Aviva plc FY 2007 Part 4

Aviva PLC 28 February 2008 Aviva plc FY07 Part 4 Part 4 of 5 ---------------------------------------------------------------------------------------------------------------------- Page 71 Appendix A1 Group capital structure Page Capital employed by segment 72 Deployment of equity shareholders' funds 72 Sensitivity analysis 73 Shareholders' funds, including minority interests 75 Analysis of return on capital employed 76 ------------------------------------------------------------------------------------------------------------------------ Page 72 A Group capital structure The Group maintains an efficient capital structure financed by a combination of equity shareholders' funds, preference capital, subordinated debt and borrowings, consistent with the Group's risk profile and the regulatory and market requirements of its business. The Group's capital structure, analysed on an EEV basis, is set out below Capital employed by segment 2007 2006 Â£m Â£m Long-term savings 23,272 20,094 General insurance and health 5,487 5,176 Other business including fund management 1,056 1,059 Corporate* (31) (19) ---------------------------------------------------------------------------------------------------------------------- Total capital employed 29,784 26,310 ---------------------------------------------------------------------------------------------------------------------- Financed by Equity shareholders' funds and minority interests 23,384 19,668 Direct capital instrument 990 990 Preference shares 200 200 Subordinated debt 3,054 2,937 External debt 1,257 1,258 Net internal debt 899 1,257 ---------------------------------------------------------------------------------------------------------------------- 29,784 26,310 ====================================================================================================================== * The 'Corporate' net liabilities represent the element of the pension scheme deficit held centrally At 31 December 2007 the Group had Â£29.8 billion (restated 31 December 2006: Â£26.3 billion) of total capital employed in our trading operations which is financed by a combination of equity shareholders' funds, preference capital, direct capital instruments, subordinated debt and internal and external borrowings. In the year to 31 December 2007, the total capital employed increased by Â£3.5 billion reflecting growth in long-term saving operations driven by operational results and foreign exchange impacts. In addition to our external funding sources, we have certain internal borrowing arrangements in place which allow some of the assets that support technical liabilities to be invested in a pool of central assets for use across the Group. These internal debt balances allow for the capital allocated to business operations to exceed the externally sourced capital resources of the Group. Although intra-group in nature, they are included as part of the capital base for the purpose of capital management. These arrangements arise in relation to the following: - Certain subsidiaries, subject to continuing to satisfy standalone capital and liquidity requirements, loan funds to corporate and holding entities, these loans satisfy arms length criteria and all interest payments are made when due. - Aviva International Insurance (AII) Ltd acts as both a UK general insurer and as the primary holding company for the Group's foreign subsidiaries. Internal capital management mechanisms in place allocate a portion of the capital of the company to the UK general insurance operations. These mechanisms also allow for some of the assets backing technical liabilities to be made available for use across the Group. Balances in respect of these arrangements are also treated as internal debt for capital management purposes. Net internal debt represents the balance of the above amounts due from corporate and holding entities, less the tangible net assets held by these entities. Financial leverage, the ratio of the Group's external senior and subordinated debt to EEV capital and reserves was 17% (2006: 20%). Fixed charge cover, which measures the extent to which external interest costs, including subordinated debt interest and preference dividend, are covered by EEV operating profit was 9.8 times (2006: 10.3 times). At 31 December 2007 the market value of the Group's external debt, subordinated debt, preference shares, including both the Aviva plc preference shares and the General Accident plc preference shares of Â£250 million, within minority interests, and direct capital instrument was Â£5,774 million (2006: Â£5,991 million), with a weighted average cost of 4.2% (31 December 2006: 3.9%). The Group WACC is 7.0% and has been calculated by reference to the cost of equity and cost of debt at the relevant date. The cost of equity at 31 December 2007 was 7.9%, based on a risk free rate of 4.6%, an equity market premium of 3% and a market beta of 1.1. ------------------------------------------------------------------------------------------------------------------------ Page 73 A Group capital structure (continued) Deployment of equity shareholders' funds In order to better reflect the risk to shareholder funds the presentation of deployment of equity shareholders' funds has been revised at 31 December 2007. To do this we have 'looked through' unitised investments which are classified as 'other' within the IFRS balance sheet and made adjustments for minority holdings that are fully consolidated on the balance sheet. In addition, we have explicitly shown the market risks within the staff pension schemes. Restated 31 December 31 December 2007 2006 ----------------------------------------------------------------------------------------------- Cash, Other Loans & Debt Invest- Other net Equities Property securities ments assets Total Total Total assets included in Â£m Â£m Â£m Â£m Â£m Â£m Â£m the statutory IFRS balance sheet 56,018 16,019 170,904 40,413 36,366 319,720 294,851 Goodwill1* (3,299) (3,299) (3,127) Acquired value of in-force business and intangible assets (3,197) (3,197) (2,728) Liabilities of the long-term, general & other businesses excluding pension fund deficit and debt (49,693) (13,094) (162,303) (35,184) (37,466) (297,740) (274,362) Minorities and other investments reclassification** 259 233 320 (3,681) 2,869 - - ------------------------------------------------------------------------------------------------------------------------ Shareholder funds 6,584 3,158 8,921 1,548 (4,727) 15,484 14,634 Pension fund 5,022 641 3,875 301 (10,017) (178) (973) ------------------------------------------------------------------------------------------------------------------------ Adjusted shareholder funds 11,606 3,799 12,796 1,849 (14,744) 15,306 13,661 Goodwill* 3,299 3,127 Additional and acquired value of in-force business and intangible assets*** 11,179 9,522 ------------------------------------------------------------------------------------------------------------------------ Assets backing total capital employed in continuing operations 29, 784 26,310 ----------------------------------------------------------------------------------------------------------------------- Notes: * Includes goodwill relating to the joint venture with the Royal Bank of Scotland Group. ** Minority and other investments reclassification represents the reallocation of unit trusts to their constituent parts net of net asset value attributable to unitholders. *** Net internal debt represents the upstream of internal loans from business operations to corporate and holding entities net of tangible assets held by those entities. ------------------------------------------------------------------------------------------------------------------------ Page 74 A Group capital structure (continued) Sensitivity analysis The sensitivity of the Group's shareholders' funds on an EEV basis at 31 December 2007 to a 10% fall in global equity markets or a rise of 1% in global interest rates is as follows: 2006 Equities Interest rates Â£bn 2007 down 10% up 1% Â£bn Â£bn Â£bn 20.1 Long-term savings* 23.3 22.3 22.4 6.2 General insurance and other 6.5 6.1 6.1 (5.4) Borrowings** (5.2) (5.2) (5.2) ------------------------------------------------------------------------------------------------------------------------ 20.9 Shareholders' funds 24.6 23.2 23.3 ======================================================================================================================== These sensitivities assume a full tax charge/credit on market value assumptions. * Assumes EEV assumptions adjusted to reflect revised bond yields. ** Comprising internal, external and subordinated debt, net of corporate tangible net assets. The table above incorporates the effect on the value of the pension scheme assets of a 10% decrease in equity and a 1% increase in fixed income bond yields. The latter sensitivity also assumes an equivalent movement in both inflation and discount rate (i.e. no change to real interest rates) and therefore, incorporates the offsetting effects of these items on the pension scheme liabilities. A 1% increase in the real interest rate only has the effect of reducing the pension scheme liability by Â£1.4 billion thereby enhancing shareholders' funds by Â£1 billion (after deducting tax). Risk management - Equity hedges The following table shows the material equity derivatives currently within the Group's shareholder funds that are used as part of a long-term strategy to manage equity risk. It excludes derivatives used for portfolio management purposes: Market fall Notional required before Outstanding Derivative Â£bn* protection starts** Duration (a) 0.7 10% 9 months (b) 0.4 2% 3-15 months Notes: * The notional amount represents the market value as at 31 December 2007 of the equities covered by the hedge. ** The 'market fall before protection starts' shows the percentage the market could fall from the 31 December 2007 positions before the derivative moves into the money. *** We use different methods to reduce the cost of derivatives. We have limited the downside protection on derivative (a) and we have created a zero cost collar by selling some of the upside on derivative (b). ------------------------------------------------------------------------------------------------------------------------ Page 75 A Group capital structure (continued) Shareholders' funds, including minority interests. 31 December 2007 31 December 2006 Closing shareholders' funds Closing shareholders'funds ------------------------------------ -------------------------------- Internally Internally IFRS net generated Total IFRS net generated Total assets AVIF equity assets AVIF equity Note Â£m Â£m Â£m Â£m Â£m Â£m Life assurance *,** United Kingdom 4,428 3,680 8,108 3,757 3,403 7,160 France 1,447 1,214 2,661 1,221 1,070 2,291 Ireland 943 195 1,138 971 48 1,019 Italy 1,020 204 1,224 688 115 803 Netherlands (including Belgium and Germany) 2,994 1,152 4,146 2,860 977 3,837 Poland 276 671 947 202 517 719 Spain 1,122 630 1,752 845 530 1,375 Other Europe 346 (90) 256 61 45 106 Europe 8,148 3,976 12,124 6,848 3,302 10,150 North America ^^ 2,202 154 2,356 2,315 (27) 2,288 Asia Pacific 512 172 684 380 116 496 ----------------------------------------------------------------------------------------------------------------------- 15,290 7,982 23,272 13,300 6,794 20,094 ----------------------------------------------------------------------------------------------------------------------- General insurance and health *,** United Kingdom 2,960 - 2,960 2,887 - 2,887 France 301 - 301 333 - 333 Ireland 423 - 423 423 - 423 Netherlands 756 - 756 684 - 684 Other Europe 295 - 295 161 - 161 Europe 1,775 - 1,775 1,601 - 1,601 North America 726 - 726 666 - 666 Asia Pacific 26 - 26 22 - 22 ------------------------------------------------------------------------------------------------------------------------ 5,487 - 5,487 5,176 - 5,176 ----------------------------------------------------------------------------------------------------------------------- Other business *,** 1,056 - 1,056 1,059 - 1,059 Corporate (31) - (31) (19) - (19) External debt (1,257) - (1,257) (1,258) - (1,258) Internal debt (899) - (899) (1,257) - (1,257) Subordinated debt (3,054) - (3,054) (2,937) - (2,937) ------------------------------------------------------------------------------------------------------------------------ (4,185) - (4,185) (4,412) - (4,412) ------------------------------------------------------------------------------------------------------------------------ Shareholders'funds,including minority interests 16,592 7,982 24,574 14,064 6,794 20,858 ======================================================================================================================== Comprising: Equities 11,741 - 11,741 14,343 - 14,343 Property 4,644 - 4,644 3,263 - 3,263 Cash, loans and debt securities 11,986 - 11,986 7,102 - 7,102 Other investments 1,865 - 1,865 1,446 - 1,446 Other net assets and pension liability (14,930) - (14,930) (12,493) - (12,493) Intangible assets *** 6,496 7,982 14,478 5,855 6,794 12,649 Borrowings (5,210) - (5,210) (5,452) - (5,452) ------------------------------------------------------------------------------------------------------------------------ Shareholders'funds, including minority interests 16,592 7,982 24,574 14,064 6,794 20,858 ======================================================================================================================= Notes IFRS net assets shown above include the allocation of tax assets and liabilities and hence differ from segmental net assets disclosed on pages 67 and 68. * Goodwill of Â£3,299 million (31 December 2006: Â£3,127 million) has been allocated as follows: life assurance Â£1,631 million (31 December 2006: Â£1,533 million); general insurance and health Â£418 million (31 December 2006: Â£390 million); other businesses Â£1,250 million (31 December 2006: Â£1,204 million). ** Intangibles of Â£1,191 million (31 December 2006: Â£638 million) have been allocated as follows: life assurance Â£622 million (31 December 2006: Â£211 million); general insurance and health Â£424 million (31 December 2006: Â£287 million); other businesses Â£145 million (31 December 2006: Â£140 million). ------------------------------------------------------------------------------------------------------------------------ Page 76 A Group capital structure (continued) Notes (continued) *** Total intangible assets of Â£14,478 million (31 December 2006: Â£12,649 million) comprise goodwill of Â£3,299 million (31 December 2006: Â£3,127 million); acquired value of in-force long-term business and intangibles of Â£3,197 million (31 December 2006: Â£2,728 million) and additional value of in-force long-term business of Â£7,982 million (31 December 2006: Â£6,794 million). The associated deferred tax liability on the intangibles of Â£811 million (31 December 2006: Â£738 million) is included within other net assets. ^ The post-tax pension fund deficit of Â£722 million (31 December 2006: Â£673 million) has been allocated as follows: life operations Â£(2) million (31 December 2006: Â£179 million), general insurance and health: Â£(23) million (31 December 2006: Â£458 million), other business Â£747 million (31 December 2006: Â£17 million) and corporate of Â£nil (31 December 2006: Â£19 million). ^^ AVIF was negative for the US life business in 2006 due to the embedded value being below its balance sheet value on an IFRS basis. This is due to the cost of locked-in required capital under EEV which is not recognised under IFRS. Analysis of return on capital employed For the year ended 31 December 2007 Restated Opening Shareholders' Annualised funds including Return on Operating return (Note 1) minority interests Capital ----------------------------- ----------------------------------- Before tax After tax Note Â£m Â£m Â£m % Life assurance United Kingdom 864 605 7,160 8.4% France 537 351 2,291 15.3% Ireland 77 67 1,019 6.6% Italy 137 85 803 10.6% Netherlands(including Belgium and Germany) 352 261 3,837 6.8% Poland 206 167 719 23.2% Spain 239 167 1,375 12.1% Other Europe (5) - 106 - Europe 1,543 1,098 10,150 10.8% North America 255 165 2,288 7.2% Asia Pacific 91 68 496 13.7% ----------------------------------------------------------------------------------------------------------------------- 2,753 1,936 20,094 9.6% ------------------------------------------------------------------------------------------------------------------------ General insurance and health United Kingdom 306 214 2,887 7.4% France 70 45 333 13.5% Ireland 162 142 423 33.6% Netherlands 169 123 684 18.0% Other Europe 41 29 161 18.0% Europe 442 339 1,601 21.2% North America 154 100 666 15.0% Asia Pacific 4 3 22 13.6% ----------------------------------------------------------------------------------------------------------------------- 906 656 5,176 12.7% ----------------------------------------------------------------------------------------------------------------------- Fund management 90 63 305 20.7% Other business (70) (49) 754 (6.5)% Corporate (82) (95) (19) 500.0% External debt (79) (55) (1,258) 4.4% Net internal debt ** (53) (37) (1,257) 2.9% Subordinated debt (179) (125) (2,937) 4.3% ----------------------------------------------------------------------------------------------------------------------- 3,286 2,294 20,858 11.0% Less: Minority interests (259) (2,137) 12.1% Direct capital instrument (37) (990) 3.7% Preference capital (17) (200) 8.5% ------------------------------------------------------------------------------------------------------------------------ Return on equity shareholders'funds 1,981 17,531 11.3% ======================================================================================================================= Notes * The operating return is based upon Group EEV operating profit, which is stated before impairment of goodwill, amortisation of intangibles, exceptional items and tax including policyholder tax, adjusted for the short-term fluctuation in investment return. ** The net internal debt return before tax of (Â£53) million comprises investment return of Â£127 million and Group internal debt costs and other interest of (Â£180) million. ------------------------------------------------------------------------------------------------------------------------ Page 77 A Group capital structure (continued) Analysis of return on capital employed (continued) For the year ended 31 December 2006 Opening shareholders' funds including Operating return (Note*) minority interests Return on Capital ----------------------------------- ------------------------------------------- Before tax After tax Note Â£m Â£m Â£m % Life assurance United Kingdom 744 521 6,524 8.0% France 402 264 2,067 12.8% Ireland (40) (35) 482 (7.3)% Italy 110 68 727 9.3% Netherlands(including Belgium and Germany) 329 235 3,055 7.7% Poland 162 132 658 20.0% Spain 221 143 1,228 11.6% Other Europe (13) (10) 95 (10.5)% Europe 1,171 797 8,312 9.6% North America 32 21 332 6.3% Asia Pacific 86 64 430 14.9% ------------------------------------------------------------------------------------------------------------------------ 2,033 1,403 15,598 9.0% ------------------------------------------------------------------------------------------------------------------------ General insurance and health United Kingdom 957 670 2,907 23.0% France 63 41 362 11.3% Ireland 172 150 545 27.5% Netherlands 139 98 553 17.7% Other Europe 54 38 167 22.8% Europe 428 327 1,627 20.1% North America 148 96 848 11.3% Asia Pacific 4 3 17 17.6% ----------------------------------------------------------------------------------------------------------------------- 1,537 1,096 5,399 20.3% ----------------------------------------------------------------------------------------------------------------------- Other business 65 45 1,876 2.4% Corporate (83) (112) (36) 311.1% External debt (61) (43) (1,002) 4.3% Net internal debt ** (77) (54) (1,481) 3.6% Subordinated debt (169) (118) (2,808) 4.2% ----------------------------------------------------------------------------------------------------------------------- 3,245 2,217 17,546 12.6% Less: Minority interests (208) (1,457) 14.3% Direct capital instrument (37) (990) 3.7% Preference capital (17) (200) 8.5% ----------------------------------------------------------------------------------------------------------------------- Return on equity shareholders' funds 1,955 14,899 13.1% ====================================================================================================================== Notes * The operating return is based upon Group operating profit, which is stated before impairment of goodwill and exceptional items including policyholder tax, adjusted for the short-term fluctuation in investment return. ** The net internal debt return before tax of Â£(77) million comprises investment return of Â£151 million and Group internal debt costs and other interest of Â£(228) million. ------------------------------------------------------------------------------------------------------------------------ Page 78 Group Capital Resources Since 1 January 2005 insurance groups have been required to report the capital adequacy to the FSA. UK insurers are required to disclose in respect of its ultimate insurance parent undertaking the Group Capital Resources (GCR), the Capital Resources Requirement (CRR) and the resulting surplus or deficit. From 31 December 2006 the Prudential sourcebook for insurers INSPRU 6.1.15R requires UK insurers to meet this requirement at the ultimate EEA insurance parent level. The statement for 2007 is given in the table below. This information represents the group solvency surplus calculated in accordance with the INSPRU 6.1. 31 December 2007 ------------------------------------------------------------------------------ UK Life Funds Other businesses Group Total Â£bn Â£bn Â£bn Group Capital Resources 7.7 8.7 16.4 Less: Capital Resources Requirement (7.7) (5.6) (13.3) ------------------------------------------------------------------------------------------------------------------------ IGD Group surplus - 3.1 3.1 ======================================================================================================================== The sensitivity of the Group's IGD surplus at 31 December 2007 to a 10% fall in global equity markets or a rise of 1% in global interest rates is as follows ----------------------------------------------------------------------------------------------------------------------- Equities Interest rates 2007 down 10% up 1% Â£bn Â£bn Â£bn ======================================================================================================================== IGD Group surplus 3.1 2.6 2.5 ======================================================================================================================== The sensitivity to equity market falls has been reduced during the year due to the sale of Â£2.6bn equities within the general insurance operations. This reduced the sensitivity by Â£0.2 billion after tax. This was partly offset by strengthening of the euro which increased the Group's sensitivity by Â£0.1 billion. Most of the IGD equity exposure is in Delta Lloyd, however we have in place a number of hedging instruments which would protect the Group's IGD solvency position against more severe equity shock. The overall IGD sensitivity to a 10% fall in equity market (excluding Delta Lloyd) is Â£0.2 billion. In 2006, the FSA further extended the requirement to reconcile Group capital resources on regulatory basis to the Group's capital resources on a statutory reporting basis. In addition, this reconciliation provides further analysis of differences between the Group capital resources and the amounts included in the capital statement made in accordance with FRS 27 and disclosed in the Group consolidated accounts. This reconciliation is given in the second table below. We continue to monitor amd actively manage our IGD equity exposure through a combination of assessing the appropriate levels of equity exposures as well as hedging transactions. The Group Capital Adequacy Report is prepared in accordance with the FSA's valuation rules (Peak 1) and brings in capital in respect of the UK life funds equal to the UK Life Capital Resources Requirement. The FRS 27 disclosure brings in the realistic value of with-profit capital resources (Peak 2). As the two bases differ, the reconciliation below is presented by removing the restricted regulatory assets and then replacing them with the unrestricted realistic assets. 31 December 2007 Â£bn Total capital and reserves (IFRS basis) 16.6 Plus: Other qualifying capital 3.4 Plus: UK unallocated divisible surplus 5.0 Less: Goodwill, acquired AVIF and intangible assets (6.3) Less: Adjustments onto a regulatory basis (2.3) ----------------------------------------------------------------------------------------------------------------------- Group Capital Resources on regulatory basis 16.4 ======================================================================================================================= The Group Capital Resources can be analysed as follows: Core Tier 1 Capital 13.6 Tier 1 waiver (implicit items) 0.2 Innovative Tier 1 Capital 1.0 ----------------------------------------------------------------------------------------------------------------------- Total Tier 1 Capital 14.8 Upper Tier 2 Capital 1.7 Lower Tier 2 Capital 2.0 Group Capital Resources Deductions (2.1) ----------------------------------------------------------------------------------------------------------------------- Group Capital Resources on regulatory basis (Tier 1 & Tier 2 Capital) 16.4 Less: UK life restricted regulatory assets (8.3) Add: UK life unrestricted realistic assets 6.9 Add: Overseas UDS - restricted asset 1.8 ----------------------------------------------------------------------------------------------------------------------- Total FRS 27 capital 16.8 ======================================================================================================================= ------------------------------------------------------------------------------------------------------------------------ Page 79 Appendix A2 FRS 27 disclosures Page Capital statement Available capital resources 80 Analysis of liabilities 80 Analysis of movements in capital of long-term businesses 81 Financial guarantees and options a) UK Life with-profits business 83 b) UK Life non-profits business 84 c) Overseas life business i) France ii) Netherlands 84 iii) Ireland 84 iv) Spain and Italy 85 v) United States 85 85 ----------------------------------------------------------------------------------------------------------------------- Page 80 A2 FRS 27 disclosures Capital statement FRS 27 requires us to produce a capital statement which sets out the financial strength of our Group entities and provides an analysis of the disposition and constraints over the availability of capital to meet risks and regulatory requirements. The capital statement also provides a reconciliation of shareholders' funds to regulatory capital. The analysis below sets out the Group's available capital resources. Available capital resources 2007 2006 ------------------------------------------------------------------------------------------ -------- Total Total Over- CGNU CULAC NUL&P UK life Other UK seas Total with- with- with- with- UK life life life life Other profit profit profit profit operat- operat- operat- operat- operat- fund fund fund*** funds ions ions ions ions ions^ Total Total Â£m Â£m Â£m Â£m Â£m Â£m Â£m Â£m Â£m Â£m Â£m Total share- holders' funds 43 42 41 126 4,412 4,538 10,751 15,289 1,303 16,592 14,064 Total other sources of capital* - - - - 200 200 49 249 2,981 3,230 3,090 Unallocated divisible surplus 1,515 1,222 2,184 4,921 41 4,962 1,823 6,785 - 6,785 9,465 Adjustments onto a regulatory basis: Shareholders' share of accrued bonus (331) (333) (528) (1,192) - (1,192) - (1,192) - (1,192) (730) Goodwill, acquired value of in- force long- term business and intangibles - - - - (400) (400) (4,029) (4,429) (2,385) (6,814) (5,638) Regulatory valu- ation and admissibility restrictions** 206 275 124 605 (1,742) (1,137) 72 (1,065) (731) (1,796) (746) ------------------------------------------------------------------------------------------------------------------------ Total available capital 1,433 1,206 1,821 4,460 2,511 6,971 8,666 