* On an IFRS basis. **From continuing operations, including long-term savings result on a European Embedded Value (EEV)
Individual Savings Accounts (“ISAs”) Lloyds TSB Registrars The Causeway 0870 242 4244* (ISA Manager) Worthing
A viva plc 2005 £1,551m Worldwide operating profit before tax £10,311m Worldwide net written premiums†
Strategy outlook Aviva is a complex and evolving business and we have recently given consideration to clarifying our strategy. In summary, our business strategy is to be a clear leader in helping our customers grow their wealth and protect their assets and their health.
In November, the Turner Report was issued by the Pensions Commission, setting out their views of the future of UK pensions and recommending changes for a new policy direction. The key recommendations were the establishment of a low cost National Pension Saving Scheme in which people are automatically enrolled and an increase in the state retirement age.
Our previous target, to grow the dividend by 5%, was put in place when the dividend was cut in 2002. Naturally, at that time, the board wanted to give a high degree of certainty to our shareholders regarding future dividend growth. The board believes that the target has become too rigid a constraint. Our future intention is to increase the dividend on a basis judged prudent using a dividend cover in the 1.5 to 2.0 times range as a guide, on an IFRS operating earnings after tax basis, while retaining capital to support future business growth.
Our dividend grew by 7.5% to 27.27 pence, and we have recommended to the pension scheme trustees that the group makes an additional deficit funding contribution of £700 million to the Aviva and RAC pension schemes over the next two years.
Supporting sport in Asia and Australia The Aviva brand is being promoted to a wider audience through sport. Tennis fans around the world saw the Aviva logo on the uniforms of more than 300 ballkids at the Australian Open tournament in Melbourne, and we have extended this highly successful sponsorship deal for another four years. We shall also be reaching millions of homes across Asia as we have agreed to sponsor three major badminton events – the China, Singapore and Hong Kong Opens – through to 2007.
Poland: life company of the decade We received a golden parasol award from Home & Market magazine for being Poland’s life insurance company of the decade. The magazine praised us for our “persistence, quality of service, recognisability and our long-term well-established position in the Polish life insurance market”.
Hours volunteered £5.7m Amount donated to charitable causes and community initiatives
Our overriding goal is to provide prosperity and peace of mind for our customers. To achieve this goal, we need to be a clear leader in helping our customers grow their wealth and protect their assets and their health.
General insurance and health 1,551 1,259 1,551 1,259 Other: Net unallocated interest charges (436) (437) (436) (437)
The overall effect of the non-life short-term fluctuations, profit on disposal of subsidiaries and integration costs is included in the IFRS profit before tax attributable to shareholders' profits of £2,528 million (2004: £1,642 million).
As at 31 December 2005: IFRS basis EEV basis 31 December 31 December 31 December 31 December £m £m £m £m
Cash flows from operating activities increased by 30% to £2,409 million (2004: £1,855 million), reflecting our strong operating performance. Conversely, investing activities generated a net cash outflow of £1,303 million, primarily due to acquisition activities.
Netherlands (including Belgium and Luxembourg) 220 214 277 2,168 80 3.7 *Excludes investment sales. Investment sales totalled £2,399 million (2004: £1,629 million) giving overall new business sales of £24,645 million (2004: £22,290 million).
Our UK business, operating as Norwich Union, provides a comprehensive suite of long-term savings products, focusing on competitive and sustainable investment returns. We are a top-three player in all our chosen life and pensions market sectors. Our business is mainly written through a network of financial advisers and we have developed a strong distribution footprint for the depolarised marketplace with major product multi-tie agreements with Sesame, Barclays, Bankhall and Millfield Alliance, together with protection multi-tie agreements with SimplyBiz and Direct Life and Pensions and a single-tie agreement with CIS.
Our life EEV operating return increased to £585 million (2004: £551 million), primarily driven by increased expected returns from in-force business and shareholders' net worth. The net impact of experience variances and operating assumption changes amounted to a loss of £150 million (2004: loss of £139 million).
