L&G Half-year Results Part 3b

RNS Number : 6252A
Legal & General Group Plc
05 August 2008
 



European Embedded Value

Notes to the Financial Statements












3.09  Analysis of tax


























Profit/(loss)

Tax

Profit/(loss)

Tax

Profit/(loss)

Tax






before

(charge)/

before

(charge)/

before

(charge)/






tax

credit

tax

credit

tax

credit










Full year

Full year






30.06.08

30.06.08

30.06.07

30.06.07

31.12.07

31.12.07






£m

£m

£m

£m

£m

£m

 

 

 

 

 

 

 

 

 

 

 












From continuing operations










UK life and pensions




506 

(152)

497 

(139)

720 

(232)

International life and pensions




58 

(18)

54 

(16)

136 

(40)

 

 

 

 

 

 

 

 

 

 

 

















564 

(170)

551 

(155)

856 

(272)

Investment management




111 

(26)

90 

(26)

196 

(57)

General insurance




(4)

(38)

12 

(67)

19 

Other operational income




(45)

14 

(14)

10 

(73)

30 

 

 

 

 

 

 

 

 

 

 

 












Operating profit




626 

(181)

589 

(159)

912 

(280)

Variation from longer term investment return


(538)

168 

197 

(61)

116 

12 

Effect of economic assumption changes


(10)

(6)

57 

(14)

Property (expense)/income attributable to minority interests

(13)

17 

(6)

Corporate restructure




161 

(45)

 

 

 

 

 

 

 

 

 

 

 












Profit from continuing operations before tax / Tax

65 

(9)

797 

(218)

1,240 

(327)

 

 

 

 

 

 

 

 

 

 

 























European Embedded Value







Page 31

Notes to the Financial Statements







3.10  Earnings per share










(a)  Earnings per share
























Profit/(loss)

Tax

Profit/(loss)

Per share

Profit/(loss)

Tax

Profit/(loss)

Per share




before tax

(charge)/

after tax


before tax

(charge)/

after tax






credit




credit






30.06.08

30.06.08

30.06.08

30.06.08

30.06.07

30.06.07

30.06.07

30.06.07




£m

£m

£m

p

£m

£m

£m

p

 

 

 

 

 

 

 

 

 

 

 












Operating profit from continuing operations

626 

(181)

445 

7.33 

589 

(159)

430 

6.62 

Variation from longer term investment return

(538)

168 

(370)

(6.09)

197 

(61)

136 

2.09 

Effect of economic assumption changes

(10)

(6)

(0.10)

(6)

(4)

(0.06)

Effect of UK Budget tax changes

-

93 

93 

1.43 

 

 

 

 

 

 

 

 

 

 

 












Earnings per share based on profit 









  attributable to equity holders


78 

(9)

69 

1.14 

780 

(125)

655 

10.08 

 

 

 

 

 

 

 

 

 

 

 






























Profit

Tax

Profit

Per share








before tax

(charge)/

after tax










credit










Full year

Full year

Full year

Full year








31.12.07

31.12.07

31.12.07

31.12.07








£m

£m

£m

p

 

 

 

 

 

 

 

 

 

 

 












Operating profit from continuing operations




912 

(280)

632 

9.81 

Variation from longer term investment return




116 

12 

128 

1.99 

Effect of economic assumption changes




57 

(14)

43 

0.67 

Corporate restructure






161 

(45)

116 

1.80 

Effect of UK Budget tax changes





93 

93 

1.44 

Tax impact of corporate restructure




206 

206 

3.19 

 

 

 

 

 

 

 

 

 

 

 












Earnings per share based on profit 









  attributable to equity holders






1,246 

(28)

1,218 

18.90 

 

 

 

 

 

 

 

 

 

 

 





















European Embedded Value







Page 32

Notes to the Financial Statements








3.10  Earnings per share (continued)








(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 shares1


after tax

of shares1







30.06.08

30.06.08

30.06.08

30.06.07

30.06.07

30.06.07






£m

m

p

£m

m

p

 

 

 

 

 

 

 

 

 

 

 












