L&G FY 2005 Results Part 6
Legal & General Group PLC
17 March 2006
Part 6
Appendices
===========
I UK funds under management
------------------------------
2005 2004
£m £m
----------------------------------------------------------------------------------------------------------------------
Total investments 204,328 162,331
======================================================================================================================
Represented by
Index tracking funds:
- UK equities 58,739 49,429
- Overseas equities 36,468 26,301
- Fixed interest 23,364 20,369
- Index linked 18,906 14,544
- Cash/deposits 170 529
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Total index tracking funds 137,647 111,172
Actively managed funds 66,681 51,159
----------------------------------------------------------------------------------------------------------------------
204,328 162,331
======================================================================================================================
By investment approach
Indexed equities 95,207 75,729
Active bonds (including index
linked funds and cash) 46,419 35,456
Indexed bonds (including index
linked funds and cash) 42,440 35,442
Active equities 11,542 8,458
Property 8,388 6,851
Private equity 332 395
----------------------------------------------------------------------------------------------------------------------
204,328 162,331
======================================================================================================================
By source of business
Institutional funds under management 1:
- Managed pension funds pooled 122,116 93,989
- Managed pension funds segregated 8,921 9,318
- Other 4,069 1,781
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Total institutional funds under management 135,106 105,088
UK Operations (unit trusts - excluding life fund investment) 10,378 7,919
UK Operations (life and general insurance funds) 58,844 49,324
----------------------------------------------------------------------------------------------------------------------
204,328 162,331
======================================================================================================================
1. Excludes institutional investments in unit trust funds.
II Capital
-------------
II a Group capital resources
----------------------------
UK UK non Overseas Total Shareholders' Total
with-profits profit and PMC life equity and
business business, SRC other
and sub-fund activities
As at 31 December 2005 £m £m £m £m £m £m
-----------------------------------------------------------------------------------------------------------------------
Ordinary shareholders' equity outside the LTF1 - - 901 901 1,398 2,299
Ordinary shareholders' equity held in the LTF - 1,958 - 1,958 - 1,958
-----------------------------------------------------------------------------------------------------------------------
Capital and reserves attributable to ordinary
equity holders of the company - 1,958 901 2,859 1,398 4,257
-----------------------------------------------------------------------------------------------------------------------
Adjustments onto regulatory basis 2:
Unallocated divisible surplus 1,527 280 87 1,894 - 1,894
Other 3 (685) (207) (409) (1,301) (27) (1,328)
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Other qualifying capital:
Subordinated borrowings 4 - - - - 809 809
Internal loans 5 - 602 13 615 (615) -
Implicit item 6 - 540 - 540 - 540
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Total available capital resources 842 3,173 592 4,607 1,565 6,172
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IFRS liability analysis:
UK participating liabilities on realistic basis:
- Options and guarantees 686 - - 686 - 686
- Other policyholder obligations 18,653 - - 18,653 - 18,653
Overseas participating liabilities - - 1,317 1,317 - 1,317
Unallocated divisible surplus 1,527 280 87 1,894 - 1,894
Value of in-force
non-participating contracts (379) - - (379) - (379)
-----------------------------------------------------------------------------------------------------------------------
Participating contract liabilities 20,487 280 1,404 22,171 - 22,171
=======================================================================================================================
Unit linked non-participating life
assurance liabilities 661 4,136 820 5,617 - 5,617
Non-linked non-participating life
assurance liabilities 2,073 13,559 1,611 17,243 - 17,243
Unit linked non-participating investment
contract liabilities 6,514 7,110 122,180 135,804 - 135,804
General insurance liabilities - - - - 292 292
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Non-participating contract liabilities 9,248 24,805 124,611 158,664 292 158,956
=======================================================================================================================
1.Society shareholder capital of £1,896m (2004: £1,973m) is included within Shareholders' equity outside the Long
Term Fund (LTF).
2.Figures extracted from draft regulatory returns.
3.Shareholders' share in realistic liabilities of £690m (2004: £447m) and changes to the value of assets and
liabilities on a regulated basis of £638m (2004: £573m) are included within Other.
