strengths of experience, diversity and an international perspective, the Board also seeks to comply with the requirements of the Combined Code on the independence of directors. The process for appointing new directors is conducted by the Nomination Committee whose report, including a description of its duties, is set out below.
The Combined Code requires that at least half the Board, excluding the Chairman, should comprise independent non-executive directors as determined by the Board. The Nomination Committee performs an annual review of directors’ interests in which all potential or perceived conflicts, including time commitments, length of service and other issues relevant to their independence, are considered. It is the Board’s view that an independent nonexecutive director also needs to be able to present an objective, rigorous and constructive challenge to management, drawing on his/her wider experiences to question assumptions and viewpoints and where necessary defend their beliefs. To be effective, an independent director needs to acquire a sound understanding of the industry and the Company so as to be able to evaluate properly the information provided. Having considered the matter carefully the Board is of the opinion that all of the current non-executive directors are independent and free from any relationship or circumstances that could affect, or appear to affect their independent judgement. Accordingly, over half of the directors, excluding the Chairman, are independent non-executive directors. Each of the directors being proposed for re-election at the 2007 Annual General Meeting has been subject to a formal performance evaluation and took part in a peer evaluation review during 2006. Biographical details of all the directors, including those proposed for re-election, are set out on pages 72 and 73.
The Chairman The respective roles of the Chairman and Group Chief Executive are set out in the Board’s terms of reference. The Chairman’s priority is the management of the Board and the Group Chief Executive’s priority is the management of the Company. The Chairman’s contractual commitment to the Company is two to three days per week and his main interests outside the Company are set out in his biographical details on page 72. There have been no material changes to these commitments during the year.
Board effectiveness The effectiveness of the Board is vital to the success of the Group. The Company undertakes a rigorous evaluation each year in order to assess how well the Board, its committees, the directors and the Chairman are performing. The process is led by the Chairman and supported by the Group Company Secretary. All directors complete a questionnaire regarding the Board and committees’ processes, their effectiveness and where improvements may be considered. The process also includes a peer review in which directors assess their fellow directors’ performance against set criteria, including the skills that they bring to the Company and the contribution they make. This process is complemented by separate meetings between each director and the Chairman where feedback is discussed. In 2006 a new format was introduced whereby directors completed a much more comprehensive questionnaire which was returned to an independent third-party who had helped with the preparation of the questions, and who collated comments, drew the conclusions and presented the findings to the Board.
Following this comprehensive review, the directors have concluded that the Board and its committees operate effectively. Additionally, the Chairman has concluded that each director contributes effectively and demonstrates full commitment to his/her duties.
Training and development The Board believes strongly in the development of all its employees and directors and it is a requirement of each director’s appointment that they commit to continue their development. The form that this development takes is subject to individual director’s requirements and the quality and relevance of the training available. During the year, directors attended a number of external courses on issues ranging from seminars for members of the Audit and Remuneration Committees to workshops on financial risks and individual capital assessments. In addition, members of the Risk and Regulatory Committee received two tailored training/induction sessions. Training sessions have been built into the Board’s and committees’ work plans for 2007. The Board made visits to the Group’s businesses located in York and India during the year to gain a closer understanding of their operations.
The Board has a comprehensive induction programme consisting of 13 separate sessions which take place over a number of months at times convenient for the director. The sessions include presentations from key members of senior management, visits to the Group’s main operating businesses, meetings with the external auditor, and one of the Company’s corporate brokers. Further or follow-up meetings are arranged where a director requires a deeper understanding on a particular item.
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Risk identification, assessment and management There is in place an ongoing process for identifying, evaluating and managing the significant risks faced by the Group which has operated throughout 2006 and up to the date of signing this report. The Group’s risk management and control framework is designed to support the identification, assessment, monitoring, management and control of risks that are significant to the achievement of the Group’s business objectives. The Group has a set of formal policies which govern the management and control of both financial and non-financial risks. The adoption of these policies throughout the Group enables a broadly consistent approach to the management of risk at business unit level. At Group level, policy owners are responsible for the Group-wide aggregation and oversight of their specific risks.
Each quarter, businesses report residual risk profiles and the adequacy of the mitigating action programmes, based on local materiality levels. These impact assessments are based on financial, reputational and operational criteria. This enables the Group risk function to assess the overall risk exposure and to develop a Group-wide risk profile that is refreshed quarterly. Material items in the Group risk report are reported to the committee of the Group’s senior executives (Executive Committee), the Risk and Regulatory Committee and in respect of social, environmental and ethical risks, the Board’s Corporate Social Responsibility Committee. The Executive Committee consider whether the residual risks are within the Group’s risk appetite, and the adequacy of the mitigating actions.
Control procedures and monitoring systems The Group has a well-developed system of planning, incorporating Board approval of a rolling three-year Group plan. Performance against the plan is subsequently monitored and reported to the Board each time it meets. This report also includes updates on relevant measures of solvency and liquidity. Performance is reported through the half-yearly publication of the Company’s results based on accounting policies that are applied consistently throughout the Group. Operational management reports quarterly to the Executive Committee on a wide range of key performance and other significant matters and the Board receives regular representations from the senior executives responsible for each principal business operation.
Internal audit The Group’s internal audit function advises management on the effectiveness of its internal control systems, the adequacy of these systems to manage business risk and to safeguard the Group’s assets and resources. Through the Group Audit Director, the internal audit function provides objective assurance on risk and control to both the Audit Committee and Risk and Regulatory Committee. The effectiveness of the Group’s internal audit function is reviewed each year by the Audit Committee. During 2006, the effectiveness of the internal audit peer review process was independently evaluated by KPMG LLP (KPMG).
The Company’s Investor Relations Department is dedicated to facilitating communication with institutional investors. The directors consider it important to understand the views of shareholders and, in particular, any issues which concern them. The Board receives reports on the matters that have been raised with management at the regular meetings held with the large investors. During the year the Chairman and the senior independent director held a meeting with the major institutional investors and the senior independent director attended investor meetings with management. In addition, the senior independent director is available to meet with major shareholders to discuss any areas of concern that cannot be resolved through normal channels of investor communication and arrangements can be made to meet with the senior independent director through the Group Company Secretary. Similarly, arrangements can be made for major shareholders to meet with newly appointed directors.
The Board consults with shareholders in connection with specific issues where it considers appropriate. For example, the chairman of the Remuneration Committee met with institutional shareholder bodies and a number of major shareholders in 2006 regarding the Company’s proposed changes to the directors’ pension arrangements and the introduction of a long-term savings arrangement, details of which are set out in the Directors’ remuneration report below.
The Company’s annual report and accounts and annual review, together with the Company’s interim reports, trading statements and other public announcements are designed to present a balanced and understandable view of the Group’s activities and prospects. The Chairman’s statement, Group Chief Executive’s review, and Business review provide an assessment of the Group’s affairs and they will be supported by a presentation to be made at the Annual General Meeting.
Morley maintains a detailed Corporate Governance and Voting Policy as part of its investment strategy, which underpins its approach to engaging and voting at company general meetings. The policy also extends to cover social, environmental and ethical issues. Its policy is applied pragmatically, after careful consideration of all relevant information. In addition, Morley makes detailed voting reports available to clients’ and publishes summary statistics on its website.
The Committee follows an agreed annual work plan. It reviews, with members of management and the internal and external auditors, the Company’s financial announcements including the annual report and accounts to shareholders and associated documentation. It places particular emphasis on their fair presentation and the reasonableness of the judgemental factors and appropriateness of significant accounting policies used in their preparation. At each meeting, the Committee receives a report from the Group Audit Director concerning the Company’s systems of internal financial control, including any significant new issues and actions taken on previously reported issues. Twice each year, the Committee receives reports on the adequacy of the Group’s life assurance and general insurance reserves. The Committee also reviews the annual work plan for the Group’s internal audit function. The Committee reports to the Board regarding the effectiveness of the Group’s overall systems of internal control. The Committee itself reviews the financial controls and works closely with the Risk and Regulatory Committee which reviews the non-financial controls.
Prior to 2006, the Committee received regular reports on risk management, financial malpractice (including fraud, anti-money laundering and “whistleblowing”), regulatory and compliance matters. The responsibility for overseeing these matters as well as the oversight of the non-financial internal controls was transferred to the Risk and Regulatory Committee following its establishment in January 2006. A separate report from that committee is set out below.
