Part 1 - Prelims Announcement
4 March 2009
Old Mutual plc Preliminary Results
For the year ended 31 December 2008
Solid performance in SA and Europe with challenges in US Life
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OMSA and Nordic: excellent growth in sales; adjusted operating profits up 14% and 23% (in local currency) respectively
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UK: sales impacted by equity market decline although strong unit-linked market position maintained
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US Asset Management: diversified asset mix provided resilience
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US Life: disappointing result although management actions to de-risk and return to profitability
The Group and its businesses remain well capitalised
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Group pro-forma FGD surplus at 31 December in excess of £0.7 billion, 1.2 times coverage ratio
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Available cash and facilities of over £600 million
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Strong capital surpluses in individual business units
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UK: 2.6 times required capital
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Nordic: 9.9 times required capital
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OMLACSA: 3.8 times required capital
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Nedbank: Tier 1 capital at 9.6%
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US Life: RBC ratio of 305% in onshore and significant excess capital in offshore
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Board decision not to pay dividends in 2009 to give further buffer on cash and capital position
Improved business structure, risk management and governance
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New Long-Term Savings division
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Risk appetite agreed for major subsidiary companies
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Enhanced governance and operational oversight from the centre
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Simplification of business will take place as global financial climate allows
Financial Summary
2008
2007
Net client cash flows
£1.2bn outflow
£23.4bn inflow
Funds under management
£264.8bn
£278.9bn
Profit before tax (IFRS)
£595m
£1,750m
Adjusted operating profit before tax (IFRS basis)*
£999m
£1,624m
Adjusted operating profit before tax (MCEV basis)
£978m
£1,631m
Adjusted operating earnings per share (IFRS basis)**
12.2p
16.9p
Basic earnings per share (IFRS)
8.6p
19.2p
Adjusted operating earnings per share (MCEV basis)
11.0p
17.0p
Adjusted MCEV per share
117.6p
166.3p
Julian Roberts, Chief Executive, commented:
'2008 presented major challenges for the Group. The rapid deterioration combined with volatility in global financial markets, most notably in the fourth quarter, gave rise to an extremely difficult operating environment, while we faced a number of specific issues in our US Life business. Nevertheless, many parts of the Group delivered strong performances, especially in the markets where we have scale and strong market positions.
'As a Group we remain well capitalised with strong surpluses over required capital levels in each of our business units, but due to the very uncertain market conditions, we have decided to conserve capital and cash levels despite our ability to withstand significant further deterioration in market conditions.
'Going forward, I am determined to rigorously drive performance improvement and strengthen governance, while at the same time reshaping the Group.'
Enquiries
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Investor Relations |
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Aleida White |
UK |
+44 (0)20 7002 7287 |
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Deward Serfontein |
SA |
+27 (0)82 810 5672 |
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Media |
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Matthew Gregorowski |
UK |
+44 (0)20 7002 7133 |
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Finsbury |
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Mike Smith / Brian Cattell |
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+44 (0)20 7251 3801 |
Notes
Wherever the terms asterisked in the Financial Highlights are used, whether in the Financial Highlights, the Chief Executive's Statement, the Group Finance Director's Review or the Business Review, the following definitions apply:
* For long-term business and general insurance businesses, adjusted operating profit is based on a long-term investment return, includes investment returns on life funds' investments in Group equity and debt instruments, and is stated net of income tax attributable to policyholder returns. For the US Asset Management business, it includes compensation costs in respect of certain long-term incentive schemes defined as minority interests in accordance with IFRS. For all businesses, adjusted operating profit excludes goodwill impairment, the impact of acquisition accounting, put revaluations related to long-term incentive schemes, the impact of closure of unclaimed shares trusts, profit/(loss) on disposal of subsidiaries, associated undertakings and strategic investments, dividends declared to holders of perpetual preferred callable securities, and fair value (profits)/losses on certain Group debt movements.
** Adjusted operating earnings per ordinary share is calculated on the same basis as adjusted operating profit. It is stated after tax attributable to adjusted operating profit and minority interests. It excludes income attributable to Black Economic Empowerment (BEE) trusts of listed subsidiaries. The calculation of the adjusted weighted average number of shares includes own shares held in policyholders' funds and BEE trusts.
Cautionary statement
This announcement has been prepared solely to provide additional information to shareholders to assess the Group's strategies and the potential for those strategies to succeed. It should not be relied on by any other party or for any other purpose.
This announcement contains forward-looking statements with respect to certain of Old Mutual plc's plans and its current goals and expectations relating to its future financial condition, performance and results. By their nature, all forward-looking statements involve risk and uncertainty because they relate to future events and circumstances that are beyond Old Mutual plc's control, including, among other things, UK domestic and global economic and business conditions, market-related risks such as fluctuations in interest rates and exchange rates, policies and actions of regulatory authorities, the impact of competition, inflation, deflation, the timing and impact of other uncertainties or of future acquisitions or combinations within relevant industries, as well as the impact of tax and other legislation and other regulations in territories where Old Mutual plc or its affiliates operate.
As a result, Old Mutual plc's actual future financial condition, performance and results may differ materially from the plans, goals and expectations set forth in Old Mutual plc's forward-looking statements. Old Mutual plc undertakes no obligation to update any forward-looking statements contained in this announcement or any other forward-looking statements that it may make.
Notes to Editors:
A webcast of the presentation and Q&A will be broadcast live at 9:00am (GMT), 10:00am (CET), 11:00am (South African time) today on the Company's website www.oldmutual.com. Analysts and investors who wish to participate in the call should dial the following numbers:
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UK (toll-free)
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0500 101 630
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US (toll-free)
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877 491 0064
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Sweden (toll-free)
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0200 887 651
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South Africa (toll-free)
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0800 991 468
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International
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+44 20 7162 0025
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Playback (available for 14 days from 4 March), using passcode 824733:
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UK (toll-free)
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0800 358 1860
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US (toll-free)
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888 365 0240
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Sweden (toll-free)
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08 5052 0333
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International
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+44 20 7031 4064
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There will also be a separate conference call at 1:30pm GMT (2:30pm CET / 3:30pm South African time) today on Old Mutual's supplementary life reporting under Market Consistent Embedded Value ('MCEV'). Analysts and investors who wish to participate in the call should dial the following numbers, quoting confirmation code 9824696:
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UK (toll-free)
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0800 028 1277
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US (toll-free)
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888 935 4577
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Sweden (toll-free)
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08 5352 6407
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South Africa (toll-free)
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0800 991 539
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International
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+44 207 806 1956
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This conference call will use VisionCast web meeting facility and slides can be viewed at http://www.livemeeting.com/cc/premconfeurope/join?id=9824696&role=attend&pw=pw7894 or by entering the VisionCast website http://www.euvisioncast.com using Meeting ID 9824696 and password pw7894. The presentation slides will also be available for download on the Company's website, www.oldmutual.com from 8:00am GMT.
Playback (available for 14 days from 4 March), using passcode 9824696#:
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UK (toll-free)
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0800 559 3271
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US (toll-free)
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866 239 0765
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Sweden (toll-free)
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08 5876 9441
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International
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+44 207 806 1970
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Copies of these Preliminary Results, together with high-resolution images and biographical details of the Executive Directors of Old Mutual plc, are available in electronic format to download from the Company's website at www.oldmutual.com.
A Financial Disclosure Supplement relating to the Company's Preliminary Results can be found on the website. This contains key financial data for 2008 and 2007.
Chief Executive's Statement
Overview
2008 presented major challenges for the Group. The rapid deterioration in global financial markets, most notably in the fourth quarter, resulted in an extremely difficult operating environment, while we faced a number of specific issues in our US Life businesses. Despite these setbacks, we delivered a strong performance across many parts of the Group, especially in the markets where we have significant scale and strong market positions.
During the second half of the year, we took major strides to address the issues in our US Life offshore business and, with these largely contained, toward the end of the year we turned our attention to the future and began a full review of the Group's activities. During that time we welcomed Philip Broadley to Old Mutual as our new Group Finance Director and we are already benefiting from his experience and skills. The actions following this review are outlined in more detail below.
Capital adequacy position
The Group's pro-forma FGD surplus at 31 December 2008 was in excess of £0.7 billion. This is in line with our self-imposed target range which ensures we have sufficient headroom to cover any capital issues across the Group's operations.
Our Nordic and UK businesses are well capitalised with solvency ratios of 9.9 times and 2.6 times the required level respectively. Our European businesses are capital light by their nature and therefore present very little capital risk. In South Africa, we have the strongest capital position and credit rating in the long-term insurance industry, with a surplus in OMLACSA of 3.8 times the required level. Nedbank's key ratios also demonstrate its capital strength. In the case of US Life, during 2008 we took action to maintain capital in the onshore business at three times its required level. £314 million of cash was injected into the US Life offshore business during 2008. This business now has significant excess capital over its regulatory requirement.
We have carried out significant capital stress testing. Historically, the highest global default rates during a recession have averaged 1.6% for investment grade (Source: Moody's). Applying these historical high default rates to our portfolio would generate losses which can be absorbed within our FGD surplus. Actual defaults on our corporate bonds for the year were £85 million resulting in a default rate of approximately 1.3% on our corporate bond portfolio. Our FGD surplus would enable us to withstand eight times that rate in a single year.
The Group has available cash and facilities of over £600 million as at 31 December 2008.
Dividend
During 2008 we paid an interim dividend of 2.45p per share. However, in view of the unpredictability of market conditions and continued uncertainty around the performance of financial markets, we believe it is prudent for us to conserve our capital and retain cash. Accordingly, the Board has determined that in order to conserve cash and capital during the current period of economic stress, no dividends will be paid by the Company during 2009. The Board will consider the position in respect of a final dividend for 2009 at the appropriate time in light of the then prevailing market and economic conditions. Longer term, the Board will look to pay a dividend based on the Group's capital, cash flow and earnings, with a view to maintaining cover of at least two times.
Strong sales and earnings growth in South Africa
In the markets where our businesses are highly developed and we have strong brands, we delivered excellent growth in both sales and profit. In South Africa, life and unit trust sales in local currency grew by 14% and 33% respectively and there was a significant reduction in net client cash outflows. The boutique model of our South African investment management business has continued to bed down well, with the majority of our boutiques delivering a better investment performance than in 2007. Old Mutual South Africa's adjusted operating profit on an IFRS basis was up 14% to R8 billion and the return on equity was up nearly four percentage points to 27.8%. This is an excellent result given the fall in equity markets and tightened consumer spending, and demonstrates the strength of our diverse product offering and our ability to adapt to an ever-changing market environment.
In contrast to the negative forecast GDP in the UK and US, the South African economy is forecast to grow by 1.2% in 2009 (Source: South Africa National Treasury) and, while it is facing its own challenges, the South African banking sector remains in good health, with the inter-bank lending market continuing to operate efficiently. Despite an increased level of impairments, Nedbank delivered an adjusted operating profit on an IFRS basis of R8.8 billion, down just 5% on 2007, and a return on equity of 17.7% with Tier 1 capital at 9.6%.
Skandia building market share across Europe
Skandia saw positive net client cash flows across all its divisions and the drop in funds under management relative to the much larger fall in the equity markets was very pleasing, reflecting good product innovation and investment performance. In Nordic, strong cash inflows were driven by a 30% increase in life sales to SEK2.6 billion and adjusted operating profit on an IFRS basis was up 23% to SEK1.1 billion. This was largely as a result of the introduction of new products and, in particular, growth in the unit-linked business in Sweden. This was very much against the trend seen in the UK and across the rest of Europe, given the general flight from equities which resulted in a significant drop in unit-linked sales. However, across Europe, we increased our market share, which will stand us in good stead when equity markets recover.
In the UK, the relative decline in sales was largely due to reduced demand for unit-linked products, especially bonds and single premium pensions, although Skandia's market share across the entire pensions market, and especially single premium personal pensions, remained strong. The core of our business is providing customers with a choice of products which are transparent, flexible and tailored to their specific needs and risk appetite, but which also provide attractive returns. Therefore, unlike many of the UK life insurers, we do not undertake any with-profits or bulk annuity business and therefore our capital requirement is much lower. While our sales have been affected by market volatility in the short term, we believe that Skandia's open-architecture model is at the forefront of the modern savings and investment market and that this will deliver excellent long-term value.
We also launched a re-pricing initiative in order to build our share of the platform market, while increasing the range of investment solutions to create wider customer appeal during this period of market volatility. For example, the Spectrum range of risk-controlled funds launched in April attracted more than £120 million of subscriptions by the year-end and the UK Strategic Best Ideas Fund was the best performing UK fund out of any sector during 2008.
Resilient net client cash flows in US Asset Management
US Asset Management continued to deliver strong long-term investment performance and our diversified asset mix provided resilience in difficult markets. Fixed income and alternatives make up over half of the total funds under management, which were down 28% to $240 billion compared to an overall US market decline of approximately 40%. Excluding the cessation of securities-lending at Dwight Asset Management, net client cash flows were positive. This is an excellent result at a time when significant net outflows are being experienced across the industry. However, the equity market decline, especially in the fourth quarter, caused a significant reduction in performance fees, although this was partially offset by a much reduced cost base.
Actions to stabilise US Life and return to profitability
Overall, the performance of our US Life businesses were heavily impacted by increased reserves related to certain single-premium immediate annuities, write-downs in relation to deferred acquisition costs and hedge losses related to variable annuity products. Difficult credit markets resulted in higher impairment losses than in 2007 and market conditions had a major impact on the level of unrealised losses on our fixed income portfolio, as is the case across the industry. Both oversight and governance have been strengthened considerably and the management team has taken a number of actions in the second half of 2008 aimed at de-risking the business and generating profitable returns.
We are in the process of transforming our onshore business into a sustainable operation, based on lower, but more profitable, sales from a considerably reduced cost base. We have eliminated unprofitable product lines, and are focused on selling less capital-intensive, more customer-centric products through closer relationships with our core distribution partners. We have consolidated a number of locations from which the business operated and reduced headcount. A strong expense discipline has been established along with a more conservative risk culture.
In the offshore business more precise fund-mapping has improved our hedging, which was 92% effective during the fourth quarter, and we have a much better understanding of sensitivities to further market and currency movements. Whilst sales have fallen dramatically due to the withdrawal of problem products, we are now focused on rebuilding this business through writing sensible, specialist investment products tailored to our international customers' needs, which will underpin a good recovery in future profitability.
Review of Business
Over the last four months, with the help of management consultants, we have conducted a thorough review of every part of our business. Our overriding conclusion is that while we have some valuable businesses with high quality people, there is a fundamental need for change. We have therefore identified five key priority areas.
1. Maintain and strengthen our capital position
As outlined above, our capital and liquidity position remains healthy. However, in the current environment, continuing to manage our capital responsibly must be our top priority.
2. Streamline the portfolio over time
We recognise that our portfolio of businesses is too broad. We operate in too many geographies and have too many lines of business, a number of which are sub-scale in their respective markets. This makes the Group complex and difficult to manage on a decentralised basis as we have done in the past. It therefore requires simplification.
However in the current environment, major rationalisation of our portfolio of businesses would be extremely difficult and, if achievable, would almost certainly destroy value for our shareholders. At this stage, we have therefore concluded that it will take some time to achieve our optimal business structure. That said, we have already taken some actions where it has been sensible to do so, namely:
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We have agreed to the sale of our Australian business.
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We have exited Portugal.
