Final Results - Part 2 of 4

Aviva PLC 02 March 2006 Part 2 of 4 ------------------------------------------------------------------------------------------------------------------ Page 16 EEV basis Summarised consolidated income statement - EEV basis For the year ended 31 December 2005 Page 2005 2005 2004 â‚¬m Â£m Â£m Operating profit before tax attributable to shareholders' profits 23 2,668 Life EEV operating return 1,814 1,611 48 75 Fund management* 51 20 49 2,281 General insurance and health 1,551 1,259 Other: 50 88 Other operations** 60 (41) 51 (200) Corporate costs (136) (188) 51 (641) Unallocated interest charges (436) (437) ------------------------------------------------------------------------------------------------------------------- 4,271 Operating profit before tax attributable to shareholders' profits 2,904 2,224 Adjusted for the following: (63) Impairment of goodwill (43) (41) (31) Amortisation and impairment of acquired value of in-force business and intangibles (21) (3) - Financial Services Compensation Scheme and other levies - (49) 4,124 Variation from longer-term investment return 2,805 662 (597) Effect of economic assumption changes (406) (318) 46 225 Profit on the disposal of subsidiaries and associates 153 34 45 (160) Integration costs (109) - - Exceptional costs for termination of operations - (40) ------------------------------------------------------------------------------------------------------------------- 7,769 Profit before tax 5,283 2,469 (1,363) Tax on operating profit (927) (618) (991) Tax on other activities (674) (32) -------------------------------------------------------------------------------------------------------------------- 5,415 Profit for the year 3,682 1,819 =================================================================================================================== Attributable to: 5,103 Equity shareholders of Aviva plc 3,470 1,641 312 Minority interests 212 178 ------------------------------------------------------------------------------------------------------------------- 5,415 3,682 1,819 =================================================================================================================== All profit is from continuing operations. * Excludes the proportion of the results of Morley's fund management businesses and of our French asset management operation Aviva Gestion d'Actifs (AGA) that arises from the provision of fund management services to our Life businesses. These results are included within the Life EEV operating return. ** Excludes the proportion of the results of Norwich Union Life Services relating to the services provided to the UK life business. These results are included within the Life EEV operating return. Other subsidiaries providing services to our life businesses do not materially impact the Group results. ------------------------------------------------------------------------------------------------------------------ Page 17 Earnings per share - EEV basis For the year ended 31 December 2005 2005 Earnings per share 2005 2004 Operating profit on an EEV basis after tax, attributable to ordinary shareholders in respect of Aviva plc 109.6c Continuing operations 74.5p 63.1p Profit after tax for the year on an EEV basis, attributable to ordinary shareholders of Aviva plc 215.1c Basic (pence per share) 146.3p 72.0p 213.4c Diluted (pence per share) 145.1p 71.4p Summarised consolidated statement of recognised income and expense - EEV basis For the year ended 31 December 2005 2005 2004 Â£m Â£m Fair value gains on AFS securities and owner-occupied properties, net of transfers to the income statement 61 130 Actuarial losses on pension schemes (547) (145) Foreign exchange rate movements (44) 119 Reserves credit for equity compensation plans 22 21 Aggregate tax effect - shareholder tax 224 (15) ------------------------------------------------------------------------------------------------------------------- Net income recognised directly in equity (284) 110 Profit for the year* 3,682 1,819 ------------------------------------------------------------------------------------------------------------------ Total recognised income and expense for the year 3,398 1,929 ================================================================================================================== * Stated before the effect of foreign exchange rate movements, which are reported within the foreign exchange rate movements line. Reconciliation of movements in consolidated shareholders' funds - EEV basis For the year ended 31 December 2005 2005 2004 Â£m Â£m Balance at 1 January 14,011 11,534 Total recognised income and expense for the year 3,398 1,929 Dividends and appropriations (note 15) (657) (570) Issue of share capital for the acquisition of RAC plc 530 - Other issues of share capital, net of transaction costs 59 25 Shares issued in lieu of dividends 100 103 Issue of direct capital instrument, net of transaction costs of Â£9 million - 981 Capital contribution from minority shareholders 212 4 Minority share of dividends declared in the year (70) (41) Minority interest in (disposed)/acquired subsidiaries (36) 45 Movement in shares held by employee trusts - 1 Other movements (1) - ------------------------------------------------------------------------------------------------------------------ Total equity 17,546 14,011 Minority interests (1,457) (1,160) ------------------------------------------------------------------------------------------------------------------- Balance at 31 December 16,089 12,851 ================================================================================================================== ------------------------------------------------------------------------------------------------------------------ Page 18 Summarised consolidated balance sheet - EEV basis As at 31 December 2005 31 December 31 December 31 December 2005 2005 2004 â‚¬m Â£m Â£m Assets 3,296 Goodwill 2,274 1,184 1,164 Acquired value of in-force business and intangible assets 803 516 9,354 Additional value of in-force long-term business 6,454 5,018 3,086 Investments in joint ventures 2,129 1,255 1,283 Investments in associates 885 873 1,283 Property and equipment 885 812 19,239 Investment property 13,275 11,057 35,571 Loans 24,544 22,055 Financial investments 150,604 Debt securities 103,917 98,719 75,426 Equity securities 52,044 47,291 38,300 Other investments 26,427 20,346 10,333 Reinsurance assets 7,130 8,503 1,475 Deferred tax assets 1,018 908 126 Current tax assets 87 - 11,168 Receivables and other financial assets 7,706 7,509 5,458 Deferred acquisition costs and other assets 3,766 3,189 3,425 Prepayments and accrued income 2,363 2,307 19,900 Cash and cash equivalents 13,732 12,779 670 Assets of operations classified as held for sale 462 - ------------------------------------------------------------------------------------------------------------------ 391,161 Total assets 269,901 244,321 ================================================================================================================== Equity 868 Ordinary share capital 599 570 6,432 Capital reserves 4,438 3,878 1,209 Other reserves 834 736 3,764 Retained earnings 2,597 1,709 9,320 Additional retained profit on an EEV basis 6,431 4,768 ------------------------------------------------------------------------------------------------------------------ 21,593 Equity attributable to ordinary shareholders of Aviva plc 14,899 11,661 1,725 Preference share capital and direct capital instrument 1,190 1,190 2,111 Minority interests 1,457 1,160 ------------------------------------------------------------------------------------------------------------------ 25,429 Total equity 17,546 14,011 ================================================================================================================== Liabilities 192,177 Gross insurance liabilities 132,602 124,122 112,042 Gross liability for investment contracts 77,309 69,555 13,012 Unallocated divisible surplus 8,978 7,549 4,546 Net asset value attributable to unitholders 3,137 2,247 4,167 Provisions 2,875 2,125 3,562 Deferred tax liabilities 2,458 1,543 1,497 Current tax liabilities 1,033 922 15,961 Borrowings 11,013 10,090 13,746 Payables and other financial liabilities 9,485 7,240 4,812 Other liabilities 3,320 4,917 210 Liabilities of operations classified as held for sale 145 - ------------------------------------------------------------------------------------------------------------------ 365,732 Total liabilities 252,355 230,310 ================================================================================================================== ------------------------------------------------------------------------------------------------------------------ 391,161 Total equity and liabilities 269,901 244,321 ================================================================================================================== ------------------------------------------------------------------------------------------------------------------ Page 19 Segmentation of summarised consolidated balance sheet - EEV basis As at 31 December 2005 Life and General Life and General related business related business businesses and other Group businesses and other Group 2005 2005 2005 2004 2004 2004 Â£m Â£m Â£m Â£m Â£m Â£m Total assets before acquired additional value of in-force long-term business 224,453 38,679 263,132 205,498 33,441 238,939 Acquired additional value of in-force long-term business 315 - 315 364 - 364 ----------------------------------------------------------------------------------------------------------------- Total assets included in the statutory IFRS balance sheet 224,768 38,679 263,447 205,862 33,441 239,303 ================================================================================================================= Liabilities of the long-term business (215,624) - (215,624) (197,054) - (197,054) Liabilities of the general insurance and other businesses - (36,731) (36,731) - (33,256) (33,256) ------------------------------------------------------------------------------------------------------------------ Net assets on