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Executives

John McFarlane - Chairman

Patrick C. Regan - Chief Financial Officer, Finance Director, Director and Chairman of Disclosure Committee

Trevor John Matthews - Executive Director of Developed Markets, Executive Director and Chief Executive Officer of Aviva UK

Analysts

Nick Holmes - Nomura Securities Co. Ltd., Research Division

Ashik Musaddi - JP Morgan Chase & Co, Research Division

Oliver Steel - Deutsche Bank AG, Research Division

James Pearce - UBS Investment Bank, Research Division

Andrew Broadfield - Barclays Capital, Research Division

Gordon Aitken - RBC Capital Markets, LLC, Research Division

Barrie Cornes - Panmure Gordon & Co. plc, Research Division

Andrew Crean - Autonomous Research LLP

Colin L. Simpson - Goldman Sachs Group Inc., Research Division

Jon Hocking - Morgan Stanley, Research Division

Marcus Barnard - Oriel Securities Ltd., Research Division

Aviva (AV) H1 2012 Earnings Call August 9, 2012 4:30 AM ET

John McFarlane

Good morning, everyone. Now it's just 1 month since I last spoke to you about the plans through to 2014. And as you'd expect, well, there's been a lot of activity inside the company in that period. The consequences of that are going to find their way into announcements not today, but over the coming months.

So first, let me deal with the interim result. Operating performance was largely in line with expectations. Of course, the main new news was the write-down of the goodwill in the U.S., following a review of its recoverability.

As I also said last month, there was a desire to hold the dividend, and that's what we've done in the half.

So notwithstanding the subdued external environment, a number of our businesses performed well, including the U.K., Canada, Poland and Singapore, and so that's been good. Others were affected, for example, by currency, in particular Europe.

Turning to the company overall, last month, we announced the results of the strategic review of 58 main businesses within the group. I'll remind you that, that concluded that we had 16 businesses that were non-core, to be exited; 15 were stand out; and there were 27 that operated around our cost of capital.

We also announced our intention to bring our capital levels up from current levels to a range of 160%-175% coverage to reduce the volatility of capital at the same time and to reduce leverage and to lower our cost by GBP 400 million.

And as a result, we ceased writing bulk purchase annuity transactions. We brought down our holdings in Delta Lloyd to below 20%. We've completed disposals in Hungary, Czech Republic and Romania. Our Italian debt holdings have been reduced by EUR 2 billion, and we plan further reductions in that when the circumstances permit, when the yield is sitting at 5.82% in the 10-year at the moment. So we really need that to drift down a little bit so that we can do that without an impact on our P&L. So that's our thinking on that.

We also began the process of disposing or running down the non-core businesses. We've appointed investment banking advisors to 10 that are planned to be sold and are in the process of reducing capital levels in capital hungry segments. We're also considering plans to improve the returns of the 27 medium return business cells.

On expenses, we are nearing the finalization of the delayering of the group. There were announcements this week, and when completed should save a significant part of the total target savings. We've also begun a review of head office, support activities and non-staff costs across the group.

As part of instituting individual accountability, each of the group executives now have revised performance objectives, and they'll be held accountable for delivering these, and that will form the basis of their variable remuneration. We've also eliminated all unnecessary committees and meetings to allow people to spend more time on our business and more time with customers.

We've also reduced the distance between the CEO and the customers, which was quite deep before.

And finally, we continue to evolve the board, which is now down to 11 people. And we expect further movement over the remainder of this year and into next year.

Anyway, it's my sense that we have got the right agenda. We've got the right people in place to execute it, although we are needing to appoint a CEO.

We are broadly on track with the program we set out last month. Over and above the actions we've already taken, you can expect further announcements in the second half and other announcements next year. And I remain confident that we'll do exactly as we said we would going forward. Thank you.

And now, I'll pass you to Pat.

Patrick C. Regan

Great, thanks, John. Good morning, everybody, nice to see you all here again. I didn't notice, actually we've put some Team GB Chocolates for everyone to enjoy in the bowls if you haven't seen.

On the results, as John said, operating results I think broadly in line with expectations. GI a little bit better than expectations, Life partly impacted by foreign exchange, euro versus sterling. We booked some additional operating costs in the first half, Solvency II and the first wave of implementing the simplified program. We have taken a decision to write down the goodwill in the U.S., I'll come back to it obviously in a bit more detail later.

Operating capital generation, up about GBP 100 million, less capital consumed in new business. New business profitability staying at pretty steady levels, both General Insurance and on the Life side. And our economic capital and IGD ratio is pretty stable versus both what we told you a month ago and versus the first quarter.

Looking at the operating profit in a little bit more detail, and we're trying to put kind of a reconciliation kind of big picture on what's going on here. So General Insurance is up, I think probably given we'd sold the RAC, and we had some additional weather costs, that's come through a bit stronger than general expectations and Life U.K. good, slightly offset by Eurozone and FX.

So big picture, some underlying profit growth generally in the General Insurance area. Last year, we made just under GBP 50 million from the RAC, so sold that and that comes out.

In weather, this is just versus last year. So if you look at against our long-term average, actually, it's slightly above our long-term average, but not, not much, but it's more than last year, last year was quite benign, and that's mainly in the U.K., a bit in Ireland.

Foreign exchange, both the euro and the zloty impacted profits, and then the higher restructuring costs as I said. On restructuring costs, you can see GBP 186 million. Within that, you've got about GBP 70 million of Solvency II costs and the remainder being the costs of simplifying, Ireland transformation, removal of the regions and the first wave of our delayering costs as well.

For the full year, I expect that number to be a bit more than double the GBP 186 million as we get through to the next phase of the simplifying program.

Looking at the Life side, there's a couple of themes here. Firstly is, it is now 7 businesses that really make up our Life results, there's 3 in General Insurance, 7 in Life, and that's kind of Aviva really.

Biggest obviously is the U.K.. U.K., Singapore and Poland are the really high returning businesses, returns significantly in excess of our cost of capital. France and Spain, resilient operating profits, about around our cost of capital and Italy and Spain below our -- sorry, Italy and Spain -- Italy and the U.S. below our cost of capital.