4.During the year the Group issued €600m of subordinated lower tier II borrowings which are treated as capital on a
regulatory basis. In 2004 the Group issued £400m of subordinated upper tier II borrowings which are also treated as
capital on a regulatory basis.
5.Legal & General Group Plc has subscribed for a total of £602m of perpetual subordinated loan stock issued by Society's
LTF. This loan qualifies as upper tier II capital of the LTF. Legal & General Overseas Holdings Limited has subscribed
for a total of €18m of perpetual subordinated loan stock issued by Legal & General Holdings (France) S.A. This loan
qualifies as hybrid capital for L&G Holdings (France) S.A.
6.The implicit item recognises profits in relation to in-force business written in the non profit part of Society's
LTF which are expected on a prudent assessment to emerge over the next 5 years. The maximum amount permitted is
determined by the FSA.
II b Movements in life business capital resources
---------------------------------------------------
2005 2005 2005 2005
UK UK non Overseas Total
with-profit profit and PMC life
business business, SRC business
and sub-fund
£m £m £m £m
----------------------------------------------------------------------------------------------------------------------
At 1 January 864 2,895 557 4,316
Effect of investment variations 294 684 42 1,020
Effect of changes in non-economic assumptions (282) (1) - (283)
Changes in management policy 72 175 - 247
Changes in regulatory requirements (121) (215) (6) (342)
New business (11) (459) (103) (573)
Cash distributions - (219) (39) (258)
Other factors 26 313 141 480
----------------------------------------------------------------------------------------------------------------------
At 31 December 842 3,173 592 4,607
======================================================================================================================
III Reconciliations
----------------------
III a Reconciliation of shareholder net worth (SNW)
----------------------------------------------------
2005 2005 2004 2004
UK life and Total UK life and Total
pensions pensions
£m £m £m £m
----------------------------------------------------------------------------------------------------------------------
SNW of long term operations (IFRS basis) 2,560 3,481 2,196 2,994
Other assets (IFRS basis) - 776 - 681
----------------------------------------------------------------------------------------------------------------------
Ordinary shareholders' equity on the IFRS basis 2,560 4,257 2,196 3,675
Purchased interests in long term business (10) (25) (13) (24)
Sub-fund 287 287 245 245
Deferred acquisition costs / income liabilities (216) (790) (242) (731)
Deferred tax 1 (810) (646) (480) (358)
Other 2 (49) (63) (146) (128)
----------------------------------------------------------------------------------------------------------------------
Shareholder net worth on the EEV basis 1,762 3,020 1,560 2,679
----------------------------------------------------------------------------------------------------------------------
Represented by:
SNW of long term operations (EEV basis) 1,762 2,244 1,560 1,998
Other assets (IFRS basis) - 776 - 681
======================================================================================================================
1.Deferred tax represents all tax which is expected to be paid under current legislation, including tax which would
arise if shareholders' assets were eventually distributed.
2.Other relates primarily to the different treatment of sterling reserves and other long term reserves under EEV
compared with IFRS.
