Annual Financial Report 2009

RNS Number : 5827J

Old Mutual PLC

01 April 2010

 



Ref 18/10 (Part 4)

BUSINESS REVIEW

The Long-Term Savings

The Long-Term Savings Division (LTS), brings all of the Group's long-term savings businesses together. The vision of LTS is aligned to that of the Group's vision, which is to be our customers' most trusted partner - passionate about helping them achieve their lifetime financial goals. We intend to achieve this vision by being the leader in the management of personal finances within our selected markets, for predominantly middle income and affluent customers.

Long-Term Savings Overview

In March 2009 we announced that one of our five strategic priorities was to "Leverage scale in our long-term savings businesses". In order to achieve this objective we announced the creation of the Long-Term Savings Division (LTS), bringing all of the Group's long-term savings businesses together for the first time. The vision of LTS is to be our customers' most trusted partner in helping them achieve their lifetime financial goals, within our selected markets. We intend to achieve this objective through the unlocking of value for customers and shareholders by:

·      Leveraging the core expertise and capabilities that we have within our businesses;

·      Ensuring more effective deployment of technology and platform; and

·      Identifying and exploiting synergies.

The LTS Executive Committee includes the CEOs of all the LTS Business Units (Emerging Markets, Retail Europe, Nordic, Wealth Management and US Life). This structure enables rigorous discussion within LTS and brings to the surface areas where synergies can be gained and capabilities replicated.

What is LTS?

LTS is Old Mutual's long-term savings business. This includes both life and non-life investment products, which we provide to help our customers improve their financial health or to manage their personal finances. Across our various businesses, we have real competitive advantage as a result of the following:

1. Access to customers

We have excellent access to customers through a range of different distribution channels, which are founded on long and trusted relationships.

2. Excellent customer solutions

We have built up a reputation for having excellent solutions which meet the needs of our customers. These are generally tied to the provision of advice, whether by us, or via independent distribution channels.

3. Scale

The scale of our LTS business allows us to achieve significant economies, including process and IT efficiencies, which permit us to deliver excellent customer service at a lower cost.

4. Delivering returns consistent with needs

Across our LTS business we have a common approach to delivering investment returns for customers. This is about delivering value and returns consistent with their needs. Customer focus is the hallmark of the LTS business. We believe it provides us with a competitive advantage as it builds trust amongst customers and can be related back to their specific needs and risk profiles.

The rationale for the business

Within LTS, returns and growth rates are high. It is well-balanced in terms of its financial characteristics, having a mix of high return, cash-generative businesses (OMSA, Namibia and Colombia), high profit growth businesses (Wealth Management and Nordic), and high embedded value growth businesses (European Retail, Africa, Asia and Mexico). The overall result of managing these businesses together is to generate a good cash return coupled with strong profit and embedded value growth over the long-term. In addition, there is a great opportunity to increase returns by identifying and further developing synergies across the Group.

Highlights of the past year

2009 was a challenging, yet exciting, year for LTS. Our goal as we began to develop the strategy for the LTS division was to create more value for customers and shareholders from combining the LTS businesses. As part of this strategy, we exited Australia, Chile and the Eastern European countries where we did not have a meaningful presence. In addition, we restructured our Wealth Management and Retail Europe businesses for optimal performance and combined China, India, Colombia, Mexico, OMSA and the Rest of Africa into an Emerging Markets business unit to leverage the extensive knowledge of emerging markets already in existence in OMSA.

Financial performance

See Group Finance Director's report.

Looking forward to 2010

2010 is going to be a key year for LTS with our focus centred around the delivery of our strategy specifically in relation to the cost and revenue synergies identified, the delivery of the Wealth Management strategy as included in its section below, and continuing to leverage our skills and capabilities. We will prepare each of the businesses in the LTS division for growth and optimal performance in their respective markets, and while the year ahead will be undoubtedly be testing as the uncertainty of the markets continues, we are confident that the LTS businesses will not only exhibit the resilience evidenced by the 2009 financial results, but also produce a strong performance in 2010 as a result of the newly-focused strategy.

Emerging Markets

LTS Emerging Markets provides innovative financial solutions addressing both protection and savings needs in 10 countries with a combined population of over 2.6 billion in Africa, Asia and Latin America. Our biggest business is in South Africa, where we are the largest financial services company (as measured by assets under management). We also serve other African countries through our operations in Namibia, Zimbabwe, Malawi, Kenya and Swaziland. Under New Markets we provide financial services to Latin America through Skandia Colombia and Mexico, and in Asia through joint ventures Old Mutual Kotak Mahindra in India and Skandia:BSAM in China.Our business comprises asset management, life insurance, banking and short-term insurance. In life insurance we provide wealth management, investment products, retirement savings, life insurance and disability insurance to individuals and groups in all 10 countries in which we operate.

In South Africa we provide asset management services through Old Mutual Investment Group South Africa's (OMIGSA) boutiques. OMIGSA's investment boutiques collectively span all key asset classes and employ unique strategies that meet the different needs and risk profiles of their customers. This gives our customers access to a comprehensive range of savings and investment solutions. We are expanding our reach outside the traditional South African customer base by offering property, infrastructure, exchange traded funds (ETF) and hedge-fund solutions that meets the needs of international investors. The investment boutiques include:

·      a number of specialist equity businesses;

·      a fixed income capability in Futuregrowth;

·      a number of businesses which blend multiple asset classes to create risk profiled solutions for investors;

·      an index-tracker capability in Dibanisa Fund Managers;

·      a property asset management and property management capability in Old Mutual Investment Group Property Investments (OMIGPI);

·      a multi-manager capability through SYmmETRY, which creates portfolios for institutional investors blending best of breed asset managers across multiple asset classes;

·      a private equity and infrastructure investment capability; and

·      Old Mutual Specialised Finance (OMSFIN), which is active in corporate lending, securities lending and structured products.

We offer life insurance services in South Africa through Old Mutual Life Assurance Company (South Africa) (OMLACSA). This has three distinctive business units:

·      Retail Affluent business provides life, disability, retirement annuities, savings and investment products to individuals earning more than R12,000 per month. Our multi-channel distribution approach gives us extensive reach. Retail Affluent has 25% market share of its 2.9 million target market of customers. In 2009 we got R2.1 billion Life APE sales from all distribution channels and R24.3 billion non-life inflows.

·      Retail Mass business meets the financial services needs of the mass market, which is defined as all those individuals who earn a monthly personal income of less than R12,000: an estimated 10.2 million individuals in South Africa. In 2009 we received R1.5 billion APE from all our channels. In the last five years, Retail Mass doubled its APE driven by demographic shifts (making it the fastest growing segment). Based on the number of customers we have a market share of 37% if we only take the traditional life company competitors into account and 24% if we incorporate all players (including banks) in this space.

·      Corporate segment provides investment, retirement, insurance, structured products and advisory services to corporate, institutional and parastatal customers. Investment products are customised depending on the investor's requirements. These include smoothed bonus portfolios (where we have 70% of the market), absolute growth portfolios, structured solutions, annuity products (which account for more than 60% of the SA market), group assurance products as well as third-party asset management. We offer other multi-managed asset management solutions and administer a range of retirement schemes for corporates and umbrella arrangements. Many of these schemes are defined contribution and open-architecture. Through Old Mutual Actuaries and Consultants (OMAC) we offer advisory services to 150 sizeable retirement funds as well as medical schemes.

In the rest of Africa most of our life products are distributed by tied agents. In Zimbabwe we offer short-term insurance through RM Insurance Company and a range of banking services through Central African Building Society (CABS), Zimbabwe's largest building society.

In Latin America we serve a mix of retail affluent, retail mass and corporate customers with an open-architecture of international and domestic unit trust funds. In China we mainly serve the affluent market and in India we mainly serve retail mass.

We continue to build on our strengths:

·      Old Mutual South Africa has a strong balance sheet and is one of the best capitalised businesses in the industry: we have a higher credit rating than any of our competitors.

·      We have the largest distribution capability in the South African long-term industry: our combination of tied agents, independent financial advisers, bank distribution, corporate advisers and direct distribution enables us to reach a full spectrum of potential customers.

·      In the rest of Africa, our businesses dominate the local markets in which they operate.

·      Excellent risk management and sophisticated product design capabilities make us a profitable one-stop financial services provider with leading products across all the customer segments we serve.

·      In Latin America we are a premier player in managing corporate voluntary pensions, with a rapidly growing market share.

·      In China we are the market leader in unit-linked investments.

Business model

Our current business is designed to maximise assets under management (AUM) and margin while minimising expenses.

We maximise AUM by:

·      Growing our sales through growing our distribution ahead of our competitors, segmenting our customer base to service affluent, mass and corporate customers appropriately, and providing class-leading products.

·      Providing attractive investment performance, aided by our model of having multiple boutiques with their own specialist focus.

·      Ensuring that money does not leave the company unnecessarily. We seek high persistency though good customer management and service, strong investment performance and sales force training to manage sales quality.

We maximise margin by leveraging our risk management and product development capabilities to yield differentiated products where we can make a good margin. For commoditised products we leverage our brand and distribution footprint to reach more customers than our competitors. As at the end of December we had 2,535 tied agents serving the Retail Affluent segment of OMSA. Our key product offerings include Greenlight, a flexible and comprehensive range of life, disability, and future needs cover. A range of retirement savings plans, annuities, investment and income products are provided through different wrappers - which include theMax, Investment Frontiers and Galaxy product ranges.

For OMSA's Retail Mass segment, channels to market include salaried tied agents selling predominantly through worksite marketing, Group Schemes, independent financial advisers (IFAs), direct channels, partnerships with other retail chain stores and banks. We offer savings, retirement and life cover and funeral cover products. In 2009 we started offering lending products to this market through Old Mutual Finance. At the end of 2009 we had 2,694 tied agents.

In Latin America, we distribute primarily through tied financial planners and in China through multiple distribution channels.

In the rest of Africa most of the life products are distributed by tied agents.

In South Africa, in 2009, the total contribution to Life (APE) sales from agents in Retail Mass was 76% and 50% in Retail Affluent.

Generally we achieve higher margins in riskier markets and segments, or where competition is lower. Margin is also affected by liability profile. We make higher margins on insurance contracts than on pure investment contracts.

We manage expenses tightly, and costs per policy are well below those in developed markets. Customer service, technology and policy administration service for the Retail Affluent, Retail Mass and Corporate businesses in OMSA and some of the other African businesses are provided by Old Mutual Service Technology and Administration (OMSTA). We established OMSTA in 2003 to improve customer service and provide IT capabilities while substantially reducing costs through economies of scale. OMSTA services all Old Mutual's customers, intermediaries and retirement fund members across our full product range through our extensive network of service centres, call centres and internet. It achieves economies while enhancing service quality, and we are looking to use its capability across the other LTS divisions to benefit from its low cost base and boost LTS's competitiveness in other geographies.

Our business plan sets delivery targets that we track monthly. The strategy development cycle, running from November to May, feeds into the business planning cycle which runs from June to October. During the strategy development cycle, the management team sets the strategy and provides context and direction to guide business planning. We set both financial and non-financial objectives for a three year cycle. Delivery against the agreed plan is reviewed monthly, quarterly and annually and we take remedial action where necessary. The plan forms part of the performance agreements for business units and is directly linked to how they are rewarded.

Sophisticated risk management processes ensure that we deliver what we promise to customers. Our capital adequacy reserves (CAR) ensure that we can weather adversity, and we add a significant margin to statutory requirements so that we can meet substantial deviations. The life company in South Africa currently holds at least 1.25 times statutory CAR as a minimum internal CAR, which, together with some strategic holdings such as investments in Nedbank and M&F, is not distributed to shareholders. We also determine economic capital (the minimum capital needed to meet worst-case loss in economic value, due to risks arising from business activities) and working to integrate that with the existing capital management framework. Staff incentives are based on economic profit.

Our distribution through bank financial advisers within Nedbank constitutes an important channel. Our key relationships with Nedbank and Mutual and Federal (M&F) are delivering real value. In Namibia and Swaziland we have a bancassurance arrangement with Nedbank. We launched the OM Investment Credit Card in South Africa with Nedbank support and are currently reviewing the possibility of transactional banking with Nedbank. We distribute some of our products through Nedbank Financial Planners, which delivered R167 million APE of sales in 2009. Procurement synergies with Nedbank and M&F are delivering cost savings on both sides. We will continue to leverage our relationship with M&F to grow the value of our business.

Product development

Among the most distinguishing features of Old Mutual's products are their simplicity and transparency, so we take care to follow this philosophy diligently when designing products and updating features.

We use a host of surveys and focussed groups to ensure that we continue to deliver on our promises and meet our customers' needs.

Experience has shown that we also develop products relatively cheaply when compared to competitors and that we are quick to market; thereby enabling us to boost our return to shareholders.

In line with international trends and the need to ensure products are appropriate for today's environment, we are now continuously developing investment and savings products which have significantly lower charges (and capital requirements), increased transparency and flexibility.

Market overview

South Africa

The impact of recession on the jobs market was much worse than anticipated. Nearly eight hundred thousand workers lost their jobs. Local equity markets followed a similar pattern to international markets, with a dramatic fall at the beginning of the year followed by a significant recovery in H2. The All Share Index rose by 29% in 2009, with dramatic variances in sector performances. Inflation fell, from a peak of 8.6% in March, to 6.3% in December. The rand appreciated by 22% against the US dollar and 14% against the British pound mainly as a result of a narrowing trade deficit.

The local financial services sector was severely affected by the South African recession as job losses led to a decline in disposable incomes. Competition has continued to increase as banks, life assurers and asset managers increase their product offerings in an effort to grow their share of customer wallets. In addition, new market entrants unburdened by legacy issues are challenging existing practices.

The overall savings rate in South Africa remains low, with a large proportion of savings being channelled into non-financial investment vehicles such as property. Demographic shifts have seen a fast-growing black middle-income market accumulating savings and wealth while the "baby-boomer" market enters the wealth-decumulation phase. The economic growth of recent years has boosted the emerging and middle-income market segments, presenting us with significant opportunity. We see further opportunities in the mass market, created by growth in customer numbers and income as well as low penetration of financial service solutions. However, in 2009 this growth was threatened by customers' high levels of indebtedness, which resulted in higher rates of early policy termination.

The regulatory regime has been evolving to secure greater transparency and protection for consumers over the past 10 years. New commission regulations for savings policies were implemented from 1 January 2009, moving from fully upfront commission to part upfront and part spread over the duration of a policy. This was a profound change for the long-term insurance sector and we implemented adviser retention strategies to ease advisers' transition to the new regime. The government also introduced a Consumer Protection Bill aimed at establishing national norms and standards for consumer protection and the Protection of Personal Information Bill which will affect the way we collect, store, process and use customer data. Amendments to the Competition Act included personal accountability for individuals who instigate cartel activity, and new corporate governance rules brought significant changes relating to Board membership and remuneration.

Future regulations that will present opportunities and threats to us are retirement fund reform and the proposed introduction of a National Health Insurance Scheme. The government is working on reforming the retirement fund industry within a broader framework of an integrated social security system, aiming to secure retirement savings.

Other Emerging Markets

In the rest of Africa, economies are expected to have achieved positive growth in 2009. According to Central Bank of Kenya, Kenya is expected to grow between 2.5% and 3.0%, while Swaziland is expected to grow by 0.4% in 2009.

In Latin America economic growth was mixed, with Mexican real GDP growth of 2.9% during Q3 signalling that recovery has started while the Colombian economy shrunk by 0.2%. However, Colombian GDP was expected to grow strongly in Q4 and we anticipate overall positive growth in 2009. The Government of Mexico is facing a decline in revenues and therefore it passed a new tax law for 2010 which primarily raises income tax to corporations and individuals.

Equity performance was mixed across the rest of our emerging markets. The Kenyan NSE All Share Index declined by 2.4% in 2009 and the Malawian All Share Index dropped by 15.4%, while equities rose 43% in Mexico and 53% in Colombia.

Inflation declined across many countries. In Zimbabwe the introduction of a multi-foreign currency regime helped to deliver lower inflation. In Mexico the central bank left rates unchanged at 4.5% in November as inflation had declined below expectation to 3.6%. During Q4 2009 Colombia's central bank reduced interest rates by 50 bps to 3.5% as inflationary had dropped to 2%.

Political stability generally increased across the rest of Africa. Peaceful elections were held in Malawi in May and in Namibia in November. Zimbabwe has seen some political stability since the formation of the all-inclusive government, although there are still outstanding issues arising from the Global Political Agreement on which it is based. Kenya has remained calm and is busy with constitutional reforms; however tensions in the alliance remain.

Strategy

Our strategy for growth aims to transform us from a traditional life insurer to a leading provider of investment and savings solutions to every South African. It will require us to:

·      Become a consistently top performing asset manager in every asset class - creating a compelling profile for OMIGSA boutiques, improving our investment performance, expanding the boutique offering and growing the number of boutiques to occupy niche positions

·      Build a leading investment brand - we are already seen as the No1 long-term insurance brand in our markets and are increasingly recognised as a leading savings and investment brand

·      Broaden our offerings to meet customers' needs - updating and improving our current product range and expanding it to include products aimed at the Foundation Market

·      Grow access to customers and distribution ahead of our competitors - this is the key to competitive advantage in our market

·      Maintain cost efficiency - operational excellence and cost control will enable us to offer our customers affordable and competitive products at a sustainable margin, and through OMSTA we will continue reducing the operational cost of the business, leveraging IT and improving customer service to provide a solid platform for growth

·      Position Old Mutual as the leading South African corporate citizen in financial services - OMSA has always played a leading role in supporting the economy and people of South Africa, and we will continue doing this through broad-based initiatives that create opportunities for disadvantaged people and businesses alike

·      Use our strong operating position in South Africa to expand selectively further into Africa - this is a source of immense growth potential, and in the parts of Africa where we already operate we intend to grow by optimising existing operations and developing wider financial services

·      Grow the value of our business in Latin America by building the brand, sharing best practice with our South African operations, extending product ranges and expanding to reach a wider range of customers.

Operational highlights 2009

South Africa

OMSA has committed to transform itself from a traditional life assurer to a modern savings and investment business. This journey has necessitated a shift in focus and step forward in performance across all areas of the business, and we have made great strides in leveraging technology to gain competitive advantage, reduce costs and raise service levels.

We continue to improve our customer value proposition by enhancing our product offering and by becoming more customer-centric. In June we launched a credit card account that lets users invest for the future every time they shop. The relaunched Severe Illness Benefit on Greenlight was well received. We launched a new bonus series for the Absolute Growth Portfolios to enhance the product attractiveness to Corporate customers following negative bonus smoothing account balances after the market fall in Q1 2009.

We aim to give our customers outstanding long-term investment performance and remain committed to our embedded boutique asset management model. At the 2009 Raging Bull Awards, Old Mutual Income Fund was named 'Best Domestic Fixed Interest Income Fund' and the Old Mutual Mining and Resources Fund was named 'Best Domestic Equity Resources & Basic Industries Fund'.

We have continued to focus on selectively growing our distribution footprint by retaining and attracting intermediaries and building relationships with them. Despite the economic challenges we expanded our tied distribution from 5,181 to 5,229 advisors in 2009. In August we gained access to a niche market of private and retirement fund customers by acquiring ACSIS. In its first full year of trading Old Mutual Finance expanded its distribution reach and had 63 branches by the year-end.

We successfully integrated Future growth into the rest of the asset management business, with remarkably high retention of key investment professionals and customers.

In South Africa we reviewed our shareholder portfolio to hold more cash and reduce exposure to equities. As a result our capital position remained strong: the ratio of admissible capital for the life company to the statutory capital adequacy requirement was 4.1 times, compared to 3.8 times at the end of 2008.

Other Emerging Markets

To extend our product offering we introduced Retail Mass products in Kenya and we have started expanding nationally utilizing innovative forms of distribution and money collection including cell phone.

In Zimbabwe, we successfully managed the transition to a dollarised environment and our strategy to maintain this business through the political and economic difficulties is starting to bear fruit. We are in the process of upgrading our infrastructure, obtaining operational efficiencies and launching new products. We are well positioned in Zimbabwe given our broad range of financial services.

In Swaziland we completed our first full year of operation and also launched a range of Corporate products.

In Namibia we developed and rolled out an innovative lending product. In addition we successfully implemented a new retirement administration system.

In Malawi we made great strides in developing a local asset management capability and this has laid the foundation for unit trusts - the first to be provided in Malawi.

Performance in 2009

Excellent results in a tough operating environment

For key figures see highlights table.

Overview

Emerging Markets' economies rallied strongly during the second half of 2009, benefiting from a weaker dollar and higher commodity prices after the credit crisis. South Africa experienced a comparatively modest and short recession in the first half of 2009, but returned to growth in the third quarter and ended the year with positive quarterly GDP growth. We expect this momentum to continue into 2010. The South African equity market enjoyed a very strong final quarter as local and foreign investors moved into equities. Growth also resumed in Latin America and Asia from the third quarter onwards. Markets rallied strongly during the second half of the year and emerging markets' currencies generally appreciated strongly against both the pound and dollar, with the closing rand rate rising against those currencies by 13% and 22% respectively. The impact of the economic volatility led to an increase in the share of risk product sales across our product lines relative to savings and investment products.

South Africa constitutes approximately 94% of the IFRS adjusted operating profit of our Emerging Markets Business Unit.

South Africa

In South Africa, our business has been resilient with strong profitability and high return on allocated capital in very difficult economic conditions, with our like-for-like sales on an APE basis up marginally compared to prior year (after excluding Nedgroup Life sales in 2008). We continued to invest in our distribution capability and as a result, we grew market share in our core product ranges and are well positioned to benefit from the recovery in consumer confidence. Nevertheless, the demand for our products during 2009 was adversely affected by rising unemployment and generally low consumer confidence across the economy. These factors, among others, have put pressure on disposable income, resulting in a number of customers terminating their policies. This poor persistency experience adversely affected the claims experience in the year. However, through continued investment, we improved the service levels to our customers. This is evidenced by the number of service awards we continue to win. We were awarded first place for service excellence in the long-term assurance category in the 2009 Ask Afrika Orange Index national surveys as well as the 2009 award for Best National Call Centre. We continued expanding our distribution footprint by retaining and attracting intermediaries and growing our relationships with them. Despite the economic challenges, we have expanded our tied distribution from 5,181 intermediaries in 2008 to 5,229 intermediaries in 2009, and we successfully completed the acquisition of a 100% share in ACSIS, a South African asset management firm, in August, thereby gaining access to a niche market of private and retirement fund customers. 2009 was also the first full year of trading of Old Mutual Finance (OMF), our new retail loan business, which has expanded our distribution reach by establishing 65 OMF branches in 2009.

