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Aviva (NYSE:AV)

Q3 2013 Interim Management Statement Call

November 07, 2013 3:30 am ET

Executives

Mark Andrew Wilson - Group Chief Executive Officer and Executive Director

David McMillan - Chair of French Board and Chief Executive Officer of Europe Operations

Patrick C. Regan - Chief Financial Officer, Executive Director, Chairman of Disclosure Committee and Chairman of Aviva Investors

David Barral - Chief Executive Officer of UK & Ireland Life Insurance

Maurice Tulloch - Former Chief Executive Officer and President

Igal Mayer - Former Chief Executive of Europe

Analysts

Jon Hocking - Morgan Stanley, Research Division

Fahad Changazi - Nomura Securities Co. Ltd., Research Division

Blair Stewart - BofA Merrill Lynch, Research Division

Andrew Hughes - Exane BNP Paribas, Research Division

Gordon Aitken - RBC Capital Markets, LLC, Research Division

Abid Hussain - Societe Generale Cross Asset Research

Greig N. Paterson - Keefe, Bruyette & Woods Limited, Research Division

Andrew Crean - Autonomous Research LLP

Ashik Musaddi - JP Morgan Chase & Co, Research Division

Alan Devlin - Barclays Capital, Research Division

Operator

Good day, and welcome to the Q3 Results Investor Relations Conference Call. Today's conference is being recorded. [Operator Instructions] At this time, I would like to turn the conference over to Mr. Mark Wilson. Please go ahead, sir.

Mark Andrew Wilson

Well, good morning, everyone, and welcome and thanks for joining us on our third quarter call. I have a number of my senior team joining me today. Of course, including Pat Regan, our CFO, as always, and the heads of our major business units. So now I want to take you through the salient points of today's market update before opening up to the questions.

In over the last 3 quarters, we've clearly made some progress. However, I'm acutely aware that 3 satisfactory quarters do not yet constitute a trend. And I for one will judge our performance over a number of years and, certainly, not by 3 quarters. Now, as a reminder, our investment thesis which we launched early in the year is cash flow plus growth.

Now first on cash. We will give you a full update on the remittances at the end of the year. So it's a little bit hard saying all the movements in cash year-to-date. But what I can say is we've maintained the operating capital generation at GBP 1.3 billion and we remain on track to deliver the GBP 1.8 billion of OCG by the year end. We've also grown -- on the growth side, we've also grown value of new business, our key measure of sales, year-to-date by 14%.

Now expense reductions are, of course, another key part of that transformation, and we've incorporated public targets on this. And the performance here is in line with targets we have communicated to you. Operating expenses are 7% lower year-on-year and, in fact, these are 14% below the 2011 baseline used to set this cost reduction target. Again, you have the details on that at the half year. We are on track to deliver a full GBP 400 million of expense savings in 2014, so we will achieve our run rate expense savings by the end of this year. And the benefit of this will flow to shareholders even after inflation so, of course, the cuts are a little bit deeper than that.

In addition, we are tackling integration and restructuring costs, which have been unacceptably high at Aviva over the last 10 years, and this will go some way toward increasing our remittance ratios. Our previous indications though of restructuring cost for the full year remain consistent. We will be within that GBP 300 million to GBP 400 million range.

Now turning to our business performance. You will remember that when I think of the businesses, I group them into 3 buckets: first, our cash generators of the U.K., France and Canada; second, our growth markets of Turkey, Poland, China and Southeast Asia; and our turnaround businesses of Italy, Ireland, Spain, and our investment arm, Aviva Investors. In our life cash generators of U.K. and France, the value of new business, which of course is our key measure of sales, was up 5% and 33%, respectively. I want to reiterate that, in my view, anyone can grow sales volumes, in life insurance or general insurance for that matter, but in life insurance, we are focused on the value of new business, which I see as a good proxy for future cash flow. In the U.K., we have made some very deliberate choices. For example, we pulled out of the large-scheme bulk purchase annuities. And this contributed to a 5% increase in VNB, despite the fall in volume. In France, we did grow volume as well, but that wasn't the objective, but we grew volume by 27%. The objective here was improving our margin, which grew by a high percentage, and the increase in France VNB was by 33%.

Now you will continue to see us take action on our portfolio at a cell level. As you know, we're just under 50 cells, we break our business into 50 cells or just below that. And I see capital allocation is one of my major responsibilities, and we will continue to make conscious decisions to pull capital away from some lines of business and add capital to others. I make no apologies whatsoever, either internally or externally, for sales volume reductions in our unprofitable cells. Equally, we are demanding far more from our profitable cells.

Now in our growth markets, turning to that in Poland, the value of new business was up 48%; Turkey, increased 40%; and Asia increased 43%. Now collectively, this group of businesses grew VNB by 44% and contributed to 22% of group VNB. This is up from 18% last year. Now in the discrete quarter, their contribution was actually 27%, although I wouldn't read too much into that because there's a lot of seasonality in some of our businesses. Now I'm very conscious that once we have finished ticking off and fixing all of the balance sheet issues and turnaround issues in the business, we need to demonstrate growth. However, we're not waiting till then to ensure we have appropriate avenues of growth, and I think these results demonstrate satisfactory progress in this regard.

Now our final group of businesses are those in turnaround, which represent only 5% of our total VNB. You will see that VNB in Spain, Italy and Ireland, has reduced significantly. And this continues the trend from the first half of the year. Now as I've said before, some of this is market-related, particularly in Spain, where the bank consolidation and housing market issues have affected our business. But frankly, there remains a lot we can do irrespective of the macro environment and some of our issues had nothing to do with the macro environment. And I certainly, wouldn't want to use economics as an excuse.

Italy remains probably, I think, our most complex business, and we are addressing the issues of business mix. There's products suitability, there's distribution issues, there's structural issues in that business. We are addressing those, and I'm very comfortable with what the team is doing. The Irish turnaround is slightly more advanced stage, but there remains much room for improvement. And on the life side in that business, VNB is paltry GBP 2 million in the first 9 months. We had new management in there. Again, I'm comfortable that their taking the right actions and, next year, we would expect a substantially improved result.