In terms of the growth versus last year, modest profit growth in the U.K., U.S. and Singapore, and I'll talk more country by country in a moment. Ireland, we talked a bit about on July 5, tough place to do Life business at the moment, the economic environment, new business profitability, et cetera.

Mainland Europe is actually reasonably resilient. When you strip out the FX impact, you're down a couple of percent in those businesses. So what you'd seen there is some lower new business sales, but good customer retention, good retention levels, good in-force business flowing through to pretty resilient operating profits.

Just going through that business by business, starting with the U.K., our biggest business. A 2% increase in operating profit, GBP 469 million, a couple of trends going on there. You started the year with lower -- obviously, lower market values from the back half of 2011, so slightly lower unit-linked values and lower unit-linked income therefore in the first 6 months.

That was then offset by higher annuity in-force, we're growing our Annuity business over time. Our earnings flowing from annuities and a lower expense base. So the net of those 3 items gives you the 2% profit increase.

Big uplift in operating capital generation. There is a onetime item in there. I think I mentioned at the first quarter of around GBP 100 million. Even you if strip that out, a good increase in operating capital generation in the U.K.

One of the themes that we are going to talk about, and this is linked to pulling out of both purchase annuities is bigger translation of operating profit to capital generation and then to internal dividend flows as well and slightly therefore dialing back Annuity business and slightly dialing up things like workplace pensions.

In France, on a constant currency basis, down about 5%. Again, really reflecting lower opening reserves in the wealth management business, but pretty resilient profits, retentions are good, slightly better than they were at the end of 2011. And again, good operating capital generation, up 16% there as we slightly dial back the more capital intensive new business and a good in-force reserves as well.

Similar story in Spain. New business is down in Spain, but that's mainly the kind of -- something close to a 50% reduction of our new business with Bankia as we go through the arbitration process. New business in our other partners is actually down a little, but not, not too much. Again, strong customer retention in Spain, therefore, your in-force reserves are pretty solid flowing through to operating capital generation and operating profit. There was a little bit of a onetime item last year, so the underlying in Spain is actually pretty flat.

And very much the same story in Italy as well. New business profit -- sorry, new business volumes down a lot, probably 60% down from a couple of years ago, and that's very much actions we've taken to dial back those more capital intensive products. Customer retention is high though. So you can see that at the consistent operating profit level and with those lower new business sales, the operating capital generation now for the first time really flipping to a positive contribution.

The U.S. profit is up slightly, but a small onetime item last year, but overcome that by increasing the margin on our in-force business. You remember in the U.S. product, we can go and reprice the back book each year, so a higher spread margin coming through in the U.S.. On the operating capital generation, we had a onetime negative of around GBP 100 million, a little over GBP 100 million in 2012. And that was the introduction of something called AG33, which is a new local stat reserving basis.

We just put down here as you just kind of additional bit of information, the returns on the U.S. are around a 4% return on capital, IFRS capital there. If you did look at it through a local lens, what would you see? There about an 8% return there.

Poland and Singapore, 2 terrific businesses. Poland, you remember we built up over about 20 years, really been primarily a pensions-based business. We got kind of 2 in the markets there. With the change in regulation, we're now selling more of the Life products. That's worked very well. About 3/4 of our sales are now non-pensions-type business, and that's good new business profitability. And again, on a constant currency basis, we're flattish on operating profit.

Singapore, a younger business, has grown strongly over the last 2 years, particularly in partnership with DBS there. Kind of the wranglings, you can't really see those average reserves growing over that period of time, but that coming through and generating operating profits and now a positive contribution on operating capital generation.

So a couple of comments on a big picture from our profit drivers. We're going on here is broadly flat income. Unit-linked down a bit, as I said. Spread margin up a bit. And slightly lower expenses as we manage that, and that's obviously a theme with our simplify program that we'll be looking to drive these numbers down going forward, and this is really reasonably broad-based, but particularly in the U.K. business again.

Underwriting margin pretty consistent. Again, pretty broad-based. New business income, slightly lower volumes as I talked to, but slightly higher pricing as well. So our new business margin value divided by AP is up a couple of percent in the first 6 months.

In terms of investment return, again, you see here unit-linked reserves down 10%, it's about 5% in the U.K., which is pretty much all market values, quite a lot of which has come back in the first 6 months, more like 15% in Europe, which is a bit of FX and again a bit of market value, a little bit of net flows, but mainly market values and FX.

And then you can see offsetting that in the kind of the annuity income if you like, high volumes in the U.K. as we've grown our annuity book and really a big increase in the spread margin as we continue to push the U.S. back book for profit.

On return on shareholder assets, obviously, that reflects slightly lower investment income as the investment yields and slightly lower income from the reattributed estate.

Turning to General Insurance, as I say, a slightly better than expectations result, as you grow profit notwithstanding losing GBP 50 million from the RAC and higher weather cost this year versus last year. Already coming from our 2 big businesses, the U.K. and Canada, which had a really kind of standout result.

Again, we tried to do kind of the RAC just to be moderately helpful there. Weather impact was about GBP 40 million in the U.K. again versus last year and other, which is mostly related to Ireland.

Business unit by business unit, if you ignore or adjust for the impact of selling the RAC, the U.K. is up about 17% profit profit-wise. Even after those higher weather costs.

What you got going on there is again strong performance on personal lines, all the personal lines in the mid-90s, continued growth of personal motor, so we added about another 185,000 policies in the first 6 months, up to about 2.4 million in-force policies on motor now. And again, particularly reflecting the success of "Happy and multicar insurance."

We also saw a nice improvement on commercial lines. If you remember last year's commercial lines combined was about 105%, it's now down to 101% and particular improvement in commercial motor, where we've taken a lot of rating and risk selection actions.

Canada posted a great result, a 90% combined ratio. Our operating profit is up nearly 50% versus last year. A little bit of a reserve release in Canada, but mainly we introduced what we think are proprietorial underwriting and pricing techniques in Canada, and that particularly you'd see in evidence in our motor and household results in Canada, so a terrific result there. Partially offset by the results of our smaller General Insurance businesses and again something that we're very focused on to improve the results of those smaller businesses, and that's definitely part of David's program.