In June 2009 we sold our shares in the Nedgroup Life and BOE Private Client joint ventures to Nedbank. As a result we now exclude Nedgroup Life sales from our life sales and embedded value for both 2009 and 2008 sales and margin numbers. However, for IFRS and AOP profit reporting, these businesses have still been included for the first 5 months to 1 June 2009 and for the full year in 2008.

Highlights (Rm)	2009	2008	% Change
Long-term business adjusted operating profit	3,263	3,398	(4%)
Asset management adjusted operating profit	958	921	4%
Long-term investment return (LTIR)	1,658	2,032	(18%)
Adjusted operating profit (IFRS basis) (pre-tax)	5,879	6,351	(7%)
Return on allocated capital (OMSA only)	26.0%	27.8%
Operating MCEV earnings (covered business) (post-tax)	2,794	5,237	(47%)
Return on embedded value (covered business) (post-tax)	9.8%	14.4%
Life assurance sales (APE)	5,178	5,105*	1%
Unit trust/mutual fund sales	36,421	41,418	(12%)
PVNBP	37,339	36,675*	2%
Value of new business	853	813*	5%
APE margin	16%	16%
PVNBP margin	2.3%	2.2%
Net client cash flows (NCCF) (Rbn)	(20.5)	(27.3)	25%

Highlights (Rm)	2009	2008	% Change
Total funds under management	518.4	552.6	(6%)
Of which, SA client funds under management	448.7	443.0	1%

* Excludes Nedgroup Life sales. The comparative including Nedgroup Life are as follows: APE: R5,537 million; PVNBP: R37,959 million; VNB: R934 million; APE margin: 17%; PVNBP margin: 2.5%

Other Emerging Markets

Namibia

We achieved remarkable results in a year of immensely tough trading conditions. Sales of recurring premium products, which is core to the life company, ended 12% up on the prior year. There was a swing to investment business and we grew our Unit Trust sales by 62% from 2008. The bulk of our Unit Trust sales went into the money market fund, which is competing effectively with similar funds run by banking institutions.

We developed and rolled out an innovative lending product. In addition, we successfully implemented a new retirement fund administration system.

Rest of Africa

We continue to manage our investments in the Rest of Africa for value, although they remain small relative to our profile in South Africa in 2009.

Latin America

Whilst our businesses in Latin America are small relative to others in the Emerging Markets Business Unit, we have had an excellent profit growth of 133% (in rand terms) in very difficult economic conditions. Non-life sales were strong despite the slow start of the year following the H1N1 outbreak. We have developed a new Retail Mass product in Mexico to be launched in 2010 and we are confident that this will significantly boost sales. We also intend to tap into the expertise in South Africa to develop a range of transferable and suitable product-types such as the "smoothed bonus" and "umbrella" products.

Asia

Old Mutual's operations in Asia consist of a joint venture with the Beijing State-owned Asset Management Company in China (Skandia: BSAM) which sells unit-linked and universal life products, and a 26% share in Kotak Mahindra Old Mutual in India, a life assurance joint venture with the Indian-listed financial services company, the Kotak Mahindra Group.

India accounts for the bulk of our Asian sales, with APE of R1.8 billion (INR10.3 billion) and, despite our business there growing faster than the rest of the sector during the first quarter of 2009, sales were down 26% in rand terms from the 2008 comparative (19% in local currency terms). Its strategy has subsequently changed to focus on more profitable growth, as opposed to pure revenue generation. Kotak Mahindra Old Mutual is still growing at an encouraging rate on a relative basis and now occupies 10th position in the industry for Individual business, with 1 million lives insured, and 9th position in the industry for Group business, with 1.4 million lives insured.

APE sales in sterling terms in China (Skandia: BSAM) increased by 19% in local currency terms from CNY77 million (R92 million) to CNY92 million (R113 million) for the year. The increase in APE sales was largely a result of a strong growth in single premium sales, up 112% to CNY679 million (R836 million). Our business in China continued to experience strong competitive pressure from a number of direct competitors in the market. The industry ranking for Skandia: BSAM, measured on a gross written premiums basis, improved from 40th at H1 2009 to 38th by year-end. A number of new products are currently in the pipeline for 2010.

Life sales summary

Over the whole year, life sales improved by 1% from 2008, despite the tough environment. In South Africa, this was mainly as a result of strong growth of recurring-premium sales of 8% which was partially offset by a 6% drop in single-premium sales.

Recurring-premium sales
Risk

Recurring-premium risk sales increased primarily due to:

·      promotion of the Severe Illness Benefit on the Greenlight product, where sales in the Affluent Market grew by 11%;

·      5% growth in our sales force in Retail Mass and an increased focus on risk products, which led to a 31% growth in the Retail Mass market; and

·      success in securing large schemes in Corporate, leading to a 62% increase in Group Assurance sales over the 2008 level.

Savings

OMSA sales of recurring-premium savings products declined 7% relative to prior year. Lower sales in our Retail segments, which were partially offset by strong sales in the Corporate segment. Sales of recurring-premium savings products were down 23% in the Retail Affluent segment as customers were reluctant to commit to long-term savings products in light of the higher risk of job losses and lower disposable incomes. In the Retail Mass segment, recurring-premium savings sales were down 5% mainly as a result of economic pressures. The new commission structure on savings products also contributed to the lower sales of recurring-premium savings products in the Retail segments. However, we grew our recurring-premium savings sales by 139% in the Corporate segment as a result of higher sales of our umbrella funds, our increased focus on building the direct sales channel and expanded distribution through retail intermediary channels.

Single-premium sales

Single-premium sales were down 6% on prior year due to lower annuity sales. Corporate annuity sales were affected by volatility in the market during the first half of the year which led to greater caution by trustees, as well as some pension funds being under-funded and, hence unwilling to transfer their business to us and having to make a net contribution to the fund.

Life sales in the second half of the year improved by 35% in rand terms compared to the first half and by 1% compared to 2008, as confidence began to return to the economy and markets rallied. In Retail Affluent, life sales improved by 26% in the second half after we enhanced our Investment Frontiers fixed bond and Greenlight products. In Retail Mass, we improved our life sales by 33% in the second half as a result of the increase in productivity of our sales team. We secured new customers into our umbrella scheme, called Evergreen, in the last quarter of the year, which boosted our Corporate recurring-premium sales by 57% compared to the first half of the year. The strong pipeline we had in Corporate in the first half of the year materialised in the second half of the year, resulting in 45% growth in single-premium sales over the first half.

Unit trust sales

Unit trust sales were 12% behind 2008, with lower flows through Old Mutual Investment Services (OMIS) in 2009 partially offset by good flows into money market unit trusts early in the year and inclusion of Future growth unit trusts in our product range in 2009. Money market unit trusts slowed down in the second half of the year as a result of a decline in interest rates. The 2008 comparative numbers were boosted by a one-off R2bn inflow into the Money Market fund from the Galaxy platform. Sales in the second half of R19.1 billion showed an improvement on the first half levels of R17.4 billion.

IFRS AOP Results

Adjusted operating profit was down 7%, driven mainly by a reduced LTIR, and the long-term business profits declined by only 4% from prior year level. This was mainly due to:

·      impact of lower equity levels on asset-based fees and investment variances;

·      mortality and disability losses on Group Permanent Health Insurance and Group Life Assurance products;

·      a small charge for share-based payments this year compared to a large credit in the prior year as a result of the strong Group share price performance; and

·      the loss of seven months' contribution to profit from joint ventures with Nedbank.

Excluding the contribution from Nedgroup Life in both 2008 and 2009, profit on the life business was flat compared to the prior year.

In South Africa, life business adjusted operating profit declined by 19% in the second half of 2009, mainly because the first half included higher contribution from reserve releases than the second half, as well as the absence of profits from Nedgroup Life and BOE.

Asset management operating profit in South Africa was down 16% on prior year as a result of:

·      lower average asset values and a reduction in the proportion of assets held in equities (which attract higher fees) adversely impacting base fees;

·      lower third-party managed funds

·      lower transactional revenue in Old Mutual Properties business;

·      mark-to-market losses in our Old Mutual Specialised Finance (OMSFIN) business; and

·      higher share-based payment costs.

The factors above were partially offset by higher performance fees earned in the second half of the year and higher revenue on the term portfolio of OMSFIN as the interest rate cycle turned. Asset management profits increased by 68% in the second half of 2009 compared with the first half following the recovery of equities and improved OMIGSA investment performance, which resulted in higher performance fees. The Emerging Markets asset management result included an increase in asset management profits in Latin America.

LTIR was 18% lower at R1,522 million after a 330 basis point decrease in the rate of expected return (from 16.6% in 2008 to 13.3% in 2009), combined with a marginally lower average asset base. The asset class split for 2009 was 30% equities, 70% cash and bonds, compared to 48% equities and 52% cash and bonds for 2008.

Value of new business and margins

The value of new business margin (excluding Nedgroup Life) remained flat at 16% on an APE basis and improved from 2.2% in 2008 to 2.3% in 2009 on a PVNBP basis mainly due to more favourable operating assumptions changes for new business.

MCEV Results

Market Consistent Embedded Value (MCEV) operating earnings after tax declined by 47% from the 2008 level. This was mainly due to lower than expected returns which decreased by R1.7 billion (based on lower one-year swap rates and a lower opening embedded value of R28.4 billion compared to R36.4 billion in 2008), and the impact of adverse operating assumption changes (-R1.0 billion) primarily related to persistency and the capitalisation of certain project expenses.

Net Client Cash Flow

Retail net client cash flow was positive but overall net client cash flow was R20.5 billion negative due to the previously reported net outflow of R16.2 billion from the Public Investment Corporation (PIC). Net client cash flow in the Retail Mass and Retail Affluent channels improved on the prior year as a result of ACSIS and unit trust sales in the Affluent segment, good sales protection sales growth and better than expected mortality experience in the Mass segment. Corporate and OMIGSA experienced net outflows. This was a result of higher benefit withdrawals (especially withdrawal benefits from pension funds on the back of job losses across the economy), two large terminations in Corporate, and net outflows from Future growth in OMIGSA, as well as the PIC outflow previously mentioned. We anticipate further withdrawals from PIC in 2010 as part of their planned mandate reallocation.

Investment performance

Overall OMIGSA investment performance continues to improve. Fifteen of our collective investment scheme funds ended the calendar year in the top quartile of their respective industry categories over one year, with ten and eleven funds achieving top quartile ranking over three and five years respectively. Notable performance has come from Macro Strategy, where all three of their Flexible, Balanced and Stable Growth unit trusts are positioned in the top quartile of their respective categories over the calendar year to end December. Similar recovery has come from Value Equity and Select Equity, where their High Yield Opportunity Fund, Growth Fund and Top Companies Fund are all in the top ten funds (out of 76) in the General Equity category over the year.

Funds under management

Funds under management of R518 billion decreased for Emerging Markets as a whole, mainly due to the inclusion in 2008 of Skandia Australia's funds under management (approximately R25 billion). Skandia Australia was sold in March 2009. FUM in OMSA improved by 2% from 2008 as a result of the acquisition of ACSIS and positive market returns, partially offset by negative net client cash flow.

Marketing

In 2009 the strength of the Old Mutual brand and its reputation for integrity, financial strength, reliability and performance enabled us to perform well in South Africa despite the difficult economic environment.

The strategic thrust of our brand communication activity in 2009 was engagement and communication with customers, distribution channels, employees and stakeholders to amplify reassurance and trust in OMSA. We took a multi-faceted approach using advertising, advertorials, material for face-to-face meetings, media activity, digital marketing and sponsorship. The campaign worked on many levels from communicating specific facts about capital strength, liquidity and performance of smoothed bonus products to emphasising the longer-term context by promoting our investment principles and providing general reassurance through 'green' TV commercials.

Our engagement and communication with stakeholders and investors during the financial crisis earned us first place among the JSE's Top Ten listed companies, ranked by revenue, in the New York-based Reputational Institute's Global Reputation Pulse 2009 survey. We also came first in the Sunday Times Top Brands Awards in the Long-Term Insurance category.

In addition to this activity, our business segments and OMIGSA maintained a stream of product and service innovations both to meet immediate customer needs and to drive longer-term competitive advantage. Examples include The Money Plan from Old Mutual Finance, which brings together a unique mix of financial services, financial education and debt repayment planning. Our Corporate business unit launched a Financial Wellbeing Programme that provides financial education to its retirement fund members and employees.

Old Mutual's thought leadership position continues to strengthen. OMIGSA's economists have been quoted extensively on the markets and the economy and the launch of the Old Mutual Savings Monitor stimulated debate on the need for higher savings in South Africa.

Customer service

We focus relentlessly on becoming more customer centred and enhancing the customer service we deliver through our call centres, internet and extensive branch infrastructure. We have combined all customer servicing for the Retail Affluent, Retail Mass and Corporate businesses in OMSTA to ensure consistently high service levels across our entire customer base and use IT to help improve service. We are also driving service levels higher by using LEAN methodology to re-engineer business processes.

Our commitment to customer service is demonstrated by:

·      Top ratings for service in the long-term assurance category in both the 2008 and 2009 Ask Afrika Orange Index Service Excellence Benchmark surveys, which measured service across 54 companies from 11 industries, and

·      Winning the 'Best Customer Service Centre' award at the 2009 Business Process enabling South Africa (BPeSA) Awards

People

We maintain a working environment that supports the recruitment of highly effective employees, improves productivity and fosters relationships that build on the diversity of the workforce. Of our total workforce, about 85% are employed in South Africa. Our employee engagement programme in South Africa (Siyakhula) aims to foster staff participation and innovation.

In line with our shift away from heavy capital products, in 2007 we introduced an economic profit based variable pay scheme for employees in South Africa (outside OMIGSA) to incentivise efficient management of capital as well as growth of profits. Employees receive a proportion of the economic profit generated in the year, to cultivate a culture of teamwork while ensuring that we appropriately reward individual effort.

In the rest of Africa we have crystallised our focus on people by developing a comprehensive People Strategy. A key element of the strategy is to support a culture of delivery and high performance. This is further supported by a robust performance management practice that aims to ensure focus on all aspects of the business.

Latin America has a performance management process implemented with active participation of the team leaders and their team members. For the senior management the process is conducted according to the balanced scorecards criteria from the group.

Risks

We continue to manage our risks and develop our Risk Management capabilities in alignment with Group's Enterprise Risk Management framework

Priorities for 2010

In 2010 we will remain focused on:

·      Growing sales through expanding distribution;

·      Continue improving our investment performance;

·      Investment in service and continuously improving the level of service delivery; and

·      Tightly controlling our expenses.

We are also continuing to focus on our expansion into the rest of Africa. Africa is an important growth market given improvements in governance and increased disposable wealth, leading to an increasing demand for financial services products.

In Latin America we will continue to focus on how to grow the business by leveraging strengths and capabilities in OMSA and the rest of the group. We will continue broadening our retail product offering, expanding our distribution and developing asset management capability for our corporate business.

Outlook

The South African economy emerged from recession in the third quarter although consumer confidence remains low. Latest government predictions are for the South African economy to grow by 2.3% in 2010, and consumer confidence is expected to continue to increase. However, some concerns remain as private debt levels are still above sustainable levels and further job cuts are expected despite the economic recovery.

We believe that the outlook for the rand is favourable because of the high interest rates, a narrowing trade deficit, the global recovery and growing confidence regarding South Africa's economic policy direction, as evidenced in the recent Budget.

The long-term outlook for the savings and investment environment is positive and is supported by a combination of factors:

·      the prudent fiscal and monetary policies of the past years are expected to continue the recent trends of the economy returning to a robust growth path by the end of 2010;

·      the growing emerging black middle class and affluent markets, supported by the reduction in interest rates in 2009, the now-growing economy and Black Economic Empowerment efforts should sustain consumer spending growth;

·      the Government's continuing investment in infrastructure and public sector employment programmes;

·      Governmental policies for the formulation of a framework for mandatory retirement savings; and improvements in the level of financial education and the transparency of financial products.

The short-term picture looks increasingly optimistic, but remains at risk from market volatility as well as volatility in the rand. We are monitoring the current situation with increasing vigilance and are well positioned to react quickly to any unfavourable eventualities.

Nordic

Our Nordic business operates in Sweden, Denmark and Norway. We provide some 2.5 million retail and corporate customers with a wide range of products including traditional life, unit-linked, healthcare insurance, banking, financial advisory and mutual funds.

We are differentiated in the marketplace by our broad product mix - combining insurance, banking and investment business - and gain competitive advantage from our market-leading expertise and proven business model.

Skandia has operated in the Swedish market for over 150 years and is a strong and well-respected brand. It became part of Old Mutual in 2006. We are organised into four business areas focused on sales to specific customer groups:

·      Private Sweden , our retail business in Sweden, offers savings products and financial advice from our banking, unit-linked, mutual funds and traditional life business

·      Corporate Sweden offers products and financial advice from our unit-linked, healthcare and traditional life business

·      Corporate Denmark offers products from our unit-linked, healthcare and traditional life business

·      Private Norway, our retail business in Norway, offers products and financial advice from our bank business.

Business model

In 1990 we launched Sweden's first fund insurance company, Skandia Link. Today Skandia Link offers savings products for both private and corporate business.

Skandiabanken, once a niche player in the Nordic banking market, is now established as a full-range online retail bank serving customers in Sweden and Norway. It is well positioned to take advantage of the growing demand for direct self-service solutions in the Nordic savings market.

Our Corporate business operates in Denmark and Sweden, serving small and medium enterprises, large companies, international corporates and the public sector. It distributes its products through independent financial advisers (IFAs), other external partners and a directly-employed sales force.

Our Retail business operates in Norway and Sweden, targeting affluent and mass affluent customers. We serve this market mainly through our directly employed advisers, the internet and IFAs.

Products offered include:

Unit-linked

We offer a wide range of unit-linked funds across a variety of asset classes and risk profiles. These funds, including those from our own fund companies, are managed externally; we select and monitor managers using our unique evaluation process.

Traditional life

Traditional life products are an important part of our integrated product offering in the Swedish market. As the market's largest life company, Skandia Liv is active in both the private and occupational pensions segments. We provide insurance products with a security profile featuring long-term savings with a guaranteed yield plus protection. In 2009 Skandia Liv was rated as one of the top traditional life assurers by independent Swedish consultants and distributors.

Mutual funds

We offer mutual fund products through our banking subsidiary, Skandiabanken. Skandia Fund Products' offering is accessible for unit-linked savings, direct savings, individual pension savings through Skandiabanken and for premium pension savings through the national Premie Pension Myndigheten (PPM) system. Customers decide how they wish their money to be managed by choosing from PPM's range of funds.

Banking

Skandiabanken is an online retail bank offering a full banking service. Its offering to private individuals is strengthened by selling our non-insurance products. It also serves as a direct distribution channel for us, targeting self-service clients with a full range of savings products through a new online platform. In 2009 it won several awards in Norway and Sweden for its outstanding service and we strengthened the savings offering by widening the fund range, introducing discounted share trading and launching a number of new saving products.

Private healthcare

We offer private healthcare products to companies and their employees. Our healthcare division also supports our unit-linked and traditional life business in Sweden and Denmark, adding value to the pension scheme products and broadening our product offering.

Skandia Liv

Skandia Liv is a traditional life assurance company serving customers in Sweden and Denmark. It is a wholly-owned subsidiary of Skandia but is run on a mutual basis. It operates within a strict local legal framework and the benefits usually associated with share ownership accrue to Skandia Liv's policyholders rather than the holding company. Consequently, Skandia Liv is not consolidated into the Group's accounts.

Product development

We aim to develop products that meet our customers' needs and demands, using customer surveys, competitor benchmarks and market analysis. In parallel to this, our product approval process assesses how effectively each new product creates value for customers - and for shareholders, for example in terms of capital efficiency and long-term profitability.

New products developed in 2009 include Hälsa in i Sjuk - a corporate healthcare product, Garanti pension Plus - an alternative product within the new PA-KFS-plan, new pregnancy insurance, property insurance in co-operation with Dina Försäkringar, Skandia Vælger - a fund of funds solution, and new funds such as the Lynx Dynamics Fund. We launched Direktpensionin Depåto replace a previous unit-linked capital insurance product which had become unprofitable because customers are reducing the length of time for which they hold savings products.

Market overview

The personal market is increasingly important in Sweden and Norway, as reduced state and employer pension benefits place more responsibility on individuals to secure their own future finances. A growing number of people are approaching and reaching retirement age and increasingly need to make their own investment allocation decisions. This means growing demand for holistic advice and close customer relationships. All our major competitors in Sweden are Nordic bancassurance entities.

The demand for advice and self-directed solutions, combined with growth in the personal market, are major business opportunities that we will focus on in the coming years. The consumer market is characterised by diversity of savings instruments and customer preferences. The main types of savings are insurance (a market worth SEK700 billion), bank deposits (SEK700 billion), mutual funds (SEK600 billion), equities (SEK600 billion) and bonds (SEK100 billion). Total industry revenues in the individual savings market are expected to grow from between SEK40 billion and 50 billion in 2008 to between SEK70 billion and 80 billion by 2015 - driven primarily by market appreciation, increasing disposable income and asset reallocation.

Customer behaviour is changing in the Nordic market. The new generation favours internet-based services, which drives demand for increased transparency and unbundling of products, services and prices. Insurance products and pricing are becoming less differentiated. The market for insurance-based long-term savings products is being impacted by the withdrawal of tax incentives.

The changing dynamics of the Swedish corporate market are leading to increased focus on the unaffiliated part of the market. Corporate pensions are the dominant segment of the Swedish life market, a sector in which we have traditionally been very strong. However, our strategies to increase sales in this segment need to reflect the way the corporate market is changing, with growing use of collective agreement procurements and increased pressure on prices. Swedish brokers are responding to these changes by shifting their focus to small and mid-sized companies and to individuals.

In Denmark the authorities continue to focus on increased transparency regarding cost of pension products and tax reforms are reducing tax benefits on insurance. A complete commission ban in Denmark will be introduced on 1 January 2011.

Strategy

Our key objectives to 2012 are to:

·      Grow in the private savings market in Sweden and Norway

·      Retain existing corporate business in Sweden

·      Strengthen our position and grow in Denmark

·      Improve and develop risk and capital management

·      Increase operational efficiency.

To achieve our vision of having the most satisfied customers in the savings market we aim to move from our current position as a product supplier mainly offering insurance products to become a more customer-oriented financial solutions provider characterised by operational excellence.

