Annual Financial Report 2010 and AGM 2011 - Part 4

RNS Number : 1783E

Old Mutual PLC

04 April 2011

 



Ref 33/11 (Part 4)

BUSINESS REVIEW

long-term savings

The Long-Term Savings (LTS) division offers life assurance, pensions and investment products and operates through four main business units: Emerging Markets, Nordic, Retail Europe and Wealth Management.

Overview

In each of these markets our vision is to be "our customers' most trusted partner, passionate about helping them achieve their lifetime financial goals". Our strategy to achieve this vision is to build a cohesive long-term savings, protection and investment division through leveraging the strength of our people and capabilities both in South Africa and around the world.

Business units:

Emerging Markets: Old Mutual South Africa (OMSA) is one of the largest and longest-established financial services provider in South Africa, providing individuals, businesses, corporates and institutions with long-term savings, protection and investment solutions. Because we are now leveraging the business into other high growth economies, we have combined it with our Latin American, Asian and African businesses.

Nordic: Operating in Sweden, Norway and Denmark under the Skandia brand, we offer banking and insurance services for individuals and corporates.

Retail Europe: Operating in Austria, Germany, Poland and Switzerland under the Skandia brand, we are one of the leading unit-linked providers - offering innovative and flexible products and strong investment knowledge.

Wealth Management: Operating mainly under the Skandia brand with businesses in the UK, Italy, France and in our offshore International bases. Our offer is based on open and guided architecture accessed through unit-linked life insurance, pensions and mutual funds.

 

Strategy

Within LTS we have three different types of businesses which together provide high returns combined with high growth:

·      High returns on equity (RoE) and high cash generation businesses 

·      High revenue growth potential businesses but which are not operationally efficient at this stage. Because of their product design and structure these businesses are very capital-efficient and new business is self-financing

·      Businesses in emerging markets, which we have the opportunity to grow. These will require funding for a number of years but in the long run will produce growth and value for shareholders.

The funding needs of the latter two business types are modest in relation to the rest of the portfolio, so in combination the three different categories provide an excellent mixture of high RoE and good growth potential, in both the medium and longer term.

Our strategy aims to:

·      complement our strong, highly profitable and mature OMSA business by leveraging our South African capabilities to grow and develop our businesses in selected African, Latin American and Asian markets

·      operate capital-efficient, fast-growth businesses in selected UK and European markets

·      exploit capital, cost and revenue synergies between the various businesses.

The strategy is underpinned by building a culture of customer focus and value creation internationally.

The LTS portfolio provides high returns combined with high growth

High RoE/High cash generation	High revenue growth potential	Opportunity to grow
·      Slow growth ·      Large market share ·      Generate high cash returns that fund new business, allow for acquisitions and Group dividend	·      Low profit generation relative ·      to enterprise value ·      High cost bases ·      Potential for rapid profit growth ·      on restructuring / efficiency gains ·      Largely self funding in terms of new ·      business and growth ·      New business tends to be cash ·      demanding	·      Require funding of business ·      at least until breakeven ·      Rapid growth of sales ·      New business tends to be ·      capital intensive ·      Potential to grow embedded / ·      enterprise value rapidly ·      Cash generation is far out
·      OMSA ·      Namibia ·      Colombia	·      Wealth Management ·      Nordic	·      Retail Europe ·      Africa ·      Asia ·      Mexico

By identifying where customer needs are not being met, we are able to exploit synergies across LTS, for example by taking proven retail products from OMSA's mass foundation cluster to other markets where product penetration levels are low and where economic growth will happen over time. We are applying strong risk capital management and performance management frameworks with strong local management teams. In addition we have developed LTS-wide roles to ensure we exploit synergies and establish centres of excellence. These roles - covering IT, product, LEAN methodology and distribution - will help us to gain competitive advantage by delivering appropriate products and services efficiently.

In South Africa we already have scale and exceptional levels of quality, straight-through processing and low unit costs. We are experienced in developing products for sophisticated markets as well as in developing simple products for middle-income markets and we have experience in pricing diverse risks. We run multiple distribution channels and have a comprehensive understanding of different types of distribution. We already have experience in leveraging these capabilities into high-growth markets such as India. Our approach to leveraging our skillset in South Africa to the rest of Emerging Markets is based on sharing product experience, people and professional skills, systems and processes, and distribution knowledge.

Through our Skandia businesses we have built excellent market positions as capital-efficient businesses in Europe and in the UK. These have a history of innovation and are very well positioned because of the customer value that they deliver, exploiting opportunities to take market share from more traditional, less customer-orientated competitors. We aim to grow their revenues while constraining costs and ultimately driving up operating performance by adopting LEAN methodology.

While we are primarily focused on leveraging our capabilities in South Africa into emerging markets and improving the operational performance of our European businesses, there are also opportunities to achieve synergies between them. Our businesses connect at a capital level and are well resourced for future growth. At the same time, there are opportunities for cost and revenue synergies. The cost synergies lie primarily in the IT area and in outsourcing some work to South Africa. The revenue opportunities lie in sharing product knowledge and ideas as well as what we know about building distribution channels.

The recent financial crisis highlighted the need for the financial industry to operate more efficient businesses in order to compete for market share among more financially-conscious customers. We have introduced a number of efficiency programmes in four basic categories:

1. Transforming Wealth Management: implementing shared services models to reduce costs by taking out expensive layers of overhead and management and producing simplified management information.

2. Transferring Retail Europe back-office to South Africa: outsourcing to lower-cost geographies, where we can achieve process efficiencies and scale.

3 Reviewing Wealth Management and Nordics: driving LEAN methodology thinking across the businesses.

4. Transforming IT: we are optimising outsourcing, shared computing and IT sharing applications. We are enabling business efficiency and innovation for both local and international competitive advantage through one IT partnership.

Achieving our LTS targets

	Implementation	Measures
Driving revenue growth	·      Exploit growth opportunities in emerging markets ·      Position for sweet spot in Europe	·      (VNB + Exp Var)/MCEV ·      NCCF / FUM
Reducing cost	·      Specific efficiency programmes in each business	·      Administration expenses
Synergies	·      Adopt LEAN methodology across all businesses ·      Potential IT synergies, particularly in outsourcing ·      Product lines extended to other markets	·      Expenses ·      APE
Capital efficiency	·      Focus on capital light products ·      Diversification benefits	·      Equity (E)

 

Achieving our LTS targets

We are focusing on four main areas to create shareholder value. Each has associated measures to track the result. These are set out in the table above.

We are gradually rolling out a common approach to creating shareholder value across all our business units. This focuses on the creation of economic profit - generating profits that exceed the risk-adjusted cost of the capital that these businesses absorb. The economic profit framework is beginning to shape all our capital allocation decisions and we are extending it to assess business performance and determine management reward.

We recognise that many of our investors favour embedded value as a measure of enterprise value. So we monitor very closely the value added by management, through the sale of profitable new business and the control of experience relative to assumptions, in adding to embedded value returns (ie (VNB +experience variance)/MCEV)). We have a large and growing part of our non-life or non-covered business and we apply these measures equally to both.

Current products and product development

We are creating long-term, sustainable competitive advantage by putting the customer at the centre of everything we do. As shown in the table below, we work in two different kinds of markets: developed countries and emerging markets. Emerging market countries generally enjoy fast GDP growth but have low average GDP per capita, whereas more mature markets such as Sweden, Germany, the UK and France offer opportunities to penetrate into wealthier customer segments. The improving demographics of the emerging market economies are likely to support economic growth through for example, larger pools of labour. As emerging economies' manufacturing exports grow, we expect corresponding growth in their labour markets and evolution of their consumer segments. By contrast, we do not anticipate such shifts in the existing wealth of the UK and European economies. Our offerings in the South African market span across the wealth divide.

In Emerging Markets we have developed a wider product set. This applies also to our business in Germany, Austria and Poland. We focus on regular premiums and delivering product value to customers - making sure that our products are transparent, that fees are clear and that customers receive the solution that best meets their needs.

Our LTS product offering aims to meet customers' needs for savings, investments, pensions and annuities as well as protection. In some of our businesses we also address their healthcare and transactional needs. While local market differences exist, the solutions our customers require in different regions are, in our experience, very similar. Essentially, customers everywhere have the same basic financial needs. What is more, products are distributed via the same distribution channels and regulatory regimes are increasingly convergent. As a result we believe we have an increasing opportunity to leverage our product knowledge and expertise across the different markets in which we operate.

Before the creation of LTS, Old Mutual and Skandia businesses around the world operated independently in a federal model within the Group. Group control was insufficient and few synergies were realised between regions. After the global financial crisis and the operational losses we incurred in Old Mutual Bermuda, we implemented stronger Group controls and risk management. As can be seen in the chart above, we are now driving an LTS product view across all our markets and we are actively leveraging capabilities from one market to another to exploit synergies.

Old Mutual and Skandia's products and propositions are generally regarded by customers, intermediaries and competitors as market-leading. Our businesses have recognised track records of innovation and we have won numerous awards in several markets for the quality of our product offering, the fund ranges we offer on our platforms, our tools for advisers and our interactive websites.

We are determined to maintain leadership in product innovation and we are implementing new techniques and processes that have successfully stimulated innovation in other industries.

In OMSA and Nordic, our product ranges are extremely comprehensive, covering almost all the financial needs of our customers. By contrast, in some of our other markets our current product offering addresses a relatively narrow spectrum of customer needs: our Wealth Management business, for example, has market-leading platform offerings but a very limited offering in the decumulation (annuity) and protection markets. Similarly, in our Retail Europe business we have good regular savings products but no meaningful decumulation, protection or lump-sum offerings. We therefore see great opportunities to expand our product offering in these and other markets by leveraging our product expertise, designs and structures and our IT platforms from markets such as South Africa and Sweden. We have already begun executing projects to do this.

In the developed countries served by our UK, French, Italian, Nordic and International businesses, we are focused mainly on the mass affluent segment. Our proposition, including products, distribution and processes, is built around that segment and is orientated to customer needs. The flexibility and transparency of our products, and the value that we deliver, place us in a good position in those markets. South Africa also has a vibrant wealth management industry, so we present a very similar offering there to the mass affluent market. Notwithstanding the platform business in the UK operates a version of the technology we developed in South Africa for the South African market.

Above and beyond the continuous enhancements we make to our product ranges every year, we will pay particular attention over the next few years to:

·      Expanding our protection offering into emerging markets outside South Africa, and into our European businesses

·      Enhancing the range of downside-protected, structured products or guaranteed investment offerings available on our investment platforms across most of our markets

·      Developing appropriate decumulation offerings to capture the investment proceeds of customers reaching retirement age.

 

Development of distribution strategy

Distribution in Emerging Markets is affected by both financial and non-financial drivers. Financial drivers such as relative wealth, money transmission mechanisms and the availability of state social support influence the types and distribution of products. Non-financial drivers such as literacy, life expectancy and respect for legal title affect pricing, product complexity, and communication techniques and content. Countries with lower average customer income need simple, cost-effective products. Here, the educational aspect of selling the product is critical.

The mature markets allow for more effective leveraging of existing relationships and capabilities, and development of new distribution channels such as the internet. Skandiabanken is an example of innovative distribution using the internet as a gateway.

The factors outlined above influence the way we think about the retail consumer in our various markets. We are carrying out detailed work to understand the evolution of customer segmentation in the new retail markets that we are targeting. And we maintain ongoing research on the framework within which customers buy or get access to financial services in their particular markets.

In bringing together the LTS division, Old Mutual is managing distribution channels across its life markets more strategically. We are intent on understanding how and what organic growth opportunities can be better leveraged to achieve growth in our various markets - and in particular on leveraging our achievements in South Africa, Namibia, Sweden, the UK and Colombia. We manage distribution country by country, using local market experts resident in those countries.

LTS will invest in the channels that are most likely to increase effective distribution. Channels are most effective where they are directed to the appropriate consumer segment and offer us the greatest control. The principal detractors from channel performance are poor persistency and poor agent productivity. Using our own agents (employed advisers) can be more expensive, but there are long-term benefits: their closeness to the customer enhances loyalty and customer retention.

The current size and projected growth of the emerging market countries where LTS operates suggest that more investment is needed in distribution to capture the growth opportunities.

Our current approach to enhancing distribution has four broad aspects:
1. Growing advisers organically. Tied agency forces are critical - particularly in Emerging Markets, where they remain the dominant form of distribution.
2. Strengthening efficiencies. An inefficient sales force incurs large overhead costs which may lead to acquiring poor-quality customers and delivering poor-quality advice to customers.
3. Strengthening bancassurance. Several of our retail markets have large, dominant retail banks.
4. Adding new channels selectively in relevant markets such as Retail Europe, Latin America and Asia.

Our distribution channels and their mix differ by market maturity and by country. The chart above shows the mix by business across all LTS markets. Tied or employed agency forces (own advisers) are dominant in Emerging Markets while independent financial advisers (IFAs) are the main distribution channel for us in Europe and the UK. The differences in distribution mix between Emerging Markets, Europe and the UK are mainly due to factors such as financial services sector development and maturity, and the relative expense of having own sales force versus the use of independent financial advisers.

There are some differences in the terminology used internationally to describe distribution channels. We use the term 'tied agency' for distribution channels contractually tied to the product provider or employed agents, or worksite marketing. The term 'IFA' is used more broadly here to include independent brokers and independent insurance advisers. Tied agency distribution gives us more control and can be targeted more accurately at the relevant consumer segments. In mature markets life companies have access to and can use independent advisers or brokers as well as retail bank or bancassurance advisers. In some mature markets, and in Asia, the fast-developing internet model offers a completely new means of accessing consumers. While we acknowledge its potential, we believe the internet's role as an effective distribution channel within a country is largely dependent on the development and widespread roll-out of broadband technology as, for example, in the Nordics.

