Annual Report & Accounts 2008

RNS Number : 7640P

Old Mutual PLC

30 March 2009

 

Ref: 14/09 (part 3)

The following information extracted from the Annual Financial Report of Old Mutual plc for the year ended 31 December 2008 is published in accordance with DTR 6.3.5(2)(b).  The two sections below are the Business Review and the Group Finance Director's Statement.

BUSINESS REVIEW

1.0 Europe and Latin America

1.1 UK and Offshore

1.2 Nordic

1.3 ELAM

1.4 Skandia Investment Group

2.0 Southern Africa

2.1 Old Mutual

South Africa

2.2 Nedbank

2.3 Mutual & Federal Insurance

3.0 North America

3.1 US Life

3.1.1 US Life onshore

3.1.2 Bermuda

3.2 US Asset Management

4.0 Asia

4.1 China and India

1.0 EUROPE AND LATIN AMERICA

The Skandia group of companies, acquired by Old Mutual in 2006, has been led by Bob Head since Julian Roberts' appointment as Old Mutual Group Chief Executive in September 2008. It is divided into three business units: UK and Offshore, Nordic and Europe and Latin America (ELAM). In addition Skandia Investment Group (SIG) provides investment management services to the three Skandia businesses as well as other businesses across the Group. Skandia's heritage lies in the Swedish market, where it has operated for over 150 years. It is a strong and well-respected brand.

1.1     UK AND OFFSHORE

This business provides products that serve the needs of long-term investors in the UK and international offshore markets. With over a million customers and £35 billion of funds under management at 31 December 2008, we are a leading player in the offshore savings market and a major investment platform company in the UK.

Our main UK operations are investment-led businesses: a life and pensions operation, Skandia Life; an investment platform company, Skandia Investment Solutions; an asset manager creating multi-manager blended solutions, Skandia Investment Management Ltd; and an adviser distribution and support service company, Bankhall.

Skandia's success in the UK has been built by establishing a strong financial adviser franchise offering excellent service and a distinctive proposition. It introduced the multi-manager concept to the UK and has built a strong position in the high-growth open-architecture segment of the UK market. It has a track record and reputation for bringing innovative ideas to market.

Skandia Investment Solutions is an investment platform (often referred to as a fund supermarket). It combines the reputation and strengths of the Selestia business, owned by Old Mutual before we acquired Skandia, with Skandia's MultiFUNDS platform. This platform gives advisers and their customers access to Individual Savings Accounts (ISAs), PEPs and Collective Investment Accounts, which are provided by Skandia MultiFUNDS Limited. In addition, the platform offers an approved pension wrapper and UK and offshore life assurance bonds.

Skandia Investment Management Ltd (SIML) is our asset management company. It provides innovative multimanager funds created by Skandia Investment Group, the part of the Skandia group that specialises in investment research and the construction of multimanager funds. The SIML funds make use of the investment research capability of third-party managers by creating 'blended' solutions of third-party managers with different styles and processes. Since SIML's launch in March 2003, funds under management have grown from around £750 million (including funds held on behalf of other Group companies) to £3.2 billion. The number of funds has expanded from 10 to 48, increasing diversification and appealing to a wider customer base. 

Skandia International is our offshore and cross-border specialist, working in partnership with other Skandia and Old Mutual businesses. It includes Royal Skandia, based in the Isle of Man, Skandia Life Ireland based in Dublin, Old Mutual International based in Guernsey and Skandia Leben based in Liechtenstein.

Providing investment solutions in more than 25 countries, Skandia International has generated significant sales and profit growth for almost a quarter of a century. Its continuing high growth potential is based on a number of factors, including the continued growth of its target customer segment, very strong distribution relationships and attractive new market and product development opportunities. In addition to its own growth, Skandia International generates benefits within the Group by working in partnership with fellow Skandia and Old Mutual businesses to create growth opportunities in domestic markets using international products and expertise.

Bankhall is a standalone division within the UK and Offshore business. It mainly provides support services, including compliance consultancy, to directly-regulated financial advisers. It has maintained a market-leading position by providing demonstrable value to advisers. Through our market-leading platform, a comprehensive range of investment solutions and tax wrappers manufactured in-house, and the competitive advantage achieved through scale, we are well placed to benefit from the growth in platform business and increasing use of platforms by the UK financial services industry.

Markets and products

Skandia UK

Skandia UK focuses on long-term investments. Unlike traditional with-profits providers, it allows each customer to have a personalised and flexible investment portfolio, suited to their goals and risk appetite.

We provide tools for customers to analyse and construct the ideal portfolio using open-architecture solutions which give access to over 1,000 funds from more than 50 top fund management companies - as well as manager-of-managers funds created both in-house and externally. Our buying power enables us to offer these funds to customers at very competitive prices.  

Since 2003 we have been at the forefront of the UK fund management industry, introducing innovative funds that have proved popular with advisers and investors. Following the launch of the Global Best Ideas Fund in 2006 and UK Strategic Best Ideas Fund in 2007, the range was enhanced in 2008 with the launch of the Skandia Alternatives Investment Fund and the creation of the Spectrum risk-rated funds launched in April 2008 which attracted over £100 million in their first eight months.

Our target market in the UK is medium- to high-net worth individuals and products are distributed through independent financial advisers (IFAs). Most customer investments come through consolidation - bringing together investments built up across a number of providers to take advantage of the increased investment flexibility that we offer.

Pensions
We provide a range of pension wrappers to meet the retirement-planning needs of individuals, employers and trustees. Our pension products offer wide investment choice in funds where the underlying investments are through third-party fund managers: 80 percent of assets are invested directly into funds and 20 percent are invested through its own manager-of-managers blended investment solutions. Pensions business represents £9.4 billion of assets under management.

Investment bonds

We offer a single-premium investment bond which is tax-efficient for certain consumer segments. As with pensions, the bond offers access to third-party funds and blended investment solutions, all managed by third-party fund managers.

Protection
We also offer premium protection solutions in the form of a unit-linked whole life product and critical illness cover and we have significant market share in these markets. 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. Protection accounts for about 3.4 percent of UK Life sales on an APE basis.

Skandia International
Skandia International provides a range of award-winning single and regular-premium insurance wrappers designed for private, trustee and corporate investors, local residents in selected markets and expatriates. All its products offer tax efficient investment growth from secure and stable offshore centres. The business is focused on six core geographic regions: Asia, Middle East, UK, South Africa, South America and Europe. These regions have varying levels of market maturity, competition and consumer needs. The common factor is the target customer base: English-speaking expatriates and selected local nationals from the affluent advice-seeking sector.

The product range includes an award-winning portfolio bond and a number of single and regular-premium savings and investment vehicles. The flexibility of the portfolio bond enables customers to invest in virtually any tradeable fund and in a variety of currencies. Our products are supported by a comprehensive suite of trust options, e-business facilities and first-class service.

Market overview

The UK has a sophisticated financial services market, with a well developed advice channel that accounts for the majority of new business in the market. It is highly regulated by the Financial Services Authority (FSA), which is moving towards a more principles-based regulation regime and a focus on outcomes that demonstrate fair treatment of the customer. In 2006 the FSA began its Retail Distribution Review, a major initiative to review the way financial services are distributed in the UK. Following discussions and consultations, the FSA is proposing to introduce a number of measures over the next four years to build consumer confidence in financial services. In particular, these aim to clarify the services being provided and have a requirement for charges to be agreed between the adviser and the customer. Our modern solutions already meet some of the new requirements and we will develop our proposition further to offer the necessary flexibility. Despite the majority of platform assets being equities, which have fallen in value by 35 percent since October 2007, platforms have grown successfully their total assets by 20 percent during the period. This is the result of collectives' continuing success as investment vehicles, investors' desire to consolidate their portfolios and the tax-efficient wrappers now available on platforms. It is estimated that assets on platforms could grow to £300 billion within the next five years (Source: Navigant Consulting).

The financial crisis is reducing customers' appetite for investing new money. However, the majority of investments made into Skandia are consolidations of existing portfolios. It is estimated that in the UK there are £3 trillion of wrappable assets in traditional savings and investments and it is expected that more of this will be moved onto platforms in future.

Compared with single domestic markets, the offshore financial services market offers greater diversity of geography, distribution and risk management - as well as the opportunities generated by variable macro and micro conditions. Such diversity gives Skandia International greater resilience against regional market effects. Skandia International conducts all business through advised intermediary channels and its distribution proposition is structured according to the needs and regulatory environment of its principal markets. Long-term global and local distribution partnerships are critical to its success and remain a core strength of the business.

Skandia International's broad geographic coverage is supported by a robust regulatory and compliance framework which ensures strong and close relationships with all its regulators. As in the UK, regulators throughout the world are expected to heighten their supervision of the financial services industry - which may lead to some convergence of regulations across markets.

Strategy for growth

We aim to build on our current position as a leader in the UK platform market by maintaining a customer-centred proposition with a full range of investment solutions, simple and transparent charges and flexible remuneration options.

Increasingly, advisers are adopting one platform for the majority of their business. To ensure that Skandia is selected as the preferred platform, our sales force is working closely with advisers to embed the platform into their businesses.

Skandia International will continue to provide leading offshore and cross-border investment solutions to affluent advice-seeking investors worldwide. We will enhance the value proposition by developing a closer relationship with our customers to improve their experience with us. We aim to grow across all core regions through continued strength of service and distribution relationships.

Positive net client cash flows despite low investor confidence 
Skandia UK and Offshore continued to deliver positive net client cash flows for the year with net inflows of £1.7 billion representing four percent of opening funds under management. This comprised strong International net inflows and positive UK net inflows which were lower than 2007. The market downturn contributed to a 17 percent decrease in funds under management but this compared favourably with the 31 percent drop in the FTSE 100 in 2008. Investment performance was driven by the diversity of our offering with significant changes in asset mix occurring as investors moved into cash based investments. Foreign currency denominated funds benefited from the weakened sterling.

Investment volatility affects sales
Life assurance sales APE declined in line with the market. The largest relative falls in sales were in the bonds and single-premium pensions products and because the 2007 pensions business figure benefited from the lingering benefits of pensions 'A-day' and higher investor confidence at the time. In 2008 the market for single-premium bonds was affected by the introduction of 18 percent fl at rate of CGT confirmed in the March 2008 Budget. Skandia's market share across the entire pensions market remained strong particularly in the core product area of single-premium personal pensions. Regular-premium business held up better, ending the year nine percent up on 2007.

Skandia International performed very well in 2008 due to its geographical diversity, full open-architecture proposition, strong distribution relationships and a focus on high net worth customers. Product and e-business developments greatly enhanced our customer proposition in 2008.

Unit trust performance impacted by volatile markets

Unit trust sales were down 25 percent on 2007 as a result of one of the lowest ISA seasons on record for the whole industry and again a reflection of the turbulent market conditions. Within this, institutional mutual fund business of £239 million was up by 45 percent over 2007. Our market share in platform business fell marginally in the year but there were indications that the re-pricing of the platform business in the latter part of the year was starting to have a positive impact on sales. We continue to increase investment solutions on the platform to create wider appeal, especially during periods of market volatility.

New business contribution
VNB fell by 17 percent to £67 million due to lower new business volumes. The reduction was partially mitigated by a strengthening of the assumptions for the amount of fee income rebated from fund managers, aligning Skandia more closely to the market. New business contribution was also positively impacted by the mix of business effects, with a shift towards sales of more profitable portfolio bond charging structures within Skandia International. The new business margin ended the year at 11 percent, in line with 2007.

Adjusted operating profit (IFRS basis) level with 2007 despite market conditions 
An excellent adjusted operating profit (IFRS basis) was generated in spite of the current climate with a decrease of three percent to £167 million for the year, in part reflecting the reduction in funds under management and sales. This was partially offset by changes to the policyholder taxation basis for Skandia UK following the market falls experienced in 2008. Additional integration costs were incurred in 2007, as previously communicated. A favourable variance of £33 million arose following the implementation of PS06/14 - the prudential reserving requirements that permit non-linked insurance business to be valued on a more realistic basis.

Increase in adjusted operating profit (covered business) (MCEV basis)

The adjusted operating profit (MCEV basis), on covered business after tax, increased by 14 percent to £235 million. This increase includes a positive impact of £56 million from operating assumption changes. This mainly resulted from the recognition of retained unit trust company rebates (referred to above) as we outsource the investment of policyholder funds to unit trust companies. Other operating assumption changes included adjustments to expense assumptions to reflect current maintenance expense experience and modeling improvements. Experience variances were positive in aggregate at £17 million due to impacts on charges and continued positive experience in relation to retained rebates assumptions.

Capital
Current levels of statutory capital for Skandia UK and Skandia International are within or above the target ranges set by management. The businesses are well capitalised with a solvency ratio of 2.6 times the required level. 

Continued investment innovation at Skandia 
During the year, we continued our track record of innovation in multi-manager investment solutions. The Spectrum range of risk-controlled funds was launched in April 2008 and attracted over £120 million of gross subscriptions by 31 December 2008. In the volatile market, the risk controlled nature of the funds proved very effective from both a return and risk perspective. In June 2008, we launched the Skandia Alternative Investments Fund which has an absolute return focus and has funds under management in excess of £30 million. The high profile Best Ideas fund range continued to attract new sales with funds under management of over £391 million at 31 December 2008. The UK Strategic Best Ideas Fund had funds under management of £80 million at 31 December, and continues to be one of the best-selling funds. Amid deteriorating equity markets the UK Strategic Best Ideas Fund has continued to perform exceptionally well, with the fund being the best performing UK fund in the IMA UK ALL Companies Sector during 2008 (a universe of over 320 funds).

Skandia supports changes in the UK distribution landscape

The FSA published its paper on the Retail Distribution Review on 25 November 2008 moving the Review from the consultation phase into the implementation stage. The paper focused on the clarity of the service (distribution channels), remuneration, professional standards and prudential requirements. We have already started to support our distributors through offering assistance in preparing our businesses for the change and assisting advisers in obtaining the necessary qualifications. The intention of the FSA is to consult with the industry on implementing the proposed changes over a period running through to 31 December 2012. 

On 3 November 2008 we announced that we are ending our membership of the Association of British Insurers ('ABI'). Our proposition is clearly differentiated from old-style life and pensions companies, finding little alignment of interests with the broader ABI membership. We announced a new pricing structure in September 2008 removing the initial charge on platform sales. This move not only made our proposition very competitively priced but it also made the charging structure simple and transparent. The price changes have been positively received by financial advisers.

Marketing

The volume of business placed electronically has continued to increase. Alongside the competitive terms that we negotiate from the fund management groups, this enabled Skandia UK to re-price its proposition in September 2008, making it highly competitive.  

Skandia International enhanced its proposition by developing a new Swedish pension and adding to its online capability.

Customer service

We continued to focus on excellent customer service, which is seen as a major differentiator in financial services.

In recognition of our outstanding customer service we achieved a five-star rating in the industry Financial Adviser Awards for the eleventh year running and became the first company to win the Outstanding Achievement Award for Pensions and Investments.  We have now won more than 30 five-star awards in the 18-year history of the Financial Adviser Awards. 

We won the MultiManager of the Year award at the annual Investment Life & Pension Moneyfacts Awards in September 2008 and were also Commended in the Best Unit Trust/OEIC Provider category. These awards recognise the outstanding achievements of providers who manage to stand out from the crowd by offering high calibre products and delivering first-class service. Skandia International continues to meet customers' service expectations through a programme of operational improvements, including establishing an optimum service model for overseas branches. Technological enhancements will support the continuing drive for greater operational efficiency.

Principal risks and uncertainties

The principal risks to Skandia UK arise from operational experience, along with market risk as Skandia UK derives income from fees which are charged as a percentage of funds under management. The Broader financial risks are limited. Skandia UK does not offer material investment guarantees. Although we offer protection business, and so have exposure to mortality and morbidity risk, the majority of the risk is transferred to reinsurance counterparties. Credit risk exposures are small; the main exposures are the risk of default on the investment of company assets. Skandia UK has exposure to risk arising from operating experience in respect of factors including persistency and management expenses. These risks are managed within the operational functions which have primary responsibility for the identification, mitigation and monitoring of risks. Risks exceeding pre-determined thresholds are escalated and reported to management and to the Group Chief Risk Officer, along with details of the mitigating management action. Recent falls in investment markets have adversely impacted fund-related revenues and new business volumes. The profitability and capital position of Skandia UK remain strong.

Outlook for 2009

Details of the changes to be introduced as part of the FSA's Retail Distribution Review are still under discussion. Meanwhile, we are already preparing to incorporate the changes that the FSA wishes to include, with the aim of optimising our position in the new model of financial services and the distribution landscape that is likely to emerge. It will be particularly important to secure significant funds under management to ensure scale in the platform market that this review will stimulate. To secure assets on our platform we are running an aggressive campaign of activity which began in 2008 with the removal of the initial margin on platform products to make our costs highly competitive.  

Our offshore business is geographically diversified, with sales in Europe, the Middle East, the Far East, Africa and Latin America, as well as in the UK. It is well positioned for further growth in 2009 and beyond. Investment in the operating infrastructure to drive efficiencies and continued excellence in customer services will support further market, product and distribution opportunities. Whilst 2009 will be a challenging year, Skandia International remains confident about long-term future growth prospects owing to a growing customer base, robust regulatory and compliance infrastructure and a strong offshore brand.

Priorities for 2009

Continue to build our position as a leading platform by widening customers' investment choices, offering greater flexibility and access to more investments, and providing simple, transparent pricing

Work more closely with distributors to help them meet the new requirements of the Retail Distribution Review

Maintain our high level of customer service and continue to improve efficiency by increasing our ability to process business electronically

Generate growth for Skandia International in new and existing markets through product and distribution efforts and building on the operational infrastructure to facilitate new product development.

1.2 NORDIC

This business operates in Sweden, Denmark and Norway, offering a wide range of products for both retail and corporate customers including traditional life, unit-linked, healthcare insurance, banking, financial advisory and mutual funds. Our vision is to have the most satisfied customers in the Nordic savings market. Our operations focus on four end-customer groups, which we class as Private Sweden, Corporate Sweden, Private Norway and Corporate Denmark.

