L&G 2007 FY Results Part 3
Legal & General Group Plc
18 March 2008
Page 20
European Embedded Value
=======================
Consolidated income statement
-----------------------------
For the year ended 31 December 2007
2007 2006
Notes £m £m
------------------------------------------------------------------------------------------------------------------------
From continuing operations
Life and pensions 3.02/3.03 856 1,030
Investment management 3.08 196 181
General insurance 4.04 (67) 9
Other operational income 3.09 (73) 13
------------------------------------------------------------------------------------------------------------------------
Operating profit 912 1,233
Variation from longer term investment return 3.06 116 460
Effect of economic assumption changes 3.02 57 2
Property (expense)/income attributable to minority interests (6) 67
Corporate restructure 3.01/3.02 161 (216)
------------------------------------------------------------------------------------------------------------------------
Profit from continuing operations before tax attributable to equity holders 1,240 1,546
Tax charge on profit from ordinary activities 3.10 (327) (422)
Effect of UK Budget tax changes 3.10 93 -
Tax impact of corporate restructure 3.01/3.10 206 322
------------------------------------------------------------------------------------------------------------------------
Profit from ordinary activities after tax 1,212 1,446
Loss/(profit) attributable to minority interests 4.14 6 (67)
------------------------------------------------------------------------------------------------------------------------
Profit attributable to equity holders of the Company 1,218 1,379
========================================================================================================================
p p
------------------------------------------------------------------------------------------------------------------------
Earnings per share 3.11
Based on operating profit from continuing operations after tax attributable to equity holders 9.81 13.45
Based on profit attributable to equity holders of the Company 18.90 21.27
Diluted earnings per share 3.11
Based on operating profit from continuing operations after tax attributable to equity holders 9.76 13.36
Based on profit attributable to equity holders of the Company 18.80 21.12
========================================================================================================================
========================================================================================================================
Page 21
Consolidated balance sheet
--------------------------
As at 31 December 2007
2007 2006
Notes £m £m
------------------------------------------------------------------------------------------------------------------------
Assets
Investments 276,438 213,228
Long term in-force business asset 3,041 2,529
Other assets 4,828 4,614
------------------------------------------------------------------------------------------------------------------------
284,307 220,371
========================================================================================================================
Equity and liabilities
Shareholders' equity 3.13/3.14 8,468 7,931
Minority interests 4.14 178 414
------------------------------------------------------------------------------------------------------------------------
Total equity 8,646 8,345
Subordinated borrowings 4.13 1,461 818
Unallocated divisible surplus 1,721 2,178
Participating contract liabilities 18,849 19,770
Non-participating contract liabilities 247,779 183,618
Senior borrowings 4.13 1,327 1,607
Other liabilities and provisions 4,524 4,035
------------------------------------------------------------------------------------------------------------------------
284,307 220,371
========================================================================================================================
Consolidated statement of recognised income and expense
-------------------------------------------------------
For the year ended 31 December 2007
2007 2006
£m £m
------------------------------------------------------------------------------------------------------------------------
Fair value losses on cash flow hedges - (3)
Exchange differences on translation of overseas operations 18 (41)
Actuarial (losses)/gains on defined benefit pension schemes (23) 3
Actuarial losses/(gains) on defined benefit pension schemes transferred to unallocated divisible
surplus 16 (1)
------------------------------------------------------------------------------------------------------------------------
Income/(expense) recognised directly in equity, net of tax 11 (42)
Profit from ordinary activities after tax 1,212 1,446
------------------------------------------------------------------------------------------------------------------------
Total recognised income and expense 1,223 1,404
========================================================================================================================
Attributable to:
Minority interests (6) 67
Equity holders of the Company 1,229 1,337
========================================================================================================================
========================================================================================================================
Page 22
Notes to the Financial Statements
---------------------------------
3.01 Capital review
-------------------
Conversion of Legal & General Pensions Limited (LGPL) to an Insurance Special Purpose Vehicle (ISPV)
----------------------------------------------------------------------------------------------------
On 1 November 2007, LGPL was converted to an ISPV and repaid subordinated debt of £400m to Legal & General Assurance
Society Limited (Society).
Society's long term fund restructure
------------------------------------
In December 2007, the Group implemented a new capital structure for Society.
A key component was the removal of the transfer formula which has limited the annual amounts of distribution from
Society's long term fund since 1996. As part of the restructure, it was also announced that the 1996 Sub-fund (£321m)
was merged into the Shareholder Retained Capital (SRC). Society's Board of Directors has undertaken to maintain an
initial £500m of assets within Society to support the with-profits business. The amount of the commitment will gradually
reduce to zero over a period not exceeding ten years.
The removal of the formula and the merger of the 1996 Sub-fund with the SRC have removed significant dividing lines
between the pools of shareholder capital within Society. From 2007, all the shareholder assets supporting the UK non
profit life and pensions businesses have been aggregated for reporting purposes and designated 'Society Shareholder
Capital'. This comprises the SRC (including the merged 1996 Sub-fund), and all Society's shareholder capital held
outside the long term fund and in LGPL.
For 2007, £1.7bn (2006: £272m) has been transferred from the SRC into the shareholder capital held outside Society's
long term fund.
Financial impacts of ISPV conversion and Society's long term fund restructure
-----------------------------------------------------------------------------
The effects of the changes on the EEV financial statements are shown in the table below:
Long Tax
ISPV term fund impact of
conver- restru- restruc-
sion(1) ture(2,3) ture(4) Total
£m £m £m £m
------------------------------------------------------------------------------------------------------------------------
Profit from continuing operations before tax 156 5 - 161
Embedded value 112 4 206 322
========================================================================================================================
1. The conversion of LGPL to an ISPV resulted in an increase in embedded value of £112m and an increase in profit before
tax of £156m. This reflects the removal of the requirement to hold a solvency margin in the ISPV and the consequent
reduction in the modelled cost of solvency capital.
2. In Society, the SRC and 1996 Sub-fund have either been required to cover the EU solvency margin or regarded as
encumbered due to the restrictions over distribution. Following the restructure, these assets are no longer
encumbered and are valued at market value less the anticipated tax charge. The Group has previously modelled EEV
operating profit assuming the SRC is released into surplus over a period of 20 years. It is assumed that the
remainder of the SRC is distributed over two years with the exception of the contingent loan balance with LGPL which
is assumed to be distributed as it is repaid.