Operating profit from continuing operations after tax

445 

6,073 

7.33 

430 

6,493 

6.62 

Net shares under options allocable for no further consideration

22 

(0.03)

37 

(0.03)

 

 

 

 

 

 

 

 

 

 

 












Diluted earnings per share




445 

6,095 

7.30 

430 

6,530 

6.59 

 

 

 

 

 

 

 

 

 

 

 































Profit

Number

Per share









after tax

of shares1










Full year

Full year

Full year









31.12.07

31.12.07

31.12.07









£m

m

p

 

 

 

 

 

 

 

 

 

 

 












Operating profit from continuing operations after tax




632 

6,444 

9.81 

Net shares under options allocable for no further consideration



34 

(0.05)

 

 

 

 

 

 

 

 

 

 

 












Diluted earnings per share







632 

6,478 

9.76 

 

 

 

 

 

 

 

 

 

 

 























(ii)  Based on profit attributable to equity holders of the Company






















Profit

Number

Per share

Profit

Number

Per share






after tax

of shares1


after tax

of shares1







30.06.08

30.06.08

30.06.08

30.06.07

30.06.07

30.06.07






£m

m

p

£m

m

p

 

 

 

 

 

 

 

 

 

 

 












Profit attributable to equity holders of the Company

69 

6,073 

1.14 

655 

6,493 

10.08 

Net shares under options allocable for no further consideration

22 

(0.01)

37 

(0.05)

 

 

 

 

 

 

 

 

 

 

 












Diluted earnings per share




69 

6,095 

1.13 

655 

6,530 

10.03 

 

 

 

 

 

 

 

 

 

 

 































Profit

Number

Per share









after tax

of shares1










Full year

Full year

Full year









31.12.07

31.12.07

31.12.07









£m

m

p

 

 

 

 

 

 

 

 

 

 

 












Profit attributable to equity holders of the Company




1,218 

6,444 

18.90 

Net shares under options allocable for no further consideration



34 

(0.10)

 

 

 

 

 

 

 

 

 

 

 












Diluted earnings per share







1,218 

6,478 

18.80 

 

 

 

 

 

 

 

 

 

 

 


1. Weighted average number of shares.























European Embedded Value







Page 33

Notes to the Financial Statements







3.11  Embedded value reconciliation























UK

UK

UK

International

Life and

Investment

Total





value of

shareholder

life and

life and

pensions

manage-






in-force

net worth1

pensions

pensions

total

ment2


As at 30 June 2008


Notes

£m

£m

£m

£m

£m

£m

£m

 

 

 

 

 

 

 

 

 

 

 












At 1 January










Value of in-force business (VIF)



2,846 

2,846 

782 

3,628 

340 

3,968 

Shareholder net worth (SNW)



4,447 

4,447 

319 

4,766 

222 

4,988 












 

 

 

 





2,846 

4,447 

7,293 

1,101 

8,394 

562 

8,956 

Exchange rate movements



34 

34 

34 

Opening adjustments



(27)

27 












 

 

 

 

 

 

 

 

 

 

 





2,819 

4,474 

7,293 

1,135 

8,428 

562 

8,990 

Profit for the period:










- New business contribution



334 

(206)

128 





- Expected return on VIF



107 

107 





- Expected return - transfer to SNW


(217)

217 





- Less: expected movement in contingent loan3

(41)

41 





- Experience variances



89 

(72)

17 





- Operating assumption changes


19 

(9)

10 





- Development costs



(16)

(16)





- Expected return on SNW



108 

108 





- Investment variances



31 

(332)

(301)





- Economic assumption changes


(29)

32 





Profit for the period4



293 

(237)

56 

(3)

53 

28 

81 

Capital movements5



(252)

(252)

(252)

(252)

Embedded value of businesses acquired6

143 

156 

299 

299 

299 

Distributions:



 

 

 





- With-profits transfer



(43)

43 





- Dividend to Group







Distributions



(43)

43 

(3)

(3)

(3)

Other reserve movements including pension deficit

(4)

(4)

(4)

(4)

Transfer to non-covered business7


(14)

(14)