And the profit drivers for GI, just a couple of things really, commission ratio is slightly higher. That really is just the impact of pulling out the RAC, which had no commissions and the claims ratio lower. If you go back 2 or 3 years, that was more like 67% a few years ago. So that's really kind of the evidence of the improvement of the General Insurance results over that time.

Our operating capital generation, a pretty simple story, really, up about GBP 100 million versus last year. The in-force generated is very consistent about GBP 1 billion from Life, about GBP 300 million from General Insurance, and we've consumed less cash in new business.

If you remember, going back a couple of years, we had about GBP 1.5 billion as our annual run rate for new business capital consumed, and we're down to actually a bit less than GBP 400 million. Now both less volumes of capital intensive business and our overall efficiency percentage improving as well.

Just turning then to the bottom line and really kind of -- I guess the bit to talk about here is the goodwill amortization point though, goodwill write-off point.

So on the back of going through the work that we described to you on July 5, the key point that we made in that was around capital allocation and allocating capital to the most profitable parts of the business. Obviously, that means allocating capital away from other parts of the business, whether they be things in non-core or whether they'd be some of the things in improve.

So as you allocate less capital to the future, that means lower profit streams, which means as you assess goodwill recoverability, that has some different impact for it. So as we went through that exercise, there were 2 adjustments, a very small goodwill adjustment in Italy and a larger one for the U.S., where we deemed on the back of that, the goodwill was no longer recoverable and therefore, we wrote it down.

It is literally no more or less than that. It is not designed to be a write-down to market value or anything like that. And I feel we've got the U.S. now on the books, David, at net assets around GBP 2.3 billion?

Unknown Executive

Right.

Patrick C. Regan

Something like GBP 2.3 billion. That then obviously is the kind of major movement in the net asset values, you've got profits flowing through and then the impact of around 30p of the goodwill write-down.

Just on capital then, a couple of things to pick up. If you pro forma, if you allow me to pro forma the impact of selling down Delta Lloyd, which we did just after the half year, the ratio has improved to 142% or about GBP 4.7 billion in pounds and pence. The improvement from the year end is about 1/2 market movements and about 1/2 actions we've taken.

On the market movements, I at least was interested in we've got a positive coming through from there, which was different from the direction it traveled from a couple of our competitors. I think the reason for that is we've obviously got a positive impact of slightly lower spreads, but we're not as impacted by lower interest rates in terms of economic capital movement.

Second thing in terms of management actions, we said to you that we'd try and take -- as we grow our capital base, that'll come from both disposals, but also a series of -- I think I'll say clever things that John listed we'll do. So he's done some clever things in the first half, not enough yet, and so these are kind of small credit risk reductions, small amounts of reinsurance, that kind of thing obviously, as well as the impact of selling down Delta Lloyd.

As of today, that ratio is still about 142%, John isn't it? IGD, pretty stable, GBP 3.1 billion or 150%. As of today, that's about 160%, partly reflecting the impact of the Delta Lloyd sell down.

On sensitivities, we've published the sensitivities to economic capital on July 5, they're basically unchanged from that date.

The other topic in terms of capital volatility is the volatility in IGD. Obviously, Delta Lloyd now being less than 20% takes out one source of volatility. The other one just kind of update on is this - this now introduction of Regulamento 43. I'm sure somebody can say that better than me. Regulamento 43, which in Italy removes the volatility of Italian government bond spreads, moving around from Solvency I. So you do not count that volatility in your Solvency I ratios going forward. So that's -- last year was quite a big source of volatility for us. Just kind of a way of reminder, Italy is about what, GBP 720 million of our net assets, so about 6% of our group net asset value and about 6% of our group operating profits.

More broadly on the overall program, I mean, John talked to this, we laid out our GBP 400 million cost-saving program. It's pretty much on track. We've announced level 5 of the 7 less, we did that this week, and we're on track over the next few weeks, and we'd hope to finish that by about October for level 6, then 7.

Ireland transformation is on track, and we're putting in place very specific plans for each of the 58 cells. The 16 of those were deemed non-core. One of them Delta Lloyd, you kind of know what happened there. For 10 of them, we've got banks appointed to help us exit those markets. And for the last 5, there's a variety of actions we're taking, the one most specifically we can talk about is stop -- we've already stopped writing the larger purchase annuity deals, and we'll look at various other options both from book and back book for those other 5 cells.

In summary then, I think operating profit performance generally pretty much in line with expectations. GI coming through pretty strongly, high restructuring cost as we're getting on with the simplify program. Capital strength pretty stable, but obviously this is an area that we're continuing to focus on over the next month and into the future. And the environment just remains challenging, but we have a plan, and we're on track with the delivery of it.

So we'll now open it up to Q&A. I think we got our usual roving mics in the audience. Nick do you want to?

Question-and-Answer Session

Nick Holmes - Nomura Securities Co. Ltd., Research Division

Yes, Nick Holmes of Nomura. A couple of questions. First is on the U.S.. I am a bit surprised by the improvement in the annuity margin, especially in the low interest rate environment and also the strong growth in sales and I just wondered if you can give us a bit more color about the competitive environment and what -- whether you think the level of performance is sustainable? And then turning to Solvency II, wondered if you could give us an update on the matching adjustment debate and whether you think that satisfactory resolution is likely on this, there seem to be different views on this. And also, whether your decision not to write the large bulks is connected with your views on this?

John McFarlane

Yes, good question. Would you like to try at this?

