In the go-go years before the global financial crisis, no European insurer showed greater ambition than the U.K.’s Aviva. With a big merger in Britain, aggressive growth in Europe and Asia and a major acquisition in the U.S., the company transformed itself from a midranked British player into a global life and property/casualty insurer able to compete with the likes of Germany’s Allianz, France’s AXA and Italy’s Generali. Andrew Moss, the CEO who played an active role in several of those deals as finance director from 2004 to 2007, recalls fondly how investors welcomed the company’s expansive ambitions. “Global growth was there for all the world to see,” he says.
Much has changed in the past three years. The recent crisis has fostered a more sober atmosphere in the financial services sector, and few companies exemplify the mood shift better than Aviva. The company suffered in the crisis more than most of its rivals and plunged deeply into the red in 2008. Moss has responded by abandoning Aviva’s empire-building strategy and focusing on a handful of major markets. Profits — not expansion — are the order of the day. “A push for global growth is not our approach, and it isn’t what you should expect from Aviva over the course of the next few years,” Moss tells Institutional Investor in a recent interview in a 23rd-floor conference room at Aviva’s headquarters, sandwiched between Lloyd’s stainless-steel headquarters and Swiss Re’s iconic “Gherkin” tower in the City of London.
Moss has been pruning Aviva’s operations. In 2009 he sold off the company’s Australian life insurance and wealth management business to National Australia Bank for A$925 million ($740 million). Over the past two years, he has spun off 57 percent of Dutch insurer Delta Lloyd Group for £1.6 billion ($2.6 billion). Currently on the block is RAC, a U.K. auto insurance and breakdown assistance subsidiary that Aviva acquired for £1.1 billion in 2005.
Under a new strategy formally unveiled last November, Aviva is devoting its attention to a select number of core markets, which Moss defines as those that contribute $100 million in net profits and generate a 12 percent return on capital or have a franchise value of more than $1 billion. Of the 30 countries where the company currently operates, only a dozen meet that threshold: the U.S., the U.K., Canada, China, India and seven European countries led by France, Spain and Poland. “We are going to invest in these key markets and get into them more deeply to grow earnings,” says Moss. “If that means deprioritizing investment in other markets, then so be it.”
The CEO is also taking steps to cut costs and shore up capital at Aviva. The insurer eliminated a £1.7 billion deficit in its employee pension plan last year by raising workers’ contributions and reducing benefits. In January executives announced plans to pare the company’s hybrid debt by at least £700 million over the next three years. The move prompted Standard & Poor’s in February to raise its outlook on Aviva’s AA credit rating from negative to stable.
The measures are delivering tangible results. Aviva, the world’s fifth-largest insurer by gross premiums and fees, boosted net income by 43.9 percent last year, to £1.9 billion, on revenue that grew 4.4 percent, to £47.1 billion. The 4.0 percent profit margin lagged the 4.9 percent margin of Allianz — the world’s largest insurer, with €106.5 billion ($154.2 billion) in premiums and fees last year — and the 10.1 percent margin of American International Group, which returned to the black with net income of ?$7.8 billion in 2010, but it exceeded AXA’s margin of 3.0 percent and Generali’s 2.3 percent.
In the first quarter of 2011, Aviva’s revenue fell 14 percent from a year earlier, to £8.8 billion. The decline reflected a 24 percent drop in life insurance revenue in Europe, especially in Italy and France, where the company is reducing sales of with-profits life products (in which policyholders share in the insurer’s profits from investments) because of low margins. The move helped boost Aviva’s internal rate of return on its European business to 13 percent in the quarter from 11 percent a year earlier.
Investors welcome the results, as well as the company’s sharper focus and back-to-basics approach. “For the first time in a long while, Aviva is focused on generating cash,” says Kevin Ryan, London-based insurance analyst for Investec Securities. Jürgen Hawlitzky, a Frankfurt-based insurance analyst for Allianz Global Investors, which has Aviva holdings among its €1.5 trillion of assets, praises the company’s decision to retrench. “It’s a good thing that Aviva is planning to get out of a lot of markets where they just don’t have enough size or profitability,” he says. “There is no interest in increased market share if it dilutes valuation. Just look at the Pru-AIA deal last year that ended up not going through.” In February 2010, Prudential, the other big U.K. insurer, proposed a $35.5 billion acquisition of AIA Group, AIG’s Asian business, only to have its shareholders reject the deal. Aviva’s stock price had gained 7.6 percent this year as of ??late May, compared with rises of 5.2 percent for Allianz and 17.0 percent for AXA.