(14)

(14)












 

 

 

 

 

 

 

 

 

 

 

Embedded value


3.12/3.13 

3,212 

4,166 

7,378 

1,129 

8,507 

590 

9,097 

 

 

 

 

 

 

 

 

 

 

 























Represented by:










  Non profit



2,531 


2,531 





  With-profits



681 


681 
















 

 

 

 

 

 

 

 

 

 

 

Value of in-force business



3,212 

3,212 

838 

4,050 

323 

4,373 

Shareholder net worth



4,166 

4,166 

291 

4,457 

267 

4,724 

 

 

 

 

 

 

 

 

 

 

 












1. Following the long term fund restructure in 2007, the shareholder net worth (SNW) of the UK life and pensions business was redefined to include the shareholder capital held outside the long term fund. The pre-tax longer term investment return earned on these assets of £46m is included in UK expected return on SNW (FY07: £52m). The long term investment return on these assets in H107 of £32m was included in Other operational income. 

2. Investment management covered business comprises managed pension funds and is included in the total Investment management shareholders' equity of £792m.

3. On an EEV basis, the contingent loan (between Shareholder capital within the LTF and LGPL) is modelled as an asset of SNW. As profits from the in-force business of LGPL are earned, cash is realised and transferred to SNW and the contingent loan asset is reduced accordingly. The expected movement includes both repayment of capital relating to in-force business and drawdown of loan relating to new business written in the period.

4. Included in the profit for the period is an inter-fund transfer from Shareholder capital within the LTF (included in SNW) to non profit (included in VIF) of £44m.

5. Capital movements comprise the £252m cost of acquiring Nationwide Life.  The acquisition of Suffolk Life was funded from Corporate funds within the non-covered business (£63m). Further information on both acquisitions can be found in Note 4.09.

6. The embedded value of businesses acquired on the date of acquisition comprises £235m from the acquisition of Nationwide Life on 31 January 2008 and £64m from the acquisition of Suffolk Life on 6 May 2008. Further information relating to the businesses acquired can be found in Note 4.09.

7. The transfer to non-covered business represents the IFRS profits arising in the period from the provision of investment management services by Legal & General Investment Management to the UK life and pensions covered business, which have been included in the operating profit of the covered business on a look through basis.  























European Embedded Value






Page 34

Notes to the Financial Statements







3.11  Embedded value reconciliation (continued)






















UK

UK

UK

International

Life and

Investment

Total





value of

shareholder

life and

life and

pensions

manage-






in-force

net worth1

pensions

pensions

total

ment2


As at 30 June 2007


Notes

£m

£m

£m

£m

£m

£m

£m

 

 

 

 

 

 

 

 

 

 

 












At 1 January










Value of in-force business (VIF)



2,428 

2,428 

652 

3,080 

281 

3,361 

Shareholder net worth (SNW)



3,828 

3,828 

261 

4,089 

194 

4,283 












 

 

 

 

 

 

 

 

 

 

 





2,428 

3,828 

6,256 

913 

7,169 

475 

7,644 

Exchange rate movements



(18)

(18)

(18)












 

 

 

 

 

 

 

 

 

 

 





2,428 

3,828 

6,256 

895 

7,151 

475 

7,626 

Profit for the period:










- New business contribution



237 

(118)

119 





- Expected return on VIF



91 

91 





- Expected return - transfer to SNW


(172)

172 





- Less: expected movement in contingent loan3

29 

(29)





- Experience variances



143 

(99)

44 





- Operating assumption changes


(12)

(9)





- Development costs



(8)

(8)





- Expected return on SNW



121 

121 





- Investment variances



24 

114 

138 





- Economic assumption changes


(11)

(9)





- Effect of UK Budget tax changes


48 

38 

86 





Profit for the period4



392 

181 

573 

29 

602 

65 

667 

Capital movements5



73 

73 

73 

Distributions:










- Non profit


5.04 (a)

 

(61)

(61)





- With-profits



(35)

 

(35)





- Shareholder net worth


5.04 (a)

 

(78)

(78)





Distributions



(35)

(139)

(174)