IV New business
-----------------
IV a UK life and pensions new business APE by quarter
---------------------------------------------------------
3 months 3 months 3 months 3 months 3 months 3 months 3 months 3 months
31.12.05 30.09.05 30.06.05 31.03.05 31.12.04 30.09.04 30.06.04 31.03.04
£m £m £m £m £m £m £m £m
------------------------------------------------------------------------------------------------------------------------
Protection 46 54 54 54 51 53 65 50
Annuities 40 35 35 44 30 38 32 26
Investments
Unit linked bonds 60 54 51 43 46 36 34 26
Pensions - Stakeholder
and other non 39 41 41 31 25 20 19 18
profit
With-profits 40 38 37 35 40 44 35 34
------------------------------------------------------------------------------------------------------------------------
Total 225 222 218 207 192 191 185 154
========================================================================================================================
IV b UK life and pensions new business annual premiums by quarter
---------------------------------------------------------------------
3 months 3 months 3 months 3 months 3 months 3 months 3 months 3 months
31.12.05 30.09.05 30.06.05 31.03.05 31.12.04 30.09.04 30.06.04 31.03.04
£m £m £m £m £m £m £m £m
------------------------------------------------------------------------------------------------------------------------
Protection 46 54 54 54 51 53 65 50
Annuities - - - - - - - -
Investments
Unit linked bonds - - - - - - - -
Pensions - Stakeholder
and other non profit 26 26 26 19 18 14 15 15
With-profits 18 19 21 19 15 20 18 14
------------------------------------------------------------------------------------------------------------------------
Total 90 99 101 92 84 87 98 79
========================================================================================================================
IV c UK life and pensions new business single premiums by quarter
----------------------------------------------------------------------
3 months 3 months 3 months 3 months 3 months 3 months 3 months 3 months
31.12.05 30.09.05 30.06.05 31.03.05 31.12.04 30.09.04 30.06.04 31.03.04
£m £m £m £m £m £m £m £m
------------------------------------------------------------------------------------------------------------------------
Protection - - - - - - - -
Annuities 401 352 348 438 300 385 316 263
Investments
Unit linked bonds 599 544 505 434 462 360 335 261
Pensions - Stakeholder
and other non profit 128 146 151 124 69 59 42 33
With-profits 217 192 161 159 249 236 174 195
------------------------------------------------------------------------------------------------------------------------
Total 1,345 1,234 1,165 1,155 1,080 1,040 867 752
========================================================================================================================
IV d International life and pensions new business APE by quarter
--------------------------------------------------------------------
3 months 3 months 3 months 3 months 3 months 3 months 3 months 3 months
31.12.05 30.09.05 30.06.05 31.03.05 31.12.04 30.09.04 30.06.04 31.03.04
£m £m £m £m £m £m £m £m
------------------------------------------------------------------------------------------------------------------------
USA 12 11 9 10 13 14 15 12
Netherlands 7 8 6 8 5 6 5 7
France 6 8 17 5 5 6 13 4
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Total 25 27 32 23 23 26 33 23
========================================================================================================================
IV e International life and pensions new business annual premiums by quarter
--------------------------------------------------------------------------------
3 months 3 months 3 months 3 months 3 months 3 months 3 months 3 months
31.12.05 30.09.05 30.06.05 31.03.05 31.12.04 30.09.04 30.06.04 31.03.04
£m £m £m £m £m £m £m £m
------------------------------------------------------------------------------------------------------------------------
USA 12 11 9 10 13 14 15 12
Netherlands 3 4 3 3 3 3 3 3
France 1 3 12 1 1 2 9 1
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Total 16 18 24 14 17 19 27 16
========================================================================================================================
IV f International life and pensions new business single premiums by quarter
---------------------------------------------------------------------------------
3 months 3 months 3 months 3 months 3 months 3 months 3 months 3 months
31.12.05 30.09.05 30.06.05 31.03.05 31.12.04 30.09.04 30.06.04 31.03.04
£m £m £m £m £m £m £m £m
------------------------------------------------------------------------------------------------------------------------
USA - - - - - 1 - -
Netherlands 41 39 32 46 23 25 23 41
France 50 49 48 44 38 39 37 31
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Total 91 88 80 90 61 65 60 72
========================================================================================================================
IV g Retail investments new business APE by quarter
-------------------------------------------------------
3 months 3 months 3 months 3 months 3 months 3 months 3 months 3 months
31.12.05 30.09.05 30.06.05 31.03.05 31.12.04 30.09.04 30.06.04 31.03.04
£m £m £m £m £m £m £m £m
------------------------------------------------------------------------------------------------------------------------
UK 67 79 94 75 34 30 76 39
France - 1 1 - 1 - 1 -
------------------------------------------------------------------------------------------------------------------------
Total 67 80 95 75 35 30 77 39
========================================================================================================================
IV h Retail investments new business annual premiums by quarter
--------------------------------------------------------------------
3 months 3 months 3 months 3 months 3 months 3 months 3 months 3 months