15,637 1,168 16,805 19,505 ======================================================================================================================= Analysis of liabilities: Participating insurance liabilities 10,689 9,895 16,876 37,460 2,148 39,608 26,485 66,093 - 66,093 63,705 Unit-linked liabilities - - - - 5,291 5,291 15,310 20,601 - 20,601 21,004 Other non- participat- ing life insurance 1,218 1,851 341 3,410 15,751 19,161 29,159 48,320 - 48,320 41,515 ----------------------------------------------------------------------------------------------------------------------- Total insur- ance liabil- ities 11,907 11,746 17,217 40,870 23,190 64,060 70,954 135,014 - 135,014 126,224 Participating investment liabilities 2,055 2,534 7,524 12,113 2,782 14,895 38,714 53,609 - 53,609 49,400 Non-partici- pating invest- ment liabili ities 55 18 2 75 26,056 26,131 18,504 44,635 - 44,635 38,958 ----------------------------------------------------------------------------------------------------------------------- Total invest- ment liabil- ities 2,110 2,552 7,526 12,188 28,838 41,026 57,218 98,244 - 98,244 88,358 ----------------------------------------------------------------------------------------------------------------------- Total liabilities 14,017 14,298 24,743 53,058 52,028 105,086 128,172 233,258 - 233,258 214,582 ======================================================================================================================= * Other sources of capital include subordinated debt of Â£3,054 million issued by Aviva and Â£176 million of other qualifying capital issued by Dutch, Italian, Spanish and US subsidiary undertakings ** Including an adjustment for minorities. *** Includes the Provident Mutual with-profit fund ^ Other operations include general insurance and fund management business ^^ Goodwill and other intangibles includes goodwill of Â£535m and JVs and associates. ^^^ On 5 February 2008 Norwich Union Life announced a one-off special bonus worth an estimated Â£2.3 billion. In accordance with FRS 27, a transfer of Â£2.1 billion has been made from the unallocated divisible surplus to increase insurance and participating investment contract liabilities. Â£0.2 billion of shareholder's share of the special bonus is included within the shareholders' share of the accrued bonus line. ------------------------------------------------------------------------------------------------------------------------ Page 81 A2 FRS 27 disclosures (continued) Analysis of movements in capital of long-term businesses For the year ended 31 December 2007 Total CGNU CULAC NUL&P UK life with- with- with- with- Other Total Overseas profit profit profit profit UK life UK life life Total life fund fund fund funds operations operations operations operations Â£m Â£m Â£m Â£m Â£m Â£m Â£m Â£m Available capital resources at 1 January 2,548 2,479 1,823 6,850 1,913 8,763 9,290 18,053 Effect of new business (54) (38) - (92) (162) (254) (325) (579) Expected change in available capital resources 208 246 169 623 153 776 492 1,268 Variance between actual and expected experience (125) (187) (201) (513) 114 (399) (598) (997) Effect of operating assumption changes (42) (57) 6 (93) (32) (125) (2) (127) Effect of economic assumption changes (165) (163) (67) (395) (13) (408) (7) (415) Effect of changes in management policy (1,195) (1,207) (19) (2,421) - (2,421) (1) (2,422) Effect of changes in regulatory requirements - - - - - - (337) (337) Transfers, acquisitions and disposals - - - - 21 21 44 65 Foreign exchange movements - - - - - - 682 682 Other movements 258 133 110 501 517 1,018 (572) 446 ----------------------------------------------------------------------------------------------------------------------- Available capital resources at 31 December 1,433 1,206 1,821 4,460 2,511 6,971 8,666 15,637 ======================================================================================================================= Further analysis of the movement in the liabilities of the long-term business can be found on notes 88 and 89. The analysis of movements in capital provides an explanation of the movement in available capital of the Group's life business for the year. This analysis is intended to give an understanding of the underlying causes of the changes in the available capital of the Group's life business, and provides a distinction between some of the key factors affecting the available capital. For the UK with-profit funds, the decrease in available capital is driven by a special bonus of Â£2.4 billion announced on 5 February 2008, which is treated as a transfer from unallocated divisible surplus to policy liabilities. Equity performance was moderate, which had a direct effect on the equity content of the estate assets. In addition, the implied market volatility for equities has increased, which raises the assumed asset share volatility and consequently guarantee costs have increased. The positive other movements relate mainly to methodology and modelling changes. The changes in management policy shown in CGNU and CULAC with-profit funds relate to the special bonus announced on 5 February 2008. For the Overseas life operations, the negative variance between the actual and expected experience is driven mainly by the increase in market interest rates, which has led to a capital depreciation of fixed interest assets and consequential reduction of the unallocated divisible surplus in France and other European businesses. ------------------------------------------------------------------------------------------------------------------------ Page 82 A2 FRS 27 disclosures (continued) In aggregate, the Group has at its disposal total available capital of Â£16.8 billion (2006: Â£19.5 billion), representing the aggregation of the solvency capital of all of our businesses. This capital is available to meet risks and regulatory requirements set by reference to local guidance and EU directives. After effecting the year end transfer to shareholders, the UK with-profit funds' available capital of Â£4.5 billion (2006: Â£6.9 billion) can only be used to provide support for UK with-profits business and is not available to cover other shareholder risks. This is comfortably in excess of the required capital margin and, therefore, the shareholders are not required to provide further capital support to this business. For the remaining life and general insurance operations, the total available capital amounting to Â£12.3 billion (2006: Â£12.6 billion) is significantly higher than the minimum requirements established by regulators and, in principle, the excess is available to shareholders. In practice, management will hold higher levels of capital within each business operation to provide appropriate cover for risk. As the total available capital of Â£16.8 billion is arrived at on the basis of local regulatory guidance, which evaluates assets and liabilities prudently, it understates the economic capital of the business which is considerably higher. This is a limitation of the Group Capital Statement which, to be more meaningful, needs to evaluate available capital on an economic basis and compare it with the risk capital required for each individual operation, after allowing for the considerable diversification benefits that exist in our Group. Within the Aviva group there exists intra-group arrangements to provide capital to particular business units. Included in these arrangements is a subordinated loan of Â£200 million from Aviva plc to the NUL&P non-profit fund to provide capital to support the writing of new business. The available capital of the Group's with-profit funds is determined in accordance with the 'Realistic balance sheet' regime prescribed by the FSA's regulations, under which liabilities to policyholders include both declared bonuses and the constructive obligation for future bonuses not yet declared. The available capital resources include an estimate of the value of their respective estates, included as part of the unallocated divisible surplus. The estate represents the surplus in the fund that is in excess of any constructive obligation to policyholders. It represents capital resources of the individual with-profit fund to which it relates and is available to meet regulatory and other solvency requirements of the fund and, in certain circumstances, additional liabilities may arise. The liabilities included in the balance sheet for the with-profit funds do not include the amount representing the shareholders' portion of future bonuses. However, the shareholders' portion is treated as a deduction from capital that is available to meet regulatory requirements and is therefore shown as a separate adjustment in the capital statement. In accordance with the FSA's regulatory rules under its realistic capital regime, the Group is required to hold sufficient capital in its UK life with-profit funds to meet the FSA capital requirements, based on the risk capital margin (RCM). The determination of the RCM depends on various actuarial and other assumptions about potential changes in market prices, and the actions management would take in the event of particular adverse changes in market conditions. The table below provides the information on the UK with-profits funds on a realistic basis. 31 December 2007 31 December 2006 ---------------------------------------------------------------------- ------------------ Estimated Estimated Estimated Realistic risk Realistic Realistic inherited capital Estimated assets liabilities* estate** margin*** Excess Excess Â£bn Â£bn Â£bn Â£bn Â£bn Â£bn CGNU Life 14.5 (13.1) 1.4 (0.3) 1.1 2.0 CULAC 13.9 (12.7) 1.2 (0.4) 0.8 2.0 NUL&P^ 26.1 (24.2) 1.9 (0.6) 1.3 1.2 ------------------------------------------------------------------------------------------------------------------------ Aggregate 54.5 (50.0) 4.5 (1.3) 3.2 5.2 ======================================================================================================================= These realistic liabilities include the shareholders' share of future bonuses of Â£1.2 billion (31 December 2006: Â£0.7 billion). Realistic liabilities adjusted to eliminate the shareholders' share of future bonuses are Â£48.8 billion (31 December 2006: Â£48.6 billion). * These realistic liabilities make provision for guarantees, options and promises on a market consistent stochastic basis. The value of the provision included within realistic liabilities is Â£0.7 billion, Â£0.8 billion and Â£3.0 billion for CGNU Life, CULAC and NUL&P, respectively (31 December 2006: Â£0.5 billion, Â£0.7 billion and Â£3.0 billion for CGNU Life, CULAC and NUL&P respectively). ** Estimated realistic inherited estate at 31 December 2006 was Â£2.5 billion, Â£2.5 billion and Â£1.8 billion for CGNU Life, CULAC and NUL&P respectively *** The risk capital margin (RCM) is 3.5 times covered by the inherited estate (31 December 2006: 4.2 times). ^ The NUL&P fund includes the Provident Mutual (PM) fund, which has realistic assets and liabilities of Â£2.1 billion and therefore does not impact the realistic inherited estate. ----------------------------------------------------------------------------------------------------------------------- Page 83 A2 FRS 27 disclosures (continued) Under the FSA regulatory regime, UK with-profit funds is required to hold capital equivalent to the greater of their regulatory requirement based on EU Directive ('regulatory peak') and the FSA realistic basis ('realistic peak') described above. For UK non-participating business, the relevant capital requirement is the minimum solvency requirement determined in accordance with FSA regulations. The available capital reflects the excess of regulatory basis assets over liabilities before deduction of capital resources requirement. For UK general insurance businesses, the relevant capital requirement is the minimum solvency requirement determined in accordance with the FSA requirements. For overseas business in the EEA, US, Canada, Australia, Hong Kong and Singapore, the available capital and the minimum capital requirement are calculated under the locally applicable regulatory regimes. The businesses outside these territories are subject to the FSA rules for the purposes of calculation of available capital and capital resource requirement. For fund management and other businesses, the relevant capital requirement is the minimum solvency requirement determined in accordance with the local regulator's requirements for the specific class of business. All businesses hold sufficient available capital to meet their minimum capital requirement. The available capital resources in each regulated entity are generally subject to restrictions as to their availability to meet requirements that may arise elsewhere in the Group. The principal restrictions are: (i) UK with-profit funds (CGNU Life, CULAC and NUL&P) - any available surplus held in each fund can only be used to meet the requirements of the fund itself or be distributed to policyholders and shareholders. With-profit policyholders are entitled to at least 90% of the distributed profits while the shareholders receive the balance. The latter distribution would be subject to a tax charge, which is met by the fund in the case of CGNU Life, CULAC and NUL&P. (ii) UK non-participating funds - any available surplus held in these is attributable to shareholders. Capital within the non-profit funds may be made available to meet requirements elsewhere in the Group subject to meeting the regulatory requirements of the fund. Any transfer of the surplus may give rise to a tax charge subject to availability of tax relief elsewhere in the Group. (iii) Overseas life operations - the capital requirements and corresponding regulatory capital held by overseas businesses are calculated using the locally applicable regulatory regime. The available capital resources in all these businesses are subject to local regulatory restrictions which may constrain management's ability to utilise these in other parts of the Group. Any transfer of available capital may give rise to a tax charge subject to availability of tax relief elsewhere in the Group. (iv) General insurance operations - the capital requirements and corresponding regulatory