L&G FY 2005 Results Part 3
Legal & General Group PLC
17 March 2006
Part 3
European Embedded Value
=======================
Consolidated income statement
-----------------------------
Year ended 31 December 2005
2005 2004
Restated
Notes £m £m
----------------------------------------------------------------------------------------------------------------------
From continuing operations
Life and pensions 3.2/3.3 901 587
Investment management 3.8 136 108
General insurance 4.4 14 32
Other operational income 4.5 41 35
----------------------------------------------------------------------------------------------------------------------
Operating profit 1,092 762
Variation from longer term investment return 3.6 870 414
Effect of economic assumption changes 3.2 8 34
Property income attributable to minority interests 81 32
----------------------------------------------------------------------------------------------------------------------
Profit from continuing operations before tax attributable to equity holders 2,051 1,242
Tax 3.9 (563) (354)
Effect of UK tax changes 3.10 (276) -
----------------------------------------------------------------------------------------------------------------------
Profit from continuing operations after tax 1,212 888
Profit from discontinued operations 4.9 13 5
----------------------------------------------------------------------------------------------------------------------
Profit from ordinary activities after tax 1,225 893
Profit attributable to minority interests 4.17 (81) (32)
----------------------------------------------------------------------------------------------------------------------
Profit attributable to equity holders of the company 1,144 861
======================================================================================================================
Earnings per share 3.11 p p
Based on operating profit from continuing operations after tax 12.02 8.46
Based on profit attributable to ordinary equity holders 17.42 13.10
Diluted earnings per share 3.11
Based on operating profit from continuing operations after tax 11.74 8.30
Based on profit attributable to ordinary equity holders 16.89 12.72
======================================================================================================================
Consolidated balance sheet
--------------------------
As at 31 December 2005
2005 2004
Restated
Notes £m £m
----------------------------------------------------------------------------------------------------------------------
Assets
Investments 186,413 147,761
Long term in-force business asset 2,738 2,535
Other assets 5,427 5,088
Non-current assets held for sale - 733
----------------------------------------------------------------------------------------------------------------------
194,578 156,117
======================================================================================================================
Equity and liabilities
Ordinary shareholders' equity 3.14 6,970 6,186
Subordinated borrowings designated as equity 4.16 394 394
Minority interests 4.17 285 214
Subordinated borrowings 4.16 415 -
Unallocated divisible surplus 1,894 1,559
Participating contract liabilities 20,277 18,817
Non-participating contract liabilities 158,956 124,193
Senior borrowings 4.16 1,634 1,446
Other creditors and provisions 3,753 2,674
Non-current liabilities held for sale - 634
----------------------------------------------------------------------------------------------------------------------
194,578 156,117
======================================================================================================================
Consolidated statement of recognised income and expense
-------------------------------------------------------
Year ended 31 December 2005
2005 2004
Restated
£m £m
----------------------------------------------------------------------------------------------------------------------
Exchange differences on translation of overseas operations 22 (10)
Actuarial losses on defined benefit pension scheme (55) (43)
Actuarial losses on defined benefit pension scheme transferred to unallocated divisible surplus 22 17
----------------------------------------------------------------------------------------------------------------------
Net expense recognised directly in equity (11) (36)
Profit from ordinary activities after tax 1,225 893
----------------------------------------------------------------------------------------------------------------------
Total recognised income and expense for the year 1,214 857
======================================================================================================================
Attributable to:
Minority interests 81 32
Equity holders of the company 1,133 825
======================================================================================================================
Notes to the Financial Statements
=================================
3.1 Restatement of 2004 comparatives
--------------------------------------
The 2004 comparatives have been restated for the following items:
1. After the 2004 Full Year Results were restated under International Financial Reporting Standards (IFRS), the
interpretation of provisions within IAS 32, 'Financial Instruments: Disclosure and Presentation', has required the
£400m 5.875% undated subordinated notes to be classified as equity, rather than as a liability. The change in
classification has resulted in an increase in reported profit after tax for 2004 of £12m, due to the corresponding
reclassification of interest payments as distributions and an increase in total equity of £398m.
2. The results of Retail investments and Institutional fund management have been combined to create a new segment
called Investment management. The Retail investments operating profit, which is prepared on an IFRS basis, of £4m in
2004 has been reclassified from Other operational income and included in Investment management.
