L&G FY Results 2006 - Part 3
Legal & General Group PLC
14 March 2007
Page 19
European Embedded Value
=======================
Consolidated income statement
-----------------------------
For the year ended 31 December 2006
2006 2005
Notes £m £m
------------------------------------------------------------------------------------------------------------------------
From continuing operations
Life and pensions 3.02/3.03 1,030 901
Investment management 3.08 181 136
General insurance 4.04 9 14
Other operational income 3.09 13 41
------------------------------------------------------------------------------------------------------------------------
Operating profit 1,233 1,092
Variation from longer term investment return 3.06 460 870
Effect of economic assumption changes 3.02 2 8
Property income attributable to minority interests 67 81
Corporate restructure 3.01 (216) -
------------------------------------------------------------------------------------------------------------------------
Profit from continuing operations before tax attributable to equity holders 1,546 2,051
-------------------------
Tax charge on operating profit : (361): (314):
Tax charge on other profits and losses : (61): (249):
-------------------------
Tax charge on profit from ordinary activities 3.10 (422) (563)
Effect of UK tax changes 3.11 - (276)
Tax impact of Corporate restructure 3.01/3.11 322 -
------------------------------------------------------------------------------------------------------------------------
Profit from continuing operations after tax 1,446 1,212
Profit from discontinued operations 4.09 - 13
------------------------------------------------------------------------------------------------------------------------
Profit from ordinary activities after tax 1,446 1,225
Profit attributable to minority interests 4.17 (67) (81)
-----------------------------------------------------------------------------------------------------------------------
Profit attributable to equity holders of the Company 1,379 1,144
========================================================================================================================
p p
------------------------------------------------------------------------------------------------------------------------
Earnings per share 3.12
Based on operating profit from continuing operations after tax 13.45 12.02
Based on profit attributable to ordinary equity holders of the Company 21.27 17.42
Diluted earnings per share 3.12
Based on operating profit from continuing operations after tax 13.36 11.74
Based on profit attributable to ordinary equity holders of the Company 21.12 16.89
========================================================================================================================
========================================================================================================================
Page 20
Consolidated balance sheet
--------------------------
As at 31 December 2006
2006 2005
Notes £m £m
------------------------------------------------------------------------------------------------------------------------
Assets
Investments 213,228 186,413
Long term in-force business asset 2,529 2,738
Other assets 4,614 5,427
------------------------------------------------------------------------------------------------------------------------
220,371 194,578
========================================================================================================================
Equity and liabilities
Ordinary shareholders' equity 3.14/3.15 7,931 6,970
Subordinated borrowings designated as equity 4.16 - 394
Minority interests 4.17 414 285
------------------------------------------------------------------------------------------------------------------------
Total equity 8,345 7,649
Subordinated borrowings 4.16 818 415
Unallocated divisible surplus 2,178 1,894
Participating contract liabilities 19,770 20,277
Non-participating contract liabilities 183,618 158,956
Senior borrowings 4.16 1,607 1,634
Other creditors and provisions 4,035 3,753
------------------------------------------------------------------------------------------------------------------------
220,371 194,578
========================================================================================================================
Consolidated statement of recognised income and expense
-------------------------------------------------------
For the year ended 31 December 2006
2006 2005
£m £m
------------------------------------------------------------------------------------------------------------------------
Fair value losses on cash flow hedges (3) -
Exchange differences on translation of overseas operations (41) 22
Actuarial gains/(losses) on defined benefit pension schemes 3 (55)
Actuarial (gains)/losses on defined benefit pension schemes transferred to unallocated divisible
surplus (1) 22
------------------------------------------------------------------------------------------------------------------------
Expense recognised directly in equity, net of tax (42) (11)
Profit from ordinary activities after tax 1,446 1,225
------------------------------------------------------------------------------------------------------------------------
Total recognised income and expense 1,404 1,214
========================================================================================================================
Attributable to:
Minority interests 67 81
Equity holders of the Company 1,337 1,133
========================================================================================================================
========================================================================================================================
Page 21
Notes to the Financial Statements
---------------------------------
3.01 Significant impacts
------------------------
The capital review update within the 2006 Review identifies three key initiatives implemented during the year. The
financial impact on EEV reporting is set out below.