capital held by overseas businesses are calculated using the locally applicable regulatory regime. The available capital resources in all these businesses are subject to local regulatory restrictions which may constrain management's ability to utilise these in other parts of the Group. Any transfer of available capital may give rise to a tax charge, subject to availability of tax relief elsewhere in the Group. Financial guarantees and options As a normal part of their operating activities, various Group companies have given guarantees and options, including investment return guarantees, in respect of certain long-term insurance and fund management products. (a) UK Life with-profit business In the UK, life insurers are required to comply with the FSA's realistic reporting regime for their with-profit funds for the calculation of FSA liabilities. Under the FSA's rules, provision for guarantees and options within realistic liabilities must be measured at fair value, using market-consistent stochastic models. A stochastic approach includes measuring the time value of guarantees and options, which represents the additional cost arising from uncertainty surrounding future economic conditions. The material guarantees and options to which this provision relates are: (i) Maturity value guarantees - Substantially all of the conventional with-profit business and a significant proportion of unitised with-profit business have minimum maturity values reflecting the sums assured plus declared annual bonus. In addition, the guarantee fund has offered maturity value guarantees on certain unit- linked products. (ii) No market valuation reduction (MVR) guarantees - For unitised business, there are a number of circumstances where a 'no MVR' guarantee is applied, for example on certain policy anniversaries, guaranteeing that no market value reduction will be applied to reflect the difference between the accumulated value of units and the market value of the underlying assets. (iii) Guaranteed annuity options - The Group's UK with-profit funds have written individual and group pensions which contain guaranteed annuity rate options (GAOs), where the policyholder has the option to take the benefits from a policy in the form of an annuity based on guaranteed conversion rates. The Group also has exposure to GAOs and similar options on deferred annuities. (iv) Guaranteed minimum pension - The Group's UK with-profit funds also have certain policies that contain a guaranteed minimum level of pensions as part of the condition of the original transfer from state benefits to the policy. In addition, while these do not constitute guarantees, the with-profit fund companies have made promises to certain policyholders in relation to their with-profit mortgage endowments. Subject to certain conditions, top-up payments will be made on these policies at maturity to meet the mortgage value up to a maximum of the 31 December 1999 illustrated shortfall. ------------------------------------------------------------------------------------------------------------------------ Page 84 A2 FRS 27 disclosures (continued) (b) UK Life non-profit business The Group's UK non-profit funds are evaluated by reference to local statutory reserving rules, including changes introduced in 2006 under the FSA Policy Statement 06/14 Prudential Changes for insurers. (i) Guaranteed annuity options - Similar options to those written in the with-profit fund have been written in relation to non-profit products. Provision for these guarantees does not materially differ from a provision based on a market-consistent stochastic model, and amounts to Â£36 million at 31 December 2007 (2006: Â£39 million). (ii) Guaranteed unit price on certain products - Certain unit-linked pension products linked to long-term life insurance funds provide policyholders with guaranteed benefits at retirement or death. No additional provision is made for this guarantee as the investment management strategy for these funds is designed to ensure that the guarantee can be met from the fund, mitigating the impact of large falls in investment values and interest rates. (c) Overseas life businesses In addition to guarantees written in the Group's UK life businesses, our overseas businesses have also written contracts containing guarantees and options. Details of the significant guarantees and options provided by overseas life businesses are set out below. (i) France Guaranteed surrender value and guaranteed minimum bonuses Aviva France has written a number of contracts with such guarantees. The guaranteed surrender value is the accumulated value of the contract including accrued bonuses. Bonuses are based on accounting income from amortised bond portfolios, where the duration of bond portfolios is set in relation to the expected duration of the policies, plus income and releases from realised gains on equity-type investments. Policy reserves are equal to guaranteed surrender values. Local statutory accounting envisages the establishment of a reserve, 'Provision pour Aleas Financiers' (PAF), when accounting income is less than 125% of guaranteed minimum credited returns. No PAF was established at the end of 2007. The most significant of these contracts is the AFER Euro fund which has total liabilities of Â£24 billion at 31 December 2007 (2006: Â£21 billion). The guaranteed bonus on this contract equals 75% of the average of the last two years' declared bonus rates and was 3.64% for 2007 (2006: 3.30%) compared with an accounting income from the fund of 4.92% (2006: 4.81%). Non-AFER contracts with guaranteed surrender values had liabilities of Â£8 billion (2006: Â£6 billion) at 31 December 2007 and all guaranteed annual bonus rates are between 0% and 4.5%. For non-AFER business, the accounting income return exceeded guaranteed bonus rates in 2007. Guaranteed death and maturity benefits In France, the Group has also sold unit-linked policies where the death and/or maturity benefit is guaranteed to be at least equal to the premiums paid. The reserve held in the Group's consolidated balance sheet at the end of 2007 for this guarantee is Â£30 million (2006: Â£8 million). The reserve is calculated on a prudent basis and is in excess of the economic liability. At the end of 2007, total sums at risk for these contracts were Â£63 million (2006: Â£38 million) out of total unit-linked funds of Â£15 billion (2006: Â£13 billion). The average age of policyholders was approximately 53. It is estimated that this liability would increase by Â£17 million (2006: Â£3 million) if yields were to decrease by 1% per annum and by Â£7 million (2006: Â£2 million) if equity markets were to decline by 10% from year end 2007 levels. These figures do not reflect our ability to review the tariff for this option. (ii) Netherlands Guaranteed minimum return at maturity In the Netherlands, it is market practice to guarantee a minimum return at maturity on traditional savings and pension contracts. Guarantees on older lines of business are 4% per annum while, for business written since 1 September 1999, the guarantee is 3% per annum. On group pensions business, it is often possible to recapture guarantee costs through adjustments to surrender values or to premium rates. On transition to IFRS, Delta Lloyd changed the reserving basis for most traditional contracts to reflect current market interest rates, for consistency with the reporting of assets at market value. The cost of meeting interest rate guarantees is allowed for directly in the liabilities. Although most traditional contracts are valued at market interest rate, the split by level of guarantee shown below is according to the original underlying guarantee. The total liabilities for traditional business at 31 December 2007 are Â£10 billion (2006: Â£8 billion) analysed as follows: Liabilities Liabilities Liabilities Liabilities 3% guarantee 3% guarantee 4% guarantee 4% guarantee 31 December 2007 31 December 2006 31 December 2007 31 December 2006 Â£m Â£m Â£m Â£m Individual 1,387 1,222 3,671 2,989 Group pensions 485 518 3,993 3,180 ----------------------------------------------------------------------------------------------------------------------- Total 1,872 1,740 7,664 6,169 ======================================================================================================================= ----------------------------------------------------------------------------------------------------------------------- Page 85 A2 FRS 27 disclosures (continued) Delta Lloyd has certain unit-linked contracts which provide a guaranteed minimum return at maturity from 4% per annum to 2% per annum. Provisions consist of unit values plus an additional reserve for the guarantee. The additional provision for the guarantee was Â£70 million (2006: Â£76 million). An additional provision of Â£19 million (2006: Â£43 million) in respect of investment return guarantees on group segregated fund business is held. It is estimated that the provision would increase by Â£211 million (2006: Â£163 million) if yields were to reduce by 1% per annum and by Â£21 million (2006: Â£25 million) if equity markets were to decline by 10% from year end 2007 levels. (iii) Ireland Guaranteed annuity options Products with similar GAOs to those offered in the UK have been issued in Ireland. The current net of reinsurance provision for such options is Â£160 million (2006: Â£152 million). This has been calculated on a deterministic basis, making conservative assumptions for the factors which influence the cost of the guarantee, principally annuitant mortality, option take-up and long-term interest rates. These GAOs are 'in the money' at current interest rates but the exposure to interest rates under these contracts has been hedged through the use of reinsurance, using derivatives (swaptions). The swaptions effectively guarantee that an interest rate of 5% will be available at the vesting date of these benefits so there is reduced exposure to a further decrease in interest rates. 'No MVR' guarantees Certain unitised with-profit policies containing 'no MVR' guarantees, similar to those in the UK, have been sold in Ireland. These guarantees are currently 'out-of-the-money' by Â£53 million (2006: Â£69 million). This has been calculated on a deterministic basis as the excess of the current policy surrender value over the discounted value (excluding terminal bonus) of the guarantees. The value of these guarantees is sensitive to the performance of investments held in the with-profit fund. Amounts payable under these guarantees are determined by the bonuses declared on these policies. It is estimated that the guarantees would be out-of-the-money by Â£46 million (2006: Â£74 million) if yields were to increase by 1% per annum and by Â£29 million (2006: Â£31 million) if equity markets were to decline by 10% from year end 2007 levels. Return of premium guarantee Hibernian Life has written two tranches of linked bonds with a return of premium guarantee after five or six years. The provision for these at the end of 2007 is Â£0.1 million (2006: Â£nil). In addition, it is estimated that the provision would increase if equity markets were to decline by 10% from year end 2007 levels by Â£1.4 million. It is estimated that the provision would increase if interest rates were to increase by 1% from year end 2007 levels by Â£0.1 million. (iv) Spain and Italy Guaranteed investment returns and guaranteed surrender values The Group has written contracts containing guaranteed investment returns and guaranteed surrender values in both Spain and Italy. Traditional profit-sharing products receive an appropriate share of the investment return, assessed on a book value basis, subject to a guaranteed minimum annual return of up to 6% in Spain and 4% in Italy on existing business, while on new business the maximum guaranteed rate is lower. Liabilities are generally taken as the face value of the contract plus, if required, an explicit provision for guarantees calculated in accordance with local regulations. At 31 December 2007, total liabilities for the Spanish business were Â£4 billion (2006: Â£3 billion) with a further reserve of Â£16 million (2006: Â£18 million) for guarantees. Total liabilities for the Italian business were Â£4 billion (2006: Â£5 billion), with a further provision of Â£48 million (2006: Â£46 million) for guarantees. Liabilities are most sensitive to changes in the level of interest rates. It is estimated that provisions for guarantees would need to increase by Â£66 million (2006: Â£66 million) in Spain and Â£14 million (2006: Â£9 million) in Italy if interest rates fell by 1% from end 2007 values. Under this sensitivity test, the guarantee provision in Spain is calculated conservatively, assuming a long-term market interest rate of 1.42% and no lapses or premium discontinuances. (v) United States Indexed and total return strategy products In the United States, the Group writes indexed life and deferred annuity products. These products guarantee the return of principal to the policyholder and credit interest based on certain indices, primarily the Standard & Poor's 500 Composite Stock Price Index. A portion of each premium is used to purchase call options to hedge the growth in interest credited to the policyholder. The call options held by the Group and the options embedded in the policy are both carried at fair value. At 31 December 2007, the total liabilities for indexed products were Â£8.4 billion (2006: Â£5.4 billion). If interest rates were to increase by 1%, the provision for embedded options would decrease by Â£89 million (2006: Â£51 million) and, if interest rates were to decrease by 1%, the provision would increase by Â£86 million (2006: Â£56 million). The Group has certain products that credit interest based on a total return strategy, whereby policyholders are allowed to allocate their premium payments to different asset classes within the general account. The Group guarantees a minimum return of premium plus approximately 3% interest over the term of the contracts. The linked general account assets are fixed maturity securities, and both the securities and the contract liabilities are carried at fair value. At 31 December 2007, the liabilities