Patrick C. Regan

On U.S. annuity market, obviously, the lower interest rate environment has quite a big impact generally across the market for all players in our part of it, which as you remember is equity indexed annuity market. Generally, pricing is moving broadly in concert so everybody's doing the same type of actions whether you're Aviva or Allianz or some of the local players as well. In terms of volumes, we put through a pricing change earlier in the year and the way that happens particularly in that market is there's a -- people know you're making -- you post that you're going to make a pricing change, so everybody buys the products before it's changed. So you get a little bit of a -- kind of a -- if you like a volume surge. Therefore, over the course of the year, the remainder of the year, I would expect annuity volumes to be a bit lower than they were last year. In terms of the back book, yes, I mean we're very focused on, of course, maintaining kind of decent levels of customer retention, just squeezing out a little bit of margin off the back book, and we've been able to do that successful without really any change to the retention levels. On Solvency II, obviously, they weren't able to reach agreements in the trialogue process in July. I think the use of some form of matching adjustment I think is a given in that program, and that would be astonishing if that was removed. And a part of the debate, that was how broad that extends. And I think my view is, there were some countries who wanted to extend that more broadly across products that have -- where you can lapse and there were parts of the trialogue that were uncomfortable that and didn't believe that met the principles of Solvency II. And I think that's one of the key debates to have is, do you have a more narrow one that meets kind of U.K., Spanish or do you have a broader one where you can say these block of cash flows are relatively certain, so you can apply it to those cash flows, and that's one of the key debates, that's one of the key parts of this impact assessment we'll go through over the next few months.

Nick Holmes - Nomura Securities Co. Ltd., Research Division

And sorry, the last question.

Patrick C. Regan

Oh, on BPAs?

Nick Holmes - Nomura Securities Co. Ltd., Research Division

Yes.

Patrick C. Regan

We -- yes and no. I mean, obviously, we're mindful of possible impacts of Solvency II. But I think kind of the -- I think you've got a pretty good rule for how it's going to impact the U.K. annuities. I think the debate is generally around the other products and more continental Europe, and I think our view was much more dictated by our own economic capital view.

John McFarlane

The return is 0, economic return. It's no-brainer.

Nick Holmes - Nomura Securities Co. Ltd., Research Division

I think most companies would say it depends on the case.

Patrick C. Regan

One company, I think would say that.

John McFarlane

I mean, we generated -- we're working on a weighted average -- longer one, with average cost of 9%, and that's what they are generate.

Patrick C. Regan

I think there's I mean as a...

John McFarlane

There's no excess for tax.

Patrick C. Regan

As an overarching statement, we are looking for a balance of risk income, annuity income that's definitely going to form part of our income stream and the balance of savings-type income, slightly lower capital intensive. We believe as you do that, there are better returns in the individual annuities than there are in the big bulk. Ashik do you want to?

Ashik Musaddi - JP Morgan Chase & Co, Research Division

Ashik Musaddi from JPMorgan. Just a couple of questions. One, your individual annuity sales increased significantly quarter-on-quarter, can you put some color on pricing there? And secondly, the reserves in France, Life reserves in France have gone down significantly. I guess partly due to ForEx, but can you give us some color on the outflows and the impact of that on there?

Patrick C. Regan

Thanks. Yes, I mean as you know, there's 2 bits of the individual annuity market we've been successful on. Obviously, converting our existing pension customers into annuity customers and historically, we've been also successful in winning kind of probably close to 40% of the open market option going there. Our returns on individual annuities have been extremely strong, north of 30%, and I think that's still true today, John, isn't it? So the returns on individual annuities remain extremely strong. What you're balancing there is just moderating the amount of credit risk and overall kind of capital you want to take in on in the business, but the returns remain strong. Within France, as you say, yes, part of the movements in reserves is foreign exchange. The other part then is, I think retention in the first half of the year is better than it was in the last half of 2011. We saw some outflows in the back half of 2011. Our credit rate particularly on the affair product now is competitive, it's not the best, but it's competitive in the market, and that's given us more stable retention levels in the first half. Andy do you want to?

Unknown Analyst

Yes, a couple of question, if I could. First one was on General Insurance investment income, I think I asked you the same question at year end and you're pretty confident that investment income in the GI side wasn't actually coming down, and it doesn't actually seem to have come down. So I'm just wondering what's going on and what it is from now because I think you said at the year end reinvestment rate was something like 3% and your peers -- say, 3.5%, and your peers you said 3% have now reduced that to 2% for new money, so I'm just wondering what your view on the kind of that compared to the earnings stream would be going forward?

Patrick C. Regan

Yes, I mean, new money Clifford, what were you saying.

Unknown Executive

3%.

Patrick C. Regan

About 3%. We got bigger assets backing it as well is the other thing. Where in the U.K., we probably got another GBP 700 million or GBP 800 million versus a year ago, partly as you know as we grown the motor book a slightly longer duration than some of the other book as well. So it's a combination of those. Oliver, do you want to?

Oliver Steel - Deutsche Bank AG, Research Division

Oliver Steel, Deutsche Bank. Just a couple of questions, first is that case you written off the U.S. Life goodwill, but you haven't really written off anything in Europe, and particularly not in Spain, so I was just sort of wondering about the rationale for that? I mean, the simple answer is obviously that you've seen no need to do it, but I wonder if you could perhaps give us a little bit more detail in your thinking on this. And the second question is on restructuring costs, perhaps you'd give us a little bit more detail on how you expect the timing of that to develop beyond this year?

Patrick C. Regan

Yes. Good question. On the Spain one, yes, I mean, you've got a couple of things going on there. Obviously, we have one arrangement that's going through the arbitration process on Bankia, so I probably won’t comment a lot more on that individual case. On the other arrangements, we've got lower sales, not as profound as they are in Bankia, they're kind of mid-teens. The profitability remains strong on that. I mean, the IRRs are still kind of mid-teens, maybe upper-teens on new business. We're seeing a little bit lower volumes so the key -- one of the decisions you make is how long will that last, what are volumes in the future, if they stayed at today's volumes, is that okay. And the broad answer is, it's a good business, it's very efficient, new business profitability remains good and therefore the good goodwill remains recoverable, that's the broad answer. On restructuring costs, I mean, very much what we're trying to do is get as much possible done this year. So you've got 2 bits to that, you've got the simplification program. There's probably a little bit of that will go into next year over I would say, much lower amounts than we're talking about this year and then similarly, Solvency II, where again similarly we need to finish most of that this year, partly for our own sanity and partly to make sure that costs don't flow much into next year. So I think 2014, you really should expect not much at all. A little bit into '13, but a lot less than this year.

