Final Results

CHESNARA PLC - PRELIMINARY RESULTS FOR THE YEAR ENDED 31 DECEMBER 2007 Strong cash generation supports 22.4% final dividend increase 3 April 2008 Chesnara today reported final results for the twelve months to 31 December 2007. The Group is committed to offering shareholders an attractive long-term income stream arising from the profits of its closed life assurance business. * Profit before tax on IFRS basis increased by 11% to £27.7m (2006: £25.0m) * Earnings per share on IFRS basis increased by 32% to 24.32p (2006: 18.41p) * On EEV basis profit before tax reduced to £6.4m (2006: £30.6m). After adjusting for non-replicating items post-tax result is comparable at £12.1m (2006 adjusted: £12.0m) * Significant reduction in mortgage endowment complaints allows provision release of £2.8m * Shareholder Net Equity on EEV basis (pre-proposed dividend payment) now £187.3m (31 December 2006: £189.1m) * Life company solvency ratio strong at 179%, post dividend (31 December 2006: 205%). Group solvency ratio, post dividend, increases significantly to 312% (31 December 2006: 225%) * Final dividend increased by 22.4% to 9.85p (2006: 8.05p) * Total dividend for year increased by 15.3% to 15.1p (2006: 13.1p) * Board remain confident about ability to deliver reliable and progressive future dividend flows * Search for value adding acquisition opportunities continues * No direct exposure to credit market issues Graham Kettleborough, Chief Executive said: 'An increase in dividend for the full year of 15.3% demonstrates the strength of our commitment to shareholders to produce a progressive and reliable dividend stream. We continue to pursue acquisitions, both in the life assurance sector and in related areas of the broader financial services market. Whilst a number of opportunities have been carefully considered, we will only act where we see value for shareholders. We believe the current dislocation of the credit and wider financial services markets will lead to further opportunities for us to consider. A 22.4% increase in the final dividend reflects our confidence in the future as we continue to balance the opportunities we see in potential acquisitions against the needs of shareholders. We continue to look to the future with some optimism.' The Board approved this statement on 2 April 2008 Enquiries Graham Kettleborough Chief Executive, Chesnara plc 07799 407519 Michael Henman Cubitt Consulting 0207 367 5100 Notes to editors: Chesnara plc, which listed on the London Stock Exchange in May 2004, is the owner of Countrywide Assured plc ("CA"). CA is a life assurance subsidiary that is substantially closed to new business. In June 2005 Chesnara acquired City of Westminster Assurance ("CWA") for £47.8m. With effect from 30 June 2006, CWA's policies and assets were transferred into CA plc. Chesnara's operating model is to maintain a relatively small governance team and outsource the majority of its back office functions. Chesnara continues to seek acquisition opportunities in the financial services sector. FINANCIAL HIGHLIGHTS Year ended 31 December 2007 2006 IFRS basis Operating profit 28.8 26.5 Financing costs (1.1) (1.2) Loss on sale of subsidiary company - (0.3) --------- --------- Profit before income taxes £27.7m £25.0m ========= ========= Basic earnings per share 24.32p 18.41p Dividend per share 15.1p 13.1p Shareholders' net equity £125.8m £114.3m ========= ========= European Embedded Value basis (EEV) Operating profit 9.7 15.0 Investment variances and economic assumption (3.3) 15.6 changes --------- --------- Profit before tax 6.4 30.6 Tax 5.7 (4.4) --------- --------- Profit for the period* £12.1m £26.2m ========= ========= Covered business Shareholder net worth 77.6 84.5 Value of in-force business 94.0 109.9 --------- --------- Embedded value 171.6 194.4 Acquired embedded value financed by debt (12.4) (16.6) Shareholders' equity in other Group companies 28.1 11.3 --------- --------- Shareholders' equity on EEV basis £187.3m £189.1m ========= ========= Life annual premium income (AP) £102.3m £113.4m Life single premium income (SP) £32.0m £54.8m Life annualised premium income (AP + 1/10 SP) £105.5m £118.9m In contrast with the IFRS basis of reporting, the EEV basis recognises the discounted value of the expected future cash flows, arising from the long-term business contracts in force at the year end, as a component of shareholder equity. Accordingly, the EEV result recognises, within profit, the movement in this component. Investment variances and economic assumption changes for the year ended 31 December 2006 are stated net of a £0.3m loss arising on the sale of a subsidiary company. * Profit for the year ended 31 December 2006 includes non-replicating items of £14.2m. CHAIRMAN'S STATEMENT Background Chesnara was listed on the London Stock Exchange in May 2004. Originally formed to become the holding company of Countrywide Assured plc on its demerger from Countrywide plc, in June 2005 it acquired City of Westminster Assurance Company Limited, a further closed life assurance company, the long-term business of which was transferred to Countrywide Assured plc on 30 June 2006. Countrywide Assured plc now manages a portfolio of some 205,000 life assurance and pension policies and is substantially closed to new business. It writes a small amount of Guaranteed Bond and protection business and accepts top-ups to existing contracts. As a substantially closed book it is expected that the embedded value of the business will decline over time as the number of policies in force reduces and as the surplus emerging in the business is distributed by way of dividends. As the portfolio runs off, the regulatory capital supporting it may also be reduced and returned to shareholders. Chesnara continues to seek to acquire similar businesses in order to meet our primary objective of delivering a steady and attractive dividend yield. Review of the Business With the recent lack of acquisition opportunities in the closed life sector in our target value range of £50m to £200m, we have, during 2007, concentrated primarily on enhancing shareholder value in the existing business. However, as the business matures the opportunity for this reduces and we have therefore also invested management time in reviewing other potential value-enhancing opportunities in the financial services sector. During the course of the year we examined a number of such opportunities. In two instances we were satisfied that, at the right price, the financial returns would complement the current business and enhance shareholder value. As such, indicative offers were made, neither of which resulted in a completed transaction. In the core business a number of our key business drivers have continued to demonstrate positive trends over the year. Our recent experience of mortgage endowment misselling complaints has been generally positive. The number of complaints has reduced significantly and an increasing proportion of those received are time-barred in line with FSA rules, while uphold rates on those complaints which are not time-barred have increased. Although we do not believe that this issue has fully run its course, we do feel able, however, whilst maintaining an element of conservatism, to reduce our redress provisions, by £2.8m, based on our revised expectation of future complaint activity. Policy lapse experience has also demonstrated better trends than we had anticipated and, whilst, with a view to future economic uncertainty, we have not significantly reset our baseline assumptions, the experience for the year adds £3.7m to our embedded value. Similarly, mortality experience has also proved positive overall, leading to a net addition of £1.5m to embedded value. As disclosed in our Interim Statement, we identified a data error in our then-existing unit pricing system. This resulted in over-deductions from our unit-linked funds for capital gains tax and we have initiated a project which has made restitution to the funds and which will recompense policyholders, in line with the principles of Treating Customers Fairly. The provision established at the half-year, net of anticipated recoveries from third parties, has been marginally increased by £0.2m to £2.5m (£1.8m net of tax) and the migration to a new unit pricing system in December has capped the compensation liability. We have taken the opportunity to review our longer-term expense assumptions and, consequently, a further reserve has been established which has reduced our embedded value by £2.5m. It is particularly pleasing that, in spite of the creation of the above compensation provision and future expense-related reserve, we are able to report a strong result on both the IFRS and EEV bases of reporting. On the IFRS basis we have posted a pre-tax profit of £27.7m for the full year ended 31 December 2007 compared with £25.0m for 2006. On the European Embedded Value ("EEV") basis of reporting, the Group recognises a pre-tax profit of £6.4m compared with £30.6m for 2006. Apart from the key influences set out above, the pre-tax result has been reduced by economic assumption changes just in excess of £4.0m. This adverse impact is almost wholly offset by the favourable impact of related changes to the