External auditor Ernst & Young LLP (Ernst & Young) was appointed auditor of the Company in 2001 having previously been the auditor of Norwich Union plc. Following the 2005 external audit effectiveness review the Committee concluded that the audit was fit for purpose and recommended that a re-tender process should not be undertaken in 2006 but that the relationship and the effectiveness of the auditor be kept under review. The audit signing partner changed as part of a rotation process in 2002 and in line with that process there has been a further rotation in audit partner following the sign-off of the statements for the 2006 financial year. Ernst & Young audits the whole of the Group other than Delta Lloyd (the Group’s subsidiary operating in the Netherlands, Belgium, Luxembourg and Germany), which is audited by PricewaterhouseCoopers LLP (PwC) and part of the RAC group which remains audited by KPMG. To fulfil its Group reporting responsibilities Ernst & Young reviews the work of PwC and KPMG in accordance with standard auditing practices.
It distinguishes between those matters where an independent view is required, such as audit and assurance work, and other advisory services. In addition to statutory audits, audit and assurance work includes reviewing statutory returns, actuarial assurance, regulatory advice requiring auditor reporting, due diligence on acquisitions and disposals, fraud investigations and control reviews and audit reviews. As a general principle the auditor cannot be engaged by the Company for any other purpose, although the policy recognises that there may be areas of minor significance where, for pragmatic reasons, it may be in the Group’s interests to use the external auditor for this work.
During the year, the Committee performed its annual review of the independence, effectiveness and objectivity of the external auditor; assessing the audit firm, the audit partner and audit teams. The process was conducted by means of a questionnaire, completed Group-wide by members of senior management and members of the Group’s finance community. The questionnaire sought opinions on the importance of certain criteria and the performance of the auditor against those criteria. The questionnaires were collated by the Group Company Secretary. Based on this review, the Committee concluded that the audit service of Ernst & Young LLP was fit for purpose and provided a robust overall examination of the Group’s business and the risks involved.
The main purpose of the Committee is to assist the Board by keeping the composition of the Board under review and conducting a rigorous and transparent process when making or renewing appointments of directors to the Board. It also advises the Board on issues of directors’ conflicts of interest and independence. The full terms of reference for the Committee can be found on the Company’s website www.aviva.com and are available from the Group Company Secretary.
During the year the Committee reviewed its executive succession plans against an indication from Richard Harvey, the Group Chief Executive, that he may wish to retire in mid–2007, three years prior to his normal retirement date. As part of the succession process the Board, with the advice and assistance of MWM Consulting agreed a process and prepared an “ideal candidate” profile for the group chief executive role. A shortlist of external candidates considered able to match the profile was prepared against which the Company’s internal candidates were benchmarked. Through this process the Committee was able to confirm that the internal candidates compared well against potential external candidates. The internal candidates were then interviewed and assessed externally and by a number of the Company’s independent nonexecutive directors. As a result of this process the Committee was able, upon Richard Harvey confirming in January 2007 his intention to retire, to make a recommendation to the Board that Andrew Moss, the Group Finance Director be appointed to succeed Richard Harvey as the Group Chief Executive. As a consequence of the above the Committee also considered the position of the Group Finance Director and made a recommendation to the Board that Philip Scott, Executive Director, Aviva International, be appointed to succeed Andrew Moss in that position.
As part of the 2006 Board performance evaluation the Board reviewed its composition and skills against what it considers the future issues and challenges facing the Company will be. The outcome of this review will be taken forward by the Committee during 2007.
The Committee has also reviewed the processes for identifying and developing those senior managers throughout the Group who are considered to have the potential to succeed members of the Group’s senior executive.
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Mary Francis (Chairman from 1 January 2007) 14 January 2006 To date
Russell Walls served as the chairman of the Committee from its inception until 31 December 2006 when he was succeeded as chairman by Mary Francis. There were no other changes in the membership of the Committee during the year. The Group Company Secretary acts as the secretary to the Committee. The Committee met on three occasions in 2006 and each member attended every meeting. In addition the Committee held separate meetings with members of senior management and Ernst & Young for the purpose of induction and training.
The Group Chief Executive, Group Finance Director, Group Audit Director and the external auditor normally attend, by invitation, all meetings of the Committee. Other members of senior management are also invited to attend as appropriate to present reports. It is the Committee’s practice at each meeting to meet separately with the Group Audit Director and the external auditor without any members of management being present. In performing its duties, the Committee has access to the services of the Group Audit Director, the Group Regulatory and Tax Director, the Group Company Secretary, the Group Financial Management Director and external professional advice.
The responsibility for overseeing risk, regulatory and compliance issues, as well as the oversight of non-financial internal controls was transferred to the Committee from the Audit Committee in April 2006. The work of the Committee since its establishment has fallen into the following broad areas: Risk management The Committee has received regular reports on the Group’s risk management processes, including the key risks facing the business and the measures being taken by management to contain them. It has also reviewed the processes and governance used by management to define the Group’s risk appetite and has reviewed the internal non-financial controls used to monitor the effectiveness of the Group’s risk management processes.
Regulation and compliance The Committee has reviewed the Group’s regulatory operating plan and has received regular reports on its relationships with its external regulators. In particular, the Committee monitors the actions being taken by management in relation to the Risk Mitigation Programme agreed with the Financial Services Authority. Reports on any material compliance issues are received by the Committee including any reputational issues which may arise. In addition, the Committee receives reports on legislative and regulatory developments which may impact the Group.
The Committee was established by the Board in January 2006 and held its first meeting in June 2006. The purpose of the Committee is to provide guidance and direction to the Group’s corporate social responsibility (CSR) programme, review the risks and opportunities relating to the eight individual elements in the programme (namely; standards of business conduct, environment, human rights, health and safety, community, customers, suppliers and workforce) and to monitor progress. The full terms of reference for the Committee are available from the Group Company Secretary and can be found on the Company’s website www.aviva.com.
During the Board’s visit to the Group’s Indian operations in September 2006, the Committee held a meeting with the senior managers responsible for CSR in the Group’s life assurance business (Aviva India) and its offshoring operations (Aviva Global Services) in order to gain a deeper understanding of the relevant local issues and assess how CSR was being embedded in those businesses.
Remuneration Committee composition The following independent non-executive directors served on the Committee during the year: Period
In line with the Combined Code requirements the Board undertook a review of the effectiveness of all its committees during the year, including the Remuneration Committee.
Advice to the Remuneration Committee Hilary Oliver, the Group Reward Director, provided material assistance to the Committee during the year, advising on market trends, practices and appropriate levels of remuneration. Deloitte, which provided actuarial, tax and IT services to the Group during the year, advised the Committee on the calculation of total shareholder return for the purposes of the long-term incentive plans. In addition, Nic Nicandrou, in his previous role as Group Financial Control Director provided material assistance to the Committee in relation to its consideration of the financial objectives relevant to the Aviva Annual Bonus Plan and determining the extent to which the objectives had been met. Richard Whitaker, the Group Company Secretary and Linklaters LLP (Linklaters) advised the Committee in relation to the operation of the Company’s share plans. Linklaters provided other legal services to the Group. In addition, the Committee considered the views of the Chairman and Group Chief Executive in assessing the performance of the executive directors.
A review of senior executive pension provisions as described in detail in this report was undertaken during 2005 and 2006. During the review Aon Consulting, which undertook other pensions related work for the Company, advised the Company and Lane Clark & Peacock LLP (LC&P), consulting actuary, was appointed by the Committee to provide an independent opinion on certain aspects of the recommendations arising from the review. LC&P provided no other services to the Group during the year.
Basic salary Basic salary is benchmarked within the range of median to upper quartile for comparable jobs. Progression within this range is dependent upon performance.
75% of basic salary is payable for “on target” performance, and up to 150% is payable for “stretch” performance.
– Annually, one-third is paid in cash and twothirds in deferred shares.
– A resignation in the year of a bonus award would result in the forfeiture of the shares awarded that year. A resignation in the following year would result in a 50% forfeiture, and in the year after that a 25% forfeiture.
– All shares would be forfeited should the director be dismissed for cause.
Target and maximum bonus levels (75% and 150% of basic salary respectively) were set with reference to the FTSE 30 and a global financial services comparator group. These levels are reviewed annually as part of the total compensation review.
The illustrations above would vary slightly for Richard Harvey, whose long-term incentive plan award is 175% of basic salary. The illustrations assume “on target” performance when 30% of an LTIP award vests and “stretch” performance when 100% of an LTIP award vests.
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Long-Term Incentive Plan This plan exists to motivate recipients to achieve the Company’s longer term objectives, to aid the retention of key personnel and to align their interests to those of shareholders.
– The Group Chief Executive is eligible to receive an annual award of shares to the value of 175% of his basic salary. The other executive directors are eligible to be awarded shares to the value of 150% of their basic salary.
– Under the scheme rules no awards may exceed 200% of a participant’s basic salary.
ROCE vesting – ROCE targets are set annually within the context of the Company’s three-year business plan. Vesting depends upon the Company’s performance over the three-year performance period against a target return. The Group’s external auditor provides a formal opinion on the ROCE calculation.