Corporate restructuring
-----------------------
On 31 December 2006, the non-linked non profit pensions and annuity business of Legal & General Assurance Society
Limited (Society) was ceded to a new, wholly owned, reinsurance company, Legal & General Pensions Limited (LGP). The
required capital and free surplus of LGP is included in the covered business. LGP has been capitalised using £1.3bn of
Society shareholder capital, £400m of which is represented by subordinated debt (£200m upper tier II, £200m lower tier
II) and £900m by equity. The reinsurance was effected on arm's length terms resulting in an initial regulatory loss in
LGP. Further funds of £571m have been injected from Society's LTF into LGP's LTF by means of a contingent loan to cover
this loss.
Prior to the capitalisation of LGP, the intra-group subordinated debt capital of £602m attributed to SRC was repaid to
Group Plc and an equivalent amount was lent to Society shareholder capital on a subordinated basis (£301m upper tier II,
£301m lower tier II).
Overall, the corporate restructuring has increased the embedded value by £171m. This arises from tax benefits totalling
£322m, which include a partial reversal of the adverse impact of the 2005 UK tax changes. This is offset by an
additional cost of solvency capital of £119m in LGP and other impacts of £32m which together total £151m. The EEV impact
of the net tax benefits is reported within the tax section of the income statement. The impact of the higher cost of
solvency capital and other impacts is reported below operating profit and grossed up for tax at 30%. The tax gross up of
£65m is included in the tax charge. The additional cost of solvency capital in respect of new business transferred to
LGP has reduced the contribution from new business by £19m.
Implementation of changes to FSA reporting and capital rules (Policy Statement 06/14)
-------------------------------------------------------------------------------------
In 2006, the FSA introduced a more realistic reserving framework for certain non profit business. As a result, there has
been a reduction in the regulatory reserves required for term assurance business of £641m (see note 5.03(c)). The
associated financial reinsurance previously in place to finance these reserves was terminated.
The impact of these changes has been to increase the EEV operating assumption changes by £64m, and contribution from new
business by £33m, due to the resulting lower capital requirements.
Review of annuity investment policy
-----------------------------------
During 2006, Society undertook a review of its asset liability matching policy for annuity business. Property assets
backing annuity liabilities were replaced with corporate bonds and Society entered into inflation swaps to mitigate
negative inflation risk. As a result, a closer match between assets and liabilities was achieved. Additionally, the
margin within the reserves to cover an interest rate mismatch was reviewed and reduced.
EEV operating profit has increased by £18m due to the reduction in the capital requirement. However, the EEV variation
from longer term investment return is reduced by £27m due to the change in asset mix.
========================================================================================================================
Page 22
3.02 Profit from continuing operations after tax from covered business
----------------------------------------------------------------------
UK Interna- Life and Investment Total
tional pensions manage-
total ment(1)
£m £m £m £m £m
For the year ended 31 December 2006 Notes
------------------------------------------------------------------------------------------------------------------------
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(2) 146 12 158 7 165
------------------------------------------------------------------------------------------------------------------------
Operating profit 874 156 1,030 151 1,181
Variation from longer term investment return(3) 387 (21) 366 13 379
Effect of economic assumption changes (5) 7 2 - 2
Corporate restructure (216) - (216) - (216)
------------------------------------------------------------------------------------------------------------------------
Profit from continuing operations before tax 1,040 142 1,182 164 1,346
Tax(2) (337) (45) (382) (49) (431)
Tax impact of Corporate restructure 322 - 322 - 322
------------------------------------------------------------------------------------------------------------------------
Profit from continuing operations after tax 1,025 97 1,122 115 1,237
========================================================================================================================
For the year ended 31 December 2005
------------------------------------------------------------------------------------------------------------------------
Contribution from new business after cost of capital 306 25 331 49 380
Contribution from in-force business:
- expected return 294 62 356 21 377
- experience variances 3.04 89 - 89 25 114
- operating assumption changes 3.05 (14) (5) (19) 14 (5)
Development costs (20) - (20) (1) (21)
Contribution from shareholder net worth 146 18 164 6 170
------------------------------------------------------------------------------------------------------------------------
Operating profit 801 100 901 114 1,015
Variation from longer term investment return(3) 653 53 706 35 741
Effect of economic assumption changes 3 5 8 - 8
------------------------------------------------------------------------------------------------------------------------
Profit from continuing operations before tax 1,457 158 1,615 149 1,764
Tax (421) (51) (472) (45) (517)
Effect of UK tax changes (276) - (276) - (276)
------------------------------------------------------------------------------------------------------------------------
Profit from continuing operations after tax 760 107 867 104 971
========================================================================================================================
1. For covered business, Investment management comprises managed pension funds and is included in the total Investment
management result of £181m (2005: £136m). See note 3.08.