John McFarlane

Yes, one of the things that we're not using much discretion here when it comes to goodwill impairment. We're actually doing what we're required to do and reassess them. And we've reassessed them all at the half, and we've done what we're required to do basically. It's as simple as that.

Patrick C. Regan

James, you want to go next?

James Pearce - UBS Investment Bank, Research Division

James Pearce from UBS. A couple of questions, first of all, on the disposal program, can you sort of tell us, are you more, less or about as confident as you were a month ago as to executing the disposals? Second, can you talk about cash flow from European businesses? Are you able to get cash out of those businesses? Are you paying dividends to the parent from them? Are you being required to put cash in? And then thirdly in Ireland, and after you blame this deterioration on the weather, but in the detail is the country the motor account, what's going on, on the non-Life in Ireland?

Patrick C. Regan

Okay. All right. Shall I take 2 and 3. Do you want to do #1?

John McFarlane

Yes. It was a month gone by, therefore, we know more than we did month ago, and so our confidence level is higher than they would've been a month ago because we actually know more. We've got more certainty on what's happening. Some of the smaller ones, we are well on with and hopefully, we'll get some announcements pretty soon on those. So the bigger ones we have more information. We know who the potential buyers are. And so again, that's progress. So we made more progress. We know more, the certainty is increasing. The uncertainty is the, obviously, the price, and that's what we're working through and ultimately, we'll end up negotiating that, we're not at that stage yet. We are in some of the smaller ones.

Patrick C. Regan

I'll take the last 2 then. On Ireland. I was more kind of actually noting that weather was higher, but I mean weather's been higher for 3 out of the last 4 years in Ireland, so well, that's a good explanation or not. There's 2 things we need to do in Ireland, and that team are very focused on. One is reducing the cost base, and we're part of the way through that, so it's certainly not showing up in the results yet, that's really going to flow through and start happening in 2013, but we're taking out a lot of expense because our expense ratio is at least 10 points too high. But it's not just expense, there's some capabilities, there's some things we're better at risk selection in the U.K. business than we are in Ireland, and that's a little bit manifesting in the results as well. On the dividends, yes, I mean, in 2011, our operating capital generation was pretty good in all of the countries, and that allowed us to flow dividends out of all our major businesses, with the exception of the ones in the Eurozone. So as you go through and hopefully a little bit clearer you can see this, operating profits turning into operating capital different, that's working pretty well in most businesses. Operating capital generation turning into dividends, that's worked pretty well in all of our businesses historically. The kind of check you do is what's the regulatory environment, what's the macro environment, does that allow you to translate operating capital generation to dividends. Last year, in the second half of 2011, that was more difficult in Eurozone, candidly in Italy, Spain and to a certain extent, France. As part of our performance improvement as we go forward, we are very focused on positioning not just those countries, but all of them to really translate the operating capital generation into dividends. So again, in U.K. Life, we're looking for actually much higher dividend flows, and that's part of the reason we're talking about the proportion of annuities and certainly bulk purchase. And certainly in France, Spain and over time in Italy as well. So it was more of an issue in 2011. We're expecting that to be less so as we go forward.

John McFarlane

I might say something more about disposals. I mean, when you think about what is it we're trying to achieve here? Clearly, we're running the organization really from a 2014 onwards view. And trying to get the run rate 2014 and beyond as high as we can get it. That's the essence of what we're trying to do, and that's important. And in that context, clearly, the company is going to get a little smaller, earnings are going to go down from the things that we disposed off. But at the same time, we've got some positive forces. We've got a cost reduction program. We've got tighter capital management within the group. By that point in time, we'll have probably finished with Solvency II implementation costs because we want to be ready by the end of 2013. So that will roll off and most of it will roll off, some of it will continue. Our expenses are clearly going to be lower. And restructuring costs will have been taken care of. And so there's a lot of moving parts there, but so we're working back from 2014, but there are 2 other priorities here. I mean, one is about financial strength, and that is, in the short run by far, the most important priority. It's the thing that shareholders have said to us that they want fixed as a primary objective, and that's the thing. The second objective, of course, is to generate enough profits and then cash flows in order to cover the dividend, and I've partly covered that just in my previous comments. And so, building that capital strength is really fundamental and clearly, this is not a great market in which to dispose of assets and everybody knows that. On the other hand, we are reasonably confident it's not going to get a lot better anytime soon. And so holding on and waiting isn't really strongly in our minds, either. But the tradeoff is going to be the price that we get and any write-off against book or tangible book. This is an enormous capital benefit. I mean, it's enormous capital benefit that we get. I mean broadly, it would take us into the beginning of our range, all things being equal if it all goes to plan. So we're going to have to make some tradeoffs at some point in time going forward. But we understand the logic of what we're dealing with, and we understand the priorities of what the shareholders are telling us that they want us to deal with. And so clearly, excess returns going forward by repositioning the group, having enough cash flow and cover to sustain the dividend, but in the very short run, it's about capital, and so we're just getting on with that.

Patrick C. Regan

Andy and then Andy. To Andy first and we'll come back to Gordon then, Andy afterwards.

Andrew Broadfield - Barclays Capital, Research Division

Andy Broadfield from Barclays. Just a bit more clarity on the capital position on the economic solvency position, you've given us the walk from year end to the half, but it has come down from the last disclosure, I think 145 I think was the number, I don't know if that was an approximate number when you last disclosed it, but it's 145 at Q1 I think.

Patrick C. Regan

Yes.

Andrew Broadfield - Barclays Capital, Research Division

And if you take out the Delta Lloyd movement], you had about 4 or 5 percentage points decline in the quarter. I was wondering whether you can explain a little bit about what the main drivers were, I appreciate you don't want to do a whole reconciliation, but is that just the market movements thing?

Patrick C. Regan

Yes. So we were taking some positive actions in the second quarter, but you also saw, I mean, spreads went out a little bit generally. Obviously, Spanish spreads went out a bit more. So it's mainly a co-credit spread impact in the second quarter, which have been kind of reasonable positive in the first was slightly negative in the second.