We will improve and develop our customer interface, enhance our product offering and make our products available to customers through different channels. The key challenge will be to build attractive offerings that provide both end-customers and distributors with advisory tools and quality advice, innovative products, top-quartile returns and the market's best customer service.

·      Private Sweden Although our current market position is relatively small compared to main competitors, we have important strengths: our customer base, well-known brand and our insurance platform and expertise. We aim to grow by moving closer to the end-customer with a new distribution model, integrated channels, a full-range savings offering and well defined service levels offering holistic advice. Our focus segments are affluent and mass market clients among our existing customer base, particularly over-55s.

·      Private Norway We are currently a niche player positioned as an innovative daily banking partner with a strong position as a customer-friendly internet bank. We aim to grow by expanding our product offering with more savings, insurance and investment products, adding advisory services to become a savings partner.

·      Corporate Denmark We are seen as a challenger and innovator providing excellent pension products for companies with under 100 employees. We aim to grow by increasing our distribution power with new channels and offerings to position us as a trustworthy deliverer of products and services to larger companies. We will focus on packaged offerings and efficient customer solutions and administration.

·      Corporate Sweden Our fundamentally strong position faces price pressures and changed market conditions. To maintain our market position we are focusing on small and medium-sized companies, owner-managed companies and management plans, mainly for businesses in our existing customer base. We will move closer to our customers and develop attractive new propositions, effective processes and improved service levels.

Performance in 2009

Continued strong net client cash flows, rising FUM and strengthened relations with distributors

For key figures see highlights table.

Sales

New sales in Nordic increased by 8% compared to the prior year, driven by the very successful SkandiaDepå product sold through Skandiabanken direct sales, the internal advisory channel and brokers. Retail business was strong with muted impact on our particular target markets from the recession. However, the effects of the economic downturn did have an adverse impact on occupational pension sales in the Swedish corporate sector with lower inflows as a result of less workforce mobility, lower salary increases, and higher than expected premium cessations due to layoffs. We closed down sales of an unprofitable unit-linked product in September 2009 and this had a meaningful impact on sales growth in the final quarter of 2009.

Nordic had excellent growth in mutual fund sales, which increased by 47% compared to the prior year. The driver behind this growth wasSkandia Global Hedge, one of the best performing hedge funds in Sweden, which attracted SEK950 million of inflows. In addition, during 2009 there was a material inflow of customer fund holdings from other banks as the result of a marketing campaign launched early in the year.

IFRS AOP results

IFRS AOP decreased 32% in 2009 compared to the prior year. The fall in interest rates in Sweden and specific differences in valuation basis between IFRS assets and the liabilities under Swedish regulations resulted in unrealised losses of SEK119 million in the assets backing reserves in the unit-linked and health businesses. Interest rates are now at a historical low in Sweden. The health insurance business (rebranded asLifeline) was also negatively affected by the higher cost of claims and lower premium income. We have re-priced the business and made changes to both products and policy conditions. In Denmark, where similar actions were taken in early 2009, the business showed considerable improvement in the second half of 2009, and similarly the Swedish business is expected to improve in 2010.

Highlights (SEKm)	2009	2008	% Change
Long-term business adjusted operating profit	502	754	(33%)
Banking business adjusted operating profit	193	283	(32%)
Asset management adjusted operating profit	42	39	8%
Adjusted operating profit (IFRS basis) (pre-tax)	737	1,076	(32%)
Return on equity*	11.7%	17.0%
Operating MCEV earnings (covered business) (post-tax)	965	1,839	(48%)
Return on embedded value (covered business) (post-tax)	8.1%	12.9%
Life assurance sales (APE)	2,819	2,599	8%
Unit trust/mutual fund sales	4,708	3,207	47%
PVNBP	13,774	12,108	14%
Value of new business	526	397	32%
APE margin	19%	15%
PVNBP margin	3.8%	3.3%
Net client cash flows (SEKbn)	11.6	7.0	66%

Highlights (SEKbn)	2009	2008	% Change
Funds under management	127.2	91.9	38%

* Return on equity is IFRS AOP (post tax) divided by average shareholders' equity, excluding goodwill, PVIF and other acquired intangibles

Skandiabanken's results were weaker due to lower net interest income following the repo rate declines during the year and the impact on the margin of prudent liquidity management. Credit losses increased marginally, but the credit loss ratio is still at a low level (0.14% in 2009 compared to 0.13% in 2008), reflecting the low-risk nature of Skandiabanken's lending business, and the stability of the Nordic residential market.

IFRS AOP was positively affected by increased investment value in the private equity portfolio of SEK51 million. The second half of 2009 showed strong results in the unit-linked business due to positive growth in FUM driven by positive stock markets trends, together with a strong NCCF, thus increasing fund-based income.

We are continuing to review the expense base of the business, and will seek to cut costs in 2010 where we are able to do so.

Skandia AB and Skandia Liv have decided that for the time being there will be no changes made to the corporate form of Skandia Liv, but that they will be moving forward with the objective "One Skandia", maintaining a close cooperation between the two companies.

Value of new business and margins

The value of new business and profit margin increased substantially during the second half of 2009, due to a more profitable business mix, positive operating assumption changes and sales growth. The business mix was positively affected by the closure of the private regular premium unit-linked product referred to above, which was replaced by a much more profitable, lower commission product. The assumption changes are driven by changed mortality pricing and positive experience as well as high transfers into the unit-linked decumulation product, thereby prolonging the duration significantly. The effects came through during the second half of 2009, and PVNBP margin improved from 3.3% for 2008 to 3.8% for 2009, and APE margin from 15% for 2008 to 19% for 2009.

The price pressure in the Swedish market continues, especially in the corporate market. In the medium term, the margin is still expected to remain in the high teens, but this will require continued high new sales, product development and cost control.

MCEV results

Operating MCEV earnings were down 48% on the comparative period mainly due to lower than expected existing business contribution arising from historically low interest rates, capitalised one-off developmental project costs, and increased outward transfer assumptions during the accumulation phase of corporate business. The closing MCEV has increased substantially, especially in the second half of the year, due to the impact on non-operating earnings of strong stock market performance leading to large positive investment variances, and a release of provisions after the settlement of certain longstanding litigation matters.

Net Client Cash Flow

Net client cash flow for the year was an exceptional, and record high of, SEK 11.6 billion, representing 13% of opening funds under management. The positive performance was largely driven by a combination of strong Life sales, especially the Investment Portfolio product, regular premium unit-linked sales, and lower outflows related to maturities and surrenders in the occupational pension business. Positive flows in mutual funds also contributed to this performance. Net client cash flow increased 66% compared to the prior year, although it weakened in the second half as a result of the increase in the pace of corporate outflows.

Funds under management

Funds under management at 31 December 2009 were SEK127 billion, up 38% from the level at 31 December 2008, and 18% from 30 June 2009. The increase was due to strong net client cash flow and positive development on the equity markets. This is a significant improvement compared to previous periods.

Our 2009 investment performance was excellent. For the third consecutive year, SkandiaLink was awarded best performance among the unit-linked companies in the Swedish market. During 2009 SkandiaLink' saverage client enjoyed investment performance of 29%. Average performance on a weighted index (66% MSCI AC World and 34% OMRX Total Market) during the same period was 15%. Customers are increasing their appetite for investment risk by weighting a larger proportion of their holdings in equities and, in particular, emerging markets equities.

Marketing

As indicated in the 'Product development' section above, we had a busy year for new product launches, which we supported with appropriate marketing and promotion.

In Sweden, Skandia Link earned the Risk & Försäkring award for 'best average return to customers on a three- and five-year basis' for the third year running. On the back of this we ran some very successful marketing campaigns focusing on our investment performance.

We believe that being a good corporate citizen is good for business. For more than 20 years we have run the Skandia Ideas for Life corporate social responsibility programme, which works to protect children and young people and support their social development. Skandiabanken has teamed-up with voluntary organisation ECPAT to block purchases of child pornography using payment systems, and this work won much positive PR and publicity in the Swedish media during 2009.

Our PR activity in 2009 doubled our positive exposure in the media, benefiting sales, net client cash flow and our brand image.

We continuously run roadshows for both corporate and private customers. These are very popular and successful both for launching new propositions and for disseminating information and education about savings and investments.

Customer service

We have launched our common vision - to have the most satisfied customers in the savings market - across the whole organisation, and this is beginning to influence our processes and customer relations:

·      Skandiabanken Sweden won the Teleperformance award for 'best customer service in all categories' in 2009 and the Q Service 'best bank customer service' award in 2010

·      Skandiabanken Norway won the Norsk Kundbarometer 2008 citation for 'most satisfied customers' for the eighth year running

·      We have simplified our customer communications and application forms

·      Skandiabanken Norway has introduced enhanced self-service functionality for lending

·      We have improved share trading facilities for corporate and personal customers

·      We have improved the information on our Skandia.se website

·      Corporate Sweden has improved its customer invoicing processes.

In our customer satisfaction research, Skandia Norway and Denmark both achieved strong results: Skandia Norway's customer satisfaction levels are among the highest for all businesses in Norway. Distributors in Sweden rated us extremely highly and we remain one of the top two in this market. Skandia Sweden's satisfaction ratings were affected by the crisis of confidence in all Swedish financial institutions which followed the market turmoil in Autumn 2008 and Spring 2009; despite this, satisfaction was unchanged among private customers and reduced only modestly among corporate customers.

People

In 2009 we launched our Nordic People Strategy initiative aimed at improving our people processes, strengthening our performance culture and supporting the overall business plan. This has made very strong progress. We have established a leadership development programme for new leaders, a talent management review process is underway and key decisions have been taken on training and development. We have also produced guidelines for handling underperformance, for implementation in 2010.

Risk

We continue to manage our risks and develop our Risk Management capabilities in alignment with the Group's Enterprise Risk Management framework.

Priorities for 2010

We will continue working towards our vision of having the most satisfied customers in the savings market. The focus will be on building high-quality, innovative offers for end-customers and distributors by providing advisory tools and quality advice, innovative products, top-quartile returns and excellent client service. We will continue to develop new investment portfolio products, supported by initiatives to achieve operational excellence. Our priorities for 2010 to 2012 are:

·      Drive growth in the Swedish and Norwegian personal savings markets, strengthen our position and grow in Denmark

·      Achieve operational excellence by retaining existing corporate business in Sweden and increasing our operational efficiency

·      Achieve excellence in risk and capital management.

Outlook

Although the financial markets continue to be volatile, the outlook for the Nordic markets remains positive. The mass corporate market is challenging with an increasing movement towards low margin tendered business. We continue to focus on strengthening the market position by delivering first-class products and offerings to customers both on the private market, as well as the higher margin segment of the corporate market. A key part of this is the improvements to the Skandia Nordic platform, Skandia.se, which was re-launched during the second quarter of 2009. With the launch of a series of combined offerings such as the Skandia Investment Portfolio, Skandia Depå, we have started to exploit the potential of decumulation products and increased cross-selling. We have also strengthened our ALM capacity, improved our operating model to be more customer oriented, and announced changes in the commission structure to improve future profitability. With increased focus on customer needs and profitability, we remain convinced that we can turn this period of disruption into a lasting opportunity. The broad product mix and market position of our business gives us a competitive advantage in a challenging market.

We are disposing of further private equity assets and expect a pre-tax profit of approximately SEK126 million from this source in 2010.

Retail Europe

Retail Europe consists of four local businesses: Skandia Austria, Skandia Germany, Skandia Poland and Skandia Switzerland. All are active in the same product market - recurring unit-linked life business focused on old-age provisioning - and have similar business models. They serve the savings and investment needs of similar retail customer segments and operate on related platforms. The core product range covers regular and single-premium unit-linked products, supported by pure investment solutions and disability solutions.

Business model

We operate in interesting markets that offer great opportunities: 140 million people - the overwhelming majority of them retail customers - threatened by financial uncertainty due to fundamental demographic change and the ongoing crisis in public retirement provision. Distribution is primarily through co-operation with about 12,000 independent distributors. Our main strengths are our innovative products, investment competence and long-standing distributor relationships.

We follow a value-driven business model, applying a strong key performance indicator focus to all relevant business areas. In sales, for instance, we are more concerned with the value of new business than the quantity of new contracts. We also pay close attention to the existing business book, maintaining quality by rewarding low surrender rates. We take business decisions at the appropriate levels to ensure we stay close to our markets without losing necessary central oversight.

Product development

In our markets we are seen as one of the leading unit-linked suppliers, with innovative and flexible products and strong investment knowledge. While our focus in the past has not been on guarantees, we add guarantee features when sensible. For instance, our businesses were the first in their markets to offer guarantee funds as investment options. In 2009 we introduced the new productSafety Plan, which includes a guarantee at maturity, in Switzerland.

We will continue to optimise our portfolio in 2010 - aided by our collaboration with Skandia Investment Group, which helps us provide innovative and return-oriented solutions for our customers.

Market overview

Driven by the European regulators, the increase in regulatory and transparency requirements to improve customer protection continues to put pressure on small and mid-sized distributors and providers in all markets. This was particularly evident in Germany with the introduction of the new Insurance Contract Law in 2008.

Regulatory pressure has led to some consolidation and a significant decline in the number of independent distributors. The impact was reinforced by some insurers seeking to secure their access to distribution by buying stakes in independent distributors.

The financial crisis has undermined customers' confidence in financial services generally and unit-linked products in particular. More than ever, they are now looking for orientation, simplicity and reliability. Traditional life insurance products from highly reputable companies could benefit significantly from this uncertainty.

Uncertainty during the financial crisis drove some customers to cut their investment in long-term savings. In addition, increasing cost transparency and customer uncertainty raised legitimacy issues for distributors. As a result, life businesses suffered from higher lapse rates and surrenders; and new unit-linked business in Germany, for instance, decreased by 33% compared to 2008. In response, some competitors increased their commission payments to compensate distributors for decreasing market volume.

Strategy

Our federal model of standalone businesses in Central Europe has been successful in growing these businesses from the outset. But the model needed some changes in response to increased competition and consolidation, as well as the increased burden of consumer protection and regulation. So we created Skandia Retail Europe in 2009 to build one efficient business unit out of four formerly autonomous local companies. This should generate scale benefits and a better allocation of resources through cross-border integration.

As a first step the new business unit appointed a cross-border senior management team bringing together new managers from other parts of the Group and experienced managers of the local companies. We then launched the new Skandia brand in all markets. The main ambition of the new senior management is to develop a common market approach that serves as a catalyst for harmonising capabilities, processes and workflows across borders. The transformation project is currently building a new harmonised operating model with the intention to transfer parts of policy administration and IT to South Africa in collaboration with OMSTA.

Our mid-term target is to increase the number of contracts in force to 1 million by 2014.

Performance 2009

Key foundations laid for the future development of the business

Sales

The countries served by Retail Europe were impacted by the difficult economic environment which affected consumer confidence in our products. Unit-linked markets decreased materially in premium size during 2009, whilst the relative attraction of guaranteed products increased. This impacted the normal increase in new business towards the year-end which did not materialise to the same degree as in previous years. Overall APE sales in Retail Europe decreased by 34% compared to the prior year.

2009 was a critical year for Retail Europe during which key foundations have been laid for the future development of the business. In particular an integrated senior management team has been established and functional heads have been appointed for key cross-European functions, such as finance and risk. The business is now working as a cross-border team whilst at the same time maintaining focus on the distributor requirements in each market.

In the second half of the year, efforts to tackle new sales development were increased within all Retail Europe businesses. The objective is to grow to achieve critical mass in all our chosen niche markets. Examples include intensifying the relationship with special distribution partners in Germany, the initiation of cooperation agreements with Deutsche Bank in Poland, and the development of the new Safety Plan product in Switzerland.

The combined impact of these initiatives and the recovery of the stock market meant that in the fourth quarter new sales rose by 57% compared to the previous three months, driven particularly by the German and Polish markets. The variance against the fourth quarter of 2008 was reduced to 10%. This impact was most marked in Poland where in the final quarter sales were 145% above the same period in 2008 and 73% above the previous quarter. Similarly, German sales in the final three months of the year exceeded the previous quarter by 76%.

Highlights (€m)	2009	2008	% Change
Adjusted operating profit (IFRS basis) (pre-tax)	25	36	(31%)
Return on equity	9.0%	18.6%
Operating MCEV earnings (covered business) (post-tax)	(49)	18	(372%)
Return on embedded value (covered business) (post-tax)	(7.9%)	2.6%
Life assurance sales (APE)	75	114	(34%)
Unit trust/mutual fund sales	27	59	(54%)
PVNBP	603	699	(14%)
Value of new business	(6)	13	(146%)
APE margin	(8%)	11%
PVNBP margin	(1.0%)	1.8%
Net client cash flows (€bn)	0.6	0.6	0%
Highlights (€bn)	2009	2008	% Change
Funds under management	4.7	3.7	27%

Overall, the rally in sales, underpinned by the rally in equity markets, positioned the business well at the end of the year after a very weak first half of 2009.

IFRS AOP Results

The IFRS AOP for 2009 was €25 million, 31% lower than in 2008, mainly affected by reduced fees, a lower investment result and a policyholder profitsharing agreement with the regulatory authorities for the German business. The main contribution to the IFRS AOP in 2009 was made by the Austrian business, exceeding the prior year result, driven by lower administration costs and reduced commission expense. All markets achieved positive IFRS results.

All businesses realised substantial cost savings in administration and staff costs in 2009, aligning the cost base to the reduced sales environment. However these savings were partially offset by the investment to integrate the new management structure, and the one-off costs from closing the businesses in Hungary and the Czech Republic, and our contribution towards the now-closed ELAM office.

Value of new business and margins

The 2009 value of new business (VNB) was negative €6 million, significantly below 2008 which was €13 million. The negative VNB and negative profit margin were mainly driven by the decrease in new sales which caused sales volume acquisition expense overruns that could not be entirely compensated for by savings in expenses. A reduction in higher margin single-premium business also added to the shortfall. Despite the lower new sales Poland maintained a positive profit margin in 2009.

MCEV Results

The decrease in 2009 MCEV operating earnings is mainly driven by the lower new business contribution, adverse experience variances and changes in operating assumptions.

In comparison to the 2008 results, experience and assumption changes had a negative impact of €24 million. This is as a result of the one-off experience variances and a further assumption change for profit-sharing in Germany, as well as expenses overruns, other minor methodology changes, and the recognition of one-off developmental project costs. This was offset by positive persistency assumption changes and less adverse persistency experience than in 2008.

The management action taken in 2009 and the rebound in the markets provide a positive backdrop to the MCEV prospects for 2010.

Net Client Cash Flow

Net client cash flow (NCCF) in 2009 remained robust at €551 million due to stable regular-premiums and was flat relative to 2008. The continued strong performance of the NCCF represented 15% of the opening funds under management.

The strong result is driven by the positive development of surrender experience which was 20% below 2008 in the unit-linked business. Actions taken to increase customer and broker communication led to this positive result despite the ongoing volatility in financial markets.

Funds under management

Funds under management ended the year 27% above the position at 31 December 2008, heavily benefiting from market performance and stable NCCF. This includes positive market movements on portfolio values of 19% of opening FUM, reflecting the rise in financial markets seen across the globe in the second half of 2009. In the German business the €2 billion mark was exceeded for the first time.

Equity funds particularly benefited from the capital market developments in 2009. Actively managed portfolios as well as guarantee funds rose in line with total client funds (31% and 27% compared to 30% in total client funds). This was close to leading market indices such as the MSCI World (in EUR) which rose by 23%.

FUM was supported by the effective asset mix of the portfolio and reflects the investment appetite of our customers. Although client funds were impacted by the fall in equity markets during the financial crisis they have benefited from the recovery that started in the second half of the year and this trend is expected to continue throughout 2010.

Customer service

All our national businesses have won awards for their outstanding service to distributors and customers alike.

People

We strive to connect company and personal targets for an optimal approach to performance management. We reward employees for achieving both company targets and individual goals. Sales force compensation is based on value-oriented targets, not mere volume.

Risk

We continue to manage our risks and develop our Risk Management capabilities in alignment with Group's Enterprise Risk Management framework.

Priorities for 2010

·      Grow through common approach to markets, developing from product supplier to solution provider

·      Streamline and optimise business and product portfolio

·      Improve services to business partners and customers

·      Share know-how and capabilities within the Group (e.g. the intended transfer of parts of policy administration and IT to South Africa in collaboration with OMSTA)

·      Embed one lean retail organisation.

Outlook

Retail Europe faces another challenging year, but we are confident of increasing market share and strengthening our position. Our core strength is the flexibility of our unit-linked concept with embedded guaranteed funds and our strong investment expertise. We have established a systematic change management approach to steer and successfully implement the ongoing transformation of the business in the challenging international environment. We continue to explore opportunities to create efficiencies by utilising the skills, and capacity available in the South African business.

Despite the ongoing uncertainty in our markets, we expect improved performance and profit growth in 2010.

Old Mutual Wealth Management

Old Mutual Wealth Management provides advice-driven, predominantly single-premium unit-linked propositions to affluent and high-networth customers across continental Europe, the UK and a number of international markets. While our target segment has a significant proportion of middle-aged customers, demographic shifts over the longer term are providing growth prospects through people living longer and through growth in individual wealth levels. Wealth transfer to the next generation provides sustainability in market prospects. In the UK, the affluent segment represents approximately 83% of managed funds and between 50% and 60% in the large European markets (Boston Consulting Group, 2007).

Our organisation comprises three strong businesses:

Skandia UK is a leading provider of long-term investments with innovative solutions for wealth building and wealth management, offered through the independent financial adviser (IFA) channel on our market-leading platform. Our proposition is based on the belief that financial services should be focused on each individual's goals, rather than on pushed products. Our offer is built on choice and transparency to enable customers to make informed financial decisions.

Skandia Wealth Management Continental Europe targets the affluent segment in continental Europe (predominantly Italy and France). It offers high-quality service through multiple distribution channels with a broad product offering to meet affluent customers' investment needs through the various phases of their lives.

Skandia International is the offshore wealth management arm of the Old Mutual Group, conducting business in Asia, the UK, South Africa, the Middle East, Europe and South America. Our aim is to offer and deliver attractive offshore market-led solutions for the long-term savings and investment needs of high-networth customers internationally, building sustainable and profitable growth in international markets.

Combining these businesses into one Wealth Management organisation provides significant opportunities. Our common focus on affluent customers, and the dominance of single-premium investment business in this segment, create significant prospects to leverage infrastructure, scale opportunities and product knowledge.

