Interim Results 2000 - Part 2

CGNU PLC 2 August 2000 CGNU plc Interim Announcement 2000 Part 2 Contents Page Achieved profit basis Summarised consolidated profit and loss account - achieved profit basis 9 Basis of preparation 10 Components of total life achieved profit 10 New business contribution 11 Analysis of life achieved operating profit 12 Embedded value of life business 12 Segmental analysis of embedded value of life business 13 Methodology 13 Principal economic assumptions 14 Other assumptions 14 Alternative assumptions 15 Independent review report 16 Modified statutory basis Summarised consolidated profit and loss account - modified statutory basis 17 Consolidated statement of total recognised gains and losses 18 Reconciliation of movements in consolidated shareholders' funds 18 Summarised consolidated balance sheet 19 Consolidated cash flow statement 20 Basis of preparation 21 Basis of accounts 21 Principal exchange rates 21 Change in accounting policy - dividend income 22 Acquisitions in the six months to 30 June 2000 22 Exceptional items 22 Geographical analysis of life and pensions and investment sales - new business and total income 23 Geographical analysis of modified statutory life profit 24 Geographical analysis of health premiums after reinsurance and operating result 24 Geographical analysis of general insurance premiums after reinsurance and operating result 25 Taxation 26 Dividends 26 Earnings per share 27 Longer-term investment return 27 Independent review report 28 Statistical supplement Segmental analysis of group operating profit at constant currency 29 Supplementary analyses 30 General insurance - geographical ratio analysis 32 General insurance - class of business analysis 33 Assets under management 35 Shareholder information 36 ------------------------------------------------------------------------------ Page 9 Summarised consolidated profit and loss account - achieved profit basis Restated 6 6 6 months months months Restated to to to full 30 June 30 June 30 June year 2000 2000 1999 1999 Em £m £m £m Premium income after reinsurance and investment sales 11,693 Life premiums 7,130 6,694 13,470 1,325 Investment sales 808 673 1,347 702 Health premiums 428 162 402 ------- ------- ------- ------- 13,720 8,366 7,529 15,219 10,140 General insurance premiums 6,183 5,819 11,227 ------- ------- ------- ------- 23,860 Total 14,549 13,348 26,446 ======= ======= ======= ======= Operating profit Life achieved operating profit 1,237 (excluding change in risk margin) 754 621 1,407 34 Health 21 11 24 36 Fund management 22 26 66 536 General insurance 327 370 660 (34) Non-insurance operations (21) (11) (30) 3 Associated undertakings 2 8 10 (159) Corporate costs (97) (65) (162) (274) Unallocated interest charges (167) (107) (240) ------- ------- ------- ------- 1,379 841 853 1,735 (67) Wealth management (41) - - ------- ------- ------- ------- Operating profit before tax, change in risk margin, amortisation of goodwill 1,312 and exceptional items 800 853 1,735 - Change in risk margin - - 89 (30) Amortisation of goodwill (18) (17) (34) - Exceptional items - (70) (163) ------- ------- ------- ------- 1,282 Operating profit before tax 782 766 1,627 Variation from longer-term investment 93 return 57 (24) 1,072 (52) Effect of economic assumption changes (32) 247 358 (20) Change in the equalisation provision (12) (35) (55) Net loss arising on the sale of - subsidiary undertakings - (9) (8) (93) Merger transaction costs (57) - - ------- ------- ------- ------- Profit on ordinary activities 1,210 before tax 738 945 2,994 Tax on operating profit before change in risk margin, amortisation of (359) goodwill and exceptional items (219) (204) (415) Tax on profit on other ordinary (100) activities (61) (87) (438) ------- ------- ------- ------- 751 Profit on ordinary activities after tax 458 654 2,141 (39) Minority interests (24) (31) (85) ------- ------- ------- ------- 712 Profit for the financial period 434 623 2,056 (15) Preference dividends (9) (9) (17) ------- ------- ------- ------- Profit for the financial period 697 attributable to equity shareholders 425 614 2,039 (525) Ordinary dividends (320) (278) (773) ------- ------- ------- ------- Retained profit for the financial 172 period 105 336 1,266 ======= ======= ======= ======= Earnings per share Operating profit on an achieved profit basis before change in risk margin, amortisation of goodwill and exceptional items, after taxation, 40.3c attributable to equity shareholders 24.6p 27.4p 55.0p Profit attributable to equity 31.0c shareholders 18.9p 27.5p 91.2p Profit attributable to equity 31.0c shareholders - diluted 18.9p 27.4p 90.8p Dividends per share 23.37c - based on parent company 14.25p 14.25p 38.00p 