Increasing economic capital levels should make the insurer more resilient and pacify concerned shareholders

Aviva announced some bold plans this morning, which it hopes will soothe shareholders’ concerns about the insurer. But doubts remain over how it will accomplish these.

Firstly, the insurer wants to increase its economic capital levels to between 160% and 170%, giving shareholders confidence that the company is strong enough to absorb shocks. The insurer’s capital level is around 140% at the moment, according to Panmure Gordon analyst Barrie Cornes.

One of Aviva investors’ concerns has been that the insurer’s surplus capital levels fluctuate a lot, so setting the bar high is designed to allay those fears.

The common analyst counterargument is that more surplus capital makes it harder to get a good return on capital, which shareholders also value, so managing these extremes can be a tricky balancing act.

Beyond this, Aviva needs to release additional capital to reach its 160-175% target, mainly by selling 16 underperforming business units. Some question, however, whether this will work at all. Investec analyst Kevin Ryan doubts that Aviva can count on offloading these companies in the current climate.

A smart move by Aviva has been to cut its Italian bond holdings by €2bn (£1.6bn). Aviva had a huge exposure to Italian bonds, and as a result when any nasty eurozone news came out, its stock price took a hammering. Reducing this amount is a step in the right direction, but the insurer did not say how many other Italian shares it was holding on to at the moment. According to its first quarter interim management statement, however, it had £6.8bn in Italian government bonds as of 31 March 2012.

Despite the constant questions, Aviva UK chairman Trevor Matthews and the Aviva team are confident that their approach will work. As director group transformation, David McMillan in particular has a big job on his hands to turn Aviva around, and it is a measure of trust from the Aviva top brass that they have entrusted him with the task.