Restatement for EEV Part 1

Aviva PLC 13 January 2005 PART 1 OF 3 13 January 2005 AVIVA ANNOUNCES RESTATEMENT OF FINANCIAL INFORMATION UNDER THE EUROPEAN EMBEDDED VALUE (EEV) PRINCIPLES • Aviva is the first European life insurer to fully implement the EEV principles, and will use this basis for reporting its 2004 preliminary results on 9 March 2005, in place of the previous Achieved Profits basis. • In adopting the EEV principles there has been no material change to the Group operating profit for the periods to 30 June 2004 and 31 December 2003. • The adoption of the EEV principles provides enhanced disclosures on life business capital requirements, the cost of options and guarantees and key economic and operating assumption sensitivities. • The restated embedded value (EV) includes a deduction £132 million at 30 June 2004 for the cost of funding the life element of pension fund deficit. • The overall impact on the embedded value is a reduction of less than 5% at each reporting date of 30 June 2004, 31 December 2003 and 31 December 2002. • Analyst meeting and teleconference at 9:30am (GMT) today. Details in notes to editors. Andrew Moss, Aviva's group finance director, said: 'We believe embedded value methodology remains the best way to value life businesses and the early adoption of the Eurpoean Embedded Value principles aligns our reported results to the sophisticated techniques and management practices employed to run our life business. Investment markets already include allowances for many of the factors taken into account in these EEV numbers. 'There is no change to the reporting basis for our statutory results, the regulatory capital position or our dividend paying capacity.' 'As the EEV principles are adopted across the European insurance sector there will be greater transparency and comparability for investors, which we welcome.' Restatement of key performance indicators 30 June 2004 31 December 2003 ------------------------- ------------------------- Restated Achieved Restated Achieved Embedded Profits Embedded Profits Value Basis Value Basis New business contribution* - before the effect of required capital £338m £324m £646m £621m New business contribution* - after the effect of required capital £251m £246m £474m £472m Operating profit** £1,145m £1,130m £1,906m £1,907m Total shareholders' funds £10,544m £11,054m £10,752m £11,165m Net asset value per share*** 474p 496p 484p 502p All operating profit is from continuing operations. * Before tax and minorities. ** Including life EEV operating return, before amortisation of goodwill and exceptional items. *** Measured on an embedded value basis. -------------------------------------------------------------------------------------------------------------------- NEWS RELEASE Enquiries: Analysts: Steve Riley Investor relations director Telephone +44 (0)20 7662 8115 James Matthews Head of investor relations Telephone +44 (0)20 7662 2137 Media: Hayley Stimpson Director of external affairs Telephone +44 (0)20 7662 7544 Sue Winston Head of group media relations Telephone +44 (0)20 7662 8221 Rob Bailhache Financial Dynamics Telephone +44 (0)20 7269 7200 Notes to editors • ANALYSTS: A presentation to investors and analysts will take place at 9:30am (GMT) at the London Underwriting Centre, 3 Minster Court, Mincing Lane, London, EC3R 7DD. There will also be a live teleconference link to the meeting on +44 (0)20 7019 9509. A replay facility will be available for two weeks on +44 (0)20 7984 7578 and enter passcode 922702# for the entire presentation including Q&A's or passcode 311192# to listen to the Q&A's only. The presentation slides will be available on the Group's website, www.aviva.com/investors/presentations.cfm from 9:00am (GMT). Photographs are available from the Aviva media centre or by clicking www.aviva.com/media • Embedded Value is a method of reporting the economic value of life insurance business. This information helps investors to value life insurance companies. Until now, the basis for preparation for this supplementary information has varied by country and in some cases by company within a country. This has made it difficult for investors and analysts to compare relative performance. • The CFO Forum www.cfoforum.nl is a high-level group formed by the Chief Financial Officers of 19 major European listed and non-listed insurance companies. Its aim is to discuss issues relating to proposed new accounting regulations for their businesses and how they can create greater transparency for investors. The Forum was created in 2002 and launched a set of embedded value principles in May 2004 ('European Embedded Value') that its members across Europe have agreed to adopt for their 2005 published accounts, with early adoption encouraged. • Aviva is one of the leading providers of life and pensions to Europe with substantial positions in other markets around the world, making it the world's fifth-largest insurance group, based on reported worldwide gross written premiums, at 31 December 2003. • Aviva's principal business activities are long-term savings, fund management and general insurance, with worldwide premium income and retail investment sales from continuing operations of £30 billion and assets under management of around £240 billion. • Overseas currency results are translated at average exchange rates. • All growth rates are quoted in local currency. • This announcement may contain 'forward looking statements' with respect to certain of