L&G Half-year Results Part 3b

RNS Number : 6252A

Legal & General Group Plc

05 August 2008

 



European Embedded Value

Notes to the Financial Statements

3.09  Analysis of tax
					Profit/(loss)	Tax	Profit/(loss)	Tax	Profit/(loss)	Tax
					before	(charge)/	before	(charge)/	before	(charge)/
					tax	credit	tax	credit	tax	credit
									Full year	Full year
					30.06.08	30.06.08	30.06.07	30.06.07	31.12.07	31.12.07
					£m	£m	£m	£m	£m	£m
From continuing operations
UK life and pensions					506	(152)	497	(139)	720	(232)
International life and pensions					58	(18)	54	(16)	136	(40)
					564	(170)	551	(155)	856	(272)
Investment management					111	(26)	90	(26)	196	(57)
General insurance					(4)	1	(38)	12	(67)	19
Other operational income					(45)	14	(14)	10	(73)	30
Operating profit					626	(181)	589	(159)	912	(280)
Variation from longer term investment return					(538)	168	197	(61)	116	12
Effect of economic assumption changes					(10)	4	(6)	2	57	(14)
Property (expense)/income attributable to minority interests					(13)	-	17	-	(6)	-
Corporate restructure					-	-	-	-	161	(45)
Profit from continuing operations before tax / Tax					65	(9)	797	(218)	1,240	(327)
European Embedded Value										Page 31
Notes to the Financial Statements
3.10  Earnings per share
(a)  Earnings per share
			Profit/(loss)	Tax	Profit/(loss)	Per share	Profit/(loss)	Tax	Profit/(loss)	Per share
			before tax	(charge)/	after tax		before tax	(charge)/	after tax
				credit				credit
			30.06.08	30.06.08	30.06.08	30.06.08	30.06.07	30.06.07	30.06.07	30.06.07
			£m	£m	£m	p	£m	£m	£m	p
Operating profit from continuing operations			626	(181)	445	7.33	589	(159)	430	6.62
Variation from longer term investment return			(538)	168	(370)	(6.09)	197	(61)	136	2.09
Effect of economic assumption changes			(10)	4	(6)	(0.10)	(6)	2	(4)	(0.06)
Effect of UK Budget tax changes			-	-	-	-	-	93	93	1.43
Earnings per share based on profit
attributable to equity holders			78	(9)	69	1.14	780	(125)	655	10.08
							Profit	Tax	Profit	Per share
							before tax	(charge)/	after tax
								credit
							Full year	Full year	Full year	Full year
							31.12.07	31.12.07	31.12.07	31.12.07
							£m	£m	£m	p
Operating profit from continuing operations							912	(280)	632	9.81
Variation from longer term investment return							116	12	128	1.99
Effect of economic assumption changes							57	(14)	43	0.67
Corporate restructure							161	(45)	116	1.80
Effect of UK Budget tax changes							-	93	93	1.44
Tax impact of corporate restructure							-	206	206	3.19
Earnings per share based on profit
attributable to equity holders							1,246	(28)	1,218	18.90
European Embedded Value										Page 32
Notes to the Financial Statements
3.10  Earnings per share (continued)
(b)  Diluted earnings per share
(i)  Based on operating profit from continuing operations after tax
					Profit	Number	Per share	Profit	Number	Per share
					after tax	of shares1		after tax	of shares1
					30.06.08	30.06.08	30.06.08	30.06.07	30.06.07	30.06.07
					£m	m	p	£m	m	p
Operating profit from continuing operations after tax					445	6,073	7.33	430	6,493	6.62
Net shares under options allocable for no further consideration					-	22	(0.03)	-	37	(0.03)
Diluted earnings per share					445	6,095	7.30	430	6,530	6.59
								Profit	Number	Per share
								after tax	of shares1
								Full year	Full year	Full year
								31.12.07	31.12.07	31.12.07
								£m	m	p
Operating profit from continuing operations after tax								632	6,444	9.81
Net shares under options allocable for no further consideration								-	34	(0.05)
Diluted earnings per share								632	6,478	9.76
(ii)  Based on profit attributable to equity holders of the Company
					Profit	Number	Per share	Profit	Number	Per share
					after tax	of shares1		after tax	of shares1
					30.06.08	30.06.08	30.06.08	30.06.07	30.06.07	30.06.07
					£m	m	p	£m	m	p
Profit attributable to equity holders of the Company					69	6,073	1.14	655	6,493	10.08
Net shares under options allocable for no further consideration					-	22	(0.01)	-	37	(0.05)
Diluted earnings per share					69	6,095	1.13	655	6,530	10.03