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We have rationalised our businesses in continental Europe, creating two hubs based in Berlin and Paris for the mass market and affluent markets respectively.
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While we remain committed to our established businesses in India and China, we will scale back significantly our aspirations in the Far East and will therefore close our office in Hong Kong.
We are also moving the governance of our businesses to a more centralised model which we believe will reduce risk and bring better control.
We will look for opportunities to make further changes as market conditions allow and we can create value for shareholders. We do not need asset sales in order to raise capital and any streamlining activity will be based on enhancing efficiency and our strategic focus.
3. Leverage scale in our long term savings businesses
We intend to bring all our long term savings businesses into a single operating structure. Skandia, OMSA, US Life and Asia Pacific will report to a single executive, Paul Hanratty, who will relocate to London as Head of Long-Term Savings.
We believe that there is a significant amount of value that can be unlocked by these businesses working more closely together. For example:
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We can deploy the distinctive technology and capabilities within our South African, UK and Nordic platform businesses more effectively across the Group.
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We believe there are operational cost efficiencies that can be achieved.
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We have product capability that can be used across the business.
4. Drive value creation within, and between our South African businesses
We have already created significant value through co-operation between Nedbank and OMSA, delivering synergies in excess of R1 billion in annual pre-tax profit. We now have a firm commitment to all our South African businesses and believe that there is more value that can be achieved through their closer co-operation.
Tom Boardman remains a member of my executive committee and both he and Paul Hanratty will be tasked with delivering greater synergies between Nedbank and OMSA as well as agreeing and delivering on new bancassurance targets.
Nedbank, which has several wealth management joint ventures with Old Mutual, may also acquire those joint ventures during the year, in exchange for Old Mutual taking an increased shareholding in Nedbank.
Mutual & Federal will focus on increasing profitability, strengthening the balance sheet and driving greater cooperation with Nedbank and OMSA.
5. Strengthen governance and risk management
In 2008 we started to invest in additional risk resources (people and systems) and, as a result, our risk and governance processes have been significantly strengthened. The next priority is to embed those processes across the Group. One consequence of these initiatives is that we are rolling out a business level risk appetite, which sets the mandatory risk levels each business must adhere to.
We have also formed iCRaFT - 'integrated Capital, Risk and Financial Transformation'. This programme is essentially aimed at ensuring we become fully compliant with Solvency II, the new regulatory regime being introduced for all European-domiciled insurers. Over and above compliance, our programme aims to implement best practice in the way that we measure and manage risk, capital and financial performance. We then integrate these in the way that we run our businesses, and in the implementation of best practice financial controls.
To ensure we manage these various Group initiatives effectively, we have appointed Paul Maddox on secondment from Ernst and Young as Head of Strategic Implementation. Paul will be a member of the Executive Committee with responsibility for driving through the change programme.
Outlook
Many of our businesses have performed well in a very difficult operating environment. This performance provides us with an excellent base from which to deal with the challenges presented by the current economic climate and the continued financial market volatility.
Going forward, I am determined to rigorously drive performance improvement and strengthen governance, while at the same time looking for opportunities to reshape the Group.
Julian Roberts
Chief Executive
4 March 2009
Group Finance Director's Review
GROUP RESULTS
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Group Highlights (£m) |
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2008 |
2007 |
% Change |
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Adjusted operating profit (IFRS basis)(pre-tax) |
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999 |
1,624 |
(38%) |
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Adjusted operating earnings per share (IFRS basis) |
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12.2p |
16.9p |
(28%) |
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Profit before tax (IFRS) |
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595 |
1,750 |
(66%) |
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Basic earnings per share (IFRS) |
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8.6p |
19.2p |
(55%) |
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Adjusted operating profit (MCEV basis) (pre-tax) |
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978 |
1,631 |
(40%) |
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Adjusted operating profit (MCEV basis) (post-tax) |
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575 |
922 |
(38%) |
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Adjusted operating earnings per share (MCEV basis) |
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11.0p |
17.0p |
(35%) |
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Adjusted group embedded value (£bn) |
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6.2 |
9.0* |
(31%) |
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Adjusted group embedded value per share |
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117.6p |
166.3p* |
(29%) |
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Life assurance sales (APE) |
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1,611 |
1,748* |
(8%) |
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Unit trust / mutual fund sales |
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6,600 |
8,383** |
(21%) |
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Value of new business |
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104 |
230* |
(55%) |
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PVNBP |
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12,262 |
14,046* |
(13%) |
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Net Client Cash Flows (£bn) |
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(1.2) |
23.4 |
(105%) |
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Funds under management (£bn) |
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264.8 |
278.9 |
(5%) |
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Total shareholders equity |
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9,577 |
9,597 |
- |
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Return on equity*** |
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9.0% |
13.2% |
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Return on embedded value |
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7.8% |
13.7% |
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Full dividend in respect of the financial year 2008 |
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2.45p |
6.85p |
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* Restated, as now reporting on an MCEV basis ** Restated net of Institutional sales in Australia *** Return on equity is calculated using adjusted operating profit after tax and minority interests on an IFRS basis with allowance for accrued coupon payments on the Group's hybrid capital. The average shareholders' equity used in the calculation excludes minorities and hybrid capital. |
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Funds under management held up well during year of market volatility
During 2008, Old Mutual delivered robust investment performance in challenging markets. Although net client cash flows were negative overall, we produced positive flows of £3.2 billion in our Skandia businesses and £0.1 billion in our combined South Africa businesses. However, these were offset by outflows in our US and Asia Pacific businesses. Excluding the outflows due to a cessation of securities lending which one of our US Asset Management affiliates suspended during the year, net client cash flows were £2.4 billion for the year. The result is pleasing, considering the challenges of delivering on absolute investment performance in the extremely volatile markets in 2008. This is demonstrated through our closing funds under management, which held up well in the year overall, down 5% to £264.8 billion, in a period when markets such as the FTSE 100, the JSE Africa All Share Index and S&P 500 all fell more than 25%.
Breadth of sales product offering in diverse geographic markets
Overall life sales on an APE basis held up well, supported by our core businesses in Nordic and South Africa. We continued to see the benefits of our investment in the Nordic sales channel, where life APE sales were up 30% in local currency. South Africa life sales were up 14% in rand terms. However in the US, sales were constrained, down 23% in local currency. UK and Offshore sales were disappointing, down 19%, with single premium sales being impacted by the market conditions mainly through lower pension sales.
Southern Africa (including Rest of Africa) unit trust sales were up an impressive 46% in local currency with investors moving to lower risk money market funds, but declines in unit trust sales in all other regions more than offset these gains due to the ongoing tough market conditions.
Value of new business
The value of new business (VNB) was down 55% to £104 million but excluding US Life, at negative £66 million, was down 15% for the year on a like-for-like basis. Excellent volumes in Nordic and a strong contribution from OMSA were offset by lower volumes in the UK, ELAM and US Life. The APE profit margin was 6%. The margin was steady in the UK and South Africa compared with 2007, but down marginally in Nordic and to a greater extent in ELAM, where it fell to 6% mainly due to lower volumes and a change in product mix. The US Life margin was negative because of a reduction in the margin of variable annuities as a result of increased guarantee costs and the exclusion of capitalised corporate bond spreads in the Old Mutual MCEV methodology.
Adjusted operating earnings (IFRS basis)
Adjusted operating profit for the year held up in most regions with good contributions from our African, European and US Asset Management businesses, however profits were adversely impacted by adjustments in our US Life businesses. Credit markets remained under stress at the end of 2008. Following review of our asset portfolio we impaired a total of £414 million, of which £28 million affected the 2008 adjusted operating profit as the total impairments are amortised over five years through adjusted operating profit. We are reviewing this policy for US Life and expect to move to an 'expected return' approach for impairments from 2009 onwards.
We also reviewed our deferred acquisition costs balances and accelerated amortisation by £159 million for the combined US Life businesses. Further, in our onshore business we stopped selling the single premium immediate annuities ('SPIA') block of business and made a £235 million adjustment in respect of additional mortality reserves where we have increased our life expectancy assumption to over 90 years. Finally in our offshore business we incurred a charge of £68 million which reflects the inefficiency of hedge mapping. A further charge of £206 million was made below the line which reflects market volatility, in line with standard industry practice.
Rand currency depreciation substantially contributed to lower earnings however this was partially offset by US dollar, Euro and Swedish Krona strengthening and in total the Group delivered adjusted operating profit before tax and minority interests 38% below 2007 and 36% below on a constant currency basis.
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Group Highlights (£m) |
|
2008 |
2007 |
2007 restated at 2008 rates |
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Adjusted operating profit (IFRS basis) (pre-tax) |
|
|
|
|
|
Europe |
|
266 |
268 |
280 |
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Africa |
|
1,191 |
1,254 |
1,157 |
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United States |
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(270) |
260 |
281 |
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Asia Pacific |
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(17) |
2* |
2 |
|
|
|
1,170 |
1,784 |
1,720 |
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Finance costs |
|
(140) |
(119) |
(119) |
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Other shareholders' expenses |
|
(31) |
(41) |
(41) |
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Adjusted operating profit before tax & minority interests |
|
999 |
1,624 |
1,560 |
|
Tax |
|
(86) |
(418) |
(401) |
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Minority interests |
|
(272) |
(292) |
(271) |
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Adjusted operating profit after tax & minority interests |
|
641 |
914 |
888 |
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Adjusted operating EPS (pence) |
|
12.2 |
16.9 |
16.4 |
|
* Includes Bermuda Asset Management (now included in USAM) |
|
|
|
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Assuming constant exchange rates, 2007 adjusted operating EPS would have been 16.4p with the currency impact being negative 0.5p. Financing costs increased over the 2007 mainly due to foreign exchange as the sterling value of non-sterling-denominated debt payments increased. Other shareholders expenses principally comprise head office costs.
Taxation
The Group's effective adjusted operating profit (IFRS basis) tax rate decreased to 9% from 26% in the comparative period. This tax rate is anomalously low due to the unprecedented market conditions in 2008 coupled with a reduced adjusted operating profit which magnifies the rate effect of any adjustment. The reduction in the tax rate is due to a number of factors. These include releases of tax provisions as a result of the closing of issues being agreed with tax authorities, consistent levels of tax exempt dividend income now representing a greater proportion of the reduced adjusted operating profit, the effect of the different basis of taxation of life tax companies, non-taxable foreign exchange gains, reduction in tax rates and more profits being earned in lower taxed jurisdictions and the utilisation of previously unrecognised deferred tax assets. These factors were partially offset by increased secondary tax on companies charges and a decreased adjusted operating profit, non-recognition of deferred tax assets arising in US Life and adjustments in respect of prior periods.
In the longer term, it is expected that the tax rate would tend to return to the 2007 level.
Return on equity
Return on equity for the Group declined to 9.0% in 2008 from 13.2% in 2007, primarily due to losses from the US Life businesses. This contained some very satisfactory performances from our South African businesses where OMSA achieved a return on allocated capital of 27.8%, Nedbank a return on equity (excluding goodwill) of 20.1% and Mutual & Federal achieved a return on capital of 33.9%.
Shareholders equity
Throughout the year, shareholders equity remained steady with retained profits and foreign exchange gains on consolidation being offset by unrealised losses in the US Life businesses and the payment of dividends.
Old Mutual Market Consistent Embedded Value (MCEV)
The Market Consistent Embedded Value Principles (the 'Principles') were published in June 2008 by the CFO Forum, a group representing the Chief Financial Officers of major European insurers, and compliance with these Principles is mandatory in 2009. These Principles provide a framework intended to improve comparability and transparency in Embedded Value reporting across Europe. Old Mutual plc has published European Embedded Value ('EEV') results since 2004. The Principles have been fully complied with for all businesses as at 31 December 2008, with the exception of the use of an adjustment of 300 basis points in the risk free rate due to current market conditions for the US Life Onshore business. This adjustment reflects a liquidity premium as at 31 December 2008, and has been determined after reviewing published and proprietary literature and data relating to corporate bond spreads with in the US Life corporated bond portfolio. The Group has replaced the European Embedded Value basis with the MCEV basis for the covered business and figures for 31 December 2007 have been restated accordingly, and comply fully with all of the Principles. The MCEV supplementary information provides details on the methodology, assumptions and results of the MCEV for the Old Mutual Group in accordance with the disclosure requirements of the Principles and includes conversion of comparative supplementary information for 2007, previously prepared on the EEV basis, to a MCEV basis.
The impact as at 31 December 2007 of moving from an EEV to a MCEV methodology is a reduction in Embedded Value of the covered business of 7.5% from £6,861 million to £6,349 million. Within the European and Southern African businesses, the aggregate allowance for risk within the EEV and MCEV approaches is broadly aligned and hence relatively minor impacts were experienced on these businesses when moving from an EEV to a MCEV approach. Most of the reduction in Embedded Value was attributable to the United States business which decreased by 57% from £1,069 million to £462 million. For this business the aggregate allowance for risk under EEV is not aligned with the requirements under the Principles and a number of factors contribute to the difference in approaches as explained in detail in the supplementary information. However, it should be noted that compared to EEV reporting, MCEV reporting merely changes the timing of recognition of profits and not the ultimate profitability that will emerge on covered business.
Adjusted Group MCEV per share 117.6p
The adjusted Group MCEV per share was 117.6p and adjusted Group MCEV was £6.2 billion at 31 December 2008 (31 December 2007: 166.3p and £9.0 billion respectively). The 48.7p decrease in adjusted Group MCEV per share was driven by the fall in equity markets and the impact of lower global interest rates and higher volatility which increased the cost of policyholder financial options and guarantees.
Return on Group MCEV
Return on Group MCEV declined to 7.8% from 13.7% at 31 December 2007. The lower adjusted operating MCEV earnings in 2008 were the net effect of higher earnings in the South African and European life businesses driven by positive operating assumption changes and the reduction in the number of shares following the share buy-back programme, offset by lower new business contributions, adverse persistency, higher financial guarantee costs, hedge losses and impairments in the United States, impairments in Nedbank and lower asset based charges in the asset management companies.
Capital position
The Group's gearing level remains within our target range, with senior debt gearing at 31 December 2008 of 4.0% (2.0% at 31 December 2007) and total gearing, including hybrid capital, of 26.7% (21.2% at 31 December 2007).
Capital requirements are set by the Board, taking into account the need to maintain desired credit ratings and to meet regulatory requirements at both the Group and local business level.
Our share buyback programme announced at the beginning of October 2007 was completed in May 2008. A total of approximately 239 million shares were repurchased through the London and Johannesburg markets at a total cost of £351 million.
The Group is in compliance with the Financial Groups Directive ('FGD') capital requirements, which apply to all EU-based financial conglomerates. Our pro-forma FGD surplus was in excess of £0.7 billion at 31 December 2008. The FSA requirement is to maintain a positive surplus at all times. Sensitivities to market movements, although not linear, are that a 1% fall in South African rand against sterling is broadly equivalent to a £14 million reduction in FGD, a 1% gain in the US dollar against sterling broadly equivalent to a £4 million fall in FGD and a 1% fall in the JSE broadly equivalent to a £4 million decline in FGD. The level of defaults, impairments and realised losses in our US corporate bond portfolio also impact on the FGD surplus. We improved the pro-forma FGD sensitivity to the dollar since our Q3 Interim Management Statement as a result of hedging activities undertaken.