estimated future liabilities for tax, which were further reduced by some £1.5m, being the effect of the prospective reduction in the rate of Corporation Tax from 30% to 28%. As a result the net-of-tax EEV profit for the period is £12.1m compared with £26.2m for 2006. The 2006 result included two non-replicating items of note: a tax gain of £10.7m arising on the merger of the Group's life businesses and the release of a reinsurer default reserve of £3.5m. Total shareholder equity, as stated on the EEV basis, pre-dividend appropriation, has reduced, albeit not as much as one might expect from the reduction in the underlying policy base, from £189.1m (£1.81p per share) at 31 December 2006 to £187.3m (£1.79p per share) at 31 December 2007. Countrywide Assured plc's post-dividend capital solvency ratio at 179% remains at a premium to the target set by the Board of 150%. It has reduced from 205% at the corresponding point last year due to significant dividend transfers to Chesnara. The Group's post-dividend solvency position has strengthened significantly from 225% as at 31 December 2006 to 312% as at 31 December 2007. Based on the strength of these results, together with the improvement in the capital solvency ratios the Board has decided, following consultation with a number of significant shareholders, to re-base the dividend and is, therefore, pleased to recommend a final dividend of 9.85p per share (2006: 8.05p per share), in respect of the year ended 31 December 2007, representing an increase of 22.4% over the final dividend for 2006. The resulting total dividend of 15.1p per share (2006: 13.1p) represents a 15.3% increase for the year. Outlook Experience in the key areas of mortgage endowment complaints and persistency has proved favourable with the added and welcome improvements in mortality. This leads the Board to continue to look to the future with some optimism. We remain aware of the importance of these issues, of the management of our outsourcers and of the maintenance of our clean regulatory position. During 2007 investment performance proved volatile and this has continued into 2008. Whilst we have no direct exposure to troublesome credit instruments we are to some extent affected by stock market weakness as it reduces future projected earnings and affects policyholder sentiment. Value-enhancing acquisition opportunities in the life assurance sector have been notable by their absence although we continue to pursue possible acquisitions, as we believe it is a matter of when, not if, companies will come to market. In addition we continue to seek other opportunities, in the wider financial services marketplace, which could leverage value from our existing capabilities. In common with many observers we expect opportunity to arise from the ongoing credit squeeze and we believe we are well placed, with our strong financial base, to be able to capitalise on this should the right opportunity arise. If there is no clearly superior investment alternative then the possibility of a return of surplus capital to shareholders will receive increasing focus. May I take the opportunity to welcome Peter Wright to the Board of Countrywide Assured plc. Peter retired as a Principal of Towers Perrin at the start of 2008 and, up to his retirement, he carried out the roles of Actuarial Function Holder and With Profits Actuary for Countrywide Assured plc. I look forward to the market insight and technical capability which Peter will provide in his new role. We believe we are well placed to fulfil our stated objective of continuing to deliver a reliable and progressive dividend flow and we wish to thank all our employees for their contribution to the Group in realising this aim. Christopher Sporborg Chairman 2 April 2008 OPERATING AND FINANCIAL REVIEW Basis of Accounting The Group reports primarily in accordance with International Financial Reporting Standards ("IFRS"). As IFRS essentially permits the "grandfathering" of the principles and bases used to measure profit arising on long-term insurance contracts under previously-adopted UK GAAP and, as the business of the Group predominantly relates to life contracts in run off, so the earnings profile of the Group will continue to be dominated by the underlying emergence of surplus in these businesses as measured for UK regulatory reporting purposes. The Group continues to provide financial information supplementary to the IFRS basis. With effect from reporting periods commencing on 1 January 2006, the Group adopted European Embedded Value ("EEV") principles as the basis for providing this supplementary information in lieu of the Achieved Profit ("AP") basis of reporting. AP and EEV methodologies are similar, insofar as both aim to measure the underlying embedded value of the Group's life assurance, pensions and annuity businesses. However, EEV principles provide a framework which is intended to improve the comparability and transparency of embedded value reporting across Europe. IFRS Result The following summarises pre-tax earnings information reflected in the IFRS Income Statement, showing, for the year ended 31 December 2007, the contribution from the constituent businesses of the Group. Amortis CA CWA Parent ation business business company of AVIF Total £000 £000 £000 £000 £000 Year ended 31 December 2007 Operating profit 18,566 12,674 1,071 (3,502) 28,809 Finance costs -- -- (1,089) -- (1,089) --------- --------- --------- --------- --------- Profit before 18,566 12,674 (18) (3,502) 27,720 income taxes ========= ========= ========= ========= ========= Year ended 31 December 2006 Operating profit 17,184 12,506 313 (3,502) 26,501 Finance costs - - (1,206) - (1,206) Loss on sale of (248) - - - (248) subsidiary company --------- --------- --------- --------- --------- Profit before 16,936 12,506 (893) (3,502) 25,047 income taxes ========= ========= ========= ========= ========= Notes (1) Financing costs arise in respect of a bank loan raised to part finance the acquisition of CWA. (2) Amortisation of Acquired Value In-Force (AVIF) represents a post acquisition charge to profits of the write down of the acquired value of CWA in-force business, as measured at the acquisition date. The pattern of amortisation is broadly intended to match the pattern of surplus arising from the run off of the underlying CWA insurance and investment contract portfolios. Overall, the result for the year ended 31 December 2007 reflects the continuing strong emergence of surplus in both CA and CWA, as the underlying in-force insurance and investment contracts run off. Positive investment performance in shareholder funds over the year, together with continuing favourable lapse and mortality experience, have led to both principal businesses posting results in excess of those for the year ended 31 December 2006, notwithstanding that: i. the in-force policy base is smaller; and ii. statutory expense assumptions relating to insurance contracts have been strengthened to take account of additional costs which may be incurred in the longer term. Within CA, this outcome has absorbed the net adverse pre-tax impact of £0.8m in respect of financial exposures comprising: i. a release of £1.7m in respect of the mortgage endowment misselling redress provision offset by ii. an additional provision of £3.0m for estimated redress to policyholders in respect of an error in the pricing of certain unit-linked funds which, net of estimated recoveries of £0.5m from third parties, results in a net charge to income of £2.5m. The CA result has also benefited, in comparison with 2006, from the fact that the result for that year is stated after a charge of £1.1m in respect of the amortisation of deferred acquisition costs relating to insurance contracts. There is no corresponding charge for 2007 as these costs became fully amortised during 2006. Within CWA, the result has benefited from a release of £1.1m in respect of its mortgage endowment misselling redress provision. The CWA result continues to make a significant contribution to Group earnings net of related parent company debt financing costs and of amortisation of acquired in-force value, both of which are identified in the table above. The pre-tax contribution from CWA, including the effect of these items, was £8m (£7.8m for the year ended 31 December 2006). The parent company operating profit comprises the return on invested retained funds which were at a significantly higher level in 2007 compared with 2006. EEV Result Supplementary information prepared in accordance with EEV principles and set out later is presented to provide alternative information to that presented under IFRS. EEV principles recognise profits as they are earned over the life of insurance and investment contracts and assist in identifying the value being generated by the life businesses. The result determined under this method represents principally the movement in the life businesses' embedded value, before transfers made to the Parent Company and ignoring any capital movements. As the Group's life assurance operations are now substantially closed to new business, the principal underlying components of the EEV result are the expected return from the business in force (being the yield at the