for total return strategy products were valued at Â£1.2 billion (2006: Â£1.4 billion). The Group offers an optional lifetime guaranteed income benefit focused on the retirement income segment of the deferred annuity marketplace to help customers manage income during both the accumulation stage and the distribution stage of their financial life. At 31 December 2007, a total of Â£0.7 billion in indexed deferred annuities have elected this benefit taking steps to guarantee retirement income. ------------------------------------------------------------------------------------------------------------------------ Page 86 (d) Sensitivity In providing these guarantees and options, the Group's capital position is sensitive to fluctuations in financial variables including foreign currency exchange rates, interest rates, real estate prices and equity prices. Interest rate guaranteed returns, such as those available on guaranteed annuity options (GAOs), are sensitive to interest rates falling below the guaranteed level. Other guarantees, such as maturity value guarantees and guarantees in relation to minimum rates of return, are sensitive to fluctuations in the investment return below the level assumed when the guarantee was made. ------------------------------------------------------------------------------------------------------------------------ Page 87 Appendix B Additional Report & Accounts disclosures The following additional disclosures have been extracted from the Group's 2007 Report and Accounts: Page Movements in insurance liabilities (i) Movements in long-term business provisions 88 (ii) Movements in general insurance and health claims provisions 90 Long-term business investment liabilities 88 Movements in the year: (i) Participating investment contracts 89 (ii) Non-participating investment contracts 89 Loss development table 91 Sensitivity analysis and capital management Long-term business - impact on profit before tax 92 Long-term business - impact before tax on shareholders' equity 93 General insurance and health business - impact on profit before tax 93 General insurance and health business - impact before tax on shareholders'equity 93 Fund management and non-insurance businesses - impact on profit before tax 94 Fund management and non-insurance businesses - impact before tax on shareholders' equity 94 ------------------------------------------------------------------------------------------------------------------------ Page 88 Movements in insurance liabilities (i) Movements in long-term business provisions The long-term business provision is calculated separately for each of the Group's life operations. The provisions for overseas subsidiaries have generally been included on the basis of local regulatory requirements, mainly using the net premium method, modified where necessary to reflect the requirements of the Companies Acts. Material judgement is required in calculating the provisions and is exercised particularly through the choice of assumptions where there is discretion over these. In turn, the assumptions used depend on the circumstances prevailing in each of the life operations. Provisions are most sensitive to assumptions regarding discount rates and mortality/ morbidity rates. Bonuses paid during the year are reflected in claims paid, whilst those allocated as part of the bonus declaration are included in the movements in the long-term business provision, as detailed below. The following movements have occurred in the long-term business provisions during the year: 2007 2006 Â£m Â£m Carrying amount at 1 January 126,614 114,430 Provisions in respect of new business 10,470 8,750 Expected change in existing business provisions (6,280) (5,678) Variance between actual and expected experience (877) 1,209 Effect of adjusting to PS06/14 realistic basis (60) (800) Impact of other operating assumption changes 95 (333) Impact of economic assumption changes (909) (1,727) Effects of special bonus to with-profits policyholders 1,728 - Other movements (324) 314 ------------------------------------------------------------------------------------------------------------------------ Change in liability recognised as an expense 3,843 1,735 Effect of portfolio transfers, acquisitions and disposals 571 12,454 Foreign exchange rate movements 4,284 (2,005) Other movements - - ----------------------------------------------------------------------------------------------------------------------- Carrying amount at 31 December 135,312 126,614 ======================================================================================================================= A transfer was made from UDS to participating contract liabilities in the UK. This reflects the expected management action to declare a special bonus to with-profits policyholders in CGNU and CULAC. No IFRS profit impact is recognised in 2007 as it is considered inappropriate to anticipate management actions in the recognition of shareholder profit. Long-term business investment liabilities Investment contracts are those that do not transfer significant insurance risk from the contract holder to the issuer, and are therefore treated as financial instruments under IFRS. Many investment contracts contain a discretionary participation feature in which the contract holder has a contractual right to receive additional benefits as a supplement to guaranteed benefits. These are referred to as participating contracts and are measured according to the methodology and group practice for long-term business liabilities. They are not measured at fair value as there is currently no agreed definition of fair valuation for discretionary participation features under IFRS. In the absence of such a definition, it is not possible to provide a range of estimates within which a fair value is likely to fall. The IASB has deferred consideration of participating contracts to Phase ll of its insurance contracts project. For participating business, the discretionary participation feature is recognised separately from the guaranteed element and is classified as a liability, referred to as unallocated divisible surplus. Investment contracts that do not contain a discretionary participation feature are referred to as non-participating contracts and the liability is measured at either fair value or amortised cost. Most non-participating investment contracts measured at fair value are unit-linked in structure and the fair value liability is equal to the unit reserve plus additional non-unit reserves if required on a fair value basis. For this business, a deferred acquisition cost asset and deferred income reserve liability are recognised in respect of transaction costs and front-end fees respectively, that relate to the provision of investment management services, and which are amortised on a systematic basis over the contract term. In the United States, funding agreements consist of one to ten year fixed rate contracts. These contracts may not be cancelled by the holders unless there is a default under the agreement, but may be terminated by Aviva at any time. The weighted average interest rates for fixed-rate and floating-rate funding agreements in 2007 were 5.21% and 5.15% (2006: 5.07% and 5.55% respectively). The funding agreements are measured at fair value equal to the present value of contractual cash flows. There is a small volume of annuity certain business for which the liability is measured at amortised cost using the effective interest method. The fair value of contract liabilities measured at amortised cost is not materially different from the amortised cost liability. ------------------------------------------------------------------------------------------------------------------------ Page 89 Movements in the year The following movements have occurred in the year: (i) Participating investment contracts 2007 2006 Â£m Â£m Carrying amount at 1 January 49,400 47,258 Provisions in respect of new business 3,009 3,001 Expected change in existing business provisions (1,978) (2,237) Variance between actual and expected experience (404) 2,131 Effect of adjusting to PS06/14 realistic basis - (105) Impact of other operating assumption changes (3) (43) Impact of economic assumption changes 178 (125) Effect of special bonus to with-profits policyholders 399 - Other movements (176) 51 ----------------------------------------------------------------------------------------------------------------------- Change in liability 1,025 2,673 Effect of portfolio transfers, acquisitions and disposals - 125 Foreign exchange rate movements 3,184 (656) Other movements - - ------------------------------------------------------------------------------------------------------------------------ Carrying amount at 31 December 53,609 49,400 ====================================================================================================================== (ii) Non-participating investment contracts 2007 2006 Â£m Â£m Carrying amount at 1 January 38,958 30,051 Provisions in respect of new business 8,575 5,695 Expected change in existing business provisions (1,094) (163) Variance between actual and expected experience (3,231) 265 Impact of operating assumption changes (2) 15 Impact of economic assumption changes 20 (5) Other movements 61 56 ------------------------------------------------------------------------------------------------------------------------ Change in liability 4,329 5,863 Effect of portfolio transfers, acquisitions and disposals 254 3,396 Foreign exchange rate movements 1,094 (352) ----------------------------------------------------------------------------------------------------------------------- Carrying amount at 31 December 44,635 38,958 ======================================================================================================================= ------------------------------------------------------------------------------------------------------------------------ Page 90 (ii) Movements in general insurance and health claims provisions Delays occur in the notification and settlement of claims and a substantial measure of experience and judgement is involved in assessing outstanding liabilities, the ultimate cost of which cannot be known with certainty at the balance sheet date. The reserves for general insurance and health are based on information currently available; however, it is inherent in the nature of the business written that the ultimate liabilities may vary as a result of subsequent developments. The following changes have occurred in the general insurance and health claims provisions during the year: 2007 2006 Â£m Â£m Carrying amount at 1 January 12,718 12,965 Impact of changes in assumptions 1 2 Claim losses and expenses incurred in the current year 8,273 7,639 Decrease in estimated claim losses and expenses incurred in prior years - General insurance (800) (520) - Health (137) (30) ------------------------------------------------------------------------------------------------------------------------ Incurred claims losses and expenses 7,337 7,091 Less: Payments made on claims incurred in the current year (4,408) (3,765) Payments made on claims incurred in prior years (3,686) (3,771) Recoveries on claim payments 315 304 ------------------------------------------------------------------------------------------------------------------------ Claims payments made in the year, net of recoveries (7,779) (7,232) Other movements in the claims provisions 36 (7) ----------------------------------------------------------------------------------------------------------------------- Changes in claims reserve recognised as an expense (406) (148) Gross portfolio transfers, acquisitions and disposals 175 207 Foreign exchange rate movements 655 (306) ----------------------------------------------------------------------------------------------------------------------- Carrying amount at 31 December 13,142 12,718 ======================================================================================================================= Releases from non-life prior year provisions The Group aims to establish non-life reserves on an appropriately conservative basis to protect against adverse future claims development. Our business is predominantly short tail in nature and loss development experience is generally favourable. As a result of conservatism applied in setting reserves, as the ultimate cost of claims becomes more certain, in the absence of adverse claims development, there may be releases from prior accident years. The impact of these prior year releases on Aviva is shown in the loss development tables set out below. The Group's approach to reserving for the current accident year remains consistent and appropriately conservative. During 2007 the Group has released Â£832 million from general insurance prior year net claim provisions (Â£800 million gross). In addition, during 2007, Â£137 million has been released from health insurance provisions, Â£130 million of which relates to the Netherlands health insurance business, which is held for sale at 31 December 2007. Releases from general insurance provisions by region United Kingdom â€¢ Â£440 million, the main components of which are: - better than anticipated bodily injury claims settlement experience, resulting in releases from personal motor, mainly accident years 2003 to 2005, and commercial motor - 'inflation busting' initiatives in 2007 mitigating claim costs and legal expenses on prior year open claims - additional reinsurance recoveries and case estimate savings as a result of decommissioning legacy systems, and releasing amounts previously held for pleural plaque claims - favourable development on commercial liability claims from accident years 1998 to 2006 - of this Â£44 million, the NUI operating profit benefited by Â£430 million Europe includes: â€¢ Â£130 million from Ireland due to lower than expected costs of settling motor and commercial liability claims and other favourable claims development â€¢ Â£173 million from the Netherlands due to continued releases from disability provisions and better than anticipated claims settlement experience North America â€¢ Â£52 million from Canada mainly due to favourable experience on personal