3. To take account of the more flexible nature of the capital in Society, the assets modelled to cover the required
capital now reflect the average investment mix of the total Society Shareholder Capital which, as a result, includes
a higher proportion of fixed interest investments.
4. The transfer from the SRC into the Society Shareholder Capital held outside Society's long term fund at the end of
2007 did not give rise to any incremental tax. The tax impact on future distributions of SRC assets has been modelled
using marginal tax rates of between 10% and 12%.
The combined impact for the four factors above on both contribution from new business after cost of capital and
operating profit was an increase of £12m.
Following the restructure, the shareholder net worth (SNW) of the UK life and pensions business has been redefined to
include the shareholder capital held outside the long term fund. The longer term investment return earned on these
assets of £52m (2006: £104m) is included in UK contribution from SNW for 2007. In the segmental analysis of ordinary
shareholders' equity, the shareholder capital held outside the long term fund of £2,109m (2006: £1,307m) has been
reallocated to UK life and pensions covered business at the balance sheet date. Prior year comparatives have not been
restated to reflect this reclassification.
========================================================================================================================
Page 23
3.02 Profit from continuing operations after tax from covered business
----------------------------------------------------------------------
UK Interna- Life and Investment Total
tional pensions manage-
total ment(1)
For the year ended 31 December 2007 Notes £m £m £m £m £m
------------------------------------------------------------------------------------------------------------------------
Contribution from new business after cost of capital 321 38 359 109 468
Contribution from in-force business:
- expected return(2) 262 80 342 30 372
- experience variances 3.04 98 3 101 21 122
- operating assumption changes 3.05 (239) 2 (237) 9 (228)
Development costs (41) - (41) (2) (43)
Contribution from shareholder net worth(3) 319 13 332 8 340
------------------------------------------------------------------------------------------------------------------------
Operating profit 720 136 856 175 1,031
Variation from longer term investment return(4) 128 (8) 120 4 124
Effect of economic assumption changes 70 (18) 52 5 57
Corporate restructure(5) 161 - 161 - 161
------------------------------------------------------------------------------------------------------------------------
Profit from continuing operations before tax 1,079 110 1,189 184 1,373
Tax (287) (32) (319) (52) (371)
Effect of UK Budget tax changes 3.10 86 - 86 7 93
Tax impact of corporate restructure(5) 3.10 206 - 206 - 206
------------------------------------------------------------------------------------------------------------------------
Profit from continuing operations after tax 1,084 78 1,162 139 1,301
========================================================================================================================
For the year ended 31 December 2006
------------------------------------------------------------------------------------------------------------------------
Contribution from new business after cost of capital 380 38 418 61 479
Contribution from in-force business:
- expected return 323 70 393 24 417
- experience variances 3.04 41 19 60 34 94
- operating assumption changes 3.05 5 17 22 26 48
Development costs (21) - (21) (1) (22)
Contribution from shareholder net worth 146 12 158 7 165
------------------------------------------------------------------------------------------------------------------------
Operating profit 874 156 1,030 151 1,181
Variation from longer term investment return(4) 387 (21) 366 13 379
Effect of economic assumption changes (5) 7 2 - 2
Corporate restructure(5) (216) - (216) - (216)
------------------------------------------------------------------------------------------------------------------------
Profit from continuing operations before tax 1,040 142 1,182 164 1,346
Tax (337) (45) (382) (49) (431)
Tax impact of corporate restructure(5) 3.10 322 - 322 - 322
------------------------------------------------------------------------------------------------------------------------
Profit from continuing operations after tax 1,025 97 1,122 115 1,237
========================================================================================================================
1. For covered business, Investment management comprises managed pension funds and is included in the total Investment
management result of £196m (2006: £181m). See Note 3.08.
2. The UK expected return on in-force is based on the unwind of the discount rate on the opening, adjusted base value of
in-force (VIF). The opening base VIF was £2,428m in 2007. This is adjusted for the effects of opening model changes
(£52m) to give an adjusted opening base VIF of £2,480m. This is then multiplied by the opening risk discount rate of
7.6% and the result grossed up at the notional attributed tax rate of 28% to give a return of £262m.
3. The UK contribution from shareholder net worth (SNW) of £319m is based on a mechanical calculation from opening
balance sheet values. It reflects a different treatment for that part of the SNW which is discounted for the time
value of money and that which is held at face value.
The first element (£277m) is based on the unwind of the discount rate on the opening, adjusted base SNW.
• The base SNW was £2,608m in 2007.
• This is adjusted for the effects of opening model changes (£18m) to give an adjusted opening base SNW of
£2,626m.
• The adjusted opening base SNW is multiplied by the opening risk discount rate of 7.6% and the result grossed up
at the notional attributed tax rate of 28% to give a return of £277m.
The second element (£99m) is the pre-tax smoothed investment return on other SNW assets held at face value. This
is offset by pre-tax corporate expenses charged to shareholders' funds of £13m.
In 2007, the contribution from SNW was also adjusted for modelling changes and second order tax effects of negative
£44m (£32m net of the notional attributed tax rate of 28%).
4. UK life and pensions variation from longer term investment return comprises £246m (2006: £185m) relating to the value
of in-force business and negative £118m (2006: £202m) relating to SNW.
5. Further details relating to the Capital review can be found in Note 3.01.
========================================================================================================================
Page 24
3.03 Life and pensions operating profit
---------------------------------------
2007 2006
£m £m
------------------------------------------------------------------------------------------------------------------------
UK 720 874
USA 75 89
Netherlands 32 45
France 29 22
------------------------------------------------------------------------------------------------------------------------
856 1,030
========================================================================================================================
3.04 Analysis of experience variances
-------------------------------------
UK Interna- Life and Investment Total
tional pensions manage-
total ment
For the year ended 31 December 2007 £m £m £m £m £m
------------------------------------------------------------------------------------------------------------------------
Persistency (25) (1) (26) 5 (21)
Mortality/morbidity 36 16 52 - 52
Expenses (19) 1 (18) (8) (26)
Other 106 (13) 93 24 117
------------------------------------------------------------------------------------------------------------------------
98 3 101 21 122
========================================================================================================================
2007 UK other experience variances of £106m principally comprise the impact of introducing market referenced fees for
the investment management services provided to Society's with-profits business by Legal & General Investment Management
(£83m), which are recognised on a look through basis.
