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Chandan Dubey
Chandan Dubey
Articles (150) 

Embrace the uncertainty (at low risk) with Aviva

May 26, 2012 | About:

The Company

Aviva (AV, $8.39) is a british multinational insurance company. It is sixth largest in terms of net premium income. It is market leader in general insurance, life insurance and pensions in the UK and has major businesses in North America, Europe and Asia.

Aviva is a old company and can trace its history back to 1696. As a cute side note, it had customers like Sir Isaac Newton, Sir Winston Churchill, The Guinness family and J F Kennedy. In its current form, the company is a product of the merger between Norwich Union and CGU plc in 2000. CGU plc itself was a merger of Commercial Union and General Insurance in 1998. The company continued to use its trading name Norwich Union in the UK until 2009 and now is formally known as Aviva.

The Business

Aviva has three major segments it does business in. These are a) Life and general insurance, b) long term savings products like investing for retirement, and c) fund management for individual and institutional clients.

Aviva with current market cap of £7.8b has 43 million customers and nearly £255b under management.

Following is a breakdown of Aviva’s sales according to the market in 2010.


The long term businesses account for 75% of the sales, the general insurance 20% and the asset management part accounts for around 5%.

A full list of Aviva’s sales network is shown in the picture below.



Aviva is a very profitable company and the quality of written insurance have improved. Following is the combined ratio for their general insurance business. In the last 10 years or so, the company has made a loss in only two years, 2002 and 2008. It is not informative to write the combined ratio of its other insurance businesses as they are quite long term (pension and life).


Analysis of investment

For an insurance company, analyzing the investments it makes is very important. And so, we plan to look at this in a lot of detail.

Aviva distinguishes the assets it invests into three different categories. These are a) policyholder assets b) participating fund assets and c) shareholder assets. The breakdown of the investments in these funds is shown below.


The policyholder assets is connected to unit-linked business. Aviva manages some of the funds for its customers by selling them specific investment product. The onus of the risk in this case lies completely with the customer. If something happens with the money in this fund, the risk is only limited to the asset management charges that Aviva gets in managing the fund. Obviously, there might be legal risks and Aviva may be sued for misrepresentation of its products ... but this risk is hard to eliminate. One hopes that Aviva does not mis-sell its products for the sake of both its customers and the shareholders.

The participating fund assets is linked to some investment and insurance contracts for which Aviva has contractual right to get additional benefits on top of guaranteed benefits. The exposure for loss in participating funds is limited to the amount of participation Aviva has in the funds.

Lastly, shareholder assets are the assets which interests us. This is the money which Aviva is managing on our behalf. Comparing this segment with the other two we see that a larger percentage of this money is in the debt securities compared to equities.

To analyze the investment we will not look at the policyholder assets because the loss there will not translate into a loss for Aviva. The first thing we want to ask is: how exposed are we to the countries in Europe that might default. The table below shows that Aviva is quite good in this sense.


** Excluding policyholder’s assets.

So, whose debt is Aviva buying ? A large percentage of Aviva’s debt portfolio contains the debt of UK, which seems to be a very stable government in Europe at the moment.

In the shareholder assets out of £58.6b debt securities £2.7b is in UK government debt, £10.6b is in non-UK government debt, £39b in corporate debt, £3.5b in other derivatives and instruments.

The breakdown of non-UK debt securities is shown in the table below. Notice that Aviva has large exposure to Italy and France but these are mainly in the participating assets. The disclosure of how much participation Aviva has in different contracts varies contract to contract and there is no breakdown of this in the annual report. But in the table above we do see the extent of Aviva’s shareholder exposure to the peripheral countries. This is at most £6.9b which is around 10% of the shareholder assets. This will hurt Aviva a bit (if all of them go belly up) but will not kill it.


Financial situation

Aviva has a very good balance sheet. It has £8.45b in borrowings, £15.3b in equity and £23b in cash. I would not worry about it having problems with liquidity in the near future. Aviva is also going to sell some of its business to pay down debt. In 2010, the debt was £15b and was reduced by selling some of the non-core assets.

Shareholder return

Aviva seems to be a very shareholder friendly company. Aviva pays its dividend two times in a year. The current dividend yield is touching the 8% mark.


Given that the shares are so cheap, I was surprised at the large dividend yield. It would be a waste to not buy back shares at these prices. And lo and behold, Aviva announced to buyback shares.

