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Summary basis of preparation Our business review has been prepared in line with section 234 ZZB of the Companies Act 1985, which reflects the European Union Accounts Modernisation Directive. To give our shareholders clear and helpful information, we have also considered the voluntary best practice principles of the Reporting statement: Operating and Financial Review (OFR) issued by the Accounting Standards Board (ASB).
The Group’s financial statements have been prepared in accordance with International Financial Reporting Standards (IFRS). However, our Board believes that non-GAAP measures, which we have used in the business review, together with other measures that are calculated in accordance with IFRS, are useful for both management and investors and make it easier to understand our Group’s performance.
All non-GAAP measures should be read together with the Group’s IFRS statutory income statement, balance sheet and cash flow statement which are presented in the Group’s financial statements in section 3.
To reflect this good performance, we are recommending payment of a final dividend of 7.7p per share, for the year to 31 December 2007, making a total of 11.5p per share for the year. This represents implied growth of 6.5%, consistent with the Group’s progressive dividend policy.
On 14 February 2008 we announced that we had reinsured more than half of our pre demutualisation UK immediate annuity portfolio to Canada Life International Re, a subsidiary of Great-West Lifeco. This amounts to £6.7bn of UK immediate annuity liabilities and significantly reduces the longevity risk exposure for our shareholders. The transaction will also have the effect of releasing capital and cash from reserves and reducing capital requirements. We also expect there to be a one off increase in embedded value operating profit before tax of at least £100m in 20081.
Leveraging our investment management expertise and performance Our investment management business, Standard Life Investments, generated a 19% increase in IFRS underlying profit before tax to £83m (2006: £70m). Worldwide third party net new business for our investment management business was up 23% to £7.9bn. Standard Life Investments’ total funds under management have increased by 9% to £143.4bn including a 24% increase in third party funds under management to £47.7bn. Our money weighted average investment performance was well above median for all time periods from 1 year to 10 years and remains in the top quartile over 3 and 5 years.
Last year we announced a Continuous Improvement Programme (CIP) to reduce underlying costs by a further £100m, net of growth, by the end of 2009. In the second half of 2007 we achieved savings of £27m, compared with a target of £15m. Through efficiency and productivity we said that we would achieve a reduction in the underlying headcount requirement to service our existing levels of business by around 1,000 by 2009. At 31 December 2007 Group headcount was 10,379, a reduction of 362 from 31 December 2006, despite the creation of 210 additional jobs from the investment in UK SIPP and Wrap.
2 The 2007 figures include mutual funds sales. The 2006 figures have been restated to reflect the inclusion of mutual funds. The 2007 impact is: PVNBP of £848m (APE of £92m). The 2006 impact is: PVNBP of £336m (APE of £34m).
The new business performance of our UK financial services division reflects strong growth in the first half of the year, followed by resilient performance in the face of difficult market conditions in the second half.
UK life and pensions sales increased by 17% to £13,324m. This increase represented a strong sales performance across a broad range of products, coupled with strength in service and functionality. A 34% increase in Group pensions sales (including Retail Ttrustee Iinvestment Pplan) was driven by strong levels of new and incremental business. Individual SIPP sales increased by 24%. We continue to innovate in our SIPP proposition, with developments such as a high-yielding cash account and the introduction of on-line servicing, the launch of the GARS (Global Absolute Return Strategy) fund link, accepting protected rights and the expected launch of a variable annuity offering for the post retirement market. Savings and investments sales also increased by 38% and sales of Offshore bonds were over seven times the level of the previous year and benefited from the launch of our Retail portfolio bond and our distribution agreement with Fidelity. A marginal fall in Investment bond sales was due to weakness in the global financial markets and uncertainty regarding proposed capital gains tax (CGT) changes. We await clarity on the CGT proposal. Any sales impact will be monitored and appropriate action taken where necessary.
In a competitive environment and difficult market conditions our banking business successfully maintained a high quality mortgage portfolio and increased gross lending to £3.7bn (2006: £3.0bn). Our healthcare sales rose by 10% to £22m (2006: £20m) despite an increasingly competitive market place.
Sales in Canada fell by 19% in constant currency to £1,654m PVNBP (2006: £2,091m). The decrease was caused by a number of large transactions boosting sales volumes in 2006, a continuing focus on margin over volume and the realignment of our distribution capability. The ongoing rebuilding of our retail sales force and sales already secured has provided a more positive start to 2008.
1.2 New business sales and profitability continued In Europe, PVNBP sales increased by 35% in constant currency to £1,179m (2006: £866m) reflecting increased popularity of our new products and strengthened distribution. The self investment options in Ireland, inspired by the UK SIPP platform, demonstrate our commitment to drive profit and exploit synergies through joint development across our business.
Continued investment outperformance drove further mandate wins at our investment management business, with third party net new business of £7.9bn (2006: £6.4bn). We have continued to perform well despite volatility in global financial markets in the second half of the year. Despite these challenges third party funds under management increased to £47.7bn (2006: £38.5bn) and total funds under management increased to £143.4bn (2006: £132.1bn). Strong third party inflows, driven by institutional funds, are expected to sustain continued growth in third party funds under management in 2008.
In Canada, NBC increased by 38% in constant currency to £37m (2006: £28m). This was mainly due to the repricing of certain life products and our shift in focus to higher margin products.
In Europe, NBC increased by 155% in constant currency to £26m (2006: £10m). The increase is a result of higher sales volumes and margins that have been enhanced by efficiency savings and new product launches.
Against volatile market conditions operating profit before tax increased by 43% to £881m (2006: £614m). Total profit before tax fell 18% to £838m (2006: £1,022m) as a result of the reduction in non-operating profits which are mainly market driven and occur as a result of investment performance being different from that anticipated in the opening EEV. Further details on operating profit and non-operating profit are given below.
Further details on the movements in operating profit by source are provided below along with a segmental analysis.
Core The 44% increase in the core element of our operating profit is mainly driven by an increase in new business contribution (NBC) of over 68% from £205m in 2006 to £345m in 2007, a turnaround in the profitability of our core non-covered business from a loss of £2m to a profit of £51m and a £45m increase in expected return on in-force business. The growth in NBC is covered in detail in section 1.2 new business sales and profitability while the increase in non-covered business is analysed in the segmental analysis of EEV operating profit. The improvement in expected return is largely attributed to the receipt of a full year’s interest income on the IPO proceeds in 2007 compared to half a year’s interest income in 2006.
Efficiency We have demonstrated continued progress in respect of our covered business maintenance costs, with efficiency benefits of over £100m, primarily arising from the UK and Canada. These gains reflect our continued focus on cost control and have contributed towards the achievement of our 2007 expense targets.
1 Core includes new business contribution, expected return and development costs for covered business excluding those development costs directly related to back book management initiatives, and for non-covered business, IFRS underlying profit excluding specific costs attributable to back book management.
2 Efficiency includes covered business maintenance expense variances and assumption changes. 3 Back book management includes all non-expense related operating variances and assumption changes for covered business plus those development costs directly related to back book management initiatives and, for non-covered business, specific costs attributed to back book management.
1.3 EEV – Group continued Back book management To complement the growth in the value of the Group through the core and efficiency elements, we are focused on reducing risks to shareholder profits that are expected to emerge from the back book. This element illustrates the impact of changes in insurance experience and assumptions, along with the results of our efforts to actively manage the value of the in-force business.
The two major insurance risks to which shareholders are exposed are lapses and mortality. Lapse variances and assumption changes have resulted in a charge of £249m in 2007 (2006: £266m), primarily arising in the UK. This includes significant strengthening of long-term lapse assumptions plus a further allowance for expected adverse experience on UK unit linked bonds where, general market volatility, the downturn in the UK commercial property market and the current uncertainty over proposed changes to capital gains tax (CGT) have led to increased lapse rates.
Mortality variances and assumption changes resulted in a charge of £95m in 2007 (2006: profit £92m), primarily from strengthened annuitant mortality assumptions in the UK and Canada. The reinsurance of £6.7bn of pre demutualisation UK annuity reserves, announced on 14 February 2008, represents a significant step in reducing the shareholders’ exposure to annuitant mortality risk. The benefits of this re insurance will be shown in our 2008 results.
The strengthening of our lapse and mortality assumptions plus the subsequent annuity reinsurance reduces the risk of future adverse variances. More detail on the UK provisions and in particular the lapse position is provided in the supplementary EEV financial statements in section 2.
Return on embedded value RoEV was 11.5% in 2007 compared to 8.9% in 2006 (after adjusting for the IPO proceeds and post tax notional interest of £21m thereon). The core area of the business contributed 2.1% of the total 2.6% increase in RoEV, driven in particular from a 1.7% increase from NBC. Efficiency and back book management recorded increases of 0.3% and 0.2% respectively, reflecting our focus on reducing risk and actively managing the value of the in-force business.
Volatility arising on different asset and liability valuation bases reflects the economic hedge loss in our banking business of £39m (2006: gain £48m).
Profit after tax Profit after tax fell from £748m in 2006 to £587m in 2007.
Group embedded value Our Group embedded value increased by £603m or 11% in 2007. Before taking into account dividends paid to shareholders, the increase was £800m, of which £600m was from capital and cash generation. Our capital and cash generation from the core elements rose £213m to £334m, mainly due to improvements in new business strain and expected return. Back book management was the other main contributor to our capital and cash generation with a return of £209m, £137m higher than 2006. Efficiency profits and non-operating items also made small positive contributions to capital and cash generation. This is discussed in more detail in section 1.5 capital and cash generation. The net worth of our Group has increased from £2,391m to £2,884m and the present value of the in-force business (PVIF) rose from £3,217m to £3,327m, reflecting our growth.
Operating profit before tax 881 614 1 Heritage With Profits Fund TVOG. 2 Excluding the profits made on life and pensions business. 3 The investment management result for both periods includes the profits of other general insurance operations managed by our investment management business. In previous periods all general insurance was included in healthcare and general insurance.
UK covered business operating profit rose by £234m to £606m. The core elements produced operating profit of £583m compared to £410m in 2006, an increase of 42%. This was mainly attributable to a £115m increase in NBC, a £54m increase in expected return and a £4m reduction in development costs. Efficiency gains contributed £77m compared to £28m in 2006. Back book management operating losses were £54m compared to £66m in 2006. In 2007 the back book management losses were largely attributed to the negative impact of lapses of £277m and mortality and morbidity charges of £47m partially offset by the positive impact of deferred annuities of £191m. Further comments on the components of UK operating profit, including the current trends in lapses, are provided in section 1.6 business segment performance.
