L&G 2008 Final Results Part 7

RNS Number : 4206P

Legal & General Group Plc

25 March 2009

 



Appendices											Page 77
I Operating profit income statement
For the year ended 31 December 2008
						Previous			Investment		Group
						Reported			manage-	Inter-	capital and
						basis	Risk	Savings	ment	national	financing
						£m	£m	£m	£m	£m	£m
From continuing operations
Life and pensions
- UK						(291)	(648)	87	-	-	270
- International						63	-	-	-	59	4
Investment management
- Legal & General Investment Management						172	-	-	172	-	-
- Core retail investments						(7)	-	-	(7)	-	-
General insurance						(2)	(2)	-	-	-	-
Other operational income						(124)	47	(21)	-	-	(150)
Operating (loss)/profit						(189)	(603)	66	165	59	124
Variation from longer term investment return						(1,239)	(29)	-	7	4	(1,221)
Property losses attributable to minority interests						(63)	-	-	-	-	(63)
(Loss)/profit from continuing operations before tax
attributable to equity holders of the Company						(1,491)	(632)	66	172	63	(1,160)
Tax attributable to equity holders						361	172	(7)	(52)	(21)	269
(Loss)/profit from ordinary activities after tax						(1,130)	(460)	59	120	42	(891)
For the year ended 31 December 2007
						Previous			Investment		Group
						Reported			manage-	Inter-	capital and
						basis	Risk	Savings	ment	national	financing
						£m	£m	£m	£m	£m	£m
From continuing operations
Life and pensions
- UK						557	154	113	-	-	290
- International						86	-	-	-	86	-
Investment management
- Legal & General Investment Management						147	-	-	147	-	-
- Core retail investments						8	-	12	(4)	-	-
General insurance						(67)	(67)	-	-	-	-
Other operational income						(73)	17	(13)	-	-	(77)
Operating profit						658	104	112	143	86	213
Variation from longer term investment return						(90)	(9)	-	4	(11)	(74)
Release of 1996 Sub-fund						321	-	-	-	-	321
Property losses attributable to minority interests						(6)	-	-	-	-	(6)
Profit from continuing operations before tax
attributable to equity holders of the Company						883	95	112	147	75	454
Tax attributable to equity holders						(165)	(32)	(33)	(44)	(22)	(34)
Profit from ordinary activities after tax						718	63	79	103	53	420
Appendices											Page 78
II  UK funds under management
										2008	2007
										£m	£m
Total investments										264,228	296,649
Represented by
Index tracking funds:
- UK equities										54,780	86,294
- Overseas equities										54,366	63,930
- Fixed interest										35,912	34,256
- Index linked										30,704	28,776
- Cash/deposits										(186)	860
Total index tracking funds										175,576	214,116
Actively managed funds										65,872	70,727
Structured solutions										22,780	11,806
										264,228	296,649
By investment approach
Indexed equities										109,146	150,224
Indexed bonds (including index linked funds and cash)										66,430	63,891
Active bonds (including index linked funds and cash)										51,439	51,546
Structured solutions										22,780	11,806
Active equities										7,576	9,816
Property										6,646	9,086
Private equity										211	280
										264,228	296,649
By source of business
Institutional funds under management1:
- Managed pension funds pooled										160,946	194,771
- Structured solutions										22,780	11,806
- Other										8,631	7,030
- Managed pension funds segregated										3,832	5,807
