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Capital management

 

C1 - Capital management

C1i - Capital Management objectives and approach

The primary objective of capital management is to optimise the balance between return and risk, whilst maintaining economic and regulatory capital in accordance with risk appetite. Aviva's capital and risk management objectives are closely interlinked, and support the dividend policy and earnings per share growth, whilst also recognising the critical importance of protecting policyholder and other stakeholder interests.

      Overall capital risk appetite, which is reviewed and approved by the Aviva board, is set and managed with reference to the requirements of a range of different stakeholders including shareholders, policyholders, regulators and rating agencies. Risk appetite is expressed in relation to a number of key capital and risk measures, and includes an economic capital risk appetite of holding sufficient capital resources to enable the Group to meet its liabilities in extreme adverse scenarios, on an ongoing basis, calibrated at a level consistent with a AA range credit rating.

      In managing capital we seek to:

n maintain sufficient, but not excessive, financial strength in accordance with risk appetite, to support new business growth and satisfy the requirements of our regulators and other stakeholders giving both our customers and shareholders assurance of our financial strength;

n 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;

n retain financial flexibility by maintaining strong liquidity, including significant unutilised committed credit facilities and access
to a range of capital markets;

n allocate capital rigorously across the Group, to drive value adding growth through optimising risk and return; and

n declare dividends with reference to factors including growth in cash flows and earnings

 

In line with these objectives, the capital generated and invested by the Group's businesses is a key management focus. Operating capital generation, which measures net capital generated after taking into account capital invested in new business (before the impact of non-operating items) is a core regulatory capital based management performance metric used across the Group. This is embedded in the Group business planning process and other primary internal performance and management information processes.

      Capital is measured and managed on a number of different bases. These are discussed further in the following sections.

Regulatory capital

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, where we have a regulatory obligation to have a positive position at all times. 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 UK and Ireland with-profit life funds. The minimum solvency requirement for our European businesses is based on the Solvency 1 Directive. In broad terms, for EU operations, this is set at 4% and 1% of non-linked and unit-linked life reserves respectively and for our general insurance portfolio of business 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 major non-European businesses (the US and Canada) a risk charge on assets and liabilities approach
is used.

Rating agency capital

Credit ratings are an important indicator of financial strength and support access to debt markets as well as providing assurance
to business partners and policyholders over our ability to service contractual obligations. In recognition of this, we have solicited relationships with a number of rating agencies. The agencies generally assign ratings based on an assessment of a range of financial factors (e.g. capital strength, gearing, liquidity and fixed charge cover ratios) and non financial factors (e.g. strategy, competitive position, and risk management).

      Certain rating agencies have proprietary capital models which they use to assess available capital resources against capital requirements as a component in their overall criteria for assigning ratings. Managing our capital and liquidity position in accordance with our target rating levels is a core consideration in all material capital management and capital allocation decisions.

      The Group's overall financial strength is reflected in our credit ratings.  The Group's rating from Standard and Poors is A+ ("strong") with a Stable outlook; Aa3 ("excellent") with a Negative outlook from Moody's; and A ("excellent") with a Stable outlook from AMBest.

 

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C1 - Capital management continued

C1 ii Economic capital

We use a risk-based capital model to assess economic capital requirements and to aid in risk and capital management across the Group. The model is based on a framework for identifying the risks to which business units, and the group as a whole, are exposed. Where appropriate, businesses also supplement these with additional risk models and stressed scenarios specific to their own risk profile. When aggregating capital requirements at business unit and group level, we allow for diversification benefits between risks and between businesses, with restrictions to allow for non-fungibility of capital where appropriate. This means that the aggregate capital requirement is less than the sum of capital required to cover all of the individual risks. The capital requirement reflects the cost of mitigating the risk of insolvency to a 99.5% confidence level over a one year time horizon (equivalent to events occurring in 1 out of 200 years) against financial and non-financial tests.

      The financial modelling techniques employed in economic capital enhance our practice of risk and capital management. They enable understanding of the impact of the interaction of different risks allowing us to direct risk management activities appropriately. These same techniques are employed to enhance product pricing and capital allocation processes. Unlike more traditional regulatory capital measures, economic capital also recognises the value of longer-term profits emerging from in-force and new business, allowing for consideration of longer-term value emergence as well as shorter-term net worth volatility in our risk and capital management processes. We continue to develop our economic capital modelling capability for all our businesses as part of our development programme to increase the focus on economic capital management and meeting the emerging requirements of the Solvency II framework and external agencies.

Capital Management

The estimated economic capital surplus represents the excess of Available Economic Capital over Required Economic Capital. Available Economic Capital is based on MCEV¹ net assets, adjusted for items to convert to an economic basis. Required Economic Capital is based on Aviva's own internal assessment and capital management policies. The term 'economic capital' does not imply capital as required by regulators or other third parties.

Summary analysis of Estimated Economic Capital Position

 

	2012 £bn	2011 £bn
Available economic capital	16.6	15.7
Standalone required economic capital	(18.1)	(18.9)
Diversification benefit	6.8	6.8
Diversified required economic capital	(11.3)	(12.1)
Estimated economic capital position at 31 December 2012	5.3	3.6
Cover Ratio	147%	130%
Proforma impacts	1.8	n/a
Estimated proforma economic capital position at 31 December 2012	7.1	n/a
Proforma cover ratio	172%	n/a

Analysis of Change

 

		2012 £bn
Economic capital position at 31 December 2011		3.6
MCEV operating earnings		0.9
Economic variances		0.7
Other non-operating items		(0.6)
Dividend and appropriations, net of shares issued in lieu of dividends		(0.7)
Net impact of fixed rate note issuance/call		0.2
Other		0.4
Change in available economic capital		0.9
Impact of trading operations and other		0.4
Impact of credit hedging		0.2
Capital requirement benefits from Delta Lloyd partial sell-down		0.2
Change in diversified required economic capital		0.8
Estimated economic capital position at 31 December 2012		5.3
Proforma impacts		1.8
Estimated proforma Economic capital position at 31 December 2012		7.1

 

 

 

 

 

 

 

 

 

 

 

1 MCEV: market consistent embedded value. In preparing the MCEV information, the directors have done so in accordance with the MCEV principles with the exception of stating held for sale operations at their expected fair value, as represented by expected sales proceeds, less costs to sell. For more information on MCEV reporting please refer to Supplement 2 MCEV Financial Statements.

 

 

 

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C1 - Capital management continued

Summary analysis of Diversified Required Economic Capital

 

	Proforma 2012 £bn	2011 £bn
Credit risk 1	2.3	3.5
Equity risk 2	1.7	2.2
Interest rate risk 3	0.1	0.2
Other market risk 4	1.5	1.5
Life insurance risk 5	1.0	1.1
General insurance risk 6	0.9	0.7
Other risk 7	2.4	2.9
Total (FY12 proforma basis)	9.9	12.1
Total (FY12 base results)	11.3	12.1

1 Capital held in respect of credit risk recognises the Group's shareholder exposure to changes in the market value of assets and defaults. Assets captured within this category include corporate bonds and non-domestic sovereign. A range of specific stresses are applied reflecting the difference in assumed risk relative to the investment grade and duration. The reduction in the year primarily reflects the disposal of the US but also includes the benefit of hedging instruments purchased in the year.