Old Mutual has a long history in southern Africa of establishing and growing new distribution channels. OMSA established independent insurance brokers or IFAs in the late 1970s and established mass market worksites shortly thereafter. Skandia has been effective at establishing IFA networks and channels. Tied agency and worksite marketing is very effective in reaching the mass market and middle market consumers, while IFAs are very effective at penetrating and developing the wealth markets of UK, Europe, China and southern Africa.

Regulatory Developments

The range of regulatory issues affecting distribution design and control is fairly consistent across our LTS division countries. Regulators in all our LTS markets have become more effective and consistent in dealing with market abuse and tightening up the approach to regulation. Regulatory enhancements are good for consumers and new regulation creates opportunities for life companies to build better, more mature, high quality sales forces and face-to-face advisory businesses.

LEAN administration and IT

Each LTS regional organisation currently has its own administration and IT structure, but these share many common products, processes, IT platforms and customer/intermediary interfaces. Our strategy is to actively seek cost synergies, drive LEAN methodology and achieve a quality service culture across all our IT provision.

LEAN administration

Our OMSA business has run its LEAN programme for four years. LEAN is about building an organisation culture that starts with the customer, identifies duplication or over-engineering of procedures across processes and then streamlines those processes using extensive standardisation and simplification. By doing this sustainably and continually, we reduce unit costs and improve customer service quality. In OMSA we have driven down unit costs year-on-year across our retail and corporate products and will continue to do so.

OMSA's unit costs compare favourably with those of our South African competitors, due mainly to our scale in South Africa and the extent to which we have used LEAN. OMSA's unit costs are also significantly lower than those of other businesses in LTS because of scale, LEAN and labour arbitrage within the business - which offers some opportunities for LTS.

LEAN methodology is allowing us to combine lower unit costs with improved service. Research shows that we have improved our customer and intermediary service year-on-year; and we have won our industry's national Best Provider of Customer Service award in South Africa three years running.

We see a number of opportunities to enhance administration across LTS:

·      Potential to move administration from other parts of LTS to South Africa, using the capability and scale we have there to improve capabilities and unit costs.  We are currently moving processes and IT from Retail Europe (Germany, Poland and Austria) to South Africa, which will give us a capability that we can exploit further in LTS

·      In businesses where it does not make sense to move administration to South Africa, we will apply LEAN principles to streamline processes, reduce unit costs, improve our service and provide a very strong foundation for future growth

·      Applying LEAN principles beyond the servicing and operations area to reduce businesses' overheads, streamline IT and even improve sales processes.

As the chart shows, we have an established history of driving down unit costs and improving service in OMSA with LEAN. We are now sharing this expertise across the LTS division.

IT

Our IT mission is to enable business efficiency and innovation for both local and international competitive advantage, through one world-class IT partnership. These potentially contradictory aims form the core strategy for running IT across LTS. IT needs to be an efficient, well-governed, common function without sacrificing the speed-to-market and innovation needed in our local markets.

LTS IT will now provide all IT services, to LTS and to the local businesses. The IT 'front-office' - the LTS-run local IT departments - will continue to manage projects and generate requirements for the local business. Free of managing IT commodity work, the local IT department will improve their focus delivering the technology that underpins the local business needs and strategy. These teams have the greatest opportunity to drive business results through harnessing the innovative use of technology.

The LTS IT back-office is focused on two goals: the Global Delivery Centres for Infrastructure and Applications will leverage the economies of scale across LTS to deliver IT more cost-effectively and more consistently across the division. The Governance and Architecture functions within the LTS IT back-office are then responsible for ensuring that LTS is well governed from an architectural, financial, risk and control perspective.

This hybrid operating model for LTS IT will comply with regulatory requirements, ensuring local accountability and control, but leveraging common governance, efficiencies and economies of scale from a modern IT function in a global business.

In transforming LTS IT, we see a number of synergy opportunities across LTS to help reduce cost, support the business strategy and drive innovation. These fall into three categories:

·      Reviewing the existing LTS IT environment
Each business or geography currently has its own set of data centres, networks and bespoke systems. To a large degree, we can consolidate these so that we can reduce costs while also improving disaster recovery and business continuity, and enabling significant business change. We have world-class platforms in some areas of LTS. Working closely with our local businesses we are aiming to share and extend the capability across the division. We are leveraging our scale and our willingness to partner with the best companies in the industry to create a lower, total cost of IT.

·      Internal partnerships with our back-office business functions. This involves working together to get value from LEAN processes to reduce errors as well as complexity and IT support costs.

·      Working cohesively across LTS as well as working in close partnership with our local businesses. This means creating economies of scale and improved delivery of IT solutions through a common IT back-office function and mutually beneficial external partnerships. This includes a consistent governance framework that will ensure correct management of IT finances, project control and improved control of IT-related risk, security and audit items. If it is possible to do that in one place, we will be more effective and efficient. More importantly, our partnerships with the local businesses improves our ability to use technology to create solutions and capability that enable new and innovative business strategies.

Review of Results 2010

LTS AOP earnings benefited from higher fees generated from positive net client cash flows particularly in Wealth Management, rising funds under management and the strengthening of the rand and Swedish krona against sterling. On a constant currency basis, earnings were up 26%.

The Emerging Markets business accounts for 60% of the LTS IFRS AOP earnings, 43% of LTS FUM, and 33% of LTS APE sales. This compares to 70% of restated AOP, 41% of FUM, and 30% of APE sales in 2009.

APE sales increased by 14% for the LTS division as a whole, with the growth coming largely from the regular premium products in the Retail businesses of Emerging Markets, and Wealth Management single premium products, notably in the UK and Italy. A managed shift in business mix in Nordic was executed with sales decreasing from prior year levels. There was encouraging growth in both single and recurring premiums in Retail Europe. Sales for the second half of 2010 were ahead of the first half for Emerging Markets and Retail Europe, and evenly spread across the year in Nordic. Wealth Management sales were slightly higher in the first half of the year than the second given the usual seasonal weighting to the first quarter of the year, and the benefit of the short-term Italian tax shield.

Mutual fund sales were up by £2,387 million, with strong performance in Wealth Management and Emerging Markets particularly in the second half of the year.

Long-Term Savings

Key performance statistics for the LTS division are as follows:

					£m
2010	Emerging Markets	Nordic	Retail Europe	Wealth Management	Total
Life assurance sales (APE)	487	201	69	734	1,491
PVNBP	3,269	1,104	513	6,380	11,266
Value of new business	86	41	7	66	200
Unit trust/mutual fund sales	3,668	581	23	4,507	8,779
NCCF (£bn)	-	0.7	0.4	3.9	5.0
FUM (£bn)	57	14	5	56	132
Adjusted operating profit (IFRS basis, pre-tax)	539	110	51	197	897
Operating MCEV earnings (covered business, post-tax)	344	45	66	112	567
(VNB + Exp Var)/MCEV (covered business)	4.7%	4.7%	2.2%	3.1%	4.1%

					£m
2009 (as reported1)	Emerging Markets	Nordic	Retail Europe	Wealth Management	Total
Life assurance sales (APE)	393	235	67	617	1,312
PVNBP	2,834	1,150	537	5,042	9,563
Value of new business	65	44	(5)	49	153
Unit trust/mutual fund sales	2,765	393	24	3,210	6,392
NCCF (£bn)	(1.6)	1.0	0.5	2.5	2.4
FUM (£bn)	44	11	4	47	106
Adjusted operating profit (IFRS basis, pre-tax)	446	62	22	106	636
Operating MCEV earnings (covered business, post-tax)	212	81	(44)	(4)	245
(VNB + Exp Var)/MCEV (covered business)	0.5%	7.5%	(5.1%)	0.6%	1.3%

1 The year ended 31 December 2009 has been restated to reflect US Life as discontinued

Across LTS as a whole, new business APE margins improved to 13% for 2010 (2009: 12%). This reflects the focus on selling more profitable products with better margins, notably in Nordic, and increased sales of a higher margin product in the first half of the year in Emerging Markets. The APE margin in Emerging Markets increased from 16% to 18%. In Nordic, the APE margin has increased from 19% to 21%, benefiting from the managed reduction of low margin product sales such as Link regular. In Retail Europe, the APE margin has improved considerably to 11% from a negative position in the comparative period. Across Wealth Management, the APE margin increased from 8% to 9%, with the UK increasing from 2% to 3%, and International from 18% to 19%. The most significant increase in APE margin was in respect of the Continental European markets, which increased from 3% to 8% as result of the increase in volumes in Italy. Sales of mutual funds, which make up the bulk of Wealth Management's sales, are not included in the APE margin. The IFRS operating margin rose to 38bps from 25bps for Wealth Management as a whole. For LTS as a whole the PVNBP margin improved to 1.8% (2009: 1.6%).

The market-consistent value of new business (VNB) improved for all of our LTS businesses, with the exception of Nordic, where although the underlying margins of the business improved, the absolute value of new business fell as a result of the decline in new business volumes (due to the cessation of sales of an unprofitable recurring premium product) and changes in assumptions.

The LTS net client cash flows more than doubled as improvements in Wealth Management and Emerging Markets more than outweighed the lower net flows in Nordic given lower sales volumes. Funds under management for LTS at 31 December 2010 increased by 25% to £131.8 billion (31 December 2009: £105.5 billion) although there were periods of substantial market movements during the year, with notable falls in the second quarter and increases towards the end of the year.

The rand started the year at 11.92 against sterling, strengthening to 11.45 at 30 June 2010, and to 10.28 by 31 December 2010. The US dollar and Swedish krona also strengthened, although to a lesser degree, appreciating 4% and 10% respectively in the year. The average exchange rates to sterling over the year were 11.31 (2009: 13.17), 1.55 (2009: 1.57) and 11.14 (2009: 11.97) for the rand, US dollar and Swedish krona respectively. The cumulative effect of foreign exchange movements for LTS was an increase of £77 million on IFRS profitability.

 

EMERGING MARKETS

Good results combined with strong growth in regular premium sales

Highlights (Rm, unless otherwise stated)	2010	2009	% Change
Adjusted operating profit (IFRS basis, pre-tax)	6,099	5,879	4%
Return on local equity	25%	25%
Return on allocated capital (OMSA only)	25%	26%
Life assurance sales (APE)	5,505	5,178	6%
Unit trust/mutual fund sales	41,488	36,421	14%
PVNBP	36,975	37,339	(1%)
Value of new business	972	853	14%
APE margin	18%	16%
PVNBP margin	2.6%	2.3%
Operating MCEV earnings (covered business, post-tax)	3,877	2,794	39%
Return on embedded value (covered business, post-tax)	13.2%	9.8%
Net client cash flows (Rbn)	0.2	(20.5)	101%
Funds under management (Rbn)	585.7	518.4	13%

Overview

Equity markets in the Emerging Markets have enjoyed a strong year, with the JSE increasing by 16%. The South African rand appreciated 13% against the US dollar and 14% against sterling. Low inflation contributed to interest rate cuts in South Africa from 10.5% to 9%.

We continue to focus on innovation and product improvements which will benefit our customers. In South Africa we developed and launched a new direct short-term insurance product, iWYZE, in conjunction with Mutual & Federal - and its success has exceeded expectations. Old Mutual Corporate launched Old Mutual SuperFund, the largest multi-employer or umbrella fund in South Africa with over 300,000 members, to provide a simple, affordable and strictly-governed platform enabling employees to save for their retirement. We launched the Futuregrowth Agri-Fund in March 2010, focusing on responsible equity investments in agricultural land, agri-businesses and farming infrastructure. As a Socially Responsible Investment fund, it seeks long-term returns and tangible social and developmental impacts.

We are integrating social, environmental and economic principles into our core business. OMSA achieved Level 2 Broad-Based Black Economic Empowerment (BBBEE) status in October 2010. Furthermore, OMIGSA attracted more than R8 billion from institutional investors into social infrastructure investment.

Our sales improved in the year, notably in the second half. This resulted in a 6% increase in APE sales compared to 2009, and we benefited from improved persistency. Our NCCF improved significantly, and we saw increasing contributions from new markets, with non-South African NCCF higher than South African NCCF (excluding flows relating to the Public Investment Corporation of South Africa).

IFRS AOP results

IFRS AOP (pre-tax) increased by 4% from R5,879 million to R6,099 million, with strong asset management profits (up 62% to R1,550 million), partially offset by lower long-term investment return (R1,221 million compared to R1,658 million in 2009).

Rm	2010	2009	% Change
Long-term business AOP	3,328	3,263	2%
Asset management AOP	1,550	958	62%
Long-term investment return (LTIR)	1,221	1,658	(26%)
AOP (IFRS basis, pre-tax)	6,099	5,879	4%

The growth in long-term business profits is mainly due to the significant improvement in Retail persistency in 2010 following the significant strengthening of the basis in 2009 as well as continued business effort to improve retention experience. Good investment performance in the annuity and permanent health insurance (PHI) portfolios and increased asset-based fees due to higher equity market levels also contributed to profit growth. The comparable 2009 life profits benefited from a number of large non-recurring items, including the impact of assumption changes and profits from the Nedbank joint ventures in the first five months of 2009. Excluding these items, underlying life profits increased by 37% over the comparative period.

Asset management profits grew significantly as a result of higher fees being earned from higher FUM, stronger performance fees in OMIGSA, a first full-year contribution from ACSIS (acquired in the second half of 2009), a higher contribution from OMF due to growth in the business, and mark-to-market profits in Old Mutual Specialised Finance (OMSFIN). These were partially offset by lower transactional income.

The LTIR decreased by 26% to R1,221 million in 2010 reflecting the reduced rate applied to OMLAC(SA) assets due to the implementation of a higher ratio of cash to equity in the asset portfolio backing the Capital Adequacy Requirement.

Life APE sales summary

APE sales increased by 6% from R5,178 million to R5,505 million, driven largely by strong growth in regular premium sales across the majority of our Emerging Markets businesses.

