Annual Financial Report

Ecclesiastical Insurance Office plc announces results

for the year ended 31 December 2018

Performance driven by strong underwriting results

Ecclesiastical Insurance Office plc ("Ecclesiastical"), the specialist financial services group, today announces its full year 2018 results.

Highlights

· Profit before tax of £15.4m (2017: £82.2m)

· Strong underwriting profit of £29.2m (2017: £27.1m), with Group COR1 of 86.4% (2017: 86.9%). This is the fifth consecutive year of growth in underwriting profit, which has benefited from favourable development of prior year claims on the Group's liability business and improvements in current year performance

· Reduced investment returns of £4.0m (2017: £72.3m), reflecting the downturn in equity markets in 2018

· Gross written premium (GWP) increased by 4% to £357.0m (2017: £342.9m), with high retention levels demonstrating the strength of our proposition in a very competitive market

· £18.8m was donated to good causes during 2018 (2017: £25.5m). We have now reached £64m towards our target of £100m in charitable donations by the end of 2020

· Continued external recognition of the Group as a trusted and specialist financial services organisation, including being named as the UK's best and most trusted insurer for the eighth time by independent ratings agency Fairer Finance, and EdenTree winning MoneyFacts Best Ethical Investment Provider for the 10th year in a row.

 1 Alternative performance measure, refer to the Reconciliation of Alternative Performance Measures note to this announcement for further explanation 

Mark Hews, Group Chief Executive Officer of Ecclesiastical, said:

"In 2018 we delivered a fifth year of sound underwriting performance, underpinned by our focus on delivering sustainable, profitable long-term growth through our disciplined underwriting approach. Underwriting profits in recent years have benefited from both our focus on loss prevention and from a more benign environment. We saw GWP growth across all our territories, thanks to a number of new business wins and high retention rates across our businesses, thanks to high levels of customer satisfaction.

Pre-tax profits were lower than in recent years, reflecting the effect of short-term stock market fluctuations on our investment portfolio. We continue to take a long-term view of the market and have benefited from strong investment returns in recent years and have seen a more positive start to 2019 in investment markets.

"Our strong capital position enabled us to invest significantly in the future of our business. This included work on a new core operating system for the UK and Ireland insurance business, which will provide a faster and more responsive service for our customers and brokers. Alongside this, we continued to look for strategic opportunities for sustainable growth. Our insurance broker SEIB acquired new books of business and we continue to monitor the market for opportunities that complement our existing offer.

"We also announced plans to move to a purpose-built head office near our current offices in Gloucester. This demonstrates a significant investment in our people, providing a better working environment for our colleagues.

"Our strategic goal is to be the most trusted and ethical specialist financial services group and we continued to win external accolades for the way we do business. For the eighth consecutive time, we were named by Fairer Finance as the best and most trusted provider of UK home insurance while EdenTree, our investment management business, was named MoneyFacts Best Ethical Investment Provider for the 10th year in a row. Our Claims team collected three awards at the Insurance Post Claims Awards for excellence in customer care and SEIB won Personal Lines Broker of the Year at the British Claims Awards.

"We also have a purpose to contribute to the greater good of society and our financial performance enabled us to make donations of £18.8m during the year, to our charitable owner and to the causes we support directly. Together, we have now given £64m of the £100m charitable giving target we set ourselves in April 2016. I would like to thank all our colleagues, customers, brokers and business partners for their support in helping us to build a movement for good."

ECCLESIASTICAL INSURANCE OFFICE PLC

ANNUAL FINANCIAL REPORT FOR THE YEAR ENDED 31 DECEMBER 2018

The Company has now approved its annual report and accounts for 2018.

This Annual Financial Report announcement contains the information required to comply with the Disclosure and Transparency Rules, and extracts of the Strategic Report and Directors' Report forming part of the full financial statements.

The financial information set out below does not constitute the Company's statutory accounts for the year ended 31 December 2018. The annual report and accounts will be available on or before 3 April 2019 on the Company's website at www.ecclesiastical.com. Copies of the audited financial statements are also available from the registered office at Beaufort House, Brunswick Road, Gloucester GL1 1JZ.

A copy of the Company's statutory accounts for the year ended 31 December 2018 will be submitted to the National Storage Mechanism and will shortly be available for inspection at www.morningstar.co.uk.

Chairman's Statement

A strong underwriting performance

In 2018 the Group delivered another strong set of underwriting results1, underpinned by its pursuit of sustainable, profitable growth over the longer-term.

Performance remained robust, with underwriting profit of £29.2m (2017: £27.1m) and GWP growth across all our territories. Pre-tax profits of £15.4m (2017: £82.2m) were lower than in recent years, reflecting the effect of short-term stock market fluctuations on our investment portfolio. Nonetheless, these results and our underlying financial strength enabled us to make donations of £17.0m to our charitable owner and £1.8m to the causes we support directly.

1 Alternative performance measure, refer to the Reconciliation of Alternative Performance Measures note to this announcement for further explanation.

Putting customers first

I have been privileged to be a member of the Ecclesiastical Board since 2007. As I step down after two years as its chair, I have been reflecting on the differences that drew me to Ecclesiastical eleven years ago, and which remain intrinsic to the Group today.

We are a specialist financial services group with a portfolio of insurance, investment management, broking and advisory businesses that are quite different from each other. Yet all these businesses are united by a common purpose - they put the customer at the centre of everything they do.

I believe that our aim of being the most expert, trusted and ethical provider in our specialist markets has seen us take customer care to a very different level. In an increasingly commoditised world, we still take the time to understand their particular issues and needs, as befits a true specialist. Thanks to that understanding, we provide products, services and advice that are right for them. And when they are in difficulty, we respond with exceptional levels of service and care.

I mentioned last year how struck I have been by the positive and affectionate feedback we receive from those who know us. It speaks to the emphasis we place on understanding and looking after our communities, both through our work and our charitable support.

Energy and pace

The Ecclesiastical Group has been through a significant period of change during my tenure. In the last five years in particular, an ambitious change programme has been central to the Group's turnaround and consistent financial performance. In that time, we have seen a strengthening of our core insurance business and ongoing development of all the companies in our portfolio. As a result, we have delivered on one ambitious target of giving £50m to good causes and we are well on the way to reaching our current goal of giving £100m by the end of 2020.

I applaud the energy of leadership that has taken our Group forward with such pace, by harnessing its distinctive strengths - a deep understanding of customers' needs, true specialism in our chosen sectors and the unique charitable purpose that sets us apart.

Governance

In 2018 we reached a major milestone, securing approval from the Prudential Regulation Authority for our internal model to meet the Solvency II regulations for insurance firms. In doing so, we have provided our Board and management team with important tools to improve the Group's risk management framework, measure performance and ensure that its decisions contribute to our capital strength.

Board developments

During the year two non-executive directors, Denise Wilson and Anthony Latham, retired from the Board after eight and ten years' service respectively. I would like to express my particular thanks to them, for the valuable expertise they brought to the Group during a period of considerable change.

In January 2019 it was announced that with effect from 19 March 2019, I will step down as chairman and David Henderson, who has been on the Board since 2016, will take my place. Also during the year Ian Campbell left the Group after four years as our Group Chief Financial Officer. We thank Ian for his service to the Group and wish him well in his future career.

The Ecclesiastical Board is strong and diverse, with an unflagging commitment to the Group and its future. It says much about Ecclesiastical that it is able to attract Board members of their calibre, given the relatively small scale of the Group. The skills of my fellow directors are exceptional and I would like to thank them all for their insight and support over the past year.

Our people

This also holds true for our employees. Over the years I have been continually impressed by the exceptional ability of our people. Above all, I have been inspired by their propensity to go above and beyond the call of duty as a matter of course, whether caring for their customers, improving business performance or supporting good causes. This, I believe, speaks to the culture that is fostered by our charitable purpose.