2007 Investment management other experience variances of £24m relates primarily to the effect of higher than assumed
'other income' and average fees.
For the year ended 31 December 2006
------------------------------------------------------------------------------------------------------------------------
Persistency (15) 2 (13) 12 (1)
Mortality/morbidity 10 (9) 1 - 1
Expenses 2 - 2 - 2
Other 44 26 70 22 92
------------------------------------------------------------------------------------------------------------------------
41 19 60 34 94
========================================================================================================================
2006 UK other experience variances of £44m principally comprise the impact of the release of prudent margins as more
data is loaded onto the BPA administration system (£33m) and opening adjustments (£34m) primarily to reflect a revision
of assessments of prior and future tax. These opening adjustments had a broadly neutral effect on the embedded value,
with the positive variance here being offset by a negative variance in the contribution from shareholder net worth. This
is partially offset by differences between actual and modelled tax and an increase in deferred tax provisions (-£21m).
2006 International other experience variances relate primarily to the impact of Triple X financing.
2006 Investment management other experience variances of £22m relate primarily to the effect of higher than assumed
average fee rates.
========================================================================================================================
Page 25
3.05 Analysis of operating assumption changes
---------------------------------------------
UK Interna- Life and Investment Total
tional pensions manage-
total ment
For the year ended 31 December 2007 £m £m £m £m £m
------------------------------------------------------------------------------------------------------------------------
Persistency (41) (4) (45) - (45)
Mortality/morbidity (191) 21 (170) - (170)
Expenses (32) (4) (36) (12) (48)
Other 25 (11) 14 21 35
------------------------------------------------------------------------------------------------------------------------
(239) 2 (237) 9 (228)
========================================================================================================================
2007 UK mortality/morbidity operating assumption changes of -£191m relate primarily to the strengthening of assumptions
for annuitant mortality (-£269m) offset by a change in assumptions for the proportion of annuitants married (£42m) and
improved mortality on individual protection and other products (£36m).
2007 Investment management other operating assumption changes of £21m primarily arise from the continuation of the ten
year lapse assumption for all contracts through the extension of the modelling period.
For the year ended 31 December 2006
------------------------------------------------------------------------------------------------------------------------
Persistency (12) 21 9 - 9
Mortality/morbidity (5) (7) (12) - (12)
Expenses (80) 4 (76) (1) (77)
Other 102 (1) 101 27 128
------------------------------------------------------------------------------------------------------------------------
5 17 22 26 48
========================================================================================================================
2006 UK expenses of -£80m relate to an assumed increase in future expenses in relation to the management of existing
protection policies (-£33m) and an anticipated rise in investment management costs (-£40m). The latter relates to the
move to new City premises in 2007 and the development of our structured solutions and US based fixed income teams.
2006 UK other operating assumption changes of £102m primarily relate to the impact of PS 06/14 on realistic protection
reserving after the recapture of financial reinsurance (£64m) and changes to annuity investment policy (£19m), together
with a reassessment of future reserve releases as data is loaded onto the BPA administration system (£23m).
2006 Investment management other operating assumption changes of £27m arise from the continuation of the ten year lapse
assumption for all contracts through the extension of the modelling period (£15m) coupled with higher fee and income
assumptions (£12m).
3.06 Variation from longer term investment return
-------------------------------------------------
2007 2006
£m £m
------------------------------------------------------------------------------------------------------------------------
Total covered business(1) 124 379
Investment management(2) - (1)
General insurance (9) (7)
Other operational income 1 89
------------------------------------------------------------------------------------------------------------------------
116 460
========================================================================================================================
1. 2007 includes the variation from longer term investment return on total Society Shareholder Capital. Further details
relating to the Capital review can be found in Note 3.01.
2. Non-covered Investment management business.
3.07 Time value of options and guarantees
-----------------------------------------
2007 2006
£m £m
------------------------------------------------------------------------------------------------------------------------
Life and pensions
UK non profit 4 4
UK with-profits 1 2
International 13 12
------------------------------------------------------------------------------------------------------------------------
18 18
========================================================================================================================
========================================================================================================================
Page 26
3.08 Investment management income statement
-------------------------------------------
2007 2006
£m £m
------------------------------------------------------------------------------------------------------------------------
From continuing operations(1)
Managed pension funds 175 151
Private equity - 4
Property 6 6
Retail investments 8 11
Other income(2) 7 9
------------------------------------------------------------------------------------------------------------------------
Operating profit from investment management 196 181
Variation from longer term investment return 4 13
Effect of economic assumption changes 5 -
------------------------------------------------------------------------------------------------------------------------
Profit on ordinary activities before tax 205 194
Tax(3) (53) (58)
------------------------------------------------------------------------------------------------------------------------
Profit on ordinary activities after tax 152 136
========================================================================================================================
Investment management comprises the managed pension funds business on an EEV basis and other investment management
business on an IFRS basis.
1. Operating profit in 2007 excludes £23m of profits arising from the provision of investment management services at
market referenced rates to the covered business. These are reported on a look through basis and as a consequence are
included in the UK life and pensions covered business on an EEV basis.
2. Other income excludes the element relating to managed pension funds on the IFRS basis.
3. 2007 includes the effect of UK Budget tax changes of £7m.
3.09 Other operational income
-----------------------------
2007 2006
£m £m
------------------------------------------------------------------------------------------------------------------------
Shareholders' other income
Investment return on shareholders' equity(1) 51 134
Interest expense(2) (119) (106)
------------------------------------------------------------------------------------------------------------------------
(68) 28
Other operations(3) 1 (2)
Unallocated corporate and development expenses (6) (13)
------------------------------------------------------------------------------------------------------------------------
(73) 13
========================================================================================================================
1. Investment return on shareholders' equity in 2007 excludes investment return on Society Shareholders Capital, which
is included in UK life and pensions.