3.2 Profit from continuing operations after tax from covered business
-----------------------------------------------------------------------
UK International Life and Investment Total
pensions manage-
Total ment(1)
Year ended 31 December 2005 Notes £m £m £m £m £m
----------------------------------------------------------------------------------------------------------------------
Contribution from new business after cost of capital 306 25 331 49 380
Contribution from in-force business:
- expected return 294 62 356 21 377
- experience variances 3.4 89 - 89 25 114
- operating assumption changes 3.5 (14) (5) (19) 14 (5)
Development costs (20) - (20) (1) (21)
Contribution from shareholder net worth 146 18 164 6 170
----------------------------------------------------------------------------------------------------------------------
Operating profit 801 100 901 114 1,015
Variation from longer term investment return 653 53 706 35 741
Effect of economic assumption changes 3 5 8 - 8
----------------------------------------------------------------------------------------------------------------------
Profit from continuing operations before tax 1,457 158 1,615 149 1,764
Tax (421) (51) (472) (45) (517)
Effect of UK tax changes (276) - (276) - (276)
----------------------------------------------------------------------------------------------------------------------
Profit from continuing operations after tax 760 107 867 104 971
======================================================================================================================
Year ended 31 December 2004
----------------------------------------------------------------------------------------------------------------------
Contribution from new business after cost of capital 241 35 276 36 312
Contribution from in-force business:
- expected return 273 49 322 18 340
- experience variances 3.4 46 17 63 15 78
- operating assumption changes 3.5 (221) 1 (220) 18 (202)
Development costs - - - (1) (1)
Contribution from shareholder net worth 135 11 146 6 152
----------------------------------------------------------------------------------------------------------------------
Operating profit 474 113 587 92 679
Variation from longer term investment return 363 3 366 11 377
Effect of economic assumption changes 15 19 34 - 34
----------------------------------------------------------------------------------------------------------------------
Profit from continuing operations before tax 852 135 987 103 1,090
Tax (238) (46) (284) (31) (315)
----------------------------------------------------------------------------------------------------------------------
Profit from continuing operations after tax 614 89 703 72 775
======================================================================================================================
1. For covered business, Investment management comprises managed pension funds and is included in the total Investment
management result of £136m (2004: £108m) see note 3.8.
3.3 Life and pensions operating profit
----------------------------------------
2005 2004
£m £m
----------------------------------------------------------------------------------------------------------------------
UK 801 474
USA 24 72
Netherlands 43 30
France 33 11
----------------------------------------------------------------------------------------------------------------------
901 587
======================================================================================================================
3.4 Analysis of experience variances
--------------------------------------
UK International Life and Investment Total
pensions manage-
Total ment
Year ended 31 December 2005 £m £m £m £m £m
----------------------------------------------------------------------------------------------------------------------
Persistency 2 2 4 15 19
Mortality / Morbidity 14 (7) 7 - 7
Expenses (6) 1 (5) 2 (3)
Other 79 4 83 8 91
----------------------------------------------------------------------------------------------------------------------
89 - 89 25 114
======================================================================================================================
2005 UK other experience variances of £79m principally comprise the impact of the release of prudent margins as more
data is loaded onto the new administration system for Bulk Purchase Annuity business (£73m).
2005 Investment management other experience variances of £8m include the effect of higher average fee rates than
assumed.
Year ended 31 December 2004
----------------------------------------------------------------------------------------------------------------------
Persistency (8) (5) (13) 10 (3)
Mortality / Morbidity 30 (5) 25 - 25
Expenses 3 2 5 2 7
Other 21 25 46 3 49
----------------------------------------------------------------------------------------------------------------------
46 17 63 15 78
======================================================================================================================
2004 UK other experience variances of £21m include the impact of margin releases as a result of loading data onto the
new administration system for Bulk Purchase Annuity business (£47m) partially offset by adverse tax variances (-£19m)
and other small variances.
3.5 Analysis of operating assumption changes
----------------------------------------------
UK International Life and Investment Total
pensions manage-
Total ment
Year ended 31 December 2005 £m £m £m £m £m
----------------------------------------------------------------------------------------------------------------------
Persistency 30 (12) 18 - 18
Mortality / Morbidity 11 (11) - - -
Expenses (24) 4 (20) - (20)
Other (31) 14 (17) 14 (3)
----------------------------------------------------------------------------------------------------------------------
(14) (5) (19) 14 (5)
======================================================================================================================
2005 UK other operating assumption changes of -£31m relate mainly to reserve strengthening relating to endowment
compensation (-£24m).