a statutory IFRS basis 9,144 1,948 11,092 8,808 185 8,993 Additional value of in-force long-term business* 6,454 - 6,454 5,018 - 5,018 ----------------------------------------------------------------------------------------------------------------- Net assets on an EEV basis** 15,598 1,948 17,546 13,826 185 14,011 ================================================================================================================= Equity capital, capital reserves, shares held by employee trusts and other reserves 5,871 5,184 IFRS basis retained earnings 2,597 1,709 Additional EEV basis retained profit 6,431 4,768 ----------------------------------------------------------------------------------------------------------------- Equity attributable to ordinary shareholders of Aviva plc on an EEV basis 14,899 11,661 Preference share capital and direct capital instrument 1,190 1,190 Minority interests 1,457 1,160 ----------------------------------------------------------------------------------------------------------------- EEV basis total equity 17,546 14,011 ================================================================================================================= * The analysis between the Group's and the minority interest's share of the additional value of in-force long-term business is as follows: Movement in 2005 2004 the year Â£m Â£m Â£m Group's share included in shareholders' funds 6,431 4,768 1,663 Minority interest share 329 250 79 Movement in AFS securities (306) - (306) ------------------------------------------------------------------------------------------------------------------ Balance at 31 December 6,454 5,018 1,436 ================================================================================================================= ** Analysis of net assets on an EEV basis is made up as follows: 2005 2004 Â£m Â£m Long-term business net assets on an EEV basis 15,598 13,826 ----------------------------------------------------------------------------------------------------------------- Comprises: Embedded value 15,113 13,014 RBSG goodwill 217 217 Goodwill allocated to long-term business 631 595 Notional allocation of IAS 19 pension fund deficit to long-term business*** (363) - ----------------------------------------------------------------------------------------------------------------- Long-term business net assets on an EEV basis 15,598 13,826 ================================================================================================================= *** The value of the Aviva Pension Scheme deficit has been notionally allocated between segments, based on current funding and the UK Life proportion has been included within the long-term business net assets on an EEV basis. ------------------------------------------------------------------------------------------------------------------ Page 20 Basis of preparation - EEV basis The consolidated income statement and balance sheet on pages 16 to 19 present the Group's results and financial position for the life and related businesses on the European Embedded Value (EEV) basis and for its non-life businesses on the International Financial Reporting Standards (IFRS) basis. The EEV methodology adopted is in accordance with the EEV Principles introduced by the CFO Forum in May 2004. In October 2005 the CFO Forum published Additional Guidance on EEV Disclosures applicable for financial reporting for the year ending 31 December 2006 which has been reflected as far as is possible in this preliminary announcement, in accordance with our previous reporting. In the Directors' opinion, the EEV basis provides a more accurate reflection of the performance of the Group's life and related operations year on year than results presented under the IFRS basis. The Directors consider that the EEV methodology represents a more meaningful basis of reporting the underlying value of the Group's life and related businesses and the underlying drivers of performance. This basis allows for the impact of uncertainty in the future investment returns more explicitly and is consistent with the way the business is priced and managed. The Group's approach to establishing economic assumptions (specifically investment returns, required capital and discount rates) was reviewed by Tillinghast, a firm of actuarial consultants, at the time of adopting the EEV principles in 2004. The approach is based on the well established capital asset pricing model theory and is in line with the EEV Principles and Guidance. The results for 2005 and 2004 have been audited by our auditors, Ernst & Young LLP. Their report in respect of 2005 is included in the Report and Accounts on page 199 of that document. Covered business The EEV calculations cover the following lines of business: life insurance, long-term health and accident insurance, savings, pensions and annuity business written by our life insurance subsidiaries, including managed pension fund business and our share of the other life and related business written in our associated undertakings and joint ventures, as well as the equity release business written in the UK. The adoption of IFRS has resulted in no change to the Group's definition of new business under EEV and so includes contracts that meet the definition of 'non-participating investment' contracts under IFRS. Covered business includes the Group's share of our joint venture operations including our arrangement with The Royal Bank of Scotland Group (RBSG) and our operations in India and China. In addition, the results of Group companies providing significant administration, investment management and other services and of Group holding companies have been included to the extent that they relate to covered business. Together these businesses are referred to as 'Life and related businesses'. New business premiums New business premiums include: â€¢ premiums arising from the sales of new contracts during the year; â€¢ non-contractual additional premiums, including future Department of Work and Pensions (DWP) rebate premiums; and â€¢ expected renewals on new contracts and expected future contractual alterations to new contracts. For products sold to individuals, premiums are generally considered to represent new business in certain circumstances, including where a new contract has been signed, or where underwriting has been performed. Renewal premiums include contractual renewals, non-contractual variations that are reasonably predictable and recurrent single premiums that are pre-defined and reasonably predictable. For group products, new business includes new contracts and increases to aggregate premiums under existing contracts. Renewal premiums are based on the level of premium received during the reporting period and allow for premiums expected to be received beyond the expiry of any guaranteed premium rates. Foreign exchange adjustments Embedded value and other balance sheet items denominated in foreign currencies have been translated to sterling using the appropriate closing exchange rate. New business contribution and other income statement items have been translated using an average exchange rate for the relevant period. The exchange rates adopted in this announcement are shown on page 43. EEV methodology Overview Under the EEV methodology, profit is recognised as it is earned over the life of products defined within covered business. The total profit recognised over the lifetime of a policy is the same as under the IFRS basis of reporting, but the timing of recognition is different. Calculation of the embedded value The shareholders' interest in the life and related businesses is represented by the embedded value. The embedded value is the total of the net worth of the life and related businesses and the value of in-force covered business. Calculations are performed separately for each business and are based on the cash flows of that business, after allowing for both external and intra-group reinsurance. Where one life business has an interest in another life business, the net worth of that business excludes the interest in the dependent company. ------------------------------------------------------------------------------------------------------------------ Page 21 The embedded value is calculated on an after-tax basis applying current legislation and practice together with future known changes. Profits are then grossed up for tax at the full rate of corporation tax for the UK and at an appropriate rate for each of the other countries based on opening year tax rates. Net worth The net worth is the market value of the shareholders' funds and the shareholders' interest in the surplus held in the non-profit component of the long-term business funds, determined on a statutory solvency basis and adjusted to add back any non-admissible assets, and consists of the required capital and free surplus. Required capital is reported net of implicit items permitted on a local regulatory basis to cover minimum solvency margins which are assessed at a local entity basis. The level of required capital for each business, which ranges between 100% and 150% of the EU minimum solvency requirement for our main European businesses, reflects the level of capital considered by the Directors to be appropriate to manage the business, allowing for our internal assessment of the level of market, insurance and operating risk inherent in the underlying products. The same definition of required capital is used for both existing and new business. The free surplus comprises the market value of shareholder assets in excess of local statutory reserves and required capital. Value of in-force covered business The value of in-force covered business is the present value at the appropriate risk discount rate (which incorporates a risk margin) of the distributable profits to shareholders arising from the in-force covered business projected on a best estimate basis, less a deduction for the cost of holding the required level of capital. In the UK, shareholders' distributable profits arise when they are released following actuarial valuations. These valuations are carried out in accordance with statutory