The group of companies against which the Company’s TSR is measured comprises: AEGON, Allianz, AXA, Fortis, Friends Provident, Generali, HBOS, ING, Legal & General, Lloyds TSB, Prudential, The Royal Bank of Scotland, Royal & Sun Alliance and Zurich.These companies were chosen for their product and geographic match to Aviva. An independent consultant determines Aviva’s performance within this group.
In December 2006, the Committee reviewed the appropriateness of relative TSR as a performance measure and agreed to include Standard Life in the above comparator group in respect of future grants.
– Discretionary payments into an employee benefit trust operated by independent trustees. Currently those executive directors who are participating are not accruing benefits in the Aviva Staff Pension Scheme.
– The level of contribution varies but will not normally exceed 50% of basic salary.
– Payments are held in trust for a minimum of five years.
Pension The Aviva Staff Pension Scheme (Pension Scheme) provides a competitive post retirement package.
– Deferred cash payable on retirement in the form of a lump sum/monthly payment.
Pension In anticipation of pension legislation (“pension simplification”) that came into effect on 6 April 2006, the Committee undertook a review of the pension provisions for its senior executives and how they relate to the total remuneration package. The review was set against a number of design principles including: – The Company’s need to continue attracting and retaining top quality management; – That future pension arrangements for senior executives should not cost the Company more than the arrangements previously in place; – The Company would not pay or compensate managers for any increase in their personal tax liability arising from pension simplification; and
The relevant features of the Pension Scheme defined benefit section, to which all the executive directors belonged prior to 1 April 2006, are: – Accrual at either one thirtieth (Richard Harvey, Philip Scott and Patrick Snowball) or one forty-fifth (Andrew Moss) of final pensionable salary for each year of service (subject to a maximum pension of two-thirds of final pensionable salary); – A contribution of 5% of pensionable salary is payable into the Pension Scheme by the employee; – No pension benefits accrue on bonuses or other benefits; – Lump sum death-in-service benefit of four times basic salary at the date of death; – Spouse’s pension equal to two-thirds of a member’s actual or prospective pension; – Post-retirement, annual review with increases guaranteed at a rate equivalent to the increase in the Retail Prices Index up to a maximum of 10% pa; and
The benefits paid from the Pension Scheme to members who joined it after June 1989 were subject to Her Majesty’s Revenue and Customs (HMRC) limits (Earnings Cap) which restricted the amount of pension which could be paid from an approved pension scheme. Where executives’ benefits exceeded the Earnings Cap, the balance was provided through an Unapproved Unfunded Retirement Benefit (UURB). Richard Harvey and Andrew Moss were both affected by the Earnings Cap limit.
Richard Harvey The value of Richard Harvey’s UURB up to the newly introduced HMRC Lifetime Allowance (LTA) of £1.5 million was transferred into the Pension Scheme and therefore at retirement he will receive a deferred pension of £75,000 per annum as increased in line with deferred pensions (lower of the increase in RPI or 5%) subject to the LTA. The balance, valued at £11.6 million, was transferred into an Employer Funded Retirement Benefit Scheme (EFRBS).
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The Aviva Savings Related Share Option Scheme allows eligible employees to acquire options over the Company’s shares at a discount of up to 20% of their market value at the date of grant. In order to exercise these options, participants must have saved the consideration through a three, five or seven-year approved savings contract, subject to a maximum savings limit of £250 per month.
Remuneration and benefits As described in this Report. The detailed operation of the annual bonus and LTIP plans is at the Company’s discretion and in the case of the long-term savings plans at the trustees discretion.
Contract dates Director Date current contract commenced Richard Harvey 6 December 2006 Andrew Moss 16 January 2007 Philip Scott 22 January 2007 Patrick Snowball 15 November 2006
Policy on external Board appointments The Company recognises that its senior executives can benefit by serving in a personal capacity as non-executive directors of non-Aviva Group companies. It therefore has a policy of allowing senior executives to serve as a non-executive director of an external company, subject to approval by the Board, and to retain any fee. However, during the year no executive director served in a personal capacity on the Board of a non-Aviva Group company.
Non-executive appointments The non-executive directors, including the Chairman, have letters of appointment which set out their duties and responsibilities. The key terms of the appointments are as follows: Provision Policy
Termination By the director or the Company giving the other one month’s written notice without compensation.
Directors’ service contracts and letters of appointment are available for inspection at the Company’s registered office during normal hours of business. All the directors seeking re-election at the Company’s 2007 Annual General Meeting are independent non-executive directors and therefore do not have a service contract with the Company.
The Chairman and non-executive directors receive no benefits in addition to their fees nor do they participate in any incentive or performance plans or pension arrangements.
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– Individual performance in the role, relative to positioning within the FTSE 50 comparator group.
Non-executive directors Guillermo de la Dehesa 86 77 – – – – – – 86 77 Wim Dik 69 59 – – – – – – 69 59
The charts below illustrate the balance between basic salary and variable performance based compensation (annual bonus and long-term incentive plans) received by each executive director in the year to 31 December 2006.
3. Payments to former directors: Since his retirement as a director in 2003, Anthony Wyand has served as a consultant and as a director on the Boards of some of the Group’s European operations. Under this arrangement, a fee of £145,000 was paid to him in 2006. During the year, shares granted to certain former executive directors under the company’s incentive plans vested. Details of these awards were fully disclosed in the year of grant.
4. For the purposes of the disclosure required by Schedule 6 to the Companies Act 1985 the total aggregate emoluments of the directors in respect of 2006 was £7.9 million. (2005: £6.0 million).
Accrued annual pension at 31 December 20064 75 20 361 289
The amount of the transfer of £11.6 million to the EFRBS was accounted for as follows: – Amount provided on the Company’s balance sheet for Richard Harvey as part of the IAS 19 charge at 31 March 2006, immediately prior to the change on 6 April 2006 is £10.8 million.
– The balance of £1.5 million was charged to the profit and loss account to take account of the increase in pension which would have been payable on his basic pay increase at 1 April 2006 (amount of pension increase £67,000 pa).
4. The “accrued pension” is the amount of annual pension to which the directors would have been entitled at age 60 had they left service at 31 December 2006.
5. Contributions of 5% of salary are made by Mr Scott and Mr Snowball towards their pension. As Mr Harvey and Mr Moss ceased accruing benefits in the Pension Scheme from March 2006 their 5% contributions ceased from that date and therefore the amounts disclosed are in relation to the period prior to that date.
6. The change in the transfer values over the year include the effect of changes made by the Trustee of the Pension Scheme to the assumptions used in respect of the market value of future investment returns and mortality. The significant reduction in relation to Mr Harvey reflects the reduction in his accrued pension benefit to £75,000 pa as described in note 1 above. Transfer values represent the estimated liability on the Scheme to pay the stated level of benefits. They are not sums paid, or due, to a director and do not represent the true cost of providing the pension benefit.
Share incentive plans Details of the directors who held executive office for any part of the financial year, and hold or held options to subscribe for ordinary shares of the Company or hold or held awards over shares in the Company, pursuant to the Company’s share-based incentive plans, are set out below.
At Options Options Options At 1 January granted exercised lapsing 31 December 2006 during year during year during year 2006 Exercise price Number Number Number Number Number p Exercise period
Richard Harvey Savings related options 2002 4,426 – – – 4,426 401.0 December 2009 – May 2010
Performance testing under the Aviva LTIP Under the Aviva LTIP, which granted awards between 2001 and 2004, shares vest subject to the attainment of TSR and ROCE performance conditions over a three-year performance period. The Company’s TSR, when compared with the TSR of a comparator group of European financial services companies, needs to match at least median performance for 20% of the awards to vest. At upper decile performance, 70% of the awards vest. Between median and upper decile, vesting is determined on a straight-line basis. ROCE of 24% in excess of RPI over the three-year period results in 24% of the shares vesting, rising to a maximum of 30% if the ROCE exceeds 30% over the same period.
At the end of the performance period relating to the awards granted in 2003, the Company was ranked eight out of the 20 companies in the comparator group and the ROCE was 33.6%. As a result, 34.9% of the awards vested based on the TSR part of the Plan and 30.0% of the awards vested based on the ROCE part, making a total of 64.9% vested. The 35.1% of the awards, which did not vest, lapsed.
The vesting history under the Aviva LTIP is as follows: Percentage of award vesting
Performance graph The following graph compares the TSR performance of the Company over the past five years with the TSR of the FTSE 100 Return Index.