In GI, as I look specifically at GI, the story is one of stability. And I think we've got this stability as a result of our geographic diversification. We announced the impact of the 2 Canadian floods at the half year, and despite these 2, 1 in 100-year events, our group COR's stable at 97% or just under 97% for the 9 months. Within the U.K., it is clear that personal lines have been under some rate pressure, but this is being offset somewhat by harder commercial lines. Now we're also in the early stages of exporting some of our market-leading capabilities and predictive analytics in Canada to the rest of the group, and the recent appointment of Maurice Tulloch as CEO of the U.K. and Ireland GI business should help accelerate this. We're also exploring quite substantial opportunities through digital and direct. And we have some -- we have some quite encouraging results in these areas and we -- obviously, one of our key objectives here is also to continuously become more efficient through automation. This will be a multiyear project and we'll measure this in terms of our cost ratios.

Now turning to the balance sheet. Our economic capital surplus now stands at GBP 8 billion. This is a over double the level reported at the start of 2012, and this is despite a more conservative calibration of the pension scheme. However, the IFRS book value has declined to 273p despite a gain on the sale of the U.S., and some pretty decent operating profits. This decline is down to 2 things. I suspect that you already know. ForEx, which took 8p off the net as the sterling appreciated against most currencies and, secondly, the pension fund movement caused an 11p decline in book value, as the double A splits narrowed. Now as you know, this movement is due to, what do I call it, the vagaries of IFRS accounting. Our Pension scheme remained adequately funded and the recent movements in IFRS pension liabilities, therefore, have no impact on our cash flow or capital, which of course, are our key areas of growth. Now for those of you who use MCEV, our MCEV per share was pretty stable. It now stands at 437p and, as you know, this gives us a little credit for our GI or asset management businesses.

Now turning to the internal line. As you know, in the first 9 months, we've made more progress than we had originally anticipated, certainly at the start of this year. However, I still understand it is an overhang on our stock, and I want to resolve it as quickly as we can. Frankly, I want to get to the stage where we don't get any further questions on our town meetings with you -- when we go out and meet with you. We have completed our modeling, so that's progress, and we are now going through our plans with the regulator. We are still discussing our plans. But what I can say is that we believe we have substantial noncash means to reduce this loan. Also, bear in mind, I guess that the proceeds from the U.S. sale have increased group liquidity to around GBP 2 billion.

So in summary -- I'll just summarize all of this, then we can turn to questions. The turnaround at Aviva is still, in my view, in its infancy. We have had a satisfactory few quarters, but there is certainly no room for complacency. But I think there's probably a little bit of room for some optimism. Over time, Aviva, is certainly capable of delivering a great deal more. And in my view, we still have a considerable distance to go.

And with that, I'll open up to the Q&A, and I have most of our major business unit heads sitting with me, and Pat, and some of the team. So operator, if we can open it up to Q&A, please.

Question-and-Answer Session

Operator

[Operator Instructions] And we will take our first question from Jon Hocking in Morgan Stanley.

Jon Hocking - Morgan Stanley, Research Division

I've got 3 questions, please. On the Life side, I wonder if you'd comment on are there still product areas where you're not happy with the returns and you're in the process of changing the product mix or redesigning products. That's the first question. And second, on the internal line, can you talk about or remind us where you're happy with the group liquidity buffer? So since you're in 2 liquidity buffers, one in AGH, one in AIL, could you remind us what you previously said on the liquidity buffer?

Mark Andrew Wilson

Okay. Jon, if we can break those down to 2. So Life product is we're happy. I mean, frankly, in terms of VNB, we're only at the start of the journey. This organization's never really focused on value of new business as a key metric. I mean, historically, we chased top line more than value, don't we? And, okay, we made some progress, but there are a lot of areas that we're still a long way off. For example, in Italy, we're doing some good things, but clearly, Italy has been a drag on VNB this year. I don't know, David, would you want to comment on that?

David McMillan

Yes. Jon, I think if you look at both Italy and France, I think the priority there is to -- we actually have reasonably good distribution in both of these markets. The priority strategically is to get both businesses selling the right product. In France, we've increased protection sales in VNB by 35% and in unit-linked, we've more than doubled the VNB. Italy needs to go on the same journey.

Jon Hocking - Morgan Stanley, Research Division

So have you got the products in place that you want? Or is this something which will be rolled out over the course of the next 12 to 18 months?

David McMillan

We've got the products in place. It's a question of getting our distribution to sell the right products.

Mark Andrew Wilson

Okay. And liquidity buffer, Pat, I'm not sure what we've disclosed before, would you want to comment?

Patrick C. Regan

Yes, I think you can assume, Jon, it definitely, will be north of GBP 1 billion that we'll keep at AGH. And probably, a bit less than GBP 1.5 billion on a normalized basis. So somewhere between the 2 of those.

Operator

And we will take our next question from Fahad Changazi in Nomura.

Fahad Changazi - Nomura Securities Co. Ltd., Research Division

Two questions, one on annuities and one on the internal loan, please. You're maintaining pricing discipline, and we did see annuity sales down 51% in Q3. Can you just talk about the general competitive environment in annuities at the moment? And going forward, do you expect normality to resume in Q1 2014 in terms of annuity sales? And on the internal loan, can I just confirm that GBP 5.1 billion, you have already highlighted that's going to decrease by GBP 300 million in the next 3 years, and this additional noncash stuff is over and above that, and I suppose I have to ask, what does substantial noncash measures actually mean?

Mark Andrew Wilson

Sure. So let's take those in turns. So on annuities, the important point in annuities is we exit just about all of our bulk purchase annuity. The reason being that we just fine margin -- too much capital fine margin, and we couldn't get a return on equity on those. So just to be very clear, we had a very good performance from annuity year to date, which is in the Individual Annuities, we've had a very strong performance. And we are quite comfortable with where we are. We do monitor annuity very closely. We come in and out of the market a bit, week by week, in fact, in terms of very detailed pricing, and you can see us come in heavier at times and pulled out a bit on others. But year-to-date, I'm very comfortable with where annuities at. But BPA, that was a very conscious decision. We're not going to put large amounts of capital to incredibly fine margins just to get top line. I mean, my CEOs hear me talk about a lot I think any idiot can get top line growth. We can turn, tap on and off, whatever you want, but our job is not to destroy shareholder value and our sales, our job is to make it. So that's where we are on annuities. On the internal loan, just giving a bit of color on the -- and I said before, we can do substantial noncash means. I'll give you some examples. So the most obvious example is the one we announced at half year, and that was just taking the guarantees off the commercial paper. Now the whole theory here is quite simple, you have a subsidiary in AIL, if you reduce the liabilities in the AIL, you reduce the capital, then you can forget the line. But it's not like an external line, it's just like borrowing money from your parents. We have -- I think, I might be saying we have about 2 dozen projects going on, on this. We have progressed quite a number of these projects. Probably, it's fair to say that we've made a little bit more progress year-to-date than what we sort of started at, at the beginning of the year on. We've actually got, for example, got some more CP we can do. We've got some things we can do, restructuring with our Irish business that reduces liabilities. There's things we can do on the product liabilities. I haven't given any more disclosure on that because, frankly, we've got a pretty good idea of the number we can reduce it down by and -- but I'm not going to be specific. And so we took off each one, which probably isn't as helpful as you want to be.