Andrew Broadfield - Barclays Capital, Research Division

Okay. And then the second question is on Solvency II and the progress there because I think talking to people involved with the project externally, I think it's been a difficult project, and I'm sure it has been for everyone, that it's been an expensive project. Just wondering where you thought it was going to be in terms of your internal systems progress on Solvency II because I appreciate it's hugely complex, and what the cost has been, what is likely to be in the tail? And I know you want to get it done by end of -- these things will have a cost tail have gone longer than '14, that's the plan. So what are the numbers for that?

Patrick C. Regan

Okay. I mean, we're broadly where we expected to be. Yes, it is complex. There's a lot of things you have to do. I mean, in a dramatic oversimplification, you need to build a super industrialized robust model that can calculate things really quickly and at a very efficient manner across your group using economic capital principles in a much more kind of, I should say, industrialized way. So there's a systems element to that on both the Life and GI side. That's broadly going according to plan. We're using the same tools that most of the market are using in terms of the systems we're using for that. Second bit then is ingraining deeply the use of economic capital and how you make decisions across the business. And that then flows into your use test, it flows into your model application stuff. I mean, you can see when we did the July 5, that's very much at the heart of how we're running the business. So in many ways, I should feel quite good that we're well-positioned the -- it's clear to everybody that we're using economic capital in how we run the business because that's how we presented it. So I think we're broadly on track with those. The bit I would say is it's costing a lot of money. It's costing probably more money than we thought when we started. There's a resource shortage in a few areas that -- it's the same for us as it is probably for other companies, particularly on the actuarial side. That means it cost you an arm and a leg for certain specialist resource. So I'd say, we'll probably spend as much again in the second half as we did in the first half. From then, it is really important in lots of senses that we transition to BAU mode. So what we're doing in each of our teams is setting up his own model for how we operate Solvency II just in a normal mode, and we're building that into a plan, whether you're in U.K. GI or U.K. Life or whatever. So the bulk of it this year, but second half is probably going to be similar to the first half.

John McFarlane

Clearly, we've got enough understanding of economic return and capital allocation to our businesses that we can sharpen that up, of course, but it wouldn't cost anything like this amount of money to do it. So where if this was voluntary, we wouldn't make this investment because we can already do what we need to do and perhaps maybe do it a little better. The other reason we need to get it done by 2013 other than we're required to do it by 2013 is we want to get it out of the way and get on with what we really need to be doing in the business. And so we really need to get it out of the way. And so we're not going to slow it down if there's any delay to the program, we'll just get it done in 2013 and draw a line on it.

Patrick C. Regan

I think it was Gordon next here.

Gordon Aitken - RBC Capital Markets, LLC, Research Division

Gordon Aitken from Royal Bank of Canada. So 3 questions. First, the U.K. pensions is bigger than any other country in terms of sales. You said you're moving more into the fee business, can you just let us know what percentage of the sales in the first half are commission paying and with the IDR up and coming at the end of this year, what should we expect for volumes in 2013 in pensions? Secondly, bulks versus individual annuities. Now you've seem to love the individual market, but you're obviously pulling out of the bulk market. But this product, you can think of bulks just as a collection of individual annuities. So is this simply come down to price and a case that consultants are just keeping the pricing a lot tighter in the bulk market than the individual market? And finally, just staying on bulks, so you're not writing any bulks, but that in itself is not going to close the solvency gap for you, and we've had a few reinsurance transactions recently with other companies. Is there something you're looking at?

Patrick C. Regan

Sure. On the first one, yes, so we've increased our workplace saving sales, I mean, gosh, probably more 100% versus 18 months, 2 years ago. Most of that's in the smaller scheme and some of the developments we're trying to do to make us equally successful in the more than 5,000 lives, the bigger scheme end. As you know, the biggest scheme ends, we're winning some of those and so probably 1/2 of our business is the commission free business in the larger scale, and about 1/2 of it is still commission paying. This really coming from the larger IFAs versus the larger consultants. Therefore, logically here into 2013, would you expect to see that growth fall away a little bit before we already ramp up towards enrollment? Yes, I think that's a reasonable assumption. On bulk purchase versus annuities, yes, we said we were staying in the very small end of BPAs because they do behave much more like pricing of individual annuities, but generally speaking, yes, at the larger end pricing is much thinner because of the dynamics you described. I mean, that's just the market force. Individual annuities, we do think it's not just about the market pricing, it's also about the ability. We believe our expense base is lower. We believe the assets we can use make us more effective and also some of the techniques. The team that run that used to work in the General Insurance business, and they brought a lot of the pricing techniques across from that into the individual Annuity business in a way that we think is more sophisticated than most in the market.

John McFarlane

I think I'm right in saying that the returns on the individual annuities are actually very attractive, generally. The new business is more attractive than the old back books basically. But it is attractive. And so a rational thing for us to do is to do lots of it because it's very good. But then you get this other problem which is, they're very capital hungry, and that's an issue for us. So if we had excess capital, we wouldn't -- could be constraint. The bulk is different because the price is -- returns are lower. And so we would do much more than we're doing, the problem is we're making this tradeoff between capital and return all the time and in that sense, there has to be some subduing of it even though the market opportunity is there for us.

Patrick C. Regan

I think your last question, would we look at opportunities to look at back book deals? Yes, I mean, you're sitting next to the right man. So yes, we'll look at that, and we'll see if there's an opportunity there for us. Everybody is looking at you now Jason. Barrie, then I'll come to Andrew.

Barrie Cornes - Panmure Gordon & Co. plc, Research Division

It's Barrie Cornes at Panmure Gordon. I just want to talk about GI insurance, particularly in the U.K. I think your weather loss is a lot less than some of us were going for. A lot of the floods occurred through the last 3 days in June. Have they been put back into July, some of these claims simply because looking at your market share it's much higher in homeowners than perhaps one of your larger competitors came with a much large figure?

Patrick C. Regan

Yes, I'm not going to comment on their numbers or estimates. I mean ours is a straight up number, we don't think there's a lot flowing into July at all or do we Clifford? So I think our kind of tale of that tale would be, we genuinely think we've got better flood mapping and therefore risk selection than perhaps others have in the market.

John McFarlane

For 5 months, they were pretty good.

Patrick C. Regan

Andrew?