2. Interest expense relates to average borrowings (excluding non-recourse financing) for 2007 (see Note 4.13).
3. Principally the regulated mortgage network and Cofunds.
========================================================================================================================
Page 27
3.10 Tax
--------
Analysis of tax
---------------
Profit/ Tax Profit/ Tax
(loss) (charge)/ (loss) (charge)/
before credit before credit
tax tax
2007 2007 2006 2006
£m £m £m £m
------------------------------------------------------------------------------------------------------------------------
From continuing operations
UK life and pensions 720 (232) 874 (262)
International life and pensions 136 (40) 156 (51)
------------------------------------------------------------------------------------------------------------------------
856 (272) 1,030 (313)
Investment management 196 (57) 181 (54)
General insurance (67) 19 9 (2)
Other operational income (73) 30 13 8
------------------------------------------------------------------------------------------------------------------------
Operating profit 912 (280) 1,233 (361)
Variation from longer term investment return 116 12 460 (128)
Effect of economic assumption changes 57 (14) 2 2
Property (expense)/income attributable to minority interests (6) - 67 -
Corporate restructure(1) 161 (45) (216) 65
------------------------------------------------------------------------------------------------------------------------
Profit from continuing operations before tax / Tax 1,240 (327) 1,546 (422)
========================================================================================================================
1. Further details relating to the Capital review can be found in Note 3.01.
For the purposes of grossing up the movement in the UK embedded value to report pre-tax profits, the notional attributed
tax rate was 28% (2006: 30%).
Effect of UK Budget tax changes
-------------------------------
The Finance Act 2007 contained two measures which increased the UK embedded value by £93m. The reduction in the UK
corporation tax rate from 30% to 28% with effect from 1 April 2008 increased the post-tax profits from the UK life and
pensions and managed pension funds businesses reported on an EEV basis over the projection period. The effect was to
increase the UK embedded value by £101m. This was offset by a reduction of £8m from the requirement to tax the loan
interest payable by LGPL to the SRC at the full UK corporation tax rate.
Tax impact of corporate restructure
-----------------------------------
There was no incremental tax for 2007 on the transfer of the SRC, whereas marginal tax rates of between 10% and 12% had
been assumed for 2006. The favourable impact on EEV was £206m. For 2006, the favourable impact of £322m arose primarily
from the reversal of the effect of the UK tax changes reported in 2005.
========================================================================================================================
Page 28
3.11 Earnings per share
-----------------------
(a) Earnings per share
-----------------------
Profit Tax Profit Per Profit/ Tax Profit/ Per
before (charge)/ after share (loss) (charge)/ (loss) share
tax credit tax before credit after
tax tax
2007 2007 2007 2007 2006 2006 2006 2006
£m £m £m p £m £m £m p
------------------------------------------------------------------------------------------------------------------------
Operating profit from
continuing operations 912 (280) 632 9.81 1,233 (361) 872 13.45
Variation from longer term
investment return 116 12 128 1.99 460 (128) 332 5.12
Effect of economic assumption
changes 57 (14) 43 0.67 2 2 4 0.06
Corporate restructure 161 (45) 116 1.80 (216) 65 (151) (2.33)
Effect of UK Budget tax
changes - 93 93 1.44 - - - -
Tax impact of corporate
restructure - 206 206 3.19 - 322 322 4.97
------------------------------------------------------------------------------------------------------------------------
Earnings per share based on
profit attributable to
equity holders 1,246 (28) 1,218 18.90 1,479 (100) 1,379 21.27
========================================================================================================================
(b) Diluted earnings per share
------------------------------
(i) Based on operating profit from continuing operations after tax
Profit Number Per Profit Number Per
after of share after of share
tax shares(1) tax shares(1)
2007 2007 2007 2006 2006 2006
£m m p £m m p
------------------------------------------------------------------------------------------------------------------------
Operating profit from continuing operations
after tax 632 6,444 9.81 872 6,483 13.45
Net shares under options allocable for no further
consideration - 34 (0.05) - 46 (0.09)
------------------------------------------------------------------------------------------------------------------------
Diluted earnings per share 632 6,478 9.76 872 6,529 13.36
========================================================================================================================
(ii) Based on profit attributable to equity holders of the Company
Profit Number Per Profit Number Per
after of share after of share
tax shares(1) tax shares(1)
2007 2007 2007 2006 2006 2006
£m m p £m m p
------------------------------------------------------------------------------------------------------------------------
Profit attributable to equity holders of the
Company 1,218 6,444 18.90 1,379 6,483 21.27
Net shares under options allocable for no further
consideration - 34 (0.10) - 46 (0.15)
------------------------------------------------------------------------------------------------------------------------
Diluted earnings per share 1,218 6,478 18.80 1,379 6,529 21.12
========================================================================================================================
The number of shares in issue at 31 December 2007 was 6,296,321,160 (2006: 6,532,261,961).