Aviva's plans and its current goals and expectations relating to its future financial condition, performance and results. By their nature, all forward looking statements involve risk and uncertainty because they relate to future events and circumstances which are beyond Aviva's control, including amongst other things, UK domestic and global economic business conditions, market-related risks such as fluctuations in interest rates and exchange rates, the policies and actions of regulatory authorities, the impact of competition, inflation, deflation, the timing impact and other uncertainties of future acquisitions or combinations within relevant industries, as well as the impact of tax and other legislation and other regulations in the jurisdictions in which Aviva and its affiliates operate. As a result, Aviva's actual future financial condition, performance and results may differ materially from the plans, goals and expectations set forth in Aviva's forward-looking statements. Aviva undertakes no obligation to update the forward-looking statements contained in this presentation or any other forward-looking statements we may make. -------------------------------------------------------------------------------------------------------------------- Contents Page Adoption of European embedded value (EEV) principles and impact on results 1 Glossary 9 Summarised consolidated profit and loss account - EEV basis 10 Earnings per share - EEV basis 11 Consolidated statement of total recognised gains and losses - EEV basis 11 Reconciliation of movements in consolidated shareholders' funds 11 Summarised consolidated balance sheet - EEV basis 12 Segmentation of summarised consolidated balance sheet - EEV basis 13 Basis of preparation - EEV basis 14 Methodology 15 Components of life EEV return 17 New business contribution 18 Experience variances 19 Operating assumption changes 19 Geographical analysis of life EEV operating return 20 Analysis of movement in life and related businesses embedded value 21 Segmental analysis of life and related businesses embedded value 22 Time value of options and guarantees 23 Minority interest in life and related businesses EEV results 23 Principal economic assumptions - deterministic calculations 24 Principal economic assumptions - stochastic calculations 25 Other assumptions 26 Sensitivity analysis - economic assumptions 27 Sensitivity analysis - non-economic assumptions 29 Other notes 30 Statistical supplement: First time adoption 35 Statistical supplement: Life new business information 42 Auditors' reports 49 -------------------------------------------------------------------------------------------------------------------- PAGE 1 Adoption of European embedded value (EEV) principles and impact on results 1. Background In May 2004 the CFO Forum, a group representing the Chief Financial Officers of major European insurers, launched the European Embedded Value (EEV) principles, with the intention of improving comparability and transparency in embedded value reporting across Europe. The CFO Forum members agreed that all participants will implement the principles in the form of supplementary reporting from the 2005 year end, with optional early implementation. The Aviva plc Board has decided to adopt these principles in respect of the financial year ended 31 December 2004 and to re-state comparative financial information for the full year 2003 and the six months to 30 June 2004. The EEV principles will therefore replace the Achieved Profits basis of reporting adopted by Aviva with effect from the 2004 preliminary results announcement. The Achieved Profits basis of reporting previously adopted by Aviva, already complied with the majority of the EEV principles. Accordingly the move from the Achieved Profits basis to EEV represents an evolution of the previously adopted approach and is not a wholesale change to Aviva's value reporting basis. The Directors continue to believe that embedded value remains the best measure of value for our long-term insurance business. By adopting these principles early the Directors are seeking to achieve, through supplementary reporting, consistency and continuity of performance reporting at a time of significant and ongoing change to primary reporting arising from the two-phase approach to accounting for insurance business under International Financial Reporting Standards. The results for 2003 have been audited by the auditors, Ernst & Young LLP. The results for the six month period to 30 June 2004 are unaudited but have been reviewed by Ernst & Young LLP. Their reports in respect of the six month period to 30 June 2004 and the year to 31 December 2003 are shown on pages 49 and 50. 