2005 Investment management other operating assumption changes of £14m arise from the continuation of the ten year
lapse assumption for all contracts through the extension of the modelling period.
Year ended 31 December 2004
----------------------------------------------------------------------------------------------------------------------
Persistency (4) 3 (1) - (1)
Mortality / Morbidity (116) (4) (120) - (120)
Expenses (8) 2 (6) - (6)
Other (93) - (93) 18 (75)
----------------------------------------------------------------------------------------------------------------------
(221) 1 (220) 18 (202)
======================================================================================================================
2004 UK operating assumption changes of -£221m relate primarily to the strengthening of assumptions for annuitant
mortality (-£240m). This charge is reflected in mortality / morbidity and as a change to valuation bases included
within other assumption changes. Also included in other is reserve strengthening relating to endowment compensation
(-£26m).
2004 Investment management other operating assumption changes of £18m arise from the continuation of the ten year
lapse assumption for all contracts through the extension of the modelling period.
3.6 Variation from longer term investment return
--------------------------------------------------
2005 2004
£m £m
----------------------------------------------------------------------------------------------------------------------
Total covered business 741 377
General insurance 8 (3)
Other operational income 121 40
----------------------------------------------------------------------------------------------------------------------
870 414
======================================================================================================================
3.7 Time value of options and guarantees
------------------------------------------
2005 2004
£m £m
----------------------------------------------------------------------------------------------------------------------
Life and pensions:
UK with-profits 2 8
UK non profit 21 24
International 5 8
----------------------------------------------------------------------------------------------------------------------
28 40
======================================================================================================================
For UK with-profits the burn through costs have reduced due to the strong 2005 investment performance and as a result
of management actions taken during 2005 to reduce the market risk to the with-profits part of the long term fund.
For UK non profit, the reduction is the result of the reduced financial impact of caps and collars on index linked
annuities.
3.8 Investment management income statement
--------------------------------------------
2005 2004
Restated
£m £m
----------------------------------------------------------------------------------------------------------------------
From continuing operations
Managed pension funds 114 92
Ventures 4 4
Property 4 3
Retail investments 7 4
Other external income 5 3
Other income 2 2
----------------------------------------------------------------------------------------------------------------------
Operating profit from investment management 136 108
Variation from longer term investment return 35 11
----------------------------------------------------------------------------------------------------------------------
Profit on ordinary activities before tax 171 119
Tax (52) (31)
----------------------------------------------------------------------------------------------------------------------
Profit on ordinary activities after tax 119 88
======================================================================================================================
Other income excludes the element relating to managed pension funds on the IFRS basis.
Investment management comprises the managed pensions fund business on an EEV basis and other investment management
business on an IFRS basis.
3.9 Analysis of tax
---------------------
2005 2005 2004 2004
Restated Restated
Profit Tax Profit Tax
before before
tax tax
£m £m £m £m
----------------------------------------------------------------------------------------------------------------------
From continuing operations
UK life and pensions 801 (230) 474 (134)
International life and pensions 100 (33) 113 (38)
----------------------------------------------------------------------------------------------------------------------
901 (263) 587 (172)
Investment management 136 (42) 108 (33)
General insurance 14 (4) 32 (9)
Other operational income 41 (5) 35 -
----------------------------------------------------------------------------------------------------------------------
Operating profit 1,092 (314) 762 (214)
Variation from longer term investment return 870 (246) 414 (129)
Effect of economic assumption changes 8 (3) 34 (11)
Property income attributable to minority interests 81 - 32 -
----------------------------------------------------------------------------------------------------------------------
Profit from continuing operations before tax / Tax 2,051 (563) 1,242 (354)
======================================================================================================================
3.10 Effect of UK tax changes
-------------------------------
This tax charge represents a one-off reduction in the embedded value arising from a change in tax law. The Finance
(No. 2) Act 2005 included provisions which change the way in which investment return is apportioned between categories
of business for the purposes of computing taxable profits earned from writing pension business. The taxable pension
business profits in the non profit part of the fund will be significantly higher from 2005 onwards.