2. In 2006, the contribution from shareholder net worth has been grossed up using a notional attributed tax rate of 30%.
The 2006 impact of changing the notional attributed tax rate on the shareholder net worth to 30% is to increase
operating profit by £12m and decrease profit before tax, and tax, by £3m. The contribution from shareholder net worth
in 2005 has not been restated for this change in estimation technique. If the notional attributed tax rate had been
30% in 2005, the impact would have been to increase operating profit by £14m and profit before tax, and tax, by £23m.
3. UK life and pensions variation from longer term investment return comprises £185m (2005: £357m) relating to the value
of in-force business and £202m (2005: £296m) relating to shareholder net worth.
========================================================================================================================
Page 23
3.03 Life and pensions operating profit
---------------------------------------
2006 2005
£m £m
------------------------------------------------------------------------------------------------------------------------
UK 874 801
USA 89 24
Netherlands 45 43
France 22 33
------------------------------------------------------------------------------------------------------------------------
1,030 901
========================================================================================================================
3.04 Analysis of experience variances
-------------------------------------
UK Interna- Life and Investment Total
tional pensions manage-
total ment
For the year ended 31 December 2006 £m £m £m £m £m
------------------------------------------------------------------------------------------------------------------------
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 relates primarily to the impact of Triple X financing.
2006 Investment management other experience variances of £22m includes the effect of higher average fee rates than
assumed (£17m).
For the year ended 31 December 2005
------------------------------------------------------------------------------------------------------------------------
Persistency 2 2 4 15 19
Mortality / morbidity 14 (7) 7 - 7
Expenses (6) 1 (5) 2 (3)
Other 79 4 83 8 91
------------------------------------------------------------------------------------------------------------------------
89 - 89 25 114
========================================================================================================================
2005 UK other experience variances of £79m principally comprise the impact of the release of prudent margins as more
data is loaded onto the BPA administration system (£73m).
2005 Investment management other experience variances of £8m include the effect of higher average fee rates than
assumed.
========================================================================================================================
Page 24
3.05 Analysis of operating assumption changes
-----------------------------------------------
UK Interna- Life and Investment Total
tional pensions manage-
total ment
For the year ended 31 December 2006 £m £m £m £m £m
------------------------------------------------------------------------------------------------------------------------
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).
For the year ended 31 December 2005
------------------------------------------------------------------------------------------------------------------------
Persistency 30 (12) 18 - 18
Mortality / morbidity 11 (11) - - -
Expenses (24) 4 (20) - (20)
Other (31) 14 (17) 14 (3)
------------------------------------------------------------------------------------------------------------------------
(14) (5) (19) 14 (5)
=======================================================================================================================
2005 UK other operating assumption changes of -£31m relate mainly to -£24m of reserve strengthening in respect of
endowment compensation.
2005 Investment management other operating assumption changes of £14m arise from the continuation of the ten year lapse
assumption for all contracts through the extension of the modelling period.