2  Capital held in respect of equity risk recognises the Group's shareholder exposure to changes in the market value of assets. The reduction in equity risk during the year primarily reflects the impact of the sell-down in Delta Lloyd.

3 Capital held in respect of interest rate risk recognises the Group's shareholder exposure to changes in the market value of assets. A range of specific stresses are applied reflecting the difference in assumed risk relative to investment grade and duration.

4Capital held in respect of other market risk recognises the Group's shareholder exposure to changes in the market value of commercial mortgages and property, but also captures risk in association with inflation and foreign exchange.

5Capital held in respect of life insurance risk recognises the Group's shareholder exposure to life insurance specific risks, such as longevity and lapse.

6Capital held in respect of general insurance risk recognises the Group's shareholder exposure to general insurance specific risks, such as claims volatility and catastrophe.

7 Capital held in respect of other risk recognises the Group's shareholder exposure to specific risks unique to particular business units. The reduction in the year primarily reflects the disposal of the US.

Solvency II

Following regulatory delays in finalising the Omnibus II Directive, which underpins Solvency II, it became clear that Solvency II would not come into effect on 1 January 2014. Currently the earliest expected effective date is 2 years later, on 1 January 2016. Aviva has been early adopting a number of Solvency II requirements into the ICA, which is the current economic regulatory basis in the UK. Aviva is well placed for review by the FSA on an "ICA plus" basis ("ICA plus" represents how the FSA is addressing the regulatory uncertainty left in the wake of continuing Solvency II implementation delays). Aviva continues to enhance and develop its economic capital infrastructure for full Solvency II compliance by the effective date and actively participate in developments through the key European industry working groups, and engaging with the FSA and HM Treasury to inform the on-going negotiations in Brussels.

 

 

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C2 - Capital performance

C2 i - Capital generation and utilisation

The active management of the generation and utilisation of capital is a primary Group focus, with the balancing of new business investment and shareholder distribution with operating capital generation a key financial priority.

      Operating capital generation for the full-year 2012 was £2.0 billion. Life businesses generated £2.1 billion of capital (FY11: £2.3 billion), with a further £0.6 billion (FY11: £0.6 billion) generated by the general insurance and fund management businesses and other operations. Capital invested in new business was £0.7 billion (FY11: £0.8 billion), and continues to benefit from management actions to improve capital efficiency. The £0.7 billion of capital investment is primarily in life new business with the impact of capital investment in non-life business broadly neutral over the period.

	2012 £bn	2011 £bn
Operating capital generation:
Life in-force profits1	2.1	2.3
General insurance, fund management and other operations profits	0.6	0.6
Operating capital generated before investment in new business	2.7	2.9
Capital invested in new business	(0.7)	(0.8)
Operating capital generated after investment in new business	2.0	2.1

1 The Life in-force profits in 2012 exclude the negative impact of a true up relating to a prior estimate of required capital, which is included in the MCEV Free Surplus Emergence, as this does not impact the actual capital generated in 2012.

Operating capital generation comprises the following components:

-  Operating Free surplus emergence, including release of required capital, for the life in-force business (net of tax and non-controlling interests);

-  Operating profits for the general insurance and non-life businesses (net of tax and non-controlling interests);

-  Capital invested in new business. For life business this is the impact of initial and required capital on free surplus. For general insurance business this reflects the movement in required capital, which has been assumed to equal the regulatory minimum multiplied by the local management target level. Where appropriate movements in capital requirements exclude the impact of foreign exchange and other movements deemed to be non-operating in nature.

-  Post deconsolidation on 6 May 2011, all Delta Lloyd capital generation, including life business, has been included within general insurance, fund management and other operations profits on an IFRS basis.

The amount of operating capital remitted to Group is dependent upon a number of factors including non-operating items and local regulatory requirements.

 

As well as financing new business investment, the operating capital generated is used to finance corporate costs, service the Group's debt capital and to finance shareholder dividend distributions. After taking these items into account the net operating capital generation after financing is £0.5 billion.

 

	2012 £bn	2011 £bn
Operating capital generated after investment in new business	2.0	2.1
Interest, corporate and other costs	(0.8)	(0.6)
External dividends and appropriations, net of shares issued in lieu of dividends	(0.7)	(0.5)
Net operating capital generation after financing	0.5	1.0

C2 ii - Capital required to write new business, internal rate of return and payback period

As set out in C2i, the Group generates a significant amount of capital each year. This capital generation supports both shareholder distribution and reinvestment in new business. The new business written requires up front capital investment, due to high set-up costs and capital requirements.

      The internal rate of return (IRR) is a measure of the shareholder return expected on this capital investment. It 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 the value of new business.

      The payback period shows how quickly shareholders can expect the total capital to be repaid. The payback period has been calculated based on undiscounted cash flows and allows for the initial and required capital.

      The projected investment returns in both the IRR and payback period calculations assume that equities, properties and bonds
earn a return in excess of risk-free consistent with the long-term rate of return assumed in operating earnings.

 

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C2 - Capital performance continued

C2 ii - Capital required to write new business, internal rate of return and payback period continued

The internal rates of return on new business written during the period are set out below.

 

Gross of non-controlling interests 2012	Internal rate of return %	Initial capital £m	Required capital £m	Total invested capital £m	New business impact on free surplus	Payback period years
United Kingdom	18%	112	164	276	6	6
Ireland	2%	31	10	41	31	25
United Kingdom & Ireland	16%	143	174	317	37	8
France	11%	33	113	146	125	8
Spain	21%	21	42	63	35	4
Italy	12%	20	69	89	41	6
Other	8%	12	1	13	15	10
Developed markets	15%	229	399	628	253	8
Poland	20%	20	8	28	25	4
Asia	11%	60	29	89	82	11
Other	28%	17	15	32	29	3
Higher growth markets	16%	97	52	149	136	8
Total - excluding United States	14.9%	326	451	777	389	8
Total - United States	17%	24	292	316	319	4
Total	15.5%	350	743	1,093	708	7

 

Gross of non-controlling interests 2011	Internal rate of return %	Initial capital £m	Required capital £m	Total invested capital £m	New business impact on free surplus	Payback period years
United Kingdom	15%	155	187	342	89	7
Ireland	6%	27	22	49	38	12
United Kingdom & Ireland	14%	182	209	391	127	8
France	11%	45	127	172	153	8
Spain	23%	25	70	95	50	4
Italy	12%	24	117	141	66	6
Other	9%	25	1	26	25	8
Developed markets	14%	301	524	825	421	7
Poland	24%	25	9	34	30	4
Asia	13%	56	31	87	80	12
Other	22%	15	12	27	27	4
Higher growth markets	17%	96	52	148	137	9
Total - excluding Delta Lloyd and United States	14.5%	397	576	973	558	7
Total - Delta Lloyd1 and United States	14%	53	328	381	376	6
Total	14.3%	450	904	1,354	934	7

1  Comparative periods include the results of Delta Lloyd up to 6 May 2011.

 

In Ireland, the closure of Ark Life to new business in the first half of 2012 has adversely impacted IRR and payback period as current expenses are spread over a smaller volume of business.