The U.K. company is not alone among insurers in scaling back. Allianz pulled the plug on its expensive foray into bancassurance by selling Dresdner Bank to Commerzbank for €9.8 billion in August 2008. AIG, which needed a $182 billion government bailout, spun off AIA Group last year and is rebuilding around its core life insurer, SunAmerica, and its global property insurer, Chartis. But the decision to retrench was a dramatic about-face for Aviva after a decade of fast-paced growth and acquisitions.
Aviva is the product of the 2000 merger of U.K. insurers CGU and Norwich Union. Richard Harvey, the Norwich Union chief executive who succeeded CGU’s Robert Scott as CEO of the combined company in April 2001, embarked on an aggressive expansion spree. In Europe he ramped up the sale of life insurance products through distribution deals and joint ventures with 50-odd banks, in the process more than doubling the region’s share of operating profits, to 54 percent in 2007 from 26 percent in 2000. He also took Aviva into Asia in 2001 by striking a distribution deal with Singapore’s largest bank, DBS Group Holdings. He later extended the DBS agreement to cover Hong Kong and reached similar distribution arrangements with local firms in China and India.
By 2006, Aviva had leapfrogged Prudential to become the U.K.’s largest insurer, and the sixth biggest in the world. That’s when Harvey overstepped. He made a takeover approach to Prudential’s board, which spurned it, then went public with a £17 billion bid only to have shareholders dismiss the offer’s modest 10 percent premium. Bruised but not dejected, the CEO turned his sights on the U.S. later that year and struck a $2.9 billion deal to acquire AmerUs Group Co., a Des Moines, Iowa–based life insurer with $24 billion in assets that was about four times larger than Aviva’s existing U.S. operation.
Then in 2007, at the pinnacle of his career and still only 57, Harvey stunned the London financial world by resigning from Aviva to devote himself to charity work in Africa. He and his wife spent a year in Malawi and Kenya financing more-efficient wood-burning stoves at village elementary schools. Now back in London, he splits his time between Concern Worldwide, an antipoverty agency, and PZ Cussons, a personal care products maker that he chairs.
As finance director and right-hand man to Harvey on the AmerUs and RAC acquisitions, Moss was a natural choice as successor. A broad-shouldered chartered accountant and University of Oxford–trained lawyer, Moss came to Aviva after a career mostly in banking. He spent more than a decade at HSBC Holdings, where he rose to chief financial officer for investment banking and markets in 1997 before moving over to Lloyd’s in 2000 as director of finance, risk management and operations. Harvey recruited him to Aviva in 2004 and groomed him as a successor, but Moss was as surprised as everybody else by his boss’s decision to step down early.
Moss was barely in the saddle when the global financial crisis erupted and Aviva’s earnings and share price tumbled. The company, which had earned £1.5 billion in 2007, posted an £885 million loss in 2008. Plunging equity markets and bond yields, which afflicted all financial services companies, caused much of the decline, leaving Aviva £2.5 billion short of its investment return predictions. But the company had other operating problems, including high costs in its U.K. p/c business, which accounts for half of the group’s nonlife revenue. The division’s ratio of expenses to premiums was a lofty 14 percent, compared with 11 to 12 percent for most of its peers. The company also demonstrated a lack of underwriting discipline, writing unprofitable business and paying high commissions to brokers in a bid to maintain market share. Even in 2007, before the crisis hit hard in the U.K., the company posted an £11 million underwriting loss in the p/c business. “The general insurance business performed miserably,” says Euan Stirling, investment director at Standard Life Investments, which owns 2.4 percent of Aviva.
Moss began addressing the problems on several fronts but didn’t articulate a change in strategy to break with the expansionism of the Harvey era. To get costs down, the company took a £326 million restructuring charge in 2008 and reduced its global head count by 17 percent over the next two years, to 45,000.
To restore underwriting profitability, Moss pushed Aviva to draw on its extensive databases and market research to cut unprofitable business and increase prices, especially in auto insurance. He also emphasized direct sales through telephone and Internet marketing rather than more-expensive insurance brokers. Although net written premiums fell from £51.4 billion in 2008 to £45 billion in 2009, Aviva returned to the black with a net profit of £1.3 billion. Moss also sold the Australian business and began spinning off a big chunk of Delta Lloyd; this helped boost Aviva’s capital surplus from £2 billion to more than £4 billion between 2007 and 2009.