3.06 Variation from longer term investment return
-------------------------------------------------
2006 2005
£m £m
------------------------------------------------------------------------------------------------------------------------
Total covered business 379 741
Investment management(1) (1) -
General insurance (7) 8
Other operational income 89 121
------------------------------------------------------------------------------------------------------------------------
460 870
========================================================================================================================
1. Non-covered Investment management business.
3.07 Time value of options and guarantees
-----------------------------------------
2006 2005
£m £m
------------------------------------------------------------------------------------------------------------------------
Life and pensions
UK non profit 4 21
UK with-profits 2 2
International 12 5
------------------------------------------------------------------------------------------------------------------------
18 28
========================================================================================================================
For UK non profit, the reduction in 2006 is primarily due to the purchase of negative inflation hedges coupled with
higher inflation expectations resulting in a reduction in inflation guarantees.
For International, the increase in 2006 arises primarily from the rise in US interest rates on universal life contracts
which have a guaranteed minimum crediting rate and a guaranteed surrender value.
========================================================================================================================
Page 25
3.08 Investment management income statement
-------------------------------------------
2006 2005
£m £m
------------------------------------------------------------------------------------------------------------------------
From continuing operations
Managed pension funds 151 114
Ventures 4 4
Property 6 4
Retail investments 11 7
Other external income 6 5
Other income(1) 3 2
------------------------------------------------------------------------------------------------------------------------
Operating profit from investment management 181 136
Variation from longer term investment return 13 35
------------------------------------------------------------------------------------------------------------------------
Profit on ordinary activities before tax 194 171
Tax (58) (52)
------------------------------------------------------------------------------------------------------------------------
Profit on ordinary activities after tax 136 119
========================================================================================================================
Investment management comprises the managed pensions fund business on an EEV basis and other investment management
business on an IFRS basis.
1. Other income excludes the element relating to managed pension funds on the IFRS basis.
3.09 Other operational income
-----------------------------
2006 2005
£m £m
------------------------------------------------------------------------------------------------------------------------
Shareholders' other income
Investment return on ordinary shareholders' equity(1) 134 127
Interest expense (106) (75)
------------------------------------------------------------------------------------------------------------------------
28 52
Other operations(2) (2) (5)
Unallocated corporate and development expenses (13) (6)
------------------------------------------------------------------------------------------------------------------------
13 41
========================================================================================================================
1. Investment return on ordinary shareholders' equity excludes the element relating to LGP on the IFRS basis.
2. Principally the Regulated mortgage network and Cofunds.
3.10 Analysis of tax
--------------------
Profit/(loss) Tax Profit Tax
before (charge)/ before charge
tax credit tax
2006 2006 2005 2005
£m £m £m £m
------------------------------------------------------------------------------------------------------------------------
From continuing operations
UK life and pensions 874 (262) 801 (230)
International life and pensions 156 (51) 100 (33)
------------------------------------------------------------------------------------------------------------------------
1,030 (313) 901 (263)
Investment management 181 (54) 136 (42)
General insurance 9 (2) 14 (4)
Other operational income 13 8 41 (5)
------------------------------------------------------------------------------------------------------------------------
Operating profit 1,233 (361) 1,092 (314)
Variation from longer term investment return 460 (128) 870 (246)
Effect of economic assumption changes 2 2 8 (3)
Property income attributable to minority interests 67 - 81 -
Corporate restructure (216) 65 - -
------------------------------------------------------------------------------------------------------------------------
Profit from continuing operations before tax / Tax 1,546 (422) 2,051 (563)
========================================================================================================================
3.11 Tax impact of Corporate restructure
----------------------------------------
The tax benefit from the Corporate restructure arose primarily from the reversal of the effect of the UK tax changes
reported in 2005.