By Cluster:

	Gross single premiums			Gross regular premiums			Total APE			Total PVNBP
New business (Rm)	2010	2009	+/-%	2010	2009	+/-%	2010	2009	+/-%	2010	2009	+/-%
OMSA
Mass Foundation1	14	16	(13%)	1,571	1,452	8%	1,572	1,454	8%	6,994	6,767	3%
Retail Affluent	9,620	8,751	10%	1,381	1,213	14%	2,343	2,088	12%	16,345	15,413	6%
Institutional2	7,892	9,205	(14%)	454	360	26%	1,244	1,281	(3%)	11,788	12,831	(8%)
Total OMSA	17,526	17,972	(2%)	3,406	3,025	13%	5,159	4,823	7%	35,127	35,011	0%
Rest of Africa 3	475	528	(10%)	196	195	1%	244	247	(1%)	1,363	1,653	(18%)
Total New Markets 4	231	432	(47%)	79	64	23%	102	108	(6%)	485	675	(28%)
Total Emerging Markets	18,232	18,932	(4%)	3,681	3,284	12%	5,505	5,178	6%	36,975	37,339	(1%)

By Product:

New business (Rm)	2010	2009	+/-%	2010	2009	+/-%	2010	2009	+/-%	2010	2009	+/-%
OMSA
Savings	14,062	13,874	1%	1,654	1,390	19%	3,060	2,773	10%	22,441	21,785	3%
Protection	6	2		1,752	1,635	7%	1,753	1,639	7%	9,228	9,132	1%
Annuity	3,458	4,096	(16%)	-	-		346	411	(16%)	3,458	4,094	(16%)
Total OMSA	17,526	17,972	(2%)	3,406	3,025	13%	5,159	4,823	7%	35,127	35,011	0%
Rest of Africa3	475	528	(10%)	196	195	1%	244	247	(1%)	1,363	1,653	(18%)
Total New Markets4	231	432	(47%)	79	64	23%	102	108	(6%)	485	675	(28%)
Total Emerging Markets	18,232	18,932	(4%)	3,681	3,284	12%	5,505	5,178	6%	36,975	37,339	(1%)

1 Previously described as Retail Mass

2 Institutional sales include Corporate and OMIGSA life sales

3 Rest of Africa represents Namibia only

4 New Markets represents Latin America only

OMSA

Regular premium sales

Regular premium sales grew by 13% compared to 2009 and by 25% in the second half of 2010 compared to the first half, with particularly strong growth in savings sales in the second half in the Mass Foundation Cluster which benefited from lower overall cancellation rates, higher average premiums, improved adviser productivity and significant improvement in the direct channel sales performance.

Retail Affluent sales growth was driven by Max Investments savings products, experiencing 21% and 31% growth for Life and LISP wrappers respectively in 2010, following the stabilisation of the economic outlook. Greenlight experienced a lower than expected growth of 6% over 2009 in some measure due to increased turnover of the Retail Affluent sales force. Corporate sales increased by 26% in 2010 - driven primarily by savings sales in the umbrella market, where the Evergreen umbrella fund grew its membership by two thirds to just over 56,000. Corporate risk sales grew strongly due to our success in selling a number of new policies to large schemes in this highly competitive market. Corporate sales have more than doubled since 2008 due to innovative product introductions.

Single premium sales

Single premium sales decreased by 2% relative to 2009, due mainly to lower institutional flows. Retail Affluent achieved strong Investment Frontiers Fixed Bond sales in the first half and an increase in new contracts issued to clients with unclaimed maturities. Annuity sales declined by 16%, driven by lower CPI-linked annuity sales in the Corporate segment as very few annuity tenders floated in 2010 were concluded. With-profit annuity sales did show a marked improvement, increasing by 48% as we continued to lead in this market segment. Retail Affluent annuity sales stabilised in the fourth quarter, following improvements in annuity rates, to end marginally below the 2009 level.

Rest of Emerging Markets

Namibian regular premium sales in the Retail Mass and Retail Affluent segments increased by 6% and 5% respectively, mainly as a result of solid sales growth from tied agents despite difficult economic conditions. Corporate segment regular premium sales decreased by 14% due to lower Orion sales volumes. Single premium sales decreased by 10%, with lower new business inflows from both Retail Affluent and Corporate businesses.

Sales growth of 36% in Mexico was largely driven by the introduction of a minimum premium for the regular premium savings product in the first half of 2010, implemented as a consequence of working closely with South Africa. We introduced a Retail Mass distribution team in December. We will continue to grow this team in the coming months and its pipeline is very promising. Included in the 2009 comparative is R28 million APE relating to the Chilean business which was sold in 2009.

APE sales in China increased by 77% from CNY92 million in 2009 to CNY163 million in 2010, despite poor sales during the first half. The significant improvement in the second half is mainly due to increased management focus on sales, supported by execution of our joint venture's product and channel diversification strategy (new bank, broker and telemarketing products were launched during the second half). The reopening of the Bank of China distribution channel in Beijing (with the assistance of our JV partner), following a three-month suspension of sales during the first half of 2010, further contributed to this improvement. Sales at our Indian joint venture, Kotak Mahindra Old Mutual Life Insurance, increased by 6% compared to 2009.

A more detailed analysis of sales by segment is included in the Financial Disclosure Supplement, available at www.oldmutual.com.

Unit trust / mutual fund sales summary

Rm	2010	2009	+/-%
OMSA	21,452	18,384	17%
Rest of Africa	5,360	4,546	18%
New Markets	14,676	13,491	9%
Total Emerging Markets	41,488	36,421	14%

In South Africa, unit trust sales recovered in the second half of 2010 following a weak first half. We achieved growth of 17% from the 2009 level, mainly due to significant flows into Old Mutual Unit Trust money market funds during the third quarter and improved flows into OMIGSA's Marriott affiliate following revised asset allocations.

We have made progress towards our goal of becoming our customers' most trusted partner, evidenced by the number of awards received during the year - including our third Ask Afrika Orange Index award for service excellence in the long-term insurance business category, and the number one position in South Africa's 500 best managed companies.

In the rest of Emerging Markets, unit trust sales also performed well. Namibian sales increased by 18% to R5.4 billion following strong inflows from institutional and corporate clients as a result of more competitive investment returns. Unit trust sales in Mexico and Colombia (COLMEX) were 9% ahead of the prior year in rand (25% in US dollars), with strong growth in Colombia resulting from a successful marketing campaign and stronger relationships with corporate and institutional customers. We increased productivity, with greater sales from fewer advisers. Mexico benefited from a large scheme acquired in September 2010 and improved performance in both fixed income and equity portfolios.

Value of new business and margins

The value of new business increased by 14% to R972 million, with a strengthening performance during the course of the year. The APE margin increased from 16% to 18% due to a higher proportion of sales of higher-margin smoothed-bonus and with-profit annuities in OMSA's Corporate business and Investment Frontier Fixed Bonds in Retail Affluent.

MCEV results

Operating MCEV earnings (post-tax) increased by 39% from the 2009 level. This was mainly due to positive experience variances and operating assumption changes in 2010, compared to negative variances in 2009. The improvement in experience variances is mainly due to an improvement in persistency, partly due to the 2009 assumption changes, and partly because management actions improved persistency. These were partially offset by a significant decrease in the expected existing business contribution due to the reduction in one year swap yields during 2009.

In addition to the effects above, other significant movements affecting the closing MCEV include a large positive impact from economic variances due to a combination of better than assumed equity returns and the effect of the changes in the shape of the swap yield curve. This was partially offset by modelling enhancements to the economic scenario generator used to calculate the investment guarantee reserve, which caused a decrease in the margin (buffer) held to protect against future market volatility, resulting in less value being released as profits in the future. The net impact of these resulted in a growth in MCEV of 16% over 2010.

We made good progress towards implementation of Solvency II as part of the overall Group programme, and also in respect of the South African equivalent framework known as SAM (Solvency Assessment and Management), launched in 2010 by the South African regulator.

Net client cash flow

NCCF for the year was R0.2 billion, a significant improvement on 2009 outflows of R20.5 billion.

South African NCCF benefited from significantly lower PIC outflows of R5.1 billion (R16.2 billion in 2009), improved inflows across a number of OMIGSA boutiques (mainly Electus and Futuregrowth), improved net flows in retail businesses and lower outflows in Corporate. Excluding PIC outflows, OMSA's NCCF for the second half of 2010 was positive R1.8 billion compared to negative R6.3 billion in the second half of 2009. Further PIC outflows are expected in 2011.

The rest of our Emerging Markets business delivered R7.6 billion in NCCF. In Colombia and Mexico NCCF increased by 12% from R4.3 billion in 2009 to R4.8 billion in 2010. The Colombian business attracted new customers within targeted segments, experiencing lower surrenders on core products and improved sales of Retail voluntary products. In Namibia, NCCF increased by R1.0 billion to R1.4 billion due to improved unit trust inflows and R672 million inflows from the rebalancing of the Government Institutions Pension Fund portfolios.

Funds under management

FUM increased by 13% to R586 billion as a result of higher market levels and overall neutral NCCF for the year. Of the total, R498 billion (2009: R449 billion) is in South Africa.

Overall, OMIGSA investment performance (over three years) was average, with satisfactory performance in specialist areas contrasted against mixed performance in our balanced capabilities.

Outlook

We have confidence in the underlying performance of the business, despite the low investment return assumptions in 2011 and mark-to-market gains recorded in the asset management results in 2010. We will continue to strive for a balance that combines strong risk management and governance with a culture that encourages innovation, across our four main strategic themes:

·      Continuing to invest in our Emerging Market business

·      Improving OMIGSA's investment performance and value creation for customers

·      Putting the customer at the centre of our business

·      Enhancing our high-performance culture and further developing our Emerging Markets management team.

Growing our sales force remains a priority, as does promoting a savings culture in Emerging Markets, designing and adapting products that are relevant to a wide range of customers, and providing easier access to financial services for our customers across our businesses.

With these strategies in place we are well positioned to optimise business opportunities in 2011 and further strengthen a highly successful Emerging Markets business.

NORDIC

Improved profitability, higher funds under management and strong APE margin

Highlights (SEKm, unless otherwise stated)	2010	2009	% Change
Adjusted operating profit (IFRS basis, pre-tax)	1,227	737	66%
Return on local equity1	11%	12%
Life assurance sales (APE)	2,238	2,819	(21%)
Unit trust/mutual fund sales	6,466	4,708	37%
PVNBP	12,292	13,774	(11%)
Value of new business	460	526	(13%)
APE margin	21%	19%
PVNBP margin	3.7%	3.8%
Operating MCEV earnings (covered business, post-tax)	503	965	(48%)
Return on embedded value (covered business, post-tax)	3.3%	8.1%
Net client cash flows (SEKbn)	7.4	11.6	(36%)
Funds under management (SEKbn)	145.4	127.2	14%

1 Return on local equity is IFRS AOP (post-tax) divided by average shareholders' equity, excluding goodwill, PVIF and other acquired intangibles

 

Overview

The economies in the Nordic countries experienced a strong recovery in 2010, with positive GDP growth (estimated at 5.6% in Sweden, 2.0% in Denmark and 2.2% in Norway). The Swedish equity market grew by 23% in 2010. The Nordic business delivered a strong IFRS AOP result in 2010. With changes in the management team, including a new CEO Mårten Andersson, we are delivering on our key priorities of strengthening distribution power and product offerings, stimulating future NCCF growth, increasing operational efficiency to secure profitable growth, and optimising structures and risk frameworks to unlock value. However, we face a challenging year of change for the business in delivering our 2011 operating sales, efficiency and profitability targets in a rapidly changing business environment.

Life sales summary

APE sales at SEK2,238 million were down by 21% compared to 2009, following management action in the Swedish Retail segment to close the unprofitable Link Regular product in late 2009. The APE of the Corporate business decreased by 14%, mainly due to slower sales of the highly competitive TPS Regular product. Denmark performed strongly, with product success in the unit-linked and healthcare markets. APE grew by 22% to SEK514 million.

	Gross single premiums			Gross regular premiums			Total APE			Total PVNBP
New business (SEKm)	2010	2009	+/-%	2010	2009	+/-%	2010	2009	+/-%	2010	2009	+/-%
Sweden
Corporate	1,429	1,471	(3%)	1,033	1,221	(15%)	1,176	1,368	(14%)
Retail	3,672	4,288	(14%)	181	601	(70%)	548	1,030	(47%)
Total Sweden	5,101	5,759	(11%)	1,214	1,822	(33%)	1,724	2,398	(28%)	9,001	11,260	(20%)
Denmark
Total Denmark	1,280	547	134%	386	366	5%	514	421	22%	3,291	2,514	31%
Total Nordic	6,381	6,306	1%	1,600	2,188	(27%)	2,238	2,819	(21%)	12,292	13,774	(11%)

Unit trust / mutual fund sales summary

Mutual fund sales of SEK6,466 million were up 37% on 2009. This was driven by improved retail investment activity spurred by rising global equity markets. However, fourth quarter sales showed a decrease compared to the same period in 2009 due to changing product demand and customer behaviour in Skandiabanken.

SEKm	2010	2009	+/-%
Skandiafonder	2,431	1,510	61%
Skandiabanken	4,035	3,198	26%
Total Nordic	6,466	4,708	37%

IFRS AOP results

The IFRS AOP (pre-tax) increased by 66% to SEK1,227 million compared to 2009. The key driver behind the improvement was higher client funds, which increased fund-based fees and rebates in the long-term business. In particular the unit-linked business performed strongly in the second half. A gain realised from divestment of a private equity holding in the first half contributed profit of SEK126 million.