3.11 Earnings per share
-------------------------
(a) Basic earnings per share
2005 2005 2005 2005 2004 2004 2004 2004
Restated Restated Restated Restated
Profit Tax Profit Per Profit Tax Profit Per
before (charge) /(loss) share before charge /(loss) share
tax /credit after tax tax after tax
£m £m £m p £m £m £m p
----------------------------------------------------------------------------------------------------------------------
Operating profit from continuing
operations 1,092 (314) 778 12.02 762 (214) 548 8.46
Variation from longer term
investment return 870 (246) 624 9.64 414 (129) 285 4.40
Effect of economic assumption
changes 8 (3) 5 0.08 34 (11) 23 0.35
Profit from discontinued operations 12 1 13 0.20 7 (2) 5 0.08
Effect of UK tax changes - (276) (276) (4.27) - - - -
Distributions on subordinated
borrowings designated as equity (16) (0.25) (12) (0.19)
----------------------------------------------------------------------------------------------------------------------
Basic earnings per share 1,982 (838) 1,128 17.42 1,217 (356) 849 13.10
======================================================================================================================
(b) Diluted earnings per share
Based on operating profit from continuing operations after tax
2005 2005 2005 2004 2004 2004
Restated Restated
Profit Weighted Per Profit Weighted Per
after average share after average share
tax number tax number
of shares of shares
£m m p £m m p
----------------------------------------------------------------------------------------------------------------------
Operating profit from continuing operations 778 6,474 12.02 548 6,479 8.46
Net shares under options allocable for no
further consideration - 38 (0.07) - 33 (0.04)
Convertible bonds outstanding 20 285 (0.21) 16 285 (0.12)
----------------------------------------------------------------------------------------------------------------------
Diluted earnings per share 798 6,797 11.74 564 6,797 8.30
======================================================================================================================
Based on profit attributable to ordinary equity holders
2005 2005 2005 2004 2004 2004
Profit Weighted Per Profit Weighted Per
after average share after average share
tax number tax number
of shares of shares
£m m p £m m p
----------------------------------------------------------------------------------------------------------------------
Profit attributable to ordinary equity
holders of the company 1,128 6,474 17.42 849 6,479 13.10
Net shares under options allocable for no
further consideration - 38 (0.09) - 33 (0.06)
Convertible bonds outstanding 20 285 (0.44) 16 285 (0.32)
----------------------------------------------------------------------------------------------------------------------
Diluted earnings per share 1,148 6,797 16.89 865 6,797 12.72
======================================================================================================================
3.12 Embedded value reconciliation
------------------------------------
UK UK UK International Life and Investment Total
Value of Shareholder life and life and pensions manage-
in-force net worth pensions pensions total ment(1)
As at 31 December 2005 £m £m £m £m £m £m £m
----------------------------------------------------------------------------------------------------------------------
At 1 January
Value of in-force business 2,885 - 2,885 431 3,316 191 3,507
Shareholder net worth - 1,560 1,560 276 1,836 162 1,998
----------------------------------------------------------------------------------------------------------------------
2,885 1,560 4,445 707 5,152 353 5,505
Exchange rate movements - - - 51 51 - 51
----------------------------------------------------------------------------------------------------------------------
2,885 1,560 4,445 758 5,203 353 5,556
Profit for the period 585 175 760 107 867 104 971
Capital movements - - - 5 5 - 5
Distributions relating to:
--------- ------------ ---------
With-profits EV : (46): : : : (46):
Non profit EV : : : (119): : (119):
Shareholder net worth EV : : : (100): : (100):
Subordinated debt : : : (26): : (26):
--------- ------------ ---------
Distributions (46) (245) (291) (2) (293) (35) (328)
Movement in pension deficit - (10) (10) - (10) - (10)
Inter-fund transfer (282) 282 - - - - -
----------------------------------------------------------------------------------------------------------------------
Embedded value 3,142 1,762 4,904 868 5,772 422 6,194
======================================================================================================================
Represented by:
With-profits 755 755
Non profit 2,387 2,387
----------------------------------------------------------------------------------------------------------------------
Value of in-force business 3,142 - 3,142 570 3,712 238 3,950
Shareholder net worth - 1,762 1,762 298 2,060 184 2,244
======================================================================================================================
1. For covered business, Investment management comprises managed pension funds and is included in the total Investment
management shareholders' equity of £506m.