Operating profit in Canada increased by £15m to £178m in 2007. Core elements accounted for £126m compared to £118m in 2006, an increase of 7%. This increase was driven by a £9m increase in NBC, a £1m increase in expected return offset by a £2m increase in development expenses. Efficiency gains were £25m compared to £53m in 2006. Back book management operating profit was £27m compared to a loss of £8m in 2006. The positive return in 2007 is largely attributable to tax variances and positive lapse assumptions partially offset by higher mortality and morbidity charges.
In Europe, operating profit fell by £19m to £26m (2006: £45m), despite an increase in the core profit of £11m to £43m, which was mainly attributable to a £16m increase in NBC. Efficiency gains were £7m compared to £14m in 2006 and the back book management operating loss was £24m, mainly arising from lapse assumption changes in Ireland, compared to a loss of £1m in 2006.
Losses in relation to ‘Other’ were in respect of the rapid expansion of the Asia Pacific business.
There was £42m (2006: £44m) of HWPF TVOG back book management operating profit in 2007 due to interest rate hedging for HWPF annuities, refinements to the interaction of dynamic management actions across the UK and German business, and the modelling of the distribution of the HWPF residual estate to with profits policyholders.
1.3 EEV – Group continued The operating profits from our non-life and pensions entities were £41m (2006: loss £2m). This increase in profits was mainly attributable to the reduction in Group Corporate Centre (GCC) costs, which fell from £89m to £57m, a full year’s investment income on assets held in the Group’s holding company, Standard Life plc, compared to half a year’s income in 2006, partially offset by £10m in respect of a provision for a guarantee, and increased profits from our investment management and healthcare businesses. These increases were partially offset by higher losses in Standard Life Savings Limited, our mutual funds and Wrap business which rose from £20m to £25m, after 2007 losses being reduced by the transfer out of £25m of certain mutual fund losses to UK covered business.
Further comments on the operating profits of each of the businesses noted above are provided in section 1.6 business segment performance.
The following table summarises the profits of our investment management operations: £m £m £m Life and pensions look through profits 35 28 7 Third party related life and pensions profits (13) (3) (10) Life and pensions profits excluding third party related profit 22 25 (3)
IFRS underlying profit before tax1 £714m £540m 32% IFRS profit after tax1 £576m £579m (1%) Diluted IFRS underlying EPS1 33.3p 21.8p 53% Dividend cover2 2.9 times 2.2 times 32%
1 2006 results are shown on a pro forma basis. 2 Dividend cover for 2006 is calculated as IFRS underlying profit after tax and minority interest for the period post demutualisation from 10 July 2006 to 31 December 2006 divided by the dividend paid in respect of this period.
IFRS profit after tax Profit after tax decreased by £3m to £576m in 2007. This small decrease included a 32% increase in underlying profit offset by a number of volatile items not included within the underlying profit. These comprised the impact of new accounting guidelines in Canada which reduced profit by £144m and volatility arising from different IFRS measurement bases for assets and liabilities which reduced profit by another £158m. There was also an offsetting £17m one off gain from the part disposal of our investment in HDFC Asset Management Limited (HDFC AM) to our Indian joint venture partner. The increase in the underlying profit before tax is explained in more detail below.
Underlying profit in 2007 includes a one off positive adjustment for PS06/14. This resulted in a significant one off release of reserves of £136m in UK life and pensions and £2m in Ireland. There was an additional £143m one off release of reserves in the UK in relation to the deferred annuity business. Mortality assumptions in the UK and Canada were strengthened by an additional £100m and £37m respectively and took into account lighter mortality experience. However these were partially offset by other assumption and modelling changes of £94m in the UK.
Adoption of PS06/14 138 Reserving change on deferred annuities 143 Other assumption/ modelling changes 94
2 Basic EPS is based on 2,138m shares (2006: 2,102m shares) and underlying profit after tax attributable to equity holders of Standard Life plc of £725m (2006: £474m).
Underlying profit before tax rose by 32% to £714m. Total life and pensions underlying profit before tax increased by 24% to £614m. Non-life operations generated a profit of £128m, an increase of 7%. There was a £32m reduction in Group Corporate Centre (GCC) costs, which meant that we achieved our target of reducing GCC costs to pre demutualisation levels. There was also an increase of £17m of other income, mainly relating to Standard Life plc, the Group’s holding company.
Non-life business Profits from our non-life businesses rose by 7% to £128m (2006: £120m). The increase was due to the strong results reported by our investment management business. This reflected strong inflows into third party funds, tight management of costs and continued strong investment performance, despite the volatile market conditions. Our banking business experienced a decline in profits due to the market pressures on net interest margin.
Please see section 1.6 business segment performance for further detail on the IFRS underlying result for our business units.
IFRS equity attributable to equity holders of Standard Life plc £3,282m £2,878m 14%
2007 Pro forma 2006 Required Net Required Adjusted Free surplus capital worth Free surplus capital net worth movement movement movement movement movement movement £m £m £m £m £m £m
Capital and cash generation from existing business 561 (12) 549 451 (15) 436 Operating capital and cash generation from new business and expected return 289 35 324 116 17 133 Capital and cash generation from variances, development costs and assumption changes 294 (1) 293 63 48 111 Total covered business capital and cash movements 583 34 617 179 65 244 Total non-covered business capital and cash movements (17) 18 Total covered and non-covered business capital and cash movements 600 262
All figures are net of tax. Net (expenses)/income directly recognised in the EEV balance sheet, including exchange differences and distributions to and injections from shareholders are not included as these are not trading related cash flows.
The analysis above highlights the most significant influences on free surplus and shareholders’ net worth, including investment of shareholder capital in new business (new business strain) and the amount of capital and cash emerging from existing business. Our operating capital and cash flows from new business and expected return have increased to £324m (2006: £133m) reflecting strong capital and cash flows from in-force business and improvements in new business strain (NBS). Despite the increase in new business we achieved a reduction in NBS. This means that we are more efficient at using the capital and cash generated by the business, which allows for further investment in the business and payment of dividends to our shareholders. In overall terms, our covered and non-covered capital and cash movements have increased from £262m to £600m in 2007.
* New business strain margin for 2005 and 2006 and the PVNBP sales for 2005 have not been restated to include mutual funds sales as covered business.
1.5 Capital and cash generation continued We also analyse capital and cash generated in the three components which reflect the focus of our business effort – core, efficiency and back book management. This analysis shows that there was positive capital and cash generation from all of our key areas of focus as well as from the non-operating items. Core and back book management were the main contributors to our impressive capital and cash generation in 2007. The core capital and cash flows of £334m reflect the lower NBS compared to the expected in-force capital and cash flows, whilst the back book management capital and cash flows of £209m include the one off impact of significant reserve releases from both the UK deferred annuities review and our adoption of PS06/14.
Dividends Our dividend policy is to pay a progressive dividend. During the year, the Group paid the final dividend for 2006 of 5.4p per share, amounting to £114m, and the 2007 interim dividend of 3.8p per share, amounting to £83m. We have proposed a final dividend of 7.7p per share, approximately £167m in total, to be paid in May 2008. Dividends in relation to the 2007 financial year including the interim would therefore be 11.5p per share or £250m in total. Dividend cover for 2007 of 2.9 times compares to 2.2 times for our first dividend paid in May 2007 in respect of our performance after demutualisation from the period 10 July 2006 to 31 December 2006. Dividend cover is calculated as IFRS underlying profit after tax and minority interest divided by the current year interim dividend plus the proposed final dividend.
Capital management Objectives and measures of Group capital The process of capital and risk management is aligned within the Group to support the strategic objective of driving sustainable, high quality returns for shareholders. The different measures of capital reflect the regulatory environment in which we operate and the bases that we consider effective for the management of the business.
IFRS equity attributable • to equity holders of Standard Life plc: 2007: £3.3bn (2006: £2.9bn) IFRS dividend cover: • 2007: 2.9 times (2006: 2.2 times)
Group EEV capital and • cash generation: 2007: £600m (2006: £262m) EEV new business strain: • 2007: £225m (2006: £303m) EEV total equity*: • 2007: £6.2bn (2006: £5.6bn)
The significant factors affecting the FGD position during 2007 were: ongoing investment of shareholder capital in the business through writing new business;•
The disposition of capital across the Group, including all of the capital resources of the long-term business funds is shown in Note 3.12 Capital statement in the IFRS financial statements.
Individual Capital Assessment The Group’s UK based insurance companies determine ICA in accordance with appropriate regulations and guidance. Both SLAL (and its regulated subsidiary companies) and Standard Life Healthcare operate with relevant capital comfortably in excess of self assessed capital requirements and any ICA guidance that may have been issued by the FSA.
Capital management policy Our capital management policy applies throughout the Group and it states that matters related to management of the Group’s capital are reserved for the Board of Standard Life plc. This policy provides a framework for the effective and consistent management of capital. The scope of the capital management policy is wide ranging, and consists of five key elements.
The capital management policy forms one pillar of the Group’s overall management framework. It operates alongside and complements the Group’s other policies and processes, in particular its risk policies and strategic planning process.
The Group continues to develop its Enterprise Risk Management (ERM) Framework to link robustly the processes of capital allocation, value creation and risk management.
The Group uses subordinated debt to provide capital to our life assurance and banking businesses•
Further analysis of the Group borrowings is provided in the financial statements in Note 3.9 Borrowings •
Note 3.12 Capital statement in the financial statements shows the external subordinated debt and internal loans made across life • and other operations
In 2007 the financial sector in particular was impacted by the liquidity crunch in the second half of the year. The Group has robust plans in place to ensure that it has access to sufficient liquidity to meet operating requirements during the current market uncertainty.
Credit ratings External credit ratings agencies perform independent assessments of the financial strength of companies. The current insurer financial strength ratings for SLAL are A1/Stable and A/Stable from Moody’s and Standard and Poor’s respectively. The ratings are unchanged from the position at 31 December 2006.
2 The PVNBP new business sales are different from those previously published in the full year new business press release issued on 30 January 2008 as they incorporate year end non-economic assumption changes.
3 2006 results are shown on a pro forma basis. 4 PVNBP margins are NBC divided by PVNBP expressed as a percentage based on the underlying unrounded numbers. 5 Includes Heritage With Profits Fund (HWPF) time value of options and guarantees (TVOG). 6 Includes UK pension scheme cost and Standard Life Savings Limited (SLS).