31.12.05 30.09.05 30.06.05 31.03.05 31.12.04 30.09.04 30.06.04 31.03.04
£m £m £m £m £m £m £m £m
------------------------------------------------------------------------------------------------------------------------
UK 3 2 7 3 4 4 8 6
France - - - - - - - -
------------------------------------------------------------------------------------------------------------------------
Total 3 2 7 3 4 4 8 6
========================================================================================================================
IV i Retail investments new business single premiums by quarter
-------------------------------------------------------------------
3 months 3 months 3 months 3 months 3 months 3 months 3 months 3 months
31.12.05 30.09.05 30.06.05 31.03.05 31.12.04 30.09.04 30.06.04 31.03.04
£m £m £m £m £m £m £m £m
------------------------------------------------------------------------------------------------------------------------
UK 642 765 874 718 295 260 684 326
France 4 11 5 5 10 4 4 4
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Total 646 776 879 723 305 264 688 330
========================================================================================================================
IV j Analysis of the distribution of UK individual life and pensions product by quarter
-------------------------------------------------------------------------------------------
3 months 3 months 3 months 3 months 3 months 3 months 3 months 3 months
31.12.05 30.09.05 30.06.05 31.03.05 31.12.04 30.09.04 30.06.04 31.03.04
£m £m £m £m £m £m £m £m
------------------------------------------------------------------------------------------------------------------------
Independent financial
advisers 165 185 180 137 137 134 133 101
Tied 76 69 95 87 61 57 77 58
Direct 7 5 10 9 6 6 12 11
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Total UK individual 248 259 285 233 204 197 222 170
========================================================================================================================
Individual life and pensions 181 180 191 158 170 167 146 131
Retail investments 67 79 94 75 34 30 76 39
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Total UK individual 248 259 285 233 204 197 222 170
Group life and pensions 44 42 27 49 22 24 39 23
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Total UK 292 301 312 282 226 221 261 193
========================================================================================================================
IV k Institutional fund management new business by quarter
--------------------------------------------------------------
3 months 3 months 3 months 3 months 3 months 3 months 3 months 3 months
31.12.05 30.09.05 30.06.05 31.03.05 31.12.04 30.09.04 30.06.04 31.03.04
£m £m £m £m £m £m £m £m
------------------------------------------------------------------------------------------------------------------------
Managed pension funds 1
Pooled funds 5,129 2,939 3,396 3,314 4,252 2,089 3,198 4,412
Segregated funds 94 41 63 42 85 80 101 962
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Total managed funds 5,223 2,980 3,459 3,356 4,337 2,169 3,299 5,374
Other funds 2 1,705 351 3 57 68 230 13 57
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Total 6,928 3,331 3,462 3,413 4,405 2,399 3,312 5,431
========================================================================================================================
1.New monies from pension fund clients of Legal & General Assurance (Pensions Management) Ltd. Corporate pensions
gross new business excludes £4.1bn (2004: £5.0bn) which was held through the year on a temporary basis, generally as
part of a portfolio reconstruction.
2.Includes segregated property, property partnerships, ventures, alternative investments and institutional clients
excluding institutional trusts.
V European Embedded Value Methodology
---------------------------------------
Basis of Preparation
---------------------
The purpose of this section is to set out the detailed methodology for producing the Group's supplementary financial
statements. The statements have been prepared in accordance with the European Embedded Value (EEV) Principles issued
in May 2004 by the European CFO Forum.
These supplementary financial statements have been audited by PricewaterhouseCoopers LLP and prepared in conjunction
with our consulting actuaries - Tillinghast Towers-Perrin and, in the US, Milliman USA.
Covered Business
-----------------
The Group uses EEV methodology to value Individual and Group life assurance, pensions and annuity business written
in the UK, Continental Europe and the US and within our Investment management business, our UK managed pension funds
company.
All other business units are accounted for on the IFRS basis adopted in the primary financial statements.
Under EEV, there is no distinction made between insurance and investment contracts in our life and pensions businesses
as there is under IFRS.
Description of Methodology
--------------------------
The objective of EEV is to provide shareholders with more realistic information on the financial position and current
performance of the Group than is provided within the primary financial statements.
The methodology requires assets of an insurance company as reported in the primary financial statements to be
attributed between those supporting the covered business and the remainder. The method accounts for assets in the
covered business on an EEV basis and the remainder of the Group's assets on the IFRS basis adopted in the primary
financial statements.
The EEV methodology recognises as profit from the covered business the total of:
i. cash transfers during the relevant period from the covered business to the remainder of the Group's
assets, as determined following a statutory valuation; and
ii. the movement in the present value of the distributable profits to shareholders arising from the
covered business over the relevant reporting period.