requirements designed to ensure and demonstrate solvency in long-term business funds. Future distributable profits will depend on experience in a number of areas such as investment return, discontinuance rates, mortality, administration costs, as well as management and policyholder actions. Releases to shareholders arising in future years from the in-force covered business and associated required capital can be projected using best estimate assumptions of future experience. In overseas businesses generally, there are similar requirements restricting payments to shareholders from life businesses. The value of in-force covered business includes an allowance for the impact of financial options and guarantees arising from best estimate assumptions (the intrinsic value) and from additional costs related to the variability of investment returns (the time value). The intrinsic value is included in the underlying value of the in-force covered business using deterministic assumptions. The time value of financial options and guarantees has been determined using stochastic modelling techniques. Stochastic modelling typically involves projecting the future cash flows of the business under thousands of economic scenarios that are representative of the possible future outcomes for market variables such as interest rates and equity returns. Allowance is made, where appropriate, for the effect of management and/or policyholder actions in different economic conditions on future assumptions such as asset mix, bonus rates and surrender rates. The time value is determined by deducting the average value of shareholder cash flows under these economic scenarios from the deterministic shareholder value under best estimate assumptions. The cost of holding required capital is the difference between the required capital and the present value at the appropriate risk discount rate of the projected release of the required capital and investment earnings on the assets deemed to back the required capital. Where the required capital is covered by policyholder assets, for example in the UK with-profit funds, there is no impact of cost of capital on shareholder value. The assets regarded as covering the required capital are those that the operation deems appropriate. The value of in-force covered business includes the capitalised value of profits and losses arising from subsidiary companies providing administration, investment management and other services to the extent that they relate to covered business. This is referred to as the 'look through' into service company expenses. In addition, expenses arising in holding companies that relate directly to acquiring or maintaining covered business have been allowed for. Where external companies provide services to the life and related businesses, their charges have been allowed for in the underlying projected cost base. Risk discount rates Under the EEV methodology, a risk discount rate (RDR) is required to express a stream of expected future distributable profits as a single value at a particular date (the present value). It is the interest rate that an investment equal to the present value would have to earn in order to be able to replicate exactly the stream of future profits. The RDR is a combination of a risk free rate to reflect the time value of money plus a risk margin to make prudent allowance for the risk that experience in future years may differ from that assumed. In particular, a risk margin is added to allow for the risk that expected additional returns on certain asset classes (e.g. equities) are not achieved. Risk discount rates for our life businesses have been calculated using a risk margin based upon a Group Weighted Average Cost of Capital (WACC). The Group WACC is calculated using a gross risk free interest rate, an equity risk margin, a market assessed risk factor (beta), and an allowance for the gearing impact of debt financing (including subordinated debt) on a market value basis. The market assessed risk factor captures the market's view of the effect of all types of risk on our business, including operational and other non-economic risk. The RDR is only one component of the overall allowance for risk in EEV calculations. Risk is also allowed for in the cost of holding statutory reserving margins, additional required capital and in the time value of options and guarantees. Hence to derive the RDR the Group WACC is adjusted to reflect the average level of required capital assumed to be held, and to reflect the explicit valuation of the time value of options and guarantees. ------------------------------------------------------------------------------------------------------------------ Page 22 In order to derive risk discount rates for each of our life businesses, the adjusted Group WACC is expressed as a risk margin in excess of the gross risk free interest rate used in the WACC calculation as described above. Business-specific discount rates are then calculated as the sum of this risk margin and the appropriate local gross risk free rate at the valuation date, based on returns on government bonds. A common risk free rate, and hence a common RDR, is used for all of our businesses within the Eurozone. Additional country-specific risk margins are applied to smaller businesses to reflect additional economic, political and business-specific risk. For example, risk margins ranging from 3.7% to 8.7% are applied to the Group's eastern European and Asian operations. Within each business, a constant RDR has been applied in all future time periods and in each of the economic scenarios underlying the calculation of the time value of options and guarantees. At each valuation date, the risk margin is reassessed based on current economic factors and is updated only if a significant change has occurred. In particular, changes in risk profile arising from movements in asset mix are allowed for via the updated risk margin calculation. Participating business Future regular bonuses on participating business are projected in a manner consistent with current bonus rates and expected future returns on assets deemed to back the policies. For with-profit funds in the UK and Ireland, for the purpose of recognising the value of the estate, it is assumed that terminal bonuses are increased to exhaust all of the assets in the fund over the future lifetime of the in-force with-profit policies. However, under stochastic modelling there may be some extreme economic scenarios when the total assets in the Group's with-profit funds are not sufficient to pay all policyholder claims. The average additional shareholder cost arising from this shortfall has been included in the time value of options and guarantees. For profit sharing business in continental Europe, where policy benefits and shareholder value depend on the timing of realising gains, apportionment of unrealised gains between policyholders' benefits and shareholders reflect contractual requirements as well as existing practice. Where under certain economic scenarios additional shareholder injections are required to meet policyholder payments, the average additional cost has been included in the time value of options and guarantees. Consolidation adjustments The effect of transactions between our life companies such as loans and reinsurance arrangements has been included in results split by territory in a consistent manner. No elimination is required on consolidation. As the EEV methodology incorporates the impact of profits and losses arising from subsidiary companies providing administration, investment management and other services to the Group's life companies, the equivalent profits and losses have been removed from the relevant segment (non insurance or fund management) and are instead included within the results of life and related businesses. In addition, the underlying basis of calculation for these profits has changed from the IFRS basis to the EEV basis. The capitalised value of the future profits and losses from such service companies are included in the embedded value and new business contribution calculations for the relevant territory, but the net assets (representing historical profits and other amounts) remain under non insurance or fund management. In order to reconcile the profits arising in the financial period within each segment with the assets on the opening and closing balance sheets, a transfer of IFRS profits from life and related business to the appropriate segment is deemed to occur. An equivalent approach has been adopted for expenses within our holding companies. ------------------------------------------------------------------------------------------------------------------ Page 23 Components of life EEV return The life EEV return comprises the following components: â€¢ new business contribution written during the period including value added between the point of sale and end of the period; â€¢ the profit from existing business equal to: - the expected return on the value of the in-force covered business at the beginning of the period, - experience variances caused by the differences between the actual experience during the period and expected experience based on the operating assumptions used to calculate the start of year value, - the impact of changes in operating assumptions including risk margins; â€¢ the expected investment return on the shareholders' net worth, based upon assumptions applying at the start of the year; â€¢ investment return variances caused by differences between the actual return in the period and the expected return based on economic assumptions used to calculate the start of year value; and â€¢ the impact of changes in economic assumptions in the period. The life EEV operating return comprises the first three of these components and is calculated using economic assumptions as at the start of the year and operating (demographic, expenses and tax) assumptions as at the end of the year. Life EEV return 2005 2004 Â£m Â£m New business contribution (after the effect of required capital) 612 516 Profit from existing business - expected return 895 819 - experience variances (39) (15) - operating assumption changes 17 (7) Expected return on shareholders' net worth 329 298 ------------------------------------------------------------------------------------------------------------------ Life EEV operating return before tax 1,814 1,611 Investment return variances 2,288 501 Effect of economic assumption changes (406) (318) ------------------------------------------------------------------------------------------------------------------- Life EEV return before tax 3,696 1,794 Tax on operating profit (566) (490) Tax charge on other ordinary activities (579) (58) ------------------------------------------------------------------------------------------------------------------- Life EEV return after tax 2,551 1,246 ================================================================================================================== There were no separate development costs reported in these periods. ------------------------------------------------------------------------------------------------------------------ Page 24 New business contribution The following tables set out the premium volumes and contribution from new business written by the life and related businesses, consistent with the definition of new business set out on page 20. The contribution generated by new business written during the period is the present value of the projected stream of after tax distributable profit from that business. New business contribution before tax is calculated by grossing up the contribution after tax at the full corporation tax rate for UK business and at appropriate rates of tax for other countries. New business contribution has been calculated using the same economic assumptions as those used to determine the embedded value as at the start of the year and operating assumptions used to determine the embedded value as at the end of the year, and is rolled forward to the end of the financial period. New business contribution is shown before and after the effect of required capital, calculated on the same basis as for in-force covered business. New business sales are expressed on two bases: annual premium equivalent (APE) and the present value of future new business premiums (PVNBP). The PVNBP calculation is equal to total single premium sales received in the year plus the discounted value of regular premiums expected to be received over the term of the new contracts, and is expressed at the point of sale. The premium volumes and projection assumptions used to calculate the present value of regular premiums for each product are the same as those used to calculate new business contribution, so the components of the new business margin are on a consistent basis. New business contribution New business margin Annual premium Present value of new before the effect of before the effect of equivalent* business premiums required capital required capital** ------------- -------------------- --------------------- -------------------- 2005 2004 2005 2004 2005 2004 2005 2004 Â£m Â£m Â£m Â£m Â£m Â£m % % Life and pensions United Kingdom 1,142 1,166 9,053 9,172 265 269 2.9% 2.9% France 384 307 3,530 2,782 135 95 3.8% 3.4% Ireland 100 86 665 561 16 19 2.4% 3.4% Italy 252 198 2,294 1,799 59 48 2.6% 2.7% Netherlands (including Belgium and Luxembourg) 271 261 2,407 2,168 88 80 3.7% 3.7% Poland 42 37 285 241 14 11 4.9% 4.6% Spain 240 248 2,013 2,110 175 143 8.7% 6.8% Other Europe 121 124 739 804 7 5 0.9% 0.6% ------------------------------------------------------------------------------------------------------------------ Continental Europe 1,410 1,261 11,933 10,465 494 401 4.1% 3.9% International 193 171 1,260 1,024 49 36 3.9% 3.4% ------------------------------------------------------------------------------------------------------------------ Total (before the effect of required capital) 2,745 2,598 22,246 20,661 808 706 3.6% 3.4% ================================================================================================================== * United Kingdom APE has been restated to include NUER APE volumes of Â£37 million (2004: Â£48 million). ** New business margin represents the ratio of new business contribution before the effect of required capital to PVNBP, expressed as a percentage. New business contribution before the effect of required capital includes minority interests in 2005 of Â£156 million (2004: Â£121 million). This comprises minority interests in France of Â£19 million (2004: Â£7 million), Italy Â£35 million (2004: Â£27 million), Netherlands Â£10 million (2004: Â£10 million), Poland Â£2 million (2004: Â£2 million), Spain Â£89 million (2004: Â£75 million) and Other Europe Â£1 million (2004: nil). ------------------------------------------------------------------------------------------------------------------ Page 25 New business contribution New business margin Life and pensions Present value of new after the effect of after the effect of business premiums required capital required capital* ---------------- ----------------- ------------------ 2005 2004 2005 2004 2005 2004 Â£m Â£m Â£m Â£m % % United Kingdom** 9,053 9,172 213 215 2.4% 2.3% France 3,530 2,782 91 54 2.6% 1.9% Ireland 665 561 13 16 2.0% 2.9% Italy 2,294 1,799 36 34 1.6% 1.9% Netherlands (including Belgium and Luxembourg) 2,407 2,168 57 43 2.4% 2.0% Poland 285 241 13 9 4.6% 3.7% Spain 2,013 2,110 155 121 7.7% 5.7% Other Europe 739 804 2 - 0.3% - ------------------------------------------------------------------------------------------------------------------ Continental Europe 11,933 10,465 367 277 3.1% 2.6% International 1,260 1,024 32 24 2.5% 2.3% ------------------------------------------------------------------------------------------------------------------ Total (after the effect of required capital) 22,246 20,661 612 516 2.8% 2.5% ================================================================================================================== * New business margin represents the ratio of new business contribution after deducting the effect of required capital to PVNBP, expressed as a percentage. ** The reduction in the level of required capital in respect of UK annuities from 200% to 150% of the EU minimum has increased the 2005 new business contribution amount by Â£13 million (2004 has not been restated). New business contribution after the effect of required capital includes minority interests in 2005 of Â£120 million (2004: Â£94 million). This comprises minority interests in France of Â£10 million (2004: Â£1 million), Italy Â£21 million (2004: Â£19 million), Netherlands Â£7 million (2004: Â£8 million), Poland Â£2 million (2004: Â£2 million), Spain Â£79 million (2004: Â£64 million) and Other Europe Â£1 million (2004: nil). EEV basis - new business contribution before the effect of required capital, tax and minority interest Annual premium Present value of new New business New business equivalent business premiums contribution* margin** 2005 2004 2005 2004 2005 2004 2005 2004 Â£m Â£m Â£m Â£m Â£m Â£m % % Analysed between: - Bancassurance channels 710 587 6,075 4,976 311 242 5.1% 4.9% - Other distribution channels 2,035 2,011 16,171 15,685 497 464 3.1% 3.0% ------------------------------------------------------------------------------------------------------------------ Total 2,745 2,598 22,246 20,661 808 706 3.6% 3.4% ================================================================================================================== * Stated before the effect of required capital ** New business margin represents the ratio of new business contribution before the effect of required capital to PVNBP, expressed as a percentage. EEV basis - new business contribution after the effect of required capital, tax and minority interest Annual premium Present value of new New business New business equivalent business premiums* contribution** business*** 2005 2004 2005 2004 2005 2004 2005 2004 Â£m Â£m Â£m Â£m Â£m Â£m % % Analysed between: - Bancassurance channels 387 328 3,238 2,728 93 74 2.9% 2.7% - Other distribution channels 1,997 1,978 15,815 15,353 248 223 1.6% 1.5% ------------------------------------------------------------------------------------------------------------------ Total 2,384 2,306 19,053 18,081 341 297 1.8% 1.6% ================================================================================================================== * Stated after deducting minority interests. ** Contribution stated after deducting the effect of required capital, tax and minority interests. *** New business margin represents the ratio of new business contribution after deducting the effect of required capital, tax and minority interests to PVNBP after deducting the minority interests, expressed as a percentage. ------------------------------------------------------------------------------------------------------------------ Page 26 Post-tax internal rate of return on life and pensions new business The internal rate of return (IRR) on life and pensions new business for the Group was 12.5% for 2005 (2004: 12.3%). The internal rate of return is equivalent to the discount rate at which the present value of the post-tax cash flows expected to be earned over the life time of the business written, including allowance for the time value of options and guarantees, is equal to the total invested capital to support the writing of the business. The capital included in the calculation of the IRR is the initial capital required to pay acquisition costs and set up statutory reserves in excess of premiums received ('initial capital'), plus required capital at the same level as for the calculation of new business contribution post cost of capital. 