Our customer offer includes unit-linked life insurance, pensions and mutual funds. It is based on open and guided architecture, giving customers and their advisers access to a wide range of funds managed by third-party providers. To meet customer demand our offer includes both regular-premium and single-premium products, although the latter predominates. The product set is customised to the needs of local markets:

Our UK business has been transitioning over time from providing an insurance-wrapped, narrow product offer to an open-architecture, platform-enabled offering in line with market trends. Our product set is therefore divided between a legacy portfolio and our market-leading platform proposition. During 2009 we transferred a large portion of our portfolio onto our platform product range, where our customers have access to a wider choice of products, funds and investment propositions.

The transition to platform enablement positions us well in the UK market, which remains primarily IFA driven. Advisers are increasingly adopting platforms as a means of managing customers' investment portfolios, driven by customer preferences for understandable and transparent propositions, regulation that requires regular review of investments, and new adviser remuneration models. As a result, our business is moving towards a more efficient structure that services IFAs better through online technologies and tools. We believe there are opportunities to extend our UK platform to our other markets across Europe and elsewhere.

We offer our UK customers several product wrapper possibilities:

Pensions - a range of pension wrappers to meet the retirement-planning needs of individuals, employers and trustees. All our pension products offer wide investment choice in funds where the underlying investments are through third-party fund managers. Assets are invested either directly into third-party funds or through our range of blended investment solutions.

Investment bonds - our investment bond offers access to third-party funds and blended investment solutions, all managed by third-party fund managers in a product structure that is tax‑efficient for certain customer segments.

Protection - we also offer premium protection solutions in the form of unit-linked whole life product and critical illness cover. Average premium sizes are high and typical customers include the self-employed and entrepreneurs as well as customers seeking protection linked to efficient inheritance tax solutions.

In Continental Europe , our offer consists predominantly of unit-linked business in a life assurance wrapper, supplemented by a mutual funds offer launched in 2009. An important part of our proposition is the ability to customise products for individual distributors' clients. Features such as automatic stop-loss enable customers to take advantage of equity market growth while managing downside risk.

The most important product for our International business is our award-winning portfolio bond. This bond's flexibility enables customers to invest in virtually any tradable asset and in a variety of currency denominations. Its portability is another attractive feature. Our product offer is supported by a comprehensive suite of trust options and online facilities.

Our distribution is advice-led, in line with the preferences of the affluent customer segment. In the UK, distribution is solely through IFAs. The larger IFAs and networks, which we manage as key accounts, represent approximately 60% of total new business income. In the last quarter of 2009 we reviewed our UK sales structure to ensure our business model is fit for the future and aligned to advisers' support needs. We closed a number of regional offices and created a new, enhanced sales organisation consisting of field consultants, a complementary centralised business consultant team and a team focused on delivering value to our corporate partners. In our international markets we distribute through international banks, private banks and financial advisers. We distribute in continental Europe through independent financial advisers, banks, sales networks and our own sales force. We also have an institutional sales force distributing Skandia Investment Group (SIG) funds to institutional customers. Our distributor offer is based on strong relationship management, high-quality service and responsiveness to market needs. Our partnering approach has succeeded in delivering new business even during 2009's difficult market conditions.

Our business success has been based on core capabilities stemming from our corporate heritage as an open-architecture pioneer. Our independence and track record of innovation continue to distinguish us in the market, while our experience in platform-enabled business is a strong asset. We strive to deliver high-quality service and responsiveness to our customers and distributors, and see this as a sustainable source of competitive advantage.

We are structured to stay close to our individual markets while benefiting from centralised capabilities, oversight and optimisation in fund range development, strategy, finance and IT functions. We believe this approach provides opportunities to leverage infrastructure and management processes across the business, especially as we build a pan-European business based on common infrastructure.

Business model

Our business model is scale-driven, with part of our income related to the value of funds under management (FUM). As FUM are driven by the attractiveness and relevance of the product offer, we continuously strive to increase product breadth and depth around local market needs. Our distribution strategies aim to maintain and develop our market presence and make us the provider of choice to distributors. Our policy is to invest in distribution channels with long-term sustainability and good persistency in business. Our strong market positions in product provision, relationships and FUM give us strong bulk purchasing power in the asset management market, which allows us to offer our fund range at very competitive prices.

The global recession has hit providers' volumes across the world, but as local economies emerge from recession we expect our new business volumes to benefit from improved investor confidence.

Since our distribution is centred mainly on independent channels, a large proportion of total expenses consist of sales incentives, which are fully variable in line with volume. As our internal expenses are, to a large extent, fixed, we achieve economies of scale as volumes increase. Operational efficiency remains important to keep costs at optimum levels. Sharing technical, operational and management infrastructure across the Wealth Management business helps us to maximise efficiency.

Our planning and control processes are focused on value creation over the long-term as well as short-term capital usage. Our decision criteria take into account the prospects of earning returns above the cost of capital, to ensure that both customers and shareholders receive added value.

Product development

Our platform provides a convenient, transparent and flexible online approach where customers are able to grow, protect and use their wealth with the support and guidance of a financial adviser. Through Skandia's platform, they can see their full investment portfolio in one place, and can understand the investment strategy that lies behind it. The platform also enables advisers to manage their customers' investments. It provides an end-to-end process starting at risk-profiling the customer through to sourcing the appropriate investments through various tools and features. During the year we further enhanced the functionality on the platform; we now offer customers access to valuation and online switching, recognising their increasing desire for self-service in line with their experience in areas such as online banking. We will further develop these features and services in 2010 to ensure that customers can access the information they need when they need it.

Enhancing our product range to better serve the needs of local markets is a priority. In 2009 we launched a number of innovative products and features, including:

·      A Latin American MCB redemption product, sold through existing distribution channels to meet the growing market need for an international non-contractual savings product

·      A non-accredited product for Singapore, launched to expand Skandia International's target customer base in this growing market

·      A refreshed version of Old Mutual Guernsey's perennially successful life account range, which offers a more competitive charging structure while maintaining its flexible method of investing overseas

·      Daily trading features in Italy, which allow greater investment flexibility and significantly enhance our offer

·      A number of distributor-specific products in France, specifically targeted at the private bank channel

·      A number of new tools and features on our platform in the UK, including an ISA allowance tool and a tax-efficient withdrawals tool.

An important part of creating winning propositions is our fund selection, development and packaging capability. This is delivered through Skandia Investment Group (SIG), which brings together all Skandia's investment research, analysis, portfolio management, open-architecture and investment product expertise. SIG works closely with the LTS business units to deliver investment management solutions that suit customer requirements in our various markets and offer us attractive economics. Central to SIG's capability is the development of blended solutions, such as the highly successful risk-targeted Spectrum fund range launched in 2009, and multi-manager propositions such as theBest Ideasrange. During 2009, SIG evolved its fund range to adapt to changing customer needs in the light of the significant market changes experienced since late 2007. The new fund range offers customers a more compelling choice of investment solutions with the benefit of improved performance.

The strength of our product offer was recognised through a number of awards in 2009, including:

·      'Best Multi-Manager' in the Money facts Awards (Investment, Life and Pensions)

·      'Best Regular Premium Investment Product (UK Offshore)', 'Best New Product (Far East)' and 'Best Online Proposition (Far East)' in the International Adviser Life Awards

·      'Best Fund Platform' in the Logica UK Platform Awards

·      'Best International Life Group' in the International Fund & Product Awards

·      'Best Fund Supermarket' in the Professional Adviser Awards.

Market overview

Demographic changes in Europe and across the globe will continue to result in individuals needing to save for the long term. The affluent and high-networth segments of the market are expected to grow as people become wealthier and wealth transfers to the next generation. Although competition in these segments is tough, we believe that the economics remain attractive. As defined-benefit schemes become increasingly unaffordable, defined contribution schemes are expected to become the norm for employer-provided premium obligations in the future, which will favour our products in the market.

The global financial crisis has reinforced an existing need for quality advice and transparency. This favours our strategic focus on advice-led, choice-driven investments - which will gain further support from forthcoming regulatory changes. In the UK, for example, the requirements proposed by the Retail Distribution Review aim to provide greater clarity about the services being provided, with the charges for this service potentially being specifically agreed between the adviser and the customer. We expect that other global markets will move to similar regulations in the future. Skandia's modern solutions already meet some of the new requirements and the proposition will be developed further to offer the necessary flexibility.

The credit crunch of 2008 and 2009 resulted in low customer appetite for investing new money, putting pressure on new sales in the financial sector. During the crisis, customers moved away from riskier asset classes such as equity into more stable categories such as cash and fixed interest. More recently we have started to see a reversal of this trend as equity markets recover.

Recent budget announcements in the UK have curtailed the tax relief available to wealthier individuals, making investments into pensions less attractive. As a result, these customers may turn to other types of savings for their retirement. We have a full range of tax wrappers to meet their needs. The recent changes to ISA allowances for over-50s, increasing their annual allowance to £10,200, caused a surge in ISA new business across the industry during Q4.

Compared with single domestic markets, the offshore financial services industry offers greater diversity of geography, customer base, distribution, risk management and competition - as well as opportunities generated by variable macro and micro conditions.

The implementation of Solvency II will emphasise our low-risk, capital-efficient business model. We expect to have an advantage over other market players that carry product guarantees on their balance sheets. This capital saving will enable us to channel comparatively more capital into the further development of business opportunities and to grow our business.

Strategy

In line with the Old Mutual Group's overall strategic initiatives, we are focused on building scale, maintaining our strong capital positions and streamlining our portfolio over time. To this end, our strategy aims to:

·      Deliver innovative products to meet local market needs and increase the breadth and depth of our product offer

·      Evolve the customer and distributor proposition as we anticipate and respond to changes in preferences, behaviour and market dynamics

·      Optimise our fund portfolio to the benefit of customers

·      Seek opportunities to expand our platform technology and infrastructure across the business

·      Pursue volume in profitable products and channels and improve profitability where opportunities arise.

During 2009 we sold Bankhall, an organisation offering support services to directly regulated advisers, to increase focus on our core business.

Performance in 2009

Improved sales performance in Old Mutual's largest market

Highlights (£m)	2009	2008	% Change
Adjusted operating profit (IFRS basis) (pre-tax)	106	150	(29%)
Return on equity*	7.9%	9.7%
Operating MCEV earnings (covered business) (post-tax)	(4)	229	(102%)
Return on embedded value (covered business) (post-tax)	(0.3%)	14.3%
Life assurance sales (APE)	617	664	(7%)
Unit trust/mutual fund sales	3,210	2,561	25%
PVNBP	5,042	5,540	(9%)
Value of new business (post-tax)	49	67	(27%)
APE margin	8%	10%
PVNBP margin	1.0%	1.2%
Net client cash flows (£bn)	2.5	2.0	25%
Highlights (£bn)	2009	2008	% Change
Client funds under management	46.9	38.9	21%

*Return on equity is IFRS AOP (post tax) divided by average shareholders' equity, excluding goodwill, PVIF and other acquired intangibles

Overview

Wealth Management operated in volatile markets during 2009. The UK has experienced a severe recession, while France and Italy have also been impacted to a lesser degree. While stock markets have now recovered somewhat, customer confidence in savings has been significantly affected by uncertainty. During the second half of 2009, sentiment improved and, as our customer proposition became sharper, we saw good growth in our sales, strong net client cash flows and a marked uplift in funds under management. The fourth quarter was particularly strong, contributing £203 million of the total £617 million APE sales for the year, and £1,066 million of the £3,210 million unit trust/mutual fund sales for the year.

Sales

UK market

In the UK, our platform proposition is working well. This was particularly evident in the second half of the year when sales reached record levels and we adjusted our product offering to sustain its relevance in the changing market environment. The degree to which business is transitioning to our platform-enabled model is highlighted by the material increase in contribution from non-covered mutual fund business in the UK, which recorded a 22% increase in sales when compared to 2008. By contrast, our covered business sales in the UK declined by 6% year-on-year as customer investment preference continued to shift towards mutual funds, and away from the more traditional life product offerings. We remained the leader in the UK platform market, with 33% market share (in assets) (source: Lipper) at the end of the fourth quarter, well ahead of our competitors. Our strong performance in the UK platform market is aligned with our focus on delivering transparent, convenient and efficient services. We are pleased with the momentum in this business which was recognised in the positive responses from a syndicated study conducted among pensions and investment providers by ORC, a UK market research company, in the third quarter.

 

International markets

In the markets in which Skandia International operates (primarily UK offshore, the Far East, Latin America and the Middle East), the negative impact of the global recession has had a lagged effect compared to 2008 when new sales were relatively unaffected, with 2009 showing falls in inflows compared to 2008. However, sales in the second half of 2009 showed some improvement on the first-half. Single-premium business represents 44% of our International business. In the UK single-premium offshore market we have overtaken two competitors and are now ranked second with a 14% market share based on statistics for the third quarter of the year (source: MSE), a 4% increase on previous periods. The UK offshore market represents 26% of our total business.

Following a change in government pension legislation, we have decided to cease writing new pension business in Finland and are reviewing our other products. Pensions were a significant profit generator for Skandia International in the past, and the curtailing of that activity there will result in changes to the emphasis of the business and reduce the cost base.

Continental Europe

In continental Europe (France and Italy), we have benefited from close and positive relationships with distributors, resulting in sustained inflows throughout the year. We continue to explore mechanisms to improve traction in these markets both in terms of the efficiency of our operational structure and the nature of our relationships with distribution channels. Our continental European business overall delivered covered business APE sales 54% higher than in 2008 (on a sterling basis), as both new and existing distributor relationships generated improved sales. In Italy our market share (assessed as new sales in the unit-linked segment) grew from approximately 4% at the end of 2008 to 12% at the end of 2009 (source: Ania). In France, the market remains oriented towards guarantee products but sales in the last quarter showed some recovery, rising by 33% over the previous quarter of 2009 in sterling terms. We have decided to reduce our activity with financial planners in Spain given the lack of business, and we will adjust our headcount accordingly.

IFRS AOP results

IFRS pre-tax adjusted operating profit was 29% below prior year levels. This reflects the operating leverage of the business, with lower year-on-year net sales and lower average levels of funds under management over the course of the year resulting in reduced management fee revenues. Lower interest rates have negatively impacted shareholder investment return and profit levels on the protection business in the UK. These negative movements were partially offset by increased policyholder contribution profit recognition in accordance with the three-year smoothing policy. The large contribution to profits of the fourth quarter of 2008 following the market weakness are smoothed over twelve quarters and so the full-year impact is only felt during 2009.

The IFRS AOP pre-tax result was negatively impacted by one-off items in 2009. As previously announced, there were a number of write-offs in the first half of the year, relating to unit allocation errors in International (£19 million) and France (£4 million), a £6 million provision in the UK for legacy product valuation and a write-down of £6 million on a property unit trust investment relating to the Glanmore fund.

On a post-tax basis, the IFRS AOP result was 8% below 2008, due to a large reduction in the AOP effective tax rate. The effective tax rate for 2008 was unusually high at 38%, compared to 19% in the current year.

A significant portion of the UK AOP result, in both 2008 and 2009, arises from gains in respect of policyholder contribution. These gains fluctuate over time, although we would expect a normalised level of gains to be £30-£35 million per annum. In 2008 and 2009, the gains recognised within the adjusted operating result amounted to £59 million (pre-tax) and £96 million (pre-tax) respectively, reflecting the market volatility experienced. In accordance with industry practice and our stated accounting policy, these gains have been smoothed through our results over a three-year period, rather than recognised immediately in AOP. In 2010 we expect the gain to be approximately £100 million (pre-tax), falling to £60 million (pre-tax) in 2011, before it reverts to normalised levels in 2012.

Under the revised management structure of the Wealth Management unit, a robust programme is underway to adjust how we serve the market, particularly in the UK, and to restructure the operational infrastructure supporting the business. Besides ensuring that our market offering is oriented towards servicing the needs of our distributors, the programme is expected to deliver cost savings across the business of £45 million on a run-rate basis by 2012, with associated one-off restructuring costs at approximately the same level. £13 million of costs have been already incurred in the 2009 AOP results, with the majority of the balance anticipated to be incurred during 2010, and an associated run-rate saving of £11 million already achieved. We have also streamlined the operations of Skandia Investment Group (SIG), appointing a new head and announcing the closure of the US sales office, which has resulted in £1 million restructuring costs in 2009.

Value of new business and margins

Compared with 2008, the value of new business and profit margins were influenced by three main factors:

·      Lower sales volumes across all markets, with APE down 7% year-on-year, which had a negative impact of £5 million on VNB and a 10 basis point reduction in the PVNBP margin.

·      This was offset by the positive impact of the reduction in the effective tax rate on business value created on new sales in our offshore markets, delivering £11 million of VNB and 22 basis points of PVNBP margin.

·      The internal expense base did not scale down in line with reduced sales production. Rather the internal acquisition expense base grew year-on-year leading to a £15 million reduction in VNB and a 30 basis point reduction in PVNBP margin. The increase in expenses reflects investments in the platform business, but highlights the opportunity for further operational efficiencies in the future.

MCEV results

The Market Consistent Embedded Value (MCEV) operating earnings after tax declined from £229 million in 2008 to a loss of £4 million in 2009. The change was mainly due to a lower than expected existing business contribution (based on lower one-year swap rates), a lower new business contribution, adverse experience and operating assumption changes partially offset by the removal of dividend tax in International. For the latter effect, the impact on adjusted net worth was recognised within the operating earnings, while the impact on VIF was recognised in non-operating earnings.

In 2009 the adverse operating assumption changes of £99 million were the net impact of:

·      strengthening persistency assumptions in both the UK and International businesses (-£81million, of which -£24 million was in response to the new regulation in Finland),

·      capitalisation of planned development and project spend together with a strengthening of maintenance expenses (-£66 million),

·      a higher fee income assumption (£36 million), and

·      changing a morbidity risk assumption in the UK to align with positive experience (£12 million).

The fall in operating MCEV earnings is the driver of the 14.6% year-on-year fall in RoEV.

Net Client Cash Flow

Net client cash flow showed a 25% improvement on the prior year, driven by good new sales inflows and improving persistency.

On the UK platform, annualised surrender rates improved from approximately 14% of average funds under management at the beginning of the year to 12% by the end of 2009. As we migrate business to the platform, the UK legacy business has seen lower inflows coupled with higher surrender rates, which resulted in negative net client cash flow for the year from this part of the business. Surrender rates on the legacy book appear to be stabilising, and a retention team has been mobilised locally to improve persistency, including assessing options for controlled transfers to the platform where this would serve customer investment objectives. However, we do anticipate that the traditional book of business will gradually decline as more investors move away from the legacy products towards the platform-enabled investment propositions.

Net client cash flow in our offshore business was impacted mainly by lower sales levels, with surrender levels remaining relatively high as a result of market conditions. 2009 surrender experience, influenced by broker-specific surrenders and changed regulations in Finland, has prompted us to review and strengthen our persistency assumptions, the effect of which can be seen in the MCEV indicators. With recent improvements in surrender rates our outlook for persistency in the coming periods is cautiously positive.

Strong inflows and maintained focus on persistency have resulted in good net client cash flows in continental Europe which were significantly higher than in 2008 and reached 19% of opening funds under management on a sterling basis.

Funds under management

Funds under management recovered strongly in 2009 as global equity markets lifted from their low levels at the start of the year and as a result of strong net client cash flows. 2009 full-year funds under management were 21% above the 2008 closing position. Net client cash flow contributed 6% in asset growth, while market movements on the portfolio added a further 15% to total funds under management. Throughout the year, we have witnessed gradual changes in the asset mix, as customers started shifting from conservative portfolios with high fixed income weightings into relatively more risky asset classes as equity markets recovered. This has a positive impact on the run-rate of our revenue streams, which are substantially driven by fund rebates.

Investment performance on funds selected and managed by SIG showed a marked improvement in 2009, with both our core range of researched third party funds and our proprietary funds performing well, particularly since the restructure of the UK fund range during 2009. In addition, SIG's Asset Allocation Model Portfolios have consistently outperformed benchmark since launch, with significantly lower levels of volatility relative to benchmark. 2009 was an excellent year for SIG, with overall fund range performance in the top quartile in the industry, having 64% of funds ahead of benchmarks.

The improvements in investment performance in 2009 were aided by the establishment of a dedicated portfolio management team, while the UK fund range restructuring concentrated effort and scale into funds, cut total expense ratios and enabled the use of tactical asset allocation for the first time. In addition, improving economic and market conditions boosted risk appetite, with active managers being rewarded for taking risk.

Marketing

Throughout 2009 we continued our drive to increase brand awareness with advisers and end-customers and to deliver solutions tailored to customer needs. Examples of our marketing activity during the year were:

·      The annual Skandia UK Trailblazer roadshows, held in September, which earned excellent feedback from the 1,600 advisers who attended. Trailblazer is a series of events designed to help distributors prepare for the changing regulatory environment and build long-term value in their business - giving us an opportunity to share our distributor support proposition

·      Our sponsorship of the Sky Sports coverage of golf and sailing during the year, to increase consumer brand awareness among key target segments. This initiative has successfully increased Skandia brand awareness in the market. Also in the sporting arena, Skandia continued its sponsorship of the GBR sailing team in 2009

·      The launch of the Skandia Global Dynamic Equity Fundin April 2009: offering customers a focused and flexible global equity solution that combines both manager selection and active asset allocation in a single fund, it has been a top-quartile performer from its inception

·      The launch of the highly successful Skandia Spectrum Funds- an investment solution giving IFAs the tools to match a customer's risk appetite with funds that aim to create the maximum return for that profile

·      The launch of the Skandia European Best Ideas Fund- an actively managed pan-European fund solution, giving European customers the benefits of robust asset allocation, manager selection and manager blending through our Multi-Manager approach. The fund has performed in the top quartile since inception

·      In France we introduced Skandia Initiatives, a roadshow programme that aims to support IFAs in business development, and again participated in the annual Patrimonia trade event. This was an opportunity to showcase our new advisory option on the Archipel platform, as well as our IFA segmentation programme. Both initiatives have been very successful in raising awareness of our products.

Customer service

We are committed to providing consistently high standards of service to customers and distributors. Recognition of our drive for service excellence during 2009 included:

·      Two five-star ratings ('Investment Provider' and 'Life & Pensions Provider') in the FT Adviser Online Service Awards and a five star rating in the industry Financial Adviser Awards for the 12th year running, recognising the high service quality we maintained despite the platform migration programme running throughout the year

·      'Best Commitment to Service' in the International Fund & Product Awards

·      Second place for quality of service in the IFA channel, in a study by a leading publication in France.

People

We use a balanced scorecard approach to performance management, measuring and rewarding employees based on their performance across a range of financial, customer, operational and organisational learning objectives. We believe in benchmarking remuneration against the market for specific roles, with variable pay reflecting the achievement of objectives linked to customer and shareholder value.