========================================================================================================================
Page 26
3.12 Earnings per share
-----------------------
(a) Earnings per share
Profit/ Tax Profit/ Per Profit Tax Profit/ Per
(loss) (charge)/ (loss) share before (charge)/ (loss) share
before credit after tax credit after
tax tax tax
2006 2006 2006 2006 2005 2005 2005 2005
£m £m £m p £m £m £m p
------------------------------------------------------------------------------------------------------------------------
Operating profit from continuing
operations 1,233 (361) 872 13.45 1,092 (314) 778 12.02
Variation from longer term investment
return 460 (128) 332 5.12 870 (246) 624 9.64
Effect of economic assumption changes 2 2 4 0.06 8 (3) 5 0.08
Profit from discontinued operations - - - - 12 1 13 0.20
Corporate restructure (216) 65 (151) (2.33) - - - -
Tax impact of Corporate restructure - 322 322 4.97 - - - -
Effect of UK tax changes - - - - - (276) (276) (4.27)
Distributions on subordinated
borrowings designated as equity - - (16) (0.25)
------------------------------------------------------------------------------------------------------------------------
Earnings per share based on profit
attributable to equity holders 1,479 (100) 1,379 21.27 1,982 (838) 1,128 17.42
========================================================================================================================
(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)
2006 2006 2006 2005 2005 2005
£m m p £m m p
------------------------------------------------------------------------------------------------------------------------
Operating profit from continuing operations after tax 872 6,483 13.45 778 6,474 12.02
Net shares under options allocable for no further
consideration - 46 (0.09) - 38 (0.07)
Convertible bonds outstanding - - - 20 285 (0.21)
------------------------------------------------------------------------------------------------------------------------
Diluted earnings per share 872 6,529 13.36 798 6,797 11.74
========================================================================================================================
(ii) Based on profit attributable to ordinary equity holders of the Company
Profit Number Per Profit Number Per
after of share after of share
tax shares(1) tax shares(1)
2006 2006 2006 2005 2005 2005
£m m p £m m p
------------------------------------------------------------------------------------------------------------------------
Profit attributable to ordinary equity holders of the Company 1,379 6,483 21.27 1,128 6,474 17.42
Net shares under options allocable for no further
consideration - 46 (0.15) - 38 (0.09)
Convertible bonds outstanding - - - 20 285 (0.44)
------------------------------------------------------------------------------------------------------------------------
Diluted earnings per share 1,379 6,529 21.12 1,148 6,797 16.89
========================================================================================================================
The number of shares in issue at 31 December 2006 was 6,532,261,961 (2005: 6,507,421,932).
1. Weighted average number of shares.
========================================================================================================================
Page 27
3.13 Embedded value reconciliation
----------------------------------
UK UK UK Inter- Life and Invest- Total
value of share- life national pensions ment
in-force holder and life total manage-
net pensions and 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 relating to:
-------------------------------
- Non profit 5.05 (a) : : (110): (110):
- With-profits : (66): : (66):
- Shareholder net worth 5.05 (a) : : (162): (162):
- Subordinated debt : : (24): (24):
-------------------------------
Distributions (66) (296) (362) (5) (367) (62) (429)
Movement in pension deficit - (9) (9) - (9) - (9)
------------------------------------------------------------------------------------------------------------------------
Embedded value 3.14/3.15 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 shareholder net worth (SNW) represents the amounts in the Society long term fund and LGP shareholder capital which
are regarded as either required capital or free surplus held within the covered business.
2. For covered business, Investment management 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 LGP, less the repayment of £602m of intra-group subordinated debt previously attributed to the
SRC.
========================================================================================================================
Page 28
3.13 Embedded value reconciliation (continued)
----------------------------------------------
UK UK UK Inter- Life and Invest- Total
value of share- life national pensions ment
in-force holder and life total manage-
net pensions and ment(1)
worth pensions
As at 31 December 2005 Notes £m £m £m £m £m £m £m
------------------------------------------------------------------------------------------------------------------------
At 1 January
Value of in-force business (VIF) 2,885 - 2,885 431 3,316 191 3,507
Shareholder net worth (SNW) - 1,560 1,560 276 1,836 162 1,998
------------------------------------------------------------------------------------------------------------------------
2,885 1,560 4,445 707 5,152 353 5,505
Exchange rate movements - - - 51 51 - 51
------------------------------------------------------------------------------------------------------------------------
2,885 1,560 4,445 758 5,203 353 5,556
Profit for the period:
-------------------------------
- New business contribution : 447 : (232): 215 :
- Expected return on VIF : 206 : - : 206 :
- Expected return - transfer to SNW : (340): 340 : - :
- Experience variances : (151): 145 : (6):
- Operating assumption changes : 14 : (23): (9):
- Development costs : - : (14): (14):
- Expected return on SNW : - : 96 : 96 :
- Investment variances : 250 : 296 : 546 :
- Economic assumption changes : 2 : - : 2 :
- Effect of UK tax changes : (125): (151): (276):
-------------------------------
Profit for the period(2) 303 457 760 107 867 104 971
Capital movements - - - 5 5 - 5
Distributions relating to:
-------------------------------
- Non profit 5.05 (a) : : (119): (119):
- With-profits : (46): : (46):
- Shareholder net worth 5.05 (a) : : (100): (100):
- Subordinated debt : : (26): (26):
-------------------------------
Distributions (46) (245) (291) (2) (293) (35) (328)
Movement in pension deficit - (10) (10) - (10) - (10)
------------------------------------------------------------------------------------------------------------------------
Embedded value 3.14/3.15 3,142 1,762 4,904 868 5,772 422 6,194
========================================================================================================================
Represented by:
Non profit 2,387 2,387
With-profits 755 755
------------------------------------------------------------------------------------------------------------------------
Value of in-force business 3,142 - 3,142 570 3,712 238 3,950
Shareholder net worth - 1,762 1,762 298 2,060 184 2,244
========================================================================================================================
1. For covered business, Investment management comprises managed pension funds and is included in the total Investment
management shareholders' equity of £506m.