Embedded Value
--------------
Shareholders' equity on the EEV basis comprises the embedded value of the covered business plus the balance of
shareholders' equity on the IFRS basis, less the value included for purchased interests in long term business.
The embedded value is the sum of the shareholder net worth (SNW) and the value of the in-force business (VIF). SNW
is defined as those amounts, held either in the UK Long Term Fund (LTF) or by other companies writing long term
business, which are regarded either as required capital for the covered business or which represent free surplus
within those companies.
The VIF is the present value of the distributable profits to shareholders arising from the covered business, projected
using best estimate assumptions, less an appropriate deduction for the cost of holding the required level of
capital and the time value of financial options and guarantees.
Service Companies
-----------------
All services relating to the UK life and pensions business, including investment management services, are charged
on a cost recovery basis.
New Business
-------------
New business premiums reflect income arising from the sale of new contracts during the reporting period and any
changes to existing contracts, which were not anticipated at the outset of the contract.
In-force business comprises previously written single premium, regular premium and recurrent single premium contracts.
DWP rebates have not been treated as recurrent and they are included in single premium new business when received.
New business contribution arising from the new business premiums written during the reporting period has been
calculated on the same economic and operating assumptions used in the embedded value at the end of the financial period.
This has then been rolled forward to the end of the financial period using the risk discount rate applicable at the
end of the reporting period.
Traditionally, new business margins have been defined as new business contribution at the end of the reporting period
divided by the annual premium equivalent. Under EEV a new measure, the present value of future new business premiums
(PVNBP), has been calculated and expressed at the point of sale. The PVNBP is equivalent to the total single premiums
plus the discounted value of regular premiums expected to be received over the term of the contracts using the same
economic and operating assumptions used for the embedded value at the end of the financial period. A revised new
business margin has been defined under EEV as new business contribution at the end of the reporting period divided by
the PVNBP. The premium volumes and projection assumptions used to calculate the PVNBP are the same as those used to
calculate new business contribution.
Projection Assumptions
----------------------
Cash flow projections are determined using realistic assumptions for each component of cash flow and for each policy
group. Future economic and investment return assumptions are based on year end conditions. Future investment returns
are projected by one of two methods. The first method is based on an assumed investment return attributed to assets
at their market value. The second, which is used in the US, where the investments of that subsidiary are substantially
all fixed interest, projects the cash flows from the current portfolio of assets and assumes an investment return on
reinvestment of surplus cash flows. The assumed discount and inflation rates are consistent with the investment return
assumptions.
Detailed projection assumptions including mortality, persistency, morbidity and expenses reflect recent operating
experience and are reviewed annually. Allowance is made for future improvements in annuitant mortality based on
experience and externally published data. Favourable changes in operating experience are not anticipated until the
improvement in experience has been observed.
All costs relating to the covered business, whether incurred in the covered business or elsewhere in the Group, are
allocated to that business. The expense assumptions used for the cashflow projections therefore include the full cost
of servicing this business.
Tax
---
The projections take into account all tax which is expected to be paid under current legislation, including tax which
would arise if surplus assets within the covered business were eventually to be distributed.
Allowance for Risk
------------------
Aggregate risks within the covered business are allowed for through the following principal mechanisms:
i. Setting required capital levels with reference to both the Group's internal risk based capital
models, and an assessment of the strength of regulatory reserves in the covered business;
ii. Allowing explicitly for the time value of financial options and guarantees within the Group's
products; and
iii. Setting risk discount rates by deriving a Group level risk margin to be applied consistently to local
risk free rates.
Required Capital and Free Surplus
----------------------------------
Regulatory capital for UK life and pensions business is provided by assets backing the with-profits business or by the
SNW. The SNW comprises the Shareholder Retained Capital (SRC) and the Sub-fund.
For UK with-profits business, the required capital will be covered by the surplus within the with-profits part of the
fund and no effect will be attributed to shareholders except for the burn-through cost, which is described later. This
treatment is consistent with the Principles and Practices of Financial Management for this fund.