Risk

We continue to manage our risks and develop our Risk Management capabilities in alignment with Group's Enterprise Risk Management framework.

Priorities for 2010

·      Build and expand the customer and distributor proposition

·      Build profitable volume through investment in products, service and distribution

·      Maintain and improve operational efficiency, reducing duplication and streamlining processes

·      Lay the foundations for extending our UK platform infrastructure to other markets.

 

 

Outlook

Over the last quarter of 2009, we attracted markedly better new business inflows on the back of sustained financial market performance during 2009. While the recovery in the global economy is still fragile and individuals' economic situations remain constrained, we believe that customer appetite for long-term investment is returning, while the gap between the need to save and actual savings levels is increasing. The sustainability, speed and strength of the economic recovery are difficult to predict; however, we are cautiously optimistic. We expect that competition will be tough in 2010 as providers race to capture the returning market. We believe that those providers with market-relevant product offers and high levels of service quality and responsiveness will be the winners.

The aftermath of the recession and its long-term impacts on customer behaviour, trust and risk appetites is likely to be significant for the industry over the next few years. However, we believe we are well-positioned to respond to these changes as we build out our product proposition and offers with continued focus on transparent, advice-led business.

Our market share has grown over 2009, which demonstrates that our products and service quality remain relevant in the market. As the market recovers, we expect this to position us strongly for further growth in funds under management. The development of product spread and depth in the UK platform market is critical to the success of the business and we will be accelerating our focus on this in the period to 2012.

Our efficiency programme is intended to align the cost base of the business with the nature of the lower-margin platform business. We expect that, coupled with improving volumes and revenue, this will have a positive effect on IFRS and MCEV results in future years. Further restructuring costs are expected in 2010. We have set ourselves goals for 2012 of delivering a return on equity of 12-15%, net client cash flow of at least 5% of opening funds under management, as well as £45 million of cost savings as previously mentioned.

US Life

US Life primarily consists of OM Financial Life Insurance Company and its subsidiary, OM Financial Life Insurance Company of New York. It covers all 50 US states as well as the District of Columbia. Our products are designed to deliver excellent profitability while providing customers with transparency and value-driven benefits.

Fixed indexed annuities (FIAs)

Our FIA products have been highly ranked in the top six companies for market share from 2004 to 2008 by Advance Index Product Sales & Marketing Report. They guarantee the policyholder no loss of principal due to market risk with a return derived from the greater of a guaranteed fixed rate or a formula relative to equity market index movements. By hedging the potential equity index upside using equity index options and futures, we give customers the potential for equity market gains while managing exposure to loss of principal. Under these contracts we invest in a portfolio of bonds and other fixed income securities that earn a spread above the cost of options and futures and rate guaranteed to the policyholder. Specific product names include the OM Index-Safety series (available in 4, 7 and 10-year durations), OM Index-Escalator(available in 6, 8 and 10-year durations), OM Index-Accelerator(available in 7 and 10-year durations) OM Index Spectrum 9, OMNYIndex-Safety 7 and OMNYIndex-Spectrum 10.

Fixed annuities

Similarly to FIAs, under these fixed-rate contracts we invest in a portfolio of bonds and other fixed income securities that earn a spread above the rate guaranteed to the policyholder. There are two main types of fixed annuities: one aims primarily to offer a tax-efficient way of saving money for retirement, and the other to provide an income stream for life. Our fixed annuity product offerings include the OM Guarantee-Platinum series and the OM Guarantee-Plusseries.

Protection products

We offer one principal protection product line: fixed indexed universal life (FIUL) products. These provide flexible life assurance protection in the event of death or disability. The indexed universal life product is designed to provide supplementary retirement income options for customers who use preferred loan features for tax advantage. Our two core FIUL products are OM Life-Choice and OM Life-Elite.

In the middle-income to upper-middle-income segment of the market that we target, consumer needs are not particularly complex. In the US, the ratio of life insurance coverage to household income is no more than 3:1, regardless of income level. By contrast in Japan, where the ratio is 10:1, there is greater understanding and appreciation of the value of life insurance.

What our customers want is a product solution for a particular financial objective, such as a tax-advantaged supplemental retirement income or a way to reduce the risk of financial loss. Customers want to trust that these products will perform as the company and agent represent. They want information available at the touch of a keystroke or within a minute of dialling a toll-free number. Meeting service expectations is critical to the long-term success of insurance companies operating in the US market.

We are building products and services that cater to customers in the 63% of American households with incomes between $35,000 and $250,000 per year. Our niche will be in the $75,000 to $150,000 household income market. Our products will be distributed through independent agents and managing general agents (MGAs) who are focused on serving our target markets. Effectively meeting the basic risk and retirement needs of this customer segment will give Old Mutual tremendous opportunity for growth and market share attainment in the US.

Most US households have not saved an adequate retirement account to assure the same quality of life they enjoyed during their income-earning years. With the market downturns of 2001 and 2008 many baby-boomers will struggle to accumulate enough funds to retire comfortably. They will look to companies to meet their income needs through guaranteed minimum income benefits via annuities and tax-free loans in cash value accumulation life policies.

The market dynamics for the US will continue to provide significant opportunities around the broader middle market and the ageing baby-boomer demographic.

Business model

We distribute our products through independent agents. The majority of sales are generated through established groups of MGAs, similar to large brokerage firms in the UK, who typically offer agents a range of annuity and life assurance products from various providers. In the US it is not economic for insurance companies to target agents directly with their products: the MGA is the intermediary between the agents and the insurance companies, of which there are about 20 core competitors in our chosen markets. After a culling process earlier in the year, we currently have contracts with some 260 MGAs.

Our relationships with our top distribution partners continue to be an area of strength. Many individual contacts date back a decade or more, and such long-term relationships help us to weather change.

We provide differentiated support to our Power Partners (key account MGAs) and their downstream agents by offering:

·      Excellent products we will continue to offer a broad portfolio of unique products built to serve the needs of middle- and upper-middle-income customers

·      Educational workshops - we host workshops designed to help advisers grow their practices to the next level and regularly deliver actionable sales programmes to agents in the field

·      Special programmes for our top producers loyalty deserves to be rewarded, so we offer a number of unique services for our most productive advisers and our compensation programs and services are tiered so that we give the best service to the most productive agents.

People, products and processes are the keys to our success, and we can be a key to the success of our distribution partners. To be successful in both the short- and long-run, we must:

·      Be innovative - adding depth and breadth to our product line and positioning ourselves creatively in the marketplace by addressing customers' income replacement and retirement income needs

·      Develop excellence in recruiting and training distribution partners - refining our processes to recruit wholesale and retail distributors, bring them into production and make them steadily more productive

·      Create positive experiences - making our customers feel important. The little things matter; positive service experiences matter.

Capital and cash management are our primary drivers for decisions, particularly in light of the severe change in the economic climate that began in Q4 2008. Our capital level is substantially dictated by regulatory and rating agency requirements, which we meet by taking appropriate action regarding types of assets, reinsurance, available product features, benefits and mix of product offerings.

In our product development process, we aim for designs that contribute to maintaining an overall return in the 10% to 12% range while generating a significant value of new business.

Our business planning and forecasting processes include detailed analysis of the sources of actual capital which is compared to the required capital level. Components of each are monitored monthly for management action, particularly on the asset side. The process includes identifying and planning for potential events that could either increase surplus or reduce required capital as well as striving to mitigate such events.

During 2009 we engaged Goldman Sachs Asset Management (GSAM) as advisers to provide oversight and additional analysis on the structured securities in the US Life investment portfolio. After a thorough review of GSAM's capabilities, including support of the impairment/audit process for structured securities at the close of the first half of the year, we engaged GSAM as lead asset manager of the US Life investment portfolio, with responsibilities spanning the full spectrum of fixed income securities. As lead manager, GSAM is also responsible for providing investment input that informs our overall asset allocation, and has dedicated actuarial resources to help us move towards portfolio segmentation. We continue to work with our existing affiliated asset managers, Dwight Asset Management and Barrow, Hanley, Mewhinney and Strauss.

Product development

The growth in the US Life business since 2000 has been predicated on a partnership with core distributors on product design and exploitation of niche markets: for example, in the mortgage term market we provide death benefit protection to individuals financing or refinancing a home. While we determine the retail strategy, the product solutions are most often created in partnership with distributors. This assures the partner company that we are on-target with the product design while also securing shelf space with MGAs that help in the development process.

Market overview

There is a push for federal regulation of the insurance business to ensure consistency across the various states. This could offer companies and agents economies of scale in compliance; but a more onerous regime similar to that for securities dealers could drive out companies and agents that sell primarily or only fixed products and do not wish to entertain the associated upfront costs and new business strain. Thus far, such a change appears highly unlikely for the next few years because the proposals under consideration in Congress generally do not apply to the insurance business.

A regulatory change - US Securities and Exchange Commission (SEC) Rule 151A -  that could reduce the viability of indexed life and annuity products is currently being challenged in the US Court of Appeals. In effect it would mean that indexed products would be treated like securities and could only be sold through agents who have securities licenses. Originally Rule 151A was scheduled to go into effect in 2011 if it survived legal challenges. The SEC has now agreed to an additional two-year deferral, which means it is unlikely to take effect before 2013; meanwhile, the SEC could decide not to go forward with it, or it could be struck down in legal challenges yet to be lodged if it is reissued. At state level, regulators continue to impose additional requirements to enhance consumer protection during the sale of insurance products.

Many of our core competitors are in the early phases of their own re-engineering efforts. Having taken tough, swift action very early on in the market downtown, we gained significant competitive edge. Many of our key distribution partners commented positively on our early action and transparency throughout the transformation process in Q4 2008 and during 2009.

Many of the customers we aim to attract are baby-boomers, a group totalling over 78 million people in the US with estimated net worth of nearly $17 trillion dollars and a need for wide-ranging life insurance and savings products (Source: US Census Bureau). The fact that many of these individuals can expect to spend a quarter to a third of their life in retirement (Source: Economist Jeffrey Brown) further compounds their need for protection, accumulation and income distribution products.

Strategy

We have scaled the business to achieve profitable growth. The agent-culling process and streamlined product portfolio have focused the company on steady, quality new business through our core distribution partners. We have made early efforts to garner support with this key group, including the introduction of information-rich marketing programmes and a more personalised approach to handling day-to-day requests.

Our core products strategy reduced the annuity portfolio from over 50 products to 23 and the life portfolio from nine products to two. By taking this streamlined approach we aimed to continue providing our agents with sustainable solutions in uncertain times: the products we continue to offer today provide the flexibility and benefits to meet customers' future expectations.

The current risk to maintaining capital levels is having to sell assets in a declining market to meet liability obligations, and the impact on required capital of declining credit ratings. Our action to mitigate these risks included liquidity analysis, which resulted in a higher than normal cash balance held through September to avoid selling assets in a depressed market, as well as monthly monitoring of ratings migration. In addition, we actively monitored and planned for beneficial regulatory action designed to relieve the impact of ratings changes as well as other surplus relief action. As surrenders have declined we have invested more cash while maintaining a prudent level based on our analysis. We have also selected assets for sale where the loss is offset by the release of required capital for asset risk.

As part of the business transformation initiative we reduced the number of internal customer service and IT staff and renegotiated all major Third Party Administrator (TPA) contracts. These changes did not reduce our service capability and we earned our best-ever ratings from agents for overall customer service levels and call centre responsiveness. The average annual cost per contract for customer service (including TPA and IT) has reduced by 22% from over $54 in 2008 to under $43 for 2009. Additional full year savings coming through in 2010 will further improve the average cost per contract.

Performance in 2009

Continued progress to improve profitability and enhance risk management

Highlights ($m)	2009	2008	% Change
Adjusted operating profit (IFRS basis) (pre-tax)	76	(425)	118%
Return on equity	10.5%	(25.3%)
Operating MCEV earnings (covered business) (post-tax)	417	(676)	162%
Return on embedded value (covered business) (post-tax)*	22.7%	(97.6%)
Life assurance sales (APE)	107	251	(57%)
PVNBP	1,000	2,307	(57%)
Value of new business	22	(21)	205%
APE margin	20%	(8%)
PVNBP margin	2.2%	(0.9%)
Net client cash flows ($bn)**	(1.5)	(0.4)	(275%)
Highlights ($bn)	2009	2008	% Change
Funds under management**	16.7	15.2	10%

* Calculated as the operating MCEV earnings (post-tax) divided by the absolute value of the opening MCEV

** Stated on a start manager basis as USAM manages $6bn of the funds on behalf of US Life

Overview

During 2009 we successfully transformed and scaled back the business. The major actions of reducing the product profile, scaling back distribution with a focus on top-tier producing agents, lowering staff numbers, and carrying out a full review of our outsourcing model are now complete. As a result of these actions, we made significant strides in addressing the three core focus areas in the business, which are operational efficiency and cost control, product and assumption risk, and the ongoing effort to de-risk the company's fixed income investment portfolio.

Sales

Total US Life sales (APE basis) were down 57% over the comparative period as a result of a planned reduction in the number of products offered as well as focusing on top-tier producing agents and conserving capital. As planned, total gross sales declined from $1,950 million in 2008 to $860 million in 2009. Elsewhere, the wider life insurance industry suffered a decline in sales not seen since the end of World War II.

The product profile was streamlined to focus on more profitable sales and products with lower new business capital strain. Fixed indexed annuity (FIA) sales were down 47% to $60 million on an APE basis. This product line is our key offering, contributing 56% of total APE for 2009 and currently offers attractive margins. It meets the needs of customers who seek principal protection, as well as fixed interest guarantees or a guaranteed fixed income. Immediate annuity sales represent 18% of total 2009 APE and remain an important offering as they contribute to capital in the year of sale.

APE for the Universal Life product suite was down 57% to $22 million on an APE basis and our core life product, Indexed Universal Life, fared the best out of all life product segments, partially due to the elimination of Universal Life products other than Indexed Universal Life. Indexed Universal Life continues to offer attractive sales potential in the life market due to indexed crediting options, and tax-advantaged growth and income options. Term Life sales were suspended in 2009 due in part to their capital inefficiency as a product.

Although volumes were managed down by design, key distributors that drive our sales remain largely intact year on year. In the annuity distribution channel, four of the top five and eight of the top ten distributors are the same in 2009 as in 2008. In the life distribution channel, three of the top five and seven of the top ten distributors are the same in 2009 as in 2008. Having recently concluded our annual distributor conference, general consensus was that US Life exceeded expectations in dealing with difficult economic conditions in 2009 through a transparent communications plan, creating a new foundation for future growth. Confidence from this group remains high and key distributor relationships are strong.

IFRS AOP results

Pre-tax adjusted operating profit (IFRS basis) was $76 million for 2009 compared to a loss of $425 million for 2008. Gross margins (prior to DAC amortisation) of $430 million in 2009 compared to a loss of $54 million in 2008. The prior year was impacted by a $436 million mortality assumption change for the Immediate Annuity line. The underlying additional $48 million of margin earned in 2009 is primarily driven by the annuity product lines which showed better underwriting experience. Mortality on the Immediate Annuity line improved over 2008 while 2009 includes a gain arising from commutation of 17 large cases. The FIA line generated higher surrender charges as a result of increased surrender activity. Offsetting the better underwriting experience was lower net investment income due to holding cash at the low interest rates of the period and the increased level of surrender activity. DAC amortisation was $354 million and $368 million respectively for 2009 and 2008. Unlocking in 2008 was due to prospective annuity assumption changes while that of 2009 was due to the retrospective amortisation impact of surrenders and the decline in premiums from Universal Life sales.

IFRS operating expenses were $58 million or 33% lower over the comparative period resulting from tight expense management and cost renegotiations of three key service providers.

Value of new business and margins

Value of new business increased by $43 million over the comparative period, with the margin for the year at 20%.The increase in margin was mainly due to higher swap rates and the focus on selling more profitable business. Management actions to improve margins on fixed indexed annuities have also increased the value of the in-force book. The traditional life business has been shrunk because of its capital inefficiency.

MCEV results

Operating MCEV earnings improved significantly up $1,093 million from the prior year loss of $676 million. This was mainly due to increased expected existing business contributions, which accounted for $363 million of earnings in this reporting period compared to $44 million in the comparative period, and the large negative experience variances and assumption changes in 2008 which were not repeated in 2009 (experience variances were negative $2 million in 2009 compared to negative $280 million in 2008, and assumption changes had a positive impact of $47 million in 2009, compared to negative $619 million in 2008). MCEV does not capitalise investment spreads in excess of the adjusted risk free reference rate up-front, as was the case under EEV. Were these spreads to be capitalised, the increase in embedded value from the 2008 level would be in excess of $900 million. Unlike for 2008, guarantees on the policies in force in 2009 although above the low reference risk free rates prevalent for the period, were generally less than the actual yield earned on the portfolio.

During the period we commuted a block of our SPIA contracts to the owners through their third party advisors at a value less than the reserve established for this block after the recent reserve strengthening, giving a positive variance. Although the experience from the total SPIA annuity block can be expected to be volatile, since it is a small book with some large individual contracts, we are confident that the reserve adjustments made in previous periods are adequate to cover the future expected outcomes in respect of this business and the transaction described above supports this view. Changes in lapse assumptions due to improved experience resulted in a small gain, while amendments to the opening TVOG (time value of options and guarantees) balance and the lapse methodology also gave a small net gain. We consider that the anticipation of attractive crediting rates available from the rise in equity markets during 2009 had a progressively beneficial impact on surrenders.

The large movements in non-operating earnings demonstrate the sensitivity of the US Life MCEV to changes in the economic environment, as market consistent methodology means that results move more directly in line with the movements in the market in general. Since assets are marked to market the high unrealised losses in the bond portfolio have a large impact on the MCEV. The $1.8 billion decrease in unrealised losses in 2009, partially offset by a significantly lowered liquidity premium assumption (100 basis points in 2009 from 300 basis points in 2008), was the key driver of a net positive $681 million and 8.30p per share impact on non operating earnings, to the Group MCEV earnings per share respectively, at 31 December 2009.

Net Client Cash Flows

Net client cash flows were negative due to the decision to reduce new business volumes and also an increase in surrender activity during the first half year. We believe that this was driven by policyholder liquidity needs and the adverse effect that the equity markets had on our fixed index annuity returns. During the second quarter of 2009, a conservation programme was introduced to focus on the reduction of full surrender activity. The programme delivered benefits and surrender experience trended downwards in the second half of 2009. By the end of the year the four-week average for full surrender activity was nearly half the level seen at the peak in the second quarter of 2009 and was in line with long-term expectations.

Funds under management

Funds under management ended the period at $16.7 billion, up 10% from the opening position primarily due to a $1.3 billion (10%) increase in the market value of the investment portfolio and investment income for the period. This was partially offset by negative net client cash flows of $1.5 billion, or 10% of opening funds under management.

Investment portfolio

The fixed income portfolio continued to be affected by poor economic and volatile financial market conditions. However, the fair value of the portfolio increased $1.3 billion from year-end 2008. The yield on the book value of the fixed income portfolio was 5.82% (including cash and other invested assets), and has not changed significantly from that of 2008, as reinvestment of cash has not materially changed the overall yield. We ended the year with $0.8 billion (5% of holdings) in cash and short term holdings, reflecting purchases of assets from cash inflows, as well as with cash proceeds from de-risking and gain-harvesting transactions. Purchase activity has targeted NAIC 1 to 2 rated securities including selectively into the financial services sector. The net unrealised loss position on the fixed income security portfolio improved to $0.5 billion at 31 December 2009 ($2.3 billion at 31 December 2008), reflecting a broad recovery in financial markets in general, and narrowing corporate credit spreads in particular and selective de-risking. It has continued to improve to below $0.2 billion as at the end of February 2010. Continued Government purchases in the residential mortgage bond markets, and increased support to the commercial mortgage market through programmes such as the Term Asset-Backed Securities Loan (TALF) and Public-Private Investment Program (PPIP) have also led to narrowing spreads across structured securities, which have also been favourable to the portfolio's unrealised loss position. As the Federal Reserve's support of the Agency market through explicit purchase of such securities comes to an end in the first quarter of 2010, it is likely that Agencies could retreat from current valuations. As such, despite excellent collateral quality, we view Agencies as posing potential spread-widening risk. Similarly, very highly-rated, long maturity securities are at risk of underperformance or negative price action as long-dated Treasury yields move higher on the back of mounting Federal deficits and the need to fund ongoing stimulus programmes.

Approximately $1.5 billion of the fixed income portfolio is classified as Loans and Receivables, which are carried at amortised cost. As a result, $45 million of unrealised losses on a mark-to-market basis are not reflected in the balance sheet in accordance with IAS 39.

During the last three quarters of the year, the financial services sector securities were generally the largest contributors to the improvement in the net unrealised loss position for the fixed income portfolio. With increased access to capital and the prospect of stabilising and improving earnings quality, the likelihood of coupon deferrals for weaker financial hybrids, such as those of US regional banks, appears to be diminishing. Against the backdrop of improved liquidity in the capital markets and a recovery in economic activity, high yield default rates are expected to decline by around 50 to 75% from prior year levels and investment grade downgrades are expected to return towards historic norms. This implies that the worst of corporate defaults and ratings downgrades has passed.

The fair value of the US fixed income investment portfolio at 31 December 2009, after recognition of the impairments, totalled $15.3 billion compared to $14.0 billion at 31 December 2008.

Impairments

During 2009, there were three defaults in the corporate bond portfolio of $14 million included in the total $389 million of IFRS impairment losses on 82 securities. These were partially offset by $35 million of net investment trading gains. As of 31 December 2009 compared to 31 December 2008, $807 million of investment grade securities were downgraded to non-investment grade and $35 million of non-investment grade securities have been downgraded further. Impairment losses included $235 million related to structured securities, with the losses being due to adverse changes in expected future cash flows. The impairment losses were primarily in residential mortgage-backed securities ($138 million), commercial mortgage-backed securities ($80 million), preferred stocks and hybrid securities ($43 million net) and 13 corporate holdings ($111 million), the most significant of which were related to financial sector issuers.

The fixed income portfolio has exposure to approximately $0.8 billion of preferred stock/hybrid instruments amounting to approximately 5% of the portfolio at 31 December 2009 compared to $0.6 billion (5% of the portfolio) at 31 December 2008, with the bulk of this exposure concentrated in the financial services sector. During the first half of 2009, these holdings came under pressure as concerns about financial institutions continued to mount In the second half of 2009, however, the fair value of these securities have recovered sharply, as results from the Federal Reserve's "stress test" of banks were released, and banks and other financial institutions successfully raised capital to bolster their balance sheets.