2005 --------------------------------------------------------------------------- Internal rate of Total invested return Initial capital Required capital capital % Â£m Â£m Â£m UK 11% 331 157 488 Continental Europe France 12% 20 97 117 Ireland 10% 33 15 48 Italy 12% 9 59 68 Netherlands (including Belgium and Luxembourg) 9% 45 78 123 Poland 19% 10 4 14 Spain 27% 15 63 78 Other Europe 13% 37 43 80 International 17% 44 41 85 ------------------------------------------------------------------------------------------------------------------ Total 13% 544 557 1,101 ================================================================================================================== The total initial capital for life and pensions new business for 2005 of Â£544 million (2004: Â£600 million) shown above is expressed at the point of sale. Hence it is higher than the impact of writing that new business on net worth of Â£536 million (2004: Â£520 million) shown on page 28, because the latter amount includes expected profits from the point of sale to the end of the reporting period, partly offset by the expected return on the initial capital. Aviva's reported internal rates of return calculations are based on the total invested capital used to support the writing of the new business. However, this underestimates the returns due to the Group's shareholders as the total invested capital includes the cash flows attributable to both the Group's debt holders as well as the Group's shareholders. As the cost of debt capital is significantly lower than the Group's IRRs this underestimates the returns on new business for our shareholders measured through the reported internal rate of return calculations. The Group could equally have defined the internal rate of return calculations based on the cash flows that are attributable to the Group's shareholders as opposed to total cash flows. The effect on the reported calculation of the internal rates of return on this basis is to increase the IRR for UK Life from 10.6% to 12.3%. The revised calculation assumes that the external capital composition of the Group, 30% debt and 70% equity, is used to finance the initial and required capital, and allows for the cost of debt by deducting the relevant proportion of the Group's debt servicing costs from the future cash flows earned over the lifetime of the products. The leveraged new business returns comfortably exceed the Group's cost of equity at 31 December 2005 of 7.6% (based on a risk free rate of 4.1%, an equity risk margin of 3% and a market assessed beta of 1.17). Experience variances Experience variances include the impact of the difference between expense, demographic and persistency assumptions, and actual experience incurred in the year. Also included are variances arising from tax, where such variances are due to management action. 2005 2004 Â£m Â£m United Kingdom (93) (81) France 32 22 Netherlands (including Belgium and Luxembourg) (8) 12 Rest of Europe 21 23 International 9 9 ------------------------------------------------------------------------------------------------------------------- (39) (15) ==================================================================================================================== ------------------------------------------------------------------------------------------------------------------ Page 27 Operating assumption changes Changes in operating assumptions are made when the assumed future levels of expenses, mortality or other operating assumptions are expected to change permanently. 2005 2004 Â£m Â£m United Kingdom (57) (58) France 14 35 Netherlands (including Belgium and Luxembourg) 47 21 Rest of Europe 11 (4) International 2 (1) -------------------------------------------------------------------------------------------------------------------- 17 (7) ==================================================================================================================== Further disclosures on experience variances and operating assumption changes on an EEV basis are provided on pages 63 and 64. Geographical analysis of life EEV operating return 2005 2004 Â£m Â£m United Kingdom 585 551 Continental Europe France 321 286 Ireland 20 40 Italy 96 79 Netherlands (including Belgium and Luxembourg) 318 277 Poland 128 93 Spain 214 180 Other Europe 33 22 International 99 83 ------------------------------------------------------------------------------------------------------------------- 1,814 1,611 =================================================================================================================== Life EEV operating return includes minority interests in 2005 of Â£216 million (2004: Â£186 million). This comprises minority interests in France of Â£24 million (2004: Â£9 million), Italy Â£52 million (2004: Â£43 million), Netherlands Â£17 million (2004: Â£26 million), Poland Â£18 million (2004: Â£16 million), Spain Â£103 million (2004: Â£90 million) and Other Europe Â£2 million (2004: Â£2 million). ------------------------------------------------------------------------------------------------------------------ Page 28 Analysis of movement in life and related businesses embedded value The following tables provide an analysis of the movement in embedded value for the life and related businesses for 2005 and 2004. The analysis is shown separately for net worth and the value of in-force covered business, and includes amounts transferred between these categories. The transfer from life and related businesses to other segments consists of service company profits and losses during the reported period that have emerged from the value of in-force. Since the 'look through' into service companies includes only future profits and losses, these amounts must be eliminated from the closing embedded value. All figures are shown net of tax. 2005 ------------------------------------------- Net worth Value of in-force Total Â£m Â£m Â£m Embedded value at the beginning of the year - Free surplus 1,894 - Required capital* 4,362 Total 6,256 6,758 13,014 ------------------------------------------------------------------------------------------------------------------ New business contribution (after the effect of required capital) (536) 955 419 Expected return on existing business - return on VIF - 624 624 Expected return on existing business - transfer to net worth 929 (929) - Experience variances and operating assumption changes 96 (115) (19) Expected return on shareholders' net worth 225 - 225 Investment return variances and economic assumption changes 785 517 1,302 ------------------------------------------------------------------------------------------------------------------ Life EEV return after tax 1,499 1,052 2,551 Exchange rate movements (54) (45) (99) Embedded value from business disposed of (19) (19) (38) Amounts injected into life and related businesses 266 - 266 Amounts released from life and related businesses (751) - (751) Transfer from life and related businesses to other segments 23 - 23 UK Life pension fund deficit transferred to analysis of net assets on an EEV basis** - 147 147 ------------------------------------------------------------------------------------------------------------------ Embedded value at the end of the year - Free surplus 2,772 - Required capital* 4,448 Total 7,220 7,893 15,113 ================================================================================================================== * Required capital is shown net of implicit items permitted by local regulators to cover minimum solvency margins. ** Reflecting CFO Forum guidance the pension scheme deficit is now being accounted for on an IAS 19 basis. Consequently, the element that had previously been included in the Life EEV analysis, being the present value of agreed deficit funding payments, has been removed from the Life EEV analysis. The embedded value of business disposed of in 2005 of Â£38 million represents the embedded value of the business in Portugal and Delta Lloyd's stake in ENNIA Caribe, a Dutch Antilles and Aruba based insurer. Required capital has increased in the year by Â£86 million. The movement comprises an increase of Â£557 million in relation to new business written, a reduction of Â£415 million in relation to in-force business and a reduction of Â£56 million in relation to movements in foreign exchange rates. The reduction in the in-force required capital includes a release of Â£245 million arising from the restructure of the UK non-profit funds and a release of Â£295 million arising from the reduction in the level of required capital for UK annuities. The underlying increase in the in-force required capital of Â£125 million reflects the effect of the reduction in long-term interest rates, which has increased statutory reserves and, therefore, capital requirements and which has more than offset the reduction in capital in respect of business run-off. 2004 ------------------------------------------- Net worth Value of in-force Total Â£m Â£m Â£m Embedded value at the beginning of the year - Free surplus 1,721 - Required capital* 4,114 Total 5,835 5,916 11,751 ------------------------------------------------------------------------------------------------------------------ New business contribution (after the effect of required capital) (520) 875 355 Expected return on existing business - return on VIF - 576 576 Expected return on existing business - transfer to net worth 738 (738) - Experience variances and operating assumption changes (98) 79 (19) Expected return on shareholders' net worth 208 - 208 Investment return variances and economic assumption changes 167 (41) 126 ------------------------------------------------------------------------------------------------------------------ Life EEV return after tax 495 751 1,246 Exchange rate movements 51 68 119 Embedded value of businesses acquired 79 23 102 Amounts injected into life and related businesses 324 - 324 Amounts released from life and related businesses (576) - (576) Transfer from life and related businesses to other segments 48 - 48 ------------------------------------------------------------------------------------------------------------------ Embedded value at the end of the year - Free surplus 1,894 - Required capital* 4,362 Total 6,256 6,758 13,014 ================================================================================================================== * Required capital is shown net of implicit items permitted by local regulators to cover minimum solvency margins. The embedded value of business acquired in 2004 of Â£102 million represents the total embedded value of Antarius, the bancassurance joint venture