Unrealised losses
In our US Life onshore business, as at 31 December 2008, 97% of our investment portfolio is cash, government backed or investment grade securities of triple B and higher. Concentration risk is low as the top ten holdings account for 5.5% of the portfolio. The portfolio is well-matched since the assets have an average duration of 6.0 years against an average duration of 5.9 years for the liabilities. US Life's net unrealised losses increased over the year to £1.8 billion at 31 December 2008 reflecting the market-wide re-pricing of credit spreads and other risks which do not relate to specific factors within the US Life portfolio. The unrealised losses account for 13% of our total portfolio on an IFRS basis. We have the ability and we intend to hold these fixed income securities to maturity, which in economic terms limits the impact of the current market dislocation.
We have adopted the reclassification amendment to IAS 39 and have elected to classify around 150 securities from the 'available-for-sale' category to the 'loans and receivables' category as at 1 July 2008. This is on the basis that the securities in question are no longer regarded as being traded in the active market. For 'available-for-sale' investments, the securities are re-valued and the unrealised losses are accounted for in shareholders' equity whereas for 'loans and receivables' no revaluations are recorded.
Holding company net debt
The table below shows the net reported debt of the Old Mutual plc holding company and its sub holding companies.
|
|
|
2008 £m |
|
2007 £m |
|
Total net debt at start of period |
|
(2,420) |
|
(2,407) |
|
Operational flows |
|
|
|
|
|
Operational receipts |
822 |
|
868 |
|
|
Operational expenses |
(191) |
|
(152) |
|
|
Other expenses |
- |
631 |
(71) |
645 |
|
Capital flows |
|
|
|
|
|
Capital receipts |
316 |
|
69 |
|
|
Acquisitions |
- |
|
(66) |
|
|
Organic investment |
(565) |
(249) |
(220) |
(217) |
|
Debt and equity movements |
|
|
|
|
|
Old Mutual plc dividend paid |
(353) |
|
(333) |
|
|
Share repurchase |
(175) |
|
(177) |
|
|
New equity issuance |
5 |
|
12 |
|
|
Other non-cash movements |
298 |
(225) |
57 |
(441) |
|
Total net debt at end of period |
|
(2,263) |
|
(2,420) |
Total net debt within the holding company at the end of 2008 was £2,263 million. A total of £1,138 million of operational and capital receipts were received from business units during 2008. £565 million was invested in the businesses and £353 million was used to pay the 2007 final and the 2008 interim dividend. In addition, £175 million was spent on repurchasing shares during the year. Other movements of £298 million mainly reflect a positive impact of the marking to market of our debt liabilities.
Risks and uncertainties
There are a number of potential risks and uncertainties that could have a material impact on the Group's performance and that could cause actual results to differ materially from expected and historical results.
We have included our view of these principal risks as well as the impact of current economic and business conditions in the Business Review sections of this report. The current economic conditions create uncertainty particularly over the future levels of world equity markets, defaults in corporate bond portfolios, particularly in the United States, currency fluctuations, demand for the Group's products and other economic factors. These uncertainties have been considered individually and in combination in the Group's forecasts and projections, taking account of reasonably possible changes in trading performance and economic conditions in the markets in which the Group operates. The results show that the Group should be able to operate within the level of its available credit facilities and with an adequate level of capital, both at a Group level and within each of its major regulated Group entities. To the extent that changes in trading performance and economic conditions prove to be more severe than thought reasonably possible, the Group has evaluated and concluded on feasible management actions that would be possible in such circumstances so as to ensure adequate levels of liquid and capital resources are maintained.
The Group continues to meet Group and individual entity capital requirements, and day-to-day liquidity needs through the Group's available credit facilities. The Company's primary existing revolving current facility of £1.25 billion does not mature until September 2012.
The Board of Directors has the expectation that the Company and the Group have adequate resources to continue in operational existence for the foreseeable future. Accordingly, they continue to adopt the going concern basis in preparing the financial statements contained with this announcement.
The Listing Rules of the UK Listing Authority (LR 9.7A.1) require that preliminary unaudited statements of annual results must be agreed with the listed company's auditors prior to publication, even though an audit opinion has not yet been issued. In addition, the Listing Rules require such statements to give details of the nature of any likely modification that may be contained in the auditors' report to be included with the annual report and accounts. Old Mutual plc confirms that it has agreed this preliminary statement of annual results with KPMG Audit Plc and that the Board of Directors has not been made aware of any likely modification to the auditors' report required to be included with the annual report and accounts for the year ended 31 December 2008.
Related party transactions
There have been no related party transactions or changes in the related party transactions described in the Company's latest Annual Report during 2008 that could have a material effect on the financial position or performance of the Group.
Philip Broadley
Group Finance Director
4 March 2009
Business Review
EUROPE: UNITED KINGDOM AND OFFSHORE
Strong profit performance in a challenging year
|
Highlights (£m) |
|
2008 |
2007 |
% Change |
|
Adjusted operating profit (IFRS basis) (pre-tax) |
|
167 |
173 |
(3%) |
|
Return on Equity |
|
5.0% |
6.8% |
|
|
Return on Equity (excluding goodwill) |
|
12.0% |
21.4% |
|
|
Adjusted operating profit (covered business) (MCEV basis) (post-tax) |
|
235 |
206 |
14% |
|
Return on embedded value (covered business) |
|
15.3% |
15.5% |
|
|
Total life assurance sales (APE) |
|
596 |
740 |
(19%) |
|
UK life assurance sales (APE) |
|
335 |
468 |
(28%) |
|
Offshore life assurance sales (APE) |
|
261 |
272 |
(4%) |
|
Unit trust / mutual fund sales |
|
1,715 |
2,275 |
(25%) |
|
Value of new business |
|
67 |
81* |
(17%) |
|
APE margin |
|
11% |
11%* |
|
|
PVNBP |
|
4,902 |
6,311* |
(22%) |
|
PVNBP margin |
|
1.4% |
1.3%* |
|
|
Net client cash flows (£bn) |
|
1.7 |
3.9 |
(56%) |
|
Funds under management (£bn) |
|
34.9 |
41.9 |
(17%) |
|
* Restated, as now reporting on an MCEV basis |
|
|
|
|
Positive net client cash flows despite low investor confidence
Skandia UK and Offshore continued to deliver positive net client cash flows for the year with net inflows of £1.7 billion representing 4% of opening funds under management. This comprised strong International net inflows and positive UK net inflows which were lower than 2007. The market downturn contributed to a 17% decrease in funds under management but this compared favourably with the 31% drop in the FTSE 100 in 2008. Investment performance was driven by the diversity of our offering with significant changes in asset mix occurring as investors moved into cash based investments. Foreign currency denominated funds benefited from the weakened sterling.
Investment volatility affects sales
Life assurance sales APE declined in line with the market. The largest relative falls in sales were in the bonds and single premium pensions products and because the 2007 pensions business figure benefited from the lingering benefits of pensions 'A-day' and higher investor confidence at the time. In 2008 the market for single premium bonds was affected by the introduction of an 18% flat rate of CGT confirmed in the March 2008 Budget. Skandia's market share across the entire pensions market remained strong particularly in the core product area of single premium personal pensions. Regular premium business held up better, ending the year 9% up on 2007.
Skandia International performed very well in 2008 due to its geographical diversity, full open-architecture proposition, strong distribution relationships and a focus on high net worth customers. Product and e-business developments greatly enhanced our customer proposition in 2008.
Unit trust performance impacted by volatile markets
Unit trust sales were down 25% on 2007 as a result of one of the lowest ISA seasons on record for the whole industry and again a reflection of the turbulent market conditions. Within this, institutional mutual fund business of £239 million was up by 45% over 2007. Skandia's market share in platform business fell marginally in the year but there were indications that the re-pricing of the platform business in the latter part of the year was starting to have a positive impact on sales. Skandia continue to increase investment solutions on the platform to create wider appeal, especially during periods of market volatility.
New business contribution
VNB fell by 17% to £67 million due to lower new business volumes. The reduction was partially mitigated by a strengthening of the assumptions for the amount of fee income rebated from fund managers, as communicated at the Interim Results aligning Skandia more closely to the market. New business contribution was also positively impacted by the mix of business effects, with a shift towards sales of more profitable portfolio bond charging structures within Skandia International. The new business margin ended the year at 11%, in line with 2007.
Adjusted operating profit (IFRS basis) level with 2007 despite market conditions
An excellent adjusted operating profit (IFRS basis) was generated in the current climate with a decrease of 3% to £167 million for the year, in part reflecting the reduction in funds under management and sales. This was partially offset by changes to the policyholder taxation basis for Skandia UK following the market falls experienced in 2008. Additional integration costs were incurred in 2007, as previously communicated. A favourable variance of £33 million arose following the implementation of PS06/14 - the prudential reserving requirements that permit non-linked insurance business to be valued on a more realistic basis.
Increase in adjusted operating profit (covered business) (MCEV basis)
The adjusted operating profit (MCEV basis), on covered business after tax, increased by 14% to £235 million. This increase includes a positive impact of £56 million from operating assumption changes. This mainly resulted from the recognition of retained unit trust company rebates (referred to above) as Skandia outsources the investment of policyholder funds to unit trust companies. Other operating assumption changes included adjustments to expense assumptions to reflect current maintenance expense experience and modeling improvements. Experience variances were positive in aggregate at £17 million due to impacts on charges and continued positive experience in relation to retained rebates assumptions.
Capital
Current levels of statutory capital for Skandia UK and Skandia International are within or above the target ranges set by management. The businesses are well capitalised with a solvency ratio of 2.6 times the required level.
Continued investment innovation at Skandia
During the year, we continued our track record of innovation in multi-manager investment solutions. The Spectrum range of risk-controlled funds was launched in April 2008 and attracted over £120 million of gross subscriptions by 31 December 2008. In the volatile market, the risk controlled nature of the funds proved very effective from both a return and risk perspective. In June 2008, we launched the Skandia Alternative Investments Fund which has an absolute return focus and has funds under management in excess of £30 million. The high profile Best Ideas fund range continued to attract new sales with funds under management of over £391 million at 31 December 2008. The UK Strategic Best Ideas Fund had funds under management of £80 million at 31 December, and continues to be one of the best selling funds. The continued deterioration in equity markets boosted the performance of the UK Strategic Best Ideas Fund, with the fund being the best performing UK fund out of any sector during 2008 (a universe of over 450 funds).
Skandia supports changes in the UK distribution landscape
The FSA published its paper on the Retail Distribution Review on 25 November 2008 moving the Review from the consultation phase into the implementation stage. The paper focused on the clarity of the service (distribution channels), remuneration, professional standards and prudential requirements. Skandia has already started to support its distribution channel through offering assistance in preparing our businesses for the change and assisting advisers in obtaining the necessary qualifications. The intention of the FSA is to consult with the industry on implementing the proposed changes over a period running through to 31 December 2012.
On 3 November 2008 Skandia UK announced that it is ending its membership of the Association of British Insurers ('ABI') as evidence that its proposition is clearly differentiated from old style life and pensions companies, finding little alignment of interests with the broader ABI membership.
Skandia UK announced a new pricing structure in September 2008 removing the initial charge on platform sales. This move not only made Skandia's proposition very competitively priced but it also made the charging structure simple and transparent. The price changes have been positively received by financial advisers.
Skandia continues to receive awards for its service and investment innovation
In recognition of its leading customer service Skandia achieved a five star rating in the industry Financial Adviser Awards for the eleventh year running and became the first company to win the Outstanding Achievement Award for Pensions and Investments. Skandia has now won more than 30 five star awards in the 18 year history of the Financial Adviser Awards.
Skandia won the MultiManager of the Year award at the annual Investment Life & Pension Moneyfacts Awards in September 2008 and was also Commended in the Best Unit Trust/OEIC Provider category. These awards recognise the outstanding achievements of providers who manage to stand out from the crowd by offering high calibre products and delivering first class service.
Principal risks and uncertainties
The principal risks to Skandia UK arise from operational experience, along with market risk as Skandia UK derives income from fees which are charged as a percentage of funds under management. The broader financial risks are limited. Skandia UK does not offer material investment guarantees. Although we offer protection business, and so have exposure to mortality and morbidity risk, the majority of the risk is transferred to reinsurance counterparties. Credit risk exposures are small; the main exposures are the risk of default on the investment of company assets. Skandia UK has exposure to risk arising from operating experience in respect of factors including persistency and management expenses. These risks are managed within the operational functions who have primary responsibility for the identification, mitigation and monitoring of risks. Risks exceeding pre-determined thresholds are escalated and reported to management and to the Group CRO, along with details of the mitigating management action. Recent falls in investment markets have adversely impacted fund related revenues and new business volumes. The profitability and capital position of Skandia UK remains strong.
Outlook
Details of the changes to be introduced as part of the FSA's Retail Distribution Review are still under discussion. Meanwhile, Skandia is already preparing its response, with the aim of optimising its position in the new model of financial services and the distribution landscape that is likely to emerge. It will be particularly important to secure significant funds under management to ensure scale in the platform market that this review will stimulate. To secure assets on Skandia UK's platform we are running an aggressive campaign which began in 2008 with the removal of the initial margin on platform products to make our charges highly competitive.
Our offshore business is geographically diversified with sales in Europe, the Middle East, the Far East, Africa and Latin America, as well as in the UK. Skandia International is a high growth business with high potential for further growth in 2009 and beyond. Investment in the operating infrastructure to drive efficiencies and continued excellence in customer services will create further market, product and distribution opportunities. Whilst 2009 will be a challenging year, Skandia International remains confident about long-term future growth prospects owing to a growing customer base, robust regulatory and compliance infrastructure and a strong offshore brand.
EUROPE: NORDIC
Strong year with excellent sales performance and strengthened relations with distributors
|
Highlights (SEKm) |
|
2008 |
2007 |
% Change |
|
Adjusted operating profit (IFRS basis) (pre-tax) |
|
1,076 |
874 |
23% |
|
Return on Equity |
|
5.6% |
4.3% |
|
|
Return on Equity (excluding goodwill) |
|
17.0% |
16.3% |
|
|
Adjusted operating profit (covered business) (MCEV basis) (post-tax) |
|
1,839 |
880 |
109% |
|
Return on embedded value (covered business) |
|
12.9% |
7.6% |
|
|
Life assurance sales (APE) |
|
2,599 |
1,992 |
30% |
|
Unit trust / mutual fund sales |
|
3,207 |
3,474 |
(8%) |
|
Value of new business |
|
397 |
313* |
27% |
|
APE margin |
|
15% |
16%* |
|
|
PVNBP |
|
12,108 |
9,329* |
30% |
|
PVNBP margin |
|
3.3% |
3.3%* |
|
|
Net client cash flows (SEKbn) |
|
7.0 |
2.7 |
159% |
|
Funds under management (SEKbn) |
|
91.9 |
116.7 |
(21%) |
|
* Restated, as now reporting on an MCEV basis |
|
|
|
|
Strong net client cash flows
Net client cash flows for the year were an exceptional SEK7.0 billion, representing 6% of opening funds under management. The positive performance was largely driven by strong net inflows in the life business benefiting from an excellent sales performance and reduced outflows. However, volatile equity markets negatively impacted asset growth during the year, with funds under management at 31 December 2008 down 21% to SEK91.9 billion.