Total institutional funds under management										196,189	219,414
UK businesses (life and general insurance funds)										57,688	65,280
UK businesses (unit trusts - excluding life fund investment)										10,351	11,955
										264,228	296,649
1. Excludes institutional investments in unit trust funds.
Appendices											Page 79
III Capital
a)		Group capital resources
										Shareholders'
					UK with-	UK non	LGPL	Overseas	Total life	equity and	Total
					profits	profit and		and PMC		other
						SRC1				activities
As at 31 December 2008					£m	£m	£m	£m	£m	£m	£m
Shareholders' equity outside the LTF					-	166	(373)	1,466	1,259	1,236	2,495
Shareholders' equity held in the LTF					-	1,093	-	-	1,093	-	1,093
Capital and reserves attributable to equity
holders of the Company					-	1,259	(373)	1,466	2,352	1,236	3,588
Adjustments onto regulatory basis2:
Unallocated divisible surplus3					950	-	-	(37)	913	-	913
Other4					(309)	(586)	-	(742)	(1,637)	(285)	(1,922)
Other qualifying capital:
Subordinated borrowings					-	-	-	-	-	1,570	1,570
Internal loans5					-	-	938	-	938	(938)	-
Proposed dividend					-	-	-	-	-	(120)	(120)
Total available capital resources					641	673	565	687	2,566	1,463	4,029
IFRS liability analysis:
UK participating liabilities on realistic basis
- Options and guarantees					1,034	-	-	-	1,034	-	1,034
- Other policyholder obligations					12,976	39	-	-	13,015	-	13,015
Overseas participating liabilities					-	-	-	2,327	2,327	-	2,327
Unallocated divisible surplus3					950	-	-	(37)	913	-	913
Value of in-force non-participating contracts					(171)	-	-	-	(171)	-	(171)
Participating contract liabilities					14,789	39	-	2,290	17,118	-	17,118
Unit linked non-participating life assurance liabilities					515	457	-	1,387	2,359	-	2,359
Non linked non-participating life assurance liabilities					1,944	19,070	-	2,255	23,269	-	23,269
Unit linked non-participating investment contract liabilities					6,835	15,300	-	174,517	196,652	-	196,652
General insurance liabilities					-	-	-	-	-	259	259
Non-participating contract liabilities					9,294	34,827	-	178,159	222,280	259	222,539
1. UK non profit and SRC includes Nationwide Life Limited and Suffolk Life Annuities Limited acquired during the year.
2. Figures extracted from draft unaudited regulatory returns.
3. The negative overseas unallocated divisible surplus arises as a result of differences between regulatory and IFRS reporting.
4. Other consists of shareholders' share in realistic liabilities of £179m and changes to the values of assets and liabilities on a regulated basis of £1,743m.
5. Internal loans wholly comprises the contingent loan (£938m) from Society shareholders' equity to LGPL, which is reflected in the
value of LGPL for regulatory purposes.
Appendices											Page 80
III Capital (continued)
b)		Movements in life business capital resources
							UK with-	UK non	LGPL2	Overseas	Total life
							profits	profit and		and PMC
								SRC1
							2008	2008	2008	2008	2008
							£m	£m	£m	£m	£m
As at 1 January							1,047	1,130	1,210	562	3,949
Effect of investment variations							(279)	(449)	(250)	15	(963)
Effect of changes in valuation assumptions							(14)	118	(779)	-	(675)
Changes in management policy							-	-	-	-	-
Changes in regulatory requirements							-	-	-	-	-
New business							(38)	(187)	(147)	(75)	(447)