Skandia Liv is a traditional life assurance company serving customers in Sweden and Denmark. It is a wholly owned subsidiary of Skandia but 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 to the holding company. Consequently, Skandia Liv is not consolidated in the Old Mutual Group accounts. In 1990 Skandia launched Sweden's first fund insurance company, Skandia Link. Today Skandia Link offers savings products for both private and corporate business.

SkandiaBanken was initially a niche player in the Nordic banking market but has now become 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 savings products.

Together, the Skandia Nordic divisions have a broad product mix, a range of insurance, banking and investment business, market-leading expertise and a proven business model. This combination differentiates us and gives us competitive advantage.

Markets and products

We have a combined Nordic customer base of around 2.5 million customers and, with our full range of product offerings, are well positioned in a challenging 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. Corporate Sweden and Denmark offer products and financial advice from our unit-linked, traditional life and healthcare businesses.  

The Retail business operates in Norway and Sweden, targeting affluent and mass affluent private customers. This market is served mainly through our directly employed advisers, the internet and IFAs. Private Sweden offers savings products and financial advice from our banking, unit-linked, mutual funds and traditional life business. Private Norway offers products and financial advice from our bank and healthcare businesses.

Unit-linked

We offer a wide range of unit-linked funds in various classes and with varying risk profiles. Funds, including those offered by our own fund companies, are managed externally and managers are selected and monitored using our proprietary evaluation process.

Traditional life

Traditional life products are an important part of the integrated product offering in the Swedish market. As the market's largest life company, Skandia Liv is active in both the private and corporate pensions segments of the Swedish traditional life market. We provide insurance products with a security profile featuring long-term savings with a guaranteed yield plus protection. In 2008 Skandia Liv was ranked top traditional life assurer by independent Swedish consultants and distributors.

Mutual funds

We offer unit trust products through our banking subsidiary, SkandiaBanken. Skandia Fund Products' offerings are available to customers via SkandiaBanken for unit-linked savings, direct savings and individual pension savings. Customers can access premium pension savings via the national PremiePensionMyndigheten (PPM) system and decide how they wish their money to be managed by choosing from PPM's range of funds.

Banking

SkandiaBanken offers a full online retail banking service. It is focused on strengthening its offering to small enterprises and private individuals by selling noninsurance products. It also serves as a direct distribution channel, targeting self-service customers with a full range of savings products through a new online platform. In 2008 SkandiaBanken won several awards in Norway and Sweden for outstanding service. During the year the savings offering was further strengthened by the widening of the fund range, introducing discounted share trading and launching new saving products.

Private healthcare

We offer private healthcare products to companies and their employees. Our healthcare division also provides support to our unit-linked and traditional life business in Sweden and Denmark, adding value to the pension scheme products and providing cross-selling opportunities for further business.

Market overview

The Swedish savings and pension market has three pillars: individual, employer-generated and state-generated savings. In 2008 the individual market held about 50 percent of assets while employer-generated and state-generated savings each held about 25 percent. The figure for state-generated savings includes only the PPM part, as this is the only part of the public pension system where the individual decides on the investment.

Traditionally, we have been very strong in corporate pensions, the dominant segment of the Swedish life market. However, the corporate market is changing. Our strategies to increase sales in this segment must now take account of pricing pressures and collective agreement procurements. Swedish brokers are shifting their focus to small- and mid-size companies and individuals.  

The individual market is expected to continue growing in significance. Factors such as reduced state and employer pension benefits will require people to take more responsibility for their future financial security. We see this growth and the demand for advice and self-directed solutions in the private business area as major business opportunities. The individual market is characterised by multiple savings instruments and varying customer preferences. The main savings forms are insurance (SEK700 billion), bank deposits (SEK700 billion), mutual funds (SEK600 billion), equity (SEK600 billion) and bonds (SEK100 billion). Revenue in the total individual savings market is expected to grow from SEK40-50 billion in 2008 to SEK70-80 billion by 2015, driven primarily by market appreciation, increasing disposable income and asset reallocation.

The current growth of advisory services in the individual market offers us a huge potential opportunity - but it will be important to manage our relationships with IFAs effectively.

The 2008 financial crisis created a move towards more traditional savings products. While the major banks lost customers to small niche banks, SkandiaBanken increased their customer numbers by 24 percent and grew market share from 12 percent to 16 percent by offering new products with high interest rates. The major banks lost funds under management of SEK35 billion in 2008, while the niche banks gained SEK11 billion.  

In the Nordic countries the crisis led to government-led initiatives including increased bank guarantees and lowered repossession rates. It is expected that further legislative change will follow.

Interest in complementary and alternative solutions to national healthcare systems remains great in the Nordic countries. However, competition in this area has intensified considerably.

Strategy for growth

Our vision is to have the most satisfied customers in the Nordic savings market. To achieve this, we will move from our current position as a product supplier mainly offering insurance products to become a more customer-oriented financial solutions provider. We will improve and develop our customer interface, enhance our product offering and make our products available to customers via different channels.

The principal challenge is to build attractive offerings that provide both end-customers and distributors with advisory tools and top quality advice, innovative products, top-quartile returns and the market's best customer service.

Strong net client cash flows

Net client cash flows for the year were an exceptional SEK7.0 billion, representing six percent of opening funds under management. The positive performance was largely driven by strong net inflows in the life business benefiting from an excellent sales performance and reduced outflows. However, volatile equity markets negatively impacted asset growth during the year, with funds under management at 31 December 2008 down 21 percent to SEK91.9 billion.

Sales performance continued to improve

 We delivered excellent growth in sales during 2008 with life sales on an APE basis up 30 percent mainly due to strong sales in Sweden. The broker sales channel accounted for the majority of this increase as a result of strengthened relationships, supported by the new investment portfolio product and faster introduction of new funds to the market. A focus on the selling of unit-linked products has continued throughout the internal sales force which together with several sales initiatives, contributed to the improved sales. The very strong upward trend in new sales continued throughout 2008 and so far there have been no negative effects on sales performance from the volatile markets.  

Mutual fund sales were down eight percent on 2007, mainly due to lower inflows to fund deposits within our bank offering, partially offset by growth through other channels. This growth was mainly through deposits in fixed income and money market funds and through a hedge fund launched in the third quarter.

VNB grew strongly in 2008

VNB of SEK397 million for the year was up 27 percent on 2007, in line with the excellent life sales. In addition to strong volume growth, the APE margin benefited from the introduction of currency spreads and tighter cost controls. These largely offset the business mix impact in Sweden, particularly from the removal of Kapitalpension product tax advantages as well as the strengthened retention assumptions in 2008 and the negative economic changes in 2007. The life new business margin ended the year at 15 percent just below the margin in 2007. In the medium term, the new business margin is expected to improve to reach the high teens.  

Strong underlying adjusted operating profits despite market turbulence 

Adjusted operating profit (IFRS basis) increased 23 percent over 2007 despite the equity market downturn. This was largely due to excellent cost control and SkandiaBanken continuing to benefit from an improved interest margin.

The adjusted operating profit (MCEV basis) was up 109 percent on 2007, mainly due to strong VNB growth and the positive effect from assumption changes. In 2007 there was a negative effect of SEK526 million relating to strengthened retention assumptions and lower fund charges on 'tick-the-box' collective agreements and tendered corporate business. In 2008 the effect from operating assumption changes was SEK391 million. This was mainly attributable to the introduction of currency spreads and increased assumption for the take-up rate for unit-linked contracts on retirement, partly offset by strengthened retention assumptions. Experience variances in 2008 of SEK142 million were driven by a higher level of fee income than assumed and tax and profits not valued within the value of in-force (e.g. Healthcare Business). Both were partly offset by a negative retention effect mainly caused by premium reductions due to a Swedish legislative change relating to the level of tax deductible pension savings contributions. 

Continued growth in banking business benefiting from market conditions with improved interest margin

SkandiaBanken is completely funded by deposits and therefore has a unique liquidity position enabling it to benefit from the current market situation with an improved interest margin and increased business volumes. SkandiaBanken has sufficient surplus liquidity and management continue to ensure that the liquidity position remains strong. The capital ratio as at 31 December 2008 was 14.1 percent (Basel II, pillar one). SkandiaBanken's lending portfolio has been built on sound lending practices and comprises of 95 percent mortgages which have excellent credit worthiness with the remaining five percent comprised of unsecured loans. The average loan-to-value in the portfolio at the end of the year was approximately 40 to 45 percent. As a consequence, the bank has been only marginally affected by the market turbulence. The credit loss ratio (credit losses as a percentage of the opening lending balance) remains low at only 0.13 percent. The net interest margin was 1.67 percent in 2008 compared to 1.32 percent in 2007. We are confident that SkandiaBanken's conservative lending policy means it is well positioned to respond to any adverse market developments.

Both deposit and loan books at SkandiaBanken increased in 2008. Excluding the divested car finance business, lending increased to SEK43.8 billion, up nine percent since 2007. The increase related mainly to successful mortgage campaigns during the year in Sweden, together with a highly competitive floating interest rate which led to increased lending volumes. As a consequence of the turbulent market conditions, customers have been switching funds from ordinary saving accounts with variable interest rates to saving accounts with fixed interest rates. Deposits of SEK52.0 billion were up three percent since 2007 and the number of customers increased seven percent over 2007. SkandiaBanken's operating profit for 2008 was SEK283 million, 48 percent higher than 2007.

Capital

Skandia Nordic's capital position is stable with sufficient surplus equity exceeding both external requirements and internal buffers. The businesses are well capitalised with a surplus 9.9 times the required level.

Other

Our integration of Skandia, Skandia Liv and SkandiaBanken continued during 2008. We implemented a new operating structure in the private and corporate business areas where there are strong potential synergies in terms of scale, brand, cross-selling and administration. Restructuring and other activities resulted in cost reductions of SEK150 million in 2008, making a significant contribution to the year's good result.  

During the year we announced that Skandia and Livfösäkringsaktiebolaget Skandia (publ) (Skandia Liv) are reviewing the potential benefits to both the Group and to Skandia Liv policyholders of demutualising Skandia Liv. The review is at a very preliminary stage and a conclusion is not likely before late 2009.  

As announced on 3 October 2008, a ruling has been passed in respect of the arbitration proceedings between Skandia AB and Skandia Liv. The arbitration board did not accept Skandia Liv's claim to any part of the purchase price paid, but ruled that Skandia AB is obliged to pay Skandia Liv a total sum of SEK580 million (£47 million) plus interest by way of compensation in relation to fees under the asset management agreement which Skandia Liv deemed to be higher than prevailing market rates. Old Mutual had already set aside SEK500 million (£41 million) to cover the arbitration within our pre-acquisition balance sheet. Skandia AB will also have to compensate Skandia Liv for future payments to DnB NOR that are higher than prevailing market rates until the contract with DnB NOR expires in 2013. A new provision of SEK426 million has therefore been set up. 

In 2008, Skandia Link won the Risk & Försäkring award for Best Average Return to Clients Over Three and Five Years in the Swedish Market, and SkandiaBanken Sweden won Privata Affärer's Initiative of the Year award.

Marketing

We successfully launched a number of innovative market-facing products including the insurance-wrapper Skandia Investment portfolio, unit-linked mutual funds such as Swedish Stars and Skandia Global Hedge, Skandia Lifeline child insurance and a number of banking products.

Customer service

Our focus on enhancing customer service delivery earned SkandiaBanken Sweden the runner-up position in the award for Best Home Loan Institute and SkandiaBanken Norway the award for Most Client-Friendly and Service-Minded Internet Bank for the seventh year running. Skandia Sweden also reclaimed top position in the broker satisfaction index.

Principal risks and uncertainties

Nordic's main risks relate to strategic and operational risks as well as market risks. The market risks mainly relate to asset based income which reduces when the value of the unit-linked funds declines. Having a diversified product range and a wide range of investment options addresses some of the market risks. Risks arising from operating experience (e.g. persistency and management expenses) are managed through the risk framework which includes a three-lines-of-defence model and risks exceeding pre-defined risk tolerance levels are escalated to the Group Chief Risk Officer. Political and regulatory changes which could have an impact on the businesses are continuously monitored and managed.

Outlook for 2009

The continuing financial crisis will make 2009 a challenging year. In addition, there will be more legislative changes that will impact on our business. 

Our corporate customers have been affected by the economic downturn and the effects of that will start to be seen in 2009. The private client market is now already under pressure and customer behaviour will be impacted. This could lead to lower customer activity during the year, however we continue to focus on developing innovative financial product solutions to address customer needs in the current economic climate.

We continue to benefit from a combination of a broad product mix, a range of insurance, banking and investment business, market-leading expertise and a proven business model. We believe ourselves to be well positioned to handle the challenges ahead, as demonstrated by the delivery of excellent results in 2008 despite the market turbulence.

Priorities for 2009

• Top quality customer service
• High quality, innovative offers for our end-customers and distributors through advisory tools and top quality advice, innovative products, top quartile returns and excellent customer service
• New investment portfolio products
• Cost control.
  
  

1.3 EUROPE AND LATIN AMERICA

Our Europe and Latin America business

(ELAM) provides long-term insurance and savings products across continental Europe and in Latin America. Our entrepreneurial approach and leadership style has enabled us to deliver strong growth since start-up in the late 1990s. We have a strongly local distribution focus, while continuously seeking to exploit the scale and revenue enhancement opportunities that come from being part of the Old Mutual Group.  

From January 2009 we have restructured the business in continental Europe to reflect our principal customer segments in order to leverage capabilities and operational efficiencies across geographies. The transition to two main business structures will take place throughout 2009:

Affluent: targets the affluent segment and currently comprises the businesses in France, Italy and Spain

Mass Retail: meets the savings needs of this significant part of the population and comprises the businesses in Germany, Austria, Switzerland, Poland and Eastern Europe.

This foundation for efficiency in Central Europe and the integration of the Southern European businesses will allow us to take advantage of further efficiency opportunities in the future in the Mass Retail and Affluent businesses.

Latin America continues to serve a mix of customer segments, primarily through tied financial planners.

Markets and products

Our products include both unit-linked insurance and mutual funds. These are invested through a wide range of open-architecture funds in various asset classes, including funds selected and tracked using our 4P (Philosophy, Process, People, Performance) process. Our managed funds allow asset allocation in line with customers' risk profiles.

To meet customer demand our offer includes both regular-premium products with optional top-ups and single-premium products. Regular-premium products create a steady flow of lower-value premium amounts with a high embedded value, while single-premium products create larger but more volatile net client cash flows. 

We sell through a number of channels. In Europe we distribute via independent financial advisers (IFAs), sales organisations, banks and networks. In Latin America most of the business is distributed via our tied financial planners. We employ a segmentation approach to distribution, understanding that each channel has different needs, objectives and drivers.

Market overview

Our external market environment is strongly regulated. Over recent years government policy has driven growth in private long-term savings as well as improved transparency for customers. This has generally been favourable to us - though some regulations aimed at the market as a whole, such as Germany's Mindestuzführungsverordnung, have not matched our niche offering well.

We believe the fundamentals of the European market remain positive over the long term. Shortfalls in public pension systems and transfer of wealth to the next generation provide opportunities for investment from individuals. Similar opportunities should emerge in Latin America as its economies mature.

In the short term, the global economic crisis is offsetting these positive market fundamentals. Government interventions in European financial markets in 2008 dampened the demand for long-term savings products through the securing of bank deposits and stimulation of private spending rather than savings.

The unit-linked segment continues to attract competition from traditional players - an indication of its relevance and future potential. In the short term, traditional life has increased its relative importance as investors seek guarantees. We believe that this is a temporary effect and that the unit-linked segment will regain ground as the market recovers.

The IFA channel remains important and is expected to continue growing, with banks and sales organisations continuing to be strong players. Consolidation in these channels will change the landscape over the longer term and will make strong relationships even more important.  

Technology continues to offer interesting opportunities for reaching and serving customers and distributors. While online direct sales are not a big driver of life insurance sales, the servicing and communication opportunities should allow providers to reduce operational costs while delivering improved service and convenience. Effective use of technology linking distributors and suppliers to make product delivery simpler is a cornerstone of the open-architecture model.

Strategy for growth

We believe that success comes from serving customers and distributors effectively through constant innovation. 

Our strategy is to place the customer at the centre of what we do and to fully focus the business on meeting customer needs. Focusing our product and service offer on specific customer segments will allow us to meet their expectations better. The key drivers for success in the Affluent segment are breadth of offer and quality of advice and service. Mass Retail business is driven by efficiency and simplicity. Institutional business is driven by investment performance and access to products.  

We remain focused on building scale in funds under management through net client cash flows and increased market share, as well as securing profitability through cost efficiency.

Strongly positive net client cash flow during market volatilityNet client cash flows were robust considering the market volatility, especially in the highly unstable fourth quarter of 2008. With the market in some of our operating countries, for example France and Italy, showing substantial outflows during the fourth quarter, our own performance compares strongly. Strong persistency, driven by pro-active retention campaigns and the ability for clients to switch to more conservative portfolios, provided support to strong net client cash flows.

Funds under management ended the year 15 percent below 2007 on a like-for-like basis (net of Palladyne which was divested during 2008). This included negative market movements on portfolio values of 27 percent of opening funds under management, reflecting the fall in financial markets across the globe throughout 2008. In comparison, the majority of European equity indices fell between 30 percent and 50 percent in 2008. Funds under management were partially supported by the effective asset mix of the portfolio which incorporates non-equity asset classes and reflects the investment appetite of customers that shifted further during 2008 towards guaranteed funds and other less risky asset classes.

Life sales impacted by constrained sales environment 

Life sales on an APE basis were down throughout the year but especially in the fourth quarter due to negative investor sentiment. This effect 

was stronger in singlepremium business, where investors typically have access to a wider range of investment opportunities and seem to have 

been taking a 'wait-and-see' approach to investing under the current conditions. Regular-premium business has been relatively more stable, 

reflecting the smaller premium sizes and habitual nature of saving on a regular-premium basis. Nevertheless, regular- premium sales have also been under pressure during the year, and the market volatility had a dampening effect on the traditional European seasonal ramp-up in sales in the final quarter, with the fourth quarter falling short of prior year levels.