The Aviva Share Plan was established in May 2004 specifically to facilitate the recruitment of Andrew Moss. The awards made under the Plan compensate Andrew Moss for the value of the long-term incentive awards granted to him by his previous employer and which lapsed when he resigned to join Aviva. Andrew Moss is the only participant in the Plan. On 10 May 2004, the date Andrew Moss joined the Company, 103,846 shares in the Aviva Employee Trust (with a market value of £540,000) were allocated to him. On 31 October 2004 67,307 of the shares vested, 23,077 vested on 31 December 2005 and the balance of 13,462 vested on 31 December 2006. The vesting of these shares was not subject to any performance conditions. This plan is now closed.
Long-Term Incentive Plan Awards At Awards Awards Awards At Market price Market price 1 January granted vesting lapsing 31 December at date awards at date awards 2006 during year during year during year 2006 granted vested
Accounting changes Major changes to accounting policies and practices in 2005, including adopting International Financial Reporting Standards and European Embedded Value principles for supplementary reporting, affected a number of the key performance indicators and performance measures used in connection with the Company’s long-term incentive plans. During the transition period the Committee received reports showing the impacts of these changes on the performance measures and satisfied itself that the evaluation of actual performance against the performance conditions which were originally set using prior accounting practices is appropriate having made allowance for the accounting changes.
Non-executive directors’ remuneration The Company’s Articles of Association provide that the total aggregate remuneration paid to the Chairman and non-executive directors will be determined by the Board within the limits set by shareholders. The current aggregate limit of £1.5 million was approved by shareholders at the Company’s 2005 Annual General Meeting. Executive directors are remunerated under their service contracts and receive no additional fee for serving as directors.
Additional fees are paid as follows: Senior independent director £10,000 pa
Carole Piwnica – 2,500 – – – – – – – –
Lord Sharman – 2,000 – – – – – – – –
Russell Walls 1,500 1,500 – – – – – – – – Former directors Derek Stevens* 2,989 3,047 – – – – – – – – André Villeneuve* 640 640 – – – – – – – –
All Employee Share Ownership Plan (AESOP) being shares purchased by them under the partnership element and shares granted under the free share element of the AESOP. Executive directors are required to build and maintain a beneficial interest in the Company’s shares equal in value to 1.5 times their annual salary (1.75 times annual salary in the case of the Group Chief Executive). The requirement was introduced as part of the revised remuneration arrangements from 2005; the holding must be attained within five years.
3. “Long-Term Incentive Awards” are awards granted under the Aviva Long-Term Incentive Plans which vest only if the performance conditions are achieved.
The following changes to directors’ interests which relate to shares acquired each month under the partnership element of the AESOP during the period 1 January 2006 to 28 February 2007 have been reported to the Company.
We have audited the group and parent company financial statements (the “financial statements”) of Aviva plc for the year ended 31 December 2006 which comprise the Accounting Policies, the Consolidated and Parent Company Income Statements, the pro forma reconciliation of Group operating profit to profit before tax, the Consolidated and Parent Company Statement of recognised income and expense, the Consolidated and Parent Company Reconciliation of movements in shareholders’ equity, the Consolidated and Parent Company Balance Sheets, the Consolidated and Parent company cash flow Statements and the related notes 1 to 53 and A to J. We have also audited the information in the Directors’ Remuneration Report that is described as having been audited.
This report is made solely to the Company’s members, as a body, in accordance with Section 235 of the Companies Act 1985. Our audit work has been undertaken so that we might state to the Company's members those matters we are required to state to them in an auditors’ report and for no other purpose. To the fullest extent permitted by law, we do not accept or assume responsibility to anyone other than the Company and the Company’s members as a body, for our audit work, for this report, or for the opinions we have formed.
We read other information contained in the Annual Report and consider whether it is consistent with the audited financial statements. The other information comprises only the Overview, the Business review, the Board of Directors, the Directors’ report, the Corporate governance report, the Audit Committee report, the Nomination Committee report, the Risk and Regulatory Committee report, the Corporate Social Responsibility committee and the unaudited part of the Directors’ Remuneration Report. We consider the implications for our report if we become aware of any apparent misstatements or material inconsistencies with the financial statements. Our responsibilities do not extend to any other information.
Basis of audit opinion We conducted our audit in accordance with International Standards on Auditing (UK and Ireland) issued by the Auditing Practices Board. An audit includes examination, on a test basis, of evidence relevant to the amounts and disclosures in the financial statements and the part of the Directors’ Remuneration Report to be audited. It also includes an assessment of the significant estimates and judgements made by the directors in the preparation of the financial statements, and of whether the accounting policies are appropriate to the Group’s and Company’s circumstances, consistently applied and adequately disclosed.
Opinion In our opinion: – The financial statements give a true and fair view, in accordance with IFRSs as adopted by the European Union, of the state of the Group’s affairs and the parent Company’s affairs as at 31 December 2006 and of the Group’s profit and the parent company’s loss for the year then ended; – The financial statements and the part of the Directors’ Remuneration Report to be audited have been properly prepared in accordance with the Companies Act 1985 and Article 4 of the IAS Regulation; and
– The information given in the Directors’ report is consistent with the financial statements.
(A) Basis of presentation From 2005, all European Union listed companies are required to prepare consolidated financial statements using International Financial Reporting Standards (IFRS) issued by the International Accounting Standards Board (IASB) and endorsed by the European Union (EU). The date of transition to IFRS was 1 January 2004. The consolidated financial statements have been prepared in accordance with IFRS applicable at 31 December 2006.
In August 2005, the IASB issued IFRS 7, Financial Instruments: Disclosures, and an amendment to IAS 1, Capital Disclosures. Although their requirements are applicable for accounting periods beginning on or after 1 January 2007, the Group has decided to adopt IFRS 7 early and reflect its impact in these financial statements. The amendment to IAS 1 brings the capital disclosures into line with those already required by FRS 27 and, although the Group is not adopting it early, this is not expected to result in any material additional disclosures.
In addition, IFRIC interpretation 8, Scope of IFRS 2, interpretation 9, Reassessment of Embedded Derivatives, interpretation 10, Interim Financial Reporting and Impairment, Interpretation 11, IFRS 2 – Group and Treasury Share Transactions, and interpretation 12, Service Concession Arrangements, have all been issued during 2006 but the last three have not yet been endorsed by the EU. None of them is applicable for the current accounting period and, on adoption, they will not have any impact on the Group’s financial reporting.
In August 2005, the IASB issued an amendment to IAS 39, Financial Guarantee Contracts, which requires financial guarantees issued to be recognised initially at their fair value, and subsequently measured at the higher of the expected liability (or receivable) under the guarantee and the amount initially recognised less any cumulative amortisation. Whilst not material at the Company or consolidated Group level, the amendment affects the Company’s subsidiaries in respect of intercompany guarantees given and taken in the ordinary course of business. Further details are given in note A to the Company’s separate financial statements.
(B) Use of estimates The preparation of financial statements requires the Group to make estimates and assumptions that affect items reported in the consolidated balance sheet and income statement and the disclosure of contingent assets and liabilities at the date of the financial statements. This is particularly so in the estimation of amounts for insurance and participating investment contract liabilities, for which further details are given in policy J below and in notes 35,37 and 46 to these financial statements. Although these estimates are based on management’s best knowledge of current facts, circumstances and, to some extent, future events and actions, actual results ultimately may differ from those estimates, possibly significantly.
(C) Consolidation principles Subsidiaries Subsidiaries are those entities (including Special Purpose Entities) in which the Group, directly or indirectly, has power to exercise control over financial and operating policies in order to gain economic benefits. Subsidiaries are consolidated from the date on which effective control is transferred to the Group and are excluded from consolidation from the date of disposal. All inter-company transactions, balances and unrealised surpluses and deficits on transactions between Group companies have been eliminated.
From 1 January 2004, the date of first time adoption of IFRS, the Group is required to use the purchase method of accounting to account for the acquisition of subsidiaries. Under this method, the cost of an acquisition is measured as the fair value of assets given up, shares issued or liabilities undertaken at the date of acquisition, plus costs directly attributable to the acquisition. The excess of the cost of acquisition over the fair value of the net assets of the subsidiary acquired is recorded as goodwill (see policy M below). Any surplus of the acquirer’s interest in the subsidiary’s net assets over the cost of acquisition is credited to the income statement.
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Prior to 1 January 2004, certain significant business combinations were accounted for using the “pooling of interests method” (or merger accounting), which treats the merged groups as if they had been combined throughout the current and comparative accounting periods. Merger accounting principles for these combinations have given rise to a merger reserve in the consolidated balance sheet. These transactions have not been restated, as permitted by the IFRS 1 transitional arrangements.