1. Weighted average number of shares.
========================================================================================================================
Page 29
3.12 Embedded value reconciliation
----------------------------------
UK UK UK Interna- Life and Investment Total
value of share- life and tional pensions manage-
in-force holder net pensions life and total ment(2)
worth(1) pensions
As at 31 December 2007 Notes £m £m £m £m £m £m £m
------------------------------------------------------------------------------------------------------------------------
At 1 January
Value of in-force business
(VIF) 2,428 - 2,428 652 3,080 281 3,361
Shareholder net worth (SNW) - 3,828 3,828 261 4,089 194 4,283
------------------------------------------------------------------------------------------------------------------------
2,428 3,828 6,256 913 7,169 475 7,644
Exchange rate movements - - - 28 28 - 28
------------------------------------------------------------------------------------------------------------------------
2,428 3,828 6,256 941 7,197 475 7,672
Profit for the period:
-------------------------------------
- New business : : : :
contribution : 510 : (279): 231 :
- Expected return on VIF : 189 : - : 189 :
- Expected return : : : :
- transfer to SNW : (331): 331 : - :
- Movement in contingent : : : :
loan(3) : (108): 108 : - :
- Experience variances : 64 : 7 : 71 :
- Operating assumption : : : :
changes : (23): (179): (202):
- Development costs : - : (34): (34):
- Expected return on SNW : - : 233 : 233 :
- Investment variances : 195 : (57): 138 :
- Economic assumption : : : :
changes : (97): 147 : 50 :
- Effect of UK Budget : : : :
tax changes : 48 : 38 : 86 :
- Corporate restructure(4) : 45 : 71 : 116 :
- Tax impact of : : : :
corporate restructure : - : 206 : 206 :
-------------------------------------
Profit for the period(5) 492 592 1,084 78 1,162 139 1,301
Capital movements(6) - (590) (590) 84 (506) - (506)
Other capital movements(1) - 1,307 1,307 - 1,307 - 1,307
Distributions:
-------------------------------------
- With-profits transfer : (74): 74 : - :
- Dividend to Group : - : (728): (728):
-------------------------------------
Distributions (74) (654) (728) (2) (730) (52) (782)
Other reserve movements
including pension
deficit - (20) (20) - (20) - (20)
Transfer to non-covered
business(7) - (16) (16) - (16) - (16)
------------------------------------------------------------------------------------------------------------------------
Embedded value 3.13/3.14 2,846 4,447 7,293 1,101 8,394 562 8,956
========================================================================================================================
Represented by:
Non profit 2,056 2,056
With-profits 790 790
------------------------------------------------------------------------------------------------------------------------
Value of in-force
business 2,846 - 2,846 782 3,628 340 3,968
Shareholder net worth - 4,447 4,447 319 4,766 222 4,988
========================================================================================================================
1. In previous periods, UK SNW represented the amounts in the Society long term fund and LGPL shareholder capital which
were regarded as either required capital or free surplus held within the covered business. As a consequence of the
Capital review, from 2007, all shareholder capital in Society and LGPL is included as SNW within the covered
business. This notional transfer of the previously excluded Society Shareholder Capital (SSC) into UK SNW is included
as Other capital movements in 2007.
2. Investment management covered business comprises managed pension funds and is included in the total Investment
management shareholders' equity of £689m (2006: £592m).
3. On an EEV basis, the contingent loan (between Society and LGPL) is modelled as an asset of SNW. As profits from the
in-force business of LGPL are earned, cash is realised and transferred to SNW and the contingent loan asset is
reduced accordingly. The movement includes both repayment of capital relating to in-force business and drawdown of
loan relating to new business written in the period.
4. Further details relating to the Capital review can be found in Note 3.01.
5. Included in the profit for the period is an inter-fund transfer from non profit (included in VIF) to SSC (included in
SNW) of £60m.
6. Capital movements comprise the repayment of £602m of intra-group subordinated debt, offset by £57m ($114m) of capital
injected into the USA and £39m injected into Legal & General International (Ireland) from Group, together with £27m
(€40m) injected into France from Society.
7. The transfer to non-covered business represents the IFRS profits arising in the period from the provision of
investment management services by Legal & General Investment Management to the UK life and pensions covered business,
which have been included in the operating profit of the covered business on the look through basis.
========================================================================================================================
Page 30
3.12 Embedded value reconciliation (continued)
----------------------------------------------
UK UK UK Interna- Life and Investment Total
value of share- life and tional pensions manage-
in-force holder net pensions life and total ment(2)
worth(1) pensions
As at 31 December 2006 Notes £m £m £m £m £m £m £m
------------------------------------------------------------------------------------------------------------------------
At 1 January
Value of in-force business
(VIF) 3,142 - 3,142 570 3,712 238 3,950
Shareholder net worth (SNW) - 1,762 1,762 298 2,060 184 2,244
------------------------------------------------------------------------------------------------------------------------
3,142 1,762 4,904 868 5,772 422 6,194
Exchange rate movements - - - (78) (78) - (78)
------------------------------------------------------------------------------------------------------------------------
3,142 1,762 4,904 790 5,694 422 6,116
Profit for the period:
-------------------------------------
- New business : : : :
contribution : 485 : (219): 266 :
- Expected return on VIF : 226 : - : 226 :
- Expected return : : : :
- transfer to SNW : (293): 293 : - :
- Experience variances : (160): 161 : 1 :
- Operating assumption : : : :
changes : (284): 286 : 2 :
- Development costs : - : (14): (14):
- Expected return on SNW : - : 112 : 112 :
- Investment variances : (56): 320 : 264 :
- Economic assumption : : : :
changes : (5): 2 : (3):
- Corporate restructure : (561): 410 : (151):
- Tax impact of : : : :
corporate restructure : - : 322 : 322 :
-------------------------------------
Profit for the period(3) (648) 1,673 1,025 97 1,122 115 1,237
Capital movements(4) - 698 698 31 729 - 729
Distributions:
-------------------------------------
- Non profit : : (110): (110):
- With-profits transfer : (66): : (66):
- SNW : : (162): (162):
- Subordinated debt : : (24): (24):
-------------------------------------
Distributions (66) (296) (362) (5) (367) (62) (429)
Other reserve movements
including pension
deficit - (9) (9) - (9) - (9)
------------------------------------------------------------------------------------------------------------------------
Embedded value 3.13/3.14 2,428 3,828 6,256 913 7,169 475 7,644
========================================================================================================================
Represented by:
Non profit 1,643 1,643
With-profits 785 785
------------------------------------------------------------------------------------------------------------------------
Value of in-force
business 2,428 - 2,428 652 3,080 281 3,361
Shareholder net worth - 3,828 3,828 261 4,089 194 4,283
========================================================================================================================
1. UK SNW represented the amounts in the Society long term fund and LGPL shareholder capital which are regarded as
either required capital or free surplus held within the covered business.
2. Investment management covered business comprises managed pension funds and is included in the total investment
management shareholders' equity of £592m.
3. Included in the profit for the period is an inter-fund transfer from non profit (included in VIF) to SRC (included in
SNW) of £1,222m.
4. Capital movements comprise £300m equity capital, £600m capital contribution and £400m of intra-group subordinated
debt attributed to LGPL, less the repayment of £602m of intra-group subordinated debt previously attributed to the
SRC.