For UK non profit business, the required capital will be maintained at no less than the level of the EU minimum
solvency requirement. This level together with the margins for adverse deviation in the regulatory reserves is, in
aggregate, in excess of internal capital targets assessed in conjunction with the Individual Capital Adequacy (ICA)
assessment.
The SRC is either required to cover EU solvency margin or is encumbered because its distribution to shareholders is
restricted due to previous understandings with the FSA. It is therefore classified as required capital and not as free
surplus for the purposes of EEV reporting. SRC is valued by assuming it is distributed from the LTF over a 20 year
period with allowance for tax payable on distribution. For this purpose, distribution of the SRC is restricted such
that there is always sufficient SRC and subordinated debt left to cover the EU solvency margin for in-force non profit
business.
The initial strains relating to new non profit business, together with the related EU solvency margin, are supported by
releases from existing non profit business and the SRC. As a consequence, the writing of new business defers the
release of capital from the SRC to free surplus. Cost of holding required capital is defined as the difference between
the value of the required capital and the present value of future releases of that capital. For new business, the
cost of capital is taken as the difference in the value of that capital assuming it was available for release
immediately and the present value of the future releases of that capital. As the investment return, net of tax, on that
capital is less than the risk discount rate, there is a resulting cost of capital which is reflected in the value of
new business.
The Sub-fund is also treated as required capital, because its distribution to shareholders is restricted by Legal &
General Assurance Society's Articles of Association.
For our UK managed pension funds business, management's capital policy has been used to set the level of required
capital. The balance of net assets within the UK Managed Funds business is treated as free surplus.
For L&G America, the Company Action Level (CAL) of capital has been treated as required capital for modelling purposes.
The CAL is the regulatory capital level at which the company would have to take prescribed action, such as submission of
plans to the state insurance regulator, but would be able to continue operating on the existing basis. The CAL is
currently twice the level of capital at which the regulator is permitted to take control of the business.
For L&G Netherlands (LGN), required capital has been set at 100% of EU minimum solvency for all products which do not
have any related financial options and guarantees (FOGs). For those products with FOGs, capital of between 112.5% and
175% of the EU minimum solvency margin has been used. The level of capital has been determined using risk based capital
techniques.
In France (LGF), 100% of EU minimum solvency margin has been used for EV modelling purposes for all products both with
and without FOGs. The level of capital has been determined using risk based capital techniques.
The contribution from new business for our Overseas businesses reflects an appropriate allowance for the cost of
holding the required capital.
Financial Options and Guarantees
---------------------------------
In the UK, all FOGs are within the UK Life & Pensions business.
Under the EEV Principles an allowance for time value of FOGs is required where a financial option exists which is
exercisable at the discretion of the policyholder. These types of option principally arise within the with-profits
part of the fund and their time value is recognised within the with-profits burn-through cost described below.
Additional financial options for non profit business exist only for a small amount of deferred annuity business where
guaranteed early retirement and cash commutation terms apply when the policyholder chooses their actual retirement date.
Further financial guarantees exist for non profit business, in relation to index-linked annuities where capped or
collared restrictions apply. Due to the nature of these restrictions and how they vary depending on the prevailing
inflation conditions we have also treated these as FOGs and recognised a time value cost of FOG accordingly.
The time value of FOGs has been calculated stochastically using a large number of real world economic scenarios derived
from assumptions consistent with the deterministic EEV assumptions and allowing for appropriate management actions
where applicable. The management action primarily relates to the setting of bonus rates where for example future
regular and terminal bonuses on participating business within the projections are set in a manner consistent
with expected future returns available on assets deemed to back the policies within the stochastic scenarios.
In recognising the residual value of any projected surplus assets within the with-profits part of the fund in the
deterministic projection, it is assumed that terminal bonuses are increased to exhaust all of the assets in the part of
the fund over the future lifetime of the in-force with-profits policies. However, under stochastic modelling there may
be some extreme economic scenarios when the total projected assets within the with-profits part of the fund are
insufficient to pay all projected policyholder claims and associated costs. The average additional shareholder cost
arising from this shortfall has been included in the time value cost of options and guarantees and is referred to as
the with-profits burn-through cost.