Investments in associates and joint ventures are accounted for using the equity method of accounting. Under this method, the cost of the investment in a given associate or joint venture, together with the Group’s share of that entity’s post-acquisition changes to shareholders’ funds, is included as an asset in the consolidated balance sheet. The Group’s share of their post-acquisition profits or losses is recognised in the income statement and its share of post-acquisition movements in reserves is recognised in reserves.
Equity accounting is discontinued when the Group no longer has significant influence over the investment.
If the Group’s share of losses in an associate or joint venture equals or exceeds its interest in the undertaking, the Group does not recognise further losses unless it has incurred obligations or made payments on behalf of the entity.
These investments are classified as available for sale (AFS) financial assets, with changes in their fair value being recorded in a separate investment valuation reserve within equity.
(D) Foreign currency translation Income statements and cash flows of foreign entities are translated into the Group’s presentation currency at average exchange rates for the year while their balance sheets are translated at the year end exchange rates. Exchange differences arising from the translation of the net investment in foreign subsidiaries, associates and joint ventures, and of borrowings and other currency instruments designated as hedges of such investments, are taken to the currency translation reserve within equity. On disposal of a foreign entity, such exchange differences are transferred out of this reserve and are recognised in the income statement as part of the gain or loss on sale. The cumulative translation differences were deemed to be zero at the transition date to IFRS.
As noted in policy A above, insurance contracts and participating investment contracts in general continue to be measured and accounted for under existing accounting practices at the later of the date of transition to IFRS or the date of the acquisition of the entity. Accounting for insurance contracts is determined in accordance with the Statement of Recommended Practice issued by the Association of British Insurers in December 2005, as amended in December 2006. However, in certain businesses, the accounting policies or accounting estimates have been changed, as permitted by IFRS 4 and IAS 8 respectively, to remeasure designated insurance liabilities to reflect current market interest rates and changes to regulatory capital requirements.
(F) Premiums earned Premiums on long-term insurance contracts and participating investment contracts are recognised as income when receivable, except for investment-linked premiums which are accounted for when the corresponding liabilities are recognised. For single premium business, this is the date from which the policy is effective. For regular premium contracts, receivables are taken at the date when payments are due. Premiums are shown before deduction of commission and before any sales-based taxes or duties. Where policies lapse due to non-receipt of premiums, then all the related premium income accrued but not received from the date they are deemed to have lapsed is offset against premiums.
General insurance and health premiums written reflect business incepted during the year, and exclude any sales-based taxes or duties. Unearned premiums are those proportions of the premiums written in a year that relate to periods of risk after the balance sheet date. Unearned premiums are calculated on either a daily or monthly pro rata basis. Premiums collected by intermediaries, but not yet received, are assessed based on estimates from underwriting or past experience, and are included in premiums written.
The long-term nature of much of the Group’s operations means that, for management’s decision-making and internal performance management, short-term realised and unrealised investment gains and losses are treated as non-operating items. The Group focuses instead on an operating profit measure that incorporates a longer term return on investments supporting its general insurance and health business. Total investment income, including realised and unrealised gains, is therefore analysed between that calculated using a longer term return and short-term fluctuations from this. Further details of this analysis and the assumptions used are given in note 8.
(J) Insurance and participating investment contract liabilities Claims Long-term business claims reflect the cost of all claims arising during the year, including claims handling costs, as well as policyholder bonuses accrued in anticipation of bonus declarations.
Long-term business provisions Under current IFRS requirements, insurance and participating investment contract liabilities are measured using accounting policies consistent with those adopted previously under existing accounting practices, with the exception of liabilities remeasured to reflect current market interest rates and those relating to UK with-profit and non-profit contracts. In the United States, shadow adjustments to the liabilities or related deferred acquisition costs are recognised directly in equity so that unrealised gains or losses on assets that are recognised directly in equity affect the measurement of the liability or related deferred acquisition costs in the same way as realised gains or losses. The Group has adopted FRS 27, Life Assurance, for liabilities relating to such contracts, which adds to the requirements of IFRS but does not vary them in any way. Further details are given in policy A above.
Present value of future profits (PVFP) on non-participating business written in a with-profit fund For with-profit life funds falling within the scope of the FSA realistic capital regime, and hence FRS 27, an amount may be recognised for the present value of future profits on non-participating business written in a with-profit fund where the determination of the realistic value of liabilities in that with-profit fund takes account, directly or indirectly, of this value. This amount is recognised as a reduction in the liability rather than as an asset on the balance sheet, and is then apportioned between the amounts that have been taken into account in the measurement of liabilities and other amounts which are shown as an adjustment to the unallocated divisible surplus.
Liability adequacy At each reporting date, an assessment is made of whether the recognised long-term business provisions are adequate, using current estimates of future cash flows. If that assessment shows that the carrying amount of the liabilities (less related assets) is insufficient in the light of the estimated future cash flows, the deficiency is recognised in the income statement by setting up an additional provision in the balance sheet.
The fair value liability is in principle established through the use of prospective discounted cash-flow techniques. For unit-linked contracts, the fair value liability is equal to the current unit fund value, plus additional non-unit reserves if required on a fair value basis. For non-linked contracts, the fair value liability is equal to the present value of expected cash flows on a marketconsistent basis.
(N) Property and equipment Owner-occupied properties are carried at their revalued amounts, which are supported by market evidence, and movements are taken to a separate reserve within equity. When such properties are sold, the accumulated revaluation surpluses are transferred from this reserve to retained earnings. All other items classed as property and equipment within the balance sheet are carried at historical cost less accumulated depreciation.
(O) Investment property Investment property is held for long-term rental yields and is not occupied by the Group. Completed investment property is stated at its fair value, which is supported by market evidence, as assessed by qualified external valuers or by local qualified staff of the Group in overseas operations. Changes in fair values are recorded in the income statement in net investment income.
(R) Financial investments The Group classifies its investments as either financial assets at fair value through profit or loss (FV) or financial assets available for sale (AFS). The classification depends on the purpose for which the investments were acquired, and is determined by local management at initial recognition. The FV category has two subcategories – those that meet the definition as being held for trading and those the Group chooses to designate as FV (referred to in this accounting policy as “other than trading”).
In general, the FV category is used as, in most cases, the Group’s investment or risk management strategy is to manage its financial investments on a fair value basis. Debt securities and equity securities, which the Group buys with the intention to resell in the short term, are classified as trading, as are non-hedge derivatives (see policy S below). All other securities in the FV category are classified as other than trading. The AFS category is used where the relevant long-term business liability (including shareholders’ funds) is passively managed.
Purchases and sales of investments are recognised on the trade date, which is the date that the Group commits to purchase or sell the assets, at their fair values less transaction costs. Debt securities are initially recorded at their fair value, which is taken to be amortised cost, with amortisation credited or charged to the income statement. Investments classified as trading, other than trading and AFS are subsequently carried at fair value. Changes in the fair value of trading and other than trading investments are included in the income statement in the period in which they arise. Changes in the fair value of securities classified as AFS, except for impairment losses and relevant foreign exchange gains and losses, are recorded in a separate investment valuation reserve within equity.
The fair values of investments are based on quoted bid prices or amounts derived from cash flow models. Fair values for unlisted equity securities are estimated using applicable price/earnings or price/cash flow ratios refined to reflect the specific circumstances of the issuer. Equity securities, for which fair values cannot be measured reliably, are recognised at cost less impairment. When securities classified as AFS are sold or impaired, the accumulated fair value adjustments are transferred out of the investment valuation reserve to the income statement.
Derivative contracts may be traded on an exchange or over-thecounter (OTC). Exchange-traded derivatives are standardised and include certain futures and option contracts. OTC derivative contracts are individually negotiated between contracting parties and include forwards, swaps, caps and floors. Derivatives are subject to various risks including market, liquidity and credit risk, similar to those related to the underlying financial instruments.
O therinform ation Aviva plc Annual Report and Accounts 2006 111
(U) Deferred acquisition costs and other assets The costs directly attributable to the acquisition of new business for insurance and participating investment contracts (excluding those written in the UK) are deferred to the extent that they are expected to be recoverable out of future margins in revenues on these contracts. For participating contracts written in the UK, acquisition costs are generally not deferred as the liability for these contracts is calculated in accordance with the FSA’s realistic capital regime and FRS 27. For non-participating investment and investment fund management contracts, incremental acquisition costs and sales enhancements that are directly attributable to securing an investment management service are also deferred.
(Y) Employee benefits Employee entitlements to annual leave and long service leave are recognised when they accrue to employees. A provision is made for the estimated liability for annual leave and long service leave as a result of services rendered by employees up to the balance sheet date.
For defined contribution plans, the Group pays contributions to publicly or privately administered pension plans. Once the contributions have been paid, the Group, as employer, has no further payment obligations. The Group’s contributions are charged to the income statement in the year to which they relate and are included in staff costs.
