Economic Capital Management

Tim Harris Ti H i

DRAFT 12 January 2011 V1

Agenda

Economic Capital and its role at Aviva

Economic Capital and Solvency II

How we calculate our Economic Capital

What Economic Capital tells us, and how we use it us

Economic Capital: Part of our continual development of risk management

Front line Accountability for y managing all risks

CEO, CFO, operational management etc

Second line S d li defence Risk Management: integral challenge & oversight

Executive level appointment

Third li Thi d line defence Independent assurance

Internal & external audit, independent dit i d d t actuarial reviews etc

A CEO & CFO team with a comprehensive knowledge & experience in financial services Deep bench of expertise with strong succession planning

Aiming for a balance of technical & business expertise Recent recruitment of recognised industry talent Ongoing and high priority development agenda
Economic Capital

A comprehensive range of leading industry advisors actively engaged in independent audits & reviews

Solvency II

Calculation

What & How

One of a range of measures used for capital assessment

Economic Capital Avivas own assessment of both capital available and capital required* Most appropriate method of assessing capital allocation

Rating Agency

Formula-based assessment of both capital available and capital required Each agency uses a defined set of rules for rating assessment

IGD (Solvency I)

Current means for assessing regulatory capital, will be replaced by Solvency II in 2013 Not a risk-based measure

ICA

UK regulated entities risk-based measure which allows some economic principles to be used

Solvency II

Detailed requirements and transition rules remain uncertain Expected to be introduced in 2013
Economic Capital

* throughout this presentation this capital is required based on internal assessment and capital management policies. The term required does not imply required by regulators or other third parties

Solvency II

Calculation

What & How

Solvency II

Solvency I
1970s Public Not market consistent Arbitrary Factor based No incentive for effective risk management

ICA
2005 Private UK regulated entities only Firms required to assess capital needed to mitigate risk to 99.5% VAR Consider all risks Incentives for improved risk management

Solvency II
2013 Public EU market consistent Based on three pillars Internal economic models Prudent person Own Risk & Solvency Assessment (ORSA)/ incentives for improved risk management

Economic Capital

Solvency II

Calculation

What & How

Solvency II on track for a sensible outcome

Recent proposals Final requirements and transitional arrangements remain unclear but: VIF expected to be allowable Hybrid debt expected to be allowable under transition provisions p Liquidity premium likely to be allowable Transition arrangements likely to be put in place to ensure European insurers are not competitively disadvantaged against the USA & other non equivalent countries

Current outlook Solvency II likely to go ahead on 1 January 2013 but lengthy transition arrangements likely to be in place QIS 5 is a request for information. y p p The final Solvency II principles will not be in line with some principles in QIS5

Economic Capital

Solvency II

Calculation

What & How

Economic Capital management

Available Economic Capital Capital resources available to the group measured on an economic basis

Required Economic Capital Capital* Our Required Economic Capital is the amount of risk capital, assessed on an economic basis basis, which is needed to cover risks taken by the group, such as market risk, credit risk, insurance risk and operational risk

* throughout this presentation this capital is required based on internal assessment and capital management policies. The term required does not imply required by regulators or other third parties

Economic Capital

Solvency II

Calculation

What & How

Setting the Target Capital Requirement

Required Economic Capital

The Target capitalisation of the Group is to have sufficient surplus capital to meet policyholder liabilities following: a 1 in 200 year loss, followed by a further 1 in 10 year loss

99.5 99 5th percentile 50th percentile

This is broadly similar to a 1:2000 calibration consistent with capital of an AA rated firm ith Surplus is expressed as the buffer over 1:200 Important to avoid excessive, inefficient, capitalisation by adding a further buffer on top of these two - better to plan management actions to g respond to risks if they occur

Target Surplus

90th percentile

50th percentile

Economic Capital

Solvency II

Calculation

What & How

Calculation of Available Economic Capital at Aviva plc

Available Economic Capital (AEC) - The amount of Economic Capital we hold Based on the audited MCEV balance sheet adjusted for: Intangible assets (excl. VIF) and goodwill are excluded GI businesses adjusted from IFRS basis to an economic valuation (by removing reserve margins and discounting the liabilities) S bordinated Hybrid debt is treated as a ailable capital Subordinated H brid available
bn Hybrid debt MCEV Balance Sheet Adjustments to a realistic basis

