Nov. 4 (Bloomberg) -- Aviva Plc, the U.K.’s second-biggest insurer, said profitability improved in its biggest life insurance and pensions market in the third quarter even as sales dropped 11 percent, missing estimates.

Profit margins on new life and pension products sold in the U.K. improved to 2.5 percent at the end of September, compared with 2.1 percent at June 30, the London-based company said today in a statement. Revenue in the first nine-months of the year dropped to 27.1 billion pounds, missing the 27.6 billion-pound estimate of three analysts surveyed by Bloomberg News.

“Although new business sales were shy of expectations, the key issue is that they’re preserving capital and their margins have moved forward nicely in the U.K.,” said Barrie Cornes, a London-based analyst at Panmure Gordon & Co. with a “buy” rating on the stock.

Revenue from new business declined to 27.1 billion pounds ($44.6 billion) in the year to Sept. 30 from 30.4 billion pounds a year earlier, the London-based company said today in the statement. That missed the 27.6 billion-pound median estimate of three analysts surveyed by Bloomberg News.

Aviva is cutting jobs, merging units and selling part of its Dutch and Australian operations as it seeks to raise funds following a financial crisis that last year pushed the company to its first net loss in six years. To help offset slowing sales, the insurer is merging its U.K. general and life- insurance operations under British CEO Mark Hodges and last month unveiled a plan to run its European operations out of one holding company based in Dublin.

U.K. Sales Drop

Life and pension sales in the U.K. were down 25 percent to 6.6 billion pounds in the period and revenue from annuity products dropped 35 percent to 1.2 billion pounds.

“In terms of pensions, you see the impact quite starkly in terms of lower wage settlements lower appetite for saving, which has driven volumes down,” Hodges said on a call with reporters. “With annuities, people are more cautious because of the uncertainty in financial markets. It could be another six or nine months before that confidence resumes and we see a pick-up in consumer behavior.”

The insurer’s capital surplus was 3.7 billion pounds at the end of September, compared with 3.2 billion pounds at the end of June. The capital buffer will improve by a further 400 million pounds once the company receives the proceeds of the sale of its Australian unit.

‘Cheapest Stock’

The stock rose 5.5 percent to 400.3 pence in London trading, the most since July 13, valuing the company at 11 billion pounds. The stock has dropped 11 percent in the past month.

The insurer’s net asset value, measured on a so-called market consistent embedded value basis, rose 25 percent to 520 pence in the third quarter. Narrowing corporate bond spreads and higher equity markets helped raise the market value of the company’s assets by more than expected, according to Marcus Barnard, a London-based analyst at Oriel Securities Ltd.

“This is the main valuation metric for life companies and it was way above expectations, highlighting the massive valuation shortfall on this stock,” Barnard said. “On my reckoning it’s the cheapest stock in the sector.”

Aviva improved margins in the U.K. by reducing commissions paid to independent financial advisers to sell savings and investment products, cutting administration costs and writing more profitable business, Hodges said on a call with reporters.

Cost Cuts

The insurer last year announced 1,800 job cuts by the end of 2010 as it seeks to reduce costs at its back-office units in the U.K. Fellow British insurers Legal & General Group Plc and Friends Provident Group Plc have also been reducing their workforce as the longest U.K. recession on record hampers demand for insurance and savings products and reduced investment returns hurts profitability.

Aviva may use the proceeds from the initial public offering of its Dutch unit, Delta Lloyd, for acquisitions, Moss said on the call. European Union Competition Commissioner Neelie Kroes has ordered Royal Bank of Scotland Group Plc and ING Groep NV to dispose of their insurance assets in return for bailout funds from the U.K. and Dutch governments.

“It’s part of our job always to look at parts of any particular portfolios make sense,” Moss said. “Certainly we might have a look at” ING’s assets.

When RBS last year tried to sell its Direct Line and Churchill brands Aviva “made it very clear that buying a large brand here in the U.K. didn’t make sense for us,” Moss said. “That hasn’t changed.”

To contact the reporter on this story: Kevin Crowley in London at kcrowley1@bloomberg.net

Last Updated: November 4, 2009 12:21 EST