========================================================================================================================
Page 31
3.13 Analysis of shareholders' equity
-------------------------------------
UK(1) Interna- Life and Investment Other Total
tional pensions manage- opera-
total ment(2) tions(3)
As at 31 December 2007 £m £m £m £m £m £m
------------------------------------------------------------------------------------------------------------------------
Analysed as:
IFRS basis shareholders' equity 4,832 880 5,712 222 (488) 5,446
Additional retained profit on an EEV basis 2,461 221 2,682 340 - 3,022
------------------------------------------------------------------------------------------------------------------------
Shareholders' equity on an EEV basis 7,293 1,101 8,394 562 (488) 8,468
========================================================================================================================
Comprising:
Shareholder net worth
- Free surplus 3,249 140 3,389 198
- Required capital to cover solvency margin 1,198 179 1,377 24
Value of in-force
- Value of in-force business 2,944 840 3,784 347
- Cost of capital (98) (58) (156) (7)
========================================================================================================================
As at 31 December 2006
------------------------------------------------------------------------------------------------------------------------
Analysed as:
IFRS basis shareholders' equity 4,213 731 4,944 194 287 5,425
Additional retained profit on an EEV basis 2,043 182 2,225 281 - 2,506
------------------------------------------------------------------------------------------------------------------------
Shareholders' equity on an EEV basis 6,256 913 7,169 475 287 7,931
========================================================================================================================
Comprising:
Shareholder net worth
- Free surplus 652 110 762 176
- Required capital to cover solvency margin 1,362 151 1,513 18
- Other required capital 1,814 - 1,814 -
Value of in-force
- Value of in-force business 2,572 703 3,275 286
- Cost of capital (144) (51) (195) (5)
========================================================================================================================
Free surplus is the value of any capital and surplus allocated to, but not required to support, the in-force covered
business at the valuation date.
1. 2007 includes total Society Shareholder Capital. Further details relating to the Capital review can be found in Note
3.01.
2. Investment management comprises managed pension funds and is included in the total Investment management
shareholders' equity of £689m (2006: £592m).
3. Other Investment management businesses included on an IFRS basis of £127m (2006: £117m) are included in Other
operations.
========================================================================================================================
Page 32
3.14 Segmental analysis of shareholders' equity
-----------------------------------------------
Covered Other Total Covered Other Total
business business business business
EEV basis IFRS basis EEV basis IFRS basis
2007 2007 2007 2006 2006 2006
£m £m £m £m £m £m
------------------------------------------------------------------------------------------------------------------------
UK life and pensions(1) 7,293 - 7,293 6,256 1,307 7,563
Embedded value of international life and
pensions business
- USA(2) 645 - 645 552 - 552
- Netherlands 270 - 270 228 - 228
- France(2) 186 - 186 133 - 133
------------------------------------------------------------------------------------------------------------------------
8,394 - 8,394 7,169 1,307 8,476
Investment management 562 127 689 475 117 592
------------------------------------------------------------------------------------------------------------------------
8,956 127 9,083 7,644 1,424 9,068
General insurance - 114 114 - 169 169
Corporate funds(3) - (729) (729) - (1,306) (1,306)
------------------------------------------------------------------------------------------------------------------------
8,956 (488) 8,468 7,644 287 7,931
========================================================================================================================
Further analysis of the covered business is included in Note 3.12.
2007 2006
£m £m
------------------------------------------------------------------------------------------------------------------------
Movement
As at 1 January 7,931 6,970
Total recognised income and expense 1,229 1,337
Issue of share capital 4 15
Share buyback (320) -
Net movements in employee scheme shares 1 (5)
Dividend distributions to equity holders of the Company during the year (369) (349)
Other reserve movements including pension deficit (8) (9)
Fair value loss after tax on reclassification of subordinated borrowings as debt - (28)
------------------------------------------------------------------------------------------------------------------------
As at 31 December 8,468 7,931
========================================================================================================================
1. Further details relating to the Capital review can be found in Note 3.01.
2. Includes capital of £57m ($114m) injected into the USA and £27m (€40m) injected into France.
3. Corporate funds include investments, subordinated borrowings and senior borrowings. The increase in Corporate funds
primarily reflects the repayment of the subordinated debt from Society shareholder capital of £602m during the year.
3.15 Reconciliation of shareholder net worth
--------------------------------------------
UK life Total UK life Total
and and
pensions pensions
2007 2007 2006 2006
£m £m £m £m
------------------------------------------------------------------------------------------------------------------------
SNW of long term operations (IFRS basis) 4,832 5,934 3,263 5,138
Other assets (IFRS basis) - (488) 950 287
------------------------------------------------------------------------------------------------------------------------
Shareholders' equity on the IFRS basis 4,832 5,446 4,213 5,425
Purchased interests in long term business (5) (19) (7) (25)
1996 Sub-fund(1) - - 313 313
Deferred acquisition costs/deferred income liabilities (139) (751) (115) (677)
Deferred tax(2) (363) (172) (693) (520)
Other(3) 122 (4) 117 54
------------------------------------------------------------------------------------------------------------------------
Shareholder net worth on the EEV basis(3) 4,447 4,500 3,828 4,570
========================================================================================================================
1. Further details relating to the Capital review can be found in Note 3.01.
2. Deferred tax represents all tax which is expected to be paid under current legislation.
3. Other relates primarily to the different treatment of sterling reserves, other long term reserves and the non profit
result of LGPL under EEV compared with IFRS.
========================================================================================================================
Page 33
3.16 Sensitivities
------------------
In accordance with the guidance issued by the CFO Forum in October 2005 the table below shows the effect of alternative
assumptions on the long term embedded value and new business contribution.