(174)

(174)

Other reserve movements including pension deficit

23 

23 

23 

23 

Transfer to non-covered business6


(3)

(3)

(3)

(3)












 

 

 

 

 

 

 

 

 

 

 

Embedded value


3.12/3.13 

2,785 

3,890 

6,675 

997 

7,672 

540 

8,212 

 

 

 

 

 

 

 

 

 

 

 























Represented by:










  Non profit



1,902 


1,902 





  With-profits



883 


883 
















 

 

 

 

 

 

 

 

 

 

 

Value of in-force business



2,785 

2,785 

707 

3,492 

310 

3,802 

Shareholder net worth



3,890 

3,890 

290 

4,180 

230 

4,410 

 

 

 

 

 

 

 

 

 

 

 












1. At HY07 UK SNW represented the amounts in the Society long term fund and LGPL shareholder capital which are regarded as either required capital or free surplus held within the covered business.

2. Investment management covered business comprises managed pension funds and is included in the total Investment management shareholders' equity of £671m.

3. On an EEV basis, the contingent loan (between SRC and LGPL) is modelled as an asset of SNW. As profits from the in-force business of LGPL are earned, cash is realised and transferred to SNW and the contingent loan asset is reduced accordingly. The expected movement includes both repayment of capital relating to in-force business and drawdown of loan relating to new business written in the period.

4. Included in the profit for the period is an inter-fund transfer from SRC (included in SNW) to non profit (included in VIF) of £35m.

5. Capital movements comprise £46m ($90m) of capital injected into the USA operation and £27m (€40m) injected into the French operation.

6. The transfer to non-covered business represents the IFRS profits arising in the period from the provision of investment management services by Legal & General Investment Management to the UK life and pensions covered business, which have been included in the operating profit of the covered business on a look through basis.
























European Embedded Value






Page 35

Notes to the Financial Statements







3.11  Embedded value reconciliation (continued)






















UK

UK

UK

International

Life and

Investment

Total





value of

shareholder

life and

life and

pensions

manage-






in-force

net worth

pensions

pensions

total

ment1


As at 31 December 2007


Notes

£m

£m

£m

£m

£m

£m

£m

 

 

 

 

 

 

 

 

 

 

 












At 1 January










Value of in-force business (VIF)



2,428 

2,428 

652 

3,080 

281 

3,361 

Shareholder net worth (SNW)



3,828 

3,828 

261 

4,089 

194 

4,283 












 

 

 

 

 

 

 

 

 

 

 





2,428 

3,828 

6,256 

913 

7,169 

475 

7,644 

Exchange rate movements



28 

28 

28 












 

 

 

 

 

 

 

 

 

 

 





2,428 

3,828 

6,256 

941 

7,197 

475 

7,672 

Profit for the period:










- New business contribution



510 

(279)

231 





- Expected return on VIF



189 

189 





- Expected return - transfer to SNW


(331)

331 





- Movement in contingent loan2


(108)

108 





- Experience variances



64 

71 





- Operating assumption changes


(23)

(179)

(202)





- Development costs



(34)

(34)





- Expected return on SNW



233 

233 





- Investment variances



195 

(57)

138 





- Economic assumption changes


(97)

147 

50 





- Effect of UK Budget tax changes


48 

38 

86 





- Corporate restructure



45 

71 

116 





- Tax impact of Corporate restructure

206 

206 





Profit for the period3



492 

592 

1,084 

78 

1,162 

139 

1,301 

Capital movements4



(590)

(590)

84 

(506)

(506)

Other capital movements



1,307 

1,307 

1,307 

1,307 

Distributions:










- With-profits transfer



(74)

74 





- Dividend to Group



(728)

(728)





Distributions



(74)

(654)

(728)

(2)

(730)

(52)

(782)

Other reserve movements including pension deficit

(20)

(20)

(20)

(20)

Transfer to non-covered business5


(16)

(16)

(16)

(16)












 

 

 

 

 

 

 

 

 

 

 

Embedded value


3.12/3.13 

2,846 

4,447 

7,293 

1,101 

8,394 

562 

8,956 

 

 

 

 

 

 

 

 

 

 

 























Represented by:










  Non profit



2,056 


2,056 





  With-profits



790 


790 
















 

 

 

 

 

 

 

 

 

 

 

Value of in-force business



2,846 

2,846 

782 

3,628 

340 

3,968 

Shareholder net worth



4,447 

4,447 

319 

4,766 

222 

4,988 

 

 

 

 

 

 

 

 

 

 

 


1. Investment management covered business comprises managed pension funds and is included in the total Investment management shareholders' equity of £689m.