I will miss many things when I leave Ecclesiastical, but it is these good and talented people whom I will miss most. On behalf of the Board, I would like to thank and congratulate them for the successes of 2018 and wish them well as they forge an exciting future for the Group.

In support of our established diversity policy, 2018 saw us publish our second gender pay gap report, which shows a falling pay gap due to a higher proportion of senior roles being filled by women. We also published our progress against the Women in Finance Charter; two years since signing up to its goals, we were pleased to report that women now make up 29.9% of our senior management roles compared with 23.3% in 2017.

Looking to the future

As you would expect, I wish the Group the most successful of futures. But what does that actually mean? For me, the Group's future success lies in continuing to do what we do well - creating competitive advantage from our deep understanding of customers' needs, our position as a trusted specialist and our responsible approach to doing business.

The Group's success also lies in taking what we do well to a bigger audience, so that a broader group of customers and partners can benefit from the unique products and services we offer. With motivated teams across the Group and a robust change programme that has already delivered so much, I know that this future is entirely possible.

Chief Executive's Report

Here for good

Ecclesiastical exists for just one purpose - to contribute to the greater good of society. That makes us a very different kind of financial services group. Because our profits go to good causes. Because we put customers' needs first. And because we stand up for what we believe in - even if that means doing things differently from everyone else.

Owned by a charity, our profits are channelled towards funding thousands of good charitable causes a year. Whether these are charities that transform the lives of homeless people, the unwell or those suffering from addiction, parish churches that have become community hubs in areas of great deprivation, or organisations that provide young people with the resources to stay safe and well in today's complex world, they share a common goal - to help and protect the most vulnerable in our society.

Our charitable purpose has also shaped the way we do business for over 130 years. Unlike others in our sector, we are driven by more than the need to satisfy short-term shareholder demands.

Our goal is to build a sustainable, values-driven business over the longer-term, while putting customers' needs first - especially in times of need or change. This has seen us develop extraordinary levels of customer understanding and care.

Trusted by our communities

This approach has built deep trust within the communities we serve, as evidenced by the roll-call of awards and accolades highlighted in the annual report and accounts. We are trusted to protect and preserve communities, cultures and heritage worldwide, by insuring palaces and castles, World Heritage sites and opera houses, schools and activity centres, churches, temples and other treasured properties. And our advisory, broking and investment businesses are trusted to provide award-winning services that have the customer's interests at heart.

Giving to our communities

Our results and our underlying financial strength enabled us to make donations of £18.8m during the year, to our charitable owner and to the causes we support directly. We have now given £64m of the £100m by the end of 2020 target we set ourselves in April 2016.

Based on the latest rankings, Ecclesiastical is the fourth largest corporate donor in the UK and the top-ranking insurance sector donor - indeed, the only insurer in the top ten. This is a considerable achievement of which we are very proud, particularly as by any measure of size or scale we are significantly smaller than any of the other top ten ranked businesses.

A resilient business

In 2018 we achieved a fifth year of sound financial performance, underpinned by our focus on delivering sustainable, profitable long-term growth. I am pleased to report that in 2018 we continued to deliver against our charitable purpose, with a pre-tax profit of £15.4m (2017: £82.2m) and GWP growth of 4.1% to £357.0m. This result includes excellent underwriting profits of £29.2m (2017: £27.1m), investment income of £35.3m (2017: £36.5m) and fair value losses of £31.3m (2017: gains of £35.8m).

Our strong solvency ratio and long-term perspective enable us to hold a relatively high proportion of higher risk investment assets, designed to deliver strong returns over the longer-term. Market downturns towards the end of the year, prompted by persistent concerns over Brexit, global trade and slowing economic growth, impacted our investment returns following two exceptionally positive years. However, our long-term stance is unmoved and the market downturn has presented some exceptional equity investment opportunities.

We reaped the benefit of holding a diverse portfolio of companies during the year, not least in the insurance business where the impact of adverse weather in Canada was offset by benign conditions elsewhere.

The UK and Ireland business achieved GWP growth of 4.8%, with particularly strong contributions from the Real Estate and Art & Private Client sectors in the UK and the Education sector in Ireland.

A strong underwriting profit of £29.4m (2017: £32.7m) benefited from significant prior year releases and a low level of weather claims.

We took the difficult decision to close our UK defined benefit pension scheme to future accrual from 30 June 2019, due to escalating scheme costs and the growing exposure to investment risk required to maintain the scheme. Having monitored and consulted on the scheme's shape and potential long-term risks over several years, we did not undertake this lightly, knowing how important pension benefits are to our colleagues. Following extensive consultation, new arrangements were agreed with our union and the scheme Trustees on members' behalf.

During the year we prepared for Brexit, identifying potential risks and putting in place steps to mitigate them. In Ireland these preparations included working closely with the Central Bank of Ireland on our application for Third Country branch status, for which we have been granted authorisation in principle. The Canadian and Australian insurance businesses delivered GWP growth of 7.6% and 5.5% respectively in local currency. Canada's underwriting loss of £2.6m was driven by a range of adverse weather events and a modest increase in casualty reserves, and Australia's £1.4m underwriting profit benefited from lower claims and increased rate strength.

EdenTree, our pioneering investment management business, delivered strong growth in net inflows1, particularly to its Higher Income Fund. Funds under management remained at £2.7bn, with gross inflows totalling £392m broadly offset by market falls. There was continued investment in the year in technology and systems to deliver its future growth plans and, as a result, profits decreased to £0.9m (2017: £1.7m).

In the broking and advisory sector, SEIB's profits were marginally decreased from the previous year at £2.4m (2017: £2.5m). The business grew organically and also acquired books of business from Equicover and Equestrian World Services that complement its existing equine offer.

1 Alternative performance measure, refer to the Reconciliation of Alternative Performance Measures note to this announcement for further explanation

Innovating for good

Today, we are a successful, ethically-run group of specialist businesses that have evolved in anticipation of our customers' changing needs, often to the extent that we revolutionise industry practice. Our investment management business EdenTree, for example, introduced pioneering ethical funds to the UK market, while our UK insurance business has taken the lead in creating greater transparency around the handling of abuse claims.

We are also renowned for efforts we make to help insurance customers manage their risks, so that ideally, they never have to make a claim. During 2018, we trialled a number of technologies across our jurisdictions, including infra-red cameras to help detect electrical hot spots and leak detection devices. We also trialled drones as risk management tools in the UK, following their successful use in our Australian subsidiary.

In collaboration with the Royal Institute of Chartered Surveyors, we provided customers and brokers with a unique Heritage Index that allows accurate reinstatement valuation of heritage properties. We also provided new advice on preventing accidental slips and trips (with the Health and Safety Laboratory) and started developing a new proposition to address cyber bullying in schools, ready for testing in 2019.

As with other activities that set us apart, understanding of our customers' worlds and the drive to put their needs first underpins this investment in loss prevention innovation.

An exciting future

While we expect continued uncertainty in investment markets and insurance markets to remain highly competitive, our consistently strong financial performance allows us to both withstand short-term uncertainties and invest in our future, laying the foundations for further sustainable and profitable growth.

The second phase of our ambitious change programme, which supports our latest target of giving £100m to good causes, is well underway. This will see us sustain and build on the distinctive position we occupy in our existing markets through organic and inorganic growth, and develop new, specialist market segments.

Investment in our technology infrastructure progresses, with the introduction of a new core operating system for the UK and Ireland insurance business underway. This will streamline processes for our staff and provide a more agile and responsive service for our customers and brokers.

Work commenced in 2018 on a new accounting system for EdenTree and during the year we installed a new platform on which to build Group websites, reinvigorating our digital presence.

During 2019, the UK's Independent Inquiry into Child Sexual Abuse will conclude its investigations into institutional abuse in England and Wales. We will provide the Inquiry with information and insight as it requires and will continue to champion transparency and fairness in the insurance sector, for the benefit of abuse survivors. We will also maintain a prudent reserving strategy for potential abuse claims for the benefit of survivors.