UK UK UK International Life and Investment Total
Value of Shareholder life and life and pensions manage-
in-force net worth pensions pensions total ment(1)
As at 31 December 2004 £m £m £m £m £m £m £m
----------------------------------------------------------------------------------------------------------------------
At 1 January
Value of in-force business 2,552 - 2,552 377 2,929 158 3,087
Shareholder net worth - 1,569 1,569 245 1,814 143 1,957
----------------------------------------------------------------------------------------------------------------------
2,552 1,569 4,121 622 4,743 301 5,044
Exchange rate movements - - - (28) (28) - (28)
----------------------------------------------------------------------------------------------------------------------
2,552 1,569 4,121 594 4,715 301 5,016
Profit for the period 423 191 614 89 703 72 775
Capital movements - - - 25 25 - 25
Distributions relating to:
--------- ------------ ---------
With-profits EV : (47): : : : (47):
Non profit EV : : : (117): : (117):
Shareholder net worth EV : : : (84): : (84):
Subordinated debt : : : (26): : (26):
--------- ------------ ---------
Distributions (47) (227) (274) (1) (275) (20) (295)
Movement in pension deficit - (16) (16) - (16) - (16)
Inter-fund transfer (43) 43 - - - - -
----------------------------------------------------------------------------------------------------------------------
Embedded value 2,885 1,560 4,445 707 5,152 353 5,505
======================================================================================================================
Represented by:
With-profits 640 640
Non profit 2,245 2,245
----------------------------------------------------------------------------------------------------------------------
Value of in-force business 2,885 - 2,885 431 3,316 191 3,507
Shareholder net worth - 1,560 1,560 276 1,836 162 1,998
======================================================================================================================
1. For covered business, Investment management comprises managed pension funds and is included in the total Investment
management shareholders' equity of £431m.
3.13 Analysis of ordinary shareholders' equity
------------------------------------------------
UK International Life and Investment Other Total
life and life and pensions manage- operations(2)
pensions pensions total ment(1)
As at 31 December 2005 £m £m £m £m £m £m
----------------------------------------------------------------------------------------------------------------------
Analysed as:
IFRS basis ordinary shareholders' equity 2,560 737 3,297 184 776 4,257
Additional retained profit on an EEV basis 2,344 131 2,475 238 - 2,713
----------------------------------------------------------------------------------------------------------------------
Ordinary shareholders' equity on an EEV basis 4,904 868 5,772 422 776 6,970
======================================================================================================================
Comprising:
Shareholder net worth
- Free surplus - 148 148 166
- Required capital to cover solvency 689 150 839 18
- Other required capital 1,073 - 1,073 -
Value of in-force
- Value of in-force business 3,148 618 3,766 243
- Cost of capital (6) (48) (54) (5)
======================================================================================================================
As at 31 December 2004 (Restated)
----------------------------------------------------------------------------------------------------------------------
Analysed as:
IFRS basis ordinary shareholders' equity 2,196 636 2,832 162 681 3,675
Additional retained profit on an EEV basis 2,249 71 2,320 191 - 2,511
----------------------------------------------------------------------------------------------------------------------
Ordinary shareholders' equity on an EEV basis 4,445 707 5,152 353 681 6,186
======================================================================================================================
Comprising:
Shareholder net worth
- Free surplus - 166 166 144
- Required capital to cover solvency 676 110 786 18
- Other required capital 884 - 884 -
Value of in-force
- Value of in-force business 2,893 479 3,372 193
- Cost of capital (8) (48) (56) (2)
======================================================================================================================
Free surplus is the market value of any capital and surplus allocated to, but not required to support, the in-force
covered business at the valuation date.
Required capital includes any amount of assets attributed to the covered business over and above that required to back
liabilities for covered business whose distribution to shareholders is restricted.
1. Investment management comprises managed pension funds and is included in the total Investment management
shareholders' equity of £506m (2004: £431m).
2. Other Investment management businesses included on an IFRS basis of £84m (2004: £78m) are included in other
operations.
3.14 Segmental analysis of ordinary shareholders' equity
----------------------------------------------------------
2005 2005 2005 2004 2004 2004
Restated Restated
Covered Other Total Covered Other Total
business business business business
EEV basis IFRS basis EEV basis IFRS basis
£m £m £m £m £m £m
----------------------------------------------------------------------------------------------------------------------
UK(1) 4,904 - 4,904 4,445 - 4,445
Society shareholder capital(2) - 1,896 1,896 - 1,973 1,973
----------------------------------------------------------------------------------------------------------------------
4,904 1,896 6,800 4,445 1,973 6,418
Embedded value of international life and pensions
business
- USA 566 - 566 489 - 489
- Netherlands 192 - 192 139 - 139
- France 110 - 110 79 - 79
----------------------------------------------------------------------------------------------------------------------
5,772 1,896 7,668 5,152 1,973 7,125
Investment management 422 84 506 353 78 431
----------------------------------------------------------------------------------------------------------------------
6,194 1,980 8,174 5,505 2,051 7,556
General insurance - 167 167 - 247 247
Corporate funds(3) - (1,371) (1,371) - (1,617) (1,617)
----------------------------------------------------------------------------------------------------------------------
6,194 776 6,970 5,505 681 6,186
======================================================================================================================