The same economic scenarios have been used to assess the time value of the financial guarantees for non profit business
by using the inflation rate generated in each scenario. The inflation rate used to project index-linked annuities will
be constrained in certain real world scenarios, for example where negative inflation occurs but the annuity payments do
not reduce below pre-existing levels. The time value cost of FOGs allows for the projected average cost of these
constrained payments for the index-linked annuities and also allows for the small additional cost of the guaranteed
early retirement and cash commutation terms for the minority of deferred annuity business where such guarantees have
been written.
In the US, financial options and guarantees relate to guaranteed minimum crediting rates and surrender values on a
range of contracts. The guaranteed surrender value of the contract is based on the accumulated value of the contract
including accrued interest. The crediting rates are discretionary but related to the accounting income for the
amortising bond portfolio. The majority of the guaranteed minimum crediting rates are between 4% and 5%. The assets
backing these contracts are invested in US dollar denominated fixed interest securities.
In the Netherlands, there are two types of guarantees which have been separately provided for: interest rate guarantees
and maturity guarantees. Certain contracts provide an interest rate guarantee where there is a minimum crediting
rate based on the higher of 1-year Euribor and the policy guarantee rate. In accordance with market practice, it is
expected that guarantees will be financed from unrealised gains on assets. This guarantee applies on a monthly basis.
Certain unit linked contracts provide a guaranteed minimum value at maturity where the maturity amount is the higher
of the fund value and a guarantee amount. The fund values for both these contracts are invested in Euro denominated
fixed interest securities.
In France, financial options and guarantees which have been separately provided for relate to guaranteed minimum
crediting rates and surrender values on a range of contracts. The guaranteed surrender value of the contract is the
accumulated value of the contract including accrued bonuses. The bonuses are based on the accounting income for the
amortising bond portfolios plus income and releases from realised gains on any equity type investments. Policy
liabilities equal guaranteed surrender values. Local statutory accounting rules require the establishment of a specific
liability when the accounting income for a company is less than 125% of the guaranteed minimum credited returns,
although this has never been required. In general, the guaranteed annual bonus rates are between 1.5% and 4.5%.
Risk Discount Rate
------------------
The risk discount rate (RDR) is a combination of the risk free rate and a risk margin, which reflects the residual
risks inherent in the Group's covered businesses, after taking account of prudential margins in the statutory
provisions, the required capital and the specific allowance for financial options and guarantees.
The risk margin has been determined based on an assessment of the Group's weighted average cost of capital (WACC).
This assessment incorporates a beta for the Group, which measures the correlation of movements in the Group's share
price to movements in a relevant index. Beta values therefore allow for the market's assessment of the risks inherent
in the business relative to other companies in the chosen index.
The WACC is derived from the Group's cost of equity and debt, and the proportion of equity to debt in the Group's
capital structure measured using market values. Each of these three parameters should be forward looking, although
informed by historic information. The cost of equity is calculated as the risk free rate plus the equity risk premium
for the chosen index multiplied by the company's beta. Forward-looking or adjusted betas make allowance for the
observed tendency for betas to revert to 1 and therefore a weighted average of the historic beta and 1 tends to be a
better estimate of the company's beta for the future period. We have computed the WACC using an arithmetical average of
forward-looking betas against the FTSE 100 index.
The cost of debt used in the WACC calculations takes account of the actual locked-in rates for our senior and
subordinated long term debt. For the Group's convertible debt, which matures in 2006, the probability of conversion is
considered low given current market conditions. The cost of debt therefore assumes an equivalent long term market cost
for this debt based on 5-year swap rates rather than the actual rate of 2.75%. All debt attracts tax relief at a
rate of 30%.
Whilst the WACC approach is a relatively simple and transparent calculation to apply, subjectivity remains within a
number of the assumptions. Management believe that the chosen margin, together with the levels of required capital,
the inherent strength of the Group's regulatory reserves and the explicit deduction for the cost of options and
guarantees, is appropriate to reflect the risks within the covered business.
A similar approach will be adopted when risk margins are reassessed in future periods.