Notwithstanding the improvement, shareholders and analysts grew impatient with the company’s lack of a clear strategy, its still-mediocre p/c results and the dreary performance of its stock price. Aviva’s announcement of a 31 percent dividend cut in August 2009 — five months after Moss had denied that any reduction was in the offing — angered many shareholders. “The market could see the cut coming, but the company denied it for half a year and then cut,” says Investec’s Ryan. Some shareholders suggested that Aviva sell its p/c business and concentrate on life insurance. The argument took on urgency in August 2010 when U.K. rival RSA Insurance Group offered £5 billion in cash for Aviva’s nonlife operations in the U.K., Ireland and Canada. Moss rejected the bid, asserting that the company’s efforts were starting to bear fruit. But some shareholders were dismayed. Standard Life Investments said it would have entertained a higher offer from RSA.
As if business wasn’t difficult enough, Moss drew adverse attention to his private life. In 2009 he left his wife, Susan, with whom he has four adult children, to live with one of his executives, Deidre Galvin. She worked as head of human resources at Aviva Investors, the asset management division, and was married to Andrew Moffat, Aviva’s head of ?human resources for Europe. With rumors swirling, Aviva chairman Lord Sharman was forced to issue a statement in October 2009 defending Moss. “Andrew has been very open with me, and I am clear that there has been no breach of company rules,” he said. “I am completely satisfied that this has in no way impacted his role as chief executive, and he retains my full confidence.” The drama did not have any effect on shareholder sentiment and soon died down in the London press. The now-separated Galvin, who also has four children, quit Aviva and lives with Moss.
With shareholder discontent rumbling in the background, Moss convened a series of meetings last year between senior management and the board to hone the group’s strategy. In those sessions he championed the idea that Aviva should remain in both the life and p/c businesses but focus its efforts on core markets where it could earn decent margins, a strategy that was formally adopted in November. “Whichever way we looked at it, we continued to come up with the answer ‘Yes, we should remain a composite insurer,’?” he says.
Participants in some of those meetings say Moss impressed his colleagues by forging a consensus. “Particularly over the last year, Andrew has done a very good job of unifying the management and supervisory boards in a strategic direction,” says Donald Moore, Morgan Stanley’s European chairman, who advised Aviva on strategic issues.
To demonstrate that Aviva was more interested in cash flow than market share, Moss brought in an articulate chief financial officer, Patrick Regan, in February 2010. Regan had been CFO and COO at Willis Group Holdings, a U.K.-based global insurance brokerage; he replaced Philip Scott, the 37-year Aviva veteran who had succeeded Moss in the post. “Aviva’s disclosure and communication to the capital markets have definitely improved,” says Blair Stewart, an insurance analyst at Bank of America Merrill Lynch in London.
Regan has played down embedded value, a concept that seeks to value an insurance company by calculating the present value of future profits and adding it to the company’s adjusted net asset value. Before the crisis many companies aggressively used embedded value as an investor relations tool to drive acquisitions and a higher stock price. As CFO, Moss had introduced the concept and promoted it enthusiastically. But projecting future profits has become a more challenging exercise since the financial crisis, and like other insurers, Aviva now puts much less emphasis on embedded value, even though it continues to use the metric in plotting corporate strategy. “We don’t use EV as much to communicate to investors,” Regan tells II after a recent trip to meet with U.S. shareholders. “There are other metrics in Europe and America that people understand better.” Earnings and cash generation, for example. “There was a realization during the financial crisis that the most precious resource a company has is capital,” says Standard Life’s Stirling, who welcomes Regan’s approach to investors. “The problem with embedded value is that it doesn’t really place a very high value on capital and allows you to claim profits based on pretty complex assumptions.”
Moss’s efforts to strengthen operating performance in core markets are starting to pay off, particularly at home. The U.K. remains by far the company’s largest market, with 19 million of its worldwide total of 53 million clients. The country accounted for 35 percent, or £16.5 billion, of group revenues last year and 42 percent, or £1.07 billion, of operating profits.