Cash distributions							-	(30)	(150)	(83)	(263)
Acquisitions							-	156	-	-	156
Other factors							(75)	(65)	681	268	809
As at 31 December							641	673	565	687	2,566
1. UK non profit and SRC includes Nationwide Life Limited and Suffolk Life Annuities Limited acquired during the year.
2. Effect of changes in in valuation assumptions includes a £650m increase in credit default reserving. The corresponding deferred tax asset is included
within Other factors.
Appendices											Page 81
IV New business
a)		Risk and Savings1 new business APE by quarter
				3 months	3 months	3 months	3 months	3 months	3 months	3 months	3 months
				31.12.08	30.09.08	30.06.08	31.03.08	31.12.07	30.09.07	30.06.07	31.03.07
				£m	£m	£m	£m	£m	£m	£m	£m
Protection				49	48	60	50	55	57	55	56
Annuities				58	45	87	91	78	38	45	44
Total risk				107	93	147	141	133	95	100	100
Unit linked bonds				30	26	35	40	53	62	62	74
Pensions, stakeholder and other non profit				82	84	93	69	60	60	64	69
With-profits savings				40	47	61	43	45	54	69	60
Total savings				152	157	189	152	158	176	195	203
Total UK risk and savings				259	250	336	293	291	271	295	303
1. Excludes core retail investments.
b)		Risk and Savings1 new business annual premiums by quarter
				3 months	3 months	3 months	3 months	3 months	3 months	3 months	3 months
				31.12.08	30.09.08	30.06.08	31.03.08	31.12.07	30.09.07	30.06.07	31.03.07
				£m	£m	£m	£m	£m	£m	£m	£m
Protection				49	48	60	50	55	57	55	56
Annuities				-	-	-	-	-	-	-	-
Total risk				49	48	60	50	55	57	55	56
Unit linked bonds				-	-	-	-	-	-	-	-
Pensions, stakeholder and other non profit				44	43	51	43	37	34	27	43
With-profits savings				25	26	32	25	23	27	45	35
Total savings				69	69	83	68	60	61	72	78
Total UK risk and savings				118	117	143	118	115	118	127	134
1. Excludes core retail investments.
c)		Risk and Savings1 new business single premiums by quarter
				3 months	3 months	3 months	3 months	3 months	3 months	3 months	3 months
				31.12.08	30.09.08	30.06.08	31.03.08	31.12.07	30.09.07	30.06.07	31.03.07
				£m	£m	£m	£m	£m	£m	£m	£m
Protection				-	-	-	-	-	-	-	-
Annuities				573	457	871	905	780	370	458	437
Total risk				573	457	871	905	780	370	458	437
Unit linked bonds				297	260	347	402	537	620	616	739
Pensions, stakeholder and other non profit				385	404	418	261	229	258	373	262
With-profits savings				155	208	304	171	217	278	240	248
Total savings				837	872	1,069	834	983	1,156	1,229	1,249
Total UK risk and savings				1,410	1,329	1,940	1,739	1,763	1,526	1,687	1,686
1. Excludes core retail investments.
d)		International1 new business APE by quarter
				3 months	3 months	3 months	3 months	3 months	3 months	3 months	3 months
				31.12.08	30.09.08	30.06.08	31.03.08	31.12.07	30.09.07	30.06.07	31.03.07
				£m	£m	£m	£m	£m	£m	£m	£m
USA				15	12	12	12	11	12	11	11
Netherlands				6	6	8	9	7	6	6	8
France				6	8	4	15	6	9	17	10
Total				27	26	24	36	24	27	34	29
1. Excludes retail investments.
Appendices											Page 82
IV New Business (continued)
e)		International1 new business annual premiums by quarter
				3 months	3 months	3 months	3 months	3 months	3 months	3 months	3 months
				31.12.08	30.09.08	30.06.08	31.03.08	31.12.07	30.09.07	30.06.07	31.03.07
				£m	£m	£m	£m	£m	£m	£m	£m
USA				15	12	12	12	11	12	11	11
Netherlands				3	4	3	3	3	3	2	3
France				2	5	-	10	1	5	9	2
Total				20	21	15	25	15	20	22	16
f)		International1 new business single premiums by quarter