Sales performance continued to improve
Nordic delivered excellent growth in sales during 2008 with life sales on an APE basis up 30% mainly due to strong sales in Sweden. The broker sales channel accounted for the majority of this increase as a result of strengthened relationships supported by the new investment portfolio product and faster introduction of new funds to the market. A focus on the selling of unit-linked products has continued throughout the internal sales force, which together with several sales initiatives contributed to the improved sales. The very strong upward trend in new sales continued throughout 2008 and so far there have been no negative effects on sales performance from the volatile markets.
Mutual fund sales were down 8% on 2007, mainly due to lower inflows to fund deposits within our bank offering, partially offset by growth through other channels. This growth was mainly through deposits in fixed income and money market funds and through a hedge fund launched in the third quarter.
VNB grew strongly in 2008
VNB of SEK397 million for the year was up 27% on 2007, in line with the excellent life sales. In addition to strong volume growth, the APE margin benefited from the introduction of currency spreads and tighter cost controls. These largely offset the business mix impact in Sweden, particularly from the removal of Kapitalpension product tax advantages as well as the strengthened retention assumptions in 2008 and the negative economic changes in 2007. The life new business margin ended the year at 15% just below the margin in 2007. In the medium term, the new business margin is expected to improve to reach the high teens.
Strong underlying adjusted operating profits despite market turbulence
Adjusted operating profit (IFRS basis) increased 23% over 2007 despite the equity market downturn. This was largely due to excellent cost control and SkandiaBanken continuing to benefit from an improved interest margin.
The adjusted operating profit (MCEV basis) was up 109% on 2007 mainly due to strong VNB growth and the positive effect from assumption changes. In 2007 there was a negative effect of SEK526 million relating to strengthened retention assumptions and lower fund charges on 'tick-the-box' collective agreements and tendered corporate business. In 2008 the effect from operating assumption changes was SEK391 million which was mainly attributable to the introduction of currency spreads and increased assumption for the take-up rate for unit-linked contracts on retirement, partly offset by strengthened retention assumptions. Experience variances in 2008 of SEK142 million were driven by a higher level of fee income than assumed, tax and profits not valued within the value of in-force (e.g. Healthcare Business) partly offset by a negative retention effect mainly caused by premium reductions due to a Swedish legislative change relating to the level of tax deductible pension savings contributions.
Continued growth in banking business benefiting from market conditions with improved interest margin
SkandiaBanken is completely funded by deposits and therefore has a unique liquidity position enabling it to benefit from the current market situation with an improved interest margin and increased business volumes. SkandiaBanken has sufficient surplus liquidity and management continue to ensure that the liquidity position remains strong. The capital ratio as at 31 December 2008 was 14.1% (Basel II, pillar one). SkandiaBanken's lending portfolio has been built on sound lending practices and is comprised of 95% mortgages which have excellent credit worthiness with the remaining 5% comprised of unsecured loans. The average loan-to-value in the portfolio at the end of the year was approximately 40% to 45%. As a consequence, the bank has only been marginally affected by the market turbulence. The credit loss ratio (credit losses as a percentage of the opening lending balance) remains low at only 0.13%. The net interest margin was 1.67% in 2008 compared to 1.32% in 2007. We are confident SkandiaBanken's conservative lending policy means it is well positioned to respond to any adverse market developments.
Both deposit and loan books at SkandiaBanken increased in 2008. Excluding the divested car finance business, lending increased to SEK43.8 billion, up 9% since 2007. The increase related mainly to successful mortgage campaigns during the year in Sweden together with a highly competitive floating interest rate which led to increased lending volumes. As a consequence of the turbulent market conditions, customers have been switching funds from ordinary saving accounts with variable interest rates to saving accounts with fixed interest rates. Deposits of SEK52.0 billion were up 3% since 2007 and the number of customers increased 7% over 2007. SkandiaBanken's operating profit for 2008 was SEK283 million, 48% higher than 2007.
Capital
Skandia Nordic's capital position is stable with sufficient surplus equity exceeding both external requirements and internal buffers. The businesses are well capitalised with a surplus 9.9 times the required level.
Other
During the year we announced that Skandia and Livfösäkringsaktiebolaget Skandia (publ) (Skandia Liv) are reviewing the potential benefits to both the Group and to Skandia Liv policyholders of demutualising Skandia Liv. The review is at a very preliminary stage and a conclusion is not likely before late 2009.
As announced on 3 October 2008, a ruling has been passed in respect of the arbitration proceedings between Skandia AB and Skandia Liv. The arbitration board did not accept Skandia Liv's claim to any part of the purchase price paid, but ruled that Skandia AB is obliged to pay Skandia Liv a total sum of SEK580 million (£47 million) plus interest by way of compensation in relation to fees under the asset management agreement which Skandia Liv deemed to be higher than prevailing market rates. Old Mutual had already set aside SEK500 million (£41 million) to cover the arbitration within our pre-acquisition balance sheet. Skandia AB will also have to compensate Skandia Liv for future payments to DnB NOR that are higher than prevailing market rates until the contract with DnB NOR expires in 2013. A new provision of SEK 426 million has therefore been set up.
Principal risks and uncertainties
Nordic's main risks relate to strategic and operational risks as well as market risks. The market risks mainly relate to asset based income which reduces when the value of the unit-linked funds declines. Having a diversified product range and a wide range of investment options address some of the market risks. Risks arising from operating experience (e.g. persistency and management expenses) are managed through the risk framework which includes a three lines of defence model and risks exceeding pre-defined risk tolerance levels are escalated to the Group Chief Risk Officer. Political and regulatory changes which could have an impact on the businesses are continuously monitored and managed.
Outlook
The continuing financial crisis will make 2009 a challenging year. In addition, there will be more legislative changes that will impact on our business.
Our corporate clients have been affected by the economic downturn and the effects of that will start to be seen during 2009. The private client market is now already under pressure and customer behaviour will be impacted. This could lead to lower customer activity during the year however we continue to focus on developing innovative financial product solutions to address customer needs in the current economic climate.
We continue to benefit from a combination of a broad product mix, a range of insurance, banking and investment business, market-leading expertise and a proven business model. As such, we are well positioned to handle the challenges ahead as demonstrated by the delivery of excellent 2008 results despite the market turbulence.
EUROPE: EUROPE AND LATIN AMERICA (ELAM)
Continuous innovation and customer focus in response to difficult market conditions
|
Highlights (€m) |
|
2008 |
2007 |
% Change |
|
Adjusted operating profit (IFRS basis) (pre-tax) |
|
14 |
43 |
(67%) |
|
Return on Equity |
|
(0.3%) |
1.5% |
|
|
Return on Equity (excluding goodwill) |
|
(1.3%) |
7.3% |
|
|
Adjusted operating profit (covered business) (MCEV basis) (post-tax) |
|
5 |
13 |
(62%) |
|
Return on embedded value (covered business) |
|
0.6% |
1.5% |
|
|
Life assurance sales (APE) |
|
211 |
276 |
(24%) |
|
Unit trust / mutual fund sales |
|
2,077 |
3,071 |
(32%) |
|
Value of new business |
|
13 |
57* |
(77%) |
|
APE margin |
|
6% |
20%* |
|
|
PVNBP |
|
1,559 |
2,182* |
(29%) |
|
PVNBP margin |
|
0.8% |
2.6%* |
|
|
Net client cash flows (€bn) |
|
1.1 |
1.8 |
(39%) |
|
Funds under management (€bn) |
|
10.3 |
13.0 |
(21%) |
|
* Restated, as now reporting on an MCEV basis |
|
|
|
|
Strongly positive net client cash flow during market volatility
Net client cash flows at ELAM were robust considering the market volatility, especially in the highly unstable fourth quarter of 2008. With the market in some of our operating countries, such as France and Italy, showing substantial outflows during the fourth quarter, our own performance compares strongly. Strong persistency, driven by pro-active retention campaigns and the ability for clients to switch to more conservative portfolios, provided support to strong net client cash flows.
Funds under management ended the year 15% below 2007 on a like-for-like basis (net of Pallayne divested during 2008). This included negative market movements on portfolio values of 27% of opening funds under management, reflecting the fall in financial markets across the globe throughout 2008. In comparison, the majority of European equity indices fell between 30% and 50% in 2008. Funds under management were partially supported by the effective asset mix of the portfolio which incorporates non-equity asset classes and reflects the investment appetite of customers that shifted further during 2008 towards guaranteed funds and other less risky asset classes.
Life sales impacted by constrained sales environment
Life sales on an APE basis were down throughout the year but especially in the fourth quarter due to negative investor sentiment. This effect was stronger in single premium business where investors typically have access to a wider range of investment opportunities and seem to have been taking a 'wait-and-see' approach to investing under the current conditions. Regular premium business has been relatively more stable, reflecting the smaller premium sizes and habitual nature of saving on a regular premium basis. Nevertheless, regular premium sales have also been under pressure during the year, and the market volatility had a dampening effect on the traditional European seasonal ramp-up in sales in the final quarter, with the fourth quarter falling short of prior year levels.
Focused activity to support mutual fund sales
Given the market volatility and our core differentiator of this business line being international equities, mutual fund sales provided a solid contribution, although down 20% compared with 2007 on a like-for-like basis. We continued our efforts to deliver innovative products and quality service. During 2008, much focus was placed on improving the productivity of financial planners in Latin America. Increased training, new product offers and planning tools assisted financial planners in generating sales in the current conditions.
Value of new business and profit margins down
VNB of €13 million was down 77% over 2007, mainly as a result of lower sales in 2008 in light of the market crisis. In addition, VNB was negatively affected by changes in operating assumptions, where in particular the changed regulation on policyholder profit participation reduced the German VNB. The APE margin deteriorated to 6% from 20% in 2007. This was attributed to lower APE sales, which for the more recently established businesses was aggravated by a relatively fixed expense base leading to acquisition expense over-runs. In addition, the strong sales of high margin business in Poland in 2007 was not sustained in 2008.
Adjusted operating profit (IFRS basis) impacted by wider market environment
ELAM generates a significant element of its revenues from funds under management and these fees were lower in line with reduced levels of funds under management. This negative impact was partially offset by the growth of the in-force book of business during the year. Furthermore the revised policyholder participation regulations implemented in Germany during 2008 both widened the definition of revenues to be shared with policyholders and increased the level of participation. This had a €20 million impact on the IFRS adjusted operating profit for the year. This calculation is net of acquisition expenses and these were lower, in line with new sales levels, and so policyholder participation levels were relatively high. To protect the bottom line, ELAM maintained its expense base at 2007 levels, identifying efficiencies to offset growth in sales force and inflationary impacts.
Adjusted operating profit (MCEV basis) suffered from weak new business contribution and negative experience variances
MCEV adjusted operating profit was €5 million for 2008, 62% lower than 2007. This was largely due to lower VNB and poorer experience variances which included divisional restructuring costs. The operating assumption changes had a negative impact on the adjusted operating profit, but not to the same magnitude as for 2007. Changes have been made to persistency rates and expense levels, both of which have been strengthened.
Capital
ELAM's businesses continue to measure and monitor their capital resources on an ongoing basis to ensure compliance with the minimum capital requirements of the regulators in each territory in which we operate. Internally we manage our businesses to maintain a buffer of at least 25% in excess of the local requirements. Due to the decrease in funds under management levels, solvency requirements across our markets reduced, while our capital employed increased and therefore solvency coverage increased significantly over the year.
Market recognition of customer focus and innovation
We continued to focus strongly on our customers, delivering a number of new products and service innovations throughout the year. Examples include annuity features in Germany, a second Easy Plan product in Switzerland, various distributor products in Italy and France, dollar cost averaging and rebalancing features in Europe and new investment alternatives in Latin America. We also improved service to our customers and distributors through differentiated service offers to top distributors, pro-active service and retention campaigns, and improved distributor tools.
These innovations have been well received by the market, as can be judged from the various product and service awards won during the year, as well as from feedback on internal and external surveys undertaken.
Business restructure
From January 2009 we have restructured the business in continental Europe to reflect our principal customer segments in order to leverage capabilities and operational efficiencies across geographies. The transition to two main business structures will take place throughout 2009:
'Affluent' targets the affluent segment and currently comprises the businesses in France, Italy and Spain. 'Mass Retail' meets the savings needs of this significant part of the population and comprises the businesses in Germany, Austria, Switzerland, Poland and eastern Europe. This foundation for efficiency in Central Europe and the integration of the Southern European businesses will allow us to take advantage of further efficiency opportunities in the future in the Mass Retail and Affluent businesses.
Principal risks and uncertainties
ELAM's business model carries limited guarantee and liability risk. Strategic and operational risk is reviewed regularly and managed through our risk framework. Our ongoing focus to build and diversify distribution aims to reduce concentration risk. The existing concentration levels remain within a reasonable range and we expect that future planned activities will assist us to manage this risk further.
ELAM's business mix, which includes regular and single premium, retail and institutional business, provides mitigating support to impacts on business results in the current volatile market conditions. However, uncertainty about the future extent and length of a global recession remains and market trends remain difficult to predict. ELAM's geographic diversity reduces the economic, market political and legal/regulatory risks that would typically exist in single-market businesses. The transition to our new business line structure carries some change risk. A strong change management programme has been defined to reduce impacts to new and existing business.
Outlook
The global financial crisis and recessionary pressures are expected to be the main influence on the market in 2009. We expect new business to be constrained during the year as investor confidence remains suppressed.
Guaranteed products are likely to remain important to investors in 2009, temporarily slowing the growth of the unit-linked segment compared with traditional life. Products such as our traditional life fund in France and our rebalancing features will help us win sales in the current climate.
Regular premium business, which has been relatively unaffected by the market crisis, is expected to help our sales development in 2009 as the averaging effect of regular premium inflows should support our sales propositions.
Our strong performance in net client cash flows and client asset values has supported our market share. We believe that we will be able to capitalise on this further once confidence returns and markets return to more stable growth patterns.
SOUTH AFRICA: LONG-TERM BUSINESS & ASSET MANAGEMENT - OLD MUTUAL SOUTH AFRICA (OMSA)
Excellent results in a very tough environment
|
Highlights (Rm) |
|
2008 |
2007 |
% Change |
|
Long-term business adjusted operating profit |
|
3,390 |
3,082 |
10% |
|
Asset management adjusted operating profit |
|
1,078 |
946 |
14% |
|
Long-term investment return (LTIR) |
|
3,521 |
2,988 |
18% |
|
Adjusted operating profit (IFRS basis) (pre-tax) |
|
7,989 |
7,016 |
14% |
|
Return on allocated capital |
|
27.8% |
24.0% |
|
|
Adjusted operating profit (covered business) (MCEV basis) (post-tax) |
|
4,972 |
3,857 |
29% |
|
Return on embedded value (covered business) (post-tax) |
|
14.4% |
11.7% |
|
|
Life assurance sales (APE)* |
|
5,145 |
4,516 |
14% |
|
Unit trust / mutual fund sales** |
|
20,648* |
15,547 |
33% |
|
Value of new business |
|
831 |
694^ |
20% |
|
APE margin |
|
16% |
15%^ |
|
|
PVNBP |
|
35,440 |
32,010^ |
11% |
|
PVNBP margin |
|
2.3% |
2.2%^ |
|
|
Net client cash flows (Rbn) |
|
(5.5) |
(18.7) |
71% |
|
SA client funds under management (Rbn) |
|
443.0 |
445.0 |
- |
|
* Life sales now exclude healthcare business. 2007 sales have been restated from R4,699 ** Unit trust / mutual fund sales now include Marriott ^ Restated as now reporting on MCEV basis |
|
|
|
|
Funds under management were flat over 2007 mainly due to lower asset values in volatile markets and improved net client cash outflows of R5.5 billion offset by the inclusion of Futuregrowth's R35 billion of funds under management. The acquisition of Futuregrowth has resulted in an expanded set of fixed income products available to the Old Mutual customer base. Retention of third party assets has improved significantly with the bedding down of the OMIGSA boutique structure leading to the overall reduction in client outflows relative to 2007. Outflows remained a challenge, affected by higher bonuses declared in 2007 and early 2008, which increased the level of normal benefit payments, particularly in Employee Benefits (EB), as well as higher member withdrawals from pension funds as a result of the deteriorating economic environment.