SEKm	2010	2009	% Change
Long-term business AOP	1,016	502	102%
Banking business AOP	181	193	(6%)
Asset management AOP	30	42	(29%)
AOP (IFRS basis, pre-tax)	1,227	737	66%

The Healthcare business showed a strong turnaround in 2010 as pricing and product changes and underwriting discipline helped stabilise claims costs in the Lifeline business - which delivered AOP of SEK26 million compared to a negative SEK42 million in 2009. The 2010 figure includes divestment costs of SEK20 million for the Lifeline branch in Norway.

Skandiabanken's results were below 2009 levels, due mainly to lower net interest income and increased development costs. Skandiabanken Sweden suffered from the exceptionally low base interest rate during the first half, although this increased towards the end of the year. Credit losses remained very low (0.09% in 2010 compared to 0.14% in 2009), reflecting the traditionally low-risk nature of our lending business. Skandiabanken Norway grew its profits, due mainly to higher net interest income.

Value of new business and margins

The value of new business decreased compared to 2009, driven by lower new sales, negative operating assumption changes for anticipated price pressure in the Corporate segment, and expectations of more adverse persistency in the future. The APE margin increased from 19% to 21% due to a more profitable business mix resulting from a higher proportion of TPS business sales in Sweden and Match product sales in Denmark.

MCEV results

Operating MCEV earnings after tax declined to SEK503 million, due to the negative assumption changes driving the decline in the value of new business. However, total MCEV increased over the year, due mainly to positive client fund performance.

The Nordic business is making good progress towards the implementation of Solvency II, as a component of the overall Group Solvency II initiative.

Net client cash flow

NCCF for the year was SEK7.4 billion, a decrease of 36% compared to 2009. This was driven by a combination of higher surrenders (because of higher fund value and an increase in partial surrenders), lower single premium sales and higher paid-ups in the occupational pension business.

Funds under management

FUM were SEK145.4 billion at 31 December 2010, up 14% from the previous year. The increase is mainly due to the positive movement of equity markets.

The investment performance in the Swedish unit-linked portfolio was good in the fourth quarter, and our average client enjoyed investment performance of 6.2% for the quarter and 10.9% for the year. Clients have generally increased their risk exposure, with the majority of all net investments being allocated to Swedish, Asian and Emerging Markets equity funds. Fund performance has been strong over the 12-month period, with 63% of our funds performing above average compared to their peers.

Outlook

The economic outlook for 2011 is positive, with forecast GDP growth of over 3% in Sweden and Norway and around 2% in Denmark, and public spending is under control. We believe household incomes will increase, that the debate over credit expansion is turning the emphasis towards savings, and increased activity in the equity market is attracting inflows. As a result of this, the Nordic savings market is expected to grow despite some ongoing concerns around the continued high level of unemployment. The competitive environment will continue to be challenging, with competition pushing down fee levels. The market is heading towards further fragmentation into two main segments: the advised market, with high levels of added value from financial advisers, and the 'self-service' market.

Management action continues to focus on improved sales, healthy margins over the long-term, reductions in the cost base, and improvement of the distribution and product offerings to enhance NCCF. We delivered cost savings of £2.5 million in 2010. In 2011, cost reduction activity will increase and we estimate restructuring costs of £30 million in the year.

RETAIL EUROPE

Foundations laid for further development of the business

Highlights (€m, unless otherwise stated)	2010	2009	% Change
Adjusted operating profit (IFRS basis) (pre-tax)	60	25	140%
Return on local equity1	20%	9%
Life assurance sales (APE)	80	75	7%
Unit trust/mutual fund sales	27	27	-
PVNBP	597	603	(1%)
Value of new business	9	(6)	150%
APE margin	11%	(8%)	-
PVNBP margin	1.4%	(1.0%)
Operating MCEV earnings (covered business, post-tax)	77	(49)	157%
Return on embedded value (covered business, post-tax)	12.8%	(7.9%)
Net client cash flows (€bn)	0.5	0.6	(17%)
Funds under management (€bn)	5.8	4.7	23%

1 Return on local equity is IFRS AOP (post-tax) divided by average shareholders' equity, excluding goodwill, PVIF and other acquired intangibles

Overview

GDP growth improved in all our markets throughout 2010 following government stimulus packages and better conditions in export markets. Although labour markets improved in Germany and Switzerland, unemployment in Austria and Poland increased slightly. Equity markets rebounded from their 2009 lows, with the German DAX index posting a 2010 gain of 16%. Our customers continued to demand primarily guaranteed products and IFAs still view unit-linked policies with caution, preferring traditional life policies.

In the light of these challenges, Retail Europe's performance in 2010 has been very positive. Our sales improved on 2009 levels, primarily driven by Germany and Poland, we continued the formation of the Retail Europe organisation, and we reduced operating costs.

In addition to our sales and marketing activities, which were focused on the end customer, we also developed initiatives to maintain and grow relationships with our existing distribution partners. These initiatives, underpinned by strong cost containment, ensured significant improvement in our IFRS, MCEV and value of new business, with IFRS profits more than doubling. The transfer of our IT and client administration functions to South Africa continues, and our office in South Africa was officially opened in December 2010.

Life sales summary

APE sales reached €80 million, an increase of 7% compared to 2009. Sales in Poland increased markedly, while Austria and Switzerland showed a slight decline. Although the unit-linked market in Germany has declined slightly, we increased our share of this market from 1.9% in the fourth quarter of 2009 to 2.2% in the fourth quarter of 2010.

	Gross Single Premiums			Gross Regular Premiums			Total APE			Total PVNBP
New business (€m)	2010	2009	+/-%	2010	2009	+/-%	2010	2009	+/-%	2010	2009	+/-%
Germany	31	24	29%	29	27	7%	32	30	7%	278	260	7%
Poland	21	14	50%	18	12	50%	20	14	43%	114	87	31%
Austria	7	6	17%	17	19	(11%)	18	19	(5%)	109	142	(23%)
Switzerland	14	15	(7%)	9	11	(18%)	10	12	(17%)	96	114	(16%)
Total Retail Europe	73	59	24%	73	69	6%	80	75	7%	597	603	(1%)

The main driver of increased sales was new product launches. In Germany we launched the new single premium Investmentpolice product towards the end of the year, combining the tax benefits of a unit-linked contract with the transparency of a pure investment contract. In Poland we launched a new regular premium product, and in Switzerland we launched Easy Combi. All these launches were successful and we expect their impact to continue in 2011. We also made concerted efforts to improve our distributor relationships through marketing campaigns designed to support our partners during these difficult times.

IFRS AOP results

IFRS AOP has increased significantly to €60 million, due to improved results in all countries. The main factors were lower administration expenses and higher fees - driven by higher fund-based fees resulting from improved equity markets.

Net client cash flow

NCCF was €465 million for the year. The decline of €86 million on 2009 reflected the increase in fund values of surrenders due to positive equity markets, although persistency levels were broadly stable year-on-year.

Funds under management

FUM of €5.8 billion at 31 December 2010 reflected a rise of 23% compared to 2009, largely driven by positive stock market performance.

Value of new business and margins

The value of new business increased by €15 million to €9 million, with a PVNBP margin for the year of 1.4% and an APE margin of 11%. The main reasons for the improvement were higher new sales and successful expense management.

MCEV results

The operating MCEV earnings after tax increased by over €100 million to €77 million compared to 2009, driven by positive experience variances and positive assumption changes for rebates and persistency.

Although the Retail Europe business expects to be a Standard Formula entity under Solvency II, we have made excellent progress as part of the Group iCRaFT programme in ensuring that all of our processes and governance structures will be Solvency II compliant.

Outlook

We anticipate that macro-economic factors will continue to have a significant impact on our markets in 2011. The development of equity and bond markets will continue to be the key to restoring consumer confidence after the financial crisis. Our customers will also be impacted by unemployment levels and their own sense of job security. Ongoing Solvency II developments and the low interest rate environment will also provide challenges for traditional insurers. While this should be positive for the unit-linked market, it may intensify competition.

Our focus in 2011 is to extend our product range and distribution through growth initiatives in Germany and Poland. At the same time we will maintain our focus on capital efficiency and cost containment through our consolidated base in Berlin and our operations in South Africa. We will incur further implementation costs for outsourcing the administration and IT support teams to South Africa but will gain scope for operational leverage in due course.

WEALTH MANAGEMENT

A very positive year for Wealth Management

Highlights (€m, unless otherwise stated)	2010	2009	% Change
Adjusted operating profit (IFRS basis, pre-tax)	197	106	86%
Return on local equity1	14%	8%
Life assurance sales (APE)	734	617	19%
Unit trust/mutual fund sales	4,507	3,210	40%
PVNBP	6,380	5,042	27%
Value of new business (post-tax)	66	49	35%
APE margin	9%	8%
PVNBP margin	1.0%	1.0%
Operating MCEV earnings (covered business, post-tax)	112	(4)
Return on embedded value (covered business, post-tax)	6.1%	(0.3%)
Net client cash flows (£bn)	3.9	2.5	56%
Funds under management (£bn)	55.9	46.9	19%

1 Return on local equity is IFRS AOP (post-tax) divided by average shareholders' equity, excluding goodwill, PVIF and other acquired intangibles

Overview

Wealth Management enjoyed a very positive year in 2010. We achieved significant year-on-year sales growth, margins improved and the cost reduction programme delivered £35 million of run-rate savings which contributed to improved profitability. The FTSE100 grew by 9% during the year, contributing to continued positive investor sentiment which in turn led to strong growth in FUM across our markets.

Sales grew across the business, particularly in the UK and Continental Europe. We continue to see a rapid shift in the UK towards both platform business with an insurance wrapper and mutual fund products. Although we do not target growth in market share as a KPI, Skandia UK's market share continued to grow in the third quarter of 2010, to 7.4% across all industry channels compared to 6.4% in the fourth quarter of 2009, suggesting the increased importance of the platform model. This is a record for Skandia in the UK and compares to a range of 3.5% to 5.5% over 2001-2007. The scale of our UK Platform, and our investment to deliver reliability and flexibility, position us ideally to lead and benefit from this industry shift; we are actively looking at how to further enhance our platform offering and rationalise our suite of products over the coming year. We are making good progress in building the Wealth Management operations and systems on a single operating model.

Throughout 2010, Skandia Investment Group's (SIG's) highly successful Spectrum range of risk-targeted funds has been launched on all the UK's major financial adviser platforms. The FUM of Spectrum exceeded the £750 million mark, and this range has now been successfully exported to Sweden as the Skala range.

Life covered sales summary

APE sales were £734 million, a 19% increase on 2009. This is mainly attributable to sales in the UK and in Continental Europe, which improved by 28% (£76 million) and 50% (£52 million) respectively compared to 2009.

	Gross single premiums			Gross regular premiums			Total APE			Total PVNBP
New business (£m)	2010	2009	+/-%	2010	2009	+/-%	2010	2009	+/-%	2010	2009	+/-%
UK
Pensions	2,021	1,452	39%	71	70	1%	273	216	26%
Bonds	597	473	26%	-	-		60	47	28%
Protection	-	-		10	8	25%	10	8	25%
Savings	-	-		9	5	80%	9	5	80%
Total UK	2,618	1,925	36%	90	83	8%	352	276	28%	3,023	2,289	32%
International
Unit-linked	324	190	71%	44	63	(30%)	77	83	(7%)
Bonds	1,253	1,154	9%	23	39	(41%)	148	153	(3%)
Total International	1,577	1,344	17%	67	102	(34%)	225	236	(5%)	1,826	1,741	5%
Continental Europe
Unit-linked	1,490	971	53%	9	6	50%	157	105	50%	1,531	1,012	51%
Total Wealth Management	5,685	4,240	34%	166	191	(13%)	734	617	19%	6,380	5,042	27%

Unit trust / mutual fund sales summary

£m	2010	2009	+/-%
UK	3,256	2,090	56%
International	1,228	1,100	12%
Continental Europe	23	20	15%
Total Wealth Management	4,507	3,210	40%

The strong UK platform performance reflects the continued conversion of IFAs to platform business and particularly strong sales during the first half in the lead-up to the end of the tax year. APE sales of £239 million were up £100 million on 2009. Second half volume growth decreased, with re-registering activity slowing and a greater impact from the UK holiday season. The majority of the mutual fund sales growth was from the platform, where buoyant markets and increased ISA allowances made positive contributions in 2010 and late 2009. Gross inflows onto the platform were £5.2 billion in 2010 (2009:£3.3 billion) - an indicator of our proposition's success.

Continental Europe APE sales volumes of £157 million were strongly ahead of 2009's £105 million. Italy has been the main contributor to increased Europe sales, with very high sales earlier in the year partially driven by changes in tax legislation. The period covered by these tax changes has now expired, and volume growth has returned to normal levels as we continue to make progress through good distributor relationships.

APE sales volumes of £225 million in the offshore International market were 5% lower than the £236 million achieved in 2009, impacted by a managed decline in regular premium sales in Finland as a result of legislation changes in 2009.

The UK Legacy business APE sales volumes of £113 million were down by £24 million compared to 2009, due to a shift in market sentiment towards platform offers. Following a review of the legacy products, we decided to close some legacy products to new business.

IFRS AOP results

IFRS AOP (pre-tax) increased by 86% to £197 million, primarily due to higher FUM, which provided a healthy boost to returns on equity because of the operating leverage in the business. FUM growth remains strongly positive, driven by NCCF and market growth.

As previously reported, the prior year AOP results benefited from the structural tax efficiency applicable to UK companies writing unit-linked business in the UK, together with the smoothing of previous years' deferred tax assets. These assets arose during the significant market volatility of the preceding two years where falls in the value of policyholder assets resulted in the recognition of significant deferred tax assets in the IFRS income statement, which were spread forward under AOP. The pre-tax smoothing for 2010 gave rise to a profit of £71 million, a similar amount to 2009. For 2011, the pre-tax impact will be a profit of £27 million, falling to nil thereafter. Within the MCEV earnings, these profits are recognised as they arise as investment variances.