2. Operating results The adoption of the EEV principles has not resulted in a significant change to the group operating profit, although classifications between lines have been revised. Analysis of operating profit The group's operating profit under the EEV basis can be analysed as follows: Originally Originally Restated reported Restated reported 6 months 6 months Full year Full year 2004 2004 2003 2003 £m £m £m £m Life EEV operating return - Life businesses 792 800 1,522 1,555 - Equity release 21 - 31 - - Non-insurance service and holding companies (26) - (75) - - Fund management service companies 12 - 18 - ---------------------------------------- Total life EEV operating return 799 800 1,496 1,555 Fund management 10 17 (4) 10 Health 33 33 61 61 General insurance 613 613 911 911 Non-insurance 8 (15) 8 (64) Corporate costs (94) (94) (160) (160) Unallocated interest charges (224) (224) (406) (406) ---------------------------------------- Operating profit before tax 1,145 1,130 1,906 1,907 -------------------------------------------------------------------------------------------------------------------- Return on capital employed 14.1% 13.4% 13.1% 12.7% ==================================================================================================================== Profits and losses from the group's fund management and other service company operations arising on trading with the group's life companies were previously reported on a statutory basis and included within the fund management and non-insurance classifications. Under the EEV basis, such operating profits and losses are incorporated in the calculation of the embedded value and their EEV basis profits and losses are included within the total life EEV operating return. As a result, the fund management segment now only includes the results from the external funds under management and the results for managing the internal funds for our general insurance operations in the UK and France. Furthermore, the non-insurance segment excludes the results of Norwich Union Equity Release (NUER), and the proportion of the results of our UK Life service company and service and holding companies in France that relate to covered business. -------------------------------------------------------------------------------------------------------------------- PAGE 2 Group profit on ordinary activities The table below sets out the group operating profit before tax on an EEV basis and as previously reported under the Achieved Profits basis: Originally Originally Restated reported Restated reported 6 months 6 months Full year Full year 2004 2004 2003 2003 £m £m £m £m Operating profit before tax 1,145 1,130 1,906 1,907 Amortisation of goodwill (49) (49) (103) (103) Financial Services Compensation Scheme levy (25) (25) - - Short-term fluctuations in investment return - general insurance and shareholder business (285) (285) 83 83 Variation from longer-term investment return - life business (202) (214) 696 683 Effect of economic assumption changes 56 205 (55) 11 Change in claims equalisation provision (11) (11) (49) (49) Profit/(loss) on disposal of subsidiary and associated undertakings 6 6 (6) (6) Exceptional costs for termination of operations (50) (50) (19) (19) -------------------------------------------------------------------------------------------------------------------- Profit on ordinary activities before tax 585 707 2,453 2,507 ==================================================================================================================== The key areas that have changed are the variation from longer-term investment return and the effect of economic assumption changes. The difference in the variation from longer-term investment return is primarily as a result of the inclusion of the time value of options and guarantees, which had a positive effect in the two periods as interest rates rose. The difference in the effect of economic assumption changes arises primarily from the harmonisation of key economic assumptions across the Eurozone under EEV. 3. Shareholders' funds / embedded value The reported value of shareholders' funds, has reduced under the EEV basis, as a result of changes to the economic basis and due to the fact that explicit allowances are now made for items previously outside the scope of embedded value reporting, such as losses in service companies. Overall the reduction on shareholders' funds is principally attributable to the UK Life businesses. The value of shareholders' funds attributable to non-life businesses are unaffected, other than for the reclassification of NUER. Originally Originally Restated reported Restated reported 30 June 30 June 31 December 31 December 2004 2004 2003 2003 £m £m £m £m Life embedded value - United Kingdom 5,036 5,513 5,200 5,673 - Continental Europe 5,899 5,846 6,009 5,894 - International 538 582 542 588 ------------------------------------------- Embedded value 11,473 11,941 11,751 12,155 RBSG goodwill 211 211 218 218 Non-life business net assets(1) 2,574 2,602 2,550 2,550 ------------------------------------------- 14,258 14,754 14,519 14,923 Minority interests (963) (949) (953) (944) Subordinated debt (2,751) (2,751) (2,814) (2,814) -------------------------------------------------------------------------------------------------------------------- Total shareholders' funds 10,544 11,054 10,752 11,165 ==================================================================================================================== (1)Non-life business net assets have reduced by £28 million at 30 June 2004 due to the reclassification of NUER net assets from the non-life segment to the life insurance segment (31 December 2003: nil). 