Andrew Crean - Autonomous Research LLP

Andrew Crean with Autonomous. Could I ask 3 questions? Could you give a little bit more color on the timing of the expense savings, in which lines they'll fall into over which years? Secondly, could you explain a bit more about the GBP 4.8 billion of internal financing from the General Insurance business in the U.K., who are you lending to within the group, what is the interest cost and what collateral do those businesses require? And then thirdly, on the -- your definition of required capital on your economic basis, this is just your internal capital. Could you say whether the FSA requires additional buffers and how big those are?

Patrick C. Regan

Great. Thank you, Andrew. On the timing of the expense base, what we said on that is when we're in sort of execution mode now, so a lot of it, we're booking the restructuring costs, we're going through the program, we're working through the delayering, the regions, so that's really in 2012. Some of that's then into your run rate as you go into 2013, particularly in the second half of 2013. And then we're really thinking all elements of that will be in the run rate going into 2014. On the interdivisional balance, if you remember, it's -- I think we show it in the appendix last time. It's a balance between 2 divisions of 1 legal entity. So it's not a formal lending arrangement perhaps as you said, the General Insurance business and you've other got the half of the same legal entity, so there were no kind of collateral arrangements or anything like that. It's a notional balance within 1 legal entity. On the required capital, I think you asked me the same question on July 5, I'll give you the same answer, which is, it is our assessment to our required capital. I hope actually we're putting out as much detail at least as much as anybody else in the broad European market on that and more than anybody else in the U.K. market. It's our assessment of capital. It's based on 100 and 200 calibration, plus 1 and 10. As we've constructed our target capital range, we've borne in mind a lot of things to be honest. We've added a bit just for kicks, we've added an extra buffer, we've added an extra buffer to say what happens in various scenarios of sovereign debt, what happens in various scenarios of pension risk, all of those kind of things. So they've all been formed where we've landed in our target capital range. So that's how I'd characterize it.

John McFarlane

I think they're broadly consistent. If we reach where we're trying to get to, then we'll be comfortable, the FSA will be comfortable as well. So that's not, and as they lower each and as comfortable as each other. So in a sense there's not a material difference here. You might say something about the mix of the expenses because the first question...

Patrick C. Regan

Yes. So we've we got in our kind of GBP 400 million, we've got about GBP 300 million or so that will be people related and about GBP 100 million or so that's non-staff related. I think actually our early estimates are we probably got a bit more on new targets just to be clear. But there's probably a little bit more we can go on the non-staff certainly as we really get into the guts of the program, but that's how it -- the split of the GBP 400 million, about GBP 300 million people related, about GBP 100 million non-people related.

John McFarlane

We actually think we can do better, but we need to work it out. Which lines?

Patrick C. Regan

Oh, I haven't got it by line, Andrew. I'll tell you offline, but I haven't got it off the top of my head by line, we'll do another person and we'll come back to you, Andy.

Colin L. Simpson - Goldman Sachs Group Inc., Research Division

It's Colin Simpson from Goldman Sachs. Can I actually ask your take on your gender neutral pricing that's coming in at the end of the year or the beginning of next year. I mean, this is -- could be hugely disruptive, and I imagine with all the management change that's happened in Aviva and people are worried about their jobs, and you have large market shares, I mean, is it fair to say that you could be one of the big losers from gender-neutral pricing?

Patrick C. Regan

Are you suggesting we're not gender neutral in our management changes? Or was that a rhetorical question? I can confirm -- we've been entirely gender-neutral in our management changes. Sure, it affects everybody in the market in terms of how you look at risk selection and pricing. We've been thinking about this for some time, Clifford, haven't we? So I don't know if you want to grab the microphone and just add?

Trevor John Matthews

This is not a problem. I mean, there are some countries around the world that already have gender-neutral pricing. Of course, we've got teams of people not just in the U.K., but in some of the continental countries as well have been working on this for some time, and they've got good plans in place, and we're very confident we'll do very well out of this and in fact we're looking be to be one of the winners. Don't forget, we got this strong analytic capability, which helps us also as we look at writing through a different set of lenses going forward. So we're in a good shape, I think.

Patrick C. Regan

Thanks, Trevor. Andy, then we'll come Jon.

Unknown Analyst

Great. 3 questions if I could. The first one is about, the breakdown of IFRS operating profit and could you possibly break it between core and non-core or at least ongoing and not to say -- but just to see how the core and improving bit is actually moving over time? And second point is unrealized gains in the IGD, I think John said you might have answered that question in the 5th of July if asked it. So I'll definitely going asking it now. So how much of the IGD surplus related to unrealized gains in the French business? And the third question was about, pulling from all those question, some companies include the goodwill in Spain in their IGD surplus. Do you do that and if you were to write off the... You don't?

Patrick C. Regan

Yes. No, on the last one. There is no goodwill. I mean, certainly, there's no goodwill impact from the U.S. either, but there would be none if we reassessed Spain. I think I told you last time that we weren't going to give country by country IGD, so I'll give you the same answer on that. I think it's order of magnitude of around EUR 1 billion, that kind of order of magnitude or something like that. I did give you the answer on that. I think what we'll do -- it's a good question on the core, non-core, what I think we'll do is we'll -- our intention will be to do that at year end just was a bit quick this time around to do the split of core versus non-core and how they're trending over time. So there is something we reminded do, Andy, but not at the half, you will probably pick that up at the year end. Jon?

Jon Hocking - Morgan Stanley, Research Division

Jon Hocking from Morgan Stanley. 3 questions please. Could you remind us of what the cross-border holdings are of Italian, Spanish debt at the end of the first half, is the first question. The second question, the revised performance objectives for management, can you talk a little bit about how that varies compared with the existing scorecard and then what you do, presumably you can't change this in the middle of the year. How do you make sure that everyone's sort of pointing in the right direction given they might be assessed on something else for the rest of calendar year 2012? And then third question, on the U.K. commercial lines, can you give us a little bit of earning commentary, sort of segment by segment where pricing is, where volume is, how you see rate, et cetera?

