L&G 2009 Final Results Part 5

RNS Number : 9840I

Legal & General Group Plc

23 March 2010

 



European Embedded Value										Page 65
Consolidated income statement
For the year ended 31 December 2009
									2009	2008
										Restated1
							Notes		£m	£m
From continuing operations
Risk							5.01		913	439
Savings							5.01		82	50
Investment management							5.08		139	130
International							5.09		170	100
Group capital and financing							5.10		47	156
Investment projects2									(32)	-
Operating profit									1,319	875
Variation from longer term investment return							5.11		(413)	(1,584)
Effect of economic assumption changes							5.12		(335)	(609)
Property losses attributable to minority interests									(19)	(63)
Profit/(loss) from continuing operations before tax attributable to equity holders of the Company									552	(1,381)
Tax (expense)/credit on profit/(loss) from ordinary activities							5.14		(114)	327
Tax impact of corporate restructure							5.01		59	81
Profit/(loss) for the year									497	(973)
Loss attributable to minority interests							2.17		19	63
Profit/(loss) attributable to equity holders of the Company									516	(910)
									p	p
Earnings per share							5.15
Based on operating profit from continuing operations after tax attributable to equity holders
of the Company									16.28	10.72
Based on profit/(loss) attributable to equity holders of the Company									8.86	(15.25)
Diluted earnings per share							5.15
Based on operating profit from continuing operations after tax attributable to equity holders
of the Company									16.19	10.68
Based on profit/(loss) attributable to equity holders of the Company									8.81	(15.25)
1. The EEV comparatives have been restated to reflect the impact of the change in definition of IFRS operating profit on non covered business (see Note 2.01).  The change has increased 2008 EEV operating profit by £5m and reduced variation from longer term investment return by £5m.  There is no impact on profit after tax or shareholders' equity.
2. Investment projects comprises Solvency II and other strategic investments.
European Embedded Value										Page 66
Consolidated statement of comprehensive income
For the year ended 31 December 2009
									2009	2008
									£m	£m
Profit/(loss) for the year									497	(973)
Other comprehensive income after tax
Exchange differences on translation of overseas operations									(88)	196
Actuarial (losses)/gains on defined benefit pension schemes									(90)	12
Actuarial losses/(gains) on defined benefit pension schemes transferred to unallocated divisible surplus									62	(8)
Total comprehensive income/(expense) for the year									381	(773)
Total comprehensive income/(expense) attributable to:
Minority interests									(19)	(63)
Equity holders of the Company									400	(710)
Consolidated balance sheet
As at 31 December 2009
									2009	2008
							Notes		£m	£m
Assets
Investments									290,550	249,185
Long term in-force business asset									2,645	3,160
Other assets									6,348	7,315
Total assets									299,543	259,660
Equity
Shareholders' equity							5.17/5.18		6,695	6,521
Minority interests							2.17		2	144
Total equity									6,697	6,665
Liabilities
Subordinated borrowings							2.16		1,870	1,657
Unallocated divisible surplus									1,284	913
Participating contract liabilities									16,176	16,205
Non-participating contract liabilities									263,085	222,539
Senior borrowings							2.16		1,407	2,314
Other liabilities and provisions									9,024	9,367
Total liabilities									292,846	252,995
Total equity and liabilities									299,543	259,660
European Embedded Value										Page 67
Notes to the Financial Statements
5.01 Profit/(loss) for the year
						Risk and	Investment	Inter-	Group	Total
						Savings	manage-	national	capital
							ment		and
									financing
For the year ended 31 December 2009				Notes		£m	£m	£m	£m	£m
Business reported on an EEV basis:
Contribution from new business after cost of capital				5.03/5.05		305		23		328
Contribution from in-force business:
- expected return1						496		118		614
- experience variances				5.07		46		17		63
- operating assumption changes				5.07		156		1		157
Development costs						(30)		-		(30)
Contribution from shareholder net worth2								16	125	141
Operating profit on covered business						973	-	175	125	1,273
Business reported on an IFRS basis:
General insurance				2.02(f)		17				17
Core retail investments						9				9
Investment management3				5.08			139			139
Group capital and financing				5.10					(78)	(78)
Investment projects									(32)	(32)
Other4						(4)		(5)		(9)
Total operating profit						995	139	170	15	1,319
Variation from longer term investment return				5.11		(501)	(4)	62	30	(413)
Effect of economic assumption changes				5.12		(249)	-	(97)	11	(335)
Property losses attributable to minority interests						-	-	-	(19)	(19)
Profit from continuing operations before tax						245	135	135	37	552
Tax (expense)/credit on profit from ordinary activities						(68)	(36)	(43)	33	(114)
Tax impact of corporate restructure5						-	-	-	59	59
Profit for the year						177	99	92	129	497
Operating profit attributable to:
Risk						913
Savings						82
1. The expected return on in-force is based on the unwind of the risk discount rate on the opening, adjusted base value of in-force (VIF).  The opening base VIF of the Risk and Savings business was £4,268m in 2009.  This is adjusted for the effects of opening model changes of £31m to give an adjusted opening base VIF of £4,299m.  This is then multiplied by the opening risk discount rate of 8.3% and the result grossed up at the notional attributed tax rate of 28% to give a return of £496m.
2. The 2009 Group capital and financing contribution from shareholder net worth (SNW) of £125m comprises the average return of 7% on the average balance of invested assets of £2.1bn (£138m); offset by an adjustment for opening tax and other modelling changes of £(2)m and pre-tax corporate expenses charged to shareholders' funds of £(11)m.