4. EEV methodology - principles and guidance The EEV principles comprise 12 main principles and supporting guidance that set out an improved approach to calculating the valuation of shareholders' interest in a life insurance company. Under the previous supplementary basis of reporting, the Group was already complying with a number of these principles. Accordingly, the Directors regard the adoption of EEV as a refinement to the Achieved Profits basis of reporting. The underlying business fundamentals are unaffected by this change. -------------------------------------------------------------------------------------------------------------------- PAGE 3 Of the 12 principles, the following affect the restatement of the Group's results: Revised economic basis: - Principle 5: Required Capital - Principle 7: Financial Guarantees and Options - Principle 10: Economic assumptions Business included in EEV calculations: - Principle 2: Covered business - Principle 9: Assessment of appropriate projection assumptions (service and holding companies) Calculation of new business contribution and margins: - Principle 8: New business and renewals In addition, Principle 12 provides details of further disclosures that must be made. In adopting EEV, Aviva has complied with all the principles and the supporting guidance. The impact on the reported results of implementing the principles set out above is described in more detail in the following sections. Revised economic basis We have re-examined the mechanism through which risk is allowed for in the overall embedded value calculation. Under the Achieved Profits basis, allowance for risk was largely captured through the risk discount rate (RDR). Risk has been allowed for within the overall EEV basis in margins in the policy liability calculations, allowance for the cost of holding capital above the regulatory minimum levels and in the explicit assessment of the cost of financial options and guarantees. We have therefore revised our approach, such that the level of risk margin in the EEV basis RDR reflects the residual risk after taking account of the other risk allowances. Principle 10 - Economic assumptions As a result of the adoption of the EEV principles, we have reviewed and reassessed all of our economic assumptions. As a consequence, risk free rates, equity and property risk premiums and expense inflation assumptions have been substantially harmonised across the Eurozone. The revised approach to setting the assumed risk margins is now based on an assessment of the Group's weighted average cost of capital (WACC) using well established capital asset pricing model (CAPM) methodology. The Group WACC has been calculated by reference to the cost of equity and the cost of debt based on the actual relative weighting at the relevant date. In arriving at the cost of equity, we have used an equity risk premium of 3% and a market assessed risk rate (beta) averaged over 2 years. Having established risk margins for the Group, these margins will be regularly reviewed, and amended in the event of a material long term change in the underlying risk margin assessment. The basis adopted produced a group-wide risk discount rate, which is equivalent to a risk margin of 2.7% above the UK pre-tax risk-free rate. When assessing risk discount rates for individual businesses within the Group, we have taken account of the relative material risks of the business written, but we have ensured that the weighted average of the risk margins adopted across the Group's businesses is consistent with the Group WACC. In practice, we have made allowance for business specific risks in the level of required capital in each territory. Hence we believe that the residual risk does not vary materially over our key UK and Continental European businesses, so a common risk margin has been adopted. Therefore the 2.7% risk margin, derived from the Group WACC methodology outlined above, was added to local risk free rates to produce the respective RDR for each of our UK and European businesses. Higher risk margins have been used to allow for higher political, business and operational risk in some small and developing businesses. Other economic assumptions used in the EEV calculations have been determined to ensure consistency with the risk discount rate. In particular, the assumption for equity returns uses the same equity risk premium of 3% as that used in assessing the Group WACC. The Group's revised approach to establishing economic assumptions (specifically investment returns, required capital and discount rates) has been reviewed by Tillinghast, a firm of actuarial consultants, who have confirmed to the Directors that, for the life business in aggregate, the approach is based on the well established capital asset pricing model theory and is in line with the EEV principles and guidance. Principle 5 - Required capital Under the EEV principles, the level of required capital is at least the minimum level of solvency capital at which the local supervisor is empowered to take action. For each business we have assessed the required capital as the amount deemed to be locked in to support the business written, based on the higher of current market and regulatory norms. We have also taken into account the Group's pricing bases and internal economic capital targets. In the UK, we have assessed the required capital for our annuity book at 200% of the EU minimum and the remainder of our non profit portfolio has been set at 100% of the EU minimum. The Directors consider that, in all cases, the level of required capital represents an appropriate level of capital to be carrying for the risks of the Group's current portfolio of business. -------------------------------------------------------------------------------------------------------------------- PAGE 4 The table below summarises the level of required capital across the business units, expressed as a percentage of the EU minimum solvency margin (or equivalent): Level of required capital United Kingdom - Annuities 