Annuities £2,672m £1,937m £494m £438m Protection £24m £42m *Includes Retail trustee investment plan
New business profitability Throughout 2007 we continued to focus on profitable areas of the market where our brand and customer service give us sustainable competitive advantage. Total new business contribution (NBC) increased to £282m (2006: £167m) with a new business margin of 2.1% (2006: 1.5%). Overall the internal rate of return (IRR) increased significantly in 2007 to 20% from 13% in 2006. The new business profitability by product is analysed as follows: NBC on Individual pensions (SIPPs and increments on existing • policies) increased to £123m from £69m in 2006, with margin improving from 1.5% to 2.3%. The improvement in margin reflects greater expense efficiency, as the size of the SIPP book grows. The underlying IRR on Individual pensions increased from 15% in 2006 to 29%, and the discounted payback period reduced from 8 years to 5 years, reflecting the greater weighting towards more capital efficient SIPP business where commission is funded by the client.
NBC on Institutional pensions grew from £2m to £17m due to improved modelling of the margins including looking through to the • margins earned by our investment management business on these products. As the capital requirements of this business are small, the IRR is very high at over 40% and the payback period is very short at less than 3 years.
Savings and investment• s comprises Onshore and Offshore bonds. In addition mutual funds sold via Wrap and Fundzone have been included in covered business for EEV purposes for the first time. Total NBC was £34m up from £31m in 2006 with a decreased margin of 1.3% (2006: 1.6%). The underlying margin on Onshore bonds reduced due to increased withdrawal assumptions while the margin on Offshore bonds improved as volumes grew, driving expense efficiencies. Overall the IRR on Savings and investments was 11% in 2006 and 2007, with a payback period of 12 years.
Performance Net flows Net flows for 2007 were positive at £2.5bn (2006: £3.2bn). Net outflows for our Savings and investments portfolio were £0.2bn (2006: £0.4bn) which is due to the downward trend in traditional life with profits products. We maintain an approach of active communication with our customers about the benefits of their with profits policies. Following our with profits bonus announcement on 31 July 2007 we started to distribute the residual estate of the HWPF.
Savings and investments £69m £123m £60m £29m £17m £2m £34m £31m
Wrap and Fundzone As at 31 December 2007, we had 8,100 Wrap customers compared to 900 at 31 December 2006 and the number of IFA firms using the platform had grown to 209 compared to 88 at 31 December 2006. With total funds on the platform breaking through £1.0bn compared to £0.2bn as at 31 December 2006 we expect further momentum in Wrap and Fundzone through 2008 and beyond.
EEV operating profit before tax UK operating profit including HWPF TVOG increased by 58% in 2007 to £624m (2006: £395m). Core elements were the main driver, contributing £559m in 2007.
In 2007, development costs for covered and non-covered business were £14m, compared to £16m in 2006. This represents investment in pensions, bonds and Wrap, including technology enhancements to SIPP and the introduction of SIPP regulations.
During 2007, we made major advances in driving value and reducing risk in our existing business. This has a positive impact on profit from back book management, which includes the effect of lapse variances and long-term lapse assumption changes, mortality variances and assumption changes.
We strengthened our mortality assumptions for annuitants and took into account lighter mortality experience for protection • business. This led to an overall decrease of £47m in EEV operating profit. On 14 February 2008 we announced that we had successfully reinsured a significant part of our pre demutualisation annuity portfolio amounting to £6.7bn of reserves at year end 2007. This will reduce shareholder exposure to longevity risk but the benefits have not been recognised in the 2007 results.
During 2007 we undertook a range of initiatives aimed at improving the efficiency of the balance sheet. This included applying • PS06/14 and a review of the underlying data and calculation methodology for group deferred annuity business. This business largely comprises bulk buy-out annuity business and group deferred annuity contracts arising from discontinued final salary schemes. Following our review we released £143m of statutory reserves, which directly benefited net worth, and generated an increase in the present value of in-force (PVIF), net of the effect of the cost of required capital, of £48m.
IFRS underlying profit before tax The IFRS underlying profit is made up of profit from existing business and the profits/losses on new business written in the year. The profit on existing business is principally determined by the Recourse Cash Flow (RCF). This is the amount which can be transferred from the HWPF to the Shareholder Fund in respect of business written before demutualisation. The IFRS underlying profit also comprises a growing component in respect of profits on business written post demutualisation.
Retail savings balances increased by 10% to £4.6bn (2006: £4.2bn) with SIPP and Wrap cash balances growing to £630m (2006: £263m). Our savings business benefited due to competitive product offerings during the second half of 2007.
We continue to maintain a high quality mortgage portfolio, with only 0.18% of total mortgages three or more months in arrears at the end of December 2007, compared with the Council of Mortgage Lenders industry average of 1.20%. This leaves us well positioned for any downturn in the market which may occur in the future.
New business sales £22m £20m 10% IFRS underlying profit before tax* £13m £12m 8% Return on equity after tax* 8% 12% (4% points) Claims ratio 70.8% 68.3% (2.5% points)
New business In a competitive market, overall new business increased by 10% to £22m (2006: £20m) whilst maintaining our strategy of writing only profitable business. The increase reflected improved performance by our direct marketing channel which resulted in a 21% increase in individual new business. Full year group sales grew by 2% compared to 2006 as we continued to focus on profitable segments of the Small and Medium Enterprise (SME) segment of the market.
Performance IFRS underlying profit before tax was £13m (2006: £12m), before taking into account one off costs relating to integration of the PMI business acquired from FirstAssist in 2006, and project costs associated with the new system development. The 2006 underlying profit included a £4m surplus on the prior year claims reserves. Excluding this surplus, the 2007 underlying profit increased by £5m. This was principally due to an improved performance and full year contribution from the acquired business together with an increase in investment income as a result of higher interest rates. Claims experience was in line with expectations. RoE for the year was 8% (2006: 12%). The 2006 RoE was benefited by the absorption of the First Assist business, however we are on track to achieve our target RoE of 15% in 2008.
UK financial services – Customers We are committed to creating exceptional customer experiences through our service strategies. By developing our people, building strong customer and adviser relationships, delivering transactional excellence and managing demand in an efficient way, we continue to deliver an award winning service.
Healthcare Best Customer Service Provider for the 7• th consecutive year from Health Insurance Awards; and
We have set our leadership aspirations and have development plans and programmes in place to help our leaders to achieve these aspirations.
We continue to engage with HM Treasury and the FSA on fiscal and regulatory developments to mitigate any adverse impact on our business or our customers.
With respect to our banking business, cost of funding and uncertainty in the housing market are expected to reduce consumer demand in the UK mortgage market. As a result, 2008 is expected to see continued margin pressure across the industry. We will continue to focus on tight cost management including more on-line transaction activity.
In July 2007, our healthcare business launched a new modular product for the SME segment made possible by the development and introduction of a new policy administration system, onto which we will migrate all of our existing customers during 2008. With this system now in place, we also plan to introduce in 2008 improved product propositions for individual and large customers, thereby growing new business and improving customer retention.
IFRS underlying profit before tax IFRS underlying profit before tax increased by 4% in constant currency to £168m (2006: £168m), excluding volatility relating to differing asset and liability valuation bases for non-linked business. Underlying profit was driven by improvements in new business profitability and continued expense reductions, which were largely offset by lower bond and equity returns in line with rising interest rates and the recent market volatility. Underlying profit also excluded the £144m impact of changes in Canadian regulations. The impact on local Canadian GAAP distributable profits was neutral. Further details explaining the impact of these changes on IFRS profit are disclosed in Note 3.8 of the IFRS financial statements.
Employees We are committed to being recognised as an employer of choice. Toward that objective, we continue to foster a culture that encourages our employees to achieve excellence. Our career programme allows employees to make the most of their strengths and build a personal path to career fulfilment. Our employees have embraced our values enthusiastically and our most recent employee engagement results reached unprecedented levels, with the latest score on our Gallup survey of 3.99 out of 5.
Looking ahead We expect market conditions to remain challenging in 2008. By rebuilding our retail sales force and expanding our distribution strategies we have the momentum needed for a positive start in 2008 and beyond. Through our new product launches and a significant visibility campaign we intend to increase significantly our visibility in the Canadian market place and re-start our growth.
New business PVNBP £1,179m £866m 36% New business APE £125m £97m 29% New business contribution1 £26m £10m 160% PVNBP margin1,2 2.2% 1.2% 1.0% point EEV operating profit before tax1 £26m £45m (42%) IFRS underlying profit before tax1 £63m £108m (42%)
New business PVNBP sales in Europe increased by 35% in constant currency to £1,179m (2006: £866m). PVNBP new business in Germany increased by 34% in constant currency to £722m (2006: £536m). Our strong performance in Germany was driven by the success of Maxxellence, our unit linked product launched in the fourth quarter of 2006. In addition, we improved our position in the employee benefit market, our products continued to be attractive to the German self-employed market segment and we enhanced ongoing initiatives to strengthen distribution. As a result, we have grown our German market share. In Ireland, new business increased by 38% in constant currency to £457m (2006: £330m) following the success of our new product range, including self investment options inspired by the UK SIPP platform, and our improved standing with financial advisers.
The new business margin for Europe increased to 2.2% (2006: 1.2%). This was due to increased cost efficiency and improved profitability of new products.
Performance EEV operating profit before tax EEV operating profit before tax reduced to £26m (2006: £45m). This was mainly due to a lapse assumption change in Ireland of £22m predominantly in relation to with profits products.
Customers and employees Like the rest of the Group, we remain committed to providing a world class level of customer service. With a focus on speed and quality of service, we continued to receive favourable feedback from our customers in 2007.
Looking ahead Markets look set to remain volatile throughout 2008. We expect the short-term growth rate across our European operations to slow from the levels seen in 2007 but anticipate that sales will be ahead of 2007.
Ireland was the second worst performing stock market in the world in 2007 and with the continued uncertainty in the property market, we have revised downwards our expected market growth in 2008. However, the demographics of the Irish life and pensions market are strong and medium term prospects are encouraging. With our market leading products and customer service proposition, we expect to continue to gain market share and grow the business.
New business PVNBP1,2 £266m £206m 48% New business APE2 £49m £29m 96% IFRS underlying loss before tax3 (£12m) (£9m) (33%)
Performance Asia Pacific IFRS underlying loss at £12m (2006: £9m) was higher than the prior year as we continued to invest in developing and expanding operations in this region. During the second half of 2007 Heng An SL received approval from the China Insurance Regulatory Commission to launch branches in Liaoning and Shandong provinces and to prepare for branches in Sichuan province. Heng An SL was the first life insurance company in China to launch a group pension plan product which attracts tax relief.
Customers and employees In common with the rest of the Group, all Asia Pacific operations are committed to maintaining the highest level of customer service. Each operation recognises the importance of its workforce, and consequently a considerable investment is made in ensuring ongoing development of its employees, particularly in relation to training.