23.37c - based on weighted average 14.25p 12.34p 34.30p ------------------------------------------------------------------------------ Page 10 Basis of preparation The achieved profit statement on page 9 includes the results of the Group's life operations reported under the achieved profit basis combined with the modified statutory basis results of the Group's non-life operations set out on pages 17 to 27. The achieved profit basis provides a more accurate reflection of the performance of the Group's life operations year on year than results under the modified statutory basis. The achieved profit methodology used is in accordance with the draft 'Guidance on accounting in Group accounts for proprietary companies long-term insurance business', circulated by the Association of British Insurers in December 1999. Further details on the methodology and assumptions are set out on pages 13 to 15. The results of the Group's life operations under the modified statutory basis, which is the basis used in the annual audited accounts, can be found on pages 17 to 27. Components of total life achieved profit Total life achieved profit comprises the following components, the first four of which in aggregate are referred to as life achieved operating profit: - new business contribution written during the year including value added between the point of sale and end of year; - the profit from existing business equal to: - the expected return on the value of the in-force business at the beginning of the period, - experience variances caused by the differences between the actual experience during the period and expected experience based on the operating assumptions used to calculate the start of year value, - the impact of changes in operating assumptions; - development costs incurred in establishing new life businesses; - the expected investment return on the shareholders' net worth, based upon assumptions applying at the start of the year; - investment return variances caused by differences between the actual return in the period and the expected experience based on economic assumptions used to calculate the start of year value; - the impact of changes in economic assumptions in the period. 6 6 months months to to Full 30 June 30 June year 2000 1999 1999 £m £m £m New business contribution 194 159 403 Profit from existing business - expected return 417 326 634 - experience variances (9) (10) 80 - operating assumption changes - - 8 Development costs (17) - (24) Expected return on shareholders' net worth 155 128 265 ------- ------- ------- 740 603 1,366 Other life and savings activities* 14 18 41 ------- ------- ------- Life achieved operating profit before tax, change in risk margin and exceptional items 754 621 1,407 Change in risk margin** - - 89 ------- ------- ------- Life achieved operating profit before tax and exceptional items 754 621 1,496 Exceptional items - - (12) Investment return variances (69) 189 851 Effect of economic assumption changes (32) 247 358 ------- ------- ------- Total life achieved profit before tax 653 1,057 2,693 Attributed tax (221) (316) (819) ------- ------- ------- Total life achieved profit after tax 432 741 1,874 ======= ======= ======= * Profits from other life and savings activities, which include service companies, have been calculated on a statutory basis. ** Impact of risk margin changes within economic assumptions. ------------------------------------------------------------------------------ Page 11 New business contribution The following table sets out the contribution from new business written by the long-term business operations. The contribution generated by new business written during the period is the present value of the projected stream of after-tax distributable profit from that business. Contribution before tax is calculated by grossing up the contribution after-tax at the full corporation tax rate for UK business and at appropriate rates of tax for other countries. Annual premium New business equivalent* contribution 6 months to 6 6 6 30 June 6 months months Local months 1999 months to to currency to at 2000 to 30 June 30 June growth 30 June assumptions 30 June 2000 1999 2000 ** 1999 £m £m £m £m £m United Kingdom 479 384 25% 137 111 106 Europe (excluding UK) France 118 97 35% 39 29 28 Ireland 45 23 116% 12 5 7 Netherlands 52 55 4% 9 15 9 Poland - Life 23 33 (26)% 5 15 15 - Pensions 109 2 n/a 22 - - Spain 9 9 6% 1 1 1 Other 60 133 (51)% 6 26 24 International 45 44 2% 5 10 10 ------- ------- ------- ------- ------- ------- Total annualised premiums 940 780 25% ====== ====== ====== Total new business contribution before cost of capital 236 212 200 Cost of capital (42) (42) (41) ------- ------- ------- Total new business contribution