We monitored closely and reduced our exposure to hybrid preferred securities and other assets in advance of adverse rating migration (e.g. Dubai Ports in 2009) through trading activity. We also selectively harvested gains to offset realised losses. We are encouraged with the progress we have been able to make with better understanding and anticipating the dynamics of the portfolio through our own processes and close co-operation with our expanded investment management roster.

OM Financial Life Insurance Company regulatory capital, including capital contributions, increased slightly compared to statutory 2008 levels as strong statutory operating earnings offset investment impairments. OM Financial Life's required capital was essentially unchanged (at the targeted 300% level). In the end, higher risk-based capital charges resulting from credit rating migration of the portfolio due to investment downgrades did not have a significant impact in 2009. As expected, credit rating migration took place within the corporate bond portfolio but this was offset by improved charges on the structured security portfolio. The main reason for this was the NAIC RMBS rating initiative that adjusted the asset risk required capital to account for loss severity in the structured security portfolio. As yet no adjustment to the CMBS ratings requirement has been agreed although this and other relief measures are likely to be discussed by the regulators and the Industry.

The risk-based capital ratio increased from 305% at year end 2008 to 312% at 31 December 2009 based on the small movement in both capital and required capital. The US Life business in aggregate did not need additional capital from the Group in 2009, although capital was repositioned between companies within the US Life Group through the transfer of $30 million from OM Re to achieve the 312% year end result. Given our anticipated level of impairments for 2010 of $55 million, and the net capital consumption of our sales plans, we do not consider it likely at this stage that we will require further new capital for this business.

Marketing

Our re-engineering and cost-cutting measures eliminated the majority of our traditional print, broadcast and web-based advertising. However, as part of the product portfolio overhaul we enhanced the look, feel and content of all the marketing materials that help our agents to sell Old Mutual products. The new materials feature more visually appealing imagery, simplified product mapping and naming to tie the product portfolio together, highly stylised concepts and sales ideas to extend Old Mutual's brand recognition and revised content to help agents understand and communicate key benefits. Launched in October, they were warmly welcomed by our field force.

Changing market dynamics dictated a shift in our presentational approach. In the past we had portrayed successful, wealthy baby-boomer types living the high life in some style and splendour. Now, and for the foreseeable future, our approach focuses on fresh, flourishing and grounded aspects of nature - characteristics that we believe end-customers can more easily relate to the products.

Customer service

A key objective in 2009 was to deliver enhanced and proactive customer service through a series of initiatives:

·      Introduce proactive service model through TPA Perot Systems

·      Implement in-force web capability

·      Provide enhanced in-force illustration capability

·      Establish case management services within underwriting

·      Establish and train sales support (pre-sales) teams in Baltimore and Lincoln

·      Implement customer relationship management capability

·      Review key distribution relationships and identify service enhancement opportunities

·      Review progress through independent research.

All these were successfully completed. Feedback from MGAs and agents has been very positive, and this anecdotal response has been confirmed by independent surveys of our writing agents by Service Quality Measurement (SQM) and LIMRA. SQM benchmarks over 350 leading North American call centres annually, asking customers about their service experience. The 2009 survey showed that we improved performance compared with 2008 and exceeded world-class benchmarks on two key measures: first call resolution and overall customer satisfaction. We asked LIMRA to conduct a fifth survey of 7,000 life and annuity producers to evaluate the service we give them and determine if service had improved since the previous survey in November 2008. Its overall finding: "Old Mutual improved in four areas since the 2008 survey - ease of doing business, call centre, sales support and new business/underwriting. These translated to a large increase in the company's overall ratings." We received the best ratings for service delivery since we started the survey in 2005.

People

Our business transformation programme in late 2008 and early 2009 reduced our workforce by approximately 50% and consolidated it into one site in Baltimore, Maryland. The process was designed to streamline and right-size the business while retaining the key talent needed to move the company forward. The impacted employees were handled with respect and dignity and offered assistance with their career transition. Communication throughout the process was key to its success.

We recognise that our future success depends on having an engaged and committed workforce, and the business is now staffed with talented employees who are delivering on our business strategy. We have a performance management system that clearly aligns employee and business goals and rewards employees for accomplishments and contributions. A special recognition programme, our Anchor Achievement Awards, rewards individuals who go above and beyond their normal work responsibilities and provide outstanding performance. We have function-specific action plans to engage every employee in our business. And our development programmes prepare our managers for the responsibilities of retaining employees and offer the general staff opportunities to grow and develop their skills. All these initiatives demonstrate our commitment to our employees, their value, and their importance to the success of the business.

Risk

We continue to manage our risks and develop our Risk Management capabilities in alignment with the Group's Enterprise Risk Management framework.

Priorities for 2010

·      Strengthen the core competencies of the business in distribution channels, asset liability spread management, product development and platform outsourcing

·      Embed risk management practices

·      Maintain 300% RBC ratio through integrated capital and sales management

·      Optimise risk/return trade-offs on investments

·      Strengthen employee experience and retain talent.

Outlook

By leveraging the business transformation successes accomplished in 2009, we are well positioned to generate modest, quality returns in the coming year. Sales levels in 2010 are expected to increase over 2009 levels, but within the capital utilisation parameters set for the business and with a targeted focus on profitable products. New FIA and Universal Life products are expected to be introduced in the second quarter of 2010. Expense actions taken in 2009 will provide a lower cost base in 2010. Capital self sufficiency is again the goal of the business for 2010 and the balance sheet, including invested assets, is more conservatively positioned than prior quarter-ends. In 2010, we are assuming a long-run rate of impairments at 30 basis points of our bond portfolio for IFRS AOP.

The economic backdrop in the US continues to be quite muddled, with financial market returns reflecting a sense of optimism and confidence that at times appears at odds with core economic metrics. The impact of the government's extraordinary stimulus efforts has had a direct effect on the narrowing of risk spreads across the board, and credit is flowing again to corporate America. However, the labour market remains challenging, with the unemployment rate hovering at around 10%, and companies still reluctant to materially expand payrolls. The backdrop of high unemployment and below-average economic growth continues to weigh on sentiment in the housing market and this gives rise to risks to surrender levels. The exposure of the US bond market to real estate impairments represents a further source of uncertainty as does the potential price impact on higher quality bonds if rates rise.

BANKING

Nedbank

Nedbank Group is South Africa's fourth largest banking group measured by assets, with a strong retail deposit franchise. Its corporate lending market share is over 20%, Nedbank Capital is ranked as one of the top three in key investment banking league tables and the bank leads the commercial property finance market with over 30% market share. Nedbank Business Banking is the second largest business bank in the urban areas and the Retail business is the fourth largest retail bank in South Africa by assets and transactional products with the second largest retail deposit market share.

Nedbank operates a universal bank model through five main business clusters; Nedbank Corporate, Nedbank Capital, Nedbank Business Banking, Nedbank Retail and Nedbank Bancassurance and Wealth. Together these offer a wide range of banking, bancassurance, asset management and wealth management services.

In addition to its Johannesburg headquarters, Nedbank has large regional operational centres and a distribution network throughout South Africa with facilities in other southern African countries. These facilities are operated through Nedbank's subsidiary and affiliated banks, as well as through branches and representative offices in key global financial centres.

Nedbank Group has a strategic alliance with the pan-African banking group, Ecobank, enabling Nedbank to provide its customers with a one bank experience across 33 African countries.

The largest portion of Nedbank's earnings and economic profit are generated from its wholesale business, supplemented by other income from lending and deposit taking activities. A key focus is to increase the non interest revenue (NIR) to expenses ratio from the current 78.9% to above 85% in the medium-to-long term.

During 2009 the group structure was further simplified through Nedbank's acquisition of Old Mutual's minority stake in the Bancassurance and Wealth joint ventures, and the outstanding 49.9% share in Imperial Bank, resulting in Nedbank having the second largest share of the vehicle financing market at 30%. The Imperial Bank acquisition became effective in February 2010.

Product Development:

Nedbank Retail

In a largely commoditised business environment Nedbank Retail has concentrated on ensuring that its processes and systems are streamlined and best suited to customers' needs. We do not expect Nedbank Retail's major product offerings to change dramatically in 2010. Some focus areas include:

·      Expanding the range and distribution of foreign exchange products

·      Enhancing cash distribution strategies

·      Prepaid and debit card acquisition strategies

·      The introduction of further bundled product options

·      Continuing review of product profitability, specifically in pricing for credit, where increased price differentiation is key to attracting good quality customers

·      Leveraging the existing cost infrastructure as well as a focus on cross-sell initiatives to grow non- interest revenue.

Nedbank Business Banking

Nedbank Business Banking operates a unique decentralised business model, allowing quicker customer decisions with better credit assessment using local knowledge. The solutions for customers include:

·      NetBank Business, an electronic banking solution for customers with some of the most advanced security technology available in South Africa. The system allows for easy offsite updating without impacting customer activity

·      Unique cash handling solutions for customers.

Nedbank Corporate

Nedbank Corporate will also focus on initiatives towards improving the level of non-interest revenue, including:

·      Bundling transactional products and services to help reinforce cross-selling and collaboration with other units of the bank

·      Developing many new products, especially with regard to cash handling solutions where several "proof of concept" initiatives have already been initiated

·      Developing "value add" information based solutions to meet customer needs. These include:

·      A new cash management solution that offers sweeping and offsetting of balances across different accounts and currencies

·      Auto reconciliation services

·      Electronic bill presentation and payment

·      E-statements.

·      Further enhancing the primary customer interface "NetBank Business"; in 2010 we will complete the original programme, allowing us to migrate the corporate client base and close down the historical channels.

While some new products are being implemented in the card and mobile space, the focus within the Africa portfolio remains on updating existing systems and ensuring that the current suite of products is run effectively and that revenue collection is optimised.

Nedbank Capital

In this challenging economic environment Nedbank Capital maintained a conservative stance in its trading activities. This included trading less risky foreign exchange and debt activities and a focus on high quality larger stocks in equity trading activities. The business also continues to grow its annuity based income.

Changes in products and services envisaged for 2010 include:

·      Extending the reach of current capabilities to new markets and selected sub-segments of the current customer base

·      Managing product profitability and customer requirements

·      Focusing on allocation of capital and resources to opportunities that generate higher non-interest revenue, while continuing to offer existing products to a wider range of customers.

Nedbank Bancassurance & Wealth

Bancassurance & Wealth delivered various new products during 2009, primarily simple savings and risk products, enabling customers to reduce risks associated with the current economic cycle. The asset management division successfully launched new international investment products including AAAf rated Money fund as well as the international Best of Breed offering.

In 2010 we intend to expand the life assurance product range beyond credit and simple life as well as growing selectively our short-term offering into personal accident, warranties and other after care products.

Market overview

The South African banking industry experienced an exceptionally tough and volatile year as a result of the global recession combined with cyclical credit stress in the domestic economy.

South Africa's banking system has remained resilient. This is reflected in the country's improvement from 15th to 6th place in the latest World Economics Forum Global Competitiveness Report ranking on the soundness of banks.

Strategy

South Africa accounts for over 60% of Africa's banking economic profit. Nedbank's primary focus is to "Win in banking in South Africa" by growing its share of economic profit in South Africa and southern Africa primarily through transactional banking growth.

Nedbank Retail

Nedbank Retail aims to grow its footprint through non-traditional channels, including cashless branches and in-retailer branch expansion. It continues to focus on growing deposits and its share of transactional and savings account balances at a rate ahead of its asset growth, in order to reduce its reliance on expensive wholesale funding.

The acquisition of Imperial Bank will allow the combined vehicle finance business to compete more effectively through cost and process efficiencies that come with scale.

Nedbank Business Banking

Business Banking's strategy for 2010 is to deliver a step change in revenue growth to achieve its vision of becoming the leader in Business Banking for South Africa by 2011. The foundations for this were laid in 2009 and, despite the challenging external environment, Business Banking maintained its focus on customer acquisition and cross-selling and was also able to ensure greater discipline and rigor with respect to customer pricing and fee collection. These initiatives will continue into 2010.

Increased focus on the cross-selling process yielded more rigorous measurement and management information, introduction of a sales steering committee to provide oversight as well as roll-out of additional training and coaching tools.

Nedbank Corporate

Corporate Banking is embarking on research into the sectoral view of the various industries. This research is expected to generate incisive value-chain analysis and therefore increase understanding of the various value drivers across the industries. This should underpin Corporate Banking's 'guarded growth' strategy of growing selected assets that generate positive and sustainable economic profit.

Property Finance is addressing the currently depressed property market segments with a selective asset growth strategy. Pricing of capital and, subsequently, assets becomes key to winning new deals. The division will be further expanded through the addition of Imperial Bank's property finance business.

Nedbank Africa will continue improving efficiencies and organic growth of its current businesses. Key areas of focus for organic growth will be on the businesses in Zimbabwe (MBCA) and Namibia. The team will also continue to pursue selective acquisitive growth within the SADC markets. Strengthening the Nedbank-Ecobank alliance will continue to be an area of focus and growth in 2010.

Nedbank Capital

Nedbank Capital is in the final stages of replacing its derivative systems, allowing improved management and risk analysis in the trading areas, and implementing an enhanced foreign exchange and money market system.

Leveraging the Ecobank alliance and penetrating African countries in sectors where Nedbank Capital has specific sector expertise remains an important growth opportunity. In addition, alliances with other institutions are being considered to address strategic deficiencies in certain products and geographies. Generation of non-interest revenue will be to continue to be a focus when providing balance sheet lending.

Nedbank was the first African bank to apply the Equator Principles and Nedbank Capital has successfully leveraged its carbon expertise to develop the carbon strategy for Nedbank and to help customers generate carbon credits.

Nedbank Bancassurance & Wealth

Bancassurance and Wealth was historically part of Nedbank Retail but from August 2009 became a separate business division. The positioning as a customer-facing business has increased the focus and opportunity to generate non-interest revenue and economic profit.

The businesses within Bancassurance and Wealth encompass life assurance, short term insurance, financial planning and insurance brokerage, fully fledged private banking and fiduciary services locally and internationally as well as asset management.

Nedbank Group acquired the Old Mutual minority stakes in the Bancassurance and Wealth joint ventures with effect from 1 June 2009:

·      50% of BoE (Pty) Limited

·      50% of Nedgroup Life Assurance Company

·      29.7% of Fairbairn Private Bank

The purchase of the joint ventures has removed all structural and legacy obstacles. This now presents an opportunity to become more customer-centric and focus on maximising value through cross-selling and further penetration of the Nedbank and Imperial Bank customer bases. As a result, the component businesses of Bancassurance and Wealth have been restructured to deliver on this strategy. The most significant change to the structure includes the consolidation of four previously independent asset management operations and the alignment of the local and international Wealth Management businesses into a single high-networth proposition.

Performance in 2009

Resilient performance in a challenging environment

The full text of Nedbank's results for the year ended 31 December 2009, released on 25 February 2010, can be accessed on Nedbank's website http://www.nedbankgroup.co.za

Highlights (Rm)	2009	2008	% Change
Adjusted operating profit (IFRS basis) (pre-tax)*	6,192	8,800	(30%)
Headline earnings**	4,277	5,765	(26%)
Net interest income**	16,306	16,170	1%
Non-interest revenue**	11,906	10,729	11%
Net interest margin**	3.39%	3.66%
Credit loss ratio**	1.47%	1.17%
Cost to income ratio**	53.5%	51.1%
ROE**	11.5%	17.7%
ROE (excluding goodwill)**	13.0%	20.1%
Highlights (£m)	2009	2008	% Change
Adjusted operating profit (IFRS basis) (pre-tax)	470	575	(18%)

*Prior year AOP included an amount of R726 million in respect of the sale of Visa shares.

**As reported by Nedbank in their report to shareholders as at 31 December 2009

Banking environment

Demand for credit slowed dramatically and retail impairments increased significantly as consumers came under severe pressure from falling income, job losses, declining asset prices and record high debt burdens. By the end of 2009 growth in asset-based finance had slowed to 1.0% year-on-year. Interest rates were reduced by 450 basis points to cushion the effects of a rapidly slowing economy and increasing unemployment.

Corporate demand for credit lost momentum due to weak global and local demand, which eroded corporate profits through weaker pricing power, lower commodity prices and a strong rand. Support came from construction projects and increased government spending, boosted primarily by the public sector's infrastructure drive and preparations for the 2010 FIFA World Cup.

Despite the negative economic trends dominating much of 2009, underlying trading conditions showed early signs of improvement around the third quarter. This was led by a rebound in growth in emerging markets, especially China and India, and was followed by initial indications of recovery in most industrialised countries, chiefly brought about by unprecedented government intervention and massive fiscal and monetary stimulation. Improved commodity prices and global demand brought an element of relief to domestic export manufacturers, lifting South Africa out of 'official' recession in the third quarter. There are early signs that the sharp drop in interest rates is starting to revive household credit demand as house prices showed modest signs of a slow recovery towards the end of the year.

Key to the outlook for 2010 will be employment growth. After job losses of nearly one million during the downturn, employment showed early signs of stabilising in the fourth quarter of 2009. Job creation in the formal sector is likely to be slow, with an overall 2% employment gain for the year being expected. This will support household income and lead to some improvement in consumer finances and therefore spending. The rebound is likely to be slower than in previous cycles given weak consumer and business confidence and tighter lending criteria.

Review of results

For Old Mutual reporting purposes, IFRS AOP (pre tax) profits fell by 30% to R6,192 million.

Headline earnings decreased by 25.8% from R5,765 million to R4,277 million. Basic earnings reduced by 24.7% to R4,826 million (2008: R6,410 million).

Diluted headline earnings per share (EPS) decreased by 29.8% from 1,401 cents to 983 cents. Diluted basic EPS declined by 28.8% from 1,558 cents to 1,109 cents. These results are in line with the guidance given in the third-quarter trading update.

Nedbank's return on average ordinary shareholders' equity (ROE), excluding goodwill, decreased from 20.1% to 13.0%. ROE decreased from 17.7% to 11.5% for the year. These declines were driven primarily by increasing retail impairment levels and the negative impact from lower endowment earnings that reduced headline earnings, together with strengthened capital levels as shareholders' equity growth far exceeded growth in total assets.

Nedbank Retail's credit quality deteriorated in 2009, with impairments worsening significantly, although the rate of new defaults slowed in the second half of the year. Business banking and wholesale banking impairments ended the year at better levels than originally anticipated.

Nedbank's funding and liquidity levels have remained sound as a result of ongoing focus on increasing and strengthening liquidity buffers, lengthening the funding profile, maintaining a low reliance on interbank, foreign and capital markets, as well as robust balance sheet management. A strong, broad-based deposit franchise also provides Nedbank with diverse funding sources.

Financial performance

Net interest income (NII)

NII grew 0.8% to R16,306 million. Following a 450 basis point interest rate cut during 2009 and the resulting effect of lower endowment income, Nedbank's net interest margin decreased in line with expectations to 3.39% from 3.66% in 2008. The primary drivers of margin compression were: liability margin compression reflecting the higher cost of term funding; lower endowment on capital and non repricing of transactional deposit accounts that are not rate-sensitive; and quicker downward repricing of interest-earning assets compared with interest-earning liabilities. These were partially offset by the repricing of asset margins in line with Nedbank's risk-based pricing policies.

Impairments charge on loans and advances

The credit loss ratio of 1.47% for 2009 (2008: 1.17%) showed signs of improvement after having peaked at 1.67% at 31 March 2009.

The credit cycle has to date largely impacted consumers and the smaller businesses, as reflected in the continued deterioration of retail credit loss ratios. High levels of unemployment, lower collateral values due to weak housing and vehicle markets, and delays in recoveries resulting from debt counselling have all played a part in the increase in defaulted advances in retail secured loans.

Wholesale banking credit loss ratios have improved since June 2009 and remained better than anticipated for this part of the economic cycle. On the whole credit quality in the Capital, Corporate and Business Banking books has remained within acceptable levels, although in this volatile economic environment the risk of corporate default remains high.

Defaulted advances increased by 56.3% from R17,301 million to R27,045 million and represent 6.0% of total advances. Total impairment provisions increased by 24.7% from R7,859 million to R9,798 million. Although early arrears have improved for the last seven consecutive months in the year, defaulted advances have continued increasing albeit at a slower rate.

Non-interest revenue (NIR)

NIR, including the consolidation of the Bancassurance and Wealth joint ventures, grew by 11.0% to R11,906 million (2008: R10,729 million). Like-for-like NIR increased by 6.1%, driven by good growth in commission and fee income and trading income offset to an extent by fair-value gains, which dropped from R368 million in 2008 to R44 million. The drop in fair-value gains is mainly the result of Nedbank reporting, in 2008, fair-value gains of R207 million from the mark-to-market of its own debt, which we mentioned was unlikely to be repeated and was highlighted as poor-quality income that was not attributed to capital. In 2009 fair-value gains on Nedbank's debt amounted to R6 million.

Commission and fee income was 12.4% higher, largely from volume growth in retail transactional banking and increases in fees charged across the bank.

Trading income increased by 18.6% from R1,553 million in 2008 to R1,841 million in 2009, reflecting robust trading activity in treasury, investment banking and the global market businesses.Bancassurance and Wealth NIR increased by 61.7% to R1,518 million for the year, driven primarily from the consolidation of the joint ventures for seven months and with good performances from the asset management, financial planning and life insurance businesses. On a like-for-like basis NIR for Bancassurance and Wealth increased by 4.7%, with good growth in the SA businesses.

Expenses

Nedbank Group continued to maintain tight control on discretionary spending while investing in strategic areas of the business. Expenses increased by 9.9% to R15,100 million (2008: R13,741 million). This increase was impacted by the consolidation of the Bancassurance and Wealth joint-venture acquisitions with effect from June 2009. On a like-for-like basis, excluding the joint-venture acquisitions, expenses increased by 7.7%.

Associate income

Associate income decreased to R55 million in 2009 (2008: R154 million) as a result of the BoE Private Clients and Nedgroup Life Assurance Company joint-venture acquisitions that were previously accounted for as joint ventures under the equity method.

Taxation

The taxation charge (excluding taxation on non-trading and capital items) decreased by 29.9% from R1,757 million in 2008 to R1,232 million.

Non-trading and capital items

Income after taxation from non-trading and capital items decreased to R549 million for the year (2008: R645 million). The main contribution in 2009 came from the accounting revaluation of the Bancassurance and Wealth joint ventures immediately prior to their acquisition, while in the previous year the main contributor was R622 million after-tax profit from the sale of Visa shares.

Capital

Nedbank Group remains focused on optimising and strengthening its capital ratios. During 2009 these ratios have increased significantly and continue to be maintained above Nedbank's target ratios. Nedbank holds a surplus of R13.5 billion above its minimum total regulatory capital adequacy requirements.