				3 months	3 months	3 months	3 months	3 months	3 months	3 months	3 months
				31.12.08	30.09.08	30.06.08	31.03.08	31.12.07	30.09.07	30.06.07	31.03.07
				£m	£m	£m	£m	£m	£m	£m	£m
USA				-	-	-	-	-	-	-	-
Netherlands				29	32	37	59	36	30	35	56
France				38	34	43	49	47	45	78	78
Total				67	66	80	108	83	75	113	134
g)		Core retail investments new business APE by quarter
				3 months	3 months	3 months	3 months	3 months	3 months	3 months	3 months
				31.12.08	30.09.08	30.06.08	31.03.08	31.12.07	30.09.07	30.06.07	31.03.07
				£m	£m	£m	£m	£m	£m	£m	£m
UK				61	53	73	42	37	38	51	35
France				2	1	2	1	-	-	1	1
Total				63	54	75	43	37	38	52	36
h)		Core retail investments new business annual premiums by quarter
				3 months	3 months	3 months	3 months	3 months	3 months	3 months	3 months
				31.12.08	30.09.08	30.06.08	31.03.08	31.12.07	30.09.07	30.06.07	31.03.07
				£m	£m	£m	£m	£m	£m	£m	£m
UK				10	12	14	5	5	5	7	4
France				-	-	-	-	-	-	-	-
Total				10	12	14	5	5	5	7	4
i)		Core retail investments new business single premiums by quarter
				3 months	3 months	3 months	3 months	3 months	3 months	3 months	3 months
				31.12.08	30.09.08	30.06.08	31.03.08	31.12.07	30.09.07	30.06.07	31.03.07
				£m	£m	£m	£m	£m	£m	£m	£m
UK				510	416	577	376	316	324	440	319
France				19	18	19	7	4	5	9	6
Total				529	434	596	383	320	329	449	325
Appendices											Page 83
IV New Business (continued)
j)		Analysis of total Risk and Savings APE
				3 months	3 months	3 months	3 months	3 months	3 months	3 months	3 months
				31.12.08	30.09.08	30.06.08	31.03.08	31.12.07	30.09.07	30.06.07	31.03.07
				£m	£m	£m	£m	£m	£m	£m	£m
Independent financial advisers				207	199	234	187	185	206	220	231
Tied				57	57	76	53	57	66	72	66
Direct				9	7	10	8	5	9	13	9
Total individual Risk and Savings				273	263	320	248	247	281	305	306
Individual Risk and Savings1				212	210	247	206	210	243	254	271
Core retail investments				61	53	73	42	37	38	51	35
Total individual Risk and Savings				273	263	320	248	247	281	305	306
Group Risk and Savings				47	40	90	86	81	28	41	32
Total Risk and Savings				320	303	410	334	328	309	346	338
1. Excludes core retail investments.
k)		Investment management new business by quarter
				3 months	3 months	3 months	3 months	3 months	3 months	3 months	3 months
				31.12.08	30.09.08	30.06.08	31.03.08	31.12.07	30.09.07	30.06.07	31.03.07
				£m	£m	£m	£m	£m	£m	£m	£m
Managed pension funds1
Pooled funds				3,423	9,748	8,254	5,308	19,903	13,989	10,646	4,922
Segregated funds				430	47	141	223	230	1,925	380	68
Total managed funds				3,853	9,795	8,395	5,531	20,133	15,914	11,026	4,990
Other funds2				890	908	3,151	568	871	492	506	499
Total				4,743	10,703	11,546	6,099	21,004	16,406	11,532	5,489
Attributable to:
Legal & General Investment Management				4,185	10,464	10,611	5,613	20,247	16,149	11,167	5,059
Legal & General Retail Investments				558	239	935	486	757	257	365	430
1. New monies from pension fund clients of Legal & General Assurance (Pensions Management) Limited exclude £7.4bn (2007: £19.4bn) held through the year on a temporary basis, generally as part of portfolio reconstructions. 2. Includes segregated property, property partnerships, ventures partnerships and institutional clients funds managed by Legal & General Investment Management and institutional investments in unit trust funds managed by Legal & General Retail Investments.