1. Includes £602m of intra-group subordinated debt capital attributed to the SRC.
2. Represents surplus capital held outside the UK long term fund, including the rights issue proceeds.
3. Includes the convertible debt of £509m (2004: £493m) and £602m of senior debt which has been on lent to the UK long
term fund.
3.15 Sensitivities
--------------------
The discount rate appropriate to any investor will depend on the investor's own requirements, tax and perception of the
risks associated with the anticipated cash flows to shareholders. The table below shows the effect of alternative
economic and non-economic assumptions on the long term embedded value and new business. These alternative assumptions
are in accordance with the guidance issued by the CFO Forum in October 2005.
Effect on embedded value as at 31 December 2005
Sensitivity to economic assumptions: As published 1% lower 1% higher 1% lower 1% higher 10% lower
risk discount risk discount interest equities/ equities/
rate rate rate property property
yields values
£m £m £m £m £m £m
----------------------------------------------------------------------------------------------------------------------
Life and pensions
- UK 4,904 333 (288) (1) 257 (344)
- International 868 59 (51) - 7 (11)
----------------------------------------------------------------------------------------------------------------------
Total life and pensions 5,772 392 (339) (1) 264 (355)
Investment management 422 10 (10) (5) 8 (15)
----------------------------------------------------------------------------------------------------------------------
Total covered business 6,194 402 (349) (6) 272 (370)
======================================================================================================================
Sensitivity to non-economic assumptions: As published 10% 10% 5% decrease 5% decrease
decrease in decrease in mortality in mortality
maintenance in lapse (UK (other
expenses rates annuities) business)
£m £m £m £m £m
----------------------------------------------------------------------------------------------------------------------
Life and pensions
- UK 4,904 45 54 (101) 26
- International 868 10 28 n/a 57
----------------------------------------------------------------------------------------------------------------------
Total life and pensions 5,772 55 82 (101) 83
Investment management 422 16 12 n/a n/a
----------------------------------------------------------------------------------------------------------------------
Total covered business 6,194 71 94 (101) 83
======================================================================================================================
Effect on new business contribution for the year
Sensitivity to economic assumptions: As published 1% lower 1% higher 1% lower 1% higher 10% lower
risk discount risk discount interest equities/ equities/
rate rate rate property property
yields values
£m £m £m £m £m £m
----------------------------------------------------------------------------------------------------------------------
Life and pensions
- UK 306 63 (55) (20) 36 (43)
- International 25 21 (18) (6) - -
----------------------------------------------------------------------------------------------------------------------
Total life and pensions 331 84 (73) (26) 36 (43)
Investment management 49 2 (2) (1) 2 -
----------------------------------------------------------------------------------------------------------------------
Total covered business 380 86 (75) (27) 38 (43)
======================================================================================================================
Sensitivity to non-economic assumptions: As published 10% 10% 5% decrease 5% decrease
decrease in decrease in mortality in mortality
maintenance in lapse (UK (other
expenses rates annuities) business)
£m £m £m £m £m
----------------------------------------------------------------------------------------------------------------------
Life and pensions
- UK 306 11 21 (10) 7
- International 25 2 5 n/a 12
----------------------------------------------------------------------------------------------------------------------
Total life and pensions 331 13 26 (10) 19
Investment management 49 3 3 n/a n/a
----------------------------------------------------------------------------------------------------------------------
Total covered business 380 16 29 (10) 19
======================================================================================================================
Opposite sensitivities to those shown above are broadly symmetrical with the exception of the effect of 1% higher
interest rates on the UK embedded value (+£34m) and on UK new business contribution (+£13m).
3.16 Assumptions
------------------
UK life and pensions
i. 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 assumption plus the appropriate risk premium. An asset mix consistent
with the current investment policy and future management intentions has been assumed within the projections. The
economic assumptions were:
31.12.05 31.12.04 31.12.03
% p.a. % p.a. % p.a.