Capital adequacy	2009 ratio	2008  ratio	Target range	Regulatory minimum
Core Tier 1 ratio	9.9%	8.2%	7.5% to 9.0%	5.25%
Tier 1 ratio	11.5%	9.6%	8.5% to 10.0%	7.00%
Total capital ratio	14.9%	12.4%	11.5% to 13.0%	9.75%

Capital adequacy ratios include unappropriated profit at year-end.

Regulatory capital adequacy ratios increased mainly due to the retention of earnings and a key focus on the optimisation of capital and risk-weighted assets, enabled by enhancing data quality and more selective asset growth using our economic-profit-based 'managing for value' philosophy. This resulted in risk-weighted assets decreasing by 8.1%, which is well below overall balance sheet growth of 0.6%. Nedbank was also able to maintain its dividend cover at 2.3 times while increasing capital.

To increase conservatism, Nedbank increased its target debt rating (solvency standard) from A- to A for internal economic capital requirements in line with the higher target ratios for regulatory capital announced early in 2009. A more conservative definition of available financial resources to cover the economic capital requirements was also introduced.

Nedbank currently holds a surplus of R11.8 billion against its economic capital requirements. This is calibrated to the new A debt rating including a 10% buffer, which is assessed against comprehensive stress and scenario testing.

Nedbank's leverage ratio (total assets to ordinary shareholders' equity) at 14.4 times (2008: 16.2 times) is conservative by international standards and in line with the local peer group.

Liquidity

Nedbank's liquidity position remains sound, with a loan-to-deposit ratio of 95.9%. Management continues to focus on diversifying the funding base, lengthening the funding profile and further strengthening and increasing the liquidity buffers.

In addition to the strong deposit franchise across Nedbank Retail, Nedbank Business Banking and Nedbank Corporate providing a diverse funding mix, Nedbank successfully increased the size of its liquidity buffer in 2009 and lengthened the overall funding profile in order to achieved improved asset-to-liability matching. Increased focus on capital market issuance under the domestic medium-term note programme, the introduction of innovative fixed-deposit products for retail clients and a broader offering of money market products were the primary drivers behind the lengthening of the funding profile.

During the year the following programmes were undertaken to diversify the funding base and lengthen the bank's existing funding profile: the issuing of R5.6 billion of senior unsecured debt, which was five times oversubscribed; the raising of R153 million in perpetual preference shares; obtaining a $100 million credit line from a foreign development bank; and focusing on the retail deposit base through innovative products.

Nedbank maintains a low reliance on interbank, capital market and foreign funding. Its small proportion of foreign funding at just over 1.0% is driven by its regional focus where 91.4% of its asset base is in South Africa. Low historic reliance in the abovementioned markets creates diversification opportunities subject to pricing.

Nedbank continues to adopt a strategy of applying best international practice, with the Basel principles on sound liquidity management having been further embedded during this financial period.

Total assets

Total assets increased by 0.6% to R571 billion (2008: R567 billion). During the year: cash and securities declined by 8.2% mainly from the maturing of R10 billion of additional liquid assets. This was offset by the purchase of replacement government bonds of R4 billion to hedge long-term debt instruments; and Nedbank showed lower trading and derivative balances mainly arising from foreign exchange movements.

This was balanced by: growth in intangible assets related to the Bancassurance and Wealth joint-venture acquisitions; growth in investments from the first-time consolidation of Nedgroup Life; and an increase in advances.

Advances and Deposits

Advances increased by 3.7% to R450 billion, reflecting: ongoing growth in Nedbank Capital and Imperial Bank; slower growth in Nedbank Corporate and Nedbank Retail; and reduced advances in Nedbank Business Banking due to a slowdown in client demand for credit and a reduction of single-product loans in line with the drive to reduce higher risk exposures and focus on primary clients.

Growth in advances took place across a number of categories, including personal loans, mortgage loans, preference shares, deposits placed under reverse repurchase agreements and other loans, offset by a decrease in low-margin overnight loans. Overall market share increased by 1.4%.

Nedbank has focused on managing for value and selective asset growth while improving margins, resulting in bank advances growth and lower levels of advances in the trading portfolio.

Nedbank retained a strong ratio of advances to deposits of 96%. It grew deposits in line with its requirement to fund the growth in balance sheet assets, with deposits increasing by 0.5% to R469.4 billion (2008: R466.9 billion). In the retail deposit market current and savings account balances remain at low levels as consumers reduce debt levels. In the wholesale deposit market current and savings accounts as well as fixed deposits have increased, partially offset by a reduction in other term deposits.

Optimising and diversifying the funding mix and lengthening the profile continued to be a key management focus. Despite intense competition in the local deposit market, Nedbank has maintained its strong deposit franchise and continues to hold the second largest share of household deposits at 24.2%. During the year a number of innovative retail deposit products were successfully introduced, including Nedbank's Equity-linked Deposit, EasyAccess Deposit and Platinum Park-It.

Marketing

Strategically aligned brand communications have continued to position Nedbank as respected, caring, understanding and aspirational bank. It has placed increased emphasis on its green credentials, community and customer involvement and range of affinity offerings.

The Nedbank Cup made a significant contribution to increasing brand awareness and positively influencing consumer perceptions. Nedbank was ranked as the number one bank sponsoring soccer in South Africa. Overall awareness of Nedbank as a soccer sponsor increased to 64% in 2009 (2008: 28%) and awareness in the mass market has doubled since 2008 to 77%.

Retail marketing focussed on driving customer acquisition, non-interest revenue, service and pricing as well as assisting customers through a very difficult year. A number of new transactional and investment offerings were introduced as well as a free software package enabling customers to budget and manage their money more effectively. On the service front, commitment to world-class service continued through the Ask Once service offering.

Business Banking maintained a high profile in the market, strengthening it's positioning as a bank that "partners for growth for a greater South Africa", whilst promoting specific investment and transactional banking product offerings to selected target markets.

In the corporate and capital markets, core positioning campaigns have aimed at raising the brand profile and communicating key business differentiators. Ongoing attention has also been given to tactical communications, highlighting selected deals as well as localised events and strategic sponsorships.

The effectiveness of the overall marketing efforts is reflected in the steady improvement in all independently measured key brand metrics. Nedbank continues to gain brand equity in presence, relevance and advantage.

Customer Service

Nedbank Retail

'World class service' is essential to Nedbank's customer-centric approach. In 2009 it extended the 'Ask Once' campaign, which is Nedbank's guarantee to customers that it will continuously enhance their banking experience, to include a specific service promise for customers wishing to switch their current accounts to Nedbank.

Nedbank Retail has made significant strides in improving its customer service in recent years, although competitors have narrowed the gap and it is important that focus is maintained on improving service further through investing in staff and innovative systems, processes and offerings tailored to customer requirements.

Nedbank Business Banking

The main focus in Business Banking was on business alignment to clearly defined customer segments. Higher complexity, high value customers are now serviced by dedicated teams with the appropriate support structure and staff experience levels. For our high volume of smaller customers with less needs and lower-value business we use more streamlined processing and a lower-cost support structure.

In the 2009 independent BMI-T survey, Nedbank Business Banking was acknowledged as having achieved the biggest improvement in customer service out of the four big banks in South Africa.

The focus in 2010 will be on strengthening Business Banking's service culture through a series of conversations, activities and campaigns.

Nedbank Corporate

Service remains a key priority for Nedbank Corporate and their top customers are supported by a dedicated service capability.

The Startrack Survey is one of the most important measures used by Corporate Banking in assessing the effectiveness of its relationship with customers and is closely monitored each year. The survey ranks the performance criteria that are important to customers and how Corporate Banking rates on those criteria. The top five performance criteria in 2009 relate to the turnaround of customer requests, accessibility, efficiency in problem solving and the relationship managers' knowledge of systems and products and their delivery on promises. In comparison to previous years Nedbank Corporate Banking improved its overall ranking. It was ahead of its competitors in three of the top five criteria and was ranked first on the criteria relating to turnaround and accessibility.

The Ecobank alliance has provided a strong platform to support customer needs across the continent and the recently launched "Centre of Excellence" gives customers a single interface for accessing services across the alliance. Synergies are also materialising as we introduce alliance customers to Nedbank Corporate's existing products, such as NedTreasury, in order to meet their banking needs.

The outsourcing arrangement with Wells Fargo (Wachovia) gives customers access to "self-service" functionality enabling them to bypass historical manual paper based systems.

Nedbank Capital

Nedbank Capital continues to focus on being an integrated investment bank. During the year it won a number of awards including:

·      Africa Investor ICT/Telecoms Deal of the Year award for the Neotel deal;

·      Africa Investor Transport Deal of the Year award for the Bakwena deal; and

·      African Banker Deal of the Year award for the Bakwena refinancing deal.

Nedbank Bancassurance & Wealth

Asset management performance, both across the unitised and private client businesses, was well above benchmarks. Nedgroup Investments recently received the award of third place in the 'Domestic Management Company of the Year', and received two Raging Bull awards for individual funds.

The wealth businesses continue to excel in customer service. BoE Private Clients was rated No.1 in service and advice in an independent survey by SMRC Marketing Solutions (Pty) Ltd and Fairbairn Private Bank was voted 'Best International Wealth Manager 2009'.

The recent changes to the Wealth Management structure will facilitate improvements in service delivery by building a consistent advice process and creating better alignment across the local and international Wealth Management businesses.

People

Nedbank's Corporate Performance Management (CPM) is based on the "Total Performance Management" approach. It is used to monitor and manage both corporate and individual performance against key performance indicators, aligned to the group's business plan, which ultimately drive economic profit.

Nedbank uses a Balanced Scorecard approach to monitoring and managing performance. Performance measures in the scorecard focus on the delivery of the business strategy, organisational culture and HR strategy and are weighted for different roles within the bank. Executive scorecards are signed off annually by the Board and are key drivers for the staff remuneration and development.

Reward mechanism

Nedbank Group adopted a total-reward philosophy that is integrated into its people management processes. Remuneration schemes are not excessive and are conservative when measured by both local and global standards. In 2004 headline earnings declined 3% and bonus pools were reduced by 33%. Bonus schemes were refocused in 2009 to recognise headline earnings and economic profit against pre determined targets, as well as increased capital and liquidity weightings in scorecards.

Performance is measured at a group, business unit and individual level - against agreed financial and non-financial targets - after the year-end results are finalised. The incentive pools are based on a combination of group economic profit (EP), headline earnings and the individual business' non-financial driver performance.

Whilst market-related remuneration is distributed for meeting the agreed targets, performance in excess of these targets is rewarded through additional incentives created through a short-term incentive scheme and recognition programme.

Nedbank's long-term incentive schemes are primarily aimed at retaining key, high-impact employees. They are intended to motivate high performers to remain with Nedbank whilst aligning their individual interests with those of shareholders.

Risk

Refer to Risk and Responsibility section for details relating to Risk Management.

Priorities for 2010

·      Improving the profitability of Nedbank Retail;

·      Improving Nedbank's non-interest revenue, particularly through bancassurance activities and improved cross-selling in other areas;

·      Increasing the number of new primary customers across all parts of the business and maintaining existing primary customers through improved value-added services;

·      Building on Nedbank's inherent strengths and substantive market share in the wholesale and business banking sectors;

·      Responding to opportunities arising from increased broadband and mobile banking accessibility and seeking innovative ways to expand the retail distribution network;

·      Optimising the allocation of capital to business activities through the business cycle in order to grow businesses with high forecast economic profits and to anticipate activities which are vulnerable to large cyclical impairments;

·      Expanding internationally within SADC and the rest of Africa within acceptable risk limits;

·      Building on Nedbank's leadership in transformation, corporate social investment and the environment.

Outlook

Nedbank currently anticipates gross domestic product (GDP) growth of around 2.2% in 2010, indicating slightly better prospects for the banking sector. The global environment and the 2010 FIFA World Cup are primary factors influencing domestic recovery, although the global recovery remains fragile and reliant on continued government support.

Local retail trading conditions are expected to improve as disposable incomes stabilise, retrenchments ease, general labour conditions start improving, debt burdens moderate and house prices start to recover. Interest rates are likely to remain steady at current levels and lead to lower impairment levels. The 2010 FIFA World Cup is expected to lift confidence and encourage an increase in household credit demand and transactional banking volumes.

Fixed-investment activity is expected to remain modest as a result of excess capacity in the private sector and some loss of momentum in the Government's infrastructure spending programme as several large World Cup-related projects are completed. These developments are likely to constrain corporate demand for credit, while strong competition will place pressure on margins.

Interest rate cuts from 2009 will continue to have a negative endowment effect on banking interest margins, but should be partially offset by a gradual decrease in impairments as recoveries and arrears levels improve. The reversal of provisions in the balance sheet is expected to take longer as defaulted advances continue to increase, albeit at a slower rate. Nedbank remains cautious about impairments as, although corporate impairments have been benign, there could be large one-off charges that are difficult to predict, and it is uncertain how the current economic challenges could further impact consumers.

While the economic environment remains fragile, the business outlook inevitably remains uncertain. The short-term outlook for 2010 assumes that interest rates will remain unchanged for the year. Nedbank Group's performance in 2010 is likely to reflect: growth in advances in the mid single-digits; continuing pressure on interest margins as a result of a continued negative endowment effect and anticipated to be compressed by a further 10 to 20 basis points; continued improvement in the credit loss ratio but remaining above the target range; mid double-digit growth in non-interest revenue, and lower double-digit expense growth, resulting from the consolidation of the Bancassurance and Wealth joint-venture acquisitions for the full period in 2010, compared with the seven months in 2009; a further strengthening of capital adequacy ratios and focus on funding and liquidity; and the drive to extract value from the acquisitions made in 2009.

Mutual & Federal

Mutual & Federal (M&F) is the second-largest short-term insurer in South Africa, with offices in South Africa, Namibia and Botswana. It provides a full range of insurance products to commercial and domestic customers, principally in four major portfolios: Commercial, Personal, Risk Finance and Credit.

The Commercial portfolio is the largest, with a broad spectrum of customers ranging from small businesses to large corporations. It covers primarily property, accident, motor, engineering, marine and crop insurance risks.

The Personal portfolio provides domestic household, motor and all-risk short-term insurance products to domestic customers of all ages and various financial groups. It offers white-labelled intermediary-branded products and an in-house branded product, Allsure, which provides comprehensive cover. It also includes a hospital cash plan and personal accident policies as well as low-cost products covering livestock and informal dwellings.

The Risk Finance portfolio, comprising alternative risk transfer products, is provided by a highly capable team which is well regarded in the industry as one of South Africa's largest suppliers of risk financing solutions, primarily to medium-sized commercial customers.

The Credit portfolio is underwritten by a subsidiary of M&F and is offered within a market segment where the group dominates the market.

Business model

The company's success is built on strong relationships with intermediaries, who introduce more than 90% of its business. These intermediaries range from small and medium-sized operations concentrating on domestic business to large national corporate brokers who provide specialised services and manage large portfolios.

Each portfolio is managed in line with the market within which it is offered. The Personal portfolio comprises higher volumes of lower-value premiums and generally requires less underwriting involvement, while the Commercial portfolio includes larger risks requiring detailed surveying, underwriting and reinsurance structuring. Because we are able to offer this full range of services, we can tailor products to customers' specific requirements and help them with their overall risk management.

M&F operates centralised claims and administration for the risks written. Management of the investment portfolio is subcontracted to Old Mutual Investment Group South Africa.

Product and service developments

We are extensively overhauling the M&F policy administration systems to ensure faster, better service and greater processing efficiency. To date we have widely implemented paperless transaction processing and introduced a new customer-orientated computer system for our flagship domestic insurance product, Allsure.

Our claims service and settlement philosophy remain a primary source of competitive advantage, and our reputation for fast, efficient and fair claims settlement continues to attract and retain customers and intermediaries.

Market overview

Although the short-tem insurance market grew in 2009, the growth was slower than in previous years due to the unfavourable economic climate. There was a sharp decline in vehicle and home sales and domestic business was particularly affected.

The market remains stable and established insurers continue to generate underwriting surpluses, albeit at a lower level than in the previous five years. Market data suggests that bank- and broker-owned insurers have shown above-average growth and direct insurers have continued to expand faster than the overall market. In some cases this has been at the expense of traditional insurers, who are continually seeking ways to regain market share.

The continuing emergence of a larger middle class and the high levels of infrastructural spending in the country have, to some extent, moderated the impact on insurers of reduced consumer spending.

The market continues to be firmly regulated by the Financial Services Board.

Strategy

M&F aspires to be the strongest and most successful short-term insurer in its chosen markets. We remain focused on profitability while addressing new and existing markets, channels and products to generate growth.

We are strongly committed to the intermediary channel and further development of broker relationships.

A new management team is in place to deliver the strategy that will make M&F a multi-channel, process-efficient company that is able to service all of its channels cost-effectively and in a way that will drive end-customers to demand the Mutual & Federal brand.

Operational highlights 2009

In 2009 we implemented a regionalisation model for our operations, introduced the Allsure computer system and improved the group's Business Process Management capability. During 2010 and 2011 the new computer system will be rolled out to other portfolios and the business processes will be further refined to enhance customer service.

The restructured group has brought a greater proportion of customer-facing staff onto a widely distributed platform, which will help to promote growth.

These changes are also expected to deliver further cost reductions in 2010 and 2011.

Underwriting profitability depends on the fundamental soundness of the company's portfolios, management's diligence in rate setting, and ongoing adherence to responsible underwriting standards.

Combined with strong management measures, the significant improvement in investment markets has helped to strengthen overall company solvency.

Performance in 2009

Return to stability

Highlights (Rm)	FY 2009	FY 2008	% Change
Underwriting result	140	299
Long-term investment return (LTIR)	791	925
Restructuring costs	(13)	(55)
Adjusted operating profit (IFRS basis) (pre-tax)	918	1,169	(21%)
Gross premiums	8,456	9,159	(8%)
Earned premiums	6,874	7,669	(10%)
Claims ratio	69.4%	67.1%
Combined ratio	98.0%	96.1%
Solvency ratio	55.9%	41.0%
Return on equity*(1 year average)	21.2%	29.0%

Highlights (Rm)	FY 2009	FY 2008	% Change
Adjusted operating profit (IFRS basis) (pre-tax)	70	76	(8%)

*The ROE is now shown over a 1 year average equity base (previously 3 years average) to achieve consistency with the rest of the Group.

IFRS AOP results

Following adverse investment conditions and high levels of claims in early 2009, the company recovered well in the later parts of 2009. Management action on profitability led to the cancellation of some personal scheme business in 2009. This contributed to a fall in premiums for 2009 as whole.

Despite the underwriting loss recorded in the first half, there was a significant improvement in underwriting results during the second half and an overall underwriting surplus of 2% was achieved. This followed the implementation of various corrective measures and a generally improved trading environment.

Investment returns were strongly higher in 2009 as world financial markets returned to greater stability. Total actual investment return for the year amounted to R660 million compared to a loss of R146 million in 2008.

During the year the company completed the implementation of a sophisticated state-of-the-art system for processing a large portion of the personal portfolio. Whilst this caused unfortunate declines in service levels in the first half these were largely remedied by the year-end and have resulted in substantial improvements in processing opportunities for customers and intermediaries.

Solvency margin

Following improvements in investment return and underwriting stability during the second half, the solvency margin (the ratio of net assets to net premiums) improved to 56% at year-end (2008: 41%). This is well within our target range.

Acquisition of minority shares by Old Mutual

The acquisition of the minority shares in M&F was concluded successfully in early February 2010. Although the finalisation was delayed by certain outstanding approvals, the overall process was completed with limited disruption to staff and customers. Management can look forward to closer working relationships with Old Mutual and increased opportunities for growth and profitability through joint ventures and other cooperation.

Marketing

We maintained our 'short moments' advertising campaign and approach in 2009. This emphasised the importance of reliable insurance and has a strong 'people' theme to further reinforce the relationship element of short-term insurance. The advertisements also aim to foster relationships with younger individuals from diverse cultural and ethnic backgrounds, as our customer base has traditionally been predominantly white and middle-aged.

The impact of our advertising and marketing has been somewhat constrained over the past two years by the potential sale of the company. But even though this resulted in some loss of drive and focus, market research indicates that the 'short moments' campaign has been successful in promoting name and logo recognition.

Customer service

Customer service suffered to some extent during 2009 as a result of the restructure, system implementation and uncertainty surrounding future company ownership. Management undertook extensive roadshows to meet intermediaries and discuss service difficulties; these meetings again evidenced the strength of our broker relationships, which will continue to improve as intermediaries experience the significant benefits which the new systems offer.

People

M&F has always enjoyed a reputation for having the most capable and qualified employees and is often regarded as the training ground of the short-term insurance industry. This is the result of our ongoing commitment to training and effective operation of recognition and reward programmes. We continue to improve employee satisfaction and drive transformation of the business; and we have made significant strides towards meeting employment equity objectives despite considerable difficulty in recruiting suitably qualified staff.

Risk

We continue to manage our risks and develop our Risk Management capabilities in alignment with the Group's Enterprise Risk Management framework. Refer to Risk and Responsibility section for details relating to Risk Management.

Priorities for 2010

M&F has been through a significant period of restructuring and systems implementation over the past two years. This was difficult but was an important and necessary step towards creating a sound base on which to grow revenue over the coming years. We now have the following priorities:

·      Growing the business through a multi-channel distribution model

·      Maintaining process enhancements and optimisation by continuously improving and bedding-down the business model

·      Completing the IT strategy of moving to state of the-art technology platforms

·      Maintaining tight control over capital and solvency.

Outlook

Despite unusually heavy rains in the Johannesburg area of South Africa, which led to higher than usual personal-lines claims in the early months of 2010, we remain confident with regard to our underwriting prospects.

M&F has a strong brand in the southern Africa market and good relationships with its intermediary partners. The next few years promise much as we look to leverage these relationships, as well as good systems and processes, in order to drive profitable and sustainable growth.

US ASSET MANAGEMENT

We have built a leading asset management business in North America through a combination of acquisitions and strong organic growth. Our business model provides a strategic framework in which boutique asset management businesses thrive. We continue to enjoy the privilege of serving some of the largest and best-known institutions (e.g. universities, corporations, defined benefit plans, defined contribution plans, sovereign wealth funds) around the world. Our strict adherence to pure institutionalised investment processes, consistently strong investment performance and concentration on customer service provides long-term partnership with our customers.