Looking ahead We expect sales in India and China to keep growing in 2008 as our joint venture operations continue to expand. HDFC SL looks set to perform well, supported by strong market growth, new product launches and more developed distribution. Given the strong momentum, both Standard Life and HDFC are committed to a future IPO of a portion of HDFC SL. We intend to launch this before the end of 2009, subject to applicable regulations. In China, Heng An SL plans to work on introducing new products and developing existing and new distribution channels. It also aims to move into new provinces and anticipates being in 30 cities by the end of 2008 compared to 14 in 2007. Our Hong Kong business has grown well from a small base and we expect sales to improve as we develop our distribution channels and launch new products.
1.6 Business segment performance continued 1.6.5 Investment management Standard Life Investments delivered a record performance in 2007 by successfully pursuing its strategy of increasing third party assets. Standard Life Investments achieved strong sales of UK Equities, Bonds and Property through both Institutional and Retail channels. The business also continued to build its capabilities in Global property, Global equities and Absolute return strategies, which are key to its future growth strategy.
Third party funds under management £47.7bn £38.5bn 24% Total funds under management £143.4bn £132.1bn 9% Third party gross new business £11.3bn £9.0bn 26% Third party net new business £7.9bn £6.4bn 23% IFRS profit before tax* £100m £70m 43% IFRS underlying profit before tax* £83m £70m 19% EBIT* £75m £65m 15% EBIT margin* 30% 28% 2% points * 2006 is shown on a pro forma basis.
The investment management result for both periods includes the profits of other general insurance operations which are managed by our investment management business. In previous periods all general insurance was included in healthcare and general insurance.
In our UK business we achieved record sales for our mutual funds during 2007 despite some industry slowdown in the last quarter of the year in reaction to volatile market conditions, with momentum in the first half building on our core strength in Retail. Our Institutional business, which represents nearly 80% of total third party FUM has remained largely insulated from the effects of market volatility and has experienced another year of record flows in both corporate pooled products and segregated mandates.
This was driven by strong underlying profit growth, up 19% to £83m (2006: £70m). Record flows of third party FUM, tight management of costs and careful control over the investment spend required to sustain our growth all contributed to this. Although income from in-house FUM was lower, EBIT margin increased to 30% (2006: 28%).
Customers We have continued to improve our level of customer service throughout 2007. High quality support by our client service teams, combined with strong investment performance from our fund management teams, have been recognised with a record thirteen awards during the year, including: Citywire Team All Stars Asset Group Winner - UK Equities and Citywire Team All Stars Sector Winner - UK All Companies at the • Citywire Team All Stars Awards 2007; 5 Star Award in the Investment Provider & Packager category at the FTAdviser Online Service Awards 2007;•
Investment Manager of the Year and Specialist Manager of the Year (UK Equities) at the UK Pensions Awards 2007;•
Best Overall Group Awards at the Lipper Fund Awards 2007 in the Equity Large and UK Equity Large categories; and•
UK Asset Management Firm of the Year award at the Financial News Awards for Excellence in Institutional Asset Management – • Europe 2007.
Employees The business and its related infrastructure have continued to grow throughout 2007. The average number of full time equivalent staff rose 3.4% from 705 to 729 as we expanded our capability in new product areas and customer service. We believe we have one of the most talented teams in the UK fund management industry. Our employee engagement levels remain high at 3.9, as assessed by our latest Gallup survey. Our sales of new mandates, our strong investment performance across equities, bonds, property and private equity, our high levels of customer service, our tightly run infrastructure and the record number of awards won all bear testament to the quality of this team.
Pro forma results To provide users with a basis for comparison, the EEV and IFRS results for 2006 have been prepared on a pro forma basis. This represents the mutual results for the period prior to demutualisation, adjusted to calculate a profit figure for the Group as if its holding company had been a listed public company at the beginning of the period. Due to the nature of the adjustments required to the EEV and IFRS mutual figures, pro forma profit figures are not directly comparable and may differ from the actual results if the holding company of the Group had been a listed public company at the beginning of the relevant period.
Derivation of IFRS pro forma underlying profit A reconciliation of the 2006 IFRS mutual results to pro forma profit is detailed in the table below with the pro forma adjustments prepared on a consistent basis with the accounting policies applied by the Group in the 2006 Annual Report and Accounts. Restated £m Total net revenue 15,432 Total operating expenses (14,751) Share of profits from associates and joint ventures 129 Profit before tax 810 Total tax expenses (415) Profit for the period 395 Shareholder tax 58 Profit before tax attributable to equity holders 453
Adjustments to derive underlying profit Volatility arising on different asset and liability valuation bases (25) Impairment of intangibles 14 Restructuring expenses 17 Underlying profit before tax attributable to equity holders and after minority interest 540
Notes £m £m Covered business UK 606 214 Canada 178 80
EEV consolidated income statement For the year ended 31 December 2007 44 Standard Life
EEV earnings per share (EPS) For the year ended 31 December 2007
EEV operating profit after tax attributable to equity holders of Standard Life plc (£m)** 617 248
Diluted EPS (pence) 28.3 11.4 Weighted average number of ordinary shares on a diluted basis (millions)* 2,177 2,173 * Includes the full dilutive effect of bonus shares committed to at the time of the demutualisation of The Standard Life Assurance Company and the flotation of Standard Life plc and share awards and share options.
Notes £m £m Fair value (losses)/gains on cash flow hedges (6) 4 Actuarial (losses) on defined benefit pension schemes ( 3) (2) Exchange differences on translating foreign operations* 19 1 (105) Aggregate tax effect of items not recognised in income statement (1) (6)
Notes £m £m Covered business Free surplus 1,237 720 Required capital 680 562 Net worth 1,917 1,282 Present value of in-force 3,639 3,480 Cost of required capital (312) (263) Total embedded value of covered business 2.2(c) 5,244 4,499
Equity Share capital 217 210 Share premium reserve 792 799 Other reserves 2,273 1,869 EEV reserves 2,929 2,730 Total equity* 6,211 5,608 * Embedded value equity per share is 285p as at 31 December 2007 compared to 258p as at 31 December 2006 based on diluted share totals of 2,177m as at 31 December 2007 and 2,177m as at 31 December 2006.
The opening and closing EEV numbers, and therefore the profit arising in the period, for the covered business are determined on an after tax basis. The tax assumptions are based upon the best estimate of the actual tax expected to arise. Profit before tax is derived by grossing up profit after tax at the standard rate of corporation tax appropriate to each territory. While for some territories this rate does not equate to the actual effective rate of tax used in the calculation of after tax profits, it provides a consistent grossing up basis upon which to compare results from one year to another and is in line with the Group’s expectation of the rate of tax applicable to business sold after demutualisation.
The investment management result for both periods includes the profits of other general insurance operations managed by Standard Life Investments (SLI). In previous periods, all general insurance was included under healthcare and general insurance.
Assumptions In the year ended 31 December 2007 corporation tax rates reflect the changes that will take effect in the UK from 1 April 2008 and in Germany from 1 January 2008, and the changes in Canadian tax rates applied from 2007.
On 14 February 2008 we announced the reinsurance of part of our UK immediate annuity portfolio to Canada Life International Re. The impact of this transaction has not been reflected in these results for the year ended 31 December 2007.
2.2 Segmental analysis – covered business (a) Segmental EEV income statement
HWPF UK Canada Europe Other TVOG Total 12 months to 31 December 2007 Notes £m £m £m £m £m £m
Expected return on free surplus 24 3 1 (12) - 16
Investment return and tax variances (105) 80 (10) - 18 (17) Effect of economic assumption changes (56) 71 - - 12 27
Contribution from in-force business: Expected return on existing business 136 47 15 - - 198
Expected return on free surplus 6 (3) 1 (7) - (3)
Investment return and tax variances 142 55 6 - 26 229 Effect of economic assumption changes 159 (36) 14 - 3 140
HWPF TVOG represents the time value of financial options and guarantees (TVOG) arising from the Heritage With Profits Fund (HWPF). Although this fund includes business written by the UK, Germany and Ireland, it is managed at a combined level by the UK financial services division and is shown separately in this analysis. The results for Canada include the cost of the Canadian TVOG, and the results for Europe include the cost of TVOG arising on business written outside of the HWPF in Germany.
The principal effect of determining the pre-tax results using the standard rate of tax compared to the actual effective rate is to decrease the effect of economic assumption changes by £67m (UK £65m, Europe £2m), arising from the impact of both investment related increases and changes in UK corporation tax rates in the value of the tax effects that have been assumed to arise as a result of funding HWPF transfers out of unallocated surplus.
The 2007 income statements for the UK and Europe reflect the changes in corporation tax rates in the UK and Germany. These changes are: in the UK, reduction from 30% in 2007 to 28% from 1 April 2008; and •
The changes in Canadian corporation tax rates from 2007 have resulted in a total gain of £26m, of which negative £15m emerges through investment return and tax variances, and £41m emerges through the effect of economic assumption changes.
The 2007 income statement for Canada includes the effect of changes in accounting policy following the implementation on 1 January 2007 of the Canadian Institute of Chartered Accountants Handbook Section 3855 Financial Instruments – Recognition and Measurement, issued by the Canadian Accounting Standards Board. This provides new valuation methods, principally moving equity and bond asset values and related liabilities to a market value basis. The impact of this change amounts to a gain of £20m which has been included within the effect of economic assumption changes line.
Profit after tax 316 237 11 (11) 51 604 Internal capital transfers (93) (63) 21 46 - (89) Transfer back of surplus to SLI (23) (2) - - - (25) Transfer back of mutual funds net worth 15 (4) - - - 11 Actuarial gains on defined benefit pension schemes - 1 4 5 - - 1 9 Foreign exchange differences - 16 4 2 6 3 - 19 3 Aggregate tax effect of items not recognised - (3) - - - (3)
Capital movements mainly reflect dividend transfers to Standard Life plc. Opening adjustments in the UK and Canada reflect the inclusion of certain mutual funds in covered business as explained in the basis of preparation Note 2.1.
HWPF UK Canada Europe Other TVOG Total Period 10 July to 31 December 2006 £m £m £m £m £m £m
Transfer back of surplus to SLI (9) - - - - (9) Transfer back of mutual funds net worth - - - - - Actuarial gains on defined benefit pension schemes - 9 1 - - 10
Analysis of EEV Free surplus 656 24 (9) 49 - 720
New Business Sales NBC PVNBP1 APE PVNBP Margins2 12 months to 31 December 2007 £m £m £m %
New Business Sales NBC PVNBP APE PVNBP Margins2 Period 10 July to 31 December 2006 £m £m £m %
‘Other’ includes an adverse variance of £83m in respect of UK deferred annuities. This needs to be considered in conjunction with £274m of UK assumption change effects due to deferred annuities, which are reported through the ‘Other’ line in operating assumption changes.