with Credit du Nord in France. ------------------------------------------------------------------------------------------------------------------ Page 29 Segmental analysis of life and related businesses embedded value Value of in-force Net worth covered business Total --------------- ----------------------- -------------- Cost of Required Free Present value required capital* surplus of in-force capital Embedded value 31 December 2005 Â£m Â£m Â£m Â£m Â£m United Kingdom 1,120 673 4,916 (396) 6,313 Continental Europe France 1,131 133 1,009 (206) 2,067 Ireland 144 142 372 (19) 639 Italy 285 317 170 (56) 716 Netherlands (including Belgium and Luxembourg) 1,024 1,068 1,253 (321) 3,024 Poland 104 109 464 (30) 647 Spain 243 19 515 (52) 725 Other 90 75 116 (25) 256 International 307 236 265 (82) 726 ------------------------------------------------------------------------------------------------------------------- 4,448 2,772 9,080 (1,187) 15,113 =================================================================================================================== * Required capital is shown net of implicit items permitted by local regulators to cover minimum solvency margins. Value of in-force Net worth covered business Embedded value --------------- ----------------------- -------------- 2005 2004 2005 2004 2005 2004 Â£m Â£m Â£m Â£m Â£m Â£m United Kingdom 1,793 1,933 4,520 3,681 6,313 5,614 Continental Europe France 1,264 1,121 803 698 2,067 1,819 Ireland 286 281 353 334 639 615 Italy 602 424 114 114 716 538 Netherlands (including Belgium and Luxembourg) 2,092 1,454 932 1,023 3,024 2,477 Poland 213 188 434 369 647 557 Spain 262 222 463 362 725 584 Other 165 149 91 64 256 213 International 543 484 183 113 726 597 ------------------------------------------------------------------------------------------------------------------- 7,220 6,256 7,893 6,758 15,113 13,014 =================================================================================================================== The shareholders' net worth is the market value of the shareholders' funds and the shareholders' interest in the surplus held in the non-profit component of the long-term business funds, determined on a statutory solvency basis and adjusted to add back any non-admissible assets. Required capital, net of implicit items, of Â£4,448 million at 31 December 2005 (31 December 2004: Â£4,362 million) is included within the net worth. The value of in-force covered business includes the effect of holding shareholders' capital to support the level of required capital and allowing for projected future releases. This impact reduces the value of in-force covered business at 31 December 2005 by Â£1,187 million (31 December 2004: Â£1,195 million). The embedded value at the end of 2005 includes minority interests of Â£1,000 million (2004: Â£796 million). This comprises minority interests in France of Â£148 million (2004: Â£120 million), Italy Â£365 million (2004: Â£276 million), Netherlands Â£70 million (2004: Â£59 million), Poland Â£106 million (2004: Â£90 million), Spain Â£310 million (2004: Â£244 million) and Other Europe Â£1 million (2004: Â£7 million). ------------------------------------------------------------------------------------------------------------------ Page 30 Time value of options and guarantees The following table sets out the time value of options and guarantees relating to covered business by territory at 31 December 2005 and 31 December 2004. 2005 2004 Â£m Â£m United Kingdom 48 44 Continental Europe France 84 79 Ireland 3 4 Italy 19 14 Netherlands (including Belgium and Luxembourg) 101 92 Poland 5 5 Spain 8 9 Other Europe 19 18 International 16 9 ------------------------------------------------------------------------------------------------------------------- 303 274 =================================================================================================================== The time value of options and guarantees (TVOG) is most significant in the United Kingdom, France and the Netherlands. In the United Kingdom, this relates mainly to non-market value adjustment (MVA) guarantees on unitised with-profit business and guaranteed annuity rates. In France, this relates mainly to guaranteed crediting rates and surrender values on traditional business including the AFER fund. In the Netherlands, this relates mainly to maturity guarantees on unit-linked products and interest rate guarantees on traditional individual and group profit sharing business. The TVOG has increased over the year to Â£303 million primarily due to the allowance included in new business contribution of Â£31 million. Also included is an increase of Â£16 million due to the 40 basis points fall in bond yields in continental Europe during 2005 which has largely been offset by the favourable impacts of investment returns and exchange rates. Minority interest in life and related businesses' EEV results 2005 2004 ------------------------------------ ------ Shareholders' Minority interest interest Group Group Â£m Â£m Â£m Â£m New business contribution before effect of required capital 652 156 808 706 Effect of required capital (160) (36) (196) (190) -------------------------------------------------------------------------------------------------------------------- New business contribution including effect of required capital 492 120 612 516 =================================================================================================================== Life EEV operating return before tax 1,598 216 1,814 1,611 =================================================================================================================== Life EEV return before tax 3,456 240 3,696 1,794 Attributed tax (1,065) (80) (1,145) (548) -------------------------------------------------------------------------------------------------------------------- Life EEV return after tax 2,391 160 2,551 1,246 =================================================================================================================== Closing life and related businesses' embedded value 14,113 1,000 15,113 13,014 =================================================================================================================== ------------------------------------------------------------------------------------------------------------------ Page 31 Principal economic assumptions - deterministic calculations Economic assumptions are derived actively, based on market yields on risk-free fixed interest assets at the end of each reporting period. The same margins are applied on a consistent basis across the Group to gross risk-free yields to obtain investment return assumptions for ordinary shares and property and to produce risk discount rates. Additional country-specific risk margins are applied to smaller businesses to reflect additional economic, political and business-specific risk, which result in the application of risk margins ranging from 3.7% to 8.7% in our eastern European and Asian business operations. Expense inflation is derived as a fixed margin above a local measure of long-term price inflation. Risk free rates and price inflation have been harmonised across territories within the Euro currency zone, except for expense inflation in Ireland where significant differences remain. Required capital is shown as a multiple of the EU statutory minimum solvency margin. Investment return assumptions are generally derived by major product class, based on hypothecating the assets at the valuation date. Future assumed reinvestment rates are consistent with implied market returns at 31 December 2006. Rates have been derived using rates from the current yield curve at a duration based on the term of the liabilities, or directly from forward yield curves where considered appropriate. Assumptions about future investment mix are consistent with long-term plans. In most cases, the investment mix is assumed to continue unchanged throughout the projection period. The changes in assumptions between reporting dates reflect the actual movements in risk free yields in the United Kingdom, the Eurozone and other territories. The principal economic assumptions used are as follows: United Kingdom France ----------------------------- ---------------------- 2005 2004 2003 2005 2004 2003 Risk discount rate 6.8% 7.3% 7.5% 6.0% 6.4% 7.0% Pre-tax investment returns: Base government fixed interest 4.1% 4.6% 4.8% 3.3% 3.7% 4.3% Ordinary shares 7.1% 7.6% 7.8% 6.3% 6.7% 7.3% Property 6.1% 6.6% 6.8% 5.3% 5.7% 6.3% Future expense inflation 3.2% 3.3% 3.4% 2.5% 2.5% 2.5% Tax rate 30.0% 30.0% 30.0% 34.4% 34.9% 35.4% Required Capital (% EU minimum) 150%/100% 200%/100% 200%/100% 115% 115% 115% Ireland Italy ------------------------------ ---------------------- 2005 2004 2003 2005 2004 2003 Risk discount rate 6.0% 6.4% 7.0% 6.0% 6.4% 7.0% Pre-tax investment returns: Base government fixed interest 3.3% 3.7% 4.3% 3.3% 3.7% 4.3% Ordinary shares 6.3% 6.7% 7.3% 6.3% 6.7% 7.3% Property 5.3% 5.7% 6.3% 5.3% 5.7% 6.3% Future expense inflation 4.0% 4.0% 4.0% 2.5% 2.5% 2.5% Tax rate 12.5% 12.5% 12.5% 38.3% 38.3% 39.8% Required Capital (% EU minimum) 150% 150% 150% 115% 115% 115% Netherlands Poland ------------------------------- ---------------------- 2005 2004 2003 2005 2004 2003 Risk discount rate 6.0% 6.4% 7.0% 8.6% 9.7% 9.7% Pre-tax investment returns: Base government fixed interest 3.3% 3.7% 4.3% 4.9% 6.0% 6.0% Ordinary shares 6.3% 6.7% 7.3% 7.9% 9.0% 9.0% Property 5.3% 5.7% 6.3% n/a n/a n/a Future expense inflation 2.5% 2.5% 2.5% 3.3% 3.4% 3.4% Tax rate 29.1% 31.5% 25.0% 19.0% 19.0% 19.0% Required Capital (% EU minimum) 150% 150% 150% 150% 150% 150% Spain ------------------------------ 2005 2004 2003 Risk discount rate 6.0% 6.4% 7.0% Pre-tax investment returns: Base government fixed interest 3.3% 3.7% 4.3% Ordinary shares 6.3% 6.7% 7.3% Property 5.3% 5.7% 6.3% Future expense inflation 2.5% 2.5% 2.5% Tax rate 35.0% 35.0% 35.0% Required Capital (% EU minimum) 125%/110% 125%/110% 125%/110% For service companies, expense inflation relates to the underlying expenses rather than the fees charged to the life company. Future returns on corporate