Life assurance sales increased 14% in 2008. This improvement was particularly pleasing considering the effect of the current economic climate on consumer spend. We achieved excellent growth in life single premium sales of 26% compared to 2007, but we experienced a slow down in single premium sales in the fourth quarter. Savings products sales grew by 12% as investors opted for more conservative fund options under the life wrapper in response to volatile investment markets, particularly in the Retail Affluent market. Annuity sales were up 85% with some good flows in the Corporate Segment's new guaranteed term annuity product as well as with-profit annuities. Our focus on working closely with consultants advising institutional investors has helped us grow our sales pipeline, although the sales process is longer as investors are more cautious in the current markets before deciding to move assets.
Life recurring premium sales were strong, up 8% over 2007. Sales of recurring premium savings products increased by 16% compared to 2007 driven by an expansion in the Retail Mass segment sales force. High interest rates adversely affected our credit life sales through the banking channel as loan advances dropped. Sales of risk products to the Retail Affluent market were largely flat over 2007 as customers faced affordability problems. In December 2008 we reached an agreement to sell our healthcare business to Lethimvula. As a result we now exclude healthcare sales from our life sales and from our embedded value calculations.
Unit trust sales of R20.6 billion were 33% higher than in 2007, showing excellent growth, albeit from a low base with investors moving to lower risk money market funds. We continue to focus on improving investment performance, as well as focus on the alignment of our unit trust fund offering to our boutique capability and allowing the OMIGSA boutiques to operate with independent investment philosophies and processes.
VNB grew 20% over 2007 driven by the increase in sales and the increase in the margin as a result of strong with-profit annuity sales in the Corporate Segment where the APE margin increased from 15% in 2007 to an outstanding 23% for 2008. The contribution of the with-profit annuity sales to the APE margin was partly offset by the higher frictional tax costs after reducing the proportion of capital invested in equities. The Retail Affluent margin also declined as a result of the lower proportion of high margin risk business following the fall in credit life sales.
Adjusted operating profit (IFRS basis) increased strongly, up 14% over 2007. Despite challenging markets, our long-term business profits increased 10%, driven by lower costs due to sound management of expenses with the lower Old Mutual plc share price impacting incentive costs. In addition we gained some significant non-repeating items including a reduction in employee benefit obligations of R128 million, interest on SARS refund of R64 million and an insurance claim of R37 million. We also saw improved general experience variances. Although we increased our allowance for worsening persistency and we increased our investment guarantee reserve (IGR) by R409 million during the year, these assumption changes were not as adverse as in 2007 when we determined the IGR on a market consistent basis for the first time. These positive factors were partially offset by lower capital charges as a result of lower asset values and the move to lower margin products such as the move by Old Mutual Staff Fund to Absolute Growth Portfolios as well as negative termination experience especially in the mass market segment.
Our asset management adjusted operating profit was up 14% due to lower expenses attributable to the impact of a lower Old Mutual plc share price on incentive costs. The impact of the move to performance based income in the current environment resulted in lower asset management fee income which was offset by strong performance in our credit operation (OMSFIN).
The LTIR increased by 18% after increasing the rate applied at the beginning of the year by 100bps to 16.6%, reflecting the high investment returns on shareholder funds achieved in 2007 and higher investible asset balances.
Adjusted operating profit (MCEV basis) increased by 29% over 2007, mainly due to higher expected return (based on higher one-year swap rates), higher new business contribution and the higher adjusted operating profits (IFRS basis) discussed above. These positive factors were partly offset by the impact of adverse termination experience particularly in the Retail segments as a result of the tougher economic environment.
Capital position
|
Rm |
|
2008 |
2007 |
% Change |
|
Admissible capital |
|
42,582 |
45,039 |
(6%) |
|
Statutory capital adequacy requirement (SCAR) |
|
11,176 |
11,739 |
(4%) |
|
Statutory capital cover |
|
3.8 times |
3.8 times |
|
Old Mutual South Africa's life company capital position remains strong in spite of turbulent markets. The statutory capital cover remained stable at 3.8 times since December 2007. Admissible capital was lower than December 2007 levels due to a fall in market values, offset by the effect of our hedging programme and increased cash holdings.
At 31 December 2008 the statutory capital requirement reduced 4% to R11,176 million as a result of a decision to hold more cash and reduce our exposure to equities. The impact of lower equity markets and the new regulatory requirement to include allowance for operational risk, credit risk and investment guarantee reserve sensitivity in capital requirements, was offset by higher assumed management actions in the investment resilience scenario used for calculating the capital requirement.
Retail Mass
|
Rm |
|
2008 |
2007 |
% Change |
|
Life sales (APE) |
|
|
|
|
|
Savings |
|
736 |
613 |
20% |
|
Protection |
|
576 |
477 |
21% |
|
Total |
|
1,312 |
1,090 |
20% |
|
Value of new business |
|
270 |
240^ |
13% |
|
APE margin |
|
21% |
22%^ |
|
|
Net client cash flows (Rbn) |
|
2.0 |
1.9 |
5% |
|
^ Restated, as now reporting on an MCEV basis |
|
|
|
|
Retail Mass sales were up a pleasing 20% over 2007 largely due to strong growth in salaried adviser manpower. The broker and direct channels also delivered strong sales growth. Net client cash flows were 5% ahead of last year. The impact of higher surrenders (indicative of the current economic conditions) and greater volumes of maturing savings business (introduced ten years ago and short term savings business introduced five years ago) was offset by favourable mortality experience.
VNB increased at a slower rate than sales due to the re-pricing of our protection product range and the impact of lower expected returns (based on assumed lower future swap yields) on the value of future profits on the segment's protection products.
Retail Affluent
|
Rm |
|
2008 |
2007 |
% Change |
|
Life sales (APE) |
|
|
|
|
|
Savings |
|
1,428 |
1,321 |
8% |
|
Protection |
|
996 |
1,056 |
(6%) |
|
Annuity |
|
219 |
197 |
11% |
|
Total |
|
2,643 |
2,574 |
3% |
|
Life sales (APE) |
|
|
|
|
|
Single |
|
907 |
868 |
4% |
|
Recurring |
|
1,736 |
1,706 |
2% |
|
Non life sales |
|
|
|
|
|
Unit trust / mutual fund sales |
|
17,978 |
13,339 |
35% |
|
Other non life sales |
|
4,782 |
4,871 |
(2%) |
|
Value of new business |
|
320 |
336^ |
(5%) |
|
APE margin |
|
12% |
13% |
|
|
Net client cash flows (Rbn) |
|
(1.1) |
(2.7) |
59% |
|
^ Restated, as now reporting on an MCEV basis |
|
|
|
|
Net client cash outflows improved over 2007 however remained negative as the prevailing adverse economic environment increased client withdrawals.
Total Retail Affluent life sales on an APE basis increased a solid 3%. Recurring premium sales experienced challenges with inflationary pressures and higher interest rates which impacted negatively on consumer disposable income. Recurring premium savings sales grew by 13% with Max Investment recurring premium sales up 6% and a full year contribution from Nedlife's Dreammaker, launched in the middle of 2007, producing a 112% increase albeit off a low base.
The shift from life-wrapped savings business to other wrappers continues with non-life recurring premiums up 32% from a relatively low base. Greenlight sales grew by 1% as a result of affordability issues among customers and credit life sales declined over 2007 after the reduction in loan volumes as a result of the high interest rate regime and the impact of the National Credit Act.
Life single premium sales were up 4% with living annuities up 20% on 2007 and conventional annuity sales were also solid as a result of the continued competitiveness of our annuity rates, enhanced by a recent re-pricing exercise. Total annuity sales including living annuities were up 11% on 2007. However, Max Investment and Investment Frontiers single premium sales were down 10% and 1% respectively on 2007 as a result of the impact of market volatility on single premium investments.
Non life single premium savings business was up 25% over 2007 due to investors moving to money market funds in the volatile investment markets and the re-launch of Galaxy Elite, an upgrade to our existing investment platform.
VNB decreased by 5% despite the overall increase in sales. In addition to the higher frictional tax costs following the change in shareholder investment mandate, (more cash, less equities) the decline was also caused by the lower credit life sales, which have high margins.
Corporate Segment
|
Rm |
|
2008 |
2007 |
% Change |
|
Life sales (APE) |
|
|
|
|
|
Savings |
|
386 |
346^ |
12% |
|
Protection |
|
125 |
145 |
(14%) |
|
Annuity |
|
350 |
111 |
215% |
|
Total |
|
861 |
602 |
43% |
|
Life sales (APE) |
|
|
|
|
|
Single |
|
671 |
393 |
71% |
|
Recurring |
|
190 |
209 |
(9%) |
|
Value of new business |
|
201 |
91^ |
121% |
|
APE margin |
|
23% |
15%^ |
|
|
Net client cash flows (Rbn) |
|
(4.0) |
(4.1) |
2% |
|
^ Restated, as now reporting on an MCEV basis |
|
|
|
|
Corporate life sales on an APE basis were 43% higher in 2008, driven by higher sales in EB savings and annuity products. Single premiums were excellent. The introduction of the Guaranteed Term Certain product boosted annuity sales, and there were also good flows into Smoothed Bonus products. Sales of protection products were below 2007 as insurers stepped up efforts to retain business thereby reducing potential new business. Our retention of protection business also improved in 2008.
VNB increased significantly in 2008 relative to the increase in sales. This was because of higher sales volumes in EB combined with the favourable mix of sales, notably the higher proportion of with-profit annuity sales. This had a flow on impact in the new business margin improving relative to 2007.
Net client cash flows in the EB arena were marginally better than in 2007. Higher inflows were almost offset by higher outflows. Terminations were similar to 2007 levels, but benefit payments were much higher. Higher bonus declarations during 2007 (smoothed bonus) and early 2008 (annuities) increased the level of normal benefits. In addition to this, a trend of increased benefit withdrawals from funds as a result of current economic pressures contributed to increased outflows.
Customers continued to transfer from the old smoothed bonus products to the Absolute Growth Portfolios launched in 2007. Transfers of R21 billion occurred during the year. These transfers are not counted as new business.
Old Mutual Investment Group South Africa (OMIGSA)
|
Rm |
|
2008 |
2007 |
% Change |
|
Life sales (APE) |
|
329 |
250 |
32% |
|
Unit trust / mutual fund sales |
|
2,669 |
2,208 |
21% |
|
Value of new business |
|
40 |
28 |
43% |
|
APE margin |
|
12% |
11% |
|
|
Net client cash flows (Rbn) |
|
(2.4) |
(13.8) |
83% |
|
Funds under management (Rm) |
|
2008 |
2007 |
% Change |
|
Life |
|
296 |
319 |
(7%) |
|
Unit trusts |
|
45 |
48 |
(6%) |
|
Third party |
|
110 |
88 |
25% |
|
Total OMIGSA managed assets |
|
451 |
455 |
(1%) |
|
Funds managed by external fund managers |
|
29 |
34 |
(15%) |
|
Total OMSA Funds under management |
|
480 |
489 |
(2%) |
|
Less: managed by group companies for OMSA |
|
(37) |
(44) |
(16%) |
|
Total OMSA client funds managed in SA |
|
443 |
445 |
- |
Life sales were ahead of 2007 as a result of good repeat investments by existing customers in SYmmETRY. Non-life sales were higher than 2007 as a result of better unit trust flows on the back of improved stability of our investment professional teams in the boutiques. Net client cash outflows were largely from institutional customers to fund benefit payments.
As our boutique structure has bedded down, our teams have stabilised. We have set strong foundations over the last two years and are seeing improving levels of acceptance and confidence in individual boutique investment philosophies and processes. The acquisition of Futuregrowth and merger of the OMIGSA Fixed Income and Futuregrowth teams has proceeded smoothly, with minimal disruption to their investment processes.
The South Africa equity market (JSE All Share Index) fell 26% during 2008. The outperformance of resources during the six months to the end of June reversed abruptly in the second half of the year, with resources down 46% relative to a -1% return from financial stocks. Compelling valuations in the financial sector meant that a number of OMIGSA boutiques were underweight resources and overweight financials from the last quarter of 2007. This positioning led to improved performance over the second half of 2008, with some of the ground lost since September 2007 regained. Performance in our fixed income area was very good. The Old Mutual Income Fund and Mining and Resources Fund won certificates for top straight performance in their respective categories for the three years ended 31 December 2008 at the Raging Bull Awards.
Investment performance across our diverse boutiques was mixed. Our relative fund performance across the majority of boutiques nevertheless ended the year better than at the end of 2007, albeit below our target levels. Over one year to the end of 2008, 57% of peer group funds outperformed the median (compared to 39% as at the end of 2007). Over three years to the end of 2008, we improved from 31% outperforming to the end of 2007 to 40% above median at end 2008, and similarly measured over five years improved from 36% to 54% above median. Compared to industry median, overall, 55% of unit trust funds were above median over one year, 35% over three years and 45% over five years to the end of December 2008.
On the benchmark performance front, the difficulty of beating inflation and cash plus benchmarks in an environment where growth assets are very negative, weighed heavily on the delivery of funds which are measured mostly against an absolute benchmark. At the end of 2008, 38% of funds measured against benchmark were outperforming over one year, compared to 50% at the end of 2007. However, over the longer term period of five years we improved slightly, with 55% of funds outperforming benchmarks compared to 50% for the five years to end 2007.
Principal risks and uncertainties
As we go into 2009 we face a number of risks from the economic environment. These include a weak equity market and the possibility of further equity falls adversely affect our earnings, our embedded value and our sales (as customers avoid investment and savings products with equity content). In addition, increased terminations due to the current economic climate puts more pressure on the net client cash flow position, earnings and embedded value. Lower sales may eventuate as a result of job losses and concerns about the global economic outlook and a further decline in longer-term swap yields and further increase in equity and swaption volatilities, which would increase the size of the Investment Guarantee Reserve.
Outlook
National Treasury expects growth in the economy for 2009 to be 1.2%. This growth rate is vulnerable to demand for our exports from developed markets and how that will impact on manufacturing output as well as levels of commodity prices and their impact on our mining sector. Growth will continue to be supported by the government's infrastructure drive.
The current economic environment has led to a significant decline in consumer confidence in the investment markets and increase in concerns about job security. There has been a shift in demand from investment vehicles with high levels of market exposure to more traditional smoothed bonus and guaranteed products, which will benefit OMSA. However, the overall pressure on the consumer will restrict sales growth until concern over the market settles and consumer starts feeling the benefits of falling inflation and interest rates.
We have received notification to terminate the existing mandate to manage the Public Investment Corporation's (PIC) assets worth about R25 billion early in 2009. This will adversely affect net client cash flows and reduce operating profit by about R21 million for 2009.