Life insurance represents the bulk of the business, generating £10.3 billion in premiums last year. The key to success has been Aviva’s strategy of aiming at the broadest possible market rather than emphasizing wealthier customers, as many other insurers have done, says Mark Hodges, chief executive of ?Aviva UK. “It is fashionable for insurers to go after high-net-worth individuals, but we are a mass-market organization and believe in the value of scale,” he says.
To penetrate deeper into the U.K. mass market, Aviva has pursued a multichannel distribution strategy instead of relying on independent brokers, who dominate the market but are expected to face tighter regulatory scrutiny. Independent brokers still account for almost 70 percent of policies, but Aviva has become the country’s leading seller of life insurance products through banks, with bancassurance generating more than 20 percent of sales. Telephone and online sales account for much of the rest.
In the nonlife sector, which generated £4.5 billion in premiums last year, Aviva’s shrewd pricing has helped it restore growth and profits. Take the auto insurance business. Aviva’s researchers spotted a costly trend of rising bodily injury claims — a phenomenon often linked to recessionary times, when unemployment is on the rise and incomes are falling — as early as 2008. So the company raised rates sooner and more gradually than most of its competitors. Largely as a result, ?Aviva added 200,000 policyholders last year, giving it 1 million auto customers, or 10 percent of the market.
Progress has been slower in Europe, prompting Moss in January to replace his European chief executive,? Andrea Moneta, with Igal Mayer, previously head of the company’s North American business. During Moneta’s nearly three-year tenure, the company began integrating its 15 European markets, which had operated like separate fiefdoms, into a single entity. “But it wasn’t happening quickly enough, so they brought over Mayer, who is an energetic guy more focused on operations than strategy,” says Investec’s Ryan.
Revenues in the European life business were flat last year at £13.54 billion, but Aviva managed to boost operating profits by 17 percent, to £893 million, mainly by introducing new unit-linked products, which offer returns tied to equities and carry higher fees. The extraordinarily low level of interest rates may be hitting investment returns, but it hasn’t dampened European customers’ appetite for insurance products. “That’s mainly because people, especially in Europe, are fed up with getting zero interest on their bank savings and are buying insurance products that give them 2 percent returns,” Ryan says. Aviva, like other insurers, is also doing a good job of guaranteeing those 2 percent returns. “We make sure the assets we buy last us as long as the underlying liabilities we have insured,” says CFO Regan.
Aviva has more work to do in its European nonlife business, where operating profits dropped 17 percent last year, to £109 million. The company blamed the decline on decreased long-term investment returns stemming from low interest rates. That’s ominous for Aviva because the company has relied on investment returns rather than good underwriting results to keep the business in the black. The operation’s combined ratio, a standard metric that measures expenses as a percentage of revenues, stood at a lofty 103 percent last year. Efforts to improve underwriting and pricing, combined with benign weather, sharply reduced the ratio to 95 percent in the first quarter.
With £450 billion in assets under management, ?Aviva ranks far behind leaders Allianz (€1.5 trillion) and AXA (€1.1 trillion). But the U.K. insurer insists that its staff of 66 investment professionals provides it with the proprietary research to make acceptable returns and avoid outsourcing asset management — a growing phenomenon in the industry. As a case in point, Aviva cites its decision last year to invest £850 million — part of the £1.2 billion in proceeds it received from the 2009 IPO for 42 percent of ?Delta Lloyd — in a liquid corporate bond portfolio. The bonds suffered no defaults or rating downgrades and in the course of 2010 returned more than £34 million, far above the £4 million to £12 million that U.K. government bonds would have yielded.
Investment returns are not likely to come any easier in the years ahead. The much stricter regulatory environment has pushed Aviva and other insurers to beef up their capital and prepare for lower returns on equity. Solvency II, a new set of regulatory requirements covering capital adequacy and risk management for European insurers, is scheduled to take effect in 2013. Although the specific terms and impact of the regulations are still unknown, it is clear that large composite insurers that combine life and nonlife businesses, like Allianz, AXA and Aviva, will benefit by effectively gaining a large discount on the capital they will be required to hold. “Mathematically, the more diverse risks you have, whether by products or type of insurance, the lower your capital requirement will be under Solvency II,” Regan says. “The composite model provides us a 30 to 40 percent lower capital requirement than if we operated life and nonlife insurance separately.” Analysts at Morgan Stanley and consulting firm Oliver Wyman came up with a similar savings estimate in a research report on Solvency II published in September 2010.