Appendices                                                                                                                                      Page 84

V  European Embedded Value Methodology

Basis of preparation

The supplementary financial statements have been prepared in accordance with the European Embedded Value (EEV) Principles issued in May 2004 by the European Insurance CFO Forum.  

Covered business

The Group uses EEV methodology to value individual and group life assurance, pensions and annuity business written in the UK, Continental Europe and the US. The UK covered business also includes non-insured self invested personal pension (SIPP) business.

For 2008, business written in our UK managed pension funds company was removed from covered business and the result of the managed pension funds business reported on an IFRS basis. 2007 comparatives have been restated accordingly.

All other businesses are accounted for on the IFRS basis adopted in the primary financial statements.

There is no distinction made between insurance and investment contracts in our covered business as there is under IFRS.

Description of methodology

The objective of EEV is to provide shareholders with realistic information on the financial position and current performance of the Group. 

The methodology requires assets of an insurance company, as reported in the primary financial statements, to be attributed between those supporting the covered business and the remainder. The method accounts for assets in the covered business on an EEV basis and the remainder of the Group's assets on the IFRS basis adopted in the primary financial statements.

The EEV methodology recognises profit from the covered business as the total of:

• cash transfers during the relevant period from the covered business to the remainder of the Group's assets; and

• the movement in the present value of future distributable profits to shareholders arising from the covered business over the relevant reporting period.

Embedded value

Shareholders' equity on the EEV basis comprises the embedded value of the covered business plus the shareholders' equity of other businesses, less the value included for purchased interests in long term business.  

The embedded value is the sum of the shareholder net worth (SNW) and the value of the in-force business (VIF). SNW is defined as those amounts, within covered business (both within the long term fund and held outside the long term fund but used to support long term business), which are regarded either as required capital or which represent free surplus.

The VIF is the present value of future shareholder profits arising from the covered business, projected using best estimate assumptions, less an appropriate deduction for the cost of holding the required level of capital and the time value of financial options and guarantees (FOGs).

Service companies

All services relating to the UK covered business are charged on a cost recovery basis, with the exception of investment management services provided to LGPL, which have been charged at market referenced rates since 1 January 2007, and to Society, which have been charged at market referenced rates since 1 July 2007. Profits arising on the provision of these services are valued on a 'look through' basis.

As the EEV methodology incorporates the future capitalised cost of these internal investment management services, the equivalent IFRS profits have been removed from the Investment management segment and are instead included in the results of the Risk and Savings segments on an EEV basis.

The capitalised value of future profits emerging from internal investment management services are therefore included in the embedded value and new business contribution calculations for the Risk and Savings segments. However, the historical profits which have emerged continue to be reported in the shareholders' equity of the Investment management segment on an IFRS basis. Since the look through into service companies includes only future profits and losses, current intra-group profits or losses must be eliminated from the closing embedded value and in order to reconcile the profits arising in the financial period within each segment with the net assets on the opening and closing balance sheet, a transfer of IFRS profits for the period from the UK SNW is deemed to occur.

New business

New business premiums reflect income arising from the sale of new contracts during the reporting period and any changes to existing contracts, which were not anticipated at the outset of the contract.  

In-force business comprises previously written single premium, regular premium and recurrent single premium contracts. 

Appendices                                                                                                                                 Page 85

V  European Embedded Value Methodology (continued)

Department of Work and Pensions rebates have not been treated as recurrent and are included in single premium new business when received.  

New business contribution arising from the new business premiums written during the reporting period has been calculated on the same economic and operating assumptions used in the embedded value at the end of the financial period. This has then been rolled forward to the end of the financial period using the risk discount rate applicable at the end of the reporting period.

The present value of future new business premiums (PVNBP) has been calculated and expressed at the point of sale. The PVNBP is equivalent to the total single premiums plus the discounted value of regular premiums expected to be received over the term of the contracts using the same economic and operating assumptions used for the embedded value at the end of the financial period. The new business margin is defined as new business contribution at the end of the reporting period divided by the PVNBP. The premium volumes and projection assumptions used to calculate the PVNBP are the same as those used to calculate new business contribution. 

Projection assumptions

Cash flow projections are determined using realistic assumptions for each component of cash flow and for each policy group. Future economic and investment return assumptions are based on conditions at the end of the financial year. Future investment returns are projected by one of two methods. The first method is based on an assumed investment return attributed to assets at their market value. The second, which is used in the US, where the investments of that subsidiary are substantially all fixed interest, projects the cash flows from the current portfolio of assets and assumes an investment return on reinvestment of surplus cash flows. The assumed discount and inflation rates are consistent with the investment return assumptions.

Detailed projection assumptions including mortality, morbidity, persistency and expenses reflect recent operating experience and are normally reviewed annually. Allowance is made for future improvements in annuitant mortality based on experience and externally published data. Favourable changes in operating experience are not anticipated until the improvement in experience has been observed.

All costs relating to the covered business, whether incurred in the covered business or elsewhere in the Group, are allocated to that business. The expense assumptions used for the cash flow projections therefore include the full cost of servicing this business.

