Aviva 2002 Annual Report Download - page 41

27 Aviva plc
Annual report + accounts 2002
Aviva group had an estimated excess regulatory capital, as
measured on the new EU Directive, of some £0.7 billion at
31 December 2002 (2001: £1.7 billion). 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 the
group’s UK life funds.
Our principal UK general insurance regulated subsidiaries are CGU
International Insurance plc (CGUII) and Norwich Union Insurance
(NUI). CGUII is the parent company of the majority of the group’s
overseas life and general insurance subsidiaries.
The combined businesses of the CGUII group and NUI have strong
solvency positions. On an aggregate basis the estimated excess
solvency margin (representing the regulatory value of excess
available assets over the required minimum margin) was
£2.3 billion at end 2002 after covering the required minimum
margin of £3.2 billion. The solvency margin of the combined
regulated group is resilient to equity market movements.
We estimate that the solvency can withstand further significant
market falls from end 2002 levels before the solvency cover
is reduced to 1.0 times.
Furthermore, as CGUII also indirectly holds the majority of our
overseas life and non-life businesses its regulatory solvency strength
is available to support these businesses. Another measure that
the group uses to assess its capital requirements is risk-based
capital. As at 31 December 2002 the risk-based capital
requirement of our worldwide general insurance businesses was
£3.1 billion in comparison to £4.0 billion of capital employed by
these businesses after deducting goodwill and adding back the
claims equalisation reserve.The combined general insurance
businesses of CGUII and NUI hold total regulated available assets of
£5.5 billion. After deducting the risk-based capital for the general
insurance businesses of CGUII and NUI of £3.1 billion and, adding
back the claims equalisation reserve of £0.3 billion, the remaining
available capital of £2.7 billion is available to fund future UK and
overseas business growth.
A common measure of the financial strength in the UK for life
insurance business is the free asset ratio (FAR). We estimate that
the average free asset ratio of our three UK life companies was
11.8% at end 2002 including implicit items (31 December 2001:
14.7%). If these implicit items were excluded then the FAR would
be 7.7% (31 December 2001: 10.8%)
The realistic strength of our with-profit funds is underpinned by
our UK orphan estate. At 31 December 2002, the orphan estate of
£4.3 billion (2001: £5.2 billion) is based upon a realistic assessment
of liabilities and is calculated after prudently allowing for over
£4 billion in respect of the expected cost of guarantees and the
glide path. The orphan estate is used to support strong business
development for the benefit of our policyholders and shareholders
alike. The orphan estate is calculated on the basis of realistic
assumptions, as distinct from the statutory basis of reserving which
uses rules specified by statute.
Management of financial risks
The group recognises the critical importance of efficient and
effective risk management systems. Close attention is paid to asset
and liability management. This is particularly important for our life
businesses, given the long-term nature of the liabilities involved.
General insurance funds are invested in fixed income securities
to match broadly our insurance liabilities, the balance of the
portfolio invested largely in equities.
Derivatives
Derivative instruments are only used to a limited extent, within
guidelines established by the Board. Derivatives are used for
efficient portfolio management, hedging debt and the outcome
of corporate transactions, or to structure specific retail savings
products. Speculative activity is prohibited and all derivative
transactions are covered fully, either by cash or by corresponding
assets and liabilities.
Exchange fluctuation
As a result of the international diversity of its operations,
approximately half of the group’s premium income arises in
currencies other than sterling. Similarly, its net assets are
denominated in a variety of currencies, of which the largest are
the euro (52%) and sterling (29%).
In managing our foreign currency exposures we do not hedge
revenues as these are substantially retained locally to support the
growth of our business and to meet local regulatory and market
requirements.
The group’s net assets and, to a more limited extent its solvency, are
exposed to movements in exchange rates. The group hedges part
of this exposure through local currency borrowings and derivatives.
Reinsurance
Reinsurance is a key tool in managing our catastrophe exposure.
In designing our reinsurance programmes we take account of
our risk assessment, the financial strength of reinsurance
counterparties, the benefits to shareholders of capital efficiency
and reduced volatility, and the cost of reinsurance protection.
Reinsurance is actively used to limit risk and capital requirements
in the inherently volatile general insurance business. In 2002,
reinsurance retentions for catastrophes were £100 million.
On renewal of the contract at 1 January 2003, reinsurance
retentions for catastrophes at a group level was increased to
£250 million for a single event covering more than one country
or a series of events throughout the calendar year. This cover
protects the net exposures of our individual business units who
have their own reinsurance in place.
Mike Biggs
Group Finance Director