3. Investment management operating profit excludes £28m (2008: £35m) of profits arising from the provision of investment management services at market referenced rates to the covered business. These are reported on a look through basis and as a consequence are included in the Risk, Savings and Group capital and financing covered business on an EEV basis.
4. On an EEV basis, Suffolk Life, operations in Ireland and business unit costs allocated to the Risk and Savings business are included in the covered business operating profit.  These are included within Other Risk and Other Savings within IFRS operating profit.
5. In 2009, in addition to current year investment return, £469m was released from the Shareholder Retained Capital and declared as surplus for tax purposes. As a result of the 2007 corporate restructure, this release along with current year movements did not give rise to any incremental tax and therefore resulted in a £59m benefit to embedded value.
European Embedded Value										Page 68
Notes to the Financial Statements
5.01 Profit/(loss) for the year (continued)
						Risk and	Investment	Inter-	Group	Total
						Savings	manage-	national	capital
							ment		and
									financing
									Restated	Restated
For the year ended 31 December 2008				Notes		£m	£m	£m	£m	£m
Business reported on an EEV basis:
Contribution from new business after cost of capital				5.03/5.05		265		32		297
Contribution from in-force business:
- expected return						370		100		470
- experience variances				5.07		12		(34)		(22)
- operating assumption changes				5.07		(100)		(15)		(115)
Development costs						(51)		-		(51)
Contribution from shareholder net worth								17	256	273
Operating profit on covered business						496	-	100	256	852
Business reported on an IFRS basis:
General insurance				2.02(f)		(2)				(2)
Core retail investments						-				-
Investment management1				5.08			130			130
Group capital and financing				5.10					(100)	(100)
Other2						(5)		-		(5)
Total operating profit						489	130	100	156	875
Variation from longer term investment return				5.11		(175)	7	(110)	(1,306)	(1,584)
Effect of economic assumption changes				5.12		(505)	-	(110)	6	(609)
Property losses attributable to minority interests						-	-	-	(63)	(63)
(Loss)/profit from continuing operations before tax						(191)	137	(120)	(1,207)	(1,381)
Tax credit/(expense) on profit from ordinary activities						54	(42)	37	278	327
Tax impact of corporate restructure3						53	-	-	28	81
(Loss)/profit for the year						(84)	95	(83)	(901)	(973)
Operating profit attributable to:
Risk						439
Savings						50
1. 2008 investment management operating profit excludes £35m of profits arising from the provision of investment management services at market referenced rates to the covered business. These are reported on a look through basis and as a consequence are included in the Risk, Savings and Group capital and financing covered business on an EEV basis.
2. On an EEV basis, Suffolk Life, operations in Ireland and business unit costs allocated to the Risk and Savings business are included in the covered business operating profit.  These are included within Other Risk and Other Savings within IFRS operating profit.
3. In 2008 £0.9bn was transferred from Shareholder Retained Capital to shareholder capital held outside the long term fund.  This transfer did not give rise to any incremental tax and therefore resulted in an £81m benefit to embedded value.
European Embedded Value										Page 69
Notes to the Financial Statements
5.02 New business summary1
					APE2	PVNBP3	Margin4	APE	PVNBP	Margin
					2009	2009	2009	2008	2008	2008
			Notes		£m	£m	%	£m	£m	%
Risk			5.03		366	2,728	10.4	488	3,811	7.1
Savings			5.03		532	3,676	0.5	650	4,722	(0.1)
International			5.05		109	876	2.6	113	896	3.6
					1,007	7,280	4.5	1,251	9,429	3.1
1. Excludes core retail investments.
2. Annual Premium Equivalent (APE) is calculated for total new business, including core retail investments but excluding investment management new business, and comprises the new annual premiums together with 10% of single premiums.
3. The present value of new business premiums (PVNBP) on the EEV basis is defined as the present value of annual premiums plus single premiums for any given period. It is calculated using the same assumptions as for the contribution from new business but determined as at the point of sale.
4. The new business margin is defined as the contribution from new business (including the cost of solvency capital) divided by the PVNBP.
5.03 Risk and Savings1 new business by product
				Annual	Present	Capital-	Single	PVNBP	Contri-	Margin
				premiums	value of	isation	premiums		bution
					annual	factor2			from new
					premiums				business3
For the year ended 31 December 2009				£m	£m		£m	£m	£m	%
Protection				180	866	4.8	-	866	68	7.9
Annuities				-	-	-	1,862	1,862	217	11.7
Total Risk				180	866	4.8	1,862	2,728	285	10.4
Unit linked bonds				-	-	-	677	677	(4)	(0.6)
Pensions, stakeholder and other non profit				144	515	3.6	1,289	1,804	(11)	(0.6)
With-profits savings				103	316	3.1	879	1,195	35	2.9
Total Savings				247	831	3.4	2,845	3,676	20	0.5
Total Risk and Savings				427	1,697	4.0	4,707	6,404	305	4.8
Cost of capital4									40
Contribution from new business before cost of capital									345
For the year ended 31 December 2008
Protection				207	1,005	4.9	-	1,005	62	6.2
Annuities				-	-	-	2,806	2,806	209	7.4
Total Risk				207	1,005	4.9	2,806	3,811	271	7.1
Unit linked bonds				-	-	-	1,306	1,306	(13)	(1.0)
Pensions, stakeholder and other non profit				181	715	4.0	1,468	2,183	(8)	(0.4)
With-profits savings				108	395	3.7	838	1,233	15	1.2
Total Savings				289	1,110	3.8	3,612	4,722	(6)	(0.1)
Total Risk and Savings				496	2,115	4.3	6,418	8,533	265	3.1
Cost of capital									65
Contribution from new business before cost of capital									330
1. Excludes core retail investments.
2. The capitalisation factor is the present value of annual premiums divided by the amount of annual premiums.
3. The contribution from new business is defined as the present value at point of sale of assumed profits from new business written in the period and then rolled forward to the end of the financial period using the risk discount rate applicable at the end of the reporting period.