Effect on embedded value as at 31 December 2007
As 1% lower 1% higher 1% lower 1% higher 1% higher
published risk risk interest interest equity/
discount discount rate rate property
rate rate yields
£m £m £m £m £m £m
------------------------------------------------------------------------------------------------------------------------
Life and pensions
- UK 7,293 355 (311) 182 (201) 170
- International 1,101 86 (74) 19 (23) 5
------------------------------------------------------------------------------------------------------------------------
Total life and pensions 8,394 441 (385) 201 (224) 175
Investment management 562 14 (14) (5) 5 10
------------------------------------------------------------------------------------------------------------------------
Total covered business 8,956 455 (399) 196 (219) 185
========================================================================================================================
As 10% lower 10% lower 10% lower 5% lower 5% lower
published equity/ maint- lapse mortality mortality
property enance rates (UK (other
values expenses annuities) business)
£m £m £m £m £m £m
------------------------------------------------------------------------------------------------------------------------
Life and pensions
- UK 7,293 (277) 71 78 (119) 39
- International 1,101 (8) 12 43 n/a 65
------------------------------------------------------------------------------------------------------------------------
Total life and pensions 8,394 (285) 83 121 (119) 104
Investment management 562 (23) 22 17 n/a -
------------------------------------------------------------------------------------------------------------------------
Total covered business 8,956 (308) 105 138 (119) 104
========================================================================================================================
Effect on new business contribution for the year
As 1% lower 1% higher 1% lower 1% higher 1% higher
published risk risk interest interest equity/
discount discount rate rate property
rate rate yields
£m £m £m £m £m £m
------------------------------------------------------------------------------------------------------------------------
Life and pensions
- UK 321 72 (62) 10 (19) 30
- International 38 18 (16) (1) 2 1
------------------------------------------------------------------------------------------------------------------------
Total life and pensions 359 90 (78) 9 (17) 31
Investment management 109 5 (5) (2) 2 3
------------------------------------------------------------------------------------------------------------------------
Total covered business 468 95 (83) 7 (15) 34
========================================================================================================================
As 10% lower 10% lower 10% lower 5% lower 5% lower
published equity/ maint- lapse mortality mortality
property enance rates (UK (other
values expenses annuities) business)
£m £m £m £m £m £m
------------------------------------------------------------------------------------------------------------------------
Life and pensions
- UK 321 (6) 16 28 (15) 9
- International 38 - 2 7 n/a 12
------------------------------------------------------------------------------------------------------------------------
Total life and pensions 359 (6) 18 35 (15) 21
Investment management 109 - - 5 n/a n/a
------------------------------------------------------------------------------------------------------------------------
Total covered business 468 (6) 18 40 (15) 21
========================================================================================================================
Opposite sensitivities are broadly symmetrical.
========================================================================================================================
Page 34
3.17 Assumptions
----------------
UK assumptions
--------------
The assumed future pre-tax returns on fixed interest and RPI linked securities are set by reference to redemption yields
available in the market at the end of the reporting period.
For annuities, separate returns are calculated for business sold before or after December 2006. This reflects a change
in investment policy applicable to the 2007 business, which has the aim of increasing the expected return whilst not
increasing the level of asset risk compared with the historic policy. This has been achieved through improved investment
efficiency and increased diversification through use of additional asset classes. The calculated return takes account of
derivatives and other credit instruments in the investment portfolio. During the second half of 2007, some aspects of
this revised strategy were also applied to the assets backing the inforce annuity business.
Where interest rate swaps are used to reduce risk, it is assumed that these swaps will be sold before expiry and the
proceeds reinvested in corporate bonds with a redemption yield 0.50% p.a. greater than the swap rate at that time.
The returns on fixed and index-linked securities are calculated net of an allowance for default risk which takes account
of the outstanding term of the securities. The allowances for default risk are set separately for the asset portfolios
supporting fixed and index-linked securities, and average 0.11% p.a. and 0.10% p.a. respectively across the portfolios
as a whole (0.15% p.a. and 0.10% p.a. at 31.12.2006).
Economic assumptions
--------------------
31.12.07 31.12.06 31.12.05
% p.a. % p.a. % p.a.
Equity risk premium 3.0 3.0 3.0
Property risk premium 2.0 2.0 2.0
Investment return
- Gilts:
- Fixed interest 4.5 4.6 4.1
- RPI linked 4.5 4.7 4.2
- Non gilts:
- Fixed interest 4.9 - 6.1 4.9 - 5.3 4.4 - 4.8
- RPI linked 4.9 - 5.3 4.6 - 5.1 4.2 - 4.6
- Equities 7.5 7.6 7.1
- Property 6.5 6.6 6.1
Risk margin 3.0 3.0 3.0
Risk discount rate (net of tax) 7.5 7.6 7.1
Inflation
- Expenses/earnings 4.4 4.2 3.9
- Indexation 3.4 3.2 2.9
UK life and pensions
--------------------
i. Assets are valued at market value.
ii. Future bonus rates have been set at levels which would fully utilise the assets supporting the policyholders'
portion of the with-profits business. The proportion of profits derived from with-profits business allocated to
shareholders has been assumed to be 10% throughout.
iii. The value of in-force business reflects the cost, including administration expenses, of providing for benefit
enhancement or compensation in relation to certain products.
iv. Other actuarial assumptions have been set at levels commensurate with recent operating experience, including those
for mortality, morbidity, persistency and maintenance expenses (excluding the development costs referred to
below). These are reviewed annually.
========================================================================================================================
Page 35
3.17 Assumptions (continued)
----------------------------
An allowance is made for future improvements in annuitant mortality based on experience and externally published
data. As at 31 December 2007, male annuitant mortality is assumed to improve in accordance with CMI Working
Paper 1, projection MC, with a minimum annual improvement of 1.5% for future experience, and 2.0% for statutory
reserving. Female annuitant mortality is assumed to improve in accordance with 75% of projection MC, with a
minimum annual improvement of 1.0% for future experience and 1.5% for statutory reserving. In each case, the
minimum annual improvement is assumed to reduce linearly after age 89 to zero at age 120.
On the revised basis, the best estimate of the expectation of life for a new 65 year old Male CPA annuitant is
25.1 years (31.12.06: 23.8 years). The expectation of life on the regulatory reserving basis is 26.2 years
(31.12.06: 25.1 years).
As at 31 December 2006, male annuitant mortality was assumed to improve in accordance with CMI Working Paper 1,
projection MC for future experience with a minimum annual improvement of 0.6%, and the average of projections MC
and LC for statutory reserving with a minimum annual improvement of 0.8%. Female annuitant mortality was assumed
to improve in accordance with the MC projection from CMI Working Paper 1 for statutory reserving and at 70% of
this rate for future experience, with the same underpinning minima as for males.
v. Development costs relate to strategic systems and the establishment of Legal & General International (Ireland)
Limited.