Based in Boston, our business consists of 18 distinct boutique investment firms managing $261 billion across all major investment strategies for institutional clients, high net worth individuals and retail investors around the world; some 25% of our clients are non-US based. Our boutiques are headquartered predominantly in North America, with two in London. Dwight Asset Management, a fixed income manager, is the largest with 22% of our total funds under management. The next largest managers are Barrow, Hanley, Mewhinney & Strauss, a value equity manager (21%), Acadian Asset Management, an international equities manager (19%), and Rogge Global Partners, a global fixed income manager (14%).

Over time the largest firms in the business may change, depending on investment performance, market cycles and demand for particular investment styles. The sources of profits within the affiliate portfolio also change. However, the diversification of asset classes in our portfolio mitigates to some degree the risk of extreme earnings volatility, reflected in our positive operating earnings and competitive margins in the current difficult market environment. As markets grow, operating leverage provides for a degree of margin expansion.

Collectively, US Asset Management offers over 140 distinct investment strategies. We grow our marketable investment capacity and maintain diversification in our offerings by seeding strategies, recruiting investment talent and acquiring firms. Each member firm has its own vibrant, entrepreneurial culture of investment management capabilities focused on its particular area of expertise. The institutional approach of the member firms ensures consistency of style and process across market cycles.

We have a distinct competitive advantage in our ability to attract and retain talented investment professionals through a consistent approach to profit sharing and equity ownership structures - thereby ensuring the longevity of the investment firms and customer relationships. Most of the boutiques have profit-sharing arrangements in which they earn a percentage of operating profit. Most also have long-term equity plans. The combination of profit-sharing and equity plans ensures that each boutique's interests are closely aligned with those of our shareholders and customers. A thoughtful approach to succession planning, which provides an orderly transfer of ownership and management responsibilities to successive generations of investment talent, also contributes to the longevity of individual firms.

Business model

Our vision is to be a market-leading asset management firm delivering high-quality investment solutions to clients while providing exceptional business results. Our business is structured as an actively-managed holding company that fosters investment autonomy among its specialised boutique firms to achieve investment and operating excellence.

The operating model has five focus areas:

·      Investment excellence: We present clearly articulated investment processes and solutions to clients through our 18 boutique investment management firms. These firms strive to exceed performance expectations through consistently applied investment processes. We recruit and retain top investment talent by offering investment autonomy and equity ownership.

·      Customer service and distribution: The 18 boutiques provide high-quality service to support client objectives. Distribution professionals embedded in boutiques, as well as centralised distribution support, continually seek opportunities to meet evolving client and market demand.

·      Diversification of investment solutions: Our experienced management team regularly reviews and positions the enterprise-wide offering of investment solutions to maximise value creation for clients and shareholders. It also aims to minimise volatility in funds under management and earnings, and to achieve diversification benefits, through effective management of the boutique portfolio.

·      Global leverage: We use existing Old Mutual Group capabilities to grow a global portfolio of client relationships. We continue to pursue partnerships and leverage existing global infrastructure at Skandia, OMIGSA and other business units to drive profitable expansion.

·      Financial and operational management: Our senior management team closely monitors financial and operational objectives to create and preserve value for shareholders aggressively. This close oversight is critical to the generation of free cash flow to provide strong returns and support growth opportunities. Effective risk management is the foundation of our business relationships and we proactively seek full compliance with internal controls and regulatory requirements.

We believe the current business model is best positioned to achieve our long-term strategic vision. It offers clear sources of competitive advantage, including:

·      Attraction of deep investment expertise with entrepreneurial drive

·      Low turnover of key investment talent

·      Firm longevity

·      Ability to source and integrate new investment capabilities

·      Thought leadership in product development, packaging and distribution

·      Diversity of boutiques, providing value and stability throughout market cycles

·      Professional business management and a scaled infrastructure platform with shared services and robust governance.

Market overview

The current market environment presents both opportunity and challenge for the asset management industry. There is continuing pressure on earnings across the industry due to the volatility of change in asset levels, although recovery of global markets has provided a stronger asset base to finish the year. The action taken by most firms to reduce headcount and expenses will provide effective operating leverage as markets return to growth in line with historic averages. Firms operating from a position of capital strength will continue to focus on adding investment talent and acquiring complementary investment capabilities. As market volatility returns closer to normal there has been some consolidation, with leading companies acquiring firms to strengthen distribution and investment capabilities as well as build scale. As part of this process, several firms have sought external capital from the public markets to fund strategic growth plans - and more will follow.

Competition in North America remains strong, with each of our boutiques facing significant competition from other specialist providers. The immediate differentiating factors between firms are often investment performance and product capabilities. Our investment managers have a record of delivering excellent long-term performance and we have the ability to leverage the diverse styles of individual investment teams. As a result, we are able to seek targeted investment opportunities to broaden our product capabilities.

Investment firms with undiversified portfolios, dominant equity weightings or performance fees with high water marks are the most susceptible to earnings pressure. A significant number of asset management firms restructured in late 2008 and 2009 to alleviate anticipated margin pressure. However, many were careful not to reduce expenses any more than necessary in the short term, to avoid compromising their positioning for the next wave of growth. Global market recovery and strong performance will help to raise performance and transaction fees.

Regulation is materially impacting the asset management industry in response to significant losses by investors across most markets. The US Government expects to deliver continued change to the nation's financial regulatory framework, including asset management organisations and retirement plan sponsors. As a result, less-established investment managers may face additional risk management and market pressures. This will present opportunities for traditional asset management firms with strong governance to gather assets and acquire new investment capabilities.

Strategy

Our strategy directly supports four of the Group's five strategic priorities:

·      Maintain and strengthen capital position: Our business continues to be a source of capital. We will continue to grow it prudently by reinvesting earnings in talent and strategic acquisitions that create shareholder value over time.

·      Streamline the portfolio over time: We made progress in achieving operational efficiencies in 2009. Old Mutual Capital's retail platform was realigned to focus on the professionally-sold marketplace. We improved the boutique investment firms' earnings potential by closing an underperforming boutique as well as targeting general expense savings. Provision of shared central services to our affiliates is a key benefit of the multi-boutique model, delivering operational leverage across the business, supporting lift-outs and incubation of new teams, and allowing investment professionals to maximise their focus on customer service. One of our key initiatives for 2010 will be to review and enhance the current shared services structure to maximise potential for further value creation.

·      Leverage scale in long-term savings businesses: We continue to seek ways to leverage scale across the Old Mutual Group and opportunities to work with Skandia Investment Group and OMIGSA to drive further synergies.

·      Strengthen governance: We work closely with the Group on strategic business planning and positioning US Asset Management within the Group model for the future. We also continue to monitor our operations closely for financial and operational risk and openly participate in implementing Group-level finance transformation initiatives.

Our business is well positioned strategically to take advantage of market, demographic and related trends as we continue to develop innovative product solutions, deliver strong investment performance and grow our business. We maintain expertise in sourcing, cultivating and integrating investment talent and capabilities in our business. We have also placed emphasis on thought leadership in product development, packaging and distribution while enabling investment professionals to focus on investment management and delivering superior investment results.

Performance in 2009

Earnings grew strongly in the second half of the year as markets recovered

 

Highlights ($m)	2009	2008	% Change
Adjusted operating profit (IFRS basis) (pre-tax)	130	181	(28%)
Return on Capital	4.1%	7.2%
Operating margin	18%	20%
Net client cash flows ($bn)	(7.1)	(5.2)	(37%)
Funds under management ($bn)	261	240	9%

Highlights ($m)	2009	2008	% Change
Adjusted operating profit (IFRS basis) (pre-tax)	83	97	(14%)

Overview

While market conditions during 2009 were challenging, it was a year in which we completed successfully a number of long-term strategic actions to reposition the business. These actions included realigning our retail platform to focus on the professionally-sold marketplace, integrating a cash-management team at Dwight, reorganising our central distribution structure and optimising our shared services model to deliver further economies of scale. Provision of central services to our affiliates is a key aspect of the multi-boutique model, delivering operational leverage across the business, supporting lift-outs and incubation of new teams, and allowing investment professionals to maximise their focus on managing money for customers.

Investment Performance

Long-term investment performance from our member firms remains strong. At 31 December 2009, 58% of assets had outperformed their benchmarks over the trailing three-year period and 50% of assets were ranked above the median of their peer group over the trailing three year period. Over the trailing five-year period, 61% of assets outperformed their respective benchmarks and 52% of assets were ranked above the median of their peer group. Value equity and global fixed-income continue to rank amongst our top performing asset classes. Recent challenges among our quantitative managers are showing signs of improvement as markets return to historical patterns of performance with a bias toward higher-quality investments.

IFRS AOP results

Strong market growth and a reduction in the expense base of the business drove significant earnings growth during the second half of the year, with IFRS adjusted operating profit of $84 million increasing 83% ($38 million) over the first-half result. IFRS adjusted operating profit of $130 million for the full year was down $51 million (28%), This was due largely to a decrease in management fees, driven by lower average funds under management as a result of market weakness in the first quarter and cyclical lows in performance fees. However the impact of lower revenues was partly offset by continued success in managing expenses. The result also includes $12 million in significant one-time restructuring costs related primarily to our retail business.

Operating margin and cost management

Operating expenses for 2009 were down 22% compared to the prior year, enabling us to experience significant leverage in 2010 from the recent and ongoing recovery in market levels. The full year operating margin of 18% was down 2% from 2008, driven by the pace and severity of market declines and lower revenues late in 2008 and early in 2009. The margin for the second half of 2009 was 21%, an improvement on our 2008 full year margin of 20%. This reflects the success of expense management actions taken by management in response to declining revenues. As previously indicated, expense reductions in our retail business will deliver $15 million to $20 million of annual expense savings from 2010.

Net Client Cash Flows

Net client cash flows of ($7.1 billion), (3%) of opening funds under management, were broadly in line with the average of our peer group for the year. The result was driven primarily by outflows at Acadian, Barrow Hanley and Dwight, partially offset by strong inflows at Heitman, Campbell and Thompson, Siegel and Walmsley. Despite the challenging environment nearly half of our managers experienced net cash inflows for the year.

Funds under management

Funds under management increased 9% ($21 billion) during 2009 with a 16% market uplift offset in part by asset outflows. Growth and diversification through international distribution remains a key element of our strategy, with non-US clients comprising 25% of total funds under management at the end of the period.

Affiliate developments

As previously announced, equity plans were implemented at five affiliates during 2009, and we will complete the rollout for the remaining firms during 2010. Alignment of the interests of affiliate management was a key factor in the success of our cost management initiatives during 2009 and remains a vital component of our long-term strategy, critical to talent retention and positioning the business for sustainable long-term growth.

Retail developments

Efforts to reposition Old Mutual's US retail platform in 2009 were successful. A strategic assessment of the business was completed and resulting recommendations executed by the end of 2009. Actions taken during the second half of 2009 provided a refreshed and more focused product offering aligned with the best of Old Mutual's institutional investment capabilities. Retail distribution will more specifically target Registered Investment Advisors (RIAs), Family Offices, and Bank Trust channels which are among the fastest growing segment of the financial services industry. The traditional and alternative investment expertise of Old Mutual's distinct institutional boutiques aligns well with the needs of the professional buyer market. Overall, retail efforts provided a reduction in spending and increased margins for the business while preserving a valuable retail shareholder base with significant opportunity for growth in an important distribution channel for the future.

Marketing

We re-organised our distribution structure by appointing internal candidates as heads of the US and non-US institutional channels and hiring a third senior executive to focus on the professional buyer channel - which encompasses Registered Investment Advisors (RIAs), family offices and bank trusts. We also hired three additional distribution specialists to support these new roles. The reorganisation is intended to add depth to individual boutiques' sales efforts without encroaching on their independence.

People

We will achieve competitive advantage through the strength and capability of our people. A continuing goal in 2010 is to sustain a work environment that manifests our core values and attracts and retains the best people. Additional goals are to implement strategies for building on the existing talent pool, refining our talent assessment and management process, and reinforcing a culture of pay for performance that will drive key talent commitment and motivation. We will also continue monitoring potential legislation to ensure that current incentives are in line with future requirements. All these efforts are vital in an increasingly competitive asset management industry.

Risk

We continue to manage our risks and develop our Risk Management capabilities in alignment with the Group's Enterprise Risk Management framework. Refer to Risk and Responsibility section for details relating to Group Risk Management.

Priorities for 2010

For 2010 and beyond we have five strategic priorities:

·      Maximise the value of our client proposition by delivering consistently high-quality investment performance, innovative solutions and best-in-class service

·      Ensure excellence in distribution and service by supporting boutiques' distribution efforts

·      Continue to diversify the marketable capacity of our investment management capabilities

·      Continue to leverage best practice in managing boutique investment firms around the Group and driving greater global distribution for our existing boutiques

·      Achieve all the above within a framework of strong financial and capital management.

Outlook

We remain cautiously optimistic on the recovery of global markets in 2010. However, there may be a wider dispersion of growth rates between regions and historically high volatility throughout the year. Difficulties within financial institutions have created significant opportunities for investment businesses with strong balance sheets to position for the next growth cycle and win the war for investment talent within the US. Market volatility has widened the gap between top quartile and bottom quartile performers with an expectation that clients will continue to increase the rate of replacement for underperforming managers and asset classes. While we have a number of accounts at risk at certain affiliates, our overall new business pipeline is robust and we expect to remain in the top half of our peer group in terms of net client cash flows.

Prior to the current market troubles, customers were migrating asset allocation decisions toward international, global and alternative strategies and we believe these trends will continue in 2010, Churn of underperforming managers in traditional domestic equity and fixed income mandates will present opportunities to gain new client funds to manage. Search activity steadily increased in the second half of 2009 with the winners being those investment firms that are truly institutional quality and offer risk management, continuity of firm personnel, strong ownership structures and transparency of investment process with longevity of performance.

Our efforts to reposition the business and the recovery in capital markets in 2009 position us well for growth in 2010. In the absence of a continued recovery in global equity markets, future earnings growth for US Asset Management will be restricted. However, our track record of investment performance and global business focus has positioned us well relative to our competitors, and our diversified asset/client mix will continue to help us weather market volatility.

Bermuda

From its inception in 2000, Old Mutual Bermuda (OMB) sold over 51,000 policies, with an aggregate premium value of over $9 billion, through a bank distribution strategy. The business model addressed a key customer niche by providing investment products to international, non-US citizen and non US resident customers seeking a wide range of investment choices (multiple funds and fund families across a variety of international asset allocation portfolios, equity, bond, money market and fixed rate accounts), exposure to international economies and confidentiality through participation in a secure structure.

A significant attraction for customers was that assets are held in segregated accounts, with our trust participation model ensuring that all plans were issued in Bermuda and governed by applicable Bermuda law. Our core business competency remains meeting the needs of large financial institutions by providing innovative and competitive investment solutions through an open-architecture platform.

Generic own brand, private label and proprietary versions of products were customised to distributors' needs and sold through over 70 financial institutions, primarily large international banks. The business also served a range of private and institutional customers.

Following a change of Group strategy and a significant recapitalisation of the business in 2008, after completion of a strategic review in 2009, OMB was closed to new business on 18 March 2009 other than where contractually obliged to accept premium add-ons up to the first policy anniversary date.

Key markets and products

As a leading and innovative provider of investment products for international banks' high net worth and affluent customers, our product mix comprises three investment plans which currently have funds under management of $5.8bn:

·      The Universal Investment Plan (UIP): an international investment plan which offers long-term growth potential with a variety of investment options including international equity, bond, hedge and money market funds, as well as fixed rate accounts. This plan also offers strategies to help protect and potentially grow the investment

·      The Guaranteed Index Plan (GIP): an investment plan with index options that link returns to the values of the world's major indices, while guaranteeing a minimum of 105% of the amount invested. This plan gives investors full participation in any upside, subject to an annual cap

·      The Guaranteed Rate Plan (GRP): an investment plan offering a fixed rate solution that allows control over maturity and flexibility of return. This plan enables investors to diversify by allocating into multiple guarantee periods.

Performance in 2009

Business transformed and delivering on run-off plan

Highlights ($m)	2009	2008	% Change
IFRS profit (pre-tax)	34	(675)	105%
Insurance reserves (excluding those held in the separate account)	2,053	3,084	(33%)
Operating MCEV earnings (covered business) (post-tax)	(29)	(436)	93%
Highlights ($bn)	2009	2008	% Change
Funds under management*	5.8	5.8	0%
Highlights (£m)	2009	2008	% Change
IFRS profit (pre-tax)	22	(365)	106%

* Stated on a start manager basis as USAM manages $1.1 billion of funds on behalf of Old Mutual Bermuda.

Overview

The business performed credibly against its core objectives, with all written policies passing their first anniversary date meaning that no further policyholder premiums have been permitted since August 2009.

Old Mutual Bermuda (OMB)'s core focus in 2009 was to retain the key staff necessary to execute the agreed run-off plan, reduce costs by half over a three-year period, improve operational efficiencies, strengthen the governance structure, manage capital and liquidity, significantly improve management information analytics and continue de-risking the in-force variable annuity book through a range of measures.

In 2009, management implemented a soft-close strategy to restrict fund choices and continued to improve hedge effectiveness by reducing basis fund mismatches. The business has been transformed with a significantly improved understanding of liabilities and associated management information systems developed, with robust financial metrics and a return to profitability.

Significant reductions in the cost base were delivered during 2009 (over 40% expense reduction year-on-year), with further savings and operational improvement initiatives targeted for 2010. Overall a leaner business operating model has been adopted, with ongoing cost efficiencies anticipated to drive down costs by a further 5-10% annually.

Aggregate surrender activity remains in line with expectations. Ultimately, surrender activity will determine the speed of run-off and the extent and timing of any associated capital, or cash, release. The business remains well capitalised and able to meet all its future obligations, with the knowledge that retention packages are in place for key employees needed to execute on the run-off plan.

IFRS results

Bermuda is now treated as a non-core business and its profit is therefore excluded from the Group's IFRS adjusted operating profit. The 2008 IFRS adjusted operating profit has been restated on the same basis.

IFRS pre-tax profit of $34 million for 2009 was significantly better than 2008 ($675 million IFRS pre-tax loss for 2008) benefiting from expense reductions, lower DAC expense (mainly due to reduced unlocking) and lower guarantee losses, primarily as a result of improved effectiveness of the hedging programme, favourable equity markets and currency movements, higher interest rates, lower volatility and improved fund basis development. The impact of selective releases of hedge positions instituted in the fourth quarter of 2009 was also beneficial in reducing guarantee losses in conjunction with reduced overall reserve requirements as a result of favourable markets.

MCEV results

The post-tax loss on the MCEV operating earnings of $29 million for 2009 was significantly better than the prior year mainly due to the large negative assumption changes made in 2008 for the GMAB strengthening and lower interest rates. Surrender development also led to persistency experience variances.

Reserves

Of total insurance liabilities of $6,741 million (2008: $7,018 million), $4,688 million (2008: $3,934 million) is held in the separate account, relating to Variable Annuity investments, where risk is borne by policyholders. The remaining reserves amount to $2,053 million (2008: $3,084 million). Of this, $763 million (2008: $1,428 million) is in respect of GMAB/GMDB liabilities on the Variable Annuity business, and $1,290 million (2008: $1,656 million) for policyholder liabilities which are supported by the fixed income portfolio (these liabilities include deferred and fixed indexed annuity business as well as Variable Annuity fixed interest investments). These non-separate account reserves represent the discounted future expected account balance needed to meet policy obligations. OMB reserves are calculated on a policy-by-policy basis and are updated frequently and verified independently through both internal and external actuarial review, as well as subject to internal and external audit, as part of the normal statutory audit.

New fund mappings developed in 2009 better allocated exposures to Asian and other emerging markets (which require higher levels of reserving given their inherent higher volatility), thereby improving the accuracy of the reserves. OMB maintains a very significant surplus to its minimum capital requirement, and no further cash or capital injections are anticipated.

Investment Portfolio

No defaults were recorded in the year, with reported impairments of $20 million (2008: $56 million) for 2009. The net unrealised loss position improved to $29 million as at 31 December 2009 ($277 million as at 31 December 2008) as spreads continued to narrow across key sectors.

The book value of the portfolio fell from $1.3 billion at the end of 2008 to $1.0 billion at the end of 2009, primarily to meet surrenders and withdrawals. The fixed income portfolio remains at an A2 average quality, with an improvement to 95% investment grade compared to 2008 of 93%.

As at 31 December 2009, the book value, fair value and unrealised loss of the investment portfolio with a market value to book value ratio of 80% or less was $71 million, $50 million and $21 million respectively (compared to $521 million, $324 million and $197 million, respectively, at 31 December 2008).

Management of Hedging

The hedge policy originally adopted by OMB focused on hedging the underlying economic risk of the guarantees. Generally this strategy reduces the income statement exposure but can result in substantial cash flow movements as the realised changes in value of the underlying derivatives are offset by an unrealised movement reflected in the reserves. In a falling market this will result in large cash inflows while, in a rising market, there will be cash outflows. During most of 2009, hedges were applied to a core number of components (interest rates, foreign exchange, equity markets), with an average hedge effectiveness of 95-96% achieved in the period to September 2009.

Given the improvement in the capital position of the Group, combined with management's improved understanding and management systems for tracking the underlying risks, a process of selective and progressive release of the hedge position commenced in the fourth quarter of 2009. This has been subject to strict oversight and is operated within risk parameters agreed with the Group Risk and Capital Committee. The control systems in place mean that the reinstatement of effective hedges could be made very quickly if required. The new approach continues to manage the underlying economics, but is more dynamic in nature, striking a balance between the potential changes in the income statement, cash flow movements and the transactional costs. Where considered appropriate, the level of hedging activity may be adjusted, subject to a strict stop-loss policy.

The OMB hedge team evaluates the hedging strategy on a continuing basis, with any proposed changes to the strategy subject to strict oversight. A stop-loss protection protocol, and daily management and reporting of Value at Risk cash and profit & loss are used by the Group to monitor business exposures.

Priorities for 2010

With the business transformed in 2009, the key priorities for 2010 are to:

·      Further improve expense and operational efficiencies delivered in 2009, maintaining cost discipline and focus to deliver further planned expense reductions

·      Manage capital and liquidity effectively

·      Further embed risk management into key business decision making processes

·      Continue to de-risk the in-force variable annuity book, appropriately executing a dynamic hedging program on key risks

·      Implement conservation efforts to better retain profitable non-guaranteed assets.

Outlook

OMB aims to continue to aggressively execute against its run-off strategy, whilst maintaining high levels of customer service through continued operational and service improvements. A return to more normal market conditions will further underpin the continued recovery in profitability, although the business expects increased volatility in earnings in the medium term, particularly as the peak of the crystallisation of guarantees approaches in 2012 and then 2017.

 

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