Fahad Changazi - Nomura Securities Co. Ltd., Research Division

Okay. Just on the Q1 2014 annuity outlook, any comments?

Mark Andrew Wilson

I'll pass it over to David Barral, who's sitting with me. What's your outlook?

David Barral

I mean, all of that. I'm saying Q3 was particularly competitive on pricing, so we maintained a pricing discipline. Those applications are already picking up again in Q4. So the focus here is on maintaining the management value, the capital we're prepared to deploy at any one payment, as Mark said, we can come in and out of those markets as conditions allow.

Mark Andrew Wilson

I mean, we are the market leader in this market. And yes, we have a favor of pricing power being shown, but we will -- we are going to be capital on the set here.

Operator

And we will take our next question from Blair Stewart in Bank of America Merrill Lynch.

Blair Stewart - BofA Merrill Lynch, Research Division

A few questions, just picking up on a few other questions that have been asked actually. But firstly, could you talk a little bit about the VNB reduction in the U.K., and Q3 discrete, just what's going on there. And in terms of the restructuring in Italy, I just wonder if you could just revisit that a little and talk about a little bit about the timing of the changes and whether in fact, you think you can get the distributors to sell the type of products that you want to? On the -- and finally

just revisit that a little and talk about a little bit about the timing of the changes and whether, in fact, you think you can get the distributors to sell the type of products that you want to? And finally, on the internal loan, just again, a bit of clarity around the timing and when do you expect to get agreement, if that's what you need to get from the regulator? And at that stage, would you be prepared to put further color on the extent of this substantial reduction you expect?

Mark Andrew Wilson

Good morning, there. Let's take each of those 3, so the VNB, in the U.K., when we signaled it, pretty clearly, at the half year, we did expect the rates of growth in the VNB in the U.K. to decline in the second half. This is for a number of reasons. There were some changes in the protection market, where the banks who withdrew on a lot of stuff, but they're now sort of coming back into it. It was pretty strong, once you -- at the European Union changes on rating, they had a pretty strong last half of the year on that. Frankly though -- although our individual Life protection business in the U.K. slept, it think it's a pretty disappointing result. And we are doing, say, a few changes and they're to address that. But I think that would be the protection side being said was one of our disappointing news. The other VNB stuff may not -- it is a bit seasonal as well, so I wouldn't read too much into a, quarter-by-quarter, as there's a seasonal decline that we have predicted and somewhat we came in and out of. Any more comments on that, David?

David Barral

I think -- so annuities, this was deliberate, Blair. As protection, Mark says at length, we'll isolate it. A very strong quarter so [indiscernible] and so from a mix point of view, that was lower margin, so that also added to kind of lower VNB. But as Mark said, we're focused on value here, not top line.

Mark Andrew Wilson

Now your second question, Blair, is on Italy. By the way, Italy, I see, is our most complex business. You've got JVs, they're doing another JV with other partners, you've got -- sometimes we have management control, and being typical Italy, some places that we don't. We've got some very good distribution and are pretty pleased with the team we've got in there. Of course, David MacMillan, heads up all of Europe, and then you have Patrick Dixneuf and his team in Italy. We're taking some pretty tough actions this year and a lot of it is structural, and a lot of it would need to do structurally to make a difference. In Italy, a number of the products are value-destroying, so the actual VNB, in pounds, was ridiculously low, GBP 7 million for this year. And a lot of that is structure, you've got a lot of value-destroying products in there that have taken us some time to get out, which is somewhat earth and heaven. But on -- but wouldn't say this, unless I had a fairly high degree of confidence, but I think you'll see some of these leave substantial results, improvement in that next year. I think we are also seeing some pretty good results in terms of what we can do on cash flow. Now will we get a dividend out of this year, I doubt it. Will we get one next year? I think that's a pretty likely outcome. David, can you add any more color?

David Barral

Yes. I think -- as Mark said, Blair, we've had -- particular a number of smaller distribution partners who have been a significant drag on our VNB result, within the process of addressing that. We've made good progress with our bigger partners, particularly, UniCredit in terms of reshaping some of the guarantee products, reducing the guarantees. So I think there's a lot of improvement that we've made in the first and second half of this year that I'm looking for those to come through into results next year.

--

Mark Andrew Wilson

Okay. And Blair, the last part of your point was time and timing on that internal loan and getting more credit. As I've said, before, although we made progress, I want to resolve this as quickly as I can, what does quickly mean? Well, it took us a lot of months to build the models mentioned, you know how complex the modeling is on this thing. It's going to take us another -- actually, reasonable period of time, discussing that with the regulator and working out of this non-cash items. I wouldn't expect any imminent update in the next few months, so over the next few days, it might [indiscernible]. But we will update you as we make progress. I'm comfortable making a lot of progress, but we're not enough to actually give you any figures and what would seem to be it, but we will as soon as we can.

Blair Stewart - BofA Merrill Lynch, Research Division

And is that just the U.K. regulator we're talking about in here, or do you have to go the various European country regulators as well?

Mark Andrew Wilson

No, it's -- look, it's primarily the U.K. regulator. I mean, there might be some minor elections in that list of a couple of dozen things that might need some other regulators to stop as well. But I wouldn't -- that's not really the issue. A lot of these internal actions, frankly, are under our own control. Some of them require regulatory approval and that sort of thing, and some of them are incredibly complex and takes some time to execute.

Operator

We will take our next question from Andy Hughes of BMP.