      Total invested capital is gross of non-controlling interests and valued on a point of sale basis. This differs from the new business impact on the free surplus which is stated net of non-controlling interests, valued on a year-end basis and benefits from the writing of new business in the UK Life RIEESA. The reconciliation is as follows:

 

	2012 £m	2011 £m
Total capital invested	1,093	1,354
Non-controlling interests1	(112)	(180)
Benefit of RIEESA on new business funding in UK	(220)	(190)
Timing differences (point of sale versus year end basis) 2	(53)	(50)
New business impact on free surplus	708	934

1 Non controlling interests primarily in Italy and Spain

2 Timing differences across all markets

 

 

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C2 - Capital performance continued

C2 iii - Analysis of IFRS basis return on equity

 

	Operating return1
2012	Before Tax £m	After tax £m	Opening shareholders' funds including non- controlling interests £m	Return on equity %
Life assurance	1,831	1,542	11,237	13.7%
General insurance and health2	858	633	5,875	10.8%
Fund management	51	36	184	19.6%
Other business	(193)	(135)	(1,102)	12.3%
Corporate3	(466)	(538)	508	n/a
Return on total capital employed (excluding Delta Lloyd and United States)	2,081	1,538	16,702	9.2%
Delta Lloyd	112	84	776	10.8%
United States	251	173	3,140	5.5%
Return on total capital employed (including Delta Lloyd and United States)	2,444	1,795	20,618	8.7%
Subordinated debt	(294)	(222)	(4,550)	4.9%
External debt	(23)	(17)	(705)	2.4%
Return on total equity	2,127	1,556	15,363	10.1%
Less: Non-controlling interests		(184)	(1,530)	12.0%
Direct capital instruments and fixed rate tier 1 notes		(55)	(990)	5.6%
Preference capital		(17)	(200)	8.5%
Return on equity shareholders' funds		1,300	12,643	10.3%

1  The operating return is based upon Group adjusted operating profit, which is stated before impairment of goodwill, amortisation of intangibles, exceptional items and investment variances.

2  The general insurance & health return on capital employed reduces when compared to 2011 due to the reallocation of goodwill from other business to general insurance and health upon the sale of RAC in 2011. 

3  The 'Corporate' loss before tax of £466 million comprises costs of £136 million, net finance charge on the main UK pension scheme of £35 million and interest on internal lending arrangements of £319 million offset by investment return
of £24 million. The corporate ROCE has been reported as 'n/a' as the opening capital is impacted by movements in the pension scheme, thereby making the percentage incomparable with the prior year.

 

	Operating return1
2011	Before Tax £m	After tax £m	Opening shareholders' funds including non- controlling interests £m	Return on equity %
Life assurance	1,926	1,512	11,356	13.3%
General insurance and health	903	657	4,747	13.8%
Fund management	62	49	192	25.5%
Other business	(207)	(148)	(119)	124.4%
Corporate2	(436)	(391)	(232)	n/a
Return on total capital employed (excluding Delta Lloyd and United States)	2,248	1,679	15,944	10.5%
Delta Lloyd	352	288	5,089	5.7%
United States	231	88	2,758	3.2%
Return on total capital employed (including Delta Lloyd and United States)	2,831	2,055	23,791	8.6%
Subordinated debt	(302)	(222)	(4,572)	4.9%
External debt	(26)	(19)	(1,494)	1.3%
Return on total equity	2,503	1,814	17,725	10.2%
Less: Non-controlling interests		(223)	(3,741)	6.0%
Direct capital instruments and fixed rate tier 1 notes		(43)	(990)	4.3%
Preference capital		(17)	(200)	8.5%
Return on equity shareholders' funds		1,531	12,794	12.0%

1  The operating return is based upon Group adjusted operating profit, which is stated before impairment of goodwill, amortisation of intangibles, exceptional items and investment variances.

2  The 'Corporate' loss before tax of £436 million comprises costs of £138million, net finance charge on the main UK pension scheme of £46 million and interest on internal lending arrangements of £284 million offset by investment return
of £32 million. The corporate ROCE has been reported as 'n/a' as the opening capital is impacted by movements in the pension scheme, thereby making the percentage incomparable with the prior year.

 

 

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C2 - Capital performance continued

C2 iv - Analysis of MCEV basis return on equity

 

	Operating return1
2012	Before Tax £m	After tax £m	Opening shareholders' funds including non- controlling interests £m	Return on equity %
Life assurance	2,206	1,630	14,148	11.5%
General insurance and health	858	633	5,875	10.8%
Fund management	24	17	184	9.2%
Other business	(186)	(130)	(1,102)	11.8%
Corporate2	(466)	(538)	508	n/a
Return on total capital employed (excluding Delta Lloyd and United States)	2,436	1,612	19,613	8.2%
Delta Lloyd	112	84	776	10.8%
United States	(378)	(244)	361	(67.6)%
Return on total capital employed (including Delta Lloyd and United States)	2,170	1,452	20,750	7.0%
Subordinated debt	(294)	(222)	(4,550)	4.9%
External debt	(23)	(17)	(705)	2.4%
Return on total equity	1,853	1,213	15,495	7.8%
Less: Non-controlling interests		(336)	(1,476)	22.8%
Direct capital instruments and fixed rate tier 1 notes		(55)	(990)	5.6%
Preference capital		(17)	(200)	8.5%
Return on equity shareholders' funds		805	12,829	6.3%

1  The operating return is based upon Group adjusted operating profit, which is stated before impairment of goodwill, amortisation of intangibles, exceptional items and investment variance.

2  The 'Corporate' loss before tax of £466 million comprises costs of £136 million, net finance charge on the main UK pension scheme of £35 million and interest on internal lending arrangements of £319 million offset by investment return
of £24 million. The corporate ROCE has been reported as 'n/a' as the opening capital is impacted by movements in the pension scheme, thereby making the percentage incomparable with the prior year.

