Fitch Affirms Ratings on Aviva plc (AV) Following Recent Review

Fitch Ratings has affirmed Aviva Plc's (NYSE: AV) Long-Term Issuer Default Rating (IDR) at 'A+' and its core insurance subsidiaries' Insurer Financial Strength (IFS) ratings at 'AA-'. The Outlooks are Stable.

Fitch has simultaneously assigned Aviva's senior notes a 'A' rating and hybrid notes a 'BBB+' rating and affirmed Aviva's and Friends Life Holding plc's hybrid notes. The ratings are in line with Fitch's notching criteria. A full list of rating actions is at the end of this commentary.

KEY RATING DRIVERS
The ratings reflect Aviva's strong business profile in the UK, diversification by business line, robust capital position and operational scale. Aviva's ratings are also underpinned by the group's geographical diversification across the UK, Europe, Canada and Asia.

Aviva's strong business profile in the UK is a key rating strength. Aviva has a strong brand and strong market positions in life and savings and non-life lines. These features are complemented by its substantial operations in Europe and Canada, which diversify earnings. In 1H16, 42% of the group's operating profit originated outside the UK and non-life insurance contributed 21% of operating profits.

Aviva's capitalisation, as measured by Fitch's Prism factor-based capital model (Prism FBM), is 'Extremely Strong' based on end-2015 results and contributes very largely to its rating. At end-1H16, the group's Solvency II (SII) ratio was 174% (2015: 180%). We believe that Aviva's SII ratio is less sensitive to market changes than peers.

We consider the group's significant profit diversification and steady improvement in operating profit as strengths. Aviva's pre-tax operating profit improved 20% to GBP2.7bn in 2015, and strengthened in 1H16 (GBP1.3bn) compared to 1H15 (GBP1.2bn). The improvement was largely due to the addition of Friends Life in 2Q15, and subsequent realised cost synergies.

However, operating profit has failed to translate to an improvement in net income. Aviva's net income return on equity, excluding minority interests, weakened to 7% in 2015 (2014:15%) and 1.5% in 1H16. These levels are significantly below Fitch's 13% criteria median for the 'AA' category. Fitch expects net income to improve gradually from 2017 as non-recurring components of non-operating items, such as integration and restructuring costs, reduce.

Aviva's financial leverage was 26% at end-1H16 (24% at end-15), weaker than Fitch's 'AA' median. However, this level is broadly consistent with similarly rated European peers. We expect leverage to remain below 30% in the medium term.

The group had a liquidity position of GBP1.2bn at 1H16, which is enough to pay for nearly three years of interest on its financial debt (based on end-2015 debt). The group targets sufficient liquidity based on an internally defined risk appetite. We expect this liquidity position to remain strong, supported by steady cash-remittances to Aviva Plc (GBP1.5bn in 2015 and GBP1.4bn in 2014).

Aviva's fixed-charge coverage ratio is weak for the ratings. It remained stable at 6x in 2015, but remains below Fitch's criteria median for the 'AA' category. We expect the ratio to remain broadly stable in the medium term as earnings rises relative to interest cost.

For Aviva plc's senior notes, we applied a baseline recovery assumption of 'below average'. As a result the rating is notched down once from the IDR.

For Aviva plc's subordinated notes, we applied a baseline recovery assumption of 'poor' and a non-performance risk assessment of 'moderate'. The latter relates to the interest deferral features of the Tier 1 and Tier 2 notes, and the mandatory redemption deferral feature of the Tier 3 notes. As a result the rating is notched down three times from the IDR, comprising two notches for recovery prospects and one notch for non-performance risk.

For subordinated notes issued by Friends Life Holdings Plc, we applied a baseline recovery assumption of 'below average'. As a result the rating is notched down once from the IDR. For XS0620022128 and XS0851688860 Fitch applied a non-performance risk assessment of 'moderate', which reflects the interest deferral features of these notes. As a result their rating is notched down an additional one notch for non-performance risk.

RATING SENSITIVITIES
The ratings could be downgraded if Aviva's net income return on equity falls to below 6% for a sustained period.

Other key rating triggers that could result in a downgrade include capitalisation, as measured by Fitch's Prism FBM, falling to a low level in the 'Very Strong' category, or financial leverage increasing above 30%.

A sustained improvement of financial leverage to below 20% could result in an upgrade, although Fitch considers this unlikely in the near term.

FULL LIST OF RATING ACTIONS
Aviva Assurances
--IFS rating affirmed at 'AA-'; Outlook Stable

Aviva Insurance Company of Canada
--IFS rating affirmed at 'AA-'; Outlook Stable

Aviva Insurance Ltd
--IFS rating affirmed at 'AA-'; Outlook Stable;
--Long-Term IDR affirmed at 'A+'; Outlook Stable.

Aviva International Insurance Ltd
--IFS rating affirmed at 'AA-'; Outlook Stable

Aviva Life & Pensions UK Limited
--IFS rating affirmed at 'AA-'; Outlook Stable

Aviva Plc
--Long-Term IDR affirmed at 'A+'; Outlook Stable

Aviva Vie
--IFS rating affirmed at 'AA-'; Outlook Stable

Friends Life Holdings plc
--Long-Term IDR affirmed at 'A+'; Outlook Stable

Friends Life Limited
--IFS rating affirmed at 'AA-'; Outlook Stable

Senior debt of Aviva Plc assigned at 'A'

Subordinated debt of Aviva Plc - Tier 1 Notes
--Tier 1 Notes guaranteed by Friends Life Limited affirmed at 'BBB+'
--Tier 1 Notes assigned at 'BBB+'
--Tier 2 Notes assigned at 'BBB+'
--Tier 3 Notes affirmed at 'BBB+'

Subordinated debt of Friends Life Holdings, guaranteed by Friends Life Limited Tier 2 Notes
--12% GBP162m (XS0430178961) affirmed at 'A'
--8.25% GBP500m (XS0620022128) affirmed at 'A-'
--7.875% USD575m (XS0851688860) affirmed at 'A-'

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