200% - Unit linked and other non participating business 100% France 115% Ireland 150% Italy 115% Netherlands 150% Poland 150% Spain - Aviva Vida y Pensiones 125% - Bancassurance companies 110% Other countries 120%-200% --------------------------------------------------------------------------------------------------------------------- Weighted average 135% ===================================================================================================================== 30 June 31 December 2004 2003 £m £m Amount of required capital for in-force covered business, net of implicit items 3,980 4,114 Cost of required capital 1,120 1,049 ===================================================================================================================== Where implicit items have been allowed by local regulators, these have been deducted from the level of required capital at each balance sheet date in the table above. The cost of required capital is the difference between the required capital and the present value of projected releases of the required capital and investment earnings on assets deemed to back that capital. Principle 7 - Financial options and guarantees Under our previous methodology, the Group embedded value included an explicit allowance for the 'intrinsic value' of financial options and guarantees, which was calculated by reference to the expected cost of the guarantee under best estimate assumptions of future economic conditions. The 'time value' of options and guarantees, which represents the additional cost arising from uncertainty surrounding future economic conditions within the embedded value, was allowed for implicitly within the risk discount rate. Under the EEV methodology, the Group has explicitly calculated the time value of financial options and guarantees using sophisticated stochastic simulations. This is determined by deducting the average value of shareholder cash flows under a large number of stochastic economic scenarios from the deterministic shareholder value under best estimate assumptions. The impact of the time value of options and guarantees has not changed significantly period on period. The time value of options and guarantees across the businesses is summarised below: 30 June 31 December 2004 2003 £m £m United Kingdom 35 36 France 66 71 Ireland 6 6 Italy 11 10 Netherlands 72 76 Poland 4 4 Spain 10 10 Other Europe 10 10 International 8 9 -------------------------------------------------------------------------------------------------------------------- 222 232 ==================================================================================================================== The time value of options and guarantees is most significant in the United Kingdom, France and the Netherlands. In the United Kingdom, this relates mainly to no-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. -------------------------------------------------------------------------------------------------------------------- PAGE 5 Business included in EEV calculations Principle 2 - Covered business Consistent with the Achieved Profits basis, the EEV principles have been applied to all of the Group's life savings and pensions operations. In addition, the equity release business in the UK has also been included as covered business within the EEV calculations. Principle 9 - Assessment of appropriate projection assumptions Assumptions for operational expenses continue to be assessed using best estimates of expected experience. The EEV principles have introduced the concept of 'look through', which requires taking account of the normalised recurring level of profits or losses of the Group's life service company operations within the embedded value. In addition, the Group also looks through the service arrangement between life businesses and the in-house fund management operations that manage the assets of the life funds. The most significant arrangements are in the UK, where Norwich Union Life Services Ltd (NULS) and Morley Fund Management provide administration and investment management services respectively to all of the UK life product companies. As a result of the adoption of the look through principle, the reported UK life result on an EEV basis reflects the results of the life operations, the life service company and that element of Morley's result which relates to the management of the UK life funds. There are also similar effects for other business units with service and holding companies, though the impact is less significant. Impact of changes in expense allowances The look through value attributable to fund management is based on the level of after-tax profits in respect of services provided to the Group's life operations and has the effect of improving the embedded value of the Group by £100 million at 30 June 2004 (31 December 2003: £94 million). The EEV basis profit and loss account therefore excludes the actual statutory basis profits arising from the provision of these services to the Group's life businesses from the fund management segment. Instead the life and related businesses segment of the profit and loss account includes the experience profit or loss compared to the assumed profitability, the return on the in-force value arising from the unwind at the risk discount rate (which includes the service profits arising in the period) and the effect on the in-force value of changes to economic and operating assumptions. Furthermore, fund management service profits