Andrew Hughes - Exane BNP Paribas, Research Division

It's Andy Hughes from Exane BNP Paribas. Three questions, if I could. There's this 2 on the GI side. So, obviously, on the U.K. GI, we had quite a few people leave the business over the past kind of couple of months or so. The key 3 numbers look pretty resilient. Just wondering if you would expect the various changes to have some sort of impact on the top line there? And the second question is on the Irish motor reserves. Obviously, one of your peers said they were reviewing their Irish metrics. So I'm just wondering what the situation is for you on that one? And the final one is, I guess, on the U.K. group personal pensions. What's the average fee on the back book, please?

Mark Andrew Wilson

Okay. Andy, thanks. So 3 questions. So the U.K. GI, since this morning, we've had quite a few comments from people saying, "Oh, they expected worse results on the U.K. GI because a few people have left and because I changed the CEO, and that often indicates bad results. Obviously, that wasn't the case. What they -- when you have a very large business, like the U.K. business, it's one of our core, it's one of our strategic businesses, you need your best people on the pitch. And I wasn't convinced that the team we had would drive that business forward to reach its potential in the timeframes that I would find acceptable. Number one, GI business, clearly, is a Canadian business and despite the flats in Canada, it's still performing exceptionally well. And a big part of that was Maurice Tulloch, which is why we brought Maurice here. The one thing that Maurice has done in Canada is build-- I think the outstanding depth of those teams, so we appointed from within and eventually, that business was the one to beat. So that's what we got, you want to pass and comment on that Maurice? Maurice is sitting on the table with me today.

Maurice Tulloch

Yes. Thanks, Mark, and good morning, Andy. I actually arrived in U.K., full time, 2 weeks ago. Yes, obviously, some what surprised that we had lost 4 senior people, coming from the K market, I hadn't lost anyone in my senior team in the past 5 years. But the way I look at this, Andy, it also creates opportunity. And the one thing about the Aviva brand, as I've gone out to hunt for new talent, I've been incredibly impressed. Our brand has attracted the crème de la crème of talent in the market. So I think you can expect from me, probably in the next couple of weeks, to make a couple of pretty important announcements. In terms of the follow-on question about impact, I don't see any impact on our business. I'm putting the right team in place. I'm getting around a meeting with our 8,000 employees and I'm actually setting a simple strategy for this business going forward.

Andrew Hughes - Exane BNP Paribas, Research Division

Yes. And the Irish matter? What's going on?

Maurice Tulloch

Yes. And you had a question on Ireland. Obviously, that's quite poignant right now. I meet quarterly with our reserving actuary, I didn't meet with him since I've come here. Following that, I had a further chance to review that, which is done quarterly. We also review those reserves annually. Periodically, we have a peer review, Having reviewed it in detail now myself, I have no concerns on our reserve position in Ireland?

Mark Andrew Wilson

I mean, the other point of reserves is non-recourse. Of course, Ireland is poor, though it's improved, it's still poor. We have seen pretty robust and now I'm observing it's fair to say, so we're pretty comfortable for those. Your point on volume, Andy, just putting that -- the interesting thing in the markets, particularly the U.K. GIs, think like motor, very commodity -- commoditized products. We can turn the tap on and off whenever you like and it can makes -- it makes the difference on the day, literally, because that is the nature of the market and this -- particularly, drink market. And we made some conscious choices as we saw the leg swathing on the personal motor line, that we didn't want to play as it went down. We will play a bit more as it goes forward, but we play in the markets, as long as it works. And again, I make no excuses for that, because that's how we allocate capital between our business lines, where we see something we can get a quicker payback or higher return, we do it. Now as my CEOs around Aviva know now, because I quote it to them all the time, capital allocation is a competitive sport. And it's a pretty tough competitive sport. And I think, at the full year, we'll let you go through our new capital allocation process and then you can judge that as you wish. So your last question, Andy, was...

Andrew Hughes - Exane BNP Paribas, Research Division

GPP charges.

Mark Andrew Wilson

GPP charges, yes. Umm, David?

David McMillan

Morning, Andy. I can't give you the precise average rate on the back book, but it's less than 1%. We brought in our own trade cap, as long ago as 2001, which was amassed from a charge of 1%. So you go for the [indiscernible], it's going to be less than that. And in terms of [indiscernible] anticipating your follow-up, the charge cap comes in at 0.75, that affects our [indiscernible] -- was 13.7 good pension assets and some are GBP 128 billion out of the total life assets, so it's a relatively small proportion of assets in the context of [indiscernible] business can do it.

Mark Andrew Wilson

Yes. I mean, the whole debate and that is a big debate on caps. People are complaining about it in the market. I don't think it's an unhealthy debate. It is with the big charges had come down over time a lot, and we're pretty competitive in that space as well. The order enrollment stuff as well, which is the point of that switches, and they're probably more like you, where I think the political debate is going to focus on. I mean, our average on that, just on the auto low pension schemes is they are 0.5 -- that's 50 bps. So just to be clear, and that's where all the focus is at, our average is 50 bps, all the cap come up 50 or 75 bps, is that my main -- who knows? But just to be clear, our average is actually at 50 bps amount already.

Operator

We will take our next question from Gordon Aitken in RBC.

Gordon Aitken - RBC Capital Markets, LLC, Research Division

Three questions, please. First on pensions. You mentioned that group personal pensions have been strong, the growth is 11% for pensions. To what extent does that reflect commission deals, which was signed or which were agreed pre-RDR? Second, so annuity sales are down 51% quarter 3 last year. You mentioned that you've written some bulks in the third quarter last year, what was the quarter-on-quarter growth rate in retail annuities, please? And the final question is, can you just update us on net inflows and assets as you did in the half year stage?

Mark Andrew Wilson

Sure. So pensions commission, David?

David Barral

Well, the -- I mean, as the last of [indiscernible] pensions coming through, that's why you saw us fake in Q3.

Mark Andrew Wilson

I mean, after that's the answer to that one.

David Barral

So it will be just the second question?

Gordon Aitken - RBC Capital Markets, LLC, Research Division

The second question was on the alternate retailer.

David Barral

The bulk and the individual was up 21% against previous quarters. So it changed last year. So individuals had been very strong.

Mark Andrew Wilson

But they'd assume from that, that the key issue there is the bulk. So as I said before, our individuals have been very strong. Perhaps that's now where we have maybe outperformed the expectations a little bit on us. And the third one, Pat?