 

	Operating return1
2011	Before Tax £m	After tax £m	Opening shareholders' funds including non- controlling interests £m	Return on equity %
Life assurance	2,888	2,062	16,673	12.4%
General insurance and health	903	657	4,747	13.8%
Fund management	28	18	192	9.4%
Other business	(204)	(144)	(119)	121.0%
Corporate2	(436)	(391)	(232)	n/a
Return on total capital employed (excluding Delta Lloyd and United States)	3,179	2,202	21,261	10.4%
Delta Lloyd	444	331	3,892	8.5%
United States	242	158	1,118	14.1%
Return on total capital employed (including Delta Lloyd and United States)	3,865	2,691	26,271	10.2%
Subordinated debt	(302)	(222)	(4,572)	4.9%
External debt	(26)	(19)	(1,494)	1.3%
Return on total equity	3,537	2,450	20,205	12.1%
Less: Non-controlling interests		(253)	(3,977)	6.4%
Direct capital instruments and fixed rate tier 1 notes		(43)	(990)	4.3%
Preference capital		(17)	(200)	8.5%
Return on equity shareholders' funds		2,137	15,038	14.2%

1  The operating return is based upon Group adjusted operating profit, which is stated before impairment of goodwill, amortisation of intangibles, exceptional items and investment variance.

2  The 'Corporate' loss before tax of £436million comprises costs of £138million, net finance charge on the main UK pension scheme of £46 million and interest on internal lending arrangements of £284 million offset by investment return
of £32 million. The corporate ROCE has been reported as 'n/a' as the opening capital is impacted by movements in the pension scheme, thereby making the percentage incomparable with the prior year.

 

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C3 - Group capital structure

The table below shows how our capital, on an MCEV basis, is deployed by products and services segments and how that capital
is funded.

 

	2012 £m	2011 £m
Long-term savings	16,337	14,148
General insurance and health	6,089	5,875
Fund management	225	184
Other business	(1,059)	(1,102)
Corporate1	(588)	508
Delta Lloyd	-	776
United States	365	361
Total capital employed	21,369	20,750
Financed by
Equity shareholders' funds	12,434	12,829
Non-controlling interests	2,214	1,476
Direct capital instruments and fixed rate tier 1 notes	1,382	990
Preference shares	200	200
Subordinated debt	4,337	4,550
External debt	802	705
Total capital employed	21,369	20,750

1  "Corporate" includes centrally held tangible net assets, the staff pension scheme surplus and also reflects internal lending arrangements. These internal lending arrangements, which net out on consolidation, arise in relation to the following:

     -                 Aviva Insurance Limited (AI) acts as both a UK general insurer and as the primary holding company for our foreign subsidiaries. Internal capital management mechanisms in place allocate a portion of the total capital of the company to the UK
    general insurance operations, giving rise to notional lending between the general insurance and holding company activities. These mechanisms also allow for some of the assets of the general insurance business to be made available for use
    across the Group.

     -                 Certain subsidiaries, subject to continuing to satisfy stand alone capital and liquidity requirements, loan funds to corporate and holding entities. These loans satisfy arm's-length criteria and all interest payments are made when due.

     -  Subsequent to the year end, the Group has taken action to improve its access to dividends from the Group's insurance and asset management businesses by undertaking a corporate restructure. This will see the Group's interest in the majority of its overseas        businesses move to Aviva Group Holdings Limited from Aviva Insurance Limited.

 

Total capital employed is financed by a combination of equity shareholders' funds, preference capital, subordinated debt
and borrowings. At FY12 we had £21.4 billion (FY11: £20.8 billion) of total capital employed in our trading operations measured on an MCEV basis.

      In May 2012 we issued US$650 million of Fixed Rate Tier 1 Notes. The Notes are perpetual and may be called from November 2017. The Notes qualify as Innovative Tier 1 capital under current regulatory rules and are expected to be treated as Fixed Rate Tier 1 capital under Solvency II transitional rules. The transaction had a positive impact on Group IGD solvency and Economic Capital measures. In June 2012 US$300 million of Lower Tier 2 floating rate notes were redeemed at first call.

      Financial leverage, the ratio of external senior and subordinated debt to MCEV capital and reserves, was 35.1% (FY11: 36.7%). Fixed charge cover, which measures the extent to which external interest costs, including subordinated debt interest and preference dividends, are covered by MCEV operating profit was 5.1 times (FY11: 8.9 times). The impact of the agreement to sell Aviva USA has meant that financial leverage under IFRS is higher at 52.6% (FY11: 37.1%).

      At FY12 the market value of our external debt, subordinated debt, preference shares (including both Aviva plc preference shares
of £200 million and General Accident plc preference shares, within non-controlling interest, of £250 million), and direct capital instruments and fixed rate tier 1 notes was £7,260 million (FY11: £5,782 million), with a weighted average cost, post tax, of 4.4% (FY11: 6.6%). The Group Weighted Average Cost of Capital (WACC) is 6.3% (FY11: 7.1%) and has been calculated by reference to the cost of equity and the cost of debt at the relevant date. The cost of equity at FY12 was 7.5% (FY11: 7.4%) based on a risk free rate of 1.9% (FY11: 2.0%), an equity risk premium of 4.0% (FY11: 4.0%) and a market beta of 1.4 (FY11: 1.3).

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C3 - Group capital structure continued

Shareholders' funds, including non-controlling interests

 

			2012			2011
	Closing shareholders' funds			Closing shareholders' funds
	IFRS net assets £m	Internally generated AVIF £m	Total Equity £m	IFRS net assets £m	Internally generated AVIF £m	Total Equity £m
Life assurance
United Kingdom	4,905	1,595	6,500	4,794	1,421	6,215
Ireland	735	361	1,096	684	365	1,049
United Kingdom & Ireland	5,640	1,956	7,596	5,478	1,786	7,264
France	2,120	1,329	3,449	1,825	1,091	2,916
Spain	1,113	340	1,453	1,160	384	1,544
Italy	1,276	(317)	959	1,266	(1,405)	(139)
Other	54	13	67	238	(140)	98
Developed markets	10,203	3,321	13,524	9,967	1,716	11,683
Poland	336	1,442	1,778	263	1,063	1,326
Asia	784	28	812	865	58	923
Other	144	79	223	142	74	216
Higher Growth markets	1,264	1,549	2,813	1,270	1,195	2,465
	11,467	4,870	16,337	11,237	2,911	14,148
General Insurance and health
United Kingdom	3,546	-	3,546	3,394	-	3,394
Ireland	355	-	355	408	-	408
United Kingdom & Ireland	3,901	-	3,901	3,802	-	3,802
France	562	-	562	480	-	480
Canada	1,039	-	1,039	1,034	-	1,034
Other	489	-	489	468	-	468
Developed markets	5,991	-	5,991	5,784	-	5,784
Higher Growth markets	98	-	98	91	-	91
	6,089	-	6,089	5,875	-	5,875
Fund Management	225	-	225	184	-	184
Other business	(1,059)	-	(1,059)	(1,102)	-	(1,102)
Corporate	(588)	-	(588)	508	-	508
Total capital employed (excluding Delta Lloyd and United States)	16,134	4,870	21,004	16,702	2,911	19,613
Delta Lloyd	-	-	-	776	-	776
United States	365	-	365	3,140	(2,779)	361
Total capital employed	16,499	4,870	21,369	20,618	132	20,750
Subordinated debt	(4,337)	-	(4,337)	(4,550)	-	(4,550)
External debt	(802)	-	(802)	(705)	-	(705)
Total equity	11,360	4,870	16,230	15,363	132	15,495
Less:
Non-controlling interests			(2,214)			(1,476)
Direct capital instruments and fixed rate tier 1 notes			(1,382)			(990)
Preference capital			(200)			(200)
Equity shareholders' funds			12,434			12,829
Less: Goodwill and Intangibles1			(2,247)			(3,479)
Equity shareholders' funds excluding goodwill and intangibles			10,187			9,350