The pace of progress that I have described would not be possible without the excellence and dedication of our specialist teams worldwide. We remain committed to investing in the development of their expertise and knowledge, so that they are equipped to meet and surpass our customers' expectations in a changing world.

Building a movement for good

Global studies tell us that people want companies to do the right thing.

2018 saw a telling development in this trend, with members of the public looking increasingly to business to take an active role in addressing societal issues. We heard that 62% of global consumers wanted companies to stand up for the issues they are passionate about1, while in the UK nine out of ten people said businesses should take a stance on the issues that are important to them2.

Across the Ecclesiastical Group such behaviour is in our DNA. We are proud to have worked alongside the communities we serve for decades, helping to champion the issues that matter to them.

In 2018 alone we campaigned with the UK charity sector for the abolition of Insurance Premium Tax on struggling charities; we urged the UK government to reduce VAT on repairs and approved alterations to listed buildings; and our funeral planning business, in the wider Group, led calls for the introduction of regulation in the face of escalating poor practice in its sector.

More broadly, we continued to sponsor young craftspeople in a bid to reverse the decline of traditional skills in our heritage sectors and also supported research to address new issues facing our estates and farming communities.

As a values-driven business, we also believe it is important to champion good practice in the financial services sector.

In 2018, we felt we needed to challenge one of the world's biggest insurers as it considered cancelling its preference shares at par, to the potential detriment of many shareholders. That was not an easy decision for our Board to make, because speaking out when others remain silent is hard to do. But we knew it was the right thing to do.

We are always looking for ways to extend the reach of our giving. Increasingly, we are doing this by putting the giving directly into the hands of the communities we serve, so they can support the causes that mean the most to them.

As people look to business to take a stand on society's most important issues, we are extending the reach of our giving and campaigning to create a network of organisations that, together, become a Movement for Good. A group of people and organisations that, together, can help change the world. For, as Archbishop Desmond Tutu put it: "Do your little bit of good where you are. It's those little bits of good put together that overwhelm the world."

1 Accenture Strategy: Global Consumer Pulse Research 2018

2 CBI: Everyone's Business research Sept 2018

Thank you for transforming lives

It is just over five years since I became chief executive of the Ecclesiastical Group. In that time we have reached our first goal of giving £50m to charity - a goal that caused colleagues to gasp aloud when I revealed it. And we have given an extraordinary £64m since.

Since 2016, and together with our owner, we have given over 5,000 donations to charities worldwide.

Each of these charities has a moving story to tell of the impact our giving can have. That is why we have captured in the annual report and accounts details from just a few of them of how our support is helping to change people's lives. I hope their stories bring to life the breadth and significance of that support and remind us that for each one of them, there are at least 300 more.

On their behalf, I would like to thank you

Thank you to our customers, brokers and business partners for entrusting us with your business and allowing us to help you champion the causes you care about. Thank you to our exceptional employees for always going the extra mile for our customers and partners. And thank you all for your tireless fundraising, volunteering and nomination of good causes that provide a helping hand to those who need it most.

To those of you who are reading about Ecclesiastical for the first time, I invite you to join us, whether as a colleague, customer or business partner, and experience for yourself how it is possible to do business differently.

Because I believe that together, we are creating something very special - a Movement for Good that touches and transforms lives in our villages, in our towns, in our communities, in this country and abroad.

Together, we are capable of more than you can imagine.

Business Review

Financial Performance Report

We delivered a pre-tax profit of £15.4m in 2018 (2017: £82.2m). Our underwriting profit remained strong at £29.2m, (2017: £27.1m) although investment market conditions were challenging and resulted in fair value losses of £31.3m (2017: gain of £35.8m).

There has been continued growth in our underwriting results over the last five years as we have successfully delivered against our redefined strategy. We remain a trusted partner to our brokers and customers, and this is reflected in our high retention and satisfaction levels. Investment returns were impacted by unrealised investment losses due to external market turbulence, including the impact of the uncertainty around Brexit. We manage the business by taking a long term view of risk, and our approach to capital management means that we are able to withstand short term volatility. In particular, our investment approach carries a level of risk, but enables us to take advantage of the opportunities to deliver higher investment returns over the long term from investing in equities, than from investing in lower risk, lower returning fixed income investments. The Group remains well capitalised and received approval for our Internal Model in 2018, which was a significant milestone. The Internal Model enables us to continue to understand and quantify our risk profile and to optimise the use of capital in the future.

In order to ensure that the Group delivers sustainable profitable growth, we continue to make strategic investments in technology, property, people and processes. We took the difficult decision to close the UK defined benefit pension scheme to future accrual from 30 June 2019, which will enable the scheme to reduce the level of risk over time and secure the payment of future benefits to members.

We made charitable grants of £18.8m (2017: £27.5m) for the year as part of our commitment towards the £100m target by 2020 and have seen the positive impact that this charitable giving makes to people's lives.

General insurance

Our underwriting performance1 for the year was a profit of £29.2m (2017: £27.1m profit), resulting in a Group COR1 of 86.4% (2017: 86.9%). Our fifth consecutive year of improvement in underwriting profits has been aided by the favourable development of prior year claims on the Group's liability business. Additionally in the UK there has been good current year experience on the liability and property accounts which helped to offset the impact of a series of weather events in our Canadian business.

1 Alternative performance measure, refer to the Reconciliation of Alternative Performance Measures note to this announcement for further explanation.

United Kingdom and Ireland

In the UK and Ireland underwriting profits decreased to £29.4m (2017: £32.7m profit) giving a COR of 80.2% (2017: 77.1%). This represents another good performance with a favourable result on the liability account and a solid outturn on the property book. It is not a level of underwriting performance on the liability account we expect to persist in the future.

The underwriting result on the property account was behind last year, impacted by adverse weather in the first half of the year with the Beast from the East and Storm Emma combined with an increase in subsidence claims following the exceptionally dry summer. Despite these events the current year loss ratios are in line with expectations and the result benefited from a distribution from our pooled terrorism reinsurance arrangements of £1.0m (2017: £1.9m).

The underwriting result from the liability account continues to perform favourably. Current year claims performance was again better than expected, and we have also had the benefit of reserve releases as historical claims have been settled at amounts that were less than anticipated. The run-off of unprofitable business we exited in 2012 and 2013 combined with the prudent approach to reserving have improved the overall result in the last three years.

In 2018, GWP has grown by 5% to £242m, (2017: £231m). The trading conditions across the year were consistently very competitive with the market remaining sensitive to changes in price. Despite this we have seen high retention levels across our UK and Ireland business demonstrating the strength of our proposition and reputation for exceptional service. Our Real Estate and Art & Private Client business delivered growth of 14% and 22% respectively as we successfully build on our investment in innovation and product development. GWP in respect of our Faith business remained in line with prior year reflecting a good result in a highly competitive market.

We expect the market to continue to be fiercely competitive. The capacity in the market and moves by generalist insurers into our core specialist risks will maintain the pressure on our GWP growth ambition. Our strategy over the medium term looks to deliver moderate GWP growth, while maintaining our strong underwriting discipline and our philosophy to seek profit over growth. We will continue to deepen our specialist capabilities through investment in technology and innovation, and to provide appealing customer propositions and excellent service.

Ansvar Australia

Our Australian business reported an underwriting profit of AUD$2.5m giving a COR of 93.7% (2017: AUD$1.2m profit, COR of 96.9%). The liability account performed well and includes the benefit of favourable development of prior year claims reserves. The property account incurred losses but improved over the prior year, driven by the more benign natural catastrophe experience in 2018.

GWP grew by 5% in local currency to AUD$101.6m (2017: AUD$96.3m). The 2018 growth in GWP was driven by the property book while GWP for liability remained constant. Property GWP increased by 9% with good levels of renewal rate more than offsetting the run-off of a proportion of the property book at the end of 2017.

Canada

Our Canadian business continued its track record of delivering premium growth, reporting an 8% increase in the branch's contribution towards Group GWP at CAD$93.5m (2017: CAD$86.9m).