Patrick C. Regan

Sure. I'll pick up 1 and 3 and then I'll let John talk to the objectives. On the cross-border, I mean, it's still -- our Italian holdings -- Spanish holdings are primarily in Spain. We've got a tiny bit in France. On Italian holdings, in pound terms, we've got somewhere between GBP 1 billion and GBP 1.5 billion. It's close to GBP 1.5 billion cross-border and the rest of it is domestically in Italy. On the U.K. commercial lines, the area we've seen the most price increase is in commercial motor, that's one of the reasons we've been able to pretty significantly improve the performance of commercial motor by -- from 113% or so, down to 101%. We've probably seen what, about 6% now, something like that in commercial line rates. Property and liability is still pretty flat.

John McFarlane

On the objectives, I mean, my own philosophy about this is if you ask somebody to do 16 things, you're asking them to do nothing basically. Because they'll come back and say I did 8 of them brilliantly and I did the 8 -- I was weak on these 8, and then you have to say, well, so what's left then? And so I like 3 and although people in Aviva seem to like 5, which is a different matter. So we've been negotiating with each individual. We have changed them all, okay? Partly during the year because if you think of objectives, even particularly financial ones, which we're not changing the structure of those because they're the obvious ones that you would think that would be in place including cash generation. So they're automatically there. However, when you put a plan together, historically, we had to put that plan together starting about now for next year. But the problem with that is as soon as you produce the document, it's a complete waste of time because time has moved on, by you get to December, it's not worth anything. So we're delaying the start of that to later in the year so that we've got more top-down starting points reinforced by the bottom-up to make sure that -- and then we'll iterate it. As you go through the year, you find that the plan that you had in place actually is productive marginally, but as time goes on, you move further and further away from it as new information comes in. And so it's very important that you have a rebalancing process or even on the financial targets during the year, not something that David's negotiating with all the individual businesses at this point. So there are even going to be changes, not to the structure of that, but to the targets because if somebody is ahead of plan and you see they say they're actually going to meet plan, and then you say, well, that's not good enough. You had a plan, we're going to lock that in. Now what are you going to do? So one of the changes we've made is we used to do a half year actual and full year forecast. And when you do it that way, it kind of looks as if you close the whole company down in the second half when you strip as to take the difference. So we've stopped doing that. We're now seeing that's first half, what are you going to do in the second half, and we'll add it up. And so in other words, you can't sandbag the second half forecast. So that's a change we've made. And then finally on individual objectives, what I've done with each individual, I've asked them to draft it, but actually I've made quite rapid -- significant changes to those drafts. So I've asked them, what are -- not just in the next 6 months, but what are the most important things, beyond the financials, that you have to deliver for this company standing back from here. And it's different for every single individual, and certainly the people who report to CEO is different. And so basically, I've edited it to the extent, changed it to the extent, these are the 3 or 4 or 5 things that each individual has to do to make this company successful, they then have to cascade that down. So we've got all those right, they're all qualitative, they're not necessarily all for just the second half, some of them might be even through 2013, 2014, but we'll measure them on an ongoing basis. You could be assured, these are the things that they have to do. We will track it and whatever they do, clearly, it's important that they meet their financial targets. But don't come back and say you haven't met your 3 or 4 or 5 objectives. That's what we're going to measure you against if you have not met them and a reasonable person would have met them, you failed. So if you've not met them and a reasonable person because of circumstances outside your control couldn't meet them, then that's fine. You've done exactly what a reasonable person would've done. And so there's a sort of judgment on how reasonable the objectives were and how reasonable the progress are, but nevertheless, as objective as we can make it. And as I've had this conversation internally, failure, material failure on these objectives and/or your financial objectives is failure. It does mean you cannot stay in that role. And therefore, somebody else because a reasonable person would have done better, somebody else would've done better. And therefore, that's why we're moving to this personal accountability. It's really important. And so it's very focused. And when you add it up, you get the right thing for the group and there are consequences. If you really do incredibly well, then your variable compensation will be linked to that too. So there's a big upside as well, as well as the downside. I might just -- I don't want to bore you with this, but we are changing the nature of how we evaluate people inside the group. We have a forced ranking now of a 20, 75, 5. And we've got a 9-box matrix with up here is performance and along here is potential. We expect in the top 3 boxes to have 20% of the people roughly, the bottom 2 boxes down here on the bottom line we expect 10% of the people and 70% spread around the rest of the matrix. There is an issue here in that the first time, the first cut of that we ran -- there are 40% of people in the top 20%, isn't that interesting. And so our ranking is not very good because if we have 40% of people, really on those top 3 boxes, we wouldn't be performing the way we are. Okay. So that can't be right. And so we will readjust that, enforce it, and to that distribution, so we then now know who are the most valuable people to us, who are the least valuable people. We are then going to change the differentiation. We actually are going to pay the most valuable people more than the middle group and more so we're effectively placing a ceiling on average performers and a floor on the most valuable people. And actual pay, that then gives up into the baseline for the bonus, so that's even highly geared, and then that's geared up into their stock allocation. So the most valuable people will be differentiated, will end up with the most. Now bonus is slightly different in that it's about how you did this year, and that sort of is a slightly different process, but it's still a meritocratic basis. So I don't know if that's all helpful, but that's how we are running the place.

Patrick C. Regan

Marcus?

Marcus Barnard - Oriel Securities Ltd., Research Division

Marcus from Oriel Securities. Pat, can you explain the GBP 90 million increase in the debt amortization charge because against GBP 1 billion of operating profit, that's quite a material increase. And I note the point you make on Page 12 about spread margins in the U.S. and one-offs in China, but is this the sort of level we should factor in going forward or is it a one-off in Half 1 '12?

Patrick C. Regan

It's -- the main dynamic there is kind of almost automatic as you make those higher earnings in the U.S., particularly driven by the higher spread margins. You get automatically a higher tax charge, so it is one goes with the other. So if you've seen what I said earlier that the higher spread margins is sustainable then you'd have that higher tax as well, yes. The 2 go kind of hand-in-hand.

All right. Well, terrific. Thank you for coming in, everybody. Nice to see you all again. Enjoy the next couple of days, the last bit of the Olympics to enjoy.

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