The UK assumption changes for lapses are made up of changes to assumptions for pensions and life with profits contracts of £88m, £154m in respect of unit linked bonds, and £7m for other UK contracts. In 2006 and 2007 the UK saw heightened lapse experience on pensions, due to A day, and on with profits policies generally, due to the long-term decline in consumer appetite for with profits products coinciding with the demutualisation of SLAC and flotation of Standard Life plc. That adverse experience has peaked and lapse rates have stabilised since the second quarter of 2007. The assumption changes now align the best estimate assumptions for pensions and with profits life policies with actual experience.
The lapse rates on UK unit linked bonds deteriorated significantly in the latter half of 2007 due to the downturn in the UK commercial property market, general market volatility and the uncertainty regarding proposed capital gains tax changes. There remains significant uncertainty around the near term experience and what the long-term impact will be. Therefore, we have made assumption changes in light of recent experience and allowing for the uncertainty, amounting to £92m, within the overall £154m of assumption changes for unit linked bonds.
Lapse assumption changes in Europe arise in Ireland and are also in respect of aligning the best estimates with the long-term assumptions following the peaking of lapse rates. The positive lapse assumption change in Canada mainly relates to Group Segregated and Main Fund contracts where experience has been better than expected.
All territories have made positive changes to maintenance expense assumptions reflecting the impact of changes made to their expense bases related to the Continuous Improvement Programme and other initiatives.
HWPF UK Canada Europe TVOG Total Period 10 July to 31 December 2006 £m £m £m £m £m
2.6 Non-covered business Non-covered business EEV operating profit is represented by IFRS underlying profit as adjusted for SLI look through profits and the return on certain mutual funds which are recognised in covered business.
Opening adjustments relate to the elimination of £13m of opening deferred acquisition costs in respect of those mutual funds transferred to covered business.
Transfer back of net worth from covered business 9 - - - - 9
2.7 EEV — reconciliation of movements in consolidated balance sheet Period 12 months to 10 July 2006 to 31 December 31 December 2007 2006 £m £m Opening EEV 5,608 4,995 Opening adjustments 19 Opening adjusted EEV 5,627 4,995
Total recognised income for the period 774 406 Distributions to equity holders (197) Capital injections - 192 Reserves credit for employee share-based payment schemes 12 15 Vested employee share-based payment schemes (5) Closing EEV 6,211 5,608
2.8 Reconciliation of EEV net assets to IFRS net assets 31 December 31 December £m £m Net assets on an EEV basis 6,211 5,608
Present value of in-force life and pensions business (3,327) (3,217) EEV net worth 2,884 2,391 Adjustment of long-term debt to market value (4) 92 Canadian mark-to-market 112 244 Deferred acquisition costs net of deferred income reserve 245 127
Investment return and tax variances 7 3 10 (22) (12) Effect of economic assumption changes 75 (11) 64 (45) 19
Transfer back of surplus to SLI (25) - (25) - (25) Transfer back of mutual funds net worth 11 - 11 - 11 Actuarial gains on defined benefit pension schemes 1 9 - 1 9 - 1 9 Foreign exchange differences 18 84 10 2 91 19 3 Aggregate tax effect of items not recognised in income statement (3) - (3) - (3)
2.9 Analysis of covered business EEV PVIF and net worth movements (net of tax) continued
Contribution from in-force business: Expected return on existing business - 1 1 206 207 Expected return transfer to net worth 392 (1) 391 (391) -
Transfer back of surplus to SLI (23) - (23) - (23) Transfer back of mutual funds net worth 15 - 15 - 15 Actuarial gains on defined benefit pension schemes - - - - -
PVIF Required net of cost Free surplus capital Net worth of capital Total Period 10 July to 31 December 2006 £m £m £m £m £m Opening EEV 686 15 701 2,247 2,948
Contribution from in-force business: Expected return on existing business - - - 95 95 Expected return transfer to net worth 172 - 172 (172) -
PVIF Required net of cost Free surplus capital Net worth of capital Total 12 months to 31 December 2007 £m £m £m £m £m Opening EEV 24 526 550 351 901
Investment return and tax variances 51 2 53 5 58 Effect of economic assumption changes 82 (12) 70 (19) 51
PVIF Required net of cost Free surplus capital Net worth of capital Total Period 10 July to 31 December 2006 £m £m £m £m £m Opening EEV 12 545 557 360 917
Contribution from in-force business: Expected return on existing business - 12 12 21 33 Expected return transfer to net worth 41 (20) 21 (21) -
2.9 Analysis of covered business EEV PVIF and net worth movements (net of tax) continued (d) Europe and Other continued
Contribution from in-force business: Expected return on existing business - - - 9 9 Expected return transfer to net worth 42 - 42 (42) -
Investment return and tax variances (1) - (1) 6 5 Effect of economic assumption changes - - - 9 9
Transfer back of surplus to SLI - - - - Transfer back of mutual fund net worth - - - - Actuarial gains on defined benefit pension schemes 1 - 1 - 1
2.10 Time value of options and guarantees (TVOG) 31 December 31 December £m £m UK and Europe HWPF (41) (92)
The fall in the provision for HWPF TVOG is largely driven by UK experience variances from interest rate hedging for HWPF annuities, refinements to the interaction of dynamic management actions across UK and German business, and the modelling of the distribution of the HWPF residual estate to with profits policyholders.
2.11 Market value of subordinated liabilities within covered business 31 December 31 December £m £m
Subordinated liabilities within EEV covered business are based on the market value of the debt. The free surplus shown in Note 2.2(c) is net of these liabilities.
Gross investment returns Risk-free 4.58 4.04 4.33 Corporate bonds 5.56 * n/a
Ireland 3.80 * Current holdings are assumed to yield in future years the earned rate for the year preceding the valuation. Future reinvestments are assumed to be in government bonds.
Gross investment returns Risk-free 4.83 4.11 3.95 Corporate bonds 5.40 * n/a
Risk margin after cost of capital adjustment 3.60 2.90 2.90 3.60 2.90
Risk discount rates – in-force business Risk-free 4.58 4.58 4.04 4.33 4.33 * Using the value of in-force business as weights, the weighted average risk margins for the UK and Europe were 3.5% and 3.3% respectively.
The impact of all these changes in risk discount rates has been included in the effect of economic assumption changes shown in Note 2.2(a). The amounts within these totals that relate to the changes in risk discount rates are for UK (£55m negative), for Europe (£23m negative) and for Canada (£54m negative).
2.12 Principal economic assumptions – deterministic calculations – covered business continued
UK Europe equity holder Europe equity holder UK HWPF owned funds Canada HWPF owned funds 12 months to 31 December 2007 % % % % % Risk margin – new business Risk margin before cost of capital adjustment: Market risk 2.10 2.00 1.80 2.10 2.00
Risk discount rates – new business Risk-free* 4.83 4.83 4.11 3.95 3.95 * As the new business contribution is calculated using start of period economic assumptions the risk free rates shown here represent market yields at 31 December 2006. **Using the value of in-force business as weights, the weighted average risk margins for the UK and Europe were 2.8% and 2.9% respectively.
Risk discount rates – new business Risk-free* 4.67 4.67 4.60 4.23 4.23 * As the new business contribution is calculated using start of period economic assumptions the risk free rates shown here represent market yields at 10 July 2006. **Using the value of in-force business as weights, the weighted average risk margins for the UK and Europe were 2.7% and 2.8% respectively.
Characteristics of ESG used for HWPF TVOG calculations — UK and Europe
Parameters used in ESG Cash and bond returns These variables are calibrated using the following instruments: conventional Government bond yields adjusted to allow for any ‘convenience premium’ associated with Government • bond prices; and a range of swaption prices.•
Property returns As there is no liquid property option market a best estimate of property return volatility is used. The property volatility is estimated from adjusted Investment Property Databank UK data.
Correlations The principal correlations in the ESG are between equity, bond and property returns. These correlations are targeted to be of the following order: equity/property = 0.2;•
2.14 Foreign exchange A description of the approach to the currency translation for foreign entities is provided in Note 2.16.
The principal exchange rates applied are: Average Closing Average to Closing 10 July to 31 December 31 December 31 December 31 December 2.15 Sensitivity analysis – economic and non-economic assumptions The tables below show the sensitivity of the embedded value and the NBC to different scenarios.
* Note the impact of the reinsurance of the immediate annuity portfolio to Canada Life International Re is not included in these results as at 31 December 2007.
The Group’s covered business is its life assurance and pensions businesses in the United Kingdom, Canada, Europe (Germany including Austria, and Ireland) and Other (Asia Pacific), as well as the current and future profits and losses from Standard Life Investments (SLI) arising on its management of funds relating to the life and pensions businesses. As the businesses included in ‘other’ are not material in the context of the Group they have been included at their IFRS value.
those elements of Wrap business that are contained within a long-term product wrapper i.e. Bonds, SIPPs and mutual funds; and•
mutual funds sold by UK Financial Services, excluding mutual funds administered on legacy systems.•
The Group’s non-covered business mainly includes the business of Standard Life Bank (SLB), Standard Life Healthcare (SLH), Standard Life plc, the third party investment management business of SLI, the non-covered business of Standard Life Savings (SLS) and other non-life and pensions entities.
Value of in-force covered business The value of future equity holders’ cash flows is calculated for each material business unit on an after-tax basis, projected using best estimate future assumptions as described below.
Free surplus The free surplus is the market value of any assets allocated to, but not required to support, the in-force covered business at the valuation date. In the UK, this comprises the market value of the assets in the equity holders’ fund, plus the value of the equity holders’ interest in the surplus of the long-term fund, after appropriate allowance for tax, less the required capital supporting the covered business.
Allowance for risk Under the EEV Principles and Guidance, risks within the covered business are allowed for in the following ways: application of risk discount rates to projected cash flows, which are derived by adding a risk margin to a risk free rate;•
holding of required capital for the covered business, determined by reference to both regulatory requirements and internal • economic capital assessments; and allowing for TVOG.•
UK and Europe (business in equity holder owned funds) – 100% of EU minimum regulatory capital, which is higher in aggregate • than Standard Life’s internal risk-based capital requirement; and
Canada – the level of required capital is taken as 150% of minimum continuing capital and surplus requirements (MCCSR).•
Time value of financial options and guarantees (TVOG) The TVOG represents the potential additional cost to equity holders where a financial option exists which affects policyholder benefits and is exercisable at the option of the policyholder.
UK and Europe - HWPF The main source of TVOG in the Group EEV arises from the HWPF. Under the terms of the Scheme, equity holder cash flows from the HWPF are held back if required to cover HWPF liabilities on the Financial Services Authority realistic or regulatory basis. This option for the UK, Germany and Ireland results in the loss of cash flows when the HWPF has insufficient assets to pay guaranteed policy benefits. The main options and guarantees within the HWPF in respect of UK and European business relate to with profits business and include minimum guaranteed rates of return.