after cost of capital 194 170 159 ======= ======= ======= * Annual premium equivalent represents regular premiums plus 10% of single premiums. ** 1999 new business contribution has been shown using the application of year 2000 economic assumptions. New business contributions have been calculated using the same assumptions as those used to determine the embedded values as at the beginning of each year. The cost of capital represents the cost of holding solvency capital equal to the minimum European Union (EU) solvency margin (or equivalent for non-EU operations). ------------------------------------------------------------------------------ Page 12 Analysis of life achieved operating profit Life achieved operating profit is calculated on an after-tax basis and then grossed up at the full rate of corporation tax for UK business and at appropriate rates of tax for other countries. 6 6 months months to to Full 30 June 30 June year 2000 1999 1999 £m £m £m United Kingdom 449 362 798 Europe (excluding UK) France 124 71 131 Ireland 33 25 53 Netherlands 76 68 168 Poland - Life 20 27 72 - Pensions 24 1 43 Spain 7 1 13 Other (8) 20 32 International 15 28 56 ------- ------- ------- Total life achieved operating profit before tax, change in risk margin and exceptional items* 740 603 1,366 ======= ======= ======= * Excludes other life and savings activities. Embedded value of life business 6 6 months months to to Full 30 June 30 June year 2000 1999 1999 £m £m £m Embedded value at the beginning of the period as previously reported: - CGU plc 5,675 4,868 4,868 - Norwich Union plc 4,742 4,415 4,415 Merger adjustments arising from alignment of embedded value methodology 101 111 111 ------- ------- ------- Restated embedded value at the beginning of the period 10,518 9,394 9,394 Total life achieved profit after tax* 422 729 1,845 Exchange rate movements 99 (229) (420) Embedded value from business acquired 56 - 89 Amounts injected into life operations 78 11 164 Amounts released from life operations (205) (190) (554) ------- ------- ------- Embedded value at the end of the period 10,968 9,715 10,518 ======= ======= ======= * Excluding profits from other life and savings activities after tax. ------------------------------------------------------------------------------ Page 13 Segmental analysis of embedded value of life business Valuation of Net worth* in-force** Total 30 30 30 30 30 30 June June June June June June 2000 1999 2000 1999 2000 1999 £m £m £m £m £m £m United Kingdom 1,887 1,675 4,291 4,053 6,178 5,728 Europe (excluding UK) France 849 751 423 323 1,272 1,074 Ireland 221 192 243 189 464 381 Netherlands 1,222 983 698 682 1,920 1,665 Poland 87 55 188 74 275 129 Spain 36 44 49 27 85 71 Other 174 122 138 87 312 209 International 383 370 79 88 462 458 ------- ------- ------- ------- ------- ------- Embedded value of life businesses 4,859 4,192 6,109 5,523 10,968 9,715 ======= ======= ======= ======= ======= ======= * The shareholders' net worth comprises the market value of the shareholders' funds and the shareholders' interest in the surplus held in the non-profit component of the long-term business funds determined on a statutory solvency basis and adjusted to add back any non-admissible assets. ** At 30 June 2000, the deduction for the cost of solvency capital was £700 million. Methodology (a) Life achieved profit The achieved profit method of financial reporting is designed to recognise profit as it is earned over the life of an insurance policy. The total profit recognised over the lifetime of a policy is the same as under the modified statutory basis of reporting, but the timing of recognition is different. Distributable profits from long-term businesses arise when they are released to shareholders following actuarial valuations. These are carried out in accordance with statutory requirements designed to ensure and demonstrate solvency in long-term business funds. Future distributable profits will depend on experience in a number of areas such as investment return, discontinuance rates, mortality and administration costs. Using realistic assumptions of future experience, we can project releases to shareholders arising in future years from the business in force and associated minimum statutory solvency capital. The life achieved profit reflects current performance by measuring the movement, from the beginning to the end of the year, in the present value of projected releases to shareholders, together with the movement in the net assets of the long-term operations held in excess of the minimum statutory solvency capital. The present value of the projected releases to shareholders is calculated by discounting back to the current time using a risk discount rate. The