Focused activity to support mutual fund sales 
Given the market volatility and our core differentiator of this business line being international equities, mutual fund sales provided a solid contribution, although down 20 percent compared with 2007 on a like-for-like basis. We continued our efforts to deliver innovative products and quality service. During 2008, much focus was placed on improving the productivity of financial planners in Latin America. Increased training, new product offers and planning tools assisted financial planners in generating sales in the current conditions.

Value of new business and profit margins down

VNB of €13 million was down 77 percent over 2007, mainly as a result of lower sales in 2008 in light of the market crisis. In addition, VNB was negatively affected by changes in operating assumptions, where in particular the changed regulation on policyholder profit participation reduced German VNB. The APE margin deteriorated to six percent from 20 percent in 2007. This was attributed to lower APE sales, which for the more recently established businesses was aggravated by a relatively fixed expense base leading to acquisition expense over-runs. In addition, the strong sales of high margin business in Poland in 2007 was not sustained in 2008.

Adjusted operating profit (IFRS basis) impacted by wider market environment

We generate a significant element of our revenues from funds under management and these fees were lower in line with reduced levels of funds under management. This negative impact was partially offset by the growth of the in-force book of business during the year. Furthermore the revised policyholder participation regulations implemented in Germany during 2008 both widened the definition of revenues to be shared with policyholders and increased the level of participation. This had a €20 million impact on the IFRS adjusted operating profit for the year. This calculation is net of acquisition expenses and these were lower, in line with new sales levels, and so policyholder participation levels were relatively high. To protect the bottom line, we maintained our expense base at 2007 levels, identifying efficiencies to offset growth in sales force and inflationary impacts.

Adjusted operating profit (MCEV basis) suffered from weak new business contribution and negative experience variances
MCEV adjusted operating profit was €5 million for 2008, 62 percent lower than 2007. This was largely due to lower VNB and poorer experience variances which included divisional restructuring costs. The operating assumption changes had a negative impact on the adjusted operating profit, but not to the same magnitude as for 2007. Changes have been made to persistency rates and expense levels, both of which have been strengthened.

Capital
ELAM's businesses continue to measure and monitor their capital resources on an ongoing basis to ensure compliance with the minimum capital requirements of the regulators in each territory in which we operate. Internally we manage our businesses to maintain a buffer of at least 25 percent in excess of the local requirements. Due to the decrease in funds under management levels, solvency requirements across our markets reduced while our capital employed increased, and therefore solvency coverage increased significantly over the year.

Marketing

The volatility of international financial markets increased the importance of marketing to reinforce our sales message in three areas:

Product innovation
Innovation focused on protecting investments to retain existing business and generate new sales. Examples included launching our own traditional life fund in France offering customers capital security and a product with annuity features in Germany.

Expansion of distribution

We continued to grow our distribution base across all our markets. In Italy we added a number of large distributors and in Spain we launched an internal sales force.

Branding

All our businesses operate under the Skandia brand name in their local markets. We carried out the first wave of rebranding to the new Skandia green brand in several markets; this enabled us to re-emphasise the benefits of our offer even in the current negative financial market environment.

Customer service

We continued to focus strongly on our customers, delivering a number of new products and service innovations throughout the year. Examples include annuity features in Germany, a second Easy Plan product in Switzerland, various distributor products in Italy and France, dollar-cost averaging and rebalancing features in Europe and new investment alternatives in Latin America. We also improved service to our customers and distributors through differentiated service offers to top distributors, pro-active service and retention campaigns, and improved distributor tools.

These innovations have been well received by the market, as can be judged from the various product and service awards won during the year, including:

• Austria: FONDS Professionell Service Award
• Germany: Runner-up, AssCompact Fondspolicen Award
• France: Gold Pyramid, Investissement Conseils Awards
• Spain: Winner, Expansion Mutual Funds Portfolio Competition
• France: Gold Medal, Dossiers de l'Epargne Awards
• France: Bronze Trophy, Le Revenu Awards.

Principal risks and uncertainties

ELAM's business model carries limited guarantee and liability risk. Strategic and operational risk is reviewed regularly and managed through our risk framework. Our ongoing focus to build and diversify distribution aims to reduce concentration risk. The existing concentration levels remain within a reasonable range and we expect that future planned activities will assist us to manage this risk further.

ELAM's business mix, which includes regular- and single-premium, retail and institutional business, provides mitigating support to impacts on business results in the current volatile market conditions. However, uncertainty about the future extent and length of a global recession remains and market trends remain difficult to predict.  ELAM's geographic diversity reduces the economic, market political and legal/regulatory risks that would typically exist in single-market businesses. The transition to our new business line structure carries some change risk. A strong change management programme has been defined to reduce impacts to new and existing business.

Outlook for 2009

The global financial crisis and recessionary pressures are expected to be the main influence on the market in 2009. We expect new business to be constrained as investor confidence remains suppressed.

Guaranteed products are likely to remain important to investors in 2009, temporarily slowing the growth of the unit-linked segment compared with traditional life. Products such as our traditional life fund in France and our rebalancing features will help us win sales in the current climate.

Regular-premium business - which has been relatively unaffected by the market crisis - is expected to help our sales development in 2009, as the averaging effect of regular-premium investments should support our sales propositions.

Our strong performance in net client cash flow and client asset values compared to the market has been positive for our market share. We believe that we will be able to capitalise on this further once confidence returns and markets return to growth.

Priorities for 2009

• Rapid transition to the new business structure, building on existing expertise and improving operational scale efficiencies while retaining day-to-day focus on customers and distributors
• Further develop the platform for reaching and servicing the Affluent segment, including products, distribution, advice and service
• Improve efficiency in the Mass Retail business, focusing on simplification and matching the offer to the market, improving profitability and increasing market share
• Innovative solutions for customers and distributors to support them through the difficult times.

1.4 SKANDIA INVESTMENT GROUP

Skandia Investment Group (SIG) is our investment management organisation. It brings together all Skandia's investment research, analysis, portfolio management, open-architecture and investment product expertise. SIG encompasses Skandia's three in-house investment management companies: Skandia Global Funds, Skandia Fonder and Skandia Investment Management Limited (SIML).

The formation of SIG created one of the world's largest multi-manager investment organisations, managing assets of around £53 billion across a variety of multimanager and open-architecture investment products.

2.0 SOUTHERN AFRICA

We operate the largest financial services business in South Africa, providing wealth management, investment products, retirement savings, life, disability and health insurance to individuals and groups.  We also offer financial services in other parts of Africa through operations in Namibia, Zimbabwe, Malawi, Kenya and Swaziland. Our banking business in Africa is conducted by Nedbank Group, in which we have a 55 percent controlling interest. Nedbank is one of the four largest banks listed on the Johannesburg Stock Exchange (JSE). We also have a 74 percent controlling interest in Mutual & Federal Insurance Company Limited, the South African general insurance company.

2.1 OLD MUTUAL SOUTH AFRICA (OMSA)

Old Mutual South Africa (OMSA) comprises asset management and life operations and has one of the largest advice-based distribution capabilities in the South African industry. The Retail division covers both the Affluent and Mass markets, while the Corporate division provides products and services to corporate, institutional and public sector customers.

Our asset management operations in South Africa are represented by Old Mutual Investment Group South Africa (OMIGSA). This multi-boutique asset management business, currently comprising 13 individual boutiques, was formed in 2007 in response to a growing demand for core and specialist investment capabilities. Our boutiques provide a range of investment capabilities designed to meet a variety of retail and institutional customer needs. We offer investment capabilities to the pension fund and corporate market, as well as managing a range of retail portfolios which individuals can access through the various Old Mutual products.  

The Old Mutual brand has very high awareness, trust and loyalty among South African consumers across all market segments. In 2008 it was rated number one for life assurance (2008 Markinor Brands Survey) and for after-sales service (2008 Ask Afrika Orange Index).  

Established in 2003, Old Mutual Service Technology and Administration (OMSTA) provides a single, cost-effective point of service, technology and administration for the Retail Affluent, Retail Mass and Corporate customer-facing businesses. It services all our customers, intermediaries and retirement fund members across our full product range through our extensive branch network, call centres, web capabilities and back office. In addition it offers technological infrastructure for OMSA, along with application development for both OMSA and other Old Mutual Group companies internationally.

Markets and products

Retail

Our Retail division covers both the Affluent and Mass markets, offering life, disability, retirement annuities, savings and investment products. We distribute these through independent brokers (IFAs), bank brokers, tied distribution (personal financial advisers for the Affluent segment and salaried sales force for the Mass segment), a direct distribution channel and other retail partnerships. Bancassurance through Nedbank's financial advisers and staff is another important channel.

Our key Retail product offerings include Greenlight, a flexible and comprehensive range of life, disability, and future-needs cover. We provide a range of retirement savings plans, annuities, investment and income products through different wrappers - including the Max, Investments Frontiers and Galaxy product ranges. In the Mass segment we offer customers savings, retirement and funeral cover products.  

To ensure products are appropriate for today's environment, our more recent investment and savings products feature significantly lower charges and capital requirements and have greater transparency and flexibility.

Our investment offering is open-architecture, but Old Mutual managed funds form a large part of the underlying assets managed for Retail customers.

Corporate
Our Corporate division sells investment, retirement, insurance, structured products and advisory services to corporate, institutional and public sector customers. Under a life wrapper, we provide underwritten investment products for retirement funds, and group life and disability insurance to retirement funds established by employers for their employees and by trade unions for their members. Group assurance products provide life cover to employees in the event of death, funeral cover and funeral support services, and a full range of disability solutions. We customise investment products to meet our individual customers' requirements. These include smoothed bonus portfolios, absolute return portfolios, structured solutions and annuity products, and 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.

Asset management
Old Mutual Investment Group (South Africa) (OMIGSA) investment boutiques collectively span all major asset classes and employ unique strategies to meet our customers' different needs and risk profiles. Together, they give customers access to a comprehensive range of savings and investment solutions. We are building on our traditional South African customer base by offering property, exchange traded funds (ETFs) and hedge-fund solutions that also meet the needs of international investors.

Our investment boutiques include:

• Specialist equity businesses
• Futuregrowth (fixed income)
• Umbono Fund Managers (index tracking)
• OMIG Property Investments (property asset management and property management)
• SYmmETRY (multi-manager portfolios for institutional investors across multiple asset classes)
• Private equity and infrastructure investment
• Old Mutual Specialised Finance (corporate advisory, corporate lending, securities lending and structured products).

Market overview

In 2008 local markets followed a similar pattern to international markets, with a dramatic fall followed by a marginal recovery at the end of the year. The Johannesburg All Share index lost over a quarter of its value, with dramatic variances between sectors.  Inflation continued to rise through the first three quarters of the year but fell back in the last quarter, prompting a reduction in interest rates at the end of the year. These factors, combined with slower global growth and lower demand for South African exports, slowed local economic growth in 2008 - after four years of strong expansion.

The financial services sector has so far remained largely unaffected by the global financial crisis. Competition has continued to increase as banks, life assurers and asset managers expand their product ranges in an effort to grow market share. New entrants challenge existing practices without the burden of legacy issues. 

Following the changes in the leadership of the African National Congress (ANC) at the end of 2007, 2008 was an eventful year on the political front. The most notable change was the replacement of Thabo Mbeki by Kgalema Motlanthe as State President in the second half of 2008. We view the peaceful change in ANC and state leadership and the subsequent emergence of a new political party as encouraging signs of the development of democracy in the country.

The regulatory regime has been evolving to provide greater transparency and protection to the consumer. New commission regulations, effective from 1 January 2009, represent one of the most profound changes to the long-term insurance sector for many years. 

The overall savings rate in South Africa remains low, and a large proportion of savings is being channelled into non-financial investment vehicles such as property. The economic growth of recent years has fuelled growth in the emerging and middle-income market segments; these segments will continue to present opportunities going forward, albeit with growth at lower levels.  

The long-term outlook for the savings and investment environment is positive for a number of reasons:

• The prudent fiscal and monetary policies of recent years are expected to continue and to guide the economy back to robust growth
• The growing black middle class and affluent markets supported by economic expansion and Black Economic Empowerment efforts will sustain growth in consumer spending
• The Government is continuing to invest in infrastructure
• There are Government plans for a mandatory retirement savings framework
• The level of financial awareness and the transparency of financial products is improving.  

Strategy for growth

Our strategic aim is to move from being a traditional life insurer to become a leading provider of investment and savings solutions to each and every South African.  

To achieve this, we are working to become a consistently top-performing asset manager in every asset class through our range of investment boutiques which we will expand to cover more niche positions.  

We are already recognised as the number 1 long-term insurance brand in the market and are building recognition and awareness as a leading savings and investment brand. We will broaden our financial services offerings, and update existing products, to satisfy a demanding customer base and new regulations. We will also add products aimed at the Foundation Market. At a time when others are expected to make cutbacks, we will unlock competitive advantage by growing access to customers and distribution ahead of our competitors. And we will use our strong operating position in southern Africa to expand selectively into other parts of Africa that offer high growth potential.  

Operational excellence and cost control are essential if we are to provide our customers with affordable and competitive products at a sustainable margin. Through OMSTA, we will continue reducing the operational cost of the business, making better use of IT to improve customer service and provide a solid platform for growth.

We also want to 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. We will continue doing this through broad-based initiatives aimed at creating opportunities for disadvantaged people and businesses alike.

Funds under management were fl at over 2007 mainly due to lower asset values in volatile markets and improved net client cash outflows of R5.5 billion offset by the inclusion of Futuregrowth's R35 billion of funds under management. The acquisition of Futuregrowth has resulted in an expanded set of fixed income products available to the Old Mutual customer base. Retention of third-party assets has improved significantly with the bedding down of the OMIGSA boutique structure leading to the overall reduction in client outflows relative to 2007. Outflows remained a challenge, affected by higher bonuses declared in 2007 and early 2008, which increased the level of normal benefit payments, particularly in Employee Benefits (EB), as well as higher member withdrawals from pension funds as a result of the deteriorating economic environment.

Life assurance sales increased 14 percent in 2008. This improvement was particularly pleasing considering the effect of the current economic climate on consumer spend. We achieved excellent growth in life single-premium sales of 26 percent compared to 2007, but we experienced a slow down in single-premium sales in the fourth quarter. Savings products sales grew by 12 percent as investors opted for more conservative fund options under the life wrapper in response to volatile investment markets, particularly in the Retail Affluent market. Annuity sales were up 85 percent with some good flows in the Corporate Segment's new guaranteed-term annuity product as well as with-profit annuities. Our focus on working closely with consultants advising institutional investors has helped us grow our sales pipeline, although the sales process is longer as investors are more cautious in the current markets before deciding to move assets.

Life recurring-premium sales were strong, up eight percent over 2007. Sales of recurring-premium savings products increased by 16 percent compared to 2007 driven by an expansion in the Retail Mass segment sales force. High interest rates adversely affected our credit life sales through the banking channel as loan advances dropped. Sales of risk products to the Retail Affluent market were largely fl at over 2007 as customers faced affordability problems. In December 2008 we reached an agreement to sell our healthcare business to Lethimvula. As a result we now exclude healthcare sales from our life sales and from our embedded value calculations.

Unit trust sales of R20.6 billion were 33 percent higher than in 2007, showing excellent growth, albeit from a low base with investors moving to lower risk money market funds. We continue to focus on improving investment performance, as well as focus on the alignment of our unit trust fund offering to our boutique capability and allowing the OMIGSA boutiques to operate with independent investment philosophies and processes.

VNB grew 20 percent over 2007 driven by the increase in sales and the increase in the margin as a result of strong with-profit annuity sales in the Corporate Segment where the APE margin increased from 15 percent in 2007 to an outstanding 23 percent for 2008. The contribution of the with-profit annuity sales to the APE margin was partly offset by the higher frictional tax costs after reducing the proportion of capital invested in equities. The Retail Affluent margin also declined as a result of the lower proportion of high margin risk business following the fall in credit life sales.

Adjusted operating profit (IFRS basis) increased strongly, up 14 percent over 2007. Despite challenging markets, our long-term business profits increased 10 percent, driven by lower costs due to sound management of expenses with the lower Old Mutual plc share price impacting incentive costs. In addition we gained some significant non-repeating items including a reduction in employee benefit obligations of R128 million, interest on SARS refund of R64 million and an insurance claim of R37 million. We also saw improved general experience variances. Although we increased our allowance for worsening persistency and we increased our investment guarantee reserve (IGR) by R409 million during the year, these assumption changes were not as adverse as in 2007 when we determined the IGR on a market-consistent basis for the first time. These positive factors were partially offset by lower capital charges as a result of lower asset values and the move to lower margin products such as the move by Old Mutual Staff Fund to Absolute Growth Portfolios as well as negative termination experience especially in the mass market segment.  

Our asset management adjusted operating profit was up 14 percent due to lower expenses attributable to the impact of a lower Old Mutual plc share price on incentive costs. The impact of the move to performance based income in the current environment resulted in lower asset management fee income which was offset by strong performance in our credit operation (OMSFIN). 

The LTIR increased by 18 percent after increasing the rate applied at the beginning of the year by 100bps to 16.6 percent, reflecting the high investment returns on shareholder funds achieved in 2007 and higher investible asset balances.

Adjusted operating profit (MCEV basis) increased by 29 percent over 2007, mainly due to higher expected return (based on higher one-year swap rates), higher new business contribution and the higher adjusted operating profits (IFRS basis) discussed above. These positive factors were partly offset by the impact of adverse termination experience particularly in the Retail segments as a result of the tougher economic environment.

OMSA's life company capital position remains strong in spite of turbulent markets. The statutory capital cover remained stable at 3.8 times since December 2007. Admissible capital was lower than December 2007 levels due to a fall in market values, offset by the effect of our hedging programme and increased cash holdings.  

At 31 December 2008 the statutory capital requirement reduced four percent to R11,176 million as a result of a decision to hold more cash and reduce our exposure to equities. The impact of lower equity markets and the new regulatory requirement to include allowance for operational risk, credit risk and investment guarantee reserve sensitivity in capital requirements, were offset by higher assumed management actions in the investment resilience scenario used for calculating the capital requirement.