Patrick C. Regan

That's on net flows, as you know, we don't give net flows each quarter. What I would say is the trends we saw at the half year were the same trends that we're seeing at this point of the year.

Gordon Aitken - RBC Capital Markets, LLC, Research Division

What's been an interesting outcome, by the way, just as [indiscernible], so RDR had a number of impacts. Everyone, and it's not just us, people are starting to see some trends of less outflows because as [indiscernible] don't get commission [indiscernible] less twisting in the back books. And I have got a hypothesis that maybe that's going to be helpful long-term, now we need to see if that comes through, but that certainly what appears to be happening at the market at the moment.

Mark Andrew Wilson

We'll see. Time will tell.

Operator

Our next question comes from Abid Hussain of Societe Generale.

Abid Hussain - Societe Generale Cross Asset Research

Just 3 questions, if I can, please. First on, cost saves. Your run rate indicates that you can achieve a GBP 400 million cost save by the end of this year or a year earlier. Or if you put it another way, it looks like you will significantly exceed the GBP 400 million target. And so I was just wondering if you could elaborate on what is actually you might be looking to reinvest the cost save over and above the GBP 400 million target? So that's the first question. And then, second question on the remittance ratios, are you able to share how these are trending I think of H1 stage, there was a ratio -- implied ratio around 16%, I realize you can't extrapolate that out for the full year, but just wondering the general direction of the trend. And then finally, I might be getting a little bit ahead of myself, potential excess capital, can you give us an idea of what you might look to do with the excess capital, which is likely to build up as you continue to generate decent cash flow and continue to dispose businesses? I'm assuming that remittance ratio does hit the 80% further down the line.

Mark Andrew Wilson

Okay, so a few questions. So the cost saves, I also have Nick Amin now, our cost enforcer amongst other tough, he is with me today. We're up to the cost, okay, so it's taking okay, and it's clear to say that all business are now on track. Second attack. I wouldn't say that would have GBP 400 million savings by the end of the year, I don't know if we've checked, the run rate would certainly be down by that, so we know the GBP 400, million -- we will be coming to the shareholders next year. So I don't want to overplay or overplay the expectations here, but we are checking where we should be. And in terms of next year, we are reallocating a further GBP 200 million, so we've got some pretty big initiatives. It'll be pretty easy for us to say to Nick, one, I have to make this another GBP 200 million on our bottom line next year and frankly, we can do that. But then what? Because my question, so what we've decided to do as a group, we're going to put in excess of GBP 100 million, reallocated cost, this is an addition to the GBP 400 million, reallocate the cost towards automation. Now automation is a process, it's claims processes and what the objective here is, I want to see, and we're going to have it in everyone's personal targets, I want to see every business in the group improve their cost income ratios every year. So this isn't a 1-year journey or 2-year journey, I mean, every year. So we're going to do -- reallocate, primarily from IT, over GBP 100 million of cost into automation and fix up legacy systems and automate processes to bring our cost income ratios down. For example, in the U.K., our cost income ratio on the GI business is about 10.1. Now that compares with Canada, which is about 8. And so, frankly, it's too high. And we've got a long way to go. Mark, anything else on cost?

Mark Andrew Wilson

We're not -- we're pretty much on track where we expected it to be, and we'll certainly, make the number in 2014.

Mark Andrew Wilson

And secondly, our remittance ratios, did you know last it was 48. I mean, it's a bit hard to model for, at least, you guys to model where it's going to be, we're -- our model is pretty good on this now, and we know the action to take in country-by-country, I'm not going to give you any guidance. What I will say is, you can expect the remittance ratio to be higher this year than last year. He's going to expect to be higher next year than this year, because we already know the actions we have in place, frankly. I've said before that I want to get it up into 80s, that's a multi-year journey, so 48 into the 80s and this is a key part of our thesis. What are we doing with the cash? In the end, that's a board decision. I've been clear. We've got a lot of things to do, we still have to deliver the business. Our external leverage, on an S&P basis is steady fee that's still too high. We might use some proceeds for some of that. Yes, there's a whole other things we can do with that cash, but I don't want us to get ahead of ourselves here. And we certainly aren't. We're focused on fixing the things we have and that kind of makes them some adequate so I guess but I wouldn't want to overplay it, we still have a lot to do. And as they focus I think that's probably.the answer we [indiscernible].

Operator

Our next question comes from Brian Paterson of KBW.

Greig N. Paterson - Keefe, Bruyette & Woods Limited, Research Division

I just wonder if you can give us the percentage of your annuities that came from enhanced annuities in the third quarter versus the half year, question one. The second one is, I was a little confused on the operating capital run rate, my understanding is you said that the underlying run rate was 1.8 and if you do the math, that's sort of 0.45 per quarter, you minus Toronto you get 0.4 per quarter, but you're running at 0.3. To me there is been some kind of deterioration in the capital generation there. But, I wonder if you could speak to that? And the third thing is I wonder if you could just update us on your plans for Indonesia to acquiring distribution there or joining a partner?

Mark Andrew Wilson

Okay. So one question, the half-year is about the same as was the half year, it's a bit above the quarter. So that's pretty stable. Now that's a nice part of our business and it is pretty stable. So it's a bit above the quarter. On the run rate, I mean, I'm not going to share with you our modeling, but Pat, you want to comment?

Patrick C. Regan

Yes, we were -- I'll make you remember Greig, we were just over 900 at the half, but we're rounding between 1.3 now. So we are basically at the numbers you just said of about GBP 400 million for the quarter, which is in -- a tad lower, a little bit seasonally for the third quarter, but...

Unknown Executive

It's [indiscernible] even line with what we saw both last year and in the first half of this year.

Mark Andrew Wilson

Yes, I think, what can I say, I think you'd be accurate to use 1.8 in your model.

Greig N. Paterson - Keefe, Bruyette & Woods Limited, Research Division

My understanding of the 1.8 is the underlying run rate, excluding one-offs.

Patrick C. Regan

Yes, we've said last year we had a little over GBP 100 million in one-offs particularly in the U.K. life business. We're flat against the position last year without that. So you can see the U.K. life stand GBP 100 million because of that item. So we haven't had anything really notable in terms of one-offs in this year and the future.