Specific details of our major bancassurance partnerships are set out in the detailed reviews of the business units.
We aim to generate organic growth with a specific focus on our strength in the unit-linked market while also taking advantage of attractive opportunities that arise for non-organic growth. Our efforts are focused on achieving greater efficiency in sales, administration and the management of our key business partnerships. We will, as always, seek to maintain high levels of customer service and market leading investment performance through our fund manager Aviva Gestion d’Actifs.
We increased our sales by 18% to £665 million (2004: £561 million) benefiting from strong sales of single premium business during the year. Our life EEV operating return was £20 million (2004: £40 million), impacted by adverse experience variances. Variances were predominantly as a result of lapses on unit-linked pension business. Our new business contribution of £16 million (2004: £19 million) with a new business margin of 2.4% (2004: 3.4%), reflects investor preference for lower-margin single premium products and the lower level of lower protection sales.
In Poland, we are developing a multi-distribution strategy, built upon the strength of our direct sales force which currently number over 3,000 sales people. We have strong product manufacturing capabilities covering single and regular premium life business aimed at both individuals and groups. Our pension business sells a unitlinked regular premium product in the compulsory private pension market. We are the largest pension provider in Poland, with a 28% market share, and have the second-largest life insurance business, with a 12% market share.
Our international operations are based in Australia, USA, Hong Kong, Singapore, India and China and all trade under the Aviva brand. The product ranges, distribution channels and strategies of each operation vary according to local market conditions.
Why buy the RAC? We aim to provide a complete range of motoring services, giving reassurance to our customers and providing sales and cost saving opportunities for the group. RAC is a well-known and highly respected brand, and research has shown that it is perceived as being both professional and trustworthy. Through this acquisition, we are aiming to generate value from the brand, become the first choice motoring services provider and increase our ‘non-cyclical’ income to produce enhanced earnings growth and stability.
Accounting bases Our capital funding, from all sources, has been allocated so that the capital employed by trading operations is greater than the capital provided to those operations by the shareholders and its subordinated debt holders. As a result, we are able to enhance the returns earned on our equity capital.
We believe that our business performance benefits if we keep our staff motivated, informed and involved in our successes and challenges. A group-wide climate survey was launched in 2005 that will enable us to benchmark externally our performance as an “employer of choice”, to draw on good practice around the group and to focus future actions accordingly. The survey has been completed by around 58% of our business units, covering over 41,000 of our employees. The remainder of the group will complete the survey for the first time in 2006.
We remain committed to other forms of dialogue with employees. We place a strong emphasis on the provision of company news through a variety of media, including intranets, Aviva radio and poster campaigns. Employee forums have been established in the UK and we continue to have a positive relationship with our European Consultative Forum.
– A group policy framework that sets out risk appetite, risk management and control and business conduct standards for the group’s worldwide operations. Each policy has a member of senior management who is charged with overseeing compliance with the policy throughout the group.
The adequacy of our general insurance reserves is ultimately approved by the Reserving committee. The committee maintains the General Insurance Reserving policy and regularly monitors the adequacy of the general insurance reserves. The reserves are subject to audit and peer review.
5. Lord Sharman of Redlynch OBE (63) Chairman Appointed to the board in January 2005 and became chairman from 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 NV (banking). Former chairman of KPMG International (auditors), former deputy chairman of Group 4 Securicor plc (security services) and a former independent nonexecutive director of Young & Co.’s Brewery PLC (drinks) and AEA Technology plc (commercial / technology).
Pursuant to amendments made to the Companies Act 1985 in 2005 companies will be required to produce a business review as part of their directors’ report in respect of financial years beginning on or after 1 April 2005. The Company has decided to comply with the Companies Act amendments early and the business review is contained on pages 16 to 49. Certain matters that are required to be disclosed within the directors’ report have been included within the business review. Accordingly, the review of the Group’s operations, current position and future prospects together with a description of its principal activities are included within the business review.