Tax

The projections take into account all tax which is expected to be paid, based on best estimate assumptions, applying current legislation and practice together with known or expected future changes. This includes tax which would arise if surplus assets within the covered business were eventually to be distributed. The benefit of certain current UK tax rules on the apportionment of income has not been reflected as it is expected that these rules will be amended before such benefit is realised.

Allowance for risk

Aggregate risks within the covered business are allowed for through the following principal mechanisms:

• setting required capital levels with reference to both the Group's internal risk based capital models, and an assessment of the strength of regulatory reserves in the covered business;

• allowing explicitly for the time value of financial options and guarantees within the Group's products; and

• setting risk discount rates by deriving a Group level risk margin to be applied consistently to local risk free rates.

Required capital and free surplus

Regulatory capital for the Risk and Savings businesses is provided by assets backing the with-profits business or by the SNW. The SNW comprises all shareholders' capital within Society, including those funds retained within the long term fund and the excess assets in LGPL (collectively Society shareholder capital). 

Society shareholder capital is either required to cover EU solvency margin or is free surplus as its distribution to shareholders is not restricted.

For UK with-profits business, the required capital is covered by the surplus within the with-profits part of the fund and no effect is attributed to shareholders except for the burn-through cost, which is described later. This treatment is consistent with the Principles and Practices of Financial Management for this part of the fund.

For UK non profit business, the required capital will be maintained at no less than the level of the EU minimum solvency requirement. This level, together with the margins for adverse deviation in the regulatory reserves, is, in aggregate, in excess of internal capital targets assessed in conjunction with the Individual Capital Assessment (ICA) and the with-profits support account.  

The initial strains relating to new non profit business, together with the related EU solvency margin, are supported by releases from existing non profit business and the Society shareholder capital. As a consequence, the writing of new business defers the release of capital to free surplus. The cost of holding required capital is defined as the difference between the value of the required capital and the present value of future releases of that capital. For new business, the cost of capital is taken as the difference in the value of that capital assuming it was available for release immediately and the present value of the future releases of that capital. As the 

Appendices                                                                                                                             Page 86

V  European Embedded Value Methodology (continued)

investment return, net of tax, on that capital is less than the risk discount rate, there is a resulting cost of capital which is reflected in the value of new business.  

For Legal & General America, the Company Action Level (CAL) of capital has been treated as required capital for modelling purposes. The CAL is the regulatory capital level at which the company would have to take prescribed action, such as submission of plans to the State insurance regulator, but would be able to continue operating on the existing basis. The CAL is currently twice the level of capital at which the regulator is permitted to take control of the business.

For Legal & General Netherlands, required capital has been set at 100% of EU minimum solvency margin for all products without FOGs. For those products with FOGs, capital of between 100% and 175% of the EU minimum solvency margin has been used. The level of capital has been determined using risk based capital techniques. 

For Legal & General France, 100% of EU minimum solvency margin has been used for EV modelling purposes for all products both with and without FOGs. The level of capital has been determined using risk based capital techniques.  

The contribution from new business for our International businesses reflects an appropriate allowance for the cost of holding the required capital.

Financial options and guarantees

In the UK, all financial options and guarantees (FOGs) are within the UK covered business. 

Under the EEV Principles an allowance for time value of FOGs is required where a financial option exists which is exercisable at the discretion of the policyholder. These types of option principally arise within the with-profits part of the fund and their time value is recognised within the with-profits burn-through cost described below. Additional financial options for non profit business exist only for a small amount of deferred annuity business where guaranteed early retirement and cash commutation terms apply when the policyholders choose their actual retirement date.

Further financial guarantees exist for non profit business, in relation to index-linked annuities where capped or collared restrictions apply. Due to the nature of these restrictions and the manner in which they vary depending on the prevailing inflation conditions, they are also treated as FOGs and a time value cost recognised accordingly.

The time value of FOGs has been calculated stochastically using a large number of real world economic scenarios derived from assumptions consistent with the deterministic EEV assumptions and allowing for appropriate management actions where applicable. The management action primarily relates to the setting of bonus rates. Future regular and terminal bonuses on participating business within the projections are set in a manner consistent with expected future returns available on assets deemed to back the policies within the stochastic scenarios.