The territory reported an overall underwriting loss of CAD$4.5m giving a COR of 106.5% (2017: CAD$12.1m loss, COR of 118.5%). The severe winter weather at the beginning of 2018 and the occurrence of four weather related mini-catastrophes which were not significant enough to trigger the catastrophe reinsurance programme, severely impacted the result. Performance in the second half of the year was stronger, reflecting the benefit of rating action and a return to more normal weather experience.

Other insurance operations

General insurance profits benefited from favourable releases of prior year reserves from our businesses in run-off, resulting in an overall profit of £1.0m (2017: £0.9m profit).

Investments

Following the strong market returns of the previous two years, 2018 saw a return to volatility in UK and worldwide stock markets which over the course of the year pushed market prices down, notably in the fourth quarter of the year. Income from financial assets remained relatively stable at £27.0m (2017: £29.0m) with the low rate environment continuing to depress overall yields. As a result of the investment market downturn at the end of 2018 the fair value of financial instruments decreased £35.5m (2017: increase of £30.3m). There has been some recovery in the markets in early 2019 but uncertainty remains over the outcomes of key issues such as global trade and Brexit. Overall investment returns for the year were £4.0m (2017: £72.3m).

The small and mid-cap bias in our UK equity portfolio had a negative impact in 2018 as the FTSE small-cap and FTSE 250 mid-cap indices lagged the FTSE 100 large-cap index and FTSE AllShare overall by 4%. 

Our allocation to lower volatility direct property investments was the largest positive contributor to total net investment returns over the period. On a relative basis our property investments delivered a return of 5.2% compared with the broader Investment Property Databank (IPD) All Properties Index return of 7.4%. A strong return on industrial properties was offset by the retail property sector where our allocation is greater than the benchmark.

The Group's bond investment portfolio has a higher weighting of shorter duration bonds and corporate bonds than the FTSE Conventional Glits Allstock Index. Overall, this has resulted in underperformance against the main index this year. An upward movement in yields led to an increase in the discount rate applied to long-tail general insurance liabilities. The change in discount rate on those liabilities resulted in a £4.4m profit being recognised within investment returns (2017: £1.4m loss).

The investment result includes a £1.6m return, net of discounting (2017: £2.8m) on assets held to support our long-term insurance liabilities. The net return more than offsets a £0.1m decrease (2017: £2.4m increase) in long-term insurance claims liabilities which benefited from a favourable development in future costs described below.

Investment management

The Group's investment management business, EdenTree, continued to develop its presence in the Charity and Institutional markets. Net inflows to funds of £181m (2017: £121m net inflow) were the best in EdenTree's history, with institutional business boosted by further mandate wins from a European global bank.

The weakness in global equity market returns in 2018 has broadly offset the net fund inflows in the period, therefore total funds under management remain at £2.7bn (2017: £2.7bn).

Fee income has grown 8% to £12.6m (2017: £11.7m). Overheads have increased by 15% in the year mainly due to continued investment in technology and systems to deliver the future growth plans of the business and support MiFID II reporting requirements. As a result pre-tax profits in the period decreased to £0.9m (2017: £1.7m).

Long-term insurance

The life business insurance result for 2018 was a profit of £1.5m (2017: £0.4m). Ecclesiastical Life Limited (ELL) is closed to new business and the main contributor to the increased profit in the year is due to the favourable development in reserves held for future costs, following the removal of the Solvency II audit requirement going forward.

Broking and advisory

The broking and advisory business comprises our insurance broker and financial advisory businesses, South Essex Insurance Brokers Limited (SEIB), Ecclesiastical Financial Advisory Services Limited (EFAS) and in 2018 Ansvar Risk Management Services (ARMS). SEIB reported a marginal decrease in profit before tax to £2.4m (2017: £2.5m). EFAS reported a small loss of £0.2m in the year (2017: £0.2m loss) and ARMS reported a loss of £0.2m.

Overall, our broking and advisory business had modest growth in income and maintained profit, reporting a pre-tax profit of £2.0m (2017: £2.3m profit).

The Group takes a long term view in its approach to managing and investing in the business and as such is focused on delivering sustainable profitability with steady, measured growth. As we look forward to 2020, we continue to focus on our vision to be the most trusted and ethical financial services group and remain optimistic about the opportunities to continue to evolve our business and contribute to the greater good of society.

Directors' Report

Principal activities

The Group operates principally as a provider of general insurance in addition to offering a range of financial services, with offices in the UK, Ireland, Canada, and Australia.

Ownership

At the date of this report, the entire issued Ordinary share capital of the Company and 3.16% of the issued 8.625% Non-Cumulative Irredeemable Preference Shares of £1 each ('Preference shares') were owned by Ecclesiastical Insurance Group plc. In turn, the entire issued Ordinary share capital of Ecclesiastical Insurance Group plc was owned by Allchurches Trust Limited, the ultimate parent of the Group.

Dividends

Dividends paid on the Preference shares were £9,181,000 (2017: £9,181,000).

The directors do not recommend a final dividend on the Ordinary shares (2017: £nil), and no interim dividends were paid in respect of either the current or prior year.

Charitable and political donations

Charitable donations paid, and provided for, by the Group in the year amounted to £18.8 million (2017: £27.5 million).

During the last 10 years, a total of £165.0 million (2017: £154.0 million) has been provided by Group companies for church and charitable purposes.

It is the Company's policy not to make political donations.

Principal risks and uncertainties

The directors have carried out a robust assessment of the principal risks facing the Group including those that threaten its business model, future performance, solvency and liquidity. The principal risks and uncertainties, together with the financial risk management objectives and policies of the Group, are included in the Risk Management section of this announcement.

Going concern

The Group has considerable financial resources: financial investments of £799.0 m, 92% of which are liquid (2017: financial investments of £859.7m, 93% liquid), cash and cash equivalents of £109.4m and no borrowings (2017: cash and cash equivalents of £93.8m and no borrowings). Liquid financial investments consist of listed equities and open-ended investment companies, government bonds and listed debt. The Group also has a strong risk management framework and solvency position, and has proved resilient to stress testing. As a consequence, the directors have a reasonable expectation that the Group is well placed to manage its business risks successfully and continue in operational existence for at least 12 months from the date of this report. Accordingly, they continue to adopt the going concern basis in preparing the Annual Report and Accounts.

Risk Management

Introduction

Strong governance is fundamental to what we do and drives the ongoing embedding of our enterprise-wide risk management framework. This provides the tools, guidance, policies, standards and defined responsibilities to enable us to achieve our strategy and objectives. This also ensures that individual and aggregated risks to our objectives are identified and managed on a consistent basis.

The risk management framework is integrated into the culture of the Group and is owned by the Board. Responsibility for implementation and oversight is delegated via the Group Chief Executive to the Group Risk Function, led by the

Group Chief Risk Officer.

The risk management process demands accountability and is embedded in performance measurement and reward, thus promoting clear ownership for risk and operational efficiency at all levels. On an annual basis, the Group Risk Committee (on behalf of the Board) carries out a formal review of the key strategic risks for the Group with input from the GMB and the Strategic Business Units (SBUs). The Group Risk Committee (GRC) allocates responsibility for each of the risks to individual members of the Group's executive management. Formal monitoring of the key strategic risks is undertaken quarterly including progress of risk management actions and any gaps in risk mitigants are challenged by the Executive Risk Committees.

Clarity of responsibility and accountability for the management of risk is the cornerstone of any effective Risk Management Framework and successful business. Ecclesiastical has clearly defined the accountabilities, roles and responsibilities of all key stakeholders in implementing and maintaining its Risk Management Framework. These are defined, documented and implemented through the terms of reference (TORs) of board sub committees, management and executive forums, position descriptions and functional charters.

The Group's Risk Management Framework itself is part of a wider Internal Control Framework.