Control environment The Group has an established governance framework. The key features include: – Terms of reference for the Board and each of its committees; – A clear organisational structure, with documented delegation of authority from the Board to executive management; – A Group policy framework, which sets out risk management and control standards for the Group’s operations worldwide; – Defined procedures for the approval of major transactions and capital allocation.
Whenever possible, all directors attend the Annual General Meeting and shareholders are invited to ask questions during the meeting and have an opportunity to meet with the directors following the conclusion of the formal part of the meeting. Details of proxy voting by shareholders, including votes withheld, are made available on request and are placed on the Company’s website.
Each of the Group’s major business units has an audit committee that provides an oversight role for their business. All such committees include members who are independent of the relevant business. The Group Audit Director reviews the papers and minutes from these committees and brings all significant matters to the Committee’s attention.
A major review of senior executive pension provisions was undertaken during 2005 and is described in detail below. The Company was supported by Aon Consulting. Lane Clark & Peacock LLP (LC&P), consulting actuaries, were 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.
Dilution Awards granted under the Aviva Annual Bonus Plan 2005 and the Aviva Long-Term Incentive Plan 2005 are met by the issue of new shares at the time that the awards vest. The Committee monitors the number of shares issued under its various allemployee and discretionary share plans and their effect on dilution limits. The relevant dilution limits established by the Association of British Insurers in respect of all share plans (10% in any rolling 10 year period) and executive share plans (5% in any rolling 10 year period) were, based on the Company’s issued share capital at
“Savings related options” are options granted under the HM Revenue and Customs-approved Save As You Earn (SAYE) share option scheme. Options are normally exercisable during the six month period following the end of the relevant (three, five or seven year) savings contract.
Deposits collected under investment contracts without a discretionary participating feature (non-participating contracts) are not accounted for through the income statement, except for the fee income (covered in policy 4) and the investment income attributable to those contracts, but are accounted for directly through the balance sheet as an adjustment to the investment contract liability.
Unallocated divisible surplus In certain participating long-term insurance and investment business, the nature of the policy benefits is such that the division between shareholder reserves and policyholder liabilities is uncertain. Amounts whose allocation either to policyholders or shareholders has not been determined by the end of the financial year are held within liabilities as an unallocated divisible surplus.
(W) Leases Leases, where a significant portion of the risks and rewards of ownership is retained by the lessor, are classified as operating leases. Assets held for use in such leases are included in property and equipment, and are depreciated to their residual values over their estimated useful lives. Rentals from such leases are credited to the income statement on a straight-line basis over the period of the relevant leases. Payments made as lessees under operating leases (net of any incentives received from the lessor) are charged to the income statement on a straight-line basis over the period of the relevant leases.
Share issue costs Incremental external costs directly attributable to the issue of new shares, other than in connection with business combinations, are shown in equity as a deduction, net of tax, from the proceeds. Share issue costs incurred directly in connection with a business combination are included in the cost of acquisition.
3,718 Profit before tax attributable to shareholders’ profits 2,528 1,642 Tax attributable to shareholders’ profits
Cash flows from financing activities Proceeds from issue of ordinary shares, net of transaction costs 27b – 59 59 3 Proceeds from issue of direct capital instrument, net of transaction costs – – – 981 Net drawdown of borrowings 43c 150 706 856 1,526 Interest paid on borrowings (203) (406) (609) (522) Preference dividends paid – (17) (17) (17) Ordinary dividends paid – (498) (498) (450) Coupon payments on direct capital instrument – (42) (42) – Finance lease payments – (8) (8) (26) Capital contributions from minority shareholders 204 8 212 4 Dividends paid to minority interests of subsidiaries – (70) (70) (41) Non-trading cash flows between operations 302 (302) – –
Equity attributable to shareholders of Aviva plc 191 242 (834) 40 344 (351) (37) 71 (334)
– Changes in the fair value of derivatives that are designated and qualify as cash flow hedges.