2. Included in the profit for the period is an inter-fund transfer from non profit (included in VIF) to SRC (included in
SNW) of £282m.
========================================================================================================================
Page 29
3.14 Analysis of ordinary shareholders' equity
----------------------------------------------
UK Inter- Life and Invest- Other Total
national pensions ment opera-
total manage- tions(2)
ment(1)
As at 31 December 2006 £m £m £m £m £m £m
------------------------------------------------------------------------------------------------------------------------
Analysed as:
IFRS basis ordinary 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
------------------------------------------------------------------------------------------------------------------------
Ordinary 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)
========================================================================================================================
As at 31 December 2005
------------------------------------------------------------------------------------------------------------------------
Analysed as:
IFRS basis ordinary shareholders' equity 2,560 737 3,297 184 776 4,257
Additional retained profit on an EEV basis 2,344 131 2,475 238 - 2,713
------------------------------------------------------------------------------------------------------------------------
Ordinary shareholders' equity on an EEV basis 4,904 868 5,772 422 776 6,970
========================================================================================================================
Comprising:
Shareholder net worth
- Free surplus - 148 148 166
- Required capital to cover solvency margin 689 150 839 18
- Other required capital 1,073 - 1,073 -
Value of in-force
- Value of in-force business 3,148 618 3,766 243
- Cost of capital (6) (48) (54) (5)
========================================================================================================================
Free surplus is the market value of any capital and surplus allocated to, but not required to support, the in-force
covered business at the valuation date.
Total required capital includes any amount of assets attributed to the covered business, over and above that required to
back liabilities, the distribution of which to shareholders is restricted.
1. Investment management comprises managed pension funds and is included in the total Investment management
shareholders' equity of £592m (2005: £506m).
2. Other Investment management businesses included on an IFRS basis of £117m (2005: £84m) are included in other
operations.
========================================================================================================================
Page 30
3.15 Segmental analysis of ordinary shareholders' equity
--------------------------------------------------------
Covered Other Total Covered Other Total
business business business business
EEV IFRS EEV IFRS
basis basis basis basis
2006 2006 2006 2005 2005 2005
£m £m £m £m £m £m
------------------------------------------------------------------------------------------------------------------------
UK(1) 6,256 - 6,256 4,904 - 4,904
Society shareholder capital (excluding LGP)(2) - 1,307 1,307 - 1,896 1,896
------------------------------------------------------------------------------------------------------------------------
6,256 1,307 7,563 4,904 1,896 6,800
Embedded value of international life and pensions business
- USA 552 - 552 566 - 566
- Netherlands 228 - 228 192 - 192
- France 133 - 133 110 - 110
------------------------------------------------------------------------------------------------------------------------
7,169 1,307 8,476 5,772 1,896 7,668
Investment management 475 117 592 422 84 506
------------------------------------------------------------------------------------------------------------------------
7,644 1,424 9,068 6,194 1,980 8,174
General insurance - 169 169 - 167 167
Corporate funds(3) - (1,306) (1,306) - (1,371) (1,371)
------------------------------------------------------------------------------------------------------------------------
7,644 287 7,931 6,194 776 6,970
========================================================================================================================
Further analysis of the covered business is included in note 3.13.