4. The 2009 cost of capital is lower than 2008 primarily reflecting the impact of lower volumes of protection and annuity business and the higher proportion of immediate annuities.
European Embedded Value										Page 70
Notes to the Financial Statements
5.04 Non profit internal rate of return (IRR) and payback period1 by product
							IRR	Payback	IRR	Payback
								period		period
							2009	2009	2008	2008
							%	years	%	years
Protection							17	5	14	5
Annuities2							>30	<0	>15	6
Unit linked bonds							8	9	6	10
Pensions, stakeholder and other non profit							6	14	7	12
1. The payback period is calculated on an undiscounted basis.
2. Given negative strain on annuity business in 2009 and an immediate IFRS payback, the IRR calculation is infinite.
5.05 International1 new business
						APE	PVNBP	Contri-	Cost of	Margin
								bution	capital
								from new
								business2
For the year ended 31 December 2009						£m	£m	£m	£m	%
USA						49	354	17	2	4.9
Netherlands						22	193	5	3	2.7
France						38	329	1	5	0.1
Total						109	876	23	10	2.6
For the year ended 31 December 2008
USA						51	372	24	6	6.3
Netherlands						29	241	7	4	3.1
France						33	283	1	4	0.5
Total						113	896	32	14	3.6
1. Excludes core retail investments.
2. Contribution from new business is reported after the cost of capital.
5.06 International1 new business in local currency
			Annual	Present	Capital-	Single	PVNBP	Contri-	Cost of	Margin
			premiums	value of	isation	Premiums		bution	capital
				annual	factor			from new
				premiums				business2
For the year ended 31 December 2009			m	m		m	m	m	m	%
USA			$76	$553	7.3	-	$553	$27	$3	4.9
Netherlands			€9	€61	6.8	€157	€218	€6	€3	2.7
France			€15	€105	7.2	€264	€369	€1	€5	0.1
For the year ended 31 December 2008
USA			$94	$691	7.4	-	$691	$44	$11	6.3
Netherlands			€16	€106	6.6	€199	€305	€9	€6	3.1
France			€21	€148	7.1	€206	€354	€2	€5	0.5
1. Excludes core retail investments.
2. Contribution from new business is reported after the cost of capital.
European Embedded Value										Page 71
Notes to the Financial Statements
5.07 Analysis of experience variances and operating assumption changes
				Risk and Savings				International
				Experience	Operating	Total		Experience	Operating	Total
				variances	assumption			variances	assumption
					changes				changes
For the year ended 31 December 2009				£m	£m	£m		£m	£m	£m
Persistency				(5)	(42)	(47)		(2)	(13)	(15)
Mortality/morbidity				(6)	114	108		13	26	39
Expenses				(19)	60	41		(7)	(12)	(19)
Other				76	24	100		13	-	13
				46	156	202		17	1	18
Risk and Savings persistency operating assumption changes relate to the strengthening of lapse assumptions for individual protection and unit linked bond policies; partially offset by improved persistency for with-profits products.
Risk and Savings mortality assumption changes relates to favourable annuitant mortality experience in 2009 which has been reflected in the latest three year average experience, and favourable individual protection mortality.
Risk and Savings expense assumption changes primarily reflects the £76m impact of the cost reductions delivered in 2009; partially offset by the impact of assumed higher future investment expenses of £(29)m.  Other smaller items have a net positive impact of £13m.  Expense experience variances include the impact of redundancy costs as a result of the cost reduction programme of £(17)m and exceptional project expenses and other items of £(8)m; partially offset by the impact of lower maintenance expenses than assumed of £6m.
Risk and Savings other experience variances includes £44m reflecting a reassessment of future reserve releases as data is loaded onto the BPA system and £43m relating to one-off modelling improvements.
International mortality operating assumption changes primarily reflects improved claims ratios on group protection business in France, following positive experience in 2009.
				Risk and Savings				International
				Experience	Operating	Total		Experience	Operating	Total
				variances	assumption			variances	assumption
					changes				changes
For the year ended 31 December 2008				£m	£m	£m		£m	£m	£m
Persistency				(12)	(114)	(126)		(5)	(2)	(7)
Mortality/morbidity				27	(49)	(22)		(12)	8	(4)
Expenses				(9)	35	26		1	(9)	(8)
Other				6	28	34		(18)	(12)	(30)
				12	(100)	(88)		(34)	(15)	(49)
2008 Risk and Savings persistency operating assumption changes of £(114)m relate primarily to the strengthening of lapse assumptions for unit linked bond policies.
2008 Risk and Savings mortality assumption changes relate primarily to annuitant mortality where the assumption has been updated to reflect the latest three year average experience where lighter 2008 experience replaced heavier 2005 experience in the calculation.
European Embedded Value										Page 72
Notes to the Financial Statements
5.08 Investment management operating profit
									2009	2008
									£m	£m
Managed pension funds1									128	117
Private equity									(1)	(1)
Property									4	4
Other income2									13	17
Legal & General Investment Management									144	137
Institutional unit trusts3									(5)	(7)
Total Investment management operating profit									139	130
1. The managed pension funds business within Investment management has been reported on an IFRS basis as management believe IFRS to be the most appropriate reporting basis for the Investment management business.
2. Other income excludes £28m (2008: £35m) of profits arising from the provision of investment management services at market referenced rates to the covered business. These are reported on a look through basis within the Risk, Savings and Group capital and financing covered business on an EEV basis.
3. Investment management operating profit excludes core retail investments, of £9m (2008: £nil), which has been disclosed as part of Savings.
5.09 International operating profit
									2009	2008
									£m	£m
USA									109	70
Netherlands									29	8
France									37	22
Other1									(5)	-
Total International operating profit									170	100
1. Other includes our joint venture operations in Egypt, the Gulf and India.