fixed interest investments are calculated from prospective yields less an adjustment for credit risk. Required capital in the United Kingdom is 150% EU minimum for Norwich Union Annuity Limited and 100% for other companies. Required capital in Spain is 125% EU minimum for Aviva Vida y Pensiones and 110% for bancassurance companies. Other economic assumptions Required capital relating to with-profit business is assumed to be covered by the surplus within the with-profit funds and no effect has been attributed to shareholders. ------------------------------------------------------------------------------------------------------------------ Page 32 Bonus rates on participating business have been set at levels consistent with the economic assumptions and Aviva's medium-term bonus plans. The distribution of profit between policyholders and shareholders within the with-profit funds assumes that the shareholder interest in conventional with-profit business in the United Kingdom and Ireland continues at the current rate of one ninth of the cost of bonus. Principal economic assumptions - stochastic calculations The time value of options and guarantees calculation allows for expected management and policyholder actions in response to varying future investment conditions. The management actions modelled include changes to asset mix and bonus rates. Modelled policyholder actions are described under 'Other assumptions'. This section describes the models used to generate future investment simulations, and gives some sample statistics for the simulations used. Two separate models have been used, for the UK businesses and for the Europe (excluding UK) and International businesses, as each of these models better reflect the characteristics of the businesses. United Kingdom Model Overall asset returns have been generated assuming that the portfolio total return has a lognormal distribution. The mean and standard deviation of the overall asset return have been calculated using the evolving asset mix of the fund and assumptions over the mean and standard deviation of each asset class, together with correlations between them. Asset Classes The significant asset classes for UK participating business are equities, property and long-term fixed rate bonds. The most significant assumption is the distribution of future long-term interest rates, since this is the most important factor in the cost of guaranteed annuity options. Summary Statistics The following table sets out the means and standard deviations (StDev) of future returns at 31 December 2005 for the three most significant asset classes. Interest rates are assumed to have a lognormal distribution with an annualised standard deviation of 13% p.a. for the natural logarithm of the interest rate. Mean* StDev** --------------------- Equities 7.1% 20% Property 6.1% 15% Government Bonds 4.1% 3.25-4.75%*** * Means have been calculated by accumulating a unit investment for the required number of years in each simulation, averaging the accumulation across all simulations, and converting the result to an equivalent annual rate (by taking the nth root of the average accumulation minus 1). ** Standard deviations have been calculated by accumulating a unit investment for the required number of years in each simulation, taking the natural logarithm of the result, calculating the variance of this statistic, dividing by the projection period (n years) and taking the square root. This makes the result comparable to implied volatilities quoted in investment markets. *** Depending on the duration of the portfolio. For the UK, the statistics are the same over all projection horizons. Assumptions are also required for correlations between asset classes. These have been set based on an assessment of historical data. Returns for corporate fixed interest investments in each scenario are equal to the return on Government bonds plus a fixed additional amount, based on current spreads less a margin for credit risk. Europe (excluding UK) and International Model Government nominal interest rates are generated by a model that projects a full yield curve at annual intervals. The model assumes that the logarithm of the short rate follows a mean reverting process subject to two normally distributed random shocks. This ensures that nominal interest rates are always positive, the distribution of future interest rates remains credible, and the model can be calibrated to give a good fit to the initial yield curve. The total annual return on equities is calculated as the return on 1 year bonds plus an excess return. The excess return is assumed to have a lognormal distribution. The model also generates property total returns and real yield curves, although these are not significant asset classes for Aviva outside the UK. Asset Classes The most important assets are fixed rate bonds of various durations. In some businesses equities are also an important asset class. Summary Statistics The following table sets out the means and standard deviations of future euro returns at 31 December 2005 for the three most significant asset classes: equities, short-term bonds (defined to be of 1 year duration) and long-term bonds (defined to be 10 year zero coupon bonds). In the accumulation of 10 year bonds, it is assumed that these are held for one year, sold as 9 year bonds then the proceeds are reinvested in 10 year bonds, although in practice businesses follow more complex asset strategies or tend to adopt a buy and hold strategy. Correlations between asset classes have been set using the same approach as described for the United Kingdom. ------------------------------------------------------------------------------------------------------------------ Page 33 5- year return 10- year return 20- year return ------------------ ------------------- -------------------- Mean* StDev** Mean* StDev** Mean* StDev** ------------------------------------------------------------------------------------------------------------------- Short Government Bonds 3.0% 1.5% 3.2% 2.9% 3.5% 5.3% Long Government Bonds 3.5% 3.8% 3.7% 3.0% 3.9% 3.3% Equities 6.2% 19.5% 6.4% 19.3% 6.5% 19.0% * Means have been calculated by accumulating a unit investment for the required number of years in each simulation, averaging the accumulation across all simulations, and converting the result to an equivalent annual rate (by taking the nth root of the average accumulation minus 1). ** Standard deviations have been calculated by accumulating a unit investment for the required number of years in each simulation, taking the natural logarithm of the result, calculating the variance of this statistic, dividing by the projection period (n years) and taking the square root. This makes the result comparable to implied volatilities quoted in investment markets. Other assumptions Taxation Current tax legislation and rates have been assumed to continue unaltered, except where changes in future tax rates have been announced. Demographic assumptions Assumed future mortality, morbidity and lapse rates have been derived from an analysis of Aviva's recent operating experience. Where appropriate, surrender and option take up rate assumptions that vary according to the investment scenario under consideration have been used in the calculation of the time value of options and guarantees, based on our assessment of likely policyholder behaviour in different investment scenarios. Expense assumptions Management expenses and operating expenses of holding companies attributed to life and related businesses have been included in the EEV calculations and split between expenses relating to the acquisition of new business, the maintenance of business in-force and project expenses. Future expense assumptions include an allowance for maintenance expenses and a proportion of recurring project expenses. Certain expenses of an exceptional nature, when they occur, are identified separately and are generally charged as incurred. No future productivity gains have been anticipated. Where subsidiary companies provide administration, investment management or other services to businesses included in the European Embedded Value calculations, the value of profits or losses arising from these services have been included in the embedded value and new business contribution. Other It has been assumed that there will be no changes to the methods and bases used to calculate the statutory technical provisions and current surrender values, except where driven by varying future investment conditions under stochastic economic scenarios. Valuation of debt Borrowings in the EEV consolidated balance sheet are valued on an IFRS basis, consistent with the primary financial statements. At 31 December 2005 the market value of the Group's external debt, subordinated debt, preference shares including General Accident plc preference shares of Â£250 million (classified as minority interests) and direct capital instrument was Â£5,868 million (31 December 2004: Â£5,953 million). 