Aviva 2007 Annual Report Download - page 58
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Please find page 58 of the 2007 Aviva annual report below. You can navigate through the pages in the report by either clicking on the pages listed below, or by using the keyword search tool below to find specific information within the annual report.Aviva plc
Annual Report and
Accounts 2007
Business review continued:
Capital management
54
Business
review
Capital
Capital management objectives
Aviva’s capital management philosophy is focused on
capital efficiency and effective risk management to support
a progressive dividend policy and earnings per share
growth. Rigorous capital allocation is one of the Group’s
primary strategic priorities and is ultimately governed by
the Group Executive Committee.
The Group’s overall capital risk appetite is set
and managed with reference to the requirements of a
range of different stakeholders including shareholders,
policyholders, regulators and rating agencies. In managing
capital we seek to:
– maintain sufficient, but not excessive, financial
strength to support new business growth and satisfy
the requirements of our stakeholders;
– optimise our overall debt to equity structure to
enhance our returns to shareholders, subject to our
capital risk appetite and balancing the requirements
of the range of stakeholders;
– retain financial flexibility by maintaining strong
liquidity, including significant unutilised committed
credit lines and access to a range of capital markets;
– allocate capital rigorously across the Group, to drive
value adding growth in accordance with risk appetite;
– increase the dividend on a basis judged prudent, while
retaining capital to support future business growth,
using dividend cover on an IFRS operating earnings
after tax basis in the 1.5 to 2.0 times range as a guide.
Capital resources
The primary sources of capital used by the Group
are equity shareholders’ funds, preference shares,
subordinated debt and borrowings. We also consider
and, where efficient to do so, utilise alternative sources
of capital such as reinsurance and securitisation in addition
to the more traditional sources of funding. Targets are
established in relation to regulatory solvency, ratings,
liquidity and dividend capacity and are a key tool in
managing capital in accordance with our risk appetite
and the requirements of our various stakeholders.
Overall, the Group has significant resources and
financial strength. The ratings of the Group’s main
operating subsidiaries are AA/AA- (“very strong”) with a
stable outlook from Standard & Poor’s, Aa3 (“excellent”)
with a stable outlook from Moody’s and A+ (“Superior”)
with a stable outlook from AM Best. These ratings reflect
the Group’s strong liquidity, competitive position,
capital base, increasing underlying earnings and strategic
and operational management. The Group is subject to
a number of regulatory capital tests and also employs
economic capital measures to manage capital and risk.
Capital allocation
Capital allocation is undertaken based on a rigorous
analysis of a range of financial, strategic, risk and capital
factors to ensure that capital is allocated efficiently to
value adding business opportunities. A clear management
decision-making framework, incorporating ongoing
operational and strategic performance review, periodic
longer term strategic and financial planning and robust
due diligence over capital allocation is in place, governed
by the Group Executive Committee and Group Capital
Management Committee. These processes incorporate
various capital profitability metrics, including an
assessment of return on capital employed and internal
rates of return in relation to hurdle rates to ensure capital
is allocated efficiently and that excess business unit capital
is repatriated where appropriate.
Different measures of capital
In recognition of the requirements of different stakeholders,
the Group measures its capital on a number of different
bases, all of which are taken into account when managing
and allocating capital across the Group. These include
measures which comply with the regulatory regimes within
which the Group operates and those which the directors
consider appropriate for the management of the business.
The primary measures which the Group uses are:
(i) Accounting bases
The Group reports its results on both an IFRS and a
European Embedded Value basis. The directors consider
that the European Embedded Value principles provide a
more meaningful measure of the long term underlying
value of the capital employed in the Group’s life and
related businesses. This basis allows for the impact of
uncertainty in the future investment returns more explicitly
and is consistent with the way the life business is priced
and managed. Accordingly, in addition to IFRS, we analyse
and measure the net asset value and total capital
employed for the Group on this basis. This is the basis on
which Group Return on Equity is measured and against
which the corresponding Group target is expressed.
(ii) Regulatory bases
Individual regulated subsidiaries measure and report
solvency based on applicable local regulations, including in
the UK the regulations established by the Financial Services
Authority (FSA). These measures are also consolidated
under the European Insurance Groups Directive (IGD) to
calculate regulatory capital adequacy at an aggregate
Group level. The Group has fully complied with these
regulatory requirements during the year.
(iii) Rating agency bases
The Group’s ratings are an important indicator of financial
strength and maintenance of these ratings is one of the
key drivers of capital risk appetite. Certain rating agencies
have proprietary capital models which they use to assess
available capital resources against capital requirements,
as a component of their overall criteria for assigning ratings.
In addition, rating agency measures and targets in respect
of gearing and fixed charge cover are also important in
evaluating the level of borrowings utilised by the Group.
While not mandatory external requirements, in practice
rating agency capital measures tend to act as one of
the primary drivers of capital requirements, reflecting the
capital strength required in relation to our target ratings.
(iv) Economic bases
The Group also measures its capital using an economic
capital model that takes into account a more realistic set
of financial and non-financial assumptions. This model has
been developed considerably over the past few years and is
increasingly relevant in the internal management and external
assessment of the Group’s capital resources. The economic
capital model is used to assess the Group’s capital strength
in accordance with the Individual Capital Assessment (ICA)
requirements established by the FSA. Further developments
are planned to meet the emerging requirements of the
Solvency II framework and other external agencies.