Aviva 2005 Annual Report Download - page 41

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Business review
Aviva plc 2005
We are subject to a number of regulatory capital tests and
also employ a number of realistic scenario tests to allocate
capital and manage risk. Overall, the group and its subsidiaries
satisfy all existing requirements. The ratings of our main operating
subsidiaries are AA/AA- (“very strong”) with a stable outlook
from Standard and Poor’s and Aa2 (“excellent”) from Moody’s.
The ratings were reaffirmed in November 2005 reflecting our
financial and capital strength, strong underlying earnings and
positive strategic management.
We measure our capital using a number of different bases which
include measures that comply with the regulatory regime and
measures that the directors consider appropriate for the
management of the business. The measures which we use are:
Accounting bases
We are required to report our results on an International Financial
Reporting Standards basis. However, the directors consider that
the European Embedded Value (EEV) methodology provides a more
accurate and meaningful reflection of the value of the group’s
life operations. Accordingly, we analyse and measure the net asset
value and total capital employed for the group on an EEV basis.
Regulatory bases
Relevant capital and solvency regulations are used to measure
and report the financial strength of our insurance subsidiaries.
These measures are based on local regulatory requirements and
consolidated under the European Insurance Groups Directive
(IGD). The regulatory capital tests verify that we retain an excess
of solvency capital above the required minimum level calculated
using a series of prudent assumptions about the type of business
written by our insurance subsidiaries.
In addition to the FSA realistic reporting regime, the UK Accounting
Standards Board requires certain capital disclosures to be made in
accordance with Financial Reporting Standard 27, Life Assurance
(FRS 27). The purpose of the capital statement is to set out the
financial strength of the entity and to provide an analysis of the
disposition and constraints over the availability of capital to meet
risks and regulatory requirements. The disclosures required by FRS
27 are set out in Note 49 on pages 176 to 178.
Economic bases
We have developed a framework using ICA principles for
identifying the risks that business units and the group as a whole
are exposed to and quantifying their impact on economic capital.
The ICA estimates the capital required to mitigate the risk of
insolvency to a 99.5% confidence level over a one year time
horizon against financial and non-financial tests.
Currently, our ICA uses a mixture of scenario based approaches and
risk-based capital models. The Financial Services Authority (FSA) will
use the results of our ICA process when discussing the target levels
of capital it believes the UK regulated businesses should maintain.
We have been discussing our ICA with the FSA over the past six
months and we expect to conclude discussions shortly.
Group capital strength and solvency
We continue to develop our risk-based capital modelling capability
for all our businesses as part of our longer-term development
programme for more complex risk modelling techniques, and to
operate increasingly our business by reference to economic and
risk-based capital requirements.
Group
Accounting bases
Our capital funding, from all sources, has been allocated so that
the capital employed by trading operations is greater than the
capital provided to those operations by the shareholders and its
subordinated debt holders. As a result, we are able to enhance
the returns earned on our equity capital.
At 31 December the group as a whole had £23.0 billion (2004:
£19.3 billion) of total capital employed in its trading operations,
financed by a combination of equity shareholders’ funds,
preference share capital, subordinated debt and borrowings.
2005 2004
Shareholders’ funds – EEV basis £17.5bn £14.0bn
Total capital employed £23.0bn £19.3bn
Net asset value per share 622p 511p
Shareholders’ funds have increased to £17.5 billion (2004:
£14.0 billion), reflecting strong operational performance in the
year and the capital raised as part of the acquisition of RAC in May.
Accordingly, our net asset value per ordinary share, based on equity
shareholders' funds, was higher at 622 pence per share.
Regulatory bases – EU group’s directive
2005 2004
Insurance Groups Directive (IGD) £3.5bn £3.6bn
Cover (times) 1.8 times 1.9 times
At 31 December 2005, we had an estimated excess regulatory
capital of £3.5 billion (31 December 2004: £3.6 billion), as
measured under the EU Group’s Directive. This measure represents
the excess of the aggregate value of regulatory capital employed in
our business over the aggregate minimum solvency requirements
imposed by local regulators, excluding the surplus held in our UK
life funds. In broad terms, this is set at 4% and 1% for non-linked
and unit-linked life reserves respectively. For our general insurance
portfolio of business, the minimum solvency requirement is the
higher of 18% of gross premiums or 26% of gross claims, in both
cases adjusted to reflect the level of reinsurance recoveries. For our
other major non-European businesses (USA, Australia and Canada),
a risk charge on assets and liabilities approach is used.
The FSA introduced further changes to the valuation rules which
applied during 2005. From 1 January 2005, our valuations of non-
insurance subsidiaries were restated from market value to net asset
value reducing IGD by £0.6 billion. Furthermore, the FSA introduced
the rules for accounting for pension fund deficits under IAS with
effect from April 2005. The impact of this is to reduce our excess
solvency by £0.4 billion. The impact of these valuation changes has
been offset by our strong solvency capital generation in the period
which amounted to £1.5 billion while the acquisition of RAC
reduced our excess regulatory capital by a further £0.8 billion.
As previously announced, completion of the sale of our Asian
general insurance in the period improved the IGD excess solvency
by £0.2 billion. The revised FSA rules do not incorporate the full
value of our pension fund deficit. Including the full value of the
deficit would have the effect of reducing the IGD by £0.5 billion.