Other post-retirement obligations Some Group companies provide post-retirement healthcare or other benefits to their retirees. The entitlement to these benefits is usually based on the employee remaining in service up to retirement age and the completion of a minimum service period. None of these schemes is material to the Group. The costs of the Canadian scheme are included within those for the defined benefit pension schemes in that country. For such schemes in other countries, provisions are calculated in line with local regulations, with movements being charged to the income statement within staff costs.
(AD) Earnings per share Basic earnings per share is calculated by dividing net income available to ordinary shareholders by the weighted average number of ordinary shares in issue during the year, excluding the average number of ordinary shares purchased by the Group and held as treasury shares.
(AE) Operations held for sale Assets and liabilities held for disposal as part of operations which are held for sale are shown separately in the consolidated balance sheet. The relevant assets are recorded at the lower of their carrying amount and their fair value, less the estimated selling costs.
Consolidated income statement For the year ended 31 December 2006 1m Note £m £m
4,887 Profit before tax 3,323 3,450 (509) Tax attributable to policyholders’ returns 12 (346) (922)
O therinform ation Aviva plc Annual Report and Accounts 2006 115
(126) – long-term business subsidiaries 16 (86) (55) (21) – long-term business associates 18 (14) (18)
4,378 Profit before tax attributable to shareholders’ profits 2,977 2,528 Tax attributable to shareholders’ profits 3,513 Profit for the year 2,389 1,898
UK 683 56 1,075 1,814 France 273 33 63 369 Netherlands 458 37 139 634 Other Europe 357 13 215 585 United States 71 – – 71 Rest of the World 54 16 188 258
Fair value gains/(losses) on AFS securities, owner-occupied properties and 550 hedging instruments 32b & 34b 374 (52)
(238) Fair value (gains)/losses transferred to profit 32b (162) 411 (3) Impairment losses on revalued assets 32b (2) (45) – Share of fair value changes in joint ventures and associates taken to equity 32b – 2
(375) Net income recognised directly in equity (255) 42 3,513 Profit for the year 2,389 1,898 3,138 Total recognised income and expense for the year 2,134 1,940
Reconciliation of movements in consolidated shareholders’ equity For the year ended 31 December 2006 1m Note £m £m 16,555 Balance at 1 January 11,092 8,993 3,185 Total recognised income and expense for the year 2,134 1,940
(112) Minority share of dividends declared in the year 34b (75) (70) 137 Minority interest in acquired/(disposed) subsidiaries 34b 92 (36) 72 Reserves credit for equity compensation plans 32b 48 22
Consolidated balance sheet As at 31 December 2006 1m Note £m £m
Financial investments Q, R & 23 168,718 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 L & 36 7,825 7,130 1,790 Deferred tax assets Z & 40b 1,199 1,018 513 Current tax assets 40a 344 87 12,088 Receivables and other financial assets 24 8,098 7,706 5,188 Deferred acquisition costs and other assets U & 25 3,476 3,766 3,858 Prepayments and accrued income 25d 2,585 2,363 21,704 Cash and cash equivalents V & 48d 14,542 13,732 – Assets of operations classified as held for sale AE & 3d – 462
Capital reserves 1,775 Share premium 27 1,189 1,167 4,882 Merger reserve C & 32a 3,271 3,271 6,657 4,460 4,438 1,482 Other reserves 32b 993 1,140 7,585 Retained earnings 33 5,082 2,597 16,980 Equity attributable to shareholders of Aviva plc 11,376 8,974 1,477 Direct capital instrument 31 990 990 2,534 Minority interests 34 1,698 1,128
Liabilities 215,269 Gross insurance liabilities J & 35 144,230 132,602 131,878 Gross liabilities for investment contracts K & 37 88,358 77,309 14,127 Unallocated divisible surplus J 9,465 8,978 5,687 Net asset value attributable to unitholders C 3,810 3,137 4,254 Provisions X, Y & 41 2,850 2,875 4,593 Deferred tax liabilities Z & 40b 3,077 2,458 1,884 Current tax liabilities 40a 1,262 1,033 18,115 Borrowings AA & 43 12,137 11,013 13,784 Payables and other financial liabilities Q & 44 9,235 9,485 6,317 Other liabilities 45 4,234 3,320
O therinform ation Aviva plc Annual Report and Accounts 2006 119
Cash flows from operating activities Cash generated from operations 48a 1,985 470 2,455 2,784 Tax paid (512) (83) (595) (375)
Cash flows from investing activities Acquisitions of subsidiaries, joint ventures and associates, net of cash acquired 48b (96) (1,793) (1,889) (1,423) Disposals of subsidiaries, joint ventures and associates, net of cash transferred 48c 102 514 616 464 Net loans to joint ventures and associates 17a & 18a (113) 9 (104) (128) Purchases of property and equipment 19 (55) (240) (295) (206) Proceeds on sale of property and equipment 10 146 156 50 Purchases of intangible assets (10) (48) (58) (60)
Cash flows from financing activities Proceeds from issue of ordinary shares, net of transaction costs 27b – 935 935 59 Net drawdown of borrowings 43c (466) 1,367 901 856 Interest paid on borrowings (367) (458) (825) (609) Preference dividends paid – (17) (17) (17) Ordinary dividends paid – (490) (490) (498) Coupon payments on direct capital instrument – (52) (52) (42) Finance lease payments – (22) (22) (8) Capital contributions from minority shareholders 295 9 304 212 Dividends paid to minority interests of subsidiaries (53) (22) (75) (70) Non-trading cash flows between operations (288) 288 – –
Cash and cash equivalents at 31 December 48d 10,420 3,426 13,846 13,067
2 – Presentation changes The results of the Group’s fund management business in the Netherlands were previously reported within the result of our other operations but are now shown as part of our fund management operations. The result reclassified in 2006 is £37 million (2005: £32 million). The related assets and liabilities reclassified at 31 December 2006 are £63 million (2005: £54 million) and £18 million (2005: £15 million) respectively.
3 – Subsidiaries (a) Acquisitions (i) Ark Life Assurance Company Limited On 27 January 2006, Hibernian Life Holdings Limited (HLH), the parent company of Hibernian Life & Pensions Limited, acquired all the shares of Ark Life Assurance Company Limited (Ark Life) from Allied Irish Banks plc (AIB) in exchange for a 24.99% stake in the enlarged HLH and a balancing cash payment of a196 million (£134 million) which also reflects the transfer of the management of Ark Life funds to Hibernian Investment Managers Limited, part of the Group’s fund management business. The final consideration has not yet been agreed with AIB but is expected to be finalised in 2007. However, any adjustment to the above figures is not expected to be material. In addition, a further deferred cash payment of up to a10 million (£7 million) is payable, subject to the fulfilment of certain performance criteria.
The results of Ark Life have been included in the consolidated financial statements of the Group with effect from 27 January 2006, and contributed £40 million to the consolidated profit before tax.
The Ark Life acquisition has given rise to goodwill on acquisition of £57 million, calculated as follows: Purchase cost: £m
Fair value of shares in Hibernian Life Holdings Limited 184 Cash paid 134 Attributable costs 4
Assets Acquired value of in-force business on insurance and investment contracts – 168 168 Other intangible assets 1 44 45 Investments 2,939 (74) 2,865 Other assets 1,225 (15) 1,210
Liabilities Gross insurance liabilities (1,767) (22) (1,789) Gross liability for investment contracts (2,066) (25) (2,091)
O therinform ation Aviva plc Annual Report and Accounts 2006 121 3 – Subsidiaries continued The value of the agreement to distribute through AIB’s networks has been identified as a separate intangible asset and valued by an independent third party at £45 million, using estimated post-tax cash flows and discount rates. It has been assessed as having a life of 25 years and is being amortised over that period, with a corresponding release of the applicable deferred tax provision.
As disclosed in the supplementary information on page 231, the embedded value of the long-term business acquired was £17 million, representing the net assets adjusted for other intangible assets net of tax.
The issue of new shares in the Company has attracted merger relief under section 131 of the Companies Act 1985. Of the £903 million above, £32 million has been credited to share capital (see note 27) and £871 million has been credited to the merger reserve (see note 32(a)). Expenses of £11 million have been charged to the share premium account.