5.10 Group capital and financing operating profit1
									2009	2008
										Restated
									£m	£m
Business reported on an EEV basis									125	256
Business reported on an IFRS basis:
Investment return									53	47
Interest expense2									(127)	(138)
Unallocated corporate expenses									(4)	(9)
									(78)	(100)
Total Group capital and financing operating profit									47	156
1. Group capital and financing represents operating profit on the shareholder assets held within the covered business, reported on an embedded value basis, and operating profit on the shareholder assets held outside the covered business reported on an IFRS basis.
2. Interest expense excludes non recourse financing (see Note 2.16).
European Embedded Value										Page 73
Notes to the Financial Statements
5.11 Variation from longer term investment return
									2009	2008
										Restated
									£m	£m
Business reported on an EEV basis:
Risk and Savings1									(513)	(146)
International									62	(110)
Group capital and financing									(8)	(1,176)
									(459)	(1,432)
Business reported on an IFRS basis:
Risk and Savings									12	(29)
Investment management									(4)	7
Group capital and financing									38	(130)
									(413)	(1,584)
1. The 2009 Risk and Savings covered business variation from longer term investment return improved significantly during the second half of 2009 as a result of the investment actions taken within the non-profit annuity credit portfolios and the general improvements in all investment markets. The reported adverse variance of £(513)m is primarily due to the £(335)m EEV impact of swap transactions undertaken in the first half of 2009 to improve the IFRS matching of annuity business which reduced the assumed future yield on the annuity assets for EEV purposes, £(77)m is due to an increased cost of capital arising from de-risking activity to reduce the equity ratio for assets backing solvency capital and £(50)m is the EEV impact of holding additional cash balances, largely to back the short term default provision. These effects were all reported in the half-year 2009 results.
5.12 Effect of economic assumption changes
									2009	2008
									£m	£m
Business reported on an EEV basis:
Risk and Savings1									(249)	(505)
International2									(97)	(110)
Group capital and financing									11	6
									(335)	(609)
1. 2009 Risk and Savings economic assumption changes include £125m relating to the decrease in the UK risk discount rate in 2009 from 8.3% to 8.0%, and £(250)m as a result of higher assumed future inflation and higher cost of capital on increased annuity reserves. In addition, increases in the realistic and statutory long term default provisions for the assets backing annuity business had an EEV impact of £(124)m.
2. 2009 International economic assumption changes primarily reflect the increase in the US risk discount rate in 2009 from 6.8% to 7.4%.
5.13 Time value of options and guarantees
									2009	2008
									£m	£m
Risk and Savings1									13	46
International									19	13
									32	59
1. Includes £9m (2008: £21m) relating to UK with-profits business, reflecting the impact of rising investment markets, and £4m (2008: £25m) relating to UK non profit business, due to a higher inflation environment than 2008 and its impact on the allowance for negative inflation within the annuity business.
European Embedded Value										Page 74
Notes to the Financial Statements
5.14 Tax
							Profit/	Tax	Profit/	Tax
							(loss)	(expense)/	(loss)	(expense)/
							before	credit	before	credit
							tax		tax
							2009	2009	2008	2008
									Restated	Restated
							£m	£m	£m	£m
From continuing operations
Risk							913	(254)	439	(125)
Savings							82	(24)	50	(11)
Investment management							139	(37)	130	(40)
International							170	(57)	100	(35)
Group capital and financing							47	(8)	156	(24)
Investment projects							(32)	9	-	-
Operating profit							1,319	(371)	875	(235)
Variation from longer term investment return							(413)	158	(1,584)	386
Effect of economic assumption changes							(335)	99	(609)	176
Property losses attributable to minority interests							(19)	-	(63)	-
Profit/(loss) from continuing operations before tax / Tax							552	(114)	(1,381)	327
5.15 Earnings per share
(a) Earnings per share
			Profit/	Tax	Profit/	Per share	Profit/	Tax	Profit/	Per share
			(loss)	(expense)/	(loss)		(loss)	(expense)/	(loss)
			before	credit	after tax		before	credit	after tax
			tax				tax
			2009	2009	2009	2009	2008	2008	2008	2008
							Restated	Restated	Restated	Restated
			£m	£m	£m	p	£m	£m	£m	p
Operating profit from continuing operations			1,319	(371)	948	16.28	875	(235)	640	10.72
Variation from longer term investment return			(413)	158	(255)	(4.38)	(1,584)	386	(1,198)	(20.07)
Effect of economic assumption changes			(335)	99	(236)	(4.05)	(609)	176	(433)	(7.26)
Tax impact of corporate restructure			-	59	59	1.01	-	81	81	1.36
Earnings per share based on profit/(loss) attributable to equity holders			571	(55)	516	8.86	(1,318)	408	(910)	(15.25)
(b) Diluted earnings per share
(i) Based on operating profit from continuing operations after tax
					Profit	Number	Per share	Profit	Number	Per share
					after tax	of		after tax	of
						shares1			shares1
					2009	2009	2009	2008	2008	2008
								Restated		Restated
					£m	m	p	£m	m	p
Operating profit from continuing operations after tax					948	5,824	16.28	640	5,968	10.72
Net shares under options allocable for no further consideration					-	33	(0.09)	-	22	(0.04)
Diluted earnings per share					948	5,857	16.19	640	5,990	10.68
(ii) Based on profit/(loss) attributable to equity holders of the Company
					Profit	Number	Per share	Loss	Number	Per share
					after tax	of		after tax	of
						shares1			shares1
					2009	2009	2009	2008	2008	2008
					£m	m	p	£m	m	p
Profit/(loss) attributable to equity holders of the Company					516	5,824	8.86	(910)	5,968	(15.25)
Net shares under options allocable for no further consideration					-	33	(0.05)	-	22	-
Diluted earnings per share					516	5,857	8.81	(910)	5,990	(15.25)