Expenses – pension scheme deficits Pension scheme deficits have been included in accordance with International Accounting Standard (IAS) 19 Employee Benefits.
2.16 EEV methodology continued Annuitant mortality assumptions use a combination of base mortality rates, which are generally set by reference to recent experience, and expected future changes in mortality. The latter uses data provided by the Continuous Mortality Investigation Bureau in the UK and the Canadian Institute of Actuaries in Canada along with other company specific considerations.
Lapse rate assumptions in the UK have been set by reference to expected future trends. Lapse assumptions on unit linked bonds assume that lapse experience will become even more adverse in 2008 before settling down to a level which is higher than the opening assumptions.
New business Definition of new business New business includes new policies written during the period and some increments to existing policies.
For the UK, classification as new or existing business is determined as follows (using the approach used for the published new business figures): new recurrent single premium business is classified as new regular premium business to the extent that it is deemed likely • to renew; Department of Work and Pensions (DWP) rebates are deemed to be new single premiums;•
pensions vesting under other group contracts and individual pensions are included as new business;•
For Germany, new business comprises new contracts written into the equity holder owned funds during the period.
The new business contribution for Germany is calculated assuming a specific level of future premium indexation. Similarly, it is assumed that premiums on ‘Low Start’ policies increase at the end of the low start period.
For Ireland, new business comprises: new contracts written during the period;•
pensions vesting into annuity contracts under existing group defined benefits contracts are not included as new business;•
pensions vesting under other group contracts and individual pensions are included as new business; and •
PVNBP and APE New business sales are expressed on two bases: present value of new business premiums (PVNBP) and annual premium equivalent (APE). The PVNBP calculation is equal to the total single premium sales received in the period plus the discounted value of regular premiums expected to be received over the term of the new contracts, and is expressed at the point of sale. The premium volumes and projection assumptions used to calculate the present value of regular premiums for each product are the same as those used to calculate NBC, except that the PVNBP is discounted using the relevant opening risk free rate rather than the risk discount rate. APE is equal to the total of regular premiums plus 10% of single premiums received during the applicable period.
Tax The opening and closing EEV numbers for the covered business are determined on an after tax basis. The tax assumptions used are based upon the best estimate of the actual tax expected to arise. Attributable tax and profit before tax are derived by grossing up profit after tax at the standard rate of corporation tax appropriate to each territory. While for some territories this rate does not equate to the actual effective rate of tax used in the calculation of after tax profits, it provides a consistent grossing up basis upon which to compare results from one year to another and is in line with the Group’s expectation of the rate of tax applicable to new business.
For non-covered business, attributed tax is consistent with the IFRS financial statements, unless otherwise stated.
Foreign exchange Embedded value and other balance sheet items denominated in foreign currencies have been translated to sterling using the appropriate closing exchange rates. NBC and other profit and loss account items have been translated using average exchange rates. Gains and losses arising from foreign exchange differences on consolidation are presented separately within the EEV consolidated statement of recognised income and expense.
Notes £m £m Revenue Net earned premium 3,646 3,963 Net investment return 5,803 10,862 Fee and commission income 593 521 Other income 71 86 Total net revenue 10,113 15,432
Expenses Net insurance benefits and claims 7,532 6,597 Net change in policyholder liabilities (199) 5,638
Change in liability for third party interest in consolidated funds (78) 116 Finance costs 122 114 Total expenses 9,674 14,751
Total tax expense 3.4 44 415 Less: Tax attributable to policyholders’ returns 3.4 (111) (357) Tax (credit)/expense attributable to equity holders’ profits 3.4 (67) 58
Attributable to: Equity holders of Standard Life plc 465 283 Minority interest 111 112
IFRS condensed consolidated income statement For the year ended 31 December 2007 80 Standard Life
Underlying profit is calculated by adjusting the profit for the period for volatility that arises from different International Financial Reporting Standards (IFRS) measurement bases for liabilities and backing assets, volatility arising from derivatives that are part of economic hedges but do not qualify as hedge relationships under IFRS, restructuring costs, significant corporate transaction expenses, impairment of intangibles and profit or loss arising on the disposal of a subsidiary, joint venture or associate. The Directors believe that, by eliminating this volatility from the equity holder profits, they are presenting a more meaningful indication of the underlying business performance of the Group.
Share premium reserve 792 799 Retained earnings 776 298 Other reserves 1,497 1,571 Capital and reserves attributable to equity holders of Standard Life plc 3,282 2,878 Minority interest 391 307 Total equity 3,673 3,185
Liabilities Non-participating contract liabilities 3.8 79,742 71,133 Participating contract liabilities 3.8 37,888 39,996 Third party interest in consolidated funds 1,501 961
Subordinated liabilities 1,908 1,834 Deferred income 340 257 Income tax liabilities 732 883 Customer accounts related to banking activities and deposits by banks 6,080 5,071 Other liabilities 5,998 5,629 Total liabilities 140,307 132,270
The impact on the consolidated statement of recognised income and expense for the year ended 31 December 2006 of the presentation adopted for the consolidated income statement in that year for the period 1 January to 10 July 2006, when the parent company of the Group was a mutual insurer, is explained in Note 3.1(b).
Notes £m £m Cash flows from operating activities Profit before tax 620 810 Non-cash movements from operating activities 47 (191) Net increase in operating assets (2,212) (14,335) Net decrease in operating liabilities 4,943 13,004 Change in unallocated divisible surplus (247) 286 Taxation paid (323) (304) Net cash flows from operating activities 2,828 (730)
Cash flows from financing activities Proceeds from other borrowings 36 119 Repayment of other borrowings (28) (131) Proceeds from issue of ordinary share capital, net of transaction costs 3.7 - 1,363 Consideration paid to eligible members in non – permitted countries - (59) Capital contributions from minority interest 495 329 Interest paid (134) (134) Distributions paid to minority interest (31) (14) Ordinary dividends paid (197) Net cash flows from financing activities 141 1,473
IFRS condensed consolidated cash flow statement For the year ended 31 December 2007 84 Standard Life
The accounting policies as set out in the Group’s Annual Report and Accounts for the year ended 31 December 2007 have been applied in the preparation of this preliminary announcement.
Prior to the demutualisation of SLAC, the results of the Group were attributable to participating policyholders and the balance on the consolidated income statement was transferred to the unallocated divisible surplus reflecting that the Group did not report a profit. However, the format of the consolidated income statement for the year ended 31 December 2006 was aligned with that of an equity owned company. The impact of the presentation adopted for the consolidated income statement for the year ended 31 December 2006 is described in Note 3.14.
The consolidated statement of recognised income and expense was revised in line with the consolidated income statement in 2006. As a result of the revision, for the period from 1 January to 10 July 2006, the ‘Total recognised income for the period’ represents an amalgamation of the ‘Net income/(expense) not recognised in the income statement’ and the ‘increase in net assets attributable to minority interest’.
(c) Restatement for gross up of cash collateral received During 2007 it was identified that IAS 39 Financial Instruments: Recognition and Measurement requires that certain cash collateral transactions resulting from stock lending arrangements should have been historically recognised on the balance sheet, with a corresponding obligation to return this collateral, instead of showing a net nil position. As a result, the lines affected in the 2006 financial statements have been restated, therefore the figures for cash and cash equivalents and investments in associates and joint ventures have been increased by £ 2, 474m and £3 90m respectively and other liabilities have been increased by a corresponding amount of £2, 864m. In addition, the investment return generated on the reinvestment of these assets and the associated expenses had previously been offset in the income statement. The 2006 comparative figures have therefore been restated in order to report separately interest income and share of profits from associates and joint ventures (increased by £83m and £12m respectively) together with the related expenses (increased by £95m).
(d) Preliminary announcement The preliminary announcement for the year ended 31 December 2007 does not constitute statutory accounts as defined in Section 240 of the UK Companies Act 1985. PricewaterhouseCoopers LLP have audited the consolidated statutory accounts for the Group for the years ended 31 December 2006 and 31 December 2007 and their reports were unqualified and did not contain a statement under Section 237(2) or (3) of the UK Companies Act 1985. The Group’s consolidated statutory accounts for the year ended 31 December 2006 have been filed with the Registrar of Companies. The Group’s Annual Report and Accounts for the year ended 31 December 2007 will be available from 4 April 2008.
3.2 Segmental analysis (a) Primary reporting format – business segments The Group is managed and organised into five (2006: five) reportable business segments: Life and pensions Life and pensions offers a broad range of pensions, protection, savings and investment products to individual and corporate customers. Within these product classes are executive and group pension products, pooled pension funds and income protection products.
Other Other primarily comprises the Group corporate centre and shared service centre. Prior to 10 July 2006, these costs were borne by the life and pensions segment.
Other items included in the income statement are: Amortisation of deferred acquisition costs 99 34 2 - - - 135 Depreciation of property, plant and equipment 3 1 - - 5 - 9
The Heritage With Profits Fund (HWPF) was established as part of the demutualisation transaction on 10 July 2006. The Scheme of Demutualisation (the Scheme) provides that certain recourse cash flows arising in the HWPF on specified blocks of UK and Irish business may be transferred out of that fund and thus accrue to the ultimate benefit of equity holders in the Company. Under the Scheme such transfers are subject to constraints to protect policyholders. If the recourse cash flows result in a negative amount, then the shareholder fund will make a transfer to the HWPF of at least the negative amount. The Scheme also provides for additional expenses to be charged by the Proprietary Business Fund (PBF) to the HWPF in respect of German branch business.
The expected future value of the defined cash flows on UK and Irish participating contracts is recognised as a reduction in the measurement of participating contract liabilities or in the unallocated divisible surplus. As these recourse cash flows arise they are no longer included in the measurement of participating contract liabilities or the unallocated divisible surplus and thus contribute to equity holder profit.
In the year ended 31 December 2007 the recourse cash flows resulted in a positive amount, the transfer of which out of the HWPF was not subject to any constraint.
The life and pensions segment profit comprises the following: £m £m Recourse cash flows arising on UK and Irish unitised contracts 378 116 Recourse cash flows arising on UK and Irish non-unitised contracts 296 42 Additional expenses charged on German unitised with profits contracts 59 51 Transfer out of HWPF 733 209 Life and pension operations outside the HWPF (140) 362 Profit before tax in the year/period 10 July to 31 December 593 571 Result attributable to period 1 January to 10 July 2006 - 172 Life and pensions segment result for the year 593 743
During 2007, the Group adopted the relaxation of reserving requirements for non-participating insurance contracts set out in the FSA’s policy statement PS06/14 (Prudential changes for insurers). This resulted in an increase in the recourse cash flows in 2007 of £138m.