The AmerUs acquisition has given rise to goodwill on acquisition of £669 million, calculated as follows: Purchase cost: £m
Liabilities Gross insurance liabilities 11,055 (50) 11,005 Gross liability for investment contracts 1,137 5 1,142 Other liabilities 1,503 187 1,690
The largest fair value adjustments above relate to the recognition of a value for the in-force business on insurance and investment contracts acquired by the Group (the AVIF) and to a reduction in Other assets. The AVIF adjustment of £1,387 million represents the excess of the value of the acquired in-force life insurance contracts over their IFRS net asset value, and is calculated as the difference between the acquired net tangible assets on a European Embedded (EEV) value basis and the same net assets on an IFRS basis. Deferred acquisition costs (DAC) totalling £1,297 million, included in Other assets in the book value column above, are not recognised in the IFRS fair value balance sheet as they have no fair value at acquisition. As DAC is reflected in the calculation of AVIF, its write-off in fair value adjustments is offset by the recognition of a fair value in AVIF.
As disclosed in the supplementary information on page 231, the embedded value of the long-term business acquired was £1,107 million, representing the net assets acquired, adjusted for other intangible assets net of tax and corporate debt.
The total consideration comprised: Cash paid 1,862 Fair value of shares 184 Attributable costs 15
O therinform ation Aviva plc Annual Report and Accounts 2006 123 3 – Subsidiaries continued (vii) Unaudited pro forma combined revenues and profit Shown below are unaudited pro forma figures for the Group’s combined revenues and profit as though the acquisition date for all business combinations effected during the year had been 1 January 2006, after giving effect to purchase accounting adjustments and the elimination of intercompany transactions. The pro forma financial information is not necessarily indicative of the combined results that would have been attained had the acquisitions taken place at 1 January 2006, nor is it necessarily indicative of future results.
Of the above pre-tax profit, £83 million has arisen since acquisition. No adjustments have been made to the profit figure above for any additional borrowing costs, integration costs or other synergies that might arise had the acquisitions been completed at 1 January 2006.
(viii) Non-adjusting post-balance sheet events On 1 January 2007, the Group acquired 100% of the shares of the Eurolloyd companies (Eurolloyd Nederland BV and Eurolloyd Belgie NV) for cash of £11 million. In view of the very recent timing and immaterial nature of this transaction, it is currently impractical to comply with the requirements of paragraph 67 of IFRS 3, Business Combinations, and to state with any certainty the fair values of the assets and liabilities acquired, and therefore to estimate the goodwill arising on this acquisition.
In addition to the above transaction, subsequent to year end, the Group has announced that it will acquire two of the units of Bumiputra-Commerce Holdings Berhad (BCHB) – 49% of each of a Life and a Takaful business - for approximately £75 million. This transaction is subject to signature and regulatory approval but completion is expected to occur by the second quarter of 2007.
On 8 February 2007, the Group announced that it planned to acquire 100% of the shares in Erasmus Groep BV in the Netherlands. Erasmus writes both general insurance and long-term business and, at 31 December 2005, had gross assets of £648 million and net assets of £29 million. The acquisition, when completed, will be effective from 1 January 2007, subject to the approval of the Dutch regulator, the relevant works council and notification to the relevant competition authorities.
(b) Disposal of subsidiaries, joint ventures and associates The profit on the disposal of subsidiaries and associates comprises: £m £m
United Kingdom (see below) 69 10 Ireland (see note 3(a)(i)) 86 – France (see note 18(b)) 79 – Asia – 165 Other small operations (12) (22)
Profit on disposal before tax 222 153 Tax on profit on disposal 13 (43)
The tax credit on the profit on disposal reflects the benefit of prior year tax credits against charges on disposals in earlier years.
Proceeds from sale 358 Net assets disposed of (310) Transaction costs (15)
Profit before tax and pension curtailment gain 33 Pension curtailment gain 36
Notes to the consolidated financial statements continued 3 – Subsidiaries continued The net assets disposed of, which total £310 million, comprised investment in joint ventures of £239 million, tangible assets of £102 million, other assets of £95 million and other liabilities of £126 million. The pension curtailment gain arose from the remeasurement of pension liabilities in the RAC plc defined benefit pension scheme, following the MSS and LVL disposals.
(i) Sale of MSS The MSS disposal was completed in three stages during the first six months of 2006, following the disposals of certain operational assets and liabilities of Hyundai Cars (UK) and the commercial fleet business of Lex Transfleet in 2005. On 10 January 2006, the Group sold Hyundai Car Finance Limited, which provides vehicle instalment finance and leasing, to Lloyds TSB. On 14 February 2006, the Group sold Lex Autologistics Limited, Lex Commercials Limited and associated properties to Imperial Holdings. On 27 April 2006, the Group completed the sale of the remaining vehicle solutions businesses, comprising Lex Transfleet Limited, Lex Defence Limited, Lex Defence Management Limited and RAC Software Solutions Limited, to VT Group plc. Receipts from the completion of the disposal of the MSS division totalled £111 million, resulting in a profit of £12 million before tax.
In 2005, the Group sold certain operational assets and liabilities of Hyundai Cars (UK) and the commercial fleet business of Lex Transfleet for total consideration of £139 million. The sale resulted in a profit of £5 million, which is included in the 2005 figures above.
Of the total consideration of £250 million received for MSS disposals in 2005 and 2006, £73 million was in respect of retained liabilities to be settled by the Group.
One of the Group’s wholly-owned subsidiaries, Delta Lloyd NV, is subject to the provisions of Dutch corporate law and particularly the Dutch “structure company” regime. Under this regime, Delta Lloyd operates under a Supervisory Board which has a duty to have regard to the interests of a wide variety of stakeholders. The Supervisory Board includes two Aviva Group representatives and is responsible for advising and supervising Delta Lloyd’s Executive Board. The shareholder is one of the most important stakeholders to whom the Supervisory Board has a duty.
Other Other activities not related to the core business segments or which are not reportable segments due to their immateriality, such as the RAC non-insurance operations, our banking businesses and service companies, are included as “Other”, in the following tables. Head office expenses, such as Group treasury and finance functions are also reported as “Other”, together with eliminations and any other reconciling items. Certain financing costs and taxes are not allocated across the segments.
The accounting policies of the segments are the same as those for the Group as a whole. Any transactions between the business segments are on normal commercial terms and market conditions.
Gross written premiums 17,308 – 11,427 – 28,735 Premiums ceded to reinsurers (776) – (725) – (1,501)
Net earned premiums 16,532 – 10,795 – 27,327 Fee and commission income 630 452 172 616 1,870 17,162 452 10,967 616 29,197 Net investment income 13,928 17 1,299 229 15,473 Inter-segment revenue – 199 – – 199 Profit on the disposal of subsidiaries and associates 12 – 88 122 222
Amortisation of acquired value of in-force business (58) – – – (58) Net Impairment of acquired value of in-force business (28) – – – (28) Amortisation and net impairment of intangible assets (32) (1) (18) (19) (70) Impairment of goodwill – – – (94) (94) Other impairment losses recognised in the income statement 6 – (5) (1) –
Segment result before share of profit/(loss) of joint ventures and associates 1,629 161 1,806 (528) 3,068 Share of profit/(loss) of joint ventures and associates 471 (7) 5 16 485
Finance costs on central borrowing comprise interest payable on borrowings by holding companies within the Group which is not allocated to operating companies.
Impairment losses, and reversal of such losses, recognised directly in equity were nil and £2 million respectively in long-term business.
O therinform ation Aviva plc Annual Report and Accounts 2006 127 4 – Segmental information continued Pro forma reconciliation to operating profit before tax attributable to shareholders’ profits
Unallocated interest and corporate cost reallocation 1 – 1 (2) –
Net written premiums 14,671 – 10,311 – 24,982 Net change in provision for unearned premiums – – (123) – (123)
Finance costs on central borrowings comprise interest payable on borrowings by holding companies within the Group which is not allocated to operating companies.
Impairment losses, and reversal of such losses, recognised directly in equity were £45 million and nil respectively in long-term business.
Operating profit before tax attributable to shareholders’ profits 1,065 124 1,551 (612) 2,128
Insurance liabilities 126,224 – 18,006 – 144,230 Liability for investment contracts 88,358 – – – 88,358 Unallocated divisible surplus 9,465 – – – 9,465 Net asset value attributable to unitholders 3,786 1 23 – 3,810 External borrowings 3,894 – 11 4,037 7,942 Other liabilities, including inter-segment liabilities 6,999 313 (712) 9,719 16,319
Capital expenditure (excluding business combinations) Intangible assets 29 14 15 32 90 Property and equipment 55 3 13 224 295
At a country level, certain classifications in 2005 have changed. 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 UK.