Systems of internal control are designed to manage rather than eliminate the risk of failure to achieve business objectives, and can provide reasonable, but not absolute assurance as to the prevention and detection of financial misstatements, errors, fraud or violation of law or regulations.

Key to the successful operation of the internal control framework is the deployment of a strong Three Lines of Defence Model whereby:

§ 1st Line (Business Management) is responsible for strategy execution, performance and identification and management of risks and application of appropriate controls;

§ 2nd Line (Reporting, Oversight and Guidance) is responsible for assisting the CRO and Board to formulate risk appetite, establish minimum standards, develop appropriate reporting, oversight and challenge of risk profiles and risk management activities within each of the business units. This includes Executive Risk Management Committees and is subject to oversight and challenge by the GRC.

§ 3rd Line (Assurance) provides independent and objective assurance of the effectiveness of the Group's systems of internal control. This activity principally comprises the Internal Audit function which is subject to oversight and challenge by the Group Audit Committee.

We seek to develop and improve our risk management framework and strategy on an ongoing basis to ensure it continues to enable us to achieve our strategy and objectives.

The Group risk appetite defines the level of risk-taking that the Board feels is appropriate for the Group as we pursue our business objectives. It is defined in line with the different categories of risk that the Group faces, and provides the backdrop against which the business plan is developed and validated. This ensures that the risk profile resulting from the business plan is in line with the risk-taking expectations of the Board. Compliance with the risk appetite is formally monitored every quarter and reported to the Group Risk Committee at each meeting.

The risk appetite is refreshed formally annually with approval and sign-off by the Board and there are ongoing assessments to ensure its continued appropriateness for the business.

The Own Risk and Solvency Assessment (ORSA) process is carried out at least once a year and is a key part of the business management and governance structure. This integrates the risk management, business planning and capital management activities and ensures that risk, capital and solvency considerations are built into the development and monitoring of the Group's business strategy and plans and all key decision making.

During 2018 the Group received regulatory approval for the use of our Internal Model as the basis for the calculation of our regulatory capital requirement.

Risk environment

The risk environment is monitored on an ongoing basis and key areas of concern escalated to the Group Risk Committee.

The uncertainty around the outcome of Brexit carries risks for all UK-based firms. The main risk facing the Group is the loss of its ability to carry out business in the Republic of Ireland using the freedom to provide services currently afforded by the United Kingdom's membership of the EU. This risk is being mitigated by the submission of an application for the Ireland branch to become regulated by the Central Bank of Ireland as a Third Country branch after Brexit. The Group has no other material business elsewhere in the EU. The uncertainty created by Brexit has the potential to result in adverse economic conditions and impact the Group's investments and our customers. We have not identified any further material risks to our business as a result of Brexit although we continue to monitor the situation closely.

During 2018 we have continued to take a high level of market risk to give the potential for investment growth. Our investment strategy has been refreshed, though there has not been a material change to our asset mix. A programme of de-risking interest rate and inflation risk in the defined benefit pension scheme was completed during the year and the company took the decision following consultation with members to cease accrual in the scheme for future service after June 2019 which will enable further decreases to the risk associated with the scheme.

Within the insurance market firms continue to enhance their analytical skills and deepen their portfolio knowledge. Therefore, high quality technical underwriting standards, pricing and portfolio management abilities are increasingly important to ensure business written and retained is profitable. Our strategy is to achieve controlled and profitable growth within our defined niches. The potential for adverse development of long-tail liability claims, particularly in respect of PSA claims, remains a risk that we continue to actively manage. The Independent Inquiry into Child Sexual Abuse in the UK is continuing and we continue to monitor this and developments in the other territories in which we operate to determine the potential impact on these claims.

Competitor activity is an ever present risk across all our business operations and chosen niches that could threaten our ability to grow or even lead to a decline in scale with resultant adverse financial impact.

There has been significant regulatory change during 2018; the most material being the implementation of GDPR, IDD, MiFID II and SMCR. Management of continued change in the regulatory environment will remain a focus for us in light of uncertainty in the direction of regulation following Brexit.

Worldwide, cyber risk remains a constantly evolving threat with potential for a significant event involving loss of customer data that could result in significant operational disruption and an impact on our service to customers as well as sizeable regulatory fines and reputational damage. Regulations such as GDPR and a greater societal focus on the importance of security and appropriate use of individuals' data also increase the prominence of data management risks for all companies.

Maintaining a positive reputation is critical to our vision of being the most trusted and ethical specialist financial services group. Our reputation could potentially be damaged as a result of a range of factors including poor business practices and behaviours. High standards of conduct are a core part of the Group's brand, values and culture and there is an ongoing focus on ensuring this is maintained.

Principal risks

There is an ongoing risk assessment process which has identified the current principal risks for the Group as follows:

Insurance risk

The risk that arises from the fluctuation in the timing, frequency and severity of insured events relative to the expectations of the firm at the time of underwriting.

Other financial risks

The risk that proceeds from financial assets are not sufficient to fund the obligations arising from insurance contracts.

Operational risk

The risk of loss arising from inadequate or failed internal processes, people and systems, or from external events.

Regulatory and conduct risk

The risk of regulatory sanction, operational disruption or reputational damage from non-compliance with legal and regulatory requirements or the risk that Ecclesiastical's behaviour may result in poor outcomes for the customer.

Directors' Responsibility Statement

The following statement is extracted from page 100 of the 2018 annual report and accounts, and is repeated here for the purposes of the Disclosure and Transparency Rules. The statement relates solely to the Company's 2018 annual report and accounts and is not connected to the extracted information set out in this announcement. The names and functions of the directors making the responsibility statement are set out on pages 92 to 94 of the full annual report and accounts.

The directors confirm to the best of their knowledge:

§ The financial statements, prepared in accordance with IFRS, give a true and fair view of the assets, liabilities, financial position and profit or loss of the Company and the undertakings included in the consolidation taken as a whole.

§ The Strategic Report within the 2018 annual report and accounts includes a fair review of the development and performance of the business and the position of the Company and the undertakings included in the consolidation taken as a whole, together with a description of the principal risks and uncertainties that they face.

§ The Annual Report and financial statements, taken as a whole, are fair, balanced and understandable, and provide the information necessary for shareholders to assess the Company's position and performance, Business Model and Strategy.

CONSOLIDATED STATEMENT OF PROFIT OR LOSS

For the year ended 31 December 2018

CONSOLIDATED STATEMENT OF COMPREHENSIVE INCOME

For the year ended 31 December 2018

CONSOLIDATED STATEMENT OF CHANGES IN EQUITY

For the year ended 31 December 2018

The revaluation reserve represents cumulative net fair value gains on owner-occupied property. Further details of the translation and hedging reserve are included in the notes to this announcement.

CONSOLIDATED STATEMENT OF FINANCIAL POSITION

At 31 December 2018

CONSOLIDATED STATEMENT OF CASH FLOWS

For the year ended 31 December 2018

NOTES TO THIS ANNUAL FINANCIAL REPORT ANNOUNCEMENT OF RESULTS

for the year ended 31 December 2018

1 Accounting policies

The Company has prepared this announcement of its consolidated results using the same accounting policies and methods of computation as the full financial statements for the year ended 31 December 2018 as prepared in accordance with International Financial Reporting Standards (IFRS) as adopted for use in the EU. The Group has adopted the following new standards or amendments to published standards however, these do not have a significant impact on the Group's consolidated financial statements.

(a) IFRS 15, Revenue from Contracts with Customers

The Group has adopted IFRS 15 Revenue from Contracts with Customers with effect from 1 January 2018. IFRS 15 introduced a five-step approach to revenue recognition and established principles for reporting useful information to users of financial statements about the nature, amount, timing and uncertainty of revenue and cash flows arising from an entity's contracts with customers.