5.0bn

(1.6)bn

Economic Balance Sheet

17.6bn 14.2bn

FY09 MCEV Shareholders Equity*

* including preference shares and DCI

Adjustments

FY09 Available Economic Capital

Solvency II Calculation What & How

Economic Capital

Calculating the Required Economic Capital

Evolution of risks Balance sheet valuation Distribution of balance sheet outcomes

Capital requirement

A L

50th percentile

A L
All-risk scenarios allowing for dependency

99.5th percentile

t=0

t=1

A L Define the confidence levels and the time horizon Model the impact of these stresses on the economic balance sheet Quantify and model dependencies or p correlations between the risks
Geographic, risk and scale diversification effects

Identify all of the risks

Choose stresses to cover all of these

Including Credit, Equity, General Insurance (reserving, underwriting, catastrophe etc.), Life Insurance (persistency, longevity, mortality etc.), operational, operational interest rate rate, foreign exchange

Spreads widen, defaults on bonds, fall in share prices, claims inflation, bodily injury, floods, higher lapses, medical breakthroughs, fraud, yield curve falls

1 in 10, 1 in 200 over (1 year)

Pension Scheme risk allowed for through five years of stressed contributions

Economic Capital

Solvency II

Calculation

What & How

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Available and Required Capital at Aviva plc FY09

bn

Surplus 4.8bn 4 8bn

Available Economic Capital (AEC) The amount of Economic Capital we hold

Surplus Within the range of a AA-calibrated risk appetite i k tit

Available Economic Capital 17.6bn Required Economic Capital 12.8bn

Required Economic Capital (REC)* The amount of capital required to cover the i k faced th risks f d

* throughout this presentation this capital is required based on Avivas own assessment and capital management policies. The term required does not imply required by regulators or other third parties

Economic Capital

Solvency II

Calculation

What & How

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Model Review and Governance

ICA capital regime in place for the last 7 years Avivas economic capital model has years. Aviva s evolved significantly over that period and will continue to do so

There are 3 internal lines of internal model review 1st Line: Review and sign off of results by Businesses, Regional teams and then Group Finance teams 2nd Line: Risk function review of results at all levels 3rd Line: Internal Audit review of processes and results Board review Avivas external auditors, Ernst & Young, provide a reasonable assurance report* on the Economic Capital in accordance with the International Standard on Assurance Engagements (ISAE 3000)

* this report is made solely to the company's directors, as a body. To the fullest extent permitted by law, Ernst & Young do not accept or assume responsibility to anyone other than the company and the company's directors for the opinions. The inherent limitations involved with setting assumptions are highlighted in the basis of opinion

Economic Capital

Solvency II

Calculation

What & How

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What does Economic Capital tell us?

The graph illustrates the relative importance of the risks we are taking: Credit is the single largest exposure for the group followed by g g p y general insurance and life insurance risks Equity risk exposure has been reduced in recent years although there is residual exposure in policyholder funds
Avivas risk profile FY09

Other market 8% Operational 12%

Credit 25%

Equity 12% Life 15% Interest rate 10%

GI 18%

Credit & Insurance related risks Other i k Oth risks

Economic Capital

Solvency II

Calculation

What & How

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How do we use Economic Capital?

Economic models (capital & risk) Strategy Product design Pricing Optimise product design Capital structure Increasingly an integral part of running the business Reinsurance Asset/liability matching t hi Investment management Hedging Enterprise risk management Transparent evaluation of assets, risks, scenarios and strategic options Optimal diversification of risk Business lines/liability mix Prosperity and peace of mind for our customers Optimise capital deployment Facilitate good risk management on an enterprise wide holistic basis

Use of Economic Capital models helps to inform strategy and support decision making to maximise return on shareholder capital while protecting policyholders

Economic Capital

Solvency II

Calculation

What & How

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Conclusion

Economic capital models calibrated to AA risk appetite

Economic capital surplus of 4.8 billion at 31 December 2009 4 8

Economic capital key to optimising financial discipline and performance

This reflects Avivas own assessment of economic capital and is separate from capital required by regulators

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