In recognising the residual value of any projected surplus assets within the with-profits part of the fund in the deterministic projection, it is assumed that terminal bonuses are increased to exhaust all of the assets in the part of the fund over the future lifetime of the in-force with-profits policies. However, under stochastic modelling, there may be some extreme economic scenarios when the total projected assets within the with-profits part of the fund are insufficient to pay all projected policyholder claims and associated costs. The average additional shareholder cost arising from this shortfall has been included in the time value cost of options and guarantees and is referred to as the with-profits burn-through cost.

Economic scenarios have been used to assess the time value of the financial guarantees for non profit business by using the inflation rate generated in each scenario. The inflation rate used to project index-linked annuities will be constrained in certain real world scenarios, for example, where negative inflation occurs but the annuity payments do not reduce below pre-existing levels. The time value cost of FOGs allows for the projected average cost of these constrained payments for the index-linked annuities. It also allows for the small additional cost of the guaranteed early retirement and cash commutation terms for the minority of deferred annuity business where such guarantees have been written.

In the US, FOGs relate to guaranteed minimum crediting rates and surrender values on a range of contracts. The guaranteed surrender value of the contract is based on the accumulated value of the contract including accrued interest. The crediting rates are discretionary but related to the accounting income for the amortising bond portfolio. The majority of the guaranteed minimum crediting rates are between 4% and 5%. The assets backing these contracts are invested in US Dollar denominated fixed interest securities.

In the Netherlands, there are two types of guarantees which have been separately provided for: interest rate guarantees and maturity guarantees. Certain contracts provide an interest rate guarantee where there is a minimum crediting rate based on the higher of 1-year Euribor and the policy guarantee rate. This guarantee applies on a monthly basis. Certain unit linked contracts provide a guaranteed minimum value at maturity where the maturity amount is the higher of the fund value and a guarantee amount. The fund values for both these contracts are invested in Euro denominated fixed interest securities.

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V  European Embedded Value Methodology (continued)

In France, FOGs which have been separately provided for relate to guaranteed minimum crediting rates and surrender values on a range of contracts. The guaranteed surrender value of the contract is the accumulated value of the contract including accrued bonuses. The bonuses are based on the accounting income for the amortising bond portfolios plus income and releases from realised gains on any equity type investments. Policy liabilities equal guaranteed surrender values. Local statutory accounting rules require the establishment of a specific liability when the accounting income for a company is less than 125% of the guaranteed minimum credited returns, although this has never been required. In general, the guaranteed annual bonus rates are between 0% and 4.5%. 

Risk discount rate

The risk discount rate (RDR) is a combination of the risk free rate and a risk margin, which reflects the residual risks inherent in the Group's covered businesses, after taking account of prudential margins in the statutory provisions, the required capital and the specific allowance for FOGs.

The risk margin has been determined based on an assessment of the Group's weighted average cost of capital (WACC). This assessment incorporates a beta for the Group, which measures the correlation of movements in the Group's share price to movements in a relevant index. Beta values therefore allow for the market's assessment of the risks inherent in the business relative to other companies in the chosen index. 

The WACC is derived from the Group's cost of equity and debt, and the proportion of equity to debt in the Group's capital structure measured using market values. Each of these three parameters are forward looking, although informed by historic information. The cost of equity is calculated as the risk free rate plus the equity risk premium for the chosen index multiplied by the Company's beta. Forward-looking or adjusted betas make allowance for the observed tendency for betas to revert to 1 and therefore a weighted average of the historic beta and 1 tends to be a better estimate of the Company's beta for the future period. We have computed the WACC using an arithmetical average of forward-looking betas against the FTSE 100 index.  

The cost of debt used in the WACC calculations takes account of the actual locked-in rates for our senior and subordinated long term debt. All debt interest attracts tax relief at a rate of 28%. 