With continued equity and bond market growth, the UK Life Companies have moved into a full XSI tax position. This raises the effective tax rate because it means that only a relatively small proportion of the Life dividend income is treated as belonging to the shareholder. This has increased the overall effective tax rate for Wealth Management to 22% in 2010 (2009: 19%).

Value of new business and margins

The value of new business increased by £17 million to £66 million due to strong sales in UK platform and Continental Europe combined with operating assumption changes at year-end 2010 across all markets in Wealth Management. This was partially offset by economic assumption changes in UK and Continental Europe (as a result of decreased assumed growth rates and increased future inflation) and the shift from UK Legacy to UK Platform offerings.

2010 PVNBP margin was level with 2009 at 1.0%, as growth in volumes and cost reductions were fully offset by the shift to the UK platform offering, the decline in regular premium business sales and higher acquisition expenses in International.

MCEV results

Covered business adjusted operating MCEV post-tax earnings increased by £116 million to £112 million. 2009 was significantly impacted by operating assumption changes reflecting surrender experience in International and UK Legacy. In 2010 VNB was higher and overall we saw a significant improvement in experience effects, especially persistency and rebates. However, persistency has worsened on the UK Legacy pension business as the market anticipates the implementation of the Retail Distribution Review. This has resulted in some product closures and consequently the MCEV assumptions have been strengthened. Planned return on MCEV was lower than in 2009 as a result of the reduction in the one-year yield on risk-free investments.

We have made excellent progress in implementing our Solvency II readiness programme, in conjunction with the Group-led iCRaFT initiative.

Net client cash flow

NCCF for the year was £3.9 billion, up 56% on 2009, driven by strong contributions from the UK platform and Italy, which outweighed surrenders in the UK Legacy book.

Funds under management

FUM grew 19% to £55.9 billion, driven by strong NCCF and the positive market movements.

Outlook

Our outlook for 2011 is optimistic, based on continuing positive investor sentiment. So far 2011 sales are in line with our expectations but below those of the prior year which included the one-off positive impact of the Italian tax shield and particularly significant UK platform sales in the build up to the 2010 tax year-end. These were helped by April 2010 changes in pension rules coupled with rising investor confidence at the time of the 2010 ISA season.

We anticipate continued strong support for the platform model in all our markets and the shift in the UK market towards a simplified investment and pension product suite. Following the closure of a number of our UK Legacy products during 2010, we have put retention strategies in place for this part of the business - anticipating that we will continue to see net client outflows from this book of business in the build-up to implementation in 2013 of the changes resulting from the Retail Distribution Review (RDR). We expect final clarification of the review in a Policy Statement during the first half of 2011. We believe that we are well-placed for the RDR changes since a large proportion of our new business is already written on the basis of client-agreed adviser remuneration. In addition, we are considering plans to introduce a fully unbundled charging structure, under which we will pass on rebates to the customer in advance of December 2012.

Our focus on cost reduction will continue and we remain confident that we will meet our 2012 expense and RoE targets.

banking

Nedbank Group is South Africa's fourth largest banking group measured by assets, with a strong deposit franchise and the second largest retail deposit base. Old Mutual owned on average 54% of Nedbank Group during 2010. Nedbank is listed on the Johannesburg and Namibian Stock Exchanges. As at 31 December 2010, its market capitalisation was £6.2bn. 

Overview

Nedbank Group provides a wide range of wholesale and retail banking services and a growing insurance, asset management and wealth management offering through five main business clusters, namely Nedbank Capital, Nedbank Corporate, Nedbank Business Banking, Nedbank Retail and Nedbank Wealth.

Focused on southern Africa, but with an aspiration to grow its business reach across the whole of the African continent, Nedbank Group is positioned as a bank for all - from both a retail and a wholesale banking perspective.

Acknowledged for its sustainability leadership, Nedbank Group is the first and only carbon-neutral financial services organisation in Africa.

Nedbank Group's headquarters are in Sandton, Johannesburg, while it has large operational centres in Durban and Cape Town, complemented by a regional branch network throughout South Africa and facilities in other southern African countries. These facilities are operated through Nedbank Group's eight affiliated banks and subsidiaries, as well as through branches and representative offices in certain key global financial centres that serve to meet international banking requirements of Nedbank Group's South Africa-based multinational clients.

Business profile

Nedbank Capital	Provides comprehensive investment banking solutions to institutional and corporate clients. Has offices in South Africa and London and a representative office in Angola.	The cluster comprises: ·      Investment Banking ·      Global Markets ·      Treasury.
Nedbank Corporate	Provides full-service corporate banking to large corporates with an annual turnover in excess of R400 million, including commercial, industrial, retail and residential property finance solutions, and Nedbank Africa, comprising operations servicing both retail and corporate market segments in Lesotho, Malawi, Namibia, Swaziland and Zimbabwe.	The cluster comprises: ·      Corporate Banking ·      Property Finance ·      Nedbank Africa ·      Transactional Banking ·      Corporate Shared Services.
Nedbank Business Banking	Provides commercial banking solutions to small- to medium-sized businesses with an annual turnover of between R7.5 million and R400 million.	The cluster comprises: ·      Four geographically decentralised client-facing business units ·      A strategic business unit, including ·      Specialised Finance, Debtor Management ·      and Client Value Propositions Specialist services, including Investment Management, Transactional Banking Sales, Finance and Business Intelligence/Client Value Management.
Nedbank Retail	Serves the financial needs of individuals and small businesses with up to R7.5 million in annual turnover. Provides transactional, card, lending and investment products and services. The Nedbank Retail Cluster also services merchants and large corporates in respect of card-acquiring services.	The cluster comprises: ·      Secured Lending, including mortgages and motor finance ·      Retail Relationship Banking, which combines Private Banking and Small-Business Services and offers products in a client-centric value proposition ·      Consumer Banking, which consists of channels, personal loans, deposits, transactional banking, client value management and mass tailored offerings based on client insights ·      Card Issuing and Acquiring.
Nedbank Wealth	Comprises three divisions, namely Insurance, Asset Management and Wealth Management, with offices in South Africa and London and on the Isle of Man, Jersey and Guernsey.	The cluster comprises: ·      Insurance includes short-term ·      insurance, life insurance and insurance broking ·      Asset Management offers a range of local and international 'best of breed' unit trusts, private client asset management and multimanagement solutions ·      Wealth Management includes private banking and fiduciary services locally and internationally as well as stockbroking and financial planning.

Strategy

During 2010 Nedbank Group's vision was refined to: 'Building Africa's most admired bank by our staff, clients, shareholders, regulators and communities'.

This represents a significant enhancement to Nedbank Group's vision and highlights the increasing focus by Nedbank Group on growing its business reach across the African continent not just in South Africa. However, the Nedbank Group recognises that, to become the most admired bank in Africa, it must achieve this in South Africa first, which is why its primary focus during 2010 was on developing more competitive domestic strategies for each of its front-line businesses.

Nedbank Group assessment of strategic operating environment

Identified trend	Nedbank Group will …
Bank returns are structurally declining.	... respond through active portfolio management and 'tilting' of its portfolio of businesses to optimise sustainable profitability, utilise capital and liquidity judiciously, invest to exploit new growth opportunities, and build a lean operating model.
The SA financial services' economic profit pool is large, but higher growth is expected in the rest of Africa in the longer term.	... focus domestically, but continue to explore expansion opportunities in Africa.
SA prospects continue to be driven by infrastructural investment (mostly government) and a wealthier consumer.	... ensure that it benefits from the opportunities created through infrastructure development, increase its focus on wholesale banking, and improve its retail proposition to capture disposable income shifts. Nedbank Group will also continue to bring more people into the formal banking system through innovative and affordable products such as M-PESA.
There is high growth from bandwidth, electronic, internet, mobile and new technology developments.	... leverage new technologies and then lead in these high-growth markets and banking markets linked to these, such as mobile banking.
SA demographic shifts are enabling consumer opportunities.	... target large and growing segment opportunities such as the underbanked, youth, small and medium enterprise and senior citizen markets. A differentiated approach is essential to service such new markets in a cost-efficient manner.
The voice of and focus on the client are increasing.	... meet the need for simplicity, convenience, choice, affordability, advice, and trust from clients. Client centricity will remain a core focus, with the aim to increase direct engagement with clients.
Non-banking solutions are growing faster than banking, but deposits have become a key priority.	... seek out add-on growth solutions while improving transactional banking capabilities, such as cross-sell, primary clients, and functionality.
Demand for talent is greater than growth of the talent pool.	... develop unique ways to retain, develop and grow the staff talent pool, especially in businesses that will be targeting higher growth.
Pressure on natural resources is increasing.	... continue to reduce and neutralise its own operational impact, consider environmental impacts in its lending activities and actively support its clients in their endeavours to reposition their businesses accordingly.

Nedbank Group's vision continues to be supported by its long-term objectives, which are referred to internally as Deep Green aspirations.

These are:

  to become a great place to work, a great place to bank and a great place to invest

  to be world class at managing risk

  to create a community of leaders

  to have the most respected and aspirational financial services brand

  to be recognised for being highly involved in the community and environment

  to lead in transformation

  to be great at collaboration

  to live its values.

Portfolio approach to capital allocation

A portfolio approach has been adopted for sustainably optimising returns in an environment where resources, capital and liquidity are scarce commodities. The Nedbank Group must be more judicious in selecting strategic business opportunities that will allow better alignment of risk and returns, taking into account liquidity, capital and credit risks. Doing so will allow a transition from some of the existing portfolios, such as retail home loans (where the economic returns continue to be poor), while growing low-capital-intensive businesses. The Nedbank Group will, however, continue to take a long-term sustainable view of its products, client needs and its societal impact.

Against this strategic backdrop the business plan for 2011 to 2013 will see Nedbank Group focus on:

  building enduring primary banking relationships with more retail and wholesale clients in South Africa

  improving its primary banking positioning across all businesses

  becoming the leader in business banking for South Africa

  becoming the public sector bank of choice

  continuing as one of the top two wholesale banks

  ramping up the wealth and asset management, and insurance businesses

  leveraging the Imperial Bank integration

  becoming the leader in client service delivery

  building on its position as a leader in, and influencer of, integrated sustainability.

The Nedbank Group will also continue to evolve its strategy of building Africa's most admired bank by:

  implementing its three-tier strategy to grow its physical network in the southern African Development Community

  leveraging boutique investment banking opportunities

  leveraging the Ecobank Nedbank Alliance to provide clients with access to a Pan-African network

  evaluating selective investment opportunities.

Solid earnings growth

Highlights (Rm)	2010	2009	% Change
Solid earnings growth
Adjusted operating profit (IFRS basis, pre-tax)	6,799	6,192	10%
Headline earnings1	4,900	4,277	15%
Net interest income1	16,608	16,306	2%
Non-interest revenue1	13,215	11,906	11%
Net interest margin1	3.35%	3.39%
Credit loss ratio1	1.36%	1.52%
Cost to income ratio1	55.7%	53.5%
RoE1	11.8%	11.8%
RoE (excluding goodwill)1	13.4%	13.4%
Core Tier 1 ratio	10.1%	9.9%
Adjusted operating profit (IFRS basis, pre-tax) (£m)	601	470	28%

1 As reported by Nedbank Group in its report to shareholders as at 31 December 2010 .Certain of the Nedbank Group's reporting ratio calculations have been adjusted. The ratios for RoE have been restated with the denominator changing from simple average to daily average for equity and total asset values, respectively. The calculation of the credit loss ratio has been changed from simple-average advances to daily-average banking advances (thereby excluding trading advances from the calculation). Comparatives have been restated accordingly.

The current strong capital position of the Nedbank Group, combined with these strategic focus areas, places it in a position for sustainable growth.

The full text of Nedbank Group's results for the year ended 31 December 2010, released on 28 February 2011, can be accessed on Nedbank Group's website http://www.nedbankgroup.co.za/financial/2010AnnualResults/downloads/NedbankGroup.pdf.

Banking environment

Real gross domestic product (GDP) in South Africa grew by 2.8% in 2010 compared with a decline of 1.7% in 2009. The local economy had a strong start to the year, primarily driven by improved global demand for commodities and a rebound in manufacturing production off the depressed levels of 2009.

Economic activity was also boosted by strong infrastructural spending ahead of the FIFA 2010 World Cup and by the event itself, with consumer spending rising steadily for most of the year. However, fixed investment by the private sector contracted for the second year off the elevated levels seen in 2008.

Growth in both the emerging and some parts of the developed world surprised on the upside, underpinned by China's economic strength and continued demand for commodities and capital goods. Massive liquidity injections by major central banks and historically low interest rates helped to stimulate economic growth further, particularly in emerging economies. In contrast, the underlying economic and financial environment remained fragile in the developed world, with fiscal difficulties in parts of Europe and America, continued weakness in credit markets, limited employment growth and inflationary concerns returning in emerging economies.

Household finances improved in South Africa as debt started to decrease and interest rates eased to the lowest levels in 36 years. The recovery in the credit cycle has proved to be more modest compared with previous cycles. Household demand for credit was contained by the consumer debt burden remaining relatively high, increased regulatory requirements, policy uncertainty and employment growth only resuming late in the year. Against this background the ratio of household debt to disposable income declined marginally to 78.2% from just over 80% at the end of 2009. At the same time debt service costs decreased to 7.5%, the lowest level since June 2006, and are now at a level that is more conducive to improving economic growth in the consumer sector.

In the corporate sector excess capacity and uncertainty over the sustainability of the local and global recovery limited spending. Government fixed-investment spending, although continuing to contract, emerged as the main foundation for growth.