UK managed pension funds
------------------------
vi. All contracts are assumed to lapse over a 10 year period. Fees are projected on a basis which reflects current
charges or, if less, anticipated charges. New business consists of monies received from new clients and
incremental receipts from existing clients, and excludes the roll-up of the investment returns. Development costs
relate to strategic systems.
International
-------------
vii. Key assumptions:
31.12.07 31.12.06 31.12.05
% p.a. % p.a. % p.a.
USA
Reinvestment rate 5.4 5.4 5.1
Risk margin 3.0 3.0 3.0
Risk discount rate (net of tax) 7.1 7.8 7.4
Europe
Government bond return 4.4 4.0 3.3
Risk margin 3.0 3.0 3.0
Risk discount rate (net of tax) 7.4 7.0 6.3
viii. Other actuarial assumptions have been set at levels commensurate with recent operating experience, including those
for mortality, morbidity, persistency and maintenance expenses.
Tax
---
ix. EEV results are computed on an after tax basis and are grossed up by the notional attributed tax for presentation
in the income statement. The tax rate used for grossing up is the corporate tax rate in the territory concerned
which for the UK was 28% (2006: 30%). For the UK, investment return on Society shareholder capital held outside
the long term fund is calculated on a pre-tax basis.
Stochastic calculations
-----------------------
x. The time value of options and guarantees is calculated using economic and non-economic assumptions consistent with
those used for the deterministic embedded value calculations.
This section describes the models used to generate future investment simulations, and gives some sample statistics
for the simulations used. A single model has been used for UK and international business, with different economic
assumptions for each territory.
Government nominal interest rates are generated using a LIBOR Money Market Model projecting full yield curves at
annual intervals. The model provides a good fit to the initial yield curve.
The total annual returns on equities and property are calculated as the return on 1 year bonds plus an excess
return. The excess return is assumed to have a lognormal distribution. Corporate bonds are modelled separately by
credit rating using stochastic credit spreads over the risk-free rates, transition matrices and default recovery
rates. The real yield curve model assumes that the real short rate follows a mean-reverting process subject to two
normally distributed random shocks.
========================================================================================================================
Page 36
3.17 Assumptions (continued)
----------------------------
Asset classes
-------------
The significant asset classes are for:
- UK with-profits business - equities, property and fixed rate bonds of various durations;
- UK annuity business - fixed rate and index-linked bonds of various durations; and
- International business - fixed rate bonds of various durations
Summary statistics
------------------
The following table sets out means and standard deviations (StDev) of future returns as at 31 December 2007 for
the most significant asset classes. Correlations between asset classes have been set based on an internal
assessment of historical data.
10-year return 20-year return
Mean(1) StDev(2) Mean(1) StDev(2)
UK Business (Sterling)
Government bonds 4.7% 3.0% 4.7% 3.3%
Corporate bonds 5.9% 3.3% 5.8% 3.5%
Property (excess returns) 2.0% 15.1% 2.0% 14.8%
Equities (excess returns) 3.0% 20.1% 3.1% 20.3%
European Business (Euro)
Long Government bonds(3) 4.5% 4.8% 5.1% 5.0%
Short Government bonds(4) 4.5% 4.2% 5.1% 8.4%
US Business (US Dollar)
Long Government bonds(3) 4.4% 5.9% 5.1% 5.8%
1. Other than for equities and property, means are calculated as the excess of 1 year bond asset return means plus
1 year bond means. Means for the equities and property excess returns are calculated as the excess of 1 year
bond asset return means. Each mean is derived by calculating the accumulated value of a unit asset invested to
time n years for each simulation, averaging the resultant values across all simulations, then calculating the
equivalent annual return required to give this average accumulation (by taking the nth root of the average
accumulation and deducting 1).
2. Standard deviations are calculated by accumulating a unit investment for n years in each simulation, taking the
natural logarithm of the result, calculating the variance of this statistic, dividing by n and taking the
square root. Equities and property values use excess returns. The results are comparable to implied
volatilities quoted in investment markets.
3. Long term bonds are defined to be 10-year par-coupon bonds.
4. Short term bonds are defined to be 1 year duration bonds.
Risk discount rate
------------------
The risk discount rate is scenario-dependent within the stochastic projection. It is calculated by applying the
deterministic risk margin to the risk free rate in each stochastic projection.
Sensitivity calculations
------------------------
xii. A number of sensitivities have been produced on alternative assumption sets to reflect the sensitivity of the
embedded value and the new business contribution to changes in key assumptions. Relevant details relating to each
sensitivity are:
- 1% variation in discount rate - a one percentage point increase/decrease in the risk margin has been assumed in
each case (for example a 1% increase in the risk margin would result in a 4.0% risk margin).
- 1% variation in the interest rate environment - a one percentage point increase/decrease in all investment
assumptions and the risk discount rate, including consequential changes to valuation bases.
- 1% higher equity/property yields - a one percentage point increase in the assumed equity/property investment
returns, excluding any consequential changes, for example, to risk discount rates or valuation bases, has been
assumed in each case (for example a 1% increase in equity returns would increase assumed total equity returns
from 7.6% to 8.6%).
- 10% lower equity/property market values - an immediate 10% reduction in equity and property asset values.
- 10% lower maintenance expenses, excluding any consequential changes, for example, to valuation expense bases or
potentially reviewable policy fees (a 10% decrease on a base assumption of £10 per annum would result in an £9
per annum expense assumption).
- 10% lower assumed persistency experience rates, excluding any consequential changes to valuation bases,
incorporating a 10% decrease in lapse, surrender and premium cessation assumptions (a 10% decrease on a base
assumption of 7% would result in a 6.3% lapse assumption).
- 5% lower mortality and morbidity rates, excluding any consequential changes to valuation bases but including
assumed product repricing action where appropriate (for example if base experienced mortality is 90% of a
standard mortality table then, for this sensitivity, the assumption is set to 85.5% of the standard table).
The sensitivities for life and pensions business allow for any material changes to the cost of financial options
and guarantees but do not allow for any changes to reserving bases or capital requirements within the sensitivity
calculation, unless indicated otherwise above.
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