Whilst the WACC approach is a relatively simple and transparent calculation to apply, subjectivity remains within a number of the assumptions. Management believes that the chosen margin, together with the levels of required capital, the inherent strength of the Group's regulatory reserves and the explicit deduction for the cost of options and guarantees, is appropriate to reflect the risks within the covered business. 

For the 2008 results the risk margin was increased to 4.5% (31.12.07: 3.0%). This 1.5% increase includes a 0.5% increase in the equity risk premium and a further 1% increase to reflect increased market perceived company specific risks in the current dislocated market conditions.

Key assumptions are summarised below:

Risk free rate	Derived from gross redemption yield on the 20 year gilt index
Equity risk premium	3.5% (UK only)
Property risk premium	2.0% (UK only)
Risk margin	4.5%

Analysis of profit

Operating profit is identified at a level which reflects an assumed longer term level of investment return. 

The contribution to operating profit in a period is attributed to four sources: 

• new business; 

• the management of in-force business; 

• development costs; and 

• return on shareholder net worth. 

Further profit contributions arise from actual investment return differing from the assumed long term investment return (investment return variances), and from the effect of economic assumption changes.

The contribution from new business represents the value recognised at the end of each period from new business written in that period, after allowing for the actual cost of acquiring the business and of establishing the required technical provisions and reserves and after making allowance for the cost of capital. New business contributions are calculated using closing assumptions.

Appendices                                                                                                                             Page 88

V  European Embedded Value Methodology (continued)

The contribution from in-force business is calculated using opening assumptions and comprises:

• expected return - the discount earned from the value of business in-force at the start of the year;

• experience variances - the variance in the actual experience over the reporting period from that assumed in the value of business in-force as at the start of the year; and

• operating assumption changes - the effects of changes in future assumptions, other than changes in economic assumptions from those used in valuing the business at the start of the year. These changes are made prospectively from the end of the year.

Development costs relate to investment in strategic systems and development capability.

The contribution from shareholder net worth comprises the increase in embedded value based on assumptions at the start of the year in respect of the expected investment return on the Society shareholder capital.

Further profit contributions arise from investment return variances and the effect of economic assumption changes. 

Investment return variances represent the effect of actual investment performance and changes to investment policy on SNW and VIF business from that assumed at the beginning of the period. 

Economic assumption changes comprise the effect of changes in economic variables on SNW and VIF business from that assumed at the beginning of the period, which are beyond the control of management, including associated changes to valuation bases to the extent that they are reflected in revised assumptions.

VI  IFRS basis of preparation

Basis of preparation

The Group's financial statements have been prepared in accordance with International Financial Reporting Standards (IFRS) issued by the International Accounting Standards Board (IASB) and as adopted by the European Commission (EC) for use in the European Union. The Group's financial statements also comply with IFRS as issued by the IASB. 

The Group presents its balance sheet broadly in order of liquidity. Given the long term nature of the Group's core business, this is considered to be more relevant than a presentation that distinguishes between before or after twelve months. However, for each asset and liability line item which combines amounts expected to be recovered or settled before and after twelve months from the balance sheet date, disclosure of the split is made by way of note.

Financial assets and financial liabilities are disclosed gross in the balance sheet unless a legally enforceable right of offset exists and there is an intention to settle recognised amounts on a net basis. Income and expenses are not offset in the income statement unless required or permitted by an accounting standard or International Financial Reporting Interpretations Committee (IFRIC) interpretation, as detailed in the applicable accounting policies of the Group.

Use of estimates

The preparation of the financial information includes the use of estimates and assumptions that affect items reported in the consolidated balance sheet and income statement and the disclosure of contingent assets and liabilities at the date of the financial statements. Although these estimates are based on management's best knowledge of current circumstances and future events and actions, actual results may differ from those estimates, possibly significantly. They are particularly relevant to the estimation of insurance and investment contract liabilities and associated balances, deferred acquisition costs, pension schemes, deferred tax liabilities and the determination of fair values of unquoted financial liabilities. 

Summary of significant accounting policies

The Group has selected accounting policies which fairly state its financial position and financial performance for a reporting period. The accounting policies have been consistently applied to all years presented, unless otherwise stated.

 

END

 

 

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