risk discount rate is a combination of a discount rate to reflect the time value of money and a risk margin to make prudent allowance for the risk that experience in future years may differ from the assumptions. The calculations are carried out on an after-tax basis and the profits are then grossed up for tax at the full rate of corporation tax for the United Kingdom and at an appropriate effective rate for each of the other countries. (b) Embedded value The shareholders' interest in the long-term business operations is represented by the embedded value. The embedded value is the total of the net assets of the long term operations and the present value at risk discount rates (which incorporate a risk margin) of the projected releases to shareholders arising from the business in force, less a charge for the cost of the solvency capital supporting the solvency requirements of the business. This cost of capital is the difference between the nominal value of required solvency capital and the present value at risk discount rates of the projected release of this capital and investment earnings on the capital. For with-profit funds in the United Kingdom, for the purpose of recognising the value of the estate, it is assumed that terminal bonuses are increased to exhaust all of the free assets over the future lifetime of the in-force with-profit policies. ------------------------------------------------------------------------------ Page 14 Principal economic assumptions The principal economic assumptions used are as follows: United Kingdom 30 31 30 31 June December June December 2000 1999 1999 1998 Risk discount rate 7.6% 7.8% 7.7% 7.2% Pre-tax investment returns: Base government fixed interest 5.0% 5.2% 5.0% 4.5% Ordinary shares 7.5% 7.7% 7.5% 7.0% Property 6.5% 6.7% 6.5% 6.0% Future expense inflation 3.8% 4.1% 4.0% 3.4% Tax rate 30.0% 30.0% 30.0% 31.0% France 30 31 30 31 June December June December 2000 1999 1999 1998 Risk discount rate 8.7% 8.7% 8.1% 7.7% Pre-tax investment returns: Base government fixed interest 5.5% 5.5% 4.6% 3.9% Ordinary shares 7.5% 7.5% 6.6% 5.9% Property 7.0% 7.0% 6.1% 5.4% Future expense inflation 2.5% 2.5% 2.5% 2.5% Tax rate 40.0% 40.0% 40.0% 40.0% Ireland 30 31 30 31 June December June December 2000 1999 1999 1998 Risk discount rate 9.1% 9.0% 8.1% 8.1% Pre-tax investment returns: Base government fixed interest 5.5% 5.6% 4.7% 4.6% Ordinary shares 8.5% 8.6% 7.7% 7.6% Property 7.0% 7.1% 6.2% 6.1% Future expense inflation 5.9% 4.0% 4.0% 4.0% Tax rate 22.0% 28.0% 28.0% 33.0% Netherlands 30 31 30 31 June December June December 2000 1999 1999 1998 Risk discount rate 8.2% 8.3% 7.7% 7.2% Pre-tax investment returns: Base government fixed interest 5.3% 5.5% 4.7% 3.9% Ordinary shares 8.2% 8.4% 7.6% 6.8% Property 6.8% 7.0% 6.2% 5.4% Future expense inflation 2.5% 2.5% 2.5% 2.5% Tax rate 25.0% 25.0% 25.0% 25.0% Poland - Life 30 31 30 31 June December June December 2000 1999 1999 1998 Risk discount rate 19.8% 19.8% 20.6% 20.6% Pre-tax investment returns: Base government fixed interest 12.5% 12.5% 12.5% 12.5% Ordinary shares 12.5% 12.5% 12.5% 12.5% Property n/a n/a n/a n/a Future expense inflation 9.2% 9.2% 9.2% 9.2% Tax rate 30.0% 33.0% 35.0% 35.0% Poland - Pensions 30 31 30 31 June December June December 2000 1999 1999 1998 Risk discount rate 17.1% 17.1% n/a n/a Pre-tax investment returns: Base government fixed interest 12.5% 12.5% n/a n/a Ordinary shares 12.5% 12.5% n/a n/a Property n/a n/a n/a n/a Future expense inflation 9.2% 9.2% n/a n/a Tax rate 30.0% 33.0% n/a n/a Spain 30 31 30 31 June December June December 2000 1999 1999 1998 Risk discount rate 9.1% 9.1% 8.6% 8.0% Pre-tax investment returns: Base government fixed interest 5.5% 5.6% 4.8% 4.0% Ordinary shares 8.5% 8.6% 7.8% 7.0% Property 7.0% 7.1% 6.3% 5.5% Future expense inflation 3.0% 3.0% 3.0% 3.0% Tax rate 35.0% 35.0% 35.0% 35.0% Other assumptions - Current tax legislation and rates have been assumed to continue unaltered, except where changes in future tax rates have been announced. - Assumed future mortality, morbidity and lapse rates have been derived from an analysis of CGNU's recent operating experience. - The management expenses of CGNU attributable to long-term business operations have been split between expenses relating to the acquisition of new business and to the maintenance of business in force. Certain expenses of an exceptional nature have been identified separately and the discounted value of projected exceptional costs has been deducted from the value of in-force business. - It has been assumed that there will be no changes to the methods and bases used to calculate the statutory technical provisions and current surrender values. - The value of in-force business does not