are also taken into account in valuing new business contribution. For administration services in the UK, under the Achieved Profits basis of reporting, the result for NULS was included within the non-insurance segment on a statutory basis and broadly comprised the difference between costs incurred and costs recharged to the product companies. The reported losses reflected, in part, the fact that NULS has been incurring maintenance expenses overruns since 2002. In addition, significant project expenditure has been incurred on productivity and cost saving initiatives including branch closures, transformation and outsourcing projects. The EEV principles require us to look through to the underlying expenses of NULS. Accordingly, the actual maintenance expenses and a normal annual level of project expense allowances relating to the product companies have been capitalised, reducing the overall embedded value of the UK life operations as these expenses are in excess of the value of the fees charged. Service company expense overruns, over and above the revised expense allowances relating to the product companies are included in the profit and loss account under the life and related businesses segment as experience losses in the period that they occur. Typically, such experience losses will represent one-off productivity enhancing project costs incurred in the year. The consequential productivity gains will be recognised in subsequent periods once they have been secured. In applying the look through principle, pension scheme costs in the UK have been allowed for at the current funding rate, including an allowance for the impact of funding the pension scheme deficit based on the agreed funding plan. As a result, the proportion of the pension scheme deficit relating to the UK life company is included within the embedded value of this business. Furthermore, the adoption of the EEV principles and the inclusion of NULS in the calculations have resulted in the recognition within EEV of the future funding obligations to the UK pension scheme in relation to future service costs. The combined impact of adopting the EEV principles in respect of NULS on the UK life business valuation is a reduction of £429 million as at 30 June 2004 (31 December 2003: £436 million). The combined impact of other non-UK service arrangements is a further reduction of £42 million at 30 June 2004. Further information is provided on page 31 and 32. -------------------------------------------------------------------------------------------------------------------- PAGE 6 Impact of EEV principles on operating return for life and related businesses The table below shows the reconciliation for life operating return from the Achieved Profits basis to the EEV basis. 6 months Full year 2004 2003 £m £m Achieved profits basis 800 1,555 Impact of changes in economic assumptions 14 15 Impact of changes in the cost of required capital (6) (24) Time value of options and guarantees (11) (12) Impact of changes in expenses (including service and holding companies) (14) (57) Other changes 16 19 ------------------------------------------------------------------------------------------------------------------- European embedded value basis 799 1,496 =================================================================================================================== Originally Originally Restated reported Restated reported 30 June 30 June 31 December 31 December 2004 2004 2003 2003 £m £m £m £m Analysed between: United Kingdom 345 356 597 659 Continental Europe 426 413 835 815 International 28 31 64 81 -------------------------------------------------------------------------------------------------------------------- 799 800 1,496 1,555 ==================================================================================================================== In the UK, the reduction of £11 million (2003: reduction of £62 million) is as a result of the inclusion of the UK Life service company on a look through basis and the consequential reduction in expected returns. This has been partially offset by the positive impact of including the results of Morley asset management business for the management of the internal funds and the Norwich Union Equity Release (NUER) business. The higher impact in 2003 reflects expense experience losses arising from one-off productivity enhancing projects which were not factored into the revised UK expense allowances. In Continental Europe, the improvement of £13 million (2003: improvement of £20 million) reflects economic assumption changes and the inclusion of the French asset management results on a look through basis, offset by changes attributable to higher levels of required capital and the time value of options and guarantees. The reduction in the International result is driven by the removal of releases of risk margins that were made in the Achieved Profits results which, following the harmonisation of the economic basis, have not been mirrored under the EEV basis. Impact of EEV principles on embedded value for life and related businesses The table below shows the reconciliation of embedded value from the Achieved Profits basis to the EEV basis in respect of covered business. 