Retail Mass sales were up a pleasing 20 percent over 2007 largely due to strong growth in salaried adviser manpower. The broker and direct channels also delivered strong sales growth. Net client cash flows were five percent ahead of last year. The impact of higher surrenders (indicative of the current economic conditions) and greater volumes of maturing savings business (introduced ten years ago and short-term savings business introduced five years ago) was offset by favourable mortality experience.

VNB increased at a slower rate than sales due to the re-pricing of our protection product range and the impact of lower expected returns (based on assumed lower future swap yields) on the value of future profits on the segment's protection products.

Net client cash outflows improved over 2007 but remained negative, as the prevailing adverse economic environment increased client withdrawals.  

Total Retail Affluent life sales on an APE basis increased a solid three percent. Recurring-premium sales experienced challenges, with inflationary pressures and higher interest rates which impacted negatively on consumer disposable income. Recurring-premium savings sales grew by 13 percent with Max Investment recurring-premium sales up six percent and a full year contribution from Nedlife's Dreammaker, launched in the middle of 2007, producing a 112 percent increase albeit off a low base.

The shift from life-wrapped savings business to other wrappers continues with non-life recurring-premiums up 32 percent from a relatively low base. Greenlight sales grew by one percent as a result of affordability issues among customers and credit life sales declined on 2007 after the reduction in loan volumes as a result of the high interest rate regime and the impact of the National Credit Act.

Life single-premium sales were up four percent with living annuities up 20 percent on 2007. Conventional annuity sales were also solid as a result of the continued competitiveness of our annuity rates, enhanced by a recent re-pricing exercise. Total annuity sales including living annuities were up 11 percent on 2007. However, Max Investment and Investment Frontiers single-premium sales were down 10 percent and one percent respectively on 2007 as a result of the impact of market volatility on single-premium investments.  

Non life single-premium savings business was up 25 percent on 2007 due to investors moving to money market funds in the volatile investment markets and the re-launch of Galaxy Elite, an upgrade to our existing investment platform.

VNB decreased by five percent despite the overall increase in sales. In addition to the higher frictional tax costs following the change in shareholder investment mandate (more cash, fewer equities) the decline was also caused by the lower credit life sales, which have high margins

Corporate life sales on an APE basis were 43 percent higher in 2008, driven by higher sales in Employee Benefits savings and annuity products. Single-premiums were excellent. The introduction of the Guaranteed Term Certain product boosted annuity sales, and there were also good flows into Smoothed Bonus products. Sales of protection products were below 2007 as insurers stepped up efforts to retain business thereby reducing potential new business. Our retention of protection business also improved in 2008.

VNB increased significantly in 2008 relative to the increase in sales. This was because of higher sales volumes in EB combined with the favourable mix of sales, notably the higher proportion of with-profit annuity sales. This had a flow on impact in the new business margin improving relative to 2007.

Net client cash flows in the EB arena were marginally better than in 2007. Higher inflows were almost offset by higher outflows. Terminations were similar to 2007 levels, but benefit payments were much higher. Higher bonus declarations during 2007 (smoothed bonus) and early 2008 (annuities) increased the level of normal benefits. In addition to this, a trend of increased benefit withdrawals from funds as a result of current economic pressures contributed to increased outflows. Customers continued to transfer from the old smoothed bonus products to the Absolute Growth Portfolios launched in 2007. Transfers of R21 billion occurred during the year. These transfers are not counted as new business.

Life sales were ahead of 2007 as a result of good repeat investments by existing customers in SYmmETRY. Non-life sales were higher than 2007 as a result of better unit trust flows on the back of improved stability of our investment professional teams in the boutiques. Net client cash outflows were largely from institutional customers to fund benefit payments.

As our boutique structure has bedded down, our teams have stabilised. We have set strong foundations over the last two years and are seeing improving levels of acceptance and confidence in individual boutique investment philosophies and processes. The acquisition of Futuregrowth and merger of the OMIGSA Fixed Income and Futuregrowth teams has proceeded smoothly, with minimal disruption to their investment processes. The South Africa equity market (JSE All Share Index) fell 26 percent during 2008. The outperformance of resources during the six months to the end of June reversed abruptly in the second half of the year, with resources down 46 percent relative to a -1 percent return from financial stocks. Compelling valuations in the financial sector meant that a number of OMIGSA boutiques were underweight resources and overweight financials from the last quarter of 2007. This positioning led to improved performance over the second half of 2008, with some of the ground lost since September 2007 regained. Performance in our fixed income area was very good. The Old Mutual Income Fund and Mining and Resources Fund won certificates for top straight performance in their respective categories for the three years ended 31 December 2008 at the Raging Bull Awards.

Investment performance across our diverse boutiques was mixed. Our relative fund performance across the majority of boutiques nevertheless ended the year better than at the end of 2007, albeit below our target levels. Over one year to the end of 2008, 57 percent of peer group funds outperformed the median (compared to 39 percent as at the end of 2007). Over three years to the end of 2008, we improved from 31 percent outperforming to the end of 2007 to 40 percent above median at end 2008, and similarly measured over five years improved from 36 percent to 54 percent above median. Compared to industry median, overall, 55 percent of unit trust funds were above median over one year, 35 percent over three years and 45 percent over five years to the end of December 2008.

On the benchmark performance front, the difficulty of beating inflation and cash-plus benchmark in an environment where growth assets are very negative, weighed heavily on the delivery of funds which are measured mostly against an absolute benchmark. At the end of 2008, 38 percent of funds measured against benchmark were outperforming over one year, compared to 50 percent at the end of 2007. However, over the longer term period of five years we improved slightly, with 55 percent of funds outperforming benchmarks compared to 50 percent for the five years to end 2007.

Marketing

Recognising the increasingly competitive environment and the need to reach new markets, we increased our marketing investment - improving our brand presence and product support, making progress in promoting the new OMIGSA boutique model, and reaching the previously under-serviced Foundation Market which we see as central to the success of the South African economy in years to come. We launched Max II, our recurring-premium product range, to meet new commission regulations. Our aim in product development is to exceed customer expectations: hence Galaxy Elite, an investment product that delivers excellent value for high net worth retail customers, and our Absolute Growth Portfolios product, which is now a market leader in the corporate segment.

We also used the uncertainty in the financial markets towards the end of the year to highlight the benefits of our smoothed bonus and guarantee products as well as our strong capital position and credit rating through the 'Certain friend in uncertain times' campaign.  This above-the-line activity supports our extensive face-to-face distribution in the retail and corporate markets.

Customer service

Customers are at the heart of our business. In 2008 we revitalised our retail sales and customer services branches. We set a new benchmark in convenient financial services by moving into retail shopping areas and opening 19 Greenzones - one-stop shops offering banking, assurance, insurance and investment products.  We extended our reach by significantly growing tied distribution and increasing our activity in both the broker and direct markets. In the corporate segment, focus on relationships with consultants is building our pipeline and sales.

We have combined all customer servicing for our Retail Affluent, Mass Retail and Corporate customer-facing businesses into OMSTA. We continually drive service levels higher through LEAN process re-engineering methodology.

Customers and intermediaries are serviced via a combination of call-centres, web capabilities and the extensive branch infrastructure. By applying OMSTA's IT expertise we reduced servicing cost per policy while improving service levels and were voted No1 for after-sales service in the 2008 Ask Afrika Orange Index.

Principal risks and uncertainties

As we go into 2009 we face a number of risks from the economic environment. These include a weak equity market and the possibility of further equity falls adversely affecting our earnings, our embedded value and our sales (as customers avoid investment and savings products with equity content). In addition, increased terminations due to the current economic climate put more pressure on the net client cash flow position, earnings and embedded value. Lower sales may eventuate as a result of job losses and concerns about the global economic outlook. Further decline in longer-term swap yields and further increase in equity and swaption volatilities, which would increase the size of the Investment Guarantee Reserve.

Outlook for 2009

National Treasury expects growth in the economy for 2009 to be 1.2 percent. This growth rate is vulnerable to demand for South African exports from developed markets and how that will impact on manufacturing output as well as levels of commodity prices and their impact on our mining sector. Growth will continue to be supported by the Government's infrastructure drive.  

The current economic environment has led to a significant decline in consumer confidence in the investment markets and increase in concerns about job security. There has been a shift in demand from investment vehicles with high levels of market exposure to more traditional smoothed bonus and guaranteed products, which will benefit OMSA. However, the overall pressure on the consumer will restrict sales growth until concern over the market settles and consumers start feeling the benefits of falling inflation and interest rates.  

We have received notification to terminate early in 2009 the existing mandate to manage the Public Investment Corporation's (PIC) assets worth about R25 billion.  This will adversely affect net client cash flows and reduce operating profit by approximately R21 million for 2009.

New regulations on commission, implemented at the start of 2009, are revolutionising the retail market. Changes include minimum early termination values on long-term savings contracts and a move to spread commission over the term of a policy, rather than the current front-loaded structure. We have already launched a set of products that meet the new requirements and have been working with intermediaries to help them move to the new environment. The legislation presents us with opportunities as our infrastructure is well equipped to deal with changes of this magnitude.

The year ahead will challenge consumers, businesses and policymakers to adapt their thinking and behaviour to a changing and more challenging economic environment. OMSA's strong capital position, brand loyalty and dominant presence will allow us to compete more aggressively in a market with declining margins and capital restrictions. Our capital position, at 3.8 times the required level, and our AAA credit rating are the best in the long-term insurance industry. As a result, we still see opportunities for growth, albeit at lower levels than in the recent past.

Priorities for 2009

• Continue our transition from a traditional life insurer to a modern savings and investment business
• Continue to grow the business and net client cash flows
• Focus on growing distribution while improving investment performance, service levels and managing our costs.

Rest of Africa

Kenya

Launched eighty years ago, Old Mutual pioneered unit trusts and offshore investments in Kenya. We continue to lead the market in both asset management and unit trusts and have been the fastest growing life assurer in Kenya. We offer a diverse product set, ranging from unit trusts, group life cover and annuities, pension fund management and third-party administration in the corporate segment, to private wealth management, unit trusts, risk products and annuities in the Retail segments. We recently launched Kenya's first ever low-cost mass market risk product, ensuring that it remains relevant to this market's financial needs.

Malawi

The operation in Malawi was established in 1930.  We are the market leader in asset management, life assurance, third-party asset management, pension fund administration and management, and property investment. Historically, we have focused on the corporate segment of the market and sell group life cover and annuities, pension fund management, credit life and funeral cover. We currently sell life cover to individuals in the retail segment and are developing additional products to meet the needs of this segment.

Namibia

Old Mutual Namibia was launched over 80 years ago and is the country's leading financial services company, dominating both the life assurance and asset management industries. We are a leader in pension fund administration and are developing the property investment side of the business. Our unit trust business offers solutions to both corporate and retail customers. We provide life, disability, retirement savings and investment products to individuals in the Retail market segment.

Zimbabwe

Our business in Zimbabwe has operated for just over 100 years and is the largest financial services company in the country, having captured the largest market share of the life assurance and asset management industries.  We also own the country's largest building society. We provide life, disability, retirement savings and investment products for both corporate and retail customers.

Swaziland

We launched our business in Swaziland in May 2008.  With ambitious plans, the business strives to be the leader in asset management, life assurance and property investment by providing relevant goal-based advice and value-for-money products. While the business launched with a focus on the retail segment of the Swazi market, solutions for the corporate market will be introduced in the near future.

2.2 NEDBANK

Nedbank Group Limited (Nedbank) is a bank holding company 55 percent owned by Old Mutual. It is one of South Africa's four largest banking groups through its principal banking subsidiaries, Nedbank Limited and Imperial Bank Limited, in which Nedbank has a 50.1 percent interest. Its shares have been listed on the JSE since 1969.

Nedbank focuses on southern Africa, positioned as a bank for all. It offers a wide range of wholesale and retail banking services through four main divisions: Nedbank Corporate, Nedbank Capital, Nedbank Retail and Nedbank Business Banking - which separated from Nedbank Corporate in January 2009.

Nedbank is based in Sandton, Johannesburg, with large operational centres in Durban and Cape Town complemented by a regional network throughout South Africa. It also has facilities in other southern African countries which are operated through its 10 subsidiary and/or affiliated banks, and branches and representative offices in key global financial centres that exist to serve the international banking requirements of its South African-based multinational customers.

Markets and products

Nedbank Corporate

This comprises the Corporate Banking, Property Finance and Nedbank Africa businesses, and the specialist Transactional Banking and Corporate Shared Services businesses. These provide lending, deposit-taking and transactional banking services to Nedbank's Wholesale banking customers. Nedbank Corporate has a strong customer base and is well placed to take advantage of opportunities, both internally through cross-selling services offered by other divisions of Nedbank and the wider Old Mutual Group, and externally in the private and public sector markets.

Nedbank Business Banking

Business Banking focuses on businesses with turnover between around R7.5 million and R400 million. It provides a full spectrum of banking products and solutions as well as advisory services and specialist solutions. To make Business Banking easily accessible to its customers, its 14 regions and over 70 area offices are organised around four geographically defined business units run as decentralised, regional, customer-centered businesses.

Nedbank Capital

Nedbank's investment banking business consists of divisions that together manage structuring, lending, underwriting, corporate finance, private equity and trading operations. It provides a full product range, from equity research to long-term project financing, enabling it to compete effectively in southern Africa and in niche areas throughout Africa. It seeks to provide seamless specialist advice, and debt and equity raising, execution and trading in all the major South African business sectors. Principal customers include a significant number of the top 200 domestic corporates, as well as public sector bodies, leading financial institutions, non-South African multinationals and customers undertaking major infrastructure and mining projects in Africa, and emerging Black Economic Empowerment consortia.

Nedbank Retail

This division provides transactional, credit card, lending, investment and insurance products and services to individuals and small businesses. It groups its customers into five primary segments: high net worth, affluent, middle, mass and small business. It is further organised around its principal product areas: card, home loans, personal loans, bancassurance and wealth, vehicle and asset-based finance, and transactional banking.

Imperial Bank
Imperial Bank focuses on motor vehicle finance, marketed through its Motor Finance Corporation brand. It also offers property, medical, aviation and supplier asset finance.

Market overview

South African banking is currently impacted by a slowing domestic economic cycle coupled with political change and the secondary effects of the global financial crisis. Increased infrastructure spending and moderate fiscal stimulus are expected to provide some opportunities for growth. The outlook for domestic inflation has improved, with the first interest rate cut of 50 basis points since April 2005 providing some relief for consumers.

Operating conditions have become increasingly difficult for Nedbank Retail, with signs of slowing growth extending to the small and medium size business sector. The tough trading conditions have also affected investment banking and debt and equity trading, resulting in lower earnings in Nedbank Capital.

The principal challenges for local banking come from pressure on margins due to the industry's reliance on wholesale funding; the increased cost of funding in international debt capital markets; rising non-performing loans and weaker recoveries in retail banking as household finances remain strained and house prices come under increased pressure; and sharply slower Retail advances, partly offset by robust Wholesale advances.

But there are also opportunities, driven by growth in the mass, black middle and SME markets; growth in Africa generally; growth in retail deposits and other funding; increases in transactional banking fees; and improving asset margins.

Strategy for growth

Nedbank's strategy is based on growing its share of economic profit in South African financial services and making the most of the increasing opportunities that emerge in selected African markets. It concentrates resources on the businesses best positioned to increase economic profit based on their capabilities and related industry growth. Businesses with lower economic profit characteristics are managed for value through strong focus on profitability. Initiatives across the various divisions include selectively growing assets, passing increased funding costs onto customers, managing risks, increasing cross-selling and transactional income, smart cost management and reacting flexibly and nimbly to opportunities.

Nedbank will also continue to investigate opportunities to expand into the southern African Development Community region. This work will be supported by its recently established regional offices in Angola and Kenya, along with its new strategic alliance with Ecobank which has operations in 25 countries mainly in Western, Central and Eastern Africa.

In addition, Nedbank will continue to grow its Retail franchise, strive for leadership in business banking, gain more public sector business and remain a top three player in the Wholesale banking market.

Performance in 2008

Banking environment

The local banking environment faced a number of challenges in 2008. These included, firstly, pressure on margins as the overall cost of longer-term funding increased. It was pleasing to note that, throughout the year, rand liquidity remained stable, with the interbank lending market continuing to operate efficiently. Local banks have been able to finance new assets in the normal course of business. Secondly, reduced capacity and increased cost of funding in the domestic debt capital markets. Thirdly, rising non-performing loans and lower levels of recoveries, especially in the Retail environment as household finances remained strained and asset prices came under pressure. This trend intensified in the second half of 2008 and has been increasingly affecting small and medium-sized businesses, and will undoubtedly also impact some larger corporates going forward. Finally, sharply slower retail advances growth, partly offset by reasonable Wholesale advances growth.

The progress made during the recovery programme and over the recent past to build a sustainable business continues to benefit Nedbank and has resulted in a number of factors including ongoing growth in the Retail Mass and middle-income segments and Corporate markets, solid growth in Retail deposits, pleasing growth in transactional banking volumes, improved margins on new advances through risk-based pricing and increased client activity in foreign exchange and interest rate markets as well as an intensified focus on improving client service levels.

The Competition Commission inquiry into bank charges issued a detailed report in December 2008. Industry stakeholders have been given an opportunity by National Treasury to comment on the recommendations contained in the report. This input will be discussed by National Treasury with the Department of Trade and Industry, the South African Reserve Bank and the Competition Commission and it is anticipated that the final outcome of the banking inquiry process and the impact on the banking industry will be finalised during 2009. Nedbank remains committed to an outcome that provides real benefit to consumers and ensures the ongoing competitiveness and stability of the financial services industry.

Basel II was successfully implemented on 1 January 2008 and was used as a catalyst to enhance the management of risk and capital across the industry.

Financial performance

Given the turmoil in the global financial markets and the slower domestic economy Nedbank is currently adopting a more conservative approach across its operations. We have intensified our focus on increasing capital levels, growing deposits and liquidity, proactive risk management, selectively growing assets in businesses that are well positioned to increase economic profit, continuing to manage for value in those businesses that have lower economic profit profiles and managing down positions in riskier lines of businesses.  At the same time we continue to invest for the future and we are not seeking to maximise short-term profitability at the expense of longer-term sustainability at this point in the cycle.