The number of shares in issue at 31 December 2009 was 5,862,216,780 (31 December 2008: 5,861,627,994).
1. Weighted average number of shares.
European Embedded Value										Page 75
Notes to the Financial Statements
5.16 Group embedded value reconciliation
				Covered business
				UK	UK	UK	Total	Inter-	Non-	Total
				free	required	value of	UK	national	covered
				surplus	capital	in-force			business
For the year ended 31 December 2009				£m	£m	£m	£m	£m	£m	£m
At 1 January
Value of in-force business (VIF)				-	-	4,268	4,268	1,059	-	5,327
Shareholder net worth (SNW)				509	1,369	-	1,878	404	(1,088)	1,194
				509	1,369	4,268	6,146	1,463	(1,088)	6,521
Exchange rate movements				-	-	-	-	(153)	65	(88)
				509	1,369	4,268	6,146	1,310	(1,023)	6,433
Operating profit/(loss) for the year:
- New business contribution1				(189)	155	253	219
- Expected return on VIF				-	-	358	358
- Expected transfer from Non profit VIF to SNW2				648	(147)	(501)	-
- With-profits transfer				46	-	(46)	-
- Experience variances				30	29	(31)	28
- Operating assumption changes				285	(23)	(152)	110
- Development costs				(21)	-	-	(21)
- Expected return on SNW				34	61	-	95
Operating profit/(loss)				833	75	(119)	789	117	42	948
Non-operating (loss)/profit for the year:
- Investment variances				(66)	2	(276)	(340)
- Economic assumption changes				(66)	75	(180)	(171)
- Tax impact of corporate restructure				59	-	-	59
Non-operating (loss)/profit				(73)	77	(456)	(452)	(21)	22	(451)
Profit/(loss) for the year				760	152	(575)	337	96	64	497
Capital movements				-	-	-	-	50	(50)	-
Intra-group distributions				(154)	-	-	(154)	(10)	164	-
Dividends to equity holders of the Company				-	-	-	-	-	(185)	(185)
Net movements in employee share schemes				-	-	-	-	-	19	19
Loss attributable to minority interests				-	-	-	-	-	19	19
Transfer to non-covered business3				(20)	-	-	(20)	-	20	-
Other reserve movements including pension deficit				(28)	-	(14)	(42)	-	(46)	(88)
Embedded value				1,067	1,521	3,679	6,267	1,446	(1,018)	6,695
Represented by:
-   Non profit						3,213
-   With-profits						466
Value of in-force business				-	-	3,679	3,679	928	-	4,607
Shareholder net worth				1,067	1,521	-	2,588	518	(1,018)	2,088
1. The free surplus reduction of £189m to finance new business includes £27m IFRS new business strain and £155m additional required capital.  Other items have a net negative impact of £7m.
2. The increase in free surplus of £648m from the expected transfer from the in-force non profit business includes £496m of IFRS operational cash generation and a £147m reduction in required capital.  Other items have a net positive impact of £5m.
3. The transfer to non-covered business represents the IFRS profits arising in the period from the provision of investment management services by Legal & General Investment Management to the UK covered business, which have been included in the operating profit of the covered business on the look through basis.
European Embedded Value										Page 76
Notes to the Financial Statements
5.16 Group embedded value reconciliation (continued)
				Covered business
				UK	UK	UK	Total	Interna-	Non-	Total
				free	required	value of	UK	tional	covered
				surplus	capital	in-force			business
									Restated	Restated
For the year ended 31 December 2008				£m	£m	£m	£m	£m	£m	£m
At 1 January
Value of in-force business (VIF)				-	-	3,460	3,460	782	-	4,242
Shareholder net worth (SNW)				2,639	1,198	-	3,837	324	(275)	3,886
				2,639	1,198	3,460	7,297	1,106	(275)	8,128
Exchange rate movements				-	-	-	-	386	(190)	196
Opening adjustment				27	-	(27)	-	-	-	-
				2,666	1,198	3,433	7,297	1,492	(465)	8,324
Operating profit for the year:
- New business contribution1				(661)	232	620	191
- Expected return on VIF				-	-	267	267
- Expected transfer from Non profit VIF to SNW				565	(115)	(450)	-
- With-profits transfer				77	-	(77)	-
- Experience variances				39	3	(38)	4
- Operating assumption changes				(31)	1	(38)	(68)
- Development costs				(37)	-	-	(37)
- Expected return on SNW				140	51	-	191
Operating profit				92	172	284	548	65	27	640
Non-operating (loss)/profit for the year:
- Investment variances				(1,092)	(83)	189	(986)
- Economic assumption changes				(531)	(3)	175	(359)
- Tax impact of corporate restructure				28	-	53	81
Non-operating (loss)/profit				(1,595)	(86)	417	(1,264)	(148)	(201)	(1,613)
(Loss)/profit for the year				(1,503)	86	701	(716)	(83)	(174)	(973)
Capital movements2				(260)	-	-	(260)	60	(115)	(315)
Embedded value of business acquired				71	85	143	299	-	-	299
Intra-group distributions				(405)	-	-	(405)	(6)	411	-
Dividends to equity holders of the Company				-	-	-	-	-	(367)	(367)
Issue of share capital				-	-	-	-	-	10	10
Share buyback				-	-	-	-	-	(523)	(523)
Net movements in employee share schemes				-	-	-	-	-	(4)	(4)
Loss attributable to minority interests				-	-	-	-	-	63	63
Transfer to non-covered business3				(25)	-	-	(25)	-	25	-
Other reserve movements including pension deficit				(35)	-	(9)	(44)	-	51	7
Embedded value				509	1,369	4,268	6,146	1,463	(1,088)	6,521
Represented by:
- Non profit						3,845
- With-profits						423
Value of in-force business				-	-	4,268	4,268	1,059	-	5,327
Shareholder net worth				509	1,369	-	1,878	404	(1,088)	1,194
1. The free surplus reduction of £661m to finance new business includes £101m of the short term default allowance, as well as £334m IFRS new business strain and £232m additional required capital.  Other items have a net positive impact of £6m.
2. Capital movements within the UK comprise the £252m cost of acquiring Nationwide Life and £8m (€10m) of capital injected from Society into France.  The acquisition of Suffolk Life (£63m) was funded from the non-covered business element of Group capital and financing.  The International capital movements comprise £52m ($96m) of capital injected into the USA and the £8m (€10m) of capital injected into France.
3. The transfer to non-covered business represents the IFRS profits arising in the period from the provision of investment management services by Legal & General Investment Management to the UK covered business, which have been included in the operating profit of the covered business on the look through basis.