Key assumptions are set out below:
Risk free rate Derived from gross redemption yields on relevant gilt portfolio
Equity risk premium 3.0% (UK only)
Property risk premium 2.0% (UK only)
Risk margin 3.0%
The risk margin has been calculated by assuming a debt ratio of 20%, a net cost of debt of 3.9% p.a. and an average
beta of 1.3. In addition, the margin allows specifically for the risks covered by the time value of financial options
and guarantees (deduction of 0.1%).
Analysis of Profit
-------------------
Operating profit is identified at a level which reflects an assumed longer term level of investment return.
The contribution to operating profit in a period is attributed to four sources:
i. new business;
ii. the management of in-force business;
iii. development costs; and
iv. return on shareholder net worth.
Further profit contributions arise from actual investment return differing from the assumed long term investment
return (investment return variances), and from the effect of economic assumption changes.
The contribution from new business represents the value recognised at the end of each period from new business written
in that period, after allowing for the actual cost of acquiring the business and of establishing the required technical
provisions and reserves and after making allowance for the cost of capital. New business contributions are calculated
using closing assumptions.
The contribution from in-force business is calculated using opening assumptions and comprises:
i. expected return - the discount earned from the value of business in-force at the start of the year;
ii. experience variances - the variance in the actual experience over the reporting period from that
assumed in the value of business in-force as at the start of the year; and
iii. operating assumption changes - the effects of changes in future assumptions, other than changes in
economic assumptions from those used in valuing the business at the start of the year. These changes
are made prospectively from the end of the year.
Development costs are associated with investment in building a new enterprise or exceptional development activity over
a defined period.
The contribution from shareholder net worth comprises the increase in embedded value based on assumptions at the start
of the year in respect of:
i. encumbered assets within the covered business - principally the unwind of the discount rate; and
ii. residual assets - the expected investment return.
Further profit contributions arise from actual investment returns differing from the assumed long-term investment
returns (investment return variances) and from the effect of economic assumption changes.
Investment return variances represent the effect of actual investment performance and changes to investment policy on
shareholder net worth and in-force business from that assumed at the beginning of the period.
Economic assumption changes comprise the effect of changes in economic variables, beyond the control of management,
including associated changes to valuation bases to the extent that they are reflected in revised assumptions.
V1 IFRS basis of preparation
------------------------------
The Group's financial statements have been prepared in accordance with International Financial Reporting Standards
(IFRS) issued by the International Accounting Standards Board (IASB) as adopted by the European Commission (EC) for
use in the European Union effective for 2005 year ends. The Group's financial statements also comply with IFRS as
issued by the IASB.
In June 2005 the IASB issued an amendment to International Accounting Standard (IAS) 39 'Financial Instruments:
Recognition and Measurement' which restricts the use of the fair value option for both assets and liabilities unless
certain conditions are met for annual periods beginning on or after 1 January 2006. The Group has early adopted this
amendment in these financial statements. The Group has also elected to early adopt the amendments to IAS 19 'Employee
Benefits', permitting the recognition of all actuarial gains and losses immediately in equity through the Statement of
Recognised Income and Expense. The amendments to these standards have been adopted by the EC.
In accordance with IFRS 4 'Insurance Contracts', the Group continues to apply existing accounting policies to its
insurance contracts and participating investment contracts, but has the option to make improvements to its policies if
the changes make the financial statements more relevant to decision making needs of the users. The Group has elected to
make improvements to its accounting policy for participating contracts in the UK by adopting FRS 27 'Life Assurance'
issued by the UK Accounting Standards Board (ASB) in December 2004. The ASB has acknowledged the difficulty of applying
the requirements of FRS 27 retrospectively and it is the Group's view that it would be impracticable to do so.
Therefore only the balance sheet at 31 December 2004 has been restated for the impact of FRS 27. No restatements for
FRS 27 have been made to either the IFRS opening balance sheet or the 2004 income statement.
The preparation of the financial statements includes the use of estimates and assumptions that affect items reported
in the consolidated balance sheet and income statement and the disclosure of contingent assets and liabilities at the
date of the financial statements. Although these estimates are based on management's best knowledge of current
circumstances and future events and actions, actual results may differ from those estimates, possibly significantly.
The accounting policies have been consistently applied to all years presented, unless otherwise stated.
This information is provided by RNS
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