IFRS 15 has been applied using the modified approach, applied retrospectively only to contracts that were not completed contracts at 1 January 2018. Under the modified approach, the cumulative effect of initially applying IFRS 15 is recognised as an adjustment to opening reserves. The adoption of IFRS 15 did not have a material impact on the Group's financial statements and consequently no adjustment has been made to opening reserves. Minor amendments have been made to the Group's accounting policies as shown below, which had no impact on the amounts recognised in the financial statements at 1 January 2018 or 31 December 2018:

§ Income generated from insurance placements through the Group's insurance broking activities was previously recognised at the inception date of the cover. Under IFRS 15 it is recognised at the point at which the performance obligation is satisfied, being the inception date of the cover, or, where this income is variable, the point at which it is reasonably certain that no significant reversal of the amount recognised would occur.

§ Fees charged for investment management services were previously recognised when the services were provided. Under IFRS 15, as the fees are variable, they are recognised over time as the services are provided, and once it is reasonably certain that no significant reversal of the amount recognised would occur.

(b) IFRS 4 (Revised), Insurance Contracts

The amendment to IFRS 4 which permits an insurer to take a temporary exemption from applying the requirements of IFRS 9, Financial Instruments, became applicable to the Group in the year. The Group qualifies for the temporary exemption, which is available until annual periods beginning on or after 1 January 2021, since at 31 December 2015 greater than 90% of its liabilities were within the scope of IFRS 4. There has been no significant change to the Group's operations since 31 December 2015 and as a result, the Group continues to apply IAS 39, Financial Instruments.

Certain entities within the Group do not qualify for the temporary exemption from the requirements of IFRS 9. Further information detailing the adoption of IFRS 9 is disclosed in the statutory financial statements of these entities.

2 General Information

Whilst the financial information included in this announcement has been prepared in accordance with the recognition and measurement criteria of IFRS, this announcement does not itself contain sufficient information to comply with IFRS. Full financial statements that comply with IFRS were approved by the Board of Directors on 19 March 2019.

The financial information set out above does not constitute the Company's statutory accounts for the years ended 31 December 2018 or 2017, but is derived from those accounts. Statutory accounts for 2017 have been delivered to the Registrar of Companies and those for 2018 will be delivered following the Company's annual general meeting. The auditors have reported on those accounts; their reports were unqualified, did not draw attention to any matters by way of emphasis without qualifying their report and did not contain statements under sections 498(2) and 498(3) of the Companies Act 2006.

This announcement was approved at a meeting of the Board of Directors held on 19 March 2019.

Ecclesiastical Insurance Office plc is a subsidiary of Ecclesiastical Insurance Group plc which is an investment holding company whose ordinary shares are not listed.

The ordinary shares of Ecclesiastical Insurance Office plc are not listed.

Copies of the audited financial statements are available from the registered office at Beaufort House, Brunswick Road, Gloucester GL1 1JZ.

The following information is included in this announcement in compliance with the Disclosure and Transparency Rules and has been extracted from the full financial statements for 2018.

Insurance Risk

Through its general and life insurance operations, the Group is exposed to a number of risks, as summarised in the Risk Management section of the Strategic Report. The risk under any one insurance contract is the possibility that the insured event occurs and the uncertainty of the amount and timing of the resulting claim. Factors such as the business and product mix, the external environment including market competition and reinsurance capacity all may vary from year to year, along with the actual frequency, severity and ultimate cost of claims and benefits. This subjects the Group to underwriting and pricing risk (the risk of failing to ensure disciplined risk selection and to obtain the appropriate premium), claims reserving risk (the risk of actual claims payments exceeding the amount we are holding in reserves) and reinsurance risk (the risk of failing to access and manage reinsurance capacity at a reasonable price).

(a) Risk mitigation

Statistics demonstrate that the larger and more diversified the portfolio of insurance contracts, the smaller the relative variability in the expected outcome will be. The Group's underwriting strategy is designed to ensure that the underwritten risks are well diversified in terms of type and amount of risk and geographical spread. In all operations pricing controls are in place, underpinned by sound statistical analysis, market expertise and appropriate external consultant advice. Gross and net underwriting exposure is protected through the use of a comprehensive programme of reinsurance using both proportional and non-proportional reinsurance, supported by proactive claims handling. The overall reinsurance structure is regularly reviewed and modelled to ensure that it remains optimum to the Group's needs. The optimum reinsurance structure provides the Group with sustainable, long-term capacity to support its specialist business strategy, with effective balance sheet and profit and loss protection at a reasonable cost.

Catastrophe protection is purchased following an extensive annual modelling exercise of gross and net (of proportional reinsurance) exposures. In conjunction with reinsurance brokers the Group utilises the full range of proprietary catastrophe models and continues to develop bespoke modelling options that better reflect the specialist nature of the portfolio. Reinsurance is purchased in line with the Group's risk appetite.

(b) Concentrations of risk

The core business of the Group is general insurance, with the principal classes of business written being property and liability. The miscellaneous financial loss class of business covers personal accident, fidelity guarantee and loss of money, income and licence. The other class of business includes cover of legal expenses and also a small portfolio of motor policies, but this has been in run off in the United Kingdom since November 2012. The Group's whole-of-life insurance policies support funeral planning products.

Below is a table summarising written premiums for the financial year, before and after reinsurance, by territory and by class of business:

(c) General insurance risks

Property classes

Property cover mainly compensates the policyholder for damage suffered to their property or for the value of property lost. Property insurance may also include cover for pecuniary loss through the inability to use damaged insured commercial properties.

For property insurance contracts, there can be variability in the nature, number and size of claims made in each period.

The nature of claims may include fire, business interruption, weather damage, escape of water, explosion (after fire), riot and malicious damage, subsidence, accidental damage and theft. Subsidence claims are particularly difficult to predict because the damage is often not apparent for some time. The ultimate settlements can be small or large with a risk of a settled claim being reopened at a later date.

The number of claims made can be affected in particular by weather events, changes in climate, economic environment, and crime rates. Climate change may give rise to more frequent and extreme weather events, such as river flooding, hurricanes and drought, and their consequences, for example, subsidence claims. If a weather event happens near the end of the financial year, the uncertainty about ultimate claims cost in the financial statements is much higher because there is insufficient time for adequate data to be received to assess the final cost of claims.

Individual claims can vary in amount since the risks insured are diverse in both size and nature. The cost of repairing property varies according to the extent of damage, cost of materials and labour charges.

Contracts are underwritten on a reinstatement basis or repair and restoration basis as appropriate. Costs of rebuilding properties, of replacement or indemnity for contents and time taken to bring business operations back to pre-loss levels for business interruption are the key factors that influence the cost of claims. Individual large claims are more likely to arise from fire, storm or flood damage. The greatest likelihood of an aggregation of claims arises from earthquake, weather or major spreading fire events.

Claims payment, on average, occurs within a year of the event that gives rise to the claim. However, there is variability around this average with larger claims typically taking longer to settle and business interruption claims taking much longer depending on the length of the indemnity period involved.

Liability classes

The main exposures are in respect of liability insurance contracts which protect policyholders from the liability to compensate injured employees (employers' liability) and third parties (public liability).

Claims that may arise from the liability portfolios include damage to property, physical injury, disease and psychological trauma. The Group has a different exposure profile to most other commercial lines insurance companies as it has lower exposure to industrial risks. Therefore, claims for industrial diseases are less common for the Group than injury claims such as slips, trips and back injuries.

The frequency and severity of claims arising on liability insurance contracts, including the liability element of motor contracts, can be affected by several factors. Most significant are the increasing level of awards for damages suffered, legal costs and the potential for periodic payment awards.

The severity of bodily injury claims can be influenced particularly by the value of loss of earnings and the future cost of care. The settlement value of claims arising under public and employers' liability is particularly difficult to predict. There is often uncertainty as to the extent and type of injury, whether any payments will be made and, if they are, the amount and timing of the payments, including the discount rate applied for assessing lump sums. Key factors driving the high levels of uncertainty include the late notification of possible claim events and the legal process.