European Embedded Value										Page 77
Notes to the Financial Statements
5.17 Analysis of shareholders' equity
						Risk and	Investment	Inter-	Group	Total
						Savings	manage-	national	capital
							ment		and
									financing
As at 31 December 2009						£m	£m	£m	£m	£m
Analysed as:
IFRS basis shareholders' equity1						199	339	1,372	2,286	4,196
Additional retained profit/(loss) on an EEV basis						3,679	-	108	(1,288)	2,499
Shareholders' equity on an EEV basis						3,878	339	1,480	998	6,695
Comprising:
Business reported on an IFRS basis						199	339	34	(1,590)	(1,018)
Business reported on an EEV basis:
Shareholder net worth
- Free surplus2								263	1,067	1,330
- Required capital to cover solvency margin								255	1,521	1,776
Value of in-force
- Value of in-force business						3,987		1,012		4,999
- Cost of capital						(308)		(84)		(392)
						Risk and	Investment	Inter-	Group	Total
						Savings	manage-	national	capital
							ment		and
									financing
As at 31 December 2008						£m	£m	£m	£m	£m
Analysed as:
IFRS basis shareholders' equity1						174	322	1,272	1,820	3,588
Additional retained profit/(loss) on an EEV basis						4,268	-	203	(1,538)	2,933
Shareholders' equity on an EEV basis						4,442	322	1,475	282	6,521
Comprising:
Business reported on an IFRS basis						174	322	12	(1,596)	(1,088)
Business reported on an EEV basis:
Shareholder net worth
- Free surplus2								144	509	653
- Required capital to cover solvency margin								260	1,369	1,629
Value of in-force
- Value of in-force business						4,576		1,156		5,732
- Cost of capital						(308)		(97)		(405)
1. Shareholders' equity supporting the non profit Risk and Savings businesses is held within Legal & General Assurance Society Limited and Legal & General Pensions Limited and is managed on a groupwide basis within the Group capital and financing segment.
2. Free surplus is the value of any capital and surplus allocated to, but not required to support, the in-force covered business at the valuation date.
Further analysis of shareholders' equity is included in Note 5.18.
European Embedded Value										Page 78
Notes to the Financial Statements
5.18 Segmental analysis of shareholders' equity
					Covered	Other	Total	Covered	Other	Total
					business	business		business	business
					EEV basis	IFRS basis		EEV basis	IFRS basis
					2009	2009	2009	2008	2008	2008
					£m	£m	£m	£m	£m	£m
Risk
- Risk reported on an EEV basis					2,530	-	2,530	3,138	-	3,138
- General insurance					-	120	120	-	99	99
- Other					-	-	-	-	2	2
Total Risk					2,530	120	2,650	3,138	101	3,239
Savings
- Savings reported on an EEV basis					1,149	-	1,149	1,130	-	1,130
- Core retail investments					-	66	66	-	59	59
- Other					-	13	13	-	14	14
Total Savings					1,149	79	1,228	1,130	73	1,203
Investment management					-	339	339	-	322	322
International
- USA					904	-	904	937	-	937
- Netherlands					316	-	316	305	-	305
- France					226	-	226	221	-	221
- Emerging markets					-	34	34	-	12	12
Total International					1,446	34	1,480	1,463	12	1,475
Group capital and financing					2,588	(1,590)	998	1,878	(1,596)	282
					7,713	(1,018)	6,695	7,609	(1,088)	6,521
5.19 Reconciliation of shareholder net worth
							UK	Total	UK	Total
							covered		covered
							business		business
							2009	2009	2008	2008
							£m	£m	£m	£m
SNW of long term operations (IFRS basis)							3,876	5,214	3,415	4,676
Other liabilities (IFRS basis)							-	(1,018)	-	(1,088)
Shareholders' equity on the IFRS basis							3,876	4,196	3,415	3,588
Purchased interest in long term business							(114)	(126)	(171)	(202)
Deferred acquisition costs/deferred income liabilities							(250)	(1,132)	(233)	(1,160)
Contingent loan1							(421)	(421)	(786)	(786)
Deferred tax2							(324)	(33)	(354)	(51)
Other3							(179)	(396)	7	(195)
Shareholder net worth on the EEV basis							2,588	2,088	1,878	1,194
1. On an EEV basis the contingent loan (between Society and LGPL) is modelled within the VIF.  On an IFRS basis the contingent loan asset is included within the Group capital and financing net assets.
2. Deferred tax represents all tax which is expected to be paid under current legislation.
3. Other in the UK covered business relates primarily to the different treatment of sterling reserves, other long term reserves and the non profit result of LGPL under EEV compared with IFRS.  Total business also includes the different treatment of the US Triple X securitisation on an EEV and IFRS basis.
European Embedded Value										Page 79
Notes to the Financial Statements
5.20 Sensitivities
In accordance with the guidance issued by the European Insurance 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 2009
					As	1%	1%	1%	1%	1%
					published	lower	higher	lower	higher	higher
						risk	risk	interest	interest	equity/
						discount	discount	rate	rate	property
						rate	rate			yields
					£m	£m	£m	£m	£m	£m
UK					6,267	376	(328)	28	(51)	106
International					1,446	107	(97)	11	(25)	3
Total covered business					7,713	483	(425)	39	(76)	109
					As	10%	10%	10%	5%	5%
					published	lower	lower	lower	lower	lower
						equity/	maint-	lapse	mortality	mortality
						property	enance	rates	(UK	(other
						values	expenses		annuities)	business)
					£m	£m	£m	£m	£m	£m
UK					6,267	(149)	77	75	(157)	59
International					1,446	(6)	13	54	n/a	89
Total covered business					7,713	(155)	90	129	(157)	148
Effect on new business contribution for the year
					As	1%	1%	1%	1%	1%
					published	lower	higher	lower	higher	higher
						risk	risk	interest	interest	equity/
						discount	discount	rate	rate	property
						rate	rate			yields
					£m	£m	£m	£m	£m	£m
UK					305	45	(39)	7	(12)	16
International					23	17	(14)	-	(2)	-
Total covered business					328	62	(53)	7	(14)	16
					As	10%	10%	10%	5%	5%
					published	lower	lower	lower	lower	lower
						equity/	maint-	lapse	mortality	mortality
						property	enance	rates	(UK	(other
						values	expenses		annuities)	business)
					£m	£m	£m	£m	£m	£m
UK					305	(19)	11	14	(12)	6
International					23	-	1	10	n/a	12
Total covered business					328	(19)	12	24	(12)	18
Opposite sensitivities are broadly symmetrical.