New regulations on commission, implemented at the start of 2009, are revolutionising the retail market. Changes include minimum early termination values on long-term savings contracts and a move to spread commission over the term of a policy rather than the current front-loaded structure. We have already launched a set of products that meet the new requirements and have been working with intermediaries to help them move to the new environment. The legislation presents us with opportunities as our infrastructure is well equipped to deal with changes of this magnitude.
The year ahead will challenge consumers, businesses and policymakers to adapt their thinking and behaviour to a changing and more challenging economic environment. OMSA's strong capital position, brand loyalty and dominant presence will allow us to compete more aggressively in a market with declining margins and capital restrictions. Our capital position, at more than 3.5 times the required level, and our AAA credit rating are the best in the long-term insurance industry. As a result, we still see opportunities for growth, albeit at lower levels than in the recent past.
SOUTH AFRICA: BANKING - NEDBANK GROUP (NEDBANK)
Resilient performance in a challenging environment
The full text of Nedbank's results for the year ended 31 December 2008, released on 26 February 2009, can be accessed on Nedbank's website http://www.nedbankgroup.co.za
|
Highlights (Rm) |
|
2008 |
2007 |
% Change |
|
Adjusted operating profit (IFRS basis) (pre-tax) |
|
8,800 |
9,220 |
(5%) |
|
Headline earnings* |
|
5,765 |
5,921 |
(3%) |
|
Net interest income* |
|
16,170 |
14,146 |
14% |
|
Non-interest revenue* |
|
10,729 |
10,445 |
3% |
|
Net interest margin* |
|
3.66% |
3.94% |
|
|
Cost to income ratio* |
|
51.1% |
54.9% |
|
|
ROE* |
|
17.7% |
21.4% |
|
|
ROE* (excluding goodwill) |
|
20.1% |
24.8% |
|
|
* As reported by Nedbank in their report to shareholders as at 31 December 2008 |
|
|||
Banking environment
The South African banking environment is experiencing the effects of a slowing domestic economic cycle and the secondary effects of the global financial crisis. In this challenging economic environment public sector infrastructure spending is expected to continue to provide some support for economic growth in the year ahead. Improved inflation statistics allowed for a 50 basis point decrease in interest rates in December 2008, the first since April 2005. A second cut of 100 basis points followed in February 2009. These interest rate cuts will provide some relief for consumers, but are unlikely to stimulate economic growth in the short term.
The local banking environment faced a number of challenges in 2008. These included, firstly, pressure on margins as the overall cost of longer-term funding increased. It was pleasing to note that, throughout the year, rand liquidity remained stable, with the interbank lending market continuing to operate efficiently. Local banks have been able to finance new assets in the normal course of business. Secondly, reduced capacity and increased cost of funding in the domestic debt capital markets. Thirdly, rising non-performing loans and lower levels of recoveries, especially in the retail environment as household finances remained strained and asset prices came under pressure. This trend intensified in the second half of 2008 and has been increasingly affecting small and medium-sized businesses, and will undoubtedly also impact some larger corporates going forward. Finally, sharply slower retail advances growth, partly offset by reasonable wholesale advances growth.
The progress made during the recovery programme and over the recent past to build a sustainable business continues to benefit Nedbank and has resulted in a number of factors including ongoing growth in the retail mass and middle-income segments and corporate markets, solid growth in retail deposits, pleasing growth in transactional banking volumes, improved margins on new advances through risk-based pricing and increased client activity in foreign exchange and interest rate markets as well as an intensified focus on improving client service levels.
The Competition Commission inquiry into bank charges issued a detailed report in December 2008. Industry stakeholders have been given an opportunity by National Treasury to comment on the recommendations contained in the report. This input will be discussed by National Treasury with the Department of Trade and Industry, the South African Reserve Bank and the Competition Commission and it is anticipated that the final outcome of the banking inquiry process and the impact on the banking industry will be finalised during 2009. Nedbank remains committed to an outcome that provides real benefit to consumers and ensures the ongoing competitiveness and stability of the financial services industry.
Basel II was successfully implemented on 1 January 2008 and was used as a catalyst to enhance the management of risk and capital across the industry.
Financial performance
Given the turmoil in the global financial markets and the slower domestic economy Nedbank is currently adopting a more conservative approach across its operations. We have intensified our focus on increasing capital levels, growing deposits and liquidity, proactive risk management, selectively growing assets in businesses that are well positioned to increase economic profit, continuing to manage for value in those businesses that have lower economic profit profiles and managing down positions in riskier lines of businesses. At the same time we continue to invest for the future and we are not seeking to maximise short-term profitability at the expense of longer-term sustainability at this point in the cycle.
Adjusted operating profit (IFRS basis) was down 5% to R8,800 million with headline earnings down 3% to R5,765 million. Basic earnings grew by 6% to R6,410 million (2007: R6,025 million). Diluted headline earnings per share (EPS) decreased by 2% from 1,429 cents to 1,401 cents. Diluted EPS grew 7% from 1,454 to 1,558 cents, driven largely by the R622 million after-tax profit on the sale of Visa shares in the first half of the year.
Nedbank's return on average ordinary shareholders' equity (ROE), excluding goodwill, decreased from 24.8% to 20.1%. ROE dropped from 21.4% to 17.7% for the year. These declines were caused by slightly lower headline earnings, mainly as a result of increasing retail impairment levels that reduced the return on assets, together with higher capital levels as capital adequacy ratios increased during 2008.
Credit quality deteriorated throughout 2008 with Nedbank Retail's impairments worsening significantly, while the wholesale banking portfolios showed a moderate deterioration in the second half of 2008. Overall impairments have increased, although the impact on earnings was partially offset by controlled cost growth. The momentum built from disciplined cost management over the past few years continued into 2008 and contributed towards the efficiency ratio improving from 54.9% in 2007 (54.3% excluding Bond Choice) to 51.1% in 2008 and the 'jaws' ratio growing to 7.5% (2007: 6.9%).
We continued to see a steady inflow of customer deposits, resulting in retail deposits growing in line with retail advances. Pressure on short-dated maturities has been partially alleviated by market expectations of decreasing interest rates and a strategy of increasing deposit duration, particularly in the second half of the year. Given our domestic focus and small foreign-funding requirements (foreign deposits are 1.3% of total Nedbank deposits), our funding and liquidity levels have remained sound with limited impact from the global financial crisis.
Net interest income (NII)
NII grew 14% to R16,170 million on the back of growth in average interest-earning banking assets of 23%. Nedbank's net interest margin for the year was 3.66%, down from 3.94% in 2007. The positive endowment impact of interest rate increases on capital and current and savings accounts was offset by a number of factors including liability margin compression reflecting the higher cost of term funding and asset margin compression from a changing asset mix. Asset pricing continues to be a key focus for improving margins, with higher margins being generated on new assets. Further offsets include the cost of holding additional liquidity buffers deemed prudent in the current environment and debits relating to the accounting for historic structured-finance transactions with related credits offset in taxation.
Impairments charge on loans and advances
The credit loss ratio increased from 0.62% in 2007 to 1.17% for the year. The growth in advances and the increase in the credit loss ratio are reflected in a 123% increase in the impairments charge from R2,164 million to R4,822 million. Retail credit loss ratios have deteriorated since June 2008 and remain above expected through-the-cycle levels, largely as a result of continuing increases in defaulted advances in the Nedbank Retail Home Loan and Vehicle and Asset Finance Divisions. Wholesale banking credit loss ratios remain below expected through-the-cycle levels, although the credit loss ratio in Business Banking increased as expected. The credit quality in the Corporate and Investment Banking books remains good but is expected to be impacted by worsening credit quality in the year ahead resulting in increased credit loss ratios on these books. Notwithstanding seasonal effects, the unsecured retail portfolio reflected encouraging signs of improvement in the latter part of 2008.
Defaulted advances increased by 75% from R9,909 million to R17,301 million and total impairment provisions increased by 29% from R6,078 million to R7,859 million.
Non-interest revenue (NIR)
NIR, excluding Bond Choice's commission and sundry income from the 2007 base, grew by 9% on a like-for-like basis. Total NIR (including Bond Choice in the 2007 base) increased by 3% to R10,729 million.
Commission and fee income grew by 14% on a like-for-like basis (5% including Bond Choice), mainly from volume growth and transactional price increases. Cheque processing fees continue to decrease with the NetBank electronic banking system now implemented for all Business Banking clients and a process of migration initiated for Corporate Banking clients. Cash handling fees and transactional banking volumes grew strongly due to the growth in customer numbers, reflecting the success of Nedbank's strategy to increase delivery channels, improve customer service and strengthen brand positioning. The sale of Bond Choice reduced commission and fee income by R578 million.
Trading income increased by 16% from R1,334 million in 2007 to R1,553 million in 2008, reflecting good trading activity in the foreign exchange and global market businesses, although equity and debt trading both had a disappointing year. Adjusting for the loss in the first six months of 2007 in respect of the Macquarie business alliance, trading income would be at similar levels year-on-year.
The sharp fall in equity markets resulted in historic unrealised gains in mark-to-market private equity positions reducing. In spite of these challenging markets Nedbank managed to record a positive NIR of R303 million from its private-equity portfolios on the back of revaluations, realisations and dividend income.
Expenses
Nedbank continues to invest in its franchise while maintaining a disciplined approach to expenses. Despite high inflation and the increased distribution footprint, expenses continued to be tightly controlled, increasing by 2% to R13,741 million (2007: R13,489 million). On a like-for-like basis, excluding Bond Choice, expenses increased by 5%.
Taxation
The taxation charge decreased by 25% from R2,336 million in 2007 to R1,757 million. The effective tax rate decreased from 26.3% in 2007 to 21.6%, mainly due to a reduction in the corporate taxation rate in South Africa from 29% to 28%, a change in tax legislation impacting investments held in private equity portfolios and increase dividend income.
Non-trading and capital items
Income after taxation from non-trading and capital items increased from R104 million in 2007 to R645 million for the year. The main contributions were the R622 million after-tax profit on the sale of Visa shares and the R15 million profit on the sale of 33.5% in Bond Choice.
Capital adequacy
Nedbank has strengthened capital ratios significantly, with a Tier 1 capital adequacy ratio of 9.6% (December 2007: 8.2% pro-forma Basel II) and a total capital adequacy ratio of 12.4% (December 2007: 11.4% pro-forma Basel II). These ratios are now above the group's historic target ranges. The core Tier 1 capital adequacy ratio was 8.2% (December 2007: 7.2% pro forma Basel II). Nedbank currently holds a surplus of R9.5 billion against its regulatory capital adequacy requirements.
Advances and Deposits
Total assets increased by 16% to R567 billion (2007: R489 billion). Growth in average interest-earning banking assets slowed to 23% (2007 growth: 29%). Advances increased by 16%, reflecting ongoing growth in Nedbank Corporate but slower growth from Nedbank Retail and a drop in advances in Nedbank Capital. Nedbank Capital's client loan book grew strongly, but this growth was more than offset by a reduction in the advances in the trading portfolio. Imperial Bank showed strong growth through most of the year.
Overall deposits increased by 21% from R385 billion to R467 billion at December 2008, with higher interest rates increasing demand for savings and investment products.
Despite strong growth in retail funding, deposit growth was still largely concentrated in the wholesale market. Management has remained focused on optimising the funding mix and profile of the group through utilising alternate funding sources, concentrating especially on the retail and business banking deposit bases, while pricing competitively for term deposits.
Nedbank's liquidity remains sound. The impact of the global financial crisis on South African markets has, to date, been largely limited to an increased cost of international funding as a result of the reduction in international liquidity. This decreased the banks ability to access such funding and has led to an increase in the cost of - and decrease in appetite for - capital market debt. Given Nedbank's domestic focus, international funding has traditionally not been a large portion of the group's funding base, while the increase in the pricing of capital market debt has increased the cost of rolling over conduit paper and new subordinated-debt issues, with volumes issued in this market also being lower.
During 2008 Nedbank successfully issued hybrid debt, raising R1.75 billion. In addition, to diversify the funding base, raise further foreign funding and lengthen the bank's existing funding profile Nedbank issued foreign syndicated club loans of $165 million and €165 million; registered a $2 billion European medium-term note (EMTN) programme; obtained a $100 million credit line from African Development Bank; and continues to focus on the retail deposit base through competitive products and pricing.
Principal risks and uncertainties
The appropriate level of capital for a bank is a function of its strategy, individual risk appetite and risk profile. This aligns with one of the key objectives of Basel II which is to differentiate capital requirements and capital buffers above the regulatory minimum, to reflect the unique risk profile on a bank-by-bank basis, rather than following the 'one-size-fits-all' approach that Basel I engendered.
Nedbank has cultivated and embedded a prudent and conservative risk appetite, primarily focused on the basics of banking in southern Africa. This is illustrated by reference to a number of factors including having neither direct exposure to US subprime credit assets nor associated credit derivative transactions and having conservative credit underwriting practices which have culminated in a high-quality, well-collateralised wholesale book and further tightening of credit criteria in our retail book since 2007 in anticipation of the economic downturn and resulting from the introduction of the National Credit Act. We have reasonable credit concentration risk levels in relation to the South African market with counterparty credit risk being restricted to non-complex, vanilla banking transactions. We have a strong, well-diversified funding deposit base (including a strong retail deposit franchise) and limited offshore funding, low securitisation risk exposure compared to global banks, low leverage ratio compared to global banks and higher ratio of risk-weighted assets to total assets ratio than that of peers, indicative of our appropriately conservative measurement of risk. In addition, we have a low level of assets and liabilities exposed to the volatility of IFRS fair value accounting, our small market trading risk in relation to total bank operations, we have a low interest rate risk in the banking book and we have low equity (investment) risk exposure, having successfully completed our non-core asset disposal strategy in 2007. We have low currency translation risk and an optimal offshore capital structure. Our earnings streams across our full commercial banking activities are well-diversified and our well-diversified subordinated debt profile have no maturities of existing Tier 2 regulatory capital until 2011. We undertake comprehensive stress and scenario testing to confirm the adequacy of our capital ratios and accompanying capital buffers.
Against this background, we believe that capital levels (both regulatory capital and internal capital assessment, based on economic capital) and provisioning for credit impairments are appropriate and conservative, and that Nedbank and its subsidiaries are appropriately capitalised relative to our business activities, strategy, risk appetite, risk profile and the external environment in which we operate. Additionally, Nedbank is currently not holding excess capital for acquisitions.
Outlook
The domestic economy is expected to continue slowing in 2009, with gross domestic product (GDP) growth currently forecast by the Nedbank group at 0.4%. The global financial crisis and resultant recessionary conditions will place more pressure on an already slowing domestic economy. Weaker international trade, lower commodity prices and continued volatility on major financial markets are expected to restrict corporate activity. Consumer finances are likely to remain strained as a result of continued pressure on disposable income, falling asset prices, increasing unemployment and the weaker rand. Lower economic activity is also placing increasing strain on corporates.
Further interest rate cuts are anticipated during the course of 2009. The benefits of these would be expected to impact positively on the South African banking environment only in 12 to 18 months' time. In the short term the decrease in interest rates will have a negative endowment effect on banking interest margins, while impairments are likely to continue to deteriorate. The reversal of the higher impairment trend typically takes longer to be reflected in earnings.