This product classification change has led to technical provisions being allocated between insurance and investment contracts. This has resulted in £57,445 million and £69,555 million of liabilities at 1 January 2004 and 31 December 2004 respectively being classified as investment contracts.
In addition to the change in liability valuation, the accounting for deferred acquisition costs has been revised in accordance with IAS 18. This restricts the types of acquisition costs that can be deferred, leading to a reduction in deferred acquisition costs as compared to UK GAAP.
Notes to the consolidated financial statements continued 1 – First time adoption of International Financial Reporting Standards continued (3) Employee benefits a) Pensions Under the Group’s UK GAAP pension policy, as set out in Statement of Standard Accounting Practice 24, Accounting for Pension Costs (SSAP 24), the cost of providing pension benefits is expensed using actuarial valuation methods which give a substantially even charge over the expected service lives of employees, and results in either a prepayment or an accrual to the extent that this charge does not equate to the cash contributions made into the schemes. Under IAS 19, Employee Benefits, the projected benefit obligation is matched against the fair value of the underlying assets and other unrecognised actuarial gains and losses in determining the pension expense for the year. Any pension asset or obligation must be recorded in the balance sheet. Aviva has not applied the “corridor approach” to valuing pension deficits.
(ii) The assets and liabilities of the banking business are no longer disclosed entirely in “other debtors” and “other creditors” but have been reported in the appropriate balance sheet classifications.
Pre-tax profit on sale 165 Tax attributable to profit on sale (43)
In December 2005, the Group sold its commercial fleet business in Lex Transfleet Limited to Fraikin Limited for a total of £69 million, of which £10 million is deferred consideration. The Group acquired 50% of Lex Transfleet Limited with the RAC group, and this company became a wholly-owned subsidiary after the Group acquired the remaining 50% of its share capital in November 2005. The sale resulted in a gain of £5 million.
4 – Segmental information (a) Primary reporting format – business segments (i) Reporting segments The principal activity of the Group is financial services, which is managed using the following reportable segments: long-term business, fund management, general insurance and health.
Long-term business Our long-term business comprises life insurance, long-term health and accident insurance, savings, pensions and annuity business written by our life insurance subsidiaries, including managed pension fund business and our share of the other life and related business written in our associates and joint ventures, as well as the equity release business written in the United Kingdom.
Impairment losses, and reversal of such losses, recognised directly in equity were £nil and £124 million respectively in long-term business.
For the year ended 31 December 2004 £m £m £m £m £m
Central borrowings are borrowings by holding companies within the Group which are not allocated to operating companies.
(ii) Basic earnings per share is calculated as follows: Net of tax, Net of tax, minorities, minorities preference preference dividends dividends and DCI and DCI
Tax attributable to shareholders’ profits (536) (94) (630) (319) 48 (271)
Of the £1,139 million arising on the acquisition of the RAC group, £1,054 million relating to subsidiaries is included in the additions figure above and £85 million relating to joint ventures is dealt with in note 17(a).
Equity Total Total Goodwill interests Loans 2005 2004 £m £m £m £m £m
Notes to the consolidated financial statements continued 21 – Loans (a) Carrying amounts The carrying amounts of loans at 31 December 2005 and 2004 were as follows: £m £m
Notes to the consolidated financial statements continued 23 – Financial investments continued
Derivative financial instruments – 467 – 467 Deposits with credit institutions 165 – – 165 Specialised investment companies 9,783 – – 9,783 Minority holdings in property management undertakings 499 – – 499
The carrying amounts of financial assets received and pledged as collateral under stocklending arrangements at 31 December 2005 are £1,869 million and £nil million respectively (2004: £3,210 million and £nil respectively).
The new preference shares, if issued and allotted, would rank, as to payment of a dividend and capital, ahead of the Company’s ordinary share capital but behind the cumulative irredeemable preference shares currently in issue. The issued preference shares are non-voting except where their dividends are in arrears, on a winding up or where their rights are altered. On a winding up, they carry a preferential right of return of capital ahead of the ordinary shares.