30 June 31 December 31 December 2004 2003 2002 £m £m £m Achieved profits basis 11,941 12,155 10,148 Impact of changes in economic assumptions 431 531 497 Impact of changes in the cost of required capital (319) (308) (274) Time value of options and guarantees (222) (232) (204) ------------------------------------------------------------------------------------------------------------------- Effect of revising economic basis (110) (9) 19 Impact of changes in expenses (including service and holding companies) (371) (382) (380) Other changes 13 (13) (2) ------------------------------------------------------------------------------------------------------------------- European embedded value basis 11,473 11,751 9,785 =================================================================================================================== -------------------------------------------------------------------------------------------------------------------- PAGE 7 Calculation of new business contribution, margins and internal rate of return Principle 8 - New business and renewals The Group's definition of new business under the previous methodology is consistent with Principle 8 and therefore there has been no change in our classification of premiums as new business or renewals. The overall approach to the valuation of new business is consistent with our previous methodology. However, as a result of the impact of other EEV principles, the value of new business: • allows for changes in economic assumptions including changes in required capital; • incorporates the time value of options and guarantees; • allows for look through expenses in Group-owned service and holding companies; and • includes the equity release business of NUER. On an aggregate basis, the value of new business contribution has increased both before and after the effect of required capital. Although there is limited change to the calculation of the new business contribution, the calculation of the new business margin will change substantially as new business sales are now calculated as the present value of future new business premiums (PVNBP), rather than the current UK industry standard Annual Premium Equivalent (APE) measure of annual premiums plus 10% of single premiums. The change to the basis of calculating margins produces a more meaningful ratio, since profit and income are now calculated using consistent economic and operating assumptions. New business contribution: Reconciliation of new business contribution before the effect of required capital from the Achieved Profits basis to the EEV basis 6 months Full year 2004 2003 £m £m Achieved profits basis 324 621 Impact of changes in economic assumption 27 35 Time value of options and guarantees (10) (19) Impact of changes in expenses (including service and holding companies) (4) (12) Other changes 1 21 --------------------------------------------------------------------------------------------------------------------- European embedded value basis 338 646 ===================================================================================================================== New business contribution is substantially unchanged, notwithstanding the fact that the EEV basis calculation explicitly allows for the cost of guarantees and options. The inclusion of equity release business, included within other changes, contributes £5 million for the six months to 30 June 2004 (2003: £19 million). Change in the calculation of new business premiums and margins The calculation of the present value of new business premiums is equal to the discounted value of new regular premiums plus the total amount of single premiums received in the year. The discounted value of regular premiums is based on the term and assumptions for the persistency of the contracts sold. This can be expressed as a capitalisation factor, representing the discounted value of new regular premiums divided by the annualised amount of new regular premiums. The capitalisation factor will vary across business units and over time, depending on product mix sold in each quarter and local market dynamics. Average capitalisation factors for the business units in the six months to 30 June 2004 and the full year 2003 are shown in the table below. Capitalisation factors 6 months Full year 2004 2003 United Kingdom 5.0 5.0 France 5.7 6.0 Ireland 5.2 5.5 Italy 5.9 6.5 Netherlands (including Belgium and Luxembourg) 6.8 7.0 Poland 5.9 6.1 Spain 5.9 5.5 Other Europe 5.4 4.2 International 4.0 4.0 -------------------------------------------------------------------------------------------------------------------- Group Average 5.3 5.3 ==================================================================================================================== The average Group capitalisation factor for the six months to 30 June 2004 is 5.3 and is unchanged from the equivalent factor for the full year ended 31 December 2003. However there are changes at a business unit level which have offset each other. There are reductions in France, Ireland, Italy, the Netherlands and Poland, offset by increases in Spain and Other Europe. Of the most significant movements, the reduction in Italy is driven by changes in product mix on a new portfolio of business acquired in 2003. In Spain the capitalisation factor has increased as a result of the change in the mix of pensions products sold, and in Other Europe the factor has increased as a result of changes in product mix in Lithuania and Turkey. -------------------------------------------------------------------------------------------------------------------- PAGE 8 The table below sets out restated new business margins expressed as a percentage of the present value of new