1  Goodwill and intangibles comprise £1,609 million (FY 2011: £2,640 million) of goodwill in subsidiaries, £921 million (FY 2011: £1,062 million) of intangibles in subsidiaries, £119 million (FY 2011: £131 million) of goodwill and intangibles in joint ventures and £nil (FY 2011: £115 million) of goodwill in associates, net of associated deferred tax liabilities of £(188)million (FY 2011: £(241) million) and the non controlling interests share of intangibles of £(214)million (FY 2011: £(228) million). The goodwill figure of £1,609 million includes a £94 million adjustment to impair goodwill which has been reflected in the additional value of in-force long-term business in the MCEV balance sheet.

 

 

 

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C4 - Sources of Liquidity

In managing the Group's liquidity requirements, there are a number of external and internal sources of cash and liquid resources, including:

n external debt issuance;

n funds generated by the sale of businesses;

n liquidity generated by operating subsidiaries, associates and joint ventures;

n internal debt; and

n central assets of cash and securities.

 

The Group uses these sources of liquidity to fund internal investment, debt repayments and payment of dividends to shareholders.

      For Aviva plc the principal source of liquidity is dividends and liquid resources provided by its subsidiaries, associates and joint ventures. The level of dividends remitted is based on two primary factors: the financial performance of operating subsidiaries, associates and joint ventures, and the local solvency and capital requirements of individual entities.

      The table below shows liquid resources provided to Group Centre from operating companies, subsidiaries, associates and joint ventures in 2012:

 

	2012 Amounts received £m
UK life insurance	150
UK general insurance	150
Canada	136
France	217
Spain	68
Poland	70
Other operations	153
	944

 

Subsequent to the year end, the Group has taken action to improve its access to dividends from the Group's insurance and asset management businesses by undertaking a corporate restructuring whereby Aviva Group Holdings ("AGH") has purchased from Aviva Insurance Limited ("AIL") its interest in the majority of its overseas businesses.

      Under UK company law, dividends can only be paid if a company has distributable reserves sufficient to cover the dividend. At 31 December 2012, Aviva plc itself had distributable reserves of £3,037 million, which would have covered three years of historic dividend payments to our shareholders. In UK Life, our largest operating subsidiary, distributable reserves, which could be paid to Aviva plc via its intermediate holding company, are created mainly by the statutory long-term business profit transfer to shareholders. While the UK insurance regulatory laws applicable to UK Life and our other UK subsidiaries impose no statutory restrictions on an insurer's ability to declare a dividend, the rules require maintenance of each insurance company's solvency margin, which might impact their ability to pay dividends to the parent company. Our other life and general insurance, and fund management subsidiaries' ability to pay dividends and make loans to the parent company is similarly restricted by local corporate or insurance laws and regulations. In all jurisdictions, when paying dividends, the relevant subsidiary must take into account its capital position and must set the level of dividend to maintain sufficient capital to meet minimum solvency requirements and any additional target capital expected by local regulators. These minimum solvency requirements, which are consolidated under the European Insurance Group Directive, are discussed later in this section under the heading 'Regulatory capital position'. We do not believe that the legal and regulatory restrictions constitute a material limitation on the ability of our businesses to meet their obligations or to pay dividends to the parent company, Aviva plc.

      The Group has received and expects to receive proceeds on completion of the disposals as disclosed in  - Note A3 - Subsidiaries.

      Aviva plc has established two main programmes for the issuance of external debt by Aviva plc. For short-term senior debt issuance we have a £2 billion commercial paper programme which allows debt to be issued in a range of currencies. At 31 December 2012, the outstanding debt issued under this programme was £603 million (FY11: £506 million excludes commercial paper issued by Delta Lloyd).

      For longer term debt we have established a Euro Medium Term Note (EMTN) programme. This programme has documentation readily available to allow quick issuance of long-term debt with a variety of terms and conditions. Debt issued under this programme may be senior debt or regulatory qualifying debt and may have a fixed or floating interest rate. At FY12, the outstanding debt issued under this programme was £2,076 million (FY11: £1,894 million).

 

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C5 - EEV equivalent embedded value

The embedded value of Aviva shown below is based on the projected future profits allowing for expected investment returns in excess of risk-free, and discounts those profits at a risk-discount rate. This result is deemed more comparable to other UK insurers who publish European Embedded Value (EEV) than market consistent embedded value.

      The expected release of future profits and required capital is shown in five-year groups. Projected cash flows are those used for Implied Discount Rate (IDR) calculations for in-force business. Held for sale operations have been stated at expected fair value, as represented by the expected sale proceeds, less cost to sell.

      The discount rate applied is 6.25% (FY11: 7.05%), based on a risk-free rate of 2.1%, a risk margin of 3.75% and an allowance for the time value of options and guarantees of 0.4%.

      The new business margin on continuing operations (net of tax and non-controlling interests) for business written during the period to 31 December 2012 is 2.9% (MCEV: 2.8%).

Segmental analysis of life and related business EEV equivalent embedded value

 

	Net worth		VIF on traditional embedded value		Embedded value
	2012 £bn	2011 £bn	2012 £bn	2011 £bn	2012 £bn	2011 £bn
United Kingdom & Ireland	4.2	4.3	3.5	3.6	7.7	7.9
Developed markets excluding United Kingdom & Ireland	3.2	2.7	1.5	1.5	4.7	4.2
Developed markets	7.4	7.0	5.0	5.1	12.4	12.1
Higher Growth markets	0.8	0.7	1.5	1.3	2.3	2.0
Total covered business excluding United States	8.2	7.7	6.5	6.4	14.7	14.1
United States					1.1	2.7
Total Covered business					15.8	16.8
Non-covered business					(0.9)	1.7
Total Group EV					14.9	18.5
Less preference share capital, direct capital instruments and fixed rate tier 1 notes					(1.6)	(1.2)
Equity attributable to ordinary shareholders on an EV basis					13.3	17.3

Maturity profile of undiscounted EEV equivalent embedded value cash flows

Total in-force business

To show the profile of the free surplus emergence implicit in the traditional embedded value calculation for in-force business, the cash flows have been split into five year tranches depending on the date when the profit is expected to emerge.