Restated Life and Investment 12 months to 31 December 2006 pensions Healthcare management Banking Other Elimination Total £m £m £m £m £m £m £m Revenue from external customers
Total revenue from external customers 14,324 247 133 704 24 - 15,432
Share of profits from associates and joint ventures 116 7 4 - 2 - 129
Tax expense attributable to policyholders’ returns 357 Tax expense attributable to equity holders’ profits 58
Other items included in the income statement are: Amortisation of deferred acquisition costs 50 31 2 - - - 83 Depreciation of property, plant and equipment 3 - - - 12 - 15
There are legal restrictions surrounding the holding of shares by occupational pension scheme trustees. Therefore, on demutualisation of The Standard Life Assurance Company, the shares to which the pension scheme members were entitled were sold as part of the Institutional Offer. The cash raised on the sale of the shares was subsequently remitted to the Group and used to enhance benefits under the policies. £224m is included in the net earned premium in 2006 in respect of the proceeds raised from the sale of these shares.
Equity Share capital and reserves 3,282 Minority interest 391 Total equity 3,673
Investments in associates and joint ventures 3,155 165 43 - 264 - 3,627
Capital expenditure incurred during the year on: Intangible assets 9 25 - 2 - - 36
Restated at 31 December 2006 United Kingdom 12,071 116,658 500 3.3 Administrative expenses £m £m Commission expenses 503 493 Interest expenses 663 558 Staff costs and other employee related costs 566 599 Restructuring and corporate transaction expenses 31 100 Other administrative expenses 534 536 Total administrative expenses 2,297 2,286
Included within administrative expenses are restructuring expenses of £31m (2006: £100m). The £31m expense in 2007 includes £18m relating to the proposed acquisition of Resolution plc, £9m relating to the Group’s Continuous Improvement Programme – mainly in relation to redundancy and consultancy costs – and £4m (2006: £13m) was incurred in relation to restructuring costs incurred by Standard Life Healthcare Limited (Standard Life Healthcare) following its acquisition in 2006 of the private medical insurance business of FirstAssist. During 2006, £80m was incurred in association with work undertaken in respect of demutualisation and flotation.
The share of tax of associates and joint ventures is £4m (2006: £2m) and is included above the line ‘Profit before tax’ in the consolidated income statement in ‘Share of profits from associates and joint ventures’.
The total income tax expense is split as follows: £m £m Current tax: United Kingdom 295 219 Double tax relief (41) (5) Canada and international 22 53 Adjustment to tax credit in respect of prior years (3) (13) Total current tax 273 254 Deferred tax: Deferred tax (credit)/expense arising from the current period (229) 161 Total deferred tax (229) 161
Attributable to equity holders’ profits (67) 58 3.5 Earnings per share (a) Basic earnings per share Basic earnings per share is calculated by dividing profit attributable to ordinary equity holders by the weighted average number of ordinary shares outstanding during the year. The weighted average number of ordinary shares outstanding during the year is the weighted average number of shares in issue less the weighted average number of shares owned by employee share trusts that have not vested unconditionally in employees.
Period Year ended 10 July 2006 to 31 December 31 December
Profit attributable to equity holders of Standard Life plc (£m) 465 283 Weighted average number of ordinary shares in issue (millions) 2,138 2,102 Basic earnings per share (pence per share) 21.7 13.5
Period Year ended 10 July 2006 to 31 December 31 December 2007 2006 Profit attributable to equity holders of Standard Life plc (£m) 465 283 Weighted average number of ordinary shares for diluted earnings per share (millions) 2,177 2,173 Diluted earnings per share (pence per share) 21.4 13.0
The dilutive effect of the bonus shares included in the weighted average number of ordinary shares above was 36m (2006: 69m).
(c) Alternative earnings per share Earnings per share is also calculated based on the underlying profit before tax and certain non-operating items after tax as well as on the profit attributable to equity holders. The Directors believe that earnings per share based on underlying profit figure provides a better indication of operating performance.
Restructuring and corporate transaction expenses (31) (1.4) (12) (0.6) Profit on part disposal of joint venture 17 0.7 - Profit before tax attributable to equity holders 509 23.8 401 19.1
Shares issued for cash on Initial Public Offering - - 556,944,945 56 Shares in respect of over-allotment provision - - 83,541,742 8 Shares issued in respect of employee share plans 518,200 - 2,066,762 Shares issued in respect of bonus issue 67,429,005 7 - At end of period 2,174,077,106 217 2,106,070,469 210
¹ At 1 January 2006, the Company had allotted and issued share capital of 2 £1 ordinary shares. On 10 May 2006, each of the 2 issued ordinary shares was subdivided into 10 £0.10 ordinary shares. An additional 10 ordinary shares of £0.10 each were issued on the same date at par for cash.
Notes £m £m Non-participating contract liabilities Non-participating insurance contracts 3.8(a) 20,980 20,202 Non-participating investment contracts 3.8(c) 58,762 50,931
Participating contract liabilities Participating insurance contracts 3.8(a) 19,446 20,225 Participating investment contracts 3.8(a) 17,491 18,563 Unallocated divisible surplus 951 1,208
Non-participating insurance contracts include £161m (2006: £152m) relating to Standard Life Healthcare and £3m (2006: £3m) relating to general insurance, conventional term assurances (Lifetime Protection Series), life contingent annuities, Perspecta Universal Life in Canada, and a small amount of linked Homeplan business.
These components are deducted in arriving at the amount of participating contract liabilities and unallocated divisible surplus (UDS) as follows: £m £m Participating contract liabilities before apportionment 37,117 38,950 Non-participating PVFP deducted (180) (162)
Participating insurance contracts 19,446 20,225 Participating investment contracts 17,491 18,563 Participating contract liabilities after apportionment 36,937 38,788
Unallocated divisible surplus before apportionment 2,373 2,968 Non-participating PVFP deducted (1,422) (1,760) Unallocated divisible surplus after apportionment 951 1,208
3.8 Insurance contract liabilities, non-participating investment contract liabilities, participating investment contract liabilities and reinsurance assets continued (a) Insurance contract liabilities, participating investment contracts and reinsurance assets The movement in insurance contract liabilities, participating investment contracts and reinsurance assets during 2007 was as follows: Non- Reinsurers’ Participating participating Participating Total share of insurance insurance investment insurance and liabilities contract contract contract participating (reinsurance Net liabilities liabilities liabilities contracts asset) 2007 £m £m £m £m £m £m
Effect of changes in: Economic assumptions (60) (94) 74 (80) (9) (89)
Total change in contract liabilities (1,090) (85) (1,161) (2,336) 311 (2,025)
Change in Unearned Premium Reserve - 5 - 5 - 5
Following demutualisation it is necessary to recognise within the participating liabilities the residual estate in the HWPF as a liability since this will in due course be distributed to existing HWPF policyholders if it is not otherwise required to meet liabilities chargeable to the HWPF in accordance with the Scheme. The movement for the year therefore includes the movement in the residual estate.
There have been a number of changes in methodology in the year including those due to changes in regulation as follows: The method applied to determine the insurance contract liabilities for the Canadian business is based on Canadian accounting and regulatory valuation principles. Canadian regulations set the value of policy liabilities for each business segment equal to the value of a selected group of assets which are projected to be sufficient to meet all expected policy liabilities when due. Prior to 1 January 2007, under Canadian Generally Accepted Accounting Principles (GAAP), bonds were measured at amortised cost and equities at move-to-market value (Canadian book value). As the Group’s policy under IFRS for measurement of investment securities is fair value through profit or loss an adjustment was made to the insurance contract liabilities (calculated under Canadian valuation principles) to reflect the impact of the different measurement basis for the investment securities backing insurance contracts. The fair value adjustment made to the insurance contract liabilities was determined for each business segment using a ratio based on total investment securities backing all Canadian policy liabilities (i.e. insurance and investment contracts).
The relaxations to reserving requirements for non-participating insurance contracts set out in the FSA’s policy statement PS06/14 have all been adopted during 2007. These relaxations cover the introduction of prudent lapse allowances where appropriate and the inclusion (where appropriate) of negative liabilities which would have previously been recognised at a zero value, which have both been adopted for certain term assurance contracts. They also cover changes to the attribution of expense allowances when calculating sterling reserves for unitised business.
Non-economic experience changes in the year primarily represents higher than expected claims (in particular surrenders and lapses).
Effect of changes in: Economic assumptions 33 (100) 40 (27) (4) (31)
Total change in contract liabilities 244 318 9 571 12 583
Change in Unearned Premium Reserve - (31) - (31) - (31)
The table above has been split to show the movements for the period from 1 January 2006 to demutualisation at 10 July 2006 and the period from demutualisation to 31 December 2006.
Non-economic experience changes in the year primarily represent lower than expected claims (including deaths, surrenders, maturities and lapses).
(b) Present value of future profits on non-participating contracts Following demutualisation on 10 July 2006, the present value of future profits on non-participating contracts can be apportioned between participating contract liabilities and the UDS. Therefore, from that date the present value of future profits on nonparticipating contracts is not shown separately.
Contributions 4,960 Initial charges and reduced allocations (5) Account balances paid on surrender and other terminations in the year (2,355) Investment return credited and related benefits 1,693 Foreign exchange adjustment (187) Recurring management charges (126) Other 3
Due between 1 and 5 years Standard Life Bank certificates of deposit – GBP - 4.97% - 6 Standard Life Funding B.V. medium term notes – GBP 6.38% 5.43% 4 12
Due after 5 years Standard Life Funding B.V. medium term notes – EUR 5.03% 3.89% 89 81
Total certificate of deposits, commercial paper and medium term notes 1,843 1,812
3.9 Borrowings continued (b) Securitisations – mortgage backed floating rate notes Loans are issued by the Group, which are subject to securitisations. Under this arrangement, the beneficial interest in these mortgages is transferred to special purpose entities. The issue of mortgage backed floating rate notes by the special purpose entities (SPEs) funded the purchase of the mortgages.
3.10 Contingencies (a) Legal proceedings and regulations The Group, like other financial organisations is subject to legal proceedings in the normal course of its business. While it is not practicable to forecast or determine the final results of all pending or threatened legal proceedings, management does not believe that such proceedings (including litigations) will have a material effect on the results and financial position of the Group.
The Group is subject to insurance solvency regulations in all the territories in which it issues insurance and investment contracts, and it has complied with all the local solvency regulations. Therefore, there are no contingencies in respect of these regulations.