2. On an EEV basis, the contingent loan (between Society and LGPL) is modelled as an asset of SNW. As profits from the in-force business of LGPL are earned, cash is realised and transferred to SNW and the contingent loan asset is reduced accordingly. The movement includes both the repayment of capital relating to in-force business and drawdown of loan relating to new business written in the period.

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 £60m.

4. Capital movements comprise the repayment of £602m of intra-group subordinated debt, offset by £57m ($114m) of capital injected into the USA and £39m injected into Legal & General International (Ireland) from Group, together with £27m (€40m) injected into France from Society.

5. The transfer to non-covered business represents the IFRS profits arising in the period from the provision of investment management services by Legal & General Investment Management to the UK life and pensions covered business, which have been included in the operating profit of the covered business on the look through basis.























European Embedded Value






Page 36

Notes to the Financial Statements







3.12  Analysis of shareholders' equity























UK1

International

Life and

Investment

Other

Total








pensions

manage-

operations3









total

ment2



As at 30 June 2008




£m

£m

£m

£m

£m

£m

 

 

 

 

 

 

 

 

 

 

 












Analysed as:










IFRS basis shareholders' equity




4,824 

900 

5,724 

267 

(1,316)

4,675 

Additional retained profit on an EEV basis


2,554 

229 

2,783 

323 

3,106 












 

 

 

 

 

 

 

 

 

 

 

Shareholders' equity on an EEV basis


7,378 

1,129 

8,507 

590 

(1,316)

7,781 

 

 

 

 

 

 

 

 

 

 

 












Comprising:










Shareholder net worth










 - Free surplus




2,828 

90 

2,918 

243 



 - Required capital to cover solvency margin


1,338 

201 

1,539 

24 



Value of in-force 










 - Value of in-force business




3,332 

903 

4,235 

331 



 - Cost of capital




(120)

(65)

(185)

(8)



 

 

 

 

 

 

 

 

 

 

 























As at 30 June 2007










 

 

 

 

 

 

 

 

 

 

 












Analysed as:










IFRS basis shareholders' equity




4,329 

803 

5,132 

230 

153 

5,515 

Additional retained profit on an EEV basis


2,346 

194 

2,540 

310 

2,850 












 

 

 

 

 

 

 

 

 

 

 

Shareholders' equity on an EEV basis


6,675 

997 

7,672 

540 

153 

8,365 

 

 

 

 

 

 

 

 

 

 

 












Comprising:










Shareholder net worth










 - Free surplus




691 

106 

797 

206 



 - Required capital to cover solvency margin


1,402 

184 

1,586 

24 



 - Other required capital




1,797 

1,797 



Value of in-force 










 - Value of in-force business




2,926 

759 

3,685 

316 



 - Cost of capital




(141)

(52)

(193)

(6)



 

 

 

 

 

 

 

 

 

 

 























As at 31 December 2007










 

 

 

 

 

 

 

 

 

 

 












Analysed as:










IFRS basis shareholders' equity




4,832 

880 

5,712 

222 

(488)

5,446 

Additional retained profit on an EEV basis


2,461 

221 

2,682 

340 

3,022 












 

 

 

 

 

 

 

 

 

 

 

Shareholders' equity on an EEV basis


7,293 

1,101 

8,394 

562 

(488)

8,468 

 

 

 

 

 

 

 

 

 

 

 












Comprising:










Shareholder net worth










 - Free surplus




3,249 

140 

3,389 

198 



 - Required capital to cover solvency margin


1,198 

179 

1,377 

24 



Value of in-force 










 - Value of in-force business




2,944 

840 

3,784 

347 



 - Cost of capital




(98)

(58)

(156)

(7)



 

 

 

 

 

 

 

 

 

 

 


Free surplus is the value of any capital allocated to, but not required to support, the in-force covered business at the valuation date.