 

		Release of future profits and required capital					Total net
2012 £bn	Free surplus	0-51	6-10	11-15	16-20	20+	of non- controlling interest
United Kingdom & Ireland	1.3	2.5	2.3	2.5	2.1	4.5	13.9
Developed markets excluding United Kingdom & Ireland	0.1	2.6	1.6	1.2	1.0	2.7	9.1
Developed markets	1.4	5.1	3.9	3.7	3.1	7.2	23.0
Higher Growth markets	0.4	1.0	0.8	0.5	0.4	1.2	3.9
Total excluding United States	1.8	6.1	4.7	4.2	3.5	8.4	26.9
United States	0.3	0.8	-	-	-	-	0.8
Total	2.1	6.9	4.7	4.2	3.5	8.4	27.7

1 For held for sale operations, cash flow emergence is reported in the 0-5 column.

 

		Release of future profits and required capital					Total net
2011 £bn	Free surplus	0-5	6-10	11-15	16-20	20+	of non- controlling interest
United Kingdom & Ireland	1.0	3.0	3.1	2.6	2.0	4.5	15.2
Developed markets excluding United Kingdom & Ireland	0.0	2.3	1.7	1.3	1.1	3.2	9.6
Developed markets	1.0	5.3	4.8	3.9	3.1	7.7	24.8
Higher Growth markets	0.3	1.0	0.6	0.4	0.4	1.1	3.5
Total excluding United States	1.3	6.3	5.4	4.3	3.5	8.8	28.3
United States	0.0	1.7	0.9	0.7	0.6	0.8	4.7
Total	1.3	8.0	6.3	5.0	4.1	9.6	33.0

 

 

 

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C6 - Regulatory capital

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, where Aviva has a regulatory obligation to have a positive position at all times. 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 UK and Ireland with-profit life funds. The minimum solvency requirement for our European businesses is based on the Solvency 1 Directive. In broad terms, for EU operations, this is set at 4% and 1% of non-linked and unit-linked life reserves respectively and for our general insurance portfolio of business 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 major non-European businesses (the US and Canada) a risk charge on assets and liabilities approach is used.

      Based on individual guidance from the FSA we recognise surpluses of £0.4 billion as at 31 December 2012 (FY 2011: £0.2 billion) in the non-profit funds of our UK Life and pensions businesses which is available for transfer to shareholders.

Regulatory capital - Group: European Insurance Groups Directive (IGD)

 

	UK life  funds £bn	Other business £bn	Total 2012 £bn	Total  2011 £bn
Insurance Groups Directive (IGD) capital resources	5.2	9.2	14.4	14.1
Less: capital resource requirement	(5.2)	(5.4)	(10.6)	(11.9)
Insurance Group Directive (IGD) excess solvency	-	3.8	3.8	2.2
Cover over EU minimum (calculated excluding UK life funds)		1.7 times		1.3 times

 

The EU Insurance Groups Directive (IGD) regulatory capital solvency surplus has increased by £1.6 billion since 31 December 2011
to £3.8 billion. The key movements over the period are set out in the following table:

 

	£bn
IGD solvency surplus at 31 December 2011	2.2
Operating profits net of other income and expenses	0.9
Dividend and appropriations, net of shares issued in lieu of dividends	(0.7)
Market movements including foreign exchange1	1.3
Pension scheme funding	(0.2)
Movement in hybrid debt	0.2
UK reinsurance transactions	0.1
Increase in Capital Resources Requirement	(0.1)
Other regulatory adjustments	0.1
Estimated IGD solvency surplus at 31 December 2012	3.8

1  Market movements include the impact of equity, credit spread, interest rate and foreign exchange movements net of the effect of hedging instruments.

 

On a proforma basis the estimated IGD solvency surplus at 31 December 2012 is £3.9 billion. The proforma 31 December 2012 position includes the impact of the announced disposals of the Aviva US Life and annuities business and related asset management operations, Malaysia and Aseval held for sale in the Group IFRS balance sheet.

 

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C6 - Regulatory capital continued

Reconciliation of Group IGD capital resources to FRS 27 capital

The reconciliation below provides analysis of differences between our capital resources and the amounts included in the capital statement made in accordance with FRS 27 and disclosed within our consolidated accounts. The Group Capital Adequacy report is prepared in accordance with the FSA valuation rules and brings in capital in respect of the UK Life valued in accordance with FSA regulatory rules excluding surpluses in with-profit funds. The FRS 27 disclosure brings in the realistic value of UK Life capital resources. As the two bases differ greatly, the reconciliation below is presented by removing the restricted regulatory assets and then replacing them with the unrestricted realistic assets.

 

	2012 £bn
Total capital and reserves (IFRS basis)	11.4
Plus: Other qualifying capital	4.4
Plus: UK unallocated divisible surplus	2.0
Less: Goodwill, acquired AVIF and intangible assets 1	(3.4)
Less: Adjustments onto a regulatory basis	-
Group Capital Resources on regulatory basis	14.4
The Group Capital Resources can be analysed as follows:
Core Tier 1 Capital	10.9
Innovative Tier 1 Capital	1.4
Total Tier 1 Capital	12.3
Upper Tier 2 Capital	1.7
Lower Tier 2 Capital	3.1
Group Capital Resources Deductions	(2.7)
Group Capital Resources on regulatory basis (Tier 1 and Tier 2 Capital)	14.4
Less: UK life restricted regulatory assets	(6.1)
Add: UK life unrestricted realistic assets	5.7
Add: Overseas UDS 2 and Shareholders' share of accrued bonus	5.0
Total FRS 27 capital	19.0

1  Goodwill and other intangibles includes goodwill of £132million in joint ventures and associates and amounts classified as held for sale.

2  Unallocated divisible surplus for overseas life operations is included gross of minority interest and amounts disclosed include balances classified as held for sale. 2012 includes a negative balance of £2 million in Italy.

Regulatory capital - UK Life with-profits funds

The available capital of the with-profit funds is represented by the realistic inherited estate. The estate represents the assets of the long-term with-profit funds less the realistic liabilities for non-profit policies within the funds, less asset shares aggregated across the with-profit policies and any additional amounts expected at the valuation date to be paid to in-force policyholders in the future in respect of smoothing costs, guarantees and promises. Realistic balance sheet information is shown below for the three main UK with-profit funds: New With-Profit Sub Fund (NWPSF), Old With-Profit Sub Fund (OWPSF) and With-Profit Sub-Fund (WPSF). These realistic liabilities have been included within the long-term business provision and the liability for insurance and investment contracts on the Group's IFRS balance sheet at 31 December 2012 and 31 December 2011.