								Profit	Number	Per share
								after tax	of shares1
								Full year	Full year	Full year
								31.12.07	31.12.07	31.12.07
								£m	m	p
Profit attributable to equity holders of the Company								1,218	6,444	18.90
Net shares under options allocable for no further consideration								-	34	(0.10)
Diluted earnings per share								1,218	6,478	18.80
1. Weighted average number of shares.
European Embedded Value										Page 33
Notes to the Financial Statements
3.11  Embedded value reconciliation
				UK	UK	UK	International	Life and	Investment	Total
				value of	shareholder	life and	life and	pensions	manage-
				in-force	net worth1	pensions	pensions	total	ment2
As at 30 June 2008			Notes	£m	£m	£m	£m	£m	£m	£m
At 1 January
Value of in-force business (VIF)				2,846	-	2,846	782	3,628	340	3,968
Shareholder net worth (SNW)				-	4,447	4,447	319	4,766	222	4,988
				2,846	4,447	7,293	1,101	8,394	562	8,956
Exchange rate movements				-	-	-	34	34	-	34
Opening adjustments				(27)	27	-	-	-	-	-
				2,819	4,474	7,293	1,135	8,428	562	8,990
Profit for the period:
- New business contribution				334	(206)	128
- Expected return on VIF				107	-	107
- Expected return - transfer to SNW				(217)	217	-
- Less: expected movement in contingent loan3				(41)	41	-
- Experience variances				89	(72)	17
- Operating assumption changes				19	(9)	10
- Development costs				-	(16)	(16)
- Expected return on SNW				-	108	108
- Investment variances				31	(332)	(301)
- Economic assumption changes				(29)	32	3
Profit for the period4				293	(237)	56	(3)	53	28	81
Capital movements5				-	(252)	(252)	-	(252)	-	(252)
Embedded value of businesses acquired6				143	156	299	-	299	-	299
Distributions:
- With-profits transfer				(43)	43	-
- Dividend to Group				-	-	-
Distributions				(43)	43	-	(3)	(3)	-	(3)
Other reserve movements including pension deficit				-	(4)	(4)	-	(4)	-	(4)
Transfer to non-covered business7				-	(14)	(14)	-	(14)	-	(14)
Embedded value			3.12/3.13	3,212	4,166	7,378	1,129	8,507	590	9,097
Represented by:
Non profit				2,531		2,531
With-profits				681		681
Value of in-force business				3,212	-	3,212	838	4,050	323	4,373
Shareholder net worth				-	4,166	4,166	291	4,457	267	4,724
1. Following the long term fund restructure in 2007, the shareholder net worth (SNW) of the UK life and pensions business was redefined to include the shareholder capital held outside the long term fund. The pre-tax longer term investment return earned on these assets of £46m is included in UK expected return on SNW (FY07: £52m). The long term investment return on these assets in H107 of £32m was included in Other operational income.  2. Investment management covered business comprises managed pension funds and is included in the total Investment management shareholders' equity of £792m. 3. On an EEV basis, the contingent loan (between Shareholder capital within the LTF and LGPL) is modelled as an asset of SNW. As profits from the in-force business of LGPL are earned, cash is realised and transferred to SNW and the contingent loan asset is reduced accordingly. The expected movement includes both repayment of capital relating to in-force business and drawdown of loan relating to new business written in the period. 4. Included in the profit for the period is an inter-fund transfer from Shareholder capital within the LTF (included in SNW) to non profit (included in VIF) of £44m. 5. Capital movements comprise the £252m cost of acquiring Nationwide Life.  The acquisition of Suffolk Life was funded from Corporate funds within the non-covered business (£63m). Further information on both acquisitions can be found in Note 4.09. 6. The embedded value of businesses acquired on the date of acquisition comprises £235m from the acquisition of Nationwide Life on 31 January 2008 and £64m from the acquisition of Suffolk Life on 6 May 2008. Further information relating to the businesses acquired can be found in Note 4.09. 7. The transfer to non-covered business represents the IFRS profits arising in the period from the provision of investment management services by Legal & General Investment Management to the UK life and pensions covered business, which have been included in the operating profit of the covered business on a look through basis.