Late notification of possible claims necessitates the holding of provisions for incurred claims that may only emerge some years into the future. In particular, the effect of inflation over such a long period can be considerable and is uncertain. A lack of comparable past experience may make it difficult to quantify the number of claims and, for certain types of claims, the amounts for which they will ultimately settle. The legal and legislative framework continues to evolve, which has a consequent impact on the uncertainty as to the length of the claims settlement process and the ultimate settlement amounts.

Claims payment, on average, occurs about three to four years after the event that gives rise to the claim. However, there is significant variability around this average.

Provisions for latent claims

The public and employers' liability classes can give rise to very late reported claims, which are often referred to as latent claims. These can vary in nature and are difficult to predict. They typically emerge slowly over many years, during which time there can be particular uncertainty as to the number of future potential claims and their cost. The Group has reflected this uncertainty and believes that it holds adequate reserves for latent claims that may result from exposure periods up to the reporting date.

Note 28 to the full financial statements presents the development of the estimate of ultimate claim cost for public and employers' liability claims occurring in a given year. This gives an indication of the accuracy of the estimation technique for incurred claims.

(d) Life insurance risks

The Group provides whole-of-life insurance policies to support funeral planning products, for most of which the future benefits are linked to inflation and backed by index-linked assets. Although assets are well matched to liabilities, there is a risk that returns on assets held to back liabilities are insufficient to meet future claims payments, particularly if the timing of claims is different from that assumed. This is not one of the Group's principal risks and new policies are no longer being written in the life fund, with only minimal premiums now being received each year.

Uncertainty in the estimation of the timing of future claims arises from the unpredictability of long-term changes in overall levels of mortality. The Group bases these estimates on standard industry and national mortality tables and its own experience. The most significant factors that could alter the expected mortality rates profile are epidemics, widespread changes in lifestyle and continued improvement in medical science and social conditions. The primary risk on these contracts is the level of future investment returns on the assets backing the liabilities over the life of the policyholders. The interest rate and inflation risk within this has been largely mitigated by holding index-linked assets of a similar term to the expected liabilities profile. The main residual risk is the spread risk attached to corporate bonds held to match the liabilities. The small mortality risk is retained by the Group.

Financial risk and capital management

The Group is exposed to financial risk through its financial assets, financial liabilities, reinsurance assets and insurance liabilities. In particular, the key financial risk is that the proceeds from its financial assets are not sufficient to fund the obligations arising from its insurance contracts. The most important components of financial risk are interest rate risk, credit risk, currency risk and equity price risk.

There has been no change from the prior period in the nature of the financial risks to which the Group is exposed. Brexit has continued to result in greater uncertainty in relation to the economic risks to which the Group is exposed, including equity price volatility, movements in exchange rates and long-term UK growth prospects. The Group's management and measurement of financial risks is informed by either stochastic modelling or stress testing techniques.

(a) Categories of financial instruments

(i) Classification applying IAS 39

*Financial liabilities are held at amortised cost.

The directors consider that the carrying value of those financial assets and liabilities not carried at fair value in the financial statements approximates to their fair value.

(ii) Categories of financial assets applying IFRS 9

The Group classifies and measures financial instruments using IAS 39 as disclosed in the accounting policies. The table below sets out the fair value of financial assets as at the balance sheet date and the change in fair value during the year, based on the classification and measurement requirements that would result from adopting IFRS 9.

Financial assets which have contractual cash flows that are solely payments of principal and interest on the principal outstanding (SPPI) would be measured at amortised cost, other than those which are held for trading or whose performance is evaluated on a fair value basis. All other financial assets would be measured at fair value.

The directors consider that the carrying value of those financial assets and liabilities not carried at fair value in the financial statements approximates to their fair value.

(b) Fair value hierarchy

The fair value measurement basis used to value those financial assets and financial liabilities held at fair value is categorised into a fair value hierarchy as follows:

Level 1: fair values measured using quoted bid prices (unadjusted) in active markets for identical assets or liabilities. This category includes listed equities in active markets, listed debt securities in active markets and exchange-traded derivatives.

Level 2: fair values measured using inputs other than quoted prices included within level 1 that are observable for the asset or liability, either directly (i.e. as prices) or indirectly (i.e. derived from prices). This category includes listed debt or equity securities in a market that is not active and derivatives that are not exchange-traded.

Level 3: fair values measured using inputs for the asset or liability that are not based on observable market data (unobservable inputs). This category includes unlisted debt and equities, including investments in venture capital, and suspended securities. Where a look-through valuation approach is applied, underlying net asset values are sourced from the investee, translated into the Group's functional currency and adjusted to reflect illiquidity where appropriate, with the fair values disclosed being directly sensitive to this input.

There have been no transfers between investment categories in the current year.

Fair value measurements based on level 3

Fair value measurements in level 3 consist of financial assets, analysed as follows:

All the above gains or losses included in profit or loss for the period are presented in net investment return within the statement of profit or loss.

The valuation techniques used for instruments categorised in levels 2 and 3 are described below.

Listed debt and equity securities not in active market (level 2)

These financial assets are valued using third-party pricing information that is regularly reviewed and internally calibrated based on management's knowledge of the markets. Where material, these valuations are reviewed by the Group Audit Committee.

Non exchange-traded derivative contracts (level 2)

The Group's derivative contracts are not traded in active markets. Foreign currency forward contracts are valued using observable forward exchange rates corresponding to the maturity of the contract and the contract forward rate. Over-the-counter equity or index options and futures are valued by reference to observable index prices.

Unlisted equity securities (level 3)

These financial assets are valued using observable net asset data, adjusted for unobservable inputs including comparable price-to-book ratios based on similar listed companies, and management's consideration of constituents as to what exit price might be obtainable. Where material, these valuations are reviewed by the Group Audit Committee.

The valuation is most sensitive to the level of underlying net assets, the Euro exchange rate, the price-to-book ratio chosen, an illiquidity discount and a credit rating discount applied to the valuation to account for the risks associated with holding the asset. If the price-to-book ratio, illiquidity discount and credit rating discount applied changes by +/-10%, the value of unlisted equity securities could move by +/-£5m (2017: +/-£5m).

The increase in value during the year is primarily the result of an increase in the price-to-book ratio.

Unlisted debt (level 3)

Unlisted debt is valued using an adjusted net asset method whereby management uses a look-through approach to the underlying assets supporting the loan, discounted using observable market interest rates of similar loans with similar risk, and allowing for unobservable future transaction costs. Where material, these valuations are reviewed by the Group Audit Committee.

The valuation is most sensitive to the level of underlying net assets, but it is also sensitive to the interest rate used for discounting and the projected date of disposal of the asset, with the exit costs sensitive to an expected return on capital of any purchaser and estimated transaction costs. Reasonably likely changes in unobservable inputs used in the valuation would not have a significant impact on shareholders' equity or the net result.

The increase in value during the year is primarily the result of a liability management exercise which restructured an investment from an equity holding to a debt holding.

(c) Interest rate risk

The Group's exposure to interest rate risk arises primarily from movements on financial investments that are measured at fair value and have fixed interest rates, which represent a significant proportion of the Group's assets, and from those insurance liabilities for which discounting is applied at a market interest rate. The Group's investment strategy is set in order to control the impact of interest rate risk on anticipated cash flows and asset and liability values. The fair value of the Group's investment portfolio of fixed income securities reduces as market interest rates rise as does the present value of discounted insurance liabilities, and vice versa.

Interest rate risk concentration is reduced by adopting asset-liability duration matching principles where appropriate. Excluding assets held to back the life business, the average duration of the Group's fixed income portfolio is two years (2017: two years), reflecting the relatively short-term average duration of its general insurance liabilities. The mean term of discounted general insurance liabilities is disclosed in note 28(a)(iv) to the full financial statements.