Adjusted operating profit (IFRS basis) was down five percent to R8,800 million with headline earnings down three percent to R5,765 million. Basic earnings grew by six percent to R6,410 million (2007: R6,025 million). Diluted headline earnings per share (EPS) decreased by two percent from 1,429 cents to 1,401 cents. Diluted EPS grew seven percent from 1,454 to 1,558 cents, driven largely by the R622 million after-tax profit on the sale of Visa shares in the first half of the year.

Nedbank's return on average ordinary shareholders' equity (ROE), excluding goodwill, decreased from 24.8 percent to 20.1 percent. ROE dropped from 21.4 percent to 17.7 percent for the year. These declines were caused by slightly lower headline earnings, mainly as a result of increasing Retail impairment levels that reduced the return on assets, together with higher capital levels as capital adequacy ratios increased during 2008.

Credit quality deteriorated throughout 2008 with Nedbank Retail's impairments worsening significantly, while the Wholesale banking portfolios showed a moderate deterioration in the second half of 2008.  Overall impairments have increased, although the impact on earnings was partially offset by controlled cost growth. The momentum built from disciplined cost management over the past few years continued into 2008 and contributed towards the efficiency ratio improving from 54.9 percent in 2007 (54.3 percent excluding Bond Choice) to 51.1 percent in 2008 and the 'jaws' ratio growing to 7.5 percent (2007: 6.9 percent).

We continued to see a steady inflow of customer deposits, resulting in Retail deposits growing in line with Retail advances. Pressure on short-dated maturities has been partially alleviated by market expectations of decreasing interest rates and a strategy of increasing deposit duration, particularly in the second half of the year. Given our domestic focus and small foreign funding requirements (foreign deposits are 1.3 percent of total Nedbank deposits), our funding and liquidity levels have remained sound with limited impact from the global financial crisis.

Net interest income (NII)

NII grew 14 percent to R16,170 million on the back of growth in average interest-earning banking assets of 23 percent. Nedbank's net interest margin for the year was 3.66 percent, down from 3.94 percent in 2007.  The positive endowment impact of interest rate increases on capital and current and savings accounts was offset by a number of factors including liability margin compression, reflecting the higher cost of term funding, and asset margin compression from a changing asset mix. Asset pricing continues to be a key focus for improving margins, with higher margins being generated on new assets. Further offsets include the cost of holding additional liquidity buffers deemed prudent in the current environment; and debits relating to the accounting for historic structured-finance transactions with related credits offset in taxation.

Impairments charge on loans and advances
The credit loss ratio increased from 0.62 percent in 2007 to 1.17 percent for the year. The growth in advances and the increase in the credit loss ratio are reflected in a 123 percent increase in the impairments charge from R2,164 million to R4,822 million. Retail credit loss ratios have deteriorated since June 2008 and remain above expected through-the-cycle levels, largely as a result of continuing increases in defaulted advances in the Nedbank Retail Home Loan and Vehicle and Asset Finance divisions. Wholesale banking credit loss ratios remain below expected through-the-cycle levels, although the credit loss ratio in Business Banking increased as expected. The credit quality in the Corporate and Investment Banking books remains good but is expected to be impacted by worsening credit quality in the year ahead, resulting in increased credit loss ratios on these books. Notwithstanding seasonal effects, the unsecured Retail portfolio reflected encouraging signs of improvement in the latter part of 2008.

Defaulted advances increased by 75 percent from R9,909 million to R17,301 million and total impairment provisions increased by 29 percent from R6,078 million to R7,859 million.

Non-interest revenue (NIR)
NIR, excluding Bond Choice's commission and sundry income from the 2007 base, grew by nine percent on a like-for-like basis. Total NIR (including Bond Choice in the 2007 base) increased by three percent to R10,729 million.

Commission and fee income grew by 14 percent on a like-for-like basis (five percent including Bond Choice), mainly from volume growth and transactional price increases. Cheque processing fees continue to decrease with the NetBank electronic banking system now implemented for all Business Banking clients and a process of migration initiated for Corporate Banking clients. Cash handling fees and transactional banking volumes grew strongly due to the growth in customer numbers, reflecting the success of Nedbank's strategy to increase delivery channels, improve customer service and strengthen brand positioning. The sale of Bond Choice reduced commission and fee income by R578 million.

Trading income increased by 16 percent from R1,334 million in 2007 to R1,553 million in 2008, reflecting good trading activity in the foreign exchange and global market businesses, although equity and debt trading both had a disappointing year. Adjusting for the loss in the first six months of 2007 in respect of the Macquarie business alliance, trading income would be at similar levels year-on-year.

The sharp fall in equity markets resulted in historic unrealised gains in mark-to-market private equity positions reducing. In spite of these challenging markets Nedbank managed to record a positive NIR of R303 million from its private-equity portfolios on the back of revaluations, realisations and dividend income.

Expenses

Nedbank continues to invest in its franchise while maintaining a disciplined approach to expenses. Despite high inflation and the increased distribution footprint, expenses continued to be tightly controlled, increasing by two percent to R13,741 million (2007: R13,489 million).  On a like-for-like basis, excluding Bond Choice, expenses increased by five percent.

Taxation

The taxation charge decreased by 25 percent from R2,336 million in 2007 to R1,757 million. The effective tax rate decreased from 26.3 percent in 2007 to 21.6 percent, mainly due to a reduction in the corporate taxation rate in South Africa from 29 percent to 28 percent, a change in tax legislation impacting investments held in private equity portfolios and increase dividend income.

Non-trading and capital items

Income after taxation from non-trading and capital items increased from R104 million in 2007 to R645 million for the year. The main contributions were the R622 million after-tax profit on the sale of Visa shares and the R15 million profit on the sale of 33.5 percent in Bond Choice. 

Capital adequacy
Nedbank has strengthened capital ratios significantly, with a Tier 1 capital adequacy ratio of 9.6 percent (December 2007: 8.2 percent pro-forma Basel II) and a total capital adequacy ratio of 12.4 percent (December 2007: 11.4 percent pro-forma Basel II). These ratios are now above the Group's historic target ranges. The core Tier 1 capital adequacy ratio was 8.2 percent (December 2007: 7.2 percent pro forma Basel II). Nedbank currently holds a surplus of R9.5 billion against its regulatory capital adequacy requirements.

Advances and deposits

Total assets increased by 16 percent to R567 billion (2007:R489 billion). Growth in average interest-earning banking assets slowed to 23 percent (2007 growth: 29 percent).  Advances increased by 16 percent, reflecting ongoing growth in Nedbank Corporate but slower growth from Nedbank Retail and a drop in advances in Nedbank Capital. Nedbank Capital's client loan book grew strongly, but this growth was more than offset by a reduction in the advances in the trading portfolio. Imperial Bank showed strong growth through most of the year.

Overall deposits increased by 21 percent from R385 billion to R467 billion at December 2008, with higher interest rates increasing demand for savings and investment products.

Despite strong growth in Retail funding, deposit growth was still largely concentrated in the Wholesale market.  Management has remained focused on optimising the funding mix and profile of the Group through utilising alternate funding sources, concentrating especially on the Retail and Business Banking deposit bases, while pricing competitively for term deposits.

Nedbank's liquidity remains sound. The impact of the global financial crisis on South African markets has, to date, been largely limited to an increased cost of international funding as a result of the reduction in international liquidity. This decreased the bank's ability to access such funding and has led to an increase in the cost of - and decrease in appetite for - capital market debt. Given Nedbank's domestic focus, international funding has traditionally not been a large portion of the Group's funding base, while the increase in the pricing of capital market debt has increased the cost of rolling over conduit paper and new subordinated-debt issues, with volumes issued in this market also being lower.  

During 2008 Nedbank successfully issued hybrid debt, raising R1.75 billion. In addition, to diversify the funding base, raise further foreign funding and lengthen the bank's existing funding profile Nedbank issued foreign syndicated club loans of $165 million and €165 million; registered a $2 billion European medium-term note (EMTN) programme; obtained a $100 million credit line from African Development Bank; and continues to focus on the Retail deposit base through competitive products and pricing.

Key performance indicators

The global economic crisis and cyclical downturn in the South African market prevented Nedbank from achieving some of its medium-term targets. The fact that it still met its targets relating to efficiency ratio, capital adequacy ratios and dividend cover reflects the conservative and risk-averse stance it has taken in these challenging times.

Marketing

Nedbank supported its positioning as a bank for all through soccer sponsorship and expanded further into the mass market by locating over 60 percent of all new ATMs and branches in previously under-serviced areas. It continues to be the most affordable bank at the lower end of the market as a result of fee cuts in 2005 and 2006.

To attract more deposits, it launched a new deposit account for individuals and small businesses Park-It, offering extremely competitive interest rates and short-term accessibility.

Nedbank's positioning as a caring brand is important to its commercial success. It continued to demonstrate this aspect of the brand through its Local Heroes programme - through which it supports causes that its customers and staff are involved in - and its Ask Once service promise ('You only have to ask once. The person you talk to will take responsibility for ensuring your request is resolved').

Customer service

Initiatives such as the Nedbank Retail Ask Once service promise are helping to position Nedbank as a leader in customer service. To ensure that it is equipped to deliver on its promises, it has employed Client Management Assessment Tool (CMAT) methodology since 2006. This framework allows it to benchmark its capability against some 700 other organisations using CMAT worldwide, and to identify and address weaknesses. In 2008 its CMAT scores remained in the top quartile for financial services companies worldwide and for the second year running Nedbank was ranked number one among South African banks for customer service in the 2008 Ask Afrika Orange Index.

The move to a more decentralised decision-making process in Business Banking is also being appreciated by customers: customer satisfaction surveys showed upward trends in relationship quality and loyalty.

Principal risks and uncertainties

The appropriate level of capital for a bank is a function of its strategy, individual risk appetite and risk profile.  This aligns with one of the key objectives of Basel II which is to differentiate capital requirements and capital buffers above the regulatory minimum, to reflect the unique risk profile on a bank-by-bank basis, rather than following the 'one-size-fits-all' approach that Basel I engendered.

Nedbank has cultivated and embedded a prudent and conservative risk appetite, primarily focused on the basics of banking in southern Africa. This is illustrated by reference to a number of factors including having neither direct exposure to US sub-prime credit assets nor associated credit derivative transactions and having conservative credit underwriting practices which have culminated in a high-quality, well-collateralised Wholesale book and further tightening of credit criteria in our Retail book since 2007 in anticipation of the economic downturn and resulting from the introduction of the National Credit Act. We have reasonable credit concentration risk levels in relation to the South African market, with counterparty credit risk being restricted to non-complex, vanilla banking transactions. We have a strong, well-diversified funding deposit base (including a strong retail deposit franchise) and limited offshore funding, low securitisation risk exposure compared to global banks, low leverage ratio compared to global banks and higher ratio of risk-weighted assets to total assets ratio than that of peers, indicative of our appropriately conservative measurement of risk.  In addition, we have a low level of assets and liabilities exposed to the volatility of IFRS fair value accounting, our small market trading risk in relation to total bank operations, we have a low interest rate risk in the banking book and we have low equity (investment) risk exposure, having successfully completed our non-core asset disposal strategy in 2007. We have low currency translation risk and an optimal offshore capital structure.  Our earnings streams across our full commercial banking activities are well-diversified and our well-diversified subordinated debt profile has maturities of existing Tier 2 regulatory capital until 2011. We undertake comprehensive stress and scenario testing to confirm the adequacy of our capital ratios and accompanying capital buffers.

Against this background, we believe that capital levels (both regulatory capital and internal capital assessment, based on economic capital) and provisioning for credit impairments are appropriate and conservative, and that Nedbank and its subsidiaries are appropriately capitalised relative to our business activities, strategy, risk appetite, risk profile and the external environment in which we operate. Additionally, Nedbank is currently not holding excess capital for acquisitions.

Outlook for 2009

The global financial crisis and resultant recessionary conditions will place more pressure on an already slowing domestic economy. Weaker international trade, lower commodity prices and continued volatility on major financial markets are expected to restrict corporate activity. Consumer finances are likely to remain strained as a result of continued pressure on disposable income, falling asset prices, increasing unemployment and the weaker rand. Lower economic activity is also placing increasing strain on corporates.

Further interest rate cuts are anticipated during the course of 2009. The benefits of these would be expected to impact positively on the South African banking environment only in 12 to 18 months' time.  In the short term the decrease in interest rates will have a negative endowment effect on banking interest margins, while impairments are likely to continue to deteriorate.

Priorities for 2009

• Focus on liability growth and the bank's strong depositor franchise
• Slow down growth in advances and focus on more profitable business
• Increase capital levels to the top end of the target ranges
• Price for risk and increased cost of funding
• Refine credit and risk parameters
• Focus on growing primary customer and transactional income
• Strengthen cross-selling
• Emphasise smart cost management
• Stay agile and alert to opportunities.

2.3 MUTUAL & FEDERAL

Old Mutual plc owns 74 percent of Mutual & Federal Insurance Company Limited (Mutual & Federal), whose shares are publicly listed on the JSE.  

Mutual & Federal is one of the leading insurance companies in southern Africa, providing tailored short-term insurance services to the personal, commercial, corporate and agricultural markets in South Africa, Namibia, Botswana and Zimbabwe.  The business has three main portfolios: Commercial, Personal and Risk Finance. The Commercial portfolio comprises Large Corporate, Credit and Agricultural accounts.

Markets and products

Mutual & Federal offers insurance products and advice to individual and corporate customers, mainly via brokers. Our professional and highly experienced brokers offer customers personal service and advice on purchasing policies, and practical assistance with claims.

Commercial

The Commercial portfolio provides comprehensive insurance services - including domestic and export credit risk, insurance against property, accident, marine, engineering, liability and motor risks and crop insurance services - to a diverse range of customers for small-and medium-sized businesses to large corporations.

Personal

The Personal portfolio provides domestic household, motor, and all-risks short-term insurance products to individual customers through white-labelled intermediary-branded and in-house products. One of our in-house products, Allsure, offers comprehensive cover by combining homeowners, household goods, personal accident and motor insurance into one policy.  The portfolio also offers hospital cash plans and personal accident policies. For the budget end of the personal market it offers policies covering livestock and informal dwellings.

Risk Finance

The Risk Finance portfolio has a significant position in the South African market. It continues to enjoy a positive profile within the industry and is one of the largest suppliers of risk financing solutions in Africa, providing all types of alternative risk transfer products.

Market overview

The southern African short-term insurance market remained competitive during 2008. There was strong growth in the direct channels, driven by individuals' and small companies' growing preference for dealing with direct channel insurers. Broker-based insurers lost business to this channel, albeit more slowly than in previous years. Growth in the overall insurance market was reduced by a slowdown in economic activity, particularly in the sale of new motor vehicles. Lower sales of furniture and other luxury items meant that the personal market in particular did not keep pace with inflation.

Overall underwriting returns reduced slightly for the third year running, after the record levels achieved in 2004 and 2005. Although current levels have allowed participants to deliver satisfactory returns overall, a number of sectors of the industry remain substantially underrated. Significant remedial measures and rate increases are required to return these portfolios to profitability and it is hoped that 2009 will see a return to responsible underwriting standards.

The motor books of most broker-based insurers have been either unprofitable or marginally profitable, and correction of the motor book remains a strong challenge for insurers. An increase in the number and severity of large corporate fires has made this portion of every insurer's portfolio unprofitable: fire risks remain underrated and correction will be required in 2009.

Strategy for growth

Our vision is to be the strongest and most successful short-term insurer in our chosen markets. These include all classes of general insurance except those that carry long-tail claims liabilities. To achieve this, we are focusing on profitability while pursuing growth through new and existing markets and channels, new regions and acquisitions, and new products.

We remain committed to continued development of the intermediary channel and the further development of relationships with brokers.

We will continue to focus on our key financial targets of sustaining a long-term average underwriting ratio of five percent and delivering a return on capital above 20 percent, while maintaining service excellence to intermediaries and policyholders. To enhance underwriting profit we will apply responsible underwriting standards in setting rates commensurate with risks. We will be rigorously disciplined in managing expenses and will carefully control claims costs through strict monitoring and management of the claims supply chain. The operational improvements following the restructuring of operations during 2008 will help us meet these goals.

Performance in 2008

Profits impacted by financial turmoil in the investment environment negatively impacting investment returns 
Adjusted operating profit (IFRS basis) declined following the lower underwriting margin, but was partially offset by the impact of a higher LTIR. This added R57 million to our Adjusted operating profit. The profit attributable to equity shareholders declined 117 percent, primarily as a result of a reduction in the value of listed equities. The underwriting surplus for the year declined by 18 percent but the 2007 result was positively impacted by the release of R96 million from reserves following refinements to estimation methods. Without this adjustment, underwriting profit increased by 11 percent. Although there were further increases in the frequency and severity of industrial fire claims in the first half of the year, trading conditions improved during the second half. This, together with corrective measures on the underperforming group schemes portfolio resulted in satisfactory levels of underwriting profitability being achieved for the full year. Gross premium income declined by two percent as growth in the commercial portfolios was offset by the cancellation of a number of personal group schemes and a contraction in the risk finance portfolio.

Investment income reduced sharply during the year following a decline of approximately 27 percent in the value of listed equities which was in line with the JSE. Whilst dividend income declined slightly, interest income increased strongly as a result of higher levels of cash holdings during the year and higher interest rates.

Restructuring undertaken during the year

During the year Mutual & Federal undertook a substantial restructure to promote customer service and operating efficiency. Staff numbers declined by more than 600 as a result of the restructure and R55 million in retrenchment costs were paid. A further non-recurring expense of R147 million was incurred from the closure of a channel development project. This project was undertaken to seek growth opportunities from a number of different channels but was prudently abandoned when it proved to be too ambitious and ill-timed.

Solvency margin in the target range

As a result of the decline in the value of investments, the net asset value per share declined by 13 percent during the year to R10.92 at 31 December 2008. The solvency margin (being the ratio of net assets to net premiums) declined to 41 percent at 31 December 2008 but remains in the target range adopted by Mutual & Federal.