risk discount rate on the related policy cash flows as they fall into surplus) together with (1) variances of actual experience from that assumed for each component of the policy in force cash flows and (2) the impact of resetting assumptions for each component of the prospective cash flows. The following is a summarised statement of the EEV result: Year ended 31 December 2007 2006 £000 £000 Operating profit before tax 9,662 14,985 Variation from longer term investment return 824 6,307 Economic assumption changes (4,043) 9,284 --------- --------- Profit before tax 6,443 30,576 Tax - current (4,379) (5,166) - deferred 10,053 793 --------- --------- Profit for the year after tax 12,117 26,203 ========= ========= Profit for the year after tax is significantly lower for the year ended 31 December 2007, as compared with the prior year. The result for the year ended 31 December 2006 benefited from the following non-replicating items: i. a projected total saving in future tax of £10.7m arising as a result of the merger of the long-term business funds of the Group's two life assurance businesses; and ii. the release of £3.5m relating to a reinsurer default reserve which was no longer required. Operating profit before tax for the year ended 31 December 2007 is some £0.5m short of the profit which would be expected from the unwind of the risk discount rate on the embedded value. The main influences underlying this variation have been: On the favourable side: £m - new business contribution 1.3 - return on shareholder net worth 2.1 - mortality experience 1.5 - net lapse experience and assumption changes 3.7 - release of mortgage endowment redress provisions 2.8 offset on the adverse side by: - provision for policyholder redress in respect of unit (2.5) pricing error - strengthening of expense assumptions (3.5) - strengthening of morbidity assumptions (2.2) - capital gains tax deductions and assumption effects (4.6) The strengthening of expense assumptions follows principally from a reassessment of additional costs which may be incurred in the longer term, while adverse capital gains tax effects have arisen from adverse investment market conditions and from a change in the recognition of the effects of deemed disposals relating to equity-based collective investment schemes. At the profit before tax level, the result for the year has been further adversely affected by some £4.0m of adverse economic assumption changes. However, this amount is broadly offset by credits to the deferred tax movement for the year (reduction in liability to future tax within the value-in-force component of embedded value), so that there is a relatively insignificant impact at the net of tax level. These effects have arisen as a result of the derivation of a higher risk margin within the risk discount rate in conjunction with changes in the projected tax position as between the market consistent and traditional embedded value approaches as explained in Note 4(e) to the Supplementary Information. The prospective reduction in the rate of Corporation Tax from 30% to 28% has given rise to a further reduction of some £1.5m in the deferred tax liability for future profits, with a consequential increase to the deferred tax credit to income for the year. Shareholders' Equity and Embedded Value of Covered Business - EEV Basis The consolidated balance sheet prepared in accordance with EEV principles may be summarised as: 31 December 2007 2006 £000 £000 Value of in-force business 94,007 109,941 Other net assets 93,308 79,167 --------- --------- 187,315 189,108 Represented by: Embedded value ("EV") of covered business 171,639 194,401 Less: amount financed by borrowings (12,469) (16,574) --------- --------- EV of covered business attributable to shareholders 159,170 177,827 Net equity of other Group companies 28,145 11,281 --------- --------- Shareholders' equity 187,315 189,108 ========= ========= The tables below set out the components of the value of in-force business by major product line at each period end: 31 December 2007 2006 Number of policies 000 000 Endowment 66 75 Protection 75 86 Annuities 4 4 Pensions 51 53 Other 9 10 --------- --------- Total 205 228 ========= ========= 31 December 2007 2006 Value in-force £m £m Endowment 58.3 70.3 Protection 63.0 73.1 Annuities 2.0 2.8 Pensions 38.1 41.7 Other 1.4 0.8 --------- --------- Total at product level 162.8 188.7 Valuation adjustments Holding company expenses (20.7) (21.7) Other (21.4) (22.5) Cost of capital (5.5) (3.4) --------- --------- Value in-force pre-tax 115.2 141.1 Taxation (21.2) (31.2) --------- --------- Value in-force post-tax 94.0 109.9 ========= ========= The value-in-force represents the discounted value of the future surpluses arising from the insurance and investment contracts in force at each respective period end. The future surpluses are calculated by using realistic assumptions for each component of the cash flow. Policyholder Funds Investment Return The CA Managed Fund, which is managed by Schroder Investment Management Limited and which represents a significant proportion of CA policyholder funds under management, returned 4.1% over the year ended 31 December 2007. The CWA Global Managed Fund, which is managed by Irish Life Investment Managers Limited and which represents a significant proportion of CWA policyholder funds under management, returned 4.8% over the same period. Overall, both funds were in line with the average of 4.5% achieved by the ABI Life Balanced Managed Fund sector. Returns to Shareholders Returns to shareholders are underpinned by the emergence of surplus in, and transfer of surplus from, the life business' long-term insurance fund to shareholder funds and by the return on shareholder net assets representing shareholder net equity. These realisations are utilised in the first instance for the repayment and servicing of the bank loan on the basis set out in Note 5. The surplus arises from the realisation of value in-force, which effectively unwinds at the risk discount rate used to discount the underlying cash flows: at 31 December 2007 this rate was reset to 7.7% (31 December 2006: 6.1%), following the methodology described in the Supplementary Information - European Embedded Value Basis. The return on shareholder net assets is determined by the Group's investment policy. Shareholder funds bear central corporate governance costs which cannot be fairly attributed to the long-term insurance funds and which arise largely in connection with the status of Chesnara as a listed company. The Board's continuing primary aim is to provide a reliable and progressive dividend flow to shareholders within the context of the emergence of surplus in the life business. In the absence of further suitable acquisition opportunities and in view of growing retained distributable funds within Chesnara, the Board has decided to re-base the level of dividend payments such that the total dividend in respect of 2007 is some 15% higher than that in respect of 2006. Towards the end of 2006 the shares generally traded within a range of 170p to 185p. From the beginning of 2007 to the end of November 2007 the shares generally traded in a range between 165p and 185p. This reflected the fact that, in accordance with its strategy, Chesnara is essentially a yield stock which, in the absence of other acquisitions, holds out the prospect of a return of capital to shareholders. However, since the end of November 2007, the shares have generally traded within a range of 160p to 170p. With total proposed dividends in respect of the year ended 31 December 2007 at 15.1p per share this implies a yield of between 8.9% and 9.4%. In accordance with this, the shares may also be characterised as trading at a discount to Group embedded value, as reported on the EEV basis as at 31 December 2007, within a range of 5.1% to 10.7%. The recent weakening of the share price is in line with general market weakness, particularly in the financial sector which has been affected by widely reported issues in credit markets. Chesnara maintains its cash balances in deposit-based accounts and fixed interest securities. It has no direct exposure to credit derivatives or similar instruments. Regulatory Capital Resources and Requirements The regulatory capital of life insurance companies in the UK is calculated by reference to FSA prudential regulations. The rules are designed to ensure that companies have sufficient assets to meet their liabilities in specified adverse circumstances. As such, there is a restriction on the full transfer of surplus from the long-term business fund to shareholder funds of the life company and on the full distribution of reserves from the life company to Chesnara. The following summarises the capital resources and requirements of the life company for regulatory purposes, before and after making provision for dividend payments from the life company to Chesnara, which were approved after the respective period ends. 31 December 2007 2006 £m £m Pre-dividend Available capital resources ("CR") 77.6 84.4 --------- --------- Long-term insurance capital requirement ("LTICR") 25.1 28.8 Resilience capital requirement ("RCR") 1.5 2.6 --------- --------- Total capital resources requirement ("CRR") 26.6 