(e) Guarantees During the year the Company issued a guarantee to an associate of the Group to cover the difference between amortised cost and marked to market value of the underlying assets of a sub-fund, should there be a need to sell assets below amortised cost to meet investor withdrawals. The guarantee is for a maximum of £60m.
Guarantees and letters of credit include guarantees in relation to the Group’s Canadian operations. Revised IAS 39 Financial Instruments: Recognition and Measurement results in these guarantees being considered financial guarantee contracts and initially recognised at fair value. The fair value at 31 December 2007 is £nil (2006: £nil).
The future aggregate minimum lease payments under non-cancellable operating leases are as follows: £m £m Not later than one year 12 12 Later than one year and no later than five years 7 13 Later than five years 6 7 Total operating lease commitments 25 32
The capital planning process is the responsibility of the Group Finance Director. Capital plans are ultimately subject to approval by the Board.
Regulatory capital The Group operates in a number of geographical regions, and local regulators, primarily the FSA, specify rules and guidance for the minimum level of capital required to meet local requirements. The Group has not breached any regulatory capital requirements at any time during the year.
The FSA requires all insurance companies and financial conglomerates to maintain capital resources in excess of their Capital Resources Requirement (CRR). Capital resources include the assets in excess of liabilities, valued on a regulatory basis, and certain other components of capital. Certain items that are classified as liabilities under IAS 32 Financial Instruments: Disclosure and Presentation are treated as capital under the regulatory basis. For the Group this applies to its subordinated guaranteed bonds, subordinated notes and mutual assurance capital securities. The CRR represents the total of the individual capital resources requirements (ICRR) of each regulated company in the Group.
There are many factors which affect the Group’s capital resources. The determination of the liabilities includes various assumptions including potential changes in market conditions and the actions management might take as a result of those changes. Changes in market conditions and other variables have the potential to significantly affect the capital position. Poor investment returns could depress capital resources, but this could be mitigated by changing the asset portfolio and by the level of bonuses declared. Future annuitant mortality could be significantly different from that assumed in the calculation of the liabilities. European Union developments on solvency requirements could also have a significant impact on the future capital position.
3.12 Capital statement continued Capital structure The Group is classified as a financial conglomerate by the FSA by virtue of its significant regulated activities, including insurance, investment management and banking operations. The largest regulated entity within the Group is Standard Life Assurance Limited (SLAL), which undertakes life assurance and pension business principally in the UK, Ireland and Germany.
The majority of life assurance and pensions business undertaken by UK regulated entities is written within long-term business funds within each regulated company. These long-term business funds are distinct from the equity holders’ funds. Business written prior to demutualisation, and the increments to that business, are written in the Heritage With Profits Fund (HWPF). Business written after demutualisation is written in the other long-term business funds, principally the Proprietary Business Funds.
Any surplus within the Proprietary Business Funds (PBF) is attributable to equity holders. Capital within the PBF may be made available to meet requirements elsewhere in the Group subject to meeting the regulatory requirements of the fund and any further restrictions imposed by the Scheme.
Capital statement The Group’s capital position is analysed between UK regulated life business, overseas life operations and other activities. The UK regulated life business is analysed by the nature of the underlying funds and includes German and Irish business written by branches of UK regulated companies. Other activities comprise investment management, general insurance and Group Corporate Centre. Standard Life Bank is a subsidiary of SLAL and therefore its capital resources are included within life business shareholders’ funds.
3.12 Capital statement continued The Group’s capital position, based on draft regulatory returns, is set out below: 2007 UK regulated life business Heritage Proprietary Life business Total UK With Profits business shareholders’ regulated life Overseas life Total life Other Group Fund* funds funds business operations business activities Total £m £m £m £m £m £m £m £m Available capital resources
Adjustments onto regulatory basis Changes to the valuation of contract liabilities 5,228 39 - 5,267 (99) 5,168 - 5,168 Exclusion of deferred acquisition costs and
Total other non-participating * Capital resources amounting to £1m (2006: £nil) in respect of other with profits funds are disclosed within the Heritage With Profits Fund column shown above.
3.12 Capital statement continued 2006 UK regulated life business Heritage Proprietary Life business Total UK With Profits business shareholders’ regulated life Overseas life Total life Other Group Fund funds funds business operations business activities Total £m £m £m £m £m £m £m £m Available capital resources
Other qualifying capital Subordinated liabilities - - 260 260 - 260 1,574 1,834
Exclusion of deferred acquisition costs and other inadmissible assets (211) (201) (24) (436) (44) (480) (27) (507)
Analysed as follows: Capital not subject to constraints - - 2,522 2,522 347 2,869 585 3,454
Participating contract liabilities amounting to £115m (2006: £24m) relating to the new with profits funds created at demutualisation are disclosed within the Heritage With Profits Fund (HWPF) column. In the 31 December 2006 consolidated financial statements, these liabilities were disclosed separately.
3.12 Capital statement continued UK regulated life business SLAL’s regulatory solvency position is determined using the FSA’s ‘twin peaks’ approach, which requires liabilities to be valued on both a realistic and a regulatory basis. The realistic basis removes some of the margins for prudence included in calculations under the regulatory basis. However, it requires discretionary benefits that are not considered under the regulatory basis, such as final bonuses, to be valued. The extent to which the realistic peak is more onerous than the regulatory peak, increases the amount of the CRR.
Based on draft regulatory returns at 31 December 2007, SLAL had available capital resources of £9.3bn (2006: £8.8bn) and a CRR of £4.9bn (2006: £4bn). The capital resources shown in the capital statement are based on the value of assets and liabilities valued on a regulatory basis, however, the CRR reflects the higher value required as a result of the application of the realistic peak.
Overseas life operations Capital resources of £1,149m (2006: £780m) which relate mainly to operations in Canada also include operations in the Asia Pacific region. The capital resources of the Canadian operations are based on local Generally Accepted Accounting Principles (GAAP) financial statements adjusted where necessary to reflect the fair value of assets with a corresponding adjustment to liabilities. The Canadian regulator sets the minimum required capital. It also requires certain assets to be held in trust to increase policyholder protection (vested assets). As a result of the combination of the capital requirement and vested assets, the overseas life capital subject to constraints amounted to £570m at 31 December 2007 (2006: £433m).
SLAL has issued subordinated loans to the Company, which SLAL treats as capital for regulatory purposes. The Standard Life Assurance Company of Canada and Standard Life Investments have issued subordinated debt of £204m (2006: £176m) and £15m (2006: £15m) respectively, to the Company. These amounts of subordinated debt are included within the capital resources of those businesses, but at Group level only subordinated debt issued to external parties is included in the Group’s capital resources.
Impact on available capital of the Scheme - 285 (374) - (89) - (89) - (89) At 10 July – after
Change in assumptions used to measure life assurance contract liabilities *Includes SLAC following demutualisation.
The investment surplus arises from changes in market conditions, and reflects the total returns earned on the assets compared with the valuation interest rates previously assumed. It also reflects the consequent change in liabilities as a result of the change in the yield currently available on the assets and therefore the current valuation interest rates.
For the period from 1 January 2006 to 10 July 2006, The Standard Life Assurance Company (SLAC) was a mutual insurer and was the principal insurance company within the Group. Its with profits fund owned all the subsidiaries of the Group. All business, including non-participating business, was written within this fund. The capital resources of the regulated subsidiaries are included when calculating SLAC’s capital resources. Therefore, the movement in capital from 1 January to 10 July 2006 is presented in a single column. At demutualisation capital was transferred from SLAC, the mutual company, as a result of the Scheme. After the date of demutualisation, analysis of the movements in capital in the Group’s life business reflects the Group’s new corporate and fund structure.
3.13 Event after the balance sheet date On 14 February 2008 Standard Life Assurance Limited (SLAL), a wholly owned subsidiary of the Company, reinsured a portfolio of annuity contracts held within its Heritage With Profits Fund (HWPF) with Canada Life International Re (the external reinsurer) a reinsurer not related to the Company.
Prior to this SLAL had transferred the longevity risk in respect of these contracts to Standard Life Investment Funds Limited (SLIF), a wholly owned subsidiary of SLAL, by a reinsurance agreement. SLIF had in turn retroceded certain of its obligations under this reinsurance agreement back to SLAL’s Proprietary Business Fund (PBF) by a separate reinsurance agreement. On 14 February 2008 SLAL recaptured from SLIF its obligations in respect of the annuity contracts which were then reinsured to the external reinsurer. The amount payable by SLIF to the HWPF related to this recapture was determined such that the economic benefits arising from entering into the reinsurance agreement with the external reinsurer were shared equally between the HWPF and the Company.
Under the agreement with the external reinsurer all longevity risk and market risk related to retaining investments to meet the payments to annuitants was transferred to the external reinsurer. To mitigate credit risk an amount equal to the reinsurance premium, which was payable by the HWPF to the external reinsurer, was deposited back by the external reinsurer to SLAL on the transaction date.
The liability recognised in the Group’s balance sheet at 31 December 2007 in respect of the annuity contracts that were reinsured with the external reinsurer on 14 February 2008 was approximately £6.7bn. It is expected that the transaction will have a positive impact on profit attributable to equity holders of the Company in 2008.
To reflect the different operating models in place over the reporting periods presented in the consolidated financial statements for the year ended 31 December 2006, the 2006 consolidated income statement was split to show separately the period from 1 January to 10 July 2006, the period from 10 July to 31 December 2006 and a third column combining these periods to show the total for the year ended 31 December 2006.
Restated to 10 July 31 December £m £m £m £m Revenue Total net revenue 10,113 15,432 5,104 10,328
Less: Tax attributable to policyholders’ returns (111) (357) (118) (239) Tax expense attributable to equity holders’ profits (67) 58 - 58 Profit for the period 576 395 52 343
3.14 Consolidated income statement presentation continued The impact of the presentation adopted for the 2006 consolidated income statement on the results for the period 1 January to 10 July 2006, when the parent company of the Group was a mutual insurer, was as follows: the amounts included in ‘Transfer to the unallocated divisible surplus’ for the period 1 January to 10 July 2006 were reported in • ‘Change in unallocated divisible surplus’ within expenses; given that the ‘Transfer to unallocated divisible surplus’ was reported within expenses, the amounts reported as ‘Profit before tax’ • was the tax expense and the increase in net assets attributable to minority interest; and
The Preliminary Results 2007 are published on the Group’s website at www.standardlife.com The Directors are responsible for the maintenance and integrity of the financial information published on the website in accordance with UK legislation governing the dissemination of financial statements. Access to the website is available outside the UK, where comparable information may be different.
Standard Life plc, registered in Scotland (SC286832), Standard Life House, 30 Lothian Road, Edinburgh EH1 2DH. +44 (0)131 225 2552.