1. H1 08 and FY 07 include total Society shareholder capital. 

2. Investment management comprises managed pension funds and is included in the total Investment management shareholders' equity of £792m (H1 07: £671m, FY 07: £689m).

3. Other Investment management businesses included on an IFRS basis at £202m (H1 07: £131m; FY 07: £127m) are included in Other operations.























European Embedded Value






Page 37

Notes to the Financial Statements







3.13  Segmental analysis of shareholders' equity























Covered

Other

Total

Covered

Other

Total






business

business


business

business







EEV basis

IFRS basis


EEV basis

IFRS basis







At 30.06.08

At 30.06.08

At 30.06.08

At 30.06.07

At 30.06.07

At 30.06.07






£m

£m

£m

£m

£m

£m

 

 

 

 

 

 

 

 

 

 

 























UK life and pensions




7,378 

7,378 

6,675 

501 

7,176 

Embedded value of international life and pensions business







 - USA




647 

647 

595 

595 

 - Netherlands




286 

286 

236 

236 

 - France




196 

196 

166 

166 

 

 

 

 

 

 

 

 

 

 

 

















8,507 

8,507 

7,672 

501 

8,173 

Investment management




590 

202 

792 

540 

131 

671 

 

 

 

 

 

 

 

 

 

 

 

















9,097 

202 

9,299 

8,212 

632 

8,844 

General insurance




98 

98 

136 

136 

Corporate funds1




(1,616)

(1,616)

(615)

(615)

 

 

 

 

 

 

 

 

















9,097 

(1,316)

7,781 

8,212 

153 

8,365 

 

 

 

 

 

 

 

 

 

 

 































Covered

Other

Total









business

business










EEV basis

IFRS basis










At 31.12.07

At 31.12.07

At 31.12.07









£m

£m

£m

 

 

 

 

 

 

 

 

 

 

 












UK life and pensions







7,293 

7,293 

Embedded value of international life and pensions business







 - USA







645 

645 

 - Netherlands







270 

270 

 - France







186 

186 

 

 

 

 

 

 

 

 

 

 

 




















8,394 

8,394 

Investment management







562 

127 

689 

 

 

 

 

 

 

 

 

 

 

 




















8,956 

127 

9,083 

General insurance







114 

114 

Corporate funds1







(729)

(729)

 

 

 

 

 

 

 

 

 

 

 




















8,956 

(488)

8,468 

 

 

 

 

 

 

 

 

 

 

 

Further analysis of the covered business is included in Note 3.12.






































Full year









30.06.08

30.06.07

31.12.07









£m

£m

£m

 

 

 

 

 

 

 

 

 

 

 












Movement










As at 1 January







8,468 

7,931 

7,931 

Total recognised income and expense






92 

665 

1,229 

Issue of share capital







Share buyback







(408)

(320)

Closed period share buyback reserve





(100)

Net movements in employee scheme shares





(9)

(9)

Dividend distributions to equity holders of the Company during the period



(248)

(248)

(369)

Other movements including pension deficit





(21)

23 

(8)

 

 

 

 

 

 

 

 

 

 

 












As at 30 June / 31 December







7,781 

8,365 

8,468 

 

 

 

 

 

 

 

 

 

 

 












1. Corporate funds includes general corporate assets held at Group level including those used to support the ongoing share buyback programme, subordinated borrowings and senior borrowings.


