Equity risk premium 3.0 3.0 3.0
Property risk premium 2.0 2.0 2.0
Investment return
- Gilts:
- Fixed interest 4.1 4.5 4.7
- RPI linked 4.2 4.5 4.6
- Non Gilts:
- Fixed interest 4.4 - 4.8 4.9 - 5.3 5.1 - 5.5
- RPI linked 4.2 - 4.6 4.7 - 5.1 5.1 - 5.4
- Equities 7.1 7.5 7.7
- Property 6.1 6.5 6.7
Risk margin 3.0 3.0 3.0
Risk discount rate (net of tax) 7.1 7.5 7.7
Inflation
- Expenses/earnings 3.9 3.8 3.8
- Indexation 2.9 2.8 2.8
The assumed returns on non-gilt securities are net of an allowance for default risk of 0.2% p.a.
(2004: 0.2% p.a.), other than for certain government-supported securities where no such allowance is made.
ii. The value of the Sub-fund is the discounted value of total projected investment returns over its lifetime.
iii. Assets are valued at market value. For the projection of fixed interest and RPI linked investment returns, asset
values are adjusted to reflect the assumed interest and inflation rates.
iv. Future bonus rates have been set at levels which would fully utilise the assets supporting the policyholders'
portion of the with-profits business. The proportion of profits derived from with-profits business allocated to
shareholders has been assumed to be 10% throughout.
v. The value of in-force business reflects the cost of providing for benefit enhancement or compensation in relation
to certain products including administration expenses.
vi. Other actuarial assumptions have been set at levels commensurate with recent operating experience, including those
for mortality, morbidity, persistency and maintenance expenses (excluding the development costs referred to
below). These are reviewed annually. An allowance is made for future improvements in annuitant mortality based on
experience and externally published data. Male annuitant mortality is assumed to improve in accordance with CMI
Working Paper 1, projection MC for future experience with a minimum annual improvement of 0.6%, and the average of
projections MC and LC for statutory reserving with a minimum annual improvement of 0.8%. Female annuitant
mortality is assumed to improve in accordance with the MC projection from CMI Working Paper 1 for statutory
reserving and at 70% of this rate for future experience, with the same underpinning minima as for males.
vii. The subordinated debt capital has been included in the embedded value at the face value of £602m (estimated market
value of £699m at 31 December 2005). If the market value of the subordinated debt capital were used, total
embedded value would increase by £31m.
viii. Development costs relate to strategic systems.
ix. Projected tax has been determined assuming current tax legislation and rates.
x. EEV results are computed on an after tax basis and are grossed up to the pre-tax level for presentation in the
profit and loss account. The tax rate used for grossing-up is the corporation tax rate of 30% (2004: 30%), except
for the profit attributable to shareholder net worth, where the rate used is derived from the tax attributed to
the contribution from shareholder net worth in the IFRS accounts. To arrive at operating profit, the contribution
from shareholder net worth is grossed up at 20% (2004: 20%) which reflects the tax associated with a longer term
investment return.
UK managed pension funds
xi. The UK life and pensions economic assumptions are used. All contracts are assumed to lapse over a 10 year period.
Fees are projected on a basis which reflects current charges or, if less, anticipated charges. New business
consists of monies received from new clients and incremental receipts from existing clients, and excludes the
roll-up of the investment returns. Development costs relate to strategic systems.
International
xii. Key assumptions are:
31.12.05 31.12.04 31.12.03
% p.a. % p.a. % p.a.
USA
Reinvestment rate 5.1 4.9 4.8
Risk margin 3.0 3.0 3.0
Risk discount rate (net of tax) 7.4 7.3 7.3
Europe
Government bond return 3.3 3.8 4.5
Risk margin 3.0 3.0 3.0
Risk discount rate (net of tax) 6.3 6.8 7.5
xiii. Other actuarial assumptions have been set at levels commensurate with recent operating experience, including
those for mortality, morbidity, persistency and maintenance expenses.
Stochastic calculations
xiv. The time value of options and guarantees is calculated using economic and non-economic assumptions consistent
with those used for the deterministic embedded value calculations.
This section describes the models used to generate future investment simulations, and gives some sample
statistics for the simulations used. A single model has been used for UK and international business, with
different economic assumptions for each territory.
Model
Government nominal interest rates are generated using a LIBOR Money Market Model projecting full yield curves at
annual intervals. The model provides a good fit to the initial yield curve.