 

	2012						2011
	Estimated realistic assets £bn	Estimated realistic liabilities 1 £bn	Estimated realistic inherited estate 2 £bn	Capital support arrangement3 £bn	Estimated risk capital  margin £bn	Estimated excess available capital £bn	Estimated excess available capital £bn
NWPSF	17.3	(17.3)	-	0.7	(0.4)	0.3	0.7
OWPSF	2.9	(2.6)	0.3	-	(0.1)	0.2	0.2
WPSF4	18.3	(16.5)	1.8	-	(0.5)	1.3	1.0
Aggregate	38.5	(36.4)	2.1	0.7	(1.0)	1.8	1.9

1  These realistic liabilities include the shareholders' share of future bonuses of £0.3 billion (FY 2011: £0.3 billion). Realistic liabilities adjusted to eliminate the shareholders' share of future bonuses are £36.0 billion (FY 2011: £38.8 billion). These realistic liabilities make provision for guarantees, options and promises on a market consistent stochastic basis. The value of the provision included within realistic liabilities is £1.8 billion, £0.3 billion and £3.5 billion for NWPSF, OWPSF and WPSF respectively (FY 2011: £1.9 billion, £0.3 billion and £3.1 billion).

2  Estimated realistic inherited estate at 31 December 2011 was £nil, £0.3 billion and £1.6 billion for NWPSF, OWPSF and WPSF respectively.

3  The support arrangement represents the reattributed estate (RIEESA) of £0.7 billion at 31 December 2012 (FY 2011: £1.1 billion).

4  The WPSF fund includes the Provident Mutual (PM) fund which has realistic assets and realistic liabilities of £1.7 billion and therefore does not contribute to the realistic inherited estate.

Investment mix

The aggregate investment mix of the assets in the three main with-profit funds was:

 

	2012  %	2011  %
Equity	23%	22%
Property	16%	17%
Fixed interest	51%	54%
Other	10%	7%

 

The equity backing ratios, including property, supporting with-profit asset shares are 71% in NWPSF and OWPSF, and 64% in WPSF.

 

 

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C7 - IFRS Sensitivity analysis

The Group uses a number of sensitivity test-based risk management tools to understand the volatility of earnings, the volatility of its capital requirements, and to manage its capital more efficiently. Primarily, MCEV, ICA, and scenario analysis are used. Sensitivities to economic and operating experience are regularly produced on all of the Group's financial performance measurements to inform the Group's decision making and planning processes, and as part of the framework for identifying and quantifying the risks that each of its business units, and the Group as a whole are exposed to.

      For long-term business in particular, sensitivities of MCEV performance indicators to changes in both economic and non-economic experience are continually used to manage the business and to inform the decision making process. More information on MCEV sensitivities can be found in the presentation of results on an MCEV basis in the supplementary section of this report.

Life insurance and investment contracts

The nature of long-term business is such that a number of assumptions are made in compiling these financial statements. Assumptions are made about investment returns, expenses, mortality rates, and persistency in connection with the in-force policies for each business unit. Assumptions are best estimates based on historic and expected experience of the business. A number of the key assumptions for the Group's central scenario are disclosed elsewhere in these statements for both IFRS reporting and reporting under the MCEV methodology.

General insurance and health business

General insurance and health claim liabilities are estimated by using standard actuarial claims projection techniques.

      These methods extrapolate the claims development for each accident year based on the observed development of earlier years.
In most cases, no explicit assumptions are made as projections are based on assumptions implicit in the historic claims.

Sensitivity test results

Illustrative results of sensitivity testing for long-term business, general insurance and health and fund management business and other operations are set out below. For each sensitivity test the impact of a reasonably possible change in a single factor is shown, with other assumptions left unchanged.

 

Sensitivity factor	Description of sensitivity factor applied
Interest rate and investment return	The impact of a change in market interest rates by a 1% increase or decrease. The test allows consistently for similar changes to investment returns and movements in the market value of backing fixed interest securities.
Credit Spreads	The impact of a 0.5% increase in credit spreads over risk-free interest rates on corporate bonds and other non-sovereign credit assets. The test allows for any consequential impact on liability valuations.
Equity/property market values	The impact of a change in equity/property market values by ± 10%.
Expenses	The impact of an increase in maintenance expenses by 10%.
Assurance mortality/morbidity (life insurance only)	The impact of an increase in mortality/morbidity rates for assurance contracts by 5%.
Annuitant mortality (life insurance only)	The impact of a reduction in mortality rates for annuity contracts by 5%.
Gross loss ratios (non-life insurance only)	The impact of an increase in gross loss ratios for general insurance and health business by 5%.

Long-term businesses

 

2012 Impact on profit before tax £m	Interest rates +1%	Interest rates -1%	Credit spreads +0.5%	Equity/ property +10%	Equity/ property -10%	Expenses +10%	Assurance mortality +5%	Annuitant mortality -5%
Insurance Participating	(45)	(15)	(110)	60	(95)	(25)	(5)	(50)
Insurance non-participating	(160)	130	(430)	-	-	(75)	(45)	(470)
Investment participating	(55)	45	-	5	(10)	(10)	-	-
Investment non-participating	(40)	35	(5)	10	(15)	(20)	-	-
Assets backing life shareholders' funds	10	(15)	(40)	45	(45)	-	-	-
Total excluding Delta Lloyd and United States	(290)	180	(585)	120	(165)	(130)	(50)	(520)
United States	880	(640)	495	-	-	-	-	-
Total excluding Delta Lloyd	590	(460)	(90)	120	(165)	(130)	(50)	(520)

 

2012 Impact on shareholders' equity before tax £m	Interest rates +1%	Interest rates -1%	Credit spreads +0.5%	Equity/ property +10%	Equity/ property -10%	Expenses +10%	Assurance mortality +5%	Annuitant mortality -5%
Insurance Participating	(45)	(15)	(110)	60	(95)	(25)	(5)	(50)
Insurance non-participating	(165)	125	(430)	-	-	(75)	(45)	(470)
Investment participating	(55)	45	-	5	(10)	(10)	-	-
Investment non-participating	(45)	40	-	10	(15)	(20)	-	-
Assets backing life shareholders' funds	(5)	-	(45)	50	(50)	-	-	-
Total excluding Delta Lloyd and United States	(315)	195	(585)	125	(170)	(130)	(50)	(520)
United States	-	-	-	-	-	-	-	-
Total excluding Delta Lloyd	(315)	195	(585)	125	(170)	(130)	(50)	(520)

 

 

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C7 - IFRS Sensitivity analysis continued

Long-term businesses continued

 

2011 Impact on profit before tax £m	Interest rates +1%	Interest rates -1%	Credit spreads +0.5%	Equity/ property +10%	Equity/ property -10%	Expenses +10%	Assurance mortality +5%	Annuitant mortality -5%
Insurance Participating	(45)	(155)	(20)	5	(95)	(45)	(10)	(50)
Insurance non-participating	(180)	130	(385)	30	(35)	(65)	(45)	(470)
Investment participating	(35)	40	(30)	50	(75)	(10)	-	-
Investment non-participating	(15)	20	(5)	15	(15)	(20)	-	-
Assets backing life shareholders' funds	135	(15)	(10)	10	(10)	-	-	-
Total excluding Delta Lloyd and United States	(140)	20	(450)	110	(230)	(140)	(55)	(520)
United States	45	(50)	10	50	(35)	(10)	(15)	-
Total excluding Delta Lloyd	(95)	(30)	(440)	160	(265)	(150)	(70)	(520)