motor claims and various mandatory auto residual market pools ------------------------------------------------------------------------------------------------------------------------ Page 91 Health insurance provision releases Â£137 million has been released from prior year health insurance provisions, Â£130 million of which relates to the Netherlands health insurance business. Included within this Â£130 million is Â£53 million due to refunds resulting from prior claim over-payments, which have only a minor impact on profit due to the offsetting effect of the lower premiums from the Verevening (central health fund) that result. In addition, greater certainty regarding ultimate claim costs in the health insurance market has also led to releases. Loss development tables The following table presents the development of claim payments and the estimated ultimate cost of claims for the accident years 2001 to 2007. The upper half of the table shows the cumulative amounts paid during successive years related to each accident year. For example, with respect to the accident year 2003, by the end of 2007 Â£5,180 million had actually been paid in settlement of claims. In addition, as reflected in the lower section of the table, the original estimated ultimate cost of claims of Â£6,218 million was re-estimated to be Â£5,851 million at 31 December 2007. This decrease from the original estimate is due to the combination of a number of factors. The original estimates will be increased or decreased, as more information becomes known about the individual claims and overall claim frequency and severity. In 2005, the year of adoption of IFRS, only five years were required to be disclosed. This is being increased in each succeeding additional year, until ten years of information is included. The Group aims to maintain strong reserves in respect of its non-life and health business in order to protect against adverse future claim experience and development. As claims develop and the ultimate cost of claims become more certain, the absence of adverse claims experience will then result in a release of reserves from earlier accident years, as shown in the loss development table. However, in order to maintain strong reserves the Group transfers much of this release to current accident year (2007) reserves where the development of claims is less mature and there is much greater uncertainty attaching to the ultimate cost of claims. The release from prior accident year reserves during 2007 is also due to an improvement in the estimated ultimate cost of claims. After the effect of reinsurance the loss development table is: Accident Year All prior years 2001 2002 2003 2004 2005 2006 2007 Total Â£m Â£m Â£m Â£m Â£m Â£m Â£m Â£m Â£m Net cumulative claim payments At end of accident year (2,970) (2,913) (2,819) (2,870) (3,281) (3,612) (4,317) One year later (4,624) (4,369) (4,158) (4,378) (4,925) (5,442) Two years later (5,088) (4,779) (4,565) (4,712) (5,344) Three years later (5,436) (5,064) (4,924) (4,986) Four years later (5,848) (5,297) (5,180) Five years later (5,763) (5,424) Six years later (5,841) Estimate of net cumulative claims At end of accident year 6,186 6,037 6,218 6,602 6,982 7,430 8,363 One year later 6,333 6,038 6,093 6,266 6,818 7,197 Two years later 6,321 5,997 6,037 6,082 6,688 Three years later 6,329 5,973 5,942 5,882 Four years later 6,286 5,912 5,851 Five years later 6,219 5,855 Six years later 6,173 Estimate of cumulative claims 6,173 5,855 5,851 5,882 6,688 7,197 8,363 Cumulative payments (5,841) (5,424) (5,180) (4,986) (5,344) (5,442) (4,317) ------------------------------------------------------------------------------------------------------------------------ 1,634 332 431 671 896 1,344 1,755 4,046 11,109 Effect of discounting (39) (3) (4) (4) (2) (3) (5) (9) (69) ------------------------------------------------------------------------------------------------------------------------ Present value 1,595 329 427 667 894 1,341 1,750 4,037 11,040 Cumulative effect of foreign exchange movements - 13 21 34 45 34 97 - 244 Effect of acquisitions 8 2 2 43 16 22 28 19 140 ----------------------------------------------------------------------------------------------------------------------- Present value recognised in the balance sheet 1,603 344 450 744 955 1,397 1,875 4,056 11,424 ======================================================================================================================== In the loss development table shown above, the cumulative claim payments and estimates of cumulative claims for each accident year are translated into sterling at the exchange rates that applied at the end of that accident year. The impact of using varying exchange rates is shown at the bottom of the table. Disposals are dealt with by treating all outstanding and IBNR claims of the disposed of entity as 'paid' at the date of disposal. The loss development tables above include information on asbestos and environmental pollution claims provisions from business written before 2001. The claims provisions, net of reinsurance, in respect of this business were Â£323 million (2006: Â£312 million). The movement in the year reflects strenthening of provisions by Â£20 million (2006: Â£9 million), foreign exchange rate movements and timing difference between claim payments and reinsurance recoveries. ------------------------------------------------------------------------------------------------------------------------ Page 92 Sensitivity analysis and capital management The Group uses a number of sensitivity test-based risk management tools to understand the volatility of earnings, the volatility of its capital requirements, and to manage its capital more efficiently. Primarily EEV, Financial Condition Reporting (a medium term projection of the financial health of the business under a variety of economic and operating scenarios), and increasingly Individual Capital Assessment (ICA) are used. Sensitivities to economic and operating experience are regularly produced on all of the Group's financial performance measurements as part of the Group's decision making and planning process, and as part of the framework for identifying and quantifying the risks that each of its business units, and the Group as a whole are exposed to. For long-term business in particular, sensitivities of EEV performance indicators to changes in both economic and non-economic experience are continually used to manage the business and to inform the decision making process. More information on EEV sensitivities can be found in the presentation of results in the EEV section of this announcement. Life insurance and investment contracts The nature of long-term business is such that a number of assumptions are made in compiling the financial statements. Assumptions are made about investment returns, expenses, mortality rates, and persistency in connection with the in-force policies for each business unit. Assumptions are best estimates based on historic and expected experience of the business. General insurance and health business General insurance and health claim liabilities are estimated by using standard actuarial claims projection techniques. These methods extrapolate the claims development for each accident year based on the observed development of earlier years. In most cases, no explicit assumptions are made as projections are based on assumptions implicit in the historic claims development on which the projections are based. As such, in the analysis below, the sensitivity of general insurance claim liabilities is primarily based on the financial impact of changes to the reported loss ratio. Some results of sensitivity testing for long-term business and general insurance and health business are set out below. For each sensitivity test the impact of a change in a single factor is shown, with other assumptions left unchanged. Sensitivity Factor Description of sensitivity factor applied ------------------------------------------------------------------------------------------------------------------------ Interest rate & investment return The impact of a change in market interest rates by +/- 1% (e.g. if a current interest rate is 5%, the impact of an immediate change to 4% and 6%). The test allows consistently for similar changes to investment returns and movements in the market value of backing fixed interest securities. Equity / property market values The impact of a change in equity/property market values by +/- 10% Expenses The impact of an increase in maintenance expenses by 10% Assurance mortality/morbidity (life insurance only) The impact of an increase in mortality/morbidity rates for assurance contracts by 5% Annuitant mortality (life insurance only) The impact of a reduction in mortality rates for annuity contracts by 5% Gross loss ratios (non-life insurance only) The impact of an increase in gross loss ratios for general insurance and health business by 5% The above sensitivity factors are applied using actuarial and statistical models, with the following pre-tax impacts on profit and shareholders' equity at 31 December 2007: Long-term business Sensitivities as at 31 December 2007 Impact on profit before tax (Â£m) Interest Interest Equity / Equity / Assurance Annuitant rates rates property property Expenses mortality mortality +1% -1% +10% -10% +10% +5% -5% Insurance participating 15 (10) - - (5) - - Insurance non-participating (205) 165 45 (35) (5) (20) (295) Investment participating (5) (25) - - (5) - - Investment non-participating (35) 40 65 (60) - - - Assets backing life shareholders'funds (115) 140 180 (175) - - - ----------------------------------------------------------------------------------------------------------------------- Total (345) 310 290 (270) (15) (20) (295) ======================================================================================================================== ------------------------------------------------------------------------------------------------------------------------ Page 93 Sensitivity analysis and capital management (continued) Impact before tax on shareholders' equity (Â£m) Interest Interest Equity / Equity / Assurance Annuitant rates rates property property Expenses mortality mortality +1% -1% +10% -10% +10% +5% -5% Insurance participating (5) 20 - - (5) - - Insurance non-participating (320) 275 105 (95) (5) (20) (295) Investment participating (5) (25) - - (5) - - Investment non-participating (170) 190 65 (60) - - - Assets backing life shareholders'funds (165) 190 460 (455) - - - ------------------------------------------------------------------------------------------------------------------------ Total (665) 650 630 (610) (15) (20) (295) ======================================================================================================================= Sensitivities as at 31 December 2006 Impact on profit before tax (Â£m) Interest Interest Equity / Equity / Assurance Annuitant rates rates property property Expenses mortality mortality +1% -1% +10% -10% +10% +5% -5% Insurance participating (5) - 35 (35) - - (5) Insurance non-participating 25 (210) 20 (40) (5) (20) (295) Investment participating (30) (35) 10 (10) (5) - - Investment non-participating (15) 15 40 (40) - - - Assets backing life shareholders'funds (280) 305 255 (255) - - - ------------------------------------------------------------------------------------------------------------------------ Total (305) 75 360 (380) (10) (20) (300) ======================================================================================================================= Impact before tax on shareholders' equity (Â£m) Interest Interest Equity / Equity / Assurance Annuitant rates rates property property Expenses mortality mortality +1% -1% +10% -10% +10% +5% -5% Insurance participating (25) 25 35 (35) (5) - (5) Insurance non-participating (240) 60 35 (50) (5) (20) (295) Investment participating (30) (35) 10 (10) - - - Investment non-participating (70) 70 40 (40) - - - Assets backing life shareholders'funds (320) 345 290 (290) - - - ----------------------------------------------------------------------------------------------------------------------- Total (685) 465 410 (425) (10) (20) (300) ======================================================================================================================= Changes in sensitivities between 2006 and 2007 arise primarily from the acquisitions of Ark Life and AmerUs, and the effect of increases in market interest rates. The different impacts of the economic sensitivities on profit and shareholders' equity arise from classification of certain assets as available for sale in some business units, for which movements in unrealised gains or losses would be taken directly to shareholders' equity. The economic impacts on profit before tax for insurance contracts relate mainly to the effect of minimum return guarantees in the Netherlands. However in the case of the interest rate sensitivities, the impacts on shareholders' equity are more than offset by the effect of changes in the market value of fixed interest securities in the United States that are classified as available for sale. The mortality sensitivities relate primarily to the UK and Ireland. The impact on the Group's results from sensitivity to these assumptions can also be found in the EEV sensitivities included in the alternative method of reporting long-term business profits section. General insurance and health business Sensitivities as at 31 December 2007 Impact on profit before tax (Â£m) Equity / Equity / Gross loss Interest rates Interest rates property property Expenses ratios +1% -1% +10% -10% +10% +5% Net of reinsurance (275) 310 110 (110) (150) (365) Impact before tax on shareholders'equity (Â£m) Equity / Equity / Gross loss Interest rates Interest rates property property Expenses ratios +1% -1% +10% -10% +10% +5% Net of reinsurance (275) 310 110 (110) (35) (365) ------------------------------------------------------------------------------------------------------------------------ Page 94 Sensitivities as at 31 December 2006 Impact on profit before tax (Â£m) Equity / Equity / Gross loss Interest rates Interest rates property property Expenses ratios +1% -1% +10% -10% +10% +5% Net of reinsurance (270) 290 370 (370) (140) (325) Impact before tax on shareholders' equity (Â£m) Equity / Equity / Gross loss Interest rates Interest rates property property Expenses ratios +1% -1% +10% -10% +10% +5% Net of reinsurance (270) 290 370 (370) (35) (325) For general insurance, the impact of the expense sensitivity on profit also includes the increase in ongoing administration expenses, in addition to the increase in the claims handling expense provision. Fund management and non-insurance businesses Sensitivities as at 31 December 2007 Impact on profit before tax (Â£m) Equity / Equity / Interest rates Interest rates property property +1% -1% +10% -10% Total (35) 35 55 (54) Impact before tax on shareholders' equity (Â£m) Equity / Equity / Interest rates Interest rates property property +1% -1% +10% -10% Total (35) 35 55 (55) Sensitivities as at 31 December 2006 Impact on profit before tax (Â£m) Equity / Equity / Interest rates Interest rates property property +1% -1% +10% -10% Total (26) 26 44 (44) Impact before tax on shareholders' equity (Â£m) Equity / Equity / Interest rates Interest rates property property +1% -1% +10% -10% Total (52) 51 78 (78) Limitations of sensitivity analysis The above tables demonstrate the effect of a change in a key assumption while other assumptions remain unchanged. In reality, there is correlation between the assumptions and other factors. It should also be noted that these sensitivities are non-linear, and larger or smaller impacts should not be interpolated or extrapolated from these results. The sensitivity analyses do not take into consideration that the Group's assets and liabilities are actively managed. Additionally, the financial position of the Group may vary at the time that any actual market movement occurs. For example, the Group's financial risk management strategy aims to manage the exposure to market fluctuations. As investment markets move past various trigger levels, management actions could include selling investments, changing investment portfolio allocation, adjusting bonuses credited to policyholders, and taking other protective action. A number of the business units use passive assumptions to calculate their long-term business liabilities. Consequently, the actual impact of a change in the assumptions may not have any impact on the liabilities, whereas assets are held at market value on the balance sheet. In these circumstances, the different measurement bases for liabilities and assets may lead to volatility in shareholder equity. Similarly, for general insurance liabilities, the interest rate sensitivities only affect profit and equity where explicit assumptions are made regarding interest (discount) rates or future inflation. Other limitations in the above sensitivity analyses include the use of hypothetical market movements to demonstrate potential risk that only represent the Group's view of possible near-term market changes that cannot be predicted with any certainty; and the assumption that all interest rates move in an identical fashion. ------------------------------------------------------------------------------------------------------------------------ Page 95 Appendix C Additional disclosures Page Operating cost base 96 Cost savings 97 Margin on assets 99 ----------------------------------------------------------------------------------------------------------------------- Page 96 Analysis of Total Group Expenses Introduction Aviva is committed to improving the efficiency of its operations. This disclosure has been developed for investors to facilitate the tracking of progress on operational efficiency and cost saving initiatives and to understand how cost saving initiatives impact profit. This disclosure shows the overall movement in the Operating Cost Base between 2006 and 2007. This is analysed into the key components of movement - impact of acquisitions/disposals, organic growth (based on growth in GWP and PVNBP / VIF), inflation, productivity savings, movements in one-off restructuring costs and realised savings from cost initiatives. Overall, this analysis shows that the total operating cost base reduced from Â£5,019 million in 2006 to Â£4,995 million in 2007, with a like-for-like reduction during 2007 of 6.5%. The Operating Cost Base The Aviva operating cost base is calculated from total IFRS Expenses - with all charges relating to claims (excluding claims handling), commissions, provisions & liabilities, financing, amortisation & impairments, and forex, removed. This increased analysis of Aviva Total Expenses, and its links to the standard analysis as set out in the table and notes below: Total Expenses & the Operating Cost Base 2007 2006 Â£m Â£m Total Expenses 38,788 42,071 Less: Claims, commissions and Changes in Provisions and Liabilities 32,253 35,780 Less: IFRS Adjustments & Amortisation 332 425 Less: Finance Costs 1,208 847 ------------------------------------------------------------------------------------------------------------------------ Total Operating Cost Base 4,995 5,019 ======================================================================================================================== Reduction in the Operating Cost Base The total Operating Cost Base has reduced during 2007, moving from Â£5,019 million to Â£4,995 million, a reduction of Â£24 million (0.5%). In order to analyse the Operating Cost Base movement in 2007 the adjustments necessary to place the 2006 figures on a like-for-like basis have been calculated. These adjustments account for the impact of inflation in the year, adjust for any impact from the cost bases of businesses disposed of / acquired, and adjust for the growth of the Group (as represented by the growth in revenues and the in-force portfolio). Adjusting for these elements increases the notional Cost Base (after productivity savings) to Â£5,342 million. Based on this total the actual Operating Cost Base for 2007 of Â£4,995 million represents a like-for-like reduction of Â£347 million (6.5%). The table and notes below set out and explain the like-for-like adjustments, their calculation, and the inherent assumptions - the two most important being that: a) A composite of Consumer Price Index and the Retail Price Index is used as a measure of inflation b) Costs are assumed to move in proportion to changes in premium / VIF. The actual relationship between these will be more complex - this is adjusted for by the separate inclusion of productivity savings The table below also sets out the different components which have then caused the reduction in the Operating Cost Base: Movement in the Operating Cost Base Â£m Total Operating Cost Base 2006 5,019 Impact of acquisitions and disposals * 42 Inflation ** 154 Organic growth *** 239 Productivity savings ^ (112) Movement in restructuring and integration spend ^^ (93) Realised savings from cost initiatives ^^^ (241) Other # (13) -------------------------------------------------------------------------------- Total Operating Cost Base 2007 4,995 ===============================================================================- ------------------------------------------------------------------------------------------------------------------------ Page 97 * Impact of acquisitions and disposals - Adjustment to the cost base for the purchase of AmerUs and the disposal of MSS ** Inflation - Notional level of inflation that would have impacted the operating cost base during the year. Calculated using a composite of the Retail Price Index and the Consumer Price Index for individual countries, applied to operating expenditure, i.e. excluding restructuring and integration costs (but including adjustments for acquisitions and disposals). The overall weighted average inflation rate is calculated at 3.0% *** Organic growth - Increase in the Cost Base implied by the growth of the organisation in revenue terms (GWP used as proxy for the GI businesses; a combination of PVNBP and VIF movements used for the Life businesses). The growth proxies, adjusted for any acquisitions / disposals, are then applied to operating expenditure, i.e. excluding restructuring and integration costs (but including adjustments for acquisitions and disposals) ^ Productivity savings - The difference between the growth in the cost base implied by the organic growth calculation and the actual change that has taken place ^^ Movement in restructuring and integration spend - Comparison of restructuring and integration spend in 2007 (Â£153 million) and 2006 (Â£246 million) ^^^ Realised savings from cost initiatives - Cost savings realised in the year, and attributable to specific initiatives (equivalent run-rate savings may be higher). These savings are as follows: NUL Cost and Efficiency Â£92 million (Principally emerging as improved new business margin and reduced in-force adverse expense variance - added to the 2006 savings this gives a cumulative figure of Â£108 million) US Integration Â£17 million NUI Cost & Efficiency and Â£132 million (Principally offsetting the impact of inflation and RAC Incremental Savings reduced premiums to deliver an expense ratio in line with prior year - impact partially offset in year by movement in deferred acquisition cost reserve) Total Realised Savings Â£241 million No savings have been delivered in 2007 in respect of the Â£350m targets announced in October 2007 (see following pages) # Other - Movements in the operating cost base which are specifically identifiable and one-off in nature. Cost saving commitments for new targets announced in October 2007 This note provides details of the Group's published commitments to deliver cost savings. At 2007 year end, the Group's UK Cost & Efficiency initiatives, RAC integration and US integration were complete and only the Â£350 million cost savings targets announced in October 2007 remain to be delivered. Consequently, only the targets announced in October 2007 are included in the table below and there is limited information to report at this year end. Aviva is, however, committed to providing this disclosure every half year so that investors can monitor delivery of the cost-saving commitments made. Impact of New targets Savings to be Savings over economic Cost announced in delivered in /(under) changes on savings year future years delivered targets c/fwd targets Movement in Costs Savings c/fwd target (recurring,annualised savings) ---------------------------------------------------------------------------------- Â£m Â£m Â£m Â£m Â£m Savings expected to be achieved in: year ended 31 December 2007 - - - - - year ended 31 December 2008 290 - - - 290 year ended 31 December 2009 60 - - - 60 ======================================================================================================================= Total 350 - - - 350 ======================================================================================================================== * Targets include Â£200 million for NUI, Â£100 million for NU Life and Â£50 million for Europe. No cost savings from these initiatives were realised (earned) in the Income Statement for the year ended 31 December 2007. All Â£82 million of costs incurred in the year were expensed in the Income Statement for the year in restructuring costs. ------------------------------------------------------------------------------------------------------------------------ Page 98 Less: Impact of Movement in initial Costs of costs now economic costs to delivery of Less: to be Increase / changes on deliver Costs new targets costs incurred in (decrease) costs Costs to Savings target announced in incurred future in costs of of delivery deliver (total expenses year in year years delivery c/fwd c/fwd incurred) -------------------------------------------------------------------------------------------- Â£m Â£m Â£m Â£m Â£m Â£m Costs expected to be incurred in : year ended 31 December 2007 82 (82) - - - - year ended 31 December 2008 178 - - - - 178 year ended 31 December 2009 70 - - - - 70 ====================================================================================================================== Total 330 (82) - - - 248 ---------------------------------------------------------------------------------------------------------------------- Footnotes * Cost savings initiatives included in this note are supported by detailed implementation plans, which identify the activities, timeframe and expected costs of delivering the planned initiatives. ** Cost Savings targets announced in the year to be achieved in 2007 are measured at the value of the relevant recurring costs in the year ended 31 December 2006. Cost savings targets announced in the year and to be delivered in 2008 and 2009 are measured at the value of the relevant recurring costs in the year ended 31 December 2007. *** The impact of economic changes will include the effect, where significant, of restating targets brought forward that are to be achieved in 2008 and future years for foreign exchange and inflation movements. ^ Cost savings 'realised' are the actual cost savings earned in the Income Statement for the year, and will be less than the amount 'achieved' when the saving was achieved part way through the year. For EEV reporting, this excludes the benefit of any reduction in related unit cost assumptions. ^^ 'Initial costs to deliver Cost Savings targets' are the total one-off, initial costs that will be required to complete and deliver announced cost savings programmes. They are measured at the real value expected to be incured when the costs arise. ----------------------------------------------------------------------------------------------------------------------- Page 99 Long-term business summary analysis by geographical segment Margin on assets (a) Introduction Aviva is committed to improving the explanation of its results to generalist investors. During 2007, a number of requests were received to present our long-term business result as a function of funds under management, consistent with practices elsewhere in the savings industry. This disclosure provides an additional perspective on the long-term business performance, as part of our intention to provide continuous improvement in the external presentation of our