European Embedded Value






Page 38

Notes to the Financial Statements







3.14  Reconciliation of shareholder net worth


































UK life and

Total

UK life and

Total

UK life and

Total






 pensions


 pensions


 pensions







At 30.06.08

At 30.06.08

At 30.06.07

At 30.06.07

At 31.12.07

At 31.12.07






£m

£m

£m

£m

£m

£m

 

 

 

 

 

 

 

 

 

 

 












SNW of long term operations (IFRS basis)


4,824 

5,991 

3,285 

5,362 

4,832 

5,934 

Other assets (IFRS basis)




(1,316)

1,044 

153 

(488)

 

 

 

 

 

 

 

 

 

 

 












Shareholders' equity on the IFRS basis


4,824 

4,675 

4,329 

5,515 

4,832 

5,446 

Purchased interests in long term business


(183)

(198)

(6)

(24)

(5)

(19)

1996 Sub-fund




326 

326 

Deferred acquisition costs/deferred income liabilities

(221)

(871)

(127)

(703)

(139)

(751)

Deferred tax1




(467)

(257)

(642)

(460)

(363)

(172)

Other2




213 

59 

10 

(91)

122 

(4)

 

 

 

 

 

 

 

 

 

 

 












Shareholder net worth on the EEV basis


4,166 

3,408 

3,890 

4,563 

4,447 

4,500 

 

 

 

 

 

 

 

 

 

 

 












1. Deferred tax represents all tax which is expected to be paid under current legislation.

2. Other relates primarily to the different treatment of sterling reserves, other long term reserves and the non profit result of LGPL under EEV compared with IFRS.














European Embedded Value






Page 39

Notes to the Financial Statements







3.15 Assumptions








UK assumptions


The assumed future pre-tax returns on fixed interest and RPI linked securities are set by reference to redemption yields available in the market at the end of the reporting period. 


For annuities, separate returns are calculated for business sold before or after December 2006. This reflects a change in investment policy applicable to the 2007 and later business, which has the aim of increasing the expected return whilst not increasing the level of asset risk compared with the historic policy. This has been achieved through improved investment efficiency and increased diversification through use of additional asset classes. The calculated return takes account of derivatives and other credit instruments in the investment portfolio.  From the second half of 2007, some aspects of this revised strategy were also applied to the assets backing the in-force annuity business.


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


The returns on fixed and index-linked securities are calculated net of an allowance for default risk which takes account of the outstanding term of the securities. The allowances for default risk are set separately for the asset portfolios supporting fixed and index-linked securities, and average 0.12% p.a. and 0.09% p.a. respectively across the portfolios as a whole (0.11% p.a. and 0.10% p.a. at 31.12.2007). 

 


Economic assumptions


30.06.08

30.06.07

31.12.07

31.12.06


% p.a.

% p.a.

% p.a.

% p.a.






Equity risk premium

3.0

3.0

3.0

3.0

Property risk premium

2.0

2.0

2.0

2.0






Investment return





- Gilts:





    - Fixed interest

4.9

5.1

4.5

4.6

    - RPI linked

5.1

5.6

4.5

4.7

- Non gilts:





    - Fixed interest

5.4 - 7.1

5.6 - 6.0

4.9 - 6.1

4.9 - 5.3

    - RPI linked

5.8 - 6.8

5.3 - 5.9

4.9 - 5.3

4.6 - 5.1

- Equities

7.9

8.1

7.5

7.6

- Property

6.9

7.1

6.5

6.6






Risk margin

3.0

3.0

3.0

3.0

Risk discount rate (net of tax)

7.9

        8.1

7.5

7.6






Inflation





- Expenses/earnings

5.2

4.5

4.4

4.2

- Indexation

4.2

3.5

3.4

3.2


UK life and pensions


i.  Assets are valued at market value.


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


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


Iv.  Other actuarial assumptions have been set at levels commensurate with recent operating experience, including those for mortality, morbidity, persistency and maintenance expenses (excluding the development costs referred to below). These are normally reviewed annually.



European Embedded Value






Page 40

Notes to the Financial Statements







3.15 Assumptions








An allowance is made for future improvements in annuitant mortality based on experience and externally published data. At 30 June 2008 and 31 December 2007, male annuitant mortality was assumed to improve in accordance with CMI Working Paper 1, projection MC, with a minimum annual improvement of 1.5% for future experience, and 2.0% for statutory reserving. Female annuitant mortality is assumed to improve in accordance with 75% of projection MC, with a minimum annual improvement of 1.0% for future experience and 1.5% for statutory reserving. In each case, the minimum annual improvement is assumed to reduce linearly after age 89 to zero at age 120.  