2006 2005
£m £m
------------------------------------------------------------------------------------------------------------------------
Movement
At 1 January 6,970 6,186
Total recognised income and expense 1,337 1,133
Issue of ordinary share capital 15 1
Net movements in employee share schemes and treasury shares (5) 7
Dividend distributions to ordinary equity holders of the Company during the year (349) (331)
Distributions during the year on subordinated borrowings designated as equity - (16)
Movements in pension deficit (9) (10)
Fair value loss after tax on reclassification of subordinated borrowings as debt (28) -
------------------------------------------------------------------------------------------------------------------------
At 31 December 7,931 6,970
========================================================================================================================
1. 2005 included £602m of intra-group subordinated debt capital attributed to the SRC, which was repaid in 2006. An
equivalent amount (£602m) was then lent to Society shareholder capital on a subordinated basis, £400m of this was
lent to LGP on similar terms.
2. Represents surplus capital held outside Society's LTF, including the rights issue proceeds, but excluding LGP
shareholder capital which is regarded as either required capital or free surplus held within the covered business.
3. Includes the convertible debt of £nil (2005: £509m), subordinated borrowings of £818m (2005: £809m) and senior debt
of £602m, which has been lent to Society shareholder capital on a subordinated basis (2005: £602m lent to the SRC on
a subordinated basis).
========================================================================================================================
Page 31
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 2006
As 1% lower 1% higher 1% lower 1% higher 10% lower
published risk risk interest equity/ equity/
discount discount rate property property
rate rate yields values
£m £m £m £m £m £m
------------------------------------------------------------------------------------------------------------------------
Life and pensions
- UK 6,256 431 (376) 138 275 (290)
- International 913 61 (54) (8) 5 (6)
------------------------------------------------------------------------------------------------------------------------
Total life and pensions 7,169 492 (430) 130 280 (296)
Investment management 475 12 (11) (3) 9 (18)
------------------------------------------------------------------------------------------------------------------------
Total covered business 7,644 504 (441) 127 289 (314)
========================================================================================================================
As 10% 10% 5% 5%
published lower lower lower lower
maintenance lapse mortality mortality
expenses rates (UK (other
annuities) business)
£m £m £m £m £m
------------------------------------------------------------------------------------------------------------------------
Life and pensions
- UK 6,256 59 71 (104) 33
- International 913 10 34 n/a 67
------------------------------------------------------------------------------------------------------------------------
Total life and pensions 7,169 69 105 (104) 100
Investment management 475 15 17 n/a n/a
------------------------------------------------------------------------------------------------------------------------
Total covered business 7,644 84 122 (104) 100
========================================================================================================================
Effect on new business contribution for the year
As 1% lower 1% higher 1% lower 1% higher 10% lower
published risk risk interest equity/ equity/
discount discount rate property property
rate rate yields values
£m £m £m £m £m £m
------------------------------------------------------------------------------------------------------------------------
Life and pensions
- UK 380 74 (65) 10 37 (32)
- International 38 16 (14) (3) 1 -
------------------------------------------------------------------------------------------------------------------------
Total life and pensions 418 90 (79) 7 38 (32)
Investment management 61 3 (3) (1) 1 -
------------------------------------------------------------------------------------------------------------------------
Total covered business 479 93 (82) 6 39 (32)
========================================================================================================================
As 10% 10% 5% 5%
published lower lower lower lower
maintenance lapse mortality mortality
expenses rates (UK (other
annuities) business)
£m £m £m £m £m
------------------------------------------------------------------------------------------------------------------------
Life and pensions
- UK 380 15 26 (11) 9
- International 38 2 6 n/a 10
------------------------------------------------------------------------------------------------------------------------
Total life and pensions 418 17 32 (11) 19
Investment management 61 - 3 n/a n/a
------------------------------------------------------------------------------------------------------------------------
Total covered business 479 17 35 (11) 19
========================================================================================================================
Opposite sensitivities are broadly symmetrical.