Review of results

Nedbank showed solid earnings growth in a challenging economic environment. After a strong fourth quarter Nedbank finished the year with earnings marginally ahead of management's expectations set out in the third-quarter trading update. Headline earnings increased by 14.6% from R4,277 million to R4,900 million. Diluted headline earnings per share increased by 8.7% from 983 cents to 1,069 cents, slightly above the forecast range of 0% to 8% provided in the third-quarter trading update. Diluted earnings per share (DEPS) decreased by 5.3% from 1,109 cents to 1,050 cents. As previously reported, 2009 DEPS included a once-off International Financial Reporting Standards (IFRS) revaluation gain of R547 million (after taxation) from the acquisition and consolidation of the Nedbank Wealth joint ventures.

Nedbank recorded a return on average ordinary shareholders' equity (RoE), excluding goodwill, of 13.4% and a RoE of 11.8%.

Nedbank maintained its well-capitalised balance sheet with core Tier 1 capital at 10.1% (2009: 9.9%), while advances grew by 5.5%, with market share gains in most lending classes aside from home loans.

The net asset value per share grew by 8.0% from 9,100 cents in December 2009 to 9,831 cents in December 2010. This is a pleasing result given the increase in the average number of shares in issue following the acquisition of the joint ventures from Old Mutual and scrip dividend distributions last year.

Financial performance

Net interest income (NII)

NII increased by 1.9% to R16,608 million (2009: R16,306 million) and Nedbank's net interest margin held up well at 3.35% (2009: 3.39%), despite the impact of lower interest rates. Average interest-earning banking assets increased by 3.0% (2009 growth: 9.0%).

Margin compression was less than expected. Margin pressure primarily resulted from a smaller endowment from lower average interest rates and the cost of lengthening the funding profile. This was partially offset by the widening of margins from asset pricing and a change in asset mix, including strong growth in Nedbank's retail motor finance and personal loans businesses, a relative prime/Johannesburg Interbank Agreed Rate (JIBAR) reset benefit as a result of less aggressive interest rate cuts during 2010 compared with 2009, and a decline in the market cost of term liquidity during the last quarter of the year.

Impairments charge on loans and advances

The credit loss ratio on the banking book improved to 1.36% for the period (2009: 1.52% (restated)).

The reduction in the impairments charge was driven mostly by Nedbank Retail, particularly in the secured portfolios that had lagged the recovery in the unsecured portfolios. Lower interest rates and the stabilising of job losses contributed to the retail credit loss ratio improving significantly from 3.17% in 2009 to 2.67%. Nedbank further strengthened its provisioning by reducing certain security assumptions in specific impairments, increasing levels of portfolio provisioning on debt restructures of R97 million and lengthening the bad debt emergence period assumptions within Nedbank Retail home loans at an additional cost of R114 million within portfolio impairments.

The credit portfolios in Nedbank Corporate, Nedbank Business Banking and Nedbank Wealth are of high quality and credit loss ratios remained within or below the respective clusters' through-the-cycle levels. Nedbank Capital impairments increased in the higher-risk private equity portfolio.

Defaulted advances declined by 1.04% to R26,765 million (2009: R27,045 million). Defaulted advances to total advances decreased from its peak of 6.01% in June 2010 to 5.63%. Total impairment provisions increased by 14.6% to R11,226 million (2009: R9,798 million) resulting in strengthened coverage ratios.

Non-interest revenue (NIR)

Nedbank's focus on NIR generated growth across all the clusters. NIR increased 11.0% to R13,215 million (2009: R11,906 million). On a comparable basis NIR growth was 10.5% after adjusting for the acquisitions in 2009 of the Nedbank Wealth joint ventures and before fair-value adjustments. The ratio of NIR to expenses improved to 79.6% (2009: 78.8%).

Core fee and commission income grew strongly by 13.7% (like-for-like growth of 11.2%, adjusting for the Nedbank Wealth joint ventures) through volume growth, new products and new client acquisitions. Nedbank reduced its retail transactional banking charges in 2006 and 2007. Since then price increases have been modest, with 2010 increases in line with inflation, resulting in current banking charges being similar to 2005 levels.

Insurance income grew 39.8% (18.4% on a like-for-like basis, adjusting for the Nedbank Wealth joint ventures) primarily as a result of the provision of insurance on a fast-growing personal loans book as well as the introduction of new products and improved levels of cross-selling.

Trading income increased by 13.9% to R2,096 million (2009: R1,841 million). In 2009 interest rates decreased at a rapid pace and created favourable trading conditions. Low volatility in the first half of 2010 resulted in difficult conditions for global markets and continued pressure on foreign exchange volumes and margins. This was offset by improved equity trading in the second half of the year.

Private equity markets remained constrained throughout the year. Listed-property private equity investments showed some modest gains. Overall NIR from the private equity portfolios decreased by 25.0%.

NIR was negatively impacted by R213 million (2009: R6 million profit) over the period as a result of the adverse fair-value adjustments of Nedbank's subordinated debt resulting from the narrowing of credit spreads. Nedbank Corporate also reflected a negative fair-value adjustment of R55 million (2009: R72 million profit) due to a downward movement in the yield curve and related convexity in the fixed-rate advances book and associated interest rate swaps.

Expenses

Nedbank has maintained a strong cost discipline over an extended period, resulting in the increase in expenses remaining below the market guidance given at the beginning of 2010. Expenses grew by 9.9% to R16,598 million (2009: R15,100 million). The increase was partly due to the acquisition of the Nedbank Wealth joint ventures and the consolidation of Merchant Bank of Central Africa. Expenses increased by 8.5% on a comparable basis.

Taxation

The taxation charge (excluding taxation on non-trading and capital items) increased by 10.9% to R1,366 million (2009: R1,232 million) arising from profit growth adjusted for dividend income as a proportion of total income being lower than in 2009, the lower provision for secondary tax on companies, owing to an increase of shareholders (81.5%) who elected to take scrip for the 2009 final dividend distribution (2008 final dividend distribution: 32.0%), and the reduced accounting effect from structured finance transactions that continued to unwind.

The effective tax rate increased marginally from 20.2% to 20.7%.

Non-trading income

Income after taxation from non-trading and capital items decreased to a R89 million loss from a R549 million profit in 2009. The main component of this was an anticipated R34 million writedown on Imperial Bank computer software following the acquisition. The 2009 profit arose from the accounting-related revaluation of BoE (Pty) Limited and Nedgroup Life Assurance Company Limited on the acquisition of the remaining shares in the joint ventures.

Capital

Nedbank's capital adequacy ratios remain well above its internal targets and marginally ahead of December 2009. This resulted from ongoing capital and risk-weighted asset optimisation, a strategic focus on 'managing for value' and a 0.6% increase in capital from higher levels of scrip takeup and other share issues for staff incentives and black economic empowerment (BEE) structures. This growth was offset by the approximately 1.3% negative impact on Nedbank's capital adequacy ratios from the cash acquisition of 49.9% of Imperial Bank and the treatment of capitalised software as an intangible asset rather than as a fixed asset for capital adequacy purposes.

Liquidity

Nedbank's liquidity position remains sound. Nedbank continues to focus on diversifying its funding base, lengthening its funding profile and maintaining appropriate liquidity buffers. Nedbank increased its long-term funding ratio from increased capital market issuances under the domestic medium-term note programme (R6.23 billion) and also increased the duration in the money market book. Nedbank's liquidity position is further supported by a strong loan-to-deposit ratio of 97% and a low reliance on interbank and foreign currency funding. Nedbank is able to leverage off its favourable retail, commercial and wholesale deposit mix, which compares well with domestic industry averages.

Loans and advances

Nedbank continued to make good progress in improving asset quality, and active management of the bank's portfolios towards higher-economic-profit businesses resulted in slower asset growth in selected areas. Nedbank grew advances ahead of the industry at 5.5% to R475 billion (2009: R450 billion).

Deposits

Deposits increased by 4.5% to R490 billion (2009: R469 billion). Optimising the mix of the deposit book remains a key focus in reducing the high cost of longer-term and professional funding. This is critical as banks compete more aggressively for lower-cost deposit pools with longer behavioural duration and as they start to take cognisance of the possible Basel III liquidity ratios. Low interest rates, coupled with low domestic savings levels and the deleveraging of consumers, led to modest growth in retail deposits during 2010. Relatively higher deposit growth in the wholesale sector indicated increasing working capital and available capacity among corporates. Throughout the year demand for higher-yielding negotiable certificates of deposit remained strong within the professional funds and corporate markets.

Capital adequacy	2010 ratio	2009 ratio	Target range	Regulatory minimum
Core Tier 1 ratio	10.1%	9.9%	7.5% to 9.0%	5.25%
Tier 1 ratio	11.7%	11.5%	8.5% to 10.0%	7.00%
Total capital ratio	15.0%	14.9%	11.5% to 13.0%	9.75%

Capital adequacy ratios include unappropriated profit

Outlook

Lower domestic interest rates and rising levels of income should boost consumer spending. Together with improving global demand, this is expected to increase confidence levels and lead to better consumer demand and capital formation in 2011 and further momentum in 2012.

Retail banking credit growth should fare better as household credit demand improves, house prices edge higher and impairments moderate. Corporate markets are expected to show modest improvement, while the small and medium enterprise (SME) market is likely to remain under pressure until fixed-investment activity improves.

Government spending should continue to underpin growth, although this is expected to be limited by the reduction in fiscal deficits over the medium term. Government's stronger focus on job creation is also positive and much will depend on the ability to create a more enabling environment for business growth. Key to this will be improvements in the building of infrastructure and a more conducive and certain regulatory and policy environment to reduce the medium-term constraints on economic growth.

Nedbank is well placed for earnings growth in 2011 and remains on track to meet its medium- to long-term financial targets in 2013. Nedbank will continue to invest to generate sustainable revenue growth, underpinned by ongoing cost optimisation and efficiency improvements. Growing the bank's overall franchise and maintaining momentum on the turnaround in the Retail Cluster, supported by a liquid and well-capitalised balance sheet, are key to delivering sustainable growth.

Margins should widen slightly, given that interest rates are expected to remain unchanged, and hence the negative effect of assets repricing quicker than liabilities out to three months will decrease. In addition, the cost of term liquidity is expected to decline as more expensive deposits mature and as below-trend economic growth continues, albeit at higher levels than last year. Overall advances growth is expected to be in the mid to upper single digits.

Impairments are expected to continue reducing in line with the improved quality of assets supported by asset pricing on new advances that appropriately reflects risk and the related cost of funds. The credit loss ratio is currently expected to decrease but to remain above Nedbank's target range in 2011.

Transactional volumes are expected to increase as the economy improves and Nedbank's focus on growing primary clients is maintained.

Nedbank's medium-term targets remain unchanged.

Nedbank Group's medium- to long-term targets

Metric	2010 Performance	Medium- to long-term target	2011 Outlook
ROE (excl goodwill) improving, impairments charge	13.4%	5% above monthly weighted average cost of ordinary shareholders' equity	Improving, remaining below target
Growth in diluted headline earnings per share (EPS)	8.7%	At least consumer price index + GDP growth + 5%	Forecast to exceed target
Impairments charge (credit loss ratio)	1.36%	Between 0.6% and 1.0% of average banking advances	Improving, remaining above target
NIR:expenses ratio	79.6%	> 85%	Improving, remaining below target
Efficiency ratio	55.7%1	< 50.0%	Improving, remaining above target
Basel II core Tier 1 capital adequacy ratio	10.1%	7.5% to 9.0%	Improving, remaining above top end of target range
Basel II Tier 1 capital adequacy ratio	11.7%	8.5% to 10.0%	Improving, remaining above top end of target range
Basel II total capital adequacy ratio	15.0%	11.5% to 13.0%	Improving, remaining above top end of target range
Economic capital	Capitalised to 99.93% confidence interval on economic capital basis (target debt rating A including 10% buffer)
Dividend cover policy	2.30%	2.25 to 2.75 times	2.25 to 2.75 times

1 Actual efficiency ratio is 55.7% including BEE costs

Short-term insurance

Mutual & Federal (M&F) is the second-largest short-term insurer in South Africa, with operations in Namibia, Botswana and Zimbabwe. It provides a full range of short-term insurance products to commercial and domestic customers in five principal portfolios: Commercial including Agriculture, Corporate, Personal, Risk Finance, and Credit. 

Overview

In 2009, Old Mutual plc announced its intention to buy out the minority stake in M&F, making it a wholly-owned subsidiary. On completion of the transaction in 2010, M&F delisted from the Johannesburg Stock Exchange and developed a three-to-five-year strategic programme to deliver a real step change for the company. To drive delivery of the programme, Peter Todd was appointed as Managing Director in December 2010, following Keith Kennedy's decision to retire in 2011.

Strategy

M&F's new vision and strategic objectives are aligned with Old Mutual Group's theme of customer-centricity. The strategy aims to deliver the desired shareholder outcomes by identifying key market segments and providing them with relevant and suitably priced product solutions and efficient services through appropriate channels. The new vision, strategy and five strategic thrusts will be delivered through the Step Change Programme.

Our vision is to become the short-term insurer of choice, trusted by our customers to provide innovative solutions to protect them financially in the event of a loss.

Our strategy is to deliver strong underwriting profit and revenue growth by building a multi-channel business focused on delivering value for the customer and fostering close relationships with our strategic business partners.

The five strategic thrusts are:

1.Embed profitable and sound underwriting processes

2. Develop compelling and innovative offerings for targeted customer and broker segments

3. Grow our customer base by servicing them through their channel of choice

4. Deliver value through efficient and customer-centric processes

5. Transform our business to benefit our people and other stakeholders.

Over the next three years, M&F will continue focusing on implementation of the Step Change Programme to build a leadership position in the South African short-term insurance market.