General annuity business after vesting IML00/IFL00 adjusted IM80/IF80 adjusted plus allowance for future plus allowance for future mortality improvement mortality improvement Pensions business after vesting PCMA00/PCFA00 adjusted PMA80/PFA80 adjusted plus allowance for future plus allowance for future mortality improvement mortality improvement
Pensions business PCMA00/PCFA00 adjusted PMA80/PFA80 adjusted plus allowance for future plus allowance for future mortality improvement mortality improvement
Changes in claims reserve recognised as an expense 214 402 Gross portfolio transfers, acquisitions and disposals (153) 2 Foreign exchange rate movements 146 32 Other gross movements 8 (64)
35 – Insurance liabilities continued Before the effect of reinsurance, the loss development table is: Accident Year £m £m £m £m £m £m £m
The tables above include information on asbestos and environmental pollution claims provisions from business written before 2001. The claim provisions, net of reinsurance, in respect of this business were £289 million (2004: £224million). These provisions were strengthened during the year by £83 million (2004: £71 million).
Carrying amount at 1 January 4,923 4,686 Premiums written during the year 11,017 10,562 Less: Premiums earned during the year (10,802) (10,339) Other movements in UPR 1 9
Changes in UPR recognised as an expense 216 232 Gross portfolio transfers and acquisitions 174 7 Foreign exchange rate movements 74 8 Other movements (6) (10)
Carrying amount at 1 January 398 348 Premiums ceded to reinsurers in the year 706 744 Less: Reinsurers’ share of premiums earned during the year (612) (688) Other movements in reinsurers’ share of UPR (1) –
37 – Liability for investment contracts continued (ii) Non-participating investment contracts £m £m
Carrying amount at 1 January 25,581 20,493 Reserves in respect of new business 5,247 3,872 Expected change in existing business provisions 936 769 Variance between actual and expected experience (1,732) 160 Impact of operating assumption changes 2 – Impact of economic assumption changes – 5 Other movements 93 78
Notes to the consolidated financial statements continued 39 – Effect of changes in assumptions and estimates during the year Certain estimates and assumptions used in determining liabilities for insurance and investment contract business were changed from 2004 to 2005, and had the following effect on liabilities and the profit recognised for the year: This disclosure only shows the impact on liabilities and does not allow for offsetting movements in the value of backing assets.
Deferred tax assets are recognised for tax loss carry forwards to the extent that realisation of the related tax benefit through future taxable profits is probable. The Group has unrecognised tax losses of £1,035 million (2004: £754 million) to carry forward against future taxable income of the necessary category in the companies concerned. These tax losses will expire as follows; £40 million 5 – 10 years and £35 million 15 – 20 years (2004: £46 million within 5 – 10 years and £12 million within 15 – 20 years). The remaining losses have no expiry date. In addition, the Group has an unrecognised capital loss of £446 million (2004: £376 million). This tax loss can only be offset against future capital gains and has not been recognised in these financial statements. This tax loss has no expiry date.
(v) The assets and liabilities of the schemes, attributable to defined benefit members, at 31 December 2005 were: UK Netherlands Canada Ireland Total £m £m £m £m £m £m £m £m £m £m
48 – Cash flow statement continued (b) Cash flows in respect of the acquisition of subsidiaries, joint ventures and associates £m £m
For UK and overseas general insurance businesses, the relevant capital requirement is the minimum solvency requirement determined in accordance with the local regulator’s requirements.
Impact of regulatory context on nature of the risks A large proportion of the Group’s long-term savings business involves insurance products where the majority of investment risks are borne by its policyholders. Risks attributable to policyholders are actively and prudently managed in order to satisfy policyholders’ risk and reward objectives. In addition, the Group’s worldwide insurance operations are subject to numerous local regulatory requirements, that prescribe the type, quality, and concentration of investments, and the level of assets to be maintained in local currency in order to meet local insurance liabilities. These requirements help to maintain the Group’s market risk levels at an acceptable level in each of the jurisdictions in which it operates.