The new regulations have some downside, though. Solvency II is expected to reduce returns on annuities, a key product that generated about a quarter of Aviva’s life insurance revenue last year. The new regulations are also expected to curtail insurers’ ability to use hybrid capital, a type of instrument that shares characteristics of debt and equity. In recent years insurers have relied increasingly on hybrid capital because it is cheaper than equity. But authorities want insurers to hold more equity as a safeguard against financial instability, just as the new Basel III accord will require banks to replace hybrid capital with equity. Aviva’s recent announcement that it would retire £700 million in hybrid debt over the next three years is “tied to Solvency II requirements,” Regan acknowledges.
Solvency II has inspired plenty of insurance company complaints across Europe. U.K. insurers have another bête noire: The Financial Services Authority is about to change the rules on selling commissions as part of its retail distribution review. The new rules, due to go into effect in December 2012, will outlaw the levying of front-end commissions by independent financial advisers, which regulators believe encourage advisers to churn clients from one insurance company to another. Many insurers fear the new rules will drive advisers out of the mass insurance market. Such a shift would suit Aviva just fine, says U.K. chief Hodges, because the company distributes an increasing portion of its life products through banks and direct sales channels. The new regulations “could leave the mass-market customer less well served, opening a bigger role for bancassurance,” he says. Aviva will strengthen its U.K. distribution this month by launching a five-year deal with Banco Santander in which the bank will sell only Aviva life policies at its 1,300 U.K. branches. The company just extended a similar exclusive U.K. distribution arrangement for nonlife insurance products with HSBC.
For all its talk of a global footprint, Aviva has bet most of its future on an aging Europe. The U.K. and European markets account for 81 percent of revenues and 85 percent of operating profits. That has been a reasonable strategy considering the size of the European market, with $8.1 trillion in life and pension assets. But Asia, although far smaller, with $1.6 trillion in the region outside of Japan, is growing at a much faster pace. Oliver Wyman expects that Asia ex-Japan will generate some $950 billion in life insurance premiums in 2012, up from $632 billion in 2007.
Aviva’s operating profits in Asia dropped to £31 million last year from £77 million in 2009, far behind those of Prudential, which boosted its Asian profits to £604 million last year from £465 million in 2009. Moss insists that Aviva can improve its Asian position through organic growth, particularly in China and India. Some analysts have their doubts, however. “Prudential benefits from the market perception of being in a growth market like Asia,” says Investec’s Ryan. This can hurt Aviva, he adds, because many investors opt for either Aviva or Prudential in their portfolios.
In the U.S., where Aviva has only a life and annuity business through AmerUs, the insurer is also committed to organic growth, with Moss emphasizing profits rather than market share. Last year operating profits more than doubled, to £174 million, from £85 million in 2009. “They managed the credit crunch quite well compared to U.S. competitors,” says Duncan Russell, a London-based insurance analyst with J.P. Morgan Cazenove.
One of Aviva’s most successful U.S. products is the equity-indexed annuity, whose sales reached £3.7 billion last year, up modestly from £3.6 billion in 2009. This annuity invests a premium mainly in corporate bonds and uses the interest income to purchase equity options, providing policyholders with exposure to higher-yielding equities. But Aviva is still only a top 20 player in the U.S. life business, and it remains to be seen whether it can advance into the top ten, Moss’s target for the next five years. “We want the U.S. business to be a net capital contributor back to the U.K.,” he says. “We want continued growth, higher profits — and dividends back to London.”
That’s just what Stirling, a longtime skeptic of Aviva’s U.S. operations, wants to hear. “Aviva is more on the right track than it has been for some time,” says the Standard Life investment director. “The criticism of lacking focus or coherency is more difficult to level at the company now.”
Whether the insurer stays on track will also depend on Moss’s management team. “He is not afraid to surround himself with people who are as good as he is,” says James O’Riordan, a London-based partner at financial advisory firm Deloitte, which has Aviva as a client. “That means there are a number of individuals in place who can eventually succeed him — Mark Hodges, Pat Regan, Igal Mayer among them.”
Moss is convinced that he and his team have put ?Aviva on a sustainable recovery path: “We are managers of risk, and we are really good at it.” That may lack the globe-straddling ambition of Richard Harvey, but it could make for just as tough an act to follow.