business premiums (the revised margin calculated using the traditional APE definition under Achieved Profits is also shown): EEV basis Achieved profits ---------------------------------------------------------------- ------------------- New business New business Present value of New business margin(2) margin(3) new business premiums contribution(1) (using PVNBP) (using APE) 6 months Full year 6 months Full year 6 months Full year 6 months Full year 2004 2003 2004 2003 2004 2003 2004 2003 £m £m £m £m % % % % Life and pensions business United Kingdom 4,299 8,516 127 250 3.0% 2.9% 22.4% 22.4% Continental Europe 5,027 9,103 195 359 3.9% 3.9% 32.2% 32.0% International 427 1,190 16 37 3.7% 3.1% 21.6% 19.8% -------------------------------------------------------------------------------------------------------------------- Total 9,753 18,809 338 646 3.5% 3.4% 27.1% 26.6% ==================================================================================================================== (1) Before effect of solvency margin which amounted to £87 million for the 6 months 2004 (Full year 2003: £172 million). (2) EEV basis new business margin represents the ratio of new business contribution to present value of new business premiums, expressed as a percentage. (3) Achieved profits new business margin represents the ratio of new business contribution on an EEV basis to annual premium equivalent, expressed as a percentage. Both margin trends are consistent with the trend previously reported. The changes to the economic bases arising from the adoption of the EEV principles has also impacted the calculation of the post tax internal rate of return (IRR) on life and pensions new business. The restated new business IRR for the Group is lower for the 6 months to 30 June 2004 at 11.8% (2003: restated IRR at 12.4%). The reduction in IRR is mainly due to the increased cost of capital on new business and the inclusion of losses from the UK life service company, NULS. -------------------------------------------------------------------------------------------------------------------- PAGE 9 Glossary Annual premium equivalent (APE): UK industry standard for calculating life, pensions and investment new business levels. It equals the total of new annualised regular premiums plus 10% of single premiums. Covered business: the contracts to which the EEV methodology has, in line with the EEV Principles, been applied. Financial Options and Guarantees: features of the covered business conferring potentially valuable guarantees underlying, or options to change, the level or nature of policyholder benefits and exercisable at the discretion of the policyholder, whose potential value is impacted by the behaviour of financial variables. Free Surplus: the amount of any capital and surplus allocated to, but not required to support, the in-force covered business. Gross risk free yields: gross of tax yields on risk free fixed interest investments, generally Government bonds. Holding Company: a legal entity with a function of being a consolidating entity for primary financial reporting of covered business. Implicit items: amounts allowed by local regulators to be deducted from capital amounts when determining the EU required minimum margin. Life EEV operating return: operating return on the EEV basis relating to the lines of business included in the embedded value calculations. Life EEV return: total return on the EEV basis relating to the lines of business included in the embedded value calculations. Look-through basis: inclusion of 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. Net asset value per share: net asset value divided by the number of ordinary shares in issue. Net asset value is based on equity shareholders' funds, adding back the equalisation provision at 30 June 2004 of £375 million (31 December 2003: £364 million). New business margin: new business margins are calculated as the new business contribution divided by the present value of future new business premiums (PVNBP), and expressed as a percentage. Previously, under the Achieved Profits basis, they were expressed as new business contribution divided by premiums measured on an annual premium equivalent (APE) basis. Present value of new business premiums (PVNBP): Present value of new regular premiums plus 100% of single premiums, calculated using assumptions consistent with those used to determine new business contribution. Required Capital: the amount of assets, over and above the value placed on liabilities in respect of covered business, whose distribution to shareholders is restricted. Service companies: companies providing administration or fund management services to the covered business. Statutory Basis: the valuation basis and approach used for reporting financial statements to local regulators. Stochastic Techniques: techniques that incorporate the potential future variability in assumptions affecting their outcome. Time Value and Intrinsic Value: a financial option or guarantee has two elements of value, the time value and intrinsic value. The intrinsic value is the discounted value of the option or guarantee at expiry, assuming that future economic conditions follow best estimate assumptions. The time value is the additional value arising from uncertainty about future economic conditions. END OF PART 1 OF 3 This information is provided by RNS The company news service from the London Stock Exchange

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