========================================================================================================================
Page 32
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. The corresponding return on equities and property is equal
to the fixed interest gilt assumption plus the appropriate risk premium. An asset mix consistent with the current
investment policy and future management intentions has been assumed within the projections.
Economic assumptions
--------------------
31.12.06 31.12.05 31.12.04
% pa % pa % pa
Equity risk premium 3.0 3.0 3.0
Property risk premium 2.0 2.0 2.0
Investment return
- Gilts:
- Fixed interest 4.6 4.1 4.5
- RPI linked 4.7 4.2 4.5
- Non gilts:
- Fixed interest 4.9 - 5.3 4.4 - 4.8 4.9 - 5.3
- RPI linked 4.6 - 5.1 4.2 - 4.6 4.7 - 5.1
- Equities 7.6 7.1 7.5
- Property 6.6 6.1 6.5
Risk margin 3.0 3.0 3.0
Risk discount rate (net of tax) 7.6 7.1 7.5
Inflation
- Expenses/earnings 4.2 3.9 3.8
- Indexation 3.2 2.9 2.8
The assumed returns on non gilt securities are net of an allowance for default risk of 0.2% pa (2005: 0.2% pa), other
than for certain government-supported securities where no such allowance is made.
UK life and pensions
--------------------
i. The value of the Sub-fund is the discounted value of total projected investment returns over its lifetime.
ii. Assets are valued at market value. For the projection of fixed interest and RPI linked investment returns, asset
values are adjusted to reflect the assumed interest and inflation rates.
iii. 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.
iv. The value of in-force business reflects the cost, including administration expenses, of providing for benefit
enhancement or compensation in relation to certain products.
v. 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. An allowance is made for future improvements in annuitant mortality based on
experience and externally published data. Male annuitant mortality is 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 is 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.
vi. The subordinated debt capital was repaid in 2006 but was included in the embedded value in 2005 at the face value
of £602m (estimated market value of £699m at 31 December 2005). If the market value of the subordinated debt
capital was used, total embedded value in 2005 would have increased by £31m. £400m of subordinated debt attributed
to Legal & General Pensions Limited (LGP) in 2006 has been included at face value. The estimated market value was
not materially different to the face value.
vii. Development costs relate to strategic systems.
========================================================================================================================
Page 33
3.17 Assumptions (continued)
----------------------------
UK managed pension funds
------------------------
viii. 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
-------------
ix. Key assumptions:
31.12.06 31.12.05 31.12.04
% pa % pa % pa
USA
Reinvestment rate 5.4 5.1 4.9
Risk margin 3.0 3.0 3.0
Risk discount rate (net of tax) 7.8 7.4 7.3
Europe
Government bond return 4.0 3.3 3.8
Risk margin 3.0 3.0 3.0
Risk discount rate (net of tax) 7.0 6.3 6.8
x. Other actuarial assumptions have been set at levels commensurate with recent operating experience, including
those for mortality, morbidity, persistency and maintenance expenses.
Tax
---
xi. EEV results are computed on an after tax basis and are grossed up by 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 30% (2005: 30%).
Stochastic calculations
-----------------------
xii. 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.
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.
========================================================================================================================
Page 34
3.17 Assumptions (continued)
----------------------------
Summary statistics
The following table sets out means and standard deviations (StDev) of future returns as at 31 December 2006 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 4.8% 2.7% 4.5% 3.0%
Corporate bonds 5.3% 3.1% 5.1% 3.3%
Property (excess returns) 2.0% 15.1% 2.0% 14.8%
Equities (excess returns) 3.0% 20.1% 3.0% 20.3%
European Business (Euro)
Long Government bonds(3) 4.0% 5.0% 4.4% 5.1%
Short Government bonds(4) 4.0% 3.7% 4.4% 7.1%
US Business (US Dollar)
Long Government bonds(3) 4.9% 5.9% 5.3% 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
------------------------
xiii. 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% lower interest rate environment - a one percentage point 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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