Mark Andrew Wilson

Indonesia is the third one, is to your question. Now, obviously, I don't comment on speculation about -- I know there's been speculation on the market on certain distribution arrangements in Indonesia. But you can see that our growth margins in Asia and Poland and Turkey are seriously gaining momentum, and there was -- I guess important things were becoming pretty material to the group and 22% of our VNB so far this year. What can I say? I can say I do like Indonesia as a market. I like markets where we have low capital and high margins. I like markets who have a population of 0.25 billion people. I like markets that had have an emerging middle class. And frankly, I also like markets where we have a lot of contacts and group contacts. I mean that's pretty helpful. So I'm not going to say anything more on that. It's safe to say we are interested in expanding our current business there and as you know, we do have a business there, we are certainly interested in expanding it. And there's some interesting distribution arrangements in that market for sure. Other than that, we will all have to wait.

Greig N. Paterson - Keefe, Bruyette & Woods Limited, Research Division

I can take it that you are speaking some people would agree, I take on that.

Mark Andrew Wilson

I couldn't possibly speak to that.

Operator

And we'll take our next question from Andrew Crean of Autonomous.

Andrew Crean - Autonomous Research LLP

Two questions. The first one is on your operating cash generation of the GBP 1.8 billion target. To what extent is this benefiting from operating -- operational variances or the acceleration of cash forward from future years. So as just relief for insurance to you, I think it's about a GBP 178 million benefit in the first half. And then the second question, on the internal loan, I mean you had been fairly clear that, that's going to come down materially through noncash means. What -- I suppose more general question, what does that really mean as it happens for shareholders. How does this affect embedded value? How does it affect capital? How does it affect your view of dividends?

Mark Andrew Wilson

Okay, [indiscernible] Pat, take the [indiscernible].

Patrick C. Regan

In the third quarter, there's nothing of note, actually on the expense guarantees or anything else in that bucket.

Andrew Crean - Autonomous Research LLP

But I mean in terms of -- I think you said about just under GBP 200 million in the first half, when you're looking at the point 1.8. Are you looking to do further [indiscernible] for insurance deals to advance cash recognition?

Patrick C. Regan

What we've said -- as we've talked about before that the 1.78 isn't acceleration of reinsurance deals. It's a variety of things, it's some positive variances, which hopefully moved expected flow throughout the time. It's some back book actions that we'll do each year. We do a little bit of that in France. that frees up a little bit of capital I expect to see all of that -- say an amount of that -- and modest amount of that flow through each year. So it's one of the things. Having said that, it was a little of any of that in the third quarter.

Andrew Crean - Autonomous Research LLP

I mean there's no relationship then between the free surplus positive variances on GBP 178 million and this negative variances of around GBP 196 million?

Patrick C. Regan

No, they're not opposite sides of the coin. They're different items.

Mark Andrew Wilson

Okay, and on the internal line, Andrew, the -- and frankly those actions make absolutely no difference to [indiscernible]. At a group level, it doesn't make difference to capital, obviously, want to reduce the capital on that subsidiary by reducing the liabilities. But at a group level, I said, it nets off. So it doesn't make any difference. The way to think about this loan is an investment from that subsidiary to another part of the group, that's the way to think about it. So as you can see it nets off. If you -- I guess and the ultimate thing and you wouldn't do this, but if you collect the structure together, what happens to the loan? I mean if you think of it that way. In terms of cash flow it can be good and bad. I mean if you reduce the loan, obviously, at the group level, we're paying 4.1% on that loan as well you increase our surplus if you reduce the loan. The question is how do you reduce it and as I said, we can do a substantial amount, noncash means and we're working through our plans, we're working through what it means. And we'll come back to and our objective is to take it off the table. So you never ask me another question on this in analyst calls. And that's what we're aiming to do.

Andrew Crean - Autonomous Research LLP

Do you have any impact on your dividend policy, do you?

Mark Andrew Wilson

I don't have any impact on the dividend policy, now.

Operator

Our next question comes from Ashik Musaddi in JP Morgan.

Ashik Musaddi - JP Morgan Chase & Co, Research Division

Just one quick question, just this morning in one of the other conference call, we heard the comment that's Solvency II has never looked better in terms of it being implemented in 2016. So can we hear your thoughts on that? And just link to that, what is the impact of Solvency II if it comes, it will be on your annuities business? And how does it compare to the return of your bulk purchase and individual pension -- individual annuities, i.e. you actively decided not to do both purchase. So what's the real difference in terms of returns, can you give us some thoughts on that?

Mark Andrew Wilson

I must in case have never heard that Solvency II has never looked better. [indiscernible]. It's fair to say we have been intimately involved in these debates, EU and the government level here. And it's fair to say at the beginning of the year there were things that just didn't make financial sense not financially logical, clearly, there has been some progress made and as you know, I oscillated on this issue month by month, one month I think [indiscernible]. As the company stands now I think there is a very, very high chance that will come in -- I think it'll probably come in 2016 and there's still a lots of work to do to realize what it means. But a company like us, we have probably more than most and maybe we're probably being bluntly, I think we are being penalized for i over a few years, but more than most, we have already embraced a risk-based approach to capital management. And we've taken a large number of steps as you know to deal with [indiscernible] balance sheet and really I guess -- optimize it and make it better for this sort of environment. No one knows the final detail yet. But I think it's heading in the right direction. I guess from a competitive standpoint, that would put us on a far more equal footing with others, and I think that's helpful. It's much closer to the basis we are already using. Now on specifically your points on annuities and some of that can you think of that?

Igal Mayer

To Mark's point, we've been running the group [indiscernible] disclosure economic capital for a while. So that's been a key part of the pricing of individual annuities. We've tried to front-run what we think is the substitute environment would be in terms of our current U.K. annuity pricing now, now as that's spawned up, that's going to broadly in line with I think what we would expect. So they're getting more clarity on matching adjustments and stuff like that, it's good in that respect.

In terms of what I mean is for returns, I mean it doesn't mean a lot in terms of the differential return between individual annuities and bulks. Our MCEV margin on individual annuities is almost double what it was last year, so the returns on that are good for us now. And I think in a current economic capital environment, perspective on Solvency II environment, the returns on things about, we would say is stronger than in pension space, and will remain so.