On this basis, the best estimate of the expectation of life for a new 65 year old Male CPA annuitant is 25.1 years. The expectation of life on the regulatory reserving basis is 26.2 years.


As at 30 June 2007, male annuitant mortality was assumed to improve in accordance with CMI Working Paper 1, projection MC for future experience with a minimum annual improvement of 0.6%, and the average of projections MC and LC for statutory reserving with a minimum annual improvement of 0.8%. Female annuitant mortality was assumed to improve in accordance with the MC projection from CMI Working Paper 1 for statutory reserving and at 70% of this rate for future experience, with the same underpinning minima as for males.  


On this basis, the best estimate of the expectation of life for a new 65 year old Male CPA annuitant was 23.8 years. The expectation of life on the regulatory reserving basis was 25.1 years.


v.  Development costs relate to investment in strategic systems and development capability.


UK managed pension funds


vi.  All contracts are assumed to lapse over a 10 year period. Fees are projected on a basis which reflects current charges or, if less, anticipated charges. New business consists of monies received from new clients and incremental receipts from existing clients, and excludes the roll-up of the investment returns. Development costs relate to strategic systems. 


International


vii.  Key assumptions:



30.06.08

30.06.07

31.12.07

31.12.06


% p.a.

% p.a.

% p.a.

% p.a.

USA





Reinvestment rate

5.6

5.8

5.4

5.4

Risk margin

3.0

3.0

3.0

3.0

Risk discount rate (net of tax)

7.1

8.1

7.1

7.8






Europe





Government bond return

4.8

4.6

4.4

4.0

Risk margin

3.0

3.0

3.0

3.0

Risk discount rate (net of tax)

7.8

7.6

7.4

7.0


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


Tax


ix.  EEV results are computed on an after tax basis and are grossed up by the notional attributed tax for presentation in the income statement. The tax rate used for grossing up is the corporate tax rate in the territory concerned which for the UK was 28% (H1 07: 28%; FY 0728%).  For the UK, investment return on Society shareholder capital, excluding the contingent loan, is calculated on a pre-tax basis.


Stochastic calculations


x.  The time value of options and guarantees is calculated using economic and non-economic assumptions consistent with those used for the deterministic embedded value calculations.


This section describes the models used to generate future investment simulations, and gives some sample statistics for the simulations used. A single model has been used for UK and international business, with different economic assumptions for each territory.


Government nominal interest rates are generated using a LIBOR Money Market Model projecting full yield curves at annual intervals. The model provides a good fit to the initial yield curve.


The total annual returns on equities and property are calculated as the return on 1 year bonds plus an excess return. The excess return is assumed to have a lognormal distribution. Corporate bonds are modelled separately by credit rating using stochastic credit spreads over the risk-free rates, transition matrices and default recovery rates. The real yield curve model assumes that the real short rate follows a mean-reverting process subject to two normally distributed random shocks.



European Embedded Value






Page 41

Notes to the Financial Statements







3.15 Assumptions







Asset classes

The significant asset classes are for:

UK with-profits business - equities, property and fixed rate bonds of various durations;

UK annuity business - fixed rate and index-linked bonds of various durations; and

International business - fixed rate bonds of various durations

Summary statistics

The following table sets out means and standard deviations (StDev) of future returns as at 30 June 2008 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

5.3%

3.4%

5.3%

3.4%

Corporate bonds

7.1%

3.7%

6.8%

3.7%

Property (excess returns)

2.0%

14.6%

2.0%

15.0%

Equities (excess returns)

3.1%

20.2%

3.0%

19.9%






European Business (Euro)





Long Government bonds3

4.9

4.5

5.2

8.4

Short Government bonds4

4.9

5.0

5.2

5.1






US Business (US Dollar)





Long Government bonds3

4.6

5.9

5.4

6.0






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 


In accordance with the dispensation within the CFO guidelines, a full sensitivity analysis is provided annually.


European Embedded Value






Page 42


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