31.4 --------- --------- Target capital requirement cover 39.1 45.8 --------- --------- Excess of CR over target requirement 38.5 38.6 --------- --------- Ratio of available CR to CRR 292% 269% --------- --------- Post dividend Available capital resources ("CR") 47.6 64.4 --------- --------- Long-term insurance capital requirement ("LTICR") 25.1 28.8 Resilience capital requirement ("RCR") 1.5 2.6 --------- --------- Total capital resources requirement ("CRR") 26.6 31.4 --------- --------- Target capital requirement cover 39.1 45.8 --------- --------- Excess of CR over target requirement 8.5 18.6 --------- --------- Ratio of available CR to CRR 179% 205% --------- --------- The CA Board, as a matter of policy, continues to target CR cover for total CRR at a minimum level of 150% of the LTICR and 100% of the RCR. To the extent that the target capital requirement cover of £39.1m as at 31 December 2007 falls short of the £40m share capital component of CR, so it follows that £0.9m of the reported excess of CR over target requirement is not available for distribution to shareholders except by way of a capital reduction. This constraint did not apply as at 31 December 2006. It can be seen from this information that Chesnara, which relies on dividend distributions from its life company, is currently in a favourable position to service its loan commitments and to continue to pursue a progressive dividend policy. Insurance Group Directive In accordance with the EU Insurance Group Directive, the Group calculates the excess of the aggregate of regulatory capital employed over the aggregate minimum solvency requirement imposed by local regulators. The following sets out these calculations pre and post the recognition of interim and final dividends for the financial year, but approved by the Board and paid to Group shareholders after the respective dates: 31 December 2007 2006 £m £m Pre-dividend Available group capital resources 93.2 79.1 Group regulatory capital requirement (26.6) (31.4) --------- --------- Excess 66.6 47.7 ========= ========= Cover 350% 252% ========= ========= Post-dividend Available group capital resources 82.9 70.7 Group regulatory capital requirements (26.6) (31.4) --------- --------- Excess 56.3 39.3 ========= ========= Cover 312% 225% ========= ========= The regulatory requirement is that available group capital resources should be at least 100% of the capital requirements. Individual Capital Assessments The FSA Prudential Sourcebooks require an insurance company to make its own assessment of its capital needs to a required standard (a 99.5% probability of being able to meet its liabilities to policyholders after one year). In the light of scrutiny of this assessment, the FSA may impose its own additional individual capital guidance. The Individual Capital Assessment is based on a realistic liability assessment, rather than on the statutory mathematical reserves, and involves stress testing the resultant realistic balance sheet for the impact of adverse events. CA completed a further annual assessment during 2007 as a result of which it was concluded that the effective current- and medium-term capital requirement constraints on distributions to Chesnara will continue to be on the basis set out under "Regulatory capital resources and requirements" above. CONSOLIDATED INCOME STATEMENT FOR THE YEAR ENDED 31 DECEMBER 2007 Year ended 31 December 2007 2006 Note £000 £000 Insurance premium revenue 103,554 112,800 Insurance premium ceded to reinsurers (18,716) (22,194) --------- --------- Net insurance premium revenue 84,838 90,606 Fee and commission income Insurance contracts 38,032 43,519 Investment contracts 9,149 9,085 Investment income 90,210 151,470 --------- --------- Total revenue (net of reinsurance payable) 222,229 294,680 Other operating income 1,298 1,195 --------- --------- Net income 223,527 295,875 --------- --------- Policyholder claims and benefits incurred (157,114) (218,541) Reinsurers' share of claims and benefits incurred 26,518 32,761 --------- --------- Net policyholder claims and benefits incurred (130,596) (185,780) --------- --------- Change in investment contract liabilities (50,697) (58,905) Reinsurers' share of investment contract liabilities 11,534 1,304 --------- --------- Net change in investment contract liabilities (39,163) (57,601) --------- --------- Fees, commission and other acquisition costs (1,546) (2,881) Administrative expenses (15,955) (17,184) Other operating expenses Charge for amortisation of intangible assets (3,734) (3,773) Reinsurance recapture premium - (1,374) Other (3,724) (781) --------- --------- Total expenses (194,718) (269,374) --------- --------- Operating profit 28,809 26,501 Financing costs (1,089) (1,206) Loss on sale of subsidiary company 3 - (248) --------- --------- Profit before income taxes 27,720 25,047 Income tax expense 4 (2,281) (5,791) --------- --------- Profit for the year 25,439 19,256 ========= ========= Basic earnings per share 8 24.32p 18.41p --------- --------- Diluted earnings per share 8 24.32p 18.41p ========= ========= CONSOLIDATED BALANCE SHEET AT 31 DECEMBER 2007 31 December 2007 2006 Note £000 £000 Assets Intangible assets Deferred acquisition costs 9,542 10,687 Acquired value of in-force business Insurance contracts 19,427 22,144 Investment contracts 12,627 13,644 Reinsurers' share of insurance contract provisions 212,353 207,279 Amounts deposited with reinsurers 27,558 63,721 Investment properties 4,983 27,750 Financial assets Equity securities at fair value through income 743,670 738,487 Holdings in collective investment schemes at fair value through income 508,857 342,352 Debt securities at fair value through income 247,152 350,524 Loans and receivables including insurance receivables 15,415 17,310 Derivative financial instruments 9,525 30,642 --------- --------- Total financial assets 1,524,619 1,479,315 --------- --------- Reinsurers' share of accrued policyholder claims 4,661 4,191 Income taxes - 260 Cash and cash equivalents 225,127 301,218 --------- --------- Total assets 2,040,897 2,130,209 --------- --------- Liabilities Bank overdrafts 1,229 - Insurance contract provisions 1,110,848 1,115,197 Financial liabilities Investment contracts at fair value through income 726,503 812,979 Borrowings 5 12,469 16,574 Derivative financial instruments 265 1,421 --------- --------- Total financial liabilities 739,237 830,974 --------- --------- Provisions 3,575 597 Deferred tax liabilities 11,847 13,946 Reinsurance payables 1,622 3,059 Payables related to direct insurance and investment contracts 22,859 24,927 Deferred income 16,362 18,231 Income taxes 743 2,023 Other payables 6,791 7,000 --------- --------- Total liabilities 1,915,113 2,015,954 --------- --------- Net assets 125,784 114,255 ========= ========= Shareholders' equity Share capital 6 41,501 41,501 Share premium 6 20,458 20,458 Other reserves 50 50 Retained earnings 7 63,775 52,246 --------- --------- Total shareholders' equity 125,784 114,255 ========= ========= CONSOLIDATED STATEMENT OF CASH FLOWS FOR THE YEAR ENDED 31 DECEMBER 2007 Year ended 31 December 2007 2006 £000 £000 Profit for the year 25,439 19,256 Adjustments for: Amortisation of deferred acquisition costs. 1,145 2,312 Amortisation of acquired in-force value 3,734 3,772 Tax expense 2,281 5,791 Interest receivable (26,650) (26,331) Dividends receivable (35,997) (30,266) Interest expense 1,089 1,206 Change in fair value of investment properties (1,873) (2,328) Fair value losses/(gains) on financial assets 31,768 (54,154) Loss on sale of subsidiary company - 248 Interest received 28,707 28,981 Dividends received 37,810 27,099 Changes in operating assets and liabilities (excluding the effect of acquisitions) (Increase)/decrease in financial assets (54,327) 20,039 Increase in reinsurers share of insurance contract provisions (5,544) (7,097) Decrease/(increase) in amounts deposited with reinsurers 36,163 (1,024) (increase)/decrease in other loans and receivables (1,975) 2,932 (Decrease)/increase in insurance contract provisions (4,349) 44,056 (Decrease)/increase in investment contract liabilities (86,476) 9,833 Increase/(decrease) in provisions 2,978 (836) (Decrease)/increase in reinsurance payables (1,437) 1,010 (Decrease)/increase in payables related to direct insurance and investment contracts (2,068) 1,061 Decrease in other payables (3,060) (1,650) --------- --------- Cash (utilised by)/generated from operations (52,642) 43,910 Income tax paid (5,399) (6,470) --------- --------- Net cash (utilised by)/generated from operating activities (58,041) 37,440 ========= ========= Cash flows from investing activities Disposal of subsidiary, net of cash disposed of - (295) --------- --------- Net cash utilised by investing activities - (295) ========= ========= Cash flows from financing activities Repayment of borrowings (4,200) (4,200) Dividends paid (13,910) (13,268) Interest paid (1,169) (911) --------- --------- Net cash utilised by financing activities (19,279) (18,379) ========= ========= Net (decrease)/increase in cash and cash equivalents (77,320) 18,766 Cash and cash equivalents at beginning of period 301,218 282,452 --------- --------- Cash and cash equivalents at end of period 223,898 301,218 ========= ========= CONSOLIDATED STATEMENT OF CHANGES IN EQUITY FOR THE YEAR ENDED 31 DECEMBER 2007 Year ended 31 December 2007 Capital Share Share redemption Retained capital premium reserve earnings Total £000 £000 £000 £000 £000 Equity shareholders' funds 41,501 20,458 50 52,246 114,255 at 1 January 2007 Profit for the period representing total recognised income and expenses - - - 25,439 25,439 Dividends paid - - - (13,910) (13,910) --------- --------- --------- --------- --------- Equity shareholders' funds at 31 December 2007 41,501 20,458 50 63,775 125,784 ========= ========= ========= ========= ======== Year ended 31 December 2006 Capital Share Share redemption Retained capital premium reserve earnings Total £000 £000 £000 £000 £000 Equity shareholders' funds 41,501 20,458 50 46,258 108,267 at 1 January 2006 Profit for the period representing total recognised income and expenses - - - 19,256 19,256 Dividends paid - - - (13,268) (13,268) --------- --------- --------- --------- -------- Equity shareholders' funds at 31 December 2006 41,501 20,458 50 52,246 114,255 ========= ========= ========= ========= ======== NOTES 1. Basis of Preparation These financial statements have been prepared in accordance with International Financial Reporting Standards including International Accounting Standards and Interpretations (collectively "IFRS") issued by the International Accounting Standards Board ("IASB") and endorsed for use by companies in the EU, and with those parts of the UK Companies Act 1985 applicable to companies reporting under IFRS. Full details of IFRS policies applied, which are unchanged from those applied for the year ended 31 December 2006 are set out in the financial statements for the year then ended, a copy of which is available from our website www.chesnara.co.uk. 2. Status of financial information The financial information contained in this preliminary announcement does not constitute the Company's consolidated statutory financial statements for the years ended 31 December 2007 or 2006, but is derived from those financial statements. The financial statements for the year ended 31 December 2006, have been delivered to the Registrar of Companies. The financial statements for the year ended 31 December 2007 will be delivered following the Company's Annual General Meeting. The auditors have reported on those financial statements; their reports were unqualified and did not contain statements under section 237 (2) or (3) of the Companies Act 1985. The financial statements will be posted to shareholders on 11 April 2008, copies of which will also be available from the Company Secretary, Chesnara plc, Harbour House, Portway, Preston, PR2 2PR. 3. Disposal of subsidiary On 15 March 2006 the Group disposed of its interest in Premium Life International Limited to LCL International Life Assurance Company Limited for a consideration receivable in cash of £1, which, net of cash balances of £ 295,067 in the subsidiary at that date, gave rise to a net cash outflow of £ 295,066. This amount is reflected as a cash outflow from investing activities in the Consolidated Statement of Cash Flows. The contribution of the subsidiary to the net profit for the year ended 31 December 2006 was not material and a loss of £248,000 arising on the disposal was recognised in the Consolidated Income Statement for that period. Following the disposal there was a reduction of £2,030,000 in the regulatory capital resource requirements of Countrywide Assured plc and there was a reduction in available capital resources of £248,000. 4 Income tax expense Year ended 31 December 2007 2006 £000 £000 Current tax expense Current year 4,883 4,212 Adjustment to prior years (503) 626 Overseas tax - 334 --------- --------- 4,380 5,172 Deferred tax expense Origination and reversal of temporary differences (2,099) 619 --------- --------- Total income tax expense 2,281 5,791 ========= ========= Reconciliation of effective tax rate on profit Year ended 31 December before tax 2007 2006 £000 £000 Profit before tax 27,720 25,047 --------- --------- Income tax using the domestic corporation tax rate of 30% (2006: 30%) 8,316 7,514 Impact of small companies rate for subsidiaries (2) - Permanent differences 66 163 Effect of UK taxing bases on insurance profits Offset of franked investment income (5,115) (3,463) Variation in rate of tax on amortisation of acquired in-force value (467) 127 Other (14) 824 (Over)/under provided in prior years (503) 626 --------- --------- Total income tax expense 2,281 5,791 ========= ========= 5 Borrowings 31 December 2006 2006 £000 £000 Bank loan 12,469 16,574 ========= ========= The bank loan which was drawn down on 2 June 2005 under a facility made available in 4 May 2005 is unsecured and is repayable in five equal annual instalments on the anniversary of the draw down date. Accordingly the current portion as at 31 December 2007, being that payable within one year, is £ 4,127,294 and the non-current portion is £8,341,962. The outstanding principal on the loan bears interest at a rate based on the London Inter-bank Offer Rate, payable in arrears over a period which varies between one and six months at the option of the borrower. 6 Share capital and share premium Group 31 December 2007 31 December 2006 Share Share Number of capital Number of capital Shares £000 shares £000 Share capital 104,588,785 41,501 104,588,785 41,501 ========= ========= ========= ======= There have been no changes in Group share capital and share premium during the year ended 31 December 2007. Under the reverse acquisition basis of accounting, at the date of acquisition of Chesnara plc (the legal parent) the amount of issued share capital in the consolidated balance sheet represents the amount of issued share capital of Countrywide Assured Life Holdings Limited (the legal subsidiary) immediately before the acquisition and the deemed cost of acquisition is taken as £nil. The number of shares, representing the equity structure, reflects the equity structure of Chesnara plc as set out below. Company The share capital of Chesnara plc comprises: 31 December 31 December 2007 2006 Authorised £ £ 201,000,000 Ordinary shares of 5p each 10,050,000 10,050,000 ========= ========= Number of Share Shares Capital Share Capital Issued £ £ Ordinary shares of 5p each 104,588,785 5,229,439 5,229,439 ========= ========= ========= There have been no changes in Company share capital and share premium during the year ended 31 December 2007. 7 Retained earnings Year ended 31 December 2007 2006 Retained earnings attributable to equity holders of the parent company comprise Balance at 1 January 52,246 46,258 Profit for the year 25,439 19,256 Dividends Final approved and paid for 2005 - (7,986) Interim approved and paid for 2006 - (5,282) Final approved and paid for 2006 (8,419) - Interim approved and paid for 2007 (5,491) - --------- --------- Balance at 31 December 63,775 52,246 ========= ========= The interim dividend in respect of 2006, approved and paid in 2006, was paid at the rate of 5.05p per share. The final dividend in respect of 2006, approved and paid in 2007, was paid at the rate of 8.05p per share so that the total dividend paid to the equity shareholders of the Parent Company in respect of the year ended 31 December 2006 was made at the rate of 13.10p per share. The interim dividend in respect of 2007, approved and paid in 2007, was paid at the rate of 5.25p per share to equity shareholders of the Parent Company registered at the close of business on 14 September 2007, the dividend record date. A final dividend of 9.85p per share in respect of the year ended 31 December 2007 payable on 20 May 2008 to equity shareholders of the Parent Company registered at the close of business 11 April 2008, the dividend record date, was approved by the Directors after the balance sheet date. The resulting total dividend of £10.3m has not been provided for in these financial statements and there are no income tax consequences. The following summarises dividends per share in respect of the year ended 31 December 2006 and 31 December 2007: 2007 2006 p p Interim - approved and paid 5.25 5.05 Final - proposed 9.85 8.05 --------- --------- Total 15.10 13.10 ========= ========= 8 Earnings per share Earnings per share is based on the following: Year ended 31 December 2007 2006 Profit for the year (£000) 25,439 19,256 --------- --------- Weighted average number of ordinary shares 104,588,785 104,588,785 --------- --------- Basic earnings per share 24.32p 18.41p --------- --------- Diluted earnings per share 24.32p 18.41p ========= ========= The weighted average number of ordinary shares in respect of the years ended 31 December 2007 and 31 December 2006 is based on 104,588,785 shares in issue at the beginning and end of those periods. There were no share options outstanding during the year ended 31 December 2006 or during the year ended 31 December 2007. Accordingly, there is no dilution of the average number of ordinary shares in issue in respect of these periods. 