The shareholders of Aviva plc (LSE:AV.) authorized a share repurchase program at its Annual General Meeting on May 3, 2012. Under the program, the company will repurchase up to 290,769,502 shares, representing 10% of its issued share capital. The share repurchase program shall be valid for 1 year. As of March 3, 2012, the company had 2,907,695,021 shares in issue.

This is +1 for the management in my opinion.

The Management

Aviva’s CEO Andrew Moss was recently fired (or has stepped down). There was a backlash about his pay which is quite small compared to what the American CEO’s make. The total executive compensation at Aviva which is a £9b company in 2011 was £6.8m. In comparison, the total executive pay at Tower Group (TWGP), a $798m company was $10.3m in 2011. Even the pay package Mr Moss got after resigning is about £1.5m (he was the CEO of Aviva since 2007).

Something else that bothers me is the fact that the shareholders did not care about the improving fundamentals of the company but their outrage was targeted at “falling share price”. Although a valid concern, I see it as a bad reason to fire the CEO. The CEO has arguably reduced the capital base of Aviva, made the offering more streamlined, got out of businesses with bad returns, got out of countries where the business was having problems and improved operational performance. These can be checked out by the investor presentation slides on the website. But apparently shareholders only care about the price (and compensation). Although in the shareholders defense 95% voted to re-elect Mr Moss, but he decided to resign. In some sense, this is going to be a good example against excessive compensation practices and probably that is the only good thing that might come out of it.

Meanwhile, the chairman John McFarlane will take the position of CEO until a replacement has been found. His priorities are quite obvious at the moment. This is his quote from the BBC article on the situation.

"My first priorities are to regain the respect of our shareholders by eliminating the discount in our share price and to find the very best leader to be our future chief executive," - John McFarlane


I do not want to talk about valuation in a lot of detail. Suffice is to say that Aviva is trading at a P/B of 0.6 and has dividend yield of near 10% which is well covered. The company is also going to buyback 10% of its shares in this year. The shareholder assets is nearly 10 times the market cap of the company. This is much larger than say Zurich Financials (6 times), which is another insurance I quite like.

Investors buying at these prices need only worry about the risks of damage to their investment portfolio (which as I showed is quite conservative). The company offers limited downside because of the dividend which puts a support on the share price.


I already discussed some of the risks with the investment in Aviva. The risk with the investment portfolio of Aviva is quite small as the exposure to the PIIGS can be contained. A default in Greece will obviously drag down every company we know of, but I will treat this as an opportunity to buy shares at the cheap.

Aviva has a recognizable brand with nearly 10x(market cap) shareholder funds under management. This is quite cheap as only 1% return from its investment will lead to a P/E of 10 (if combined ratio is at most 100). This is a very good price to pay in my opinion because a 4% return can be a conservative target for returns.

The downside is further limited by a well covered 10% dividend yield and £5.95 in Net Asset Value.

About the author:

Chandan Dubey
I invest because I want to be free by the time I reach 40 years of age i.e., 2025. My investment style is to find a small number of bets with large margins of safety. I pay a lot of attention to management and their incentive. Ideally, I like to buy owner operator businesses. I am fortunate to have a strong inclination towards studying. I aid my financial understanding by extensive reading in psychology, economic, social sciences etc.

Rating: 4.2/5 (23 votes)


Vgm - 5 years ago    Report SPAM
Nice write-up. Thanks.

I agree Aviva looks cheap and has a whopping dividend approaching 10%.

As you say, the exposure to peripheral European country debt is limited. The big(ger) risk seems to be exposure to debt securities of European banks - perhaps especially Spain.

With the important exception of Ireland, the Euro-banks have not been cleaned up yet, as Buffett reminded us recently. And even in the past few days the Spanish banking crisis has deepened, with Bankia (which was created out of some 7 failing regional banks less than a year ago) requesting an extra 20 billion Euro bailout from the government, largely because of soured real estate and non-performing loans.

No-one knows how big the property hole is for Spain's banks, and because of its struggling economy, including almost 25% unemployment, bad loans are still rising.
Cdubey - 5 years ago    Report SPAM
From the annual report, we see that exposure to Spain's bank is less than £1.18b. This is maybe what Aviva pays as dividend in a year and half. I don't see this as a major problem.

Gross of non-controlling interests, our direct shareholder assets exposure to worldwide banks debts securities and equities is

£7.4 billion. The majority of our holding (58%) is in senior debt (covered, secured and senior unsecured). The primary exposures

are to United States (28%), Spain (16%) and United Kingdom (15%) banks. Our holdings include strategic holdings in Unicredit

and other Italian banks of £439 million.

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