 

2011 Impact on shareholders' equity before tax £m	Interest rates +1%	Interest rates -1%	Credit spreads +0.5%	Equity/ property +10%	Equity/ property -10%	Expenses +10%	Assurance mortality +5%	Annuitant mortality -5%
Insurance Participating	(45)	(155)	(25)	5	(95)	(45)	(10)	(50)
Insurance non-participating	(180)	130	(385)	30	(35)	(65)	(45)	(470)
Investment participating	(35)	40	(30)	50	(75)	(10)	-	-
Investment non-participating	(15)	20	(5)	15	(15)	(20)	-	-
Assets backing life shareholders' funds	125	-	(15)	15	(15)	-	-	-
Total excluding Delta Lloyd and United States	(150)	35	(460)	115	(235)	(140)	(55)	(520)
United States	(540)	455	(350)	50	(35)	(10)	(15)	-
Total excluding Delta Lloyd	(690)	490	(810)	165	(270)	(150)	(70)	(520)

 

Changes in sensitivities between 2012 and 2011 reflect movements in market interest rates, porfolio growth, changes to asset mix and the relative durations of assets and liabilities and asset liability managment actions. The sensitivities to economic movements (excluding the United States) relate mainly to business in the UK. In general, a fall in market interest rates has beneficial impact on non-participatng business, due to the increase in market value of fixed interest securities and the relative durations of assets and liabilities; smilarly a rise in interest rates has a negative impact. The mortality sensitivities also relate primarily to the UK.

     In the Unites States, most debt securities are classified as AFS for which movements in unrealised gains or losses are taken directly to shareholders' equity. This limited the overall sensitivity of IFRS profit to interest rate and credit spread movements. Following the classification of the business as held for sale in 2012 it was remeasured to fair value less costs to sell. It has been assumed that economic movements would not materially impact the fair value less costs to sell and the impact on shareholders' equity is therefore reported as £nil. As a result, were eceonomic movements to occur, the correseponding movements in AFS assets which would be taken directly to shareholders' equity, are reversed out through profit before tax in order to maintain the remeasurement value of the US at fair value less costs to sell.

 

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C7 - IFRS Sensitivity analysis continued

General insurance and health businesses

 

2012 Impact on profit before tax £m	Interest rates +1%	Interest rates -1%	Credit spreads +0.5%	Equity/ property +10%	Equity/ property -10%	Expenses +10%	Gross loss ratios +5%
Gross of reinsurance excluding Delta Lloyd	(260)	235	(125)	45	(50)	(120)	(300)
Net of reinsurance excluding Delta Lloyd	(300)	285	(125)	45	(50)	(120)	(285)

 

2012 Impact on shareholders' equity before tax £m	Interest rates +1%	Interest rates -1%	Credit spreads +0.5%	Equity/ property +10%	Equity/ property -10%	Expenses +10%	Gross loss ratios +5%
Gross of reinsurance excluding Delta Lloyd	(260)	235	(125)	50	(50)	(25)	(300)
Net of reinsurance excluding Delta Lloyd	(300)	285	(125)	50	(50)	(25)	(285)

 

2011 Impact on profit before tax £m	Interest rates +1%	Interest rates -1%	Credit spreads +0.5%	Equity/ property +10%	Equity/ property -10%	Expenses +10%	Gross loss ratios +5%
Gross of reinsurance excluding Delta Lloyd	(205)	180	(125)	50	(55)	(130)	(300)
Net of reinsurance excluding Delta Lloyd	(275)	275	(125)	50	(55)	(130)	(290)

 

2011 Impact on shareholders' equity before tax £m	Interest rates +1%	Interest rates -1%	Credit spreads +0.5%	Equity/ property +10%	Equity/ property -10%	Expenses +10%	Gross loss ratios +5%
Gross of reinsurance excluding Delta Lloyd	(205)	180	(125)	50	(55)	(30)	(300)
Net of reinsurance excluding Delta Lloyd	(275)	275	(125)	50	(55)	(30)	(290)

 

For general insurance, the impact of the expense sensitivity on profit also includes the increase in ongoing administration expenses,
in addition to the increase in the claims handling expense provision.

Fund management and other operations businesses ¹

 

2012 Impact on profit before tax £m	Interest rates +1%	Interest rates -1%	Credit spreads +0.5%	Equity/ property +10%	Equity/ property -10%
Total excluding Delta Lloyd	(5)	-	30	(90)	10

 

2012 Impact on shareholders' equity before tax £m	Interest rates +1%	Interest rates -1%	Credit spreads +0.5%	Equity/ property +10%	Equity/ property -10%
Total excluding Delta Lloyd	(5)	-	30	(90)	10

 

2011 Impact on profit before tax £m	Interest rates +1%	Interest rates -1%	Credit spreads +0.5%	Equity/ property +10%	Equity/ property -10%
Total excluding Delta Lloyd	(10)	10	-	(40)	75

 

2011 Impact on shareholders' equity before tax £m	Interest rates +1%	Interest rates -1%	Credit spreads +0.5%	Equity/ property +10%	Equity/ property -10%
Total excluding Delta Lloyd	(10)	10	-	(40)	75

1 The Fund management and other operations are not shown excluding the United States as their sensitivities are immaterial to the group.

 

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C7 - IFRS Sensitivity analysis continued

Delta Lloyd

The full-year 2012 sensitivities contained in the above tables exclude any contribution from Delta Lloyd following deconsolidation
of this business.

Limitations of sensitivity analysis

The previous tables demonstrate the effect of a change in a key assumption while other assumptions remain unchanged. In reality, there is a correlation between the assumptions and other factors. It should also be noted that these sensitivities are non-linear, and larger or smaller impacts should not be interpolated or extrapolated from these results.

      The sensitivity analyses do not take into consideration that the Group's assets and liabilities are actively managed. Additionally,
the financial position of the Group may vary at the time that any actual market movement occurs. For example, the Group's financial risk management strategy aims to manage the exposure to market fluctuations.

      As investment markets move past various trigger levels, management actions could include selling investments, changing investment portfolio allocation, adjusting bonuses credited to policyholders, and taking other protective action.

      A number of the business units use passive assumptions to calculate their long-term business liabilities. Consequently, a change
in the underlying assumptions may not have any impact on the liabilities, whereas assets held at market value in the statement of financial position will be affected. In these circumstances, the different measurement bases for liabilities and assets may lead to volatility in shareholders' equity. Similarly, for general insurance liabilities, the interest rate sensitivities only affect profit and equity where explicit assumptions are made regarding interest (discount) rates or future inflation.

      Other limitations in the above sensitivity analyses include the use of hypothetical market movements to demonstrate potential risk that only represent the Group's view of possible near-term market changes that cannot be predicted with any certainty, and the assumption that all interest rates move in an identical fashion.