In light of progress made by Nedbank and taking into account the current economic environment and Nedbank's interest rate expectations, we have revised our medium- to long-term targets and have set short-term objectives for the 2009 financial year. The economic environment remains uncertain and this, together with heightened market volatility, ongoing global uncertainty and the potential for an extended global recession, increases forecast risk. The short-term outlook, which is management's current best estimates for the year ahead, is that the Nedbank headline earnings will reduce by approximately 10% in 2009, but Nedbank will continue to improve its efficiency ratio and strengthen its capital position. This outlook assumes a reduction of 227 basis points in the average prime rate.
SOUTH AFRICA: GENERAL INSURANCE - MUTUAL & FEDERAL
Challenging trading conditions
The full text of Mutual & Federal's results for the year ended 31 December 2008, released on 6 February 2009, can be accessed on Mutual & Federal's website http://www.mf.co.za
|
Highlights (Rm) |
|
2008 |
2007 |
% Change |
|
Adjusted operating profit (IFRS basis) (pre-tax) |
|
1,169 |
1,256 |
(7%) |
|
Gross premiums* |
|
9,159 |
9,323 |
(2%) |
|
Earned premiums* |
|
7,669 |
7,948 |
(4%) |
|
Claims ratio* |
|
67.1% |
65.8% |
|
|
Combined ratio* |
|
96.1% |
95.4% |
|
|
Solvency ratio* |
|
41% |
42% |
|
|
Return on capital* (3 year average) |
|
33.9% |
31.7% |
|
|
* As reported by Mutual & Federal in their report to shareholders as at 31 December 2008 |
|
|||
Profits impacted by financial turmoil in the investment environment negatively impacting investment returns
Adjusted operating profit (IFRS basis) declined following the lower underwriting margin, but was partially offset by the impact of a higher LTIR. This added R57 million to our Adjusted Operating Profit. The profit attributable to equity shareholders declined 117%, primarily as a result of a reduction in the value of listed equities. The underwriting surplus for the year declined by 18% but the 2007 result was positively impacted by the release of R96 million from reserves following refinements to estimation methods. Without this adjustment, underwriting profit increased by 11%. Although there were further increases in the frequency and severity of industrial fire claims in the first half of the year, trading conditions improved during the second half. This, together with corrective measures on the underperforming group schemes portfolio resulted in satisfactory levels of underwriting profitability being achieved for the full year. Gross premium income declined by 2% as growth in the commercial portfolios was offset by the cancellation of a number of personal group schemes and a contraction in the risk finance portfolio.
Investment income reduced sharply during the year following a decline of approximately 27% in the value of listed equities which was in line with the JSE. Whilst dividend income declined slightly, interest income increased strongly as a result of higher levels of cash holdings during the year and higher interest rates.
Restructuring undertaken during the year
During the year Mutual & Federal undertook a substantial restructure to promote client service and operating efficiency. Staff numbers declined by more than 600 as a result of the restructure and R55 million in retrenchment costs were paid. A further non-recurring expense of R147 million was incurred from the closure of a channel development project. This project was undertaken to seek growth opportunities from a number of different channels but was prudently abandoned when it proved to be too ambitious and ill-timed.
Solvency margin in the target range
As a result of the decline in the value of investments, the net asset value per share declined by 13% during the year to R10.92 at 31 December 2008. The solvency margin (being the ratio of net assets to net premiums) declined to 41% at 31 December 2008 but remains in the target range adopted by Mutual & Federal.
Principal risks and uncertainty
There are two main risks and uncertainties facing the business. The first is operational risk and the second is a credit risk item. Operational risk arises from the introduction of a new computer system across all operations and branches taking place in 2009. A smooth transition and introduction of the new operating environment is critical to the future profitability and success of the business, to the degree that some business may be lost if the conversion fails. While the re-insurance panel of the company is graded on average 'A' and above (Standard and Poors), the failure of a re-insurer could cause significant solvency strain and going-concern problems to the business.
Outlook
The impact of the turmoil experienced at the end of 2008 in Europe and the United States is expected to be felt in South Africa in 2009. Economic growth will be challenged as commodity prices continue to fall. This will further dampen South African consumer spending in 2009 and inevitably inhibit growth in the short-term insurance industry. While government infrastructure spending and the anticipated 2010 Football World Cup may provide some growth opportunities, much of this business is inadequately rated and will decline. As consumers are stretched, we are unlikely to see meaningful growth in existing personal portfolios.
If commodity prices stay low the local currency will remain weak, particularly if the Reserve Bank follows the example of Europe and the United States with aggressive interest rate cuts. Any decline in the value of the rand threatens to increase claims costs because of the large imported component in motor vehicles and replacement plant and equipment.
Despite these factors, we remain committed to producing underwriting profits in 2009, and although the economic downturn may subdue growth, our streamlined structure should provide us with a competitive advantage.
UNITED STATES: US LIFE
Immediate annuity mortality experience and market driven challenges in variable annuity business depress 2008 results
|
Highlights ($m) |
|
2008 |
2007 |
% Change |
|
Adjusted operating profit (IFRS basis) (pre-tax) |
|
(679) |
195 |
(448%) |
|
Return on equity |
|
(50.0%) |
5.9% |
|
|
Adjusted operating (loss) / profit (covered business) (MCEV basis) (post-tax) |
|
(1,112) |
65 |
(1,811%) |
|
Return on embedded value (covered business) |
|
(121.4%) |
4.1% |
|
|
Life assurance sales (APE) |
|
519 |
671 |
(23%) |
|
Value of new business |
|
(122) |
63* |
(294%) |
|
APE margin |
|
(23%) |
9%* |
|
|
PVNBP |
|
4,990 |
6,375* |
(22%) |
|
PVNBP margin |
|
(2.4%) |
1.0%* |
|
|
Net client cash flows ($bn)** |
|
1.0 |
1.6 |
(38%) |
|
Funds under management ($bn)** |
|
20.7 |
24.1 |
(14%) |
|
* Restated, as now reporting on an MCEV basis ** Stated on a start manager basis as USAM manages funds on behalf of US Life |
|
|||
Decrease in funds under management driven by unprecedented equity and credit market movements
Despite the turbulent markets, net client cash flows were 4% of opening funds under management. Funds under management ended the year at $20.7 billion, down 14% from the opening position primarily due to a 21% decrease in the market value of funds under management. The net unrealised loss on the fixed income portfolio increased by $2.3 billion to $2.6 billion and Old Mutual Bermuda ('OMB') variable annuity separate account asset values decreased by $2.4 billion. The market value decrease was mainly the result of widening credit spreads in the bond markets and dramatic declines in global equity markets.
Sales driven by variable annuities
Total life sales on an APE basis were $519 million, down 23% over 2007. Sales by OMB were the largest contributor to APE. However as a consequence of the high cost of guarantees in the volatile environment, we withdrew the guaranteed variable annuity riders from the Hong Kong book in May, and from the remainder of the business effective 15 August 2008, and therefore the OMB sales in the last four months of the year were significantly lower.
Fixed indexed annuity sales, down 40% over 2007, were affected by difficult market conditions. However, fixed annuity sales of $60 million were up 216% over 2007, following the industry trend as customers seek fixed interest guarantees during this period of extreme equity market volatility and economic instability.
Value of new business
VNB reduced by $185 million in 2008 compared to 2007, with a margin of negative 23% compared to 9% in 2007. The decrease in margin was mainly due to the reduction in swap rates, which affects our US Life onshore business by which reducing management capacity to retain additional income above guaranteed minimum crediting rates, the additional provisions for non-modelled risk on OMB variable annuity business sold, and the recognition of higher expected guarantee costs on variable annuity business, in particular on the Hong Kong book.
Review of reserving basis
We continually monitor our assumptions and make adjustments based on experience as appropriate. During 2008 we lowered the mortality assumption for life contingent single premium immediate annuities ('SPIA'), which increased the IFRS reserve and reduced embedded value. We modified the expected lapse rates for deferred and indexed annuities to reflect higher expected surrenders when the contracts exit the surrender charge period, which resulted in DAC unlocking. We also included a non-performance risk factor in discount rates used to determine the indexed annuity embedded derivative liability and the variable annuity guaranteed minimum accumulation benefit (GMAB) liability, which decreased the liabilities. Finally, we updated the variable annuity GMAB assumptions related to fund indices, mortality, free partial withdrawal utilisation, services fees and volatility, which resulted in a net decrease in the liability.
Underlying adjusted operating profit (IFRS basis) results
Adjusted operating profit (IFRS basis) decreased $874 million from the level at 2007 to a loss of $679 million for 2008. The 2008 loss reflects $436 million of additional mortality reserves related to life SPIA's, a $295 million charge in the fourth quarter for revisions to estimates of future gross profits which resulted in an 'unlocking' of the deferred acquisition cost asset (DAC), and $126 million of hedge losses related to variable annuity product guarantees. The latter was part of a total IFRS pre-tax and pre-DAC charge of $508 million relating to the variable annuity product with $382 million flowing through the short-term fluctuations line.
Difficult credit markets resulted in higher impairment losses and volatile equity markets increased the costs associated with the guaranteed benefits on our variable annuity contracts.
Market Consistent Embedded Value results
Adjusted operating profit (MCEV basis) was significantly lower in 2008 than in 2007, mainly due to the large negative assumption changes made in 2008: strengthening of SPIA mortality reduced the VIF by $280 million, an increase in expense assumptions reduced the VIF by a further $291 million, and the strengthening of OMB GMAB reserves reduced the ANW by $126 million. Experience variances were also significantly adverse due largely to higher than expected lapses and the impact of reinsurance deals which had been priced to be broadly cost-neutral on a real world basis. Other negative experience variances included lighter than expected SPIA mortality and an expense overrun, which resulted in the operating assumption changes already outlined.
Credit update
The markets finished the year on a slightly positive note, as credit spreads tightened from historical wide levels in November. Overall, the markets remained fragile as continued financial sector rescue and economic stimulus initiatives were required to boost economic activity and confidence. The recessionary environment projected for 2009-10 depressed all market sectors.
US Life's fixed income portfolio aggregate credit experience continued to be affected by poor economic and financial market conditions. For 2008, impairments total $768 million on 43 securities with 3 of the 43 being subprime asset-backed securities and another 15 indirectly linked to subprime or monoline insurer exposures. 3.4% of US Life's fixed income portfolio has direct exposure to sub-prime mortgage collateral. The majority of the sub-prime exposure remains highly rated but has experienced several ratings downgrades. Of sub-prime holdings at 31 December 2008, 67% was rated AAA, 80% AA and higher, 93% A and higher with an aggregate 68% fair value-to-book value ratio.
Approximately 2.9% of US Life's fixed income portfolio has exposure to monoline insurers, of which $508 million (89% of the total exposure) is indirect (wrapped) exposure, with an 82% fair value-to-book value ratio, and $64 million is direct (unsecured) exposure, with a 56% fair value-to-book value ratio. The indirect exposures include $197 million of sub-prime asset-backed securities which are wrapped by monoline guarantees.
Many large, high profile financial firms suffered failures and regulatory interventions during the year, resulting in creditor losses, almost completely illiquid credit markets, dramatically wider credit spreads and lower bond prices in all sectors. In line with other US insurers, our fixed income portfolio aggregate credit experience and current unrealised loss position have been affected by these events and market conditions. US Life's fixed income portfolio recorded impairments of $237 million in the fourth quarter of 2008, contributing to total impairments of $768 million for the 2008 year. The main components of this were public fixed income security losses principally in respect of Washington Mutual ($78 million), Lehman Brothers ($50 Million), three foreign financial institutions ($98 million), several structured securities ($165 million), three monoline insurers ($38 million) and losses on preferred stocks ($225 million) of which Freddie Mac and Fannie Mae was the majority ($151 million). US Life's net unrealised losses on the fixed income security portfolio was $2.6 billion at 31 December 2008 reflecting the market-wide re-pricing of credit spreads and continuing fallout from the sub-prime mortgage crisis. Actual defaults on our corporate bonds for the year were $158 million resulting in a default rate of approximately 1.3% on our corporate bond portfolio. The value of our US investment portfolio at 31 December 2008, after recognition of these impairments totaled $20,347 million.
US Life onshore update
|
Highlights ($m) |
|
2008 |
2007 |
% Change |
|
Adjusted operating profit (IFRS basis) (pre-tax) |
|
(425) |
111 |
(483%) |
|
Life assurance sales (APE) |
|
251 |
312 |
(20%) |
|
Value of new business |
|
(21) |
(13) |
(62%) |
|
APE margin |
|
(8%) |
(4%) |
|
|
PVNBP |
|
2,307 |
2,778 |
(17%) |
|
PVNBP margin |
|
(0.9%) |
(0.5%) |
|
|
Funds under management ($bn) |
|
14.9 |
18.1 |
(18%) |
Our US Life onshore business is conducted through OM Financial Life and its wholly-owned subsidiary, OM Financial Life of New York. US Life onshore is focused on transforming and scaling its entities to improve performance by drawing the business back to reduced sales volume but more profitable sales, lowering new business capital strain and reducing operating expenses while creating a more efficient foundation for potential future business growth.
The key focus will be on the successful implementation of the business transformation strategy. The new product profile will be less capital intensive through streamlining the current product portfolio and eliminating unprofitable lines. The sales strategy will centre on core distribution partners to produce more effective relationships. In addition to the consolidation of locations and reduced headcount, a strong expense discipline will be employed throughout the organisation. US Life will embed a risk management framework that reinforces a conservative risk culture into the business operations.
The specifics of the transformation strategy have been finalised, and the implementation actions required are intended to be in place early in the second quarter of 2009. The preferred outcome will be to allow the business to focus on the distribution channels and products which are most efficient and profitable, such as its fixed annuity products. Key activities for the remainder of the year include managing the investment portfolio to reduce exposures to potential impairment losses in the current fragile credit market conditions.
An additional capital injection of $225 million was made in February 2009 to US Life onshore from the Group to maintain the Risk Based Capital in line with the operating target. The total capital injection for 2008 and early 2009 was $325 million, resulting in and RBC ratio of 305%.
Principal risks and uncertainties
US Life onshore is exposed to a number of risks, including the attraction and retention of key staff during the business restructure, retaining the capital required to meet target risk based capital levels, funding and meeting product guarantees, and asset liability management, including the need to maintain sufficient liquidity to protect the bond portfolio from crystallising losses in the current volatile market. In addition, defaults, downgrades or other events impairing the value of our fixed maturity securities portfolio may reduce our earnings. Changes in market interest rates may significantly affect our profitability and a downgrade in our financial strength or credit rating could result in a loss of business. A further decline in equity markets or a sustained increase in volatility may adversely affect sales of our investment products and our profitability
Outlook for 2009
Despite the economic conditions we remain optimistic about our core products, which offer customers guarantees, flexibility and transparency as we work with them to meet their risk and retirement needs.
Experience in previous recessions suggests that this economic downturn will have only a limited effect on sales in the life industry. During the last recession, total new premiums for individual life insurance dipped but were trending upward again before the recession ended. We expect traditional insurance sales to small businesses to be strong as companies recognise the need for asset protection and indemnification, and look for simpler solutions to meet their objectives.