2005 2004 Â£m Â£m Borrowings per summarised consolidated balance sheet - EEV basis 11,013 10,090 Less: Securitised mortgage funding (6,303) (5,193) ------------------------------------------------------------------------------------------------------------------- Borrowings excluding non-recourse funding - EEV basis 4,710 4,897 Less: Operatonal financing by businesses (900) (598) ------------------------------------------------------------------------------------------------------------------ External debt and subordinated debt - EEV basis 3,810 4,299 Add: Preference shares (including General Accident plc) and direct capital instrument 1,440 1,440 ------------------------------------------------------------------------------------------------------------------ External debt, subordinated debt, preference shares and direct capital instrument - EEV basis 5,250 5,739 Effect of marking these instruments to market 618 214 ------------------------------------------------------------------------------------------------------------------ Market value of external debt, subordinated debt, preference shares and direct capital instrument 5,868 5,953 ================================================================================================================== ------------------------------------------------------------------------------------------------------------------ Page 34 Sensitivity analysis - economic assumptions The tables below show the sensitivity of the embedded value as at 31 December 2005 and the new business contribution before the effect of required capital for 2005 to: â€¢ one percentage point increase and decrease in the discount rates; â€¢ one percentage point increase and decrease in interest rates, including all consequential changes (including assumed investment returns for all asset classes, market values of fixed interest assets, risk discount rates); â€¢ one percentage point increase and decrease in the assumed investment returns for equity and property investments, excluding any consequential changes to the risk discount rate; â€¢ 10% rise and fall in market value of equity and property assets (not applicable for new business contribution); and â€¢ decrease in the level of required capital to 100% EU minimum (or equivalent) (not applicable for new business contribution). In each sensitivity calculation, all other assumptions remain unchanged except where they are directly affected by the revised economic conditions. For example, future bonus rates are automatically adjusted to reflect sensitivity changes to future investment returns. Embedded value As reported on 1% increase in 1% decrease in 1% increase in 1% decrease in (net of tax) page 29 discount rates discount rates interest rates interest rates 31 December 2005 Â£m Â£m Â£m Â£m Â£m United Kingdom 6,313 (450) 535 (300) 345 Continental Europe France 2,067 (125) 140 (75) 60 Ireland 639 (30) 35 (30) 30 Italy 716 (20) 20 25 (40) Netherlands (including Belgium and Luxembourg) 3,024 (130) 160 165 (410) Poland 647 (30) 35 (5) 5 Spain 725 (45) 50 (35) 35 Other 256 (10) 10 10 (35) International 726 (30) 30 (20) 5 ------------------------------------------------------------------------------------------------------------------ 15,113 (870) 1,015 (265) (5) =================================================================================================================== 1% increase in 1% decrease in 10% rise in 10% fall in EU equity/ equity/ equity/ equity/ minimum Embedded value As reported on property property property property capital (net of tax) page 29 returns returns market values market values (or equivalent) 31 December 2005 Â£m Â£m Â£m Â£m Â£m Â£m United Kingdom 6,313 220 (225) 395 (400) 90 Continental Europe France 2,067 70 (65) 125 (135) 35 Ireland 639 20 (20) 35 (35) 5 Italy 716 10 (5) 15 (15) 5 Netherlands (including Belgium and Luxembourg) 3,024 275 (310) 335 (335) 100 Poland 647 5 (5) 5 (5) 10 Spain 725 20 (25) 15 (15) 5 Other 256 5 (10) 10 (10) 10 International 726 5 (5) 5 (5) 15 -------------------------------------------------------------------------------------------------------------------- 15,113 630 (670) 940 (955) 275 ==================================================================================================================== In general, the magnitude of the sensitivities will reflect the size of the embedded values, though this will vary as the sensitivities have different impacts on the different components of the embedded value. In addition, other factors can have a material impact, such as the nature of the options and guarantees, as well as the types of investments held. The interest rate sensitivity will vary significantly by territory, depending on the type of business written: for example, where non-profit business is well matched by backing assets, the favourable impact of reducing the risk discount rate is the dominant factor. Sensitivities will also vary according to the current economic assumptions, mainly due to the impact of changes to both the intrinsic cost and time value of options and guarantees. Options and guarantees are the main reason for the asymmetry of the sensitivities where the guarantee impacts to different extents under the different scenarios. This can be seen in the sensitivity of a 1% movement in the interest rate for the Netherlands, where there is a significant amount of business with investment return guarantees. The reduction of 40 basis points to the assumed pre-tax investment returns at 31 December 2005 has significantly increased this sensitivity, reflecting the level of the guarantees relative to the interest rate assumption. ------------------------------------------------------------------------------------------------------------------ Page 35 Sensitivities to a 1% movement in the equity/property return will only impact the value of the in-force covered business, whereas a 10% movement in equity/property values may impact both the net worth and the value of in-force, depending on the allocation of assets. New business contribution before required capital As reported 1% increase in 1% decrease in 1% increase in 1% decrease in (gross of tax) on page 24 discount rates discount rates interest rates interest rates 2005 Â£m Â£m Â£m Â£m Â£m United Kingdom 265 (58) 70 (28) 35 Continental Europe France 135 (13) 15 (1) (3) Ireland 16 (4) 5 4 - Italy 59 (2) 3 4 (8) Netherlands (including Belgium and Luxembourg) 88 (11) 14 22 (50) Poland 14 (1) 1 - - Spain 175 (12) 14 (8) 9 Other 7 (3) 1 1 (5) International 49 (7) 8 (6) 3 ------------------------------------------------------------------------------------------------------------------ 808 (111) 131 (12) (19) =================================================================================================================== New business contribution before required capital As reported 1% increase in 1% decrease in (gross of tax) on page 24 equity/property returns equity/property returns 2005 Â£m Â£m Â£m United Kingdom 265 25 (25) Continental Europe France 135 6 (6) Ireland 16 3 (3) Italy 59 1 (1) Netherlands (including Belgium and Luxembourg) 88 16 (16) Poland 14 - - Spain 175 1 (1) Other 7 1 (1) International 49 1 (1) -------------------------------------------------------------------------------------------------------------------- 808 54 (54) ==================================================================================================================== One of the key assumptions underpinning the new business contribution is the appropriate level of required capital supporting different types of products. The effect of the assumptions relating to levels of required capital is most significant in relation to annuity business written in the UK. Following a review of the Individual Capital Assessment results in the third quarter of 2005, Aviva concluded that the appropriate level of capital required to support the risks for this business is equivalent to 150% (2004: 200%) of the EU required minimum margins (RMM), notwithstanding the prudent margins incorporated in the technical provisions. This brings the required capital used to report business performance closer in line with the economic capital required to support the business. Changing the assumption of the required capital backing annuities to 100%, increases the reported value of new business contribution reported after the effect of required capital for 2005 by Â£13 million and increases the embedded value by Â£90 million, as shown on page 34. ------------------------------------------------------------------------------------------------------------------ Page 36 Sensitivity analysis - non-economic assumptions The tables below show the sensitivity of the embedded value as at 31 December 2005 and the new business contribution before the effect of required capital for 2005 to the following changes in non-economic assumptions: â€¢ 10% decrease in maintenance expenses (a 10% sensitivity on a base expense assumption of Â£10pa would represent an expense assumption of Â£9pa). Where there is a 'look through' into service company expenses, the fee charged by the service company is unchanged while the underlying expense decreases; â€¢ 10% decrease in lapse rates (a 10% sensitivity on a base assumption of 5%pa would represent a lapse rate of 4.5%pa); â€¢ 10% decrease in both mortality and morbidity rates. No future management actions are modelled in reaction to the changing non-economic assumptions. In each sensitivity calculation, all other assumptions remain unchanged. 10% decrease in 10% decrease in Embedded value As reported maintenance 10% decrease in mortality/ (net of tax) on page 29 expenses lapse rates morbidity rates 31 December 2005 Â£m Â£m Â£m Â£m United Kingdom 6,313 205 70 (120) Continental Europe France 2,067 35 30 35 Ireland 639 10 10 5 Italy 716 5 - 5 Netherlands (including Belgium and Luxembourg) 3,024 70 10 (65) Poland 647 20 35 15 Spain 725 10 30 15 Other 256 5 5 - International 726 10 10 20 ------------------------------------------------------------------------------------------------------------------- 15,113 370 200 (90) ==================================================================================================================== New business contribution 10% decrease in 10% decrease in before required capital As reported maintenance 10% decrease in mortality/ (gross of tax) on page 24 expenses lapse rates morbidity rates 2005 Â£m Â£m Â£m Â£m United Kingdom 265 22 19 11 Continental Europe France 135 6 6 6 Ireland 16 2 2 1 Italy 59 2 3 2 Netherlands (including Belgium and Luxembourg) 88 8 4 2 Poland 14 1 2 3 Spain 175 4 17 9 Other 7 - 1 (1) International 49 3 4 4 ------------------------------------------------------------------------------------------------------------------- 808 48 58 37 =================================================================================================================== The demographic sensitivities shown above represent a standard change to the assumptions for all products. Different products will be more or less sensitive to the change, and impacts may partially offset. END OF PART 2 OF 4 This information is provided by RNS The company news service from the London Stock Exchange

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