9 Additional information Additional information relating to the Company can be found on its website www.chesnara.co.uk. 10 Forward looking statements This document may contain forward-looking statements with respect to certain of the plans and current expectations relating to future financial condition, business performance and results of Chesnara plc. By their nature, all forward-looking statements involve risk and uncertainty because they relate to future events and circumstances that are beyond the control of Chesnara plc including, amongst other things, UK domestic and global economic and business conditions, market-related risks such as fluctuations in interest rates, inflation, deflation, the impact of competition, changes in customer preferences, delays in implementing proposals, the timing, impact and other uncertainties of future acquisitions or other combinations within relevant industries, the policies and actions of regulatory authorities, the impact of tax or other legislation and other regulations in the jurisdiction in which Chesnara plc and its subsidiaries operate. As a result, Chesnara plc's actual future condition, business performance and results may differ materially from the plans, goals and expectations expressed or implied in these forward-looking statements. SUPPLEMENTARY INFORMATION - EUROPEAN EMBEDDED VALUE BASIS SUMMARISED CONSOLIDATED INCOME STATEMENT Year ended 31 December 2007 2006 Note £000 £000 Operating profit of covered 6 business 9,678 15,684 Other operational result (16) (699) --------- --------- Operating profit 9,662 14,985 Variation from longer-term investment return 824 6,307 Effect of economic assumption changes (4,043) 9,284 --------- --------- Profit before tax 6,443 30,576 Tax 5,674 (4,373) --------- --------- Profit for the period 12,117 26,203 ========= ========= Earnings per share Based on profit for the period 11.59p 25.05p --------- --------- Diluted earnings per share Based on profit for the period 11.59p 25.05p --------- --------- SUPPLEMENTARY INFORMATION - EUROPEAN EMBEDDED VALUE BASIS SUMMARISED CONSOLIDATED BALANCE SHEET 31 December 2007 2006 Note £000 £000 Assets Value of in force business 5,8 94,007 109,941 Reinsurers' share of insurance contract provisions 187,486 183,033 Amounts deposited with reinsurers 26,702 62,794 Investment properties 4,983 27,750 Deferred tax assets 88 121 Financial assets Equity securities at fair value through income 743,670 738,487 Holdings in collective investment schemes at fair value through income 508,857 342,352 Debt securities at fair value through income 247,152 350,524 Loans and receivables including insurance receivables 15,415 17,310 Derivative financial instruments 9,525 30,642 --------- --------- Total financial assets 1,524,619 1,479,315 --------- --------- Reinsurers' share of accrued policy claims 4,660 4,191 Income taxes -- 260 Cash and cash equivalents 225,127 301,218 --------- --------- Total assets 2,067,672 2,168,623 --------- --------- Liabilities Bank Overdraft 1,229 - Insurance contract provisions 1,086,581 1,091,889 Financial liabilities Investment contracts at fair value through income 744,222 832,025 Borrowings 12,469 16,574 Derivative financial instruments 265 1,421 --------- --------- Total financial liabilities 756,956 850,020 --------- --------- Provisions 3,575 597 Reinsurance payables 1,622 3,059 Payables related to direct insurance and investment contracts 22,859 24,927 Income taxes 743 2,023 Other payables 6,792 7,000 --------- --------- Total liabilities 1,880,357 1,979,515 --------- --------- Net assets 187,315 189,108 ========= ========= Shareholders' equity Share capital 41,501 41,501 Share premium 20,458 20,458 Other reserves 50 50 Retained earnings 125,306 127,099 --------- --------- Total shareholders' equity 5,8 187,315 189,108 ========= ========= SUPPLEMENTARY INFORMATION - EUROPEAN EMBEDDED VALUE BASIS SUMMARISED CONSOLIDATED STATEMENT OF CHANGES IN EQUITY Year ended 31 December 2007 2006 £000 £000 Shareholders' equity at 1 January 189,108 176,173 Profit for the period representing total recognised income and expense 12,117 26,203 Dividends paid (13,910) (13,268) --------- --------- Shareholders' equity at 31 December 187,315 189,108 ========= ========= SUPPLEMENTARY INFORMATION - EUROPEAN EMBEDDED VALUE BASIS NOTES TO THE SUPPLEMENTARY INFORMATION 1. Basis of preparation This section sets out the detailed methodology followed for producing these Group financial statements which are supplementary to the Group's primary financial statements which have been prepared in accordance with International Financial Reporting Standards ("IFRS"). These financial statements have been prepared in accordance with the European Embedded Value ("EEV") principles issued in May 2004 by the European CFO Forum and supplemented by Additional Guidance on EEV Disclosures issued by the same body in October 2005. The principles provide a framework intended to improve comparability and transparency in embedded value reporting across Europe. 2. Covered business The Group uses EEV methodology to value its individual life assurance, pension and annuity business, which has been written, with only insignificant exceptions, in the UK ("covered business"). This business comprises the Group's long-term business operations, being those contracts falling under the definition of long-term insurance business for UK regulatory purposes. The Group has no business activities other than those relating to the covered business. In particular, the operating activities of the holding company, Chesnara plc, are treated as an integral part of the covered business. Under EEV principles no distinction is made between insurance and investment contracts, as there is under IFRS, which accords these classes of contracts different accounting treatments. On 30 June 2006, under the provisions of Part VII of the Financial Services and Markets Act 2000, the long-term business of City of Westminster Assurance Company Limited, the principal operating subsidiary of CWA Life Holdings plc, was transferred to Countrywide Assured plc ("CA"), the primary operating subsidiary company of the Group. As a result, the whole of the covered business of the Group effectively subsists within CA with effect from that date. The transfer gives rise to benefits which have been recognised within the covered business, including determination of the capital requirement of the covered business on a combined basis and reduced costs relating largely to audit and consultancy fees. The impact of these, together with the consequential relief of tax losses in CA, which had not hitherto been recognised in the cashflow projections relating to the value of business in force, was recognised in these financial statements as at 31 December 2006 and for year then ended. 3. Methodology a) Embedded Value Overview Shareholders' equity comprises the embedded value of the covered business, together with the net equity of other Group companies, including that of the holding company which is stated after writing down fully the carrying value of the covered business. The embedded value of the covered business is the aggregate of the shareholder net worth (SNW) and the present value of future shareholder cash flows from in-force covered business (value of in-force business) less any deduction for the cost of required capital. It is stated after allowance has been made for aggregate risks in the business. SNW comprises those amounts in the long-term business, which are either regarded as required capital or which represent surplus assets within that business. New business Much of the covered business is in run-off and is, accordingly, substantially closed to new business. The Group does still sell guaranteed bonds but, overall, the contribution from new business to the results established using EEV methodology is not material. Accordingly, not all of those items related to new business values, which are recommended by the EEV guidelines, are reported in this supplementary financial information. Value of in-force business The cash flows attributable to shareholders arising from in-force business are projected using best estimate assumptions for each component of cashflow. The present value of the projected cash flows is established by using a discount rate which reflects the time value of money and the risks associated with the cashflows which are not otherwise allowed for. There is a deduction for the cost of holding the required capital, as set out below. Taxation The present value of the projected cashflows arising from in-force business takes into account all tax which is expected to be paid under current legislation, including tax which would arise if surplus assets within the covered business were eventually to be distributed. The value of the in-force business has been calculated on an after-tax basis and is grossed up to the pre-tax level for presentation in the income statement. The amount used for the grossing up is the amount of shareholder tax payable in the policyholder fund plus any direct tax charge within the shareholder fund. Cost of capital The cost of holding the required capital to support the covered business (see 3b below) is reflected as a deduction from the value of in-force business and is determined as the difference between the amount of the required capital and the projected release of capital and investment income. Financial options and guarantees The principal