European Embedded Value

Page 80

Notes to the Financial Statements

5.21 Assumptions

UK assumptions

The assumed future pre-tax returns on fixed interest and RPI linked securities are set by reference to the portfolio yield on the relevant backing assets held at market value at the end of the reporting period.  The calculated return takes account of derivatives and other credit instruments in the investment portfolio.  Indicative yields on the total portfolios, after allowance for long term default risk, are shown below.

For annuities, separate returns are calculated for new and existing business.  

Where cash balances are held at the reporting date in excess of or below strategic investment guidelines, it is assumed that these cash balances are immediately invested, or disinvested, at current yields.

Where interest rate swaps are used to reduce risk, it is assumed that these swaps will be sold before expiry and the proceeds reinvested in corporate bonds with a redemption yield 0.70% p.a. (0.70% p.a. at 31.12.08) greater than the swap rate at that time (i.e. the long term credit rate).

Additionally where reinvestment or disinvestment is necessary to rebalance the asset portfolio in line with projected outgo, this is also assumed to take place at the long term credit rate above the swap rate at that time.

The returns on fixed and index-linked securities are calculated net of an allowance for default risk which takes account of the credit rating, outstanding term of the securities and increase in credit defaults over the short term.  The allowance expressed as a level rate deduction from the expected returns was 40bps at 31 December 2009 (32bps at 31.12.08).

Economic assumptions

		31.12.09	31.12.08	31.12.07
		% p.a.	% p.a.	% p.a.
Equity risk premium		3.5	3.5	3.0
Property risk premium		2.0	2.0	2.0
Investment return
- Gilts:
- Fixed interest		4.0	3.8	4.5
- RPI linked		4.5	3.7	4.5
- Non gilts:
- Fixed interest		4.4 - 6.2	4.2 - 8.2	4.9 - 6.1
- RPI linked		5.1 - 6.1	4.7 - 5.9	4.9 - 5.3
- Equities		8.0	7.3	7.5
- Property		6.5	5.8	6.5
Risk free rate1		4.5	3.8	4.5
Risk margin		3.5	4.5	3.0
Risk discount rate (net of tax)		8.0	8.3	7.5
Inflation
- Expenses/earnings		4.6	3.6	4.4
- Indexation		3.6	2.6	3.4

1. The risk free rate is the gross redemption yield on the 20 year gilt index.

UK covered business

i.           Assets are valued at market value.

ii.          Future bonus rates have been set at levels which would fully utilise the assets supporting the policyholders' portion of the with-profits business. The proportion of profits derived from with-profits business allocated to shareholders has been assumed to be 10% throughout.

iii.         The value of in-force business reflects the cost, including administration expenses, of providing for benefit enhancement or compensation in relation to certain products.