Marketing

Our business restructuring aimed to provide better service to customers, more customer-facing sales staff and cost efficiencies that allow us to price more competitively. We have been working to make significant inroads into specialist insurance markets, and appointed two new underwriting agencies specialising in classes of business that we had previously not underwritten. We appointed a new advertising agency, which also took over the Company's PR function. An entirely new advertising strategy has been devised with the intention to enhance Mutual & Federal's brand profile in the market. Work began on refreshing the Company brand for launch in 2009 and 2010.

We also established a dedicated team to grow our share of the growing black consumer market.

Customer service

A specific goal of the business restructuring was to enhance customer service and shorten turnaround times for settling claims and issuing policies. New business processing systems introduced in 2008 are moving us rapidly towards becoming paperless, and in 2009 a state-of-the-art underwriting system will further enhance our service levels.

Principal risks and uncertainties

There are two main risks and uncertainties facing the business. The first is operational risk and the second is a credit risk item. Operational risk arises from the introduction of a new computer system across all operations and branches taking place in 2009. A smooth transition and introduction of the new operating environment is critical to the future profitability and success of the business, to the degree that some business may be lost if the conversion fails. While the re-insurance panel of the Company is graded on average 'A' and above (Standard and Poors), the failure of a re-insurer could cause significant solvency strain and going-concern problems to the business.

Outlook for 2009

The impact of the turmoil experienced at the end of 2008 in Europe and the United States is expected to be felt in South Africa in 2009. Economic growth will be challenged as commodity prices continue to fall. This will further dampen South African consumer spending in 2009 and inevitably inhibit growth in the short-term insurance industry. While Government infrastructure spending and the anticipated 2010 FIFA Football World Cup may provide some growth opportunities, much of this business is inadequately rated and will decline. As consumers are stretched, we are unlikely to see meaningful growth in existing personal portfolios.

If commodity prices stay low the local currency will remain weak, particularly if the Reserve Bank follows the example of Europe and the United States with aggressive interest rate cuts. Any decline in the value of the rand threatens to increase claims costs because of the large imported component in motor vehicles and replacement plant and equipment.

Despite these factors, we remain committed to producing underwriting profits in 2009 and, although the economic downturn may subdue growth, our streamlined structure should provide us with a competitive advantage.

Priorities for 2009

• New products and exploration of alternative distribution channels and emerging markets
• Profitable premium growth; cancel persistently unprofitable portfolios
• Evaluate opportunities in the direct insurance market, where we do not currently compete. Growth in this market has outpaced the broker-based market in recent years, and margins are higher as direct insurers can select risks more rigorously and apply policy conditions more strictly
• Achieve operational efficiencies through new business processes and technology: our new systems and revised structure should significantly reduce the cost of delivering products and time taken to implement new products
• Improve employee satisfaction and realise significant transformation in the workplace
• Rejuvenate the brand to meet the challenges of the current and future markets.

3.0 NORTH AMERICA

Our activities in North America span annuities, life insurance and asset management.

Headquartered in Baltimore, US Life offers a diverse portfolio of annuities and life insurance products distributed through agents across the United States. Old Mutual (Bermuda), part of US Life, is an offshore business that develops and distributes investment products to non-US customers in a variety of markets around the world. US Asset Management, based in Boston, comprises 20 investment boutiques offering high-quality, actively managed investment products in all the major asset classes and investment styles for individual and institutional customers.

3.1 US LIFE

Our US Life business consists of two businesses: US Life onshore, and our offshore, Bermudan, business. They serve different customer groups, offering different products to each as detailed in the relevant sections below.

We entered the US life insurance market in 2001 by acquiring several established insurance companies, the largest being Fidelity and Guaranty Life Insurance Company (now OM Financial Life Insurance Company). Our Bermudan business enjoys a progressive regulatory environment. Bermuda is a major offshore financial centre with a reputation for high quality business. It offers a well-developed legal framework, providing certainty and effectiveness in accordance with international standards of best practice and offers a highly sophisticated infrastructure with efficient banking, trust, investment, accounting, custodial and legal services.

Performance in 2008

Decrease in funds under management driven by unprecedented equity and credit market movements

Despite the turbulent markets, net client cash flows were four percent of opening funds under management. Funds under management ended the year at $20.7 billion, down 14 percent from the opening position primarily due to a 21 percent decrease in the market value of funds under management. The net unrealised loss on the fixed income portfolio increased by $2.3 billion to $2.6 billion and Old Mutual Bermuda (OMB) variable annuity separate account asset values decreased by $2.4 billion. The market value decrease was mainly the result of widening credit spreads in the bond markets and dramatic declines in global equity markets.

Sales driven by variable annuities

Total life sales on an APE basis were $519 million, down 23 percent from 2007. Sales by OMB were the largest contributor to APE. However as a consequence of the high cost of guarantees in the volatile environment, we withdrew products during the year and therefore the OMB sales in the last four months of the year were significantly lower.

Fixed indexed annuity sales, down 40 percent from 2007, were affected by difficult market conditions. However, fixed annuity sales of $60 million were up 216 percent from 2007, following the industry trend as customers seek fixed interest guarantees during this period of extreme equity market volatility and economic instability.

Value of new business (VNB)

VNB reduced by $185 million in 2008 compared to 2007, with a margin of negative 23 percent compared to nine percent in 2007. The decrease in margin was mainly due to (a) the reduction in swap rates which reduces the investment returns relative to guaranteed minimum crediting rates in US Life onshore; and (b) the additional provisions for non-modelled risks and higher guarantee costs in respect of the offshore variable annuity business.

Review of reserving basis

We continually monitor our assumptions and make adjustments based on experience as appropriate. During 2008 we lowered the mortality assumption for life contingent single-premium immediate annuities (SPIA), which increased the IFRS reserve and reduced embedded value. We modified the expected lapse rates for deferred and indexed annuities to reflect higher expected surrenders when the contracts exit the surrender charge period, which resulted in the unlocking of a portion of deferred acquisition costs (DAC). We also included a non-performance risk factor in discount rates used to determine the indexed annuity embedded derivative liability and the variable annuity guaranteed minimum accumulation benefit (GMAB) liability, which decreased the liabilities. Finally, we updated the variable annuity GMAB assumptions related to fund indices, mortality, free partial withdrawal utilisation, services fees and volatility, which resulted in a net decrease in the liability.

Underlying adjusted operating profit (IFRS basis) results 

Adjusted operating profit (IFRS basis) decreased $874 million from the level at 2007 to a loss of $679 million for 2008. The 2008 loss reflects $436 million of additional mortality reserves related to life SPIAs, a $295 million charge in the fourth quarter for revisions to estimates of future gross profits which resulted in an 'unlocking' of the deferred acquisition cost asset (DAC), and $126 million of hedge losses related to variable annuity product guarantees. The latter was part of a total IFRS pre-tax and pre-DAC charge of $508 million relating to the variable annuity product with $382 million difficultiesing through the short-term fluctuations line.  

Difficult credit markets resulted in higher impairment losses and volatile equity markets increased the costs associated with the guaranteed benefits on our variable annuity contracts.

Market Consistent Embedded Value (MCEV) results 

Adjusted operating profit (MCEV basis) was significantly lower in 2008 than in 2007, mainly due to the large negative assumption changes made in 2008: strengthening of SPIA mortality reduced the VIF by $280 million, an increase in expense assumptions reduced the VIF by a further $291 million, and the strengthening of OMB GMAB reserves reduced the ANW by $126 million. Experience variances were also significantly adverse, due largely to higher than expected lapses and the impact of reinsurance deals which had been priced to be broadly cost-neutral on a real world basis. Other negative experience variances included lighter than expected SPIA mortality and an expense overrun, which resulted in the operating assumption changes already outlined.

Credit update

The markets finished the year on a slightly positive note, as credit spreads tightened from historical wide levels in November. Overall, the markets remained fragile as continued financial sector rescue and economic stimulus initiatives were required to boost economic activity and confidence. The recessionary environment projected for 2009-2010 depressed all market sectors. 

US Life's fixed income portfolio aggregate credit experience continued to be affected by poor economic and financial market conditions. For 2008, impairments total $768 million on 43 securities with three of the 43 being subprime asset-backed securities and another 15 indirectly linked to sub-prime or monoline insurer exposures. 3.4 percent of US Life's fixed income portfolio has direct exposure to sub-prime mortgage collateral. The majority of the sub-prime exposure remains highly rated but has experienced several ratings downgrades. Of sub-prime holdings at 31 December 2008, 67 percent was rated AAA, 80 percent AA and higher, 93 percent A and higher with an aggregate 68 percent fair value-to-book value ratio.  

Approximately 2.9 percent of US Life's fixed income portfolio has exposure to monoline insurers, of which $508 million (89 percent of the total exposure) is indirect (wrapped) exposure, with an 82 percent fair value-tobook value ratio, and $64 million is direct (unsecured) exposure, with a 56 percent fair value-to-book value ratio. The indirect exposures include $197 million of sub-prime asset-backed securities which are wrapped by monoline guarantees.

Many large, high profile financial firms suffered failures and regulatory interventions during the year, resulting in creditor losses, almost completely illiquid credit markets, dramatically wider credit spreads and lower bond prices in all sectors. In line with other US insurers, our fixed income portfolio aggregate credit experience and current unrealised loss position have been affected by these events and market conditions. US Life's fixed income portfolio recorded impairments of $237 million in the fourth quarter of 2008, contributing to total impairments of $768 million for the 2008 year. The main components of this were public fixed income security losses principally in respect of Washington Mutual ($78 million), Lehman Brothers ($50 million), three foreign financial institutions ($98 million), several structured securities ($165 million), three monoline insurers ($38 million) and losses on preferred stocks ($225 million) of which Freddie Mac and Fannie Mae was the majority ($151 million). US Life's net unrealised losses on the fixed income security portfolio was $2.6 billion at 31 December 2008 reflecting the market-wide repricing of credit spreads and continuing fallout from the sub-prime mortgage crisis. Actual defaults on our corporate bonds for the year were $158 million resulting in a default rate of approximately 1.3 percent on our corporate bond portfolio. The value of our US investment portfolio at 31 December 2008, after recognition of these impairments, totalled $20,347 million.

3.1.1 US LIFE ONSHORE

Our US Life onshore business consists of OM Financial Life Insurance Company and its subsidiary, OM Financial Life Insurance Company of New York. US Life's fixed income investments are managed by our US Asset Management business on a commercial basis. The majority of its administrative functions are outsourced to third-party service providers.

Markets and products

Implementation of our core product strategy was completed by the beginning of 2009. We have pared back the range of fixed annuity products we offer and stopped selling seven life products and our US variable annuity product, to focus our range on indexed annuities, fixed annuities including immediate annuities, and protection products such as indexed universal life and mortgage term life. These are designed to deliver higher profitability while providing customers with transparency and value-driven benefits.

Fixed indexed annuities (FIAs)
Our FIA product has been rated in the top five of its US product segment by LIMRA International for most of the past few years. It guarantees 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. The potential equity index upside is hedged using equity index options and futures, enabling us to provide the potential for gains while managing exposure to loss of principal.

Fixed annuities

Under these fixed-rate contracts we invest in a portfolio of bonds 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.

Protection products

We offer two principal protection product lines: term life protection and fixed indexed universal life products. These provide flexible life assurance protection in the event of death or disability. Quick underwriting turnaround times and the introduction of product features such as return of premium benefits enabled these products to maintain market share in 2008 despite the rapidly declining housing market. The indexed universal life designs specialise in providing supplementary retirement income options for customers who use preferred loan features on a tax advantaged basis.

Our products are distributed through various channels. The majority of sales are generated through established groups of managing general agents (MGAs) who typically offer agents a range of annuity and life assurance products from various providers.

Market overview

Although the economic downturn has hit sales of high net worth and middle market products, US life insurance remains a fundamentally attractive market with significant prospects. Demographic and economic changes (increasing life expectancy and earlier retirement) will continue to generate new customers and new needs and to increase the average time people spend in retirement. The Baby Boomer generation represent a huge opportunity for the next 20 to 30 years as they head towards retirement and look for products with income and risk management features. While discretionary spending is likely to fall in 2009, 75 percent of middleincome consumers see life insurance and retirement savings as necessary.

US sales of individual annuities continued at a record pace in 2008, reaching $197.1 billion through the first three quarters. Variable annuities were down 18 percent on the previous year but fixed annuity sales rose dramatically, up 46 percent. Traditional fixed annuities saw the most dramatic increases (81 percent) while fixed indexed annuity gains were more modest (five percent).  

Most fixed annuities are sold through independent agents and banking channels, but the channel mix is changing: bank sales in 2008 increased by 90 percent from the previous year while sales through independent agents increased by only 16 percent.  

Although demand for the guarantees offered by insurance products is growing, the capital available to support them is not. This has led many significant insurance industry players to apply to buy regional banks so as to qualify for Troubled Asset Relief Program (TARP) funds. The difficulties insurance companies face in hedging guarantees has led many to restructure their products by repricing them and simplifying product features.  

There is a push for federal regulation of the insurance business to assure 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 expense (upfront cost and new business strain) involved.  

A regulatory change 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 licences.

Strategy for growth

We are well placed to take advantage of current demographic trends and are striving to develop innovative product solutions, deliver strong investment performance and enhance our retail presence. 

In the fourth quarter of 2008 we launched a major transformation initiative to improve profitability and dramatically reduce our cost structure. We streamlined product offerings to focus on profitable core products, and revised sales targets downwards to achieve capital management and profitability goals.

The cost structure was re-engineered for lower sales volumes, with specific action to consolidate locations, comprehensively restructure the organisation and reduce headcount. With these changes made, the business is on a better footing to tackle the challenges ahead in 2009.

Performance in 2008

We are focused on transforming and scaling our business to improve performance by drawing back to reduced volume but more profitable sales, lowering new business capital strain and reducing operating expenses while creating a more efficient foundation for potential future business growth.

The key focus will be on the successful implementation of the business transformation strategy. The new product profile will be less capital intensive through streamlining the current product portfolio and eliminating unprofitable lines. The sales strategy will centre on core distribution partners to produce more effective relationships. In addition to the consolidation of locations and reduced headcount, a strong expense discipline will be employed throughout the organisation. We will embed a risk management framework that reinforces a conservative risk culture into the business operations.  

An additional capital injection of $225 million was made in February 2009 to US Life onshore from the Group to maintain the Risk Based Capital in line with the operating target. The total capital injection for 2008 and early 2009 was $325 million, resulting in a RBC ratio of 305 percent.

Marketing

Throughout 2008, US Life collaborated with US Asset Management in a drive to make Old Mutual a household name in the US. Targeting key distribution segments, prospective partners and, for the first time, consumers, this integrated approach significantly increased visibility with the target audiences.

The two business units also teamed-up on several high profile sponsorships including the 2008 Tavistock Cup, 2008 Masters Champion Trevor Immelman and all the Triple Crown Thoroughbred events. These events doubled as hospitality opportunities for our key distribution partners, affiliates and strategic partners -and we achieved significant efficiencies by building milestone and planning meetings into the event timetables.  

A US Life roadshow, which visited over 30 cities, allowed leaders from the sales and compliance areas to demonstrate best sales practices, dos and don'ts, suitability examples and motivational techniques. It attracted higher attendance by existing and prospective distributors than the previous two years' roadshows.

Customer service

A service platform that fosters exceptional customer experiences is the foundation for attracting and retaining customers.

Our 2008 operational initiatives aimed to provide an experience' rather than merely service for customers calling our service centres. Competitive benchmarking studies show that service levels have improved on average by 17 percent since 2007. Our reputation for treating all customers professionally and fairly continues to improve, and we are confident that this will aid the growth and retention of customers. At the same time, we continued to improve our monthly unit costs in respect of our one million in-force policyholders.  

As part of enhancing the services we provide to our MGAs, we implemented online self-service capabilities for key distribution partners, allowing them to aggregate data from our systems and present a consolidated portfolio for their customers. Our distribution partners can now also contract and license new agents electronically via our secure internet portals.

Principal risks and uncertainties

US Life onshore is exposed to a number of risks, including the attraction and retention of key staff during the business restructure, retaining the capital required to meet target risk-based capital levels, funding and meeting product guarantees, and asset liability management, including the need to maintain sufficient liquidity to protect the bond portfolio from crystallising losses in the current volatile market. In addition, defaults, downgrades or other events impairing the value of our fixed maturity securities portfolio may reduce our earnings. Changes in market interest rates may significantly affect our profitability and a downgrade in our financial strength or credit rating could result in a loss of business. A further decline in equity markets or a sustained increase in volatility may adversely affect sales of our investment products and our profitability.

Outlook for 2009

Despite the economic conditions we remain optimistic about our core products, which offer customers guarantees, flexibility and transparency as we work with them to meet their risk and retirement needs.  

Experience in previous recessions suggests that this economic downturn may have only a limited effect on sales in the life industry. During the last recession, total new premiums for individual life insurance dipped but were trending upward again before the recession ended.  

We expect traditional insurance sales to small businesses to be strong as companies recognise the need for asset protection and indemnification and look for simpler solutions to meet their objectives.  

We will continue working proactively to improve capital efficiency and investment portfolio performance. Measures to do this include the defensive restructuring of the asset portfolio, reducing the concentration of exposures to corporations in recession prone sectors, reducing financial credit exposures, upgrading commercial mortgage-backed security and sub-prime portfolios and increasing treasury and liquidity balances.

Priorities for 2009

• Continue the transformation of the business
• Maintain current risk-based capital levels, aided by the streamlined and less capital-intensive product profile
• Focus sales strategy on core distribution partners to build more effective relationships
• Consolidate locations, reduce headcount, and maintain strong cost discipline throughout the organisation
• Embed into the business a risk management framework that reinforces a conservative risk culture
• Continue to concentrate on the most appropriate markets and distribution channels to create a foundation for future growth.

3.1.2 OLD MUTUAL (BERMUDA) LIMITED

Old Mutual (Bermuda) Limited (OMB) provides investment products to international, non-US and non-US resident customers seeking a wide range of investment choices including fixed rate accounts and international mutual funds quoted in US dollars. A significant attraction for customers is the fact that the assets are held in segregated accounts and the investment plans are held within a trust structure outside their own country.

Our core competency lies in building and developing relationships with large financial institutions, meeting their needs by providing innovative and competitive products on an open-architecture platform.