Increasingly risk-based capital models are being used to support the quantification of risk under the ICA framework. All general insurance business units undertake a quarterly review of their insurance risks, the output from which is a key input into the ICA and risk-based capital assessments.
Financial assets are graded according to current credit ratings issued. AAA is the highest possible rating. Investment grade financial assets are classified within the range of AAA to BBB ratings. Financial assets which fall outside this range are classified as speculative grade. Credit limits for each counterparty are set based on default probabilities that are in turn based on the rating of the counterparty concerned.
(v) Operational risk Operational risk arises as a result of inadequately controlled internal processes or systems, human error, or from external events. This definition is intended to include all risks to which the Group is exposed, other than the financial risks described previously, and strategic and Group risks that are considered elsewhere. Hence, operational risks include for example, information technology, information security, human resources, project management, outsourcing, tax, legal, fraud and compliance risks.
Notes to the consolidated financial statements continued 51 – Derivative financial instruments The Group uses cash flow, fair value and net investment hedges to mitigate risk, as detailed below.
Unit trusts, OEICs, Peps and Isas 16,188 10,527 Segregated funds 30,821 24,899
There were no services provided by related parties in either 2004 or 2005.
At 31 December 2005, the Company has four wholly-owned subsidiaries, all incorporated in Great Britain. These are CGNU Holdings (Australia) Limited, General Accident plc, Norwich Union Limited and Norwich Union Holdings Limited. CGNU Holdings (Australia) Limited and Norwich Union Holdings Limited are intermediate holding companies, whilst General Accident plc and Norwich Union Limited no longer carry out this function. The principal subsidiaries of the Aviva Group at 31 December 2005 are listed on page 222.
4,271 Operating profit before tax attributable to shareholders’ profits 2,904 2,224 (63) Impairment of goodwill (43) (41) (31) Amortisation and impairment of acquired value of in-force business and intangibles (21) (3)
In the directors’ opinion, the EEV basis provides a more accurate reflection of the performance of the Group’s life and related operations year on year than results presented under the IFRS basis. The directors consider that the EEV methodology represents a more meaningful basis of reporting the underlying value of the Group’s life and related businesses and the underlying drivers of performance. This basis allows for the impact of uncertainty in the future investment returns more explicitly and is consistent with the way the business is priced and managed.
Risk discount rate 6.0% 6.4% 7.0% Pre-tax investment returns: Base government fixed interest 3.3% 3.7% 4.3%
This section describes the models used to generate future investment simulations, and gives some sample statistics for the simulations used. Two separate models have been used, for the UK businesses and for the Europe (excluding UK) and International businesses, as each of these models better reflect the characteristics of the businesses.
Principal economic assumptions – deterministic calculations continued Valuation of Debt Borrowings in the EEV consolidated balance sheet are valued on an IFRS basis, consistent with the primary financial statements. At 31 December 2005 the market value of the Groupís external debt, subordinated debt, preference shares including General Accident plc preference shares of £250 million (classified as minority interests) and direct capital instrument was £5,868 million (31 December 2004: £5,953 million).
Spain Aseguradora Valenciana SA, de Seguros y Reaseguros (50.0%) Aviva Vida y Pensiones, Sociedad Anonima de Seguros y Reaseguros Bia Galicia, de Seguros y Reaseguros SA (50.0%) Caja Espana Vida, Compania de Seguros y Reaseguros (50.0%) General Vida, Sociedad Agencia de Seguros, S.L. (25.0%) Unicorp Vida, Compania de Seguros y Reaseguros (50.0%)
Group financial calendar for 2006 Announcement of first quarter long-term savings new business figures 27 April Annual General Meeting 10 May Announcement of unaudited six months’ interim results 9 August Announcement of third quarter long-term savings new business figures 26 October
basis before amortisation of goodwill. † Return based on opening equity shareholders’ funds on an EEV basis. ‡ From continuing operations, including share of associates’ premiums. ≠ On an EEV basis.