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Morningstar | Aviva's 1H Shows Resilient U.K. Long-Term Margins, Canada Dragging; Shares Undervalued

Aviva reported a clean operating profit of GBP 1.4 billion for the first half, ahead of our expectations. However, the solvency ratio at half-end was a little low at 187%, and operating capital generation was down GBP 200 million at GBP 0.9 billion. Cash remittances were higher at a total GBP 1.49 billion, including a GBP 500 million special U.K. insurance remittance. While there are some poorer headlines, we still believe in Aviva’s ability to drive the business forward, and we are maintaining our GBX 575 fair value estimate and no-moat rating.

Financially, this was a good set of results. Operating profit was up high single to low double digits almost across the board. Corporate expenses and debt costs were down. U.K. life in the main performed well.

U.K. life annuities and equity release was significantly higher, but the business has won a GBP 0.9 billion bulk purchase annuity, its largest, that we are not particularly keen on. Bulk purchase annuities are not part of Aviva’s stable, and a business line that carries high risk. We would prefer to see Aviva steer clear of these corporate transactions because we think in-force management would be much harder if conditions change and deteriorate.

In U.K. life long-term savings, assets under administration on Aviva’s platform have risen 12% since the end of last year. This takes Aviva’s platform assets under administration to GBP 23 billion, and total long-term savings assets under administration to GBP 121 billion, an 11% rise on the comparable. One thing that makes us apprehensive about rising platform flows is the potential for margin compression. We do not especially like platform business because we find that it drives businesses away from sticky wealth management offerings, which we find quite attractive in long-term savings and life insurance markets. Platforms essentially, for us, devalue the value of advice, though that is largely because of the less sophisticated, or less wealthy, client base. Presently, Aviva has shown to some degree it can fight this and has maintained its 25-basis-point long-term savings in-force margin. Operating profit in U.K. life long-term savings was up markedly.

Protection was the laggard in U.K. life. This seems to be the result of adverse claims experience in the second half of last year. Subsequently, the business looks to have hardened pricing, resulting in greater sales discipline. Operating profit declined from GBP 133 million to GBP 108 million for the period, but we think in time this will be reversible as the business reattracts volume at better pricing.

Canada remains the main unit causing concern. Historically, this has been one of Aviva's better-performing markets. However, a change in Canadian regulation has led to a spike in frequency of motor bodily injury claims because of claims farmers and the plaintiff bar looking to recycle files. The personal combined ratio remains significantly above 100% as the business unit implements a recovery plan. Rate increases are being used to pay for the backdated claims. There is still almost 10 points of travel left to get the business back to its combined target, but we think this is more than achievable by 2020. An increase in net premiums written also intimates this.

We still think Aviva is largely an undervalued stock; the market is probably focusing on the potential for margin compression in long-term savings. While we do see that this is likely in platforms, though it may be reaching its base, Aviva is demonstrating that it can offset this in other areas. Also, platforms are not the biggest part of U.K. life income. We do see the Canada situation as background improving.