For the Group's life business, consisting of policies to support funeral planning products, benefits payable to policyholders are independent of the returns generated by interest-bearing assets. Therefore, the interest rate risk on the invested assets supporting these liabilities is borne by the Group. This risk is mitigated by purchasing fixed interest investments with durations that match the profile of the liabilities. For funeral plan policies, benefits are linked to the Retail Prices Index (RPI). Assets backing these liabilities are also linked to the RPI, and include index-linked gilts and corporate bonds. For practical purposes it is not possible to exactly match the durations due to the uncertain profile of liabilities (e.g. mortality risk) and the availability of suitable assets, therefore some interest rate risk will persist. The Group monitors its exposure by comparing projected cash flows for these assets and liabilities and making appropriate adjustments to its investment portfolio.

The table below summarises the maturities of life business assets and liabilities that are exposed to interest rate risk.

Group financial investments with variable interest rates, including cash and cash equivalents, and insurance instalment receivables are subject to cash flow interest rate risk. This risk is not significant to the Group.

(d) Credit risk

The Group has exposure to credit risk, which is the risk of non-payment of their obligations by counterparties and financial markets borrowers. Areas where the Group is exposed to credit risk are:

§ counterparty default on loans and debt securities;

§ reinsurers' share of insurance liabilities (excluding provision for unearned premiums) and amounts due from reinsurers in respect of claims already paid;

§ deposits held with banks; and

§ amounts due from insurance intermediaries and policyholders.

The Group is exposed to minimal credit risk in relation to all other financial assets.

The carrying amount of financial and reinsurance assets represents the Group's maximum exposure to credit risk. The Group structures the levels of credit risk it accepts by placing limits on its exposure to a single counterparty. Limits on the level of credit risk are regularly reviewed. Where available the Group also manages its exposure to credit risk in relation to credit risk ratings. Investment grade financial assets are classified within the range of AAA to BBB ratings, where AAA is the highest possible rating. Financial assets which fall outside this range are classified as sub-investment grade. 'Not rated' assets capture assets not rated by external ratings agencies.

The debt securities portfolio consists of a range of mainly fixed interest instruments including government securities, local authority issues, corporate loans and bonds, overseas bonds, preference shares and other interest-bearing securities. Limits are imposed on the credit ratings of the corporate bond portfolio and exposures regularly monitored. Group investments in unlisted securities represent less than 1% of this category in the current and prior year.

The Group's exposure to counterparty default on debt securities is spread across a variety of geographical and economic territories, as follows:

Reinsurance is used to manage insurance risk. This does not, however, discharge the Group's liability as primary insurer. If a reinsurer fails to pay a claim for any reason, the Group remains liable for the payment to the policyholder. The creditworthiness of reinsurers is considered on a regular basis through the year by reviewing their financial strength. The Group Reinsurance Security Committee assesses, monitors and approves the creditworthiness of all reinsurers, reviewing relevant credit ratings provided by the recognised credit rating agencies, as well as other publicly available data and market information. The Committee also monitors the balances outstanding from reinsurers and maintains an approved list of reinsurers.

Group cash balances are regularly reviewed to identify the quality of the counterparty bank and to monitor and limit concentrations of risk.

The table below summaries the principal ways in which the Group assesses its exposure to credit risk by category of financial asset.

A detailed breakdown of the Group's current debt securities, reinsurance debtors and cash credit exposure based on S&P or equivalent rating is presented below.

*Cash includes amounts held on deposit classified within financial investments and disclosed in note 22 to the full financial statements. Cash balances which are not rated relate to cash amounts in hand.

The Group's credit risk policy details prescriptive methods for the collection of premiums and control of intermediary and policyholder debtor balances. The level and age of debtor balances are regularly assessed via monthly credit management reports. These reports are scrutinised to assess exposure by geographical region and counterparty of aged or outstanding balances. Any such balances are likely to be major international brokers that are in turn monitored via credit reference agencies and considered to pose minimal risk of default. The Group has no material concentration of credit risk in respect of amounts due from insurance intermediaries and policyholders due to the well-diversified spread of such debtors.

An external agency is used to rate agents, brokers and intermediaries on a scale of 0 to 100. A database of their ratings is maintained and updated daily. These ratings are adapted to internal credit ratings based on the Group's credit rating matrix, which rates the agency from very high risk to very low risk.

A breakdown of the Group's current amounts due from insurance intermediaries split by credit quality is shown below. All balances are shown gross of impairment losses.

The Group manages its credit risk at business unit level. All business units are required to implement credit risk management processes and ensure detailed reporting and monitoring of their exposures. Credit management processes differ across business units and as result the Group is unable to rate all intermediary balances in the same categories. Those which cannot be categorised are included as not rated.

The level and age of policyholder debtor balances are regularly assessed via monthly credit management reports. Credit risk ascribed to amounts due from contract holders and other debtors is based on the age of outstanding balances. The following table provides the past due status of outstanding contract holder balances. All balances are shown gross of impairment losses.

*Other debtors includes accrued income but excludes non-financial assets and amounts due to related parties.

No amounts due to related parties are past due.

For financial assets meeting the SPPI test that do not have a low credit rating, the carrying amount disclosed above is an approximation of their fair value.

 (e) Equity price risk

The Group is exposed to equity price risk because of financial investments held by the Group which are stated at fair value through profit or loss. The Group mitigates this risk by holding a diversified portfolio across geographical regions and market sectors, and through the use of derivative contracts from time to time which would limit losses in the event of a fall in equity markets.

The concentration of equity price risk by geographical listing, before the mitigating effect of derivatives, to which the Group is exposed is as follows:

 (f) Currency risk

The Group operates internationally and its main exposures to foreign exchange risk are noted below. The Group's foreign operations generally invest in assets and purchase reinsurance denominated in the same currencies as their insurance liabilities, which mitigates the foreign currency exchange rate risk for these operations. As a result, foreign exchange risk arises from recognised assets and liabilities denominated in other currencies and net investments in foreign operations. The Group mitigates this risk through the use of derivatives when considered necessary.

The Group exposure to foreign currency risk within the investment portfolios arises from purchased investments that are denominated in currencies other than sterling.

The Group's foreign operations create two sources of foreign currency risk:

§ the operating results of the Group's foreign branches and subsidiaries in the Group financial statements are translated at the average exchange rates prevailing during the period; and

§ the equity investment in foreign branches and subsidiaries is translated into sterling using the exchange rate at the year-end date.

The Group has designated certain derivatives as a hedge of its net investments in Canada and Australia, which have Canadian and Australian dollars respectively as their functional currency. The forward foreign currency risk arising on translation of these foreign operations is hedged by the derivatives which are detailed in the derivative financial instruments note to this announcement.

The largest currency exposures, before the mitigating effect of derivatives, with reference to net assets/liabilities are shown below, representing effective diversification of resources.

The figures in the table above, for the current and prior years, do not include currency risk that the Group is exposed to on a 'look through' basis in respect of collective investment schemes denominated in Sterling. The Group enters into derivatives to hedge currency exposure, including exposures on a 'look through' basis. The open derivatives held by the Group at the year end to hedge currency exposure are detailed in the derivative financial instruments note to this announcement.

(g) Liquidity risk

Liquidity risk is the risk that funds may not be available to pay obligations when due. The Group is exposed to daily calls on its available cash resources mainly from claims arising from insurance contracts. An estimate of the timing of the net cash outflows resulting from insurance contracts is provided in note 28 to the full financial statements. The Group has robust processes in place to manage liquidity risk and has available cash balances, other readily marketable assets and access to funding in case of exceptional need. This is not considered to be a significant risk to the Group.

Non-derivative financial liabilities consist of finance leases, which are not material to the Group, and other liabilities for which a maturity analysis is included in note 31 to the full financial statements.

(h) Market risk sensitivity analysis

The sensitivity of profit and other equity reserves to movements on market risk variables (comprising interest rate, currency and equity price risk), each considered in isolation and before the mitigating effect of derivatives, is shown in the table below. This table does not include the impact of variables on retirement benefit schemes. Financial risk sensitivities for retirement benefit schemes are disclosed separately in note 19 to the full financial statements.