We will continue working proactively to improve capital efficiency and investment portfolio performance through measures such as the defensive restructuring of the asset portfolio, reducing exposures to corporations in recession prone sectors, reducing financial credit exposures, upgrading CMBS and subprime portfolios and increasing treasury and liquidity balances
US Life offshore update
|
Highlights ($m) |
|
2008 |
2007 |
% Change |
|
Adjusted operating profit (IFRS basis) (pre-tax) |
|
(254) |
84 |
(402%) |
|
Life assurance sales (APE) |
|
268 |
359 |
(25%) |
|
Value of new business |
|
(101) |
76 |
(233%) |
|
APE margin |
|
(38%) |
21% |
|
|
PVNBP |
|
2,683 |
3,597 |
(25%) |
|
PVNBP margin |
|
(3.8%) |
2.1% |
|
|
Funds under management ($bn) |
|
5.8 |
6.0 |
(3%) |
Our US Life offshore business is conducted through Old Mutual Bermuda ('OMB'). During the year, continuing market volatility and significant strengthening of the US dollar led to further increases in guarantee reserves in respect of variable annuity contracts. In 2008, we recognised a total loss in respect of this business of $508 million, of which $126 million was recognised in adjusted operating profit. Cash of $582 million was transferred to OMB during 2008; it now has a significant excess to the minimum Bermuda regulatory capital requirement.
The Universal Guarantee Option ('UGO'), which was launched in January 2007, was an optional benefit connected to the Universal Investment Plan ('UIP'). When selected, the UGO provided a Guaranteed Minimum Accumulation Benefit ('GMAB'), that guaranteed the policyholder's account value would grow by 5% over five years (i.e. if the fund is below 105% of the initial premium, it would be 'topped up') and by 20% over 10 years. There was also in some cases a Highest Anniversary Value ('HAV') guarantee on death and / or maturity. The UGO was withdrawn from the Hong Kong book in May, and from the rest of the market on 15 August 2008.
The death and living benefit guarantees, which are embedded within the variable annuity products issued by OMB, have similar risk profiles to 'put-type' options. This means that OMB bears the risk associated with market downturns as a result of having sold these guarantees. These 'put-type' options are considered to be exotic in nature since policyholder behaviour influences the ultimate payoff. In addition, since the guarantees are defined in US dollars but are backed by funds that are invested in foreign currency denominated securities, OMB bears foreign currency exchange risk in connection with these exposures. Since the funds backing the guarantees are not directly hedgeable, linear combinations of liquid market indices are used to proxy the return of every fund ('fund mapping'). For effective hedging, the explanatory power of these fund mappings should be as high as possible establishing good linkage between the funds and the chosen set of hedgeable indices.
The turbulent economic conditions and failure to fully hedge certain risks, coupled with hedge ineffectiveness, meant that the cost of providing the guarantees increased substantially in 2008. This resulted in swift and decisive action in the second half, including senior management changes, the withdrawal of the UGO, strengthening of governance and risk management practices, the adoption of more conservative assumptions, implementation of improved fund mapping and the launch of the 'Accelerated Universal Guarantee Option (UGO)' offer.
Improved fund mapping has enabled OMB to have a much clearer understanding of its exposures in terms of the guarantees it has offered. While considerable basis risk remains, OMB has been able to significantly improve hedge effectiveness, from around 75% measured over the full year, to around 92% in the fourth quarter of 2008. Enhanced attribution reporting has also resulted in a better understanding of the sensitivity of our reserves to changes in the underlying markets. As a general guidance, a 1% decrease in equity markets results in a loss of approximately $10 million, a 1% strengthening in the US dollar results in an adverse impact of around $4 million and a 1% parallel increase in volatility costs approximately $15 million.
Better asset and liability management of the margin and bank accounts was instituted in the fourth quarter of 2008 to help increase yields, reduce counterparty exposure and minimise unintentional currency exposure. 24 hour monitoring and trading began in October 2008 to improve reaction time as markets moved around the globe. Moreover, enhanced valuation methodologies to ensure assets and liabilities were calculated on a consistent basis helped remove unnecessary profit and loss volatility. A new product development process has been implemented, which includes the sign-off of product by the Group Chief Actuary, as well as the sign-off of the hedging strategy and hedge cost by the Chief Investment Officer and risk tolerance by the Chief Risk Officer.
On 5 November 2008, OMB announced an offer permitting direct customers (excluding the Hong Kong book, on which OMB is the reinsurer) who had elected the UGO guarantee riders, many of whom had seen their initial investments fall substantially, to accelerate the guarantees under these riders. The UGO Acceleration Plan enabled customers to receive an immediate top-up to their account value to 85% of their initial investment (less any subsequent redemptions). In return, all guarantees would be terminated and the fees associated with these guarantees would no longer be charged. The offer was closed on 28 November 2008, with 14% of policyholders subjected to the offer accepting the take-up. Such measures represented a further step in de-risking the business and resulted in a cash payout of $94.5 million, and a release of reserves of $133.4 million.
OMB has also delivered significant operational improvements, including the development of a multi-currency facility and the implementation of process improvements that will substantially eliminate breakage (costs arising form a mismatch in the pricing contractually agreed with a customer and the actual price achieved, resulting from inefficiency of systems and / or processes).
Looking forward, further action will be taken on a number of fronts, including restructuring the business to further improve governance, risk management and accountability; further de-risking the existing book through improved hedge performance and regular monitoring of fund performance and the soft closing of funds that exhibit poor hedging characteristics. Further action will also be taken in the development of new investment and insurance products that meet customers' needs, such as Shariah compliant funds and guaranteed funds based on quoted indices, asset allocation models or volatility-controlled funds that facilitate effective hedging.
OMB is confident that a return to more normal market conditions and the launch of a range of new hedgeable products will underpin a good recovery in profitability, although some modest volatility in earnings is still expected in the medium term.
Principal risks and uncertainties
OMB is primarily exposed to risks which include basis risk, being the risk that customers' investments in the underlying mutual funds underperform relative to the liquid market indices used to hedge the exposure, or the assumptions as to currency exposure prove to be inaccurate; and credit risk in connection with its fixed account assets. Another risk is an increase in the cost of hedging as a result of increased market volatility. OMB does not currently hedge volatility, but would look to hedge on a strategic basis, should this be deemed appropriate. One further risk is that of further reductions in terms of fee income should the value of the assets under management upon which the company earns fees continue to fall.
Outlook for 2009
In 2009, OMB aims to rebuild its position as a leading distribution platform. It does face challenges in terms of delivering innovative new products that will meet customers' needs within our risk appetite. However, a return to more normal market conditions and the launch of a range of new hedgeable products will underpin a good recovery in profitability.
UNITED STATES: US ASSET MANAGEMENT
Results dampened due to difficult market conditions
|
Highlights ($m) |
|
2008 |
2007 |
% Change |
|
Adjusted operating profit (IFRS basis) (pre-tax) |
|
181 |
324 |
(44%) |
|
Return on Capital |
|
7.2% |
11.3% |
|
|
Operating margin |
|
20% |
27% |
|
|
Unit trust / mutual fund sales |
|
1,892 |
3,782 |
(50%) |
|
Net client cash flows ($bn) |
|
(5.2) |
35.2 |
(115%) |
|
Funds under management ($bn) |
|
240.3 |
332.6 |
(28%) |
Investment performance strong through a difficult investing environment
Aggregate long-term investment performance from our member firms remained strong. Over three years, 53% of institutional assets had outperformed their benchmarks and 54% of institutional assets were ranked above the median of their peer group over the trailing three year period. These numbers represent significant improvement from the third quarter and demonstrate that our affiliates' disciplined investment processes, based on sound valuation and business fundamentals, continue to deliver for clients.
Net flows and funds under management impacted by market turbulence
Net client cash flows for the year were a solid $1.5 billion, however including securities lending at Dwight Asset Management which we suspended in the third quarter, total outflows were $5.2 billion. Given the difficult market conditions and the net outflows being experienced across the industry, our result for the year was encouraging and favourable to our peers. Affiliates contributing positive flows included Heitman, The Campbell Group, Rogge Global Partners, Ashfield Capital Partners, 2100 Xenon Group and Larch Lane Advisors. Our track record of investment performance coupled with our diverse multi-boutique model positions us well to continue to attract net inflows despite the current market climate.
Funds under management ended the year at $240.3 billion, a 28% decrease from 2007. $89 billion (96%) of the reduction was due to negative market returns. Our diversified asset mix helped to lessen the impact with fixed income and alternatives being less volatile and uncorrelated in periods of market instability. Such asset classes represented over half of the total funds under management at year end. On 1 July 2008, Rogge Global Partners acquired ING Ghent, which contributed $1.5 billion to funds under management during the year.
Retail sales challenges
Like most of our competitors, retail sales faced a challenging year in 2008. OMAM UK unit trust sales and Old Mutual Capital mutual fund sales for the year were $1.1 billion and $831 million, respectively, down a combined $1.9 billion (50%) from 2007. At 31 December 2008, 12 of Old Mutual Capital's mutual funds carried four or five star rankings by Morningstar, and we remain confident in the competitiveness of the underlying products we offer.
Adjusted operating profit (IFRS basis) down 44%
Adjusted operating profit for the year was down 44% over 2007. The decrease was primarily a result of lower management fees as well as performance fees, both of which were negatively impacted by the volatile markets. In addition, while we recorded $11 million in realised gains on seed investments in 2008, we also recorded $35 million of unrealised losses in adjusted operating profit. The operating margin, which is calculated inclusive of minority interest expense, also declined from 2007. Actions were taken to reduce costs across the business in the fourth quarter, and we remain committed to managing expenses through the current operating climate.
Continued focus on product development and distribution
We remain committed to the delivery of unique and innovative investment options. Recent product focus has included asset allocation and risk-adjusted return objectives which have positioned us well in the current market environment. Specifically, we recently launched Old Mutual Target Plus Portfolios, the only target-retirement mutual funds with three risk-specific asset allocation strategies. These funds enable Old Mutual to capitalize on the trend of target date funds as retirement plan default options.
To capitalise on the movement of asset flows towards both global and alternative products we launched the following strategies: Copper Rock International Small Cap Growth (managed by a newly acquired team), Barrow Hanley International Value, Thomson Siegel & Walmsley Global Equity, Acadian Emerging Market Debt, 2100 Managed Futures, and 300 North Capital Long/Short.
In addition to our continued focus on product quality we have begun to build out the next generation distribution model adding several new team members covering Alternatives, Defined Contribution Investment Only, and Wall Street and Global Distribution. This is an example of our commitment to grow the business and bring in talented experienced people to serve the evolving needs of our clients.
Risk management
Old Mutual is committed to the objective of increasing shareholder value by operating in a manner consistent with our risk appetite. Risk management is not limited solely to consideration of downside impacts or risk avoidance, but also encompasses taking risk knowingly for competitive advantage.
An independent review of risk management across Old Mutual involving external experts was completed during 2008, and we have implemented a number of initiatives to improve our governance, risk management and internal control processes including implementation of an Enterprise Risk Management programme. These improvements include the recruitment of significant additional risk and compliance personnel at Group and Business Unit level; the development and roll out of a global risk appetite framework; the development of comprehensive and focused risk reporting, including introduction of a risk recording and reporting tool; the implementation of a revised and more comprehensive risk categorisation model at Group; the revision of the Old Mutual policy suite and framework to reflect increased oversight from Group Risk over Business Units; and the development of formal standards for internal loss data collection and increased use of Key Risk Indicators.
Our priority for 2009 is to embed these enhancements and further strengthen our system of risk management.
Principal risks and uncertainties
The broad market downturn had, and will continue to have, an impact on the US asset management business ('OMAM'). The exposure to current market fluctuation continues to impact assets under management, revenues and earnings targets thereby affecting our ability to execute against the overall business strategy. In addition, given activities over the last year, there is a high likelihood of regulatory reform across the financial services industry. In aggregate, these factors create an environment that could result in OMAM facing continuing pressure on earnings as well as higher than normal levels of litigation and reputational risks.
Outlook
We see good potential both in the US and globally. Difficulties within financial institutions have created a significant opportunity to attract investment talent within the US. Market volatility also creates opportunities for managers to provide outperformance for customers at a time when the gap between the top and bottom quartile performers has widened.
Before the current market difficulties, client cash flows were driving asset allocation decisions towards international, global and alternative strategies. We believe these trends will continue in 2009, but many customer searches have been halted given the recent volatility. Search activity should return with client cash flows as the volatility in the financial markets subsides, but customers will remain wary. They will put a premium on companies that are truly institutional in quality and offer effective risk management, continuity of staff, strong ownership structures, transparency of investment process and longevity of performance.
Until global equity markets recover, our earnings growth will be restricted. However, our investment track record has positioned us well relative to competitors, and our diversified asset mix will continue to help us weather market volatility.
OTHER: ASIA PACIFIC
Continued focus on existing businesses
|
Highlights (£m) |
|
2008 |
2007 |
% Change |
|
Adjusted operating (loss)/profit (IFRS basis) (pre-tax) |
|
(17) |
2** |
(950%) |
|
Australia unit trust / mutual fund sales |
|
418 |
719 |
(42%) |
|
Australia institutional sales |
|
123 |
115 |
7% |
|
Skandia:BSAM (China) Gross Premiums * |
|
28 |
122 |
(77%) |
|
KMOM (India) Gross Premiums * |
|
279 |
163 |
71% |
|
Net client cash flows (£bn) |
|
(1.6) |
- |
(100%) |
|
Funds under management (£bn) |
|
3.5 |
6.5 |
(46%) |
|
* This represents 100% of the businesses; OM owns 50% of Skandia:BSAM and 26% of KMOM ** Includes Bermuda Asset Management (now included in USAM) |
||||
During 2008, we continued to focus on broadening our footprint in the Asia Pacific region through new initiatives, increasing distribution and our expanding product. Our portfolio of businesses consists of a retail mutual funds platform and institutional asset manager in Australia, a joint venture with the Beijing State-owned Asset Management Company in China selling unit-linked and the newly-launched universal life products (Skandia:BSAM) and a 26% holding in a life assurance venture in India (Kotak Mahindra Old Mutual).
In India, we increased our KMOM business branch network with 197 branches now open across the country compared to 106 in 2007.
Results impacted by current market conditions
A combination of stock market volatility and increased competition resulted in tough business conditions for the year. Sales and net client cash flows were disappointing with total outflows of £1.6 billion, primarily as a result of the lower equity markets and the impact of large institutional client redemptions in Australia. Funds under management reduced accordingly, partially offset by the strengthening of local underlying currencies against sterling.
We incurred an adjusted operating loss (IFRS basis) for the year of £17 million. This was largely due to lower revenues which were impacted by weakened sales and significant market value depreciation caused by the market downturn. Non-recurring expenses relating to the new regional office set-up and the inclusion of costs for new initiatives contributed to the higher operating losses.
Principal risks and uncertainties
As uncertainties in market and economic conditions persist, the market downturn may continue to impact on the growing economies of emerging markets. The Chinese local regulator, CIRC, has placed stricter regulations on the distribution of unit-linked products and has also suspended all new branch openings, new products and funds placing further strain on business performance. Given that some of our businesses or investments in the region are joint venture partners, our challenges remain on managing risks through adequate representation on the relevant boards, audit committees and working reports from internal and external auditors.
Outlook
Although we believe there is good long-term growth in the Asia Pacific region, we have decided for the foreseeable future to scale back our aspirations for this area. We have therefore reached an agreement to sell our Australian business and rein back our expansion plans to focus on our established businesses in India and China. Reflecting this change in strategy we have decided to close our regional head office in Hong Kong.
This information is provided by RNS
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