Markets and products

We distribute through over 70 institutions, primarily international banks, as well as serving a range of private and institutional customers in over 150 countries. As a leading and innovative provider of investment products for international banks' high net worth and affluent customers, we focus on developing customised products. Customisation generally involves tailoring a proprietary product to each distributor's branding guidelines, giving it the look and feel of the institution's own products.

The current product mix comprises three investment plans:

• 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. The 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 percent of the amount invested. The plan provides investors with 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. The plan enables investors to diversify by allocating into multiple guarantee periods.

Market overview

Record low levels of consumer and business confidence are creating a difficult operating environment with consumers switching their investments away from equity-based products into safer deposit options. Weak equity markets, lower bond yields and higher volatility have reduced variable annuity (VA) profitability in the marketplace - highlighting that companies have not been effectively hedging all risks associated with associated guaranteed rider products.

The largest unhedged risk that companies providing such products are facing is that of policyholder behaviour. As expected, there has been an increase in the use of guaranteed withdrawals to help distressed customers meet their cash needs.

Lower equity markets and yields, coupled with increased hedge costs, are likely to lead to significant changes to VA pricing and product design. This could significantly change the competitive landscape and weaken overall consumer demand. Trust needs to be rebuilt through leadership, with a clear focus on delivering the right products to meet changing market needs.

Strategy for growth

While falling asset values and actions to de-risk the existing book have adversely affected sales and funds under management in the short-term, we believe our open-architecture platform and distribution capability place us in a strong position for the future.

We have a number of strategies for building our market presence and enhancing profitability. We aim to rebuild distribution with a more customer-centred focus on increasing sales to institutions. Increased use of index funds and fixed income options, as well as the introduction of asset allocation and/or volatility controlled funds, will enable effective hedging and help us to provide cost-effective guarantees. Our newly developed multi-currency capability will allow customers to invest in currencies other than the US dollar, and we are introducing products specifically designed to meet retirement needs. We are also undertaking a range of cost management initiatives.

During the year, continuing market volatility and significant strengthening of the US dollar led to further increases in guarantee reserves in respect of variable annuity contracts. In 2008, we recognised a total loss in respect of this business of $508 million, of which $126 million was recognised in adjusted operating profit. Cash of $582 million was transferred to OMB during 2008; it now has a significant excess to the minimum Bermuda regulatory capital requirement.

The Universal Guarantee Option (UGO), launched in January 2007, was an optional benefit connected to the Universal Investment Plan (UIP). It provided a Guaranteed Minimum Accumulation Benefit (GMAB), guaranteeing that the policyholder's account value would grow by at least five percent over five years (i.e. if the fund is below 105 percent of the initial premium, we would 'top it up') and by 20 percent over 10 years. There was also in some cases a Highest Anniversary Value (HAV) guarantee on death and/or maturity. The UGO was withdrawn from the Hong Kong book in May, and from the rest of the market on 15 August 2008.

The death and living benefit guarantees, which are embedded within the variable annuity products issued by OMB, mean that OMB bears the risk associated with market downturns. In addition, since the guarantees are defined in US dollars but are backed by funds that are invested in foreign currency denominated securities, OMB bears foreign currency exchange risk in connection with these exposures. The funds backing the guarantees are not directly hedgeable, and therefore linear combinations of liquid market indices are used to proxy the return of every fund in a technique known as fund mapping. For effective hedging, the correlation between the funds and the chosen set of hedgeable indices should be as high as possible.

The turbulent economic conditions and failure to fully hedge certain risks, coupled with hedge ineffectiveness, meant that the cost of providing the guarantees increased substantially in 2008. This resulted in swift and decisive action in the second half, including senior management changes, the withdrawal of the UGO, strengthening of governance and risk management practices, the adoption of more conservative assumptions, implementation of improved fund mapping and the launch of the 'Accelerated Universal Guarantee Option (UGO)' offer.

Improved fund mapping has enabled us to have a much clearer understanding of our exposures in terms of the guarantees we have offered. Whilst it is not possible to eliminate risk entirely, we have been able to improve significantly hedge effectiveness, from around 75 percent measured over the full year, to around 92 percent in the fourth quarter of 2008. We have also taken action which has given us a better understanding of the sensitivity of our reserves to changes in the underlying markets. As a general guidance: a one percent decrease in equity markets results in a loss of approximately $10 million; a one percent strengthening in the US dollar results in an adverse impact of around $4 million; and a one percent parallel increase in volatility costs approximately $15 million.

Better asset and liability management of the margin and bank accounts was instituted in the fourth quarter of 2008 to help increase yields, reduce counterparty exposure and minimise unintentional currency exposure. As market turmoil increased worldwide, we introduced 24-hour monitoring and trading in October 2008 to improve our reaction time. We enhanced our valuation methodologies to ensure assets and liabilities are calculated on a consistent basis, reducing unnecessary profit and loss volatility. A new product development process has been implemented, which includes the sign-off of products by the Group Chief Actuary, as well as the sign-off of the hedging strategy and hedge cost by the Chief Investment Officer and risk tolerance by the Chief Risk Officer.

Many customers who had opted for UGO guarantees had seen their initial investments fall substantially as a result of market falls. In November we offered to accelerate these guarantees for direct customers i.e. excluding the Hong Kong book, on which OMB is the reinsurer). The offer was to restore their account value to 85 percent of their initial investment, less any subsequent redemptions. In return, all guarantees would be terminated and the associated fees would no longer be charged. In little over three weeks, 14 percent of policyholders receiving the offer accepted. This was a further step in de-risking the business. It resulted in a cash payout of $94.5 million, and a release of reserves of $133.4 million.

We also delivered significant operational improvements, including the development of a multi-currency facility and the implementation of process improvements that will substantially eliminate breakage (costs arising from a mismatch in the pricing contractually agreed with a customer and the actual price achieved, resulting from inefficiency of systems and/or processes).

Looking forward, further action will be taken on a number of fronts, including restructuring the business to further improve governance, risk management and accountability; further de-risking the existing book through improved hedge performance and regular monitoring of fund performance and the soft closing of funds that exhibit poor hedging characteristics. Further action will also be taken in the development of new investment and insurance products that meet customers' needs, such as Shariah compliant funds and guaranteed funds based on quoted indices, asset allocation models or volatility-controlled funds that facilitate effective hedging.

Marketing

We continue to target international bank customers interested in wealth accumulation, wealth preservation, estate planning and trust management, primarily through our relationships with global banks and financial intermediaries.

We are also committed to serving the needs of our distribution partners: partnering with them enables us to deliver our promise of creating innovative products aimed at meeting the needs of international investors.

Customer service

We made major service improvements during the year, including the enhancement of websites catering for seven languages, and the offshore hosting of our production web portal in Geneva.

Having confronted the challenges of 2008 we are able to return to our global bank partners who have, themselves, been addressing the consequences of the global economic crisis with new offerings that provide the security of confidential investment in a wide selection of underlying assets. One of the benefits of our approach is that accumulated investments can be passed on from generation to generation, with guarantees that can be delivered whatever the economic environment.

Principal risks and uncertainties

OMB is primarily exposed to risks which include basis risk, being the risk that customers' investments in the underlying mutual funds underperform relative to the liquid market indices used to hedge the exposure, or the assumptions as to currency exposure prove to be inaccurate; and credit risk in connection with its fixed account assets. Another risk is an increase in the cost of hedging as a result of increased market volatility. OMB does not currently hedge volatility, but would look to hedge on a strategic basis, should this be deemed appropriate. One further risk is that of further reductions in terms of fee income should the value of the assets under management upon which the company earns fees continue to fall.

Outlook for 2009

In 2009, we aim to rebuild our position as a leading distribution platform while maintaining high levels of customer service.

A return to more normal market conditions and the launch of a range of new hedgeable products will underpin a good recovery in profitability, although we still expect some modest volatility in earnings in the medium term.

Priorities for 2009

• Restructure to further improve governance, risk management and accountability
• Further de-risk the existing book through better hedge performance, supported by improved fund mapping, regular monitoring of fund performance and the soft closing of funds that exhibit poor hedging characteristics
• Develop new investment and insurance products that meet customers' needs, such as Sharia-compliant funds and guaranteed funds based on quoted indices, asset allocation models or volatility-controlled funds, which facilitate effective hedging.

3.2 US ASSET MANAGEMENT

We have built a significant asset management business in North America through acquisitions as well as strong organic growth over the past seven years. We have created an environment in which unique, entrepreneurial asset management boutiques can thrive.  

US Asset Management, based in Boston, consists of 20 distinct boutique firms, including asset managers who specialise in high-quality, active investment strategies for institutional customers, high net worth individuals and retail investors around the world. Our boutiques are located mainly throughout North America, with two in London. Dwight Asset Management, a fixed income manager, is the largest with 27 percent of total funds under management. Barrow, Hanley, Mewhinney & Strauss, a value equity manager accounts for 19 percent and Acadian Asset Management, an international equities firm, holds another 18 percent. Over time, the size rankings within the business may change, depending on the market environment and investment styles in favour at the time.

Collectively, we offer over 100 distinct investment strategies. Individually, each boutique has its own vibrant, entrepreneurial culture and capabilities focused on its own area of expertise.

Our structure combines the investment focus of boutique managers with the stability and resources of a large, international firm. This delivers significant benefits - for example, offering a diversity of investment styles which minimises exposure to the changing preferences of investors. It provides the efficiency savings that come from central capabilities in product development, infrastructure and distribution. The boutiques themselves are free to focus on delivering strong investment performance and customer service. Most of the boutiques now operate under profit-sharing arrangements under which we pay them a percentage operating profit, after overheads and salaries. Long-term equity plans have also been implemented within most of them, with final implementation planned for 2009. This model differentiates us from competitors and the combination of profit-sharing and equity plans ensures that the interests of the boutiques are closely aligned with those of our shareholders and customers.

Markets and products

Institutional accounts

We offer actively managed investment products in all the major asset classes and investment styles. Our investment capabilities span US and global equities, fixed income, property and alternative asset classes. Separate accounts and actively managed commingled accounts are offered across a range of asset classes and investment strategies. We have been a pioneer in 130/30 and similar strategies that seek to enhance the alpha produced through active management. Several of our affiliates manage assets in this fastgrowing area for investors, where products typically command higher fees. Our customer base is now diversifying, with a significant proportion of our net client cash flows coming from investors outside the US.

Retail accounts

The Old Mutual Advisor Funds offered through our retail distribution arm (Old Mutual Capital) allow individual investors access to institutional-quality management in a mutual fund format.

We offer individual mutual funds in a wide range of asset classes and investment styles. Funds are offered as single-strategy mutual funds, or alternatively as diversified asset allocation funds under the Pure Portfolio brand. We currently offer single-strategy mutual funds in US equities, fixed income, international equities, emerging markets, property investment trusts and money markets. In addition, we offer multi-strategy funds that draw on the capabilities of our boutiques as well as those of selected outside managers.

Market overview

The current market environment presents significant challenges for the asset management industry. Earnings pressure exists across the industry due to the steep drop in asset levels resulting from depressed global markets. Few indexes have remained positive and most of the major indexes have had negative three- and five-year returns as a result of 2008 market performance. A general lack of confidence and liquidity continues to inhibit recovery.

Investment firms with undiversified portfolios, heavy equity weightings or performance fees with high thresholds are the most susceptible to earnings pressure. A significant number of asset management firms restructured during the fourth quarter of 2008 to alleviate anticipated margin pressure. But many are wary of cutting deeper than necessary in the short term and so risking their market positioning for the next wave of growth.

Competition in North America is strong, and each of our boutiques faces significant competition from other specialist providers. The differentiating factors between firms are often investment performance and product capabilities. Our investment managers have a record of excellent long-term performance, and by applying the diverse styles of our individual firms we can target new investment opportunities to broaden our product offering.

The significant losses incurred by investors as a result of hedge fund strategies are prompting pressure for tougher regulation of the asset management industry. The new US Presidential Administration is expected to push for a significant overhaul of the US financial regulatory framework. As a result, fringe strategies and non-transparent hedge strategies are experiencing great market pressure - which presents opportunities for traditional asset management models to gather assets and institutionalise alternative offerings for clients.

Strategy for growth

We are focused on optimising the multi-boutique investment management model to deliver high-quality investment solutions to our customers, grow profitably and deliver exceptional returns to shareholders. Our business is well placed to take advantage of market, demographic and other related trends as we continue working to develop innovative products, deliver strong investment performance and grow our business. We continue to maintain expertise in sourcing, cultivating and integrating investment talent and capabilities within our business. We have also concentrated effort on delivering thought leadership in product development, packaging and distribution while enabling our investment professionals to focus on investment management and delivering superior investment results for customers.

Performance in 2008

Investment performance strong through a difficult investing environment
Aggregate long-term investment performance from our boutiques remained strong. Over three years, 53 percent of institutional assets had outperformed their benchmarks and 54 percent of institutional assets were ranked above the median of their peer group over the trailing three-year period. These numbers represent significant improvement from the third quarter and demonstrate that our affiliates' disciplined investment processes, based on sound valuation and business fundamentals, continue to deliver for clients. 

Net flows and funds under management impacted by market turbulence 
Net client cash flows for the year were a solid $1.5 billion. Including securities lending at Dwight Asset Management, which we suspended in the third quarter, total outflows were $5.2 billion. Given the difficult market conditions and the net outflows being experienced across the industry, our result for the year was encouraging and compares favourably to our peers. Our track record of investment performance coupled with our diverse multi-boutique model positions us well to continue to attract net inflows despite the current market climate. 

Funds under management ended the year at $240.3 billion, a 28 percent decrease from 2007. $89 billion (96 percent) of the reduction was due to negative market returns. Our diversified asset mix helped to lessen the impact with fixed income and alternatives being less volatile and uncorrelated in periods of market instability. Such asset classes represented over half of the total funds under management at year end. On 1 July 2008, Rogge Global Partners acquired ING Ghent, which contributed $1.5 billion to funds under management during the year.

Retail sales challenges
Like most of our competitors, retail sales faced a challenging year in 2008. OMAM UK unit trust sales and Old Mutual Capital mutual fund sales for the year were $1.1 billion and $831 million, respectively, down a combined $1.9 billion (50 percent) from 2007. At 31 December 2008, 12 of Old Mutual Capital's mutual funds carried four- or five-star rankings by Morningstar, and we remain confident in the competitiveness of the underlying products we offer.

Adjusted operating profit (IFRS basis) down 44 percent
Adjusted operating profit for the year was down 44 percent from 2007. The decrease was primarily a result of lower management fees as well as performance fees, both of which were negatively impacted by the volatile markets. In addition, while we recorded $11 million in realised gains on seed investments in 2008, we also recorded $35 million of unrealised losses in adjusted operating profit. The operating margin, which is calculated inclusive of minority interest expense, also declined from 2007. Actions were taken to reduce costs across the business in the fourth quarter, and we remain committed to managing expenses through the current operating climate.

Continued focus on product development and distribution

We remain committed to the delivery of unique and innovative investment options. Recent product focus has included asset allocation and risk-adjusted return objectives which have positioned us well in the current market environment. Specifically, we recently launched Old Mutual Target Plus Portfolios, the only target retirement mutual funds with three risk-specific asset allocation strategies. These funds enable Old Mutual to capitalise on the trend of target date funds as retirement plan default options.

To capitalise on the movement of asset flows towards both global and alternative products we launched the following strategies: Copper Rock International Small Cap Growth (managed by a newly acquired team), Barrow Hanley International Value, Thompson Siegel & Walmsley Global Equity, Acadian Emerging Market Debt, 2100 Managed Futures, and 300 North Capital Long/Short.

In addition to our continued focus on product quality we have begun to build out the next generation distribution model adding several new team members covering Alternatives, Defined Contribution Investment Only, and Wall Street and Global Distribution. This is an example of our commitment to grow the business and bring in talented experienced people to serve the evolving needs of our customers.

Marketing

In addition to partnering with US Life on a number of sponsorships, we hosted industry events showcasing our boutiques' investment capabilities in key market areas. We hosted a 130/30 conference in February to showcase several of our boutiques and emphasise our leadership in this field. We also continued to seed new investment strategies to broaden our capabilities in areas of high demand and support continued growth.

Customer service

Our boutiques enhanced their customer service and took extra steps in communicating with customers during the market volatility. The success of these efforts is evident in our net client cash flows relative to our peers.

Principal risks and uncertainties

The broad market downturn had, and will continue to have, an impact on the US asset management business (OMAM). The exposure to current market fluctuation continues to impact assets under management, revenues and earnings targets, thereby affecting our ability to execute against the overall business strategy. In addition, given activities over the last year, there is a high likelihood of regulatory reform across the financial services industry. In aggregate, these factors create an environment that could result in OMAM facing continuing pressure on earnings as well as higher than normal levels of litigation and reputational risks.

Outlook for 2009

We see good potential both in the US and globally.  Difficulties within financial institutions have created a significant opportunity to attract investment talent within the US. Market volatility also creates opportunities for managers to provide outperformance for customers at a time when the gap between the top and bottom quartile performers has widened.

Before the current market difficulties, client cash flows were driving asset allocation decisions towards international, global and alternative strategies. We believe these trends will continue in 2009, but many customer searches have been halted given the recent volatility. Search activity should return with client cash difficulties as the volatility in the financial markets subsides, but customers will remain wary. They will put a premium on companies that are truly institutional in quality and offer effective risk management, continuity of staff, strong ownership structures, transparency of investment process and longevity of performance.

Until global equity markets recover, our earnings growth will be restricted. However, our investment track record has positioned us well relative to competitors, and our diversified asset mix will continue to help us weather market volatility.

Priorities for 2009

• Maximise the value of the multi-boutique portfolio and maximise its value by delivering consistently high quality investment performance and retaining assets with consistently active management
• Maintain a co-ordinated strategy aimed at managing the portfolio of companies to meet the changing demands of the market
• Continue to build on existing global success by sharing best practice in managing boutique investment firms and driving greater global distribution for our existing boutiques
• Continually energise excellence in our distribution and customer service model by supporting the boutiques' distribution efforts; augment those efforts for products - such as investment-only defined contribution - or distribution channels that are not easily serviced by traditional institutional asset management firms
• Continue to diversify the core of our business, which is based in institutional asset management, by sourcing investment teams and firms, identifying new distribution channels and creating innovative products
• Achieve all this within a framework of strong financial and capital management focused on cost management, prioritising efficient capital spending, and our seed capital programme.