The total annual returns on equities and property are calculated as the return on 1 year bonds plus an excess
return. The excess return is assumed to have a lognormal distribution. Corporate bonds are modelled separately by
credit rating using stochastic credit spreads over the risk-free rates, transition matrices and default recovery
rates. The real yield curve model assumes that the real short rate follows a mean reverting process subject to
two normally distributed random shocks.
Asset Classes
The significant asset classes are for:
- UK with-profits business - equities, property and fixed rate bonds of various durations;
- UK annuity business - fixed rate and index-linked bonds of various durations; and
- International business - fixed rate bonds of various durations.
Summary Statistics
The following tables set out means and standard deviations (StDev) of future returns as at 31 December 2005 for
the most significant asset classes. Correlations between asset classes have been set based on an internal
assessment of historical data.
10-year return 20-year return
Mean(1) StDev(2) Mean(1) StDev(2)
UK Business (Sterling)
Government bonds 4.2% 4.1% 4.2% 3.6%
Corporate bonds 4.7% 3.0% 4.8% 3.4%
Property (excess returns) 2.1% 15.4% 2.1% 15.5%
Equities (excess returns) 3.1% 20.3% 3.0% 20.2%
European Business (Euro)
Long Government bonds(3) 3.4% 4.6% 3.8% 4.8%
Short Government bonds(4) 3.4% 3.2% 3.8% 6.4%
US Business (US Dollar)
Long Government bonds(3) 4.6% 5.6% 5.0% 5.6%
1. Other than for equities and property, means are calculated as the excess of 1 year bond asset return means
plus 1 year bond means. Means for the equities and property excess returns are calculated as the excess of 1
year bond asset return means. Each mean is derived by calculating the accumulated value of a unit asset
invested to time n years for each simulation, averaging the resultant values across all simulations, then
calculating the equivalent annual return required to give this average accumulation (by taking the nth root
of the average accumulation and deducting 1).
2. Standard deviations are calculated by accumulating a unit investment for n years in each simulation, taking
the natural logarithm of the result, calculating the variance of this statistic, dividing by n and taking the
square root. Equities and property values use excess returns. The results are comparable to implied
volatilities quoted in investment markets.
3. Long term bonds are defined to be 10-year par-coupon bonds.
4. Short term bonds are defined to be 1 year duration bonds.
Risk discount rate
The risk discount rate is scenario-dependent within the stochastic projection. It is calculated by applying the
deterministic risk margin to the risk free rate in each stochastic projection.
Sensitivity calculations
xv. A number of sensitivities have been produced on alternative assumption sets to reflect the sensitivity of the
embedded value and the new business contribution to changes in key assumptions. Relevant details relating to each
sensitivity are:
- 1% variation in discount rate - a one percentage point increase/decrease in the risk margin has been assumed
in each case (for example, a 1% increase in the risk margin at end 2005 would result in a 4% risk margin).
- 1% reduction in equity/property yields - a one percentage point decrease in the assumed equity/property
investment returns, excluding any consequential changes, for example, to risk discount rates or valuation
bases, has been assumed in each case (meaning, for example, a 1% increase in equity returns would increase
assumed total equity returns from 7.1% to 8.1%).
- 10% reduction in equity/property market values - an immediate 10% reduction in equity and property asset
values.
- 1% reduction in interest rate environment - a one percentage point decrease in all investment assumptions and
the risk discount rate, including consequential changes to valuation bases.
- 10% decrease in maintenance expenses, excluding any consequential changes, for example, to valuation expense
bases or potentially reviewable policy fees (meaning a 10% decrease on a base assumption of £10 per annum
would result in a £9 per annum expense assumption).
- 10% decrease in assumed persistency experience rates, incorporating a 10% decrease in lapse, surrender and
premium cessation assumptions (meaning a 10% decrease on a base assumption of 7% would result in a 6.3% lapse
assumption).
- 5% decrease in both mortality and morbidity rates, excluding any consequential changes to valuation bases but
including assumed product repricing action where appropriate (meaning, for example, if base experienced
mortality is 90% of a standard mortality table then, for this sensitivity, the assumption is set to 85.5% of
the standard table).
The sensitivities for life and pensions business allow for any material changes to the cost of financial options
and guarantees but do not allow for any changes to reserving bases or capital requirements within the sensitivity
calculation, unless indicated otherwise above.
This information is provided by RNS
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