European Embedded Value										Page 34
Notes to the Financial Statements
3.11  Embedded value reconciliation (continued)
				UK	UK	UK	International	Life and	Investment	Total
				value of	shareholder	life and	life and	pensions	manage-
				in-force	net worth1	pensions	pensions	total	ment2
As at 30 June 2007			Notes	£m	£m	£m	£m	£m	£m	£m
At 1 January
Value of in-force business (VIF)				2,428	-	2,428	652	3,080	281	3,361
Shareholder net worth (SNW)				-	3,828	3,828	261	4,089	194	4,283
				2,428	3,828	6,256	913	7,169	475	7,644
Exchange rate movements				-	-	-	(18)	(18)	-	(18)
				2,428	3,828	6,256	895	7,151	475	7,626
Profit for the period:
- New business contribution				237	(118)	119
- Expected return on VIF				91	-	91
- Expected return - transfer to SNW				(172)	172	-
- Less: expected movement in contingent loan3				29	(29)	-
- Experience variances				143	(99)	44
- Operating assumption changes				3	(12)	(9)
- Development costs				-	(8)	(8)
- Expected return on SNW				-	121	121
- Investment variances				24	114	138
- Economic assumption changes				(11)	2	(9)
- Effect of UK Budget tax changes				48	38	86
Profit for the period4				392	181	573	29	602	65	667
Capital movements5				-	-	-	73	73	-	73
Distributions:
- Non profit			5.04 (a)		(61)	(61)
- With-profits				(35)		(35)
- Shareholder net worth			5.04 (a)		(78)	(78)
Distributions				(35)	(139)	(174)	-	(174)	-	(174)
Other reserve movements including pension deficit				-	23	23	-	23	-	23
Transfer to non-covered business6				-	(3)	(3)	-	(3)	-	(3)
Embedded value			3.12/3.13	2,785	3,890	6,675	997	7,672	540	8,212
Represented by:
Non profit				1,902		1,902
With-profits				883		883
Value of in-force business				2,785	-	2,785	707	3,492	310	3,802
Shareholder net worth				-	3,890	3,890	290	4,180	230	4,410
1. At HY07 UK SNW represented the amounts in the Society long term fund and LGPL shareholder capital which are regarded as either required capital or free surplus held within the covered business. 2. Investment management covered business comprises managed pension funds and is included in the total Investment management shareholders' equity of £671m. 3. On an EEV basis, the contingent loan (between SRC and LGPL) is modelled as an asset of SNW. As profits from the in-force business of LGPL are earned, cash is realised and transferred to SNW and the contingent loan asset is reduced accordingly. The expected movement includes both repayment of capital relating to in-force business and drawdown of loan relating to new business written in the period. 4. Included in the profit for the period is an inter-fund transfer from SRC (included in SNW) to non profit (included in VIF) of £35m. 5. Capital movements comprise £46m ($90m) of capital injected into the USA operation and £27m (€40m) injected into the French operation. 6. The transfer to non-covered business represents the IFRS profits arising in the period from the provision of investment management services by Legal & General Investment Management to the UK life and pensions covered business, which have been included in the operating profit of the covered business on a look through basis.
European Embedded Value										Page 35
Notes to the Financial Statements
3.11  Embedded value reconciliation (continued)
				UK	UK	UK	International	Life and	Investment	Total
				value of	shareholder	life and	life and	pensions	manage-
				in-force	net worth	pensions	pensions	total	ment1
As at 31 December 2007			Notes	£m	£m	£m	£m	£m	£m	£m
At 1 January
Value of in-force business (VIF)				2,428	-	2,428	652	3,080	281	3,361
Shareholder net worth (SNW)				-	3,828	3,828	261	4,089	194	4,283
				2,428	3,828	6,256	913	7,169	475	7,644
Exchange rate movements				-	-	-	28	28	-	28
				2,428	3,828	6,256	941	7,197	475	7,672
Profit for the period:
- New business contribution				510	(279)	231
- Expected return on VIF				189	-	189