financial options and guarantees are (i) guaranteed annuity rates offered on some unit-linked pension contracts and (ii) a guarantee offered under Timed Investment Funds that the unit price available at the selected maturity date (or at death, if earlier) will be the highest price attained over the policy's life. The cost of these options and guarantees has been assessed, in principle, on a market-consistent basis, but, in practice, this has been carried out on approximate bases, which are appropriate to the level of materiality of the results. Allowance for risk Allowance for risk within the covered business is made by: 1) setting required capital levels by reference to the Directors' assessment of capital needs; 2) setting the risk discount rate, which is applied to the projected cash flows arising on the in-force business, at a level which includes an appropriate risk margin; and 3) explicit allowance for the cost of financial options and guarantees and, where appropriate, for reinsurer default b) Level of Required Capital The level of required capital of the covered business reflects the amount of capital that the Directors consider necessary and appropriate to manage the business. In forming their policy the Directors have regard to the minimum statutory requirements and an internal assessment of the market, insurance and operational risks inherent in the underlying products and business operations. The capital requirement resulting from this assessment represents 150% of the long-term insurance capital requirement ("LTICR") together with 100% of the resilience capital requirement ("RCR"), as set out in FSA regulations. The required capital is provided by the retained surplus in the long-term business fund and the retained earnings and issued share capital in the shareholder fund. c) Risk Discount Rate The risk discount rate ("RDR") is a combination of the risk-free rate and a risk margin. The risk-free rate reflects the time value of money and the risk margin reflects any residual risks inherent in the covered business and makes allowance for the risk that future experience will differ from that assumed. In order to reduce the subjectivity when setting the RDR, the Board has decided to adopt a 'bottom up' market-consistent approach to allow explicitly for market risk. Using the market-consistent approach each cash flow is valued at a discount rate consistent with that used in the capital markets: in accordance with this, equity-based cash flows are discounted at an equity RDR and bond-based cash flows at a bond RDR. In practice a short-cut method known as the "certainty equivalent" approach has been adopted. This method assumes that all cash flows earn the risk-free rate of return and are discounted at the risk-free rate. In general, and consistent with the market's approach to valuing financial instruments for hedging purposes, the risk-free rate is based on swap yields. Where, however, non-linked business is substantially backed by government bonds, the yields on these assets have been taken. Within the risk margin allowance also needs to be made for non-market risks. For some of these risks e.g. mortality and expense risk it is assumed that the shareholder can diversify away any uncertainty where the impact of variations in experience on future cashflows is symmetrical. For those risks that are assumed to be diversifiable no adjustment to the risk margin has been made. For any remaining risks that are considered to be non-diversifiable risks there is no risk premium observable in the market and therefore a constant margin of 50 basis points has been added to the risk margin. The RDR is determined by equating the results from the traditional embedded value approach, including the assumed actual investment returns and traditional cost of capital, to that derived using the market-consistent method, this process being known as calibration of the RDR. The risk margin is then the difference between the derived RDR and the risk-free rate. The selection of the assumed actual investment returns and the reported cost of capital will have no impact on the reported result, as changes in these produce corresponding changes in the RDR. A market-consistent valuation approach also generally requires consideration of 'frictional' costs of holding shareholder capital: in particular, the cost of tax on investment returns and the impact of investment management fees can reduce the face value of shareholder funds. In the Group's case, the expenses relating to corporate governance functions eliminate any taxable investment return in shareholder funds, while investment management fees are not material. d) Analysis of Profit The contribution to operating profit, which is identified at a level which reflects an assumed longer-term level of investment return, arises from three sources: i. new business; ii. return from in-force business; and iii. return from shareholder net worth. Additional contributions to profit arise from: i. variances between the actual investment return in the period and the assumed long-term investment return; and ii. the effect of economic assumption changes. The contribution from new business represents the value recognised at the end of each period in respect of new business written in that period, after allowing for the cost of acquiring the business, the cost of establishing the required technical provisions and after making allowance for the cost of capital. The return from in-force business is calculated using closing assumptions and comprises: i. the expected return, being the unwind of the discount rate over the period applied to establish the value of in-force business at the beginning of the period; ii. variances between the actual experience over the period and the assumptions made to establish the value of business in force at the beginning of the period; and iii. the net effect of changes in future assumptions, made prospectively at the end of the period, from those used in establishing the value of business in force at the beginning of the period, other than changes in economic assumptions. The contribution from shareholder net worth comprises the actual investment return on residual assets in excess of the required capital. e) Assumption Setting There is a requirement under EEV methodology to use best estimate demographic assumptions and to review these at least annually with the economic assumptions being reported at each reporting date. The current practice is detailed below. Each year the demographic assumptions are reviewed as part of year-end processes and hence were reviewed in December 2007. The detailed projection assumptions, including mortality, morbidity, persistency and expenses reflect recent operating experience. Allowance is made for future improvement in annuitant mortality based on experience and externally published data. Favourable changes in operating experience, particularly in relation to expenses and persistency, are not anticipated until the improvement in experience has been observed. Holding company expenses (for the Chesnara Group such expenses relate largely to listed company functions) are allocated to the covered business as the whole business of the Chesnara Group is the transaction of life assurance business through the subsidiary companies. Hence the expense assumptions used for the cash flow projections include the full cost of servicing this business. The economic assumptions are reviewed and updated at each reporting date based on underlying investment conditions at the reporting date. The assumed discount rate and inflation rates are consistent with the investment return assumptions. The assumptions required in the calculation of the value of the annuity rate guarantee on pension business have been set equal to best-estimate assumptions. 4. Assumptions a. Investment Returns (pre- tax) The assumed future pre-tax returns on fixed interest and RPI linked securities are set by reference to redemption yields available in the market at the end of the reporting period. The corresponding return on equities and property is equal to the fixed interest gilt assumptions plus an appropriate risk margin. For linked business the aggregate return has been determined by reference to the benchmark asset mix within the Managed Funds. 