European Embedded Value

Page 81

Notes to the Financial Statements

5.21 Assumptions (continued)

iv.         Other actuarial assumptions have been set at levels commensurate with recent operating experience, including those for mortality, morbidity, persistency and maintenance expenses (excluding the development costs referred to below). These are normally 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 30, projection MC, with a minimum annual improvement of 1.5% for future experience, and 2.0% for statutory reserving. Female annuitant mortality is assumed to improve in accordance with 75% of projection MC, with a minimum annual improvement of 1.0% for future experience and 1.5% for statutory reserving. In each case, the annual improvement is assumed to reduce linearly after age 89 to zero at age 120.

On this basis, the best estimate of the expectation of life for a new 65 year old Male CPA annuitant is 24.5 years (31.12.08: 25.2 years).  The expectation of life on the regulatory reserving basis is 25.7 years (31.12.08: 26.4 years).

v.          Development costs relate to investment in strategic systems and development capability that are charged to the covered business.  Projects charged to the non-covered business are included within Investment projects in Group capital and financing.

International

vi.         Key assumptions:

		31.12.09	31.12.08	31.12.07
		% p.a.	% p.a.	% p.a.
USA
Reinvestment rate		5.1	5.4	5.4
Risk margin		3.5	4.5	3.0
Risk discount rate (net of tax)		7.4	6.8	7.1
Europe
Government bond return		3.6	3.5	4.4
Risk margin		3.5	4.5	3.0
Risk discount rate (net of tax)		7.1	8.0	7.4

vii.        Other actuarial assumptions have been set at levels commensurate with recent operating experience, including those for mortality, morbidity, persistency and maintenance expenses.

Tax

viii.       The profits on the covered business, except for the profits on the Society shareholder capital held outside the long term fund, are calculated on an after tax basis and are grossed up by the notional attributed tax rate for presentation in the income statement.  The tax rate used for grossing up is the corporate tax rate in the territory concerned, which for the UK was 28% (31.12.2008: 28%).  The profits on the Society shareholder capital held outside the long term fund are calculated before tax and therefore tax is calculated on an actual basis.

Stochastic calculations

ix.         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 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

 

European Embedded Value

Page 82

Notes to the Financial Statements

5.21 Assumptions (continued)

Summary statistics:

The following table sets out means and standard deviations (StDev) of future returns as at 31 December 2009 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
	Mean1	StDev2	Mean1	StDev2
UK Business (Sterling)
Government bonds	4.4%	3.6%	5.0%	3.8%
Corporate bonds	6.0%	3.8%	6.4%	4.1%
Property (excess returns)	2.0%	15.2%	2.0%	14.9%
Equities (excess returns)	3.6%	20.2%	3.6%	20.5%
European Business (Euro)
Long Government bonds3	3.8%	4.9%	4.8%	5.0%
Short Government bonds4	3.8%	4.1%	4.8%	8.6%
US Business (US Dollar)
Long Government bonds3	4.3%	6.3%	5.4%	6.2%

1.     For asset classes other than for equities and property, mean returns are calculated as the mean return in excess of 1 year government bonds plus the mean return on 1 year government bonds. Mean excess returns for the equities and property are calculated as the mean return in excess of 1 year government bonds. Each mean return 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

x.          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 4.5% risk margin).

-               1% variation in interest rate environment - a one percentage point increased/decreased parallel shift in the risk-free curve with consequential impacts on fixed asset market values, investment return assumptions, 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 8.0% to 9.0%).

-               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.

European Embedded Value

Page 83

Notes to the Financial Statements

5.22 Methodology

Basis of preparation

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

Covered business

The Group uses EEV methodology to value individual and group life assurance, pensions and annuity business written in the UK, Continental Europe and the US. The UK covered business also includes non-insured self invested personal pension (SIPP) business. The managed pension funds business has been excluded from covered business and is reported on an IFRS basis, as management believe IFRS to be the most appropriate reporting basis for the investment management business.

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

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

Description of methodology

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

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

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

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

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

Embedded value

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

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

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

Service companies

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

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

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

New business

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

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

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Notes to the Financial Statements

5.22 Methodology (continued)

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

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

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

Projection assumptions

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

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

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

Tax

The projections take into account all tax which is expected to be paid, based on best estimate assumptions, applying current legislation and practice together with known or expected future changes.

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

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

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

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

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

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Notes to the Financial Statements

5.22 Methodology (continued)

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

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

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

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

Financial options and guarantees

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

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

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

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

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

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

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

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

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Notes to the Financial Statements

5.22 Methodology (continued)

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

Risk discount rate

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

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

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

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

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

For the 2009 results the risk margin was decreased to 3.5% (31.12.08: 4.5%).  The decrease reflects the reduction in the market perceived company specific risks that were apparent in the dislocated market conditions at the 2008 year end.

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 relate to investment in strategic systems and development capability.

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Notes to the Financial Statements

5.22 Methodology (continued)

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

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

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

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

 

END

 

 

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