- Expected return - transfer to SNW				(331)	331	-
- Movement in contingent loan2				(108)	108	-
- Experience variances				64	7	71
- Operating assumption changes				(23)	(179)	(202)
- Development costs				-	(34)	(34)
- Expected return on SNW				-	233	233
- Investment variances				195	(57)	138
- Economic assumption changes				(97)	147	50
- Effect of UK Budget tax changes				48	38	86
- Corporate restructure				45	71	116
- Tax impact of Corporate restructure				-	206	206
Profit for the period3				492	592	1,084	78	1,162	139	1,301
Capital movements4				-	(590)	(590)	84	(506)	-	(506)
Other capital movements				-	1,307	1,307	-	1,307	-	1,307
Distributions:
- With-profits transfer				(74)	74	-
- Dividend to Group				-	(728)	(728)
Distributions				(74)	(654)	(728)	(2)	(730)	(52)	(782)
Other reserve movements including pension deficit				-	(20)	(20)	-	(20)	-	(20)
Transfer to non-covered business5				-	(16)	(16)	-	(16)	-	(16)
Embedded value			3.12/3.13	2,846	4,447	7,293	1,101	8,394	562	8,956
Represented by:
Non profit				2,056		2,056
With-profits				790		790
Value of in-force business				2,846	-	2,846	782	3,628	340	3,968
Shareholder net worth				-	4,447	4,447	319	4,766	222	4,988
1. Investment management covered business comprises managed pension funds and is included in the total Investment management shareholders' equity of £689m. 2. On an EEV basis, the contingent loan (between Society and LGPL) is modelled as an asset of SNW. As profits from the in-force business of LGPL are earned, cash is realised and transferred to SNW and the contingent loan asset is reduced accordingly. The movement includes both the repayment of capital relating to in-force business and drawdown of loan relating to new business written in the period. 3. Included in the profit for the period is an inter-fund transfer from non profit (included in VIF) to SRC (included in SNW) of £60m. 4. Capital movements comprise the repayment of £602m of intra-group subordinated debt, offset by £57m ($114m) of capital injected into the USA and £39m injected into Legal & General International (Ireland) from Group, together with £27m (€40m) injected into France from Society. 5. The transfer to non-covered business represents the IFRS profits arising in the period from the provision of investment management services by Legal & General Investment Management to the UK life and pensions covered business, which have been included in the operating profit of the covered business on the look through basis.
European Embedded Value										Page 36
Notes to the Financial Statements
3.12  Analysis of shareholders' equity
					UK1	International	Life and	Investment	Other	Total
							pensions	manage-	operations3
							total	ment2
As at 30 June 2008					£m	£m	£m	£m	£m	£m
Analysed as:
IFRS basis shareholders' equity					4,824	900	5,724	267	(1,316)	4,675
Additional retained profit on an EEV basis					2,554	229	2,783	323	-	3,106
Shareholders' equity on an EEV basis					7,378	1,129	8,507	590	(1,316)	7,781
Comprising:
Shareholder net worth
- Free surplus					2,828	90	2,918	243
- Required capital to cover solvency margin					1,338	201	1,539	24
Value of in-force
- Value of in-force business					3,332	903	4,235	331
- Cost of capital					(120)	(65)	(185)	(8)
As at 30 June 2007
Analysed as:
IFRS basis shareholders' equity					4,329	803	5,132	230	153	5,515
Additional retained profit on an EEV basis					2,346	194	2,540	310	-	2,850
Shareholders' equity on an EEV basis					6,675	997	7,672	540	153	8,365
Comprising:
Shareholder net worth
- Free surplus					691	106	797	206
- Required capital to cover solvency margin					1,402	184	1,586	24
- Other required capital					1,797	-	1,797	-
Value of in-force
- Value of in-force business					2,926	759	3,685	316
- Cost of capital					(141)	(52)	(193)	(6)
As at 31 December 2007
Analysed as:
IFRS basis shareholders' equity					4,832	880	5,712	222	(488)	5,446
Additional retained profit on an EEV basis					2,461	221	2,682	340	-	3,022
Shareholders' equity on an EEV basis					7,293	1,101	8,394	562	(488)	8,468
Comprising:
Shareholder net worth