allow for future premiums under recurring single premium business or non-contractual increments. The value arising therefrom is included in the value of new business, when the premium is received. Department of Social Security (DSS) rebate premiums have been treated as recurring single premiums. ------------------------------------------------------------------------------ Page 15 Other assumptions - continued - The value of the in-force business has been determined after allowing for the cost of holding solvency capital equal to the minimum EU solvency requirement (or equivalent for non-EU operations). Solvency capital relating to with-profit business is assumed to be covered by the surplus within the with-profit funds and no cost has been attributed to shareholders. - Bonus rates on with-profit business have been set at levels consistent with the economic assumptions and CGNU's medium-term bonus plans. The distribution of profit between policyholders and shareholders within the with-profit funds assumes that the shareholder interest in conventional with-profit business in the United Kingdom and Ireland continues at the current rate of one-ninth of the cost of bonus. Alternative assumptions The table below shows the sensitivity to a one percentage point increase in interest rates and in the discount rate for new business contribution and embedded value. New business Embedded contribution value Interest Discount Interest Discount rates rate rates rate £m £m £m £m United Kingdom 10 (20) (400) (375) Europe (excluding UK) France 5 (5) (40) (70) Ireland 1 (1) (5) (15) Netherlands 5 (5) (50) (100) Poland - Life - - - (5) - Pensions - (2) - (5) Spain - - - (2) Other - (2) - (10) International - (2) (5) (10) ------- ------- ------- ------- 21 (37) (500) (592) ======= ======= ======= ======= Profits are affected by a change in underlying interest rates. When interest rates change, expected future investment returns will also change and this in turn will affect projected cash flows. A change in interest rates will also result in a change in the discount rate used to calculate the present value of the projected cash flows. The impact of an increase of one percentage point in interest rates incorporates all such changes. The impact of an increase of one percentage point in the discount rate is calculated with all other assumptions remaining unchanged. ------------------------------------------------------------------------------ Page 16 Independent review report to CGNU plc on the alternative method of reporting long-term business We have been instructed by the Company to review the information on pages 9 to 15 which has been prepared in accordance with the achieved profit basis as set out under the methodology and principal economic assumptions sections on pages 13 and 14. This information should be read in conjunction with the accounts prepared on the modified statutory solvency basis, which are on pages 17 to 27. Directors' responsibilities The interim report, including, as described on page 28, the accounts prepared on a modified statutory solvency basis, is the responsibility of, and has been approved by the directors. The directors are also responsible for preparing the information on the above achieved profit basis. The Listing Rules of the Financial Services Authority require that the accounting policies and presentation applied to the interim figures should be consistent with those applied in preparing the preceding annual accounts except where any changes, and the reasons for them, are disclosed. Review work performed We conducted our review in accordance with the guidance contained in Bulletin 1999/4 issued by the Auditing Practices Board. A review consists principally of making enquiries of group management and applying analytical procedures to the information on the above achieved profit basis and based thereon, assessing whether the accounting policies and presentation have been consistently applied unless otherwise disclosed. A review excludes audit procedures such as tests of controls and verification of assets, liabilities and transactions. It is substantially less in scope than an audit performed in accordance with Auditing Standards and therefore provides a lower level of assurance than an audit. Accordingly, we do not express an audit opinion on the above achieved profit basis. Review conclusion On the basis of our review, we are not aware of any material modifications that should be made to the financial information above prepared on an achieved profits basis as presented for the six months ended 30 June 2000. PricewaterhouseCoopers Ernst & Young Chartered Accountants London London MORE TO FOLLOW

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