IFRS result and enable these results to be better understood. This disclosure presents the overall profit from the long-term business as if generated by a margin on the income- bearing assets supporting that business. In the analysis which follows two net margin figures are highlighted. Firstly, the operating profit margin is based on our new definition of life operating profit, which excludes the effect of economic volatility in the period. Secondly, the margin based on profit before shareholder tax includes the impact of economic volatility and other non-operating items. (b) Margins on average assets As margin on average assets (basis points) ---------------------------------------------------------------------------------------------- Full Year 2007 Profit Average Acquisition Other non- before Assets Operating & Admin Operating Economic operating shareholder (Â£bn) revenue costs profit items items tax ====================================================================================================================== UK 124.8 179 (121) 58 (9) (1) 48 France 48.7 123 (73) 50 17 0 67 Netherlands 28.8 269 (206) 63 80 (2) 141 Other 40.6 275 (188) 87 (1) (5) 81 Europe 118.1 211 (145) 66 26 (2) 90 North America 16.3 228 (165) 63 (112) (35) (84) Asia Pacific 4.2 385 (311) 74 3 (2) 75 ----------------------------------------------------------------------------------------------- Total 263.4 200 (138) 62 1 (4) 59 =============================================================================================== As margin on average assets (basis points) ----------------------------------------------------------------------------------------------- Full Year 2006 Profit Average Acquisition Other non- before Assets Operating & Admin Operating Economic operating shareholder (Â£bn) revenue costs profit items items tax ======================================================================================================================= UK 117.6 243 (190) 53 (2) 1 52 France 44.3 128 (77) 51 7 0 58 Netherlands 27.2 220 (183) 37 126 3 166 Other 34.2 249 (155) 94 5 (11) 88 Europe 105.7 191 (130) 61 38 (3) 96 North America 5.1 286 (260) 26 51 (43) 34 Asia Pacific 3.6 577 (457) 120 20 6 146 ----------------------------------------------------------------------------------------------- Total 232.0 225 (168) 57 18 (2) 73 =============================================================================================== ------------------------------------------------------------------------------------------------------------------------ Page 100 The above tables are based on the IFRS income statement and balance sheet for the long-term business segment: (i) average assets is the arithmetic average of the opening and closing balance sheet value of assets, together with non-consolidated funds under management and excluding certain non-financial assets; excluded assets are goodwill, acquired value of in-force business (AVIF) and other intangibles, reinsurance assets, deferred acquisition costs and other assets, and prepayments and accrued income; (ii) operating revenue items include premium and investment income, claims and movements in liabilities, based on expected investment returns on financial investments backing shareholder and policyholder funds; (iii) acquisition and administration costs include fee and commission expense, other operating expenses and finance costs; (iv) operating profit is equal to operating revenue less acquisition and administration costs; (v) economic items include the effect of variances between actual and expected investment returns and the impact of changes in economic assumptions on liabilities, which are excluded from operating profit; (vi) other non-operating items include impairment of goodwill, amortisation of intangibles other than AVIF, profit on disposal of subsidiaries and integration and restructuring costs; and, (vii) the final column is based on profit before tax attributable to shareholders' profits, which combines the operating profit, economic items and other non-operating items. (c) Reconciliation of net margins to segmental result and balance sheet Full year 2007 Full year 2006 ---------------------------------- -------------------------------- Average Net Average Net Profit assets margin Profit assets margin ----------------------------------------------------------------------------------------------------------------- Â£m Â£bn bpts Â£m Â£bn bpts Long-term business result before tax 1,571 2,045 less: Tax attributable to policyholder returns (15) (346) ------------------------------------------------------------------------------------------------------------------ Result after policyholder tax 1,556 263.4 59 1,699 232.0 73 ================================================================================================================== Operating profit before tax attributable to shareholders' profits 1,634 263.4 62 1,334 232.0 57 ------------------------------------------------------------------------------------------------------------------ Closing Average Opening Closing Average Opening ------------------------------------------------------------------------------------------------------------------ Â£bn Â£bn Â£bn Â£bn Â£bn Â£bn Segment assets 278.9 255.9 255.9 224.8 ------------------------------------------------------------------------------------------------------------------ Adjustments: Additional funds under management 11.7 8.5 8.5 6.7 Goodwill and other intangibles (4.0) (3.6) (3.6) (1.1) Other excluded assets (11.1) (9.5) (9.5) (8.8) Weighting for USA acquisition (8.8) ------------------------------------------------------------------------------------------------------------------ Asset base 275.5 263.4 251.3 242.5 232.0 221.6 ------------------------------------------------------------------------------------------------------------------ (d) Methodology and observations This disclosure presents the overall profit from the long-term business as if generated by a margin on the income- bearing assets supporting that business. Advantages of this presentation are: â€¢ consistency with metrics used by the fund management industry, presented in a fashion which may be more accessible to the generalist investor; â€¢ the margin on assets is an appropriate measure for investment contracts and insurance contracts that are predominantly savings vehicles; and, â€¢ the calculation normalises the profit emerging from different sized operations to give an indication of relative profitability. However, there are a number of limitations to this analysis for the Aviva group, which offers a full range of long-term policies, including protection, annuity and with-profits business, in addition to non-participating savings and investment contracts. In particular: â€¢ the method assumes that profit emerges as a function of the asset base; for contracts that provide protection benefits the measure is less useful, as there is no direct link between profit emergence and the supporting assets; â€¢ the variety in levels of margin between business units and regions partly reflects differences in business mix and the relative importance of assets under management as a profit driver; for example the net margin on assets backing investment contracts will generally be lower than for annuity and protection business as the latter includes profits arising from mortality margins; â€¢ the measure can show spurious volatility for smaller or rapidly developing operations with a low asset base; and, ----------------------------------------------------------------------------------------------------------------------- Page 101 â€¢ the analysis is based on IFRS results, which does not reflect value creation in our long-term business, and may show new business strain in rapidly growing businesses. The disclosure could be enhanced by splitting investment and protection business, but this is not facilitated by IFRS product classification, under which many contracts with savings characteristics are classified as insurance contracts. Furthermore, our long-term business units are managed on an integrated basis, with various contract types supported by common administrative and investment services. (e) Commentary on 2007 and 2006 margins The total operating profit margin on assets increased from 57 bps in 2006 to 62 bps in 2007. The increase was driven mainly by the UK, Netherlands and USA, reflecting organic activity and acquisition of new operations. The overall margin increase of 5 bps can be further analysed between an increase of 11 bps for growth in operating profit less a reduction of 6 bps to allow for the increased asset base. Economic items had a neutral net impact on profit in 2007, with favourable investment variances in the Europe region offset by negative effects in the USA and UK. In Europe, positive variances related mainly to realisation of capital gains on securities in the Netherlands and France. In the USA, realised and unrealised losses on investments were driven by the widening of credit spreads on securities, while in the UK there was a negative investment variance on surplus assets backing annuity business due to interest rate changes. This compares to a significantly positive net impact of economic items on profit in the previous year. In 2006 the positive investment variance was driven primarily by favourable equity market performance worldwide and increases in market interest rates in the Euro zone. In particular, there was a significant reduction in the cost of investment guarantees in the Netherlands as market interest rates increased. The non-operating items relate mainly to integration costs and amortisation of other intangibles arising from the acquisitions in Ireland (included in Europe Other) and the USA in 2006. For the UK business, the operating profit margin increased from 53 bps in 2006 to 58 bps in 2007. The margin increase of 5 bps is composed of 16 bps from growth in underlying profits, less 8 bps for the net effect of one-off profit items which had a greater impact in 2006, and 3 bps for the effect of growth in the asset base. For non-profit business the improved result is driven by expense savings, growth in the in-force book and lower new business stain. This is combined with an increased contribution from the with-profits business, due to higher bonus rates and removal of market value reductions. The UK margins on assets presented above are blended margins combining our participating (with-profits) and non-participating business. Average assets of the UK with-profits business were Â£64.0 billion (2006: Â£62.8 billion) with operating profit of 28bps (2006: 23bps) and profit before shareholder tax of 28bps (2006: 23bps). This apparently low return reflects IFRS accounting for the share of bonuses accruing to policyholders, rather than the underlying performance within the participating funds. Average assets of the UK non-participating business were Â£61.1 billion (2006: Â£55.3 billion) with operating profit of 89bp (2006: 87bp) and profit before shareholder tax of 65bp (2006: 64bp). This reflects the underlying strength of the profitability of our UK life business measured on an IFRS basis. The French long-term business shows a stable operating margin progression, based on its well-established portfolios of AFER and other unit-linked investment contracts. Favourable investment variances over the period further augment the margins based on profit before shareholder tax. In the Netherlands, the operating profit margin increased significantly. The margin based on profit before shareholder tax margin was affected by economic volatility, in particular the impact of movements in market interest rates and the timing of realisation of capital gains on equities. For this disclosure, Other Europe includes our well-established and profitable operations in Ireland, Italy, Poland and Spain as well as newer developing businesses in Central and Eastern Europe. Operating margins were stable, boosted by high margins on protection business portfolios in Poland and Spain. The newer smaller operations currently make a negative net contribution to margins due to the effect of the low asset base and development costs. The North America margins include results from the AmerUs business acquired in November 2006, with average assets for 2006 weighted to allow for timing of the purchase. The increase in operating profit margin in 2007 reflects the inclusion of the acquired business for a full year for the first time. The negative economic variances seen for the US business were driven by realised and unrealised losses on investments as a result of the widening of credit spreads on assets predominantly relating to funding agreement business. The assets and liabilities for this business are both carried at fair value, are matched in terms of duration, and the assets are of high quality. However, a temporary accounting mismatch has arisen due to widening of credit spreads. This has resulted in a temporary adverse movement on the asset not matched by a corresponding movement on the liability, which it is anticipated will reverse prior to settlement of the contract. The Asia Pacific region combines our well-established profitable business in Australia, which shows high stable profit margins, and the new and rapidly developing Asian operations. ------------------------------------------------------------------------------------------------------------------------ Page 102 (f) Future developments From 2008 we intend to provide further disclosure of IFRS profit drivers, using a format similar to the embedded value analysis of movements. We consider that this will provide more relevant information on the sources of profit for all types of long-term business. In the meantime, however, we believe there is merit in presenting this 'margin on average assets' disclosure as an additional perspective on the financial results of our life businesses. ------------------------------------------------------------------------------------------------------------------------ End of Part 4 of 5 This information is provided by RNS The company news service from the London Stock Exchange

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