4.0 ASIA

The Asia region consists of operations in two countries, China and India, which are managed through joint ventures. In 2008 the region also included operations in Australia but in March 2009 Old Mutual announced the sale of its Australian businesses.

4.1 ASIA

China

Our business in China, Skandia: BSAM is a 50:50 life insurance joint venture established in 2004 with the Beijing State-Owned Asset Management Company (BSAM). It provides retail unit-linked assurance solutions for high net worth individuals and operates in Beijing, Shanghai, Jiangsu Province and Guangdong Province. Distribution is exclusively through third parties including banks, securities houses and brokers.

India

Kotak Mahindra Old Mutual Life Insurance Ltd, our joint venture with Kotak Mahindra Bank (one of India's leading financial services groups), was established in 2001 and is expanding rapidly. It has nearly 200 branches in 142 cities across India and more than 5,500 employees. It sells predominantly unit-linked investment policies and offers a complete range of traditional life assurance products. We currently own a 26 percent stake, with an option to increase this to 48 percent when legislation permits.

In July 2008 we established an office in Bangalore to support the development of wealth management and asset gathering opportunities in India under the Old Mutual brand.

Markets and products

China

In China, we sell retail unit-linked and universal life products through banks and independent advisers. We continue to expand our distribution footprint, geographically as well as by channel, and are broadening our product range.

India

Kotak Mahindra Old Mutual Life Insurance offers a full range of assurance products although, in common with the rest of the industry, most of its sales over the past few years have been unit-linked investment products. It distributes through multiple channels - a large tied-agency force, exclusive bancassurance relationships with local banks, and other alternative and direct channels.

Market overview

China

China's economy is already the world's second largest in terms of purchasing power parity. A number of studies have already predicted that Asia, particularly China, will significantly outpace the rest of the world in growth in GDP and power consumption. A recent Economist Intelligence Unit study forecast that by 2020, China's economy measured at purchasing power parity exchange rates will be on a par with the US and Asia's overall share of the global economy will rise to 43 percent from about 30 percent today.

China's industry assets under management (AUM) grew by 5.2 percent over the final quarter of 2008 to RMB1.94 trillion after three consecutive quarters of double-digit declines. This was however, well below the 2007 year-end AUM of RMB3.27 trillion.

India

India has one of the world's fastest growing economies, achieving over 8.5 percent GDP growth in both 2006 and 2007. In terms of purchasing power parity, it is the fourth largest global economy. It has a large and growing middle to upper income population and well-developed money, debt, foreign exchange and equities markets.

The Insurance Amendment Bill, which would increase the foreign direct investment limit from 26 percent to 49 percent, has already been introduced to Parliament - although its adoption remains uncertain.

Funds under management across the industry have shown compound annual growth of 47 percent over the past five years - consistently outgrowing the stock market index, indicating a significant difficulties of funds into the mutual fund industry. 

Strategy for growth

Our strategy in Asia aims to maximise the performance and potential of our existing businesses and to seek new opportunities to extend our portfolio in India and the Greater China region.

Our existing businesses in India and China are making good progress but are still young and, like all start-ups, have some ground to cover before becoming significant contributors to the Group's overall profitability.  

In India, we increased our KMOM business branch network with 197 branches now open across the country compared to 106 in 2007.

Performance in 2008

Results impacted by current market conditions 

A combination of stock market volatility and increased competition resulted in tough business conditions for the year. Sales and net client cash flows were disappointing with total outflows of £1.6 billion, primarily as a result of the lower equity markets and the impact of large institutional client redemptions in Australia. Funds under management reduced accordingly, partially offset by the strengthening of local underlying currencies against sterling.

We incurred an adjusted operating loss (IFRS basis) for the year of £17 million. This was largely due to lower revenues which were impacted by weakened sales and significant market value depreciation caused by the market downturn. Non-recurring expenses relating to the new regional office set-up and the inclusion of costs for new initiatives contributed to the higher operating losses.

Marketing

Skandia:BSAM established a three-year branding strategy and launched a new investment education brand - SWV (Skandia Wealth Vision). We produced our first TV commercial for China. We enhanced the Company's brand influence and set up distribution marketing, investment marketing and product marketing functions which gave great support to both internal communication and external business. Following the Sichuan earthquake in 2008 we made a substantial donation to the affected areas.

Customer service

Throughout 2008, we won awards for customer service and staff engagement. In September we were recognised as one of the 10 Best Industrial Employers in China and in early December we were rated among the top five in the CIRC's 2008 Life Insurance Customer Satisfaction Survey.

Principal risks and uncertainties

As uncertainties in market and economic conditions persist, the market downturn may continue to impact on the growing economies of emerging markets. The Chinese local regulator, CIRC, has placed stricter regulations on the distribution of unit-linked products and has also suspended all new branch openings, new products and funds, placing further strain on business performance. Given that some of our businesses or investments in the region are with joint venture partners, our challenges remain on managing risks through adequate representation on the relevant boards, audit committees and working reports from internal and external auditors.

Outlook for 2009

Although we believe there is good long-term growth potential in the Asia Pacific region, we have decided for the foreseeable future to scale back our aspirations for this area. We have therefore reached an agreement to sell our Australian businesses (Skandia Australia and Intech Investments) and intend to rein back our expansion plans to focus on our established businesses in India and China.

Priorities for 2009

Continue to support organic growth of our existing businesses in China and India

Seek to distribute more Old Mutual products in India and capture a greater share of total assets under management

Evaluate opportunities to extend our portfolio in the Greater China region.

GROUP FINANCE DIRECTOR'S STATEMENT

'The Group has a sound capital footing and we are well placed to withstand the risks to which our business is exposed. Each of our businesses has sufficient capital to continue writing new business and growing according to its current plans.' (Philip Broadley, Group Finance Director)

Funds under management held up well during year of market volatility 

During 2008, Old Mutual delivered robust investment performance in challenging markets. Although net client cash flows were negative overall, we produced positive flows of £3.2 billion in our Skandia businesses and £0.1 billion in our combined South Africa businesses.  However, these were offset by outflows in our US and Asia Pacific businesses. Excluding the outflows due to a cessation of securities lending which one of our US Asset Management affiliates suspended during the year, net client cash flows were £2.4 billion for the year.  The result is pleasing, considering the challenges of delivering on absolute investment performance in the extremely volatile markets in 2008. This is demonstrated through our closing funds under management, which held up well in the year overall, down five percent to £264.8 billion, in a period when markets such as the FTSE 100, the JSE Africa All Share Index and S&P 500 all fell more than 25 percent.

Breadth of sales product offering in diverse geographic markets 

Overall life sales on an APE basis held up well, supported by our businesses in Nordic and South Africa. We continued to see the benefits of our investment in the Nordic sales channel, where life APE sales were up 30 percent in local currency.  South Africa life sales were up 14 percent in rand terms.  

However in the US, sales were constrained, down 23 percent in local currency. UK and Offshore sales were disappointing, down 19 percent, with single-premium sales being impacted by the market conditions mainly through lower pension sales.

Southern Africa unit trust sales were up an impressive 46 percent in local currency with investors moving to lower risk money market funds, but declines in unit trust sales in all other regions more than offset these gains due to the ongoing tough market conditions

Value of new business

The value of new business (VNB) was down 55 per cent to £104 million but excluding US Life, at negative £66 million, was down 15 percent for the year on a like-for-like basis. Excellent volumes in Nordic and a strong contribution from OMSA were offset by lower volumes in the UK, ELAM and US Life. The APE profit margin was six percent. The margin was steady in the UK and South Africa compared with 2007, but down marginally in Nordic and to a greater extent in ELAM, where it fell to six percent mainly due to lower volumes and a change in product mix. The US Life margin was negative because of a reduction in the margin of variable annuities as a result of increased guarantee costs and the exclusion of capitalised corporate bond spreads in the Old Mutual MCEV methodology.

Adjusted operating earnings (IFRS basis) Adjusted operating profit for the year held up in most regions with good contributions from our African, European and US Asset Management businesses, however, profits were adversely impacted by adjustments in our US Life businesses. Credit markets remained under stress at the end of 2008. Following review of our asset portfolio we impaired a total of £414 million, of which £28 million affected the 2008 adjusted operating profit as the total impairments are amortised over five years through adjusted operating profit. We are reviewing this policy for US Life and expect to move to an 'expected return' approach for impairments from 2009 onwards.

We also reviewed our deferred acquisition costs balances and accelerated amortisation by £159 million for the combined US Life businesses. Further, in our onshore business we stopped selling the single-premium immediate annuities (SPIA) block of business and made a £235 million adjustment in respect of additional mortality reserves where we have increased our life expectancy assumption to over 90 years. Finally in our offshore business we incurred a charge of £68 million which reflects the inefficiency of hedge mapping. A further charge of £206 million was made below the line which reflects market volatility, in line with standard industry practice.

Rand currency depreciation substantially contributed to lower earnings however, this was partially offset by US dollar, Euro and Swedish Krona strengthening and in total the Group delivered adjusted operating profit before tax and minority interests 38 percent below 2007 and 36 percent below on a constant currency basis.  

Assuming constant exchange rates, 2007 adjusted operating EPS would have been 16.4p with the currency impact being negative 0.5p. Financing costs increased over 2007 mainly due to foreign exchange as the sterling value of non-sterling-denominated debt payments increased. Other shareholders' expenses principally comprise head office costs.

Taxation

The Group's effective adjusted operating profit (IFRS basis) tax rate decreased to nine percent from 26 percent in the comparative period. This tax rate is anomalously low due to the unprecedented market conditions in 2008 coupled with a reduced adjusted operating profit which magnifies the rate effect of any adjustment. The reduction in the tax rate is due to a number of factors.  These include releases of tax provisions as a result of the closing of issues being agreed with tax authorities, consistent levels of tax exempt dividend income now representing a greater proportion of the reduced adjusted operating profit, the effect of the different basis of taxation of life tax companies, non-taxable foreign exchange gains, reduction in tax rates and more profits being earned in lower taxed jurisdictions and the utilisation of previously unrecognised deferred tax assets. These factors were partially offset by increased secondary tax on companies' charges and a decreased adjusted operating profit, non-recognition of deferred tax assets arising in US Life and adjustments in respect of prior periods.

In the longer term, it is expected that the tax rate would tend to return to the 2007 level.

Return on equity

Return on equity for the Group declined to 9.0 percent in 2008 from 13.2 percent in 2007, primarily due to losses from the US Life businesses. This contained some very satisfactory performances from our South African businesses where OMSA achieved a return on allocated capital of 27.8 percent, Nedbank a return on equity (excluding goodwill) of 20.1 percent and Mutual & Federal achieved a return on capital of 33.9 percent.

Shareholders' equity

Throughout the year, shareholders' equity remained steady with retained profits and foreign exchange gains on consolidation being offset by unrealised losses in the US Life businesses and the payment of dividends.  

Old Mutual Market Consistent Embedded Value (MCEV)

The Market Consistent Embedded Value Principles (the 'Principles') were published in June 2008 by the CFO Forum, a group representing the Chief Financial Officers of major European insurers, and compliance with these Principles is mandatory in 2009. These Principles provide a framework intended to improve comparability and transparency in Embedded Value reporting across Europe. Old Mutual plc has published European Embedded Value (EEV) results since 2004.  The Principles have been fully complied with for all businesses as at 31 December 2008, with the exception of the use of an adjustment of 300 basis points in the risk free rate due to current market conditions for the US Life onshore business. This adjustment reflects a liquidity premium as at 31 December 2008, and has been determined after reviewing published and proprietary literature and data relating to corporate bond spreads within the US Life corporated bond portfolio.  The Group has replaced the EEV basis with the MCEV basis for the covered business and figures for 31 December 2007 have been restated accordingly, and comply fully with all of the Principles. The MCEV supplementary information provides details on the methodology, assumptions and results of the MCEV for the Old Mutual Group in accordance with the disclosure requirements of the Principles and includes conversion of comparative supplementary information for 2007, previously prepared on the EEV basis, to a MCEV basis.  

The impact as at 31 December 2007 of moving from an EEV to a MCEV methodology is a reduction in Embedded Value of the covered business of 7.5 percent from £6,861 million to £6,349 million. Within the European and southern African businesses, the aggregate allowance for risk within the EEV and MCEV approaches is broadly aligned and hence relatively minor impacts were experienced on these businesses when moving from an EEV to a MCEV approach. Most of the reduction in Embedded Value was attributable to the United States business which decreased by 57 percent from £1,069 million to £462 million. For this business the aggregate allowance for risk under EEV is not aligned with the requirements under the Principles and a number of factors contribute to the difference in approaches as explained in detail in the supplementary information.  However, it should be noted that compared to EEV reporting, MCEV reporting merely changes the timing of recognition of profits and not the ultimate profitability that will emerge on covered business.

Adjusted Group MCEV per share 117.6p 

The adjusted Group MCEV per share was 117.6p and adjusted Group MCEV was £6.2 billion at 31 December 2008 (31 December 2007: 166.3p and £9.0 billion respectively). The 48.7p decrease in adjusted Group MCEV per share was driven by the fall in equity markets and the impact of lower global interest rates and higher volatility which increased the cost of policyholder financial options and guarantees.

Return on Group MCEV

Return on Group MCEV declined to 7.8 percent from 13.7 percent at 31 December 2007. The lower adjusted operating MCEV earnings in 2008 were the net effect of higher earnings in the South African and European life businesses driven by positive operating assumption changes and the reduction in the number of shares following the share buy-back programme, offset by lower new business contributions, adverse persistency, higher financial guarantee costs, hedge losses and impairments in the United States, impairments in Nedbank and lower asset based charges in the asset management companies.

Capital position

The Group's gearing level remains within our target range, with senior debt gearing at 31 December 2008 of 4.0 percent (2.0 percent at 31 December 2007) and total gearing, including hybrid capital, of 26.7 percent (21.2 percent at 31 December 2007).

Capital requirements are set by the Board, taking into account the need to maintain desired credit ratings and to meet regulatory requirements at both the Group and local business level.

Our share buy-back programme announced at the beginning of October 2007 was completed in May 2008.  A total of approximately 239 million shares were repurchased through the London and Johannesburg markets at a total cost of £351 million.

The Group is in compliance with the Financial Groups Directive (FGD) capital requirements, which apply to all EU-based financial conglomerates. Our pro-forma FGD surplus was in excess of £0.7 billion at 31 December 2008. The FSA requirement is to maintain a positive surplus at all times. Sensitivities to market movements, although not linear, are that a one percent fall in South African rand against sterling is broadly equivalent to a £14 million reduction in FGD, a one percent gain in the US dollar against sterling is broadly equivalent to a £4 million fall in FGD and a one percent fall in the JSE is broadly equivalent to a £4 million decline in FGD. The level of defaults, impairments and realised losses in our US corporate bond portfolio also impact on the FGD surplus. We improved the pro-forma FGD sensitivity to the dollar since our Q3 Interim Management Statement as a result of hedging activities undertaken.

Unrealised losses

In our US Life onshore business, as at 31 December 2008, 97 percent of our investment portfolio is cash, government backed or investment grade securities of triple B and higher. Concentration risk is low as the top ten holdings account for 5.5 percent of the portfolio.

The portfolio is well-matched since the assets have an average duration of 6.0 years against an average duration of 5.9 years for the liabilities. US Life's net unrealised losses increased over the year to £1.8 billion at 31 December 2008 reflecting the market-wide re-pricing of credit spreads and other risks which do not relate to specific factors within the US Life portfolio.  The unrealised losses account for 13 percent of our total portfolio on an IFRS basis. We have the ability and we intend to hold these fixed income securities to maturity, which in economic terms limits the impact of the current market dislocation.

We have adopted the reclassification amendment to IAS 39 and have elected to classify around 150 securities from the 'available-for-sale' category to the 'loans and receivables' category as at 1 July 2008. This is on the basis that the securities in question are no longer regarded as being traded in the active market. For 'available-for-sale' investments, the securities are re-valued and the unrealised losses are accounted for in shareholders' equity whereas for 'loans and receivables' no revaluations are recorded.

Holding company net debt

Total net debt within the holding company at the end of 2008 was £2,263 million. A total of £1,138 million of operational and capital receipts were received from business units during 2008. £565 million was invested in the businesses and £353 million was used to pay the 2007 final and the 2008 interim dividend. In addition, £175 million was spent on repurchasing shares during the year. Other movements of £298 million mainly reflect a positive impact of the marking to market of our debt liabilities.

Risks and uncertainties

There are a number of potential risks and uncertainties that could have a material impact on the Group's performance and that could cause actual results to differ materially from expected and historical results. 

We have included our view of these principal risks as well as the impact of current economic and business conditions in the Business Review sections of this report. The current economic conditions create uncertainty particularly over the future levels of world equity markets, defaults in corporate bond portfolios, particularly in the United States, currency fluctuations, demand for the Group's products and other economic factors. These uncertainties have been considered individually and in combination in the Group's forecasts and projections, taking account of reasonably possible changes in trading performance and economic conditions in the markets in which the Group operates.  The results show that the Group should be able to operate within the level of its available credit facilities and with an adequate level of capital, both at a Group level and within each of its major regulated Group entities.  To the extent that changes in trading performance and economic conditions prove to be more severe than thought reasonably possible, the Group has evaluated and concluded on feasible management actions that would be possible in such circumstances so as to ensure adequate levels of liquid and capital resources are maintained.

The Group continues to meet Group and individual entity capital requirements, and day-to-day liquidity needs through the Group's available credit facilities.  The Company's primary existing revolving current facility of £1.25 billion does not mature until September 2012.  

The Board of Directors has the expectation that the Company and the Group have adequate resources to continue in operational existence for the foreseeable future. Accordingly, they continue to adopt the going concern basis in preparing the financial statements contained with this announcement.

Related party transactions

There have been no related party transactions or changes in the related party transactions described in the Company's latest Annual Report during 2008 that could have a material effect on the financial position or performance of the Group.

Philip Broadley

Group Finance Director

4 March 2009

 

END

 

 

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