- Free surplus					3,249	140	3,389	198
- Required capital to cover solvency margin					1,198	179	1,377	24
Value of in-force
- Value of in-force business					2,944	840	3,784	347
- Cost of capital					(98)	(58)	(156)	(7)
Free surplus is the value of any capital allocated to, but not required to support, the in-force covered business at the valuation date. 1. H1 08 and FY 07 include total Society shareholder capital.  2. Investment management comprises managed pension funds and is included in the total Investment management shareholders' equity of £792m (H1 07: £671m, FY 07: £689m). 3. Other Investment management businesses included on an IFRS basis at £202m (H1 07: £131m; FY 07: £127m) are included in Other operations.
European Embedded Value										Page 37
Notes to the Financial Statements
3.13  Segmental analysis of shareholders' equity
					Covered	Other	Total	Covered	Other	Total
					business	business		business	business
					EEV basis	IFRS basis		EEV basis	IFRS basis
					At 30.06.08	At 30.06.08	At 30.06.08	At 30.06.07	At 30.06.07	At 30.06.07
					£m	£m	£m	£m	£m	£m
UK life and pensions					7,378	-	7,378	6,675	501	7,176
Embedded value of international life and pensions business
- USA					647	-	647	595	-	595
- Netherlands					286	-	286	236	-	236
- France					196	-	196	166	-	166
					8,507	-	8,507	7,672	501	8,173
Investment management					590	202	792	540	131	671
					9,097	202	9,299	8,212	632	8,844
General insurance					-	98	98	-	136	136
Corporate funds1					-	(1,616)	(1,616)	-	(615)	(615)
					9,097	(1,316)	7,781	8,212	153	8,365
								Covered	Other	Total
								business	business
								EEV basis	IFRS basis
								At 31.12.07	At 31.12.07	At 31.12.07
								£m	£m	£m
UK life and pensions								7,293	-	7,293
Embedded value of international life and pensions business
- USA								645	-	645
- Netherlands								270	-	270
- France								186	-	186
								8,394	-	8,394
Investment management								562	127	689
								8,956	127	9,083
General insurance								-	114	114
Corporate funds1								-	(729)	(729)
								8,956	(488)	8,468
Further analysis of the covered business is included in Note 3.12.
										Full year
								30.06.08	30.06.07	31.12.07
								£m	£m	£m
Movement
As at 1 January								8,468	7,931	7,931
Total recognised income and expense								92	665	1,229
Issue of share capital								7	3	4
Share buyback								(408)	-	(320)
Closed period share buyback reserve								(100)	-	-
Net movements in employee scheme shares								(9)	(9)	1
Dividend distributions to equity holders of the Company during the period								(248)	(248)	(369)
Other movements including pension deficit								(21)	23	(8)
As at 30 June / 31 December								7,781	8,365	8,468
1. Corporate funds includes general corporate assets held at Group level including those used to support the ongoing share buyback programme, subordinated borrowings and senior borrowings.
European Embedded Value										Page 38
Notes to the Financial Statements
3.14  Reconciliation of shareholder net worth
					UK life and	Total	UK life and	Total	UK life and	Total
					pensions		pensions		pensions
					At 30.06.08	At 30.06.08	At 30.06.07	At 30.06.07	At 31.12.07	At 31.12.07
					£m	£m	£m	£m	£m	£m
SNW of long term operations (IFRS basis)					4,824	5,991	3,285	5,362	4,832	5,934
Other assets (IFRS basis)					-	(1,316)	1,044	153	-	(488)
Shareholders' equity on the IFRS basis					4,824	4,675	4,329	5,515	4,832	5,446
Purchased interests in long term business					(183)	(198)	(6)	(24)	(5)	(19)
1996 Sub-fund					-	-	326	326	-	-
Deferred acquisition costs/deferred income liabilities					(221)	(871)	(127)	(703)	(139)	(751)
Deferred tax1					(467)	(257)	(642)	(460)	(363)	(172)
Other2					213	59	10	(91)	122	(4)
Shareholder net worth on the EEV basis					4,166	3,408	3,890	4,563	4,447	4,500
1. Deferred tax represents all tax which is expected to be paid under current legislation. 2. Other relates primarily to the different treatment of sterling reserves, other long term reserves and the non profit result of LGPL under EEV compared with IFRS.