Mark Andrew Wilson

And the one other thing, I should probably add is what appears to be clear is that there will be quite a long term transition for the back book of all companies and that makes I think a lot of sense. And that helps I think everyone and this has become to be reasonable acceptable outcome. But we'll see. It's still got to be clear, it's still good to go through several rounds of discussion of the EU side. And we remain actively involved in it. But the only change on it really is I now do think it is highly likely to come in -- and I think in 2016.

Operator

We have a follow-up question from Mr. Andy, Exane BNP.

Andrew Hughes - Exane BNP Paribas, Research Division

A couple of quick questions, one was a follow-up on the U.K. GI business. I think you said that enhanced -- you made a comment about U.K Motor and in fact, their volumes could increase quite dramatically and if I'm thinking about enhanced analytics, what those are really going to make a difference? Is it fair to say it was more personalized than it would be on a commercial book? So I guess the question is do you wait to reduce the cost ratio in U.K. GI to start growing the business again? Or does it help the analytics identify areas within personalized but the -- and you can grow in much earlier than that? And should we be thinking about U.K. GI business growing sometime soon? How long does it will take to implement the -- kind of inhouse analytics approach? And the second question was on, just a comment on legal and general made about the runoff of the high fee products and also with profit stuff in the U.K. over the coming few years with sharp runoff of the investment bonds. Do you see the same impact from the business and what does that mean for the kind of U.K. Life earnings?

Mark Andrew Wilson

Okay, can I take the second when first if I may, then I hand over the other to Maurice. The runoff, when profit spoke, what can I say? At half year, we gave some, I think some pretty full on detailed disclosure about the cash that gets thrown off from our life back books, which has a lot of other profits and stuff in it. If you look at that, you'll see it's pretty stable and very resilient. The runoffs that you see, we certainly haven't seen the increase in terms of runoffs. You see it stable. We -- I guess we're in the -- I think a lot of companies that look at us and say, they'd love to wake up in the morning after new years eve and see that you have GBP 1 billion in capital surplus, coming off your back book this year, and that's what we have. As you go through -- if you have a look at those disclosures, we can send them out to again if you wish, table of those disclosures, you can see that, that is in excess GBP 1 billion -- in excess of GBP 1 billion for the next 10 years, so it's very resilient in terms of the cash flow of the capital surplus generation, which is the most important factor. Now in U.K. GI, I know it's a bit unfair, he's only been in the business a few weeks, but I am going to put you on the spot here, just before you answer, I'll remind you, that we're not going to chase volume that is not profitable on any market, obviously.

Maurice Tulloch

And I never chase volume. Andy, a couple of points, in some of this market is very soft right now and a lot of our competitors in my opinion, they've probably been a bit aggressive on the Jackson and the lots of and we've seen that in the rates. We made a deliberate choice to look at our mix. Actually, our customer count hasn't really fallen much. We're down at just about 2%, over the last year. As Mark mentioned, it's just a couple of weeks, but I'll give you some observations, and perhaps, tackle your sort of second underlying point. I find this market very sophisticated, the distribution, the marketing, the use of aggregate -- aggregated, but I don't find this market as sophisticated in the quarter of insurance around pricing, underwriting, particularly used of predictive analytics. Certainly, that was the hallmark in successful companies in North America. But also a hallmark in our Aviva Canada business, and certainly, something that I am bringing over to U.K. in terms of Life attendance measure, you're probability looking at 12 to 18 months, and I think what that allows us to do is it allows us to accelerate our business, but not at the cost of choosing volume over value.

Operator

[Operator Instructions] And we'll take our next question from Alan Devlin and Barclays.

Alan Devlin - Barclays Capital, Research Division

Just a follow-up to Andrew's question, can you -- what's a major concern do you -- internal leverage or the external leverage? And then a quick question on Aviva Investors, the investors see as the weaker in Q1 2012 is that business, [indiscernible] starts or you're taking actions, or what's going on with Aviva Investors?

Mark Andrew Wilson

Alan, certainly, to the regulators, it's internal leverage, distantly. I mean just to be clear on my comments on external leverage, we've said we want to reduce by a ratio over the medium-term. And we'll do that as we get some close -- simple bring it down by maybe 500. But I don't want to overstate that one. If you have a look -- I think we haven't helped ourselves a lot of -- -- we use an internal measure that seems to be far more restrictive than anyone in the market, if you look in the S&P basis, 33, while that's still too high, we'll set more -- with risk far more than the others with our risk, we don't have any high-risk products, we don't have any U.S. business, et cetera. So we can carry, a bit more debt than most than most. At the same the reason I want to reduce just to give us a bit more financial flexibility is the way I'll call it. Please, don't assume that this is the regulator pushing for the store. Now on the internal levers, it would be fair to say that the regulator and us both agree on that, I said that before. We're working hard on it. The question is what should it come down to, frankly, and the message, we'll get there. And I haven't got all the answers for you today. What I can say is we've made substantial progress, we know we can reduce a lot with noncash flow means, and there's the question, of course, that will you use any cash to do it? And the answer, frankly, is I don't know yet. What I do know is we've got a lot of noncash means we can put in it and that's substantial. And we're working through that and I've never satisfied with anything but I think we made satisfactory progress on it, and frankly, it's a bit more than we would have said at the beginning of the year. So AIL is the other one, and that's taking the -- it's taking a lot of our time, I had Jason Windsor who is head of strategy and M&A and he's the guy doing the disposals, so doing the U.S. and other things, he's been pretty busy. [indiscernible]

Unknown Executive

Sure. On AIL obviously a business the transition [indiscernible] staff in January. And we expect them to unlock some of the potential. Within the performance this year, we've seen sales on roughly flat, slightly up 3% at the gross level as over last year and the team down there, doing a good job continuing to put in strong investment performance externally [indiscernible]

Mark Andrew Wilson

I mean if you have a business like that, let's be really clear, if you have a business like that with GBP 250 billion, GBP 260 billion and you only make GBP 36 million in profit out of it, you and I are going to say that's totally unacceptable. And you've got some great PMs, we've got some good performance at the group level, it's adding value that way but frankly, the business, I'm quite unhappy with it. And I don't invest probably use to anyone that only used to that team. And the prospect and I got given this step last week when one of the sales guys has said, we have more inbound call from active management consultants since his announcement than we've had in the last 3 years, which is quite a telling stead. I mean he is -- a good -- but I also want a manager expectations here, I seem to do that a lot. But one of manager expectations, I do see the turnaround in Aviva Investors taking longer than the turnaround in some of the other insurance businesses. Partly, because we started it earlier, partly because it takes time. We're doing a lot of start on cost income ratios, we need a lot on our offering, we're very clear on what our strategy is, and we recruited you and -- to align to the strategy, rather than. But I'm normally going to let you and talk about when he comes in here, and we haven't announced that [indiscernible] market. So it is very disappointing from a shareholder perspective. And that one will take some time.