O therinform ation Aviva plc Annual Report and Accounts 2006 131 4 – Segmental information continued (ii) Segmental results and balance sheets – geographical segment
Year ended 31 December 2006 £m £m £m £m £m £m £m
Year ended 31 December 2005 £m £m £m £m £m £m £m
Gross written premiums 11,510 4,250 3,878 4,316 522 1,823 26,299 Premiums ceded to reinsurers (914) 35 (22) (306) (5) (105) (1,317)
Net earned premiums 10,471 4,269 3,858 4,032 517 1,712 24,859 Fee and commission income 1,002 200 192 239 – 218 1,851
Total life and pensions (including share of associates and joint ventures) 18,639 15,926 1,394 1,151 16,837 14,932
Total long-term savings (including share of associates and joint ventures) 23,501 19,238 1,442 1,176 21,747 18,269
Included within new business sales is £6,365 million of single premiums and £615 million of regular premiums (2005: £5,071 million and £357 million respectively) in respect of contracts that meet the definition of “non-participating investment” contracts under IFRS 4, Insurance Contracts. Under IFRS, the premiums on these contracts are not included in the Group income statement under earned premiums, but are included on the balance sheet as a deposit.
Gross written premiums (note 4a) Long-term: Insurance contracts 13,188 9,916 Participating investment contracts 4,120 5,366
General insurance and health 11,427 11,017 28,735 26,299 Less: premiums ceded to reinsurers (note 4a) (1,501) (1,317) Gross change in provision for unearned premiums (note 35e) 89 (216) Reinsurers’ share of change in provision for unearned premiums (note 36c) 4 93 Net change in provision for unearned premiums 93 (123)
From financial instruments designated as trading and other than trading 5,444 5,500 From AFS investments and financial instruments at amortised cost 951 896 6,395 6,396 Dividend income 2,115 1,778 Other income from investments designated as trading
Realised gains and losses 4,989 4,502 Unrealised gains and losses (998) 8,771 3,991 13,273 Realised gains on AFS investments 162 154 Net income from investment properties: Rent 757 747 Expenses relating to these properties (27) (19) Realised gains on disposal 46 41 Fair value gains on investment properties 1,507 1,571
Claims and benefits paid Claims and benefits paid to policyholders on long term-business
Claims and benefits paid to policyholders on general insurance and health business 7,232 6,523 24,470 20,501 Less: Claim recoveries from reinsurers
Claims and benefits paid, net of recoveries from reinsurers 23,444 19,706
Change in investment contract provisions Investment income allocated to investment contracts 3,122 3,633 Other changes in provisions
Commission expenses for insurance and participating investment contracts 2,919 2,700 Change in deferred acquisition costs for insurance and participating investment contracts 210 (208) Deferrable costs for non-participating investment contracts 230 165 Other acquisition costs 1,376 1,245 Change in deferred acquisition costs for non-participating investment contracts (159) (258) Reinsurance commissions and other fee and commission expense 467 686
Staff costs and other expenses 2,750 2,613 Central costs and sharesave schemes 160 108 Global finance transformation programme – 28 Corporate costs 160 136 Depreciation (note 19) 122 112 Impairment of goodwill on subsidiaries (note 15) 94 43 Amortisation of acquired value of in-force business (note 16) 58 26 Amortisation of intangible assets (note 16) 72 39 Net impairment of acquired value of in-force business (note 16) 28 29 (Reversal of impairment)/impairment of intangible assets (note 16) (2) 6 Integration and restructuring costs (note 3c) 246 109
Impairments Net (reversal of impairment)/impairment on loans (4) 4 Net (reversal of impairment)/impairment on financial investments (1) 5 Net impairment on receivables and other financial assets 5 10 Net impairment on non-financial assets – 38
Notes to the consolidated financial statements continued 7 – Analysis of net investment return The total investment return reflected in profit before tax comprises: £m £m
Allocated costs (600) (361) Unallocated interest charges: Subordinated debt (169) (169) Other borrowings (61) (79)
Net investment return before unrealised gains 14,425 13,030 Unrealised investment gains on financial investments and loans designated as at fair value through profit or loss 717 10,384
In addition to the investment return recognised above, £347 million of investment gains (2005: losses of £110 million) have been recognised directly in equity as detailed in the statement of recognised income and expense.
Net investment income (note 4a(ii)) 1,299 1,603 Less: Internal charges included under other headings (77) (40)
Longer term investment return 1,073 1,046 Short-term fluctuation in investment return 149 517
O therinform ation Aviva plc Annual Report and Accounts 2006 137 8 – Longer term investment return continued (e) The table below compares the actual return on investments attributable to the general insurance and health business, after deducting investment management expenses and charges, with the aggregate longer term return over a three year period. This table will be built up over time to give aggregate and comparative figures over a five year period.
Equities 1% higher/lower Group operating profit before tax 31 29 Properties 1% higher/lower Group operating profit before tax 4 4 9 – Employee information The average number of persons employed by the Group during the year was: Number Number
United Kingdom 35,701 33,827 France 4,303 4,351 Netherlands 6,447 6,338 Other Europe 6,091 5,667 United States 531 379 Rest of the World 4,946 4,229
Fees payable to Ernst & Young LLP for the statutory audit of the Aviva Group and Company financial statements 1,452 1,525 Fees payable to Ernst & Young LLP and its associates for other services to Group companies: Audit of Group subsidiaries pursuant to legislation 7,507 7,453 Other services pursuant to legislation 2,326 1,834 Tax services 187 114 Services relating to information technology 40 177 Services relating to corporate finance transactions 1,432 762 All other services – Supplementary reporting (see below) 885 862
Current tax For this year 1,022 799 Prior year adjustments (287) (212)
Deferred tax Origination and reversal of timing differences 221 881 Changes in tax rates or tax laws (7) (5) Write-down of deferred tax assets (15) 89
(ii) The Group, as a proxy for policyholders in the UK, Ireland and Australia, is required to record taxes on investment income and gains each year. Accordingly, the tax benefit or expense attributable to UK, Irish and Australian life insurance policyholder returns is included in the tax charge. The tax expense attributable to policyholders’ returns included in the charge above is £346 million (2005: £922 million).
Tax calculated at standard UK corporation tax rate of 30% (2005: 30%) 997 1,035 Different basis of tax for UK life insurance 209 616 Adjustment to tax charge in respect of prior years (287) (253) Non-assessable dividends (55) (26) Non-taxable profit on sale of subsidiaries and associates (80) (4) Disallowable expenses 46 55 Different local basis of tax on overseas profits 201 168 Deferred tax assets not recognised (60) (25)
Operating profit attributable to ordinary shareholders 3,110 2,146 86.9 2,128 1,415 60.5 Non-operating items: – Amortisation and net impairment of acquired additional value of in-force business (note 16 & 18) (100) (83) (3.4) (73) (73) (3.1) – Amortisation and net impairment of intangibles (note 16) (70) (48) (1.9) (45) (42) (1.8) – Financial services compensation scheme and other levies 6 4 0.2 – – – – Short-term fluctuation in return on investments backing general insurance and health business (note 8b) 149 189 7.7 517 430 18.2 – Profit on the disposal of subsidiary and associates (note 3b) 222 235 9.5 153 110 4.7 – Integration and restructuring costs (note 3c) (246) (188) (7.7) (109) (76) (3.2)
Profit attributable to ordinary shareholders 2,977 2,161 87.5 2,528 1,721 73.5
Earnings per share has been calculated based on the operating profit before impairment of goodwill and other non-operating items, after tax, attributable to ordinary shareholders, as well as on the profit attributable to ordinary shareholders. The directors believe the former earnings per share figure provides a better indication of operating performance.
Total of shares Per share Total of shares Per share £m m p £m m p
Profit attributable to ordinary shareholders 2,161 2,469 87.5 1,721 2,340 73.5 Dilutive effect of share awards and options – 27 (0.9) – 20 (0.6)
Diluted earnings per share on operating profit attributable to ordinary shareholders is 86.0 pence (2005: 60.0 pence).
693 598 Preference dividends declared and charged to equity in the year 17 17 Coupon payments on direct capital instrument 52 42
Goodwill additions relate to contingent consideration paid in respect of past acquisitions of subsidiaries. Goodwill arising on acquisitions completed before 1 January 1998 was charged directly to reserves. Goodwill arising on the Group’s investment in joint ventures and associates is included within the carrying value of those investments (see notes 17 and 18).
Goodwill and intangibles with indefinite useful lives have been tested for impairment in these businesses as follows: UK (general insurance and health) The recoverable amount of the UK general insurance and health unit has also been determined based on a value in use calculation. The calculation uses cash flow projections based on business plans approved by management covering a three year period and a risk adjusted discount rate of 10.45% (2005: 10.45%). Cash flows beyond that three year period have been extrapolated using a steady 3% growth rate (2005: 3%). The recoverable amount significantly exceeds the carrying value of the cash generating unit including goodwill and intangible assets with indefinite useful lives and a reasonably possible change in a key assumption will not cause the carrying value of the cash generating unit to exceed its recoverable amount.