European Embedded Value						Page 39
Notes to the Financial Statements
3.15 Assumptions

UK assumptions

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. 

For annuities, separate returns are calculated for business sold before or after December 2006. This reflects a change in investment policy applicable to the 2007 and later business, which has the aim of increasing the expected return whilst not increasing the level of asset risk compared with the historic policy. This has been achieved through improved investment efficiency and increased diversification through use of additional asset classes. The calculated return takes account of derivatives and other credit instruments in the investment portfolio.  From the second half of 2007, some aspects of this revised strategy were also applied to the assets backing the in-force annuity business.

Where interest rate swaps are used to reduce risk, it is assumed that these swaps will be sold before expiry and the proceeds reinvested in corporate bonds with a redemption yield 0.70% p.a. greater than the swap rate at that time.  

The returns on fixed and index-linked securities are calculated net of an allowance for default risk which takes account of the outstanding term of the securities. The allowances for default risk are set separately for the asset portfolios supporting fixed and index-linked securities, and average 0.12% p.a. and 0.09% p.a. respectively across the portfolios as a whole (0.11% p.a. and 0.10% p.a. at 31.12.2007). 

Economic assumptions

	30.06.08	30.06.07	31.12.07	31.12.06
	% p.a.	% p.a.	% p.a.	% p.a.
Equity risk premium	3.0	3.0	3.0	3.0
Property risk premium	2.0	2.0	2.0	2.0
Investment return
- Gilts:
- Fixed interest	4.9	5.1	4.5	4.6
- RPI linked	5.1	5.6	4.5	4.7
- Non gilts:
- Fixed interest	5.4 - 7.1	5.6 - 6.0	4.9 - 6.1	4.9 - 5.3
- RPI linked	5.8 - 6.8	5.3 - 5.9	4.9 - 5.3	4.6 - 5.1
- Equities	7.9	8.1	7.5	7.6
- Property	6.9	7.1	6.5	6.6
Risk margin	3.0	3.0	3.0	3.0
Risk discount rate (net of tax)	7.9	8.1	7.5	7.6
Inflation
- Expenses/earnings	5.2	4.5	4.4	4.2
- Indexation	4.2	3.5	3.4	3.2

UK life and pensions

i.  Assets are valued at market value.

ii.  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.

iii.  The value of in-force business reflects the cost, including administration expenses, of providing for benefit enhancement or compensation in relation to certain products.

Iv.  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 normally reviewed annually.

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Notes to the Financial Statements
3.15 Assumptions

An allowance is made for future improvements in annuitant mortality based on experience and externally published data. At 30 June 2008 and 31 December 2007, male annuitant mortality was assumed to improve in accordance with CMI Working Paper 1, projection MC, with a minimum annual improvement of 1.5% for future experience, and 2.0% for statutory reserving. Female annuitant mortality is assumed to improve in accordance with 75% of projection MC, with a minimum annual improvement of 1.0% for future experience and 1.5% for statutory reserving. In each case, the minimum annual improvement is assumed to reduce linearly after age 89 to zero at age 120.  

On this basis, the best estimate of the expectation of life for a new 65 year old Male CPA annuitant is 25.1 years. The expectation of life on the regulatory reserving basis is 26.2 years.

As at 30 June 2007, male annuitant mortality was 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 was 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.  

On this basis, the best estimate of the expectation of life for a new 65 year old Male CPA annuitant was 23.8 years. The expectation of life on the regulatory reserving basis was 25.1 years.

v.  Development costs relate to investment in strategic systems and development capability.

UK managed pension funds

vi.  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

vii.  Key assumptions:

	30.06.08	30.06.07	31.12.07	31.12.06
	% p.a.	% p.a.	% p.a.	% p.a.
USA
Reinvestment rate	5.6	5.8	5.4	5.4
Risk margin	3.0	3.0	3.0	3.0
Risk discount rate (net of tax)	7.1	8.1	7.1	7.8
Europe
Government bond return	4.8	4.6	4.4	4.0
Risk margin	3.0	3.0	3.0	3.0
Risk discount rate (net of tax)	7.8	7.6	7.4	7.0

viii.  Other actuarial assumptions have been set at levels commensurate with recent operating experience, including those for mortality, morbidity, persistency and maintenance expenses.

Tax

ix.  EEV results are computed on an after tax basis and are grossed up by the notional attributed tax for presentation in the income statement. The tax rate used for grossing up is the corporate tax rate in the territory concerned which for the UK was 28% (H1 07: 28%; FY 07: 28%).  For the UK, investment return on Society shareholder capital, excluding the contingent loan, is calculated on a pre-tax basis.

Stochastic calculations

x.  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.

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.

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Notes to the Financial Statements
3.15 Assumptions

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 table sets out means and standard deviations (StDev) of future returns as at 30 June 2008 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
	Mean1	StDev2	Mean1	StDev2
UK Business (Sterling)
Government bonds	5.3%	3.4%	5.3%	3.4%
Corporate bonds	7.1%	3.7%	6.8%	3.7%
Property (excess returns)	2.0%	14.6%	2.0%	15.0%
Equities (excess returns)	3.1%	20.2%	3.0%	19.9%
European Business (Euro)
Long Government bonds3	4.9	4.5	5.2	8.4
Short Government bonds4	4.9	5.0	5.2	5.1
US Business (US Dollar)
Long Government bonds3	4.6	5.9	5.4	6.0

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 

In accordance with the dispensation within the CFO guidelines, a full sensitivity analysis is provided annually.

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