And I think we got the last question now online.

Operator

And we'll take our last question from Grant Pattison and KBW.

Greig N. Paterson - Keefe, Bruyette & Woods Limited, Research Division

What, unusually, I am confused -- not by you guys, I'm just always confused, but if I was thinking about 2 years, we were all holding to Aviva and we -- on the GI side and we had a detailed presentation on I think it was probably, Aviva Motor Pricing Index, and all the work have been done et cetera, et cetera, and it sounds pretty much like the Canadian predictive analytics, that you're going to bring in and so, either the black box didn't have anything before and someone was playing with truth, or are there some difference between the 2? I wonder if you can just explain between the Aviva Motors pricing index, that just spent so much money [indiscernible] and predictive analytics, what's the difference?

Mark Andrew Wilson

I mustn't -- I don't know what the presentation you're referring to, it isn't here. But I know someone who will know, because he was in Canada and is now here and that's Maurice.

Maurice Tulloch

Yes, sure, and I think what was the -- and I can't specifically recall the presentation, but certainly what we did in U.K. Motor 4 years ago was we brought over credit scoring and it actually came over from the business and the term we used here was and it's actually served the U.K. business tremendous well. And we can see that our motor results -- we're at 97 and in a very competitive market. So we're actually outperforming the market. I think when I talk about -- the world moved on, certainly, moved on from use of credits, we went into multivariate analysis, we went into behavioral predictions, we went into voice, we went into predictive analytics unplugged. So while the U.K. is leaving this market, it's not a point, this market is incredibly sophisticated as it can be in that space. I think there's far more to come. And that's why I'm looking forward to do. That's sort of turnaround won't be immediate. It's about data. It's about people. It's about talent, but that's certainly what we're going to do.

Mark Andrew Wilson

For example, in the [indiscernible] as in Canada, about a month ago, and we saw a presentation on the fraud modeling. And the systems we used -- the same system that Interpol uses, is one from the [indiscernible] and we can predict [indiscernible] by groups, we're using Facebook, we're using social media and basically, you create webs for the people and you can get webs of the fraudsters. And frauds, just by using that one thing we think fraud accounts in excess of 10% of our total plans. We have that right, and I think that's a major problem global, general insurance. And so we're putting in a lot of money into using the old way of using fraud will be to have gumshoes and this together, find out people it's about big data here as well. And some of the stuff we've done first in Canada and again, we're learning and, frankly, the whole industry is learning on this. And no one is really done effectively, but we got to say, the initial results in Canada somewhat surprising. I mean positively not negatively. So I think this is a journey, it's all a part of predictive analytics journey, the thing I should say is this its -- it does not standstill. This predictive analytics and big data, it keeps on moving. It moves with us every month. If you look at 80 people, sitting in the room in Canada, all they do with their whole life is try and find correlations between days at risk and then build algorithms. What that may not found the most exciting thing to -- you are necessarily, but it's for the industry in terms of results.

Greig N. Paterson - Keefe, Bruyette & Woods Limited, Research Division

Do you -- I just want to take another point, do you have -- I know you're talking about technical pricing, do you have what I call a new pricing or market pricing technology where you consider finetuning your pricing on the price compression website, so is that [indiscernible] development going forward?

Mark Andrew Wilson

Yes, we did, Maurice, do you?

Maurice Tulloch

Yes, we actually lead in that space, both here in the U.K. and in Canada. The actual benefit was getting into sort of predictive analytics that's only relevant to know where the market is at, because you'll actually -- that the market is a straight line on a 45, you'll find your line on the weight of the line, which point in that line using economic capital of choosing your returns, but you still need that as a basis and yes, we do have it.

Mark Andrew Wilson

At end, I mean some of that's real time on the online systems and stuff. But again, this isn't a point in time thing. It changes pretty much each week as we -- we also have a lot of the state on the left side, by the way, and a different way in the annuities. Why do we so in annuities, one reason is we got more data enabling us because we've been in that longer than everyone else. And equally because we're just not going to chase volume and we cross different points on different ages and different risk, enhance annuity differently because we have all this longevity data. Longevity risk is a science. And to have a science like that, it is all about data, it really is.

Greig N. Paterson - Keefe, Bruyette & Woods Limited, Research Division

Didn't you enhance data -- -- you're enhanced data is only 4 years old, I mean, you can put it as 10 and 20, doesn't it leave your competitor at a disadvantage?

Mark Andrew Wilson

I don't know, which seems to [indiscernible] in the market, but that would be...

Unknown Executive

[indiscernible] in the last 4 or 5 years, but I take the basis, going back.

Mark Andrew Wilson

Well, our base on annuities is you keep a lot of data on people when you -- on annuities or on life insurance, we're talking as well, obviously. What we have seen on that is you've seen a large increase in it as it has become, I'll say a fashion in the market. It's become a fashion in the market. So we're major player in that and it's -- just to be very clear, I mean it's -- and I'm asking you as a key part of our business. But, frankly, there's a lot of heart around the business, it's a beautiful market in total, frankly. It is real. You have got some good benefits to customers. But from an investor's perspective, I don't think you should care too much whether it's enhanced or not enhanced annuity. Frankly, it doesn't make a whole lot of difference to an investor. But it's nice marketing angle, and we're participating in that and [indiscernible] since we've done it. I mean, I wouldn't -- I definitely wouldn't want to overstate it.

So, thank you for joining us. Yes, we have -- having much to do. As I said before, there's 0 complacency, 0 arrogance, but a whole lot of focus and we've got lots more quarters, where we need to good results before we even start to think about us, making progress. Okay. Thanks for the call, and we'll follow up later.

Operator

That will conclude today's conference call. Thank you for your participation, ladies and gentlemen. You may now disconnect.

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