Business profile

Commercial	The Commercial portfolio is the largest, with a broad spectrum of customers ranging from small businesses to large corporations. It covers primarily property, accident, motor, engineering, marine and crop insurance risks.
Corporate	The Corporate portfolio focuses on corporate clients, from mid-size companies to large multi-nationals. Corporate offerings include protection, fire policies accident policies and motor fleet insurance. This portfolio is staffed with specialists in corporate insurance, supporting the major brokers in this sphere, with expertise in mining, engineering, chemical production, motor manufacture and other major sectors.
Personal	The Personal portfolio provides domestic household, motor and all-risk short-term insurance products to domestic customers of all ages and various financial groups. It offers white-labelled intermediary-branded products and an inhouse branded product. Allsure, which provides comprehensive cover. It also includes a hospital cash plan and personal accident policies as well as low-cost products covering livestock and informal dwellings.
Risk Finance	The Risk Finance portfolio, comprising alternative risk transfer products, is provided by a highly capable team which is well regarded in the industry as one of the South Africa's largest suppliers of risk financing solutions, primarily to medium-sized commercial customers.
Credit	The Credit portfolio is underwritten by a subsidiary of M&F and is offered within a market segment where it dominates the market.

Strong performance following renewed focus

Highlights (Rm)	2010	2009	% Change
Underwriting result	519	140	271%
Long-term investment return (LTIR)	639	791	(19%)
Restructuring costs	(8)	(13)	38%
Income from associates	12	-	-
Adjusted operating profit (IFRS basis, pre-tax)	1,162	918	27%
Gross premiums	8,442	8,456	-
Earned premiums	6,859	6,874	-
Claims ratio	63.8%	68.7%
Combined ratio	92.4%	98.0%
Solvency ratio	73%	56%
Return on equity	19.0%	21.2%
Adjusted operating profit (IFRS basis, pre-tax) (£m)	103	70	47%

Market context

In 2010, although market conditions had improved compared to 2009, tough economic conditions prevailed for consumers, and spending was constrained.

The improvement in market conditions resulted from several factors - including successive interest rate cuts during the year, which reduced the cost of debt; consumer inflation declining and remaining within the target range, and improved customer confidence. GDP grew at the expected rate of 3.0% by the end of 2010, a turnaround from the 1.8% decline in 2009. Car sales increased as a result of car rental company purchases for the 2010 Soccer World Cup, and consumers bought motor vehicles in anticipation of the new CO₂ emissions tax. Lastly, there was growth in the short-term industry market - particularly in the mass market area, where penetration is still low.

On the other hand, challenges were presented by debt-income ratios and unemployment that remained high, constraining spending, particularly retail expenditure. Market competition has intensified with the entry and growth of direct businesses, aggregators and banks in the short-term insurance space. In addition, the short-term insurance industry has had to face increased legislation such as the Financial Advisory and Intermediary Services Act (FAIS) Amendment to the General Code of Conduct enacted in October 2010.

Review of results 2010

Mutual & Federal delivered a very strong underwriting result in 2010, with exceptional performance from the commercial, corporate and credit insurance portfolios assisted by a relatively benign claims environment. As a result of seasonal weather factors our performance in the second half is traditionally stronger than the first half, which is affected by heavy rains. This was particularly marked in 2010, when our performance steadily improved throughout the year after a weak first quarter, also helped by the absence of significant fire claims.

We were pleased to record an improvement in client service in 2010. This was confirmed when we took second place in the Ask Afrika Orange survey on short-term insurance, which assesses customer service standards. The year also marked our first entry into the direct insurance market, with the launch of our iWYZE initiative in May. This has progressed extremely well, although it will continue to require investment in the near term. We are also making good progress in our preparation for Solvency II and its equivalent in South Africa, which is known as Solvency Assessment and Management (or SAM).

Underwriting and IFRS AOP results

Premiums remained flat on 2009 levels, largely as a result of the cancellation in late 2009 and early 2010 of some unprofitable portfolios that had consistently run at claims ratios above 80%. Our claims ratio decreased from 68.7% to 63.8% due to the favourable trading environment and focused management of claims costs.

The improving quality of our book of business, combined with a focus in 2010 on claims costs and improved pricing, allowed the business to deliver an underwriting result of 7.6%. Our operations in Namibia and Botswana continued to generate about 11% of our underwriting result between them.

Our expenses increased by 13% - primarily driven by inflation and profit-related pay, given the improved underwriting result.

Solvency margin

There has been a pleasing improvement in the solvency ratio (the ratio of net assets to net premiums) from 56% to 73%. This reflects the capital generated from the much-improved underwriting result and investment income.

 

 

Outlook

In 2011 we will continue to see the benefits of increased collaboration with OMSA, both in further growth of the iWYZE initiative, and as we identify opportunities for capital optimisation. Under our new Managing Director, Peter Todd, we have begun delivering our three-year strategic Step Change Programme. This aims to enhance profitability by focusing on growth while improving operating efficiencies across the business. However, the benign local claims environment in 2010 is likely to see a softening in rates in 2011, which will put some pressure on underwriting margins.

While we will continue to maintain our focus on the broker market and look to grow our share of this channel through improved systems and service, 2011 will see a growing contribution from alternative channels. Besides the expected growth from iWYZE, we will increase our focus on niche businesses through alternative channels.

Following the successful buy-out of minorities in 2010, the business is well positioned to extract more value from full membership of the Old Mutual Group. Coupled with a strong balance sheet and a greater focus on building new distribution channels, this should see us grow revenue while improving our expense ratios.

US ASSET MANAGEMENT 

Trading as Old Mutual Asset Management (OMAM) and based in Boston, US Asset Management (USAM) is a global multi-boutique investment organisation serving institutional and individual investors around the world. Our 18 boutique firms specialise in active investment management, offering more than 160 investment strategies that span an array of asset classes and investment solutions.

Over 160 investment strategies across a wide array of categories
US Equities	Global & Non-US Equities		Fixed Income		Alternatives
·      Large, Mid, Small, Micro, ·      All-Cap ·      Growth, Value, Core ·      Fundamental, ·      Quantitative	·      Global, International, ·      Regional, Country ·      Specific ·      Large, Small, All-Cap ·      Developed, Emerging, ·      Frontier Markets		·      Long Duration, ·      Intermediate, Short-Term ·      Core, Core Plus, High ·      Yield ·      Stable Value ·      Liquidity Management, ·      Money Market ·      TIPS ·      Global, International, ·      Emerging Markets		·      130/30 ·      Long/Short Variable ·      Bias ·      Market Neutral ·      Absolute Return ·      Global Tactical Asset ·      Allocation ·      Portable Alpha ·      Hedge Fund Seeding ·      Hedge Fund Emerging ·      Managers ·      Options Overlay ·      Managed Futures ·      Volatility Management ·      Currency Management ·      Real Estate (Public, ·      Private, Global) ·      Timber
Full offering of investment vehicles
·      Mutual Funds ·      Separate Accounts		·      Commingled Funds ·      Collective Trusts		·      Hedge Funds ·      Fund of Hedge Funds
Designed to meet investor needs
·      High Net Worth ·      Individual Investors ·      Sub-Advisory		·      Plan Sponsors (Private& Public) ·      Endowments & Foundations ·      Corporations		·      Defined Benefit ·      Defined Contribution ·      Taft-Hartley

Markets and strategy overview

The investment environment in 2010 was characterised by a continued rebound in equity markets globally, although investors remained cautious in the wake of the global financial crisis. As a result, fixed income and alternative strategies remained in high demand among both individual and institutional investors while equity strategies (excluding emerging markets) broadly experienced outflows.

Profits up 4% on higher average FUM, improving investment performance as markets began returning to fundamentals

Highlights ($m, unless otherwise stated)	2010	2009	% Change
Adjusted operating profit (IFRS basis, pre-tax)	135	130	4%
Return on Capital	4.2%	4.1%
Operating margin	18%	18%
Net client cash flows ($bn)	(18.0)	(7.1)	(254%)
Funds under management ($bn)	259	261	(1%)
Adjusted operating profit (IFRS basis, pre-tax) (£m)	87	83	5%

USAM seeks to become the leading multi-boutique investment organisation globally, with several sources of competitive advantage:

  A proven model for multi-boutique management. Over the past 10 years, USAM has demonstrated the ability to manage and develop a diverse portfolio of investment firms successfully. Our boutiques enjoy investment autonomy and equity incentives that attract and retain talented investors and promote business continuity. We enhance our boutiques' growth and profitability through central services, including distribution, product development, capital support, strategic planning, risk management and a scaled shared services platform.

  Investment-focused and broadly diversified. As boutique investment managers singularly focused on asset management, our firms succeed when our clients succeed. Our boutiques invest with conviction and discipline, employing rigorous and consistent investment processes focused on delivering long-term results. Our firms serve institutional and individual investors around the world and benefit from the insights gained through a global client base.

  Well-positioned for profitable growth. Our boutiques offer sought-after traditional and alternative products with significant FUM capacity. Capital investments offer the potential to accelerate growth by funding acquisitions and lift-outs, seeding new products, and making operating investments. With access to the breadth and depth of a large international financial services company like Old Mutual, USAM is well-positioned to continue its expansion outside the US.

USAM represents an attractive business partner for talented investment managers. The business continues to invest in growth by expanding investment capabilities and growing its global client base through international distribution.

Review of results 2010

FUM across all affiliates totalled $259 billion, of which $217 billion (84%) was in long-term investment products and $42 billion (16%) was in short-term products. Long-term investment products were broadly diversified across equities ($127 billion, 49%), fixed income ($60 billion, 23%) and alternative investments ($29 billion, 11%). Short-term products comprised stable value funds ($41 billion, 16%) and cash ($1 billion, <1%).

USAM profits improved 4% over 2009 due primarily to higher average FUM, although year-end FUM were flat versus 2009. Gains from market appreciation and net inflows into fixed income products were offset by net outflows from equity, alternative and stable value products.

In February 2011, we announced the appointment of Peter Bain as USAM's new Chief Executive Officer. Peter has over two decades of experience in leading and advising asset management firms, and his appointment is a key milestone in the firm's growth plans.

Investment performance

Investment performance improved during the year across global equity, non-US equity and fixed income products. US equity strategies underperformed for the year as a whole, but showed improvement in the fourth quarter as the return to fundamentals began in US markets. Stable value products underperformed due to the impact of prior years' underperformance in current-year returns.

In aggregate, 51% of FUM across all strategies outperformed their respective benchmarks for the year, while 38% and 67% of FUM outperformed over three- and five-year time periods. This compared to 51%, 58% and 61% in 2009. Excluding short-term products, 60%, 45% and 60% of long-term assets outperformed over one-, three- and five-year periods. Management remains confident that its multi-boutique model, which encourages investment conviction and retention of investment talent, will deliver investment outperformance over full market cycles.

IFRS AOP results

IFRS adjusted operating profit increased 4% or $5 million to $135 million in 2010, benefiting from higher average FUM. Management fees were up $50 million or 8%, while other revenues were flat. Performance fees increased during the second half compared to the second half of 2009, reflecting recent improvements in investment performance.

Operating margin and cost management

Our operating margin of 18% was consistent with 2009, although we realised annual expense savings of $23 million through restructuring actions undertaken in 2009.

Total expenses were 8% or $46 million higher than 2009. The increase was driven by higher variable compensation, in line with revenue growth, one-time charges associated with acceleration of the DAC write-off given net client cash outflows in 2010, and equity plan implementations.

Net client cash flows

Net client cash outflows totalled $18.0 billion (2009: $7.1 billion) as net inflows into fixed income products were offset by outflows in equity, alternative and stable value products. Similar trends were observed in our US peer group. Net outflows were primarily driven by rebalancing-related withdrawals from continuing clients as both institutions and individuals continued to favour fixed income over equity investments during the year. The bulk of the net outflows was concentrated in three affiliates and was weighted towards the second half, traditionally a peak period for mandate changes. Gross inflows from new accounts exceeded $10 billion as all 18 USAM affiliates won new business during the year, with fixed income and international equity products attracting the bulk of new investment.

Funds under management

FUM were $259 billion at the year-end (2009: $261 billion). The USAM business is broadly diversified, with, for example, international and global equity products accounting for 22% of the FUM. Non-US clients accounted for 29% of FUM. The addition of Echo Point Investment Management in October 2010 brought $1.6 billion in FUM, while the sale of Thomson Horstmann & Bryant reduced FUM by $1.7 billion. The restructuring of the discontinued US Life business portfolio resulted in the transfer of $5.4 billion of FUM from USAM during the year.

Affiliate developments

Echo Point Investment Management began operation as a USAM affiliate on 1 October 2010, launching with $1.6 billion in FUM in international growth equities. During the fourth quarter the firm received additional investment commitments from two current clients as it demonstrated its ability to operate effectively in a multi-boutique structure.

Product and distribution developments

Barrow, Hanley, Mewhinney & Strauss surpassed $1.9 billion FUM in its international value product as investors bought into this non-US equity application of the firm's proven expertise in value investing. The firm also launched a global equity product in the fourth quarter, and with a mandate from Old Mutual's South African business, the product now has $1.0 billion in FUM.