31 December Operating profit/(loss) before tax 2007 2006 Equity risk premium 2.7% 2.7% Property risk premium 2.7% 2.7% Investment return Fixed Interest 4.6% 4.6% Equities 7.3% 7.3% Property 7.3% 7.3% Inflation RPI 3.1% 3.1% b. Actuarial Assumptions The demographic assumptions used to determine the value of the in-force business have been set at levels commensurate with the underlying operating experience identified in the periodic actuarial investigations. c. Taxation Projected tax has been determined assuming current tax legislation and rates continue unaltered, except where future tax rates or practices have been announced. d. Expenses The expense levels are based on internal expense analysis investigations and are appropriately allocated to the new business and policy maintenance functions. These have been determined by reference to: (i) the outsourcing agreements in place with our third-party business process administrators; (ii) anticipated revisions to the terms of such agreements as they fall due for renewal; and (iii) corporate governance costs relating to the covered business. The expense assumptions also include the expected future holding company expenses which will be recharged to the covered business. No allowance has been made for future productivity improvements in the expense assumptions. e. Risk Discount Rate The risk-free rate is set by reference to the sterling bid swap rates available in the market at the end of the reporting period. Where, however, non-linked business is substantially backed by government bonds, the yields on these assets have been used. An explicit constant margin of 50 basis points is added to the risk-free rate to cover any remaining risks that are considered to be non-market, non-diversifiable risks, as there is no risk premium observable in the market. This margin gives due recognition to the fact that: (i) the covered business is substantially closed to new business; (ii) there is no significant exposure in the with profits business, which is wholly reinsured; (iii) expense risk is limited as a result of the outsourcing of substantially all policy administration and related functions to third-party business process administrators; and (iv) for much of the life business the Group has the ability to vary risk charges made to policyholders. 31 December 2007 2006 Risk-free rate 5.0% 4.8% Non-diversifiable risk 0.5% 0.5% Risk margin 2.2% 0.8% Risk discount rate 7.7% 6.1% The risk margin is derived as a result of the calibration of the RDR, as explained in Note 3c above. The significant increase between 31 December 2006 and 31 December 2007 reflects a change in the projected long-term tax position of the covered business. As at 31 December 2006, there were differences in the projected tax basis and, hence, in the absolute level of projected tax as between the market-consistent approach and the traditional embedded value approach: these differences were, effectively, eliminated by the calibration process and this resulted in an apparently lower level of derived risk margin. As at 31 December 2007, the projected tax position between the two approaches is consistent so that there are no differences which are eliminated by the calibration process and this results in a higher level of derived risk margin. 5. Analysis of shareholders' equity 31 December 2007 2006 £000 £000 Covered business Required capital 39,149 45,792 Free surplus 38,483 38,668 --------- --------- Shareholder net worth 77,632 84,460 Value of in-force business 94,007 109,941 --------- --------- Embedded value of covered 171,639 194,401 business Less: amount financed by (12,469) (16,574) borrowings --------- --------- Embedded value of covered business attributable to shareholders 159,170 177,827 Net equity of other Group 28,145 companies 11,281 --------- --------- Total shareholders' equity 187,315 189,108 ========= ========= The movement in the value of in-force business comprises: Value at beginning of period 109,941 109,961 Amount charged to operating (15,934) (20) profit --------- --------- Value at end of period 94,007 109,941 ========= ========= On 2 June 2005, the Group drew down £21m on a bank loan facility, in order to part fund the acquisition of CWA Life Holdings plc. This effectively represented a purchase of part of the underlying value in force of CWA by way of debt finance and it follows that the embedded value of the covered business is not attributable to equity shareholders of the Group to the extent of the outstanding balance on the loan account at each balance sheet date. The loan is repayable in five equal annual instalments on the anniversary of the draw down date, the funds for the repayment effectively being provided by way of the realisation of the underlying value of in-force business of the covered business. In accordance with this, £4.2m of the loan was repaid on 2 June 2006 and a further £4.2m was repaid on 2 June 2007, leaving principal outstanding at that date of £12.6m. 6. Analysis of profit of covered business Year Ended 31 December 2007 2006 £000 £000 New business contribution 1,261 1,599 Return from in-force business Expected return 10,206 10,386 Experience variances 394 7,459 Operating assumption changes (4,236) (5,072) Return on shareholder net worth 2,053 1,312 --------- --------- Operating profit 9,678 15,684 Variation from longer-term 824 6,307 investment return Effect of economic assumption (4,043) 9,284 changes --------- --------- Profit on covered business before 6,459 31,275 tax Tax 5,677 (4,496) --------- --------- Profit on covered business after 12,136 26,779 tax ========= ========= The profit of covered business varies from amounts presented in the summarised consolidated income statement in respect of the pre-tax result of the holding company presented as "other operational result", and in respect of any tax pertaining thereto, which is included in "other tax". The variation from longer-term investment return for the year ended 31 December 2006 is stated net of a loss of £248,000 arising on the sale of a subsidiary company. 7. Sensitivities to alternative assumptions The following table shows the sensitivity of the embedded value of the covered business as reported at 31 December 2007 to variations in the assumptions adopted in the calculation of the embedded value. Sensitivity analysis is not provided in respect of the new business contribution for the year ended 31 December 2007 as the reported level of new business contribution is not considered to be material (see Note 3a) above). It largely relates to guaranteed bond business, where a close asset/liability matching approach leaves values largely insensitive to changes in experience. Embedded Value ("EV") of covered business as at 31 December 2007 £171.6m Change in EV (£m) Economic sensitivities 100 basis point increase in risk discount rate -4.7 100 basis point reduction in yield curve 2.9 10% decrease in equity and property values -5.2 Operating sensitivities 10% decrease in maintenance expenses 1.9 10% decrease in lapse rates 3.7 5% decrease in mortality/morbidity rates Assurances 1.8 Annuities -0.8 Reduction in the required capital to statutory minimum 1.8 The key assumption changes represented by each of these sensitivities are as follows: Economic sensitivities i. 100 basis point increase in the risk discount rate. The 7.7% RDR increases to 8.7%; ii) 100 basis point reduction in the yield curve. The fixed interest return is reduced by 1% and the equity/property returns are also reduced by 1%, thus maintaining constant equity/property risk premiums. The rate of future inflation has also been reduced by 1% so that real yields remain constant. In addition the risk discount rate has also reduced by 1%; and iii. 10% decrease in the equity and property values. This gives rise to a situation where, for example, a Managed Fund unit liability with a 60% equity holding would reduce by 6% in value. Operating sensitivities i. 10% decrease in maintenance expenses, giving rise to, for example, a base assumption of £20 per policy pa reducing to £18 per policy pa; ii. 10% decrease in persistency rates giving rise to, for example, a base assumption of 10% of policy base lapsing pa reducing to 9% pa; iii. 5% decrease in mortality/morbidity rates giving rise to, for example, a base assumption of 100% of the parameters in a selected mortality/morbidity table reducing to 95% of the parameters in the same table; and iv. the sensitivity to the reduction in the required capital to the statutory minimum shows the effect of reducing the required capital from 150% of the LTICR plus 100% RCR to the amounts of 100% LTICR plus 100% RCR, being the minimum requirement prescribed by FSA regulation. In each sensitivity calculation all other assumptions remain unchanged except where they are directly affected by the revised economic conditions: for example, as stated, changes in interest rates will directly affect the risk discount rate. The sensitivities to changes in the assumptions in the opposite direction will result in changes of similar magnitude to those shown in the above table but in the opposite direction. 8. Reconciliation of shareholders' equity on the IFRS basis to shareholder equity on the EEV basis 31 December 2007 2006 £000 £000 Shareholders' equity on the IFRS basis 125,784 114,255 Adjustments Deferred acquisition costs Investment contracts (8,961) (10,074) Deferred income 15,426 17,239 Adjustment to provisions on investment contracts, net of amounts deposited with reinsurers (18,220) (19,596) Adjustments to provisions on insurance contracts, net of reinsurers' share (600) (936) Acquired in-force value (23,785) (25,933) Deferred tax 3,664 4,212 --------- --------- Group shareholder net worth 93,308 79,167 Value of inforce business 94,007 109,941 --------- --------- Shareholders' equity on the EEV basis 187,315 189,108 ========= ========= Group shareholder net worth comprises: Shareholder net worth in covered business 77,632 84,460 Shareholder's equity in other Group companies 28,145 11,281 Debt finance (12,469) (16,574) --------- --------- Total 93,308 79,167 ========= =========

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