USAM boutique investment managers

Affiliate	Established	Investment style	Funds under management 31 December 2010
300 North Capital	1951	Fundamental US growth manager	$0.5bn
2100 Xenon	2005	Quantitative commodity trading adviser of managed futures portfolios	$0.2bn
Acadian	1986	Quantitative US, global & international equity manager	$49.0bn
Analytic Investors	1970	Quantitative equity & fixed income manager	$6.3bn
Ashfield Capital Partners	1973	Fundamental US growth manager	$4.0bn
Barrow, Hanley, Mewhinney & Strauss Inc	1979	Fundamental US global & international value equity & US fixed income manager	$60.3bn
The Campbell Group	1981	Second-largest timber investment management company in the US	$5.7bn
Copper Rock Capital Partners	2005	Fundamental US small/SMID growth & global equity manager	$1.7bn
Dwight Asset Management Company	1983	US fixed income manager	$47.3bn
Echo Point Investment Management	2010	Fundamental international growth equity manager	$1.6bn
Heitman	1966	Public and private real estate, real estate debt manager	$16.9bn
ICM	1972	Fundamental US value equity manager	$2.4bn
Larch Lane Advisors LLC	1999	Multi-strategy fund of hedge funds manager & hedge fund seeding specialist	$1.5bn
Lincluden	1982	Fundamental global value equity and fixed income manager	$2.9bn
OMCAP Investors	2009	Fundamental concentrated US equity manager	$0.7bn
Old Mutual Asset Managers	1986	Fundamental & quantitative global and fixed income manager	$7.1bn
Rogge	1981	Fundamental global fixed income manager	$42.8bn
Thomson, Siegel & Walmsley	1969	Fundamental US/international value equity & fixed income manager	$8.0bn

Larch Lane Advisors launched the Alpha Evolution Fund, a fund of hedge funds that leverages the firm's expertise in early-stage hedge funds by identifying and investing in smaller and/or newer funds. Target investors for Alpha Evolution are primarily institutions that are unable to commit to a long lock-up of their capital because of liquidity guidelines, but want the potential benefits of an investment in early-stage hedge funds.

USAM affiliates launched several new UCITS vehicles in 2010 to tap global investors' growing preference for registered pooled vehicles. Rogge Global Partners (Global High Yield), Acadian Asset Management (Emerging Market Equities) and Heitman (Global REIT) each introduced new UCITS products that expand the global marketability of their respective investment capabilities.

Our global distribution continued to expand, with the addition of new staff and the opening of an office in the Middle East. We continue to focus our US retail distribution efforts on professional buyer channels that value the institutional orientation of USAM affiliates.

Outlook

During the recent period of market dislocation, investors and their advisers increased their focus on macro investment performance rather than investing on a fundamentals basis. Many USAM affiliates found it challenging to deliver superior performance in these conditions, and this contributed to net client cash outflows. However, 2010 saw the beginning of a return to fundamentals-based investing and our investment performance improved as a result. If US markets maintain this trend in 2011, we are well positioned to achieve further improvements in investment performance and, over time, a reversal of net client cash outflows. In an environment where investors begin to increase their risk appetite and migrate towards equities, our extensive equity product portfolio is positioned to capture its share of growing flows. The growing attractiveness of non-US equity exposure in both investment allocation and equity management should favour the USAM business model and strategy.

Non-core and discontinued business operations

US Life

Life sales summary

APE sales at $143 million increased by 34% relative to the comparative period. Fixed indexed annuities, which represent more than half of the total APE, increased 30% in 2010 compared to 2009. The increase was driven by product revisions and competitive annuity rates. The sales levels are within the range set for the business and reflect the approach to managing capital within the business. Our top 10 annuity distribution partners who have represented an average of 60% of our total sales volume over the past five years grew sales collectively by 62% in 2010.

IFRS results

The IFRS pre-tax profit for the year for the US Life business was $50 million (2009: loss of $195 million), with financial performance benefiting from lower impairment losses and the reversal of prior impairments, partially offset by higher deferred policy acquisition costs amortisation as a result of higher gross profits.

Value of new business

The value of new business decreased by $66 million relative to the comparative period. The decrease in VNB was mainly due to the extended low yield environment and a lower assumed liquidity premium. The negative VNB position is largely the result of the MCEV basis used, where credit spreads in addition to the liquidity premium are not valued in the determination of MCEV, but shown as earnings when earned. Although we believe that the VNB is positive on an EEV basis, the negative figure on the MCEV basis quantifies the extent to which the business would rely on earning credit spreads in order to provide the guarantees underwritten. Management actions taken during the period included lowering commission rates and increasing bonus on certain products, which improved consumer value.

MCEV results

The 2010 operating MCEV earnings after tax of $72 million decreased significantly relative to the comparative period. This was mainly due to the 2009 expected returns being based off higher asset yields, higher credit spreads and a very depressed starting position. The persistency assumption changes of Universal Life insurance plans (UL) and Return of Premium term insurance plans (ROP) also contributed to the lower MCEV operating earnings. Operating experience variances were higher than 2009. Fixed Indexed Annuity (FIA) contributed most to the favourable result in 2010. The positive variance of FIA was primarily due to higher than expected surrenders of FIA contracts that are unprofitable on an MCEV basis, while in 2009, the positive impact from higher than expected surrenders were more than offset by the negative impact from lower than expected interest margins.

MCEV increased by $220 million over the year. In addition to the effects above, other significant movements affecting the closing MCEV were the variances related to the change in economic conditions, largely due to reduced risk-free rates and lower credit spreads, partially offset by the liquidity premium reducing from 100 bps to 75 bps.

Funds under management

Funds under management ended the year at $17.2 billion, up $0.5 billion from the opening position, primarily due to a $0.8 billion increase in the market value of the investment portfolio for the year and increased net investment income. Net client cash flows improved by 47% in 2010 compared to 2009 primarily due to lower surrender activity and higher sales in 2010. Net cash and short term holdings at 31 December 2010 were $630 million.

Investment portfolio

The net unrealised position on the fixed income security portfolio improved to a net gain of $309 million at 31 December 2010 ($497 million net unrealised loss at 31 December 2009 and $138 million net unrealised gain at 30 June 2010). Although the increase in Treasury yields during the fourth quarter of 2010 negatively affected the net unrealised position, as credit spreads were tighter overall on a year-on-year basis, the unrealised position improved compared to the prior year. In addition, management undertook selective de-risking of the investment portfolio. As at 31 December 2010, $546 million of the total $551 million of the specified securities in the stock purchase agreement with Harbinger Capital Partners had been sold at terms better than those expected on signing of the sale agreement. The remaining $5 million of specified securities have been sold since the year end.

The quality of the investment portfolio improved throughout the year and 92% of the total portfolio had a market-to-book value ratio greater than 90% at the end of 2010. The market to book value ratio of the fixed income portfolio improved from 97% at the beginning of the year to 102% at 31 December 2010.

There were no defaults in 2010. Net realised gains in 2010 of $19 million include $22 million of trading gains on previously impaired securities that had recovered in fair value and $70 million of losses realised on the sale of securities in anticipation of the sale of the company. US Life also generated $64 million of net gains on de-risking trades during favourable market conditions. Expected cash flows on certain previously impaired structured securities improved significantly in 2010, resulting in $54 million of revaluation gains. These revaluation gains were partially offset by impairments.

During 2010, IFRS impairments were $50 million, generally in line with our long-term assumption of $48 million, and compared to $389 million in 2009. The 2010 impairments on 42 securities related primarily to structured securities, with the losses due to adverse changes in expected cash flows, or the likelihood of diminished loss coverage from distressed monoline insurers that guaranteed the performance of the security. The impairment losses were primarily in RMBS ($30 million), ABS ($8 million), and CMBS ($6 million).

Capital

OM Financial Life's risk-based capital ratio increased from 312% as at 31 December 2009 to 350% as at 31 December 2010. Regulatory capital grew $83 million during 2010 driven by strong statutory operating earnings. OM Financial Life's required capital decreased (at the targeted 300% level) primarily due to a lower risk investment portfolio offset by capital required for new business growth. The US Life Group distributed a total of $109 million to Old Mutual plc in 2010 comprising of $59 million from OM Financial Life Insurance Company and $50 million from OM Re.

Bermuda

As disclosed in our Preliminary Results in March 2010, Bermuda remains a non-core business, and as such its profits are therefore excluded from the Group's IFRS adjusted operating profit. A review of the operating performance of Bermuda is set out below:

Overview

The business continued to perform well against its strategy with significant enhancements delivered in 2010 including business service improvements, further enhancements to liability management and to management information to improve the dynamic management of exposures and further de-risk the Guaranteed Minimum Accumulation Benefits (GMABs) attached to certain of the in-force variable annuities.

Surrender activity in 2010 occurred largely in respect of variable annuity contracts without GMABs, with the business instituting a focused conservation strategy supported by high customer interaction in order to retain as much of this profitable business as possible. Surrender behaviour with respect to variable annuity contracts with GMABs is directly influenced by the differential between the value of the underlying funds and the nominal level of the guarantee, as well as the financial circumstances of the policyholder. The recovery across global equity markets, particularly in the fourth-quarter in 2010, resulted in an increase in the number of contracts where the underlying fund values were greater than the level of the guarantee. This resulted in a sharp increase in the levels of contracts with GMABs surrendering in the fourth quarter of 2010, with overall surrender activity across GMAB contracts for the year at close to double 2009 levels (2010: 1,211 policies; 2009: 638 policies). Further gains across global equity markets in 2011 would be expected to result in increased levels of surrenders across variable annuity contracts with GMABs, accelerating the run-off of these contracts. Ultimately, surrender activity will determine the speed of the run-off and the extent and timing of any associated capital, or cash release for this business. In February 2011, the business launched an offer to account holders with non-Hong Kong UGO contracts permitting them to surrender their contracts without incurring penalties. The special offer increased the rate and number of surrenders across this book, further de-risking the business. The take-up rate was 6.2% at 4 March 2011. Management will continue to assess demand for similar such offers in the future.

IFRS Results

The IFRS pre-tax profit for the year for the Bermuda business was $34 million (2009: $34 million), with financial performance benefiting from lower guarantee losses as a result of the improved effectiveness of the hedging programme, improved basis risk management, favourable equity markets and currency movements. The impact of the dynamic hedging programme over the course of 2010 was also beneficial in reducing losses in respect of GMABs and favourable equity markets over the course of the year further resulted in lower GMAB reserve requirements at the end of the year.

MCEV results

The 2010 operating MCEV earnings resulted in a loss after tax of $36 million, a marginal decrease relative to the comparative period. Operating earnings include negative corrections and modelling changes in 2010 compared to significant positive corrections and modelling changes in 2009. This is however partially offset by much improved persistency experience variances in 2010 and large negative persistency assumption changes in 2009 that were not repeated.

In addition to the effects above, other significant movements affecting the closing MCEV related to the movement in GMAB reserve requirements due to market performance and changes in economic conditions, net of the effects of hedging guarantees. Performance benefited from favourable equity and currency markets, with improved basis risk management and effectiveness of the hedging programme. This was dampened by reductions in interest rates as hedges were lifted early on in the year.

Reserves

Of total insurance liabilities of $6,106 million (2009: $6,741 million), $4,495 million (2009: $4,688 million) is held in the separate account, relating to variable annuity investments where all risk is borne by policyholders. The remaining reserves amount to $1,611 million (2009: $2,053 million), which is split into $672 million (2009: $766 million) in respect of GMAB / GMDB liabilities on the variable annuity business, and $939 million (2009: $1,290 million) in respect of policyholder liabilities which are supported by the fixed income portfolio (these liabilities include deferred and fixed indexed annuity business as well as variable annuity fixed interest investments). Non-separate account reserves are calculated on a policy-by-policy basis, updated frequently and verified independently.

GMAB / GMDB reserve calculations rely on the mapping of policyholder investment funds to hedgeable indices to determine market-consistent assumptions. Fund mapping updates are performed at least quarterly, the results of which better allocate exposures to Asian and other emerging markets (which require higher levels of reserving given their higher inherent volatility) thereby improving the accuracy of the reserve calculations. Overall, this market-consistent valuation methodology is guided by the fund mapping process. Throughout the year, the business continued to maintain a very significant statutory capital surplus against its minimum required capital of $250,000, ending the year with statutory surplus capital of $625 million (2009: $586 million).

Investment portfolio

No defaults or impairments were recorded during 2010 (2009: $20 million). The net unrealised position improved to a gain of $31 million as at 31 December 2010 ($29 million loss as at 31 December 2009) as a result of de-risking efforts within the portfolio through the sale of a number of holdings offsetting gains and losses and the narrowing of corporate spreads. The book value of the portfolio reduced from $1.0 billion at the end of 2009 to $0.8 billion as at 31 December 2010, largely as investments were sold to meet surrender activity and withdrawals. The fixed income portfolio remained at an average credit quality of A2 (Moody's rating scale), with investment grade quality holdings continuing to represent more than 90% of the portfolio. As at 31 December 2010, the book value of the investment portfolio with a market value to book value ratio of 80% or less was $3 million (compared to $71 million at 31 December 2009).

Management of hedging

Over the course of 2010, the business continued to dynamically manage the underlying economics of the hedging programme in order to strike a balance between the potential changes in the income statement, available cash, liquidity and transactional costs arising from movements in market levels. A number of adjustments to the hedging programme were made over the course of 2010 as a result of turbulent market conditions, with the business ending the year approximately 57% hedged against adverse equity and foreign exchange market movements. The accumulated unrealised profit or loss, as measured by the stop-loss metric from the time the current hedge framework was implemented on 17 September 2009 was a gain of $145 million by 31 December 2010 (2009: $104 million). The hedging team evaluates the hedging strategy, including the most appropriate level of hedges on a continuing basis, with any proposed changes to the strategy subject to strict oversight. The stop-loss protocol established in September 2009 remains in place, and continues to be monitored daily by Group to ensure that a common understanding of the resultant impact on capital, cash and profit and loss on a timely basis.

Outlook

Whilst turbulent market conditions could have a material impact, the business has performed credibly over the past year, with the key priorities for 2011 focused on continuing this momentum through continued efforts to de-risk the GMAB exposure in the variable annuity book, through a range of measures. These include execution against the stated dynamic hedging strategy to contain key risk exposures; continued implementation of the conservation strategy to better retain profitable non-guaranteed business, supported by enhanced customer and service offerings; ongoing prudent management of capital and liquidity; ongoing evaluation of risk management and key business decision-making processes across the business to align with Group's Enterprise Risk Management framework; and maintenance of cost discipline, with a focus on delivering further planned expense reductions.

 

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